Good day and welcome to the nLIGHT Fourth Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] I would now like to turn the conference over to Joe Corso, Vice President of Corporate Development and Investor Relations. Please go ahead.

Thank you; and good afternoon, everyone. With us today are Scott Keeney, nLIGHT's Chairman and CEO; and Ran Bareket, Chief Financial Officer. Today's discussion will contain forward-looking statements including financial projections and plans for our business. 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, and we undertake no obligation to update publicly any forward-looking statement, except as required by law. During the call, we will be discussing certain non-GAAP financial measures. 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.

Thank you, Joe. Starting on the slides 3 and 4. 2021 was an important year for nLIGHT. Year-over-year growth in each of our end markets enabled us to generate record annual revenue of $270 million. Overall revenue in 2021 grew approximately 21% in line with our long-term compound annual growth rate of 23%. To put that in perspective, total revenue was nearly double what we generated in 2017, the year immediately prior to our IPO. We continued to execute on our strategy of increasing sales to industrial customers outside of China and in aerospace and defense. Over the long term, we continue to believe that we can meet or exceed our historical revenue CAGR of 20% and product gross margins of 40 plus percent. To meet these long-term objectives, we will continue to invest in automated capacity in the U.S. and optimize our manufacturing footprint in China. While this important operational transition will result in pressure on our gross margin and operating margin for the next few quarters, as we look beyond 2022, we believe it will enable us to achieve higher levels of profitability as we scale to address anticipated robust customer demand. Turning to Slide 5. 2021 was an important year for our transition in our geographic focus. Our results illustrate how our business has evolved since our IPO in 2018. In just a few years, we've migrated from a strategy that had included significant focus on both operations and markets in China to a strategy that is primarily focused on both operations and markets outside of China. In 2021, revenue from customers outside of China grew 41% year-over-year to approximately $215 million, which represented approximately 80% of our total revenue. Turning to slide 6. In Q4, revenue from customers outside of China grew by 26% year-over-year to…

Thank you, Scott, and good afternoon, everyone. Beginning on Slide 12, nLIGHT delivered record revenue for the full year of 2021, driven by a 41% year-over-year increase from sales to customer outside of China. Full-year 2021 revenue increased 21% to $270.1 million. Develop revenue increased from $37.9 million in 2020 to $64 million in 2021, driven by higher revenue associated with direct energy development projects. Fourth quarter revenue was approximately $67.5 million. Q4 revenue from customers in our core strategic market outside of China grew 27% year-over-year to approximately $60.1 million. In China, Q4 revenue decreased approximately 60% year-over-year, which was offset reduction in sales of our fiber laser product to customer in China. Q4 development revenue was $16.5 million versus $14 million in Q4 2020. Turning to Slide 13 to provide more detail into our gross margins. For year 2021, gross margin was 28.6%, compared with 26.6% in the full-year of 2020. Product gross margin was 35.6% for the full-year 2021, compared to 30.6% in the full-year of 2020. The 500 basis points year-over-year improvement in product gross margin in 2021 was driven mainly by higher sales to customers outside of China and more favorable product mix and better utilization, offset partially by increased manufacturing costs. In Q4, we experienced a 280 basis points reduction in product gross margin compared to the fourth quarter of 2020. This reduction was driven by additional overhead expenses as we invested in additional automated capacity in the United States, and a low factory utilization in China. Moreover, we experienced additional costs related to labor, freight, and materials. Turning to slide 14. non-GAAP operating expenses were $18.8 million during the fourth quarter, compared with $18.1 million in the prior quarter and $14.7 million in Q4 2020. The year-over-year increase in R&D was related mainly…

Thank you, Ran. I'd also like to, again, say thank you to Ran for four great years of service to nLIGHT. It's been a privilege to work with you. I want to sincerely thank you for all your hard work and dedication. I wish you all the best in your retirement. With that, I'll turn the call back over to the operator for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] At this time, we will pause momentarily to assemble our roster. Our first question comes from Greg Palm with Craig-Hallum Capital Group. Please go ahead.

Good afternoon and thanks for taking the questions. Ron, enjoyed working with you and Joe, congrats and look forward to working with you more.

Thank you.

Thank you.

I guess, just starting on the gross margin line, I'm curious if you can quantify specifically the overhead costs from the investments in automated capacity for Q4 specifically and also what is inherently baked in the guidance in Q1 as well.

Yeah. I will take it. It's hard to quantify exactly what was the impact. But what we can tell you that there was some impact in Q4 and definitely in the guidance that we provided for Q1 for two main things. The first one is the excess capacity that we have in China. The reduction in volume in China was -- occurred even faster than what we anticipated. And as a result of that, we have an excess capacity in China that we are maintaining for now while we are building automated capacity here in the U.S. So in one hand, you have an excess capacity in China, in another hand, we invested in capacity here in the U.S. which is mainly, maybe the only, automated capacity that are not fully utilized. That definitely impacts our margin in Q4 and will impact our margin in Q1, and going forward in the next few quarters. Add to that as I mentioned in my opening remarks, some headwinds like inflation, labor costs, freight costs, and other supply chain disruption that impacted our margin in Q4, and we anticipated it will impact our margin in Q1 as well.

