Nlight, Inc. Q3 FY2020 Earnings Call

Welcome to the nLIGHT Third Quarter 2020 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Joseph Corso, Vice President of Corporate Development and Investor Relations. Please go ahead.

Thank you and good afternoon everyone. As the operator said, I am Joe Corso, nLIGHT's Vice President of Corporate Development and Investor Relations. Scott Keeney, Chief Executive Officer of nLIGHT and Ran Bareket, Chief Financial Officer will be the speakers on today's call. If you have any questions after the call, please direct them to me at joe.corso@nlight.net. A copy of today's earnings press release and 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 In addition, you can access an archived version of today's call from our website.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 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, Joe. Q3 was a record revenue quarter for nLIGHT. On both an organic and inorganic basis, our revenue and profitability exceeded the high end of the guidance we provided in August. We achieved year-over-year growth in each of our end markets and increased sales, which, combined with a favorable mix of business and disciplined OpEx spending, enabled us to improve profitability. While we continue to monitor an uncertain macroeconomic environment, we experienced strong demand from our customers during the quarter, which has continued into Q4. The key driver of our performance in the third quarter was the strong execution of our strategy, which is focused on two core areas: increasing sales from key industrial customers outside of China and continued focus on the A&D end market. At the same time, we see sustained demand in microfabrication and the high power segment of the Chinese fiber laser market. Turning to slide 4, in the third quarter, we generated $62 million of revenue, which is a record for our company. In China, our revenue grew 10% year-over-year to $19.2 million. Third quarter sales to customers outside of China grew 61% year-over-year to $42.5 million, representing 69% of our total revenue, which is the highest in our company's history. Turning to slide 5, in addition to growing revenue in all geographies, we also grew in all end markets in the third quarter. Beginning with Aerospace and Defense, we grew revenues 43% year-over-year on an organic basis and 123% including the $9.2 million contribution from Nutronics. The ongoing integration of nLIGHT and Nutronics has enabled us to develop products and know-how that is creating additional opportunities for us. In addition to Nutronics, our core A&D business remains strong, and we are seeing additional directed energy applications outside of Nutronics. Within Microfabrication, our sales increased 6% compared with the third quarter of 2019. Demand across multiple applications remained relatively flat with the second quarter. However, we are encouraged by the growing number of applications that require laser processing. Finally, our Industrial business grew 15% year-over-year in the third quarter. Globally, strength in the quarter was driven by continued demand for both our high power and programmable fiber lasers. In China, we continue to see a trend toward higher power. In the rest of the world, we have been successful in converting design wins into revenue, which has been driven by strong demand for high power programmable fiber laser solutions. Moving to slide six, across all geographies, we continue to see our fiber laser sales shift to higher power. During Q3, sales of our six kilowatt industrial fiber lasers grew by approximately 80% compared to Q3 2019 and represented 58% of our total industrial fiber laser sales. We are particularly proud of this achievement as technical challenges increase as power scales. We continue to invest heavily in our product roadmap to deliver world-class fiber lasers with increasing power, programmability, and serviceability to our global customer base. Turning to slide seven, during the third quarter, we expanded our technology capabilities and our geographic footprint to better serve our industrial customers, particularly for the important growth opportunity in welding applications. In July, we acquired OPI, which was a privately-held business in Turin, Italy. We have worked with OPI for several years and we have a deep understanding of their technology, which includes couplers, coulometers, switches, and diode laser packaging technology that we have integrated into our industrial fiber lasers. Post-merger integration has gone well, and we have already qualified and shipped fiber lasers with OPI's technology that are being used in production environments. In the United States, we recently opened an nLIGHT office in Detroit that brings us closer to our important Midwestern industrial customers and partners. Our Detroit facility includes an applications lab and a demo center, which we believe offers significant long-term benefits as we continue to drive adoption of our welding solutions into the industrial market. Turning to slide eight, yesterday, we announced the introduction of AFX, a new fiber laser that aims to fundamentally change the economics of metal additive manufacturing. Designed specifically for use in powder bed fusion systems, nLIGHT's AFX laser is the world's first programmable high power fiber laser that can switch between a true single mode beam and other larger beam profiles without the use of free space optics. Changing size and beam shapes from inside the laser is the most economical, repeatable, and reliable way to maximize productivity in powder bed machine tools. nLIGHT's AFX laser can replace multiple lasers, optics, and a scanner. AFX-based powder bed tools have demonstrated higher quality parts at significantly faster build rates, which will enable the use of metal additive manufacturing tools for series production across a broad range of industries and applications. I will now turn the call over to Ran to discuss our third quarter financial results.

