Good morning, and welcome to IPG Photonics Third Quarter 2022 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 me today is IPG Photonics CEO, Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen. Let me remind you that 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 are detailed in IPG Photonics' Form 10-K for the period ended December 31, 2021, and our 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 as of today, November 1, 2022, only. 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, earnings call presentation and the Excel-based financial data workbook posted on the Investor Relations website. We will post these prepared remarks on our Investor Relations website following the completion of this call. With that, I'll now turn the call over to Eugene Scherbakov.

Good morning, everyone. We continue to see upward momentum in our emerging growth products in the third quarter. We saw strong results in welding, cleaning, solar cell manufacturing, medical, and 3D printer applications. These were offset by several headwinds including unfavorable currency translations, weaker economic conditions in Europe, and COVID-related lockdowns in China. Softness in general industrial demand in Europe and China negatively impacted sales in high-power cutting applications. At the same time, we saw modest growth in North America, and we are pleased it has continued to increase e-mobility sales driven by new investment in electric battery capacity across all geographies. Emerging growth product sales were 43% of our total revenue in the third quarter. Many of these products are benefiting from global macro trends such as e-mobility and automation, as well as increased focus on sustainability, renewable energy, and energy efficiency, most specifically the record sales in A&B lasers, driven by growth in EV battery and welding. We also saw strong demand in our green lasers for solar cell manufacturing applications. This market is rebounding, driven by increasing investment in renewable energy solutions globally. Additionally, the revenue for lasers used in cleaning applications, which provides sustainability benefits by reducing the use of abrasives and chemicals, grew significantly this quarter. In August, we announced the sale of our telecom transmission business to Lumentum as this business required additional investment and was non-core to IPG. This divestiture had only a minor impact on sales but will meaningfully reduce our operating expenses going forward. I believe that the sale of the telecom business and the decision to exit our cinema business will allow IPG to focus R&D and other resources on core growth opportunities such as e-mobility, welding, and medical. Now, I will go over each of these core opportunities in more detail. We had another great quarter in EV applications as revenue and orders increased across all geographies. There are additional investments into EV battery plants in Europe and North America, and we are seeing increased activity in the U.S. during the recently announced government incentives. Third-party estimates suggest that global lithium ion battery capacity will triple by 2025 and may reach 6 terawatts by 2030, a sevenfold increase compared to the 2021 level. This growth in battery capacity presents a significant addressable market for our lasers. To focus on global EV opportunities, we implemented some organizational changes and increased our sales and marketing capabilities. IPG has a leading position in welding and foil cutting applications for EV batteries. We offer a broad range of solutions to customers from laser sources to complete production lines for existing and emerging battery technologies. We sold several complete systems and production lines to R&D and experimental battery production in the quarter. We continue to introduce and are seeing strong initial demand for our picosecond ultra and ultra-high power pulse lasers. IPG recently increased its production offering in e-mobility applications with new QCW and advanced technology lasers, which offer excellent performance. We continue to explore additional opportunities in foil cutting and electric motor assembly. The adoption of IPG monitoring and real-time reading monitoring software has been very successful in e-mobility applications. The related revenue accounted for approximately 20% of our total sales in the quarter, up from 10% in 2021 sales. We expect that the EV investment cycle will continue and e-mobility sales will remain strong in the next 3 to 5 years, despite the less favorable outlook for the global economy. This was another record quarter for welding revenue that benefited from growth in electric vehicle batteries, but also growth in LightWELD. LightWELD is still on other parts of our growth trajectory, rapidly increasing the sales and orders globally in a market dominated by non-laser technologies. The system received CE marking and started selling the LightWELD in most of the larger European countries in the third quarter. We have established distribution partners and continue to see high interest from the welding community during the trade shows. LightWELD is tailored for small and midsized fabricators that provides an easy-to-use welding process. Additionally, IPG is also working with automation companies to introduce LightWELD combinations that help customers implement automation of welding processes at a relatively low cost. Our medical business also had another record quarter, with revenue increasing more than 70% year-over-year, showing continued growth in bookings. Our thulium lasers and consumable fiber for urology applications, which are considered a new global standard, continue to replace traditional lasers, rapidly gaining adoption in the urology market. As we grow the number of installed units, recurring revenue from consumable fiber is also growing. I am pleased to see that we are well ahead of our target to double the business in 2 to 3 years as our medical revenue should approach $70 million this year, up from $43 million last year. Before I turn the call to Tim, let me provide the update on our operations in Russia. During the first 9 months in 2022, we managed to navigate complex and evolving regulations, including sanctions without material disruption to our ability to meet customer demand. We are continuing to increase manufacturing capacity and build safety stock of critical components in the United States and Europe. In addition, we have started to purchase many less critical components from third parties that were qualified earlier this year. Recently, the EU announced a new package of functions and new license requirements which place even more limitations on trade with Russia, essentially curtailing our ability to import components to our European facility and export items to our Russian facility, effective early January of next year. We believe that the contingency plans we are executing will enable us to eliminate our dependence on Russian production before the new European sanctions take effect. We will continue to monitor the situation closely and, with our Board of Directors, are assessing the strategic options for our Russian facilities. I will turn the call to Tim to discuss financial highlights in the quarter.

