Luna Innovations Incorporated
Q1 2021 Earnings Call Transcript

Published: 17 May 2021

[Operator:]

Good day, and thank you for standing by. Welcome to the Q1 2021 Luna Innovations Inc. Earnings Conference Call. . And please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Allison Woody, Director of Administration. Please go ahead.

[Allison Woody:]

Thank you, and good afternoon, and thank you, everyone, for joining us today. This afternoon, we issued our first quarter 2021 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.

[Scott Graeff:]

Good afternoon, everyone, and thanks for taking the time to join our call. It's amazing to me that as we sat here today in the middle of May 2021, we have more than lapped a year since the beginning of the COVID pandemic. And like many of you, I'm very happy to see most of our colleagues having been fully vaccinated and seeing a return to some level of normalcy. For Luna, we started the year very focused on basic blocking and tackling. You may recall that throughout last year, we continue to put into place many of the processes and systems that will allow us to scale well into the future. We are continuing to roll out the use of new tools, including the January 1 go-live of our new ERP system. And we made these investments because as we look forward, we see an abundance of opportunities for strong and rapid growth. We need to ensure that we are well positioned for that growth and can scale comfortably. You should expect to see us continuing to invest in our business as we progress through this year and into 2022.

[Eugene Nestro:]

Thank you, Scott. Before I proceed, I want to note that our reported numbers include the results of the two acquisitions we completed towards the end of last year, New Ridge Technologies and OptaSense, and their related integration, transaction and amortization expenses. In addition, our results also include expenses related to our continuing portfolio activities. With that as background, I'll now shift to cover our first quarter results. As Scott noted, our revenues for Q1 2021 were $26.3 million compared to revenues of $17.1 million for Q1 2020, representing a 53% year-over-year increase. The increase in revenues was composed of an 82% increase in our Lightwave segment and a 5% decrease in our Luna Labs segment. Within the Lightwave segment, year-over-year growth was driven by our acquired businesses and strong performance from both our sensing and communications test businesses, including particularly strong commercial sales in our comms test space, resulting in double-digit growth. As you can see, Luna Labs was down year-over-year. As Scott mentioned, COVID was a factor. We heard from several partners that they were unable to do certain work, which pushed out planned work on our end. As an example, the decrease was driven partly by lower sales of our True Clot line of bleeding control training products as face-to-face EMS and first responder training were affected by COVID restrictions. Our gross profit increased to $13.4 million for the quarter compared to $8.4 million for the same quarter last year, representing a gross margin of 51% in Q1 2021 compared to 49% in Q1 2020. Gross margin improved as Lightwave grew and became a larger percentage of Luna sales. Recall that Lightwave has a higher gross margin than Luna Labs. While not material to the quarter, I would like to point out that gross profit does include approximately $0.2 million of noncash amortization of inventory step-up related to our recent acquisitions. We expect approximately $0.2 million in Q2 with slightly lower amounts in Q3 and Q4. The inventory step-up will be fully amortized in Q4 2021 with no carryover to FY 2022. Operating expenses were $14.2 million in Q1 '21, which includes $1.2 million of amortization, integration and transaction costs related to our recent acquisitions and ongoing portfolio activities. Our Q1 '21 OpEx as a percent of revenue was up slightly year-over-year, and you may continue to see this as we aggressively invest in our business for our next stage of growth. Just to be clear, Q1 '21 OpEx includes this $1.2 million, which, along with the $0.2 million of amortization of inventory step-up included in gross profit, negatively impacted our Q1 2021 operating income by a total of $1.4 million, as Scott previously mentioned. Due in part to this $1.4 million, we recognized an operating loss of $800,000 in Q1 2021 compared to operating income of $400,000 in Q1 of last year. I would like to take a moment to talk about our amortization expense included in our operating expenses. In Q1 2021, we have approximately $840,000 of total amortization expense. This includes amortization of intangibles related to our prior acquisitions and our recent OptaSense and New Ridge technology acquisitions, along with amortization of our patents. We expect total amortization expense and operating expense of approximately $820,000 per quarter for the rest of 2021. We do disclose annual amortization by year in our 10-Q, so you can refer to it for future amortization expenses. As a reminder, if we acquire additional companies, we expect to have additional amortization related to those acquisitions. Net loss for Q1 2021 was $300,000 or a loss of $0.01 per share compared to a net loss of $1.1 million or $0.03 per share for Q1 2020. Adjusted EPS was $0.03 per share for Q1 2021 versus $0.02 for Q1 2020. Income tax benefit for Q1 2021 differs from our statutory rate primarily due to equity compensation. We estimate our 2021 effective tax rate to be 22% to 25%. And finally, a key metric reflecting our underlying operations is adjusted EBITDA. As Scott mentioned, adjusted EBITDA increased to $2.1 million for the first quarter 2021 versus $1.6 million for Q1 2020. Let me now move to the balance sheet. We ended the quarter with $11.8 million of cash and cash equivalents compared to $15.4 million at the end of 2020. The decrease was largely due to the cash payment of accrued deal-related expenses. Our working capital was $47.3 million at March 31, 2021, compared to $45.4 million on December 31, 2020. Remember that at the time of the OptaSense acquisition, we announced a new debt facility comprised of 2 separate financing vehicles, a term facility and a revolving facility. So at the end of the quarter, we had total debt outstanding of $18.9 million. Of that amount, $11.4 million is in term debt, and $7.5 million was drawn on our revolver. We have access to an additional $7.5 million in the revolving credit facility should we need it. As I mentioned last quarter, we exited 2020 stronger than when the year began as a result of a series of strategic acquisitions, continued operational improvements and further investment in our core foundation of the company. I am very comfortable with the reaffirmation of guidance today, and I'm very bullish on the prospects for Luna in 2021. With that, I will turn the call back over to Scott.

