LUNA Luna Innovations

Allison Woody Director of Administration
Scott Graeff President & Chief Executive Officer
Gene Nestro Chief Financial Officer
Brian Soller Senior Vice President & General Manager-Lightwave Division
James Garrett Senior Vice President & General Manager of Technology Development
Barry Sine Spartan Capital Securities
Jim Marrone Singular Research
Dave Kang B. Riley
Tim Savageaux Northland Capital
Call transcript

Good afternoon Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2020 Luna Innovations, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Ms. Allison Woody, Director of Administration. Please go ahead, ma'am.

Allison Woody

Thank you, Mary. Good afternoon and thank you for joining us today. This afternoon, we issued our third quarter 2020 earnings press release.

In addition, we posted to the Investor Relations section of our website, a presentation with supplemental information for the quarter.

If you do not have a copy of the release or the supplemental materials, please check our website at

We will also post a replay of this call to our website.

Some of our comments and discussions today are based on non-GAAP measures, specifically adjusted EBITDA. These adjusted numbers exclude the effect of certain non-cash expenses and other items. The adjusted results are a supplement to the GAAP financial statements. Luna believes the presentation and exclusion of these items is useful in order to focus on what we deem to be a more reliable indicator of ongoing operating performance.

Before we proceed with our presentation today, let us remind you that statements made on this conference call, as well as in our public filings, releases and websites, which are not historical facts, may be forward-looking statements that involve risks and uncertainties and are subject to changes at any time, including, but not limited to, statements about our expectations regarding future operating results or the ongoing prospects of the company. Actual results may differ materially as a result of a variety of factors. More complete information regarding forward-looking statements, risks and uncertainties is available in the company's SEC filings, which can be found on the SEC website and our website. We disclaim any obligation to update any such factors or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or developments, except as required by law. After our prepared remarks, Scott Graeff, our President and Chief Executive Officer; Gene Nestro, our Chief Financial Officer; Brian Soller, Senior Vice President and General Manager of our Lightwave Division; and James Garrett, Senior Vice President and General Manager of our Luna Labs Division, will be available to take your questions. And at this time, I'd like to turn the call over to Scott.

Scott Graeff

Good afternoon, everyone. And thanks for taking the time to join our call. 2020 continues to be a remarkable and unexpected year. At this time last year, as we're getting ready to wrap up our 2019 fiscal year and we're finalizing the planning and budgeting for 2020. We never could have imagined how this year would unfold. I'm sure most of you relate to this sentiment. And yet here we are today, three quarters into an unprecedented fiscal year and a full two quarters into a devastating global pandemic. From the beginning we placed a priority on ensuring a constant flow of open and honest communication, as well as focusing on employee health, safety and well-being. These two things have been a critical part of supporting the collaboration and teamwork that has driven our success and as a result, Luna is announcing our best quarterly results ever. I am proud to be part of a team of talented and dedicated individuals who believe in and demonstrate Luna's values in all they do. The team has stayed laser focused on looking out for one another.

As they continue to serve our customers with the highest level of excellence, advancing Luna’s mission to enable the future with fiber. I can't say thank you enough to these committed individuals for choosing to be part of the Luna team.

We will share with you today our financial results for the quarter and provide an update on some of the projects and initiatives that represent the continued investment in our company. We're obviously mindful of the current environment and the speed with which it can change.

While we remain flexible, we just delivered the strongest quarter in our history, which helps to give us increased confidence in the potential of Luna’s future opportunities.

We continue to invest strategically in our business so that we can grow and scale significantly well into the future.

We have accomplished or currently implementing some of the following foundational ideas Items. Implementing our new cloud based NetSuite ERP. This system is replacing four legacy ERP’s and we're on track with this project. Implementing the platform providing critical tools and information to our sales teams throughout the enterprise. Hiring into key positions, both in operations and incorporate shared services, enhancing the employee experience through investing in significant upgrades, to several core systems that will allow better functionality for our employees.

For example, we change to different partners for payroll/ human capital management, 401-k record keeping and for expense reporting. Launching our first offering period in our employee stock purchase plan with a robust 59% enrollment and finally, hosting a celebratory 30th anniversary launch at all locations with gifts for the employees. I believe recognition and celebration are a critical part of maintaining our culture, and building enthusiasm about what we see as an incredibly bright future? As I detail the significant investments we're making, and the work we're doing, I hope you take away from this discussion that all of this investment has created a strong, contemporary, consistent and scalable foundation. This foundation will allow us to drive organic and acquisitive growth for the longer term without the need for additional investment in our core infrastructure and systems.

As we continue to do acquisitions, these modern global platforms will allow for much quicker and efficient integration of future transactions.

Now on to details about the third quarter.

Let's begin with recent accomplishments and our third quarter financial results.

