Good day and welcome to the nLIGHT Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr.

Jason Willey, Senior Director of Investor Relations. Please go ahead..

Thank you, and good afternoon everyone. As the operator said, I am Jason Willey, nLIGHT's Senior Director of Investor Relations and Corporate Development. Scott Keeney, Chief Executive Officer of nLIGHT; and Ran Bareket, Chief Financial Officer will be speakers on today's call.

If you have any questions after the call, please direct them to me at 360-567-4890 or at jason.willey@nlight.net. A copy of today’s earnings press release is available on our website at www.nlight.net. In addition, you can access an archived version of today's call from our website.

In today's call, our discussion will contain forward-looking statements, including statements about financial projections, future business growth trends, and related factors, prospects for expanding and penetrating addressable markets, and our strategic focus and objectives.

Forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, including the risks and uncertainties described from time-to-time in our SEC filings. Our results may differ materially from those projected-on today's call. We undertake no obligation to update publicly any forward-looking statement.

Additionally, certain non-GAAP financial measures will be discussed on this call. We have provided reconciliations of these non-GAAP financial measures against the most directly comparable GAAP financial measures in our earnings release, which can be found on the Investor Relations section of our website.

I will now turn the call over to Ran to go through the financials and outlook. Scott will then provide additional color on the business. We will then be glad to take your questions..

Thank you, Jason and good afternoon everyone. We delivered second quarter revenues, gross margin, and adjusted EBITDA within the range we provided in early-May. Revenues for the second quarter were 48 million, down 7.1% year-over-year.

During Q2, sales to the industrial end markets were 20.9 million, representing 44% of total revenues and down 17% year-over-year. Sales to microfabrication end markets were 18.1 million or 38% of total revenues and down 7% year-over-year.

Aerospace and defense sales were 9 million or 19% of total revenues and grew 30%, compared with the second quarter of 2018. On geographic basis, sales to China were 18.2 million in the second quarter of 2019 or 38% of total revenues, down 23% compared with Q2 2018.

Sales in North America were $18.1 million, representing 38% of total revenues and up 11% year-over-year. Rest of the world sales were 11.7 million, flat compared with the second quarter of 2018 and were 24% of total revenues. Gross margin was 33% in the second quarter, a decrease of 116 basis points year-over-year.

Compared to the second quarter of 2018, gross margin in Q2 2019 was negatively impacted by approximately $800,000 or 170 basis points related to the U.S.-China tariff implemented in the past year. Gross margin was also negatively impacted by reduced pricing in the Chinese industrial end market.

These headwinds were partially offset by cost reduction and positive product mix from increased aerospace and defense and high-power fiber laser contribution. The Chinese industrial end market represented approximately 24% of overall revenues during the second quarter of 2019, compared with 34% in the comparable period in 2018.

Operating expenses were 15.1 million during the second quarter, compared with 12.1 million in the second quarter of 2018. Q2 2019 operating expenses include 2.1 million of stock-based compensation, an increase of approximately 1.4 million year-over-year.

Operating expenses reflect high run rate G&A expenses, post our public offering in April 2018, an investment in R&D to position the business for the long-term growth opportunity we see across high-power laser markets. On a substantial basis and excluding stock-based compensation, our operating expenses were essentially flat.

Second quarter operating income of $805,000 was 1.7% of revenues and compared with operating profit of 5.5 million or 10.7% of revenues in the second quarter of 2018. Our adjusted EBITDA for the second quarter was $5.5 million or 11.4% of revenues. This compares to $8.5 million or 16.5% of revenues in Q2 2018.

GAAP net loss for the second quarter of 2019 was $155,000, compared with net income of 4.7 million in Q2 2018. GAAP EPS for the second quarter of 2019 was $0.00 per diluted share compared with net income per diluted share of $0.11 in the second quarter of 2018.

Non-GAAP EPS, which exclude the impact of stock-based compensation and assume the conversion of all outstanding preferred stock in the period to common stock was $0.05 per diluted share in Q2 2019, compared with $0.14 per diluted share in Q2 2018. Turning to the balance sheet. We ended Q2 with total cash and cash equivalents of 143 million.

DSO for the second quarter of 2019 was 57 days. Inventory at the end of the quarter was 42 million, representing 116 days in the inventory. During Q2, we generated $3.8 million of cash in operating activities, reflecting improve of working capital conversation.