Thank you, Scott, and good afternoon everyone. Beginning on slide 10, we achieved record organic and inorganic revenue. Third quarter revenue of $61.7 million was above the high end of our outlook, up 41% year-over-year, and up 20% on an organic basis when adjusting for the $9.2 million contribution from Nutronics. Total revenue includes $51.1 million of product revenue and $10.6 million of development revenue. The primary drivers of the better-than-expected revenue were strong demand from North America and Rest of the World industrial and microfabrication customers, growth in nLIGHT A&D business, and increased demand for high-power fiber lasers in China. Moving to slide 11, gross margin was 27.8% in the third quarter, compared with 29.6% in the comparable period of 2019. Product gross margin was 32.2% in the third quarter compared to 29.6% in the third quarter of 2019, and development gross margin was 6.5%. Our third quarter product gross margin reflects the strong implementation and execution of our core strategy focusing on strategic customers outside of China, investment in our A&D business, and continuing the increased sales of high-power fiber lasers in China. Quarter-over-quarter, our Q3 product gross margin improved by 450 basis points. Turning to slide 12, operating expenses were $21.1 million during the third quarter, compared with $13.7 million in Q3 2019. Operating expenses included $6.2 million of stock-based compensation, an increase of $5.4 million year-over-year. Also included in Q3 results were $696,000 of purchased intangible amortization related to the Nutronics and the OPI acquisition, compared with no purchased intangible amortization in Q3 2019. Excluding stock-based compensation and purchase amortization, operating expenses in the third quarter increased by $1.3 million compared with Q3 2019, which was mainly R&D related as we continue to make necessary R&D investments to drive future growth. Moving to slide 13, GAAP net loss for the third quarter of 2020 was a loss of $2.1 million compared with the loss of $800,000 during Q3 2019. GAAP EPS for the third quarter of 2020 was a loss of $0.05 per share, compared with the loss of $0.02 per share in the third quarter of 2019. On a non-GAAP basis, our non-GAAP EPS for the third quarter was $0.12 compared with $0.01 during Q3 2019. Income tax expenses for the third quarter were a benefit of $1.5 million compared with an expense of $837,000 in Q3 2019. The change in income tax expense was driven mainly by purchase accounting adjustments related to the Nutronics acquisition. Going forward, we expect to have approximately $300,000 of both cash and tax expenses in the third quarter. Our adjusted EBITDA for the third quarter was $6.2 million or 10.1% of revenues. This compares to $2.7 million or 6.2% of revenues in Q3 2019. Our third quarter adjusted EBITDA demonstrates the leverage in our operating model. During Q3, we generated $7.7 million of cash from operating activity. Capital expenditure for the quarter was $2.4 million or 4% of revenues. Moving to slide 14, we ended Q3 with total cash equivalents of $110 million. In the third quarter, we repaid the $15 million that we had used in conjunction with the purchase of our commerce facilities earlier this year. So for the third quarter of 2020, we had 75 days inventory at the end of the quarter sales was $53 million, representing 105 days in inventory. Moving to slide 15, regarding the outlook for Q4. Based on the information available today, we expect Q4 revenues to be in a range of $59 million to $65 million at the midpoint of $62 million. This includes approximately $51 million of product sales and approximately $11 million of development revenue. Included in our Q4 revenue guidance is approximately $10 million of revenue from Nutronics. While we remain concerned about the impact that COVID-19 could have on our business and global geopolitical concerns, we continue to see positive demand trends across each of our commercial end markets and geographies. Assuming the midpoint of our Q4 guidance, we expect our full years of 2020 revenue to be approximately $219 million, which reflects 24% growth over 2019 revenue and 9% on an organic basis when excluding Nutronics. Based on our current expectation for product mix, we see gross margin for Q4 2020 in a range of 25% to 29%, which includes approximately $600,000 of stock-based compensation. Product gross margin is expected to be in a range of 29% to 33%. We expect development gross margin to be approximately 6.5%. Operating expenses for Q4 2020 are expected to be approximately $21.5 million, which includes approximately $6.3 million of stock-based compensation and approximately $700,000 of purchase intangible amortization related to the Nutronics and the OPI acquisition. For the fourth quarter, we expect adjusted EBITDA in a range of $3 million to $7 million. We expect Q4 average diluted shares to be approximately 39.5 million.

