Ipg Photonics Corp Q3 FY2021 Earnings Call

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

Thank you, Rob, and good morning, everyone. With us today is IPG Photonics Chief Executive Officer, Dr. Eugene Scherbakov, 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. This risks and uncertainties include the impact of the COVID-19 pandemic on our business and those details in IPG Photonics Form 10-K, for the period ended December 31st, 2020, in our reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investor 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 as of today, November 2nd, 2021 only. The Company assumes no obligation to publicly release any updates or revisions to any such statements. For additional details on the reported results please refer to their earnings press release, earnings call presentation, and Excel based financial data we'll post it on our Investor Relations website. We will post these prepared remarks on our Investor Relations website following the completion of this call. With that, I will now turn the call over to Eugene Scherbakov.

Thank you, Eugene. And good morning, everyone. We are deeply saddened by the passing of Valentin Gapontsev, the Founder and Executive Chairman of IPG. This tremendous loss for our Company and the broader Photonics community has benefited greatly from his technical innovations and strategic reasoning. Because of his reasoning and lessons learned, our products have become cost-effective, reliable, and effective tools that have mass applications in global industrial production. He was recognized as a father of the fiber laser industry and a great entrepreneur. Following in his footsteps, we will continue to focus on innovation and invest internally in manufacturing and research and development capabilities to make the highest quality components and the most reliable products. At IPG, we are also exploring new markets and applications. The fiber lasers replace existing laser and non-laser technologies by improving efficiency and productivity, enabling technological breakthroughs for our customers. Our technology is playing well into the major micro trends, including investments in electric vehicles and renewable energy, as well as a focus on energy efficiency, industrial automation, and media utilization. This will transform the way products are created. As part of our strategy, we have diversified away from the highly competitive and more cyclical copy market in China. Our results this quarter demonstrate successful execution of this strategy. We are pleased to deliver revenue and EPS at the top end of our guidance. Results were driven by strong growth in emerging markets, as well as cleaning semiconductors and several other products and applications. Demand for IPG continues to improve in North America and Europe, especially in welding and cutting applications. We've also seen increased orders and business activity in Japan, which is recovering from the pandemic and experiencing increased investment in factories and automation in Europe. We are benefiting from widespread investments in electric vehicle production globally. Our lasers are used in a variety of welding and cleaning applications for EV battery manufacturing. We're also seeing opportunities for laser welding in EV motor assembly and body-in-white applications. These investments are likely to continue for the next three to five years as automotive manufacturers address the need for EV batteries and new technologies to meet aggressive global carbon emission standards. We're excited about the increased demand we've seen in products and applications. Each contributed just under 30% of our total revenues this quarter, with record sales in AMB lasers and medical, along with strong growth in high power pulse lasers. Both AMB and high power pulse lasers are benefiting from increased investment in EV battery capacity worldwide. Our medical products are rapidly gaining adoption, and both our thulium laser and IPG disposable fibers are becoming the standards in the industry. Our business will continue to grow significantly, potentially doubling in size over the next two to three years. One of our newest products, the Conoco laser, which launched earlier this year, is generating widespread interest and a significant response in the welding community. We launched an improved version of LightWELD in September, which has cleaning capability in addition to many preset welding parameters. Some customers may choose LightWELD just for cleaning purposes as it can save time, money, and reduce costs. This was the highlight of our presentation at FABTECH this year. We signed agreements with nationwide distributors that operate hundreds of retail stores in the U.S. We expect to sell tens of thousands of units per client over the next three to five years. As expected, software demand in the China capital market during the second quarter was moderated. The combination of a softer demand environment impacted by widespread supply chain issues, high shipping costs, and power shortages, along with more aggressive price competition from local manufacturers negatively impacted demand for cutting applications in China during this quarter. At the same time, we are seeing record demands in the world, and the situation in China has resulted in strong sales in EV battery applications and increased revenue from marking and 3D part printing. In several cases, we saw customers returning to IPG after lower-cost local suppliers failed to meet customer quality and technical support expectations. They continued to benefit from our vertically integrated product model, which enabled a technological advantage while minimizing supply chain disruptions. We have seen some impact on our customer base from ongoing supply chain issues worldwide, but we successfully overcame these challenges this quarter. As we announced earlier, the board selected John Peeler as non-executive Chair. John has served as Lead Independent Director since 2017, and his appointment provides continued stability as we have worked together well over the years. These developments follow the separation that started in May 2021, and I look forward to working with John in his new position. With that, I will turn the call over to Tim to discuss the financial highlights of the quarter and the fourth quarter outlook.

