nLIGHT, Inc. (LASR) Q2 2022 Earnings Report, Transcript and Summary

Good day, and welcome to the nLIGHT Second Quarter 2022 Earnings Conference Call. All participants will be in a 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 Joe Corso, Chief Financial Officer. Please go ahead, sir.

Thank you and good afternoon everyone. I'm Joe Corso, nLIGHT's Chief Financial Officer. With me today is Scott Keeney, nLIGHT's Chairman and CEO. 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 nonfinancial 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 Slide 3. Q2 was a solid quarter for nLIGHT. Despite the significant operational challenges and uncertainties we faced due to the prolonged COVID-related lockdown in Shanghai, we delivered revenue that was within our guidance range. Favorable product mix and solid execution of our strategic growth objectives helped drive gross margins above the high end of our guidance, which resulted in positive adjusted EBITDA for the quarter. Turning to Slide 4. Growth in revenue from strategic areas enabled us to generate $60.8 million of revenue in Q2. Our second quarter revenue reflects the continued geographic and strategic transformation of our business. In Q2, revenue from customers outside of China grew 12% year-over-year to $56.2 million or approximately 92% of revenue compared to $50.3 million or 73% in Q2 2021. Our focus on strategic growth areas outside of China have resulted in eight consecutive quarters with year-over-year growth in our non-China industrial and microfabrication business. Our global manufacturing team did an outstanding job during a quarter in which our key assembly facility was either closed or running a suboptimal capacity for two months. A small percentage of our total workforce was able to gradually reenter our facility during the Shanghai lockdown, which began on March 28, but much of our productive capacity was completely idle until June 4 when we officially reopened our facility. Although the COVID-related lockdown in Shanghai lasted longer than we could have predicted our team rapidly resumed normal multi-shift production, enabling us to meet nearly all demand from our key customers. Despite the reopening of Shanghai, we continue to see challenges in the broader global supply chain. Lead times for many of our critical components continued to extend and the cost of materials, labor, freight and logistics continue to rise. Our recent experience with the COVID-related lockdowns in Shanghai have reinforced our decision to continue to invest in our manufacturing capabilities in the United States. Last quarter, we reported that we had installed the initial equipment required for the first phase of automation. In Q2, we began to increase the productive capacity out of our installed equipment. And in the coming quarters, we expect to increase output yields and add additional equipment to meet our automation targets. Finally, I'm pleased to announce that Chris Schechter has joined our team as Chief Operating Officer. Chris most recently was VP of Operations, Aerospace and Defense at Celestica and brings a strong manufacturing background to support our continued growth. Turning to Slides 5 through 6, where I will discuss revenue by end market. In microfabrication, we had another solid quarter. We generated $16.4 million of revenue which represented approximately 27% of total revenue. Lower sales from microfabrication customers in China resulted in a 19% year-over-year decline compared to the record microfabrication revenue we generated in Q2 of 2021. We believe the current softness in our China microfabrication business is largely macro driven, and we continue to maintain a market leadership position, which we believe will enable us to grow as the macro environment in China improves. Outside of China, Q2 revenue increased year-over-year and overall demand signals remained positive. We remained well positioned to continue our global leadership position by introducing innovative high-power, high brightness semiconductor lasers for existing and new markets. In the second quarter, we developed a novel semiconductor laser with record peak power by leveraging our semiconductor device design and manufacturing capabilities. This technology has a wide range of applications, including LIDAR and other short pulse imaging and sensing applications. We also continue to make excellent progress in the medical market, particularly for our newly released two micron wavelength laser. We believe that this laser addresses a broad range of urological and other applications and offers like yet another long-term growth opportunity. In Aerospace and Defense, second quarter revenue declined 6% year-over-year to $22.5 million, representing 37% of sales. Excluding Advanced Development revenue, Q2 Aerospace and defense revenue increased approximately 18% and to $9.7 million. Overall sales in our Aerospace and Defense business was driven primarily by delays in receiving material required for certain directed energy development programs and fewer advanced technology development projects during the quarter. We view these delays as temporary as we continue to receive material required for our key directed energy programs and have signed several new advanced development contracts during the quarter. In the directed energy market, we had two major milestones during the quarter. First, we continue to demonstrate the ability to scale the power of our high-energy lasers, which we believe is critical for future defense systems. Second, we have expanded and deepened our engagement with potential customers, both in the United States and abroad. Our vertical integration, combined with U.S. manufacturing enables us to take a system-level view of our customers' requirements and again across multiple product levels, including diodes, fiber amplifiers and beam combined lasers. During the second quarter, we generated product revenue from the sale of laser products to multiple U.S. defense contractors and foreign allies and have engaged in many additional design-in opportunities with foreign allies seeking to deploy land, sea and airbase lasers. As a result, we believe we have both expanded our served market and increased our near-term revenue opportunities. Finally, turning to the industrial end market. Revenue declined 12% year-over-year in the second quarter to $21.9 million, representing 36% of total sales. However, industrial revenue from customers outside of China increased 43% year-over-year to $20.2 million. On a percentage of revenue basis, Q2 industrial revenue from customers outside of China increased to 92% versus 57% in the same period in 2021. Industrial growth outside of China continues to come from strategic customers as we continue to deliver innovative solutions that enable our customers to increase their market share and at the same time, increase their spend within nLIGHT. One of our key differentiators in the industrial market is the programmability of our lasers. We first introduced our programmable lasers to the cutting market in 2018, where they were quickly adopted as they address the long-standing between high speed for cutting of thin metal and outstanding edge for cutting a thick mild steel. We have continued to expand our line of beam control technology. And recently, we extended the dynamic range of the beam area by 4x, thus allowing a 5-kilowatt nLIGHT fiber laser to the same cutting speed as an 8-kilowatt conventional laser for thin metal cutting – well, maintaining outstanding edge quality for thick metal. For laser additive manufacturing, we are enabling our customers to continue to dramatically improve productivity in this growing market by offering lasers that provide benefits along two key dimensions. First, our highly reliable and stabilizers enable new multi-laser tools, which improve productivity and rose cost per part. Second, our programmable lasers can increase the build rate for additive manufacturing by 2 to 8x with excellent material quality. In addition, our lasers allow the microstructure to be engineered lower, thus optimizing the material properties, such as ductility, strength and hardness, introducing an entirely new capability for additive manufactured parts. For example, recently, our programmable lasers were used to print turbomachinery components with spatially optimized mechanical properties that would not otherwise be possible without the use of our lasers. Finally, our programmable lasers are also being employed in welding applications to increase productivity and part quality. We are also deploying integrated process monitoring technology, which will further expand our market opportunity. I will now turn the call over to Joe to discuss nLIGHT's second quarter financial results.

