Earnings Call Transcript - IPGP Q1 2024

Eugene Fedotoff, Senior Director, Investor Relations

Good morning, and welcome to IPG Photonics' First Quarter 2024 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 Senior Director, Investor Relations, for introductions. Please go ahead with your conference. 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, 2023, and other 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. Any forward-looking statements made on this call are the company's expectations or predictions as of today, April 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 our investor relations website. We will also post these prepared remarks on the website following the completion of this call. With that, I'll now turn the call over to Eugene Scherbakov.

Eugene Scherbakov, CEO

Good morning, everyone. In addition to our earnings release, we announced a leadership transition this morning. Let me start by commenting on the quarterly results first and then I will speak about the CEO change later in the call. In the first quarter, we continued to generate strong operating cash flow, reduced inventories, managed product costs, and returned capital to shareholders. We achieved this while facing soft demand in general industrial manufacturing and e-mobility end markets, which together represented over 60% of our total sales and negatively impacted revenue across many applications. Our book-to-bill was above one and we believe that we are seeing a bottom in demand with a potential modest improvement toward the end of the year. At the same time, we remain focused on execution of our long-term strategy to displace other laser or non-laser tools with our fiber lasers and grow revenue in a number of focus applications such as welding, cleaning, heating, and medical, diversifying away from more competitive applications such as cutting and marking. Revenue in our emerging growth products accounted for 45% of total sales in the first quarter. These laser products and solutions can provide significant improvements in speed and quality of manufacturing processes while reducing energy consumption and other environmental impacts. I will cover highlights and comment on revenue by applications first and Tim will cover our financial results in more detail. Starting with our largest application, welding revenue declined year over year, primarily due to lower demand from e-mobility customers. Significant reduction in new battery investments in China, compared to the prior year, and delayed EV battery projects in North America reduced demand for our welding products and solutions. At the same time, we believe that we are able to gain some market share in EV welding, closing new business opportunities both with significant new customers and in new applications. Additionally, we are working with a number of leading automotive manufacturers on new fiber laser applications in batteries and general automotive assembly. We remain optimistic that EV battery investments may increase again toward the end of 2024 into 2025, resuming a multi-year trend of building out required battery capacity to support the transition from internal combustion vehicles to battery-electric cars or plug-in hybrids. Additionally, we were pleased to see a pickup in demand from consumer electronics battery applications as well as growth in welding revenue in general automotive and general industrial applications. Adoption of our real-time welding monitoring system and complete automated welding solutions are also showing good results. Our handheld welder sales slowed in North America in the quarter with some smaller customers being impacted by uncertainty in demand and higher financing costs, but order pipeline and customer interest remain strong. In addition, we are starting to ship these devices to Miller Electric, which will help handheld welder sales in the second quarter and will have a more measurable impact in the second half of the year. Sales in cutting applications declined in the first quarter due to continued soft industrial demand across all major geographies. Large OEM customers were managing their inventories, which negatively impacted our cutting sales in Europe, North America, and Japan. Market conditions remain difficult but appear to be more stable compared to the last several quarters and we expect that improvements in general economic conditions and reduced customer inventories should result in more stable demand in the second half of the year. Foil cutting sales also remained soft due to weak demand in e-mobility, but our systems sales showed some improvement year over year. In other materials processing applications, cleaning sales were negatively impacted by softer demand in e-mobility, but we are making progress introducing our cleaning solutions across many general manufacturing applications. Cleaning revenue has been increasing and the application is becoming a meaningful contributor to total sales. While still relatively small, heating and drying lasers is another area of future growth for IPG. The application delivered strong increase in sales this quarter as we shipped a large order for foil drying to an e-mobility customer. Additionally, we are working with a number of large manufacturers from across several application areas to build innovative heating and drying solutions to suit their needs. Finally, revenue increased in 3D printing applications as the industry is using a large number of high-quality lasers to melt metal powder to create parts. IPG has a strong position in this market, providing lasers with high stability beam characteristics. Outside of materials processing, other applications revenue declined due to lower sales in medical and advanced applications. Our medical business was negatively impacted by a large customer managing inventories in the first quarter. We expect medical revenue to normalize in the second quarter and we are working on several new opportunities that will launch in 2025 and 2026 and should help this business to grow and become a more meaningful contributor to IPG's total sales. Before I turn the call to Tim, I will provide a few comments on the leadership transition we announced this morning. I would like to welcome Mark Gitin as IPG's next CEO. The Board performed an extensive search and selection process and chose Mark Gitin because he possesses a unique combination of relevant scientific expertise and a proven ability as a successful operator in our industry. I look forward to helping him make the transition seamless for our customers, employees, and other stakeholders. I would also like to thank the IPG team for its contributions over the last 30 years. I was fortunate enough to be a part of the team that transformed the laser industry and helped IPG to become a global industry leader. I believe that the best opportunities are still ahead for IPG, and fiber lasers will continue to displace other technologies, driving future growth for the company. I will miss my day-to-day interactions with my IPG colleagues, but I make this transition knowing that we have accomplished great things. This will be my last earnings call, but I will remain on the Board supporting the next leg of the journey for IPG, and I will also be involved as an advisor to Mark and to the Board. With that, I will now turn the call over to Tim to discuss financial results.