For the third quarter, total revenues were up a robust 14% to about $21.1 million compared to the prior year's quarter. The Lightwave segment had an increase of 17% year over year to $15.4 million in total revenues. We expanded gross margin by 200 basis points, improved our operating income by almost 800,000 and delivered adjusted EBITDA of $4.3 million, up $1.4 million over last year.

Someone recently asked me how we have continued to deliver such strong results throughout this year in the face of everything going on. And I think there are a number of distinct factors that have helped us to drive this success.

First, we have a superior product portfolio with products that are needed by companies regardless of whether we're in the middle of something like a pandemic.

Second, the end markets into which we serve have been less affected by COVID, then have some other industries and the organizations in these markets still require our products.

Third, the key mega trends that support Luna’s growth continued to be relevant and strong fiber, 5g lightweighting and civil structure monitoring. Fourth, we have been successful in pivoting to the way we are selling and have successfully used virtual tools, such as webinars to sell.

Of course, it definitely helps it all companies are in the same situation. Fifth, from day one, we have taken this virus and the danger very seriously.

We have delegated the authority to our managers to decide based on the circumstances in their locations, when to work exclusively from home, and when to bring people into our offices and assembly facilities. We've put strict safety guidelines in place for in office work, including social distancing, mask wearing sanitation procedures, and staggered shifts when possible.

Finally, as I mentioned previously, open and frequent communication has been critical to our being able to operate safely, efficiently and successfully. And our ability to operate well is the result of the ultimate team effort and cooperation of every employee at Luna.

Now, let me discuss Lightwave in more detail. Revenues in our Lightwave division grew 17% in Q3 versus the same period last year. That growth was evenly split between our two segments in Lightwave with both sensing and coms test growing in double digits relative to last year.

Let's look at some of the accomplishments in these two segments starting with our sensing segment.

As a reminder, our sensing solutions focused on two areas.

First, our fiber sensing products, ODiSI and HYPERION, which focus on the integration of optical fiber sensors in and on advanced materials and structures. And second, our T-Ray products, which use terahertz waves to see through opaque materials to measure thickness for process control applications.

As I mentioned, total revenues in Q3 increased by double digits compared to the prior year. This growth was driven primarily by increased shipments of our ODiSI and HYPERION fiber optic sensing products. ODiSI is our short range high resolution solution that is used within the aerospace and automotive sectors to enable next generation designs using composite materials. There are many other applications for this product.

We are also enabling smarter designs in multiple industries and have seen growth driven by the adoption of ODiSI technology in geotechnical and energy related applications.

Our HYPERION product is longer range and is paired with sensors for applications, ranging from monitoring civil structures like bridges and dams, to enhancing the security of perimeters and the safety of offshore oil exploration and extraction. In Q3 deliveries in the latter category drove growth as we delivered over 20 HYPERION systems to customers. HYPERION is an integrated into industrial systems that monitor the structural health in part of the structure that is used to transfer oil in offshore operations.

We continue to make progress with sales of our terahertz products.

While results in Q3 were down slightly on a year over year basis, we continue to see strong indications of the potential for sustainable long term growth of our terahertz product, especially in the industrial process control space and we will keep you all informed as we see that potential manifest in increased sales.

Moving to our communications test vertical, remember that this is the business focuses on the ever growing need for more bandwidth and communications networks. Optical fiber is a key enabler in high speed communications. This ability runs the gamut from core telecommunications networks to data centric networks to enabling cloud computing and 5G Mobile networking.

Our products feed the need for speed and include the OBA or Optical Vector Analyzer, the OBR or Optical Backscatter Reflectometer, and a suite of polarization instruments and photonics controllers.

In addition, hopefully, you saw that we recently announced the acquisition of New Ridge Technologies, whose solutions are a perfect complement to our communications test and measurement portfolio. This acquisition is strategically very important to Luna, but it's very small and immaterial from a financial perspective. The transaction was very much in keeping with our strategy to look for tuck in technologies that helped us to advance our product roadmap. The integration of New Ridge products with Luna will help our customers enhance connectivity by developing faster communications networks to support everything from the 5G build out to the continued expansion of bandwidth inside data centers.

As we've discussed in the past, there are two main growth drivers in this segment.

The first is the integration of optical and electronic systems in silicon, generally known as silicon photonics. In Q3 orders from customers working in silicon photonics development, were strong.

The second main growth driver in this segment is the new portable version of our OBR product, the model 6200. We've spoken previously about orders of this new product that were delivered to Lockheed Martin in support of the F-35 program. Remember, that we initially developed this product for field support of the F-35 by making the 6200 portable with an easy to use green light red light touch screen. I am pleased to share that recently we have received confirmation from Lockheed of the need for over 100 units. This is a major milestone for Luna because it is the highest quantity order that we've ever received. We strongly believe that we have the opportunity to move some of our business from the small quantity orders we have historically received to larger volume orders, which allow for faster and more predictable growth. I believe we're just getting started with this product line as we move into the support operations of other military aircraft.

