Hello, and welcome to the nLIGHT Second Quarter 2023 Earnings Conference Call. All participants are in a listen-only mode. After today’s presentation, there will be an opportunity to ask question. [Operator Instructions] Please note, this call is being recorded. At this time, I would like to hand the call over to Joe Corso, nLIGHT's Chief Financial Officer. Please go ahead.

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, some 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 statements 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. In the second quarter, we delivered results that were largely in line with guidance. Revenue of $53.3 million was above the midpoint of the guidance range. Products gross margin of approximately 29% and continued operating expense control resulted in adjusted EBITDA that was also above midpoint of the guidance range. We also made significant progress in three areas critical to our strategic growth objectives. In aerospace and defense we kicked off the HELSI-2 program and made excellent progress in our new defense applications. In industrial, we continue to improve our position with key customers and have seen increased traction with our process monitoring solutions. And operationally we have continued to diversify and derisk our manufacturing strategy. We have established automated assembly of semiconductor lasers in the US, and in addition have begun shipping from a contract manufacturer in Thailand. I will provide a brief update on each of these three initiatives and our revenue outlook. In aerospace and defense, revenue increased 9% year-over-year to $24.5 million, representing 46% of total revenue. Second quarter development revenue increased 8% year-over-year to $13.7 million and defense products revenue increased 9% year-over-year to approximately $10.8 million. As we announced in early May, we were awarded a new $86 million contract to produce a more powerful higher performance laser related to the second phase of the Department of Defense High-Energy Laser Scaling Initiative, which we refer to as HELSI-2. In late Q2 we kicked off HELSI-2 activities and recognized initial revenue from this program, which we expect to continue for approximately two-plus years. In addition, we also announced that our HELSI-1 laser was formally accepted by the government and is being prepared for integration within the US Navy's high-energy laser counter anti-ship cruise missile program. We continue to believe that our unique…

Thank you, Scott. nLIGHT generated revenue and adjusted EBITDA above the midpoint of our guidance. Growth in gross margin improvement is a core focus of the nLIGHT leadership team. While scale and mix were the primary drivers of gross margin the combination of higher output and efficiency of our U.S. automation coupled with the outsourced assembly of some of our semiconductor lasers to Fabrinet offers further room for gross margin improvement. In a period of continued macroeconomic softness, we are carefully monitoring operating expenses and capital expenditures so that at higher revenue levels we are able to drive better levels of profitability. Total revenue for the second quarter of 2023 was $53.3 million above the midpoint of guidance compared to $60.8 million for the second quarter of 2022. Products revenue was $39.6 million compared to $48.2 million for the second quarter of 2022. Revenue decreased year-over-year in both the industrial and microfabrication markets, but increased year-over-year in Aerospace & Defense. Gross margin was 23% compared to 25% for the second quarter of 2022. Products gross margin was 29% compared to 30% for the comparable period in 2022. Products gross margin in the second quarter was negatively impacted by negative manufacturing variances and lower production volumes, but positively impacted by favorable product mix and decreased overall manufacturing costs. Non-GAAP operating expenses were $16.6 million, a decrease of $2.7 million compared to $19.3 million for the second quarter of 2022. The decrease in operating expenses was driven by a decline in employee compensation costs, primarily due to lower headcount, decreases in R&D project spending and higher administrative costs that were allocated to development projects. On a GAAP basis, operating expenses were $23.8 million, a decrease of $1.9 million compared to $25.7 million for the second quarter of 2022. Net loss on a…

Thank you. We will now begin the question-and-answer session [Operator Instructions] The first question today comes from Ruben Roy with Stifel Nicholas. Please go ahead.

Thank you. Hi, Scott and Joe. I wanted to start Scott with a question on guidance and sort of – kind of thinking about the out quarter. In the earnings release you had a little statement talking about being optimistic about strong growth returning in subsequent quarters and into 2024. You talked a lot about 2024. But as we think about Q4, should we expect some of the materials that are necessary to keep HELSI going to become available? And is that going to help you get back to sort of revenue growth in Q4, or any signs of sort of a bottoming process in microfab? Any detail around that would be helpful.

Yes, absolutely, Ruben. Thanks for the question. As I noted, the delta I described was due to timing for HELSI and then sort of the macro effect. So as we look out in time, certainly the HELSI program the contract's in place and so we fully expect to be ramping there as material and other resources are available. Now with respect to the macro environment that's harder to predict what's going on in the macro environment. But in addition, we have other opportunities that we're making good progress in; notably both in defense and in the industrial markets. So that's the reason for our optimism about the core bets that we've made for growth and the relatively near-term outlook for those to come to fruition.