Capital expenditures for the quarter were 4.2 million or 8.7% of revenues, driven by investment in automation and capacity expansion. Turning to the guidance for the third quarter of 2019. We expect revenues to be in a range of 42 million to 46 million.

Given ongoing US, China trade tension and increasing global macro uncertainties, it is unlikely we will generate the modest revenue growth we had previously forecasted for the full-year of 2019.

Based on our current expectation for product mix, we see gross margin for Q3 2019 in a range of 29% to 32%, which includes approximately $400,000 of stock-based compensation, and negatively impact from tariff introduced since last September of approximately $1 million or 230 basis points.

Operating expenses for Q3 are expected to be approximately 16.5 million, which include approximately 3.3 million of stock-based compensation. For the third quarter, we expect adjusted EBITDA in a range of 2 million to 4 million.

We expect Q3 average basis shares of approximately 37.5 million and an average fully-diluted shares to be approximately 41.6 million. I will now turn the call over to Scott..

Thank you, Ran. As Ran reviewed, our second quarter results reflect solid execution across a number of key areas. However, our business was negatively impacted by growing global economic uncertainties, ongoing U.S.-China trade tensions, and competition in the Chinese fiber laser market.

These market headwinds have persisted well beyond what we expected in 2019 and our visibility into when these headwinds will lift is limited. Despite these challenges, we continue to see progress in a number of key growth areas. Our aerospace and defense business grew 30% year-over-year.

The sixth consecutive quarter of double-digit year-over-year growth for this end market. Our industrial business outside of China grew 20% year-over-year. Here we continue to gain traction with large global customers driven by differentiation with our Corona laser.

We also began to ramp sales of our 12-kilowatt fiber laser during the quarter, enabling us to address a growing segment of the Chinese market. Our view of the underlying fundamentals driving growth in the high-power laser market has not changed.

We see opportunities for lasers to continue displace legacy technologies across industrial, micro fabrication, and aerospace and defense end markets. We believe continued improvement in both cost and performance will support double-digit market growth over the longer-term.

In the industrial end market, our revenues declined 17% year-over-year in the second quarter, all of this reduction was in China, as we grew industrial revenue year-over-year in both North America and the rest of the world.

In China, trade uncertainties and the rapidly evolving competitive landscape have created a very different operating environment than we experienced just 12 months ago. While China remains one of the largest markets for industrial lasers, we expect the Chinese industrial laser market to decline year-over-year in 2019.

This is the first time this market has declined since we entered China in 2004. We believe this decline in sales is due to a combination of the projected trade war and aggressive pricing. Our focus in China is on serving the high-power market.

During Q2, we generate revenue from our 12-kilowatt product and expect volumes for our ultra-high-power products to continue to ramp in the second half. There is growing customer interest in high-power offerings in China, a second of the market where there remains a more limited competitive landscape.

During Q2, our 6-kilowatt and above fiber laser sales grew year-over-year. Sales in this category accounted for approximately 35% of our total fiber laser sales, which compares to 24% in the comparable period in 2018. Sales in the 2-kilowatt to 5-kilowatt range were approximately 48% of fiber laser sales in Q2 2019.

In geographies outside of China, we continue to see strong interest in Corona, our programmable fiber laser solution. Late June, we released Corona for the 6-kilowatt and 8-kilowatt power nodes. This expansion broadens the applications addressable by Corona and further enhances our competitive differentiation in variable being profile solutions.

While Cutting is driving Corona sales today, we are seeing growing interest from customers and other applications such as welding and additive manufacturing. In the coming quarters, we expect our fiber laser business outside China to continue to expand as customers embrace our differentiated technology and strong customer support.

The microfabrication market revenues declined 7% year-over-year during the second quarter. Sales into this end market rebounded from the slower activity in the first quarter, but are experiencing some impact from softer global demand trends. This is most evident with customers serving consumer electronics and applications.

As a reminder, we serve a wide set of customers and end applications in this market. Our semiconductor lasers are critical components for the world's leading diode-pumped solid-state lasers serving applications including electronics, automotive, medical, scientific, R&D and consumer products.

We continue to expand our customer base in microfabrication during the second quarter. We see cost and performance improvements of our semiconductor lasers, enabling new applications across a variety of markets.

This is evident in the UV market, where we see growing activity from existing and new customers that are integrating our lasers to serve various non-metal marking and cutting applications, as well as drilling for ceramic and glass. In the aerospace and defense market, we grew revenues 30% year-over-year in the second quarter.

