Good day and welcome to the nLIGHT First Quarter 2020 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 Jason Willey, nLIGHT’s Senior Director of Investor Relations and Corporate Development. 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 speaker on today’s call. If you have any questions after the call, please direct them to me at 360-567-4890 or jason.willey@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 In addition, you can access an archived version of today’s call from our website.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. As 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 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 would also like to note that members of nLIGHT management will participate in several virtual conferences over the coming weeks, including Oppenheimer on May 12, Needham on May 19, and Craig-Hallum on May 27. I’m going to 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, Jason. Before discussing nLIGHT’s financial and business performance, I want to say a few words on the COVID-19 pandemic, which has had an unprecedented impact on global daily life and economic activity. Through these uncertain times, our priority is ensuring the health and well-being of our global workforce and the communities in which we operate. At the same time, we remain focused on supporting the needs of our customers, suppliers and partners. As a provider of essential products and technologies to a variety of critical aerospace and defense, industrial and medical-end applications, all of our manufacturing facilities remain open. We have implemented safety procedures at our facilities based upon local and federal government guidelines to protect the wellbeing of each of our employees. I want to express my deep gratitude and appreciation for all nLIGHT employees who put an extra effort to sustain our operations through these difficult times. We continue to invest in the development of our differentiated technology. And we remain steadfast in our belief that we are positioned to deliver significant growth over the long term. In industrial applications, high-power lasers remain underpenetrated, particularly in geographies outside of China. Additionally, global manufacturing operations increasingly require the ability to work with complex parts in an automated manner. Both these dynamics are key drivers for future laser adoption. We are well positioned to capitalize on these trends with our industry-leading semiconductor laser technology, a full portfolio of highly reliable fiber lasers and truly differentiated offerings such as programmability. In aerospace and defense, we expect spending on directed energy lasers to expand meaningfully over the coming years. Fiber laser technology continues to improve and governments are increasing their focus on deploying laser technology in the field. Here, we are a leader with our vertical integration of key enabling…

Thank you, Scott, and good afternoon, everyone. Beginning on Slide 9. Revenue of $43.2 million was up 3.2% year-over-year and down 7.4% on an organic basis when adjusting for the $4.4 million contribution from Nutronics. Total revenue include $36.9 million of product revenue and $6.3 million of development revenue. While we face significant challenges in the quarter as COVID-19 impacted global economic activity, our performance exceeded the outlook range we provided in mid-February. The primary driver of the better-than-expected results was our ability to meet greater portion of customer demand compared with our initial expectations. Our Chinese manufacturing operation ramped faster than we anticipated post-shutdown, and we experienced only limited supply chain disruption. Demand in the quarter also proved more resilient than we expected, particularly in the industrial business outside of China. Moving to Slide 10, gross margin was 22% in the first quarter compared with 32.3% in the comparable period of 2019. Product gross margin was 24.5% and development gross margin was 7.5%. Overall gross margin was negatively impacted by lower product sales volume, price declines and unfavorable mix, which was partially offset by cost improvements. During the quarter, we saw an almost $5 million year-over-year decrease in product revenue, significantly lower contribution from the microfabrication end market and $6.3 million of development revenues at 7.5% gross margin. The negative impact on Q1 gross margin of U.S.-China tariff implemented since mid-2018 was approximately $1 million. Turning to Slide 11, operating expenses were $16.2 million during the first quarter compared with $14.6 million in the first quarter of 2019 and $19 million in Q4 2019. First quarter operating expenses included $3.4 million of stock-based compensation, an increase of $1.7 million year-over-year. Also included in Q1 results was $656,000 of purchase intangible amortization compared with no intangible amortization in Q1 of…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from John Marchetti with Stifel. Please go ahead.

Thanks very much. Scott, I was wondering if you could talk a little bit about how you’re seeing demand outside of China as you’re looking at this 2Q here, maybe either by end-market or a little bit more by geography. And I’m just curious within that, if you have an expectation built in for a negative impact from COVID beyond just the sort of uncertainty that you’re still seeing out there.

