Good day, and thank you for standing by. Welcome to the Q1 2022 Luna Innovations Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being record.

I would now like to hand the conference over to your speaker today, Allison Woody, Director of Administration. Please go ahead..

Thank you. Good morning, and thank you for joining us today. This morning, we issued our first quarter 2022 earnings press release. In addition, as usual, 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. 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, maybe 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; and Brian Soller, our Chief Operating Officer, will be available to take your questions. And at this time, I’d like to turn the call over to Scott..

Good morning, everyone, and thanks for taking the time to join our call. This first quarter was again, full of accomplishments for Luna, operationally and financially. I am incredibly proud of the team for delivering a solid start to 2022 with first quarter results coming in above our expectations.

This recent first quarter includes, puts and takes when compared to last year's Q1. Gene and I will review some of these in our remarks. And after we do, I hope you'll see that Luna's underlying operational performance is very strong. For Q1 2022, we reported total revenues up 7% and above the first quarter guidance range we provided on our Q4 call.

Gross margin expanded to 64% compared to 58% in Q1 2021. Gene will talk more about this in a moment. Adjusted EBITDA increased by $400,000 and adjusted EPS came in at $0.05, a full $0.02 higher than Q1 of last year. So let me provide a little color on the puts and takes I just mentioned. And what gives me confidence about Luna's future.

Then I'll provide an update on the business lines. First, recall that in December 2020, we closed on the acquisition of OptaSense with only two weeks left in that year.

At the time of the closing and as we said on our earnings calls, OptaSense exited 2020 with a large backlog because the revenue recognition from this business depends on delivery and installation of product.

With the virus raging in December 2020 and availability of vaccinations only beginning, OptaSense had been unable to deliver and install before year end.

As vaccines became available and the world opened up, OptaSense made significant progress in clearing out the backlog and getting deliveries made to customers during Q1 2021 before delta challenged deliveries again.

In addition, the OptaSense business was historically on a different fiscal year than Luna where Luna's Q1 was OptaSense’s Q4, and strongest quarter. These combined factors created an unusually high Q1 for OptaSense in 2021.

When the team and I sat down to review operations and budget for this year, we planned for this, knowing that the comparison of our Q1 2022 to last year's Q1 would be challenging. That is why I'm so pleased that the team drove solid top and bottom line growth this quarter.

A few additional reminders as context for Q1 2022 and comparisons against last year's corresponding quarter. First, the difficult comparison involving OptaSense that I just highlighted. Second, the impact of the investments that we've made and continue to make in order to be best positioned for future growth. More about this in a minute.

And third, the fact that LIOS, our most recent acquisition only contributed two weeks to the quarter based on the timing of the acquisition close. To underscore overall the performance of the business in Q1 and start to 2022 was very solid.

I want to speak for a moment to the investments we've been making as they are critical to our long-term success and how we think about and measure that progress. You heard me say on our Q4 call that 2021 was a year of blocking and tackling. We put into place many of the processes and systems that will allow us to scale well into the future.

I told you that we made these investments because as we look to the future, we seek significant opportunities for strong and rapid growth. And so these investments help to ensure that we are well positioned to capitalize on that growth and can scale appropriately.

On the Q4 call, I also mentioned that you should expect to see us continue to invest in our business as we progress through this year and into 2022. And we have done just that.

So when I look at the performance at the end of 2021, and in the beginning of 2022, we are extremely pleased and excited about the technologies, products, and talent that we've acquired. We are also pleased with the payoff we've seen from the organic internal investments about which you've heard us talk.

As a result of this, I'm not using operating leverage as a metric to measure our M&A because at this point, we are still investing in our future.

Instead, I'm looking at operating efficiency, how well is the organization performing overall and have the acquisitions integrated well into Luna's culture? Do we have the right people in place and do they have the right tools required to perform at the highest levels.

Is the sales force right sized? What is our backlog? Do we understand our customer's challenges? And are we addressing customer's needs while servicing them with excellence? As CEO, those are the questions that I want to make sure that we address.

Because if we get the operating efficiency right, then the operating leverage and increasing profitability will quickly follow. We have focused on this and are seeing the results. For example, divesting Luna Labs frees us up to grow and take on larger contracts and orders. Simply put, we are no longer constrained as a small business.

Since the limiters imposed on us as a government SBIR contractor are gone. So while the divestiture creates a bit of short-term top and bottom line gap, the freedom created has just begun to result in some larger orders and larger contracts. In coming quarters, you will see us build on the traction that we've already begun.

In addition, with respect to our pipeline and backlog across nearly all businesses, it was what our COO, Brian Soller characterized as a knockout quarter.

As an example, for our terahertz products, our order backlog is no longer the typical 14-week lead time, but instead we are booked through year end 2022, due to the rapid increase in demand for these products. This impressive accomplishment is a result of tremendous focus and execution by the team.

As we move forward, in addition to continuing the effort on selling Luna's terahertz capabilities, the team is also working on the significant expansion of manufacturing capacity, which is expected to increase fourfold within the next year. There are similar significant pipelines for several of our other product lines.

