nLIGHT Q2 2023 Earnings Call Transcript

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August 3, 2023

There are 6 speakers on the call.

Operator

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 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.

Speaker 1

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 statement, except as required by law.

Speaker 1

During the call, we will be discussing certain non GAAP financial measures. We have provided reconciliations of these non GAAP financial measures 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.

Speaker 2

Thank you, Joe. In the Q2, we delivered results that were largely in line with guidance. Revenue of $53,300,000 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 3 areas critical to our strategic Growth objectives.

Speaker 2

In Aerospace and Defense, we kicked off the healthy 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 de risk our manufacturing strategy. We have established automated assembly of semiconductor lasers in the U. S.

Speaker 2

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 $24,500,000 representing 46% of total revenue. 2nd quarter development revenue increased 8% year over year to $13,700,000 And defense products revenue increased 9% year over year to approximately $10,800,000 As we announced in early May, We were awarded a new $86,000,000 contract to produce a more powerful, higher performance laser related to the 2nd phase of the Department of Defense high energy laser scaling initiative, which we refer to as LC2. In late Q2, we kicked off LC2 activities and recognized initial revenue from this program, which we expect to continue for approximately 2 plus years.

Speaker 2

In addition, we also announced that our HELSI-one laser was formally by the government and is being prepared for integration within the U. S. Navy's high energy laser counter anti ship cruise missile program. We continue to believe that our unique technology and vertical integration from chip through beam control are well suited to be scaled to increasingly higher powers. And we are proud to continue to support the U.

Speaker 2

S. Government's efforts in higher power directed energy lasers. We are excited About our current programs in Directed Energy and we are working on several new opportunities that we look forward to sharing in coming quarters. In non directed energy defense, we generated higher revenue from existing long running programs and we made significant progress on a number of new programs. We expect to continue to Our long learning programs well into the future and we believe our new programs remain on track to transition to production sometime in 2024.

Speaker 2

Turning to the industrial end market. Industrial revenue in the 2nd quarter declined 24% year over year to $16,600,000 representing 31% of total revenue. In cutting, we continue to leverage our all fiber programmable technology to deliver innovative Increasingly higher powered lasers to our customers. Revenue from cutting customers was relatively flat year over year and in line with our expectations When we provided 2nd quarter guidance. While the overall demand environment remained muted, we did gain share with 1 of our top customers And again, increase the overall number of 15 kilowatt and 20 kilowatt lasers sold.

Speaker 2

In Welding, we continue to expand our process monitoring sales In the European, North America and Chinese EV battery market, our suite of process monitoring solutions and battery monitoring experience opened up new opportunities for both Process monitoring and laser sales in the EP market. Part of the strategic rationale for our acquisition of Plasma last year was to capitalize on cross selling opportunities While revenue from welding customers is a relatively small part of our overall industrial business today, During the Q2, we had several new customer wins and significantly increased our engagement with potential customers. Additive continues to offer significant long term growth opportunities for us. Our Corona single mode AFX fiber laser has been widely demonstrated to increase build rates By a factor of 2x to 8x, which substantially reduces part cost. In addition, our laser simultaneously maintains excellent Material quality increases the process window and reduces deleterious effects such as soot, spatter and porosity That affect laser powder bed fusion tools based on legacy fiber lasers.

Speaker 2

Our lasers have enabled tools by leading integrators including DMG Mori, Fellow3d, AMCM, Aconity 3d and several others that we are not able to specifically call out. Q2 additive revenue was slightly above what we had expected when we provided guidance for the quarter, but was down year over year as one of our customers Still in the process of integrating lasers they had purchased last year. In microfabrication, Revenue in the Q2 of 2023 declined 26% year over year to $12,200,000 which represented approximately 23% of total revenue. We continue to believe that we are a leader in the market, but global demand remains soft as customers continue to adjust existing inventory. While we saw some signs of recovery during the beginning of the quarter, revenue did not materialize in the way that we had hoped, particularly in China.

