Ipg Photonics Corp Q2 FY2021 Earnings Call

Good morning and welcome to the IPG Photonics Second Quarter 2021 Conference Call and Webcast. Today's call is being recorded and webcast. At this time, I'd like to turn the call over to Eugene Fedotoff, IPG's Director of Investor Relations for introductions. Please, go ahead, sir.

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

Good morning, everyone. We are pleased to report another good quarter for IPG. Our second quarter revenue was significantly above the same period of last year and increased from strong results in the prior quarter, driven by improved macroeconomic conditions in most major geographies, growth in emerging products as well as excellent execution by the IPG team. We saw higher end market demand for our core material processing product, where our fiber lasers are replacing traditional tools and handheld welders, and we continue to pursue opportunities in emerging markets. We remain focused on growing sales in applications that require innovative solutions. Our expertise in fiber laser technology and superior quality of product, such as advanced applications, electric vehicle battery production, medical and microprocessing, are transforming the way products are created, enabling production of smaller and more complex devices, improving the products we use every day, and bringing advanced manufacturing capabilities to the electric vehicle and renewable energy industries, helping to address climate change and sustainability initiatives. Our investment in new products and the applications are paying dividends.

Thank you, Valentin, and good morning, everyone. During the quarter, we demonstrated excellent progress in our core material processing market across all major geographies, with accelerated growth in high power and ultra-high power lasers for cutting applications in the U.S. and Europe, and strong growth in welding in China and Europe. We also delivered robust growth in emerging products and applications. Revenue from material processing applications increased 27% year-over-year and contributed 93% of total revenue in the quarter. Sales in welding applications grew significantly in the last several quarters due to increased sales of our AMB adjusted motor beam lasers for general manufacturing purposes and electric vehicle battery welding applications. Battery manufacturers are facing challenges welding together different types of materials such as copper, sulfur, and aluminum. These materials are extremely reflective and need to be welded with high precision and reliability. Each battery model requires hundreds of welds, and our AMB lasers can address these challenges, offering superior speed and weld quality or competence solutions with a broad range of beam tunability and spotless welding. We also saw strong demand in emerging and micro material processing applications such as solar cell manufacturing and 3D printing. Sales of our green pulsed lasers, which are used to improve solar efficiency, more than tripled compared to the prior year and are becoming a more meaningful part of IPG's revenue. We are taking advantage of opportunities created by increased focus on sustainability globally and expect future solar cell manufacturing capacity to grow, driving additional sales in our green lasers. We are also increasing the pulse energy of the green lasers to enable next-generation applications in solar, drilling, and copper welding for consumer electronics. Revenue from our other applications increased by 5% year-over-year. Medical sales showed good growth both year-over-year and sequentially as a result of improved demand for our surgical lasers. Advanced application sales improved year-over-year, while telecom revenue declined compared to the same period in the prior year.

Thank you, Eugene, and good morning everyone. Revenue in the second quarter was $372 million, which increased 25% year-over-year and 8% sequentially. Revenue from materials processing applications increased 27% year-over-year, and revenue from other applications increased 5%. Sales of high-power CW lasers increased 20% year-over-year and represented approximately 51% of total revenue. Sales of ultra-high power lasers at six kilowatts or greater represented 51% of total high-power CW laser sales and increased 15% compared to the prior year. Medium power laser sales increased 70% on growth in cutting, welding, 3D printing, and semiconductor applications. QCW laser sales increased 13% year-over-year on higher demand from welding applications. Pulsed laser sales increased 45% year-over-year, with strong growth in green pulsed lasers used in solar cell manufacturing and higher sales of our infrared lasers for marking and cleaning applications, as well as foil cutting applications in the electric vehicle batteries manufacturing process. System sales increased 19% year-over-year with improved sales for Genesis and ILT. Other product sales decreased 4% year-over-year. We estimate that supply chain constraints impacted our revenue by $7 million to $10 million in the quarter.

Great. We will now be conducting a question-and-answer session. Our first question today is coming from Jim Ricchiuti from Needham & Company. Your line is now live.

Hi. Good morning. Tim, I think I heard you say the impact that you saw from supply constraints in Q2 was around $7 million to $10 million. So, is that just to be clear, is that a direct impact to you, or is that what you're seeing from some of your customers? It seems like a fairly modest number. That's why I'm asking.

