Hello, and welcome to the nLIGHT Second Quarter 2023 Earnings Conference Call. All participants are in a listen-only mode. After today’s presentation, there will be an opportunity to ask question. [Operator Instructions] Please note, this call is being recorded.

At this time, I would like to hand the call over to Joe Corso, nLIGHT's Chief Financial Officer. Please go ahead..

Thank you and good afternoon, everyone. I'm Joe Corso nLIGHT's Chief Financial Officer. With me today is Scott Keeney, nLIGHT's Chairman and CEO.

Today's discussion will contain forward-looking statements, including financial projections and plans for our business, some 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 statements 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 the call over to Scott..

Thank you Joe. In the second quarter, we delivered results that were largely in line with guidance. Revenue of $53.3 million was above the midpoint of the guidance range. Products gross margin of approximately 29% and continued operating expense control resulted in adjusted EBITDA that was also above midpoint of the guidance range.

We also made significant progress in three areas critical to our strategic growth objectives. In aerospace and defense we kicked off the HELSI-2 program and made excellent progress in our new defense applications.

In industrial, we continue to improve our position with key customers and have seen increased traction with our process monitoring solutions. And operationally we have continued to diversify and derisk our manufacturing strategy.

We have established automated assembly of semiconductor lasers in the US, and in addition have begun shipping from a contract manufacturer in Thailand. I will provide a brief update on each of these three initiatives and our revenue outlook.

In aerospace and defense, revenue increased 9% year-over-year to $24.5 million, representing 46% of total revenue. Second quarter development revenue increased 8% year-over-year to $13.7 million and defense products revenue increased 9% year-over-year to approximately $10.8 million.

As we announced in early May, we were awarded a new $86 million contract to produce a more powerful higher performance laser related to the second phase of the Department of Defense High-Energy Laser Scaling Initiative, which we refer to as HELSI-2.

In late Q2 we kicked off HELSI-2 activities and recognized initial revenue from this program, which we expect to continue for approximately two-plus years.

In addition, we also announced that our HELSI-1 laser was formally accepted by the government and is being prepared for integration within the US Navy's high-energy laser counter anti-ship cruise missile program.

We continue to believe that our unique technology and vertical integration from chip through beam control are well-suited to be scaled to increasingly higher powers. And we are proud to continue to support the US government's efforts in higher-power directed energy lasers.

We are excited about our current programs in directed energy and we are working on several new opportunities that we look forward to sharing in coming quarters. In non-directed energy defense, we generated higher revenue from existing long-running programs and we made significant progress on a number of new programs.

We expect to continue to support our long-running programs well into the future and we believe our new programs remain on track to transition to production sometime in 2024. Turning to the industrial end market. Industrial revenue in the second quarter declined 24% year-over-year to $16.6 million, representing 31% of total revenue.

In cutting, we continue to leverage our all-fiber programmable technology to deliver innovative increasingly higher-power lasers to our customers. Revenue from cutting customers was relatively flat year-over-year and in line with our expectations when we provided second quarter guidance.

While the overall demand environment remained muted, we did gain share with one of our top customers and again increased the overall number of 15-kilowatt and 20-kilowatt lasers sold. In welding, we continue to expand our process monitoring sales in the European, North America and Chinese EV battery market.

Our suite of process monitoring solutions and battery monitoring experience opened up new opportunities for both process monitoring and laser sales in the EV market. Part of the strategic rationale for our acquisition of Plasmo last year was to capitalize on cross-selling opportunities between nLIGHT lasers and Plasmo process monitoring solutions.

While revenue from welding customers is a relatively small part of our overall industrial business today during the second quarter, we had several new customer wins and significantly increased our engagement with potential customers. Additive continues to offer significant long-term growth opportunities for us.

Our Corona single-mode AFX fiber laser has been widely demonstrated to increase build rates by a factor of 2x to 8x, which substantially reduces part cost.

In addition, our lasers simultaneously maintains excellent material quality increases the process window and reduces deleterious effects such as swift [ph], spatter and frosty that affect laser powder bed fusion tools based on legacy fiber lasers.

Our lasers have enabled tools by leading integrators, including DMG Mori, Velo3D, AMCM, ACON3D and several others that we are not able to specifically call out.

Q2 Additive revenue was slightly above what we had expected when we provided guidance for the quarter, but it was down year-over-year as one of our customer is still in the process of integrating lasers they had purchased last year.