Okay. Thank you, Scott. I guess a follow-up to that would be around the Fabrinet contract. Just kind of wondering about the timing about the contract given kind of where we are in the macro. And I guess longer term, if you have some detail or comments to make about how you're thinking about mix to internal outsource and if we should think about any longer-term margin impacts on commercial laser products as that mix shifts potentially over to contract manufacturing?

Yes, good. Let me take the first part of the question and I'll hand over to Joe on the margin impact. On the first part of the question in terms of timing, I think the -- we're really pleased with the progress that the team has made here and we will start shipping from Fabrinet this quarter. And we see this as part of our overall derisking strategy. And we see this as an important part of our mix going forward in particular making sure we have the capacity in the US for ramping defense programs, while having a balanced portfolio of capabilities to continue to serve the commercial market. So, pleased with the progress there and with the portfolio we have in place now to address both the industrial and the defense markets. And then with respect to the margin implications, let me hand it to Joe to answer that question directly.

Yes. Good question, Ruben. So from a margin perspective, we expect that margin to be neutral or potentially positive. If you think of what a relationship with Fabrinet or a contract manufacturer does, it effectively enables us to variabilize some portion of our manufacturing and match demand with manufacturing output. And so hopefully be able to sort of avoid some of those peaks and valleys. So over time, we think at worst this is margin-neutral at best it gives us the opportunity to continue on our path to 40% products gross margins or better.

That's great. Thanks for that detail, Joe. If I can sneak one last one in. It's great to hear about the Plasmo traction. Scott, I think you mentioned that you're seeing sort of attached laser sales with Plasmo, but just wondering if that's what you meant in terms of the new wins, or is it a combination of both kind of your vertically integrated systems, plus monitoring wins with non-nLIGHT-lasers that are out there in EV installations?

Yes, very good question, Ruben. It is both. We do think that having the process monitoring from Plasmo, gives us the opportunity for new design wins that we might not otherwise have, but then also gives us cross-selling for our current lasers and notably new lasers that we are developing for that market and further insights into the road map for what's going on there. So, yes, that was something we wanted to note, that we're making progress there. It was about a year ago that we acquired Plasmo and we do think that process monitoring is a very important part of many of the applications that we serve and that by integrating that with our lasers, it provides a complete and further-optimized solution and in particular here in the EV battery market and in a market that is very dynamic and growing.

Great. Excellent. That’s all I had. Thank you.

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

Hi, good afternoon. I wanted to go back to the Fabrinet announcement. And maybe you could just walk us through the time line. Obviously, you've known these guys for a while. They're pretty well known in terms of this industry. But the actual decision to go this route, it sounds like this was being driven by the momentum that you've seen in the defense business, but maybe if you could just help us understand, the whys and timing around it.

Yes Jim, I certainly have known Fabrinet for a long time and I've always been impressed. We did look at multiple sems here and in the end they're -- we're very pleased with the capabilities of Fabrinet. They've done a very good job serving the industry for many years now. And in terms of the decision here, it's about diversifying and mitigating manufacturing risk further. As we've talked about, we're transitioning manufacturing from our current manufacturing in China. We've got our automation up and running in the US, but the contract manufacturing piece of this serves particular products and particular markets in an optimized way. So it's about having that portfolio that both diversifies risk and as Joe mentioned to variabilize as part of our manufacturing capacity. So, those are the overarching reasons. We've been working on this for some time. I've been engaged with them for many years now. But we're pleased to announce that we are shipping from Fabrinet and we're pleased with this transition that we've talked about for some time.

Okay. I think, I can understand the optimism that you have around the defense business, so as you think about 2024, but we're still a ways off from early 2024 to have some line of sight that gives you optimism on the industrial side. So, it sounds like you're working with some newer customers. Can you help us understand the types of applications and the confidence that you have that that could contribute to revenues early next year or presumably early next year?

Yes, exactly, Jim. Yes. So as you know in the defense market, obviously, we've got longer-term visibility. In the industrial markets, it's -- in many cases, it's harder to see out. However, when we're talking about design wins that's where we do have the visibility. And notably in both additive and as I just mentioned in welding that's where there's a longer-term design-in process and we're seeing good progress. I mentioned the process monitoring a minute ago. But in addition, our Corona programmable beam technology continues to be adopted across all of our markets. But I would highlight again in additive manufacturing, we do think that the Corona AFX technology has a distinct advantage. And we look forward to making announcements at the appropriate time in coming trade shows, and other venues for these design wins and new product launches. There's upcoming trade shows in the fall in the industrial markets both in battery market and in the additive market. But that's -- those are the key drivers for us that give us the optimism for new design wins that our new products with current customers and new customers that give us that optimism.