In addition, we can expand beyond military into civil aircraft and other applications such as data centers. I want to thank our long term customer, Lockheed Martin, for their incredible collaboration as well as their confidence in us. Their input has been key to successfully developing a user friendly, portable device that will enable them to dependently troubleshoot fiber optic based issues in the aircraft.

As we mentioned, our last quarter's call, we continue to take precautions, while importantly, advancing our sales and customer initiatives in the face of this new normal brought on by the ongoing pandemic.

Let me just underscore a few things.

First, as an essential business, we continue to maintain 100% continuity of operations, working closely with our supply chain partners, and our delivering to our global network of customers at 100% capacity.

Second, we continue to maintain flexible work schedules and environments, and to take all the safety precautions recommended by health and other state and federal agencies.

We are now allowing domestic travel on a selective basis. From a supply chain perspective, we're working very closely with our partners we have not seen and do not anticipate any significant disruptions to our supply base. And finally, as I mentioned earlier, our end markets and customers have remained relatively resilient through this pandemic, although we're still experiencing some selling challenges, as we continue to be very limited in our customer in person interaction.

So we have continued our customer outreach through digital means. We've executed nine webinars over the last six months, where our customers and community of users join us virtually for interactive demonstrations of the unique capabilities of our products. These webinars have generated 3000 registrants, over 1300 live attendees, and more than 1400 new leads.

Let's move on to a discussion of Luna Labs. At Luna Labs we leverage third party contract research to build a portfolio of technologies outside our core strategic fiber optic offerings, which are commercialized through direct sales, distributors, or licensing agreements. Most of the funding for Luna Labs comes from the federal government, primarily the Department of Defense.

So our contracts there have not been materially affected by the pandemic. Total revenues for the division were $5.7 million in the third quarter of 2020, which represents an 8% increase versus the prior year. Last quarter, I spoke about the challenges of working with our academic collaborators through the spring and summer, as universities remained partially shut down and laboratories were closed, or operating on very limited schedules. We saw significant improvement in this workflow during Q3 as these partners got their labs open, with students getting back to work.

Let me give you an example of the work we do here.

One of the mature technologies about which I've spoken in is our corrosion sensors. These compact, durable and rugged devices have already been deployed on numerous military aircraft around the world. They were recently selected by Lockheed Martin to help monitor corrosion on the Orion spacecraft that is part of the Artemis missions to send astronauts back to the moon, and ultimately to Mars. The University of Dayton Research Institute and the US Air Force also recently placed a large order for these corrosion sensors, as part of the effort to reduce the cost of aircraft maintenance associated with corrosion. Q3 was a strong quarter for Luna Labs, which contributed robustly to our overall success this quarter. The pandemic has presented some challenges, but this division is well diversified with a mix of Government funding from a variety of agencies and commercial revenue from an array of products and licensing.

In addition to the Q3 revenue success for this division, we also completed the consolidation of our Danville Virginia facility into our Luna Labs headquarters in Charlottesville, Virginia. This move has made the whole division more efficient, and created new opportunities for collaboration and growth.

We expect a strong finish to the year.

Let me make a few comments about the reaffirmation of our outlook for 2020.

As we always do my leadership team and I did a full review of our forecast assumptions and experience here today to inform our decisions and our disclosures.

We have also spent considerable time recently planning and budgeting for 2021. And I look forward to sharing with those with you during our Q4 and year-end call.

As a reminder on seasonality, we've shared previously that Luna recognizes approximately 44% to 46% of annual revenue in the first half of the year, with the larger portion of the annual results being realized in the second half of the year.

As we're now in the final quarter of 2020, we’re tracking to that seasonality. Today, we're reaffirming our 2020 outlook range, which is total revenues of $81 million to $83 million and adjusted EBITDA of $10 million to $12 million. In summary, this has been an unprecedented and challenging year for all of us. I believe that Luna’s clarity about its vision and purposes have served us well as we've navigated these stormy waters. I am grateful to the Luna team for their focus and work. And I could not be more proud that our hard work delivered these record breaking results for all of our stakeholders. I'll now hand the call over to Gene for more the financial details on the quarter. Gene?

Gene Nestro

Thank you, Scott.

Before I dive into the third quarter financials in more detail, I want to provide some broad thoughts on the progression of this year and prospects for the future. Coincidentally, I'm just a couple of weeks away from my one year anniversary with the company. Obviously, I never could have envisioned the challenges that this year would bring. But as I sit here with you today, I am more excited than ever about the growth prospects for Luna. And I'm very happy that I had the opportunity to join such a terrific company. Despite the challenges brought by the global pandemic, Luna has continued investing in people, processes and platforms to support our ability to grow aggressively. I am proud of the progress that we've made this year in driving superior operating and financial results.

