Nlight, Inc.: Form 10-Q for the period ended Sep 30, 2022

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by the following words: "ability," "anticipate," "attempt," "believe," "can be," "continue," "could," "depend," "enable," "estimate," "expect," "extend," "grow," "if," "intend," "likely," "may," "objective," "ongoing," "plan," "possible," "potential," "predict," "project," "propose," "rely," "should," "target," "will," "would" or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words.

These statements involve risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we believe that we have a reasonable basis for each forward-looking statement, we caution you that these statements are based on a combination of facts and factors currently known by us and our projections of the future, about which we cannot be certain. Forward-looking statements include, but are not limited to, statements about: our business model and strategic plans; the impact of the COVID-19 pandemic and the related lockdown in Shanghai on our business; our future financial performance; demand for our semiconductor and fiber laser solutions; our ability to develop innovative products; our expectations regarding product volumes and the introduction of new products; our technology and new product research and development activities; the impact of inflation; the impact of seasonality; the effect on our business of litigation to which we are or may become a party; and the sufficiency of our existing liquidity sources to meet our cash needs.

You should refer to the "Risk Factors" section of this report for a discussion of other important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this report will prove to be accurate. In addition, statements that "we believe" and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this report, which although we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted a thorough inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Overview

nLIGHT, Inc., is a leading provider of high‑power semiconductor and fiber lasers for industrial, microfabrication, and aerospace and defense applications. Headquartered in Camas, Washington, we design, develop, and manufacture the critical elements of our lasers, and believe our vertically integrated business model enables us to rapidly introduce innovative products, control our costs and protect our intellectual property.

We operate in two reportable segments consisting of the Laser Products segment and the Advanced Development segment. Sales of our semiconductor lasers, fiber lasers and directed energy products are included in the Laser Products segment, while revenue earned from research and development contracts are included in the Advanced Development segment.

Revenues decreased to $185.4 million in the nine months ended September 30, 2022 compared to $202.7 million in the same period of 2021 as a result of a decrease in product sales to customers in China and development revenue, partially offset by an increase in product sales to customers outside of China. We generated a net loss of $31.9 million for the nine months ended September 30, 2022 compared to a net loss of $20.9 million for the same period of 2021.

Factors Affecting Our Performance

Impact of the COVID-19 Pandemic

The COVID-19 pandemic and related global liquidity concerns and macro-economic volatility continues to adversely impact our end-markets, including reduced economic activity and demand for our products, and delays in new capital expenditure decisions and implementations. While our manufacturing operations generally remained open throughout the pandemic, including our manufacturing facilities in the United States, the COVID-related lockdown of Shanghai by the Chinese government forced us to halt operations in our Shanghai manufacturing facility for approximately two months during the second quarter of 2022. Our Shanghai facility manufactures products that are sold directly to end customers as well as components that are shipped to our facilities in the United States to be integrated into finished products. Although we are increasing our manufacturing capabilities in the United States, our Shanghai manufacturing facility remains an important part of our global operations. The closure of our Shanghai facility during the second quarter of 2022 has had a negative impact on our 2022 year-to-date financial results, and any additional closures, or partial closures, could have an adverse impact on future periods.

There are ongoing risks to our business that depend on the progression of the COVID-19 pandemic, including risks related to the potential return of limitations on certain government functions, business activities and person-to-person interactions. Global trade conditions may further adversely impact us and our industry. For example, pandemic-related issues exacerbated port congestion and caused intermittent supplier shutdowns and delays, resulting in additional expenses and challenges to obtaining critical parts. The full impact of the COVID-19 pandemic on our financial condition and results of operations will depend on future events and developments.

Demand for our Semiconductor and Fiber Laser Solutions

In order to continue to grow our revenues, we must continue to achieve design wins for our semiconductor and fiber lasers. We consider a design win to occur when a customer notifies us that it has selected one of our products to be incorporated into a product or system under development by such customer. For the foreseeable future, our operations will continue to depend upon capital expenditures by customers in the Industrial and Microfabrication markets, which, in turn, depend upon the demand for these customers’ products or services. In addition, in the Aerospace and Defense market, our business depends in large part on continued investment in laser technology by the U.S. government and its allies, and our ability to continue to successfully develop leading technology in this area and commercialize that technology in the future.