Speaker 2

We remain actively engaged with our key existing customers and we expect that as global demand environment becomes more constructive, our semiconductor laser business will grow off the current levels. Turning to operations. We again made excellent progress in automation during the quarter. By the end of the second quarter, we achieved key milestones in the utilization of our equipment Manufacturing throughput. We also continue to mature our overall automation process flow, which over time will result in better yields and additional potential output.

Speaker 2

We are also pleased to announce that we signed a manufacturing agreement with Fabrinet, a world class contract manufacturer provider with a strong footprint in Thailand. Fabrinet has a long history of delivering outsourced manufacturing services to the photonics industry. Our partnership with Fabrinet provides additional high quality, low cost semiconductor laser assembly for our commercial business and enables increased flexibility for us to Scale with demand, effectively making a portion of our manufacturing capacity variable. Most importantly, however, Is that working with Fabrinet enables us to dedicate a greater proportion of our U. S.

Speaker 2

Based manufacturing capacity to our defense business, which is expected to ramp significantly in the coming quarters. Our initial qualifications have gone well and we expect to begin shipping products with Fabrinet assembled lasers in the coming weeks. Now, we'll turn to our current revenue outlook for the Q3 and beyond. We currently expect 3rd quarter revenue to be in the range of $47,000,000 to At the time of our last earnings call in May, we had been anticipating a Q3 that was approximately $5,000,000 to $10,000,000 higher than the midpoint of our Q3 guidance. While we remain highly optimistic about both our near and long term prospects, I'd like to describe the 2 primary drivers that are impacting our current Q3 outlook.

Speaker 2

First, the initial ramp of healthy 2 is going a bit slower than we Due to the availability of materials affecting the amount of work that we've been able to perform on the project. This slower than anticipated ramp accounts for approximately half There have been no changes to our longer term schedule and we expect revenue to begin to ramp more significantly over the next few quarters. The other half of the delta was driven by lower overall demand, particularly in microfabrication. As we look towards 2024 however, Our customer demand pipeline and revenue visibility have actually strengthened quite a bit. So although our revenue ramp in Q3 is a bit slower than what We had expected a quarter ago.

Speaker 2

New defense program wins and continued execution in our commercial business will begin to come to fruition in 20 24 resulting in even stronger growth than we had expected entering this year. In summary, We've made excellent progress over the last several quarters despite the fact that our top line revenue is currently ramping more slowly than our expectations. Our opportunities in defense in both directed energy and our core business have continued to expand. We also believe that our core technology, particularly our programmable lasers and process monitoring capabilities, coupled with strong secular trends in Additive and Welding are driving strong expected growth in 2024 and beyond. I will now turn the call over to Joe.

Speaker 1

Thank you, Scott. NLIGHT generated revenue and adjusted EBITDA above the midpoint of our guidance. Growth and gross margin improvement is a core focus of the nLIGHT leadership While scale and mix are 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.

Speaker 1

In a period of continued macroeconomic softness, We are carefully monitoring operating expenses and capital expenditures so that higher revenue levels we are able to drive better levels of profitability. Total revenue for the Q2 of 2023 was $53,300,000 above the midpoint of guidance compared to $60,800,000 for the Q2 of 2022. Products revenue was $39,600,000 compared to $48,200,000 for the Q2 2022. Revenue decreased year over year in both the industrial and microfabrication markets, but increased year over year in aerospace and defense. Gross margin was 23% compared to 25% for the Q2 of 2022.

Speaker 1

Products gross margin was 29% compared to 30% for the comparable period in 2022. Products gross margin in the Q2 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 $16,600,000 a decrease of $2,700,000 compared to $19,300,000 for the Q2 of 2022. The decrease in operating expenses was driven by a decline in employee compensation costs, primarily due to lower headcount, Decreases in R and D project spending and higher administrative costs that were allocated to development projects. On a GAAP basis, Operating expenses were $23,800,000 a decrease of $1,900,000 compared to $25,700,000 for the Q2 of 2022.