Thank you, Eugene. And good morning, everyone. My comments generally will follow the earnings call presentation, which is available on our website. I will start with the financial review on slide 3. Revenue in the third quarter was $379 million, which increased 19% year-over-year and 2% sequentially. Third quarter GAAP gross margin was 49%, an increase of 100 basis points year-over-year. Compared with the year-ago period, the increase in gross margin was driven primarily by lower inventory provisions and a reduction of unabsorbed manufacturing expenses as a percentage of sales. GAAP operating income was $102 million, and operating margin was 26.9%. Third quarter net income was $75 million or $1.40 per diluted share. The effective tax rate in the quarter was 26%. As a reminder, last year's results were negatively impacted by a goodwill impairment charge of $45 million. During the quarter, we recognized an after-tax foreign exchange gain of $2 million or $0.04 per diluted share, primarily related to the depreciation of the euro and Chinese yuan. If exchange rates relative to the U.S. dollar had been the same as last year, we would have expected revenue to be $9 million lower and gross profit to be $6 million lower. Moving to slide 4, sales of high-power CW lasers decreased 4% year-over-year and represented approximately 47% of total revenue. Sales of ultra-high power lasers at 6 kilowatts or greater represented 51% of total high-power CW sales. Medium power laser sales increased 109% from growth in cutting, welding, 3D printing, and semiconductor applications. QCW laser sales increased 8% year-over-year due to higher demand for marking, engraving, and drilling applications. Pulse laser sales, including high power pulse lasers, increased 69% year-over-year, with strong growth in foil cutting applications for EV battery manufacturing, solar cell applications, and higher sales of our infrared lasers for marking and cleaning. System sales increased 56% year-over-year with improved revenues for Genesis and ILT, along with a ramp-up in LightWELD sales. Other product sales increased 58% year-over-year, benefiting from higher sales in medical and beam delivery. Examining our performance by region on Slide 5, revenue in North America increased 55% year-over-year, driven by materials processing with growth in welding, and increased sales of high power lasers for cutting applications. We also saw record quarterly revenue in medical, as our products continued to gain acceptance. System sales improved in the third quarter with both laser and non-laser systems posting strong revenue growth. In Europe, revenue increased 50% year-over-year, driven by accelerated demand in cutting and welding applications, as well as strong growth in marking and additive applications. Our revenue in China decreased 7% year-over-year in the third quarter, representing approximately 36% of total sales. Soft sales of high-power lasers and cutting applications more than offset higher demand in welding applications, high power pulse lasers for foil cutting, and growth in marking and additive applications. Sales in Japan were up 11% and revenue in the rest of Asia increased 15% year-over-year. Moving to a summary of our balance sheet and cash flow on Slide 6, we ended the quarter with cash equivalents and short-term investments of $1.5 billion and total debt of $35 million. Strong operational execution resulted in cash provided by operations of $102 million during the quarter. Capex was $40 million in the third quarter, and we expect capital expenditures to be between $130 million and $150 million for the full year. During the quarter, we repurchased 200 thousand shares for $36 million and have bought approximately another 135 thousand shares so far in the fourth quarter. Commenting on the outlook for the next quarter, third quarter book-to-bill remained above 1. We expect stable demand in North America and Europe and continue to see growth opportunities in welding and high-power cutting in those regions. Foil cutting and welding applications for EV battery production across many geographies, as well as opportunities in solar cell manufacturing, medical procedures, and advanced applications. We also see LightWELD sales continuing to gain traction. However, sales in China will be down sequentially in the fourth quarter due to softer demand in cutting applications. Uncertainty due to supply chain issues and power outages may impact demand for our products, as well as ongoing competitive pricing. For the fourth quarter of 2021, IPG expects revenue of $330 million to $360 million. The Company expects the fourth quarter tax rate to be approximately 25%, excluding any discrete items. IPG anticipates delivering earnings per diluted share in the range of $1 to $1.13 with approximately 54 million diluted shares outstanding. I would like to remind you that financial guidance provided this quarter continues to be subject to greater risk and uncertainty given the COVID-19 pandemic and its associated impacts on the global business environment, supply chain, public health requirements, and government mandates. Please refer to the Safe Harbor passage of today's earnings press release for more details on risks and uncertainties associated with our forward-looking statements. And with that, we'll be happy to take your questions.

