Good day and welcome to the nLIGHT Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] I would also like to turn the conference over to Joe Corso. Please go ahead..

Thank you, and good afternoon, everyone. With us today are Scott Keeney, nLIGHT's Chairman and CEO; and Ran Bareket, Chief Financial Officer. Today's discussion will contain forward-looking statements, including financial projections and plans for our business.

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, and we undertake no obligation to update publicly any forward-looking statement, except as required by law. During the call, we will be discussing certain non-GAAP financial measures.

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 over the call to Scott..

Thank you, Joe. Starting on Slide 3. Q2 was a record quarter for nLIGHT. We generated approximately $69 million of revenue, which exceeded the top end of the guidance range we provided in May. Q2 revenue increased by 33% year-over-year and was driven by broad-based demand from customers outside of China in each of our end markets.

The combination of secular demand trends for higher power lasers and our strategy to increasingly focus on industrial customers outside of China and aerospace and defense, continues to drive our growth.

In Q2, we generated record revenue from industrial customers outside of China, continue to deliver leading-edge products to our microfabrication customers and made progress in directed energy. Overall, the demand we saw from our global semiconductor and fiber laser customers during the quarter has continued into Q3.

Although, we are navigating an increasingly challenging supply chain environment, we remain optimistic about our prospects for the second half of 2021 and our long-term growth trajectory. Turning to Slide 4 to discuss revenue by end market.

In the second quarter, Aerospace and Defense revenues increased by 57% year-over-year and represented 35% of our total revenue in the quarter. Year-over-year growth was driven by the strong base of business we have with our long-term core defense customers and continued development work in directed energy.

In our core Aerospace and Defense business, we executed against long-term contracts we have with our top defense customers. Revenue this quarter was limited by material shortages and vendor quality issues but both of these issues are temporary in nature and we expect will have no long-term impact on our business.

In fact, during this quarter, we executed another multiyear contract just under $50 million and is a continuation of an existing long-running program with a large defense customer. In Direct Energy, we continue to achieve important technical milestones that further demonstrate the capabilities of our directed energy laser technology.

This progress would not be possible without nLIGHT's vertical integration from diode to beam control. And we continue to believe that we are well positioned to capitalize on directed energy opportunities well into the future. In the industrial market, our business grew 10% year-over-year in the second quarter.

Q2 revenue from industrial customers outside of China was a record for nLIGHT and drove much of the year-over-year increase in this market. We expect the strong demand that we experienced for our non-China customers in Q2 to continue into Q3. And we've been increasingly successful in converting design win momentum into repeatable revenue.

In particular, demand for our programmable lasers, especially hard power has increased sequentially in each of the past five quarters and continues to be an important driver of our growth in the industrial market.

We've also continued to make significant progress in additive manufacturing, where we are now engaged with leading powder bed fusion systems OEMs.

Our lasers have shown higher throughput and competing products and offer significant process improvements for end-users The productivity stability and price performance of our lasers are expected to drive adoption for a wide range of use cases from manufacturing of complex low-volume parts through series production.

Building upon our strong heritage of technology innovation, we look forward to announcing the release of our 20-kilowatt fiber lasers and other products for the industrial market at FabTech in Chicago in early September. In microfabrication, our sales increased 42%, compared with the second quarter of 2020 to a quarterly record of $20.3 million.

We experienced strong growth from customers outside of China, which was driven by the secular trend of broad-based demand from laser-based manufacturing. Key drivers of this growth included growth in consumer electronics, solar cell manufacturing, 5G-related spending accelerated electric vehicle production and increased demand for OLED applications.

Turning to Slide 5 to discuss revenue by geography. In the second quarter, sales to customers outside of China grew 64% year-over-year to a quarterly record of $50.4 million, which represented approximately 73% of total revenue. In China, Q2 revenue declined approximately 13% year-over-year to $18.8 million.