While we also implement the systems and hire the professionals that will allow us to scale significantly without further investment in back office infrastructure.

Let me provide some details.

First, we recorded a terrific Q3 despite the environment in which we were working.

Our sales, profitability and cash position are all healthy.

Second, Scott already mentioned the progress on implementation of our new ERP. The project is going well and will not only streamline our current finance and accounting work, but will also make the integration of future acquisitions much easier.

Third, to position us well for the future, we've hired some excellent new talent into an already skilled and energized finance team.

Our new controller brings 25 years of experience from a large public company advanced auto, where he was recently involved in a $3 billion acquisition.

Our new FPNA manager brings over 15 years of experience from both GE’s Energy division and also from ABB. Fourth, the main impact of COVID has been an extension in the time it takes for us to get a purchase order through our sales pipeline.

We have not seen cancellations in orders, although a few contracts are taking longer than expected to obtain final signatures. And fifth, as I noted last quarter, Q2 was the first full quarter of lapping the general photonics acquisition. Thus year over year comparisons for this third quarter do not contain any first year acquisitive results. Obviously year to date year over year comparisons do include the impact of the Q1 2019 acquisition. But that is context I'll now shift to cover our third quarter results. Remember that last quarter; we began to present our financial results in two segments Lightwave and Luna Labs.

For those of you who are not able to join our Q2 call or do not have the pro forma financials for the new reporting structure. They can be found in the Q2 supplemental earnings materials which are posted on our website under the investor relations section.

Our revenues for Q3 2020 were $21.1 million compared to revenues of $18.4 million for Q3 2019, representing a 14% year over year increase. The increase in revenues year over year was composed of a 17% increase in our Lightwave segment and an 8% increase in our Luna lab segment.

Within the Lightwave segment year over year, growth was driven by strong performance from both our sensing business and our communications test business. Within Luna Labs growth was driven by later stage commercial products.

Our gross profit increased to $10.9 million for the quarter compared to $9.3 million for the same quarter last year, representing a gross margin of 52% in Q3 2020, compared to 50% in Q3 2019. The gross margin improvement was primarily due to product mix as revenue from higher margin Lightwave products increased to 73% of total revenue in Q3 20 versus 71% in Q3 19. Within Lightwave gross margin improved due to increase the absorption on our cost of sales base, operating expenses were $8.7 million or approximately 41% of revenue in Q3 2020 compared to $7.8 million, or about 42% of revenue in Q3 2019.

Our Q3 20 results reflect appropriate expense control combined with continued operating leverage on our increasing sales, including an operating expense in Q3 2020 our $668,000 related to our footprint consolidation within our Luna Lab segments.

Third quarter SG&A expense increased to $6.5 million versus $5.7 million in the prior year. This increase is primarily due to increased sales and marketing expenses in our Lightwave segment to support the increasing sales. Q3 2020 G&A included approximately 425,000 in recurring non-cash amortization expense associated with the acquisitions of general photonics and micron optics.

With the revenue growth and gross margin expansion, our operating profit improved to $2.3 million in Q3 2020, compared to a loss of $1.5 million in Q3 of last year. Net income from continuing operations for Q3 2020 was $3.1 million or $0.10 per share, compared to $1.2 million or $0.04 per share in Q3 2019. We claimed R&D tax credits for 2018 and 2019 and we plan to claim R&D credits for 2020. These credits claimed are approximately $1.7 million. These credits helped to reduce our effective tax rate resulting in a 6% negative effective tax rate for Q3 2020. And finally, a key metric reflecting our underlying operations is adjusted EBITDA.

As Scott mentioned, adjusted EBITDA increased to $4.3 million for the third quarter of 2020 versus $2.9 million for Q3 2019. This solid performance was driven primarily by top line growth from both our legacy businesses and those businesses we acquired combined with our ongoing expense management.

Let me now move to the balance sheet. We ended the quarter with $26.4 million of cash and cash equivalents compared to $25 million at the end of 2019.

Our working capital was $49.3 million at September 30, compared to $41.1 million on December 31, 2019.

Our working capital increased primarily due to Q3 sales, increasing AR inventory build in anticipation of Q4 sales and the timing of accrued expenses.

In addition, we have access to a $10 million revolving credit facility should we need it. Without repeating the 2020 outlook Scott provided, I'll just say that we again did a comprehensive bottoms up analysis which provided good insight into our forecast for the remainder of this year. This is predicated on assumptions that customer orders are delayed, not canceled.