As you know, we've now acquired two organizations, LIOS and OptaSense, and have been working to fully integrate them.

I've been out meeting with the engineering and sales teams and Salvan Farooqui, our Senior Vice President and Head of Sales has been working nonstop to ensure that our sales forces are appropriately integrated, incentivized and highly motivated.

So that now beginning in 2022, we have been able to incorporate the technologies and products from what were previously three distinct companies into one compelling Luna offering. Let me illustrate what I mean.

The DAS, or distributed acoustic sensing system and expertise that we acquired with OptaSense combined with LIOS' leading temperature and strain sensing technology and Luna's own product and technology improvements creates an offering to the customer that is more compelling than ever before.

Luna is no longer only a test and measurement business that generates revenue by shipping boxes off the dock, relying mostly on turns in any given quarter with lower levels of backlog. We are now also selling systems and solutions, which are delivered over longer periods of time and are often repeat in nature and come in much larger dollar amounts.

For example, when a customer comes to us, Luna can now provide them with the hardware, install the software and run the data analytics. And we are now the biggest player in the distributed fiber sensing market. The work that we've done in M&A has filled out the breadth of Luna's capabilities and allowed us to bundle solutions.

This now allows us to do more strategic selling, which in turn supports stronger growth. It broadens our playing field relative to test and measurement, greatly expands the market for our products and results in strategic sales and customer stickiness.

Especially with the combination of LIOS and OptaSense, the hardware, software and data analytics that we provide creates long-term customer relationships. One example of how we are seeing this evolve just over the past 12 months is by looking at both percentage of repeat customers, as well as the size of our larger orders.

When we look at the size of our larger orders in dollars that has doubled over the past 12 months. So we are continuously focused on building out capacity thus my comments about investing for our future.

In sum, with all three of these leading entities now integrated, we are working with customers to do the installations as quickly as possible while continuously innovating our product offerings and fulfilling larger blanket orders.

The powerful combination capabilities from Luna plus OptaSense plus LIOS truly positions us as a world class leader in fiber optic sensing. Now I would like to briefly cover some highlights for the first quarter. For the first quarter of 2022, total revenues were up 7% to $22.5 million compared to the prior year's quarter.

In sensing, revenues overall were flat year-over-year, but given the dynamic in the first quarter comparison of OptaSense that I described earlier. If we exclude that business, revenues grew in the solid double digits.

In communications testing, revenues grew double digits compared to Q1 2021, driven by record sales for Luna's high-speed communications test instruments, the OVA and OVR.

Overall, commercial demand continues to be strong in both sensing and comms test segments and we are looking at a record backlog overall, as we exited Q1 driven by another quarter of book to bill of 1.2. And we delivered adjusted EBITDA of $1.7 million in Q1 2022, a $400,000 increase compared to the prior year quarter.

Adjusted EPS increased by $0.02 to $0.05 in Q1 2022 compared to last year's Q1. Gene will provide more financial details on the quarter, but before I turn it over to him, I want to highlight some exciting accomplishments and opportunities in our two business units, sensing and communications test.

As you've heard me mention before, we have a good number of significant customers in the aerospace, automotive EV, infrastructure and industrial process control industries. For our sensing business, Odyssey, Hyperion, Terahertz, OptaSense, and now LIOS products.

We made significant progress this quarter in a number of areas with customer orders and expanding existing accounts. I'll highlight a few of these. First, we quickly got our newest team members at LIOS, working globally with our legacy sales teams to identify opportunities to bring a combined solution to customers.

And I am happy to say this early work on identifying topline synergies is going very well for applications like power cable and pipeline monitoring. I am more confident than ever in our ability to take one plus one and make three with the addition of LIOS to our portfolio.

Second, you may remember us speaking about a very large customer order for our Phoenix lasers that we received in 2019. That order was on a four-year delivery schedule.

And I'm pleased to say that we have not only met that schedule, but are likely to complete these deliveries by the end of this calendar year about a year ahead of that original schedule. Stay tuned for some more news on this front in the coming weeks. Third, you will recall our multi-year partnership with Meggitt in regards to work with Airbus.

We are making good progress with that partnership and hope to be sharing an update with you sometime this summer. And fourth, our Terahertz products continue to rapidly penetrate industrial process control applications like the production of EV batteries.

In Q1, we continue to successfully penetrate this and several other fast-growing industrial applications. Switching to communications testing. You may have seen the release earlier this month, announcing that we secured an incremental multi-unit purchase order for OBR 6200.

The portable backscatter reflectometer through a continued strong relationship with Lockheed Martin. You will recall that Lockheed is using the OBR 6200 for sustainment of the F-35 airplanes. This demonstrates Luna's strong partnership with customers and the traction we've had at these leading products.

Shipments on this order will start in the second half of this quarter. Our Comms Test segment includes both instruments and control modules and OEM lasers. Sales of modules and lasers account for slightly more than half of all communications test business. And during Q1 2022, we saw growth with several larger strategic wins.

Notable wins include our orders fulfilled for Luna's tunable filters with RIO laser products for customers in medical, fiber sensing, aerospace and industrial markets, and for fast-growing applications, such as LiDAR in the case of the RIO laser.