Demand for our products also fluctuates based on market cycles, continuously evolving industry supply chains, trade and tariff terms, as well as evolving competitive dynamics in each of our end-markets. Erosion of average selling prices, or ASPs, of established products is typical in our industry, and the ASPs of our products generally decrease as our products mature. We may also negotiate discounted selling prices from time to time with certain customers that purchase higher volumes, or to penetrate new markets or applications. Historically, we have been able to offset decreasing ASPs by introducing new and higher value products, increasing the sales of our existing products, expanding into new applications and reducing our manufacturing costs. Although we anticipate further increases in product volumes and the continued introduction of new and higher value products, ASP reduction may cause our revenues to decline or grow at a slower rate.

Technology and New Product Development

We invest heavily in the development of our semiconductor, fiber laser and directed energy technologies to provide solutions to our current and future customers. We anticipate that we will continue to invest in research and development to achieve our technology and product roadmap. Our product development is targeted to specific sectors of the market where we believe the power and performance requirements of our products can provide the most benefit. We believe our close coordination with our customers regarding their future product requirements enhances the efficiency of our research and development expenditures.

Manufacturing Costs and Gross Margins

Our product gross profit, in absolute dollars and as a percentage of revenues, is impacted by our product sales mix, sales volumes, changes in ASPs, production volumes, the corresponding absorption of manufacturing overhead expenses, production costs and manufacturing yields. Our product sales mix can affect gross profits due to variations in profitability related to product configurations and cost profiles, customer volume pricing, availability of competitive products in various markets, and new product introductions, among other factors. Capacity utilization affects our gross margin because we have a high fixed cost base due to our vertically integrated business model. Increases in sales and production volumes drive favorable absorption of fixed costs, improved manufacturing efficiencies and lower production costs. Gross margins may fluctuate from period to period depending on product mix and the level of capacity utilization.

Our Development gross profit varies with the type and terms of contracts, contract volume, project mix, and progress on projects during the period. Most of our Development contracts are structured as cost plus fixed fee due to the technical complexity of the research and development services.

Seasonality

Our quarterly revenues can fluctuate with general economic trends, holidays in foreign countries such as Chinese New Year in the first quarter of our fiscal year, the timing of capital expenditures by our customers, and general economic trends. In addition, as is typical in our industry, we tend to recognize a larger percentage of our quarterly revenues in the last month of the quarter, which may impact our working capital trends.

Results of Operations

The following table sets forth our operating results as a percentage of revenues for the periods indicated (which may not add up due to rounding):

Revenues by End Market

Our revenues by end market were as follows for the periods presented (dollars in thousands):

The decreases in revenue from the Industrial and Microfabrication markets for the three and nine months ended September 30, 2022, compared to the same periods of 2021, were driven by decreases in unit sales in China, partially offset by increases in unit sales outside of China. The closure of our Shanghai facility for approximately two months during the second quarter of 2022 due to the COVID-19 pandemic had a negative impact on year-to-date sales in China. The decreases in revenue from the Aerospace and Defense market for the three and nine months ended September 30, 2022, compared to the same periods of 2021, were due to decreased activity on research and development contracts, and a decrease in unit sales for the third quarter of 2022 compared to the same period of 2021 due primarily to supply chain disruptions.

Revenues by Segment

Our revenues by segment were as follows for the periods presented (dollars in thousands):

The decreases in Laser Products revenue for the three and nine months ended September 30, 2022, compared to the same periods of 2021, were driven by decreased units sales across each end market as discussed above. The decreases in Advanced Development revenue for the three and nine months ended September 30, 2022, compared to the same periods of 2021, were primarily due to decreased activity on research and development contracts. Most of our Advanced Development revenue is generated from cost plus fixed fee research and development contracts, and all Advanced Development revenue is included in the Aerospace and Defense market.