[Scott Graeff:]

Thank you, Gene. At this time, I'd like to open the call for questions. Brian Soller, Chief Operating Officer; and James Garrett, Senior Vice President and General Manager of our Luna Labs division, are with Gene me at this time and also available to address questions. As always, I wanted to assure that the proper folks are on the call today to address any specific business questions you might have. So Laurie?

[Operator:]

. And our first question is from Barry Sine from Spartan Capital Securities.

[Barry Sine:]

A couple of questions. First of all, on the labs R&D work. Do you expect to make that revenue up back in the next 3 quarters so that the full year is unaffected? Or is that revenue kind of gone forever?

[Eugene Nestro:]

No. That revenue will - I'll let James address it because he knows specifically. But what we went through when we went through this, and you know, anyone on the call knows as unusual that is with the Luna Labs being slightly down. That just pushed. That just pushed into Q2, and some of that has already been captured here in early Q2. James, you want to?

[James Garrett:]

Yes, sure. Barry, this is James. So like Gene said, some of this was COVID-related. So we had partners and subcontractors that couldn't get work done kind of over the winter. Either people were working remote or just weren't - didn't have the resources, but that's still work that is on the contracts that we have. So that's work that we need to do, and so that will get captured later this year. So it's more of a timing event than revenue that is lost. So we're going to pick that up later in the year because that is still on the contracts that we have, so it's stuff that still needs to get done.

[Barry Sine:]

And then my second question on the slide deck in the first quarter highlights, the third bullet point talks about functional integration of OptaSense will begin after the first year. So will - it sounds a little curious. So what exactly are you not integrating? Are you not integrating the product lines? You have an integrated product line or the sales force? Will customers now get calls by 2 Luna sales rep and OptaSense and a Luna sales rep? And then continuing on that point, the financial impact of that, you had some nonrecurring integration expenses. Does that mean that those will continue into 2022 when you actually do the integration? And how does that lack of integration impact the margins? I'm assuming the margins will be lower with them not integrated and stand-alone than they would be if the company was integrated.

[Scott Graeff:]

Yes. Yes, quite a bit in that question, but let me try to address some of it, and I'll let Brian address it. So Barry, what we were talking about was keep in mind, I haven't been able to - Brian hasn't been able to be over to the U.K. yet. So Jamie is running that operation - will continue to run that operation. We just haven't been able to integrate some of the sales teams. We have calls. The guys are talking to each other, but we haven't fully integrated some of those operational savings and sales savings yet. They will. They will. And you saw the appointment that we made to Salvan Farooqui running all of sales. He will get to know, and as travel opens up, get to see some of these products, and there will be some synergies that will be shared over time. Just right now, we just need to continue to focus on delivering. As an example here, this was the largest - this was the biggest bookings quarter we've ever seen. So when you see - sometimes we're still having some lingering effects, especially in Q1 of some COVID-related items where the order is in-house, but we cannot deliver on the order because the customer may not be working in the field for us to show up. So there are some delays and those are all things that are just being pushed. We've had several orders that were slated to be delivered in Q1 that have already been delivered. Just like we were talking about with Luna Labs, there's things that have been done in April that just kind of slipped due to some movement around on the COVID. I'll let you talk a little bit more, Brian, about the integration of what's going on and why we're doing it in the stage of what we are.