And there are further growth opportunities for modules to be sold to customers in green energy, medical imaging, fiber optic gyros, as well as the space and satellite communication industries to name a few. There is one comment I want to make relating to supply chain.

We are still managing pandemic-caused delays in both our supply chain and that of our customers, particularly in availability of printed circuit assemblies. Delays are specifically caused by semiconductor part availability combined with increasing lead times and prices.

The Luna team is doing its best to manage through this, including where possible design changes to replace unavailable components and pre-ordering in larger quantities than we would have in the past.

So while there is significant demand from our customers for Luna products, we have felt and expect to continue to feel the effects from sourcing of semiconductor parts in order to complete customer orders. The industry consensus is that these shortages will continue through 2022.

We believe we have sufficient supply to fulfill customer orders for the near-term and are focused on managing this impact.

On a related note, Luna's new composition as a pure-play in fiber sensing and measurement combined with our relatively larger size as a result of recent M&A now allows us to evaluate and optimize our sourcing in a more strategic manner.

The team is working on aligning products in categories and evaluating vendors in order to best maximize our ability to source efficiently and cost effectively. We will expect that this will create a more scalable structure and help to identify and eliminate any bottleneck in our supply chain.

There is no question that the strategic moves we've made over the past 18 months already have had a positive impact on Luna. One of our key priorities will always be the prudent and thoughtful deployment of capital that hasn't changed, but right now, and for the near-term, we are very focused on the execution to grow our existing businesses.

Before I turn the call over to Gene, I just want to reiterate that based on the solid start to 2022, we are again, reaffirming the 2022 outlook that we provided on our Q4 call. As a reminder, that guidance for 2022 is total revenue of $109 million to $115 million and adjusted EBITDA of $10 million to $12 million.

In addition to help you our shareholders with understanding the new quarterly cadence for Luna, given the recent mix of acquisitions and divestitures, we are once again, providing quarterly topline guidance. For Q2 2022, we anticipate revenues in the range of $25 million to $27 million.

In summary, the year for Luna is off to a great start and we remain optimistic about 2022 and beyond. As always, I am grateful to the Luna team for their focus and hard work. And I continue to be confident that Luna has the right strategy and will continue to make significant progress against it as we progress through this year.

We continue to be sharply focused on our purpose to enable the future with fiber, and we will continue to make the changes necessary to capture the opportunities in front of us. I'll now hand the call over to Gene for more of the financial details on the quarter.

Gene?.

Thank you, Scott. Before I proceed, I want to highlight three topics. First, our reported numbers for Q1 2022 include two weeks of LIOS, our most recent acquisition. Second, we have fully lapped the acquisitions of OptaSense and New Ridge Technology. So the results for both companies are now included in organic results.

And third, and perhaps most importantly, I want to reiterate Scott's comments about operating efficiency. That's an important term efficiency. And what I mean when I say efficiency is that Luna will continue to invest in capabilities and talent to support our growth, while at the same time streamlining and right-sizing where appropriate.

For example, as our products move more frequently from the laboratory to the manufacturing floor in the field, we need to invest in modification of those products and the manner in which we are manufacturing them.

While we are constantly looking to remove redundancies and inefficiencies as we integrate our acquisitions, we are also identifying areas where investments are needed in order to sufficiently support future growth, both near and long-term.

Now that we are in this growth phase, we think about operating efficiency rather than leverage because we are investing in the right and key areas for Luna's future. With that is context, let's move on to reviewing this quarter's financials.

As Scott noted, our Q1 2022 revenues were $22.5 million compared to revenues of $21 million for Q1 2021, representing a 7% year-over-year increase. The increase is primarily due to revenue generated by our LIOS acquisition.

Gross profit increased to $14.3 million for the quarter compared to $12.3 million for the same quarter last year, representing a gross margin of 64% in Q1 2022 compared to 58% in Q1 2021. The improvement was primarily due to product mix for the quarter.

In Q1 2022, we had higher sales of higher margin products in both our sensing and test and measurement products relative to Q1 2021, which had a higher portion of project revenue. I want to note here that we do not anticipate a gross margin run rate in the mid-60s going forward, but rather in the high 50% range as we previously stated.

Operating expenses were $16.6 million in Q1 2022, as a result of the continued investments we've made and our making to prepare for our next stage of growth in efficient included in the $16.6 million is $700,000 of LIOS OpEx. $1.8 million of deal costs related to the acquisition of LIOS and $800,000 of amortization related to intangible assets.

We recognized an operating loss of $2.4 million in Q1 2022 compared to an operating loss of $1.6 million in Q1 last year. Net loss from continuing operations for Q1 2022 was $1.3 million. During the quarter, we recorded a $10.9 million gain on the sale of Luna Labs. Including this gain, net income for Q1 2022 was $9.6 million or $0.30 per share.

Adjusted EBITDA for Q1 2022 was $1.7 million, up $400,000 compared to Q1 2021. Correspondingly, adjusted EPS increased to $0.05 in Q1 2022 compared to $0.03 in the prior quarter. Income tax benefit for Q1 2022 was $1.1 million and was primarily impacted by stock compensation and the LIOS acquisition.

