nLIGHT, inc (LASR) Q3 2021 Earnings Call Transcript

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nLIGHT, inc (LASR -0.92%)
Q3 2021 Earnings Call
Nov 4, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the nLIGHT Third Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Joseph Corso, Vice President, Corporate Development and Investor Relations. Please go ahead.

Joseph Corso -- Vice President, Corporate Development and Investor Relations

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 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.

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Thank you, Joe. Starting on slide three. Q3 was a strong quarter for nLIGHT. We generated a record $72 million of revenue, which was a 17% increase year-over-year. Overall, revenue growth this quarter was driven by growth in each of our end markets, which highlights the diversity in our business model. We continue to focus on serving customers in multiple attractive markets and geographies with a diverse portfolio of high-powered laser solutions. In the third quarter, more than 80% of our total revenue was from outside of China, and we achieved another record revenue quarter from industrial customers outside of China. As a result, we generated 37% products gross margin, the highest in our history as a public company. In microfabrication, our high-power, high-brightness semiconductor lasers continue to lead the industry.

In this market, our products serve as the energy source for many of the world's leading pulse laser manufacturers, which are used to manufacture products in a wide range of industries from consumer electronics to semiconductor manufacturing to electric vehicles. We continue to design and develop next-generation semiconductor lasers that will enable our customers to meet the secular demand of the industries that they address. In the industrial market, we continue to sharpen our focus on our business outside of China where our innovative products enable our customers to create a strong competitive advantage for their end systems. Our focus on developing market-specific solutions like programmable lasers for cutting and welding and single-mode programmable lasers for additive manufacturing have led to deeper customer engagement and have enabled us to secure new design wins and increase our share with multiple strategic customers.

For example, nLIGHT lasers are uniquely suited for the next generation of series production additive manufacturing equipment where high-speed control and extremely stable output are critical. In defense, we continue to deliver critical lasers to both our core long-term defense programs and new directed energy applications. As we've mentioned in the past, direct energy is a significant growth opportunity for nLIGHT. In this market, we have developed capabilities across the entire laser value chain, and we continue to engage with the U.S. government each of the armed services, defense primes and foreign allies on a wide range of exciting programs and projects. Turning to slide four to discuss quarterly revenue by end market. In the third quarter, aerospace and defense revenues increased by 8% year-over-year and represented 38% of total revenue.

Year-over-year growth was driven by an increase in revenue from the direct energy development work we are performing for the U.S. government. In direct energy, the capability and performance of our semiconductor lasers, amplifiers, beam combination and beam control solutions, continue to improve at a rapid pace. Moreover, we are engaged in multiple new direct energy-related activities that can create additional long-term opportunities for our DE business. As a result, our development revenue in the third quarter increased by 68% year-over-year to $17.8 million. Put that in context, in Q1 2020, which is the first full quarter post the acquisition of Nutronics, we generated approximately $6.3 million of revenue.

In our core A&D business outside of direct energy, we have long-term contracts to deliver mission-critical products to defense customers. Revenue was lower this quarter than the comparable quarter a year ago as we experienced certain temporary material shortages and vendor quality issues related to some of the products we sell to core defense customers. In industrial, our business grew 22% year-over-year in the third quarter to $26.7 million, a new record for our business. Furthermore, revenue from industrial customers outside of China was the highest in our company's history and was 40% higher than our previous record, which we achieved just last quarter.

The shift in our strategy to focus primarily on industrial customers outside of China has had a profound impact on both our business model and our financial results. In the third quarter, more than 2/3 of our industrial revenue came from customers outside of China. This is a significant shift in the composition of our revenue versus where we were in the industrial market several years ago when it was more typical for 2/3 of our revenue to come from China. Our growth in the third quarter highlights our customers' desire to work with a laser partner that offers a wide portfolio of high-performance, innovative, reliable and serviceable lasers that in turn enable them to distinguish their products in the market. Revenue from our programmable lasers grew for the sixth consecutive quarter and continues to create additional revenue opportunities from both new and existing customers.

In additive manufacturing, we experienced another strong quarter of growth and secured a new design win from a leading OEM. In microfabrication, our sales increased 26% compared with the third quarter of 2020 to $17.7 million. In Q3, the primary driver of our growth was sales to customers outside of China. As a market leader in high-power semiconductor lasers, our revenue continues to be driven by long-term design wins in our customers' current and next-generation products across a wide range of applications and geographies. We continue to see favorable demand trends from a wide range of applications, ranging from consumer electronics, displays, solar cell manufacturing and EV production. Turning to slide five to discuss revenue by geography. In the third quarter, sales to customers outside of China grew 38% year-over-year to $58.5 million, which represented approximately 81% of total revenue.

