IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Yes. Good morning, and welcome to the IPG Photonics Corporation presentation. I'm Rick Eastman, senior analyst here at Baird. I head up our advanced industrial equipment team at Baird. IPG, I'll just provide a quick overview here, an introduction to IPG and then IPG -- and I will then turn it over to Tim Mammen, Chief Financial Officer. But IPG Photonics is a company that has been on our research radar screen for some time. And it's a pleasure for me to introduce the company and welcome them to our conference. As a quick introduction, IPG Photonics Corporation is the world leader in high-powered fiber lasers, fiber amplifiers, hybrid fiber, solid-state lasers and diode lasers for use in a wide range of markets, including materials processing, advanced technologies, telecommunications and medical applications. Fiber lasers enable greater precision, higher speed processing, more flexible production methods and enhanced productivity within many industrial and nonindustrial markets. So I'm going to turn the presentation over to Tim. Tim has a slide presentation that will provide us an overview. And if there's a few minutes left at the end of the presentation, if you want to e-mail me your questions at reastman@rwbaird.com, I will get those into -- and present those to Tim at the back end of the presentation. With that, Tim, please take it away.

Thank you, Rick. First of all, I just want to draw your attention to the fact that we will be making some forward-looking statements during the course of this presentation. Those statements involve certain risks and uncertainties. I draw your attention to the additional risk factors and disclosures that we have on file with the SEC in our quarterly and annual reports. So can everybody see -- Rick, can you see the presentation here?

Yes, I can. Yes.

So IPG really is the pioneer of fiber laser technology. Fiber lasers really bring significant advantages compared to traditional technologies. They combine the long-life reliability and electrical efficiency of semiconductor diodes and high amplification that enables really a very precise beam to be created that brings together greater advantages within many different applications. So these include improvements in productivity as well as improving the flexibility of the device to enable different and disparate materials, for example, to be processed in many different applications. These advantages are both over existing lasers as well as non-laser machine tools, and fiber lasers have certainly expanded the market for laser applications and materials processing, displacing non-laser cutting applications such as machine tool dies, starting to address plasma laser-cutting systems with ultra-high power lasers. In welding, we displace many different types of traditional welding applications. And then, for example, in emerging applications in additive manufacturing, you're changing potentially the way that machining is done or even casting of materials is done. We're very much the leader within -- in the fiber laser space and are also looking at many different emerging applications outside of materials processing, which I'll talk about, and where we put a significant amount of investment into. We've really revolutionized the laser registry over the last 10 or 15 years because fiber lasers bring significant benefits as compared to traditional laser technologies, such as gas lasers like carbon dioxide or lamp-pumped YAG lasers. So a fiber laser is a device that is basically monolithic. It's extremely robust. It's very well suited to be used in industrial-type applications. It's easily integratable with many automated processes. So the trend towards automation is being driven and enabled by fiber lasers, where perhaps it was being held back with some of the other traditional technologies. Lasers overall basically improve the precision of processing, the control and also the flexibility. So a single machine can be used to process many different types of materials of different -- not just different thicknesses but, for example, a cutting machine or process reflective and nonreflective materials, hardened steel, mild steel, aluminum, copper are some of those examples. A fiber laser is generally much more -- I mentioned it's very rugged, so it's very reliable in terms of industrial applications. It generally takes less floor space and, crucially, improves productivity because of the better beam quality. In addition to that, has significantly better electrical efficiency that is beneficial both from a cost of ownership perspective but also from an environmental perspective, where any reduction -- and the reduction in electric consumption is of benefit. Many of the changes in electrical consumption are very significant to traditional lasers. So our electrical efficiency is now above 45%, where traditional technologies will have electrical efficiency of 2% to maybe 15%. And even competing fiber technologies only have electrical efficiency of about 20%. I think there are 4 main points we really want to make about the industry and the company. The first is that we are the global market leader in fiber laser technology with approximately 60% share across many different applications in materials processing. Those applications are expanding. I mentioned cutting applications are displacing things like plasma, punches, presses, dyes, mechanical saws, water jet applications, welding is displacing many traditional MIG, TIG,, friction, spot welding applications as well. So the market is significant and large. We are also well known for being the most vertically integrated manufacturer within the laser industry. So we make all of our own key optical