Good day. My name is Jordan and I'll be your conference operator today. At this time, I would like to welcome everyone to the Q2 2023 Luna Innovations Incorporated Earnings Conference Call. [Operator Instructions]. Thank you. Allison Woody, Senior Director of Administration. You may being your conference..

Good afternoon and thank you for joining us today. This afternoon after market closed we issued our Q2 2023 earnings press release. As always, you can find the release and supplemental presentation posted to the Investor Relations section of our website.

If you do not have a copy of the release or the supplemental materials, please check our website at lunainc.com. We will also post a replay of this call to our website. Some of our comments and discussions today are based on non-GAAP measures. These adjusted numbers exclude the effect of certain non-cash expenses and other items.

The adjusted results are a supplement to the GAAP financial segments. Luna believes the presentation and exclusion of these items is useful to focus on what we deem to be a more reliable indicator of ongoing operating performance.

Before we proceed with our presentation today, let us remind you that statements made on this conference call, as well as in our public filings, releases and websites, which are not historical facts, 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 for the ongoing prospects of the company.

Actual results may differ materially as a result of a variety of factors. More complete information regarding forward-looking statements, risks and uncertainties is available in the company's SEC filings, which can be found on the SEC website and our website.

We disclaim any obligation to update any such factors or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or developments, except as required by law.

After our prepared remarks, Scott Graeff, our President and Chief Executive Officer; Gene Nestro, our Chief Financial Officer; and Brian Soller, our Chief Technology Officer, will be available to take your questions. And at this time, I'd like to turn the call over to Scott..

Good afternoon, everyone, and thank you for joining us today. It's great to be back together after seeing so many of you at our May Investor Day in New York. I look forward to sharing with you some of the progress we've made since then and some of the dynamics we're seeing in the market.

Importantly, my team and I continue to see an abundance of opportunities for our technology, and as the largest player in fiber optic Sensing, we believe we're well positioned to capture those prospects.

As you know, if you attended our Investor Day, we entered this year as a pure play fiber optics company after five years of execution against our strategy, to focus on our core capabilities. And as we began the second quarter of 2023, we lapped the sale of Luna Labs and the acquisition of LIOS.

Therefore, any growth we talk about going forward is organic growth. We made good progress this quarter on many fronts, and if I had to highlight one in particular, it would be that we got much closer to and made major progress in several of our top strategic accounts.

We had some incredibly productive discussions with customers, both existing and new, and some of those discussions led to agreements that have been quarters, if not years, in the making. Our Sensing business, of which a large component is those project-based solutions, grew incredibly well.

I will highlight some of our achievements in this business in just a moment. In Comms Test, we saw pressure consistent with what we are seeing in some macro trends. As a reminder, this business is more product-based and more subject to slowdowns in discretionary spend.

Inflation has slowed purchasing and some of the projects that we expected to move into procurement phase this quarter are moving more slowly than we anticipated. We are hearing consistently that many of our peers, as well as technology companies more broadly, are experiencing similar dynamics.

Despite some of the current market forces, we continue to have confidence, which is supported by a strong sales pipeline and order intake as we entered the third quarter. You may have seen in last week's press release that we continue to secure large multi-unit follow-on orders.

We are laser focused on the service and expansion of our strategic accounts across geographies, and we continue to leverage our lead position in our primary markets. As many of you know, our last two acquisitions, both of which are significant businesses, are located in Europe.

As we’ve continued to refine our integration of these assets to ensure efficiency and to expand our growth opportunities, we recently named a Managing Director for our Europe, Middle East and Africa region.

With an expanded European footprint, significant international presence, and more than a third of our employees outside the U.S., it was clear that we needed to put in place a leader who could help us fully integrate our European locations and drive efficiencies leading to profitable growth in our European business.

Thomas Oldemeyer is an industry veteran, coming to us with more than 30 years of experience. Prior to our acquisition of LIOS, he spent nearly 12 years as their CEO, engaged in the development, production, and global sales of fiber optic distributed temperature sensors.

Having someone with deep history and broad experience in technical environments, joining the team will be an incredible asset to our EMEA operations and the company as a whole. Thomas's appointment in EMEA is an example of the types of investments that Luna will continue to make in order to support our growth.

