Scott Graeff - President, Chief Executive Officer Gene Nestro - Chief Financial Officer Brian Soller - Chief Operating Officer James Garrett - Senior Vice President, General Manager Allison Woody - Director of Administration.

Good day! Thank you for standing by and welcome to the Second Quarter 2021, Luna Innovations Incorporated Earnings Conference Call. At this time all participants are in a listen-only mode. . As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Allison Woody, Director of Administration.

Ma’am the floor is yours..

Good afternoon, and thank you for joining us today. This afternoon, we issued our second 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 through our website. Some of our comments and discussions today are based on non-GAAP measures. These adjusted numbers exclude the effect of certain non-cash expenses and other items.

The adjusted results are a supplement to the GAAP financial statements. Luna believes the presentation and exclusion of these items is useful 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, our Chief Operating Officer; 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..

sensing and communications testing. For the second quarter 2021, the revenue growth I just mentioned was driven by both, the acquisition of OptaSense and strong commercial sales in legacy Lightwave’s comms testing.

Let's dig a little deeper into the sensing segment, which you may recall is a segment where we use the fiber as the physical sensor to create smart, materials and structures. Revenues grew by 63% versus Q2 last year, driven by both the acquisition of the OptaSense product lines, as well as legacy Luna products.

As a reminder, we added the OptaSense distributed acoustic sensing or DAS technology to gain access to fully distributed measurement capabilities over long range applications to augment our already industry leading line of fiber optic sensing products.

The addition of long range distributed capability to our offerings establishes Luna as new global market leader in fiber optic sensing with diversified geographies and applications. While on the topic of OptaSense, we hit important integration milestones in Q2.

We successfully completed the integration of the functional support elements, IT, HR, Finance, that were previously handled under our transition services agreement with Connecticut.

We have more integration work in front of us as we look to maximize our growth potential, but the heavy lifting of integrating the back office function is now largely behind us. Staying with our sensing vertical, we made important progress on several strategic growth areas.

We saw a significant increase in oilfield activity with campaigns for major North American operators and an extended seismic mapping job in the North Sea. In addition, bidding activity in Canada and the Middle East is increasing.

Despite challenges caused by the pandemic, we have delivered a number of major contracts to South American customers for infrastructure monitoring, further positioning Luna as a trusted supplier and recognized world leader within these markets.

We made progress in expanding into the new markets, we’re tracking gain in the telecoms industry, following an extended period of investigation, a major U.S. cloud services provider chose to invest in Luna’s sensing solution to help monitor their fiber optic networks.

And we launched the 6th Generation of our acquisition and interpretation platform for linear assets like borders and pipelines. In this release we feature a simplified layout and display, making it easier to use. We also included an auto tuning capability using machine learning, which helps to accelerate setup up time.

Now switching to Communications Test Vertical. These product lines grew strongly, 79% in Q2 versus the prior year period. For some additional clarity, it's important to know that the RIO Laser business acquired through the acquisition of OptaSense is included in our comms test results.

Without OptaSense, our legacy Luna comms test business grew more than 40% in Q2 versus last year.

With the addition of the RIO Laser products, and the general photonics products we added in early 2019, this business is now 50% test and measurement for communication devices, and 50%t optical component in laser modules for a variety of photonics applications such as medical devices, sensing systems and LiDAR.

If we look at the legacy part of comms testing, our core products the OVA and OBR grew nearly 100% on a year-over-year basis, driven by a continuation of the strong commercial environment we discussed in Q1 and the continuation of deliveries of our newest product in this category, the OBR 6200.

You'll remember that last year we announced our partnership with Lockheed Martin and their order for over 100 units in Q4, 2020. Our deliveries to Lockheed have proceeded without interruption. In general, comms testing drove significant overall improvement in commercial sales over last year with multiple system sales to large corporate customers.

And now let's move on to a discussion of Luna Labs, where as a reminder we leveraged third party contract research to build a portfolio of technologies. These technologies which are commercialized through direct sales, distributors or license agreements are outside our core strategic fiber-optic offerings.

In terms of the second quarter, Luna Labs saw many positive business indicators as employees returned full time to the office. Government customers were able to travel again and trade shows resumed in-person meetings. For Q2 2021 Luna Labs reported $6 million in revenue, a 6% increase over Q2, 2020.

Returning to in-person trade shows, allows us to reconnect with customers and demonstrate some of the new products we have developed recently. For example, in our existing corrosion monitoring product line, we made progress expanding aerospace sensors in the automotive markets.

We recently delivered and order a Jaguar, Land Rover in support of a two year, 400,000 kilometer test across North America. Jaguar, Land Rover is using the Luna Lab sensors to forecast new material behavior as we investigate next generation Lightwave materials.

Before I turn it over to Gene for a deeper dive into Q2 results, I want to make a few comments on the continuing effects of the global pandemic, building on the comment I made earlier. Luna’s operations have only been slightly affected by COVID-19 pandemic thus far, in supply chain and in sales cycles.

For supply chain we've largely been able to mitigate risk for electronic parts by building in more safety stock and working closely with our supply partners to ensure delivery. Going forward, we are taking steps to eliminate hard to get parts and replacing those in our designs with parts we know, we can more readily source.