Revenues by Geographic Region

Our revenues by geographic region were as follows for the periods presented (dollars in thousands):

Geographic revenue information is based on the location to which we ship our products. The decrease in North America revenue for the three months ended September 30, 2022, compared to the same period of 2021, is a result of decreased revenue from the Aerospace and Defense market, partially offset by increased revenue from the Industrial and Microfabrication markets. The increase in North America revenue for the nine months ended September 30, 2022, compared to the same period of 2021, was the result of increased revenue from the Industrial and Microfabrication markets, partially offset by decreased revenue from the Aerospace and Defense market.

The increase in Rest of World revenue for the three months ended September 30, 2022, compared to the same period of 2021, was due to increased revenue from the Microfabrication market, partially offset by decreased revenue from the Industrial market. The increase in Rest of World revenue for the nine months ended September 30, 2022, compared to the same period of 2021, was due to increased revenue from the Microfabrication and Industrial markets.

The decreases in China revenue for the three and nine months ended September 30, 2022, compared to the same periods of 2021, was the result of decreased sales in the Industrial and Microfabrication markets, primarily as a result of deteriorating market conditions. The closure of our Shanghai facility for approximately two months during the second quarter of 2022 due to the COVID-19 pandemic also had a negative impact on year-to-date sales in China.

Cost of Revenues and Gross Margin

Cost of Laser Products revenue consists primarily of manufacturing materials, labor, shipping and handling costs, tariffs and manufacturing-related overhead. We order materials and supplies based on backlog and forecasted demand from our customers. We expense all warranty costs and inventory provisions as cost of revenues.

Cost of Advanced Development revenue consists of materials, labor, subcontracting costs, and an allocation of indirect costs including overhead and general and administrative.

Our gross profit and gross margin were as follows for the periods presented (dollars in thousands):

20

*NM = not meaningful

The decreases in Laser Products gross margin for the three and nine months ended September 30, 2022, compared to the same periods of 2021, were driven by sales mix and decreased factory utilization, increased investments in U.S. based manufacturing, and increased production and freight costs, partially offset by an increase in duty reclaim. The changes in Advanced Development gross margin for the three and nine months ended September 30, 2022, compared to the same periods of 2021, are not material and primarily the result of changes in the composition of research and development contracts.

Operating Expenses

Our operating expenses were as follows for the periods presented (dollars in thousands):

Research and Development

The decrease in research and development expense for the three months ended September 30, 2022, compared to the same period in 2021, was driven by a decrease in project-related expenses, a decrease in stock-based compensation of $0.6 million, and a decrease in purchased intangible amortization of $0.4 million. The decrease in research and development expense for the nine months ended September 30, 2022, compared to the same period in 2021, was primarily due to a decrease in stock-based compensation of $1.0 million and a decrease in purchased intangible amortization of $0.8 million, partially offset by an increase in salary costs and project-related expenses.

Sales, General and Administrative

21

The increase in sales, general and administrative expense for the three months ended September 30, 2022, compared to the same period in 2021 was primarily due to increases in salary costs, professional service fees, facility expenses and decreases in administrative cost allocated to development projects, partially offset by a decrease in stock-based compensation of $1.9 million. The decrease in sales, general and administrative expense for the nine months ended September 30, 2022, compared to the same period in 2021 were driven by a decrease in stock-based compensation of $8.3 million, partially offset by increases in salary costs, professional service fees, facility expenses and decreases in administrative cost allocated to development projects. The decreases in stock-based compensation for the three and nine months ended September 30, 2022, compared to the same periods of 2021, were the result of forfeitures and decreases in expected achievement related to performance-based stock awards.

Interest Income (Expense), net

The increase in interest income, net, for the three and nine months ended September 30, 2022, compared to the same periods in 2021 was driven by increases in interest rates and the investment in marketable securities during the second quarter of 2022, as well as the payoff of our long-term debt in the third quarter of 2021.

Other Income (Loss), net

Changes in other income (loss), net, are primarily attributable to changes in net realized and unrealized foreign exchange transactions resulting from currency rate fluctuations.