We estimate our 2022 effective tax rate to be in the 22% to 25% range. Let me now move on to the balance sheet. We ended the quarter with $10.8 million of cash and cash equivalents compared to $17.1 million at the end of 2021.

The decrease in cash is due to our acquisition of LIOS in March, which we funded with the proceeds from the sale of Luna Labs, existing cash and our revolver. Our working capital was $47.4 million at March 31, 2022 compared to $49.8 million at year-end 2021.

We have a debt facility comprised of two separate financing vehicles, a term facility and a revolver facility. At the end of Q1 2022, we had total debt outstanding of $22.3 million. Of that amount $7.3 million is in term debt and $15 million was drawn on our revolver.

As a result of the solid start to 2022 and based on what we see already for Q2, we are reaffirming the 2022 outlook that we originally provided on the Q4 2021 call. As a reminder that 2022 outlook is total revenue of $109 million to $115 million for the full-year 2022, adjusted EBITDA of $10 million to $12 million for the full-year 2022.

And as Scott mentioned, we are providing Q2 2022 revenues in the range of $25 million to $27 million. With that, I will turn the call back over to Scott to open it up for Q&A.

Scott?.

Thank you, Gene. At this time, I'd like to open the call for questions. Brian Soller, Chief Operating Officer with Gene and me at this time and available to address any questions that you may have. Tanya, please open the Q&A line..

And our first question comes from Barry Sine of Spartan Capital. Your line is open..

Hey. Yes, good morning. Good way to start the week. Couple of questions if you don't mind. First on LIOS, the acquisition, a number of questions to get us more acquainted with that.

If you could discuss the product line, maybe size it a little bit, what was their historic organic growth, the integration status, especially on the topline cross-selling between the sales forces and then what kind of long-term growth does this now present for the company as a whole?.

Yes. Hey, Barry. I'll start it off, and I'll let, Brian Soller, and Gene jump in as need be. LIOS was something a little bit different than say OptaSense, for example, it was a division pretty much under one roof there in Germany did not come with the big senior C-suite type titles that OptaSense came with. Those folks all stated NKT.

So that allowed us to immediately, I mean, out of the gate on the original the first all-hands meeting. We were able to identify right out of the gate with who the different folks reported to inside of Luna's organization.

So from an integration hub into our organizational structure was much cleaner than some of the other acquisitions because it didn't come with some of those bigger titles. So that's worked out really, really well. They've already been here, we've been there. So that's kind of hit the ground running.

We see those topline synergies that I mentioned earlier, right out of the gate. There were customers that they were kind of in a holding pattern on because they didn't have some of the expertise that we had vice-versa. There were some things that customers wanted temperature that we couldn't fulfil.

So we were immediately able to see some of those synergies right out of the gate. So we see this together, it's really blending into our European operations, OptaSense and LIOS are really running as one organization blended over there. And so continue to drive that.

Brian, if you want to talk about the product and how it's fitting in and some of those growth opportunities that you've seen while being over there..

Sure. Hey, good morning. The strategy we've been executing in terms of our distributed sensing products has been to add modalities and/or performance that really fill out our portfolio. So with LIOS, what we bring is a long range sensing system, world class in the market in measuring temperature, for instance, over very long ranges with fiber sensors.

We can also add with the acquisition distributed strain measurement capability over long ranges. So when combined with OptaSense products and Luna's legacy products, we really have the suite now nearly fully covered. There will always be areas we want to improve, but now we can really bring a fulsome solution to the market.

They've had a focus historically on infrastructure, tunnels, power cable monitoring, where Luna has not had those longer range solutions in house.

So we are marrying those now with our legacy and DAS solutions to bring a full-suite to the market, we’ve already identified as we've gotten our teams working dozens of opportunities that require both what Luna already had in terms of DAS and these LIOS products.

So we can actually combine them and even early days here out of the gate drive some early synergies through finding these low hanging fruit.

And historically, they've actually been running over the last several years in those growth rates mid-teens kind of growth rates and everybody's kind of had a little impact from COVID, so it doesn't necessarily account for the last 18 months, but we expect to get them back on a growth path that's similar to Luna's and we've seen – even in the early days here, as I've mentioned, we've seen the capability to do that..

So does that put Luna as a whole on a kind of mid-teens long-term growth capability?.

Yes. When we had the Luna Labs business with us, we believed we had a mid to upper teens growth business, Barry. And now with the divestiture of Luna Labs and the pickup of OptaSense and LIOS, we believe that is a high teens to low 20s, and that's organic, and that’s over the next 12, 24 months..

And obviously getting out of COVID and supply chain constraints?.

Certainly, and – we certainly are hedging ourselves on that especially from a guidance perspective, just being careful with that. But we do believe that what we're seeing and the book-to-bill and the amount of business certainly that is where we believe we should be..

