Earnings Call Transcript - LASR Q2 2020

Operator, Operator

Good day and welcome to the nLIGHT Second Quarter 2020 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Jason Willey. Please go ahead.

Jason Willey, Senior Director of Investor Relations and Corporate Development

Thank you, and good afternoon everyone. As the operator said, I am Jason Willey, nLIGHT's Senior Director of Investor Relations and Corporate Development. Scott Keeney, Chief Executive Officer of nLIGHT and Ran Bareket, Chief Financial Officer will be speakers on today's call. If you have any questions after the call, please direct them to me at jason.willey@nlight.net. A copy of today's earnings press release and the earnings slide presentation are available on the Investor Relations section of our website at investors.nlight.net. In addition, you can access an archived version of today's call from our website. In today's call, our discussion will contain forward-looking statements, including statements about the potential impact of the ongoing COVID-19 pandemic, financial projections, future business growth, trends and related factors, prospects for expanding and penetrating the addressable markets, and our strategic focus and objectives. Forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, including the risks and uncertainties described from time to time in our SEC filings. Our results may differ materially from those projected on today's call. We undertake no obligation to update publicly any forward-looking statement, except as required by law. Additionally, certain non-GAAP financial measures will be discussed on this call. We have provided reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures in our earnings release, which can be found on the Investor Relations section of our website. I will now turn the call over to Scott, who will provide an update on the current environment and the markets we serve. Ran will then go through our financials and outlook. We will then be glad to take your questions.