[Brian Soller:]

Yes. Barry, this is Brian. We're just - we're taking a very measured thoughtful approach to making sure the integration goes properly given some of the limitations of travel, and Scott already hit on that. This process would take about this long, I think, anyway. These locations overseas, in particular, all have functional groups in engineering, sales, marketing, finance, administration, et cetera. And we will integrate all those groups under the different levels of leadership that we've already described, some of them on this call, and that will get to be a little easier to do when we can travel a little bit here going into later in the year. We had always said that for the OptaSense acquisition, we were acquiring a fully functional business that would stand on its own, and it would operate that way for about a year. And we're right on track with that. And I'll let Gene talk to the financial points, but from my perspective, there will be no impact on gross margin as it relates to these integration elements.

[Eugene Nestro:]

No. Thanks. Yes. So just to be clear, on the IT systems, we had to unentangle them from their parent company and stand them up on their own. And from an IT perspective, that's essentially complete. I think we have another week or so to go on that. And so then we'll be off of the IT TSA. So in relation to those costs, they were spent about 50% in Q1 and about 50% through this quarter. And financial systems, they're mapped into our consolidation process. And so from that perspective, I would say we're essentially complete with those.

[Barry Sine:]

And next year, when you do the full integration, what financial impact should we expect to see when it's fully integrated?

[Eugene Nestro:]

On the system side?

[Barry Sine:]

On the financial side, on the operating margin, I guess. So I'm assuming lower overhead costs.

[Eugene Nestro:]

So they don't have a lot of overhead within OptaSense. And so both of us - so they run an SAP version that's similar to NetSuite that are both cloud-based. And so really, your only costs there are storage and licensing. And so there's not going to be a lot of savings from that. So we're all fairly lean on the back office accounting side.

[Scott Graeff:]

Yes. These integration efforts amongst engineering, sales and marketing will really result more in some more internal efficiencies and teams working more well together under some common leadership. So that's kind of the way to think about those remaining integrations that we have to do. They're not - there's not a lot of heavy lifting in terms of systems or any, what I'd say, material costs. And again, I'll let Gene speak specifically to that. But the benefits will be more on more of a coherent approach, for instance, into the market with products and with customer wins, and we're already doing all of that. Those teams are already working together to leverage those activities and then they'll have a common reporting structure as we get through the end of the year and get fully integrated.

[Eugene Nestro:]

Right. Yes.

[Operator:]

Our next question is from Jim Marrone of Singular Research.

[Jim Marrone:]

Yes. Just want to talk about the Lightwave revenue. I think you may have mentioned it in the prepared statements. Just in regards to the 82% revenue increase, was there any sense of how much of that was organic revenue, stripping out the acquisition impact? And just as a follow-up question to that revenue growth, you mentioned that the Lockheed Martin contract was still ongoing, but you also mentioned other corporate customers. Maybe if you can just shed a little bit more light on that? Is it from a military perspective? Or is it going into commercial customers? And if you could just provide a little bit of color with that.

[Scott Graeff:]

Yes. Jim, Typically, we look to quickly roll these into the division. So you've heard me say before, we really don't get into legacy or organic versus inorganic, just because of how it can be. In this case, it was a larger transaction. So it is a little bit easier. We will have it part of Lightwave. It will roll up into Lightwave. I can tell you from now what it made. The impact, I believe, the organic side of Lightwave is around 12% to 13%, somewhere in that range organically. And then the big increase happens from rolling in OptaSense into that. What was the other part? The commercial, yes, go ahead.

[Brian Soller:]

Sure. Yes. The deliveries to Lockheed Martin have gone very well here in Q1, as we mentioned. But in terms of other customers, we did have several on the order of half a dozen or so new wins with other defense-related customers or activities. So that would be for either airframe measurements or in this case, we had a win for measuring on submarine application. So new product, it takes time to build that customer base up, but that's right on track with what we expect is to be bringing on these new customers on a pretty consistent basis on the defense application side. And then we also had, as we mentioned in the script, a couple of really nice wins for data center testing. And we mentioned in the past that this product has applications in the data center with measuring latency in particular, which is the - a delay measurement, which is critical for financial data centers, and we had several wins on that front as well, which is more on the commercial side rather than the defense side. So it was a nice start to the year for that new product.

[Jim Marrone:]

Okay. Great. Just one other question in regards to the adjusted EBITDA. So you guys recorded 2.1, but you're reaffirming guidance of $16 million to $19 million. So I'm assuming that guidance is based on having a strong second half to 2021 based on a 50 - 55% weight to business in the second half?

[Eugene Nestro:]

That's correct.

[Jim Marrone:]

Yes. All right. So it's still being reaffirmed. There's really no other risk in regards to hitting those numbers?

