Ipg Photonics Corp Q1 FY2020 Earnings Call

Good morning and welcome to IPG Photonics First Quarter 2020 Conference Call. Today’s call is being recorded and webcast. At this time, I’d like to turn the call over to James Hillier, IPG’s Vice President of Investor Relations for introductions. Please go ahead, sir.

Thank you, Doug, and good morning, everyone. With us today is IPG Photonics’ Chairman and CEO, Dr. Valentin Gapontsev; Chief Operating Officer, Dr. Eugene Shcherbakov; and Senior Vice President and CFO, Tim Mammen. Statements made during the course of this call that discuss management’s or the company’s intentions, expectations or predictions of the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause the company’s actual results to differ materially from those projected in such forward-looking statements. These risks and uncertainties include the impact of the COVID-19 pandemic on our business and those detailed in IPG Photonics’ Form 10-K for the period ended December 31, 2019, and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors section of IPG’s website or by contacting the company directly. You may also find copies on the SEC’s website. Any forward-looking statements made on this call are the company’s expectations or predictions only as of today, May 5, 2020. The company assumes no obligation to publicly release any updates or revisions to any such statements. For additional details on our reported results, please refer to the earnings press release and the Excel-based financial data workbook posted to our Investor Relations website. We will post these prepared remarks on our Investor Relations website following the completion of the call. With that I’ll now turn the call over to Valentin.

Good morning, everyone. Before I discuss our results and strategic initiatives, I want to address how IPG is navigating the effects of the novel coronavirus outbreak. The well-being of our people, our customers, and our partners is our highest priority. IPG employees who can work from home are doing so. In all regions, we continue to manufacture and service our solution. Although there are some restrictions to US production, the impact to date has not been material during our products are used across a wide variety of critical infrastructure sectors. In Germany, we didn’t stop work practically at all. In Russia, it’s posed only one week of vacation during these two months. In order to save our people, we have employed additional distancing and cleaning measures in our facilities. We forced masks for use in our production and introduced very effective UV means for total disinfection of all production optics rooms, along with temporary increased wages for our employees who continue to work on-site. As a result, as of today, we are proud to report that IPG did not have any COVID-19 infected cases at any of our locations in spite of more than 80% of our staff going to work on-site practically during these two months. IPG has also tried to help local communities. In China, we have donated approximately RMB 1 million to those affected by this worldwide epidemic. In the US, we have donated many tens of thousands of masks to local hospitals in need. In Russia, we donated a modern CT imaging system to local hospitals as well as masks and other necessities. Eugene will discuss the impact of COVID-19 on our operations in greater detail. I want to assure you that at IPG, we are doing all we can to help save our people and communities. During this time of uncertainty, which is unlike anything we have experienced before, it is unclear what will happen to global demand over the coming weeks and months. This uncertainty makes forecasting our business very challenging in the near- to medium-term. Nonetheless, our strong balance sheet, ample cash reserves, and lean model depth provide us flexibility in responding to coronavirus-related disruptions and to emerge from this crisis with the ability to seize the many opportunities we expect to see. We plan to continue our investment in strategic resources and capital projects that will drive the next wave of our market share capture for our fiber laser technology. Because our fiber lasers are a key enabler of automated precision manufacturing, we expect to disproportionately benefit from an eventual recovery in the industrial cycle. Turning to results, we delivered first quarter revenue at the high end of our guidance range on better-than-expected performance in China and strengths in new products. Despite the weaker demand environment, we have seen strong customer interest in a number of our leading-edge welding solutions. In cutting and welding applications, our ultra-high-powered lasers of 12, 15, or 20 kilowatts have demonstrated superior attributes compared to competing products including faster cutting and welding speeds, better beam parameters, higher wall plug efficiency, and significantly better reliability. IPG lasers continue to deliver peace of mind and lower lifetime costs by enhancing end-user productivity. We received our first volume order for our adjustable-mode beam lasers for electric vehicle battery welding. As a reminder, our AMB lasers permit the broadest range of beam tunability enabling spotless welding. In addition, there was more than double sales of high power nanosecond pulsed lasers at 300 watts and 500 watts used for foil and coating in electric vehicle battery products and applications. IPG remains the only reliable laser supplier of these products, and we continue to expect strong growth in this application during the year. Product innovation remains core to IPG’s success. During the first quarter, emerging product and application sales were 23% of total revenue, increasing more than 20% year-over-year despite the softer demand environment for IPG laser systems during COVID-19. Sales of green pulsed lasers used to improve solar cell efficiency increased by more than 50% year-over-year. Sales of ultrafast pulsed lasers increased modestly as customer acceptance and traction were curtailed by the uncertain demand environment. However, we continue to target more than 50 new projects for these lasers across a wide range of applications, processing glass, ceramics, circuit boards, OLED films, batteries, and solar cells. Sales of medical lasers reached a record $10 million in Q1, increasing more than 500% year-over-year. We continue to ramp sales of our thulium laser solution for urology and other soft tissue applications, benefitting from partnerships we established several years ago and FDA approval late last year. Our medical laser business includes sales of consumable fibers, a recurring revenue stream that will grow as the number of installed systems increases. Advanced application revenue more than doubled year-over-year with strong growth in government, semiconductor, and scientific applications. We will continue to invest in transformative new products, including new medical treatments, mid-infrared lasers for spectroscopy, inspection and sensing applications, and ultra-high power single-mode lasers for aerospace and defense. These new solutions will enhance our growth and margins while providing greater geographic and end market diversification. Finally, I want to express my gratitude to the IPG team for their outstanding performance during this most challenging time. I believe their execution, combined with our laser technology leadership and robust balance sheet, will enable IPG to capitalize on the long-term secular growth in laser technology and to deliver on our mission to make our fiber laser technologies the tool of choice in mass production. With that, I will turn the call over to Eugene.