An industry prediction suggests that we should see some easing of the situation in Q4. While we don't currently predict the situation will adversely affect our results, we want to be clear that we do rely on a steady supply of electronic parts and boards that are increasingly difficult to source.

Finally, with regard to the timing of sales cycles, we did see some impact from the pandemic this quarter as certain geographic regions have experienced limited travel and in person meetings.

These have only been timing issues, and we have seen all effective sales ultimately close, but I did want to mention it, especially in light of recent news about the variant. In summary, I'm extremely pleased with the progress so far this year. We'll continue to focus on fundamental blocking and tackling, as well as building for the long term.

I'm incredibly grateful to the Luna team for their focused work and continue to be confident that we have the right strategy to capitalize on opportunities in our growing markets. I'll now hand the call over to Gene, for more of the financial details on the quarter. Gene..

Thank you, Scott. Scott mentioned the addition of Bhaskar to our Luna Leadership Team. I have also strengthened my finance team. Ray Matty joined Luna a few months ago as our VP of Financial Planning and Analysis. Ray has over 30 years of FP&A and finance experience with well-known companies such as Armstrong Industries, TE Connectivity and Shop Vac.

He has already begun to build our FP&A function to support our continued growth. We also recently added Andy Brown as Corporate Controller. Andy has over 22 years of corporate accounting experience with advance auto. I believe we now have a strong finance leadership team to support Luna’s growth.

Before I proceed, I want to note that our reported numbers includes the results of the two acquisitions we completed towards the end of last year, New Ridge Technologies and OptaSenses 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 ship to cover our second quarter results. As Scott noted, our revenues for Q2, 2021 were $27.9 million compared to revenues of $18.6 for Q2, 2020 representing a 50% year-over-year increase.

The increase in revenues was composed of a 70% increase in our Lightwave segment and a 6% increase in our Luna Labs segment compared to prior periods.

Within the Lightwave segment, year-over-year growth was driven by our acquired businesses and strong performance from both our sensing and our communications test businesses, including particularly strong commercial sales in our communications test business resulting in double digit growth.

Luna Lab showed improvement compared to Q1 growing 6% in Q1, 2021 versus Q2, 2020. Our gross profit was approximately $14 million for the quarter compared to $9.5 million for the same quarter last year, representing a gross margin of 50% in Q2, 2021 compared to 51% in Q2, 2020.

Gross margin declined slightly, driven in part by higher sales of lower gross margin products and Lightwave. Gross margin in quarters one and two of this year include $168,000 of non-cash amortization of inventory step up related to our recent acquisitions.

This number will decrease to $100,000 in Q3 and $70,000 in Q4, at which point the inventory step-up will be fully amortized. Operating expenses were $15 million in Q2, 2021 versus $7.7 million in Q2, 2020.

This increase was primarily driven by the operating expenses of our recent acquisitions, increased headcount to support our growth, $991,000 of integration and transaction costs related to our recent acquisitions and our ongoing portfolio activities and $320,000 of amortization related to our OptaSense acquisition.

We recognized an operating loss of $1 million in Q2, 2021 compared to operating income of $1.8 million in Q2 of last year. As a reminder, the operating loss of $1 million in Q2, 2021 includes the amortization in both, cost-of-revenues and operating expenses that I just discussed.

Acquisitions are an important partner of Luna’s strategy and so we will continue to see impacts to gross margin and operating income from these amortization items assuming we continue to be acquisitive. While these amounts are not insignificant, we believe we can drive substantial incremental value to Luna from our acquisitions.

To give you a sense of a magnitude, Luna’s total amortization expense for the quarter was $773,000, largely driven by our acquisitions. We do disclose annual amortization by year in our ten 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 Q2, 2021 was $0.2 million or a loss of $0.01 per share compared to net income of $1.4 million or $0.04 per share for Q2, 2020.

Income tax benefit for Q2, 2021 differs from our statutory rate primarily due to equity compensation. We estimate our 2021 effective tax rate to be 18% to 20%. And finally, a key metric reflecting our underlying operate is adjusted EBITDA. As Scott mentioned, adjusted EBITDA was $2.1 million for Q2, 2021 versus $3 million for Q2, 2020.

Adjusted EPS was $0.06 per share for Q2, 2021 versus $0.06 for Q2, 2020. Let me now move to the balance sheet. We ended the quarter with approximately $12 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 during Q1.

Our working capital was $47.8 million at June 30, 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 two separate financing vehicles; a term facility and a revolving facility.

So at the end of the second quarter, we had total debt outstanding of $17.9 million. Of that amount, $10.4 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.

I remain comfortable reaffirming our guidance today, given the vast opportunities that Luna has in 2021 and beyond. Let me give you some additional color related to how we see the second half shaping up. In terms of revenue for the second half, we expect that revenue will be skewed more towards the fourth quarter.

As we mentioned, we expect 54% to 56% of our full year revenue to occur in the second half of the year. We typically realize about 30% of our annual revenue in the fourth quarter, and this year we expect the weighting to be even heavier towards Q4.

We've been building backlog in our sensing business throughout the first two quarters and when COVID restrictions and supply chain delays ease, we will be better positioned to convert the backlog to revenue.