We've spoken frequently about our need to invest in scalable platforms, processes, and people, in order to capture the opportunities we see. For those of you who have followed Luna for some time, you will remember that we've periodically had pressure on margins and earnings due to investments in the areas like engineering and sales.

Our highest priority is to continue to build value for the long term, and we know that we will need to tolerate some lumpiness as we make the necessary investments. We have a very clear long-term vision and are focused on investments that will drive long-term growth and profitability.

As you look at our balance sheet, you probably see some of that lumpiness reflected in our inventory numbers for the quarter.

The higher inventory levels resulted from our making strategic purchases, to ensure that we are able to service new accounts as soon as they come through the door, while also provisioning for next-gen platforms for several of our product lines.

In addition, in some areas we continue to deal with the supply chain lag that began with the onset of COVID. Let's turn now to some of the specifics of Q2, 2023, including financial performance and a few business highlights. After that, I'll turn the call over to Gene.

For the second quarter of 2023, we recorded total revenues of $29.2 million, an increase of 11% compared to the prior year period. Our gross margin was 58%. Adjusted EBITDA was $2.7 million for the quarter versus $1.2 million in the prior year quarter. Our adjusted earnings per share was $0.04 for the three months ended June 30.

Now, let me share some specifics about each of our businesses. Our Sensing vertical had a very strong quarter, realizing 21% year-over-year growth. The growth was driven primarily by strong performance in our distributed Sensing products, which we often refer to as our project-based business.

Product lines in those project-based businesses grew in the strong double digits, realizing 43% year-over-year growth, which was driven by significant commercial progress in a number of different areas, including multiple large wins in our staple markets of pipeline and perimeter monitoring, and significant wins in emerging applications such as power cables, industrial battery storage, and mining.

For example, with power cables, we secured a nearly $2 million project for a monitoring system combining our DAS and DTS products, an industry-leading software for the largest power utility in Italy. In the mining market, we won initial contracts in Q2 for the fire detection and conveyor belt monitoring with a partner in South Africa.

This is an emerging market that we are investing in to grow. Shifting focus to our Terahertz business, I'm pleased to note that in Q2 we experienced triple-digit revenue growth and record bookings. Not surprisingly, the automotive EV market continues to be the largest driver for this business.

We were fortunate to secure a large follow-on multi-unit order in the EV battery market from our largest customer for this product line. And Q2 was our first full quarter of production on the redesigned Terahertz systems after successful transfer of production to our Atlanta facility.

Revenue in our Communications Test vertical was down 4% year-over-year. As a reminder, revenue in this segment includes test instruments for telecommunications, control modules for a variety of photonic applications, and laser sources. Some of these areas were stronger than others, and we believe that any slowness was due to macroeconomic factors.

On the positive side, revenue for our RIO offerings grew at a healthy 22%, with satellite communications and LiDAR applications continuing to drive growth. Module revenues were down in Q2 compared to the prior year after growing at a healthy rate in recent quarters.

Timing factors, including near-term pressure on discretionary spending and inflated inventories at several large customers impacted revenue realization for the quarter. We are encouraged by the fact that order intake has been strong.

We had multiple key wins in this area, including a seven-figure blanket order for polarization modules from a major data center hyperscaler, and significant OEM wins for new customers in multiple key growth segments, including defense systems, quantum computing and medical applications.

We did experience some spending delays for our higher-end test equipment, especially from several of our larger government and defense customers, resulting in the flattish performance in Q2. We believe this is related to postponements in program spending rather than reductions.

We continue to have very positive conversations with customers, but I will share that many of those conversations span a longer period of time. Because we are now selling more comprehensive solutions and driving larger multiple unit orders, we have seen longer sales cycles as we've previously discussed.

But once we get the order in the books, there is certainly real stickiness to it. I'm encouraged that sales pipelines are strengthening and the longer-term outlook remains strong, as we manage through some of the uncertainties we've faced that I've discussed. All-in-all, I want to express my optimism for Luna's future.