Results in Q2 again benefited from higher activity at several long running programs where lasers are critical components.

We believe our industry leading semiconductor laser technology with our track record of reliability and innovation positions us well for the current and long-term positive investment trends across aerospace and defense applications.

Within directed energy, we are aggressively developing our technology and we continue to gain traction with leading customers. The recently delivered prototypes of our latest smaller and lower weight semiconductor lasers into a leading directed energy customer, further driving our industry, leading power, efficiency and size capabilities.

While current activity and directed energy remains focused on development programs, over the coming years, we see significant opportunity for growth from this market.

In conclusion, our results for the second quarter met our expectations and demonstrated solid execution in areas key for future growth, including the industrial markets outside of China and aerospace and defense.

However, the environment over the past several quarters has been more challenging than anticipated, particularly in the industrial market in China. We are disappointed in the current market outlook and with the limited visibility that today's uncertain environment is allowing.

But we nevertheless remain focused on driving our technology to ensure we are well positioned for long term growth in each of our end markets. In closing, I would like to thank the entire nLIGHT team for their efforts during the second quarter. And with that, we now hand the call over for Q&A..

We will now begin the question and answer session. [Operator Instructions] And our first question comes from Greg Palm of Craig-Hallum Capital Group. Please go ahead..

Yes, good afternoon. Thanks for taking the questions, I guess just starting with the pricing environment. In China specifically, some of our checks have suggested that it's intensified somewhat over the last six weeks to eight weeks. And I guess I'm specifically talking on the fiber side.

So, can you talk a little bit more detail on what you're seeing over there?.

Yes, absolutely, Greg. So, I think your checks are correct. We've seen increasing competition has led to price declines that are greater than the historical average of what we see in the past of around 10%. So, we're seeing greater price declines due to the competition, primarily in lower power fiber lasers in China.

We continue to see growth, though, in the higher power segment where we see limited competition..

Okay.

And in terms of the gross margin guidance for Q3, I mean, any way to sort of quantify what's baked in from a competitive standpoint in terms of the gross margin guidance?.

So, the only thing that we quantified for Q3 like we did for many quarters it’s the impact of the additional tariff, and our estimate that it's going to be roughly $1 million and this is what we guided. But if you will do the calculation, you can see that this is the majority of the impact there.

There are many, many other things that impacted the margin, pricing, the mix, mix between the product, mix between higher power and low power, mix between the end markets, but we did not quantify each of them separately..

Okay, fair enough. And I know inventory ticked up again sequentially, I think previously you were expecting more of a second half ramp. Obviously, you alluded to the fact that it doesn't look like that will occur this year.

So, I guess what's your comfort level there? At what point do you start work in some of that off?.

The way that we are looking at the inventory is mainly on the level of inventory days and as you can see our inventory days this quarter was 116 and we are feeling comfortable anywhere between 100 to 120. This is our target.

If it's going to be higher than that we will try to reduce the inventory, but the inventory level that we have right now, we are feeling comfortable with it..

Okay, perfect. I'll hop back in the queue. Thanks for the color..

Sure, thank you..

Our next question comes from Jim Ricchiuti of Needham & Company. Please go ahead..

Hi, thanks. Good afternoon. Hi, Ran, I just want to make sure I heard you correctly.

If we think about China Industrial, was that down about 35% year-over-year?.

No, we are not going there to that level on China Industrial, but if you look at the industrial end market in general, the industrial end markets year-over-year went down 17%. We did not disclose how much was it in China. Obviously, it was higher than the 17% because outside of China we had a growth..

Well, let me ask you this.

Was the microfabrication business up in China for the quarter?.

Good, yes. Jim. We are not breaking out the micro – or the end markets by geography..

What I'm getting to. I'm just trying to find out.

Are you seeing weakness as well in the microfabrication business or has that part of the business held up better?.

Yes. Jim, this is Scott. So, I think, you know, directionally there, yes. We are seeing signs of, better growth actually in China in microfabrication. So, I think the new products that we have launched have done well and we've seen adoption by new customers around the world, but also in China..

Okay. And then two quick questions. I'm wondering how we might think about seasonality in Q4. And I'm not asking for guidance for Q4, but you know normally you would see seasonal weakness.

Is it fair to assume sequentially we should think along those lines?.

