Good afternoon. And welcome to the nLIGHT Third 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 Joseph Corso, Chief Financial Officer. Please go ahead.

Thank you, and good afternoon, everyone. I am 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 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 everyone for joining us this afternoon. Starting on slide three, nLIGHT’s third quarter revenue was within the range of guidance provided in August. Products revenue was slightly below the midpoint, a lower than expected project base from development revenue resulted in overall revenue at the low end of the range. But products and overall gross margins were within the guidance range, but adjusted EBITDA was below the bottom end. Operationally, we continue to increase the level of automation in the U.S. We have added incremental capacity to each of the lines we established earlier this year and we are in the process of adding one additional line to our facility in Camas, Washington. With the installation of this equipment, we will have installed enough capacity to support our anticipated growth over the next several years. Beyond capacity, we are focused on further improving our yields and the overall efficiency of our newly installed capacity. We expect to have installed the majority of our automated capacity in the U.S. sometime in the first half of 2023. Before discussing the performance of our business in the third quarter, I’d like to comment on the trends we are seeing in the semiconductor and fiber laser market, and the impact that we expected to have on our business. We are projecting near-term growth from many of our strategic customers, primarily due to new product introductions and market share gains. However, we are seeing signs of a weakening near-term demand environment. We don’t believe that softening demand reflects fundamental changes in the markets or customers we serve, but rather response to changes in the global business environment. While these global changes are significant, they continue to reinforce two fundamental opportunities for nLIGHT. First, rapidly evolving global supply chains are driving continued improvements in…

Thank you, Scott. Beginning on slide seven, total revenue for the third quarter of 2022 was $60.1 million, a decrease of $12.1 million or 17% compared to the third quarter of the prior year and near the bottom end of our guidance range. Products revenue for the third quarter of 2022 was $48 million, a decrease of $6.4 million or 12% compared to the third quarter of the prior year. The decrease in products revenue year-over-year was driven primarily by a decrease in sales to customers in China, partially offset by increases to sales to both industrial and microfabrication customers outside of China. Development revenue for the third quarter of 2022 was $12.1 million, a decrease of $5.8 million or 32% compared to the third quarter of the prior year. The decrease in development revenue is attributable to the timing of project based work we performed in the Defense market. Turning to slide eight, overall gross margin for the third quarter of 2022 was 22.4%, compared to 29.6% for the third quarter of the prior year and on the lower end of our guidance range. Products gross margin for the third quarter of 2022 was 26.4%, compared to 37.1% for the third quarter of the prior year. The year-over-year decrease in product gross margin was driven by sales mix, and as discussed last quarter, decreased capacity utilization, increased investments in U.S. based manufacturing and continued increases in production and freight costs. Turning to slide nine, non-GAAP operating expenses for the third quarter of 2022 were $19.4 million or 32% of revenue, compared to $18.1 million or 25% of revenue for the third quarter of the prior year. The majority of the year-over-year increase was related to increases in salary costs, professional service fees, facility expenses and a decrease in administrative…

[Operator Instructions] And our first question will come from Greg Palm of Craig-Hallum Capital Group. Please go ahead.

Yeah. Thanks. Good afternoon, everyone. I wanted to start with just the commentary on the demand outlook and I am curious if you can maybe characterize it a little bit differently, whether do you see this as cancellations as push outs. What’s your kind of visibility into the next couple of quarters? And then, Joe, specifically, you mentioned Q1, the restructuring and the impacts, did you sort of mean to imply or direct that that’s what Q1 can look like or were you just sort of setting the bar, so we know what the impact of the restructuring actually was?

Thanks, Greg. It’s Scott here. I will start and then I will hand it over to Joe for the second part of your question. We have limited visibility beyond Q4. Certainly, there’s some particular areas where we have specific items of push outs. We don’t think they reflect fundamental demand issues for us, but there are particular issues in all of our sectors. But in addition to that, we do think, based upon our read of not only our customers but as we talk to our customer’s customers, people are cautious in pulling back, and certainly, changes in the global environment are being discussed and that gives us pause for our outlook from a more macro standpoint. But no, otherwise, I think, that if there are particular issues with respect to specific customers, specific contracts where there are some push outs. But with respect to Q1, I will let Joe cover that.

Yeah. Greg, thanks for the question. We were really trying to allude to the fact that the operational changes that we will make in the business, most of those will happen in Q4 and so I wasn’t trying to imply that we are guiding to a $55 million or $60 million quarter in Q1. I think what we wanted to get across was that, after we get through the changes that we will make here, assuming the current mix of business, if we are able to achieve $55 million to $60 million of revenue we should be able to have EBITDA breakeven or hopefully better than that.

Okay. Fair enough. One segment that maybe strikes me as a little surprising given the commentary is Aerospace and Defense, because that seems to be a space that you are seeing good spending overall and directed or advanced development revenues down, but even outside of that, on a year-over-year basis were down as well. So, maybe if you can just spend a minute and just sort of parse through what you are seeing in that area as well?