Okay. My second question, you mentioned that you're not just shipping no longer just shipping boxes off the loading dock. You now have a services component to your revenue stream, so maybe more visibility on that because that presumably has higher margin potential. What exactly are you doing? Presumably those are recurring contracts.

What kind of margins do those carry and what percent of revenue is that today?.

Yes. Well, you've heard us talk about it for several years, about that we believed we needed to be in the pockets of our customers in providing them that service after the installation. And when we talked about this, we did kick off a program internally that was moving slowly.

But in the acquisition of OptaSense and LIOS, they had already been doing this. So it really kick-started across all of our products in moving to this, not only kind of the box sale, but the installation, the servicing, and the data analytics.

So it's still a small portion of our revenue right now, but it is a huge opportunity for us that will carry a larger margin for us. You've seen it this quarter, just like, we saw it, I think it was maybe Q3 last year, we pop in and we show a 62%, 64% gross margin. And then it goes down to 58%.

We believe overall, we're trying to guide to that upper-50s, low-60s is where we'll be average wise. It really does relate to that product mix. If we have quarter more a quarter that's bigger on having some service revenue, it does carry a higher revenue, I mean, higher margin. But it's a smaller portion right now.

I don’t not know, Brian, if you want to talk a little bit more about how it – these guys were well sophisticated in this position, and it's what excited us about these acquisitions that they already had the 24/7 monitoring in place..

Yes.

So just to add a little bit, maybe more detail of that Barry, if you look at the revenue mix for us and just look at this here, for instance, annualized, about $45 million, $50 million of that revenue is going to have a project flavor to it, which is to say that we'll deliver hardware, software, and service to a larger project, say a pipeline or a bridge, a tunnel, et cetera.

So of that $50 million, predominantly, still hardware and software, but you might see 15%, 20% of that actually service in terms of field installation and turn up. And what we're trying to do from a strategic perspective is to take that service element and make it purely recurring.

So as we stand today, that's not strictly speaking a recurring revenue element because it comes with the system in the project delivery. Once that's done, we go on to the next one, but we do have about 5% of our total revenue in kind of a purely recurring flavor today.

That is to say, after the project is done and as it lives on for years in the field, it produces revenue for Luna through service warranty, software, et cetera. And that's what we're looking to grow. So we're looking to take that 5% over the next couple years, make it 10% just as a starting point..

Okay. And then my last question, I think I heard you say that you're investing in increasing your manufacturing capability. I think you said 4x.

So where are you doing that? Are you knocking out walls? Can you do that in your existing footprint? And if I combine that with the comment you made on terahertz being sold out through year end, obviously, you'd want to take a look at increasing capacity there.

So can you give us a little more color on what you're doing manufacturing and also include the impact on capital spending as a result of that?.

Yes. Sure. If you remember, when we sold the Picometrix business to MACOM back in 2017, we held on to that terahertz piece of that business out in Ann Arbor and folks like Steve Williamson, who were key and instrumental, we just felt like it was being starved a little bit.

And so we invested some money into that because when we would talk to customers who were using the terahertz system, they were overwhelmed. They thought it was the greatest thing ever. And it just took some time to get some processes in place and to engineer out some things or the laser and do some things.

And sure enough, those investments are paying off in spades now. You heard me mention, we now are quoting delivery times, well, into Q1 of 2023 for the terahertz products, and that's not because we can't get parts, we can get all the parts in the world. The problem is capacity. So we have to increase capacity. So we're doing that.

We're building out additional facilities in our Atlanta facility to make the terahertz products to make the laser. So – and we were able to make about one of those a week in Q3, we'll make two of those a week. And in Q4 or into Q1 – early into Q1, we're going to make four of those a week.

We have all these processes set up, that our Senior Vice President of Operations, Jackie Kline has been all over setting up these processes, but that's the real expansion in being able to quadruple our output of these terahertz, we are seeing more business than we can handle right now.

And we see it continuing to grow once we've been able to get that product really out, get the right sales approach to it, the right marketing approach, put more engineers around it. So we're seeing that grow the really laser again, we're quoting many, many quarters out for the RIO laser.

There's a lot of opportunity there that we're expanding our facilities to be able to handle this and it's a good problem to have..

And does that include expansion in Virginia and then also the CapEx impact on manufacturing expansion?.

Yes. Barry, it's Gene. Yes, just to highlight a couple things that Scott said there, there's two major areas this year that are going to require more than our normal CapEx and that's building out not just our Terahertz product and moving that to Atlanta, but also our laser side. So normally we're about – we've been running about 1% of revenue.

So we would normally be about a million or so dollars this year. This year, we'll probably double that maybe even a little more, depending on the timing. And then going forward, we're modeling instead of the 1% to 1.5%, we're modeling more like a 2% going forward because we do see a lot of growth coming down in the pipeline..

Okay. Great. Those are my questions. Thank you, gentlemen..

Thanks, Barry..

And our next question comes from Alex Henderson of Needham. Your line is open..

Good morning, Alex..

Yes. Can you hear me? Yes, I guess my headset wasn't working properly. I headed off mute. But anyway, hi guys. So just following up on that last question, and I apologize for the speakerphone since the headset wasn't working properly.