Yes. It was a fairly modest number. I'd agree with that. It's a variety of things. It's both the impact internally on the ability to supply some products and also an impact from slightly lighter demand from some customers because they can't get components for some of their systems, which delays shipments of their systems, and then they don't want to take the lasers at the same time they did before. And the other thing is that it is across most geographies. So it's not just in one specific location. China was impacted a bit, but also North America and even Europe as well.

Do you anticipate that being a little worse this quarter?

No. It's probably going to be at a similar level. So in Q3, it's a combination of that as well as some of the softness in the China cutting market that are really impacting guidance. It's not that that is specifically driving the guidance number down more significantly.

Got it. And just my follow-up question. Just with respect to North America, you showed strong year-over-year growth. And clearly that's an easier comparison relative to the pandemic last year. But on a sequential basis, I'm just curious the decline there, 10% or so sequentially. Are you seeing any signs of the US North American market either slowing down or potentially being impacted by some of these external factors that we're hearing about?

No. Not specifically. I think with North America it was more about the timing of revenue. We had a very strong start to the year in Q1. We still had some backlog. For example, I think one of those 100-kilowatt lasers was recognized as revenue in the first quarter. So that was a bit of a benefit, which resulted in a slightly slower quarter in Q2. I will say that overall North American backlog continues to be very strong. And the guidance number we have, I can't remember, sequentially I think it will be basically flat but again continuing to show growth on a year-over-year basis. So the backlog in North America remains pretty robust even though Q2 performance was a little bit later.

Thank you, Eugene, and thank you Tim.

Thank you. Next question today is coming from Nik Todorov from Longbow Research. Your line is now live.

Yeah. Thank you. I want to double-click on the China demand particularly in cutting. If we go back a quarter ago, I think you were talking about macro indicators showing signs of weakness, but I think your data points were strong. We were talking about strong freight agreements that were usually tied to high demand for ultra-high power lasers. If I look at the high-power sales and breaking down between ultra-high power and the low six-kilowatt, we can see that ultra-high power lasers grew very incrementally on a sequential basis. Also on a year-over-year basis, while below six-kilowatt lasers grew I think 24% or 25% year-over-year and about 10%, 15% sequentially. So that implies that China sales should have been strong. So I just want to double-click and see the reasons if you can give us more around the softness in China cutting?

So China sales in the second quarter were strong both on a sequential and even on a year-over-year basis. The growth on a year-over-year basis was a bit lower than some other geographies, but don't forget that China had recovered already a significant round of revenue in the second quarter of 2020. So the comparison there is a bit more difficult. I wouldn't say I was concerned about performance in China in Q2. In fact, bookings as well were strong. The issue is that I think a couple of companies even that have announced in the last couple of days have pointed out a weaker macro environment in China and even the government being concerned about a potential slowdown. Yes, we highlighted that in some of the PMI data that initially came out I think in April. So there is a bit of a concern that China is a bit weaker than expected, and that's clearly driving some of our expectations in addition to the supply chain constraints in the third quarter. So I mean bookings are good, but we expect those orders to be delivered over a slightly longer time than necessarily would have been if the demand environment had remained resilient or stronger. It's still resilient and strong.

Okay. If I can click on the supply chain dynamics, I think we heard that there were some challenges with delivering chillers that were causing some lead time extensions. Maybe can you give us what components are impacting your lead times and when do you expect those to get resolved? And what are you doing to address that?

Yes. Earlier there were some components, but they're not critical components. First of all, what I also mentioned is that the price for some materials has also increased dramatically. For example, for copper welding and also for our components based on these materials. But for our production, it's not dramatic, and I think we will deliver in time not only chillers but also other products during this quarter.

Okay. Last quick one. Germany sales were down sequentially. I think European sales overall are very strong. What is the reason why Germany sales are kind of diverging from the rest of Europe?

So, actually let's go and look at the data on that, which customer it was specifically there. We tend to focus on total European sales rather than just the individual countries there. And as you point out, total European sales continue to perform pretty strongly. I'd have to look at which customer was the change between Q1 and Q2.

And from the other side, Germany again demonstrated a very high amount of orders for ultra-high power lasers and it was keeping 22-kilowatt and more for the first time.

Got it. Okay. Sounds good there. Thank you and good luck.

Thanks.

Thank you.

Thank you. Next question today is coming from Tom Diffely from D.A. Davidson. Your line is now live.

Yes. Good morning. Maybe one more question on China. You talked in your prepared remarks and said that pricing pressure remained. I'm curious if that has moved up into the high power region. You had most of the pricing pressures still at the low power?