Thank you. At this time, we'll be conducting a question-and-answer session. One moment please while we poll for questions. Our first question comes from Jim Ricchiuti with Needham & Company. Please proceed with your question.

Hi. Good morning. I had a question about China. If we exclude the cutting business in China, can you give us some sense as to how the business performed across the rest of the portfolio? Are you still seeing weakness in China or did that business perform better, excluding cutting in China? And I have a follow-up.

The Q3, Jim, excluding cutting, the rest of the business was very robust. I mean, clearly EV battery applications are a very strong driver of growth. We're actually really pleased as well; we got some good demand coming from additive applications there, which are with lower power lasers, but very high-quality lasers. Competitively, that's been a very positive trend. The other positive trend I think was on some of the marking and engraving applications, which are increasingly being used in automated production lines. Therefore, where the quality of the laser is very important, that also performed well. So other applications outside of cutting were more than robust. I'd say they're good.

But for cutting applications also, we have to see some lower-end applications, of course, there's some competition from China. But for high-end, we have a very good position against competitors, including Chinese competitors.

And the follow-up question I have is just with respect to LightWELD. I know it's early days, but judging by the interest at Fabtech and every time I saw the booth, it was packed with people looking at the demonstration of that. At what point will you see the benefit of the expanded distribution channels? Will that hit in Q4, or is that something that really begins to benefit you in early '22? I don't know if there's a high level of training that goes on with the channel partners, but can you give us a sense as to how you're thinking about LightWELD?

Of course, you would like to get a great benefit from this quarter. But, of course, it will take time because there are a lot of different opportunities, and many different customers already participated in this. And we have to sometimes train customers to use it. And, of course, we cannot expect the benefits to fully materialize until the first quarter of next year. But it is very important that we introduced the new options for our LightWELD, and they will be demonstrated at the end of this quarter and the beginning of the first quarter of next year.

And this will be — do you anticipate this is going to be a catalyst for your systems business? Because the rest of the systems business also seems to be recovering. But as we look at that, you're clearly seeing a turn in that part of your business.

Yes. About the catalyst, I don't think it will be. Of course, our rest of our business also has grown. And we are optimistic about our prognosis and forecast for next year. Definitely.

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

And thanks, guys, and good morning. The gross margin is holding pretty well despite the softness in China cutting, so that's obviously a change from the prior cycles. Can you talk about the levers that are allowing you to maintain consistent gross margin despite the decline in China cutting? Are you seeing offsets from new products or are you seeing more discipline in pricing? What are the drivers of the Brazilian gross margin?

So there are a number of drivers. I think the first thing is the strategy about being disciplined around pricing, both in China and globally, is really paying dividends in that regard. The second, there are probably two or three more drivers. With slightly lower sales of cutting applications in China and higher sales of other applications, we generally have a mixed benefit from that. In addition, you've got a geographic mix benefit with some of the strongest sales in Europe and North America around both cutting and other applications, which will also benefit. And then we've got strong sales coming out of areas like medical and even some of the semiconductor applications. So we're trending in the direction that we'd like to see from a mix and diversification perspective. There is also a benefit on the gross margin side from all of those areas.

We continue to prolong our special project, which was installed two years ago about optimizing manufacturing costs for our components for our devices, and this trend will continue into next year. Definitely.

Okay. As a follow-up, Tim, can you provide any preliminary comments on 2022? I know you're not going to guide specifically, but I think last quarter you talked about a double-digit sales growth algorithm. How do you see maybe 2022 relative to that framework? Any comments would be helpful there. Thanks.

Well, I'm not going to comment on double-digit growth for next year. I mean, we provided a medium-term to long-term target of continuing to grow the business at a double-digit growth rate. We're not giving any guidance for next year at this point in time. It would be the wrong point in time to do that. We'll also have to make a decision as to whether we provide annual guidance. Overall, though, we remain quite optimistic about next year. You've got major growth drivers that we talked about. The macro trends out there with EV battery manufacturing, EV motor manufacturing, body-in-white applications, new product introductions in other parts of the welding market, growth in medical applications. The high-power cutting market is transitioning to much higher power levels globally, as well as in China. We're going to start rolling out our ultra-compact laser at higher power levels than 1 and 1.5 kilowatts, transitioning during the course of the year, early on in the year to 3 kilowatts and 6 kilowatts, and then ultimately probably in the second half of the year to 8 kilowatts with the ultra-compact device. So there's a whole host of different applications that we think are going to make next year an interesting and exciting one. Maybe from a geographic perspective, you continue to see robust economic data in North America and Europe, and maybe a little bit of moderation, but not a fundamental shift. Geographically, we're starting to see some recovery in Japan as well, and we've gotten lots of opportunities in some of the other Southeast Asian markets like Korea.