In microfabrication, revenue in the second quarter of 2023 declined 26% year-over-year to $12.2 million, which represented approximately 23% of total revenue. We continue to believe that we are a leader in the market but global demand remains soft as customers continue to adjust existing inventory.

While we saw some signs of recovery during the beginning of the quarter revenue did not materialize in the way that we had hoped particularly in China. We remain actively engaged with our key existing customers and we expect that as global demand environment becomes more constructive our semiconductor laser business will grow off the current levels.

Turning to operations. We again made excellent progress in automation during the quarter. By the end of the second quarter, we achieved key milestones in the utilization of our equipment and manufacturing throughput.

We also continue to mature our overall automation process flow which over time will result in better yields and additional potential output. We are also pleased to announce that we signed a manufacturing agreement with Fabrinet a world-class contract manufacturing provider with a strong footprint in Thailand.

Fabrinet has a long history of delivering outsourced manufacturing services to the photonics industry.

Our partnership with Fabrinet provides additional high-quality low-cost semiconductor laser assembly for our commercial business and enables increased flexibility for us to scale with demand effectively making a portion of our manufacturing capacity variable.

Most importantly, however is that, working with Fabrinet enables us to dedicate a greater proportion of our US-based manufacturing capacity to our defense business, which is expected to ramp significantly in the coming quarters.

Our initial qualifications have gone well and we expect to begin shipping products with Fabrinet-assembled lasers in the coming weeks. Now, I'll turn to our current revenue outlook for the third quarter and beyond. We currently expect third quarter revenue to be in the range of $47 million to $51 million.

At the time of our last earnings call in May, we had been anticipating a third quarter that was approximately $5 million to $10 million higher than the midpoint of our Q3 guidance. While we remain highly optimistic about both our near- and long-term prospects, I'd like to describe the two primary drivers that are impacting our current Q3 outlook.

First, the initial ramp of HELSI two is going a bit slower than we anticipated due to the availability of materials affecting the amount of work that we've been able to perform on the project. This slower-than-anticipated ramp accounts for approximately half of the delta.

There have been no changes to our longer-term schedule and we expect revenue to begin to ramp more significantly over the next few quarters. The other half of the delta was driven by lower overall demand particularly in microfabrication.

As we look towards 2024, however, our customer demand pipeline and revenue visibility have actually strengthened quite a bit. So although, our revenue ramp in Q3 is a bit slower than what we had expected a quarter ago.

New defense program wins and continued execution in our commercial business will begin to come to fruition in 2024 resulting in even stronger growth than we had expected entering this year.

In summary, we've made excellent progress over the last several quarters despite the fact that our top line revenue is currently ramping more slowly than our expectations. Our opportunities in defense in both directed energy and our core business have continued to expand.

We also believe that, our core technology particularly our programmable lasers and process monitoring capabilities coupled with strong secular trends in additive and welding are driving strong expected growth in 2024 and beyond. I will now turn the call over to Joe. .

Thank you, Scott. nLIGHT generated revenue and adjusted EBITDA above the midpoint of our guidance. Growth in gross margin improvement is a core focus of the nLIGHT leadership team. While scale and mix were the primary drivers of gross margin the combination of higher output and efficiency of our U.S.

automation coupled with the outsourced assembly of some of our semiconductor lasers to Fabrinet offers further room for gross margin improvement. In a period of continued macroeconomic softness, we are carefully monitoring operating expenses and capital expenditures so that at higher revenue levels we are able to drive better levels of profitability.

Total revenue for the second quarter of 2023 was $53.3 million above the midpoint of guidance compared to $60.8 million for the second quarter of 2022. Products revenue was $39.6 million compared to $48.2 million for the second quarter of 2022.

Revenue decreased year-over-year in both the industrial and microfabrication markets, but increased year-over-year in Aerospace & Defense. Gross margin was 23% compared to 25% for the second quarter of 2022. Products gross margin was 29% compared to 30% for the comparable period in 2022.

Products gross margin in the second quarter was negatively impacted by negative manufacturing variances and lower production volumes, but positively impacted by favorable product mix and decreased overall manufacturing costs.

Non-GAAP operating expenses were $16.6 million, a decrease of $2.7 million compared to $19.3 million for the second quarter of 2022.

The decrease in operating expenses was driven by a decline in employee compensation costs, primarily due to lower headcount, decreases in R&D project spending and higher administrative costs that were allocated to development projects.