Thank you, Eugene, and good morning, everyone. My comments generally will follow the earnings call presentation, which is available on our Investor Relations website. I will start with the financial review on Slide 4. Revenue in the third quarter was $349 million, a decline of 8% year-over-year, primarily due to foreign currency headwinds, which accounted for approximately 7% of the decline. We also saw lower sales in China, Europe, and Japan, primarily in general industrial applications. Our sales in North America were slightly higher year-over-year. Revenue from materials processing applications decreased 10% year-over-year, and revenue from other applications increased 10%. GAAP gross margin was 43.1%, a decrease of 590 basis points year-over-year due to increased cost of products sold, higher inventory reserves, as well as higher shipping costs and tariffs. We did see slightly better absorption of manufacturing costs in the quarter as we continued to increase our inventories of safety stock. In the long term, we remain committed to our gross margin target of 45% to 50%. If exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $26 million higher and gross profit to be $14 million higher. GAAP operating income was $93 million, and operating margin was 26.7%. Net income was $76 million or $1.47 per diluted share. The effective tax rate in the quarter was 21%. Foreign currency transaction gains related to remeasuring foreign currency assets and liabilities to period-end exchange rates only had a minor positive impact on operating expenses of less than $1 million. At the same time, we had several unusual items in the quarter. There was a $22 million or $0.32 per diluted share gain on the sale of the telecom transmission business, and a $1 million or $0.01 per diluted share restructuring charge related to shutting down the remaining telecom business. Excluding the currency transaction gain, gain on sale of assets, and restructuring charge, operating expenses declined year-over-year, primarily in research and development as we reduced spending on telecom product development following the sale and restructuring of the business. We are also looking at ways to further reduce our expenses, including the sale of the corporate aircraft and two underutilized buildings. Freed up resources will be available for activities that are core to our strategy. Moving to Slide 5. Sales of high-power CW lasers decreased 14% and represented approximately 44% of total revenue. Sales of ultra-high power lasers above 6-kilowatt represented 45% of total high-power CW laser sales. The decline was primarily due to lower demand in cutting applications in China and Europe as a result of lower economic activity that negatively impacted demand in general industrial applications. Pulse laser sales decreased 6% year-over-year due to lower demand in cutting and marking applications, partially offset by strong sales into solar cell manufacturing and cleaning applications. System sales increased 10% year-over-year, driven by growth in laser systems and higher sales of LightWELD. Medium power laser sales decreased 16%, and QCW laser sales were down 30% year-over-year, negatively impacted by lower sales to consumer electronics applications. Other product sales increased, driven by record sales in medical applications. Looking at our performance by region on Slide 6. Revenue in North America increased 1%, driven by growth in cutting, welding, and medical applications, which was offset by lower sales in non-laser systems as well as the telecom divestiture. In Europe, sales decreased 13% as a result of lower demand across all major materials processing applications and the weaker euro. Customers are delaying projects as a result of high energy costs and economic uncertainty in Europe. However, e-mobility orders remained strong despite overall softness in the economy. Revenue in China decreased 14% year-over-year as growth in welding for EV battery applications and 3D printing applications was offset by COVID-related lockdowns, continued softness in the cutting market, and currency headwinds. Moving to a summary of our balance sheet on Slide 7. We ended the quarter with cash, cash equivalents, and short-term investments of $1.2 billion and total debt of $16 million. Cash provided by operations was $76 million during the quarter, and capital expenditures were $25 million in the quarter. While continuing to maintain a strong balance sheet, we have returned a significant amount of capital to shareholders with our ongoing stock repurchases this year. During the quarter, we repurchased shares for a total of $71 million. Most of the repurchasing in the third quarter happened in the second half of September as we had a cooling-off period between our 10b5 programs. We continued to repurchase shares in October. Since the beginning of the year, IPG has repurchased shares for a total of $383 million as of the end of the third quarter and approximately $440 million year-to-date. Our CapEx has been trending below our initial expectations, and we will likely finish the year at approximately $110 million, well below our previous guidance of $130 million to $140 million. As Eugene mentioned earlier, we are assessing strategic options for our Russian operations. In addition, we are evaluating the effect of the new sanctions on our ability to recover the value of our working capital and long-lived assets located in Russia. As of the end of the third quarter, we had approximately $44 million in cash and short-term investments and approximately $150 million in working capital, including $116 million in inventory in Russia. The net value of long-lived assets in Russia is approximately $95 million. Moving to outlook on Slide 9. Third quarter book-to-bill was slightly above 1. We saw further moderation in orders in Europe as well as reduced bookings in China, primarily due to softening macroeconomic conditions, which impacted demand in general industrial markets. However, we are seeing continued strong orders in e-mobility and medical applications as well as more stable operating conditions in North America. We continue to benefit from growth opportunities created by major macro trends such as electric vehicle battery manufacturing and renewable energy. In addition, LightWELD and medical sales further diversify our revenue. We believe these trends and diversity will enable us to weather downturns in the economy with greater resiliency. For the fourth quarter of 2022, IPG expects revenue of $300 million to $330 million. The company expects the fourth quarter tax rate to be approximately 25%. IPG anticipates delivering earnings per diluted share in the range of $0.70 to $1, with approximately 51 million diluted common shares outstanding. We continue to expect currency headwinds and estimate that the fourth quarter revenue guidance range is reduced by about $20 million due to the strength of the U.S. dollar in the current quarter as compared to the fourth quarter of 2021. As discussed in the safe harbor passage of today's earnings press release, 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 safe harbor and the company's reports with the SEC. With that, we will be happy to take your questions.

