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Edited Transcript of LUNA.OQ earnings conference call or presentation 9-Nov-20 10:00pm GMT

·47 min read

Q3 2020 Luna Innovations Inc Earnings Call ROANOKE Nov 10, 2020 (Thomson StreetEvents) -- Edited Transcript of Luna Innovations Inc earnings conference call or presentation Monday, November 9, 2020 at 10:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Allison Woody Luna Innovations Incorporated - Director of Administration * Brian J. Soller Luna Innovations Incorporated - Senior VP & GM of Lightwave Division * Eugene J. Nestro Luna Innovations Incorporated - CFO, Principal Financial Officer & Principal Accounting Officer * James T. Garrett Luna Innovations Incorporated - Senior VP & GM of Luna Labs * Scott A. Graeff Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director ================================================================================ Conference Call Participants ================================================================================ * Barry Sine Spartan Capital Securities, LLC, Research Division - Director of Research * Jim Marrone Singular Research, LLC - Equity Research Analyst * Ku Kang B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components * Timothy Paul Savageaux Northland Capital Markets, Research Division - MD & Senior Research Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to Q3 2020 Luna Innovations Earnings Conference Call. (Operator Instructions) I would now like to hand the conference over to your speaker today, Ms. Allison Woody, the Director of Administration. Thank you. Please go ahead, madam. -------------------------------------------------------------------------------- Allison Woody, Luna Innovations Incorporated - Director of Administration [2] -------------------------------------------------------------------------------- Thank you, Mary, and good afternoon, and thank you for joining us today. This afternoon, we issued our third quarter 2020 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. Some of our comments and discussions today are based on non-GAAP measures, specifically adjusted EBITDA. These adjusted numbers exclude the effects of certain noncash expenses and other items. These adjusted results are a supplement to the 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 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 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; Brian Soller, Senior Vice President and General Manager of our Lightwave division; and James Garrett, Senior Vice President and General Manager of our Luna Labs division, will be available to take your questions. And at this time, I'd like to turn the call over to Scott. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [3] -------------------------------------------------------------------------------- Good afternoon, everyone, and thanks for taking the time to join our call. 2020 continues to be a remarkable and an unexpected year. At this time last year, as we're getting ready to wrap up our 2019 fiscal year and we're finalizing the planning and budgeting for 2020, we never could have imagined how this year would unfold. I'm sure most of you relate to this sentiment and yet, here we are today, 3 quarters into an unprecedented fiscal year and a full 2 quarters into a devastating global pandemic. From the beginning, we placed a priority on ensuring a constant flow of open and honest communication as well as focusing on employee health, safety and wellbeing. These 2 things have been a critical part of supporting the collaboration and teamwork that has driven our success. And as a result, Luna is announcing our best quarterly results ever. I am proud to be part of a team of talented and dedicated individuals who believe in and demonstrate Luna's values in all they do. The team has stayed laser-focused on looking out for one another. As they continue to serve our customers with the highest level of excellence, advancing Luna's mission to enable the future with fiber, I can't say thank you enough to these committed individuals for choosing to be part of the Luna team. We will share with you today our financial results for the quarter and provide an update on some of the projects and initiatives that represent the continuing investment in our company. We are obviously mindful of the current environment and the speed with which it can change. While we remain flexible, we just delivered the strongest quarter in our history, which helps to give us increased confidence in the potential of Luna's future opportunities. We continue to invest strategically in our business so that we can grow and scale significantly well into the future. We have accomplished or are currently implementing some of the following foundational items: implementing our new cloud-based NetSuite ERP, this system is replacing 4 legacy ERPs, and we're on track with this project; implementing the salesforce.com platform, providing critical tools and information to our sales teams throughout the enterprise; hiring into key positions, both in operations and in corporate shared services; enhancing the employee experience through investing in significant upgrades to several core systems that will allow better functionality for our employees, for example, we changed the different partners for payroll/human capital management, 401(k) recordkeeping and for expense reporting; launching our first offering period in our employee stock purchase plan with a robust 59% enrollment; and finally, hosting a celebratory 30th anniversary launch at all locations with gifts for the employees. I believe recognition and celebration are a critical part of maintaining our culture and building enthusiasm about what we see as an incredibly bright future. As I detailed, the significant investments we're making and the work we're doing, I hope you take away from this discussion that all of this investment has created a strong, contemporary, consistent and scalable foundation. This foundation will allow us to drive organic and acquisitive growth for the longer term without the need for additional investment in our core infrastructure and systems. As we continue to do acquisitions, these modern global platforms will allow for much quicker and efficient integration of future transactions. Now onto details about the third quarter. Let's begin with recent accomplishments and our third quarter financial results. For the third quarter, total revenues were up a robust 14% to $21.1 million compared to the prior year's quarter. The Lightwave segment had an increase of 17% year-over-year to $15.4 million in total revenues. We expanded gross margin by 200 basis points, improved our operating income by almost $800,000 and delivered adjusted EBITDA of $4.3 million, up $1.4 million over last year. Someone recently asked me how we have continued to deliver such strong results throughout this year in the face of everything going on. And I think there are a number of distinct factors that have helped us to drive this success. First, we have a superior product portfolio with products that are needed by companies regardless of whether we're in the middle of something like a pandemic. Second, the end markets into which we serve have been less affected by COVID than have some other