[Scott Graeff:]

Yes. Jim, the way that we approach this, it doesn't do us any good to get out ahead of ourselves. So what we give guidance is what we see in front of us. All we can - all I can do in all these times, be transparent with everyone and lay out what I see in front of us. And I think when you look historically, if you look at the last 5 years, 5, 6 years, 4% to 6% of our revenue comes from the first half of the year and then the remainder in the second half. And right now with what we see and the bookings that we've seen in Q1 and what we're seeing halfway through Q2, it has us very confidently reaffirming the guidance both on the top on the revenue side and on that adjusted EBITDA. Because of the different things that we're looking at, the acquisitive things, we guide on the adjusted EBITDA on the bottom. So we feel good about with what we see today and what's in front of us, reaffirming that guidance that we gave back last quarter.

[Operator:]

Our next question is from Robert Silvera of R.E. Silvera and Associates.

[Unidentified Analyst:]

Gentlemen, well done in difficult time frames. I noticed that the diluted share number has climbed by just over 800,000 year-over-year. And I was wondering, is that share number climbing because of stock-based compensation or from what else?

[Eugene Nestro:]

Yes. No. It's from stock-based compensation.

[Unidentified Analyst:]

Okay. Is that the exercising of options?

[Scott Graeff:]

I think there's exercising options. I think there's incentivizing senior management. When we do the acquisition with OptaSense, we want to make sure that everyone is symbiotic with all of us and making sure that we - yes, tying our performance to performance stock units.

[Eugene Nestro:]

Yes. And also because you're referring to diluted, when they're issued and we do the dilution calculation that they get added in there as if they were going to be - as if they were issued.

[Scott Graeff:]

Right.

[Unidentified Analyst:]

Right. Okay. The other thing I have is a question on the debt that you have. Do you have any intentions of trying to accelerate debt reduction?

[Eugene Nestro:]

Not on the term. So we have two pieces and the term is 3 years with 4 quarterly payments each year. So we're planning to pay that off roughly $1 million a quarter. And the revolver, what we'll do is we'll pay that down if we think that's the best use of our cash. And so we do plan if that's the case that we would pay the revolver now, not the term.

[Scott Graeff:]

Yes. I mean, no reason if the revolver stands out there at 7.5% available, 7.5% drawn right now, there's no reason to use - not to use excess cash to kind of pay that down and you can - and knowing that it's always there on your availability. So not only anyone here is big on paying interest, just to pay interest. So I think we'll probably use that as a fluctuation of excess cash.

[Operator:]

Our next question is from Dave Kang of B. Riley.

[Dave Kang:]

My first question is actually a clarification. So regarding Luna Labs, you talked about COVID impact. Can you kind of quantify, is that about $1 million or so?

[Scott Graeff:]

James, I don't know whether you quantify - I mean, you can talk about it. I mean I know there's contracts that we were planning on as we sit here and do forecasts and budgets that was going to happen in Q1. Some of the labs that we were dealing with, some of the customers we were dealing with saw the spikes coming out of the holidays that trickled into Q1. And I mean it's certainly a number. I don't know what we were flashing in the beginning of the year, but I would bet - it's a number. I mean it's $0.5 million to $1 million that was pushed out of Q1 into Q2 and further. Is that fair, James, somewhere in that range?

[James Garrett:]

Yes. I think that's the right ballpark. Like Scott said, we're down about 5% year-over-year from Q1 of last year. But I don't think it's much bigger than that. So I think that's kind of the order of magnitude that we're talking about something - we probably would have seen growth over last year. Now that's typical for us to be growing year-over-year compared to the same quarter last year. So for us to be down this year is unusual. As Scott said earlier, so something in the $500,000 to $1 million range is probably about the right range. Like we said earlier, it's more of a timing issue. So that revenue is not really lost. It's more delayed through the rest of the year. We expect to pick it up.

[Scott Graeff:]

Yes. I think you'll see a different story in Q2 with Luna Labs, Dave.

[Dave Kang:]

Got it. And then certainly, a lot of equipment companies, they've been talking about supply chain constraints because of chip shortages. Were you impacted? Or do you expect to be impacted during the upcoming quarters?

[Brian Soller:]

Dave, this is Brian. We don't expect to be impacted in a material way. We've been managing that very closely. We've talked about it every quarter now for 3 or 4 in a row, I think. We certainly have seen lead times grow and delays. For the size of our business and for what we consume and what we need, we've been able to manage through those delays and garner more inventory where needed and put buffers, emergency buffers in place. So we've been able to continue to manage through it. And so we don't anticipate it's going to have a big impact, but something we're keeping a very close eye on.

