Earnings Call Transcript - IPGP Q2 2024

Operator, Operator

Good morning, and welcome to IPG Photonics’ Second Quarter 2024 Conference Call. Today's call is being recorded and webcast. At this time, I'd like to turn the call over to Eugene Fedotoff, IPG's Senior Director, Investor Relations for introductions. Please go ahead with your conference.

Eugene Fedotoff, Senior Director, Investor Relations

Thank you and good morning, everyone. With me today is IPG Photonics CEO, Dr. Mark Gitin; 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 the 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, 2023, 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 on the SEC's website directly. Any forward-looking statements made on this call are the company's expectations or predictions as of today, July 30, 2024 only, and 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 financial data workbook posted on the Investor Relations website. We will also post these prepared remarks on our website after this call. MD&A With that, I'll now turn the call over to Mark.

Mark Gitin, CEO

Good morning, everyone. I'm excited to be here with you on my first earnings call as CEO of IPG Photonics. I look forward to meeting many of you and to talking more about our story and our plans at IPG. Before diving into our second quarter performance, I'd like to spend a moment on my background, why I took this role and what I've been focusing on since I joined just over seven weeks ago. For the past 35 years, I have been actively involved with lasers and laser applications, leading different functions at Coherent and the Photonics Solutions Division at MKS Instruments. I joined MKS to integrate the Newport acquisition and significantly improve the performance of the business over five years. During my career, I've always admired IPG, its industry leadership, culture of innovation and ability to drive fiber lasers into new use cases. I'm thrilled to have joined such an innovative and dynamic organization and see a lot of great opportunities ahead of us. Since joining in June, I focused on diving deep into key aspects of the business. The dedication, creativity and passion of IPG's team is truly inspiring and conversations with employees have given me an even deeper appreciation of the team's knowledge and expertise. I'm especially excited about IPG's R&D pipeline. I believe we have a number of projects in process that will put us in a strong position to extend our industry leadership, provide further differentiation and reduce product costs. I know that in the current macroeconomic cycle, we've seen competitors get more aggressive, particularly in cutting. Competition is expected and as a leader, it's important to keep driving innovation. Our team has been focusing on multiple initiatives to increase technological moats around laser products and provide complete solutions and world-class support to customers, which cannot be easily replicated. We're clearly seeing these efforts bear fruit in the areas such as EV battery welding and 3D printing. We're also expanding into new applications and use cases for new fiber lasers in areas where we offer significant advantages relative to other laser and non-laser solutions, including efficiency, speed and environmentally friendly solutions. In the coming months, I will be working with my management team to enhance existing strategies and develop new goals and objectives that provide a foundation for IPG's success in the coming years. On the operational side, we will be investing in our business where we can generate attractive returns, while managing our discretionary costs. I strongly believe that by providing our customers with the highest quality solutions, the best service and optimizing our operational efficiencies, we will be best positioned to drive shareholder value in the long term. Internally, we will prioritize a continued focus on collaboration, growth and continuous improvement. I look forward to being able to share more details about these strategies with you in the future. Moving on to the second quarter results. We continued to generate strong operating cash flow in a challenging demand environment as we executed on inventory reduction initiatives. Second quarter sales and earnings per share were above the midpoint of our revenue guidance with overall demand conditions stabilizing at a low level, particularly in general manufacturing and EV markets. Revenue was relatively stable in Asia sequentially and improved in North America, helped by stronger sales in the emerging growth products such as light weld and medical. Trends in Europe continued to moderate with industrial markets facing persistent headwinds and macroeconomic uncertainty. Turning to the key applications that we serve. In welding, revenue decreased year-over-year, primarily due to lower demand in e-mobility and partially offset by growth in handheld welding. However, I'm pleased to see that welding revenue was stable sequentially, and we were able to gain market share in Europe, winning EV customer accounts even in a challenging operating environment. IPG's strength is our unique knowledge of laser material interaction and process know-how that significantly increases the speed and quality of welding. Putting this together with our real-time process monitoring enables meaningful yield improvements for our customers. Our laser welding processes and real-time weld monitoring have been widely adopted in EV battery manufacturing, where faulty wells can have catastrophic results. We feel very good about our competitive position as investment spending in EV battery capacity resumes. Furthermore, we saw a strong pickup in sales of our handheld welding solutions, driven by our new partnership with Miller Electric, a leader in welding solutions. Continuous innovations are driving improved efficiency, a smaller form factor and lower cost, enabling the commercial viability of laser welding for middle fabricators and shops, opening up a huge new market opportunity for IPG. Moving on to our second largest application, cutting, where we've seen the greatest impact on our business over the past several years from Chinese competition. The good news is that our China cutting OEM business now accounts for less than 5% of our total revenue. In our European, US and Japanese businesses, we have a stronger competitive position and customers who value productivity and uptime. This business was impacted by our customers working down inventory as they manage through significantly lower end market demand. Now we're starting to see those customers' inventories normalizing, but the overall demand conditions in general industrial markets remain weak, primarily in Europe. We have strong relationships with all of the major global cutting OEM customers and are confident the decline is macro-driven. We're working closely with our customers to understand their needs, enhance our service capabilities and reduce product costs. This approach ensures that our products not only stand out from the competition, but also deliver higher value to our customers. We're excited to announce the launch of a series of innovative products over the next two quarters, which are designed to foster win-win relationships and solidify our market position. I'm particularly excited about the new growth opportunities for IPG where fiber lasers can replace incumbent technologies. There are areas where we can innovate to provide solutions to specific problems in a way that is much better for the environment as we are replacing processes that are typically done with harmful chemicals or significant use of electricity. A perfect example would be cleaning and heating applications. IPG is extremely proud to provide the most energy-efficient and environmentally friendly solutions in these areas. Medical is another exciting area for the company with significant barriers to entry. We have a strong growth pipeline in urology applications and are seeing robust demand in lasers for skin rejuvenation and lesion removal. We believe that new product launches in 2024 and 2025 will result in strong revenue growth opportunities for this business. Moving to the outlook. Our second quarter book-to-bill was below one. We're seeing more stable demand sequentially in China, but macroeconomic uncertainty is still negatively impacting demand across general industrial markets and applications in Europe and North America. While we believe strongly in the future of EVs, the well-publicized slowdown in EV adoption in Europe and the US has prompted several customers to delay further investment in battery capacity around the world. Our prior expectation for a rebound in demand in the second half seems less likely to materialize, and we currently are not expecting to see a meaningful recovery in our laser sales until sometime in 2025. Before I turn the call over to Tim to discuss financial results, I would like to thank Dr. Scherbakov for his significant contributions to IPG in the laser community over the last 30 years. I would also like to thank the Board for their trust in me. I look forward to leading this company, pushing the boundaries of innovation and transforming the world around us by applying light in ways that improve life. With that, I would like to now turn the call over to Tim.

