Ipg Photonics Corp Q4 FY2020 Earnings Call

Greetings and welcome to IPG Photonics' Fourth Quarter 2020 Conference Call. Today's call is being recorded and webcast. At this time, I would like to turn the call over to Eugene Fedotoff, IPG's Director of Investor Relations, for introductions. Please go ahead, sir.

Thank you, operator, and good morning, everyone. With us today is IPG Photonics' Chairman and CEO, Dr. Valentin Gapontsev; Chief Operating Officer, Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen.

Good morning, everyone. We are pleased with our fourth quarter results as we delivered revenues that were 10% higher than the fourth quarter of 2019 and were within our guidance range. In addition, book-to-bill was above one in the fourth quarter as we saw traction in order flow that continued from the third quarter into the fourth quarter and into 2021. We are benefiting from the advantages of our leading-edge products, technology differentiation, low-cost production capabilities, and a global footprint. We continue to see strong revenue in China, which was significantly higher on a year-over-year basis as volume growth more than offset the overall selling prices in the region. We're also pleased to see a sequential improvement in revenue in Europe and strong sequential revenue growth in North America in the fourth quarter. Our system sales also improved modestly but continue to be below last year, primarily due to the impact on the economy from COVID-19. We are demonstrating good progress in our core markets, thanks to our technology differentiation and low-cost production capabilities. In high power lasers, we delivered strong year-over-year growth in both our rack-mounted 1 to 4 kW lasers for the high-volume market and our ultra-high-power lasers for leading-edge cutting systems as sales of lasers above 6 kilowatts increased 34% compared to the fourth quarter and were 56% of total high-power sales.

Thank you, Valentin, and good morning. The impact of COVID-19 on our production capabilities continues to be minimal, and we are focused on ensuring the safety of our employees with social distancing and enhanced cleaning and filtration measures in place. Otherwise, we are operating normally. Despite the increase in COVID-19 cases in the Northern Hemisphere with the fall and winter, production has remained fully operational, and we managed COVID-related absences effectively.

Thank you, Eugene, and good morning, everyone. Revenue in the fourth quarter was $337 million, an increase of 10% year-over-year, driven by growth from most of our key product lines. Revenue from materials processing applications increased 10% year-over-year, and revenue from other applications increased 12%. Sales of high power CW lasers increased 17% and represented approximately 55% of total revenue. Sales of ultra-high power lasers above 6 kW represented 56% of total high-power CW laser sales. Pulsed laser sales increased 55% year-over-year, with strong growth driven by high power nanosecond pulsed lasers used in EV battery manufacturing, green pulsed lasers used in solar cell manufacturing, as well as higher sales of our new UV and ultrafast pulsed lasers, which were partially offset by lower sales of low power pulsed lasers for marking applications.

Thank you. At this time, we'll be conducting a question-and-answer session. Our first question comes from John Marchetti with Stifel. Please proceed with your question.

Thanks very much. Tim, I was wondering if you could just talk about some of the puts and takes on the longer term view. I know you mentioned that the underlying fundamentals continue to get a little bit better here. But as we're looking out through the course of the year, all else being equal, would you expect that we're getting back to a double-digit revenue growth range maybe off of 2019, as opposed to 2020, given that 2020 was such a challenging year?

We're not going to comment on annual guidance or targets. Except for your last comment, John, I think we’re talking about puts and takes, so a number of them articulated in the script. First of all, the continuing shift to higher power lasers for cutting applications, a lot of the new product introductions, we're optimistic about the handheld welder and growth in revenue from that. All of our emerging products in Q4 performed exceptionally well; we have a pretty broad portfolio of items that are starting to drive incremental growth. So whether it's the green lasers, the high power nanosecond pulse lasers for EV, or some increasing traction for ultrafast and UV. Medicals performed very well during the whole course of the year with the lithotripsy application. Other newer product introductions, the multi-channel QCW for displacing YAG lasers in spot welding. We had good orders for AMB. So, if you continue to see traction and momentum across what is now a pretty broad base and diverse set of products and applications, we continue to see improvements in some of the key macro-economic indicators that we follow. Certainly, this year looks like it could be set up to be significantly better than the last two years we've been through. The main target is to get out of some of the volatility that we've seen, which sometimes impacted the second half of the year as has happened in 2019, or has resulted in a slow start to the year like the pandemic did last year. So, the main target is to get out of more of the volatility and get to consistent year-over-year growth on a quarterly basis, and we've got significant drivers for that.