While we continue to serve leading customers in China, we are being selective with respect to our customer engagement and new business. As we focus strategically on growth outside of China, we expect the revenue contribution from non-China customers to become a larger percentage of our overall business.

Looking forward, we believe we are well positioned to outgrow the market over time. Our increased strategic focus on the non-China industrial and aerospace markets, where we are delivering innovative solutions are the key areas of our growth going forward.

In summary, I'm pleased with our execution during the quarter, and I'd like to thank our employees for their continued dedication to our success. I will now turn the call over to Ran to discuss nLIGHT's second quarter financial results..

Thank you, Scott and good afternoon, everyone. Beginning on Slide 7. Second quarter record revenue of $69.1 million exceeded the top end of our guidance range and was up 33% year-over-year.

Second quarter product revenue was $53.6 million, an increase of 19% above the second quarter of 2020 and second quarter development revenue was $15.6 million, an increase of 121% above Q2 2020.

The increase in development revenue in the second quarter of 2021 was mainly driven by higher development revenue related to direct energy project work that we perform for the US government. Turning to Slide 8 to provide more detail into our gross margins.

Overall gross margin was 29.4% in the second quarter versus 25% in the comparable period of 2020. Product gross margin was 36.1% in the second quarter, compared to 27.7% in the second quarter of 2020, an improvement of 840 basis points.

Our year-over-year margin improvement was a direct result of our implementation of our strategy to increase sales to rest of the world industrial and A&D customer, additional leverage on our fixed manufacturing cost base and further cost reduction efforts. Turning to Slide 9.

Non-GAAP operating expenses were $17.6 million during the second quarter, compared with $12.8 million in Q2 2020. The majority of the year-over-year increase was related to higher R&D investment to support our product roadmap and long-term growth opportunities.

Compared to the prior quarter, R&D expense increased by approximately $1.8 million, as we added R&D resources. As a percentage of revenue, our total non-GAAP OpEx was 25%, which compares to 24% in Q2 2020. Turning to Slide 10.

Non-GAAP net income in the second quarter was $4.4 million compared with a loss of $0.1 million during the second quarter of 2020. Non-GAAP EPS for the second quarter was $0.09 per diluted share compared with $0.00 per share in the second quarter of 2020.

On a GAAP basis, EPS for the second quarter was a loss of $0.19 compared with a loss of $0.18 during the second quarter of 2020. Second quarter adjusted EBITDA was $6.3 million compared with $3.3 million in Q2 2020.

Our year-over-year improvement in adjusted EBITDA in Q2 was a result of higher gross profit, partially offset by continued investment in R&D. In the second quarter, we used approximately $1 million of operating cash versus $8.1 million of cash flow from operation in Q2 2020.

Cash used in operation for the second quarter of 2021 was driven mainly by net working capital requirement to support our revenue growth. Our capital expenditure in Q2 2021, were $4.8 million versus $1.9 million in the second quarter of 2020.

Capital expenditures in the quarter were related mainly to capacity expansion and increased facility automation. Turning to Slide 11. We ended Q2 with cash and cash equivalents of approximately $175 million.

We continue to carefully manage our net working capital, which grew during the quarter as a result of higher revenue and strong customer demand trends. DSO for the second quarter was 45 days. Inventory at the end of the quarter was $63 million, representing 113 days of inventory. Turning to slide 12 for our outlook for Q3.

Based on the information available today, we expect Q3 revenue to be in a range of $68 million to $74 million. At the midpoint of $71 million, this includes approximately $52 million of product sales and approximately $19 million of development sales. The midpoint of our revenue guidance imply year-over-year growth of 15%.

We continue to monitor the supply chain constraint that Scott mentioned earlier, as well as the potential impact that COVID-19 could have on our customers' demand. Based on our current expectation for revenue mix, we see gross margin for Q3 in a range of 26% to 30%. Product gross margin is expected to be in a range of 34% to 38%.

We expect development gross margin to be approximately 6.5%. For the third quarter, we expect adjusted EBITDA to be in a range of $4 million to $7 million. Our Q3 adjusted EBITDA range assume that non-GAAP OpEx increase slightly, and depreciation and amortization is approximately $3.9 million.