components across, for example, starting with our semiconductor diodes to the packages, micro optics, bulk optics, the glass fibers, the different types of technology that enable the energy to be coupled out of the laser into the glass. From combining the glass and the packaged diodes together, you build a module. We have core technologies around combining those modules together that enable us to produce lasers with a tremendous range of power from 10 to 50-watt lasers up to 100 kilowatt, 100,000 watts of laser at the highest level. The market opportunity as a result of this that we're addressing, both within materials processing is -- and outside the materials processing, is expanding. So we have put a lot of investments into new products with different wavelengths and, for example, different pulse durations. We're putting investment into, for example, the ability to integrate the lasers within different types of systems and that is being incorporated with different capability on process and know-how. And that process and know-how, it means that the moat around the company's technology and ability is expanding, where some of the competitive dynamics around the core laser applications as we've added the ability to deliver the light source to the work surface, we are developing processes, we're developing capability to monitor how those processes are being done real time, and we're developing capability to enable, for example, through scanning systems, that process to be speeded up and the productivity to be enhanced. The other thing we just want to draw attention to is that continue to have industry-leading margins and earnings, and we have a very strong cash flow generation model. And even with some of the difficulties this year, we've managed to, with cost reduction initiatives, improve our margins. And I'm particularly pleased with some of the cash flow generation that we've achieved in a difficult environment with the discipline we've shown around managing working capital. First of all, maybe just look at the market a little bit and the opportunities for industrial lasers. There are many different applications in industrial lasers that are shown on this slide. The most interesting thing, I think, is that if you look at the total machine tool industry, which is about $80 billion, it does vary depending upon how the underlying economic -- economy is growing and macroeconomic data is varying. Lasers' total penetration into that machine tool industry is still very low. It's less than 10%. Now you do actually have to step back a little bit and strip out some of the applications that within machine tools would not be addressable by lasers. And when we do that, we estimate that laser systems are probably 25% penetrated into the market opportunity. So despite the tremendous progress that's been made in growing laser-based applications and systems, there is very significant headway for future growth into all of these different areas. Penetration, for example, into the welding industry is still at a very early stage. The welding industry tends to be quite conservative in adopting new technologies. There's often different aspects of qualification and meeting different types of standards across multiple different industries that has to be addressed before you start to see significant growth there. But notwithstanding that, IPG has addressed welding in many different areas. Some of the newer industries will adopt some of these applications faster. So for example, consumer electronics or EV, battery manufacturing is a fast adopter of these newer applications, where some of the more -- the older industries are a little bit more conservative in the speed with which they adopt new technologies. The actual market for laser sources is much larger than just materials processing. In fact, if you look at the applications outside of the core markets that IPG has been focused on over the last 15-plus years, the other markets are actually larger than industrial laser applications for cutting, welding, marking, graving and additive manufacturing. The largest of these other areas are things like microelectronics processing that use ultrafast pulse lasers, UV lasers. So these are either shorter wavelength or shorter pulse duration lasers. There are significant opportunities in advanced government applications, for example, in defense. This is an area we called out at the end of the third quarter, where we had significant order flow. We took orders for single-mode lasers and very high power lasers in the 100-kilowatt range. There are a lot of opportunities within sensors and instrumentation. That would be a longer-term growth area for the company. Another area where we are already making significant progress is in medical applications. We've introduced a laser that's really become the gold standard in kidney stone removal. It has the capability, as compared to other technologies to, regardless of the size of a kidney stone, reduce it basically to dust particulate. It enables the kidney stone to be flushed through the system painlessly. We also have shorter wavelength lasers that are being used in entertainment and display applications. Our backlog for that, despite the difficult environment, given the technical advantages of that system, is actually relatively strong. So if IPG can continue to execute with these new products, within a few years, we estimate that our total business will be much more diverse in terms of the end markets and applications that we address, and that's a very core part of our technology. In the last quarter, our emerging products contributed about 20% of total revenue. Some of those are in emerging areas in materials processing and some of them are in these newer