industries, and the organizations in these markets still require our products. Third, the key megatrends that support Luna's growth continue to be relevant and strong: fiber, 5G, light-weighting and civil structure monitoring. Fourth, we have been successful in pivoting to the way we are selling and have successfully used virtual tools such as webinars to sell. Of course, it definitely helps that all companies are in the same situation. Fifth, from day 1, we have taken this virus and the danger very seriously. We have delegated the authority to our managers to decide based on the circumstances in their locations when to work exclusively from home and when to bring people into our offices and assembly facilities. We've put strict safety guidelines in place for in-office work, including social distancing, mask wearing, sanitation procedures and staggered shifts when possible. Finally, as I mentioned previously, open and frequent communication has been critical to our being able to operate safely, efficiently and successfully. And our ability to operate well is the result of the ultimate team effort and cooperation of every employee at Luna. Now let me discuss Lightwave in more detail. Revenues in our Lightwave division grew 17% in Q3 versus the same period last year. That growth was evenly split between our 2 segments in Lightwave with both sensing and comms test growing in double digits relative to last year. Let's look at some of the accomplishments in these 2 segments, starting with our sensing segment. As a reminder, our sensing solutions focus on 2 areas: first, our fiber sensing products, ODiSI and HYPERION, which focus on the integration of optical fiber sensors in and on advanced materials and structures; and second, our T-Ray products, which use Terahertz waves to see through opaque materials to measure thickness for process control applications. As I mentioned, total revenues in Q3 increased by double digits compared to the prior year. This growth was driven primarily by increased shipments of our ODiSI and HYPERION fiber optic sensing products. ODiSI is our short-range, high-resolution solution that is used within the aerospace and automotive sectors to enable next-generation designs using composite materials. There are many other applications for this product. We are also enabling smarter designs in multiple industries and have seen growth driven by the adoption of ODiSI technology in geotechnical and energy-related applications. Our HYPERION product is longer range and is paired with sensors for applications ranging from monitoring civil structures, like bridges and dams, to enhancing the security of perimeters and the safety of offshore oil exploration and extraction. In Q3, deliveries in the latter category drove growth as we delivered over 20 HYPERION systems to 2 customers. HYPERION is then integrated into industrial systems that monitor the structural health in part of the structure that is used to transfer oil and offshore operations. We continue to make progress with sales of our Terahertz products. While results in Q3 were down slightly on a year-over-year basis, we continue to see strong indications of the potential for sustainable long-term growth of our Terahertz product, especially in the industrial process control space. And we will keep you all informed as we see that potential manifest in increased sales. Moving to our communications test vertical. Remember that this is the business focuses on the ever-growing need for more bandwidth in communications networks. Optical fiber is a key enabler in high-speed communications. This ability runs the gamut from core telecommunications networks to data-centric networks to enabling cloud computing and 5G mobile networking. Our products feed the need for speed and include the OVA or Optical Vector Analyzer, the OBR or Optical Backscatter Reflectometer, and a suite of polarization instruments and photonics controllers. In addition, hopefully you saw that we recently announced the acquisition of New Ridge Technologies, whose solutions are a perfect complement to our communications test and measurement portfolio. This acquisition is strategically very important to Luna, but is very small and immaterial from a financial perspective. The transaction is very much in keeping with our strategy to look for tuck-in technologies that help us to advance our product road map. The integration of New Ridge's products with Luna's will help our customers enhance connectivity by developing faster communications networks to support everything from the 5G buildout to the continued expansion of bandwidth inside data centers. As we've discussed in the past, there are 2 main growth drivers in this segment. The first is the integration of optical and electronic systems in silicon, generally known as silicon photonics. In Q3, orders from customers working in silicon photonics development were strong. The second main growth driver in this segment is the new portable version of our OBR product, the model 6200. We've spoken previously about orders of this new product that were delivered to Lockheed Martin in support of the F-35 program. Remember that we initially developed this product for field support of the F-35 by making the 6200 portable with an easy-to-use green light/red light touch screen. I am pleased to share that recently, we have received confirmation from Lockheed of the need for over 100 units. This is a major milestone for Luna because it is the highest-quantity order that we've ever received. We strongly believe that we have the opportunity to move some of our business from the small-quantity orders we have historically received 2 larger-volume orders, which allow for faster and more predictable growth. I believe we're just getting started with this product line as we move into the support operations of other military aircraft. In addition, we can expand beyond military into civil aircraft and other applications such as data centers. I want to thank our long-term customer, Lockheed Martin, for their incredible collaboration as well as their confidence in us. Their input has been key to successfully developing a user-friendly, portable device that will enable them to dependently troubleshoot fiber optic-based issues in the aircraft. As we mentioned on last quarter's call, we continue to take precautions while importantly advancing our sales and customer initiatives in the face of this new normal brought on by the ongoing pandemic. Let me just underscore a few things. First, as an essential business, we continue to maintain 100% continuity of operations, working closely with our supply chain partners and are delivering to our global network of customers at 100% capacity. Second, we continue to maintain flexible work schedules and environments and to take all the safety precautions recommended by health and other state and federal agencies. We are now allowing domestic travel on a selective basis. From a supply chain perspective, we're working very closely with our partners. We have not seen and do not anticipate any significant disruptions to our supply base. And finally, as I mentioned earlier, our end markets and customers have remained relatively resilient through this pandemic, although we're still experiencing some selling challenges as we continue to be very