We expect Q3 average basic shares to be approximately 43.3 million and non-GAAP diluted shares to be approximately 47.5 million. With that, I will turn the call back to the operator for questions..

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from John Marchetti with Stifel. Please go ahead..

Thanks very much. I was wondering guys, if we could start with the China market. Obviously what happened earlier in the week with one of your large competitors? And Scott, you were pretty -- I thought pretty clear in your comments as you kept calling out rest of world and really didn't talk all that much about China.

Can you just spend a minute as to what you're seeing there, and things are elongating out and things of that way. And maybe, if you could just also tie that to the guidance? At the midpoint of your range, it looks like product revenue would be down sequentially.

And I'm wondering, given the commentary on rest of world that we should read into that, that that's primarily China weakness..

Yeah, Good. Thanks, John. Let's see, I'll try to unpack that and talk about a few different topics.

I think first, strategically, yeah, in my prepared comments, pretty clear that we expect that revenue contribution from non-China is really strategically where we're focused for growth and we'll continue to run the business along those lines and certainly we're being disciplined with the sort of opportunities that we do see in China and it's an area where we do see opportunities, but we see bigger opportunities elsewhere in the world.

And with respect to the product revenue guidance, we're seeing good growth fundamentally, actually in some of our -- the programs we're working on and Q3 is usually lower in China anyways. So those are some of the factors that affect what we see going on. We don't see dramatic changes.

We don't see any signs of cyclical peaking in China, but we continue to be disciplined with that strategy that we've outlined..

Got it. And then if I could just ask one other question, you mentioned the new contract in the aerospace/defense market.

Is that a new contract with an existing customer or is that a new logo that you brought in?.

Yeah, correct. It is an existing customer, a long-standing customer, and so it's part of the long-term business that we have in our core A&D business..

Great, thank you very much..

Thanks, John..

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

Yeah, thanks. Good afternoon, everyone. I want to stick on questions by geography for a few minutes.

So I guess, thinking about rest of world and the growth there, I'm curious how much of that is just driven by the overall market recovery and how much would you consider more or less like share gains?.

Good. I think a combination Greg. Certainly, we see continued growth as we focus on in particular industrial customers in the rest of the world indeed we see a majority of our business in Industrial now in the rest of the world. So, we see nice growth there that is a function both of new design wins with business where we're expanding new applications.

We noted additive manufacturing is just one of those and then certainly, continue to make progress in the established businesses in cutting with some of the larger players in the rest of the world..

Okay. And then just following up on the previous question on China specifically. Has anything fundamentally changed in recent months? I mean I know this has been kind of a long-term strategy to focus on rest of the world.

But I'm just kind of curious whether it comes to just the general macro over there or increased competition if anything has changed significantly more recently that you're maybe accelerating your sort of shifting focus elsewhere?.

Yes, I think you described it well. I think it's been part of our longer-term strategy we've been talking about. So, that continues. And certainly the factors that lead us to that strategic conclusion continue. So, I don't see dramatic changes, but see continued reasons to make sure we're focused in other geos for continued growth..

Okay, fair enough. And then last one was just a clarification on a comment. I don't know if it was just associated with A&D, but it was revenue limited by some vendor issues.

So, I guess just overall did you see or can you quantify what the revenue impact you saw from some of the supply chain issues that everybody seems to be dealing with?.

Yes correct. I'm sure everybody is dealing with this. And we've tried to take a cut at that. It's hard to take a precise cut. There's certainly very specific components commodities that we would buy. But then there's also the effect on our customers and that's certainly harder to really ascertain.

So, as we sort of digested the data it's hard to quantify it precisely, but I'd say it did have a modest impact on our business, but it wasn't a dramatic impact. We do anticipate that we're not through this yet. I think we're still -- the whole world is working through a number of issues.