We expect that gross margin will expand slightly in the second half from the Q1 levels as our fixed costs are absorbed across a higher revenue base. We also expect a significantly lower level of integration and deal related costs in the second half of the year versus the first half as the bulk of our integration costs are behind us.

In summary, I'll reiterate Scott's comments. In Q2 we continue to work on basic blocking and tackling, refining the back office systems we recently implemented in integrating our recent acquisitions. Importantly, we continue to further invest in the core foundation of our company.

Like Scott, I'm also thrilled to welcome our new colleagues to the senior team. They've already begun to dig in and make an impact on our processes and performance. I feel really good about the finance team we now have in place. I feel we now have the right capabilities to support the organization's growth and critical strategic decisions.

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

Thank you, Gene. At this time, I'd like to open the call for questions. Brian Soller, our Chief Operating Officer 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 questions.

Leah?.

Thank you. . And your first question comes from the line of Jim Marrone from Singular Research. Please go ahead. .

Yes, thank you for taking my call. So my question is just in regards to the affirmation of guidance and you've mentioned that there's headwinds in terms of the supply chain. And so I'm just trying to reconcile that you recognize there’s headwinds in the supply chain, but yet you're still reaffirming that guidance.

And so maybe if you could just give a little bit of color as far as your justification for reaffirming guidance given those headwinds, and then I have a ...

Sure. I mean, I'm happy to address that Jim. So, my approach to guidance is open, honest and transparent. What I see in front of me is what I will pass along to shareholders and I wanted to make reference to some of the things that we had seen, that we hadn't seen on the supply side and some of the slippage of the revenue.

I was pleased to see that there were some big deals. I referenced that large dam in South America that didn't get done due to some COVID. People in the office, not in the office, not there for us to install, but it did happen the first week of July.

We've all been there where we said things have pushed around and pushed out and then you get to the end of the next quarter and they haven't been done yet and you realize that was a sales guy kind of telling you something.

But, what I've seen and what I see laid out strength my ability to reaffirm guidance and it's what I see in front of me and I believe we can work through the supply side and the challenges that we have, certainly on our side we're working through them.

It's a matter of what will our customers see, and we have certainly reached out to many big customers and talked through what they see and everyone believes that it won't be the strong headwinds, that we will see some relief here and not get worse, and with that all I can do is lay out what I see today The landscape in front of me supports reaffirming guidance.

If I didn't feel like it was that way, I would certainly pull back on it. But that's what we see. We met as a team. Brian, myself, Gene, all the lieutenants out there that are managing the day-to-day and we all came back with the same answer. So that's what we chose to go with here today, Jim..

Alright, I appreciate that. And I also recognize your second half of the year is typically you're stronger part of the year, so I recognize that. But let’s just say these headwinds persist.

So will that be impacting like top line or bottom line or a combination of the two? Can you give us a sense of exactly where it's hitting your income statement?.

Yeah, I think it's a combination of both. It all depends where it is. We saw some things here in Q2 and really the first half of the year in getting our sea legs underneath us with OptaSense. There's a lot of fixed costs associated with OptaSense, because they don't just sell a product. They sell a product and then installation and a service.

So, we have folks that are sitting around waiting to go out and do that installation. So if things get delayed and pushed from one quarter to another or they get pushed around from one month to another, there are fixed costs that we're having.

So if – it all depends where the lightness would happen on that revenue, but it could affect both the top and the bottom. We will certainly manage operating expenses, and like Gene said, we won't see a lot of the integration costs that we saw in H1 in the second half now that we are through a lot of those.

So, we seeing a lot of strength on the commercial side right now. The commercial environment is super strong. So we're not seeing backed off in our orders, in our commercial activity. It's robust. It's moving things around and being able to go out and deliver on them.

Legacy Luna was a lot more, I don't want to say predictable, but just we can see the landscape down, there was a matter of getting a product off the dock. With OptaSense I have to coordinate much, much more with the end customer. Like I said with that large, you know very large order of the dam in South America.

There's a lot of paperwork involved and you have to coordinate with having them there. You can't get on-site without them..

Okay. I appreciate that.

So, going on with that then, so is that business part of the Lightwave segment then?.

It is. Yeah, we've rolled that in, that all rolls up to Brian. .

Okay, and so with regards to Lightwave, is the Lockheed Martin still on the same trajectory? Or are you like diversifying away from that by getting into these more infrastructure plays or can you just comment on the nature of the business and where it's going?.

Yes sure. Hey Jim! This is Brian. I'll take that one. We're still on track and making really good progress with Lockheed Martin and the deliveries against the order we announced. We announced it was a Q4 order we announced in Q1, that's going very well.

We are working on a plan to diverse five those revenues and to grow outside of the one aircraft, which is the F-35 that we're currently tied to and we have made good progress. We've got other aircraft now that we are in the early stages of working with and beginning to make deliveries to.

We also have other applications outside of aircraft that we've started to see heat up, in particular in the data center market, so that's all going to plan. You asked about infrastructure. We're certainly seeing infrastructure side of the business come back this year. That was part of the business that was affected more by COVID last year.