We are seeing greater than ever potential for uses of our technologies. We are aligned with macro trends in industries with vast market potential, and I firmly believe that the opportunities ahead of us are abundant. As we shared at our Investor Day, we've set the stage for meaningful expansion.

We remain confident in our strategic direction, and we remain focused on scalability and capturing market share. For Q3, we anticipate revenues in the range of $29 million to $32 million. And for the full year, our guidance remains total revenue of $125 million to $130 million, and adjusted EBITDA of $14 million to $18 million.

As you can see, we're reaffirming our annual guidance. However, the back half of the year, and particularly the fourth quarter, are dependent on the timing of revenue recognition from some of those larger project-based sales.

That, in combination with some of the overall market uncertainty, makes me more comfortable at the low end of our annual guidance range. While I'm not happy about the impact that recent market uncertainty has had on Luna, I want to express that on the whole, I'm proud of what we achieved this quarter.

We've proven to be a nimble enterprise as we've continued to build and refine the structure we need to drive the efficiency that will allow us to scale. We have identified unique opportunities to collaborate with our customers on grander scales, and to strengthen those partnerships.

We're generating great momentum on targeted development projects that we believe will lead to long-lasting, high-value relationships. We have a positive outlook for long-term growth, and we're moving purposefully to capture the opportunities that lie ahead of us.

With that overview, let me turn the call over to Gene for his commentary on the quarter's financials. .

Thank you, Scott, and good afternoon everyone. As you just heard from Scott, we continue to drive the Luna business, even as we experience some pressure in the sales cycles of some of our products. This was the reason for some of the buildup in inventory that you see on our balance sheet. More on the subject of inventory in a moment.

Let me start by providing some detail on our Q2 results. As a reminder, now that we have lapped the sale of Luna Labs and the acquisition of LIOS, all of our results are now on an organic basis. Revenue this quarter was $29.2 million, an increase of 11% year-over-year.

The increase was driven largely by performance in the Sensing business, specifically organic growth from OptaSense and LIOS. As Scott mentioned, we did see an impact from slowdowns in discretionary spend in our Comms Test business. Gross profit for the quarter increased 6% to $16.9 million.

Our gross margin was 58% for the three months ended June 30, 2023, compared to 61% for the three months ended June 30, 2022. Our gross profit increased in total due to the increased revenue from our Sensing business.

Our gross margin decreased because the Sensing business, which is primarily project-based, has lower gross margins than our products, so the net impact was an overall decrease in gross margin percentage. Operating expenses were $17.1 million, a decrease of 7%.

That's largely attributable to our continuous work to consolidate operations, operate on standardized processes and platforms, and drive efficiencies. As we focus on our One Luna philosophy, we are able to better leverage our support functions.

Operating loss was $214,000 for the three months ended June 30, compared to an operating loss of $2.5 million for the prior year period. We had a net loss of $1.6 million, compared to a loss of $2.4 million in the prior year period. Adjusted EBITDA for the quarter was $2.7 million, an increase of 131% over the prior year period.

We ended the quarter with $3.3 million of cash and cash equivalents, compared to $6 million at the end of 2022. Our working capital was $63.8 million at the end of the quarter, compared to $54.2 million at the end of 2022.

As I mentioned earlier, we are carrying a disproportionately large amount of inventory due to the lag on COVID-related supply issues, new product introductions, and the expected increase in Q3 and Q4 sales. The operations team is continuing to focus on inventory levels, lead times, and improved forecasting to drive overall inventory levels lower.

Our total debt outstanding is $30.7 million, as compared to the December 31, 2022 amount of $23.2 million. The increase is primarily due to tax payments related to the gain on the sale of Luna Labs and the increase in inventory to support second-half sales. Overall, we had a solid performance in the first half of the year.

I'm particularly proud of the work the teams have done on operating expenses, and we will continue to look for ways to be more efficient as we drive strong growth on the top line. With that, I will turn the call back over to Scott. .

Thank you, Gene. Now Brian, Gene, and I would be happy to take any questions that you may have. So Jordan, please open the call for Q&A. .

Thank you. [Operator Instructions]. Your first question comes from the line of Alex Henderson from Needham. Your line is live. .