It's hard to anticipate where they fall out, but I'd characterize them as modest..

Okay.

But fair to say there's maybe some of that built up in the Q3 guide as well?.

Indeed we're being prudent with Q3 as we folded those in. It's a difficult time to manage the business as we're not sure what's happening with COVID and a whole host of other factors. At the same time, we see significant growth in stimulus.

So, the air bars are a little bit harder to manage the business but the impact, yes, I'd still characterize as modest..

Okay. All right. Thanks. Best of luck going forward..

Appreciate it..

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

Hi, good afternoon. Maybe just related to the last question.

Are the -- some of the supply chain dynamics that you're seeing with your customers, are they more prevalent within micro fabrication within that customer base or is it both in microfabrication and industrial?.

Yes, thanks Jim. It's a good question. I think I can think of anecdotes that across all segments of the business. It could be microelectronics component that we need in defense for example could be labor issues that affect any of our end markets.

So, it's a wide range of supply chain issues and that then affect our customers and both from component supply and really labor issues that we see. So, broad based, but there's not one segment that I would highlight as particularly pronounced..

Okay. Scott, you're also seeing a fairly healthy growth in the microfabrication business. And you highlighted a few areas that are pretty good growth opportunities at least from what we certainly hear. You talked about OLED applications, solar applications.

Is there a way to help us understand maybe how the profile of that business might be changing with some of these newer opportunities, or maybe it is -- but just curious if what -- if you were to kind of rank order some of the bigger applications, is it different than it was a year ago?.

Boy I think it's a continued trend. Yes, so it was a good quarter with really nice growth 42% year-over-year in micro. And so seeing the long-term sort of secular trends to using lasers in a broad range of applications.

And indeed we did extend the list of applications here a little bit further to reflect that broad-based set of applications that are driving it. So, the theme remains moving to shorter pulse lasers in particular which requires much higher performance semiconductor lasers that we provide that then go into really that broad range.

And yes, I wish there was an easy way to break out that -- to give you better guidance there. But I think that broad theme is a good one to think about and will continue..

Okay. And then the other area I just want to pursue a little bit for a second. Just on additive. I think a couple of quarters now where you've been calling it out.

Is this already contributing meaningfully to industrial, or is this something that as the customer base expands and it sounds like you're now working with a larger base of customers that this has the potential to be more meaningful in 2022? How do we think about additives?.

I think directionally the latter is probably the right way to think about it. We're certainly seeing meaningful growth of revenue. But more importantly we're seeing a very strong funnel of opportunities that are enabled by the new lasers that we've introduced.

And so I commend your attention the video we put out on our AFX product, it's on our YouTube channel you can see it. Rob Martinson our CTO provides an overview. I think it's a good overview of some of the features and benefits that we provide.

And that has certainly been a successful launch that is getting traction in really a broad range of those customers. So, yes, we do see that funnel building for more substantial revenue looking ahead..

Okay. Thanks a lot..

Our next question comes from Brian Gesuale with Raymond James. Please go ahead..

Hey good afternoon guys. Just most of my questions have been asked but just a few others. Scott you mentioned a bunch of sequential growth. I think you've called out five quarters of sequential growth with programmable lasers.

Can you talk about maybe some of the areas where those are getting the most traction and really if we're going to see kind of ongoing momentum there or how we should think about the addressable market for some of those programmable lasers?.

Yeah. Thanks, Brian. I appreciate that question because I do think that frames an important theme that we've seen. We've launched our programmable lasers a little over two years ago and we've continued to broaden the product portfolio there. So we started in cutting and we see further expansion in the metal cutting market.

And we anticipate that will continue to expand. I think the upcoming Chicago FabTech show in September will be a good example where customers are using and adopting and understanding the benefits in that space. And maybe the other extreme would be in the additive manufacturing space.

Certainly, it applies to welding too but the other extreme where the even the higher performance exists is in additive manufacturing. It's our AFX product line. And there that is a new product that we've introduced where the benefits are even stronger than we had anticipated in terms of providing for greater productivity for those end customers.