limited in our customer in-person interaction. So we have continued our customer outreach through digital means. We've executed 9 webinars over the last 6 months where our customers and community of users join us virtually for interactive demonstrations of the unique capabilities of our products. These webinars have generated 3,000 registrants, over 1,300 live attendees and more than 1,400 new leads. Let's move on to a discussion of Luna Labs. At Luna Labs, we leverage third-party contract research to build a portfolio of technologies outside our core strategic fiber optic offerings, which are commercialized through direct sales, distributors or licensing agreements. Most of the funding for Luna Labs comes from the federal government, primarily the Department of Defense. So our contracts there have not been materially affected by the pandemic. Total revenues for the division were $5.7 million in the third quarter of 2020, which represents an 8% increase versus the prior year. Last quarter, I spoke about the challenges of working with our academic collaborators through the spring and summer as universities remain partially shut down and laboratories were closed or operating on very limited schedules. We saw significant improvement in this workflow during Q3 as these partners got their labs open with students getting back to work. Let me give you an example of the work we do here. One of the mature technologies about which I've spoken is our corrosion sensors. These compact, durable and rugged devices have already been deployed on numerous military aircraft around the world. They were recently selected by Lockheed Martin to help monitor corrosion on the Orion spacecraft that is part of the Artemis missions to send astronauts back to the moon and ultimately to Mars. The University of Dayton Research Institute and the U.S. Air Force also recently placed a large order for these corrosion sensors as part of the effort to reduce the cost of aircraft maintenance associated with corrosion. Q3 was a strong quarter for Luna Labs, which contributed robustly to our overall success this quarter. The pandemic has presented some challenges, but this division is well diversified with a mix of government funding from a variety of agencies and commercial revenue from an array of products and licensing. In addition to the Q3 revenue success for this division, we also completed the consolidation of our Danville, Virginia facility into our Luna Labs headquarters in Charlottesville, Virginia. This move has made the whole division more efficient and created new opportunities for collaboration and growth. We expect a strong finish to the year. Let me make a few comments about the reaffirmation of our outlook for 2020. As we always do, my leadership team and I did a full review of our forecast assumptions and experience year-to-date to inform our decisions and our disclosures. We have also spent considerable time recently planning and budgeting for 2021, and I look forward to sharing those with you during our Q4 and year-end call. As a reminder on seasonality, we've shared previously that Luna recognizes approximately 44% to 46% of annual revenue in the first half of the year, with the larger portion of the annual results being realized in the second half of the year. As we're now in the final quarter of 2020, we are tracking to that seasonality. Today, we're reaffirming our 2020 outlook range, which is total revenues of $81 million to $83 million and adjusted EBITDA of $10 million to $12 million. In summary, this has been an unprecedented and challenging year for all of us. I believe that Luna's clarity about its vision and purpose have served us well as we've navigated these stormy waters. I am grateful to the Luna team for their focus and work, and I could not be more proud that our hard work delivered these record-breaking results for all of our stakeholders. I'll now hand the call over to Gene for more of the financial details on the quarter. Gene? -------------------------------------------------------------------------------- Eugene J. Nestro, Luna Innovations Incorporated - CFO, Principal Financial Officer & Principal Accounting Officer [4] -------------------------------------------------------------------------------- Thank you, Scott. Before I dive into the third quarter financials in more detail, I want to provide some broad thoughts on the progression of this year and prospects for the future. Coincidentally, I'm just a couple of weeks away from my 1-year anniversary with the company. Obviously, I never could have envisioned the challenges that this year would bring. But as I sit here with you today, I am more excited than ever about the growth prospects for Luna, and I'm very happy that I had the opportunity to join such a terrific company. Despite the challenges brought by the global pandemic, Luna has continued investing in people, processes and platforms to support our ability to grow aggressively. I am proud of the progress that we've made this year in driving superior operating and financial results, while we also implement the systems and hire the professionals that will allow us to scale significantly without further investment in back-office infrastructure. Let me provide some details. First, we recorded a terrific Q3 despite the environment in which we were working. Our sales, profitability and cash position are all healthy. Second, Scott already mentioned the progress on implementation of our new ERP. The project is going well and will not only streamline our current finance and accounting work, but will also make the integration of future acquisitions much easier. Third, to position us well for the future, we've hired some excellent new talent into an already skilled and energized finance team. Our new Controller brings 25 years of experience from a large public company, Advance Auto, where he was recently involved in a $3 billion acquisition. Our new FP&A Manager brings over 15 years of experience from both GE's energy division and also from ABB. Fourth, the main impact of COVID has been an extension in the time it takes for us to get a purchase order through our sales pipeline. We have not seen cancellations in orders, although a few contracts are taking longer than expected to obtain final signatures. And fifth, as I noted last quarter, Q2 was the first full quarter of lapping the General Photonics acquisition. Thus, year-over-year comparisons for this third quarter do not contain any first year acquisitive results. Obviously, year-to-date year-over-year comparisons do include the impact of the Q1 2019 acquisition. With that as context, I'll now shift to cover our third quarter results. Remember that last quarter, we began to present our financial results in 2 segments: Lightwave and Luna Labs. For those of you who are not able to join our Q2 call or do not have the pro forma financials for the new reporting structure, they can be found in the Q2 supplemental earnings materials, which are posted on our website under the Investor Relations section. Our revenues for Q3 2020 were $21.1 million compared to revenues of $18.4 million for Q3 2019, representing a 14% year-over-year increase. The increase in revenues year-over-year was composed of a 17% increase in our Lightwave segment and an 8% increase in our Luna