It's been very active this year and especially with the announcement of an infrastructure bill here recently, we're looking forward for that segment to grow well into the coming years. So, that kind of hits on the two questions you had there..

Yes, okay great.

And you're anticipating a little bit more traction once the live events NOI conferences start up and can you tell me again when you're anticipating that?.

Well, we've started – they've already started. There's been some cancellations we've seen due to recent news related to the Delta variant, but in general things are starting to open up and people are meeting more live, certainly than they have over the last 15 months. .

Yeah, I haven't heard the latest, but ECOC in September was certainly planning on being face-to-face, and that was late – middle of September in – I think it was Burgundy or something like that, right. So, as far as I know it's still face-to-face Jim and I think that is a big thing with getting people back together. .

Yeah. Okay, thank you for your answers gentlemen. .

Thanks Jim. .

And your next question comes from the line of Barry Sine from Spartan Capital Securities. Your line is open. .

Hey, good afternoon folks. I wanted to start-off asking about OptaSense integration, and correct me if I'm wrong. I think you've said that you're going to push some of that activity into next year to kind of make sure that they're not disrupted this year.

I think you also said that you've completed an on-site, in person, all-hands meeting recently, which would be interesting given travel restrictions. So how are you integrating that? I recognize the challenges of they being a European operation and COVID related travel restrictions.

But could you kind of give us an update on that integration and have you been able to get over there and actually visit them?.

Yeah, we have not. What I referred to Barry was a staff meeting of mine where we brought everyone together into our Atlanta office and we held a face-to-face there. That was everyone, but Jamie Pollard, who dialed in from the UK. So all of the other direct reports and a lot of Brian's direct reports were in that meeting.

There was probably about 15 of us for a couple of day strategy session and get together. Jamie was the only one who did not travel. So we were not able to do that.

We did – I also referenced on the call that we've made progress and have for the most part completed the integration of Finance, HR, IT, kind of the services that were on our TSA with Kinetic. So we completed those.

What we look forward to is the integration of bringing sales together and that will like I said last time, we will push that into the second half of this year and into 2022 to not be disruptive to them. But that in person meet was everyone, but Jamie. We have not traveled there yet, and they have not traveled here yet in regards to the UK. .

Okay. And then shifting gears, there was a pretty significant news announcement in the quarter and I wanted to get your kind of generic comments, and I'm referring to the condominium collapse that occurred in Sunrise, Florida.

Yeah, there's no announced cause of that, but there is media speculation about structural issues and not just residential buildings, but there's a number of commercial buildings around the world that use similar type construction techniques. So I don't know if your sensing solutions are applicable for structures like that, how you would go about it.

And now that you have a new head of strategy, if you're looking, that is it your opinion that there may be a more significant market opportunity down the road now that perhaps we may see a zoning loss change and require some type of sensing in structures that would give you a bit of a early warning for events like that.

Can you just generally comment – obviously not comment on that specific event, but just comment on how that market may develop?.

Yeah, for sure. We have spent a lot of time on that. As you can imagine, a good chunk of our strategy session, what was in regard to structural health not only in regards to that event itself, which is tragic. There was 15 minutes that went between cracking on the pool deck until the building collapsed. I mean, they just had no monitoring at all.

Had we had fiber on that building, it would have been much, much longer than that. So I'll let Brian – Bhaskar is with us here as well. Obviously we've spent a lot of time – he's probably spent his first kind of two months here kind of going through a lot of these things.

But I'll let Brian talk about how we're chasing that and what we're going after in regards to that. But we have a lot of interesting ideas and have talked so some municipality is about this structural health. .

Yes, so a great question, Barry. The fact of the matter is we have systems all over the world, thousands of systems doing this already, monitoring structures for the overall safety, well-being of inhabitants, etc. and so this wouldn't be a new set of applications for us.

It'd be a new market because to date as you mentioned, the regulatory environment does not require such systems.

But yeah, we're certainly working with our contacts and behind the scenes with localities, municipalities to educate folks on the benefits of using systems like ours to enhance the safety of residential buildings, and it wouldn't be a new thing.

It's something we have a lot of experience doing and our mission is to enhance the safety security connectivity of people, so it hits home for us and it's something that we look forward to adding value to. .

I know it's still early going. Do you get any sense that we may see a change in the regulatory environment around the country where there maybe requirements to put structural sensing in there. And if so, when might we see some impact on the financial statements. So I mean, I know it's going to be a couple of years.

But might that be material and when might that occur?.

Yes, that's about right. That's about how we're looking at it.

We certainly are – we certainly do believe that the situation may evolve in the direction of requiring this type of monitoring, and in fact we've seen this with our customer base in Europe and other places, particularly in Southeast Asia, where certain types of structures or buildings are starting to require sensing systems for early warning and detection of issues.

So yeah, we just don't see any reason that that wouldn't necessarily happen here as well. It's very early days and these types of regulatory things are hard to predict, so I will make that caveat. .

Yeah, but I do believe it's a matter of when. I mean the energy and activity on – you know from the insurance agencies to the regulatory agencies, I mean there is a lot of talk you know, because we are actively out there telling them, we have the fiber, we have the solution you know.