Timothy P.V. Mammen, CFO

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 5. Despite the headwinds to our revenue, I am pleased with the resilience of our financial model and the company's ability to generate strong cash flow from operations to support current and future investments as well as continued opportunistic share repurchases. Revenue in the first quarter was $252 million, a decline of 27% 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 decreased 25%. GAAP gross margin was 38.7%, a decrease of 360 basis points year over year due to lower absorption of manufacturing costs as a result of lower revenue and higher inventory provisions. These negative impacts were partially offset by improved product costs, mostly as a result of product mix, and lower shipping and tariff costs. On a sequential basis, gross margin improved due to lower product cost, a decrease in expenses related to scrap and duty, which were partially offset by an increase in inventory provisions and unabsorbed manufacturing expenses expressed as a percent of revenue. Operating expenses came in at the high end of our expectations and increased both year over year and sequentially, primarily in research and development and sales and marketing, as we invested in resources to drive future growth while still controlling general and administrative expenses. FX headwinds also had a negative impact on revenue and gross profit in the quarter. If exchange rates relative to the U.S. dollar had been the same as one year ago, we would have expected revenue to be $8 million higher and gross profit to be $5 million higher. GAAP operating income was $19 million and operating margin was 7.6%. Net income was $24 million, or $0.52 per diluted share. The effective tax rate in the quarter was 28%. Foreign currency transaction losses related to re-measuring foreign currency assets and liabilities to period-end exchange rates had a negative impact on operating income of $2 million, or $0.03 per share. We continued to optimize our footprint and, as a result, we sold 2 buildings during the quarter. The gain on sale of these assets increased operating income by $7 million and increased diluted EPS by $0.11. Moving to revenue performance by region on Slide 6. Sales in North America decreased 16%. We saw a decline in revenue in medical, welding, cleaning, and advanced applications, partially offset by growth in cutting systems and increased revenue in parts and services. Uncertainty in the general demand environment and lower e-mobility sales as well as cutting OEMs and medical customers managing inventories were the main reasons behind the decline in North America. In Europe, sales decreased 21% as growth in welding was more than offset by reduced sales in cutting applications due to large cutting OEM customers reducing purchases to manage inventories. Demand in 3D printing applications was also soft in the region. Economic conditions in Europe remain challenging but we saw some improvements in e-mobility sales and benefited from a continued rollout of LightWELD in the region. Revenue in China decreased 38% year-over-year as demand declined in general industrial and e-mobility markets, negatively impacting sales across cutting and welding applications. On the other hand, sales to 3D printing applications increased in China as the industry is seeing growing investments in the region. 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. Our inventories continued to decrease sequentially and we are targeting further reductions over the course of 2024. Cash provided by operations was $55 million and capital expenditures were $28 million during the first quarter. As I mentioned earlier, we sold 2 buildings in the quarter, realizing $25 million in proceeds, which means net capital expenditures were just under $3 million, well below the same period last year. While maintaining a strong balance sheet, we have been returning a significant amount of capital to shareholders through opportunistic share repurchases. We spent $90 million on share repurchases in the first quarter and continue to view current share prices attractive at current levels. Moving to our outlook on Slide 9. First quarter book-to-bill was slightly above 1. However, macroeconomic uncertainty is still negatively impacting demand across all of our major markets and resulting in project delays and reduced orders. Additionally, project delays related to battery capacity expansion are providing headwinds to our sales in China and North America. On a bright side, leading manufacturing indicators have been improving in the U.S. and China and bottoming in Europe and Japan, which should lead to more stable demand for our customers. We also expect that medical and LightWELD will return to more normalized revenue levels in the second quarter. For the second quarter of 2024, we expect revenue of $240 million to $270 million. The second quarter gross margin estimate is between 37% and 40%. We anticipate delivering earnings per diluted share in the range of $0.30 to $0.60, with approximately 46 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. Before we move on to questions, I would like to express our gratitude to Dr. Scherbakov on behalf of the Board, management team, and employees of IPG. He has made vast contributions over the past 30 years, too many to describe today. But we should recognize his contributions particularly during his time as CEO, including by strengthening IPG’s competitive position and laying the foundation for our next phase by establishing a clear strategic plan focused on key growth markets and applications, reorganizing R&D, and disposing of non-core assets. We all look forward to continuing to work with Dr. Scherbakov in his capacity as a director.