We continue to monitor and evaluate the effects from this pandemic on a daily basis to ensure that we understand any potential impact on our business.

We will continue to be transparent and should things change significantly, we will communicate that information. With that I turn the call back over to Scott.

Scott Graeff

Thank you, Gene. At this time, I'd like to open the call for questions. Brian Soller, Senior Vice President and General Manager of our Lightwave Division and James Garrett, Senior Vice President and General Manager of our Luna Labs Division, are with Gene and me at this time and are also available to address questions. I wanted to ensure that the proper folks were on the call today to address any specific business questions you might have.

So, Mary?


[Operator Instructions] Barry Sine from Spartan Capital Securities.

Your line is now open.

Barry Sine

Hey, it's Barry Sine. Good evening. Couple of questions, Brian, I'll put you in the hot seat.

First, could you talk about what your hot products were in terms of top sellers in the quarter? And were you seeing the most interest in the order book going forward?

Brian Soller

Sure. Absolutely, hey Barry how you’re doing? So for Q3 we had a couple of couple standouts we mentioned I think all three of them on the call.

You know, we really had the first quarter here in Q3 of really getting into the full ship and motive our new OVR6200. And, we launched that at OSC this year. And that was been in March. And it takes some time to get business moving through the pipeline and so that really started to hit in Q3 and was a nice contributor there to our growth and comms test. And that was anticipated. But nice results to see that with our newest product and as you know and we really see that as a game changing product. And we mentioned that the things are coming here in Q4 and into the future with that as well, with our announcement of the first relatively large round quarters from Lockheed Martin of over a 100 of those.

So that was a nice element to Q3 and it will be going forward as well.

You know, we also hit on in the prepared remarks that in the sensing side of the business we had double digit growth. And really it was both of our fiber sensing products.

We have three products in that segment, our ODiSI and HYPERION and our T-Ray Terahertz products, while T-Ray did not have a great quarter in Q3, both of our fiber sensing products did really well.

So diverse set of applications and strong performance in Q3.

I think you asked at the end there about going forward.

You know, kind of already hit on that the 6200 we really do expect to be that's the OBR.

You know, really probably our hottest selling products here over the next few quarters, especially with the addition of that relatively large order from Lockheed in support of the F-35.

Barry Sine

Okay, that's really helpful. Very thorough. Thank you on that. The New Ridge acquisition, from a financial analyst standpoint pretty stealthy. The only clue I heard so far is you said it was financially immaterial. And I guess that's both in terms of contribution, as well as the amount paid for that. Could you talk a little bit more and what was the back story there? Do they come to you trying to sell it or did you go to them? How long have you known them? What are their products?

Brian Soller

This is one of those. We've known them for a long time. It's a the principal there the founder Henry Jaffe, I would argue Henry and Steve Yao, who was the founder of general photonics that we bought last year, are probably two of the top five photonics polarization folks in the world.

And so we've known Henry for a long time.

So this is something we've been talking about for a while. And, I think you probably know as well as anyone that some of these smaller deals take some time to get them comfortable with joining another organization.

Just made sense, I mean, anytime we can do a tuck in on a deal that pulls our product roadmap forward, we would certainly do as you saw, I did put out an 8-K, I didn't want people to be to wonder what was going on, I did go out and give them a little bit of color of what do I mean, first time, we've done a kind of what I'm calling a tuck in technology.

So gave a little bit more color around that, I don't know, if I continue to do 8-K's, if we do more deals that are that size. But you know, it just gave you a flavor for what I'm talking about. I don't think in 2020, you see a meaningful impact, I mean, getting Henry as part of the team. And talking, he's already collaborating with us and working towards the next generation thing, he brings some products with them.

So it doesn't have a real material effect both on what we spent to get it and, and what we'll be going for the material part of that, and why talk about that being important, is what he does to the team. And Brian can talk more about that too. But he is down here in our Blacksburg facility, working directly with all the folks in the back and talking about the things that we have in our roadmap.

Scott Graeff

He's kind of a key thought leader as the way to look at it in the space of photonics and looking at the technology that we've built our product portfolio on and we had a product very similar to the one that he's brought to market through New Ridge in our pipeline, or roadmap to bring to market.

And so it was a bit of a builder by it's more of a little bit more down the road from a financial impact. But it was an important technology for us to get in the 10th [ph], so to speak.

So yes, it's a good little touch.

So really good add on, when we're in front of some customers, you know, anytime when we're in front of these customers, and they're buying something from the key sites, or [indiscernible] of the world that we believe this is a superior product, that we can sell while in front of that customer is a good thing.

You know, we have a lot of real top sales folks that run our communications test vertical, both here in the US and in Europe. And I think to add this arrow to their quiver is an important piece.