We’re the seat belt to the accident here a little bit and so I believe it is when and that's a big question, but I do believe that's where we're going. .

Okay, that's really helpful. And my last question, I wanted to circle back to guidance. It sounds like I'm hearing a couple things that you're kind of back end loading, you know the guidance in terms of when we'll see the revenue.

You know you're talking about supply chain issues, many of which are outside of your control and obviously we hear about that from a lot of companies and a lot of industries, so that's not unique to you.

But it seems as if I'm kind of handicapping it, there’s some very small, but perhaps growing probability that maybe you don't quite make the guidance numbers this year. If you can kind of handicap that for us, and I guess if you didn't, anything that you miss would probably show up in the first few months of next year. .

Yeah, like I said, when Jim danced around that question a little bit, I take guidance very seriously and we went out and I talked to Gene and to James and to Brian and to Eve and to Jamie and to Salvan.

I mean, this senior team, talk about it guys, what do you see? What do you see now, because talk to the customers, talk to our folks in China, in Japan to Europe and looking at the pipeline, like I said, if we didn't see the activity, the commercial activity so strong or if we saw something – you know I gave sites to some things that we just hadn't seen and maybe that was adding the OptaSense side of it and such large orders, million dollar orders catering on not happening by June 30 and happening on July 8, and that's a big movement when you think 28 versus 29 or 29 versus 30.

I mean – but I can tell you this Barry. I would not go out and give the range. I wouldn’t list 122 to 127 if I didn't believe that's the range we were going to in. It just doesn't do me any good to do that. So, you know I guess I'll take the bruises if that happens, but I can tell you, you won't be surprised by it. We won’t give you insight into it.

I try to be as transparent as I can with what we see and that's why I wrote all that language around what we're seeing and there's some strange things that we're seeing on that supply side, not necessarily supply to us, supply to a lot of our customers and that's what hits us really outside of our control. .

Right. Okay, understood. Thank you very much for fielding my questions. .

Sure. Thanks Barry..

And your next question comes from the line of Dave Kang from B. Riley. Your line is open..

Thank you, good afternoon. My first question is Scott, I think you said demand remains very strong.

Can you give us maybe what the book-to-bill was maybe without a specific number? Was it like well over one or barely over one, any color on that?.

Yes. I'll let Brian talk about that. We went through this in detail at one of our finance sessions here, and I'll let Brian on an operations perspective, you want to give some of those..

Yes, it was over one, and it was in a nice kind of range. Without giving an exact number, you know in the low 1.1, kind of in that area, which is right where you want to be when you're looking to continue to grow. So the bookings were there.

We did see some things here and there related to effectuating the revenue, COVID related things, but the bookings were right on target. .

Got it. And then some of your peers that have reported already, their assessment is top line impact, revenue impact has ranged from low single digit to high single digits and margin impact has been around 50 bips to 150 bips.

Care to characterize how what – you know what kind of impact you experienced in the second quarter and maybe what to expect in the third quarter if there's is any?.

Yes. I mean like we – we mentioned on the call and I hit a little bit of it and Gene hit some of it. We have a level of fixed costs that are sitting on the OptaSense side. So if we have some things slip, we will see some margin creep on that as well. So the COVID pandemic as it relates to pushing things around on it.

So customers say, “Well, why don't you just come next month, next quarter, rather than now.” So that does have an effect on us and we made some reference to that.

In regards to second half Gene, you want to talk about that?.

Yes, sure. So like I mentioned, we are expecting larger revenue in the second half and based on past years, we think Q4 this year was going to be a little heavier than what we've seen in other quarters.

And to Scott's point, if we get out and can’t perform these services, we see actually some margin improvement from the 50%, again all predicated on our folks being out there and able to install and travel to where they need to go to..

Got it. And then on Terahertz, can you just talk about the pipeline? I think during one of the recent meetings, I think you mentioned about product acceptance and the point was that before you were selling onsies and twosies and now volume is definitely getting larger.

Just can you give us an update on that?.

Yeah. So, we're making really good progress on that, getting qualified into applications where systems will be used in production, you know rather than in kind of R&D type environments. That cycle does take some time, so it's not going to be a material or really major impact in any of the quarters this year.

But looking into next year is when we'll start seeing that, because the qualification process will take about that long through the end of the year and then we will be good to start getting that ramp.

And it's been in a couple of areas, predominantly the two most significant areas are in easy battery space and then in plastics manufacturing, so two unrelated end user markets, but similar function of the product. .

On EV battery, obviously we know who the biggest one is.

I mean are there multiple customers behind the customer?.

Yeah, we're working with half a dozen or so folks in that space with several of our products in fact, both our Terahertz product and our ODiSI product. So yes, we made good progress over the last year in kind of going after those applications and growing our footprint there.

And so yes, there are some names that are a little bigger than others, but Dave as you know, every car company in the world has a roadmap to electrification that is coming at us fast. .

What about the solar then? I mean, you know with – I don’t know where you live, but here in California with drought and all that, you know solar plus battery seems to be playing larger roles.

I mean, have you looked into that solar batteries market?.

It's not as much of a play there. We do have a couple of areas within the green energy market that we're going after, you know taking energy off of offshore wind farms is one of the structural integrity for wind turbines, those sorts of things, Carbon sequestration mapping.