Thanks. So, I just popped over from the VIAVI call and was listening to them talking about a gradual improvement in the Comms Test market.

They obviously went into the weakness in the Comms Test market a lot earlier, but they are now saying that with the current quarter and their pipeline that they are actually seeing some improvement in the willingness of service providers to spend on operational OpEx related Comms Tests.

How long do you think the weakness in that Comms Test that you're looking at, that started so much later, is likely to last? And do you think it's a short-term kind of thing, or do you think it takes two or three, four quarters to play out? Can you characterize the curve of that?.

Yes, sure. Well, I believe it's going to be shorter, but I'm going to let Brian answer because he was most recently out with a couple of these customers and getting a feel with that.

So Brian, do you want to?.

Yes. Hey, Alex. This is Brian. I think it's a shorter-term situation. And remember, for our Comms Test business, we segment that out, and the bigger customers in there are actually military defense customers, and that's where we saw more softness than in the general communications kind of market.

So yes, that's a good point to clarify, that within our Comms Test, the end market that was a little softer was actually government spending and defense in particular. And we actually see that likely to pick up here as the new government year starts later this year. .

The VIAVI comments on military and aero was that it was pretty strong with good visibility. Just to pass that along.

In terms of the back half of the year, can you characterize how you expect your spending to go? Do you anticipate given the strength of the back half, that you'll invest along with that growth or do you expect to provide more leverage, meaning more leverage on the OpEx lines?.

Yes. We certainly believe the second half will be able to leverage more. We have spent some of this up front. You saw it in the form of inventory and some other things. So we really believe, and we've been increasing that OpEx, but we believe that the OpEx has somewhat leveled off.

And we believe we should be able to get some leverage out of that in the second half of the year. So Gene, [Cross Talk]. .

Yes, I think the primary increase will probably be additional commissions on the higher sales of variable stuff with there. But yes, as Scott said, nothing, no material change to it. .

Great. Thanks. .

Thanks, Alex. .

Thank you. Your next question comes from the line of Dave Kang from B. Riley. .

Thank you. Good afternoon. My first question is regarding your outlook. So if I back out the first three quarters, you're implying fourth quarter revenue will be $40 million, about $40 million. It's a pretty big sequential uptake from third quarter.

What will drive that? Is that going to be mainly Sensing or do you, as Brian alluded earlier, that maybe Comms Test will contribute some sequential growth in the fourth quarter from the third quarter?.

Yes. No, it's a good point Dave. We look at – and if we look historically at Luna, anywhere between $42 million and $44 million, somewhere in that range, $42 million to $45 million, is what we see in revenue that comes in H1 versus H2.

So I don't – looking not necessarily at the number that needs to happen in Q4, although with the scalability that we've done, we know that we can do larger numbers. But when you kind of look at it that way, we spent a lot of time going through the second half funnel with the sales guys and things, and I will let Brian talk a little bit to that.

But a lot of big deals out there, a lot of sensing and multiple unit orders, things like that, that we see, teeing up in the second half of the year, I felt it was worth being a little bit more conservative here in Q3 to make sure that we get back and really look at the second half with giving a little bit of top line there in Q3. Brian. .

Yes, sure. Hey, Dave. The math there works out, I think you got it right. Q4, in order to achieve that, if you look at last year Q4 versus what we're forecasting here for the rest of the year, frankly both segments will get back into that growth mode. So we'll be in growth, both communications tests and from sensing.

And our visibility level is pretty high, because as we've evolved over the last year and a half or so, a lot of these orders tend to be on the larger side. We just announced a large order with an EV manufacturer that was in the mid-seven figures. That's scheduled for the back half of the year.

We tend to have a lot higher tick up in the defense business for our test equipment in the second half of the year, in particular in Q4 as the new government year starts, as I mentioned previously. So yes, really close. .

Yes, I think that's a fair point. There also is a lot of investment that goes in when – when you're able to convince and then bid and win a mid-seven figure deal that we just announced. It does take a lot of upfront investment to get that set, to see the harvesting of that in the second half, so we certainly anticipate that. .