Two questions. The first question just relates to gross margins. And, Tim, I'm wondering if you could talk to some of the factors that might have contributed to the gross margin coming in a little below the expectations for Q3. I assume some of that's volume driven, and also how we might think about gross margins in the current quarter? And I have a follow-up.

Thanks, Jim. Gross margins were a bit lower this quarter, coming in at the bottom end of our guidance range, which was 44%. We are facing several challenges, including increased shipping costs and higher import duties, as well as foreign currency headwinds. For instance, average selling prices in Europe, Japan, Korea, and other regions where we sell in local currency saw a slight decline due to mix, while they remained stable in China. Additionally, with 50% of our manufacturing costs incurred in the U.S., this has created a headwind for us. The strong ruble is also affecting our business model amid these challenges. Furthermore, compared to last year, our inventory reserves remain high due to the elevated levels of inventory we are currently carrying.

And just given all that, any color you could provide on how we might think about gross margins given these moving parts for the current quarter?

Yes. Sorry, that is in the financial presentation deck. We've got 42% to 44% is assumed in our guidance range.

It's my fault. I have a follow-up question that I’m unsure if you can answer. The COVID lockdowns affected sales in China, and I'm trying to better understand whether the non-cutting business in China performed well outside of those lockdowns. Is there any way you can comment on the overall health of the business in China, excluding cutting, and discuss the impact of the lockdowns?

Yes. So certainly, on a year-over-year basis, the non-cutting business was significantly up in China and cutting was quite a bit weaker than it was in Q3. Our view is that the COVID lockdowns are more impacting the industrial end market demand that would drive some of that cutting, whereas some of the other macro trends around EV or the share gains that we have around additive are generally pretty positive trends. Foil cutting was just because of the timing of projects was a little bit weaker in Q3 compared to Q2. I can't quite remember where it was a year ago, but that's really just the timing of orders rather than any competitive dynamics on the foil cutting projects.

By the way, when we are talking about cutting, first of all, we are talking about the metal-cutting not foil cutting. The foil cutting business is growing steadily because it's a different kind of application, not a standard of foils, but we have to separate. Standard starting with metal cutting and foil cutting which we are using for a specific purpose.

First, for Tim. Tim, can you maybe just talk a little bit about how you're thinking about OpEx in this environment as we look out over the next couple of quarters? We've got the telco asset divested and just thinking about the macro and the currency headwinds. Any color you can give us on how to think about spending, that would be helpful.

Yes, I believe we have some guidance on operating expenses for the quarter, which falls within the range of $78 million to $79 million. Compared to the run rate at the beginning of the year, this represents a decrease of $5 million to $6 million, primarily benefiting from our telecommunications sector. Additionally, we mentioned other actions that, while not strictly classified as operating expenses, include the disposal of our corporate aircraft, which should provide some extra benefits to general and administrative costs as we move into 2023. We are also reviewing some of our less utilized facilities, which affects not just operating expenses but also depreciation that impacts cost of sales and sales and marketing. We are carefully managing our expenses, but recognize the need to invest in key areas like core research and development projects that are likely to yield better returns and align with our objectives, as well as in sales and marketing. Although we are focused on managing expenses, we understand that continued investment is essential to meet our medium and long-term growth targets.

