Good day and welcome to the nLIGHT Second Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jason Willey. 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 jason.willey@nlight.net. A copy of today's earnings press release and the earnings slide presentation are available on the Investor Relations section of our website at investors.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 In addition, you can access an archived version of today's call from our website.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 the potential impact of the ongoing COVID-19 pandemic, financial projections, future business growth, trends and related factors, prospects for expanding and penetrating the 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 current environment and the markets we serve.

Ran will then go through our financials and outlook. We will then be glad to take your questions..

Thank you, Jason. Q2 was another strong quarter of execution for nLIGHT in what remains a challenging operating environment. We generated record quarterly revenues and delivered financial results at or above the high end of the outlook we provided in May.

The key driver of the better than expected performance was our Industrial end market, where sales grew 8% year-over-year, even as global economic uncertainty remained elevated due to COVID-19. Our business in China was strong in the quarter as the demand rebound that we experienced in April continued throughout the quarter and in July.

The strong revenues flowed through to improvements in product segment margin, relative to the past two quarters and generated better than expected overall profitability.

The stronger sales, combined with cost controls, enabled us to grow our net cash position during the quarter, while continuing to invest in the R&D roadmap we believe is necessary to drive sustainable long term growth. I will start with Slide 4 of our earnings presentation and look at the current business environment for our three end-markets.

As we sit here today, demand continues to remain resilient globally, particularly in the industrial end markets, even as macro uncertainties and operational challenges related to COVID-19 persist.

Beginning with Aerospace and Defense, we grew revenues 5% year-over-year on an organic basis and 68% including the $5.7 million contribution from Nutronics.

This performance demonstrates the solid and sustainable foundation of business we have with our core defense customers and the early stages of the long term opportunity we see in the directed energy market.

nLIGHT has a long history of serving Aerospace and Defense customers and is a key supplier of semiconductor laser and related technology to a number of ongoing programs for applications including, countermeasures guidance and measurement. As we look out over the next several years, our primary focus within Aerospace and Defense is directed energy.

We see solutions serving the directed energy market having the potential to drive growth in both our products and development segments. During the second quarter, we continued to make good progress at Nutronics with work on several key government contracts.

Within directed energy, we believe we are positioned as a leader in the market with our vertical integration of key enabling technologies from semiconductor lasers through beam control. Within Microfabrication, our sales were down 21% compared to the second quarter of 2019, but grew sequentially for the first time since Q2 of last year.

Compared with 2019, sales remained constrained by more limited market activity across several key end applications, including consumer electronics and automotive. However, we are encouraged by the signs we saw from several of our key global customers and we had record contribution from Chinese manufacturing customers.

We believe the primary end driver for this strength in China is investment in ramping product manufacturing to support 5G, including networks and handsets. Our Industrial business grew 8% year-over-year in the second quarter, the highest level of revenue from this end market since Q2 of 2018.

Strength in the quarter was driven by strong demand in China where we continue to see growing customer interest in our high powered fiber lasers. We made good progress in ramping recent design wins globally and we expect this success to be even more evident in our revenues over the coming quarters.

We've enhanced our position within a number of key accounts globally by providing differentiated technologies such as programmability, the introduction of enhanced solutions for welding applications, and by continuing to offer strong customer support. Moving to Slide 5. Across all geographies, our fiber laser sales continue to shift to higher power.

During Q2, our 6 kilowatt and above fiber laser sales more than doubled year-over-year. Sales in this category accounted for approximately 54% of our total fiber laser sales, which compares to 35% in the comparable period in 2019.

We continue to drive our product roadmap to support higher power levels and provide customers with highly reliable differentiated solutions. We are well-positioned within the industrial markets to benefit from our customers' increasing focus on diversifying their supply chains.

With the growing movement to examine and diversify the location of manufacturing operations and supply chains, we see opportunity for the integration of more automation and lasers into industrial production.

While these types of decisions and movements do not happen overnight for most companies, we are seeing clear signs of increased interest in these types of initiatives globally. We believe this can be a long term tailwind for the laser industry and nLIGHT. Turning to Slide 6.

