Nlight, Inc. Q4 FY2020 Earnings Call

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 In addition, you can access an archived version of today’s call from our website.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. Starting on Slide 3. 2020 was a year I will not forget. We started the year with the hope of a global manufacturing recovery after a difficult 2019. But early in the year, we faced the profound uncertainty of the COVID-19 pandemic. Throughout the year, our global team met the unprecedented challenges of this crisis, and we not only were able to operate safely, but we also ended the year with record revenue. In 2020, we generated $223 million of revenue, which was an increase of 26% over 2019 and in line with our long-term historical compound annual growth rate of 23%. We exited Q4 with 50% growth over Q4 2019. And while our future growth will be subject to global macroeconomic factors, we believe over the long run that our strategy will enable us to meet or exceed our historical long-term revenue compound annual growth rate of greater than 20%. Turning to Slide 4. Breaking down revenue by end market, I will begin with aerospace and defense. 2020 marked the fourth consecutive year of annual growth in our aerospace and defense business. We grew 2020 revenues 36% on an organic basis, and we grew 102% year-over-year when including the $31.8 million contribution from Nutronics. We have been serving the aerospace and defense market since we founded nLIGHT 2 decades ago, and we view ourselves as a dual-use technology company. We have a long history of supplying mission-critical lasers into long-running programs and our work in directed energy represents an important long-term opportunity. November marked the 1-year anniversary of our acquisition of Nutronics, and I’m happy to report that the integration of nLIGHT and Nutronics has gone well. Confirming our fundamental thesis, that being vertically integrated from the semiconductor laser through beam control is critical to developing high-power cost-effective lasers required for directed energy applications. Today, we believe we are the only laser company with this level of vertical integration, which offers us a competitive advantage as directed energy applications are expected to move to programs of record. Turning to the industrial end market, our business grew 10% year-over-year in 2020. We saw continued demand growth in China beginning in mid-2020 that continues today, particularly as our customers continue their migration towards higher power laser solutions. In contrast, our global industrial customers generally operate at lower power levels and value our differentiated programmable laser technology. The sales cycle for many of these global industrial customers is quite long, and the design wins we’ve secured offer significant long-term growth potential. We’re also excited about the opportunities we have in metal additive manufacturing with our newly introduced AFX 1000 single-mode programmable laser. Turning to microfabrication. In 2020, our microfabrication sales declined by 10% year-over-year. However, after bottoming in Q1, we saw a rebound in our microfabrication business beginning in the second quarter that continued throughout the year. And in Q4, our microfabrication revenues increased by 15% versus the comparable period in 2019. We continue to improve performance and reduce costs of our high-power high-brightness semiconductor lasers, which we believe will enable us to meet the growing demand from a broad base of electronics manufacturing applications that require the use of lasers. We expect that the microfabrication market will be driven by continued improvements in next-generation applications in 5G networks and handsets, as well as the increased use of flexible printed circuits in consumer electronics devices, medical applications, displays, and other advanced electronics applications. Turning to Slide 5. In 2020, we increased our revenue in all geographies. In China, our 2020 revenue grew 10% year-over-year to $70.9 million. Full year 2020 sales to customers outside of China grew 35% year-over-year to $151.9 million, representing 68% of our total revenue versus 64% in 2019. Turning to Slide 6. In the fourth quarter, we had record quarterly revenue of $66 million, and we grew 53% year-over-year with growth in all of our end markets. Beginning with aerospace and defense, we grew revenues 57% year-over-year on an organic basis and 122%, including the $12.5 million contribution from Nutronics. A&D revenue in the quarter was driven by executing against long-term contracts with our core aerospace and defense customers and ongoing directed energy development work. Our industrial business grew 29% year-over-year in the fourth quarter. Growth in our industrial business was driven across all geographies as demand for both high-power and programmable fiber lasers continue to increase. Finally, within microfabrication, our sales increased 15% compared with the fourth quarter of 2019. During the quarter, we saw positive demand trends from multiple customers across a wide range of microfabrication applications.

