NLIGHT, INC. (LASR) FY 2021 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K 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 ability to develop innovative products; the implementation of our business model and strategic plans, including estimates regarding expenses and capital requirements; our competition and our ability to successfully compete; the impact of the COVID-19 pandemic on our business; demand for our semiconductor and fiber laser solutions; our technology and new product research and development activities; our ability to source key components and raw materials from our suppliers; the impact of inflation; our future financial performance; our utilization of vertical integration; our ability to adequately protect our intellectual property rights; 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 increased to $270.1 million in the year ended December 31, 2021 compared to $222.8 million in the same period of 2020 as a result of higher revenue across all end markets. We generated a net loss of $29.7 million for the year ended December 31, 2021 compared to a net loss of $20.9 million for the same period of 2020, primarily as a result of a $12.3 million increase in stock-based compensation.

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Factors Affecting Our Performance

Impact of the COVID-19 Pandemic

The COVID-19 pandemic and related global liquidity concerns and significant macro-economic volatility continues to adversely impact our end-markets, including reduced economic activity and demand for our products, delays in new capital expenditure decisions and implementations, and restrictions on individual and business activities and travel. While our global manufacturing operations have generally remained open throughout the pandemic, including our manufacturing facilities in the United States which are considered essential businesses, we have previously been affected by the temporary closure of our Shanghai manufacturing facility due to government-imposed restrictions. Some of our non-manufacturing and technical service personnel have been partially working from home since March 2020. In recent periods, labor issues have also become more pronounced as a result of the COVID-19 pandemic and we have experienced higher than expected increases in wages and other compensation costs as well as increased competition for qualified employees.

There are ongoing related risks to our business depending on the progression of the COVID-19 pandemic, including from the potential returns to limited or closed 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 have 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, such as the duration and magnitude of the pandemic and the conditions and timing under which restrictions will be lifted or re-imposed, impacts on our supply and distribution chains as well as our customers, the demand for our products and whether the pandemic leads to recessionary conditions in any of our key markets.

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.

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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):

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The increase in Industrial market revenue for 2021 compared to 2020 was driven by increases in unit sales outside of China, partially offset by a decrease in unit sales in China and lower average selling prices due to changes in product mix. The increase in unit sales outside of China was driven by increased customer demand for fiber lasers used in cutting applications and new products for additive manufacturing, while the decrease in unit sales in China was the result of increased competitive pressure and declining sales prices for fiber lasers used in cutting applications. The increase in Microfabrication market revenue for 2021 compared to 2020 was attributable to increases in customer demand and unit sales of semiconductor lasers. The increase in Aerospace and Defense market revenue for 2021 compared to 2020 was primarily due to increased activity on existing research and development contracts, offset partially by a decrease in product sales.

The increase in Industrial market revenue for 2020 compared to 2019 was driven by increased unit sales and changes in sales mix towards high-power fiber lasers. The decrease in Microfabrication market revenue for 2020 compared to 2019 was driven primarily by lower unit sales to customers for consumer electronics and semiconductors. The increase in Aerospace and Defense market revenue for 2020 compared to 2019 was primarily due to the acquisition of Nutronics, and an increase in unit sales to new and existing customers for defense applications.

Revenues by Segment

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

The increase in Laser Products revenue for 2021 compared to 2020 was primarily due to higher revenue and demand from the Industrial and Microfabrication markets outside of China, offset partially by a decrease in product sales to the Aerospace and Defense market. The increase in Advanced Development revenue for 2021 compared to 2020 was driven by increased activity on existing research and development contracts with the U.S. Government.

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The increase in Laser Products revenue for 2020 compared to 2019 was driven by higher revenue and demand from the Industrial and Aerospace and Defense markets, offset partially by lower revenue from the Microfabrication market. The increase in Advanced Development revenue for 2020 compared to 2019 was primarily due to the acquisition of Nutronics in November 2019.

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 deliver our products and services. The increase in North America revenue for 2021 compared to 2020 was primarily driven by increased revenue from the Aerospace and Defense and Industrials markets. The decrease in China revenue for 2021 compared to 2020 was due to decreased sales in the Industrial market as a result of deteriorating market conditions. The increase in Rest of World revenue for 2021 compared to 2020 was primarily due to increased sales in the Microfabrication and Industrial markets.

The increase in North America revenue for 2020 compared to 2019 was primarily driven by the acquisition of Nutronics and increased sales in the Aerospace and Defense market, partially offset by decreased sales in the Microfabrication market. The increase in China revenue for 2020 compared to 2019 was primarily due to increased sales in the Industrial market. There was no significant change in Rest of World revenue for 2020 compared to 2019.

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 customer orders. We expense all warranty costs and inventory provisions as cost of revenues. Cost of Advanced Development revenue consists of materials, labor, subcontracting costs, 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):

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The increase in Laser Products gross margin for 2021 compared to 2020 was primarily due to sales mix and improved factory utilization from higher production volume, offset partially by increases in manufacturing costs. The decrease in Advanced Development gross margin was driven primarily by changes in the composition of research and development contracts. Most of the Advanced Development segment revenue in 2021 was generated from cost plus fixed fee research and development contracts.

The increase in Laser Products gross margin for 2020 compared to 2019 was primarily due to product cost improvements, higher production volume and factory utilization, and lower import duty costs, offset partially by overall price reductions in the Industrial market, increased reserve charges, and changes in sales mix. Changes in Advanced Development gross margin are driven by changes in project mix since the acquisition of Nutronics in November 2019. Most of the Advanced Development segment revenue in 2020 was generated from cost plus fixed fee research and development projects.

Operating Expenses

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

Research and Development

The increase in research and development expense for 2021 compared to 2020 was driven primarily by an increase in stock-based compensation costs of $3.7 million, and increased employee headcount and related costs, and project-related expenses, to support our development efforts.

The increase in research and development expense for 2020 compared to 2019 was driven primarily by increases in stock-based compensation costs of $6.4 million and purchased intangible amortization of $2.4 million from the Nutronics and OPI acquisitions in November 2019 and July 2020, respectively, and increased project-related expenses to support our development efforts.

Sales, General and Administrative

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The increase in sales, general and administrative expense for 2021 compared to 2020 was primarily driven by an increase in stock-based compensation costs of $7.6 million, increased headcount and compensation costs, and increased professional fees.

The increase in sales, general and administrative expense for 2020 compared to 2019 was primarily driven by an increase in stock-based compensation costs of $8.9 million, partially offset by a decrease in executive cash compensation, lower professional fees and decreased marketing and travel costs due to COVID-19.

Interest Income, net

The decrease in interest income (expense), net, for 2021 compared to 2020 was primarily attributable to an increase in bank charges and changes in the market rates on money market funds, offset partially by the March 2021 cash infusion from our public offering of stock.

The decrease in interest income, net, for 2020 compared to 2019 was primarily attributable to lower balances in our money market funds coupled with a decrease in the market rates on those funds.

Other Income (Expense), net

The changes in other income, net, in 2021 compared to 2020, and 2020 compared to 2019, are primarily attributable to changes in net realized and unrealized foreign exchange transactions resulting from currency rate fluctuations.

Income Tax Expense (Benefit)

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The decrease in tax expense to a net benefit for 2021 compared to 2020 was primarily related to the release of tax expense, interest and penalties associated with uncertain tax positions for which statutes of limitations have expired and prior year true ups in foreign jurisdictions. Our 2021 tax benefit was impacted by the geographic location of our pre-tax book income and was primarily related to our operations in Finland and foreign withholding taxes on undistributed earnings. There is limited tax expense associated with our operations in the U.S. and China as we maintain a full valuation allowance against our U.S. and China deferred tax assets. Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss by jurisdiction, changes to the valuation allowance, changes to U.S. federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates and deductibility of certain costs and expenses by jurisdiction.