Thank you, Ran. Turning to slide 16, at the midpoint of our Q4 guidance, we expect to generate record revenue in 2020, thus extending our long-term compound annual growth rate of 20% revenue growth. In addition, stronger sales and a more favorable mix of business has enabled us to improve our margins and overall profitability. 2020 has been a challenging environment in which to operate a global business. We have faced supply chain shortages, the ongoing trade war, geopolitical unrest, and a global pandemic. While macro uncertainty persists, the demand for our products has remained strong throughout 2020, and the steps we took earlier this year have allowed us to continue to serve our customers. Our global employee base has performed remarkably in what has been a very challenging year in which to operate. I'd like to acknowledge the dedication and professionalism of our employees, who have enabled us to continue to innovate, support our customers, create a safe workplace, and continue to execute our long-term growth opportunities. Finally, turning to page 17, I would like to announce the addition of retired Army Major General, Camille Nichols to the nLIGHT Board of Directors. Camille is a proven leader who brings significant professional experience and groundbreaking personal achievements to our Board. During this distinguished three-decade career in the United States Army, Camille managed complex organizations with significant budgets. Camille spent 20 years working in key roles in Department of Defense acquisition and operations and completed operational assignments in Asia and across the U.S. Camille began her career at the U.S. Army as an enlisted soldier and subsequently matriculated to the United States Military Academy at West Point, where she graduated with an engineering degree as part of the second class that included women at West Point. Camille also received a Master's degree in Systems Management from the University of Southern California and a PhD in Engineering Management from George Washington University. Camille Nichols brings nLIGHT an important and unique perspective as we continue to grow our A&D business, and I'm thrilled to welcome Camille to the nLIGHT Board. With that, I will turn the call back over to the operator for questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Greg Palm with Craig-Hallum Capital Group. Please go ahead.

Yeah, All right. Thanks. Hey, everyone. Nice – really nice results here.

Thank you, Greg.

I guess just starting out, I mean, one thing that really stood out to us was activity and certainly, the growth levels in A&D outside of directed energy. So, curious, if that was driven by your core customer there or anything that was maybe one-time or non-recurring in nature? And how you – they can specifically about the mix of that versus the other segments for Q4?

Yeah. Good question. In Q3, we continued to make progress in Nutronics A&D, but in addition to that, we continue to expand customers that go beyond the customers focused solely on Nutronics. And in Q3, we did have a bigger than expected new customer – it is directed energy, but it is a new customer. We don't expect that level of revenue next quarter, but we do expect future revenue from that customer as their programs develop further.

Okay. Good. And then presumably, I mean, if I look at the guidance for Q4, it implies, I think even us making some assumptions around A&D that you're taking some share in – at least in industrial and just kind of curious, how you're thinking about new customer activity? I mean, how much of the recent results and certainly the outlook is driven by maybe existing customers that are taking share versus maybe some new customer opportunities for your own products?

And you're focused solely on industrial now that what you're getting at?

Industrial and you could throw micro fab in there, but yeah, outside of A&D?

Okay, good. Let me split it. So I think in micro fab, right. We have seen growth there. And we certainly expect to see continued growth in the future with new applications. So our customers that are winning in new applications in that space we've noted include 5G and medical applications. It's really a broad range of end applications there. With respect to industrial, we continue to make very good progress with our product development and launches. So we continue to make progress with our industrial, high power fiber lasers going into first the cutting market, and programmability continues to be an important dimension there, which is leading to design wins, particularly focused on sales in the rest of the world there. Second, the welding set of applications continues to be an attractive space, where we have very limited share today. And so the ability to win in new applications continues to be a good opportunity for us, like electric vehicles and other applications. And then finally, I would commend your attention to the presentation that we gave just yesterday, launching our new AFX product for the additive manufacturing space. So, again, it is a programmable laser. In this case, it's a much more refined single mode programmable laser. And in that presentation, we will give you more details on that. But we are excited about the application space as we continue to enable improved efficiency in additive manufacturing.

