Good afternoon and welcome to the nLIGHT Fourth 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 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 jason.willey@nlight.net. Copy of today's earnings press release and the earnings slide presentation are available on the Investor Relations section of 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 In addition, you can access an archived version of today's call from our website.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 except as required by law. Additionally, certain non-GAAP financial measures will be discussed on this call.

We have provided reconciliations of these non-GAAP financial measures to 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 Scott, who will provide an update on the market and our long-term strategy.

Ran will then go through the financials and outlook before turning the call back over to Scott for closing remarks. We will then be glad to take your questions..

first, in industrial applications in geographies outside of China, where fiber laser products remain under-penetrated.

Second, in aerospace and defense, where we expect the directed energy opportunity to continue to expand meaningfully over the next several years as fiber laser technology continues to improve and governments increase their focus on deploying laser technology in the field.

Despite the near-term challenges, we believe there is significant long-term expansion opportunity for both the industry and nLIGHT. Now I will discuss our strategy in each of our three end markets. Turning to slide 6, within microfabrication we go-to-market at the component level with our leading semiconductor laser technology.

We are enabling our customers to launch innovative products that are increasingly displacing non-laser-based processes in various markets across electronics, automotive, medical and scientific research. While our technology leadership in microfabrication remains as strong as ever 2019 was a difficult year for this end market.

As discussed during our Q3 conference call, we've seen much slower activity across our customers' focus on consumer electronics and automotive and applications. Specifically in consumer electronics applications, we believe more muted design and technology refreshes have resulted in limited manufacturing retooling.

We expect the next generation of a number of consumer electronics devices and the initial rollout of 5G networks, could generate meaningful supply chain retooling. This is a key driver for new purchases of certain of our customers' lasers that incorporate our core semiconductor laser technology.

Moving to slide 7, in 2019 we drove significant innovations in our leading semiconductor laser technology. We believe our focus on enhancing brightness and improving cost performance enable us to maintain our leadership across our product portfolio and open new application opportunities for lasers to displace legacy technologies.

We have introduced a number of new products in this area including the e24i which can generate in excess of 350 watts of power in a single lightweight package. This product serves as a foundational technology across each of our three end markets.

Turning to slide 8, within the industrial end market we are integrated from semiconductor through fiber lasers and our customers integrate our products into their systems for applications in metal cutting, welding and additive manufacturing. Our vertical integration enables us to continue to develop high-performance high-reliability products.

This is proved crucial in our ability to scale up in power opening up more attractive portions of the market particularly in China. We launched a number of new fiber laser products during 2019 including our highest power 15-kilowatt offering.

As shown on slide 9 our fiber laser business continues to shift towards higher-power and ultra-high power sales. During Q4 our 6-kilowatt and above fiber laser sales almost doubled year-over-year.

Sales in this category accounted for approximately 47% of our total fiber laser sales which compares to 27% of total fiber laser sales in the comparable period in 2018. Moving to slide 10, in 2019 we made significant progress in expanding our differentiated product offerings within the industrial end market.

We released several enhancements to Corona, our programmable fiber lasers and drove improved end user understanding of this truly differentiated offering across cutting, welding and additive manufacturing. We view the overall manufacturing shift to automation as a key driver for future laser adoption.

This is particularly true in the welding market an opportunity that spans various end applications with electric vehicle batteries offering an attractive near-term opportunity, while our historical exposure to laser welding has been relatively limited, greatly enhanced our product offering in 2019 with the introduction of our fiber laser welding platform and through the evolution of the Corona platform.

Turning to slide 11, our progress with Corona and in driving the performance of our fiber laser platforms is reflected in our non-China industrial sales growing almost 10% year-over-year in 2019.

We have made significant progress in expanding our customer footprint and business within key accounts across Asia, Europe and North America with Corona driving a number of new design wins in 2019. Turning to slide 12. Aerospace and defense has been a long-standing focus for nLIGHT and is a market we view as a key driver for future growth.