On a GAAP basis, operating expenses were $23.8 million, a decrease of $1.9 million compared to $25.7 million for the second quarter of 2022. Net loss on a non-GAAP basis was $900,000 or $0.02 per diluted share compared with a net loss of $3.3 million or $0.07 per diluted share for the second quarter of 2022.

Net loss on a GAAP basis was $8.8 million or $0.19 per share compared to a net loss of $10.3 million or $0.23 per share for the second quarter of 2022. Adjusted EBITDA was a negative $150,000, above the midpoint of guidance compared to positive $200,000 for the second quarter of 2022.

Cash used in operations was $4.1 million compared to cash used for operations of $4.8 million for the second quarter of 2022. Included in cash flow from operations was an $8.4 million increase in accounts receivable, due primarily to the timing of billings and collections during the quarter.

Capital expenditures were $1 million compared to $7.9 million for the second quarter of 2022. While capital expenditures will increase in subsequent quarters, overall CapEx in 2023 will be down significantly year-over-year.

We also used approximately $3 million of cash and tax payments related to stock award issuance during the quarter, which we do not expect to repeat at this level in subsequent quarters. Turning to the balance sheet.

Our balance sheet remains strong as we ended the second quarter of 2023 with total cash, cash equivalents, restricted cash and investments of $102 million and no debt. Our DSO for the quarter was 70 days and inventory at the end of the second quarter was $64.9 million, representing 144 days of inventory. Turning to guidance.

Based on the information available today, we expect revenue for the third quarter of 2023 to be in the range of $47 million to $51 million. The midpoint of $49 million includes approximately $36 million of products revenue and approximately $13 million of development revenue.

As Scott discussed earlier, at the time of our last earnings call, we were expecting our third quarter to be approximately $5 million to $10 million higher than the midpoint of today's guidance range.

About half of the difference is simply related to the availability of materials limiting how quickly we could ramp on our HELSI two program while the other half is really driven by a slower recovery in macroeconomic demand for our microfabrication business.

We've made excellent progress in HELSI two during the third quarter but it's still difficult to predict when the macroeconomic environment will really begin to drive higher demand in microfabrication. Turning to gross margin.

Third quarter 2023 products gross margin is expected to be in the range of 27% to 31% and development gross margin to be approximately 7% resulting in an overall gross margin range of 22% to 25%. Finally, we expect adjusted EBITDA for the third quarter of 2023 to be in the range of approximately negative $3 million to breakeven.

As a reminder, over the last several quarters we have significantly streamlined our cost structure and continue to expect to return to positive adjusted EBITDA at a quarterly revenue run rate in the $55 million to $60 million range. With that I will turn the call over to the operator for questions. .

Thank you. We will now begin the question-and-answer session [Operator Instructions] The first question today comes from Ruben Roy with Stifel Nicholas. Please go ahead..

Thank you. Hi, Scott and Joe. I wanted to start Scott with a question on guidance and sort of – kind of thinking about the out quarter. In the earnings release you had a little statement talking about being optimistic about strong growth returning in subsequent quarters and into 2024. You talked a lot about 2024.

But as we think about Q4, should we expect some of the materials that are necessary to keep HELSI going to become available? And is that going to help you get back to sort of revenue growth in Q4, or any signs of sort of a bottoming process in microfab? Any detail around that would be helpful..

Yes, absolutely, Ruben. Thanks for the question. As I noted, the delta I described was due to timing for HELSI and then sort of the macro effect. So as we look out in time, certainly the HELSI program the contract's in place and so we fully expect to be ramping there as material and other resources are available.

Now with respect to the macro environment that's harder to predict what's going on in the macro environment. But in addition, we have other opportunities that we're making good progress in; notably both in defense and in the industrial markets.

So that's the reason for our optimism about the core bets that we've made for growth and the relatively near-term outlook for those to come to fruition..

Okay. Thank you, Scott. I guess a follow-up to that would be around the Fabrinet contract. Just kind of wondering about the timing about the contract given kind of where we are in the macro.

And I guess longer term, if you have some detail or comments to make about how you're thinking about mix to internal outsource and if we should think about any longer-term margin impacts on commercial laser products as that mix shifts potentially over to contract manufacturing?.