But those are kind of the areas that we're looking at in the green energy market. .

Got it. Thank you. .

Thanks Dave. .

And your next question comes from the line of Michael Haymaker, a Private Investor. Please go ahead. .

Yeah, hi gentlemen. I had a couple of questions for you. One, as an investor who came over from API, I got used to them managing to loose zero point three dollars every quarter. And I'm hoping that your plans are not to continue on operating loss into the perpetual future, and so that's a kind of one question. .

Yeah. No, there's no plans on continuing losses. If you look at the operating income and I would suggest – if you came out from API, you've seen the changes that we've made, especially in the last kind of four or five years here in what we've done.

But we believe in order to set up the right team for success, the additional operating expenses that we have, the things that go along that are non-cash in this amortization and inventory step up, it does hit that, we tried to break that out.

Having a million dollars of operating loss, we try to spell out – well, there was $1.5 million or $2 million of this amortization and things like that. So no, it's not our plan, but it does take time to get through some of these things as we look at being acquisitive and bringing some of these things onboard. .

Right, right. So you've had – again as an investor I noticed a lot of what looked to be fairly expensive new hires and promotions in the quarter.

And I'm just curious, are you fairly – are you pretty much done with that for a while now or have you got who you need to go forward now?.

Yeah, I would say some of those things we had laid out over the last two strategy sessions in the team to fill, and some of these things come along with – when they come along, you kind of jump on them a little bit.

You know we talked about Bill Van Anglen, In Human Resources, someone that I met years ago you know when he was at MACOM and Fidelity and then Bhaskar, most recently someone I met during the May contracts. So these are folks that you know a high talent that you bring onboard. But yes, I believe this team is filled up.

I tried to make reference to that when I talked about looking around the room going in such short period of time, filling seats that we needed to fill folks that not where we've been, not where we are, but where we're going.

And I believe with some of the additions that you heard me announce over the last couple of months, are critical positions are where we're going. But yes, I would say I have the team right now. We have the team together to go forward on this. .

Okay, that's good to hear. I guess another question around this big infrastructure bill, that's I guess just about to be signed.

I was wondering what was going – are you doing anything obviously, are you doing anything with integration partners to kind of get into the government business and kind of get positioned with them or are we waiting to see a good sign first?.

No, no, no. We've been working on this for a year. We have lobby firms up there. We have folks up there, and I'll let Brian, because he is knee deep in this infrastructure. He's our infrastructure bill expert here. So I'll let him talk a little bit about some of the places that we're….

Yes, so we work through several associations within the kind of the Capital Hill side of things in terms of lobby and industry organizations to ensure that our message is getting put in front of policy makers. We've been actively doing that, as it relates to this bill to make sure that the infrastructure, even the terminology is used.

The terminology we like is smart infrastructure.

And so we've been working really hard on that, and there are a number of areas that we’ll – as the content of the bill are becoming more clear, there are half dozen areas in there that should result in business for Luna at some point down the road and in order to do that, you mentioned working with integration partners and that's another element of how we're working this.

It’s making sure that we stay in touch with the prime contractors that will actually win the major parts of this funding and that we would step in as the supplier to them for the smart sensing technology ..

Great.

Do you think there any language around smart sensing that's going to be in the bill already or is it just going to be about smart interest?.

Well, yes. So we have actually seen that. You know in the roads and bridge side of things, it calls for the secretary transportation to consider innovative technologies, so that's just short of smart sensing. But that language means you need to go high-tech, which plays to our strength.

There's development of leak detection technology for the drinking and wastewater infrastructure.

There is modernization of our natural gas pipelines, which is also something that is a pretty significant part of our sensing business pipeline monitoring and there's a lot of money for high speed Internet and broadband deployment to rural areas, which also specifically calls out optical fiber to be put in ubiquitously, which then we can tap into to make smart grid, smart city type solutions.

So there's quite a bit in it already, but as it goes to the house, there's still time for us to try to work with our partners to impact to make sure the language is even better. .

That's great.

When do you think the funds would start flowing in your direction, say it gets passed in the next couple weeks? It’s going to be years or is it going to be sooner?.

No, no, I think we'd start seeing the effect of it next year. I don't think – no one's waiting around.

Once this gets inked and fully approved probably later in the year by the house and whatever form it takes, I think it will take a few months to start flowing out the private industry, but you should start seeing at least some impact after that at some point next year. .

Yeah, we've dedicated a lot of time to make sure they know who Luna is and pointing out the things that you're putting out there. We're all over the world, we're already doing it, we're already doing it. There's no reason that we shouldn't be top of that list. .

Yeah. That sounds good to me. The final question I had was, I thought last quarter, you guys were talking about you were really close to some kind of electric vehicle battery deal a with manufacturer that you could name at that point.

It sounds like from your earlier comments, that that's kind of fading or not going anywhere or hasn't happened or can you just talk about that again?.

No, actually just….

Yeah, it’s going very well. But as I mentioned previously, there's a process for qualification, and we're going through the process. As I said, we work with at least a half dozen customers in this space to get our technology into helping them improve the decisions see of these systems. And no, it's going well. .