Within aerospace and defense, we have historically supplied specialized laser solutions into various defense and space applications. This core business delivered another year of solid growth in 2019, supported by our critical positioning with several long-standing programs.

Reinforcing the ongoing opportunity within this portion of our aerospace and defense business is a $38 million order received in Q4 for the continuation of a long-standing program with a large defense contractor. We expect this order to be delivered over the course of 2020 and 2021.

With the acquisition of Nutronics in November, we significantly enhanced our capabilities to serve the directed energy market and position nLIGHT as a vertically integrated supplier from chip through beam control.

Our integration of Nutronics is progressing to plan and we are pleased with the initial response from customers and potential partners within the directed energy community. We are focused on ramping our capabilities to serve the directed energy market and to deliver on several key contracts.

We see a meaningful long-term opportunity within the directed energy market. With that, I'll turn the call over to Ran..

The first segment, which we will call Laser Products will include our commercial products including our traditional defense sales to prime contractors. The second segment which we call Advanced Development will include our development work mainly with the U.S. government in aerospace and defense.

The Advanced Development segment will include Nutronics and what was our historical government research and development activity. So this – the Advantage and Development [ph] segment, essentially all expense will be recognized in the cost of revenue lines. Moving to our outlook for Q1 2020.

Based on the information available today, we expect Q1 revenues to be in the range of $37 million to $43 million. At the midpoint of $40 million this includes approximately $34 million for Laser Product sales and approximately $6 million of Advanced Development sales.

Based on our current expectation for product mix, we see gross margin for Q1 2020 in the range of 17% to 21%, which includes approximately $450,000 of stock-based compensation and negative impact from tariff introduced since mid-2018 of approximately $1 million or around 250 basis points.

Laser product gross margins are expected to be in the range of 19% to 23% and advanced development gross margin are expected to be approximately 7.5%.

Operating expenses for Q1 2020 are expected to be approximately $19 million, which includes approximately $4.3 million of stock-based compensation and $650,000 of purchase intangible amortization related to the Nutronics acquisition. For the first quarter, we expect adjusted EBITDA in a range of a loss of $5 million to a loss of $2 million.

We expect Q1 average basic shares to be approximately $38.2 million. The full company outlook for Q1 2020 includes a reduction of approximately $8 million in revenue, due to the currently anticipated business disruption impact from the COVID-19 virus.

The impact on the gross margin is estimated at approximately 500 basis points due to a lower revenue, lower manufacturing utilization and additional mitigation costs. Forecasting our business in China and the impact of the virus on the global demand and our supply chain is very challenging at this point.

This impact are our best estimate based on information available today and reflect multiple variables. This includes a combination of our inability to meet identified businesses due to the delay in manufacturing and sourcing within our operation in China.

Additionally, we believe certain customer and temporary delay order due to the general disruption uncertainty related to the virus. We currently expect most of the delayed demand will be realized in the future quarters.

These comments and the outlooks provide that assume information we have available as of today and assume no future worsening of the situation.

Given the level of global uncertainty around the impact of the COVID-19 virus, we will not provide financial commentary for our individual end market beyond what we have provided for this first quarter of 2020. We continue to expect Nutronics to contribute between $25 million to $40 million in revenue during 2020.

I will now turn the call back to Scott for some closing comments..

Thank you Ran. While the near-term environment has presented a number of challenges we continue to expect long-term market growth across the high-powered laser industry and we see significant opportunity to expand our addressable market and market share. We remain focused on two core areas we believe offer opportunity for outsized growth.

First, the industrial markets in rest of world. We see significant opportunity for our differentiated fiber laser products. We remain under-penetrated in a number of geographies and in the global fiber laser welding market in particular.

Second, in aerospace and defense, we expect the directed energy market to expand meaningfully over the next several years. Our core semiconductor laser technology combined with the beam combination and beam control capabilities of Nutronics uniquely positions us to capitalize on this opportunity. With that, we'll now open the call for questions..

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Tom Diffely of D.A. Davidson. Please go ahead..