Yes, good. Let me take the first part of the question and I'll hand over to Joe on the margin impact. On the first part of the question in terms of timing, I think the -- we're really pleased with the progress that the team has made here and we will start shipping from Fabrinet this quarter. And we see this as part of our overall derisking strategy.

And we see this as an important part of our mix going forward in particular making sure we have the capacity in the US for ramping defense programs, while having a balanced portfolio of capabilities to continue to serve the commercial market.

So, pleased with the progress there and with the portfolio we have in place now to address both the industrial and the defense markets. And then with respect to the margin implications, let me hand it to Joe to answer that question directly..

Yes. Good question, Ruben. So from a margin perspective, we expect that margin to be neutral or potentially positive. If you think of what a relationship with Fabrinet or a contract manufacturer does, it effectively enables us to variabilize some portion of our manufacturing and match demand with manufacturing output.

And so hopefully be able to sort of avoid some of those peaks and valleys. So over time, we think at worst this is margin-neutral at best it gives us the opportunity to continue on our path to 40% products gross margins or better..

That's great. Thanks for that detail, Joe. If I can sneak one last one in. It's great to hear about the Plasmo traction.

Scott, I think you mentioned that you're seeing sort of attached laser sales with Plasmo, but just wondering if that's what you meant in terms of the new wins, or is it a combination of both kind of your vertically integrated systems, plus monitoring wins with non-nLIGHT-lasers that are out there in EV installations?.

Yes, very good question, Ruben. It is both.

We do think that having the process monitoring from Plasmo, gives us the opportunity for new design wins that we might not otherwise have, but then also gives us cross-selling for our current lasers and notably new lasers that we are developing for that market and further insights into the road map for what's going on there.

So, yes, that was something we wanted to note, that we're making progress there.

It was about a year ago that we acquired Plasmo and we do think that process monitoring is a very important part of many of the applications that we serve and that by integrating that with our lasers, it provides a complete and further-optimized solution and in particular here in the EV battery market and in a market that is very dynamic and growing..

Great. Excellent. That’s all I had. Thank you..

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

Hi, good afternoon. I wanted to go back to the Fabrinet announcement. And maybe you could just walk us through the time line. Obviously, you've known these guys for a while. They're pretty well known in terms of this industry.

But the actual decision to go this route, it sounds like this was being driven by the momentum that you've seen in the defense business, but maybe if you could just help us understand, the whys and timing around it..

Yes Jim, I certainly have known Fabrinet for a long time and I've always been impressed. We did look at multiple sems here and in the end they're -- we're very pleased with the capabilities of Fabrinet. They've done a very good job serving the industry for many years now.

And in terms of the decision here, it's about diversifying and mitigating manufacturing risk further. As we've talked about, we're transitioning manufacturing from our current manufacturing in China.

We've got our automation up and running in the US, but the contract manufacturing piece of this serves particular products and particular markets in an optimized way. So it's about having that portfolio that both diversifies risk and as Joe mentioned to variabilize as part of our manufacturing capacity. So, those are the overarching reasons.

We've been working on this for some time. I've been engaged with them for many years now. But we're pleased to announce that we are shipping from Fabrinet and we're pleased with this transition that we've talked about for some time..

Okay. I think, I can understand the optimism that you have around the defense business, so as you think about 2024, but we're still a ways off from early 2024 to have some line of sight that gives you optimism on the industrial side. So, it sounds like you're working with some newer customers.

Can you help us understand the types of applications and the confidence that you have that that could contribute to revenues early next year or presumably early next year?.

Yes, exactly, Jim. Yes. So as you know in the defense market, obviously, we've got longer-term visibility. In the industrial markets, it's -- in many cases, it's harder to see out. However, when we're talking about design wins that's where we do have the visibility.

And notably in both additive and as I just mentioned in welding that's where there's a longer-term design-in process and we're seeing good progress. I mentioned the process monitoring a minute ago. But in addition, our Corona programmable beam technology continues to be adopted across all of our markets.

But I would highlight again in additive manufacturing, we do think that the Corona AFX technology has a distinct advantage. And we look forward to making announcements at the appropriate time in coming trade shows, and other venues for these design wins and new product launches.

There's upcoming trade shows in the fall in the industrial markets both in battery market and in the additive market. But that's -- those are the key drivers for us that give us the optimism for new design wins that our new products with current customers and new customers that give us that optimism. .

So, Scott, do you have customers in the EV battery manufacturing market that you're adding other than the customers that you're working with where you've had traction with the process monitoring solutions? I'm talking specifically about the lasers..

Correct. Yes, these are new customers. Some existing customers who are expanding and some new customers also. Again, that market is a rapidly growing one. It's one that is evolving fairly rapidly. And we've always had good relationships, but we're expanding those. And we've got good presence not only in the U.S., Europe, South Korea and China. .

So as you look out to 2024 you think that this part of the industrial business does it have the potential to be meaningful in your overall industrial revenue stream?.

Well, I think from a revenue standpoint, I would highlight defense and probably additive on the incremental adds more. But in terms of the progress we're making certainly we hope to provide more background there in battery welding also. .

Yes. Thanks a lot..

Thanks, Jim. .

The next question comes from Greg Palm with Craig-Hallum Capital Group. Please go head..

Hi. This is Danny Eggerichs on for Greg today. Thanks for taking the question, guys. I think first maybe just digging into the Q3 guide a little bit more and some of the assumptions behind that.

I guess, from a geographic perspective, what you're seeing out there it seems like North America held up relatively well and maybe there was some weakness in Europe and then end markets. I appreciate the color on microfab.

But are you expecting solid growth in A&D still and then maybe industrial falls somewhere in between there?.

Yes. Thanks, Danny. I think the way that I would characterize the guide is, we have a little bit more visibility obviously in the defense business. So we have a better perspective on what we can do in defense as we talked about in Q2. Part of that is really going to be sort of some of this project timing both from a labor and material perspective.

And we continue to sort of see macroeconomic challenges in the third -- sorry, macroeconomic weakness in both the industrial and micro markets. So it's been really difficult to predict how the customers are -- what their take rate is really going to be. And that's globally. That's both in China and the rest of the world.

So I almost would categorize the third quarter a couple of million dollars either way as sort of hopefully kind of bumping along the bottom. But as Scott said earlier right we've got what we think the right design wins in place with the right customers coupled with some defense wins that we do think that that is going to grow.

But in the third quarter, it's a lot of the same that we saw in the second quarter quite frankly. .

Okay. Makes sense. And then maybe one on gross margin in Q2, just looking at kind of the sequential step-down off similar revenues to Q1 and it sounds like mix wasn't necessarily a factor.

Can you just go through what was kind of the drivers behind that sequential step-down?.

Yes great. It was limited sort of exclusively to manufacturing quarter-over-quarter, right? I mean we as we are changing our overall manufacturing processes right we still don't have perfect either visibility or the ability to predict what things like scrap and yield are always going to be quarter-over-quarter. So that was one of the pieces.

The other piece is we talked about Fabrinet there were some onetime charges that we needed to take. Again not huge but 100 basis points to 150 basis points can explain half of the sequential step-down quarter-to-quarter.

At the same time if you look at what we are doing on a normalized basis and our ability to leverage our overhead and manufacturing that continues to trend in the right direction. I know your question was relative to the prior quarter.

But as we are looking at the business and we're looking at progress on the manufacturing front if you were to kind of go back a year from -- a year ago and look at what our product revenue was and that was $9 million or $10 million higher than it was in the second quarter and the gross products gross margin was about the same.

So that gives us the optimism that we're really starting to dial in the manufacturing and the expenses around it such that as revenue grows we're going to be able to put a lot more through to the bottom line from both an adjusted EBITDA and a cash flow basis..

Okay. Got it. Maybe one last one on HELSI. Good to hear that started in the quarter.

Can you just remind us of how we should think about the timing of that revenue ramp? Is it linear? Is it going to build throughout 2024, or how should we think about that?.

Yes. It's definitely not going to be linear. I don't think we've said anything nor has anything been released publicly specifically about the period of performance on that contract. But it's a multiyear contract.

I think directionally it will move up particularly as we start to allocate more resources and more material and hit milestones of that program. But hard to sort of say, we can draw a line from zero straight up with the same slope to $86 million. But it will increase over the coming periods. .

Right. Thanks. All leave it there..

Sure. Thanks you, Dan..

Seeing no further questions this concludes the question-and-answer session. I would now like to pass the call back over to Joe Corso for closing remarks. .

Yes. Thanks everybody for joining today and for the interest in nLIGHT. We look forward to talking to many of you during the quarter. Have a good afternoon. .

The conference has now concluded. Thank you for your participation. You may now disconnect..