Yeah. Thanks, John. So with respect to aerospace and defense, I think our outlook there remains strong. And obviously, the budgets that drive that demand are not affected directly. Certainly, we see supply chain disruptions across the board, but in demand you have very strong outlook there. Outside of China in the industrial and microfabrication markets, it’s more difficult. We certainly are seeing strong demand right now. But beyond Q2, it’s difficult to understand the implications of COVID.

And then, I guess, just – as part of that, in the actual 2Q guidance, is there an expectation for a hit from COVID directly the way that you highlighted that $8 million in the first quarter? Or do you see it really more just a function of as demand shapes up, it’s already incorporated sort of in that?

Yeah, already incorporated, that we’re seeing good demand across all markets for the Q2 outlook that we provided.

Great. And then just maybe as a last follow-up for me, if I think about the China market specifically, obviously, you continue to look for ways to mitigate some of the competitive pressures there and then seem to be succeeding at that. Can you talk at all about what the pricing environment looks like there for you right now?

Yeah, I think with respect to China and pricing, we’ve seen sort of more normal pricing as of late. And as I mentioned, I think as we showed the data, we’re certainly seeing the shift to higher power lasers. And as you go to higher power, technology gets more difficult and certainly less competition there.

Great. Thank you very much for the color.

Thanks John.

Our next question comes from John – I’m sorry – Joe Wittine with Edgewater Research. Please go ahead.

Hi, thanks. Can you guys hear me?

Yeah, no problem, Joe.

Okay, awesome. Great results. In D&A, I was wondering if there is any sign that orders were pulled in ahead of the supply disruptions, or is this just kind of organic demand, the strength you saw?

Yeah, it’s organic. We didn’t see any pull-ins there. So we saw demand across both the new segment we’re listing for development, but also in our legacy products also continued growth there.

Okay. And then, maybe as a follow-on to the prior question on price declines, Scott, I think you said China industrial is not impacted. But, Ran, you mentioned at some point, I think in your gross margin commentary that there were some price declines that impacted the GM line. Could you go into detail on just what segment or products that implies?

Sure. When Scott commented on the price decline, he talked about Q1 first quarter compared to the previous quarter, where we saw some stability there. In my opening remarks, I talk about previous quarter, previous year in Q1 2019 versus Q1 2020, obviously, year over year there is some price impact on the margin from China.

Got it. Sorry, I misinterpreted that. Maybe just finally for me, on the commentary, Scott, on fiber lasers being underpenetrated, I think you said outside of China. Could you give any more details there on where the most fertile market opportunity is for the broad market and specifically for nLIGHT from a product and geographic perspective?

Yeah, sure. I mean we certainly see opportunities for growth across the globe. I think outside of China, where we’re seeing strong continued growth really in all of the end-markets in cutting, especially as we continue to ramp our products that offer the programmability. Well-being, I think we’re still in the earlier days there. We’re seeing some good initial demand, obviously, in EV and other areas. And then finally, additive manufacturing remains an opportunity that I think will be important for the future. So really across the board, we see the opportunity for lasers to continue to displace, and then, also continue to enable new applications. And as I mentioned, automation is certainly one of the general themes that we see driving a lot of this demand.

Understood. Thanks, guys.

Great. Thank you.

And our next question today comes from Tom Diffely with D.A. Davidson. Please go ahead.

Yes, good afternoon. I was hoping you can give us a little color on what you’re seeing on the higher margin microfabrication part of your business.

Good. Hi, Tom. We’re definitely seeing demand picking up in that area. And the end demand that appears to be driving that is notably in 5G and infrastructure and handsets, as short pulse, lasers continue to be important in that space. We have a very strong position in providing differentiated semiconductor lasers that drive those sort of lasers. There are other end markets also, such as marking and new applications that are using those lasers. But I think at the highest level, the 5G demand does appear to be one of the drivers of demand growth there.

Okay. Would you expect the percentage of microfabrication to be larger next quarter?

Percentage overall or?

Yeah. Well, percentage of your products.

Tom, we are not breaking out the – in the guidance to the different end markets. But I can tell you that we are seeing for – embedded in the Q2 guidance that we gave, we are seeing a strong demand throughout the 3 end markets that we’re serving.