So yeah, I think that is that programmability is something that we really only started talking about in the industry really over the last couple of years.

And I think that's a theme that we'll continue on both in industrial where we're adjusting the beam and certainly in the defense market too where the beam profile also needs to be adjusted for a different set of applications..

That's great. Maybe on the defense market. Can you maybe talk about some of the -- I don't know if you can really be too specific on milestones.

But do you think of 2021 as kind of a meaningful year of test milestones that push these programs forward, or what are some things that you're maybe looking for to kind of judge the adoption rate because we -- I think we all feel very strongly that directed energy is going to be adopted.

It's more the timing of that?.

Yeah, it's a great question. And it is a little difficult to talk about many details, but I think I can comment that one of the key programs the healthy contracts we're one of the recipients of that contract. And certainly in 2021, there are a number of important milestones there.

And yeah, we are proud of the work that the team has continued to do there to hit key milestones. And whether much more will be public in 2021, it's a little hard to say. But yeah, I think over the next six to 12 months that is one program that will be a very important program to watch for results.

There are others, but I think Healthy is one of the most important ones broadly in DoD..

Great. Yeah. It's an exciting time of development across the space there from our industry folks. Maybe just one for Ran on you always have a variety of kind of puts and takes on your margins.

Can you maybe talk about some of those may be from a mix standpoint from a geography standpoint and maybe even on an input cost or freight or anything like that that you kind of contemplated as we move into the third quarter?.

Sure. So in the last few quarters, we talked about our strategy implementation. And as Scott mentioned with the moving towards more growth from our industrial ROW microfabrication as well as definitely as well as A&D, you will see that margin improvement. I think that we saw that in the last few quarters Q2.

This quarter it is definitely a good demonstration of our ability to improve the margin. If we look at Q2 actuals, the product margin was 36.1% versus 27.6% from last year, it's 840 basis points improvement year-over-year.

And as we move forward again as long as we will continue to implement this strategy, we will see margin improvement that's coming from mainly three areas. First of all, that revenue grows from area that we have a better margin, obviously better than China. This is one thing.

Secondly, it goes without saying growing the top line and better utilization of our fixed costs. But at the same time investing in cost reduction in automation here to reduce our product cost..

Great. Thanks a lot. I'll jump back into the queue..

Sure..

[Operator Instructions] Our next question comes from Tom Diffely with D.A. Davidson. Please go ahead..

Yeah. Good afternoon. Ran, maybe just following up on the last question.

Are you starting to see the margins between industrial and microfabrication start to close a bit, or is there still a fairly large gap there?.

It's -- first of all the answer the direct answer is, yes. However, I think that we talked about it in the past.

To talk about industrial as one umbrella of margin, it's a little bit different because different application in different geographies and different products are coming with different market is right for programmable laser versus nonprogrammable lasers.

It is right for additive manufacturing versus cutting or welding and it's definitely right for product that we are selling in China or outside of China. So what I'm trying to say is that even with the industrial end market itself there is some differences in the application that we are setting in terms of the margin.

But definitely that gap is closing. And definitely, again, as we move to application and geographies where we have a better margin we will continue to see that margin improvement..

Okay.

That sounds like there might be a little bit more exposure on the industrial side to the kind of the lower-margin China markets?.

Sorry, can you repeat this question?.

A little more exposure to the industrial side of the business to China versus microfabrication?.

I'm not sure that I'm following you.

In terms of the margin?.

So just the Industrial segment seems to maybe have more exposure to China where the margins aren't as strong versus microfabrication and more exposure to the rest of the world?.

Yeah, maybe trying to understand. This is Scott. I think in the Industrial segment, I mentioned that majority of our revenue now is rest of the world. So that has a better exposure, if that's where you're getting at..

Okay. Okay. That's good. So Scott, when you look at the Advanced Development segment and projecting 20% sequential growth here.

