Nlight, Inc.: Form 10-Q for the period ended Sep 30, 2023

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; our expectations regarding manufacturing; 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, fiber amplifiers, and other directed energy laser 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 $158.0 million in the nine months ended September 30, 2023 compared to $185.4 million in the same period of 2022 due primarily to decreased sales in the Laser Products segment, particularly in China. We generated a net loss of $28.4 million for the nine months ended September 30, 2023 compared to a net loss of $31.9 million for the same period of 2022.

Factors Affecting Our Performance

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 product and 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 performance of our products provide a significant benefit to our customers. 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. We have invested heavily in U.S.-based manufacturing capabilities in the last several years. 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, execution on projects during the period, and estimated costs to project completion. 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, the timing of capital expenditures by our customers, holidays, 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, 2023, compared to the same periods in 2022, were driven by decreases in unit sales due to lower global market demand, and lower average selling prices in China. The decreases in revenue from the Aerospace and Defense market for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were the result of decreases in product unit sales, offset partially by new development contracts.

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, 2023, compared to the same periods in 2022, were primarily the result of decreased revenue from the Industrial, Microfabrication and Aerospace and Defense markets as discussed above.

The increases in Advanced Development revenue for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were driven by new 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 decreases in North America revenue for the three and nine months ended September 30, 2023 compared to the same periods in 2022, were driven by decreased revenue from the Industrial, Microfabrication, and Aerospace and Defense markets as previously discussed. The decreases in China revenue for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were the result of decreased revenue from the Industrial and Microfabrication markets due to a decline in market conditions and our decision to exit the fiber laser cutting market in China during the fourth quarter of 2022. The decreases in Rest of World revenue for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were the result of decreased revenue from the Microfabrication and Industrial markets due primarily to lower demand.

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):

*NM = not meaningful

The decrease in Laser Products gross margin for the three months ended September 30, 2023, compared to the same period of 2022, was driven by decreased factory utilization due to a decrease in production demand, an increase in production variances, and changes in sales mix, partially offset by decreased manufacturing spend. The decrease in Laser Products gross margin for the nine months ended September 30, 2023, compared to same period of 2022, was not significant.

The changes in Advanced Development gross margin for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were primarily due to changes in the mix of research and development contracts. Most of our Advanced Development revenue consists of cost plus fixed fee contracts, and the fee earned on costs incurred vary by contract.

Operating Expenses

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

Research and Development

The decreases in research and development expense for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were driven by decreases in employee headcount and project-related expenses, and decreases in stock-based compensation of $0.6 million and $1.9 million, respectively.

Sales, General and Administrative

The decreases in sales, general and administrative expense for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were primarily due to decreases in employee compensation, including incentive compensation, and an increase in administrative costs allocated to development projects, partially offset by an increase in stock-based compensation of $1.0 million for the nine months ended September 30, 2023. In addition, the three months ended September 30, 2023 includes an increase in professional fees and outside services, while the nine months ended September 30, 2023 includes a decrease in professional fees and outside services

Interest Income, net

The increases in interest income, net, for the three and nine months ended September 30, 2023, compared to the same periods in 2022, were driven by increases in interest rates and increased investment in marketable securities.

Other Income (Expense), net

*NM = not meaningful

Changes in other income (expense), net, are primarily attributable to realized gains on the sale of marketable securities and changes in net realized and unrealized foreign exchange transactions resulting from currency rate fluctuations.

Income Tax Expense (Benefit)

We record income tax expense (benefit) 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 (benefit) 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, 2023.

The increase in income tax expense for the three months ended September 30, 2023, compared to the same period of 2022 was driven by higher profitability in foreign jurisdictions, while the decrease in income tax expense for the nine months ended September 30, 2023, compared to the same period in 2022, was driven by a discrete tax benefit related to expiring statutes of limitations of unrecognized tax positions recorded in the second quarter of 2023.

Liquidity and Capital Resources

We had cash and cash equivalents of $52.1 million and $57.8 million as of September 30, 2023 and December 31, 2022, respectively. In addition, we had marketable securities of $59.5 million and $50.4 million at September 30, 2023 and December 31, 2022, respectively. Our total balance of cash, cash equivalents, restricted cash and marketable securities increased by $3.4 million from December 31, 2022 to September 30, 2023.

For the nine months ended September 30, 2023, our principal uses of liquidity were to fund our working capital needs. The primary source of cash was collections from customers. 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):

Net Cash Provided by (used in) Operating Activities

During the nine months ended September 30, 2023, net cash provided by operating activities was $9.7 million, which was the result of a $28.4 million net loss, offset by increases in working capital of $5.0 million and non-cash expenses totaling $33.1 million related primarily to depreciation, amortization, and stock-based compensation. Changes in working capital were driven by a $5.5 million decrease in inventory, and $2.4 decrease in accounts receivable, net, for the nine months ended September 30, 2023, compared to an $8.8 million increase inventory and a $3.4 million increase in accounts receivable, net, over the comparable period of 2022.

Net Cash Used in Investing Activities

During the nine months ended September 30, 2023, net cash used in investing activities was $13.2 million, which was driven by the net purchase of marketable securities of $8.8 million and capital expenditures of $4.4 million.

Net Cash Used in Financing Activities

During the nine months ended September 30, 2023, net cash used in financing activities was $2.1 million, which consisted of taxes paid on the net settlement of stock awards of $3.7 million, partially offset by proceeds from stock option exercises and employee stock plan purchases of $1.6 million.

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, 2023 and we were in compliance with all covenants.

Contractual Obligations

There have been no material changes to our contractual obligations as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.

Inflation

While we do not believe that inflation had a material effect on our business, financial condition or results of operations during the nine months ended September 30, 2023, we experienced increases in wages and other compensation costs, materials, and shipping costs in 2022 and the nine months ended September 30, 2023. 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, 2022. Our exposure to market risk has not changed materially since December 31, 2022.

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

There were no changes in our internal control over financial reporting that occurred during the three months ended September 30, 2023 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, 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, 2022.