In the second quarter, 41% of our sales were in China, up 18% compared with the year-earlier period. During Q2, we experienced a typical seasonal rebound that we believe was amplified by stronger customer activity post Q1 COVID-19 headwinds. Customer activity in China reflects robust demand across both the Industrial and Microfabrication end markets.

Outside of China, we saw resilient demand across the Industrial end market and we continue to enhance our positioning at key customers. Within Microfabrication, we saw positive signs at a handful of our global customers as sales grew sequentially, but activity in this end market remains below levels seen in late 2018 and early 2019.

As we look to the third quarter and beyond, we are encouraged by the progress we continue to make in the long term growth drivers in our Industrial business outside of China and in directed energy. We expect this progress will be even more evident in our Q3 results and our financial performance moving forward.

I would also like to take a moment to note that we celebrated our 20th anniversary in Q2. We founded nLIGHT in June 2000 with a vision that semiconductor laser technology will continue to improve rapidly and open new markets and new applications.

What seemed impossible 20 years ago has become reality with high power lasers deeply embedded in critical tools and applications across multiple end markets.

Even with all that, we, in the industry, have accomplished over the past 20 years, I'm more excited today about the opportunity in front of us than I have been at any point in the company's history.

nLIGHT continues to be guided by the same principles upon which the company was founded to rapidly innovate our technology and drive further adoption of high-power laser solutions.

Finally, I'd like to end my prepared remarks today, as I did last quarter, by extending a word of gratitude to our global employee base for their extraordinary efforts over the past two quarters.

The dedication of all nLIGHT employees through these challenging times has helped ensure that we not only sustain our operations and support our customers and partners, but have continued to drive our innovation and enhance our ability to deliver sustainable long-term growth.

I will now turn the call over to Ran to provide more detail around our Q2 financial performance and outlook for the third quarter..

Thank you, Scott, and good afternoon, everyone. Beginning on Slide nine. Second quarter revenues of $52.1 million was above the high end of our outlook, up 8.5% year-over-year and down 3.4% on an organic basis when adjusting for the $5.7 million contribution from Nutronics.

Total revenue includes $45.1 million of product revenue and $7 million of development revenue. The primary driver of the better-than-expected revenue was strong demand in China across industrial and microfabrication end markets. Moving to Slide 10. Gross margin was 25% in the second quarter compared with 33% in the comparable period of 2019.

Product gross margin was 27.7%, and the development gross margin was 7.8%. Our Q2 product gross margin was impacted by price reduction and unfavorable mix compared with Q2 2019. This included lower microfabrication sales and higher proportion of revenues from China.

Partially offsetting these margin headwinds were ongoing cost reductions and lower-than-expected tariff costs. On a sequentially basis, gross margin improved by 300 basis points. Turning to Slide 11. Operating expenses were $19.1 million during the second quarter compared with $15.1 million in Q2 2019.

Operating expenses included $5.7 million of stock-based compensation, an increase of $3.6 million year-over-year. Also included in Q2 results were $656,000 of purchased intangible amortization related to the Nutronics acquisition, compared with no purchased intangible amortization in Q2 2019.

Excluding stock-based compensation and purchase amortization, operating expenses were essentially flat compared with Q2 2019. Our second quarter OpEx demonstrates continued focus on controlling costs, while ensuring we are making the necessary research and development investment to drive future growth. Moving to Slide 12.

GAAP net loss for the second quarter of 2020 was a loss of $6.8 million compared with a loss of $155,000 during Q2 2019. GAAP EPS for the second quarter of 2020 was a loss of $0.18 per share compared with $0.00 per share in the second quarter of 2019. Our adjusted EBITDA for the second quarter was $3.3 million or 6.2% of revenues.

This compares to $5.5 million or 11.4% of revenues in Q2 2019. While the second quarter adjusted EBITDA declined year-over-year, the results were above our outlook range driven by better than expected revenues and cost controls. During Q2, we generated $8.1 million of cash from operating activities.