Okay.

Was that terahertz or was that..?.

We mentioned specifically the use of our terahertz system, yeah, so that's one of the products in the mix. And we are using our ODiSI fiber optic sensing product as well for temperature mapping within sci electric batteries. .

Okay, alright. Thanks guys. .

Alright. Thanks Mike. .

And your next question comes from the line of Mark Morris of Private Investors. Sir, your line is open. .

Hello, sirs!.

Hello!.

I have a few quick questions here, just to check on some of the things that you might be looking into or may not be looking into. If you've mentioned them or I haven't heard of them, that's fine.

Just let me know, but safer like the trucking industry, say for like the flatbed bed trailers they are used to haul a lot of things around for infrastructure. Are there anything in the works or trailer weight, whether they're being bored, etc.? And somewhat along in that line since there's a lot more say Class A campers out there.

Is there anything that we're for seeing if they're overloaded this way or that way? I'm just asking some ideas here..

Yes. No, they are all good ideas..

The other one is like the water mains and even the sewer lines. .

Yeah. That's been addressed in some of the infrastructure bill itself. Brian gave us ...

Yeah, we work with state DOTs on and we're working with several right now on some new traffic flow monitoring concepts, so it's a smaller part. If you look at the markets we are in, this one is emerging, it's still relatively small revenue wise.

But yes, we're combining several of our sensing products get to fiber optics and to monitor traffic flow and do axle counting and weigh motion type solutions and that would go for all the types of vehicles you mentioned. So that's actually an active part of business development for us and the infrastructure build should accelerate some of that.

And on the water side of things, as I mentioned, some of the contents that the bill that came out of the senate did include modernization of our drinking and wastewater infrastructure. So we have a leak detection technology that can potentially help with that. .

And then another one that I had a question on was what about like farm irrigation equipment? Because I know that stuff blows in the wind and farmers do lose X amount over that product. .

Yeah, it's an interesting idea. We're going to have to look into that one. We haven't done that one yet..

And then how about anything with space industry, that's happening now for landing barges or anything like that type of item?.

Yeah, we have a couple of press releases we've done recently about different technology we've developed for a couple of different application, space based type applications, both in Luna Labs and our Lightwave business.

We'll have those press releases available on our, they are available on our website and we can have someone send them over if you're interested and have a look. .

And then how about like for just consumer ships, yachts, larger boats, things like that. .

Yeah, we do home monitoring for large boats, for wave slap and those sorts of things. Again, not a big application, but we do have sales every year for home monitoring systems for boats. .

Now, going forward where I know you said that you with those stuff going on and not traveling as much. Do you have any type of say small samples that you can send out and do some virtual meetings to help aggregate the sales maybe a little faster or….

Yes.

So that's how we've had to – everybody’s had to adjust how they do manage their sales efforts and yes, we're more in person and back to kind of traveling to see people these days, but over the course of the last 15 to 18 months, we've had to adjust to doing a lot more Zoom type meetings and sending samples and convincing people that they want and/or need our technology a little bit of a different way and it’s been very success.

.

And North America, within North America; Europe within, Europe, we're traveling. It's just we haven't done really any international right now, even though the U.K. opened up just a little while ago, a couple of weeks ago I guess, but we just haven't, we've been kind of swamped and haven't been able to schedule that. But we do plan and opening that up.

We just want to be – we want to be safe about it. We've waited this long, we don't want to jump through that, but we are continuing to do that, use the virtual ways to kind of sell this and go from there..

Well, I was just going to say, I want to check on like the farm irrigating equipment possibly and any military ships that you might be involved with as well. .

Yes, yeah for sure. Okay, great..

I think it’s covered. Thank you Sir. .

Yeah, thank you. I appreciate it. Thanks Mark..

And your next question comes from the line of. Sir, your line is open. .

Thank you very much and thank you for taking my question. And also thank you for continuing to grow Luna and growing the revenue. I think that's a key point that you brought out today, the revenue is up drastically up and that's great. You spoke about having strategy meetings for near, mid and long term.

Can you give us a couple of examples of what you're looking at in the mid to long term?.

Sure. I mean, I think when we talk about infrastructure, you see what's going on out there. We think there's limitless opportunities in using this fiber as the sensor itself.

I think infrastructure and you're talking about perimeter security and bridges and tunnels and dams and I think, I believe I forget who it was, maybe Barry who asked the question about the building down in Miami, and you – and certainly we are trying to educate everyone.

We've had meetings, like I said with insurance companies, with the municipalities, with developers. The cost to make these buildings and structures smart is just not overwhelming to the overall cost of the unit.

We've talked about our partnership with Meggitt and getting fiber on these planes and being able to sense heat detection and fire suppression, all those kind of things. Those are our medium and long term kind of opportunities, I have mentioned before. You know a $100 million of our company is selling twosies, threesomes of these things in many cases.

And I think the big growth story with Luna will come and we continue to get more of these orders like we did at Lockheed Martin, a 100 plus units, when we sell ten of them 10 of them, 20, 50, 100, that's the big thing.

Getting specked in say with Airbus for example, getting specked into the A320 neo aircraft and being on every plane that aircraft, that airbus makes, that's the long term opportunity, getting involved in these infrastructure kind of projects. That's the long term big play here.