Thank you, Scott, and good afternoon, everyone. Beginning on Slide 8. Total revenue for the second quarter of 2022 was $60.8 million, a decrease of $8.3 million or 12% and compared to the second quarter of the prior year and was within our guidance range. Product revenue for the second quarter of 2022 was $48.2 million, a decrease of $5.4 million or 10% and compared to the second quarter of the prior year. The decrease in product revenue year-over-year was driven by lower sales to industrial and microfabrication customers in China, partially offset by higher sales to strategic customers outside of China. Development revenue for the second quarter of 2022 was $12.6 million, a decrease of $2.9 million or 19% compared to the second quarter of the prior year. The decrease in development revenue year-over-year is attributable to the timing of project-based work we perform in the defense market. Turning to Slide 9. Overall gross margin for the second quarter of 2022 was 25.3% compared to 29.4% for the second quarter of the prior year. Better-than-expected product mix enabled us to generate gross margins that were above the top end of our guidance. Products gross margin for the second quarter of 2022 was 30.1% compared to 36.1% for the second quarter of the prior year. The year-over-year decrease in product gross margin was driven by sales mix, decreasing capacity utilization of our Shanghai manufacturing facility, increased investments in U.S. manufacturing and continued increases in production and freight costs. Turning to Slide 10. Non-GAAP operating expenses for the second quarter of 2022 were $19.3 million or 32% of revenue compared to $17.6 million or 25% of revenue for the second quarter of the prior year. The majority of the year-over-year increase is related to increases in salary costs, headcount, professional service fees and investment in R&D projects to support our product road map and long-term growth opportunity. Turning to Slide 11. Non-GAAP net loss for the second quarter of 2022 was $3.3 million or $0.07 per diluted share compared to non-GAAP net income of $4.4 million or $0.09 per diluted share for the second quarter of the prior year. The year-over-year decrease in non-GAAP profitability was driven by a combination of the decrease in product gross profit and an increase in OpEx spending. On a GAAP basis, net loss for the second quarter of 2022 was $10.3 million or $0.23 per diluted share compared to $7.9 million or $0.19 per diluted share for the second quarter of the prior year. Adjusted EBITDA for the second quarter of 2022 was approximately $200,000 compared with $6 million for the second quarter of the prior year. Net cash used by operating activities was $4.8 million for the second quarter of 2022 compared to $1 million for the second quarter of 2021. The increased operating cash usage is the result of lower profitability, as previously discussed and changes in working capital. Capital expenditures for the second quarter of 2022 were $7.9 million, compared to $4.8 million for the second quarter of the prior year. We continue to invest in directed energy for the defense market and automation of our U.S. facilities to serve our customers outside of China. Turning to Slide 12. We ended the second quarter with cash, cash equivalents and marketable securities of approximately $121 million, and we had no debt. DSO for the second quarter of 2022 was 61 days, and we had 157 days in inventory. DSO in the second quarter of 2022 was negatively impacted by the timing of shipments compared to prior periods and the increase in inventory was driven primarily by material purchases for the defense and directed energy markets. Turning to Slide 13 for our outlook for the third quarter. Based on the information available today, we expect third quarter revenue to be in the range of $60 million to $66 million. The midpoint of $63 million includes approximately $49 million of product sales and approximately $14 million of development sales. Turning to gross margin. Third quarter product gross margin is expected to be in the range of 26% to 30% and development gross margin to be approximately 6.5%. And resulting in an overall gross margin range of 21% to 25%. For the third quarter, we expect adjusted EBITDA to be between negative $1 million and positive $2 million. We expect third quarter average basic shares to be approximately 44.6 million and non-GAAP diluted shares to be approximately 47.1 million. With that, I will turn the call back over to the operator for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Greg Palm with Craig-Hallum. Please go ahead.