No. Some of the competitors are entering the ultra-high power market with products at higher power levels, like 12-kilowatt lasers. Their only competitive strategy is based on pricing. The low end of the market is shifting upwards in power and this is affecting prices. However, our strategy remains to focus on delivering the value of IPG's products rather than getting involved in a price war at the low end of the market, which lacks emphasis on device reliability and quality. So far, our approach has proven effective with strong sales in China and good profitability, and we are satisfied with how our gross margin and overall operating margin have performed in the second quarter.

Okay. Yes. A year or so ago you talked about using your strong cost structure to maybe get more aggressive in the marketplace. And it sounds like you've been a little bit more disciplined than over the last year than I thought you may have been after some of those comments. But have you used pricing at all from your side or is it just in response to what you're seeing from the competitors?

No. We've introduced some of the lower cost rack-mounted lasers that's enabled us to reduce the selling price of those and make them a bit more competitive, while maintaining margins on that, but we're not using pricing as our strategy within the China market. It really would be a bit of a terrific victory in terms of gaining a significant amount of share but at a significantly lower average price per watt. And then having to draw even more resources to building products that would have a lower profitability on it, so we're focused on the high end of the market. And also outside of cutting, very strong growth in some of the welding applications for EV, the foil cutting applications for EV. Even some mid-power laser growth for some of the additive applications in China. And then surprisingly some of the pulse lasers, even at lower power levels for marking applications, where the quality of our product is recognized has actually held up quite well. So, there's a number of different areas we're focused on trying to drive that value at the highest level possible.

Okay. That sounds great. Just one final housekeeping question. What's in your category of emerging products right now?

Anything really introduced in the last three-plus years. So it includes things like high-power pulse lasers, the AMB, green, ultrafast, UV, some of the systems applications, accessories, so beam switches and cutting and welding heads, scanners, some of the telecom product advanced applications as well.

And also integrated systems and subsystems based on our laser strong components.

Okay, great. Thank you.

The next question today is coming from Michael Feniger from Bank of America. Your line is now live.

Michael can't hear you.

Our next question is coming from Paretosh Misra from Berenberg. Your line is now live.

Thanks, guys. Good morning. Maybe first of all on the electric vehicle, if you could just talk about how is that market evolving in North America and perhaps maybe your most current estimate as to what percentage of your sales are now going to EV?

The EV market, of course, is growing very fast. And you see first of all for battery welding and cutting applications, different materials and production of components for e-vehicles. But also you see a new tendency especially in Europe. They are starting to produce and develop a new body in white for future e-vehicles. Because after now they're using the standard. And now based on new technologies and new projects, they are based also on laser welding and cutting for such kind of transaction. They start to produce new models based on such kind of approach. And this market grows dramatically and we see also our opportunity to participate in this by using not only our lasers or components of a subsystem, but we also have some proposals to produce a full production system from battery production or some other components in e-vehicles.

Not just production systems, production-wise full production-wise.

That's correct.

Got it. And currently, it's what? Like it's on all these different sales combined to about 5% of your total revenue, give or take?

No. Previously, we estimated a weak quarter to be 5% and a strong quarter to be 10%. In Q2, it actually exceeded 10% of total sales. We continue to see strong growth. Additionally, if you consider capacity rollouts for battery investments, it could potentially increase significantly. Over time, total capacity investments might reach around 20% of quarterly revenue.

Got it. Interesting. And maybe just one is there a way to think of your year-over-year sales growth in terms of how much was volumes versus pricing?

Most of the change was due to volume since the average selling price per kilowatt on a global level remained relatively stable, experiencing only a slight decrease year-over-year.

Great. Thanks, guys. That’s all I have.

Our next question is coming from Joe Wittine from Edgewater Research. Your line is now live.

Hey, good morning. I want to ask on the China cutting competition. I know somebody already asked on this, but really just wanted a clarification on whether the prepared remarks from Dr. Scherbakov had intended to signal there was more competition than your expectations 90 days ago, or am I reading too far in?

You see in principle, we don't have any competitors because our product is the best in the world and we are producing the best not only lasers also other components. From this point of view again, we already mentioned in our presentation that up to now, for more than 20 years nobody could produce a product with parameters or performance better than IPG laser did. From this point of view, there's no competition. Of course, there exists some competition from, first of all, in China and with Chinese production. But for this, some people are using combination work like acceptable quality made, but it's not acceptable quality for us. Our goal is to produce the best quality product. For this product, we can guarantee up to five and seven years. This is our goal, and from this point of view, again, nobody can compete with us.