Yes. Good afternoon. Just first a question on the coronavirus and the $8 million impact.

Is most of that supply-driven versus demand driven, or can you parse out the two pieces?.

Hey, Tom. Thank you for the question. Some of it is related to supply, some of it is related to demand. You need to understand on the supply side, our manufacturing site in China is not fully utilized. There is also -- we monitor very closely, our supply chain and we believe there is going to be some impact in this area as well.

But definitely there is impact from the demand side as well..

Okay. And I guess when you look at the 500 basis points impact.

Is that just from a lower level of revenue? Are you seeing some increased costs for expediting parts or something along those lines?.

Both. It is mainly due to the reduction in revenue obviously, but there is going to be an additional cost to mitigate some of the risk that we have some of the demand that we would like to fulfill this quarter. So it is going to be additional cost. But most of it is from the $8 million reduction in revenue..

Okay. And then finally when you look at the Neumonics revenue stream going forward.

Is that going to be a pretty lumpy revenue stream based on when you finish certain milestones, or is it going to be a fairly metered revenue stream over time as you go through projects?.

Yes. Tom this is Scott. I think you're thinking about the right way it's based upon milestones. It's not based upon order intake and those milestones will have some variation in them. But it's not like they're big different contracts, it's -- they're milestone based..

Okay. Thank you for your time..

Thank you, Tom..

Our next question comes from John Marchetti of Stifel. Please go ahead..

Scott, just following up on some of that Nutronics stuff.

You also talked in the A&D about signing that $38 million contract, should we see some of that the bulk of that? How do we think of that contributing in 2020, given that that was signed in 4Q?.

Yes good. So that was signed in the fourth quarter. It's for a long-standing business and we'll see that revenue over 2020 and into '21..

Okay. And then just -- and given the way that you guys are now talking about laser products versus the aerospace and defense.

Can you just help us level set, I guess what that laser product, if you diced it the same way would have been in 1Q 2019? Just so I've got a sense of how we're looking at that as we go forward from a growth perspective?.

So going forward, we will present our financial in two different segments. The laser product if you will it's all of the legacy product that we have in nLIGHT including three -- those three end markets aerospace and defense, industrial and microfabrication.

The Advanced Development it's going to be mainly Nutronics revenue, but there is also some legacy revenue within nLIGHT that it's the same profit portfolio as the Nutronics which is fixed fee contract. There is some revenue from nLIGHT as well. And therefore, we will present it under the Advanced Development segment.

During 2020, we will also provide what is the revenue from Nutronics as a standalone. So it's going to be easier to compare apple-to-apple and organic versus inorganic growth..

Excellent. Okay. And then just lastly as I look at 2020, Scott you had mentioned some of the demand drivers appearing to firm up a little bit prior to the impact of the coronavirus coming in.

Just wondering if you could spend a minute or two sort of expanding on that a little bit whether that was mix driven, whether you've seen it across a couple of different markets, but just some sense there as we start to think out beyond the more near-term impacts of corona and think maybe about the second half of '20 and even beyond there? Thank you..

Yes good. We saw broad-based of different indicators certainly from the broad market areas like in microfabrication certainly interest in 5G and other factors there that we're seeing some improvement in the outlook overall. And then in addition, our ability then to gain share around the world certainly, we are seeing continued progress there.

So we do think the COVID-19 virus -- certainly it has an impact in the near term, we do believe that it will be temporary and we're watching it very closely..

Thank you..

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

Thanks. Good afternoon. Just again a question on the impact of the virus on the Q1 results.

Is there a bigger impact on what we have been previously discussing as the microfabrication business just given the margin hit?.

No. Jim we will not go to that level.

What is exactly that $8 million where it's coming from which end markets? However what I can tell you, as Scott mentioned in the opening remarks before the virus at the beginning – at the end of last quarter at the beginning, before the Chinese New Year at the beginning of this quarter, we saw strength in the demand across all of the end markets.