Yes. Good afternoon. Thanks for taking the question. I guess starting with China, what makes you confident that what is going on over there is macro driven and not maybe share loss from increased competition. Do you have any visibility into that? And then can you let us know if or how much revenue that you've maybe actively walked away from over in that region?

Yes. Good, Greg. Thanks for the question. I think as we've talked about previously, in China, where we see our strength is in the microfabrication market. And there best of our abilities, we continue to see strong engagement with design wins based upon the leading technology that we have, but the macro environment there was very challenging in Q2. And with respect to the fiber laser – industrial fiber laser business, as we've discussed, certainly, we're not engaging with unprofitable business there. But we're not breaking out how much of that we're walking away from [indiscernible].

Okay. Fair enough. And as it relates to the lockdowns, can you help us understand what the impact of those prolonged lockdowns were in Q2? And is there any assumption of continued impacts in the Q3 guide?

Yes, Greg. So the lockdown lasted for longer than we had expected when we provided guidance in May. At the same time, when the facility reopened, we were able to ramp quite quickly. Kudos to the team operationally for being able to get back to multiple shifts as quickly as they have. So we left a couple of million dollars on the table during the quarter, but had we been open the entire quarter, I don't think it would meaningfully change your perspective or how we really did during the quarter, frankly…

Okay. Thanks so much. All right…

…from a revenue perspective.