I would like to add that some customers, both in China and outside of China, are starting to ask about these ECO lasers. IPG lasers have efficiencies greater than 50%. Nobody else is producing such kinds of lasers today. This will also present an opportunity for us to provide very high-power lasers with such high efficiency. We will also demonstrate this product at the end of this quarter and at the beginning of the next quarter, and we are already engaging with some potential customers regarding this.

Got it. Thanks, guys, good luck.

Thank you.

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

Hey, guys. Yes. Thanks for taking my question. I want to be respectful in how I ask this question. There are a lot of investors wondering what happened to Valentin and his trust and the voting shares, as he's a significant shareholder. In your 10-K filing, his ownership position is cited as a material risk. We saw yesterday, there were some 13D filings that occurred last night. Just because it does come out with investors, could you provide an update given those filings? What is the status on his ownership and his trust position at this point?

So Michael, there's no material change to the ownership structure. The estate planning around Dr. Gapontsev's ownership in IPG was not only started but completed many years ago. There's no change, and the trustees appointed to manage the trust and U.K. Company. There’s no major change there as Dr. Scherbakov is the managing Director and will vote those shares. So I think this transition has been thought through and planned quite well.

Fair enough, Tim. And I guess on that, is there any change in strategic direction for IPG following the events? Any change in capital allocation with the significant cash balance? Any change that we should be aware of? Management, we saw the new Executive Chairman, but just curious if there's any changes post this news on strategy and IPG going forward?

I think the first thing is if we were going to make any fundamental changes or anything, it would be a material announcement we'd have to make, and we've made all of the announcements around the events of the last couple of weeks. In terms of strategy, we talked about this when Dr. Scherbakov took over as CEO. At a high level and a broad level, the strategy was developed by Dr. Scherbakov and Dr. Gapontsev, and even other members of the executive team over many years. So we will continue to pursue the rollouts of fiber laser technologies across multiple applications and end markets. Therefore, there's no significant change in that direction. Dr. Scherbakov has mentioned a couple of things regarding the optimization of the manufacturing footprint and efficiencies that we have. We're not changing our gross margin guidance range of 45% to 50%, and we are getting increasingly comfortable in achieving the top end of that range while pursuing initiatives that keep us on average at the top end. Of course, there could be some variance depending upon where quarterly revenues fall out. And regarding capital allocation, we've continued to enhance and develop the capital allocation strategy over time, regularly executing our existing $200 million buyback and quickly and effectively completing the prior one. So no fundamental changes out there. Otherwise, we would have had to articulate them.

Makes sense. Thanks for that, Tim. And then how do we think about, with all these supply chains and the cost inflation? With you guys being so vertically integrated, I'm curious how that impacts you with some of these supply chains trying to get certain components. But also, I feel like the expense number was in line with your expectations, around $87 million. How do we think about — are you seeing more efficiency in the business as you head into the fourth quarter in 2022? What should we consider with those moving parts on SG&A, and labor and things like that? Thank you.

Of course, you can see the influence of, first of all, on our customers and also on our power supply. There are some component issues, particularly with electronic chips and so on, but we have made some requests regarding this. We have enough stock of these components to organize stable production of our lasers and avoid interrupting our customers. However, we have to think about our strategy because we see prices for metals growing dramatically—20% for aluminum, about 30% for copper. Some chip prices also increased—not by 20% or 30%, but sometimes by 3 to 10 times. In such conditions, we need to consider optimization and discuss future preparations with our existing and potential customers. Of course, there are uncertainties, but we believe that next year will bring more stable conditions.

Then just regarding the operating expenses, I can address those SG&A and R&D. We were right in line with what we guided to for Q3. We're actually running at a bit higher level on some of those operating expenses compared to a year ago, first of all, because our variable compensation accruals have increased due to the overall performance of the business year-to-date with near 20% growth in Q3. This is slightly above our budgeted level, so our variable compensation accruals are a bit high. Additionally, we see some expense returning from, for example, trade shows and fairs on the selling side, so Fabtech. The variable compensation, relatively speaking, next year will likely moderate a bit depending on how we perform relative to next year's budget. We're looking for optimization of those expenses on the operating side. Overall, we're being very disciplined in how we manage that. But we also have to ensure we're hiring enough salespeople to support growth and focusing on R&D to complete key projects and products that will drive revenue growth.