Yes, I think you meant Q2 as well. What's your visibility beyond the next couple of quarters? I mean, can you get back to more of that more recent gross margin in the second half or is it going to take some time? I assume a lot is probably dependent as well on volumes and the excess capacity you have in China, but what's your thinking as of right now?

Again, I don't think that it's the right things to try to predict exactly when we will go back to the margin that you saw -- product margin, I mean that you saw in Q2, Q3 last year. As you mentioned, the impact on the gross margin will be vary from the volume, from the mix, and that additional overhead cost that we have currently. But I think that again, we are always talking about the long run as I mentioned, as Scott mentioned. We believe again for the long run, it will take a few quarters as we mentioned. But for the long run, we believe that we can go back to the 40% or we can reach to 40 plus percent product gross margin.

Understood. And then I guess just last one for me. You only guided here for Q1, and at the midpoint, it's quite a bit lower than your -- I think your 15% annual growth bogey. I even think last quarter you made the comment about 20% being sustainable over the longer-term. How should we think about the remainder of the year in that context?

You're talking about top-line or you're talking about --

Top-line. Yeah. Sorry. Correct. Top-line.

So again, look at 2021. 2021, we grew 21% despite the fact that China went down significantly. And we mentioned several times, by the way since the IPO, and it was the case since the IPO, even prior to IPO, that nLIGHT grew more than 20% CAGR. And we believe that for the long run, it will be the case as well. Again, there are many, many -- it's a transition year. 2021, 2022 is going to be a transition year. Meaning in 2022 the revenue from China from Cutting is going to be very, very minimal. In 2021, we had a revenue from Cutting from China. So we will continue to grow, maybe in some area in the business faster than 20%, but you need to take all of that into consideration to see how 2022 will look like, and that's by the way, one of the reasons why we are not talking about specifically, it's too early to talk about specifically the 2022 growth. However, again, for model perspective, it is the right thing to look at nLIGHT as a 20% plus CAGR for the future.

Okay. Great. I'll hop back in the queue. Thanks, and good luck.

Thank you.

Our next question comes from Patrick Ho with Stifel. Please go ahead.

Thank you very much. And likewise, Ran, I want to congratulate you. Thanks for your efforts. And Joe, I look forward to working with you more on a going-forward basis.

Thank you.

Maybe first off for Scott. Obviously, with your diversification strategy taking hold, we're seeing the growth in other market regions as well as your new products. As you just look at '22, just for this year, which of those three variables, whether it's markets, region, or new product expansion, which do you see as being the biggest driver for nLIGHT, at least from that breakdown?

Yeah. I think as we look ahead, we see strong continued growth opportunities both in industrial and in defense. In industrial, we've launched a number of new products, in '21 we'll be launching more products, in '22, just announced this acquisition of Plasmo that will enhance the products. So we see strong opportunities to continue to grow outside of China in those industrial markets. Notably, I think one market that we see very nice overall growth and growth in our business is in additive manufacturing where the economics of laser additive manufacturing is inflecting. And then in defense, we see continued opportunities for growth. How those hit the top line in '22, that's where it's harder to predict, given that it takes time for those programs to hit in terms of programs record. But we see strong growth opportunities in both of those markets and continued secular growth in the microfabrication space.

Great, that's helpful. And maybe for the team, whoever wants to answer this, the supply chain and the input costs have been a struggle for a lot of technology sectors over the past six months or so. From your vantage point, are you seeing more pressures from "supply chain shortages" or are the input costs, whether it's related to paying more for components or freight and logistics costs, which of those variables are having, I guess, the biggest headwinds at least for you in the near term?

Yeah. Patrick, we see challenges in all of those areas. There's not one that we would highlight. But yeah, it's a difficult time to be managing when we're dealing with shortages. And it could be a very small component that causes a problem for us or one of our customers. Certainly, freight is challenging and then just inflationary uncertainties also. And on top of that, with continued COVID -- continued -- hopefully, your -- will evolve, but continued issues just managing the company through this. So we see across that entire spectrum that you outlined, there's nothing we would highlight that is the single material impact to the business, but it is challenging.

Great. Thank you again, and good luck, Ran.

Thank you.

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

Yes. Good afternoon. And thanks for the question. First of all, when you look at the fourth quarter decline, a sequential decline, largely just explained by the lower revenue in China. And curious what you're seeing there. Is it just the Chinese market is a little bit softer with the supply chain issues, or was it just your choice to de -emphasize that market and walk away from potential business?

I think all of those factors, Tom, at some level, I think the overall economy and industrial sector in China in Q4, I think was softer across the board. But in addition to that, it's the intentional decision that we've made some time ago to be very careful about which markets we serve there and there's a limited set of markets that are truly attractive markets there. So it's both our decisions and indeed a softer economy in China.