Thank you, Valentin, and good morning, everyone. I will begin my discussion with the effects of COVID-19 on our production. Currently, all three of our major production facilities in Germany, the US, and Russia remain open. However, we have scaled back production in Massachusetts to the products required to support essential businesses. These include lasers and laser systems used in transportation, medical, agriculture, communications, and defense end markets among others. Our German operations are operating on a more normalized basis, albeit with social distancing measures in place. In Russia, our employees are working on a rotating basis to limit contact. Our highest priority remains the safety of our employees, their families, our business partners, and community. As Valentin noted, we have put in place additional health safety and workplace measures to safeguard the health and well-being of our valued employees and colleagues. Our vertical integration production model continues to provide us with critical advantages in this time of supply chain disruption. Also, we source certain raw materials from third parties. We internally produce the more complex components and modules used in our technology. Our leading-edge components and modules are the critical technical performance and cost differentiators between IPG and our competition. We continue to leverage this advantage from more than 20 years of investments in technology, people, and processes. Many of our third-party suppliers remain open, providing the components we need. However, the supply chain constraints we face are primarily related to logistics including available air cargo space and higher freight rates. Available cargo space on flights between the US and Europe is limited, so shipments are taking longer. In addition, shipments to Europe are limited to the countries most affected by COVID-19 and experience some delays in other places due to checks at border crossings. Recognizing this situation is fluid and subject to change, we believe we have the ability to meet near-term demand for our products. In total, manufacturing and operating expenses were approximately $20 million lower in Q1 compared to the peak level in Q2 2019. Some of these reductions are due to the lower level of activity but are primarily attributed to the cost reduction actions we undertook in the second half of 2019. We remain committed to managing our cost structure and working capital to align with the business environment. Examining our performance by region, revenue in China decreased 40% year-over-year and represented approximately 28% of total sales. As we expected, performance was impacted by weaker demand due to the coronavirus outbreak. However, we do see a strong recovery in orders during the latter half of March and April. We continue to face aggressive price competition in the region; however, pricing was more stable on a sequential basis. In Europe, where the industrial demand environment remains very challenging, revenue decreased 15% year-over-year. Revenue in North America increased 4% year-over-year, driven by strong growth in medical lasers and advanced applications. Our growth in North America illustrates the benefit of our diversified portfolio strategy. We are increasing the adoption of emerging laser solutions and applications to offset the softness in industrial markets. Sales in Japan decreased 12% year-over-year given ongoing macroeconomic weakness in the region. Sales in Korea decreased 26% year-over-year due to the effects of COVID-19 in the region. Finally, sales in Turkey decreased 36% year-over-year due to various macroeconomic challenges affecting cutting businesses in the region. With that, I will turn the call over to Tim to discuss the financial highlights in the quarter.