Got it. And then just a couple of questions on Terahertz. I was looking at my note and I think you were supposed to expand Terahertz capacity by 4x during the quarter. Did you accomplish that? And then second question on Terahertz is that I think last quarter you were booked, fully booked for the rest of this year.

So with additional second quarter bookings, are you booked beyond this year?.

Yes, our goal was to get to – the ability to get to four and we have achieved that. Last year we were running – excuse me, last quarter, just to get caught up, three, three and a half. We'll probably continue to run in that range with the ability to go to four when needed.

And we have pulled deliveries in now, so we're booking in to the latter part of this year into Q4 with delivery dates. .

And some of – yes, some of those larger orders, multiple unit orders, have taken some of that backlog out as well, so. .

Got it. Thank you. .

Yes. Thanks, Dave. .

Your next question comes from the line of Chris Sakai from Singular Research. .

Yes, hi Scott, Gene and Brian. I'm in for Jim. .

Oh, great. .

Can you guys talk more about your significant wins for monitoring systems? Are these long-term contracts and what sort of impact on revenue will they have?.

Brian, do you want to talk about? We have quite a few that we're landing. .

Yes, so if you look at the wins in quarter, as we mentioned Chris, what we kind of look at the core business, which is pipelines and perimeters. We had multiple strong wins there. In the security side, an airport, several airports in Europe, residential property in South Florida, we landed several refineries, utility in Italy. .

Really, really excited about the step into the mining, the conveyor belt. .

Our first significant win in mining, which is an area that we view as a growth area. We did talk about the largest utility in Italy, which is a power cable monitoring. For the most part, these are multimillion-dollar wins that still have a positive impact on revenue, to answer your question.

They are for the most part in-year, scheduled in-year and they are a combination of hardware delivery, sensor cables and software. .

Okay. Okay, sounds good. And then are you seeing – I know you guys recently have had some news for the EV battery production monitoring.

Are you seeing a pickup there in demand as far as concurrently with demand for electric vehicles?.

Yes, absolutely. Yes, the demand there is really the main driver of demand behind our Terahertz solution. We talked about our win that we had in Q2, that was a very significant win. Similar to the types of larger wins, the strategy we put in place to go from selling one or two to selling 10, 20, 50-plus. A lot of development actually went into that.

That product had to be completely revamped to get into that application, in-line monitoring for the production of these batteries. So this is really our first major step here in Q2, along with getting the production up in Atlanta, and that is all driven by the global demand for EVs.

And we've got other customers that we're developing behind that one major customer we've talked about, and I think the outlook is pretty positive. .

Okay. Great. Sounds good. Thanks for your answers. .

Thanks, Chris. .

Thanks, Chris. .

Your next question comes from the line of Ruben Roy from Stifel. Your line is live. .

Thank you. Scott, Brian hi, and Gene. I joined a little late, so I apologize if you talked through this, but I wanted to touch on the EV win. Congrats on the order and getting Atlanta up and running.

Just thinking through the guidance for the year, reiteration of the guidance and the new order, and it sounds like you're expecting delivery through the remainder of this year. I would imagine that would be incremental to how you were thinking about full year guidance.

Is that correct? And if so, are there some other moving parts elsewhere? Are you being conservative on the guidance for the full year? If you could just walk me through how you're thinking about that, please. .

Yes, I don't see that as incremental. The way we step back and look at it, everything that is going to happen and for us in many cases, it's a timing thing. And just given, I'm interested to see the write-up and listening to what VIAVI was saying on the comms test side, that's interesting, but – given what we've seen.

But we step back and look at a lot of these bigger deals and we've always looked at annual guidance. That's what we used to just only give the annual guidance and we look at it and say, you got to be pretty damn certain on the bottom, and then you have opportunities to be the higher end of the range.

And we take it very seriously and go through it in detail to bottoms up look at these things. It just comes down to timing, and that's a matter of the way we look at it. So there's some – the things that are in-house, that we have orders in already, we're working on, and we factored into reaffirming that guidance.

There are some things that would take – that would move you around within that range, but that's kind of how we step back. I've always looked at guidance as what do I see in front of me now, to just try to be absolutely straightforward and transparent with what we see today, to give you what's out there and that's how we guide. .