Third quarter revenue from outside of China was another record for nLIGHT on both an absolute basis and a percentage of total revenue. In China, Q3 revenues declined approximately 29% year-over-year to $13.7 million. Our year-over-year revenue decline in China was driven by lower sales of fiber lasers into the industrial end market, offset by year-over-year increases in sales to microfabrication customers. As you may recall, nLIGHT serves both the microfabrication and industrial markets in China. Each of these markets require a different set of nLIGHT products and have different competitors and customers. In microfabrication, we sell primarily semiconductor lasers to manufacturers of high-powered diode-pumped solid-state lasers, and we focus primarily on providing technically challenging products for the most demanding applications in this market.

While we face competition, like we do in here market in which we compete, we believe that our multi-decade history of continued development of the brightest, most reliable semiconductor lasers offers us a significant and sustainable competitive advantage. In industrial, we sell primarily fiber lasers for cutting and welding applications. As we've discussed in the past, the industrial fiber laser market in China, particularly in cutting, has continued to deteriorate. As prices continue to erode, we are being even more selective with respect to the business we are pursuing in the China industrial fiber laser market. In summary, I'm pleased with our quarterly results, which I believe reflect the execution of our business strategy.

Our core strategy to serve customers in the global industrial and aerospace and defense market has enabled us to increase both our revenue and our profitability. Multiple positive secular trends across each of our end markets continue to drive the adoption of lasers and the demand of our products. Despite a challenging supply chain environment, our conviction in our long-term growth thesis remains firmly intact, and we are optimistic in our ability to continue to grow our business organically in both the near and long term. Assuming the midpoint of our Q4 guidance, we will again increase our year-over-year revenue by more than 20% in 2021, a growth rate that we believe is sustainable over the longer term. I will now turn the call over to Ran to discuss nLIGHT's third quarter financial results.

Ran Bareket -- Vice President and Chief Financial Officer

Thank you, Scott, and good afternoon, everyone. Beginning on slide seven. Third quarter record revenue of $72.2 million was above the midpoint of our guidance range and was up 17% year-over-year. Third quarter products revenue was $54.4 million, an increase of 6% above the third quarter of 2020. Our products revenue growth was driven by higher sales to both our semiconductor and fiber laser to customers outside of China. This growth in Rest of the World product revenue was mainly offset by a decline in revenue to customers in China. Third quarter development revenue was $17.8 million, an increase of 68% above Q3 2020. The increase in development revenue in the third quarter of 2021 was mainly driven by higher development revenue related to direct energy project work that we performed for the U.S. government.

Turning to slide eight to provide more detail into our gross margins. Overall gross margin was 29.6% in the third quarter versus 27.8% in the comparable period of 2020. Product gross margin was 37.1% in the third quarter compared to 32.2% in the third quarter of 2020, an improvement of approximately 490 basis points. Our year-over-year margin improvement was a direct result of the implementation of our strategy to increase sales to the rest of the world industrial and A&D customers, additional leverage on our fixed cost manufacturing and further cost reduction efforts. Turning to slide nine. Non-GAAP operating expenses were $18.1 million during the third quarter compared with $14.3 million in Q3 2020.

The majority of the year-over-year increase was related to higher R&D investment to support our product road map and long-term growth opportunity. As a percentage of revenue, our total Q3 non-GAAP opex was 25%, consistent with the prior quarter and with Q3 2020. Turning to slide 10. Non-GAAP net income in the third quarter was $3.9 million compared with $5.3 million in the third quarter of 2020. Non-GAAP EPS for the third quarter was $0.08 per diluted share compared with $0.12 per diluted share for the third quarter of 2020. The decrease in non-GAAP net income and EPS compared to the prior year was mainly driven by a noncash tax credit in Q3 2020 related to foreign taxes of approximately $1.5 million or $0.04 per diluted share. Going forward, we expect tax expense to be approximately $200,000 to $400,000 per quarter. On a GAAP basis, EPS for the third quarter was a loss of $0.16 compared with a loss of $0.05 during the third quarter of 2020.