Tim Mammen, CFO

Thank you, Mark, 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 5. Revenue in the second quarter was $258 million, a decline of 24% year-over-year. Foreign currency headwinds reduced revenue growth by approximately 2%. Revenue from materials processing applications decreased 28% year-over-year, while revenue from other applications increased 24%. GAAP gross margin was 37.3%, a decrease of 610 basis points year-over-year due to the lower absorption of manufacturing costs as a result of lower revenue and our continued effort to reduce inventory, which reduced gross margin by over 700 basis points. This was despite achieving a $23 million decrease in manufacturing expenses compared to the prior year. Higher inventory provisions added another 200 basis points to the headwinds in the quarter. I'm happy with the progress we are making on the inventory side, but more work needs to be done before we get back to more normalized levels. These negative impacts to gross margins were partially offset by a decrease in import duty and shipping costs. Operating expenses came in at the low end of our expectations due to reduced variable compensation by the increased year-over-year primarily due to increased investment in research and development and sales and marketing. FX headwinds also had a negative impact on revenue and gross profit in the quarter. Exchange rates relative to the US dollar had been the same as one year ago, we would have expected revenue to be $6 million higher and gross profit to be $3 million higher. GAAP operating income was $12 million, and operating margin was 4.7%. Net income was $20 million or $0.45 per diluted share. The effective tax rate in the quarter was 19% and benefited from certain discrete items. Foreign currency transaction losses as a result of remeasuring foreign currency assets and liabilities due to period-end exchange rates had a negative impact on operating income of $3 million or $0.05 per share. We continue to optimize our footprint and had a gain on the sale of assets in the quarter, which increased operating income by $1 million and increased diluted EPS by $0.01. Moving to revenue performance by region on Slide 6. Sales in North America decreased 2% year-over-year. We saw strong growth in medical, 3D printing, and advanced applications, which was offset by lower revenue in cutting, welding and cleaning applications. Sales in North America held up relatively well, but macro headwinds have continued in the general industrial markets, as well as led to reduced EV investments. In addition, continued inventory management by cutting OEMs is leading to a more uncertain outlook in the region. In Europe, sales decreased 27% compared to the prior year. Similar to the trends we saw in North America, cutting sales were impacted by large OEM customers reducing purchases as they manage their inventories. Economic conditions in Europe seem to be deteriorating further and impacting investments in industrial and automotive markets. EV investments are also delayed and current projects are being pushed out into 2025. Revenue in China decreased 34% year-over-year as demand declines in general industrial and e-mobility markets, negatively impacting sales across cutting and welding applications. On the other hand, sales to cleaning and 3D printing applications continued to increase in the region. China revenue improved sequentially, and we are seeing some stabilization there. Moving to a summary of our balance sheet and cash flow on Slide 7. We ended the quarter with cash, cash equivalents, and short-term investments of $1.1 billion and no debt. We continue to manage inventory, reducing it by $31 million from the prior quarter. We're targeting further reductions in inventory over the course of 2024. The cash provided by operations was $53 million and capital expenditures were $24 million during the quarter. While maintaining a strong balance sheet, we have been returning a significant amount of capital to shareholders through opportunistic share repurchases. We spent $122 million on share repurchases in the second quarter and $212 million year-to-date. Since the beginning of 2021, we have returned over $1 billion to shareholders through share repurchases. Moving to our outlook on Slide 9. For the third quarter of 2024, we expect revenue of $210 million to $240 million. The third quarter gross margin is estimated to be between 34% and 37%. We anticipate delivering earnings per diluted share in the range of $0.00 to $0.30, with approximately 45 million diluted common shares outstanding. 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.