Okay. That's helpful. Thanks, Scott. And also I was curious on the automation front, is this mainly long lead-time custom tool that you have to produce or bring in-house and what is the lead time to get that automation up and running?

Indeed, yes. Automating complex processes to assemble lasers as there's no off-the-shelf technology there. It is a largely custom, very long lead-time set of projects that we started in some cases multiple years ago. And glad that we did that several years ago and it's great to see progress as those tools come online.

So is this an ongoing process or do you feel like you're fairly good at capacity?

Yeah. It's ongoing. It's been one that as I said, started more than two years ago. It's an ongoing continued process as we advanced new products that are designed for automation and then the automation itself. So we're seeing good progress there, but it will be a theme that we will continue for quite some time.

Great, and then Ran, one last question for you, before you leave. On the OpEx side, was the sequential increase driven by just increased costs, or did you increase headcount as well?

First of all, I'm not leaving. I'm going to be with Joe here until the end of June to make sure that we have a good transition that's point number. Second point, going back to your OpEx question. Yeah, it's both. It's increasing labor cost, it's increasing in professional fees, and headcount in some cases, yes.

Great. Well, thank you all for your time.

Thank you.

Thank you, Tom.

Your next question comes from Chris Gringo with Needham & Company. Please go ahead.

Hi. Good afternoon. Thank you for taking my questions. And congrats, Ran. On additive, it sounds like it's picking up there. And I was just wondering if you could provide any color on the pipeline or what you're seeing in terms of demand there. And whether there's any indications that the sales cycle could be compressing on any data points with respect to wins with existing customers. Thank you very much.

Yeah. Appreciate the question. So what -- we've been working in additive for many years and what we're seeing is strong growth. I think you can look at the standard market reports out there that are calling growth -- north of 20% growth in that space and indeed that's what we're seeing. And its result of significant improvements in a whole host of different technologies. But I do think the lasers play a really important role here, notably in systems where there's multiple lasers and the drive throughput in these tools, and also more advanced lasers like our AFX Laser. And we've posted some of the presentations that we had at the recent Formnext Trade Show. So we see continued expansion in the overall market. We see design wins, and we see most importantly, new applications that are now economic for Laser powder bed fusion applications. And indeed, we're using these in our own products.

Great. And just on Plasmo, as you're going through the process of planning for integration, how are you thinking about integrating that product base with your existing offering? Is the Plasmo offering something that we'll continue to offer on a standalone basis or could you integrate the sensor suite with the existing power source? How are you thinking about that?

Yeah. Good. It will be a product line that fits very nicely with our lasers and it allows us to expand the product portfolio. It also allows us to engage with customers where Plasmo has had success in their own design wins in various industrial applications. So it will augment our products and also expand our channels.

Great. Thank you very much.

[Operator Instructions] Our next question comes from Mark Miller with The Benchmark Company. Please go ahead.

Best wishes for your future. I have a question. You've talked -- you continue to talk about going to 40% margins long term. What are the drivers? How do investors access your progress? And what's the road map to 40% gross margins?

Sure. But just to be clear, we're talking about product gross margin and not total gross margin. Keep in mind that we have a portion of our revenue is coming from development revenue with 6.5% margin. But going back to product gross margin, I think that 2021 was a perfect example how we -- how can we improve our margin by better mix with products outside of China especially with aerospace and defense and industrial outside of China application where the margin it's much higher. But in order to continue to improve the margin, we need to do two main things. The first one is to some extent to adjust the excess capacity that we have today in China and in the U.S. to the level of production. Currently as I mentioned in the beginning, there is an excess capacity in China and excess capacity or lower utilization in the U.S. Once we will finalize the automation here in the U.S., we can reduce the capacity in China and produce more product here with automated lines in the U.S., which definitely will help us with the margins, with the cost. So that's point number 1. Second point is, obviously continued to grow the top line and have a better utilization on our fixed costs. And the last one is continue to grow the top line, but growing the top line with application, again, like aerospace and defense, and industrial products outside of China where the margin is much higher.

Okay. And what percent of sales were represented by greater than 6 kilowatt fiber lasers of your fiber lasers sales?

I'll get on that. I'll get that number for you, Mark. In the quarter, Mark, greater than 6 kilowatts was 40%.

What about less than 2 kilowatts, do you have that?

Yes. We have less than 2 kilowatts. It's actually 31% during the quarter, which is the highest it has been in a while, and I think that that is a testament to what we've done in metal additive manufacturing. Most of the lasers by power in additive manufacturing are a kilowatt and below, and most of those sales are to customers that are obviously outside of China, which is why you've seen that tick up sequentially over the last couple of quarters.

Thank you.

Your welcome.

This concludes our question-and-answer session as well as our conference for today. Thank you for attending today's presentation. You may now disconnect.