Thank you, Scott, and good afternoon, everyone. Beginning on Slide 9. nLIGHT delivered record organic and inorganic revenue for both full year 2020 and in the fourth quarter. Full year 2020 revenue of $222.8 million was up 26% year-over-year and up 10% when adjusting for the $31.8 million contribution from Nutronics. Total revenue includes $184.8 million of product revenue and $37.9 million of development revenue. Fourth quarter revenue of $65.7 million was above the high end of our outlook, up 53% year-over-year and up 72% on an organic basis when adjusting for the $12.5 million contribution from Nutronics. Total revenue includes $51.7 million of product revenue and $14 million of development revenue. For year 2020, gross margin was 26.6% compared with 29.6% in the full year of 2019. Product gross margin was 30.6% for full year 2020 compared to 29.9% in the full year of 2019. Gross margin was 29.9% in the first quarter compared with 23.3% in the comparable period of 2019. Product gross margin was 35.9% in the fourth quarter compared to 24% in the fourth quarter of 2019. Turning to Slide 10 to provide more detail into our gross margins. It is important to remember that nLIGHT reports its revenue and gross margin in 2 segments: product and development. Our development gross margins are associated primarily with advanced technology development projects for the U.S. government, including the work we performed at Nutronics. Prior to the acquisition of Nutronics in November 2019, we reported our business and gross margin in a single segment. While we have always worked on advanced technology development programs, revenues from those programs were not material. Therefore, when evaluating our gross margin trends over time, it is important to compare what we classified as product gross margin today with our overall gross margin prior to the acquisition of Nutronics in Q4 2019. In the fourth quarter, we generated product gross margin of approximately 36%, which was approximately 1,200 basis points higher than our product gross margin in Q4 last year. While some of those improvements in our product gross margin is associated with a higher revenue level, the two primary drivers for our product gross margin expansion are increased product sales to strategic industrial and aerospace customers outside of China and continued cost performance improvement of our semiconductor lasers. As we look forward to the future, we believe that we can expand our product gross margin above 40%. This improvement will not be linear and will experience fluctuations quarter-over-quarter. We believe that our focus on strategic growth with our commercial customers outside of China, a growing proportion of sales to the high-power segments of the market in China, and continued success in our core defense business will enable us to further improve our gross margin over time. Turning to Slide 11. Operating expenses without stock-based compensation were $15.4 million during the fourth quarter compared with $15 million in Q4 2019. While we remain focused on controlling our operating expenses, we continue to invest in research and development to capitalize on an expanding set of organic growth opportunities. Turning to Slide 12. Non-GAAP net income for full year 2020 was $7.3 million compared with $1.1 million during 2019. Non-GAAP EPS for full year 2020 was $0.17 per diluted share compared with $0.03 per diluted share in 2019. On a GAAP basis, EPS for full year 2020 was a loss of $0.55 compared with a loss of $0.35 during 2019. Non-GAAP net income for the fourth quarter was $5.2 million compared with a loss of $2.1 million during the fourth quarter of 2019. Non-GAAP EPS for the fourth quarter was $0.12 per diluted share compared with a loss of $0.06 per share in the fourth quarter of 2019. On a GAAP basis, EPS for the fourth quarter was a loss of $0.12 compared with a loss of $0.29 during the fourth quarter of 2019. Full year 2020 adjusted EBITDA was $18.2 million or 8.1% of revenues. This compares to $9.9 million or 5.6% of sales during 2019. Fourth quarter adjusted EBITDA was $8.4 million or 12.9% of sales. This compared with a loss of $1.4 million in Q4 2019. Our improvement in adjusted EBITDA in both the full year and in Q4 was a result of higher gross margin and strong operating expenses control. It also demonstrates the operating leverage we generate from incremental product sales. During 2020, we generated approximately $13 million of operating cash versus a use of $4.3 million in 2019. While our operating cash flow will fluctuate on a quarterly basis, as it did in the fourth quarter when we consumed $1.7 million of operating cash, we continue to focus on maintaining the appropriate amount of working capital on our balance sheet to support our strong growth. Our capital expenditures for the full year of 2020 were $23.4 million. Included in this number is approximately $12.5 million that we used to purchase our Camas facility in early 2020. Excluding our expenditure on our Camas facility, CapEx as a percentage of sales was approximately 5%. We expect to continue to invest in CapEx related mainly to facility automation, infrastructure and manufacturing capacity. Turning to Slide 13. We ended Q4 with total cash and cash equivalents of $102 million. DSO for the fourth quarter was 38 days. Inventory at the end of the quarter was $55 million, representing 106 days in inventory. Our DSO and days of inventory remained relatively consistent with the prior quarter.