Right. I appreciate that detail. That's a good segue for my follow-up, which is around medical, it's great to see the progress there and almost doubling revenue this year, it looks like, versus last year. How are you sizing that market sort of longer term? How should we think about the opportunity there? And is it mostly urology? Or are there other areas of potential opportunity from a competitive displacement perspective? And any other markets that you could talk about around medical, and how to think about the TAM longer term, that would be helpful?

Of course, we are thinking about the different other applications of lasers because in principal now the main revenue from the business is from special thulium lasers, but there exists, of course, different other laser systems which can be used for many potential medical applications. Of course, we are thinking about this. We are also discussing some interesting projects to penetrate or integrate our fiber laser into existing applications, medical applications. There are big opportunities to penetrate with fiber laser technology to the medical applications, definitely.

In terms of the market, I can just give you some detail on that, Ruben. The total medical market is about $5 billion, but it includes a significant proportion of aesthetic applications. The market for surgical is about 20% of that or $1 billion, and that's the area we're primarily focused on. The interesting thing about this, I think, like most medical end markets is that the growth rates are expected to be fairly robust, so in excess of 10% per year. And then the other aspect we like to the business is that there is a consumable fiber that generates recurring revenue as we deploy more systems into different applications.

I apologize, Tim, that you addressed this earlier, just trying to understand the puts and takes. So there's a transition of the footprint reducing dependency in Russia to the U.S. and Germany. That's always been part of the plan that you guys have kind of outlined earlier this year. You then mentioned this increasing sanctions, I believe, in January 1, and assessing strategic options. So what are the strategic options to explore that we need to kind of consider by January 1? Is this a new development relative to the last call? And is there any shift in the timeline on the contingency plans that you guys outlined early this year? Just trying to flesh out some of these moving pieces.

Yes. This is a change due to the recent EU sanctions. We are currently evaluating various strategic options but are not ready to discuss those regarding our Russian operations. The level of business in Russia will be significantly reduced as we enter the new year. Therefore, we need to assess our cost structure and determine the best approach to realize value from our business. Regarding contingency planning, we have been clear that through a combination of increasing capacity, building inventory of critical components, and qualifying third-party suppliers for less critical components, we believe we can manage the situation effectively. We will be exploring these strategic alternatives over the next few weeks and possibly months, and we expect to provide a more detailed update by Q1 based on the outcomes of our evaluations.

Understood. And the Q4 margin guide, the gross margin guide, is that still with you guys producing in your Russia facility? Or is that starting to take into account some of this transition of ramping where production in Germany and the U.S.?

Definitely, yes, because we start already the mass production in the United States and also in Europe for such components. Of course, it's a little bit decreased our gross margin. But taking into account that we're not only making some expansion of our production. Every time, I'm also thinking about how we can optimize this production manufacturing of some components. This is why, by installing this production in Europe, we demonstrated much more optimal conditions and much more optimal results from the effectiveness of this production. The next step will be to introduce automation for the production of some components. I think it will be our goal for next year indeed. We would like to expand our R&D activity in this area. Our main goal will be to transition as much as possible to automated production of mass components, which we are using for our fiber laser production.

Understood. And just if I could squeeze 1 more in, just when we think of the seasonality of the business, does the business seasonally build in Q1 off of Q4? Or do we kind of start the year softer and build through the year? I understand it's way too early to talk about 2023. Just conceptually, when we think of how the business typically moves seasonally from Q4 to Q1, if there's anything you kind of want us to think about, Tim, as we try to get a starting point for next year?

Yes. The issue with seasonality has been quite challenging to predict over the last couple of years. Typically, if you have a weaker fourth quarter, you can expect the first quarter to be flat or slightly up in relation to that. Interestingly, our third quarter book-to-bill ratio was just above 1, yet our guidance is somewhat weaker. For instance, in China, bookings were down year-over-year but relatively strong compared to the guidance provided. They have some electric vehicle projects with orders expected to be delivered in the first half of next year, some in the first quarter. We also received numerous medical orders that should help at the start of the year. However, it’s difficult to provide a clear answer at this time. If you review the trends from previous quarters, you will see where they differ. Additionally, exchange rates are significantly affecting the fourth quarter. Currently, the dollar is expected to remain strong against the euro and the Chinese yuan, while the Japanese yen is notably weak. I don’t anticipate any relief from currency challenges in the first quarter, but it will largely depend on the direction of monetary policy across various regions worldwide.

Could you tell us some of your sales from recently introduced products?

They were 43%.