Okay. Good enough. And then, Ran, when you look at the $2 million-plus that’s come out of the OpEx over the last quarter, it looks like it’s going to stay out. Are those driven by just kind of your temporary cost reduction measures? Or are some of those – some of that reduction more permanent?

So if you look at the OpEx, the right way to look at the OpEx is without stock-based compensation. There is a little bit up and down in stock-based compensation since some of the costs there depend on the stock price. If you will take out the stock-based compensation, a good range for our OpEx, it’s anywhere between $12.5 million to $13 million a quarter. It was right for the last 5 quarters or so. And it would be right for the next quarter as well.

Okay. And then finally, I guess, when do you plan to move into your new facility?

We’re in process right now. It will be an ongoing process. Moving sophisticated manufacturing processes does take time. But we are excited about implementing our new automated manufacturing in this facility. It’s a nice facility. Sharp Laboratories was the previous site. And we’re out looking forward to ramping up over the coming quarters.

Great. Thanks for your time.

Thank you, Tom.

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

Thank you. Good afternoon. Hey, Scott, I’m looking at the Nutronics revenue range that you’re providing for 2020. And it’s a little surprising. We’re 4 months into the year, and that range isn’t moving much. And I’m wondering, if you could help us maybe to understand what you might be seeing and when you might have a better idea of how that portion of the business plays out?

Yeah. Good. Yeah, certainly, what we’re seeing is the end demand is solid there. There – to date, there’s been some delays on the supply chain there. But that end demand is remains solid. So the timing on that revenue is what leads to that uncertainty. But we have pretty good visibility into the end demand that is driving that.

And if we think about getting to the mid or higher end of that range, is this line of sight for revenue late in the year? Or there are some projects that could hit earlier, but it sounds like whatever is you’re seeing is getting shifted a little bit to the right.

Yeah. It’s just timing. So the demand doesn’t change. It’s just the timing on when we deliver and when we recognize that revenue. Does that help you?

Okay. Yeah, it does. Ran, if I look at the laser product revenue guidance at the midpoint, the $41.5 million for the June quarter? I’m wondering, how we should think about gross margins and when you could – at what levels of higher product revenues could we begin to really see the gross margin lift that maybe we’re more accustomed to going back to early 2019?

Sure. So you’re looking at it correctly, and you need to look at the product segment rather than the entire company, obviously, the development segment is coming with 7%, 7.5% margin, which would impact in higher margin for the company. However, for the product segment, you saw that we improved the margin quarter-over-quarter from Q4 to Q1, and the guidance that we provided is also with higher margin on the product segment. Going forward, again, it’s the same story. As we will continue to grow the company, especially the microfabrication where the margin is higher as well as the industrial, where we are moving more and more to getting revenue outside of China. And within China, revenue, you see that we grow significantly the high-end or high-power 6-kilowatt and above year-over-year. And that portion will even grow further as well. All of those factors will help us to improve the margin. Obviously, there is always the tariff that we are paying this quarter. In Q1 2020, we paid $1 million, as I mentioned, which is more than 2% on our margin. Once that will go away, and hopefully, it will be soon, the margin will improve as well. So the same factor was that that we saw in previous years, definitely, we will see that going forward as we grow the company.

But it sounds like one of the big levers in this is going to be the eventual pickup and sustainable pickup in microfabrication.

This is correct.

Yeah. Okay. Thank you.

Sure.

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

Thank you. I was just wondering, IPG reported last night that while China was showing some signs of improvement late in the quarter, but other areas such as Europe and North America were softening. I’m just wondering what you’re seeing in terms of the trend geographically?

Yeah. I think, we’re seeing a strong pickup in China. Outside of China, it’s a little harder to say, Mark. The visibility is just limited.

Okay. Can you provide your North American sales as a percent, please?

Hold on a sec. You know, Ran?

Yeah. Give me must one second. North America sales in Q1 was 48%, $21 million for the entire company.

Okay. Just wanted to confirm, the Nutronics sales last quarter were $4.4 million.

Correct.

Thank you.

Thank you.

Our next question comes from Greg Palm with Craig-Hallum Capital Group. Please go ahead.