Scott Keeney, Chief Executive Officer

Thank you, Jason. Q2 was another strong quarter of execution for nLIGHT in what remains a challenging operating environment. We generated record quarterly revenues and delivered financial results at or above the high end of the outlook we provided in May. The key driver of the better than expected performance was our Industrial end market, where sales grew 8% year-over-year, even as global economic uncertainty remained elevated due to COVID-19. Our business in China was strong in the quarter as the demand rebound that we experienced in April continued throughout the quarter and in July. The strong revenues flowed through to improvements in product segment margin, relative to the past two quarters and generated better than expected overall profitability. The stronger sales, combined with cost controls, enabled us to grow our net cash position during the quarter, while continuing to invest in the R&D roadmap we believe is necessary to drive sustainable long-term growth. I will start with Slide 4 of our earnings presentation and look at the current business environment for our three end-markets. As we sit here today, demand continues to remain resilient globally, particularly in the industrial end markets, even as macro uncertainties and operational challenges related to COVID-19 persist. Beginning with Aerospace and Defense, we grew revenues 5% year-over-year on an organic basis and 68% including the $5.7 million contribution from Nutronics. This performance demonstrates the solid and sustainable foundation of business we have with our core defense customers and the early stages of the long-term opportunity we see in the directed energy market. nLIGHT has a long history of serving Aerospace and Defense customers and is a key supplier of semiconductor laser and related technology to a number of ongoing programs for applications including, countermeasures guidance and measurement. As we look out over the next several years, our primary focus within Aerospace and Defense is directed energy. We see solutions serving the directed energy market having the potential to drive growth in both our products and development segments. During the second quarter, we continued to make good progress at Nutronics with work on several key government contracts. Within directed energy, we believe we are positioned as a leader in the market with our vertical integration of key enabling technologies from semiconductor lasers through beam control. Within Microfabrication, our sales were down 21% compared to the second quarter of 2019, but grew sequentially for the first time since Q2 of last year. Compared with 2019, sales remained constrained by more limited market activity across several key end applications, including consumer electronics and automotive. However, we are encouraged by the signs we saw from several of our key global customers, and we had record contribution from Chinese manufacturing customers. We believe the primary end driver for this strength in China is investment in ramping product manufacturing to support 5G, including networks and handsets. Our Industrial business grew 8% year-over-year in the second quarter, the highest level of revenue from this end market since Q2 of 2018. Strength in the quarter was driven by strong demand in China where we continue to see growing customer interest in our high powered fiber lasers. We made good progress in ramping recent design wins globally and we expect this success to be even more evident in our revenues over the coming quarters. We've enhanced our position within a number of key accounts globally by providing differentiated technologies such as programmability, the introduction of enhanced solutions for welding applications, and by continuing to offer strong customer support. Moving to Slide 5. Across all geographies, our fiber laser sales continue to shift to higher power. During Q2, our 6 kilowatt and above fiber laser sales more than doubled year-over-year. Sales in this category accounted for approximately 54% of our total fiber laser sales, which compares to 35% in the comparable period in 2019. We continue to drive our product roadmap to support higher power levels and provide customers with highly reliable differentiated solutions. We are well-positioned within the industrial markets to benefit from our customers' increasing focus on diversifying their supply chains. With the growing movement to examine and diversify the location of manufacturing operations and supply chains, we see opportunity for the integration of more automation and lasers into industrial production. While these types of decisions and movements do not happen overnight for most companies, we are seeing clear signs of increased interest in these types of initiatives globally. We believe this can be a long-term tailwind for the laser industry and nLIGHT. Turning to Slide 6. In the second quarter, 41% of our sales were in China, up 18% compared with the year-earlier period. During Q2, we experienced a typical seasonal rebound that we believe was amplified by stronger customer activity post Q1 COVID-19 headwinds. Customer activity in China reflects robust demand across both the Industrial and Microfabrication end markets. Outside of China, we saw resilient demand across the Industrial end market and we continue to enhance our positioning at key customers. Within Microfabrication, we saw positive signs at a handful of our global customers as sales grew sequentially, but activity in this end market remains below levels seen in late 2018 and early 2019. As we look to the third quarter and beyond, we are encouraged by the progress we continue to make in the long-term growth drivers in our Industrial business outside of China and in directed energy. We expect this progress will be even more evident in our Q3 results and our financial performance moving forward. I would also like to take a moment to note that we celebrated our 20th anniversary in Q2. We founded nLIGHT in June 2000 with a vision that semiconductor laser technology will continue to improve rapidly and open new markets and new applications. What seemed impossible 20 years ago has become reality with high power lasers deeply embedded in critical tools and applications across multiple end markets. Even with all that, we, in the industry, have accomplished over the past 20 years, I am more excited today about the opportunity in front of us than I have been at any point in the company's history. nLIGHT continues to be guided by the same principles upon which the company was founded to rapidly innovate our technology and drive further adoption of high-power laser solutions. Finally, I'd like to end my prepared remarks today, as I did last quarter, by extending a word of gratitude to our global employee base for their extraordinary efforts over the past two quarters. The dedication of all nLIGHT employees through these challenging times has helped ensure that we not only sustain our operations and support our customers and partners, but have continued to drive our innovation and enhance our ability to deliver sustainable long-term growth. I will now turn the call over to Ran to provide more detail around our Q2 financial performance and outlook for the third quarter.