Income Tax Expense (Benefit)

22

We record income tax expense for taxes in our foreign jurisdictions including Finland, Italy, and Korea. While our tax expense is largely dependent on the geographic mix of earnings related to our foreign operations, we also record tax expense for uncertain tax positions taken and associated penalties and interest. We consider all available evidence, both positive and negative, in assessing the extent to which a valuation allowance should be applied against our deferred tax assets. Due to the uncertainty with respect to their ultimate realizability in the United States, Austria, and China, we continue to maintain a full valuation allowance in these jurisdictions as of September 30, 2022.

The decrease in income tax expense for the three months ended September 30, 2022 compared to the same period of 2021 was driven by lower profitability in foreign jurisdictions, while the increase in income tax expense for the nine months ended September 30, 2022, compared to the same period in 2021, was driven by a discrete tax benefit related to return to provision true ups and expiring statutes of limitations of unrecognized tax positions recorded in the second quarter of 2021.

Liquidity and Capital Resources

We had cash and cash equivalents of $62.2 million and $146.5 million as of September 30, 2022 and December 31, 2021, respectively. In addition, we had marketable securities of $50.2 million at September 30, 2022. Prior to the second quarter of 2022, we had no marketable securities.

For the nine months ended September 30, 2022, our principal uses of liquidity were to fund our working capital needs and purchase property, plant and equipment. We believe our existing sources of liquidity will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements may vary materially from period to period and will depend on many factors, including the timing and extent of spending on research and development efforts, the expansion of sales and marketing activities, the continuing market acceptance of our products and ongoing investments to support the growth of our business. We may in the future enter into arrangements to acquire or invest in complementary businesses, services, technologies and intellectual property rights. From time to time, we may explore additional financing sources which could include equity, equity‑linked and debt financing arrangements.

The following table summarizes our cash flows for the periods presented (in thousands):

23

Net Cash Provided by (Used in) Operating Activities

During the nine months ended September 30, 2022, net cash used in operating activities was $14.6 million, which was the result of a $31.9 million net loss and use of cash for working capital of $17.2 million, partially offset by non‑cash expenses totaling $34.7 million related primarily to depreciation, amortization, and stock-based compensation. Changes in working capital were driven by a $3.4 million increase in accounts receivable, net, a $8.8 million increase in inventory, and a $5.8 million decrease in accounts payable. The increase in accounts receivable, net was primarily due to the timing of shipments and collections in the third quarter of 2022 compared to the fourth quarter of 2021. The increase in inventory was due to an expected increase in future sales and an increase in safety stock during 2022 to mitigate supply chain risks, lower demand primarily from China, and anticipated demand for recently introduced products. The decrease in accounts payable was due to a decrease in inventory purchasing in the third quarter of 2022 compared to the fourth quarter of 2021, and the timing of vendor payments.

During the nine months ended September 30, 2021, net cash provided by operating activities was $2.7 million, which was primarily driven by non‑cash expenses totaling $43.4 million related to depreciation and amortization, stock-based compensation, and other items, a $9.7 million increase in accounts payable and a $0.9 million increase in accrued and other long-term liabilities. These items were partially offset by our net loss of $20.9 million and increases of $16.2 million in inventory and $4.6 million in accounts receivable. The increase in inventory was driven primarily by an expected increase in future period sales. The increase in accounts receivable was attributable to the increase in revenue and timing of shipments during the quarter. The increase in accounts payable was attributable to the increase in inventory and the timing of vendor payments.

Net Cash Used in Investing Activities

During the nine months ended September 30, 2022, net cash used in investing activities was $67.5 million, primarily resulting from the purchase of $50.0 million of marketable securities and $16.4 million of capital expenditures related to investments in directed energy, manufacturing equipment and facilities.

During the nine months ended September 30, 2021, net cash used in investing activities was $14.2 million, primarily

resulting from $13.6 million of capital expenditures related to investments in manufacturing equipment and improvements to our corporate facility.