Capital expenditures for the quarter were $1.9 million or 3.6% of revenues. Moving to Slide 13. We ended Q2 with total cash and cash equivalents of $121 million and $15 million in debt. DSO for the second quarter of 2020 was 44 days. Inventory at the end of the quarter was $51 million, representing 115 days in inventory.

Our balance sheet remains strong and provides ample flexibility to execute our long term strategy. Turning to Slide 14 and the outlook for Q3 2020. Based on the information available today, we expect Q3 revenues to be in the range of $54 million to $60 million.

At the midpoint of 57 million, this includes approximately $46.5 million of product sales and approximately $10.5 million of development sales. We continue to see positive demand trends across each of our commercial end markets and geographies.

Based on our current expectation for product mix, we see gross margin for Q3 2020 in the range of 22% to 26%, which includes approximately $600,000 of stock-based compensation. Product gross margin is expected to be in a range of 26% to 30% and development gross margin is expected to be approximately 7%.

Operating expenses for Q3 2020 are expected to be approximately $20.5 million, which includes approximately $6 million of stock-based compensation and $656,000 of purchase intangible amortization related to the Nutronics acquisition.

Included in this outlook is an additional $0.5 million in SG&A expenses primarily for additional spending related to Sarbanes-Oxley, and move costs associated with our new Camas, Washington facility. For the third quarter, we expect adjusted EBITDA in a range of $1 million to $5 million.

We expect Q3 average basic share to be approximately $39 million. We now expect the full year's revenue contribution from Nutronics to be in a range of $28 million to $30 million. The updated outlook reflects continued progress on work for key programs, but some delays in hiring and on-boarding new employees and supply chain disruption.

We view this delay as short-term in nature and there has been no change to the structure of funding associated with the Nutronics key contracts. We will now open the call for questions.

Operator?.

[Operator Instructions]. Our first question will come from Greg Palm with Craig-Hallum Capital Group. Please go ahead..

Yes. Thanks for taking the questions and congrats on the results. I guess, first, I wanted to just go through, maybe, the cadence of order activity or demand in the quarter. And I think, Scott, you mentioned something about how order rates or demand continue to add strong rates here in the month of July.

So just wanted to be sure I'd heard that correctly..

Hi, Greg. Yeah, you did hear that correctly. We did note that we saw continued strong demand in July..

And do you think that's a result of share gains? I mean, it sounded like that was a large driver, specifically in Industrial in Q2 and sort of your optimism, but maybe a little bit more detail on what you're seeing in July. Is it market growth? Is it across all segments? Any more color would be helpful..

Yeah, no problem. So what we're seeing is strong growth really across all of our end markets and we listed those in Q2 and we see continued growth. And so for Q3, we see continued strong demand and, longer term, we continue to remain very optimistic about the continued displacement across all those different end applications.

I do want to say that, given the ongoing uncertainty related to COVID, we're certainly not in a position to talk much beyond Q3, but we continue to focus on execution and that's why we noted what we're seeing in July..

Okay, that's helpful. And it looks like you're guiding up product revenue a bit sequentially from Q2. Gross margin is maybe just up very slightly at the midpoint. So I guess that implies that mix in Q3 stays relatively consistent with what you saw in Q2 or maybe even gets worse by a touch.

Is that the right way to think about it? And I guess, as we look forward, what's it going to take to get product gross margin back up into the 30 plus percent? Is it just -- is it more weighted toward mix of the business or can you get there from sort of cost absorption alone, if you see a larger recovery in volume?.

Yeah, sure. So let me take it. And you saw between Q1 to Q2, around 300 -- and I'm talking about product, obviously, margin on this product segment, not on the development. That will be roughly 7% to 8%. But on the product you saw a 300 basis points improvement from Q1 to Q2.

That improvement came first of all from the volume, and secondly from lower cost and growth in area where we have higher power. Let me remind you, when you’re talking about mix, the growth is coming from area where we have a better margins. And I will tell you where the mix is coming with a better margin.

So obviously, revenue from the rest of the world on the industrial end market, revenue from industrial end market in China and outside of China on the high-power, everything above six kilowatt -- six kilowatt and above, mainly 12 and 15 kilowatt, incremental revenue from microfabrication and definitely defense end market.