I can add also not only in China, China is a damaged product. China is absolutely a lower-quality product up to now. But nobody from the best American and European company was able to compete with us in quality or pricing. So up to now, after 20 years, typically any new product needs one to two years to provide some similar product. And I would think in a unique situation, for 20 years, nobody in the East or West has been able to compete with IPG product in quality and cost. We are the only leader here.

Yeah. I mean, I don't think any of that's debatable. Your quality has proven out over decades in the channel, but is the market shifting more towards price focus – a price versus focus right now, because this is a point in the cycle where you wouldn't necessarily expect that, or again, am I reading too far into just the second quarter trends?

We believe that the current situation in China is quite unique. The Chinese government has implemented policies that strongly favor local production, discouraging customers from purchasing goods from outside the country. These regulations have led to a preference for products made in China, regardless of quality, which poses a challenge for international competitiveness. Unfortunately, this impacts regular, mass customers simply due to the government policy. It's not just China that's adopting such measures; many other countries are following suit, particularly in the wake of last year's trade regulations. Companies are now looking to promote local products, with the U.S. also encouraging a buy local initiative that wasn't the case 20 or 30 years ago. This shift is reminiscent of the past, as new governmental policies reshape global trade relations that had been established over the last two decades. Now, we find ourselves in a waiting period.

Great. Maybe just one follow-up just on every topic, I'm curious on your take on Raycus being put on the US blacklist. I don't think there's a bunch of Raycus units ending up in the US so probably not much of an immediate direct impact on your business, but wondering if you may have any nuanced views there? Thank you.

We're not entirely sure how that's going to impact them on the global stage. And in terms of US sales, it clearly does. And then we know that they are, and believe know for certain that they're buying some components from US suppliers. And I think, we'll watch what they say in terms of what their impact on any critical components that they have and then how that may impact them going forward. It's obviously not a positive development for them at all.

Great. Thanks, Tim.

And your next question is coming from Michael Feniger from Bank of America. Your line is now live.

Hey, guys. Yeah. Thanks for taking my questions. Apologies, I had some issues. So if it was asked, I apologize. But Tim, what's baked into Q3 on the gross margin range? Can you kind of help us there?

Yeah. I mean, sort of very similar to Q2 in the range of 47% to 49%. And OpEx, I think last quarter guided like $83 million to $85 million. We're more in that sort of $85 million to $86 million range for Q3 as well.

Okay, great Tim. There's a lot of investor concern regarding China right now. Given the tough comparisons you mentioned with a slowing market, can you clarify the extent of this issue? In 2019, your China revenue dropped 25% sequentially. In other years, it has seen a more moderate decline of 5% sequentially. Can you help us understand why the market is so worried at this time? Are we experiencing a similar drop-off to what we saw in 2018 and 2019, or is this a more modest sequential decline? The current stock performance shows significant concern regarding this for Q3 and Q4.

No. It's not a similar comparison to 2018 or 2019, where we saw a steep contraction and drop-off. We're experiencing some weakness in the cutting market, but there is still significant strength and demand coming from various other applications where we have inherent advantages, and these markets continue to grow both in China and abroad. I'm not going to provide a specific number on what is included in our guidance; however, it’s nowhere near that 25%. The impact on Q3 sequentially compared to Q2 is much lower than that. While we do expect a decline in China, it is far from that level.

Okay. Thank you.

You cannot expect the cutting market to grow in the next 50 years. Each share application has reached saturation and is declining. The cutting market has been established for 15 years, which is much longer than many others. Currently, the trend in the cutting market indicates saturation and decreasing unit growth because the focus is shifting toward high-power cutting lasers. For instance, a single 20-kilowatt cutting system with 20-kilowatt lasers can outperform five or even ten mid-power cutting systems due to greater efficiency and speed. I can confidently say we are moving into high power, but soon we will see work units saturate and decline. This trend is inevitable and cannot be altered. Despite this outlook, we are developing new applications for cutting, such as for electric vehicles. Previously, we achieved about 80% very high temporary growth, which they refer to as cutting. We are now advancing with a new process for cutting very thick metal. Just five to seven years ago, experts believed fiber lasers could only manage a few millimeters, but we are now capable of cutting thicknesses up to 20 millimeters at unprecedented speeds and qualities, successfully replacing plasma cutting with new applications. This is a significant market, and we are introducing this process and new applications. We are also developing applications for green lasers tailored for cutting thin metals, which serve high production demands and niche areas like medical micro cutting. We continuously develop new processes, steering away from commodity products like those offered by China. China may invest in short-term dreams, but that does not lead to high-tech products; it results in a commodity market. We aim to remain distinctive, avoiding commodities with variable margins in favor of unique high-tech solutions.