Got it. And then maybe just as a follow-up on the gross margin side. As we're looking out over the next several quarters, any expectations that we should assume maybe some additional charges like we saw this quarter, or really treat that more as a one-off here in 4Q and be back to a more normalized environment for gross margin as we're looking out over the first half and into 2021? Thank you.

I'm much more definitively expecting a normalized gross margin over the coming year. During the course of the year, not just in Q4, given some of the volatility related to the pandemic, we have had significant inventory provisions and charges, and the last charge at the end of the quarter positions us well for a more normalized operating position going forward. I think we've got a good start to the year in that context as well. And on the other side on gross margin, we've got other benefits coming through from some of the product mix, as we continue to grow revenue, better absorption of fixed costs. If, for example, the ultra compact laser starts to generate more meaningful revenue, that will be a significant improvement in gross margin. We're also looking at design changes on the ultra compact lasers, which can be incorporated into higher power lasers up to I think 7 to 8 kilowatts. So, there are many initiatives on cost reductions that we're optimistic about.

Thanks, Tim.

Valentin speaking. We expect our gross margin this year to return back to our usual trend, above 50%. But we were very careful with our current quarter reporting. The situation in quarters three and four did not yield better results. So quarter one and quarter two are promising targets, but of course, this year we are guiding to be very careful in consideration.

Understood.

Our next question comes from Tom Diffely with D.A. Davidson. Please proceed with your question.

Yes. Good morning. Thanks for the question. When you look at the strong activity, sounds like you had pre-Chinese New Year in China on the order front. Do you expect China to grow as a percentage of the order book over the next couple of quarters? Or is that being matched by growth in some of the other regions?

Tom, relative to Q1 last year when China order flow slowed down dramatically, and then it really picked up in April and May, I would expect China order flow to remain relatively consistent as a percentage of the total because the growth in Europe and North America is also recovering more meaningfully. The growth in some of the emerging products, which are not just strong in China, but are also strong elsewhere, leads us to expect a more even contribution rather than a China-centric focus on revenue for the year. Notwithstanding that, China order flow has been very strong prior to Chinese New Year. For example, not just shippable orders, but even frame agreements have been very good. Those are generally a place to get licenses so that shipments can take place during the course of the year.

Okay. No, thanks for the extra color. That's helpful. And then as a follow-up, how big is the EV battery market right now for lasers? And where do you think that goes over time?

I don't have a specific number regarding the current size of the market. However, we mentioned that it could be a potential investment cycle lasting a decade. If electric vehicle production meets expected levels, with targets discussed ranging from 25% to 50% of total vehicle sales over the next 10 to 15 years, it could generate hundreds of millions of dollars in laser-based investments for EV battery manufacturing and in the manufacturing of EVs themselves. This presents a significant long-term opportunity, as there will be a considerable demand for laser-based processing. Even some older battery technologies, such as cylindrical batteries, are starting to explore the use of lasers for processing more than ever before.

Okay. Great. Thanks for your time today.

Our next question comes from Nik Todorov with Longbow Research. Please proceed with your question.

Thanks. Good morning, guys. Tim, in the life cycle you guys have been very consistent in achieving about 60% incremental gross margin. I understand guiding sales is difficult, but how should we think about the incremental gross margin? You highlighted multiple cost initiatives. Should we think about that 60% as a base case, or could you see some upside? And also, can you talk about what are the limitations of rolling that ultra-compact design above 8 kilowatts? And I have a follow-up. Thanks.