Got it. Got it. It is a pretty small part of the business today. But how do you view the growth opportunities and maybe the overall size of that market opportunity?

Indeed. Yes, it's a very small part of our business today. And we are engaged with a good number of customers in different application areas that are working on what I'd call the next generation additive tools. And with AFX, we're able to take it to the next level. And so it is an area that we think that will be an attractive overall market and an important market for us.

Yeah, okay. Good. I'll leave it there. Thanks.

Thanks, Ed.

Our next question comes from Jed Dorsheimer with Canaccord Genuity. Please go ahead.

Hey, thanks. So congratulations on a great quarter. I guess just starting first housekeeping. What did you say the provision was, Ran, for next quarter for taxes?

So this quarter you saw an income or a benefit of $1.5 million. The majority of that came from a purchase accounting, an accounting transaction, if you will. Going forward, you will see roughly $300,000 for cash and expense a level perspective a quarter.

Got it. And then Scott, how much of the margin increase that you saw in Q3 was a function of the abatement or easing of price pressure in sort of the sub, I guess sub-10 kilowatt lasers over in China in the industrial sector?

Yeah. Jed, not a big factor in this quarter. And I'll let Ran give you more details on the mix and other changes. But yeah, that lower power segment wasn't a big factor in changes in the margin.

Got it.

If I may add, we're talking for several quarters about our strategy, as Scott mentioned in the opening remark, focusing on industrial outside of China, cutting, welding, additive manufacturing, focusing on A&D, as well as more and more to high power in China, in terms of high power lasers. This quarter, if you look at our presentation, the high power worldwide, not just in China for industrial laser was 58%, which is a record high. So all of those trends, if you will, coming with higher margin, obviously, the volume helps us, it's a record volume and forecast that help us to improve the margin. However, that mix is significant and important for us to improve the margin. And as we mentioned in the previous quarter, as long as it will continue to grow in those areas, the margin will improve as well.

Got it. One last or maybe two. But just as we look at the shift in the auto sector, or the mobility sector in general, because it's not certainly limited just to autos, in the move from internal combustible to electric that extensively changes the manufacturing facilities for both newcomers that don't have anything, obviously have to build and as well as the incumbent. So I was wondering if you might be able to comment on quote activity that you're seeing whether that maybe to throw into this to the repatriating manufacturing onshore here domestically, but also just is an extension in the EV sector? What you're seeing in terms of level of activity, that might not be hitting the books in terms of backlog at this point in time?

Great question, Jed. So you're right, it's good to be on autos. But broadly, the EV sector is one in which we're seeing a whole host of new players. That represents a good opportunity for us. Traditionally, the automotive sector has been one in which the designing process is very long. And frankly, as a result of that, we had not prioritized that segment. So our exposure to generally in automotive is fairly modest. As we see new players in the broad EV sector from batteries to new assembly processes, we are seeing significant improvement in not only the number of opportunities that we see, but indeed our ability then to use our differentiated technology to enable those applications. So it's much more dynamic and I think innovative in the end set of processes and that benefits us.

Great. I'll jump back in the queue. Thanks, guys.

Thank you.

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

Hi, good afternoon. Could you provide some insights on the AFX, the newly announced laser? It seems we're witnessing a new generation of additive machines, particularly regarding the number of fiber lasers being incorporated into these machines. Scott, can you help us understand the factors driving the market? We will review the presentation you mentioned, but I'm also curious about what sets your company apart in this space, which I suspect might involve programmability. Can you share how many customers you are currently engaging with, in approximate numbers?

It involves a regional customer base, and while I can't provide specific details, we have been collaborating with several customers in this area for a significant time. We're seeing an increase in interest from both existing clients and new entrants, which includes some lesser-known or stealth companies. I appreciate the video, and we will upload it to our website for easier access. In summary, we have developed what we believe is the first truly single mode programmable laser in additive manufacturing, ideal for creating very fine features. Typically, a single mode laser is used to achieve a small 75-micron spot, allowing for precise powder centering to produce those parts. To enhance speed, there are a few approaches you can take, such as adjusting the beam or incorporating additional lasers. However, we have shown that the most effective method to increase speed while maintaining or improving part quality is to modify the beam for faster processing. Throughput is a key aspect of this process. While I've provided a high-level overview, the video goes into greater detail. Overall, we believe this represents a significant advancement for numerous applications.