Thanks. Thank you for that. And with all that you just said about cutting, you said about saturation cutting, growth in new applications and your view on China. Just helping to level set for everybody when we think of 2022, if global GDP is at 5% next year and what you're talking about with new applications versus cutting like how do we normally should be thinking about the puts and takes for next year, if your backdrop is what you're playing out right now and you're thinking of GDP might be in the 5%. Can you just help us frame some of the moving pieces there to think about? Thank you.

Yes. I'm not going to core draw on guidance for 2022 at this point in time. But if global GDP remains strong, the underlying materials processing markets, particularly with some of the growth coming from other areas and welding has been a standout performer, not just on EV but in other areas, recovery and additive, ablative processes for cleaning, the foil cutting applications, and even the other cutting applications. Generally, that market will grow at a significant premium to global GDP, sometimes as much as twice that amount. And then you have expected growth from some of our new and emerging products to be additive to that, like medical, for example, ultrafast, microprocessing applications, the systems business and accessories and other areas. So though that still gets us towards our double-digit growth rate that we are targeting and continuing to target for the medium term for the company.

Thank you.

Thank you. Next question today is coming from Mark Miller from The Benchmark Company. Your line is now live.

Thank you for the question. The strong growth in green lasers, besides solar, what else was the driver there in terms of the growth – in green laser sales?

Primarily, at the moment, the green is being driven by solar applications that actually improve the efficiency of the solar cells by a couple of hundred basis points, which is extremely – it's actually quite an extremely high increase in total efficiency. There are other green applications we're working on things like microprocessing and semiconductor valve and just referenced now the development of much higher power green lasers for cutting and even welding as reflective materials. So, but those needed to get to kilowatt-scale green power.

Do you have any estimates in terms of the supply constraints, when they might ease? Would it be later this year do you feel?

No. I mean our insights into this is the same as everybody else's insight, relatively uncertain. A lot of it is around the electronic component supply chain and processes and CPUs and things like that. So it's probably going to take a few months for us to really fully remediate or potentially a bit longer. We don't have any specific...

Don't forget, now inflation is growing very fast. More and more companies, not even western companies, which now you in the way of delivery shipment product because waiting when the price will grow to provide higher price, all the planning to increase price for their products. Because it's inflation and very fast, nobody can predict what would be priced through three, four months, maybe even 50% more even sometimes even 200%, 300% more. Now, the many electronic components which help now happen.

Such kind of components, the price was more than three times, up to 10 times. Of course, it's not a big component, but it demonstrates the tendency in this market.

The trend.

Thank you.

Thanks. Our next question today is a follow-up from Jim Ricchiuti from Needham & Company. Your line is now live.

To also go back to the growth you're seeing in emerging, and I wonder if you could just comment a little bit more specifically about the biggest components to the growth in that area?

The biggest component to the growth in Q2 were the very high-power pulse lasers for foil cutting A and B green, some of the accessories I think.

Medical.

Medical was there. Yes, medical as well.

Okay.

Four or five areas.

Tim, regarding operating expenses, you provided some details for Q3. Overall, your operating expenses have increased significantly. How much of this is due to the return of some temporary expense savings that were reinstated in the business in Q2, or are there new investments being made?

Some of this is just the layering back expense. The other thing is that relative to the budget that was put together, our performance is above that. So total variable comp is a bit higher, significantly higher than it was a year ago. So that will probably moderate over time. And then, we're continuing to invest, for example in R&D to ensure that we're getting more emerging products and applications to the market for future growth of the company. So we're not pulling back on things like R&D at this point in time. The other area on G&A, which requires some investment is the sort of whole cybersecurity thing, where you need to continue to invest in the IT infrastructure there. The cost of having a more significant cyber event on us. It's a challenge faced by every organization. You've got to invest in that to make sure that you harden your security and protect yourself as much as possible.

Thank you. We reached the end of our question-and-answer session. I would turn the floor back over to Eugene for any further closing comments.

Thank you for joining us this morning and your continued interest in IPG. We look forward to speaking with you over the coming weeks and we'll participate in a number of virtual investor events this quarter. Great day everyone.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time. And have a wonderful day. We thank you for your participation today.