I think some of the incremental gross margins are probably not far off where we were historically, maybe a little below that 60%. We're cautious is that as we get into a more normal environment, operating expenses will pick up in the second half of the year a little. So that drop-through won't be straight to the bottom line. In terms of migrating the design of the ultra-compact to higher power lasers, Eugene, would you like to talk about that and the potential rollout over time?

In phase four, we have several generations of compact lasers, particularly high-power lasers exceeding 2 to 3 kilowatts. The first stage has already been demonstrated, and we have shipped sales into such applications. The next step will be to utilize rack-mounted compact lasers for high power applications, meaning output exceeding one, two, three, and four kilowatts. Such lasers will be supplied effectively to all customers for various applications. The next generation is being introduced this year. It’s much more compact, capable of up to 8 kilowatts. The initial results indicate very good performance, and we're confident that it will represent the next generation of ultra-compact rack-mounted laser cutting applications. It is important to note that this design allows us to dramatically reduce our production costs and offer better prices to our customers.

Okay. Very helpful. Thanks. And just to follow up, can you talk about the adoption curve you expect for the handheld welding laser? It sounds like you’ve received extremely positive feedback. How much do you think you will need to educate the customer or prove the product’s effectiveness? It seems like they are seeing the benefits outright; I just want to understand your thoughts on the adoption curve.

VG, do you want to take that?

Our shipments are normal only in the United States. We’ve sold more than 24,000 units to small drops using this manual welding for instrumentation, representing a potential revenue of $600 million on this product line. If each customer buys only one unit, it’s 24,000 units; if they purchase increments of 10 instead of one or two, we have the potential for significant sales increases. We are currently providing more than 70 such demos for testing in the U.S., and customers are recognizing the fantastic benefits of these devices, which increase the quality of welding significantly compared to traditional methods, while also offering cleaning advantages and reducing wait times for operations. They are just waiting for formal qualifications related to electrical emissions. We began shipping units to customers in the U.S. weeks ago and expect to have numerous orders this year and ramping up to 10,000 units next year. The market for this product is growing very quickly, given the competition we face and the technological innovation in our products.

It's also easier to use, which requires less training for operators compared to traditional welding methods.

It's very easy to use. A normal welder requires many months of training, whereas this only takes a few hours for basic demonstrations. It's practically accessible to everyone. This is also an advantage, as the number of professional welders is decreasing.

Got it. Thank you.

Our next question comes from Jim Ricchiuti with Needham and Company. Please proceed with your question.

Hi. Thank you. Good morning. On the topic of the handheld lasers, I'm wondering if you are going to market any differently with this product offering, just given the market size and price points? And how are the gross margins on this product?

At the moment, we are rolling this out in phases with key customers. Many job shops have evaluated it, and we are also considering distribution arrangements that may require us to expand the salesforce as volumes ramp up to support a broader customer base compared to our typical OEM clients. We continue to evaluate how best to develop an efficient model around this. The gross margins on these products are very good, benefiting from design improvements around the ultra-compact lasers.

Okay. And as a follow-up, you showed a nice recovery in North America at least on a sequential basis. Looking at that business over the next couple of quarters, how sustainable do you think it is? Is it broadly based? And do you feel confident that this recovery in the U.S. is sustainable?

Yes, the underlying materials processing business has improved. In fact, some of the order flow in Q4, including some of our specialty AMB lasers, has also increased in North America. We still have revenue to recognize on advanced applications as the medical growth will continue; however, it's not going to be as strong as last year due to a smaller base. Still, the medical business has continued to perform well, and we have growing visibility into medical sales in the second half of the year. The backlog for green lasers going to Southeast Asia is good, although they are currently made in the U.S. The only area where we lack longer-term visibility is in advanced applications as we are still waiting for some defense applications to reach commercialization and become consistently profitable.

Thanks.

We share a product that does not depend on China. It is for advanced applications and traditional metal sheet cutting. We've seen positive increases, up to 28%, but we expect to increase up to 50% over a couple of years. The majority of these new advanced applications are developed internally in the U.S., leading to essential increases in sales in that market. Gross margins in the U.S. are primarily contributing to our net income; we’ve seen a decline in sales of diodes recently, but we expect positive growth in that area again.