But can you quantify the Terahertz, size of that business today just to help scale it for us?.

Yes. I mean, I think it's a still – it's a smaller portion of our overall revenue. If you look at where we guide it, I would say it's right in that 10% range or so a little bit less maybe, but growing kind of in that, call it, 8% to 10% of our overall business is the Terahertz.

But it's coming off of a small number and it – last two years, it's in essence doubled year-over-year..

Well, it sounds like if you're getting to four a week from one a week, that that's a pretty big increase in the 2023 revenue stream on a year-over-year basis. If I'm doing my math, right, that alone could give you double-digit increase in revenues..

Yes. I mean, I think if we continue to be – and again, like we've talked about before, and I tried to mention on the call here. Getting away from the onesie, twosies and being box stars into selling multiple units, getting specked in to a lot of these organizations is what's driving some of this.

I mean, these are no longer someone's placing an order for one unit. We're now getting orders for eight, 10 units. The Terahertz product sells in the mid-150 range or so. So getting an order for eight, 10 units is a meaningful order..

Just going back to the visibility on that, so that's a pretty big increase in capacity, you're sold out through year end. As you get into the first quarter of next year and I didn't realize this is starting to look out beyond a reasonable level of forward thought process.

But do you think you will have half a year plus of visibility to that business so that you can be confident that that production will be adequately utilized in 2023, 2024 timeframe?.

Yes. Hey Alex, it's Brian. We do – the nature of the customers that are the big customers that are filling the capacity are such that we have really strong visibility into where these systems are going, what they're being used for, why they're needed and how many that they need. So, yes, we have really nice visibility into that..

You talked about increasing your capacity on inventory by ordering more and purchasing commitments. Can you talk about the degree to which that inventory that you're bringing in is safe to stock? Let's hypothetically say we went into a recession globally.

Would you have any risk of carrying that inventory having obsolescence occur or is this stuff that is just so fungible that you're not at risk at all on that inventory carry?.

Yes. Our inventory is primarily electronic, boards and other electronic components. And so there's a couple things going on. To answer your question directly, we don't think so because we see – it's not like we're ordering two years worth, we're just ordering out a little further than we normally would.

But also Scott alluded to it in his comments, as we see this growth coming over the next couple of years, we're doing a lot on our procurement side of operations. And so we're putting in a more global view and working on combining our buys and working with some other vendors to utilize our buying power.

So there's a lot going on in the inventory right now. So I think you'll see – we're up a little bit on inventory right now, but we expect that to hold steady the inventory as our sales are increasing and we start to consolidate some of our commodity codes and things like that..

Just going back to EMEA, given the macro conditions there, can you talk about any exposure you think you might have to a meaningful slowdown in that economy?.

Yes. A lot of times remember the products that we're selling are kind of the next thing that people are doing. So it's for safety, it's for efficiency. And so certainly, we would – that could impact us, but a lot of these things, we don't really see having a huge impact.

And when you look at our overall sales and May is roughly around 20%, but we're not seeing that right now coming through the sales team, coming through our orders or coming through our backlog..

Just to be clear, you priced in dollars in EMEA?.

For the most part, it's a little bit – the LIOS business is more in the euro, but a lot of the OptaSense, again, when you're in the oil and gas industry, a lot of that is in the U.S. dollar..

So no currency impact from the double-digit decline in the euro currency versus the dollar?.

We have seen a little bit there. I think it maybe a couple hundred thousand, but nothing super significant at the moment..

Going back to the backlog for a second, then I'll see the floor. So the backlog, is that a function of supply chain causing delays in shipments or is that just simply you've got a very robust orders because you've got great products. I assume it's probably a mixture of it.

Could you talk a little bit about that record backlog and the 1.2 book to bill, the mix between change and duration versus real order growth?.

Yes. I'll answer the first part of that. It's not related to supply chain. It's more related to a really robust pipeline for orders..

So no duration issues there though, Gene I can't get the part and therefore I'm going to order further out..

We're not seeing any of that, Alex..

Perfect. Great. Okay. I'll see the floor. Thanks..

All right. Thanks Alex..

And our next question comes from Chris Sakai of Singular Research. Your line is open..

Hi, good morning..

Hey, Chris..

I had a question on the growth of the book-to-bill ratio.

You know what were the main drivers there, and how much do you expect that to grow with LIOS coming into full swing in the next quarter?.

Yes. I mean, I think we've mentioned before. Historically, Luna has run at a flat one book-to-bill.

As long as I can recall, certainly the last five years and really that has – obviously with COVID and some other things going on, it has crept up, but we're now seeing more of a 1.2 where a lot of demand for our business and just not able to get it necessarily off the dock with some larger orders shifting from just a box seller to solution seller and needing to get out into the field and things like that.

We do see that book-to-bill. LIOS brings that same kind of dynamic to it that OptaSense brought a solution type of sale where it requires – it's a bigger order and it requires getting out to install, not just getting the product off the dock, but actually getting out into the field and doing the installation and things like that.