Jim, theoretically, you are right. And this is what we want to assume, but as we mentioned in the opening remarks. You know with the environment that we have right now, specifically on China, cannot repeat just the recent news that we heard related to China? It is very, very difficult to say what will happen in China in Q4..

I understand. How about aerospace and defense? That's really holding up better and I thought we were thinking – going into the year, I thought we would see some slowing, but it's remained strong.

Can that maintain this kind of not necessarily this kind of growth, but are you feeling pretty optimistic about the second half on this part of the business?.

Well, yes, I think you're exactly right, Jim, that we've seen continued growth there. We've got – we've got very strong track record for many years in this space. And we have ongoing programs that continue to do well. And in some cases – even better than we expected.

Longer term, the directed energy programs are going to be some of the key drivers of growth. And while we – it's difficult to forecast the details there, we can tell you a little bit more about what's going on there. And we continue to get design wins.

One particular one we can mention is, the Navy HELIOS program, which is one of the larger programs where we're supplying the key semiconductor laser technology. We've got differentiated technology that is lower weight, smaller size, very efficient. And we think we're very well positioned in this space..

Got it. Thanks very much..

Thanks Jim..

Our next question comes from Andrew DeGasperi of Berenberg. Please go ahead. [Technical Difficulty] Our next question comes from Tom Diffely of D.A. Davidson. Please go ahead..

Yes. Good afternoon. I guess digging a little bit more into your guidance for the third calendar quarter, it sounds like from a commentary that most of the difference that you're seeing in that versus your previous expectations is on the mid-range of the industrial market.

Sounds like the high-end is holding up pretty much as expected?.

Yes, I think that's right, Tom. You know, we have very limited visibility with the noise we are all seeing in the end the markets, but we continue to see strength in the new products that we've launched and higher power is one of those along with new products in our semiconductor lasers. And, you know, continue progress in defense also..

Okay.

Have you seen any meaningful share shifting going on in this space or is it mainly everyone's participating in the price declines?.

Are you referring to China specifically, Tom?.

China specifically? Yes..

In China, what we've seen as we've talked about is, in the lower power segment, that's where we see Chinese domestic players notably. And those price declines, as I noted previously, are greater than we've seen in the past. And as a result of that, the overall market for industrial lasers in China is expected to decline this year.

It's the first time, we've ever seen that happen. And so, there's pressure on all of the players in China, in particular at the lower power levels. Again, when you get to the higher power levels, that's where we see much more limited competition..

Okay.

And is there anything that you can ascertain as far as the health of the smaller kind of second, third tier players in this space and where the pain level is? Whereas, there might be a backstop to pricing at some point?.

You know, it's hard to understand all of the details of, the economics, but certainly we believe that for those lower power levels, you know, the pricing there is very challenging for the players. Even in China, you know, we have our own manufacturing assembly in China. So, we've got a good understanding of the cost structure.

So, I certainly believe that low end of the market is one that we're not looking to for sure for growth. And it's one that I think will be very challenging for the players even in China..

Okay. And then last question.

When you look at the tariff impact, is that just for the wafers you're sending to China? So, the Chinese tariff on your wafer is going to be packaged?.

It is mainly that, but not just only that. I can tell you one thing about the tariff, which is important or on the gross margin in general. The reason – one of the reasons that we have quantified that is to explain that the change in the margin. If we will take as a point reference this quarter.

We end up the quarter with 33% margin versus last year of 34.2% without the tariff impact, the additional tariff that was implemented last year, as a matter of fact this quarter with everything in it, the pricing and all of the topics that we are talking about, our margin would be higher than last year margin.

Unlike at the beginning of the year, we are looking at the tariff as probably for here to stay and we are actively doing a few things in order to reduce the impact of the tariff, including moving manufacturing from the U.S. to China and vice versa, including changing some of the supply chain that we have from China to the U.S.

All of that will help us to mitigate and reduce that cost. And we expect to see everything being equal. We expect to see an impact of those action at the beginning of next year..

Alright. Sounds good. Thanks for your time..

Thank you..

Our next question comes from David Ryzhik of Susquehanna Financial Group. Please go ahead..

Hi. Thanks, so much for taking the questions. Just to clarify on HELIOS.

Are you the sole laser provider to the HELIOS? To the Navy contract? Just want to clarify that?.

Yes. Good. Sorry, we can't comment further on that. we can't say that we are providing semiconductor laser technology for that program. Other details that program have to leave others to announce..

And anyways you think about when that program emerges from R&D stage into actual – putting products in the field?.