So we are growing in the area where the margin is better than where you saw in Q1, for example. And as we continue to do that going forward, you would see an incremental improvement in the margin..

Okay. Make sense, appreciate the color best of luck going forward..

Thank you..

Our next question will come from Tom Diffely with D.A. Davidson. Please go ahead..

Yes. Good afternoon. So Scott, maybe the first question on the microfabrication market. It's typically the time of year when things pick up a bit.

I'm curious, did COVID kind of wipe out the growth this year? Or what are you seeing from an activity point of view?.

Yes, Tom. With respect to microfabrication, while year-over-year, we're not seeing the same levels we saw in the past, we are seeing growth. And we're seeing growth driven by -- 5G is certainly one driver, but it's a really broad set of end applications.

So 1 application we saw was in marking and the manufacturing of masks, and there was a spike in Q2 for the obvious demand there. So there's really a broad range of end applications. And we are seeing continued growth in that segment.

Whether it gets back to where it was in the past due to various cycles, it's harder to say, but we are seeing growth there now..

Okay.

And so if you look at a couple of years, is your view on that market still as strong as it has been driven by consumer electronics and industrial -- smaller industrial applications?.

Well, indeed, and really, there's a lot more than that in there, too. I mean, medical, for example, is in there for us. We put all -- there's a lot of different end applications there. So yes, I think that we will continue to see a rich set of end applications in what we call microfabrication.

And consumer electronics has historically been an important one, and it will continue to be part of that. But we do see a really broad range of applications that will continue to be enabled by lasers..

Okay. Great.

And then just as a follow-up quickly, just maybe an update on the Camas facility and what the milestones are there and what that does to your ultimate capacity in protecting your margin profile?.

Good. Yes. So we are moving in. We already have one production line up and running in Camas. And yes, we're back in the office every day there. And one of the benefits of Camas is we have more space to spread out. So with respect to managing in the COVID crisis, it provides a much enhanced need. We were pretty jammed in our previous offices.

So that's been good. And we're going to continue to build out manufacturing lines, and we are doing that right now. So we're on track, and it certainly has been a very nice unforeseen benefit given the COVID crisis..

Our next question will come from Jim Ricchiuti with Needham & Company. Please go ahead..

Hi, good afternoon. Just couple of questions. Some of your competitors have talked about activity in China. In the case of one, they talked about severe deceleration in demand as the quarter progressed and continues [indiscernible] to see any of the strength [indiscernible] maybe to an earlier question [indiscernible] market share gains..

Yes, Jim, it was cutting out slightly there.

Can you just repeat the fundamental question? It was, somebody was commenting on deceleration, was that correct? In China?.

Yeah. Scott, I hope that you can hear me..

Yes..

One of your competitors talked about the activities in China in the quarter and that began to decelerate as the quarter progressed and saw additionally end market decline. I'm just wondering if you've seen any of those or some of the dynamics in China for you....

Yes..

...for market share..

Very good. Yes. Got you, Jim. So typically Q2, just after Chinese New Year is a very strong quarter in China and then typically, we see that tapering off in the summer months going into Q3. So we saw a strong demand as you can see in the numbers in Q2 and we are seeing ongoing demand that is stronger than is typical for Q3 right now.

But we always see a bit of a fall-off in Q3 in -- typically in China. But as we said, in July, we're seeing that demand continue..

Got it. And on the [indiscernible] side, the Nutronics business narrowing their range, it seems like there has been a little slippage, a little bit of that.

Do you see some of that [indiscernible] revenue coming in early next year?.

Yes, I think, I just want to replay, it's cutting out a bit. But this is with respect to Nutronics. Is that what you're....

Yes..

Yes. Yeah, so....

So you're talking about narrowing of the range and [indiscernible] that additional revenue comes in, in [indiscernible]..

Yes. Good, exactly, this is all about revenue recognition. The bookings are there. It's a question of when we recognize that revenue and there certainly has been some impact from COVID on supply delays -- just delays and personnel issues also, nothing fundamental.