Yes. Okay. And just in terms of the Q3 guide, any assumptions of whatever continued impacts or challenges? Or at this point, are you more or less back to normal?

Our operations are back to normal in Shanghai. So there are still some minor lingering effects. I mean there was turnover and getting new folks into the facility. So that always takes a little bit of time to get back to the exact level of efficiency at which we were operating prior to the lockdown. But there's nothing that we see right now that looks like it will affect us the way we were affected in the prior quarter. Of course, we're concerned with the overall environment and the potential for COVID and other related lockdowns to happen in Shanghai. But our guide this quarter assumes that it's business as usual in our Shanghai facility.

Okay. Good. I will leave it there. Thanks.

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

Hi, good afternoon. I just wanted to get an update on the automation activities in the U.S. At what point do you think that becomes less of a headwind? It sounds like you're satisfied with the pace of the progress you're making in this area. I wonder if you could give us a little better handle on how – maybe update us on the time line?

Yes. Good, Jim. Thanks for the question. It's a very important strategic topic for us. We continue to ramp up automation in the U.S., and we're currently seeing benefits of that ramp. We have more work to do, but we're certainly continuing to focus on the majority of our business in the fiber laser market outside of China, having that automated for 2023, but we're continuing to make progress on that ramp and continues to be a top priority.

And then turning to the industrial, the growth outside of China was pretty healthy. You've highlighted a couple of the areas. I mean new deck, you talk about welding and additive. I wonder if you can give us any more granularity in terms of the magnitude of those drivers in that 43% growth that you registered in? If I could just slip one in on the medical opportunity, is there a way for you to frame that opportunity for us as we think about possibly 2023 and beyond?

Good. Jim, let me just make sure I've got the question. The first one is on the 43% year-over-year industrial growth outside of China and one of the key drivers here? The second was going back to automation, again, is that right, Jim?

No. The – on the industrial growth, I just want to – maybe we'll take one at time, I apologize. You highlighted some of the progress you're making in metals additive manufacturing. But if we could drill down further into that 43% growth, what were the major catalyst for that growth that you saw? And to what extent should you anticipate that continuing in Q3 and Q4?

Good. Yes, I think the short answer, Jim, is the reason we talked about what we're doing in additives that is a key driver of our growth. I think it's been – it's an application area that has grown nicely, but it still has a lot of promise for laser additive manufacturing to be truly viable. We, as an industry, need to continue to drive productivity up significantly. And to do that, a couple of the key levers are more lasers per tool that gets you more parts at lower cost and more effective lasers. And we are demonstrating continued progress not only in the technology but also the adoption in that market. And so we do see opportunities for continued growth there. How they play out quarter-over-quarter, that's harder to predict. But I do see laser additive manufacturing, becoming a more important theme that will continue to drive growth.

How many customers are you working with can you say, Scott?

Yes. We don't break out the details, but it's more than 10 that are good customers and there's quite a long tail there, Jim, of companies in this space that are doing some really interesting work that are sometimes below the radar. So it's a dynamic space that has the opportunity for continued growth.

Okay. And just quickly, just on the medical opportunity, which you seem excited by. I wonder if you could talk a little bit about how we might think of that – that contributing to revenues.

Good. Yes, I think it is – it is worth noting that we're making good progress there with a new product. Urology is the first application, which is driving demand, and we're seeing significant growth from small numbers this year, but it is a market that is – certainly has the opportunity to be tens of millions of dollars of revenue for us, and over time, medical can be a more important part of our business. We don't break it out today. We put it into the micro space, but we do want to highlight that, that is one of the drivers of what's going on in the micro segment for us.

Yes, thanks. I will jump back in the queue.

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

Thank you very much. Scott, maybe first off on the products and the market opportunities. I think you highlighted in your prepared remarks the 2 micron series of lasers. Where are you seeing the, I guess, the earliest or the greatest adoption? Because if I recall, it was targeting several markets, which markets are you seeing the greatest traction for that product initially?