Thank you, Ran. We continue to believe in the long-term growth opportunities for semiconductor and fiber lasers, and that we are well positioned to outgrow the broader market. We believe that the market growth will be driven by two key factors: first, technology will continue to improve in a Moore’s Law-like cadence, which will enable lasers to continue to displace legacy technologies. Second, there are a broad range of end market catalysts that will drive demand, including long-term secular drivers from electric vehicles, additive manufacturing use for series production, adoption of next-generation 5G infrastructure and handsets, and new aerospace and defense applications. Our core strategy positions us well to increase our share of this growing market. nLIGHT is solely focused on providing high-power semiconductor and fiber lasers, and we believe that our vertically integrated business model is a critical differentiator. We continue to focus on the global industrial and aerospace and defense markets, which are the two key areas that we believe will drive our growth going forward. The combination of our technology and product portfolio, customer traction, new product introductions, and a commitment to these markets offers attractive growth opportunities. Over the past 20 years, we have remained tenaciously focused on the promise of high-power lasers, and the last year marks an important year in our history. I’d like to thank all of our employees for their exceptional performance and what shaped up to be a very challenging year in which to safely operate and grow a global business. With that, I will turn the call back over to the operator for questions.

And the first question will come from John Marchetti with Stifel.

Scott, could you take a moment to discuss the breakdown by different power levels in the presentation? It seemed that high-power was a bit weaker, while the strength was more pronounced at the low-power end. I would appreciate any insights you can provide regarding those dynamics.

Sure, John, it’s Scott. No problem. So yes, we didn’t emphasize the power here because it gets a little more complex. The bottom line is our growth outside of China was overwhelming the growth in the high power. So as you recall, in China, there’s a tendency to use relatively higher power fiber lasers for cutting; whereas in the global industrial customers outside of China, there’s less focus on the extreme high powers and more focus on the high-performance and notably the programmability that we provide. So as we grow outside of China, that brings that average down. We continue to see, nevertheless, a general expansion in high power both in China and the rest of the world. It’s just that the relative levels between the two are different today.

Got it. Okay. And then just on the margin side, Ran, if I can. When I think about your guidance for next quarter coming off of the 36% or so that you did non-GAAP and product gross margin in this last quarter. Is that largely a function of mix? How do I think about that step down from the 36% in this most quarter to sort of a midpoint of 32%, given the outlook? Is it volume-driven? Is it mix-driven? Just curious for some color there?

It is certain. It is both volume-driven and mix-driven.

The next question will come from Greg Palm with Craig-Hallum Capital.

Nice results. Maybe just starting off, would love to get your kind of thoughts on an order commentary thus far for Q1. I mean, any areas of strength, either by segment or geography that you want to call out?

Yes. Thanks, Greg. Scott here. Yes, nothing really calling out right now. We’ve continued to see improvements in microfab. We’ve really seen improvements throughout 2020 in all areas. As we said, the growth through the year, it was accelerating through the year. So we’ve seen that to continue. You always have Q1, the Chinese New Year uncertainty. I think underneath that, as you may know, this year in China, there’s far less travel, which probably will shorten and reduce the impact of the Chinese New Year this year, but you never know until you’re on the other side of that. So in general, throughout 2020, we saw acceleration in all of our markets and certainly heading into this year with the promise of a vaccine, certainly anticipating continued strength.

Okay. Maybe if I could expand upon that last answer I mean, I know you don’t typically give full year guidance. But just in terms of the cadence of how the year might shake out, I mean, going back a few years, I recall sort of Q1 starting off as the low point in building throughout the year. The last 2, I think, have been a little bit unique with all the puts and takes. Maybe just remind us kind of how you’re thinking about seasonal trends this year.

Yes. Let me remind you, typically, Q1 in the industrial market is the softest because of the Chinese New Year. And then conversely, Q2 tends to be one of the more dramatic growth quarters as we come out of the Chinese New Year. And you fold in some other cycles around microfabrication and upgrades and whatnot, it gets a little more complex there. But that’s, to the extent there is a cadence, that’s typically what we’ve seen. You layer in, each segment has different dynamics in aerospace and defense. We’re working on the government budget cycle. So there’s a little bit there. But the first order, I think, it’s that Q1 is softer, Q2 is stronger because of industrial, it’s probably the most pronounced sort of trend we typically see.

The next question will come from Jim Ricchiuti with Needham & Company.

Could you discuss the strength you’re observing in the industrial sector outside of China regarding programmable lasers? Scott, could you elaborate on the key applications where you're finding success?