Hey, guys. This is Danny Eggerichs on for Greg today. When we’re looking at China and kind of the rebound scene starting in March and then going and escalating into April, is there a way to kind of stack that up and look at demand and activity levels compared to like what you were seeing last year at this time?

Yeah. I mean, what we’re seeing is typical for China coming out of Chinese New Year. So it’s a little hard to break it out. There is that seasonal change. In China, we were shut down for formally for a week, but there’s been delay due to the COVID shutdowns around the country. So there’s some of that also going on. It’s a little hard to break those things out. But certainly coming down Chinese New Year, we always see increase in demand.

Okay. Thank you. And I guess, in terms just of how you’re managing the business in the near-term and kind of balancing long-term investments. I know, you said you plan to continue on investing in the business. Has anything changed in terms of different segments you plan on investing in given the recent events?

Nothing materially is different. So we continue to see opportunities across all the key markets that we serve.

Okay. Great. And then just a last one for me, I guess, within microfab, kind of visibility into the second half, specifically in end-market like consumer electronics. Can you give a little bit of color on that and what you’re seeing there?

Yeah, as I said, there remains just uncertainty beyond Q2. There always is a good bit of that with the crisis, makes even harder to predict. What we’re seeing right now is an uptick in demand in that segment.

Alright. Thanks, guys. It’s all for me.

Thanks, Dan.

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

Hi, thanks. I asked your competitor this yesterday. I guess I’d like to ask you guys the same thing. With respect to China and kind of the uptick in – Scott, I know you said that you’re seeing some of the typical signs kind of post Chinese New Year. One of the things I struggle with is that China being an export economy and the rest of the world being shut down from a demand perspective, where the true driver is coming from? Because it doesn’t seem like it’s coming from a capacity expansion perspective. So are you seeing the early signs? Is this a function of kind of factories being shut down and doing up-fits or planned efficiency increases that’s driving some of this or do you think that you’re seeing actual capacity expansions? Wondering if you could just opine and give us a bit of color on that?

Sure. It’s difficult to tell, obviously, but we are seeing capacity expansions that are real as in industrial as companies move from lower power to higher power lasers, and benefit from those efficiency gains in doing so. And then, in microfabrication, I’d note again, the 5G investments for real capacity that is needed for not only handsets but also all the infrastructure that appears to be driving demand also. I think your concern is one that we’re all concerned about, it’s what does the global economy do. Don’t know from what we see coming out of China. We do see increases in real capacity, both in industrial and microfabrication right now.

And any specific end-markets within those categories that are kind of driving; for example, in auto, are you seeing for battery assembly for example, color on that within those things?

Yeah. Good. So with micro that’s clear. With industrial, I think that the biggest source of the demand growth really is in standard broad range of industries that use lasers for metal cutting, which is primarily not automotive there. However, we do see some automotive also, especially with electric vehicles, some of that demand also driving some of this growth that we’re seeing.

Got it. I jumped on a little bit late. Did you talk about the directed energy program? And any sort of updates with the DOD and the work that you’re doing on that side of things?

Well, let’s see. What we’re – definitely this was a very strong quarter, with 34% organic growth in our aerospace and defense segment. That’s without Nutronics. So with Nutronics, it’s up to about 39% of our overall revenue for the quarter. So we’re definitely seeing strong end-demand for direct energy, and that demand provides us with the ability to see how that’s going to continue to grow over time, with the only uncertainty being the timing on our revenue in that segment.

Got it. Last question for me, did you, in fact, see – your competitor mentioned that in the low-power side of the market that prices have in fact stabilized after about a year of coming down. Are you seeing the same thing there or just as we look at the – yeah…?

Yeah, we’re seeing a more normal pricing in those segments right now, in China. Yeah.

Great. Great, thank you.

Thanks, Jed. Appreciate it.

And, ladies and gentlemen, this concludes the question-and-answer session. I would like turn it back over to the management team for any final remarks.

So thank you, everyone, for your participation today. And we look forward to chatting over the coming weeks and months. Have a good rest of your day. Take care.

Thank you. This concludes today’s conference call. You may disconnect your lines at this time and have a wonderful day.