James Ricchiuti, Analyst

First, congratulations to Dr. Scherbakov on his many accomplishments at IPG, and I wish him the best of luck. I have a couple of questions. With a book-to-bill ratio of 1, it seems you are suggesting that we may see a bottom and a recovery later in the year. Can you help me understand what gives you confidence in this modest recovery for the second half of the year? What insights do you have regarding emerging areas, including the electric vehicle and welding markets?

Timothy P.V. Mammen, CFO

So Jim, I believe the first positive sign we might see is that the book-to-bill ratio, though from a low revenue base, has risen above 1 for the first time in a year. We have experienced a significant period of macroeconomic challenges. Additionally, when we consider some of the key economic indicators we track, there are some positive developments in North America and even in China. The PMI data shows a slight increase. While the PMI figures in Europe and Japan seem to have hit a low point, they are starting to show signs of improvement, particularly in Japan, although Europe is still not strong. More specific to our business, I mean, the cutting market ex-China is still quite weak. You perhaps have seen some of the results from the major cutting companies in Europe that are public. So they're not seeing a specific churn in that business at this point in time, but they do expect some improvement in the second half of the year. I'd say that improvement is probably more towards the latter part of the year at this point. They are starting to run down some of the inventories that they've had. On the electric vehicle side, there are always some positives, especially in Europe, where we've qualified with several new customers and are working on projects. The welding business in Europe has been quite decent. We have several projects in Asia and China that we're looking to gain more visibility on. There is a lot of activity happening there that should become clearer in June based on feedback I've received from the sales team. So there is at least some activity that appears to be starting in that direction. I'd say though that it still remains a difficult time and improvements. Clearly, the guidance in Q2 only shows a very small improvement that reflects the modest positive book to bill that we've seen. I think I covered a lot of different things in my answer.

James Ricchiuti, Analyst

You did, Tim. I appreciate that insight. As we look ahead to 2025 and consider some of these emerging opportunities, are there any that you feel particularly optimistic about that could be significant? I was a bit surprised by LightWELD; perhaps it's due to some seasonality, but I expected it to gain more traction. It might still be early days with the partnership with Miller, and that could develop over the next year or so. Regarding the emerging opportunities in medical, what gives you greater confidence as you look beyond this challenging period?

Timothy P.V. Mammen, CFO

I think, well, with LightWELD, you've got the Miller relationship that's starting to accelerate. You're seeing the demand cycle in Europe as we've introduced that product start to ramp up. An improvement in the underlying macro in North America will help with that. The product still has tremendous acceptance in the market. So we strategically remain very optimistic about that. We still remain optimistic about the EV market. I think one of the largest battery makers in China discussed that their utilization was at about 70% overall last year. EV battery demand grew globally, I think, by about 37% and 35% in China specifically. The growth, by the way, in storage battery was over 50% last year. So whilst utilization is still not like 80% or 90%, it continues to increase. So we think that perhaps about 1.5 terawatts of battery capacity is being built out and that still needs to increase dramatically over time as both EV sales continue to grow and storage capacity is added to. I think the other areas of strategic growth, the medical business is going to come back in Q2. We're working with numerous new product introductions and other major partners on medical. I think that we'll start to bear greater performance and better performance and traction around growth in 2025 and we actually had a good quarter on some of our micro-processing business. It's still small, but some of the ultrafast business performed reasonably well with strong deliveries of ultrafast product. I think we had the strongest quarter on ultrafast. We continue to have a strong belief in the work we are doing in cleaning, heating, and drying applications. Strategically, as we've mentioned, there is a solid foundation despite the various challenges in different parts of the business. However, we are actively working on building long-term relationships with customers in each of these areas.

Eugene Scherbakov, CEO

I also want to mention our new products that we will begin introducing this quarter. These include a single-mode laser specifically designed for our 3D applications, and we have already shipped the first batch to both potential and existing customers. The initial feedback has been very positive. The primary benefits of these lasers are their compact size, improved efficiency, and cost reductions through optimization. We believe this product will open up additional business opportunities for our 3D applications.

James Ricchiuti, Analyst

Congratulations, Dr. Scherbakov.