The decrease in tax expense for 2020 compared to 2019 was primarily related to recording a valuation allowance against our China deferred tax assets due to uncertainty with respect to their ultimate realizability in 2019, offset partially in 2020 by changes in the mix of earnings by tax jurisdiction, and the recording of a purchase accounting adjustment in 2019 related to not making a tax election to treat the Nutronics share purchase as an asset purchase for tax purposes.

Liquidity and Capital Resources

We had cash and cash equivalents of $146.5 million and $102.3 million as of December 31, 2021 and 2020, respectively.

For the year ended December 31, 2021, our principal uses of liquidity were to fund operating activities, acquire plant and equipment and tax payments related to stock award issuances. The primary source of cash was our public offering in March 2021.

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. However, we may raise additional capital to expand the commercialization of our products, fund our operations, further our research and development activities or for other corporate purposes. 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 year ended December 31, 2021, net cash used in operating activities was $7.4 million, which was the result of a $29.7 million net loss and use of cash for working capital of $33.7 million, offset partially by non‑cash expenses totaling $56.0 million related primarily to depreciation, amortization, and stock-based compensation. Changes in working capital were driven by a $19.0 million increase in inventory, a $9.5 million increase in accounts receivable, and a $3.6 million increase in prepaid expenses and other current assets.

The increase in inventory was driven primarily by an increase in safety stock to address risks related to the supply chain, logistics, and manufacturing disruptions, and to support new product introductions. The increase in accounts receivable was attributable to the timing of shipments and increases in revenue, and the increase in prepaid expenses and other current assets was attributable to an increase in contract assets.

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During the year ended December 31, 2020, net cash provided by operating activities was $13.0 million, which was primarily driven by $20.9 million of net loss reported for the period, and non-cash adjustments of $42.1 million related to depreciation and amortization, stock-based compensation, and other items. These items were partially offset by a $6.9 million increase in inventory and changes in other operating assets and liabilities. The increase in inventory supported new product introductions, decreased customer lead times and increased safety stock.

Net Cash Used in Investing Activities

During the year ended December 31, 2021, net cash used in investing activities was $21.9 million, including $19.3 million of capital expenditures related primarily to investments in manufacturing equipment and improvements to our corporate facility.

During the year ended December 31, 2020, net cash used in investing activities was $24.5 million, primarily resulting from $23.4 million of capital expenditures related to the acquisition of commercial property in Camas, Washington, and other investments in manufacturing equipment for our worldwide operations.

Net Cash Provided by (Used in) Financing Activities

During the year ended December 31, 2021, net cash provided by financing activities was $73.7 million, which was primarily driven by our follow-on public offering of $82.4 million, net of offering costs, and $2.7 million of proceeds from stock options exercised and employee stock plan purchases, partially offset by $10.6 million of withholding tax payments related to vesting of restricted stock awards.

During the year ended December 31, 2020, net cash used in financing activities was $3.8 million, which was primarily driven by $6.4 million of withholding tax payments related to vesting of restricted stock awards, offset by $2.8 million of proceeds from stock options exercises and employee stock program purchases. In addition, the $15.0 million in proceeds from our revolving line of credit drawn in the first quarter of 2020 was paid in full during the third quarter of 2020.

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.

On September 24, 2021, we amended the LOC to extend the maturity date to September 24, 2024, remove LIBOR references and update the financial covenants.

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 December 31, 2021 and 2020 and we were in compliance with all covenants.

Contractual Obligations

The following table sets forth a summary of our significant contractual obligations to make future payments in cash as of December 31, 2021 (in thousands):

Critical Accounting Policies and Significant Estimates

Our critical accounting policies consist of policies relating to revenue recognition and inventory. See Notes 1, 3 and 7 of Notes to Consolidated Financial Statements for detailed discussions of our critical accounting policies and significant estimates.

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Inflation

While we do not believe that inflation had a material effect on our business, financial condition or results of operations through December 31, 2021, we experienced higher than expected increases in wages and other compensation costs, as well as increased shipping costs, during 2021, which is a trend we expect to continue in the near term. We expect those 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.

Recent Accounting Pronouncements

See Note 1 of Notes to Consolidated Financial Statements.