The increase in loss per share compared to the comparable period in the prior year was driven by an increase in stock-based compensation cost and tax credit previously discussed. Third quarter adjusted EBITDA was $7.2 million compared with $6.2 million in Q3 2020. Our year-over-year improvement in adjusted EBITDA in Q3 was a result of higher gross profit, partially offset by continued investment in R&D. In the third quarter, we used approximately $400,000 of operating cash versus $7.7 million of cash flow from operation in Q3 2020. Cash usage during the quarter was related mainly to an increase in working capital. We made further investment in inventory during the quarter in order to mitigate potential supply chain disruption and to ensure that we are able to satisfy the demand we are seeing from our customers.

Our capital expenditure in Q3 2021 were $5.7 million versus $2.4 million in the third quarter of 2020. We continue to accelerate the automation of our U.S. facility to serve our customer outside of China. Turning to slide 11. We ended Q3 with cash and cash equivalents of approximately $166 million and no debt. We continue to carefully manage our net working capital, which grew during the quarter as a result of higher revenue, positive demand trends and strategic inventory purchases. DSO for the third quarter was 46 days. Inventory at the end of the quarter was $71 million, representing 119 days of inventory. Turning to slide 12 for our outlook for Q4. As Scott mentioned earlier, we are operating in a highly dynamic supply chain environment. Our Q4 guidance takes into consideration our current view on capacity constraints, freight cost, material cost and availability.

Based on the information available today, we expect Q4 to be in the range of $66 million to $72 million. At the midpoint of $69 million, this includes approximately $49 million of product sales and approximately $20 million of development sales. While demand trends from our customer outside of China remains strong, we see further weakness in China. Turning to gross margin. Q4 product gross margin is expected to be in the range of 34% to 36%, and we expect development gross margin to be approximately 6.5%. As a result of higher expected development revenue in the fourth quarter, we see overall gross margin for Q4 in a range of 25% to 28%. For the fourth quarter, we expect adjusted EBITDA to be in a range of $3 million to $5 million. Our Q4 adjusted EBITDA range assumes non-GAAP opex increase slightly and depreciation and amortization is approximately $4 million. We expect Q4 average basic shares to be approximately 43.4 million, and non-GAAP diluted shares to be approximately 47.8 million.

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

Questions and Answers:

Operator

As a reminder, a copy of today's slide presentation can be found on the Investor Relations section of nLIGHT's website. [Operator Instructions] The first question comes from Greg Palm with Craig-Hallum Capital Group. Please go ahead.

Greg Palm -- Craig-Hallum Capital Group -- Analyst

Yeah, hi, good afternoon everybody. Thanks for taking the questions here, I guess, just starting off on supply chains. If I heard you right, I think you had mentioned something along the lines of constraints or supply chain challenges, and I was curious if that inhibited your ability to fulfill some demand specifically in Q3? And as we think about Q4, is there also some added impact inherent in the guidance as well, whether that's capacity-constrained supply challenges, etc?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Yes, Greg. It's a good question. Certainly, like everybody, we are facing numerous different supply chain issues and logistics issues. We've been able to manage those with minimal impact to our business. Certainly, our customers also see that. And so certainly some of the demand that we'd hope for our customers have been affected. But I think in Q3, it wasn't a material impact in the quarter. As we look ahead, we see those issues continuing and we're continuing to manage them, and we don't see anything that is material that we want to highlight, but it is an ongoing challenge to continue to manage that in terms of our supply chain, in terms of our customer supply chain and in terms of cost, too. So those are all factors that are key topics that we're managing.

Greg Palm -- Craig-Hallum Capital Group -- Analyst

Okay. Fair enough. And looking at Q3 specifically from a geographic standpoint, Rest of World really stood out, not just on a year-over-year basis, but it was up quite a bit sequentially. So what type of regions are you seeing the most growth? And is it across the board? Or is it contained in new specific segment like industrial? What are you seeing exactly?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Yes. We are seeing growth across the board, but industrial grew 40% quarter-over-quarter in Q3. So some very strong growth there. And you're exactly right. Certainly, one of the topics we want to highlight that is a -- as part of our strategy, and Q3 certainly reinforces what we're doing to focus on growth in the rest of the world.

Greg Palm -- Craig-Hallum Capital Group -- Analyst

Any specific region you want to call out? Or don't you want to get that specific?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

I don't believe there's any region that merits specific calling out. We certainly see strength in U.S., Japan, Korea and some good growth in Europe also.