We're on track, but from a revenue recognition standpoint, that's why we wanted to refine what we're seeing there now. But, now, good progress on integration and then also fundamentally on validating the thesis for the acquisition to optimize what we're doing and what Nutronics had been doing and truly integrate the technologies well..

Okay, final question, just with respect to where we are today versus where we were a few months ago, if I look at the businesses, so Microfabrication and the Industrial, where have you been perhaps more surprised that the business has been resilient?.

Yes, I think surprise is a reasonable word to use, Jim. We -- certainly, when the crisis first hit, we were very cautious and were thoughtful about potential scenarios that we needed to manage to. And what we've seen is continued good demand across the board.

So, I wouldn't say -- it's not a surprise or it's a shock, but it's a better outcome than we had worried about when the crisis first hit. I think we will remain that much more concerned than typical on outer quarters as we've noted. But we are seeing continued strength in really all of our end markets at least for Q3..

Okay, thanks a lot..

Thanks, Jim..

[Operator Instructions] Our next question will come from Jed Dorsheimer with Canaccord Genuity. Please go ahead..

Hi, thanks, and good quarter. I guess just two questions, one on the cost structure and the other on the margins. Maybe just on -- first on opex, and I joined a little bit late, but I'm a little surprised, with the lack of travel, that we're not seeing lower opex.

And so I was wondering, is that a function of the acquisition until we expect greater cost reductions in the future here, or is this kind of a low point that we grow off of?.

No, no, no. So, first of all, if you look at the opex, without stock-based compensation and amortization of intangibles related to the Nutronics acquisition in the last, whatever, give or take eight quarters or so, we are pretty much flat around anywhere between $12.5 million to $13 millions. Now, by the way, travel for us, it's not a big expense.

We have travel -- we are not travel first class. Let's put it like that. However, what you can see, it's a reduction in SG&A, and an increase in R&D.

We are investing more and more in R&D in one hand, and SG&A in another hand went down just because we have a good control on our opex and from those reason that you just mentioned like travel, which again, it was not significant.

Going forward, and again, without stock-based compensation and amortization of intangible, we should see a slight increase in opex, give or take, roughly $0.5 million a quarter, again going to the range of $13 million, $13.5 million, but not more than that due to Sarbanes-Oxley, as well as the costs for the move to the new facility in Camas..

Got it. It does. Thank you. I just wanted to make sure....

Sure, sure..

...I was looking at it correctly.

Just in terms of the gross profit margin on a go-forward basis, is that largely tied to volumes and therefore the spread of the fixed cost or, I guess, how much is mix shift playing in as we look at that on a potential ramp here?.

Our ability to improve the margin depends on mainly three things. First of all, it's obviously increase the top-line, goes without saying. Secondly, it's our ability to reduce the cost and I think that we demonstrated in the last few years a significant cost reduction that offset most of the ASP reduction that we saw in the market.

And lastly, it's the mix that we are -- we will control the mix, meaning mixed world, a product or markets that coming with a higher margin.

And I mentioned those, i.e., revenue in the industrial end market outside of China, high-power in China and outside of China in the industrial end market, our ability to increase the top line for microfabrication and aerospace and defense revenue..

Got it. And then last question for Scott.

Just curious, as you look at the directed energy program, do you see that agnostic, politically speaking, or do you see -- I'm just trying to gauge sort of risk of -- if we look at defense budget, how much of that will be tied to, domestically speaking, a Democrat versus Republican? Or whether or not that is fairly insulated from a investment spending perspective going forward?.

Yes. Good question, Jon. So if we look historically, I would say that the directed energy funding has been very strongly bipartisan. The budget effectively doubled under Obama and the DE Caucus is a strongly bipartisan group. So I don't think first order, there's a strong influence in the typical partisanship in D.C.

Obviously, defense budgets as all budgets, there'll be that much more pressure. But I will say that directed energy is one of the highest priorities for DoD. So yes, it's not a first order concern that we're thinking through..

Got it. I’ll jump back in the queue. Thanks guys..

Thank you..

We are showing no further questions at this time. So this will conclude our question-and-answer session. I'd 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 we look forward to speaking with many of you over the coming weeks. [Indiscernible] everyone, stay safe..

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