It's really getting out there and having people see what the use of, what you can do is something that is nearly weightless, thinner than a human hair and non-conductive, and what we can do with that fiber and the information we can get. Nothing like that should ever happen in Florida again.

If we can just get the fiber out there in these structures, and that's about us getting out there and being knowledgeable. .

Thank you very much. Just one follow-up.

Do you also look at it the mid to long or near future acquisitions, is that also on the strategy?.

Sure, of course. I mean I think I said on the previous call or one of the meetings. We reached out to OptaSense, we reached out Kinetic three years ago and said we were interested in talking about OptaSense, and they just weren't interested.

But we stayed in contact with them, so when it came time, it came time to shop OptaSense, we were certainly on their list to call and say, “hey, I think I know someone that might be interested” and they called us and said, “hey, you called a couple of years ago, are you still interested?” And we were.

So I think yes, we're looking at things that are now, the small kind of add-ons like New Ridge Technologies and the bigger transactions like OptaSense. I think you can continue to see us look and be acquisitive on short, medium and long term. .

Sir, thank you very much. .

Thank you..

And your next question comes from the line of Charles Mills a Private Investors. Sir, your line is open. .

Hey, guys. Thanks, for another buying opportunity here. Seriously, I think it’s great. Brian, you didn't think I'd let you of the hotspot. I see that we have sites really getting informative.

There's couple of things like, that barrier you have the can spray for surgery, that would be neat if you would give exactly how it works and maybe what all FBGs can do, whether you monitor carbon dioxide, carbon monoxide, and we just want to take this time to say, I'm an API following and I've been doing cart wheels over what you all have been doing.

And I wish that all the API guys that I've used to contact, I have told them they should contact their state federal reps and tell them what all you're doing. So I think we're the best lobbiest as people that are contacting their own representatives. .

No, I agree with that. And Chuck, we have James Garrett sitting here with us. I think what – that might be best to do a follow-up. I know James would love to have kind of the principal investigator that wrote that contract and is knee deep in that follow-up and get with you. I think that would be a good opportunity to kind of talk about that.

We have a lot of those opportunities that sit in James’s group, kind of in that R&D have been funded on say Phase I, Phase II follow on. It’s had a couple of million dollars of federal funding behind it, so – and I know you have good contacts with some of the state folks there.

That would be a good contact if you're willing to kind of have that conversation with us. .

Oh yeah! I love Luna. That’s - it's fantastic. Back with, I was talking to Rob Risser and Steve Reece in back early 2000s. They had done this study with ABBA Laboratories where with the T-rays they could scan a pre-packaged pharmaceutical and give 100% accuracy of its contents, so that's really why I got invested in API.

It was man, that – if they could get the pharmacy procured, that would be huge and so I hope you all. I don't know anybody in the pharmacy or I'd be hitting them hard. But if that's still – I was wanting to get Steve on here though, get him in the hotseat. I think that's another wonderful….

I was just texting with Steve the other day. So we are still in contact. He's still very interested in Luna and so we have some ideas. So you never know where we go. Steve is always a scientist, and he's not willing the let it go. So we bounced some things off him recently, so. .

That was great. Well I guess that's about all. Thanks. Things are looking great. .

Alright, great. Thanks Chuck..

Thanks Chuck. .

. I’m showing no further questions. I'm sorry, we have another one here on the queue of a follow-up question from Michael Haymaker a Private Investors. Please go ahead, sir. .

Yeah, thank you. Hey, you triggered a thought when you were talking about the infrastructure.

Is there a retrofit opportunity for the products you sell or does it all have to go into new construction, new builds?.

No, absolutely. Yeah, a lot of the bridges, tunnels, dams that we do out there. This big order that we did down in South America, that's an existing dam. We're on that, putting fiber on that existing dam and we do it a lot on existing bridges and tunnels, all the infrastructure.

So big, big, big time opportunity on retroing, right Brian?.

Yes, it's not that new. I mean, if it's new, we can embed it inside the concrete or inside the composite, but yes, it’s certainly an opportunity to retro. .

Okay. I wonder if the infrastructure bill is going to talk about retrofitting new technologies to oil structures or if it’s all just about building new. .

No, no, no, no. There's a lot of the dollars in roads, bridges portion. We’ll be allocated to improving aging infrastructure. That's a big part of this bill. .

Okay, great. Thanks. .

I'm showing no further question at this time. I would now like to turn the conference back to Mr. Scott Graeff. Please go ahead, sir..

Well, thank you everyone for joining us today. I know I spent a lot of time about getting the right team in place for the many opportunities in front of us. But as you've heard me say before, culture is critical.

The numbers are always going to be important, but so is making investments to ensure we have the right people, platforms and processes in place. Feel free to reach out to Gene, Allison and myself, anyone with any questions that you have, and I look forward to speaking tomorrow with some of you at the Oppenheimer Conference.

Thanks for your time and interest in Luna Innovations and now Leah, I'll turn it back to you for wrap up. .

Thank you, sir. And this concludes today's conference call. Thank you all for your participation. Have a wonderful day! You may all disconnect..