Yes. Good, Patrick. Yes, the initial traction is in medical and in urology. But you're right, we have highlighted the fact that 2 micron does apply to a broader range of markets. There are defense applications, there are industrial applications, but for the current products that we're shipping medical is what's driving that. Over time, we do see is yet another example of a laser which enables a broad range of different end vertical markets.

Great. That's very helpful. And maybe, Joe, for you on the cost side and the supply chain, didn't hear much of it on this call. Have you seen improvements on the supply chain front? How do you look at the situation on a going-forward basis?

Yes, Patrick, I think the good news is that we haven't seen the supply chain deteriorate further during the quarter. So in some areas, it's been relatively flat. I will tell you that flat in terms of what we're seeing in terms of the health of our suppliers. The lead times have continued to extend. There are certain parts that are not as challenging for us to get, but costs are definitely up. Cost of materials are up, freight and logistics are up, cost of labor are up. And we think that they are going to remain at this level for some time.

Would you want to put any quantification on that? Like is it a 100 to 200 basis point impact? Or what's your thought on that?

Yes, sure. So I'm happy to do that. So as we look kind of quarter-over-quarter, it was a couple of hundred basis points that we saw of incremental costs between freight, logistics and materials.

Great. Thanks a lot guys.

Thanks, Patrick.

Thank you.

Our next question will come from Hans Chung with D.A. Davidson. Please go ahead.

Hi. Thank you for taking my questions. So I just want to follow up on the gross margin. So for third quarter, we have revenue coming up a little bit from a sequential basis. And then product gross margin kind of deep a little bit. And I guess there's definitely a factor, I mean including the product mix or the cost premium you just mentioned due to the supply chain. So any color, I mean, regarding the proven tax and gross margin for the third quarter? And how should we think about the gross margin, let's say, into the 2023?

Yes, sure. Thanks for the question, Hans. You hit the nail on the head, the biggest – there are two big impacts as we look at the margin in Q3 of 2022. The first of which is the mix of business. In Q2, we had a pretty favorable mix. It doesn't take much with our level of product revenue to sort of improve the product gross margin. In the second quarter, we obviously saw lower revenue from China, both in industrial and in our microfabrication business. And we also saw a more favorable mix of business inside of our fiber laser business. And obviously, offsetting that were freight, logistics, consumables, all of those costs that we've talked about. So as we sit here, right, our best view of Q3 is that the mix of business will moderate to something that is more in line with our expectation, and we won't get exactly the same mix benefit that we got in the prior quarter. But at the same time, we're going to see better absorption as Shanghai is not shut down for two quarters. So you look at that and you say that from a supply chain perspective, right, labor materials, things like that are going to remain relatively flat is how we got to our gross margin guide for Q3, Hans.

Got it. That's very helpful. So – and then if I look at the revenue mix by product type and then it is like the low-power mix, I mean, going up and then median power are going down. Does that reflect to the weakness in microfabrication? And then just any comment on that dynamics?

No. What you're seeing there is this quarter in Q2, percent of our business were below the 2-kilowatt and below. That is largely driven by continued growth in the additive manufacturing business, where power is not the figure of merit like it was historically in the cutting market, particularly in China. So when you're looking at mix based on power, and you can see if you go back four or five quarters, you'll see that the low power percentage of total fiber laser revenue has continued to increase. That's largely a function of the growth in our additive manufacturing business.

Got it. Got it. Okay. And then if I look at the inventory level, it's continued to go up. And then I know you kind of explained this related to some purchases for the direct energy program. But is it also kind of strategic investment in just in inventory overall because the supply chain constraint? And then how should we think about the inventory management strategy going forward?