Barry Sine

Okay, and then a financial question, Gene, if I could put you in the hot seat, please. Looks like and I think you alluded to this in the comments; you sold one of your physical locations.

So I noticed a pretty big drop in Net Pete [ph] property plant equipment, there was a proceeds and they [indiscernible] and that a loss on that that flowed through the income statement. Could you give me any more color on that?

Gene Nestro


As we mentioned, we consolidated that facility into our Charlottesville Virginia facility for Luna Labs. That was a building that had building improvements and equipment with it that we didn't need to move all of it to Charlottesville.

And so we ended up selling the building for 400,000. And then we had depreciation that we needed to write off.

And so that's what you see on the income statement. We call out on adjusted EBITDA is in addition to that, we also had other relocation costs, whether it was for employees that relocated to Charlottesville or other equipment that that we did move to Charlottesville.

Scott Graeff

Yes, Barry, this is a building that we got into this market. And it's about two hours from here. It's not far but it was an old tobacco warehouse that the local municipality gave us some grant money. And the tobacco commission gave us some grant money back in 2004. We build out facility was going to be the nano-manufacturing facility; we have since you know kind of exited that outside of contract work. And James Garrett resides in our little labs headquarters in Charlottesville, where the University of Virginia's and it made sense to get everyone under that roof and work on IP and collaboration together. And that was something that James pushed on and a quite frankly, we were able to keep the majority of those folks and move them there. And really not skip a beat.

You know, the team did a fabulous job of moving up two hours up the road to our Charlottesville office.

Barry Sine

Okay, just to follow up on that, so you've adjusted that out of adjusted EBITDA, so that's a normalized number. But in the bottom line, the $0.10 EPS you reported, that loss is still flowing through there.

So on a normalized basis EPS will be a little bit higher, correct?

Gene Nestro


Barry Sine

Okay, got it. Thank you very much, gentlemen.


Next question comes from the line of Jim Marrone from Singular Research.

Your line is now open.

Jim Marrone

Thank you. Yes, very nice quarter on that revenue line.

Just speaking with the revenue still.

You mentioned in the comments that the military applications was looking to be expanded, could you give us an idea which product lines on the military space that it could be expanded to? And then you'll also mention that they’re going to be soon to be commercial applications? Can you give us an idea as what type of product lines in the commercial space? And what kind of timeframe are we looking at?

Scott Graeff

Well, you know, Jim, I'll start and I'm going to let Brian talk a little bit more about that. We’ve talked about this before of our relationship with Lockheed Martin. And it started with the F-35, really the collaboration to build out the 6200 with Lockheed Martin, and it's initially starting with the F-35. But they've made it very clear; they think it has applications across all of their aircraft to include the F-22. The F-18, the C-130, the F-16 all those products will be using the 6200.

So I'll let Brian, I think he talks with them quite a bit. They are a close collaborator of ours down at Lockheed Martin.

So I'll let Brian talk about that. But that's just, that's one customer that when I was there, and they talked about, you know, needing this across all of their fleet. Those are the products that we're talking about.

In fact, I believe there is some follow up work already going on the F-22.

So I'll let Brian give a little bit more color.

Brian Soller

With that product we're in earlier state, we're definitely later stages with F-35 aircraft, right. But I'd say we're in earlier stages of developing business with multiple customers for other aircraft, as Scott mentioned F-22, F-18, C-130, E-2Dd Hawkeye all aircraft that we've actually now sold into part of why Q3 was as nice as it was. And the way the business works, as they typically will order just a handful of systems to get them spected and test it out. And then that will go through that procurement sort of the government to take that more widely into the field.

So that timeframe is about a year.

So we've already got that process started.

So that's the good news on that.

On the commercial side, we have aircraft as well.

So there's fiber optics, on a lot of these military aircraft that we've hit on, but that the similar topologies are being integrated in commercial aircraft as well.

So we're working with those folks.

You know, the Boeing Airbus is in the world to get that business going, as well. We'll see that hit next year. And I also mentioned another good application for this product is the data center market, we're very early stage in penetrating that space. But we've already sold systems into several data centers, in particular financial data centers, for testing a very specific type of test that's required in a financial data center that supports high speed trading, there's really no other product on the market that can measure with the level of accuracy that's required for this specific test.

So we see that as starting to be additive as well, next year, probably more so mid late in the year with some preliminary stuff happening in the first part of the year.

Jim Marrone

All right, so we're looking into 2021 in regards to both spaces.

So would guys be putting that into the guidance that you're going to be providing, I believe next quarter in regards to 2021?

Scott Graeff

Yes, I mean, I think when we go through that and have a better handle on that.

You know, when we give Q4 and full year earnings, we will certainly give 2021 guidance as well.