Unfortunately, that virus we have estimated currently based on what we know that the impact will be $8 million and it's coming from industrial as well as microfabrication end markets..

Okay. And your facility is in – near Shanghai.

Is that right?.

Correct..

Correct. Yes. In Pudong Shanghai..

Yes. So just curious in terms of workforce, how many folks have you got back in the facility? And what kind of – maybe you can just talk a little bit to the disruption within the workforce in that facility..

Yes good. And that's what we've seen is that in the near term it's certainly a significant impact as people were coming back from Chinese New Year and there were travel restrictions. There's limitations on the ability to even leave one's apartment. And then there's quarantines also. So all of those factors come together.

And we certainly – we are back up and running. We had more limited capacity to start with. So certainly, over the next month, there's a more significant impact. But as we get into March, I think we'll be back to – substantially back to normal by then. And yes, I've been in Shanghai.

The data that comes out of China it's a little bit difficult to know exactly which data to rely on. But according to Johns Hopkins, there's been relatively more limited impact in Shanghai. So we're fortunate and our team is coming back together..

Got it. And with respect to Nutronics.

Is that margin that you saw for part of the quarter? Is that one way to – I'm wondering how Ran, we should think about the gross margin profile of that business, or should we think about it in terms of what you've outlined in the outlook section?.

Yes, what I outlined in the outlook section. The Advanced Development segment, which again is going to be mainly Nutronics, the way to look at it the gross margin will be high-single-digit margin.

And to be honest with you as I mentioned before, it's going to be the majority, if not all of the costs will be recorded in the cost of goods sold and therefore the profit is going to be close to those numbers as well as the EBITDA. The EBITDA in Q4 for the $2.5 million $2.6 million, Nutronics contribution was 10%.

And it's going to be roughly maybe a little bit lower than that but roughly going forward this is the EBITDA that we should expect to get from Nutronics or from the Advanced Development segments..

And yes, I can understand this business is milestone-driven. I'm just wondering as we go through the year, how should we think about you're being able to possibly tighten the range of revenue that you could be seeing from this business.

I'm just wondering, at what point as we go through the year, are we going to get maybe a little bit more granularity on the contribution from the business.

Or is that just going to be difficult because maybe it's back-end loaded?.

Yes. As Scott mentioned, yes it is milestone-driven. And as we progress with the year we will – obviously, we will give you more and more information and that range will be smaller and smaller.

So we will give you as much as information that we can as much as accurate information that we can for the Nutronics business as we move on and as we deliver those milestones..

Okay. And last question if I may just. I don't know if you gave color on Q4, the industrial business and we'll probably not going to hear this much going forward but the industrial business Q4 inside and outside China..

Yes. So I think we will continue to grow outside of China roughly 10% growth there and inside China, it's down 20%. So we're seeing growth outside of China with adoption particularly Corona in larger OEMs around the world..

Okay. Thank you..

Thank you, Jim..

Our next question comes from Greg Palm of Craig-Hallum Capital Group. Please go ahead..

Yeah. Thanks. You threw a bunch of numbers at us here.

So I may have missed it, but Nutronics contribution in Q4 what was that?.

So Nutronics contribution in Q4 again was $2.6 million on the top line on the revenue. It was 11.4% margin -- gross margin I'm sorry and roughly 10% or $250,000 EBITDA..

Okay. And so stripping that out it looks like -- so revenue was still a little bit above the previous outlook on the high end.

So I mean what in your mind drove that strength versus the previous guidance whether that's segment related or based on geography?.

You are talking about the $40 million -- roughly $40.3 million for nLIGHT right?.

Yes, yes versus the $36 million to $40 million?.

Correct. It is mainly came from the industrial and mainly came from industrial rest of the world in China, but specifically more in China yes..

Okay. And Ran, you mentioned something about the expectation that the shortfall of revenue the $8 million will get maybe pushed out or realized in certain periods.

I mean I guess what's your visibility in there? I mean what's your best guess that this gets pushed out to further quarters to some point later this year or next? I mean what's your best guess at this point?.