Yes, I mean, it's one of many programs and those programs are still in the science technology development stages, but when specifically, they'll be launched? It's a little difficult to comment on. But what we are seeing are two trends.

One, we're seeing more programs and we're seeing some of those programs pull in to be notionally much sooner than we previously thought. There's still – fairly slow relative to commercial markets in terms of the development milestones, but we are seeing increased number of programs and generally pull-ins there..

Got it. Thank you.

And just on Corona, can you remind us why you talk about Corona outside of China? I realize China's a very challenged market right now, but what are the reasons why Corona would not make sense for some of your Chinese industrial customers?.

Yes, it's a good question. We're not highlighting it right now, given all of the noise in China. But yes, certainly we believe that the economics of Corona makes sense around the world. And so, in the future, we'll address that a little bit more in detail, but right now, we're seeing significant interest, primarily outside of China.

But over time, we think it will certainly address markets, not only around the world and in China, but also in really all of the applications that we serve from cutting, welding to additive manufacturing..

Great. And then just last one for me on that topic, and we've talked about this before, the welding opportunity.

What are you seeing? What were the conversations like with welding customers, perhaps in the auto industry? What are you hearing? What kind of reception are you getting for Corona? Maybe when can we start to see some traction in welding with Corona?.

Yes. Good. It has been well-received, we're getting strong interest from customers and there's nothing that we're announcing explicitly, publicly right now. But in coming quarters, we'll be talking more about that and automotive is one of the application areas where there's a strong benefit to the quality of the wells that Corona provides..

Great. Thanks so much, Scott..

Our next question comes from Andrew DeGasperi of Berenberg. Please go ahead..

Thanks for taking my question.

Maybe first, when – if we could look at the June-July activity in China and in Europe, I know it's not a big portion of revenue, but could you let us know outside of pricing how that's been moving? Is it deteriorating a lot faster or is it being consistent with what you're seeing prior to June 1?.

Yes, it's obviously very noisy, but certainly the sort of macro trends that we're seeing in the paper every day. You know, anecdotally, we're seeing that also in really a broad range of different markets from consumer electronics through, CapEx decisions on industrial equipment.

So, our data is anecdotal and partial, but we're certainly it would certainly support the general macro trends that we're seeing..

Got it. And then in the ultra-high-power side.

Just curious to know, have you been able to broaden your customer base from what's been traditionally one or two players with the sales growth that you've had?.

You know, it hasn't been a significant area of emphasis for us more recently for high power. We're more focused on a broader range of customers with Corona and that's where we see the adoption occurring in a broader range of customers..

Got it. Thank you very much..

[Operator Instructions] And our next question will come from Patrick Ho of Stifel. Please go ahead..

Thank you very much, Scott.

Maybe just first off, in terms of the business conditions that you mentioned in China and the challenges there, can you, I guess, give a little color on how you decide, especially in the low power range? Did you gain share over the last couple of years? How do you rationalize between walking away from a potential business deal because of the pricing pressures versus I guess, accepting them and taking a margin hit?.

Yes, good. Patrick, obviously, a very specific detail set of analysis that we go through.

But, in general, we're focused on high power where there is less competitive pressure at the low-end where it's very competitive and with really a set of products that are different, the reliability of the products that we see in many cases in China are just very different. So, it's really comparing apples to oranges.

And if that's the case, yes, we will work from those opportunities..

Great, that's helpful. And, given the mix and the shift towards your ultra-high-powered lasers like you mentioned the 12 kilowatts that you've introduced that also targets the Chinese market.

And you've mentioned that you haven't seen the pricing pressures there yet, but have you seen the application drivers and I guess the demand for the these ultra-high-powered lasers be there given the current market environment?.

Yes, we have. We've seen continued very strong interest to continue to increase power. And, and we will continue to drive our roadmap for a higher power. But in addition to that, and indeed we think perhaps even a bigger opportunity is with Corona worldwide. Really outside of China too where we get much higher performance, even at lower power levels.

So, looking ahead, there is where we see the interesting growth are in many cases in the near-term outside of China. In industrial markets and then obviously in aerospace and defense sector..

Great. Thank you very much..

Pleasure..

This concludes our question and answer session. I would now like to turn the conference back over to Jason Willey for any closing remarks..

I'd like to say thank you to everyone for your continued interest. Please feel free to reach out if anyone has any additional questions. Have a great rest of your day..

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect..