Good day and welcome to the nLIGHT Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Jason Willey, Senior Director of Investor Relations. Please go ahead.

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 360-567-4890 or at jason.willey@nlight.net. A copy of today’s earnings press release is available on our website at www.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 In addition, you can access an archived version of today's call from our website.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 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. Additionally, certain non-GAAP financial measures will be discussed on this call. We have provided reconciliations of these non-GAAP financial measures against 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 Ran to go through the financials and outlook. Scott will then provide additional color on the business. We will then be glad to take your questions.

Thank you, Jason and good afternoon everyone. We delivered second quarter revenues, gross margin, and adjusted EBITDA within the range we provided in early-May. Revenues for the second quarter were 48 million, down 7.1% year-over-year. During Q2, sales to the industrial end markets were 20.9 million, representing 44% of total revenues and down 17% year-over-year. Sales to microfabrication end markets were 18.1 million or 38% of total revenues and down 7% year-over-year. Aerospace and defense sales were 9 million or 19% of total revenues and grew 30%, compared with the second quarter of 2018. On geographic basis, sales to China were 18.2 million in the second quarter of 2019 or 38% of total revenues, down 23% compared with Q2 2018. Sales in North America were $18.1 million, representing 38% of total revenues and up 11% year-over-year. Rest of the world sales were 11.7 million, flat compared with the second quarter of 2018 and were 24% of total revenues. Gross margin was 33% in the second quarter, a decrease of 116 basis points year-over-year. Compared to the second quarter of 2018, gross margin in Q2 2019 was negatively impacted by approximately $800,000 or 170 basis points related to the U.S.-China tariff implemented in the past year. Gross margin was also negatively impacted by reduced pricing in the Chinese industrial end market. These headwinds were partially offset by cost reduction and positive product mix from increased aerospace and defense and high-power fiber laser contribution. The Chinese industrial end market represented approximately 24% of overall revenues during the second quarter of 2019, compared with 34% in the comparable period in 2018. Operating expenses were 15.1 million during the second quarter, compared with 12.1 million in the second quarter of 2018. Q2 2019 operating expenses include 2.1 million of stock-based compensation, an increase of…

Thank you, Ran. As Ran reviewed, our second quarter results reflect solid execution across a number of key areas. However, our business was negatively impacted by growing global economic uncertainties, ongoing U.S.-China trade tensions, and competition in the Chinese fiber laser market. These market headwinds have persisted well beyond what we expected in 2019 and our visibility into when these headwinds will lift is limited. Despite these challenges, we continue to see progress in a number of key growth areas. Our aerospace and defense business grew 30% year-over-year. The sixth consecutive quarter of double-digit year-over-year growth for this end market. Our industrial business outside of China grew 20% year-over-year. Here we continue to gain traction with large global customers driven by differentiation with our Corona laser. We also began to ramp sales of our 12-kilowatt fiber laser during the quarter, enabling us to address a growing segment of the Chinese market. Our view of the underlying fundamentals driving growth in the high-power laser market has not changed. We see opportunities for lasers to continue displace legacy technologies across industrial, micro fabrication, and aerospace and defense end markets. We believe continued improvement in both cost and performance will support double-digit market growth over the longer-term. In the industrial end market, our revenues declined 17% year-over-year in the second quarter, all of this reduction was in China, as we grew industrial revenue year-over-year in both North America and the rest of the world. In China, trade uncertainties and the rapidly evolving competitive landscape have created a very different operating environment than we experienced just 12 months ago. While China remains one of the largest markets for industrial lasers, we expect the Chinese industrial laser market to decline year-over-year in 2019. This is the first time this market has declined since we entered…

We will now begin the question and answer session. [Operator Instructions] And our first question comes from Greg Palm of Craig-Hallum Capital Group. Please go ahead.

Yes, good afternoon. Thanks for taking the questions, I guess just starting with the pricing environment. In China specifically, some of our checks have suggested that it's intensified somewhat over the last six weeks to eight weeks. And I guess I'm specifically talking on the fiber side. So, can you talk a little bit more detail on what you're seeing over there?

Yes, absolutely, Greg. So, I think your checks are correct. We've seen increasing competition has led to price declines that are greater than the historical average of what we see in the past of around 10%. So, we're seeing greater price declines due to the competition, primarily in lower power fiber lasers in China. We continue to see growth, though, in the higher power segment where we see limited competition.

Okay. And in terms of the gross margin guidance for Q3, I mean, any way to sort of quantify what's baked in from a competitive standpoint in terms of the gross margin guidance?

So, the only thing that we quantified for Q3 like we did for many quarters it’s the impact of the additional tariff, and our estimate that it's going to be roughly $1 million and this is what we guided. But if you will do the calculation, you can see that this is the majority of the impact there. There are many, many other things that impacted the margin, pricing, the mix, mix between the product, mix between higher power and low power, mix between the end markets, but we did not quantify each of them separately.

Okay, fair enough. And I know inventory ticked up again sequentially, I think previously you were expecting more of a second half ramp. Obviously, you alluded to the fact that it doesn't look like that will occur this year. So, I guess what's your comfort level there? At what point do you start work in some of that off?

The way that we are looking at the inventory is mainly on the level of inventory days and as you can see our inventory days this quarter was 116 and we are feeling comfortable anywhere between 100 to 120. This is our target. If it's going to be higher than that we will try to reduce the inventory, but the inventory level that we have right now, we are feeling comfortable with it.

Okay, perfect. I'll hop back in the queue. Thanks for the color.

Sure, thank you.

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

Hi, thanks. Good afternoon. Hi, Ran, I just want to make sure I heard you correctly. If we think about China Industrial, was that down about 35% year-over-year?

No, we are not going there to that level on China Industrial, but if you look at the industrial end market in general, the industrial end markets year-over-year went down 17%. We did not disclose how much was it in China. Obviously, it was higher than the 17% because outside of China we had a growth.

Well, let me ask you this. Was the microfabrication business up in China for the quarter?

Good, yes. Jim. We are not breaking out the micro – or the end markets by geography.

What I'm getting to. I'm just trying to find out. Are you seeing weakness as well in the microfabrication business or has that part of the business held up better?

Yes. Jim, this is Scott. So, I think, you know, directionally there, yes. We are seeing signs of, better growth actually in China in microfabrication. So, I think the new products that we have launched have done well and we've seen adoption by new customers around the world, but also in China.

Okay. And then two quick questions. I'm wondering how we might think about seasonality in Q4. And I'm not asking for guidance for Q4, but you know normally you would see seasonal weakness. Is it fair to assume sequentially we should think along those lines?

Jim, theoretically, you are right. And this is what we want to assume, but as we mentioned in the opening remarks. You know with the environment that we have right now, specifically on China, cannot repeat just the recent news that we heard related to China? It is very, very difficult to say what will happen in China in Q4.

I understand. How about aerospace and defense? That's really holding up better and I thought we were thinking – going into the year, I thought we would see some slowing, but it's remained strong. Can that maintain this kind of not necessarily this kind of growth, but are you feeling pretty optimistic about the second half on this part of the business?

Well, yes, I think you're exactly right, Jim, that we've seen continued growth there. We've got – we've got very strong track record for many years in this space. And we have ongoing programs that continue to do well. And in some cases – even better than we expected. Longer term, the directed energy programs are going to be some of the key drivers of growth. And while we – it's difficult to forecast the details there, we can tell you a little bit more about what's going on there. And we continue to get design wins. One particular one we can mention is, the Navy HELIOS program, which is one of the larger programs where we're supplying the key semiconductor laser technology. We've got differentiated technology that is lower weight, smaller size, very efficient. And we think we're very well positioned in this space.

Got it. Thanks very much.

Thanks Jim.

Our next question comes from Andrew DeGasperi of Berenberg. Please go ahead. [Technical Difficulty] Our next question comes from Tom Diffely of D.A. Davidson. Please go ahead.

Yes. Good afternoon. I guess digging a little bit more into your guidance for the third calendar quarter, it sounds like from a commentary that most of the difference that you're seeing in that versus your previous expectations is on the mid-range of the industrial market. Sounds like the high-end is holding up pretty much as expected?

Yes, I think that's right, Tom. You know, we have very limited visibility with the noise we are all seeing in the end the markets, but we continue to see strength in the new products that we've launched and higher power is one of those along with new products in our semiconductor lasers. And, you know, continue progress in defense also.

Okay. Have you seen any meaningful share shifting going on in this space or is it mainly everyone's participating in the price declines?

Are you referring to China specifically, Tom?

China specifically? Yes.

In China, what we've seen as we've talked about is, in the lower power segment, that's where we see Chinese domestic players notably. And those price declines, as I noted previously, are greater than we've seen in the past. And as a result of that, the overall market for industrial lasers in China is expected to decline this year. It's the first time, we've ever seen that happen. And so, there's pressure on all of the players in China, in particular at the lower power levels. Again, when you get to the higher power levels, that's where we see much more limited competition.

Okay. And is there anything that you can ascertain as far as the health of the smaller kind of second, third tier players in this space and where the pain level is? Whereas, there might be a backstop to pricing at some point?

You know, it's hard to understand all of the details of, the economics, but certainly we believe that for those lower power levels, you know, the pricing there is very challenging for the players. Even in China, you know, we have our own manufacturing assembly in China. So, we've got a good understanding of the cost structure. So, I certainly believe that low end of the market is one that we're not looking to for sure for growth. And it's one that I think will be very challenging for the players even in China.

Okay. And then last question. When you look at the tariff impact, is that just for the wafers you're sending to China? So, the Chinese tariff on your wafer is going to be packaged?

It is mainly that, but not just only that. I can tell you one thing about the tariff, which is important or on the gross margin in general. The reason – one of the reasons that we have quantified that is to explain that the change in the margin. If we will take as a point reference this quarter. We end up the quarter with 33% margin versus last year of 34.2% without the tariff impact, the additional tariff that was implemented last year, as a matter of fact this quarter with everything in it, the pricing and all of the topics that we are talking about, our margin would be higher than last year margin. Unlike at the beginning of the year, we are looking at the tariff as probably for here to stay and we are actively doing a few things in order to reduce the impact of the tariff, including moving manufacturing from the U.S. to China and vice versa, including changing some of the supply chain that we have from China to the U.S. All of that will help us to mitigate and reduce that cost. And we expect to see everything being equal. We expect to see an impact of those action at the beginning of next year.

Alright. Sounds good. Thanks for your time.

Thank you.

Our next question comes from David Ryzhik of Susquehanna Financial Group. Please go ahead.

Hi. Thanks, so much for taking the questions. Just to clarify on HELIOS. Are you the sole laser provider to the HELIOS? To the Navy contract? Just want to clarify that?

Yes. Good. Sorry, we can't comment further on that. we can't say that we are providing semiconductor laser technology for that program. Other details that program have to leave others to announce.

And anyways you think about when that program emerges from R&D stage into actual – putting products in the field?

Yes, I mean, it's one of many programs and those programs are still in the science technology development stages, but when specifically, they'll be launched? It's a little difficult to comment on. But what we are seeing are two trends. One, we're seeing more programs and we're seeing some of those programs pull in to be notionally much sooner than we previously thought. There's still – fairly slow relative to commercial markets in terms of the development milestones, but we are seeing increased number of programs and generally pull-ins there.

Got it. Thank you. And just on Corona, can you remind us why you talk about Corona outside of China? I realize China's a very challenged market right now, but what are the reasons why Corona would not make sense for some of your Chinese industrial customers?

Yes, it's a good question. We're not highlighting it right now, given all of the noise in China. But yes, certainly we believe that the economics of Corona makes sense around the world. And so, in the future, we'll address that a little bit more in detail, but right now, we're seeing significant interest, primarily outside of China. But over time, we think it will certainly address markets, not only around the world and in China, but also in really all of the applications that we serve from cutting, welding to additive manufacturing.

Great. And then just last one for me on that topic, and we've talked about this before, the welding opportunity. What are you seeing? What were the conversations like with welding customers, perhaps in the auto industry? What are you hearing? What kind of reception are you getting for Corona? Maybe when can we start to see some traction in welding with Corona?

Yes. Good. It has been well-received, we're getting strong interest from customers and there's nothing that we're announcing explicitly, publicly right now. But in coming quarters, we'll be talking more about that and automotive is one of the application areas where there's a strong benefit to the quality of the wells that Corona provides.

Great. Thanks so much, Scott.

Our next question comes from Andrew DeGasperi of Berenberg. Please go ahead.

Thanks for taking my question. Maybe first, when – if we could look at the June-July activity in China and in Europe, I know it's not a big portion of revenue, but could you let us know outside of pricing how that's been moving? Is it deteriorating a lot faster or is it being consistent with what you're seeing prior to June 1?

Yes, it's obviously very noisy, but certainly the sort of macro trends that we're seeing in the paper every day. You know, anecdotally, we're seeing that also in really a broad range of different markets from consumer electronics through, CapEx decisions on industrial equipment. So, our data is anecdotal and partial, but we're certainly it would certainly support the general macro trends that we're seeing.

Got it. And then in the ultra-high-power side. Just curious to know, have you been able to broaden your customer base from what's been traditionally one or two players with the sales growth that you've had?

You know, it hasn't been a significant area of emphasis for us more recently for high power. We're more focused on a broader range of customers with Corona and that's where we see the adoption occurring in a broader range of customers.

Got it. Thank you very much.

[Operator Instructions] And our next question will come from Patrick Ho of Stifel. Please go ahead.

Thank you very much, Scott. Maybe just first off, in terms of the business conditions that you mentioned in China and the challenges there, can you, I guess, give a little color on how you decide, especially in the low power range? Did you gain share over the last couple of years? How do you rationalize between walking away from a potential business deal because of the pricing pressures versus I guess, accepting them and taking a margin hit?

Yes, good. Patrick, obviously, a very specific detail set of analysis that we go through. But, in general, we're focused on high power where there is less competitive pressure at the low-end where it's very competitive and with really a set of products that are different, the reliability of the products that we see in many cases in China are just very different. So, it's really comparing apples to oranges. And if that's the case, yes, we will work from those opportunities.

Great, that's helpful. And, given the mix and the shift towards your ultra-high-powered lasers like you mentioned the 12 kilowatts that you've introduced that also targets the Chinese market. And you've mentioned that you haven't seen the pricing pressures there yet, but have you seen the application drivers and I guess the demand for the these ultra-high-powered lasers be there given the current market environment?

Yes, we have. We've seen continued very strong interest to continue to increase power. And, and we will continue to drive our roadmap for a higher power. But in addition to that, and indeed we think perhaps even a bigger opportunity is with Corona worldwide. Really outside of China too where we get much higher performance, even at lower power levels. So, looking ahead, there is where we see the interesting growth are in many cases in the near-term outside of China. In industrial markets and then obviously in aerospace and defense sector.

Great. Thank you very much.

Pleasure.

This concludes our question and answer session. I would now like to turn the conference back over to Jason Willey for any closing remarks.

I'd like to say thank you to everyone for your continued interest. Please feel free to reach out if anyone has any additional questions. Have a great rest of your day.

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