Speaker 1

Net loss on a non GAAP basis was $900,000 or $0.02 per diluted share compared with a net loss of $3,300,000 or $0.07 per diluted share for the Q2 of 2022. Net loss on a GAAP basis was $8,800,000 or $0.19 per share compared to a net loss of $10,300,000 or $0.23 per share for the Q2 of 2022. Adjusted EBITDA was a negative $150,000 above the midpoint of guidance compared to positive $200,000 for the Q2 of 2022. Cash used in operations was $4,100,000 compared to cash used for operations of $4,800,000 for the Q2 of 2022. Included in cash flow from operations was an $8,400,000 increase in accounts receivable due primarily to the timing of billings and collections during the quarter.

Speaker 1

Capital expenditures were $1,000,000 compared to $7,900,000 for the Q2 of 2022. While capital expenditures will increase in subsequent quarters, Overall CapEx in 2023 will be down significantly year over year. We also used approximately $3,000,000 of cash on tax payments related to stock award issuance during the quarter, which we do not expect to repeat at this level in subsequent quarters. Turning to the balance sheet. Our balance sheet remains strong as we ended the Q2 of 2023 with total cash, cash equivalents, restricted cash and investments of $102,000,000 and no debt.

Speaker 1

Our DSO for the quarter was 70 days and inventory at the end of the second quarter was 64,900,000 representing 144 days of inventory. Turning to guidance. Based on the information available today, we expect revenue for the Q3 of 2023 to be in the range of $47,000,000 to $51,000,000 The midpoint of $49,000,000 includes approximately $36,000,000 of product revenue and approximately $13,000,000 of development revenue. As Scott discussed earlier, at the time of our last earnings call, we were expecting our Q3 to be approximately $5,000,000 to $10,000,000 higher than the midpoint of today's guidance range. About half of the difference is simply related to the availability of materials limiting how quickly we could ramp on our LC2 program, while the other half is really driven by a slower recovery in macroeconomic demand for our microfabrication business.

Speaker 1

We've made excellent progress in healthy 2 during the Q3, but it's still difficult to predict when the macroeconomic environment will really be in to drive higher demand in microfabrication. Turning to gross margin. 3rd quarter 2023 products gross margin is expected to be in the range of 27% to 31% And development gross margin to be approximately 7%, resulting in an overall gross margin range of 22% to 25%. Finally, we expect adjusted EBITDA for the Q3 of 2023 to be in the range of approximately negative $3,000,000 to breakeven. As a reminder, over the last several quarters, we have significantly streamlined our cost structure and continue to expect to return to positive adjusted EBITDA at a quarterly revenue run rate in the $55,000,000 to $60,000,000 range.

Speaker 1

With that, I will turn the call over to the operator for questions.

Operator

Thank you. We will now begin the question and answer session. At this time, we will pause momentarily to assemble our roster. The first question today comes from Reuben Roy with Stifel Nicolaus. Please go ahead.

Speaker 3

Thank you. Hi, Scott and Joe. I wanted to start, Scott, With a question on guidance and sort of how to think 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 in 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 healthy going To become available and is that going to help you get back to sort of revenue growth in Q4 or any signs of Yes, sort of a bottoming process in microfab, any detail around that would be helpful.

Speaker 2

Yes, absolutely, Ruben. Thanks for the question. As I noted, the delta I described was due to timing for healthy and then sort of the macro effects. So as we look out in time, certainly the healthy program, the contract is in place. And so We fully expect to be ramping there as material and other resources are available.

Speaker 2

Now with respect to the macro environment, that's harder to predict what's going on in the macro environment. But in addition, we 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.

Speaker 3

Okay. Thank you, Scott. I guess a follow-up to that would be around the FiberNet 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 Detailed comment to make about how you're thinking about mix internal to outsourced and if we should think about any longer term margin impacts Commercial laser products as that makes shifts potentially over to contract manufacturing?

Speaker 2

Yes, good. Let me take the first part of the question 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 that we have the capacity in the U.