So we do see that going up. Brian, if you want to talk a little bit about. We obviously track by business, by location, what our book-to-bill is, and it's larger in some areas and lower in others. So I don't know if you want to give a little more color on that. Brian, I know you have..

Yes, sure. The way our business runs in the seasonality actually tends to be a little lower book-to-bill in Q1, as we harvest the higher book to bills we have at the end of the year in Q4. But what you can see is a little bit of that shift in the business.

Scott was talking about here and that we're still for quarter one here in that 1.2 range, which means we're booking business for not only delivery in this quarter, but for the balance of the year. I think our exiting backlog for Q1 was in the $45 million, $46 million dollar range.

Certainly, there will be quarters where we try to harvest that and accelerate the actuation of that revenue.

But in general, as the business has shifted towards a larger portion being more of a project nature, you're just going to see more larger orders that will affect over a longer period of time versus the legacy business where we'd get an order in on any given day and typically had the capability to shift that out and recognize the revenue within a week.

And there's nothing wrong with either, they're both good, but it's the mix that's really driven the higher book-to-bill..

Okay, great.

And to go on the acquisition of LIOS, how is that being integrated? Are you seeing any extra costs in Q2 from that?.

Yes, like I said earlier, I mean, that was an immediate integration into Luna's organization. We had identified the four or five key business unit, heads there and rolled them right into to Luna's existing from a sales, marketing, engineering, operations perspective rolled immediately into our organization.

And our key leaders were on site the day that we announced it to all those folks. So that has done really, really well and moved a lot more quickly than some of our other acquisitions. Like I said, since they – it rolled in, it was so synergistic with our OptaSense business. It was critical to move quickly on that.

Brian, I don't know if you want to talk about.

We continue to still – when I say we're fully integrated, we're integrated from a structure perspective, there's still some things that need to be done from an IT perspective to make sure we get on all the same system from a finance perspective to get on the same systems, but this has moved very quickly in helping to identify immediate synergies.

You've heard me say before when we look at these acquisitions. I don't like using the word synergy to justify any purchase price, but obviously we all want synergies from a cost perspective and from a revenue perspective going forward. I just don't like them when people try to use them to justify a certain price, which we will not do.

So we do believe that there are cost synergies, and we do believe there are revenue synergies that we're seeing immediately..

Yes. The teams are fully integrated into our management structure, so all the functional elements in terms of sales, marketing, operations et cetera, engineering product development are all integrated within my team.

And we've got – we got everyone working together to go, as I mentioned, previously to go after those low hanging fruits, if you will, the synergies and we've identified right out of the gate within the first couple weeks, we've identified over a dozen opportunities where we can bring a combined solution, so that part's going really well.

We're operating under a TSA for a few more months to get the rest of the back office things fully connected inside Luna, that just takes some time in terms of the ERP systems and the finance systems, et cetera. But all in all, it's gone very smoothly. The ability to travel has certainly helped immensely in getting the teams working together.

And yes, I mean, I personally, and my whole team very excited about the addition of this team and these products to Luna..

Chris, it’s Gene. Yes, you'll see a couple hundred thousand over the course of Q2 and Q3 for a third party integration expense that we'll have, particularly around the IP side, we're using BDO digital. Again, they helped us with OptaSense.

And so there will be a little – some deal, some integration costs you'll see in Q2 and Q3, couple hundred thousand probably..

Okay. Great. Thanks for the answers..

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

Thank you. Good morning.

My first question is may have missed it, but did you give the mix between sensing versus comp test and which has a better pipeline?.

I don't know, did we give the mix? I don't know if we did – we did not give the mix, typically it's two-third sensing and one-third comms test, both pipelines, both backlogs are very strong.

With the acquisition of LIOS and then only represented a couple weeks, but with OptaSense, we certainly guide to sensing makes up about two-thirds of the revenue. And it was about 60%, 65%, 64% or so. So 65%, 35%, Dave is the mix between sensing to comms test, but both backlog on both businesses, both net market segments here are very, very strong..

Got it.

And regarding your 2022 revenue outlook, how much of LIOS are you expecting to contribute?.

Yes. We talked about that. When we announced the deal, I think, 2021, they did somewhere in the €12 million type of business. And from a guidance perspective, we've kind of run that flat in our guidance. But we believe that there is opportunity now that we've gotten into it.

We put together these numbers and came out with the annual guidance for Luna prior to really being able to bring them across the fence here and bring them in and they've spent. Their management team has been here spending several days in deep dives and things like that with all of Luna's management and down into our organization.

So we feel very, very strongly about the value add that they will have to our topline, and the synergies going forward with the other businesses that we have..

Got it. And then my last question is regarding supply chain.

I don't know if you talked about the impact on both revenues as well as on your margins?.

Yes. Hey, Dave. From a revenue perspective, what we're seeing is about 5% impact to the topline.

We were anticipating a little bit more at the margin line, frankly, maybe 50 basis points – 50 to 100 basis points, but what you saw in our results was that our combination of the team really getting on top of these issues and the mix being as strong as it was towards higher margin business.

Yes, it’s fair to say, no impact at the margin line in quarter one..