That's helpful. I appreciate the detail, Scott. Maybe for Brian, you're obviously gaining traction in EV. It's an exciting space. Previously you had a win for temperature sensing, temperature monitoring, I guess.

What are the synergies like for that type of product, along with the Terahertz thickness sensing? Moving forward, do you expect kind of synergistic sales and kind of additional opportunities because of having a broader portfolio of testing products for that market?.

Yes, yes, for sure. Good question. A little bit probably hard to quantify at this point, but we are seeing activity levels increase organically.

But through partnerships between the sales teams that sell, cross-sell these different products, certainly we've seen new opportunities arise because of – for the temperature sensing, because of the EV work we've done, because it's exciting and it's pretty high profile within the company.

Now, that said, there's also internal synergies, because the platform strategy that we developed is driving commonality between all these platforms.

So we're not there yet on these two particular products, but they'll be using a lot of the same components, a lot of the same internals, the optics, the mechanicals, the kind of constitute all the products are all highly leverageable across these platforms, so we get some internal synergies as well. .

Excellent. Thank you. .

Thanks, Ruben. .

Thanks, Ruben. .

Your next question comes from the line of Tim Savageaux from Northland Capital Markets. Your line is live. .

Hi. Good afternoon.

Also coming in a bit late, but hopefully not repetitive here, but you've been talking a lot about some pretty significant wins in the quarter, mostly on the sensing side of the business, and I wonder if you have any commentary kind of at a higher level around bookings or backlog, book-to-bill, either – sounds like some of these are heading in Q3 as well, either for the June quarter or heading in December, what sort of trends we're seeing there? Thanks.

.

Yes, I think – and I'd have to – I looked at it, about north of one, about one, two maybe on the product side of the business. If you look at, some of the businesses, we are booking more than we're able to get out the door on some of those larger orders. It just carries in and that leads into can we get it out? Some of these are very large orders.

Does it spill into Q3, Q4, even into next year in some of these larger orders?.

Okay, great. I think you covered. I was going to ask if that 1.1 and 1.2 I assume was Q2, but you expect that to sustain in Q3, sounds like. .

Yes, I mean – some of that roll-up is, it could be that or even higher in Q3, in some of these things that we're looking at. You just -- they just don't move as easily as when you can ship a box out the door on the comms test side.

Some of it, when they come in and say that they want to place an order for larger numbers and things like that, many times it requires these upfront investments, because they don't come in and say, I love the OBR that you make today. I want to place 10 a month for the next 10 years.

They come in and go, can that OBR do something? And you have to work on it and invest and invest more in R&D to get to what we're doing. So I see the book-to-bill continuing to run pretty hot for us, because of those larger orders. Is that – I mean Brian, you tell me if that's fair. .

Yes, no, that's fair. Yes. And then we've got several larger blankets we're looking at for next year deliveries on things that we've talked about in the past, lasers in particular, that would drive that book-to-bill even higher. But again, it's the kind of thing hits this year and delivers next. But it drives visibility into ’24, so that's good. .

Right. And I guess that from a laser perspective you're looking at LiDAR as the end application. I did have a question on the commercial side if you will, the comms test business or the silicon photonics side.

Are you seeing any activity as a result of what the cloud guys or their suppliers are doing on the AI front?.

Yes, that's a good question. We've been digging a lot into that, that's a very rapidly evolving area. And one of the large orders we talked about in our narrative was with a cloud player, and we're digging into the nature of that we do believe is driven by AI build out.

As you know, it can be a little bit hard to determine what and where these things eventually are ending up in terms of their endpoint. But the level of activity on the commercial comms test side and the test stands that we're building into, the one in particular we talked about was a really nice seven figure win.

And it was one of the product lines that was down year-on-year for us revenue wise, but was really strong bookings wise, just because deliveries are in the latter part of the year, and we do believe that AI is playing a part in that. .

Great. Thanks very much. .

All right. .

Thanks, Tim. .

Your next question comes from the line of Paul Essi from William K. Woodruff. Your line is live. .

Thank you for taking my questions. A lot of my questions have been answered. I do have one. I know you mentioned in the sensing area, some of the wins. I mean, you've had these companies together now for a year.