Speaker 2

S. 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 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.

Speaker 1

Yes, good question, Ruben. So from a margin perspective, we I expect that margin to be neutral or potentially positive. If you think of what a relationship with Fabrinet, our 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 Peeks and valleys, so over time, we think at worst, this is margin neutral at best. It gives us the opportunity Continue on our path to 40% product gross margins or better.

Speaker 3

That's great. Thanks for that detail, Joe. If I'll just sneak one last one in. It's great to hear about the plasma traction. Got it.

Speaker 3

I think you mentioned that you're seeing sort of attached Laser sales with Plasma, 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 laser that are lasers that are out there in EV installations.

Speaker 2

Yes, very good question, Rivete. It is both. We do think that having the process monitoring from plasma It gives us the opportunity for new design wins that we might not otherwise have, but then it 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 was about a year ago that we acquired POSMO and we do think that Process monitoring is a very important part of many of the applications that we 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, in a market that is very dynamic and growing.

Speaker 3

Right. Excellent. That's all I had. Thank you.

Speaker 2

Thanks, Ruud.

Operator

The next Question comes from Jim Ricchiuti with Needham and Company. Please go ahead.

Speaker 4

Hi, good afternoon. I wanted to go back And maybe you could just walk us through the timeline. Obviously, you've known these guys for a while. They're Mike, this was being driven by the momentum that you've seen in the defense business. But maybe if you could just So help us understand the whys and timing around it.

Speaker 2

Yes, Tim, certainly I've known Fabrinet for a long time and have always been impressed. We did look at multiple CMs here and 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.

Speaker 2

We've got our automation up and running in the U. S. 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 Variableize is 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.

Speaker 2

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.

Speaker 4

Okay. I think I can understand the optimism that you have around the defense business 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?

Speaker 2

Yes, exactly, Jim. Yes. So, as you know, in the defense market, obviously, we've got longer term visibility in the industrial markets. 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.

Speaker 2

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 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.

Speaker 4

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, but I'm talking specifically about the lasers. Correct.

Speaker 2

Yes. These are new customers. Some existing customers were expanding and some new customers also. Again, that market is a rapidly growing one. It's one that is evolving fairly rapidly.

Speaker 2

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.

Speaker 4

So as you look out to 'twenty four, you think that this part of the industrial business, Does it have the potential to be meaningful in your overall industrial revenue stream?

Speaker 2

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.

Speaker 4

Okay. Thanks a lot.

Speaker 2

Thanks, Jim.

Operator

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

Speaker 5

This is Danny Eggerich on for Greg today. Thanks for taking the questions 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 expecting solid growth in A and D still and then maybe industrial

Speaker 1

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 Labor and material perspective, and we continue to sort of see macroeconomic challenges in The 3rd 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 It's really going to be and that's globally, that's both in China and the rest of the world.

Speaker 1

So I almost would categorize The Q3, a couple of $1,000,000 either way is 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 Q3, it's a lot of the same that we saw in the Q2, quite frankly.

Speaker 5

Okay. Makes sense. And then maybe one on gross margin in Q2, just looking at kind of the Sequential step down. It's 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?

Speaker 1

Yes, great. It was Limited sort of exclusively to manufacturing quarter over quarter, right. I mean, 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 pieces we talked about FAPRIMET, there were some one time charges that we needed to take.

Speaker 1

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 ago and look at what our product revenue was and that was $9,000,000 or $10,000,000 higher than it was in the 2nd quarter and the gross products gross margin was about the same. 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

Speaker 5

Okay. Got it. Maybe one last one on healthy. 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?

Speaker 5

Is it Linear, is it going to build throughout 2024? Or how should we think about that?

Speaker 1

Yes. It's definitely not going to 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 0 straight up with the same slope To $86,000,000 but it will increase over the coming periods.

Speaker 5

All right. Thanks. I'll leave it there.

Speaker 1

Sure. Thank you, Dan.

Operator

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

Speaker 1

Yes. Thanks everybody for joining today and for the interest

Operator

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

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