And we did in Q1 implement a price increase to help offset that did not see the full impact, I don't think here yet in Q1 because obviously we have purchase orders in the pipeline.

So again, a couple of things, mitigating it with the price increase also with pulling our purchasing, globally together and renegotiating some opportunities, we're actually hoping to keep our material costs flat if not see a little bit of a benefit as we get through the year, so….

Got it. Thank you..

All right. Thanks, Dave..

Our next question comes from. Your line is open..

Hello, Scott and group. The report of my death was an exaggeration by Mark Twain comes to mind. I see the stock is up tremendously pre-market and I chuckle when I remember Scott saying you can't go after every rabbit hole.

Back when I first went up to meet with Steve and Rob and Craig, , they told me about this habit lab study, where they can – with the terahertz determine with a 100% accuracy, the purity of pre-packaged pharmaceuticals.

And that just seemed like the way they check drugs one out of every thousand for human and every 10,000 per veterinarian that that would be a great thing, but that's just another rabbit hole I wanted you to know about. I get nervous talking to you guys, but I'm really happy with what you're doing.

The one question I sort of had with this money extra that seems like you have, I know you're having to do a lot of incentive stock incentives to keep scientists and find new ones. I was just wondering if you do have any plans in your buybacks while the stock is low to offset these incentives..

Yes. Well, thanks, Chuck. I appreciate it.

And I think, what you're seeing, and I know you've followed this for a long time and I think the hard work and dedication that was put in, all through the years by folks like Steve Williamson, who really is the inventor and brains behind a lot of this, what he did early on with guys, we have the Gregs that are out there that have done phenomenal work, the works that Rob supported for years, you can't underestimate the many hours that Irl Duling put into this.

It was – you had to be a believer in this and I'm telling you, boy, what we're seeing now is this is just taking off and becoming instrumental to the customers that we're working with. Some of the big, big companies out there, this is a critical piece to be measuring not just thickness, but density in real time on their production line.

So this really, really is paying off. In regards to stock buyback, believe me, we would love to do some of those things. We just – these things that we've done recently, these acquisitions that we've done, we chose to take the approach of funding those off of our own balance sheet.

So using cash plus any kind of divestiture that we could do and this all started back in 2017 when we divested Picometrix. And since then, and then Opta using that cash to redeploy in our space to reiterate this fiber optics, fiber is the future, enabling the future with fiber has been our north star, if you will.

So I don't – we're just not in a position right now. We're in a comfortable position with our balance sheet. We just don't believe that would be a good use of our cash right now to do that. From a lockdown perspective, look, these things have to happen.

We have to make sure the market is crazy out there with the phone calls that we all get in trying to entice us away and big companies are paying big incentives to make you hold, to walk away for what you're walking away from.

And so you have to firm up the foundation pieces, these things that, that we have, guys like Gene and Brian and Salvan, these are foundation blocks of the company, along with many, many others in the organization. We reach down deep in the organization to try to keep them seated and not return those calls. And we'll continue to do that.

We have to do that that's in the company's best interest and certainly in the shareholder's best interest to make sure that there is no cracks in the foundation. So we'll continue to do that. And then there'll be a time when it makes sense to, as you know, historically we have done stock buybacks repurchase, but now's not the time to do that.

We got to make sure that that foundation doesn't have one hairline crack in it. And that's my focus right now. .

Hey, Charles, it's Gene. I would tell you something you can get excited about today is with all these acquisitions and I know you've followed the company for a long time, where we're at today is we have the DAS technology, the DTS technology, and the classic Luna stress and strain technology.

And we believe we're the only company that has all of those. And so we have products today and IP today for all three of those. And then what we have are the engineers experts and all three of these through all the acquisitions.

We have the expertise in the engineering and on the manufacturing side to combine these and develop the solutions for customers in the future. So we have products and IP for today, and we have the people and the talent that we need for what's going to be coming down. So I would just pass that on to you..

Yes. I've enjoyed reading the bios of all of you guys, quite accomplished. I hope you had some fun too..

Yes. Let's get out of this pandemic and maybe we'll get back to fun.

But right now there's a lot of – and I think, again, setting that strategy was the best thing that we've done five years ago to be able to really stay the course through this and put the processes in place, look, I mean, we've done, what is it, five or six acquisitions and three divestitures over the last five years.

So we stay focused on what we're trying to do to make this a pure plan. I think we're there. So thank you..

Great. Thank you. Bye..

And I'm showing no further questions. I would now like to turn the conference back to Scott Graeff for closing remarks..

All right. Thank you, everyone for joining us today. With a great start to 2022 and the teams executing well, we are optimistic about this year and our long-term potential. We continue to believe that we are on the right side of a market shift in trends towards light-weighting and 5G. And we're seeing Luna's offerings helping to accelerate these trends.

So we will continue to invest in our business, ensuring we have the right leaders and that they are appropriately supported and empowered. With that, thank you for your attention on today's call. And I hope to see some of you next week in California at the B. Riley Conference. Feel free to reach out with any questions.

Tanya, that concludes this earnings call..

Thank you. Ladies and gentlemen, thank you for participating. You may now disconnect..