Absolutely, Jim. Let’s see a few things. All three segments are important. I’ll start with cutting. In cutting, it’s a market that we had a smaller share to date. It’s a market where the design-in is a long process to get designed in. And we’ve worked through that over the last really five years. And the introduction of our programmable fiber lasers, I think, has been instrumental in our design wins there. So we’ve continued to make progress in that market with key larger customers. I think as we look ahead this year, Jim, I think the big trade show there, at least in the U.S., would be Fabtech, and then Europe will follow thereafter. And so there’ll be more information later this year. But we continue to make traction because of our programmability. Similarly, in the welding markets, it’s a very different set of markets, much more fragmented. But I’d say the high level there is to think about the EV from battery through new OEMs, and we’ve got some good design wins there. But a much more fragmented market. There aren’t as big design wins tend not to be as large. And then finally, in additive manufacturing in Q4, we launched our AFX product, which is our programmable fiber laser for that market. And we’ve been working in that space for many years now. I think that product launch has exceeded our expectations. And I think we’re really demonstrating some really pretty fundamental advantages in that market. It’s the smallest of the three markets, but it is one that is starting to inflect, where the productivity that we’re seeing is such that attitude is going beyond the really niche applications and into some really important higher volume applications. So continue to make traction there. So really all those markets, that’s a short summary of what we see going on.

That’s helpful, Scott. And just on the microfabrication business. Well, let me back up a second. And again, not looking for guidance necessarily beyond Q1. But can you characterize the visibility in the industrial business and microfabrication business, looking out beyond the quarter, just to give us a sense as to what you’re seeing? For instance, are you seeing any pickup as a result of the stronger smartphone cycle in microfabrication? Or is that still a relatively small part of the business?

Yes. Good, Jim. So in terms of visibility, just kind of high-level again. In some sense, defense, we have the best visibility, the longest term sort of outlook. Probably industrial is second, although it is much more limited. And then finally, microfabrication is probably the least visibility. We have indications of where things are going. But because that market is so fragmented, and we’re also back in the channel, we focus on the semiconductor laser that goes into other lasers that go into the systems that go to that market. It’s more difficult to get a very clear read on what we see. Having said that, we are seeing a pickup. And yes, we believe that part of that is driven by 5G new consumer electronics that are using lasers in new ways. But again, it’s a broad-based market. And we’ve talked a little bit about medical in the past. That’s an area where we see some continued expansion in that space. And then going forward, we continue to see that market proliferating and opening up quite a large number of new applications.

What was that growth that you saw in Q4, that 15% in the microfabrication, was that more or less in line with your expectations?

I think Q4 turned out better than we expected, but it was still in line with our projections.

The next question will come from Jed Dorsheimer with Canaccord Genuity.

Congrats on the quarter. First one, just on the upstream. I’m curious on the manufacturing, what the wavelength range is across your product offering from a materials perspective, not frequency doubling?

Yes, it's quite specialized at around 600 nanometers, really specialized. On the other end, just below 2 microns is also very specialized. However, we cover a wide range of wavelengths. We do have some presence in the blue, but it is quite specialized at this time. The majority of our work is focused around 1 micron for most applications.

Got it. And do you think the reason that I’m asking is just with the aerospace and defense business being a focus area, particularly around directed energy? Do you see that as being the area in terms of potential expansion on the upstream? Or do you think from a wavelength perspective, it will be tight around that range that you have?

Yes, generally in defense and particularly in directed energy, it's mainly around 1 micron. There are uses for longer wavelengths, like the eye-safe wavelengths of about 1,500 nanometers. While there are some applications in that range, most directed energy applications focus on around 1 micron. Other wavelengths may be used for different applications, but they often involve classified uses. Currently, and likely in the future, the volume remains around 1 micron.

Got it. So for eye-safe applications, would you need indium phosphide if you're not using a doubling technique, or can you achieve that with another material?

Yes. There are at least two ways to achieve this, Jed. One method involves using indium phosphide semiconductor lasers, where we have maintained a leadership position for a considerable time. We utilize our own semiconductor lasers for this. Another method involves using fiber lasers with different rare earth elements, with thulium being one example and erbium being another. These fiber lasers can be pumped at more conventional semiconductor laser wavelengths to reach the longer wavelengths needed for these applications.

Got it. One last question here. With the changes happening in the industry and the discussion about the benefits of your vertical integration, do you believe there will be a greater demand from the end application further downstream?

There is a lot happening, making it challenging to predict outcomes. However, we believe there are two key elements that are fundamentally important. First, focus is crucial, and we are dedicated exclusively to high-power semiconductor lasers, specifically direct semiconductor lasers and fiber lasers that are pumped by semiconductor lasers. This singular focus means we have developed a range of technologies and business systems related to this market. That’s point one. Secondly, we believe vertical integration is essential. This was a key reason for acquiring Nutronics; we felt that vertical integration was necessary to optimize the entire chain from the chip to beam control, ensuring there are no gaps in the value chain. We firmly support both of these principles and look forward to seeing how the industry progresses. This is at the heart of our critical beliefs.

The next question will come from Tom Diffely with D.A. Davidson.