As a reminder, if you'd like to ask a question, please press star one on your telephone. One moment while we poll for questions. Our next question comes from Paretosh Misra, with Berenberg. Please proceed with your question.

Thank you. Good morning. I guess just going back to that inflation discussion. So looking at it a little differently, some of your competitors have been cutting prices in recent years. So I'm just curious if this inflation and component pricing and freight are making it more difficult for those guys to cut prices. In other words, could this inflation lead to some price stabilization even for the low power lasers?

No, we can't really talk to how people in the competitive market will behave because I think it's interesting though—if you looked at the results of one of those competitors that was announced last week, even relative to Q1, their gross margins are down by almost 600 basis points. So they are certainly being very aggressive around pricing, and with that aggressiveness around pricing, they are certainly not reducing their cost base because of that impact to the gross margin. I can't predict how they will behave strategically in the future.

Got it. And as a follow-up, if you could talk a bit more about your solar business, any thoughts on how big is that right now and how big you think it could be in the next several years? Also, where exactly are your products used in that whole process?

It's not just one product, it's several products. Unfortunately, I don't know the specific part of the solar business to date. But in different areas of pulse laser spot, we mean in the micrometer region and also getting very good in power pulse lasers. For next year, we're optimistic as well; I think we have new applications for lasers and we're optimistic again about this business.

Okay. Thank you.

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

Hey, good morning. My condolences on the passing of Valentin. From an investor-facing point of view, I will miss his spirited responses to any questions that were focused on competition, which clearly showed his technical pride in the products, so my condolences.

Thank you, Joe.

China — yeah. The prepared remarks — piecing together two separate comments on the prepared remarks. One acknowledging the China competition is continuing, but on the positive side, when discussing gross margin, you mentioned price discipline. Can you expound upon those dynamics? Does that imply you're walking away from certain machines or potentially even customers, or is anything really changing in those dynamics in the second half of the year?

I don't think anything is really fundamentally changing. There is a high volume, low end of the market that really only buys on price. And there continues to be a higher end of the market that generally serves high volume manufacturing and automated manufacturing systems where reliability is key to the systems. So for example, if you have downtime of even a few hours in a production line, the cost of that downtime will far exceed the cost of the laser. So it's in those areas that we continue to focus on where our share remains very high. It's a bit of a pyrrhic victory trying to play within the very high-volume, low-end of the market. What we did say though was that as we expand the offering of our ultra-compact lower-cost lasers, there's certainly an opportunity to increase our share as we go to 3, 6, and ultimately 8 kilowatts there. In the rest of the China market, we’re dealing with much more sophisticated applications where our competitive products perform significantly better. So whether it’s the AMB laser or the high power pulse lasers, or even at lower power levels, the single mode lasers being used on some of the additive and welding applications, we have clear advantages in all of those areas.

Thanks. Maybe if you could comment on automotive investments as well. Beyond electric vehicles, which I think is understood, I'm just wondering if there's any impact on the appetite to invest for the core body-in-white and tailor-welded blanks type of applications with production generally being depressed short-term throughout the light vehicle space?

We're not seeing significant investment in that as a couple of North American manufacturers have started a program to replace some older lasers that are 8 to 10 years old. There's a few orders I've seen coming in from some major manufacturers in Europe, and some recovery is happening in Japan from a major manufacturer there looking to roll out some specialized welding processes on a broader scale, but many of those orders are on the non-EV side. We don't have major projects we can point to at this point in time. The EV market is really dominating automotive at the moment.

Definitely, yes.

Great. And then finally, just wondering if there are any notable supply chain-driven callouts this quarter. I think at least in cutting, your downstream customers' lead times are extending, and it's often due to key components that aren't the laser. So I'm wondering if that resulted in any delay to your shipments during the quarter?

No, internally, we've managed the supply chain very well. However, there was certainly some softness in the end markets, some of the issues in China with power outages and higher shipping costs are part of the impact on the cutting market in China.

But there is an obligation to our customers where we made our typical lead time for our product; it's between 6 to a maximum of 8 weeks.

We have reached the end of the question-and-answer session. I would now like to turn the call back over to your host, Eugene Fedotoff. Thank you.

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 we will be participating in a number of virtual investor events this quarter. Have a great day, everyone. Goodbye.

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