So, Scott, do you have customers in the EV battery manufacturing market that you're adding other than the customers that you're working with where you've had traction with the process monitoring solutions? I'm talking specifically about the lasers.

Correct. Yes, these are new customers. Some existing customers who are expanding and some new customers also. Again, that market is a rapidly growing one. It's one that is evolving fairly rapidly. And we've always had good relationships, but we're expanding those. And we've got good presence not only in the U.S., Europe, South Korea and China.

So as you look out to 2024 you think that this part of the industrial business does it have the potential to be meaningful in your overall industrial revenue stream?

Well, I think from a revenue standpoint, I would highlight defense and probably additive on the incremental adds more. But in terms of the progress we're making certainly we hope to provide more background there in battery welding also.

Yes. Thanks a lot.

Thanks, Jim.

The next question comes from Greg Palm with Craig-Hallum Capital Group. Please go head.

Hi. This is Danny Eggerichs on for Greg today. Thanks for taking the question, guys. I think first maybe just digging into the Q3 guide a little bit more and some of the assumptions behind that. I guess, from a geographic perspective, what you're seeing out there it seems like North America held up relatively well and maybe there was some weakness in Europe and then end markets. I appreciate the color on microfab. But are you expecting solid growth in A&D still and then maybe industrial falls somewhere in between there?

Yes. Thanks, Danny. I think the way that I would characterize the guide is, we have a little bit more visibility obviously in the defense business. So we have a better perspective on what we can do in defense as we talked about in Q2. Part of that is really going to be sort of some of this project timing both from a labor and material perspective. And we continue to sort of see macroeconomic challenges in the third -- sorry, macroeconomic weakness in both the industrial and micro markets. So it's been really difficult to predict how the customers are -- what their take rate is really going to be. And that's globally. That's both in China and the rest of the world. So I almost would categorize the third quarter a couple of million dollars either way as sort of hopefully kind of bumping along the bottom. But as Scott said earlier right we've got what we think the right design wins in place with the right customers coupled with some defense wins that we do think that that is going to grow. But in the third quarter, it's a lot of the same that we saw in the second quarter quite frankly.

Okay. Makes sense. And then maybe one on gross margin in Q2, just looking at kind of the sequential step-down off similar revenues to Q1 and it sounds like mix wasn't necessarily a factor. Can you just go through what was kind of the drivers behind that sequential step-down?

Yes great. It was limited sort of exclusively to manufacturing quarter-over-quarter, right? I mean we as we are changing our overall manufacturing processes right we still don't have perfect either visibility or the ability to predict what things like scrap and yield are always going to be quarter-over-quarter. So that was one of the pieces. The other piece is we talked about Fabrinet there were some onetime charges that we needed to take. Again not huge but 100 basis points to 150 basis points can explain half of the sequential step-down quarter-to-quarter. At the same time if you look at what we are doing on a normalized basis and our ability to leverage our overhead and manufacturing that continues to trend in the right direction. I know your question was relative to the prior quarter. But as we are looking at the business and we're looking at progress on the manufacturing front if you were to kind of go back a year from -- a year ago and look at what our product revenue was and that was $9 million or $10 million higher than it was in the second quarter and the gross products gross margin was about the same. So that gives us the optimism that we're really starting to dial in the manufacturing and the expenses around it such that as revenue grows we're going to be able to put a lot more through to the bottom line from both an adjusted EBITDA and a cash flow basis.

Okay. Got it. Maybe one last one on HELSI. Good to hear that started in the quarter. Can you just remind us of how we should think about the timing of that revenue ramp? Is it linear? Is it going to build throughout 2024, or how should we think about that?

Yes. It's definitely not going to be linear. I don't think we've said anything nor has anything been released publicly specifically about the period of performance on that contract. But it's a multiyear contract. I think directionally it will move up particularly as we start to allocate more resources and more material and hit milestones of that program. But hard to sort of say, we can draw a line from zero straight up with the same slope to $86 million. But it will increase over the coming periods.

Right. Thanks. All leave it there.

Sure. Thanks you, Dan.

Seeing no further questions this concludes the question-and-answer session. I would now like to pass the call back over to Joe Corso for closing remarks.

Yes. Thanks everybody for joining today and for the interest in nLIGHT. We look forward to talking to many of you during the quarter. Have a good afternoon.

The conference has now concluded. Thank you for your participation. You may now disconnect.