Ran Bareket, Chief Financial Officer

Thank you, Scott, and good afternoon, everyone. Beginning on Slide nine. Second quarter revenues of $52.1 million were above the high end of our outlook, up 8.5% year-over-year and down 3.4% on an organic basis when adjusting for the $5.7 million contribution from Nutronics. Total revenue includes $45.1 million of product revenue and $7 million of development revenue. The primary driver of the better-than-expected revenue was strong demand in China across industrial and microfabrication end markets. Moving to Slide 10. Gross margin was 25% in the second quarter compared with 33% in the comparable period of 2019. Product gross margin was 27.7%, and the development gross margin was 7.8%. Our Q2 product gross margin was impacted by price reduction and unfavorable mix compared with Q2 2019. This included lower microfabrication sales and a higher proportion of revenues from China. Partially offsetting these margin headwinds were ongoing cost reductions and lower-than-expected tariff costs. On a sequential basis, gross margin improved by 300 basis points. Turning to Slide 11. Operating expenses were $19.1 million during the second quarter compared with $15.1 million in Q2 2019. Operating expenses included $5.7 million of stock-based compensation, an increase of $3.6 million year-over-year. Also included in Q2 results were $656,000 of purchased intangible amortization related to the Nutronics acquisition, compared with no purchased intangible amortization in Q2 2019. Excluding stock-based compensation and purchase amortization, operating expenses were essentially flat compared with Q2 2019. Our second quarter OpEx demonstrates continued focus on controlling costs, while ensuring we are making the necessary research and development investment to drive future growth. Moving to Slide 12. GAAP net loss for the second quarter of 2020 was a loss of $6.8 million compared with a loss of $155,000 during Q2 2019. GAAP EPS for the second quarter of 2020 was a loss of $0.18 per share compared with $0.00 per share in the second quarter of 2019. Our adjusted EBITDA for the second quarter was $3.3 million or 6.2% of revenues. This compares to $5.5 million or 11.4% of revenues in Q2 2019. While the second quarter adjusted EBITDA declined year-over-year, the results were above our outlook range driven by better than expected revenues and cost controls. During Q2, we generated $8.1 million of cash from operating activities. Capital expenditures for the quarter were $1.9 million or 3.6% of revenues. Moving to Slide 13. We ended Q2 with total cash and cash equivalents of $121 million and $15 million in debt. DSO for the second quarter of 2020 was 44 days. Inventory at the end of the quarter was $51 million, representing 115 days in inventory. Our balance sheet remains strong and provides ample flexibility to execute our long-term strategy. Turning to Slide 14 and the outlook for Q3 2020. Based on the information available today, we expect Q3 revenues to be in the range of $54 million to $60 million. At the midpoint of $57 million, this includes approximately $46.5 million of product sales and approximately $10.5 million of development sales. We continue to see positive demand trends across each of our commercial end markets and geographies. Based on our current expectation for product mix, we see gross margin for Q3 2020 in the range of 22% to 26%, which includes approximately $600,000 of stock-based compensation. Product gross margin is expected to be in a range of 26% to 30% and development gross margin is expected to be approximately 7%. Operating expenses for Q3 2020 are expected to be approximately $20.5 million, which includes approximately $6 million of stock-based compensation and $656,000 of purchase intangible amortization related to the Nutronics acquisition. Included in this outlook is an additional $0.5 million in SG&A expenses primarily for additional spending related to Sarbanes-Oxley, and move costs associated with our new Camas, Washington facility. For the third quarter, we expect adjusted EBITDA in a range of $1 million to $5 million. We expect Q3 average basic share to be approximately $39 million. We now expect the full year's revenue contribution from Nutronics to be in a range of $28 million to $30 million. The updated outlook reflects continued progress on work for key programs, but some delays in hiring and onboarding new employees and supply chain disruption. We view this delay as short-term in nature and there has been no change to the structure of funding associated with the Nutronics key contracts.

Operator, Operator

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

Greg Palm, Analyst

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

Scott Keeney, Chief Executive Officer

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

Greg Palm, Analyst

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

Scott Keeney, Chief Executive Officer

Yeah, no problem. So what we're seeing is strong growth really across all of our end markets, and we listed those in Q2 and we see continued growth. For Q3, we see continued strong demand, and, longer term, we remain very optimistic about the continued displacement across all those different end applications. I do want to say that, given the ongoing uncertainty related to COVID, we're certainly not in a position to talk much beyond Q3, but we continue to focus on execution, and that's why we noted what we're seeing in July.

Greg Palm, Analyst

It's helpful to see that you're projecting a slight increase in product revenue compared to Q2. The gross margin appears to be slightly up at the midpoint, suggesting that the mix in Q3 is likely to remain similar to what was observed in Q2, or potentially decline slightly. Is this an accurate interpretation? Looking ahead, what will it take to boost product gross margin back to over 30 percent? Is this primarily influenced by the mix of the business, or can it be achieved through cost absorption if volume increases significantly?

Ran Bareket, Chief Financial Officer

Sure. So from Q1 to Q2, we saw an improvement of approximately 300 basis points in product margin, which equates to about 7% to 8%. This enhancement was primarily driven by increased volume, lower costs, and growth in segments where we achieve higher power outputs. The growth is occurring in areas with better margins, notably from industrial revenues both inside and outside of China, particularly in the high-power segment—specifically for products over six kilowatts, like the 12 and 15-kilowatt models. Additionally, we are seeing incremental revenue from microfabrication and the defense market. Our growth is coming from segments with improved margins compared to Q1, and I anticipate that as we continue this trajectory, we will experience further improvement in margins moving forward.

Greg Palm, Analyst

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

Ran Bareket, Chief Financial Officer

Thank you.

Operator, Operator

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

Tom Diffely, Analyst

Yes. Good afternoon. So Scott, maybe the first question on the microfabrication market. It's typically the time of year when things pick up a bit. I'm curious, did COVID kind of wipe out the growth this year? Or what are you seeing from an activity point of view?

Scott Keeney, Chief Executive Officer

Yes, Tom. In terms of microfabrication, although we are not experiencing the same year-over-year levels as before, we are witnessing growth. This growth is being fueled by various factors, including 5G, but there is a wide array of end applications contributing to this trend. One application noted was in marking and mask manufacturing, which saw a significant increase in demand in Q2. Overall, there is a diverse range of end applications, and we are observing continued growth in this segment. While it's uncertain if it will return to previous levels due to various cycles, we are currently seeing growth.

Tom Diffely, Analyst

Okay. Given the developments over the past couple of years, do you still maintain a strong outlook on that market, particularly with respect to consumer electronics and smaller industrial applications?

Scott Keeney, Chief Executive Officer

There is indeed much more to consider. Medical applications are one area for us. We have a variety of different end applications. Therefore, I believe we will continue to see a diverse set of end applications in what we refer to as microfabrication. Consumer electronics has always been significant, and that will remain the case. However, we also observe a very wide range of applications that will keep being supported by lasers.

Tom Diffely, Analyst

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

Scott Keeney, Chief Executive Officer

Good. Yes. So we are moving in. We already have one production line up and running in Camas. And yes, we're back in the office every day there. One of the benefits of Camas is we have more space to spread out. So with respect to managing in the COVID crisis, it provides a much enhanced need. We were pretty jammed in our previous offices. So that's been good. And we're going to continue to build out manufacturing lines, and we are doing that right now. So we're on track, and it certainly has been a very nice unforeseen benefit given the COVID crisis.

Operator, Operator

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

Jim Ricchiuti, Analyst

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

Scott Keeney, Chief Executive Officer

Yes, Jim, it was cutting out slightly there. Can you just repeat the fundamental question? It was, somebody was commenting on deceleration, was that correct? In China?

Jim Ricchiuti, Analyst

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

Scott Keeney, Chief Executive Officer

Yes.

Jim Ricchiuti, Analyst

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

Scott Keeney, Chief Executive Officer

Yes.

Jim Ricchiuti, Analyst

...for market share.

Scott Keeney, Chief Executive Officer

Typically, the second quarter, just after Chinese New Year, is a very strong period in China, and we generally see that demand taper off during the summer months heading into the third quarter. In Q2, we experienced strong demand, as reflected in our numbers, and currently, we are observing ongoing demand that exceeds what we typically see for Q3 at this time. However, we usually notice some decline in Q3 in China, but as we mentioned, demand has been holding steady in July.

Jim Ricchiuti, Analyst

Got it. And on the Nutronics side, the Nutronics business narrowing their range, it seems like there has been a little slippage, a little bit of that. Do you see some of that revenue coming in early next year?

Scott Keeney, Chief Executive Officer

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

Jim Ricchiuti, Analyst

Yes.

Scott Keeney, Chief Executive Officer

Yes. Yeah, so... Got it. So you're talking about narrowing of the range and that additional revenue comes in, in the upcoming quarters. Yes, this is all about revenue recognition. The bookings are in place; it’s a matter of when we will recognize that revenue. There has certainly been some impact from COVID resulting in supply delays and personnel issues, but nothing fundamental. We are on track, and from a revenue recognition perspective, we wanted to clarify what we are observing now. We are making good progress on integration and on validating the acquisition's thesis to enhance our efforts and what Nutronics has been doing by fully integrating the technologies.