Thank you, Eugene, and good morning, everyone. Revenue in the first quarter declined 21% year-over-year to $249 million. Revenue from materials processing applications decreased 28% year-over-year while revenue from other applications increased 123%. Sales of high power continuous wave (CW) lasers decreased 33% year-over-year and represented approximately 48% of total revenue. Sales of ultra-high power lasers at 6 kilowatts or greater represented nearly 50% of total high power CW laser sales. Pulsed laser sales increased 1% year-over-year with growth in green and high power pulsed lasers, partially offset by lower sales of lower power pulsed lasers for marking applications. Systems sales decreased 43% year-over-year as growth in systems for medical device manufacturing was offset by lower sales of other IPG laser systems and Genesis non-laser systems. Medium power laser sales decreased 28% due to continued softness in additive manufacturing and the transition to kilowatt-scale lasers in cutting, while QCW laser sales decreased 30% year-over-year. Other product sales increased 38% year-over-year driven by growth in medical laser sales and total service revenue. Q1 GAAP gross margin was 41%, which declined 600 basis points year-over-year. Compared with the year-ago period, the year-over-year decline in gross margin was driven by several factors, including 200 basis points from less favorable absorption of manufacturing expenses, 190 basis points from higher inventory reserves, and 90 basis points from an increase in shipping costs. Q1 GAAP operating income was $45 million, and operating margin was 18%. During the quarter, we recognized primarily related to the revaluation of US dollar cash and other assets in Russia given the depreciation of the ruble versus the US dollar. Excluding this foreign exchange gain, operating margin was 10%. Q1 net income was $36 million or $0.68 per diluted share. The previously referenced foreign exchange gains increased EPS by $0.28. The effective tax rate in the quarter was 23%. If exchange rates relative to the US dollar had been the same as one year ago, we would have expected revenue to be $5 million higher and gross profit to be $3 million higher. We ended the quarter with cash, cash equivalents, and short-term investments of $1.2 billion and total debt of $41 million. As Valentin noted earlier, our strong balance sheet provides us with ample flexibility in responding to coronavirus-related disruptions, particularly around investing for future growth opportunities. Effective operational execution resulted in cash provided by operations of $57 million during the quarter. Capital expenditures were $18 million in the quarter and are trending below our target of $115 million to $125 million for 2020. During the quarter, we repurchased 109,000 shares for $30 million. Today, IPG also announced that its Board of Directors has authorized the purchase of up to $200 million of IPG common stock in open market transactions or otherwise, subject to market conditions and other relevant factors. This new authorization is in addition to the company’s existing $125 million stock repurchase program authorized in February 2019, of which approximately $60 million remains available under that prior program. In March and April, we extended our credit lines with Bank of America and Deutsche Bank for five and three additional years respectively. Bank of America also increased the total unsecured availability to $75 million from $50 million. First-quarter book-to-bill was meaningfully greater than one and above normal seasonality, reflecting solid bookings growth and the weaker revenue quarter in China. Normally, this would have translated into stronger guidance for the second quarter, but the global demand environment remains very uncertain given the effects of COVID-19 on manufacturing facilities and customer confidence around the world. While we have seen a rebound in China-based order volumes in the latter half of March and April, this has coincided with declining bookings in other regions, including Western Europe, North America, and other countries in Asia. As such, visibility into a recovery and global demand remains uncertain at this time. Despite the uncertain near-term demand environment, we continue to target significant longer-term growth opportunities in laser welding, electric vehicle battery processing, and our portfolio of new products. Our strong balance sheet will help us through the crisis and emerge with the ability to capitalize on the many opportunities we have ahead. For the second quarter of 2020, IPG expects revenue of $260 million to $290 million. The company expects the second-quarter tax rate to be approximately 26%. IPG anticipates delivering earnings per diluted share in the range of $0.40 to $0.70 with 53.1 million basic common shares outstanding and 53.7 million diluted common shares outstanding. Financial guidance provided this quarter is subject to greater risk and uncertainty given the COVID-19 pandemic and its associated impact on the global business environment and government policies. As discussed in the safe harbor passage of today’s earnings press release, actual results may differ from our guidance due to factors including, but not limited to, goodwill and other impairment charges, product demand, order cancellations and delays, competition, tariffs, trade policies, health epidemics, and general economic conditions. Our guidance is based upon current market conditions and expectations, assumes exchange rates referenced in our earnings press release, and is subject to risks outlined in the company’s reports with the SEC. With that, Valentin, Eugene, and I will be happy to take your questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from John Marchetti with Stiefel. Please go ahead with your question.

Thanks very much. I was just wondering, Valentin, if you could comment a little bit or add some color to your pricing commentary about the China market. It sounded like pricing there at least was a little bit more stable on a quarter-over-quarter basis. I'm curious if you think that is something that's somewhat more sustainable or if it has to do more with the restrictions that we saw in place during the March quarter?

Okay. China’s market is now demonstrating more stability than it did two years ago in 2018. In 2019, prices were much lower as battery prices became more stable. The situation is, of course, very uncertain, and it's quite complex. Important experience for us now, looks much greater than we expected. For example, over the last two months, we received orders for mid-power lasers much more than before. In only the last two months, we received orders that were about half of what it was a year ago. So if this trend continues, we can expect to double our business in mid-power lasers this year as compared to 2019. Of course, nobody can predict what happens next month, but even in a very pessimistic scenario, the outlook looks promising. We are introducing new generations of mid-power lasers that have much better functionality and capability compared to what we have developed in the past. In the second half of this year, when we introduce this new generation mid-power lasers, the market response is expected to be very positive. The situation for high-powered lasers in China is also growing fast, and we see increasing purchases of high-power lasers with more than 10 kilowatts. Our production facilities, especially in Germany and Russia, are now busy, with 80% of our workforce working on-site. We are currently looking for ways to create new production lines to manage this demand.