You know, we have talked about whether we do that on the top and the bottom and the bottom being adjusted even as a EPS we're not sure what our guide [ph] will be, but we will continue to give guidance and that will factor those things in to our, when we do give that annual guidance.

Jim Marrone

All right, very good. And also just one last question.

So it seems like you guys are pretty insulated in terms of what happened in 2020 with regards to the pandemic, so can you just maybe touch upon just the change in the administration for the US government? What do you see in terms of government spending, whether that's in defense or auto, or energy and in gas? And how that will could impact Luna at all? Is there any color?

Scott Graeff

Yes. I don't see a lot of change with who's in the White House? If that's what you're asking. And I'll let James give a little bit of his take on this. And in running Luna Labs he is very connected with the government. And we have a very good relationship with all the DOD entities military and it's such and I don't know, James, if you see anything, everything I've heard and talking with some of the customers they really don't see a lot of change in what's going on.

So do you have any?

James Garrett

Hey, Jim, this is James Garrett. I mean, I've been watching this pretty closely for the last six months, as we've been coming up to the election, and everybody in government, and even all the defense contractors, most of them have been saying they don't see a big change in defense spending, coming, regardless of who's in the White House. And I think if there's any sort of divided government that that's even going to be more true.

So we don't anticipate a big change in defense spending, which is our largest piece, really, the only thing that might change would be an increase in the health spending, if we see a big uptick in spending to address the pandemic further into next year.

So that's really the only thing we're looking at is probably similar spending levels in defense and possibly an uptick in the spending on the health side.

Scott Graeff

Well, and Jim, on the sensing side, I know Brian has been looking at closely if there is an infrastructure bill, that this administration chose to bring out if they got there. Everything is being done from a smart perspective, so any structure that is being done, whether that's a retro and existing or putting new, we are in front of them and everyone is moving towards making sure that fiber is on or embedded into any of those structures to make them smart.

You saw some of our announcements about the bridge and things like that.

So infrastructure bill, if that's where this administration took it would be a big plus for us.

Jim Marrone

Yes, that's like full in color. Thank you, gentlemen.


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

Your line is now open.

Dave Kang

Thank you. Good afternoon. My first question is back to Lockheed about 100 units. Can you tell us what timeframe that will be?

Scott Graeff

Yes, we we've been talking about that for quite some time.

We haven't, we've kind of honed in now the number of units and certainly is in excess of 100. It is something that is in our 2020 numbers. It's something that we said will happen in 2020.

And so I think you can count on that, that here in the remainder of the year.

So that's kind of where we are, we have not changed our position. Like I said, we talk with Lockheed on a regular basis it is much more than a customer relationship. We really have a very close relationship with them.

Dave Kang

And then you talked about other platforms such as F-22. I mean, with that, hopefully next year, could Lockheed become a 10% customers sometime next year?

Scott Graeff

Interesting. I don't know, Brian, it could be. I would say it would see that 10% for sure. I mean, I don't, when it gets to10%. I don't know, but it will be a very meaningful customer.

Let's say that.

Gene Nestro

I don't think it'd be quite 10%. But it'll be north of 5% and it can be pushing out there.

Scott Graeff

We talked about that if it does drift that way. We'll make sure that everyone's aware.

Dave Kang

Got it. And just regarding not that you've repeated or reiterated this year’s outlook, we can back out the first three quarters.

So you essentially gave us a fourth quarter outlook. Can you just go over some of your assumptions, especially on COVID cases rising again and you know, some countries going back to lockdown mode. What are your assumptions regarding COVID?

Scott Graeff

Well, you know, a lot of our product is coming out of backlog; we're halfway through the quarter now, or almost halfway through the quarter.

Some things have pushed out, we talked about that even, even in Q1 got pushed into Q2 got pushed into Q3, and we've seen some of those things even push into Q4 here.

So, we looked at this from the bottom up and believe that the low end of our range is still a good guidance. I mean, we gave at 183, we believe at 183 is still the right number with what we see today.

You know, I've always said we sit down and evaluate everything why we did it.

As late as yesterday, we were making sure that the latest information that we have is what we put out to you folks.

And so that's what we know, today, Dave, and given what's going on, and obviously we have a presence in Europe with feet on the street in Germany and France and the UK with what we know today, we believe the guidance that we gave is solid.

Dave Kang

Just a couple more.

Regarding OpEx, I mean, will OpEx this trend up next year as things become more normalized? I know a lot of companies their understanding of this because a lot of people are not traveling, so OpEx up this trend up next year. And then how should we think about with New Rigid Technology, there are OpEx. And that's on tech side you had a benefit last quarter, how should we think about tax rate going forward?

Gene Nestro

Yes, sure. This is Gene, I'll take those.

So OpEx, what we say and what we try to do is we look at our effects as a percent of revenue.

And so we try to lower OpEx as a percentage of revenue year on year.