Jim Ricchiuti, Analyst

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

Scott Keeney, Chief Executive Officer

Yes, I think "surprise" is a reasonable word to use, Jim. When the crisis first hit, we were very cautious and thoughtful about the potential scenarios we needed to manage. What we've seen is continued good demand across the board. So, I wouldn't say it's a surprise or a shock, but it's a better outcome than we had worried about when the crisis first began. We will remain more concerned than usual about the outer quarters as we've noted. However, we are seeing continued strength in all of our end markets, at least for Q3.

Jim Ricchiuti, Analyst

Okay, thanks a lot.

Scott Keeney, Chief Executive Officer

Thanks, Jim.

Operator, Operator

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

Jed Dorsheimer, Analyst

Hi, thanks, and good quarter. I have two questions: one regarding the cost structure and the other about the margins. First, I'm curious about operating expenses. I joined a bit late, but I'm somewhat surprised that, despite the lack of travel, we aren't seeing lower operating expenses. Is this related to the acquisition, and should we expect more significant cost reductions in the future, or is this the low point we will grow from?

Ran Bareket, Chief Financial Officer

First of all, if you examine the operating expenses, excluding stock-based compensation and the amortization of intangibles related to the Nutronics acquisition over the last eight quarters, we have remained fairly consistent, hovering between $12.5 million and $13 million. Additionally, travel is not a considerable expense for us; we do not travel first class. What is evident is a decrease in selling, general, and administrative expenses coupled with an increase in research and development. We are continuously investing more in R&D, while SG&A has decreased because we are effectively managing our operating expenses, including minimal travel costs. Looking ahead, again excluding stock-based compensation and amortization, we anticipate a slight increase in operating expenses, roughly around $0.5 million per quarter, leading to a range of $13 million to $13.5 million. However, it will not exceed that amount due to compliance with Sarbanes-Oxley and costs associated with relocating to the new facility in Camas.

Jed Dorsheimer, Analyst

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

Ran Bareket, Chief Financial Officer

Sure, sure.

Jed Dorsheimer, Analyst

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

Ran Bareket, Chief Financial Officer

Our ability to enhance the margin largely relies on three key factors. Firstly, an increase in revenue is essential. Secondly, our success in reducing costs, which we have significantly achieved over the past few years, has countered much of the decline in average selling price we experienced in the market. Lastly, we will manage the product mix to focus on areas that yield higher margins. This includes revenue from the industrial market outside of China, high-power segments both in China and globally, along with our efforts to increase revenue in microfabrication, aerospace, and defense sectors.

Jed Dorsheimer, Analyst

Got it. And then last question for Scott. Just curious, as you look at the directed energy program, do you consider it politically neutral, or do you see it affected by the defense budget in relation to whether a Democrat or Republican holds office? I'm trying to understand the potential risks and whether investment spending in this area will remain fairly insulated moving forward.

Scott Keeney, Chief Executive Officer

Yes. Good question, Jon. So if we look historically, I would say that the directed energy funding has been very strongly bipartisan. The budget effectively doubled under Obama and the DE Caucus is a strongly bipartisan group. So I don't think first order, there's a strong influence in the typical partisanship in D.C. Obviously, defense budgets as all budgets, there'll be that much more pressure. But I will say that directed energy is one of the highest priorities for DoD. So yes, it's not a first-order concern that we're thinking through.

Jed Dorsheimer, Analyst

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

Unidentified Company Representative, Company Representative

Thank you.

Operator, Operator

We are showing no further questions at this time. So this will conclude our question-and-answer session. I'd like to turn the conference back over to Jason Willey for any closing remarks.

Jason Willey, Senior Director of Investor Relations and Corporate Development

I'd like to thank everyone for their participation today. And we look forward to speaking with many of you over the coming weeks. Everyone, stay safe.

Operator, Operator

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