It's really, really hard to say. And the only assumption that we can have right now is when we are comparing where we were before the Chinese New Year or before the virus and where we are today. Those $8 million was the best assessment that we have before the Chinese New Year. This is where we are today.

The only logic assumption that when the business will come back specifically in China when we will have a full utilization in our factory we will be able to deliver all of that demand. If it will be in Q2 or Q3 really, really difficult to say at this point..

Do you have better visibility into some of these supply chain impacted -- impacts that you mentioned?.

No..

Okay. And I guess just last one. As it relates to the Tier 1 customer announcement that you mentioned on the last call.

Are you still expecting a ramp-up of activity this year with that customer given everything that's going on, or is anything on hold? Has anything changed with those initial expectations?.

Yes, we're still expecting the ramp this year. And largely that's outside of China. So there certainly will be some supply chain interruptions, but to first order that still is progressing ahead..

Okay. That’s what I figure. All right. Thanks..

Thank you..

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

Yeah. Thanks for taking my questions. First on the gross margin side.

I wanted to know in terms of the product mix you have in Q4 and in Q1 and given the acquisition do you -- when do you think you might be able to return to that 30% plus gross margin level? Could it be a 2020 event, or do you think it would take longer than that?.

Good question. So first of all when we are talking about the margin, it's important to distinguish between the two segments that we have, right? Again the Advanced Development which is again mainly Nutronics will come with a low margin. As I mentioned before, it will be roughly high single-digit margin.

And in order to compare apples-to-apples to where we were like you did with the 30% or above 30%, you need to take that out from the equation.

And this is one of the main reasons why we will report it on a two separate segments, so it's going to be easier for our investors to understand what is the margin that we have in our Laser Product versus what is the margin that we have in the Advanced Development. So this is first point that, I want to make and we need to take that out.

If we are comparing apple-to-apple on Laser Products then the revenue in Q4 was definitely a low revenue. It was without Nutronics 24%. It was a low revenue. And the main reason was mix – mix and lower volume obviously.

If you – if I will refer back to our presentation that we just presented and you can find it in our website on slide 17, you can see a water-flow of the margin last – in Q4 2018 versus Q4 2019. There was a 10% impact or 1,000 basis points impact due to the mix and due to the volume.

The mix with the lower microfabrication more revenue from China et cetera, et cetera impact our margin as well as the lower revenue.

However, what we are going forward and again put aside the coronavirus, it's really difficult to talk about that variable as well, but put that aside the opportunities that we have going forward on laser product it is mainly growing the company outside of China.

Going back to call it normal level of microfabrication revenue grew – continue to grow the top line on industrial rest of the world as well as aerospace and defense. That additional revenue with better mix than where we were in Q4 2019 definitely will improve the margin. When we will go back to the 70-70 plus percent margin it's hard to say.

But it's definitely we will improve the margin as long as we will be able to continue to grow the top line, and continue to grow the top line with that, call it quality revenue outside of China and aerospace and defense..

Got it. And then maybe as a follow-up in terms of stock-based comp. I noticed that, it perked up in Q4, I think. I'm not sure – correct me, if I'm wrong that's a similar level in Q1.

Should this be the rate that we assume going forward, or was there some kind of acquisition/timing due to the end of the year?.

So in Q4, the stock-based compensation was around $4.3 million impact on the quarter where roughly – almost $400,000 out of it was in COGS, the rest of it is in OpEx. As a result of the acquisition that we did with Nutronics, if you recall we provided $15.8 million in our RSUs.

Those RSUs the cost of those RSUs that vested over four years it's roughly $1 million a quarter. We already recognized $0.5 million out of it in Q4. So we will have an additional $0.5 million in Q1. Therefore, you should expect that the Q1 stock-based compensation costs to be higher by roughly $0.5 million more than what it was in Q4 2019..

Got it. This is very clear. Thank you..

Thank you..

Our next question comes from Mark Miller of The Benchmark Company. Please go ahead..