Greg Palm -- Craig-Hallum Capital Group -- Analyst

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

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Thanks, Greg.

Operator

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

Patrick Ho -- Stifel -- Analyst

Congrats on a nice quarter in a challenging environment. Scott, in your prepared remarks, you talked about the diversification into new regions and things of that nature where power isn't the only criteria your customers are looking at. You mentioned service, reliability and performance. If you could give a little more color in terms of the performance attributes that are more and more important for customers outside of China, which I believe have become more commoditized. What are some of the performance characteristics that are differentiating what you offer?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Yes. Very good point, Patrick, that in the past, it was easier to describe the increases in power as a key theme, and that still is a theme that we will see. But I believe that increases in performance may be even more important. And there are a number of different dimensions of performance from very specific topics of the stability of our lasers for things like additive manufacturing to the programmability of our lasers that are unique in many of these different verticals. And I think those themes will continue to be important, and we'll be talking about more of those products as we release them. In the additive manufacturing trade show, Formnext, will be week after next, and we'll continue to be releasing new products in that market. Welding continues to be an important market. And even in cutting, while there is some more standard lasers that are used, I think the use of the programmable lasers will continue to be even more important there.

Patrick Ho -- Stifel -- Analyst

Great. That's really helpful. And maybe as my follow-up question, in the aerospace and defense market, it's always a little bit lumpy depending on the timing of projects and things of that nature. Directed energy is obviously a long-term opportunity for you guys. But I guess in just some more traditional aerospace and defense projects, how do you see the pipeline in that area over the next few years? Is that something that's also potentially growing? Or is all the growth is going to be coming from directed energy?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Yes, I'm glad you asked that question. I think we are seeing growth in other markets beyond direct energy and more than we have seen perhaps in previous quarters, what, three meetings this week on new interesting opportunities outside of directed energy space is certainly one area where we're very proud of our space qualified lasers. In fact, we just learned today that our laser that's on the NASA ICESat-2 satellite just reached one trillion shops and is exceeding its lifetime goals and providing data for changes in the environment and very proud of the work there, and we see a number of new opportunities in other applications in both aerospace and defense. So I hope to be talking more about those as they become public. But yes, it goes beyond directed energy.

Patrick Ho -- Stifel -- Analyst

Great, thank you very much.

Operator

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

Tom Diffely -- D.A. Davidson -- Analyst

Yes, good afternoon and thanks for the question. Scott, first, a question on China. So obviously, there's weakness there, and fiber laser pricing is pretty weak. But how is the market for the components for the semiconductor lasers, the diodes?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Yes. Very good question, Tom. While the industrial market is less attractive, the market for our high-performance semiconductor lasers that go into notably pulse lasers, that continues to be strong. That's a market that does require higher performance. And it's one that we are more differentiated, and we have a 20-year history of leading that industry. So that part of the market is an attractive part of the market.

Tom Diffely -- D.A. Davidson -- Analyst

Okay. That's good to hear. And we haven't heard you mention tariffs much lately. Is that the thing in the past? Or are those ongoing?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

We haven't, have we? No, it's not a first-order issue for us at the present time and don't anticipate direct tariffs to be an issue. I think certainly, there's a wide range of nontariff barriers that are out there. But no, we don't see tariffs as a first-order issue.

Tom Diffely -- D.A. Davidson -- Analyst

Okay. Good to hear. And then, Ran, when you look at the gross margin guidance, I would have thought that with China coming down as a percentage of business again, but at least the high end of that margin range would have been up a little bit.

Ran Bareket -- Vice President and Chief Financial Officer

Sure. So keep in mind, when we are talking about quarter-over-quarter, there are other mix between the different markets, different products that can impact the margin, not to mention that product revenue, at least based on our guidance, predict to go down. All of that would influence -- would impact our margin in Q4. But again, if you will see the trends over the last few good quarters on product margin, you can see a significant improvement, which we anticipate to continue next year as well.

Tom Diffely -- D.A. Davidson -- Analyst

Okay, great, well thank you both for your time today.

Ran Bareket -- Vice President and Chief Financial Officer

Thank you.

Operator

The next question comes from Paretosh Misra with Berenberg Capital Markets. Please go ahead.