First of all, do you consider that a long-term project that's going to set a new bar for that business? And does it require a certain amount of associated R&D investments or hiring?.

Yeah. No, I think it is important to note that we've been successful in winning important contracts that establish us for long-term programs. But the quarter-over-quarter revenue signal that comes from that is really second order. So no, I wouldn't set it as a bar for where we're looking to expand the business.

It's a business that is fully funded, has reasonable EBITDA but it's not -- we're doing it in order to make sure we're developing the right technology to be in a position to then ship products in the future..

Okay. I appreciate the insights..

Thanks, Tom..

Thank you..

Our next question is from Mark Miller with The Benchmark Company. Please go ahead. .

The last slide of your presentation, kind of indicates as a percent of sales. The sales of high power and medium power lasers has kind of been flattish maybe down compared to four or five quarters ago while low-power lasers as a percent of sales has increased.

Can you give a little color on that?.

Yes. Sure Mark. You're referring to the slide just to make sure we're on the same page, this slide on power by -- percent of revenue by Power segment.

Is that right?.

Yes. It's the last slide in your presentation. .

Yes good. Yes. Well it's an important question. I'm glad you asked it Mark, because in the cutting market this progression towards higher power is an important theme. And as we are focused on the cutting market this was important to share. As we look ahead, this data doesn't tell a simplistic story.

For example, as we make progress in the additive market those lasers are much lower power. They would be in the below 2-kilowatt segment. And so that's one of the reasons that you're seeing that. So we see that as a successful migration is going on.

Did you get that Mark?.

So it's basically mixed?.

Yes. Good. It's mixed. Exactly right. .

Thank you..

Thank you..

Our next question is from Paretosh Misra with Berenberg. Please go ahead. .

Hi guys. Thanks for taking my there. And I joined the call a little bit late so apologies if this has been asked.

But any updated thoughts on the use of cash on the balance sheet as to when and where you might allocate that?.

Yes. I’m good, Paretosh. No it hadn't been asked before. So thank you for asking the question. So certainly, we got a strong balance sheet.

And one of the reasons that we wanted to have a strong balance sheet and did our following was that we see opportunities to continue to grow by investing internally and investing in CapEx but also looking at opportunities for M&A and we continue to do so. And we'll be prudent and careful in that process.

And certainly during COVID where travel was restricted it's not a great time to be aggressively pursuing M&A but we nevertheless have been continuing to look at a number of different opportunities and those remain the key themes that we're thinking about with respect to cash. .

Got it. Thanks. And then on the macrofab business a very good quarter.

Is that sustainable this current revenue run rate, or there's some lumpiness in the order that we have to think about on a going-forward basis?.

Well yes very strong this quarter, very strong last quarter. We see long-term secular trends there that will drive that business. But indeed there is some of reversion there as companies have come back and we've benefited as both inventory has been worked out of the channel and new applications have come on.

So we don't expect that level of year-over-year growth to be sustained but we do see continued growth in that space..

Got it. And last one for me. So it sounded like the -- your industrial business that is exposed to China is now a smaller part of that segment. What are you I guess seeing in that market? I mean some of the headline indicators are indicating weakness and one of your competitors also mentioned that on their call.

What was your observation during Q2? And how is your order book maybe looking like in Chinese industrial business?.

Yes. Yes we have covered down. The short answer there is really focused on -- strategically focused on growth outside of China. We have -- we continue to see opportunities in China but we're being very disciplined about, which opportunities we pursue. So we're not looking to aggressively drive growth in China.

And usually Q3 is a little softer than Q2 in general anyways. So looking ahead, we will continue with that same strategy and would anticipate the similar sort of seasonal trends in China too..

Understood. Thank you. That’s all I had..

Thanks, Paretosh.

This concludes the question-and-answer session. I would like to turn the conference back over to Joe Corso, for any closing remarks. .

Thank you everyone for joining this afternoon and for your continued interest in nLIGHT. We look forward to speaking with you during the quarter. Have a great evening. .

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