Ruben Roy, Analyst

And I'd like to echo my congratulations and best wishes to you, Dr. Scherbakov. For my first question, it's sort of a follow-up, I guess, to Jim's question, Tim, which is sort of thinking through the improving book-to-bill and what sounds like a little bit of improving visibility on where your customers stand with inventory and project delays, etc. But at the same time, it seems like there's been a little bit of a push out on how you're thinking about recovery. So recovery modest and maybe pushed out to the end of the year versus last quarter when we were thinking about a second-half recovery in EV perhaps. Is that the right way to think about it? Are you being conservative on recovery just because of what we've seen and the difficulty in assessing customer progression? Or has something changed on kind of the timing or scheduling of the recovery as you're thinking about it?

Timothy P.V. Mammen, CFO

Yes, I believe we have adjusted our expectations for the level of improvement in the second half of the year. Our book-to-bill ratio was a bit stronger in the first quarter and that momentum was definitely starting to build, giving us greater confidence. However, I think the significant progress is more likely to occur later in the year. There are several electric vehicle projects we are waiting to get updates on in June, and those projects have a sort of decision point associated with them. I think you can see from the cutting business, whilst it was okay in North America, Europe is really challenged by that if you've seen some of the results from some of the major players there. So I think we're feeling that we're turning the corner of it. But I would say our tone around that is that it's not going to be an immediate ramp into the end of Q2, Q3, with some more modest improvement into the end of the year. It's how I would characterize it.

Ruben Roy, Analyst

Right. Okay. That's helpful. And then just a question on the gross margins as inventory comes down again and just thinking through perhaps a little bit of a better half revenue-wise. I know you're working on working capital, etc. But from here, it looks like we've got sort of stabilization in gross margins. So as revenue improves, one would expect that you get a little bit of an additional bump as your inventories have come down. Can you just walk me through how you're thinking about the second half on gross margins?

Timothy P.V. Mammen, CFO

Yes. Revenue is clearly increasing, which improves absorption. When I reviewed this in detail for Q1, I was pleased with the gross margin for the actual product. There was some benefit from the mix, as we had some ultra-high power single-mode lasers. As Dr. Scherbakov mentioned regarding the additive, the single-mode laser offers a better cost profile. We're also rolling out higher-power lasers with a lower bill of materials, which is still on track to begin product delivery by the end of Q2 and into Q3 and Q4. So one of the things I always look at is what's the gross margin of the product, and that's holding up pretty well, and we have these cost reduction initiatives that should start to benefit things. If revenue picks up, that will help with the absorption side. So it's really relative to a year ago, it was absorption rather than, say, pricing or a structural shift on product gross margin that affected us in actually both Q4 and Q1 this year.

Mark Miller, Analyst

Let me also extend my congratulations to Dr. Scherbakov. I enjoyed working with him and truly value all the contributions he has made to IPG. I would like to explore further the factors you mentioned; it seems that welding and cutting continue to be weak, but there was a significant sequential decline in high-power laser sales.

Timothy P.V. Mammen, CFO

The cutting market, especially in Europe, has continued to show weakness. Additionally, at the end of last year, we had several EV welding programs that we supplied products for in North America. Therefore, the demand for EVs in North America was also weak in the first quarter. Those are the two main factors. There are a few significant projects for the EV welding market in North America expected in the fourth quarter.

Mark Miller, Analyst

You mentioned a large order. I think it was for foil related. Can you give a little more color on that also?

Eugene Scherbakov, CEO

You mean the drying applications? Yes. We've seen this big enough order this quarter is for foil drying. It's a very important customer for us. And also the first demonstration that how successful can be used our diode, high-efficiency diode lasers with efficiency more than 57% for such kind of applications. And of course, it's only first such kind of shipment and you'll see a very big opportunity to use this later for such kind of application.

Mark Miller, Analyst

Okay. So it was foil drying application.

Keith Housum, Analyst

Great. I want to extend my congratulations to Dr. Scherbakov for an impressive career and all your contributions. I have a quick question regarding the performance during the quarter. I understand the markets are currently challenging, but can you provide insight into the impact of pricing versus volume?

Timothy P.V. Mammen, CFO

It's primarily volume-related pricing that remains stable in the market. We have not altered our pricing policy. On average, there may be a slight mix benefit due to the sale of some ultra-high products for advanced applications, which had a very strong average selling price per kilowatt. Currently, volume is the main factor contributing to the weaker results.

Keith Housum, Analyst

Got you. I appreciate that. In terms of the gross margins, can you help us understand the inventory reserves or provisions you took in the quarter and the impact that had on gross margins this quarter versus perhaps last year?

Timothy P.V. Mammen, CFO

Specific amount, I haven't got to hand. It was probably 100 basis points higher or something like that on the total provision. The provision will be in the Q, the specific number.

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 again soon. 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.