Paretosh Misra -- Berenberg Capital Markets -- Analyst

Thanks, and good afternoon, Scott, given the widespread inflation in the industry -- across many industries actually, can you discuss how the cost structure of the industry is evolving? What I'm trying to get at is that could you be better placed than maybe some other competitors because maybe you're more insulated due to vertical integration, whereas the high-cost guys, they are seeing a faster inflation, so there could be -- long term, that could be good for pricing?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Yes. Interesting. Let me think. We are vertically integrated. So there is some insulation there. We are seeing inflationary pressures from the components, especially electrical electronic components that we buy. But that's a relatively, to your point, relatively small part of our BOM. So yes, there is some insulation there. But I think those inflationary concerns are concerns that every business is going through right now.

Paretosh Misra -- Berenberg Capital Markets -- Analyst

Got it. And any sense you could provide as to where pricing is in the industry? I don't know if you could care a dollar per watt price, but maybe just how it is versus last year, like how far it has gone down maybe for the commodity grades?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Well, I'll say this. Look, China and others have reported this. Even the companies in China have reported that pricing in China for the standard more commoditized kind of lasers, that pricing remains very difficult and continues to be declining. That is just one market, and that is a market for a specific type of laser with certain set of specifications. As you go to other markets even in China, but elsewhere, you're really talking about very different performance, different lasers, and now we're not seeing that kind of price pressure in those other markets.

We certainly expect and our core thesis for the company we started 20 years ago is that we're going to continue to drive the technology, improve performance and bring down price so that we can displace other legacy technologies. So we certainly believe there's a secular long-term trend to displace other technologies. But kind of from a quarter-over-quarter basis, most of the markets, we don't see a dramatic change, but certainly in China, unattractive in general for those commodity markets.

Operator

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

Mark Miller -- The Benchmark Company -- Analyst

Congratulations on your record revenues. You mentioned some design wins, and I was just wondering if you can give a little more color was one in additive manufacturing?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Indeed, yes. Yes, we've made -- Mark, we've made great progress in additive. I think we've seen a number of the new players coming out with next-generation products that are enabled by our next-generation fiber lasers. And it will be interesting to see the announcements in two weeks at Formnext, which is the big trade show. And there should be more public information over time as to who's doing these next-generation systems. But -- and the thing that I think is very interesting in this space is that we're seeing the economics really change for series production and innovations coming from some of the newer players in that space. So standby, there will be more information it's released publicly.

Mark Miller -- The Benchmark Company -- Analyst

Can you break out the laser sales by power like over six kilowatts in the medium power?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

I can. Yes, we continue to disclose those data. However, as I mentioned earlier, it's a little less meaningful as power is one dimension, performance is another dimension. So actually, in Q3, our less than two kilowatt laser sales were 27% of the overall mix and higher power above six kilowatt was 50%. And the remainder 23%. But that low power below two kilowatt at 27% was the highest it's been, oh boy, for like three years, which reflects that higher performance segment that is enabling welding and additive markets.

Mark Miller -- The Benchmark Company -- Analyst

And finally, would you contribute the malaise in the Chinese cutting market to? Is it overcompetition or macro conditions?

Scott H. Keeney -- Co-Founder and Chief Executive Officer

A bit of both, I think. It's always a little hard to tell. But certainly, there are macroeconomic factors going on in China that you've read about, everything from power shortages to all kinds of macro econ effects. And then the very aggressive playbook of companies that are SOEs that are driving prices even to the levels that they are publicly saying are less attractive. So it's a playbook that we've seen in other sectors. But as we've said for a long time, we're focused on growth in other markets.

Mark Miller -- The Benchmark Company -- Analyst

Thank you.

Operator

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

Joseph Corso -- Vice President, Corporate Development and Investor Relations

Thank you, everyone, for joining this afternoon and for your continued interest in nLIGHT. We experienced some technical difficulties during a portion of today's webcast. So if anyone has any challenges accessing the slides for any portions of our call, please feel free to reach out to me, Joe Corso at [email protected]. We look forward to speaking with you during the quarter, and have a great evening.

Operator

[Operator Closing Remarks].

Duration: 34 minutes

Call participants:

Joseph Corso -- Vice President, Corporate Development and Investor Relations

Scott H. Keeney -- Co-Founder and Chief Executive Officer

Ran Bareket -- Vice President and Chief Financial Officer

Greg Palm -- Craig-Hallum Capital Group -- Analyst

Patrick Ho -- Stifel -- Analyst

Tom Diffely -- D.A. Davidson -- Analyst

Paretosh Misra -- Berenberg Capital Markets -- Analyst

Mark Miller -- The Benchmark Company -- Analyst

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