43%.

That's a significant increase from the previous quarters. Interest expense has risen, and I'm curious about the reasons behind that and how we should approach it moving forward.

Yes. I mean that's basically because of the yield that you're getting on cash and cash equivalents and short-term investments going up, so probably on a weighted average basis in because interest rates carried on going up, you'd expect to see some small increase in that coming into Q4 as well.

First, can you elaborate on the weakness in pulse lasers in the third quarter? What drove the sequential and year-over-year decline?

In the third quarter, we observed a slight decline in pulse cutting. However, cleaning applications remained strong, particularly at high power levels. In contrast, marking engraving, which is linked to consumer electronics, experienced a drop compared to the same period last year. Last year, marking engraving was notably robust in the second and third quarters, despite competition from local suppliers in China, primarily due to the reliability of our lasers. This year, demand in consumer electronics has been quite weak.

By the way, we are talking about the cost lasers, please take into consideration, power, you're not talking about, it's from 10 watts, I mean average power, up to several kilowatts. Of course, small power pulse lasers, our revenue a little bit less in comparison to the previous quarter. But for high power, I mean, from past average power, more than 1 kilowatt, is growing very fast. First of all, we demonstrated a very brilliant result concerning the cleaning applications, but also for foil cutting, special foil cutting, and also start to use our high-power fiber laser. It's very important for future growth in our business in this area.

Great. That's helpful. So in terms of the Q4 guidance, can you provide some color around the trends of the sequential change by application, like which segment will be down the most and which will be more resilient?

We don't get into guidance by applications and trends at all. And we do give some color around regions. I mentioned that relative to China order flow their Q3 revenue is a little bit lighter than Q3. Europe still got currency headwinds and the weakness. I think the North American business looks relatively resilient. We have a reasonable guide from revenue on Japan on the back of good order flow from Japan and a relatively stable situation in Korea, but we just don't get into it on a granular level of guidance by application.

Got it. That's fair. So one last question, if I may. I'm curious why the gross margin in the fourth quarter of solar remains steady sequentially while we see a 10% decline in revenue. I wonder if anything contributed to the gross margin side?

No. I mean I factored in there even some quite high inventory provisions. I didn't change assumptions fundamentally around things like product cost of sales, or import duties and tariffs. So we'd be expecting sort of relatively speaking, good absorption of costs and relative to the revenue level good cost management related to total output and production. So I think it's a reasonably conservative guide even where I take your point, the revenue is down, it's a reasonably conservative guide on gross margin still.

The follow-up question I had is just with respect to the orders in Europe and in North America as you went through the quarter, just given concerns people have about the slowing macro environment. Did you notice any change in customer behavior as you went through Q3 in those regions?

Yes. I think, in Europe, I mean, Jim, it's reflective of where the guidance number is that we got from Europe, but it is certainly weaker there. It's interesting. We actually saw a big pickup in orders coming into the end of the quarter. The other issues in Europe like August is never a good bellwether for what's going on because it's the middle of summer. If anything, overall, the quarter started weak globally and then saw some improvement into September and actually total orders booked in the last few weeks of September were exceptionally strong. I have pointed out that some of that is like medical and EV that's going to benefit us at the beginning of next year and it's not driving the guide on Q4.

Got it. And I also wanted to ask a quick question just because it seems like you're seeing really nice traction with LightWeld. I wonder if you would talk to what the contribution in broad terms through the first 9 months has been for that product line and maybe how you see the growth over the next year? It sounds like you're getting some very nice traction in the market with this.

Yes. As we mentioned in our presentation, we already received certification for Europe and we started sales of our system in different European countries. But also, we have very strong sales, not only in the United States, but also in Japan. In Japan and very good sales with the systems. And taking into account that it's also possible to integrate LightWELD, it's opening new opportunities for us in this business. Our estimate is that we have to minimum double our business next year in comparison to this year. And then in 3 to 5 years, we may predict that our business is growing, for this application definitely. What kind of percentage of growth, it's difficult now to make this forecast. But next year, definitely our business will be strong.

Quantitatively, Jim, I mean, we're approaching a $10 million a quarter run rate and in revenues growing at sort of 80% year-over-year and sequentially very robustly as well. So the product continues to get very, very high marks and acceptance from the end market.

It is also significant that we are not relying on just one model. Each quarter, we introduce new models. There are special options such as cleaning or a single laser that also provide much better welding or cleaning results for our customers. It's important to note that we are not limited to a single product.

Thank you for joining us this morning and for your continued interest in IPG. As always, we'll be participating in a number of investor events this quarter and are looking forward to speaking with you over the coming weeks. Have a great day, everyone. Bye.

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