Can you give us a sense for what you're seeing in the funnel that's building, that you've been able to put together? What areas do you see strength and any sense of when you expect these things to kind of break and everybody starts to jump in?.

Yes. Hey, Paul. Yes, so the funnel is robust, right, and so we talked at our Analyst Day about, numbers north of 200 million in terms of opportunities that we're chasing and those would be for the next year timeframe.

Energy, in particular, power cable monitoring, where we're combining the solutions from the two recent acquisitions is a big one and we've got visibility in that area into some significant wins. There's some work to do. There's work to do on the products. There's work to do on the customer development side.

But that's one area that's really growing, rapidly both domestically and in Europe. We talked about the power cable opportunity in Italy that we've recently won. Those are coming at a higher rate than they have even in the previous several quarters and they're coming at a higher dollar value. So but we're seeing good activity.

That segment was up north of 40% this quarter, and it's driven by not only that, but infrastructure has been strong. Pipelines have been strong. We mentioned some new applications like mining. We're working on product developments for the main products in that category.

The three main products that we use to service that category, or really four, that will result in new products between the end of this year and the beginning of next year that will allow us to really begin to harvest some of that at a faster rate. So, as I said, there's work to be done. But we're aimed in the right direction.

I believe we've got the right resource behind it. .

And how about the infrastructure builds? Some of these, I know you said you're starting to see a little bit of the funds starting to flow last quarter.

Is any pickup there, seeing any design work coming across?.

Yes. So the work there, I would categorize that as still pretty early days. There have been something like 2,800 projects let from that bill, over $100 billion in spending. But what we're learning is that most of that is for filling the cracks, so to speak. It's really making sure the damaged infrastructure is just fixed and working properly.

But we do have some work going on with a number of institutions across the country, still relatively low from a revenue standpoint, but we do expect to see a pickup. Timing-wise, we've always said hard to predict. Right now, probably looking at mid-late next year to see anything significant, but lots of activity.

Once they start, you know, they're five-year programs. So that, once they do get going, they should have a nice five-year tail to them that will generate business for us, kind of over that timeframe. .

Okay. Thank you. Another question.

Do you expect another follow-on order for the handheld for the F-35 this year?.

Yes. So that's, certainly we expect continued follow-on orders for that. We have a frame agreement in place for annual quantities. The outlook for this year is a little cloudy on that. It's one of the things that drives the uncertainty we talked about. So right now, we're looking at getting that into the aperture for this year.

But some of that government spending has been a little less predictable than it has in previous years. I think just driven by delays, programmatic delays, delays in getting equipment in the field. But so, whether or not we get that into this calendar year or not is still something we're working on, but it's a question of, when more than if. .

Okay. And my last question is, your manufacturing footprint, I think it's your – in your Investor Day, Jackie Kline talked about optimizing the East Coast and the Atlanta, the Atlanta facility in particular.

First question, have you seen any impact on gross margin because of that and can you quantify it? And then secondly, I know that the next step is to do the West Coast in Europe.

Where do you stand there? And in both cases, what type of impact do you expect to have on gross margin when all this is done?.

Well, some of that build out, can be a drag on the margin, right and so, we've seen a little bit of that. The majority of what you saw in the gross margin this quarter, I believe, was more product mix. But it would really be in the coming quarters where you'd start to see the tailwind on that and then going into next year. .

Yes. I think you know – and I think it's probably worth, you know, Gene commenting on that as well in the margins, Paul.

But, you know, Jackie, you remember at the Investor Day talked about these core competencies, and I think you have to be careful to make sure the core competencies grow at a rate that revenue is growing, to make sure that we don't get out ahead of ourselves on some of those things.

And that sometimes in moving something and you're creating redundancies until you get to the point where, you can kind of streamline that; can have short-term effects on margin. But I would think it would clean out. But Gene, why don't you give a little comment on gross margin going forward, right. .

Yes, right. You know, we said full year we thought we'd be around 60%. We still think that to the point that Brian made, as you're transitioning, there's a little bit of headwind there, but then you get the tailwinds later on. And so for the most part, they're through the move from Ann Arbor to Atlanta, that's up and running.