Jim Ricchiuti, Analyst

Hi. Thanks. I'm wondering if you could talk a little bit about whether you're seeing much variability in the book-to-bill by region. It looks like North America seems to be holding up, although I'm sure you've seen some pockets of weakness in some of its industrial markets that you talked about. But maybe that's my first question.

Tim Mammen, CFO

Yes. Jim, the book-to-bill for the quarter was below one. The weakness continues to really be in Europe. So that was down compared to the first quarter. North America altogether was relatively stable, but we saw some headwinds around the industrial and other businesses. We actually had a strong quarter on bookings for medical. Asian bookings, as we've alluded to, are really much more stable than Europe. So we're actually quite pleased with the performance of underlying bookings in Asia as a whole, both China, Japan, and South Korea as well.

Jim Ricchiuti, Analyst

Excluding the legacy business in China, how would you describe your current observations in the market there, particularly in light of the weakness you're seeing in the electric vehicle sector?

Mark Gitin, CEO

Hello, Jim, this is Mark. China remains a crucial part of our business, accounting for approximately 25%. Over time, we have successfully diversified that segment, with the cutting market now representing less than 5%. We have shifted our focus to sectors like electric vehicles and welding, achieving notable success due to our advanced capabilities. Our AMB lasers offer a special mode that allows for spatter-free welding, complemented by our scanning and sensing abilities that assess conditions in real-time. This has proven essential for quality control and safety for our customers, maintaining a strong market presence in the EV sector. In 3D printing, our high-power single-mode lasers are unmatched, operating with low noise levels critical for high-speed machines requiring superior performance. These are a few areas where we have made significant progress. Additionally, we have a robust business in China where we are also early adopters of new technologies from our roadmap. The willingness of the Chinese market to embrace these innovations early on has been beneficial as we continue to diversify our operations there.

Ruben Roy, Analyst

Thank you very much, and Mark, welcome. I appreciate the preview on the areas of focus and your thoughts on things at IPG. Mark, I'd like to ask you about your comment regarding the significant market in China, which is smaller but still important for IPG. You also mentioned the macro-driven decline in Europe, suggesting it's not a competitive issue. Previously, IPG management has indicated that cutting outside of China could be a potential growth area in the long term since cutting in other regions has not yet reached critical mass. As you reflect on cutting and R&D in that area, could you provide more insight into your view of the market and how IPG is positioned in these markets outside of China? That would be helpful.

Mark Gitin, CEO

Thank you for the question, Ruben. Cutting remains a significant aspect of our business, but welding has become the largest segment for IPG. As you pointed out, our competition has primarily been in China, where that portion of our business is now less than 5%. In regions like Europe, Japan, and the US, we have strong relationships with OEMs, who recognize the value we bring through reliable system uptime. This is crucial for our customers, and we maintain constant communication with them, ensuring we do not lose market share in this area. Our offerings include service, support, and comprehensive packages for OEMs, and we are focused on expanding in this sector. We will soon be launching new high-power lasers that represent a significant advancement in technology, featuring a smaller form factor and reduced costs by 15% to 20%. This is an essential development. Additionally, we have heavily invested in our service infrastructure to better support OEMs, which is equally important.