Yeah. Absolutely. Greg, it’s a good question. First, let me respond by saying, yeah, the decline in A&D reflects, again, to build on what I said previously, particular issues, primarily two. One is really delays in supply chain issues. While the programs that we are referring to here, the end demand is strong, and indeed, the outlook is even stronger. There have been delays with the specific components that we source in these complex systems and that’s led to part of the delay. And then, second, in the development programs, there have been some delays there, both in terms of the current programs and in new programs that we are working on. But again, that doesn’t reflect any fundamental change in what we are doing, our position indeed. The progress we reported on HELSI and other matters remain positive. And I think, as you said, I think, the broader context here is one in which deepening global discord is leading to interest in lasers for a number of applications and I think we are very well positioned for that -- those opportunities. So, again, it’s particular issues that are driving the near-term revenue.

Are you able to quantify what that sort of supply chain impact has been and I guess do you have any visibility on when that might free up?

Let’s see. I will let Joe -- I will try to make sure we are clear about quantifying. In terms of freeing up, boy, it’s -- there’s a set of issues that have -- the root cause issues have been largely resolved. It still takes time for those to work their way through over the coming quarters for one or two of the key programs I am referring to. But, yeah, I don’t see fundamental issues there and we have been able to address the root cause issues. We don’t see those issues of gaps in supply chain. Those particular ones we face are persisting.

Yeah. Greg, in terms of quantification, if you look at the last -- if you look at Q3, we were down $3 million or $4 million in revenue from one of -- a couple of those kind of core A&D programs, because of supply chain. But I think that gives you hopefully a sense for the quantification of that.

Yeah. Okay. That’s helpful. All right. I will hop back in queue. Thanks and good luck.

Thanks, Greg.

Thanks, Greg.

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

You mentioned you had some share gains. I was just wondering in what areas.

Well, we have seen share gains in really all of our end markets in microfabrication. We continue to make progress in new areas, in Aerospace and Defense continuing to win new design slots, and then finally, in industrial, we are continuing to get new design wins across our applications there. So across the Board, we have released new products and seeing continued expansion of our customer base.

Spread across the power spectrum, high power, low power or it’s more concentrated in one power area?

Really across the Board, Mark, we have just released a 20-kilowatt Corona laser as an example of higher power work that we are doing, but similarly, lower power for welding, additive manufacturing. There, it’s more about the sophistication of the beam, the Corona products. But similarly, in Aerospace and Defense, we are making great progress there, too.

Thank you.

Thanks.

The next question comes from Hans Chung of D.A. Davidson. Please go ahead.

Thank you for taking my questions. So, first, I was wondering what your drivers in microfabrication outside China and then, so how big is China typically in this segment?

Let’s see. Hans, if you can repeat the last part of that question again, I didn’t quite hear it.

So, first part is, what’s the key driver for the microfabrication outside China in the quarter and then a follow-up on that is, how big is China versus non-China in this segment?

Good. So, first part of your question, outside of China, we continue to get design wins in a broad set of different markets, in the broader electronics segment, but also continue to make good progress in medical applications and we continue to see, as we mentioned, a strong outlook there. And then with respect to China, I will let Joe cover that.

Yeah.

Yeah. Thanks, Hans. In non-China was the bulk of the microfabrication revenue this quarter. We have seen our China microfab business, right, in a couple of million dollars, $2 million, $3 million of revenue range over the last few quarters. At the same time, we have actually seen the outside of China microfab grow into sort of the mid-teens to give you a sense of the breakdown between China versus non-China.

Got it. That’s helpful. So, and then -- so in terms of gross margin and it seems like in Q4, the gross margins in the development revenue is going to be 4%. I think it has been like steady around 6% to 7%, right? And then I was wondering, is that just one time event or is a new base and then what’s the reason for that?

Yeah. Great question, Hans. Now this is primarily a one-time event as there are certain programs that we are closing out and sort of truing up to actuals. The margin is going to be we think about 4% this year, every program carries a little bit of a different margin, but when we look at the balance of the programs, they are about 6.5%. So I think outside of -- towards the end of life of a program, I expect that we would still be in that kind of 6%, 7% range going forward. But nothing structural has really changed about the way that we are prosecuting that development business.

Got it. And then as we look into 2023 in, I mean, the whole -- the main environment being stopped. But I am just wondering like what’s the kind of highlights or bright spots would you expect for next year?

Yes. I think as we look out in time, we share your point of view that, I think, there are some challenging times ahead that are a result of continuing infraction of economic times around the world and other discord around the world. But as we noted, both of those factors also represent opportunities for us. First, in the industrial markets, we continue to see expansion of more advanced technology in manufacturing areas like additive manufacturing. We see very strong progress there and we are launching new products this month at the big trade show Formnext in Frankfurt. And then second, we do see the Defense sector as a strong area where we are very well positioned and we see continued opportunities to expand over the medium term there.