Labs segment. Within the Lightwave segment, year-over-year growth was driven by strong performance from both our sensing business and our communications test business. Within Luna Labs, growth was driven by later-stage commercial products. Our gross profit increased to $10.9 million for the quarter compared to $9.3 million for the same quarter last year, representing a gross margin of 52% in Q3 2020 compared to 50% in Q3 2019. The gross margin improvement was primarily due to product mix as revenue from higher-margin Lightwave products increased to 73% of total revenue in Q3 '20 versus 71% in Q3 '19. Within Lightwave, gross margin improved due to increased absorption on our cost of sales base. Operating expenses were $8.7 million or approximately 41% of revenue in Q3 2020 compared to $7.8 million or about 42% of revenue in Q3 2019. Our Q3 '20 results reflect appropriate expense control combined with continued operating leverage on our increasing sales. Including in -- included in the operating expenses in Q3 2020 are $668,000 related to our footprint consolidation within our Luna Labs segment. Third quarter SG&A expense increased to $6.5 million versus $5.7 million in the prior year. This increase is primarily due to increased sales and marketing expenses in our Lightwave segment to support increasing sales. Q3 2020 G&A included approximately $425,000 in recurring noncash amortization expense associated with the acquisitions of General Photonics and Micron Optics. With the revenue growth and gross margin expansion, our operating profit improved to $2.3 million in Q3 2020 compared to a loss of $1.5 million in Q3 of last year. Net income from continuing operations for Q3 2020 was $3.1 million or $0.10 per share compared to $1.2 million or $0.04 per share in Q3 2019. We claimed R&D tax credits for 2018 and 2019, and we plan to claim R&D credits for 2020. These credits claimed are approximately $1.7 million. These credits helped to reduce our effective tax rate, resulting in a 6% negative effective tax rate for Q3 2020. And finally, a key metric reflecting our underlying operations is adjusted EBITDA. As Scott mentioned, adjusted EBITDA increased to $4.3 million for the third quarter of 2020 versus $2.9 million for Q3 2019. This solid performance was driven primarily by top line growth from both our legacy businesses and those businesses we acquired, combined with our ongoing expense management. Let me now move to the balance sheet. We ended the quarter with $26.4 million of cash and cash equivalents compared to $25 million at the end of 2019. Our working capital was $49.3 million at September 30 compared to $41.1 million on December 31, 2019. Our working capital increased primarily due to Q3 sales increasing AR, inventory build in anticipation of Q4 sales and the timing of accrued expenses. In addition, we have access to a $10 million revolving credit facility, should we need it. Without repeating the 2020 outlook Scott provided, I'll just say that we, again, did a comprehensive bottoms-up analysis, which provided good insight into our forecast for the remainder of this year. This is predicated on assumptions that customer orders are delayed, not canceled. We continue to monitor and evaluate the effects from this pandemic on a daily basis to ensure that we understand any potential impact on our business. We will continue to be transparent. And should things change significantly, we will communicate that information. With that, I turn the call back over to Scott. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [5] -------------------------------------------------------------------------------- Thank you, Gene. At this time, I'd like to open the call for questions. Brian Soller, Senior Vice President and General Manager of our Lightwave division; and James Garrett, Senior Vice President and General Manager of our Luna Labs division, are with Gene and me at this time and are also available to address these questions. I wanted to ensure that the proper folks were on the call today to address any specific business questions that you might have. So Mary? We seem to have lost our operator. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Barry Sine, your line is now open. Barry from Spartan Capital Securities, your line is now open. -------------------------------------------------------------------------------- Barry Sine, Spartan Capital Securities, LLC, Research Division - Director of Research [2] -------------------------------------------------------------------------------- Hey, it's Barry Sine. Can you hear me, guys? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [3] -------------------------------------------------------------------------------- Yes. Hey, Barry, yes, we can hear you. -------------------------------------------------------------------------------- Barry Sine, Spartan Capital Securities, LLC, Research Division - Director of Research [4] -------------------------------------------------------------------------------- A couple of questions. Brian, I'll put you in the hot seat first. Could you talk about what your hot products were in terms of top sellers in the quarter and where you're seeing the most interest in the order book going forward? -------------------------------------------------------------------------------- Brian J. Soller, Luna Innovations Incorporated - Senior VP & GM of Lightwave Division [5] -------------------------------------------------------------------------------- Sure. Yes, absolutely. So for Q3, we had a couple of standouts. We mentioned, I think, all 3 of them on the call. We really had the first quarter here in Q3 of really getting into the full shipment mode of our new OBR, the 6200. And we launched that at OFC this year, and that would have been in March, and it takes some time to get business moving through the pipeline. And so that really started to hit in Q3 and was a nice contributor there to our growth in comms test. And that was anticipated, but nice result to see that with our newest product. And as you know, we really see that as a game-changing product. And we mentioned that good things are coming here in Q4 and into the future with that as well with our announcement of the first relatively large round orders from Lockheed Martin of over 100 of those. So that was a nice element to Q3 and it will be going forward as well. We also hit on in the prepared remarks that in the sensing side of the business, we had double-digit growth. And really, it was both of our fiber sensing products. We have 3 products in that segment: our ODiSI, our HYPERION and our T-Ray Terahertz products. While T-Ray did not have a great quarter in Q3, both of our fiber sensing products did really well. So a diverse set of applications and strong performance in Q3. I think you asked at the end there about going forward. I kind of already hit on that. The 6200, we really do expect to be, that's the OBR, really probably our hottest-selling product here over the next few quarters, especially with the addition of that relatively large order from Lockheed in support of the F-35. -------------------------------------------------------------------------------- Barry Sine, Spartan Capital Securities, LLC, Research Division - Director of Research [6] -------------------------------------------------------------------------------- Okay. That's really helpful and very thorough. The New Ridge acquisition, from a financial analyst standpoint, pretty stealthy. The only clue I've heard so far, as you said, it was financially immaterial. And I guess that's both in terms of contribution as well as the amount paid for that. Could you talk a little bit more? And what was the back story there? Did they come to you, trying to sell? Or did you go to them? How long have you known them? What are their products? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [7] -------------------------------------------------------------------------------- This is one of those we've known them for a long time. It's a -- the principal there, the founder, Henry Yaffe. I would argue, Henry and Steve Yao, who was the founder of General Photonics that we bought last year, are probably 2 of the top 5 photonics polarization folks in the world. And so we've known Henry for a long time. So this is something we've been talking about for a while. And I think you probably know as well as anyone that some of these smaller deals take some time to get them comfortable with joining another organization. It just made sense. I mean any time we can do a tuck-in kind of deal that pulls our product road map forward, we would certainly do. As you saw, I did put out an 8-K. I didn't want people to be -- to wonder what was going on. I did go out and give them a little bit of color of what do I mean. It's the first time we've done a kind of, what I'm calling, a tuck-in technology, so gave a little bit more color around that. I don't know if I'll continue to do 8-Ks if we do more deals that are that size. But it just gave you a flavor for what I'm talking about. I don't think in 2020, you'd see a meaningful impact. I mean getting Henry as part of the team and talking, he's already collaborating with us and working towards the next-generation thing. He brings some products with him. So it doesn't have a real material effect, both on what we spent to get it and what it will be going forward. The material part of that and why I talk about that being important is what he does to the team, and Brian can talk more about that, too. But he is down here in our Blacksburg facility, working directly with all the folks in the back and talking about the things that we have in our road map. -------------------------------------------------------------------------------- Brian J. Soller, Luna Innovations Incorporated - Senior VP & GM of Lightwave Division [8] -------------------------------------------------------------------------------- Yes. He's kind of a key thought leader is the way to look at it in the space of photonics and looking at the technology that we've built our product portfolio on. And we had a product very similar to the one that he's brought to market through New Ridge in our pipeline -- our road map to bring to market. And so it was a bit of a build or buy. It's more of a -- a little bit more down the road from a financial impact, but it is an important technology for us to get in the tent, so to speak. So yes, it's a good a little touch. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [9] -------------------------------------------------------------------------------- It's a really good add-on when we're in front of some customers. Any time when we're in front of these customers and they're buying something from the Keysights or VIAVIs of the world that we believe this is a superior product that we can sell while in front of that customer is a good thing. We have a lot of real top sales folks that run our communications test vertical, both here in the U.S. and in Europe, and I think to add this arrow to their quiver is an important piece. -------------------------------------------------------------------------------- Barry Sine, Spartan Capital Securities, LLC, Research Division - Director of Research [10] -------------------------------------------------------------------------------- Okay. And then a financial question, Gene, if I could put you in the hot seat, please. It looks like, and I think you alluded to this in the comments, you sold one of your physical locations. So I noticed a pretty big drop in net property, plant, equipment. There was a proceeds in the cash flow statement and then a loss on that, that flowed through the income statement. Could you give me any more color on that? -------------------------------------------------------------------------------- Eugene J. Nestro, Luna Innovations Incorporated - CFO, Principal Financial Officer & Principal Accounting Officer [11] -------------------------------------------------------------------------------- Sure. As we mentioned, we consolidated that facility into our Charlottesville, Virginia facility for Luna Labs. That was a building that had building improvements and equipment with it that we didn't need to move all of it to Charlottesville. And so we ended up selling the building for $400,000, and then we had depreciation that we needed to write off. And so that's what you see on the income statement. And then what we call out on adjusted EBITDA is, in addition to that, we also had other relocation costs, whether it was for employees that relocated to Charlottesville or other equipment that we did move to Charlottesville. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [12] -------------------------------------------------------------------------------- Yes. Barry, this is a building that we got into this market, and it's about 2 hours from here. It's not far, but it was an old tobacco warehouse that the local municipality gave us some grant money and the tobacco commission gave us some grant money back in 2004. We built that facility. It was going to be the nano manufacturing facility. We have since kind of exited that outside of contract work. And James Garrett resides in our Luna Labs headquarters in Charlottesville, where the University of Virginia is. And it made sense to get everyone under that roof and work on IP and collaboration together. And that was something that James pushed on. And quite frankly, we were able to keep the majority of those folks and move them there and really not skip a beat. The team did a fabulous job of moving up 2 hours up the road to our Charlottesville office. -------------------------------------------------------------------------------- Barry Sine, Spartan Capital Securities, LLC, Research Division - Director of Research [13] -------------------------------------------------------------------------------- Okay. Just to follow up on that. So you've adjusted that out of adjusted EBITDA, so that's a normalized number. But in the bottom line, the $0.10 EPS you reported, that loss is still flowing through there. So on a normalized basis, EPS would be a little bit higher, correct? -------------------------------------------------------------------------------- Eugene J. Nestro, Luna Innovations Incorporated - CFO, Principal Financial Officer & Principal Accounting Officer [14] -------------------------------------------------------------------------------- Yes. -------------------------------------------------------------------------------- Operator [15] -------------------------------------------------------------------------------- Next question comes from the line of Jim Marrone from Singular Research. -------------------------------------------------------------------------------- Jim Marrone, Singular Research, LLC - Equity Research Analyst [16] -------------------------------------------------------------------------------- Yes, very nice quarter on that revenue line. Just speaking with the revenue still, you mentioned in the comments that the military applications was looking to be expanded. Could you give us an idea which product line is on the military space that it could be expanded to? And then you also mentioned that there's going to be soon-to-be commercial applications. Can you give us an idea as what now what type of product line is in the commercial space? And what kind of time frame are we looking at? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [17] -------------------------------------------------------------------------------- Well, Jim, I'll start, and I'm going to let Brian talk a little bit more about that. We've talked about this before of our relationship with Lockheed Martin. And it started with the F-35, really the collaboration to build out the 6200 with Lockheed Martin. And it's initially starting with the F-35, but they've made it very clear, they think it has applications across all of their aircraft to include the F-22, the F-18, the C-130, the F-16, all those products will be using the 6200. So I'll let Brian -- I think he talks with them quite a bit. They are a close collaborator of ours down at Lockheed Martin. So I'll let Brian talk about that, but that's just -- that's one customer that when I was there, and they talked about needing this across all of their fleet, those are the products that we're talking about. In fact, I believe there is some follow-up work already going on, on the F-22. So I'll let Brian give a little bit more color on that. -------------------------------------------------------------------------------- Brian J. Soller, Luna Innovations Incorporated - Senior VP & GM of Lightwave Division [18] -------------------------------------------------------------------------------- Yes. With that product -- Jim, with that product, we're in earlier state -- we're definitely in later stages with the F-35 aircraft, right? But I'd say we're in earlier stages of developing business with multiple customers for other aircraft, as Scott mentioned. F-22, F-18, C-130, E-2D Hawkeye are all aircraft that we've actually now sold into, part of why Q3 was as nice as it was. And the way the business works is they typically will order just a handful of systems to get them inspected and tested out. And then that will go through kind of procurement through the government to take that more widely into the field. So that time frame is about a year. So we've already got that process started. So that's the good news on that. On the commercial side, we have aircraft as well. So there's fiber optics on a lot of these military aircraft that we've hit on. But the similar technologies are being integrated in commercial aircraft as well. So we're working with those folks, the Boeing, the Airbuses of the world to get that business going as well. We'll see that hit next year. And I also mentioned another good application for this product is the data center market. We're very early stage in penetrating that space, but we've already sold systems into several data centers, in particular, financial data centers for testing a very specific type of test that's required in a financial data center that supports high-speed trading. There's really no other product in the market that can measure with the level of accuracy that's required for the specific test. So we see that as starting to be additive as well next year, probably more so mid-late in the year with some preliminary stuff happening in the first part of the year. -------------------------------------------------------------------------------- Jim Marrone, Singular Research, LLC - Equity Research Analyst [19] -------------------------------------------------------------------------------- All right. So we're looking into 2021 in regards to both spaces. So will you guys be putting that into the guidance that you're going to be providing, I believe, next quarter in regards to 2021? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [20] -------------------------------------------------------------------------------- Yes. I mean I think we will -- when we go through that and have a better handle on that, when we give Q4 and full year earnings, we will give -- we will certainly give 2021 guidance as well. We have talked about whether we do that on the top and the bottom, and the bottom being adjusted EBITDA, is it EPS, we're not sure what our guidance will be. But we will continue to give guidance, and that will factor those things into our -- when we do give that annual guidance. -------------------------------------------------------------------------------- Jim Marrone, Singular Research, LLC - Equity Research Analyst [21] -------------------------------------------------------------------------------- All right, very good. And also, just one last question. So it seems like you guys are pretty insulated in terms of what happened in 2020 with regards to the pandemic. So can you just maybe touch upon just the change in the administration for the U.S. government? What do you see in terms of government spending, whether that's in defense or auto or energy and gas? And how that will -- could impact Luna at all? Is there any color around that? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [22] -------------------------------------------------------------------------------- Yes. Well, I don't see a lot of change with who's in the White House, if that's what you're asking. And I'll let James give a little bit of his take on this. I mean he -- in running Luna Labs, he's very connected with the government, and we have a very good relationship with all the DoD entities, military and such. And I don't know, James, if you see anything -- everything I've heard in talking with some of the customers, they don't -- they really don't see a lot of change in what's going on. So do you have any... -------------------------------------------------------------------------------- James T. Garrett, Luna Innovations Incorporated - Senior VP & GM of Luna Labs [23] -------------------------------------------------------------------------------- Yes. Hey, Jim, this is James Garrett. I mean I've been watching this pretty closely for the last 6 months as we've been coming up to the election. And everybody in government and even all the defense contractors, most of them have been saying they don't see a big change in defense spending coming regardless of who's in the White House. And I think if there's any sort of divided government, that's even going to be more true. So we don't anticipate a big change in defense spending, which is our largest piece. Really, the only thing that might change would be an increase in the health spending if we see a big uptick in spending to address the pandemic further into next year. So that's really -- the only thing we're looking at is probably similar spending levels in defense and possibly an uptick in the spending on the health side. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [24] -------------------------------------------------------------------------------- Well, and Jim, on the sensing side, I know Brian has been looking at closely if there is an infrastructure bill that this administration chose to bring out if they got there. Everything has been -- is being done from a smart perspective. So any structure that is being done, whether that's a retro and existing or putting new, we are in front of them, and everyone is moving towards making sure that fiber is on or embedded into any of those structures to make them smart. You saw some of our announcements about the bridge and things like that. So infrastructure bill, if that's where this administration took it, would be a big plus for us. -------------------------------------------------------------------------------- Operator [25] -------------------------------------------------------------------------------- Your next question comes from the line of Dave Kang from B. Riley. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [26] -------------------------------------------------------------------------------- My first question is back to Lockheed, about the 100 units. Can you tell us what time frame that will be? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [27] -------------------------------------------------------------------------------- Yes. We've been talking about that for quite some time. We haven't -- we've kind of honed in now the number of units, and it certainly is in excess of 100. It is something that was -- is in our 2020 numbers. It's something that we said will happen in 2020. And so I think you can count on that here in the remainder of the year. So that's kind of where we are. We have not changed our position. Like I said, we talk with Lockheed on a regular basis. It is much more than a customer relationship. We really, really have a very close relationship with them. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [28] -------------------------------------------------------------------------------- And then you talked about other platforms, such as F-22. I mean with that, hopefully, next year, could Lockheed become a 10% customer sometime next year? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [29] -------------------------------------------------------------------------------- Interesting. I don't know, Brian, it could be -- I would say it would see that 10%, for sure. I mean I don't -- will it get to 10%? I don't know. But it will be a very meaningful customer, let's say that. -------------------------------------------------------------------------------- Brian J. Soller, Luna Innovations Incorporated - Senior VP & GM of Lightwave Division [30] -------------------------------------------------------------------------------- I don't think it'll be quite 10%, but it will be north of -- it could be north of 5%, and it could be pushing up there. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [31] -------------------------------------------------------------------------------- Got it. Really helpful -- yes? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [32] -------------------------------------------------------------------------------- Certainly, we'll make sure we talk about that. If it does drift that way, we'll make sure that everyone is aware. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [33] -------------------------------------------------------------------------------- Got it. And just regarding -- now that you repeated or reiterated this year's outlook, we can back out the first 3 quarters. So you essentially gave us a fourth quarter outlook. Can you just go over some of your assumptions, especially on COVID cases rising again and some countries going back to lockdown mode? What are your assumptions regarding COVID? -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [34] -------------------------------------------------------------------------------- Well, a lot of our product is coming out of backlog. We're halfway through the quarter now or almost halfway through the quarter. Some things have pushed out. We talked about that. Even in Q1 got pushed into Q2, got pushed into Q3, and we've seen some of those things even push into Q4 here. So we looked at this from the bottom up and believe that the low end of our range is still a good guidance. I mean we gave you $81 million to $83 million. We believe $81 million to $83 million is still the right number with what we see today. I've always said we sit down and evaluate everything why we did it. As late as yesterday, we were making sure that the latest information that we have is what we put out to you folks. And so that's what we know today, Dave. And given what's going on, and obviously, we have a presence in Europe with feet on the street in Germany and France and the U.K., with what we know today, we believe the guidance that we gave is solid. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [35] -------------------------------------------------------------------------------- Got it. Then just a couple more. Regarding OpEx, I mean, will OpEx trend up for next year as things become more normalized? I know a lot of companies, they're underspending OpEx because a lot of people are not traveling. So will OpEx trend up next year? And then how should we think about with New Ridge Technologies, there are OpEx? And lastly, on tax side, you had a benefit last quarter. How should we think about tax rate going forward? -------------------------------------------------------------------------------- Eugene J. Nestro, Luna Innovations Incorporated - CFO, Principal Financial Officer & Principal Accounting Officer [36] -------------------------------------------------------------------------------- Yes, sure. This is Gene. I'll take those. So OpEx, what we say and what we try to do is we look at OpEx as a percent of revenue. And so we try to lower OpEx as a percent of revenue year-on-year, and so I think we'll still see that next year. Your point is very valid in we've had more success this year or we beat our budget, I would say, on the OpEx, on the underspend, like you said, due to travel, and we're running behind our original budget for OpEx. But I think year-on-year, the percentage of OpEx as a percent of sales should be improved slightly. And so we see then correspondingly operating income going up. Long term, 2, 3 years, we think OpEx certainly can be in 13%, 16% range, somewhere like that, if we manage it properly. So hopefully, that answers your question on the OpEx. And what was your other question again? -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [37] -------------------------------------------------------------------------------- Tax. -------------------------------------------------------------------------------- Eugene J. Nestro, Luna Innovations Incorporated - CFO, Principal Financial Officer & Principal Accounting Officer [38] -------------------------------------------------------------------------------- Oh, yes. So our tax rate, we had negative 6% tax rate because of our R&D credits. For the full year, with the R&D credit baked in, it's probably going to be around 14% to 16%, maybe 16.5% for the full year. And then without the tax credits, it would probably be in the 21% to 22% range. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [39] -------------------------------------------------------------------------------- Yes, Dave, as I'm sure, Dave, I'm sure you took note that I did take some time to talk about in my prepared remarks about the infrastructure that we have put in place. We -- I was really trying to make the point that we have spent some things that are foundational type of items that should allow for the growth that we see over time to handle some of that. So you should not see incremental growth in expenses based on the revenue that we incur. -------------------------------------------------------------------------------- Operator [40] -------------------------------------------------------------------------------- (Operator Instructions) Your next question comes from the line of Tim Savageaux from Northland Capital. -------------------------------------------------------------------------------- Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [41] -------------------------------------------------------------------------------- A couple of questions. I think there was commentary around strength in silicon photonics orders in the quarter. I wonder if you could provide any more color in terms of applications, I assume mostly inside the data center, but maybe some telecom as well or customer types in terms of driving that strength. Is that kind of run rate on current products or anything new there? And then I'll follow up. -------------------------------------------------------------------------------- Brian J. Soller, Luna Innovations Incorporated - Senior VP & GM of Lightwave Division [42] -------------------------------------------------------------------------------- Yes. Hey, Tim, it's Brian. Yes, it was another good quarter, solid quarter for OVA and OBR products selling to customers working on silicon photonics-type devices. It was a mix of commercial and academic-type R&D. So the academic side can be just about anything, including quantum computing, really advanced photonics designs for communications, et cetera. Some really nice applications there. We had several really nice orders for commercial customers as well. Folks working primarily, as you said, on data center-type applications. A couple of the bigger names out there were repeat customers of ours that we've mentioned on these calls before and that we've worked with over the years, and they're names that you would recognize. Several systems to cloud service providers that do their R&D or development for silicon designs in-house. So it's really a good mix in Q3. And we've continued to see the activity level there remain fairly strong, I'd say, consecutively for 4 or 6 quarters now, and that held up in Q3. -------------------------------------------------------------------------------- Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [43] -------------------------------------------------------------------------------- Great. And that sort of leads me into my next question, actually, which is kind of another cut at the Q4 question. Your guidance does imply a pretty decent step-up. It sounds like the new product going into Lockheed and maybe elsewhere is going to be the primary driver there. But given that commentary just now, it sounds like silicon photonics could contribute as well. As you look at a pretty decent sequential uptick into Q4, I wonder if you can characterize what products might be key in driving that. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [44] -------------------------------------------------------------------------------- Well, look, Tim, I'll let -- again, I'll let Brian jump in on this one. But you've been around long enough in this test and measurement telco space to know or datacom space that Q4 is the best quarter, right? We always -- people are spending budget, people that, in many ways, drag on, I mean, they pull the trigger. We're starting to move up to selling multiple units of both the OVA and OBR in multi-units. And Brian, if you want to add more as far as what you're seeing in this -- in the funnel and pipeline, by all means. But it is -- we've been around a long time, maybe not as long as you, Tim. But we've been around in Luna here 20 years, Brian, I've been here 18 of them. And Q4, as you know, Q4 is a really good quarter. -------------------------------------------------------------------------------- Brian J. Soller, Luna Innovations Incorporated - Senior VP & GM of Lightwave Division [45] -------------------------------------------------------------------------------- Yes. Q4 just tends to be our strongest quarter in that segment by a pretty good stretch. And as you pointed out, sales of the 6200 product to Lockheed are going to be a big part of the growth that we'll see in Q4. But I will say that what we've seen so far or what we have indications of are another strong quarter for our communications test business. And that is consistent with what we've said, I think, throughout the year when you look at the effects of the global market on our business communications... -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [46] -------------------------------------------------------------------------------- I mean the data center, the foundries... -------------------------------------------------------------------------------- Brian J. Soller, Luna Innovations Incorporated - Senior VP & GM of Lightwave Division [47] -------------------------------------------------------------------------------- Yes, the foundries, the data center, home manufacturers, the OEMs are all -- they're still -- they're gearing up, and there's a lot of stress on the network these days. And so build-outs are coming, and we expect to see a good quarter in Q4. I should say we expect that segment to be a nice contributor to what we've already said about Q4, which will be a strong quarter. -------------------------------------------------------------------------------- Operator [48] -------------------------------------------------------------------------------- (Operator Instructions) I'm showing no further questions at this time. I would now like to turn the conference back to Scott Graeff. -------------------------------------------------------------------------------- Scott A. Graeff, Luna Innovations Incorporated - President, CEO, Treasurer, Secretary & Director [49] -------------------------------------------------------------------------------- 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. Given the environment we are in, I believe our financial and operational success during these first 9 months underscores this belief. We continue to believe in our potential and that we're on the right side of a market shift in trends toward light-weighting and 5G. In fact, our capabilities can help to accelerate these trends. Please feel free to reach out to Gene, Allison or myself with any questions, and we look forward to speaking with some of you soon. Thank you for your time and interest in Luna Innovations. And Mary, that concludes our call. -------------------------------------------------------------------------------- Operator [50] -------------------------------------------------------------------------------- Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.