Ruben Roy, Analyst

That's very helpful detail. Thanks, Mark. And then as a follow-up around the discussion on EV, I think most of us understand that adoption has slowed and then there's a lot of macro impacts, interest rates and otherwise kind of creating issues for the market. But when you talk to your customers, it sounds like you're pushing out any expectations for improvement out to somewhere in 2025. What drives that improvement? I mean, are we close on the inventory level? Are you seeing some signs from your discussions that there will be some capacity added as you get into 2025? Any detail on actual customer feedback would be helpful.

Mark Gitin, CEO

Thank you for the follow-up question. We are in a strong position in the EV market. I previously mentioned our technical solutions in EV, which include locking in both the AMB laser and scanning, as well as the ability to measure those wells. This gives us a solid standing at both the component subsystem and systems levels in the EV market. In discussions with our customers last quarter, they expressed optimism about a rebound in the second half of the year, expecting some projects to resume then. Recently, however, they indicated that progress seems to be pushed out to 2025. This is the feedback we are currently receiving.

Tim Mammen, CFO

On gross margin, the underperformance continues to be due to under absorption, despite our efforts to reduce manufacturing costs. When I look at the product gross margin in isolation, it is holding up well. I expect that as we implement some of the cost production initiatives towards the end of this year and into next year, we will see improvements in product margins since we will retain some of the cost reductions. As we begin to grow the business again, we should start recovering some of the under absorption of fixed costs. At this revenue level, if we can make any recovery from here, gross margin should be at a low point. Additionally, we need to continue reducing inventory while facing headwinds around revenue, which is also contributing to under absorption. As we move closer to our target inventory levels—which we still need to address in the second half of the year—I expect this situation to improve significantly by 2025. The combination of lower revenue and inventory reduction should help us improve in both areas, leading to better gross margins.

Mark Gitin, CEO

And then Ruben, as Tim was saying, this is largely an under-absorption issue. So we've been investing and are continuing to invest in our product roadmap driving differentiation. We've got a lot of exciting things in a number of areas. You've heard us talk about the heating and drying applications. We've been very successful in the medical products, those are growing. You've heard us talk about LightWELD and the combination with Miller; those are all areas that are going to drive growth. As that growth drives, of course, that's going to improve the absorption, and we'll see the gross margins improve. So that, plus the cost balancing that Tim was saying, are important areas.

Keith Housum, Analyst

Good morning. Thank you. And Mark, congratulations and welcome aboard. The investment in SG&A and R&D, I guess, maybe if you look at the SG&A in particular, after several years of down results, obviously, I appreciate the investment in SG&A. But is there a particular strategy or area that you guys are focused on in order to help drive growth into the future?

Mark Gitin, CEO

Yes. I can take that. Thanks very much for the question, Keith. As we said, again, we have a very exciting roadmap and absolutely investing in R&D. We've got a lot of capability there. I have to tell you, I'm really thrilled coming, of course, was looking at the company very closely over a number of years. Before coming to IPG, I looked very closely at what I saw as technology and product road maps but now being here, seeing under the covers, it's even better than I expected. So really great innovation. There are great things to drive the product roadmap that drives differentiation. You've heard us talk about some of the new products. It's beyond products now just lasers and components; we've been investing into the applications and the process development side. That's a very critical piece for us because we're able to go in, we're able to work with the customers. We now have these labs and capabilities all over the world. We're working with the customers. We're seeing the problems that they need to solve. We're developing solutions, it’s the laser, but it's also beam delivery. It's also I talked about some of the sensing capability. When you put all of those things together and wrap that process together and then be able to deliver to the customer a subsystem and a system, that's a whole new way to put a moat around the product. So another area where we're absolutely investing on that SG&A side that will continue to drive growth in the business.

Keith Housum, Analyst

Okay. So just to clarify, in terms of investing in applications and solutions, are you planning to compete more with some of your OEMs and integrators, or are you just looking to develop beyond lasers and take on more of the work they typically would have done themselves?

Mark Gitin, CEO

What I would tell you is that we've got development on the lasers, development again on the delivery and process side. A lot of the processes that we're growing in our new processes, things like heating and cleaning, those are big areas for us to grow in particular markets. That's something that we've done in the EV, for example, the cleaning application where we can rid some of those processes of harmful chemicals and be able to do that with lasers. We're really driving improvements or new laser parameters that can do that by understanding the process and then being able to provide some of the wraparound pieces that really are unique because of our process knowledge. So that allows us to expand into unique new applications as well.