Net Cash Provided by (Used in) Financing Activities

During the nine months ended September 30, 2022, net cash used in financing activities was $1.6 million, which was primarily driven by $4.0 million of withholding tax payments related to the vesting of stock awards, partially offset by $2.3 million of proceeds from stock options exercises and employee stock plan purchases.

During the nine months ended September 30, 2021, net cash provided by financing activities was $75.1 million, which was primarily driven by our follow-on public offering of $82.4 million, net of offering costs, and $1.7 million of proceeds from stock options exercises and employee stock program purchases, partially offset by $8.3 million of withholding tax payments related to the vesting of stock awards.

Credit Facilities

We have a $40.0 million revolving line of credit, or LOC, with Pacific Western Bank dated September 24, 2018, which is secured by our assets and matures September 24, 2024.

The LOC agreement contains restrictive and financial covenants and bears an unused credit fee of 0.20% on an annualized basis. The interest rate on the LOC is based on the Prime Rate, minus a margin based on our liquidity levels. No amounts were outstanding under the LOC at September 30, 2022 and we were in compliance with all covenants.

Contractual Obligations

For the nine months ended September 30, 2022, our operating lease obligations decreased by approximately $1.5 million. There have been no other material changes to our contractual obligations as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021.

Inflation

While we do not believe that inflation had a material effect on our business, financial condition or results of operations through September 30, 2022, we have experienced higher than expected increases in wages and other compensation costs, materials, and shipping costs during 2022. We expect these increases will continue to impact our cost structure. If our costs become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could materially adversely affect our business, financial condition and results of operations.

For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” contained in Part II of our Annual Report on Form 10-K for the year ended December 31, 2021. Other than the addition of marketable securities consisting of U.S. Treasuries to our investment portfolio, our exposure to market risk has not changed materially since December 31, 2021.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and our chief financial officer, have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and our chief financial officer have concluded that, as of such date, our disclosure controls and procedures were, in design and operation, effective.

Changes in Internal Control over Financial Reporting

Our chief executive officer and our chief financial officer did not identify any changes in our internal control over financial reporting in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act during the three months ended September 30, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Internal Control

Control systems, including ours, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems’ objectives are being met. Further, the design of any control systems must reflect the fact that there are resource constraints, and the benefits of all controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Control systems can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based, in part, on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business, but cannot assure you that such improvements will be sufficient to provide us with effective internal control over financial reporting.

For risk factors related to our business, reference is made to Item 1A, "Risk Factors," contained in Part I of our Annual Report on Form 10-K for the year ended December 31, 2021 and Item 1A, "Risk Factors," contained in Part II of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2022. There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2022. , except as described below.

We are subject to governmental export and import controls that could subject us to liability, impair our ability to compete and otherwise adversely affect our business, financial condition, results of operations and growth prospects.

The United States and various foreign governments have imposed controls, export license requirements and restrictions on the import or export of certain products, technologies, and software. For example, the U.S. government recently announced new controls restricting the ability to send certain products and technology related to semiconductors, semiconductor manufacturing and supercomputing to China without an export license. These new controls including the licensing requirement also apply to certain hardware containing these specified integrated circuits, or ICs. In many cases, these licenses are subject to a policy of denial and will not be issued. The U.S. government also recently added additional entities in China to restricted party lists impacting the ability of U.S. companies to provide products and technology to these entities. These controls may impact our ability to export certain products and technology to China and restrict our ability to use certain ICs in our products. Additionally, these restrictions could disrupt the ability of China to produce semiconductors and other electronics and impact our ability to source components from China. It also is possible that the Chinese government will retaliate in ways that could impact our business.

We must export our products in compliance with U.S. export controls and we may not always be successful in obtaining necessary export licenses. Denials of export licenses or limitations imposed on our ability to export or sell our products imposed by these laws, may harm our international and domestic revenues. Furthermore, noncompliance with these laws could have negative consequences, including government investigations, penalties and reputational harm. Any failure to adequately comply with these laws could result in civil fines or suspension or loss of our export privileges, as well as substantial expense and diversion of management resources and attention, any of which could materially adversely affect our business, financial condition, results of operations and growth prospects.