Thank you for taking my question. You mentioned that you were seeing a pickup prior to coronavirus uptake in microfabrication.

Does that include a pickup in diode orders from our semiconductor customers?.

Yeah. We don't break out the end demand, Mark there. So – and frankly, in many cases we don't know where the end products are going. So we sell into diode-pumped solid-state laser manufacturers and they laser manufacturers and they use their products in a wide range of different end markets. So yeah, we saw a pickup there..

Just was wondering Apple was concerned about some supply chain disruptions.

Do you have a concern that if there are supply chain disruptions there might be some inventory builds at some of your customers?.

Do you mean in the past inventory or because of COVID-19? So you're....

Because people can't – say people can't make a certain product that involves your diodes or whatever that – since they can't build the products they might start building up inventory because they're acquiring components but they're not using them in the builds..

Yeah. To be honest we haven't really thought about all the permutations. Right now, we're trying to get our team back together in building products. We certainly see demand there and what's likely to happen as ramifications there and it's hard to speculate there..

The tick up in R&D in December quarter that was just Nutronics and that's expected to continue roughly at that level through the rest of 2020?.

So, first of all no. Most of the pickup was investment in Q4 was investment that we did here in Laser Product or nLIGHT. In terms of the OpEx, I think that, there are a few. In Q4, there were two unique items in the OpEx. One of them was the amortization of intangibles as a result of the acquisition.

The other one was $0.5 million expenses related to the acquisition. Going forward without stock-based compensation, OpEx roughly will be flat; maybe will be -- during 2020, it will go up slightly as a result of merit increase in those type of costs, but not more than that..

So what type of tax expense are you modeling for 2020? Is it going to be roughly 25% a quarter, or is it going to go down?.

The right way to look at it is not as a percentage of revenue. The right way to look at it it's going to be roughly anywhere between $600,000 to $800,000 expense a quarter..

Thank you..

You are welcome..

Our next question comes from Joe Wittine of Edgewater Research. Please go ahead..

Thank you.

In the China fiber portion of the industrial market, I'm wondering if Scott, do you have any quick updates there or thoughts on competitive intensity specific to China fiber?.

Meaning from Q4?.

Yes..

Yes. Q4 we saw sort of similar trends that we've seen over past few years. So, no big uptick there. We continue to make progress with our higher-power fiber lasers for cutting and also making progress in welding also in that market..

Okay. And sticking with fiber.

For Corona, what is the -- what is your baseline expectations Scott for what -- how big of a piece adjustable will represent kind of as a percent of your overall industrial fiber segment?.

Yes. As we're working with new customers and new design wins, it's the vast majority of those design wins. There are certain customers that aren't necessarily looking at Corona. But that's the minority. Majority of what we're looking at is in most applications Corona adds significant value. So it's a key for those design wins..

Okay great. And then finally on Nutronics. Ran, you described how the OpEx has essentially stuffed into COGS.

Do you have an apples-to-apples kind of EBIT or EBITDA comparison to perhaps your other AD business, so we can model that? And then, secondarily, does that Advanced Development gross margin that you disclosed which is really helpful by the way, does that have room to kind of grow going forward and show some economies of scale or -- because you're selling to primes, does it kind of stay relatively stable?.

Yes let me -- Joe I'll start and maybe Ran can jump in too. So, I think look the economics of -- the reason we broke this out is because the economics of the business is just different.

We've always had this business in place with the DARPA contracts or other government-funded research contracts where gross margins frankly not a really super helpful metric. And Ran give a good overview what the EBITDA looks like there. So that's why we broke it out. And so we'll be breaking out to show Nutronics and our legacy business.

As those development programs transition into products those products are in our core laser business. And over time, that's where those programs go and that's where they've gone in the past. And then you're talking about just different economics there..

I see. Thank you..

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

I'd like to thank everyone for their participation today. And let you know we're available over the coming days and weeks if you have any follow-up questions. Have a good rest of your day..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..