Would this laser, for instance, enable additive manufacturers to perhaps not have to use as many fiber lasers in the system because of the functionality of AFX?

Yeah, I think the short answer, Jim, is yes; it depends on all the particulars. But yes, that is a trade space that where we provide a benefit.

Okay. And if I could also just on the comments about opening an office in Detroit, again, we don't normally associate you guys with automotive, but it's also an area that's not just automotive; there's a lot of additive manufacturing work being done in that area. Can you talk a little bit about the rationale behind that and what you expect to be able to do with this new applications lab?

Yes. Good. It's about being close to really all of our industrial customers. And, certainly, it includes not only automotive but other industrial customers, so having that proximity to the customers, having the right talent that comes from these vertical markets. And it'll include not only sales but service; it includes applications work that we're doing. And so it's a commitment to the industrial market broadly.

Okay. And then last question, are there any material revenues associated with OPI?

I think the answer is no. We have integrated OPI into our products, and it's been very helpful in expanding our products, but we don't view OPI as a material source of external merchant revenue.

Thanks very much.

Great. Thanks, Jim.

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

Congrats on your quarter. I just had a couple of housekeeping questions. You already stepped up significantly, sequentially. And it looks like it's going to continue to be at that level for the December quarter. What's behind that?

Say that again?

Just Mark clarified; it’s a little bit hard to hear. But the question is around the step up in R&D spending? Why, I guess. Is that right?

Yes. And it looks like it's going to stay that level roughly for the December quarter. Is that correct?

Yes, that’s correct. If you examine our operating expenses year-over-year, you won’t see much growth, especially without stock-based compensation. Most of our spending is focused on research and development, and we plan to continue investing in R&D as needed. While you shouldn't expect a significant increase in overall expenses, our investment in R&D will grow due to the various opportunities and new technologies we are pursuing, such as welding, the OPI acquisition, additive manufacturing, and industrial applications. All of these will necessitate additional R&D investment.

I believe you indicated for December, there'll be $6.3 million in stock-based compensation. Is that correct?

This is correct, yes.

Okay. And you also have a large other income. And what was that due to?

Most of it is due to exchange rate fluctuations from the euro and RMB.

Thank you very much.

Thank you, Mark.

Our next question comes from Tom Diffely with D.A. Davidson. Please, go ahead.

Yes. Good morning or good afternoon. I was wondering if you could talk a little bit about just the pricing and competitive environment. Now that we've had a little bit of an industrial comeback in China, things basically flattened out from a pricing point of view over the last couple quarters. And, I guess, probably, more importantly for you, pricing outside of China.

Yes. So I don't think there's anything substantially different, Tom, than what we had discussed on our last call. We see a continued competitive environment. And we certainly expect that in a lot of the lower power applications, prices to continue to come down over time. We're continuing to reduce our costs at the same time, so nothing dramatically different from what we have talked about previously. And certainly, as we access the other markets outside of China, and particularly markets where we have our programmable fiber lasers, we’re really talking about a different set of products, different set of advantages and higher differentiation. And so, certainly, that was one of the benefits that drove margin improvement.

Okay, great. And then, earlier today Two Six talked about really ramping up their diode or semi laser capacity without having any kind of material impact on you or your markets?

It's hard to speculate on that. I'm not exactly sure all of the specific applications that are driving their decision to ramp. So it's a little hard to speculate.

Okay. And then finally, I guess, just with the change or potential change of administration, does that change your outlook at all, for the defense contract part of your business?

The short answer is, no. We've seen strong bipartisan support for directed energy. And with respect to the Washington State delegation and the Oregon delegation, we've had very strong support. And it's really certainly both sides of the aisle. So, I believe, even under Obama, the directed energy budget doubled. And it remains a very high priority for DOD.

Great to hear and thanks for your time today.

Thanks, Tom.

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

You indicated it, I believe it was a 42% organic growth in aerospace, but it was over 100% year-over-year growth. Is that correct? Could you tell me what in total your year-over-year growth was, organic and inorganic?

Yes. Once again, it's 123% overall, 43% organic.

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

Thank you everyone for joining this afternoon and for your continued interest in nLIGHT. We will be participating in several virtual investor conferences this quarter, and we look forward to speaking with you soon. Have a great day. Thanks.

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