areas outside of industrial markets. I won't just spend quite a lot of time talking about the emerging growth opportunities on this slide. So we'll move on to some of the other parts of the presentation. We mentioned that laser systems are a large part of the laser market. Systems are interesting because they often incorporate a lot of processing application and know-how. IPG's strategy in this area is very specific, either looking at parts of the market that are underserved by the existing OEM base or parts of the market where the laser is a fundamental part of the process, and we think that we can add value to the end user and the customer and, by adding that value, grow the total laser opportunity more significantly than we would be able to without being involved in the systems part of the business. Fiber lasers continue to have very significant advantages compared to traditional technologies. I've mentioned some of these in terms of their monolithic design, the fact they have no moving parts. Our fiber laser, even compared to other people fiber -- other competitive fiber lasers, our solution is very modular, very scalable. As I mentioned, we've sold lasers up to more than 100 kilowatts in output power, where competing technologies, whether they're fiber or CO2, find it a lot more difficult to scale the power. That scalable power means that you can start expanding the application set that you are addressing. The electrical efficiency of our devices, as we also mentioned, is significantly better. That's much more important, particularly as you get to higher power levels. It's also becoming increasingly important in terms of environmental concerns. But the lasers also improve and reduce costs in other ways by improving productivity, even reducing the amount of floor space that's required because the footprint is smaller and because of the electrical efficiency reduce the amount of cooling that is required. As I mentioned, we've continued to expand the portfolio of fiber lasers that we are introducing to the market. So that now, where historically we supplied lasers that were primarily ytterbium in the near infrared 1-micron range. We're supplying lasers with both shorter wavelength. So we talk about lasers in the visible spectrum, red, green, blue and ultra-violet. Medical lasers are in the longer wavelength. So thulium lasers are approximately 2 microns. We have also a group that is really focused on developing devices for the mid-infrared spectrum, and that's an area where instrumentation is going to become increasingly important. So these are the kinds of devices that may be able to analyze the human breath or pollutants in the air, for example, or improve traceability to ensure that manufacturing processes are adhering to different types of standards. So that's sort of the mid-infrared. The other aspect of what we do is to change the way that we deliver the energy to the work surface. So you can either deliver, as you can see in the bottom left-hand part of this slide, you either deliver the energy in a continuous average power level. Where you can start to modulate that power with relatively long pulse durations and then transition to shorter and shorter pulse durations. And the shorter the pulse duration for a given average power, the higher the total energy that's delivered. And then as you get to very, very short pulse durations, at pico and femtosecond, you're actually delivering very high energy for very short periods of time, and those enable you to process different materials without thermally damaging them. And you can, therefore, process many, many more diverse types of materials in the nonmetal environment and even processing. For example, in ophthalmology, femtosecond lasers are used there, so you can get into processing of human tissue, for example. One of the other things that has enabled us to -- and I won't talk to these slides in detail, but there are several just examples here of how we've added specification and capability around the core materials processing lasers that's enabling us to maintain an advantage in the market. So for example, our Adjustable Mode Beam laser enables the way that the power density and the beam is delivered to the work surface to be adjusted. This is enabling, for example, cutting of thicker materials, but also, crucially, improving the weld quality that's achievable. So in EV battery manufacturing, it's reducing the amount of spatter that's generated with a weld, and that improvement substantially improves the quality of the weld. So AMB is a feature set that we're delivering to the market that's starting to gain increasing traction. Our high peak power HPP lasers are starting to be adopted more broadly on cutting applications. This enables, for example, the initial penetration of the part that's being cut, the piercing of the part to happen more quickly and also more efficiently and effectively by reducing again the area that is disrupted during the piercing process. Ultimately, what that means is that you can nest pass complex parts of your cutting closer together and, therefore, improve the yield of the metal that you're processing. So again, this is taking a core technology and adding capability around it to improve the functionality of the laser. Another application enhancement that really is driving improvements in welding is what we call our weld quality monitoring. This enables us to really monitor the quality of a weld on the fly. So instead of welding a part within one part of the production process and then having to move that part to a different fixture and then determine and analyze the quality of the weld, that weld monitoring actually happens within the main fixture where the welding is happening. And