Great. Got it. And then, lastly, just -- I just want to touch base on the LiDAR application. I think you mentioned this last quarter or before. Just curious what’s your plans here, are you going to -- what kind of product are you going to provide and then what’s your competitive advantage?

So, for us, where we participate in the LiDAR market is at the higher performance side of that market. And so there are programs in Aerospace and Defense and there are some other programs that are earlier stage in other more advanced markets and so we do see opportunities there. They are not near-term opportunities, but we will -- we look forward to providing more as those opportunities develop.

Got it. Great. Thank you.

[Operator Instructions] And our next question will come from Ruben Roy of Stifel. Please go ahead.

Yeah. Hi. Thank you for taking my question. Joe, I wanted to follow up on the gross margin quickly. You cited a number of factors for the margin dynamics, including mix and some of the costs related with the business. Just wondering, as the mix has shifted out of China, I think, the margins would be a little bit better outside of China. Maybe you could just help us with kind of some of the dynamics around that, and then as you look into 2023, maybe you could give us some puts and takes on how you are thinking about those different factors and how we could -- we should think about margins over the next several quarters? That would be helpful. Thank you.

Yeah. Yeah. Sure, Ruben. Thanks. So when you think about margin as we are going from Q3 and even to where we are guiding in Q4, right? We have got revenue that’s down by, call it, $4 million at the midpoint. There are, obviously, a lot of puts and takes. Some of it is mix, right, as we look at the diodes business we are selling in both China and non-China. We expect to get slightly better absorption as we go into Q4, because of most of these lower expected spending. But frankly, the revenue shift has been faster than the manufacturing shift and as we are ramping our business here in, excuse me, when we are ramping our automated capacity here in the U.S., that’s not big enough yet to satisfy our demand for both our microfab and our fiber laser customers. So we are still in a position where we have got effectively redundant capacity when you look at China and the U.S. So that continues to be a headwind. Looking forward, I think, there are a couple of things that will drive the gross margins to that 40% plus range that we have set our long-term target, right? The first is revenue. I think you can pretty clearly see, even over the last couple of quarters, as the leverage that we have in the model, right? It’s easier to scale from a people perspective, but we have got some pretty significant fixed costs that enable us to grow revenue far in excess of where we are today. So that’s one piece. The second piece is, right, it’s that redundant capacity, right? So we have got to optimize our -- we do a better job of optimizing our capacity. And then third, as the mix of business changes, as we continue to push further into the directed energy market and we have got a little bit better recovery on the non-directed energy A&D side of the business, right? That’s what will help drive our margins higher, hopefully, in 2023, right? I just want to be cautious because of the demand that we are seeing here over the next couple of quarters isn’t robust. But I don’t think that changes where we think we are going to be long-term from a gross margin perspective.

That’s great. Thanks for that detail, Joe. Very helpful. And then just as a follow-up, I guess, Scott, as you take a step back over the next -- over the last quarter or two, and you look at the macro and then sort of on the other side you see a lot of interesting things going on in the U.S. fiber budget and some of the programs and even seeing a lot of interest from your customers here for these various markets that you talked about, medical, microfab, industrial. I am just wondering if you have any updates on the way you are thinking about the longer term TAM, kind of on the one side, we have got the near-term macro dynamics, but from a longer term perspective, has anything improved or declined in the way you are thinking about the overall TAM for your fiber lasers?

Yeah. I think that’s -- I appreciate the question very much and just building on what I said previously. I think the near-term is, there’s a challenging environment out there. There’s no question about that. But for the -- even the medium-term, I think, that those same trends that we are seeing that affect the near term creates even stronger opportunities for us. So I think in the advanced technology and industrial, we are making progress across the Board, but as we noted, particularly excited about the upcoming tradeshow a couple of weeks in Frankfurt in additive manufacturing. I think that’s a space that we have been in for some time. But it’s quite rewarding to see the progress in adoption of lasers and the cost effective production of few parts from the use of our lasers. So I think that’s one theme that I think is even stronger than what we have seen in the past. And then similarly, on the Defense side, while there is -- as I noted, there’s near-term choppiness due to really particular factors, the longer term remains very important. In fact, the U.S. Defense strategy was just published yesterday or this week and again reinforce directed energy lasers as one of the top priorities and with the progress that I noted on our HELSI program, yeah, we are continued strong interest in adopting really new technology and a set of new applications in directed energy. So I think those are the two of the themes that are even stronger than what we would have seen a year ago.

Appreciate the detail, Scott.

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 your continued interest in nLIGHT. We look forward to speaking with you during the quarter. Have a great evening. Thanks.

The conference has now concluded. Thank you for attending today’s presentation and you may now disconnect.