[Dave Kang:]

Got it. And then regarding Lightwave, you said comp test was strong. Any particular areas that you can point to where you saw strength?

[Brian Soller:]

Yes. Well, we started the year with deliveries in the - for the 6200 platform for Lockheed Martin, and we've talked a lot about that on our last couple of calls. So that was a nice driver. We had a nice large order at the end of last year, and that drove revenue this year. But the good news was, as Scott mentioned, bookings were strong. Book-to-bill was good. And the commercial sector, I think we specifically mentioned in the comments, was strong in Q1. We had a really nice order flow for communication systems provider. So for our test equipment, driving volume on their sides and build-outs for their manufacturing using our equipment, which is part of our growth strategy is to get our equipment more into manufacturing type applications. And we saw that in Q1 start to pick up on the commercial side.

[Dave Kang:]

Got it. And then my last question is regarding OptaSense. I think you said last year, oil and gas verticals, they underspend because of the pandemic. Are we - have we seen any kind of signs of improvement from those verticals?

[Brian Soller:]

Yes. So Q1 was a very interesting quarter. OptaSense had - the business unit had good strong performance. It was not particularly driven by oil and gas in Q1 per se. But with the price of oil reaching in Q1, $55 or so What we're seeing now already in Q2 was a really strong start to that segment in April, and we're seeing that carry over into May, and we expect a nice - So we had good performance in Q1 with a little bit of a lag in the oil and gas side of the equation, and that's picking up now in Q2. So that will just - that will add to what was already kind of a good start to the year.

[Operator:]

. Our next question is from Tim Savageaux of Northland Capital Markets.

[Timothy Savageaux:]

Just wanted to focus back in on the commentary on strong bookings, and I think you gave a little bit more color there on equipment manufacturers and mentioned data center earlier as well as being drivers organically. My question, does that commentary include OptaSense on a comparable basis in terms of kind of record bookings for the company? Or is there a comparability issue there?

[Scott Graeff:]

Yes. Yes. I'll let Brian talk about that, Tim. But yes, it does. Keep in mind of the business model that they have. In many ways, you book the business and you have to go out into the field to do some installation and things like that. You are at the mercy of the customer being available to be out in the field to be there. You can't - you kind of need them as part of the process, and - but when I mentioned the very strong bookings in Q1, I was including OptaSense. And Brian, you can talk about that as well.

[Brian Soller:]

Yes. So the bookings numbers do include OptaSense. But even without, order flow was very strong in Q1, and the book-to-bill was very good. And so historically not - Q1 is our lowest quarter from a bookings and revenue perspective, but we actually had a very strong Q1 from a bookings perspective. So I think that's the way to look at it. And as I said, the commercial side relative to last year where in those spaces, Tim, that you mentioned in communications test and data centers, we actually had a good year. Commercial was okay, but military defense, defense-type spending was actually stronger this year we had. I think our best Q1 ever on an apples-to-apples basis for bookings of that type of equipment in that segment by a fair amount. It was a really good start to the year.

[Timothy Savageaux:]

Okay. Great. And if I could just follow up on that particular comment. You mentioned - well, I don't know if there's some easier compares here or what have you, but is it safe to say that on the commercial communications side, orders were - revenues were not only up year-over-year, but orders and bookings came in stronger than you would have expected at the beginning of the quarter?

[Brian Soller:]

I think that's a fair assessment. Yes, the order book was very good, as I said, and the commercial element was a strong driver. So a lot of work in silicon photonics and semiconductor photonic applications and a number of other really nice applications as well outside of that specific area. And then as I already mentioned, the portable handheld product we introduced at the end of last year and have talked about for Lockheed Martin also had some nice new wins in Q1. So that all added up to a good start to the year.

[Operator:]

. There are no further questions on queue. I would now like to turn the call over to Scott for final comments.

[Scott Graeff:]

All right. Well, thank you, everyone, for joining us today. You've heard me say repeatedly that we believe we are on the right path with the right vision. We continue to believe in our potential and that we're on the right side of a market shift in trends towards lightweighting and 5G. In fact, our capabilities can help to accelerate those trends. That's why we're investing heavily in our business and are also very focused on making sure that we have the right leaders and bench strength in place. Feel free to reach out to myself, Gene, Allison, James or Brian, with any questions that you may have, and I look forward to speaking with you guys soon. And thank you for your time and interest in Luna Innovations. And now Laurie, I think I'll turn it back to you to end the call.

[Operator:]

And ladies and gentlemen, this concludes today's conference call. Thank you for your participation, and have a wonderful day. You may all disconnect.