They're fully staffed, they're ready to go. And so we would see that coming up to the 60%. I think you would see most of the positive impact though later maybe in Q4 and then into early part of next year. .

Yes, I think, it was encouraging for us. All units that went off the dock in Q2, Terahertz related I'm talking about, all came out of Atlanta. That has been 100% in Atlanta. And don't underestimate what that takes. It seems trivial, but boy, it is not in moving production line from Michigan to Georgia. It was the right thing to do.

It just it takes twice as long as you think it was and a little bit more cost than we thought. But we really, feel really good about where we are. .

Last question on the subject.

Gene, what type of drag do you expect? Can you quantify the drag this year and maybe into next year with all these changes, including what may take place in Europe?.

Drag on the gross margin?.

Yes, yes. From like what Scott had said, there will be some disruptions. .

We had some of them in Q2. .

We had some of them - migration costs that you can see in our adjusted EBITDA schedule. We have that in there. Probably the bigger drag we will see is we didn't talk about it, but we are putting up – we are increasing our production capacity in our laser facility in California.

That is coming online here at the end of Q3 and into Q4, so there has been a slight little drag there, but I think when you look at our sales level, 1% is typically a couple hundred thousand, so I would say in that range, probably. .

Okay. Very good. That’s all I had. Thank you. .

All right. Thanks, Paul. .

Your next question comes from the line of Alex Henderson from Needham..

Thanks. So, it seems to me that you guys ought to be viable for the CHIPS Act, particularly given you have U.S. manufacturing.

Can you talk about whether you have any intention of getting any funding from that?.

We are looking into that. That is something that, I don't want to get out ahead of that, but yes, I think that is something that we agree with you. .

Then the second thing is, I wanted to understand a little bit more about the “seven-figure blanket order polarization.” First off, what is a blanket order? I'm not sure I know what that term implies. And then second, it's a little bit of a contrast to what we are hearing out of that segment.

A lot of people are seeing a lot of consolidation and slowdown in that business.

Is that a function of, tying into the AI, that that is something that you are getting now going into an environment where conditions are tightening?.

Yes, I will let Brian talk. A blanket order, the way we use the term blanket order, if someone comes in and says, ‘hey, I need 100 of these things over the next 18 months’ or something like that, that is a blanket. We obviously can't get 100 of them out in the current quarter, current month, maybe current half of the year.

So we look at it as a blanket order. They place the order. They are all the same. And we will pick off that and usually work with them on a delivery schedule. So that is what we are talking about when we say a seven-figure blanket order. They’ve come in.

We have used it before, like with Intuitive Surgical, when they have come in and said, I want to place a $14 million blanket order to get lasers over an 18-month period or something like that. .

I see. .

Yes, and that order in particular was for data center for testing with one of the larger players in that space. And yes, we do believe that it is driven by some AI build-out. .

So what exactly is the polarization module doing? Is it testing the contrast of light going down a fiber? Is this fiber testing that we are looking at?.

It is built into a test system that stress tests very high channel count stress testing of receivers, data center receivers, for polarization sensitivity, which can bring a whole line down, which it’s not catastrophic, but it is very expensive. .

Right.

CWDM, I assume?.

Yes. .

Great. Thanks. .

[Operator Instructions].Your next question comes from Chris Sakai from Singular Research.. Your line is live. .

Yes, just a follow-up on that blanket order. I wanted to get a sense of the timing on that.

Over what time frame could we expect that order?.

This is next quarter.

Yes, this is Q3, right?.

Yes. .

Yes. It just came in Q2. We couldn't get it out the door. .

Q3. .

Q3, Q4, maybe – into Q4. .

Okay. All right great. Sounds good. That was all I had to ask. .

No problem. Thanks, Chris. .

There are no further questions at this time. Mr. Scott Graeff, I turn the call back over to you. .

All right. Thanks, Jacob. I appreciate it. Thank you, everyone for joining us today. As always, we appreciate your time. And if you have any follow-up questions, I mean, feel free to reach out to any one of us. We'd be happy to address them. So with that, we'll end today's call. I appreciate it. .

This conference is now ended. You may disconnect..