Michael Feniger, Analyst

Hello everyone. I appreciate the opportunity to ask my question. Mark, you mentioned this earlier, but I'm interested in how we can increase the use of lasers in industrial applications. Does IPG need to consider different pricing strategies to boost adoption? Could it be related to the market applications, or perhaps the go-to-market strategy? I know we've discussed this in relation to some OEMs and distributors. I'm wondering if you believe that improving our penetration outside of China might require a different approach.

Mark Gitin, CEO

Thank you very much for your question. We are taking a more in-depth approach to some aspects, which is somewhat different from previous strategies. For instance, in the area of handheld welding, we have adopted a new go-to-market strategy. We have partnered with Miller Electric, a leading welding supplier in North America, to enhance our LightWELD system. They have experience in providing conventional MIG and TIG welding solutions and are collaborating with us to market this as a Miller product. They believe this direction is the future of welding because our LightWELD system allows for process customization. This means you can specify the materials you are working with, such as aluminum on aluminum or aluminum on copper, and the system will automatically adjust accordingly. Traditionally, MIG or TIG welders might spend years training to master these processes, but with our system, one can gain confidence in just hours. This partnership with Miller reflects our refreshed go-to-market strategy. Additionally, we focus on application and process development, such as using lasers for cleaning, which can replace chemical processes in a more environmentally friendly way. We are optimizing high-power lasers with short pulses for these applications. We've developed high-speed scanners specifically for cleaning applications that work in conjunction with the laser technology. Our approach aims to solve problems in non-laser applications as well, ensuring we provide comprehensive solutions at both the subsystem and system levels. This investment underscores our commitment to an evolving go-to-market strategy that we intend to continue pursuing.

Michael Feniger, Analyst

Understood. And Tim, just curious on seasonality; if you look back, typically Q4 might be down a little bit versus Q3, depending on some years. But this year, obviously, because of some of the macros and the factors, it feels like Q3 is actually a little bit weaker seasonally than normal. I'm just curious, Tim, is there anything you want to flag in terms of, like, seasonal factors as we kind of think about this year, if it's different than what you kind of see in prior years when we think of the seasonality of the business?

Tim Mammen, CFO

Michael, the situation is quite different right now. Any historical trends related to seasonality can be overlooked. We are currently experiencing a significant downturn, especially in Europe. The dynamics of the China business are also different. Demand is weak, although that sector has stabilized. Typically, we would expect Q2 and Q3 to be stronger quarters due to demand from those regions. However, at this time, seasonality is not indicative of anything meaningful. We have indicated that we do not anticipate a substantial recovery until sometime in 2025.

Mark Gitin, CEO

Sure. Thanks for that follow-up question. First of all, I want to emphasize the product roadmap and the technology here. First and foremost is continuing to drive that. We've got a great lineup of things that we're working on that will absolutely drive growth. In the material processing side, you've heard me talk about the lasers and then some of the components like the fast scanning, tying those things together and driving growth with the subsystem and system capability. Also in other areas like medical that we've seen fantastic growth, and we have a great roadmap that we're investing in that will give us great growth over the next years. And, of course, I'm always interested in anything that could drive that growth faster, give us differentiation and faster time to market, put us into adjacent markets. The M&A, I'm certainly always interested, looking, but in that area, not looking for any giant transitional acquisitions. We have a really great opportunity to continue to grow that business.

Mark Miller, Analyst

I, too, would like to welcome Mark to IPG. I had a question on General Motors and Ford recently reported strong EV sales. Just wondering what you're seeing in terms of EV-related sales in both North America and China.

Mark Gitin, CEO

Yeah, I can take that. Yeah, Mark, thank you for the questions. Again, as I mentioned earlier in the call, we're in a really good position on the EV, because of the solutions that we bring, not only in the laser but also the wraparound process there. So we have a great share in that. What we've seen, again, as we talk to the customers, those projects are being pushed to the right where we thought they were going to come in, in the second half of this year. The customers in each of the regions are talking about those projects being more into 2025.

Tim Mammen, CFO

There's a couple of good data points. I think overall EV sales in the first half of the year are up 20%. In China, they're up 30%. Europe is a bit flat at the moment. Off a smaller base, North America has actually performed quite well. Total battery capacity utilization, we think, has increased by about 20%. That's going to help drive higher utilization overall globally and supports the thesis that we start to see a recovery in 2025.

Mark Miller, Analyst

Thanks. Last question is in terms of recently introduced products, what percent of sales at 45%?

Tim Mammen, CFO

46%, this quarter.

Eugene Fedotoff, Senior Director, Investor Relations

Thank you for joining us this morning and your continued interest in IPG. We will be participating in a number of investor events this quarter and are looking forward to speaking with you soon again. Have a great day, everyone.

Operator, Operator

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