First, Ran, with regards to your guidance on the advanced development part of the business being down as well. Is there normal seasonality in the defense business? Or is that just kind of quarterly lumpiness that we’re looking at?

No, it’s quarterly lumpiness. There is no seasonality with the defense in general.

Okay. Great. And then Scott, kind of similar to what Jim was asking earlier. When you look at your semi-laser business versus your fiber laser business, which one do you think is a bigger component of growth in 2021?

For ‘21 and really beyond what we’re focused on is the industrial market for those global players, and the vast majority of that is going to be driven by fiber lasers. Similarly, the directed energy application in defense will also be driven by fiber lasers. Important to remember that the semiconductor laser is critical technology in there. So there’s really important product development that we’re working on that supports that, but the end product for those two key growth areas are fiber lasers.

Okay. And then the final question related to that, has the margin structure for you between fiber lasers and semiconductor lasers decreased?

I don’t want to dodge the question because it is very complex. We don’t break out the margin across both categories; there are certain fiber laser categories that have much higher margins, and some that are more commoditized and have lower margins. So there’s variation across both, and we’re seeing continued improvement in our margins over the past few quarters. We expect to keep making progress in product margins. That said, our primary focus is on ongoing growth and adoption in the key markets we’ve discussed. As we’ve mentioned before, product margin is somewhat less meaningful regarding the R&D revenue associated with directed energy at this time.

Okay. I should ask, any impact from the unexpected snowstorm in the area?

Yes, we experienced some impact. There was a snow and ice event here in the Portland region. Fortunately, we maintained power on the Washington side, but a few of our employees in Portland are having some difficulties. However, we are managing.

Our next question will come from Paretosh Misra with Berenberg Capital Markets.

Great. So just curious if you could provide any color on your order book as to what you’re seeing? And how is it versus this time last year?

Yes. We do not disclose our bookings. However, we did observe continued growth in our markets throughout the year and are seeing good visibility. It is always challenging in the first quarter due to Chinese New Year, which makes long-term visibility difficult. That said, there is a strong pipeline of opportunities across all the markets we serve, and we are making progress in all of them.

Got it. And could I ask one more question? How significant is the automotive business for you? I’m assuming it falls under the industrial sector. Also, do you have any insights on the electric battery business and its current size for you?

Yes. Good. On a sort of relative basis, our exposure to automotive is relatively modest. We are relatively less penetrated into the automotive exposure. But we do have some exposure. Obviously, there’s some through cutting, but probably there’s more through the welding set of applications. And indeed, as you alluded to, it’s really the EV space that has opened up more opportunities for us. And it goes from the battery manufacturers, notably in Korea, Asia, China, to the new OEMs around the world that are developing new cars, new car parts that are using our lasers for both cutting and for welding. And again, as I mentioned, it’s a pretty fragmented market. I think we have significant room to continue to grow in that space. It’s a market that is expanding. It is opening up a number of new applications for lasers. And it’s a market that our products are well positioned for in a number of those key markets, and we have room to continue to grow.

Our next question will come from Mark Miller with The Benchmark Company.

Yes. I was just wondering in terms of the breakout of fiber laser sales, how did they do above 6 kilowatts? Was that stronger this quarter or weaker?

Yes. We provided the details, which you can find. This quarter, the sales above 6 kilowatts were slightly lower. I think, sorry, Ran, do you want to add anything about the numbers?

Yes. Mark, it was, it was 47% this quarter versus 58% in Q3 or 54% in Q2.

Yes, as I mentioned earlier, we observed an interesting trend across the industry. In China, there is a greater use of higher power fiber lasers compared to the rest of the world. As we move beyond China, this average may decrease somewhat, but we still see a continued global trend toward higher power.

In terms of the Chinese market, has the situation stabilized regarding pricing?

We don’t see significant changes there. We have observed some of the smaller players in that space struggling, and it's unclear what has happened to a few of them. Therefore, the number of competitors in that area does not appear to be increasing, and we don't anticipate substantial shifts in that market.

Just a couple of housekeeping issues. Your tax rate has been jumping around. What should we estimate for 2021?

So on a quarterly basis, you should estimate roughly $200,000 to $300,000 expense a quarter.

Okay. Stock-based compensation has been lower this quarter and is expected to be around $5 million or $6 million. Is that a good estimate?

No. This quarter, it was around $9 million, and that estimate should remain for 2021 as well.

So, it will be $9 million in the first quarter of this year also?

Roughly.

Yes. We’d like to thank everybody for joining the call today and the interest in nLIGHT, and we look forward to speaking with you all during the quarter. Have a great afternoon.

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