Yes. Great question, Hans. So you're right, inventory has gone up, and you've identified a couple of pieces of it. The first is that as the lead times for the material that we need have increased, we've strategically used our balance sheet to make sure that we are able to support our customers. As we've said in the past, organic growth is the primary thrust of what we are doing at nLIGHT. And we want to be in a position to be reactive to our customers' demands and many of the customers that we are serving today, they are growing, but we are growing our share of wallet inside of those customers. So we've made a strategic decision that today with the supply chain where it is to invest more heavily than typical in our inventory levels. And then as we mentioned in our prepared remarks, there have been a couple of areas in which we've invested in inventory, right? Directed energy is one of those areas. This quarter, we talked about initial volume sales of laser products to customers, right? In order to support what we see over the coming quarters and years, we need to be in a position to turn that inventory into revenue. And then the third piece of it, Hans, is that costs have continued to rise, right? So part of the inventory growth is that what we are buying and putting on the balance sheet is more costly today than it was a quarter ago or a year ago. So that's kind of the current situation. As we look in the future, right, we're taking a really hard look at where to continue to strategically invest in inventory or not strategically invest in inventory. There will be some period of time where you'll see it around these levels as we continue to transition some of our manufacturing from Shanghai to the U.S. as we build buffer stock and the like. So it's something that we are managing. But today, we're in a strong position from a balance sheet perspective to be able to do that to support our growth going forward.

Got it. Thank you.

You're welcome.

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

Thanks for taking my question. Can you talk about your order book, given the seasonality and whatnot? Is it slightly weaker for the time of the year? Or you think it's kind of in line versus last year or so?

Yes, Paretosh. I think short answer, I'd say, is in line. I think the – what we're seeing, as we noted in the prepared remarks is very good traction in the strategic growth opportunities in directed energy, in additive manufacturing, in medical and continued traction in our core markets. But from an order book standpoint, I think, in line with where we typically are.

Got it. Thanks. And can you give us some sense of pricing also in your laser product? So – sorry, to be oversimplifying, but maybe on some sort of dollar per kilowatt price metric? Are prices still falling versus, say, last year? Or given the very high inflation that we have seen, perhaps you're seeing prices stabilize or maybe even go up?

Yes, I think the short answer is stability in general. There are some areas where we've seen price increases. But in general, stability, I think, would be the answer especially as we're not engaged in the very low price business and cutting in China.

Understood. And maybe last one. What's the best way to think about the dollar – U.S. dollar sensitivity or impact on your business on your revenue as well as your operating income?

Yes, thanks, Paretosh. The impact that we have from currency is relatively insignificant today, most of the revenue that we generate outside of China anyway is in U.S. dollars. We have a little bit in euro. And then when you look to the China business, we've got a natural hedge because we both sell in RMB, and we satisfy expenses in RMB. So we don't have a big exposure from a currency perspective today given the geographic composition of our business.

Thanks guys. That's all I had.

Thank you.

Thanks.

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

Thank for the question. What percent of fiber laser sales were for over 6 kilowatts?

Over 6 kilowatts this quarter was 40%, Mark.

And can you just remind me again on the margin comparison between the high power versus the low power in terms of margin contribution?

I think you've got to look at it by market. So certainly, when you look at the – when you look at the cutting market, the higher power lasers carry much better gross margins than the lower power lasers. But there's also – for our business, all of the high-power lasers are not made equally either, particularly when you start talking about certain configurations, whether they're programmable or not. And then I said market because it's important to make the distinction between the cutting market and the additive manufacturing market. So when you look at the additive manufacturing market, the product margins in additive manufacturing lasers, which are we report as low power tend to be higher than cutting lasers today.

And you indicated you're getting some traction on the welding application area. Can you give a little more color on that because that's been a dominant part of sales from one of your competitors?

Yes. I think it's an area that we do see traction. I think we've highlighted other markets where we see more material growth for us, but it is a market that is an important market, especially with the expansion of EV and we'll continue to be a market that we address.

Thank you.

Thanks, Mark.

This concludes our question-and-answer session. I would like to turn the conference back over to Joe Corso for any closing remarks.

Thank you, everyone, for joining this afternoon and for your continued interest in nLIGHT. We look forward to speaking with you during the quarter. Have a great afternoon.

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