Tim, maybe just a quick one for you. Last quarter, you talked about an expected impact of around $45 million. I'm curious how that actually played out in the quarter, if you are above, below that, or in line there. And maybe with the guidance that you've given, if you can maybe quantify a little bit of what you can say that the revenue impact and maybe the EPS impact of the ongoing virus situation is? Thank you. Given that we came in at the top end of the guidance range we provided for Q1, the actual impact in the first quarter was slightly below the $45 million that we had outlined for Q1 guidance. This was due to a strong rebound in demand in China in March, which helped mitigate what was characterized as a lost month in February. Overall demand in Europe held reasonably strong in Q1 with total order flow. North America actually grew a little bit year-over-year, particularly with strength in new medical applications, so that demand environment held up reasonably well.

Great. And then, Tim, just a quick one for you. Last quarter, you talked about an expected impact of around $45 million. I'm curious how that actually played out in the quarter, if you are above, below that, or in line there. And maybe with the guidance that you've given, if you can quantify a little bit what you can say that the revenue impact and maybe the EPS impact of the ongoing virus situation is? Thank you.

Jim, I mean some of the rebound is from very little demand that happened for a six-week period. But I think it's in part not necessarily new capacity coming on board. It's that of probably all of the economies that have gone through the coronavirus and COVID-19. China went into lockdown earlier. China is certainly exhibiting at this point in time more of perhaps a V-shaped recovery in terms of the letters that everyone is talking about. Total demand for some of the lower power kilowatt scale lasers has rebounded strongly. We’ve also seen good demand from higher power pulsed lasers for electric vehicles and higher-power lasers for welding. Like everybody, it's uncertain how sustainable this can be. If it is sustained, it does point to a potential recovery in our business over a reasonable timeframe into Q2 and potentially Q3. There’s just so much uncertainty out there about whether a V-shaped recovery in China will be sustained or what recovery we'll see in Europe, North America, and other Asian countries as we emerge from this.

Regarding the systems business down pretty significantly in Q1, it is fair to say that this is mainly a US business to a lesser extent in Europe? Was the decline more concentrated in medical device manufacturing? Is this an area of business that perhaps has more uncertainty to it or do you see some recovery off these low levels? Demand for the medical device systems used to manufacture medical devices is distinct from the medical lasers used in medical procedures. The demand within that application has held up well. The weakness is primarily for the smaller form compact cutting systems affected by investment decision delays. This business has shown a slowdown.

At the moment, we're not making solid changes to the long-term target models. We are clearly operating at revenue levels below even medium and longer-term targets, and that's why the current performance is below that range. We are still trying to manage the business and are aiming to get back to the 45% to 50% range.

From the point of component supply, we didn’t face any major problems because we took measures beforehand. We have enough components to maintain continuous operation, and our main components are in stock. The COVID-19 effect on our customers led them to delay orders and ask us to postpone deliveries for some existing orders. However, we don’t see any major issues related to COVID-19 affecting our supply chain.

Hi. Thanks for taking my question. I have two of them. Tim, just wanted to get your thoughts on the Commerce Department ruling from last week expanding the scope of the export rules. Given the fact that you guys have quite a bit of exposure to China, how do you think about it to the extent that you understand and interpret those rules? And then, I had a follow-up.

I can’t answer that question at this point in time. I haven't done enough to ascertain the implications of the new export rules and how they might impact us.

Thanks, and it's nice to see a positive outlook here. I guess my question concerns the uptick with respect to what I presume is pent-up demand from things being shut down over in China. I'm curious; if we look at China's GDP being largely export, and we look at the rest of the world largely seeing a decline in GDP from a consumption perspective, how do you reconcile the pickup in manufacturing capacity? Is it a function of utilization or upgrades in existing facilities that contribute to the demand? Thanks.

There continues to be uncertainty as to how global GDP and China's GDP, North America, and European GDP will recover over the next six to nine months. With regard to the China rebound and demand specifically, some investments are in response to increased local consumption rather than just exports. Many of the industries we serve are not simply export-oriented; they're also driven by internal demand. Over the medium-term, we will be focusing on how regional and global economic indicators and trends evolve.

That is all the time we have for questions. I'd like to turn the call back to management for closing remarks.

Thank you for joining us this morning and for your continued interest in IPG. We look forward to speaking with you over the coming weeks. We’ll be participating in a number of virtual investor conferences this quarter. Have a great day and keep safe, everyone.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.