Thank you.

Our next question comes from Michael Feniger with Bank of America. Please proceed with your question.

Hey, guys. Thanks for squeezing me in. Tim, I recognize that you may not want to comment directly on one of your competitors. I was just hoping to get a sense of the big picture here. Some investors fear that with this bidding war, it creates a bigger competitor that could be much more aggressive in attacking the industrial markets with aggressive pricing at scale of R&D. Can you help us understand the competitive landscape in laser technology a little more and how IPG positions itself to maintain that leadership? Does this type of bidding war validate some of the mega trends accelerating with automation, EV, dual supply chains? Do you see more consolidation going forward around laser technology and automation markets? I'm curious about your thoughts on this.

There are many elements to your question, Mike. First, we are not going to comment on the ongoing bidding war. The focus here should really be on IPG's strengths, not only in core industrial markets but also in our emerging product offerings. None of the current parties involved in the bidding process have the same core strengths and capabilities that IPG does. We don't view this situation as being a threat to our core strategies or capabilities. Furthermore, we are developing numerous emerging products that are driving our growth, backed by the inherent advantages of our technologies. Whoever our competitors may be, IPG's fiber laser technology is unique in many aspects, and our fundamental strength comes from vertical integration, rapid development speed, and the ability to reduce costs. Our diverse product portfolio shows that we are achieving a higher return on our internal R&D compared to acquisitions. We do not see ourselves as a consolidator in the industry. Regarding some of the trends, they are evident: flexibility, automation, and increasing acceptance of lasers across various applications and technologies. Energy efficiency is also increasingly becoming a driver for IPG, where we lead the industry with electrical efficiency nearing 50%, while no one else is even close. Thus, instead of worrying about larger-scale competitors that may not have advantageous positions like ours, we should reflect on our unique benefits. Also, to note, there has already been significant consolidation in this industry, so there are fewer substantial acquisition targets remaining.

Perfect. Thanks for that, Tim. Following up, if we get the higher end of your Q1 guidance and see a typical 15% to 20% sequential growth in Q2, would you then be close to that $400 million sales figure? Do you feel more confident in driving gross margins above 50% at that point? Please help us understand what type of margins we can anticipate as we reach these revenue levels.

As Valentin mentioned earlier in the call, we're cautiously optimistic about reaching the top end of our guidance range, around 45% to 50% gross margins. If we start getting revenue back up to the $400 million level, we have many production cost initiatives in place, and Valentin is increasingly comfortable with the prospects of returning to an optimal gross margin operating model, rather than just being best in class.

Our next question comes from Mark Miller with The Benchmark Company. Please proceed with your question.

Thank you for the question. You've indicated several times the opportunity for battery welding for EVs. However, there is a chip shortage impacting auto sales. Do you see that affecting you over the next couple of quarters?

No, Mark. We don’t believe the chip shortage in the semiconductor industry will impact us. Although it may affect the auto industry due to some facility shutdowns, we have no visibility indicating it will impact our growth. We are not currently facing similar supply chain challenges, especially given our integration, and we have built-up inventory of electronic components.

Germany's sales also saw a sequential and year-over-year decline. Is that also COVID-related, like in Japan?

I haven’t looked at the German numbers specifically, but overall Europe was up sequentially. I can't recall exactly where the revenues originated, but generally we were pleased with the overall performance in Europe rather than singling out Germany, as we looked broadly at Northern Europe, Italy, and even Western Asia, Turkey, which saw some slight sequential improvements. So, I don't have more detailed commentary on that.

Thank you.

Our next question comes from Joe Wittine with Edgewater Research. Please proceed with your question.

Hey, thank you. Good morning. I wanted to ask about welding. There's evident interest in the AMB for EV batteries and the handheld systems. However, I'm curious about how you view the broader macro welding market adopting lasers, including standalone lasers and systems mix as this broader cycle evolves. Could there be a tipping point where adoption has been slow?

Eugene will address this.