And so I think we'll still see that next year.

Your points very valid in we've had more success this year, or we beat our budget, I would say on the effects on the underspend, like you said due to travel, and we're running behind our original budget for OpEx. But I think year on year, the percentage of OpEx as a percent of sales should be improved slightly and so we see then correspondingly, operating income going up. Long term two, three years; we think OpEx certainly can be in 13% to 16% range somewhere like that, if we manage it properly.

So, hopefully that answers your question on the OpEx. And what was your other question again?

Dave Kang


Gene Nestro

So our tax rate, we have negative 6% tax rate, because of our R&D credits for the full year, with the R&D credit baked in, it's probably going to be around 14% to 16%, maybe 16.5% for the full year. And then without the tax credits, it would probably be in the 21% to 22% range.

Scott Graeff

Dave, I'm sure you took note that I did take some time to talk about in my prepared remarks about the infrastructure that we have put in place. I was really trying to make the point that, we have spent some things that that are foundational type of items that should allow for the growth that we see over time to handle some of that.

So you should not see incremental growth in expenses based on the revenue that that we incur.

Dave Kang

Got it. Thank you.


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

Your line is now open.

Tim Savageaux

Hi, good afternoon. Couple of questions.

I think there was commentary around strength in silicon photonics orders in the quarter. I wonder if you could provide any more color in terms of applications, assume mostly inside the data center but maybe some telecom as well or customer types in terms of driving that strength set kind of run rate on current products or anything new there. And then I'll follow up?

Brian Soller

Tim its Brian. Yes, it was another good quarter, solid quarter for OVR products selling to customers working on silicon photonics type devices. It was a mix of commercial and academic type R&D.

So the academic side can be just about anything, including quantum computing, that really advanced photonics designs for communications, etcetera.

So really nice applications there, we had several really nice orders for commercial customers as well. Folks working primarily, as you said, on data center type applications. A couple of the bigger names out there were repeat customers of ours that we've mentioned on these calls before, and then we've worked with over the years and their names that you would recognize. Several systems to cloud service providers that do there R&D or development for silicon designs in house.

So it's really a good mix, in Q3, and we've continued to see the activity level there remain fairly strong, I'd say consecutively for six quarters now, and that held up in Q3.

Tim Savageaux

Great. And that sort of leads me into my next question, actually, which is kind of another cut at the Q4 question.

Your guidance does imply a pretty decent step up, it sounds like the new product, you're going into Lockheed maybe elsewhere, is going to be the primary driver there. But given that commentary just now sounds like silicon photonics could contribute as well.

Now, as you look at a pretty decent, sequential uptick into Q4, I wonder if you can characterize what products might be a key in driving that?

Scott Graeff

Look, Tim, again, I'll let Brian jump on this one. But you've been around long enough in this test and measurement Telco space to know or data com space that Q4 is the best quarter, right? We always, people are spending budget, people that many ways drag on I mean they pull the trigger, we're starting to move up to selling multiple units of both the OVA, and OBR in multiple units. And Brian, do you want to add more in far as what you're seeing in this in the funnel and pipeline by all means. But it is, we've been around a long time, maybe not as long as you, Tim, but we've been around in Luna here. 20 years, Brian, I've been here, 18 of them. And Q4 as you know, Q4 is a really good quarter.

Brian Soller

Yes, Q4 just tends to be our strongest quarter in that segment, by a pretty good stretch. And as you pointed out, you know, sales of the 6200 product to Lockheed are going to be a big part of the growth that we'll see in Q4. But I will say that what we've seen so far or what we have indications of are another strong quarter for our communications test business. And that is consistent with what we've said, I think, throughout the year, when you look at the effects of the global market on our business communications, I mean, the data center, the foundries, the data center component manufacturers, the OEMs they are gearing up. And there's a lot of stress on the network these days.

And so build outs are coming. And we expect to see a good quarter in Q4. I should say we expected that segment to be a nice contributor to what we've already said about Q4, which will be a strong quarter.

Tim Savageaux



[Operator Instructions] I'm showing no further question at this time. I would now like to turn the conference back to Scott Graeff.

Scott Graeff

Well, thank you, everyone for joining us today.

You've heard me say repeatedly that we believe we're on the right path with the right vision.

Given the environment we are in, I believe our financial and operational success during these first nine months underscores this belief.

We continue to believe in our potential and that we're on the right side of a market shift and trends toward lightweighting and 5G.

In fact, our capabilities can help to accelerate these trends. Please feel free to reach out to Jeanne, Allison or myself with any questions, and we look forward to speaking with some of you soon. Thank you for your time and interest in Luna Innovations. And Mary, that concludes our call.


Ladies and gentlemen, this concludes today's conference call. Thank you for participating.

You may now disconnect.