if the weld is determined not to be of sufficient quality, it can be immediately redone. So there's an improvement in productivity and yield for the part. So weld quality monitoring is an extremely important part of what we are doing within welding applications. I mentioned we're very vertically integrated. I won't spend much time on this, but all of the key optical components that are required to build the fiber laser and increasingly deliver the optical beam to the work surface and even the processes that are used amongst many different applications have been developed within the company. So this provides a tremendous amount of depth and breadth to the technologies that the company has and it provides an increasing barrier around the company in terms of competitive dynamics. So it's one thing to be able to produce, for example, a claim that you produce a laser that can compete with us. It's an entirely different proposition to be able to compete, particularly among some of the emerging applications that the company has developed. I always talk as well about one of the other key aspects of the company's DNA, and this has become increasingly important with some of the -- with the competitive dynamics that we faced. IPG has taken cost out of all aspects of the device. The most notable one is the diode, where last year, the latest iteration of the diode took approximately another 20% out of the cost of the diode, if not a bit more. The cumulative cost reduction on diodes over the last 10-plus years is about 85%. The cost per watt is less than $1 per watt for the diode. And interestingly, because we now get more power out of a single chip, you will notice here that in 2019, we actually produced fewer chips. In part, that was because of a bit of a slowdown in the market in the second half of the year. But it's also because we're getting more power out of each individual chip. And that means that the benefit is that we've actually been able to improve some of the redundancy within our production capacity and in the future potentially reduce the total amount of CapEx that's required, particularly on producing the new generation of chip. Because you're getting more power out of a chip, the number of chips that's required to produce that power is reduced. So that was a very interesting development that the company really achieved last year. We've continued to invest in our global presence. We have 3 main manufacturing locations in total about 5 manufacturing, 2 smaller ones. 25 locations around the world in total, 6,000 employees, more than 4,000 customers. Our breakdown in sales is approximately 40-plus percent of sales coming out of China. 25-plus percent out of Europe, 15% to 20% out of North America and then 10% to 15% out of the rest of Southeast Asia. The main markets in Southeast Asia being Japan, Korea, Singapore. There's also an increasing number of lasers that are deployed in countries such as Vietnam and Thailand, for example. And that's evidence of some of the investments that are happening outside of China to support supply chains. In the near to medium term, perhaps not the near, but the medium term, we expect to benefit from transitions in automation, for example, but also the reshoring of supply chains where potentially they become less global, and that's become of particular importance, people have seen over the last 6 months with the impact of the pandemic and even some of the geopolitical risks that exist out there. Finally, I'll talk a little bit about our long-term financial model. Continue to target, despite the last 2 years' difficult growth with some of the market dynamics, getting to double-digit growth. Again, this requires the materials processing market to get to a more stable environment and continued growth in the core applications there. The underlying driver of that would be really a stronger macroeconomic environment. So next year, for example, GDP growth is expected to recover, so long as the pandemic doesn't have an ongoing impact. There's clearly some positive news around vaccinations. But the other part of this is clearly growing the emerging markets more strongly. So we've talked about things like the advanced applications, medical, microprocessing, entertainment and display and instrumentation would be core to achieving this double-digit growth rate. We've made very good progress on starting to recover some of our gross margin from the trough level. So we're now reporting gross margins in the midpoint of the 45% to 50% gross margin range that we've given historically. And operating margins in the last quarter were, if you exclude the impact of the goodwill impairment that reduced operating margins and if you include the benefits of foreign exchange gains that improved operating margins, our operating margin was about 24%. This year, we are benefiting a little bit. There's lower activity on things like travel and attending of trade shows and trade fairs and conferences. So that OpEx is a little bit below the levels it would be if you had a more normal environment. So they'll -- probably about $1.5 million of quarterly benefit coming from that. But even if you added that back, you'd still be below -- significantly below where your peak operating costs were in Q2 of 2019. I think we had about $84 million, where right now we're at $78-odd million of OpEx. Continue to have strong operating cash flow and free cash flow this year. CapEx will be in the $80 million to $100 million as compared to $134 million in 2019 and a strong return on invested capital that approaches about 20%. And that brings me to the end of this presentation. So Rick, I don't know whether you're doing any Q&A at all or we've got maybe a minute or 2 for any questions.