Regarding the welding market, it is currently being driven by EV vehicle applications, but also includes cutting and foil cutting. Our advantage is that we are not only supplying lasers but also components — different kinds of optical heads for cutting or welding, blast monitoring systems like LGD, and we have started producing complete systems for battery welding. We have already supplied these to some automotive customers, and we are ready to launch additional systems to other customers. Although we consider this not a new product, it nonetheless represents a strong opportunity for us to supply comprehensive systems in Europe, China, and the United States. The overall welding market is growing steadily, not only associated with automotive applications but also with other metals; the demand is increasing year-over-year.

Okay. I wanted to revisit your comments about rolling out features from the ultra-compact designs to higher power units, I believe you mentioned up to 8 kilowatts. I’m curious if there are trade-offs you encounter, such as in efficiency, flexibility, or durability, and do you plan to offer those units side-by-side with the existing full-featured versions?

When producing these ultra-compact lasers, we need to dramatically decrease our production costs. Customers adopting these lasers must be ready to change their systems to accommodate them. If there’s no exchange, new machines will be necessary to ensure our product has better efficiency and pricing benefits. Thus, we see excellent opportunities for better performance and pricing with ultra-compact models.

The development process from CO2 lasers for cutting to high-power fiber lasers took ten years; our competitors are just starting to catch up but at a very slow pace. We've progressed significantly over the years, now achieving cutting of up to 50 millimeters, whereas previously we couldn't even consider it. It's a long process, and while we're moving ahead, it's important to recognize that others may still struggle.

Sure. Additionally, I want to note that we have never introduced a product that has less reliability, durability, or lower electrical efficiency. These new lasers utilize the same optical components while remaining compact and sophisticated in their design.

Perfect. That’s great color. Just what I was looking for. If I may squeeze in one more time, regarding the 20 to 30 kilowatt lasers, can you share which geographies those units are currently shipping to? Are they primarily in China, such as for the pencils and others? Is there interest from Western countries? What applications might be relevant there?

The demand is not limited to 20 to 30 kilowatts. We've recently received requests for 40-kilowatt lasers for cutting applications, and we’re ready to supply these products. Primarily, these lasers are used for cutting applications, but some are also being utilized in welding. Our first customer for such high-capacity lasers is indeed in China, not in Europe or the United States.

Okay, well, thanks, and congratulations.

Thank you.

Our last question comes from the line of Paretosh Misra with Berenberg. Please proceed with your question.

Thank you. Good morning and thanks for taking the question. Regarding your CapEx guidance of $150 million to $160 million, could you provide some color on the larger projects included in that range, and anything to note as potential future growth drivers?

For CapEx, we need to shift some construction projects to this year, as there have been delays due to supply chain issues. Now we need additional assembly facilities to handle increased demand for new products and mass production. We aim to improve and enhance our production capabilities while maintaining healthy demand. We aren’t planning to buy out smaller businesses, focusing instead on enhancing our technology capabilities through strategic investments that support our future prospects.

Understood. I appreciate it.

It's okay, Paretosh. Next question.

Sorry. My follow-up was hoping you could share some high-level insights on how pricing and volume changed last year? Any color would be great.

Year-over-year, pricing declined in a more normalized range of approximately 10% to 15%. However, pricing has stabilized over the last three quarters since Q2. As demand improves, competitor antics have become less extreme. We remain disciplined regarding our pricing structure, indicating the inherent value of our laser technology. Current pricing methods do not require drastic changes to influence adoption. It's good to observe greater stability, and we’ve seen beneficial trends moving towards higher power levels for cutting applications, which reflect our competitive advantages. Also, pricing gains in emerging products, like the high power nanosecond pulse lasers, are exclusive to IPG, allowing us to maintain robust average selling prices for these applications. The mix has positively contributed as well.

Great. Thank you so much.

I can close today's question-and-answer session. At this time, I'd like to turn the call back over to Eugene Fedotoff for closing comments. 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 and will be participating in several virtual investor conferences this quarter. Have a great day, everyone.

This concludes today's conference webcast. You may disconnect your lines at this time, and we thank you for your participation.