IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Good morning. Welcome to the 23rd Annual Meet up Virtual Growth Conference. My name is Jim Ricchiuti, and I'm a Senior Research Analyst here in the equity research department at Needham. I'm pleased to be hosting a fireside chat this morning with the CFO of IPG Photonics, Tim Mammen. Tim, welcome to our virtual fire side.

Thank you, Jim.

So we're very familiar with the company. Why don't you just spend a moment, if you would, just a very short overview of IPG, just for people who may be getting reacquainted and then we'll jump right into the Q&A.

So IPG is the market leader and the company that's credited with commercializing fiber laser technology, initially, primarily, for many of the industrial markets. So for materials processing applications, such as cutting, welding, cladding, additive manufacturing, ablative processes, such as marking and cleaning, we've really developed reliable, industrial-grade devices that have superior electrical efficiency to most other technologies in the marketplace and other competing fiber technologies that are emerging at this point in time. We're also really accredited with being the company that successfully increased the power that's available from a fiber laser that has broadened those applications very dramatically over the last 15 years. Many of these advances we made happened over a decade ago. So we've been producing kilowatt-scale lasers since 2003 and 2004. Another key thing that we've done is really reduce the cost of the technology to make it not only competitive against other laser technologies, but fundamentally more competitive against non-laser technologies. So in the machine tool business, punches, presses, dyes, displacing welding applications in additive manufacturing, displacing reductive processes in marking, displacing applications that use inks or chemicals to abrase services. So we basically have a very flexible device that has very high electrical efficiency, extremely high reliability, is easily integratable into automated processes and robotics. So that's been a key driver of our business. And we've been a driver of enabling that automation as well. I'd say the other important things about the company at a very high level to understand is that we are a deeply vertically integrated company. So we produce all of the key components that go into the lasers internally. Both from our semiconductor diodes to the packaged diodes as well as to all the key glass components, whether it be the actual specialty optical fibers or coupled as isolators, and gratings, for example, the mirrors that are embedded within the fiber. So we actually produce a slightly different, not slightly, we produce a different type of fiber, primarily used with our ytterbium lasers and other lasers that's got different compounds. And the way we dope that fiber is different from anybody else in the industry, and we believe that's one of the things that drive some of the improvements in electrical efficiency that other people are not able to match. And it's also fundamentally important to ensuring the reliability of a fiber laser as you go to higher and higher powers. So we have these core advantages in very deep technology within the company. Given that we've been in the market for over 20 years, we have a very widespread global distribution network. 85% to -- 80% of our sales are actually outside of the U.S., although, the U.S. is starting to perform much more strongly recently. And we've built that distribution network up over the last 20 years or so. So we've got major manufacturing and distribution in Europe. We've got some low cost manufacturing, but high-tech manufacturing in Russia and then very strong operations in China, in Korea, Japan, India, Southeast Asia and some of the other European countries. So we're able to service the customer base extremely well. 70% of our sales at the moment continues to come from OEM customers. So there's a tremendous amount of leverage that's generated from that. And about the other 30% of sales goes directly to the end users. But even with the end users, once they adopt the technology, there's often a significant number of repeat sales and increase in the volume of lasers. So there's an inherent amount of leverage even within the end user applications as they start to consume more lasers within the application specific to them.

Good. So let's talk a little bit about what we saw from the company in Q3, a nice recovery. I want to just spend a little time on what some of those factors were. You saw a nice rebound in China as well and yes, elsewhere, you alluded to some strengthening in the U.S. And talk about some of those dynamics in that pickup.

So in Q3, clearly, a lot of it was driven by China, right? You had -- really China came out of its lockdown and the impact of the coronavirus pretty much dissipated in Q2 where there was a very significant increase in total order flow. That then started to be -- those orders started to be called off in Q2. The underlying demand trends, though, remained very strong in Q3. So we saw strong demand for all different types of cutting applications, both at lower power levels as well as significant shift to volume at higher power levels with lasers as high as 30 kilowatts being used. So that's clearly a benefit. Seeing underlying strength in some of the EV manufacturing, so particularly for battery. You saw very strong demand, again, coming from cutting from some of the heavy equipment in construction manufacturing industries. We saw some demand from consumer electronics. It wasn't particularly strong. So it wasn't a banner year for consumer electronics, and there's some discussion that 2021 should be a bit stronger. Elsewhere, we saw signs of really some small stabilization in places like Korea and order flow in Korea started to improve, and the guidance for Q4 is quite reasonable. In Europe, you certainly started to see what we thought was a trough. In fact, European revenue and orders, they weren't brilliant, but they outperformed where we forecast them to be at the beginning of Q3. So that helped as well. And then in North America, again, not in total revenue, not an outstanding quarter by any means. But, yes, again, some improvements, but the real benefit that we saw coming into the end of Q3 outside of China was very strong order flow in North America. So we mentioned some of our advanced applications. We also saw strong order flow coming out of Southeast Asia for some of the solar cell applications that use our green lasers. They are actually made in the U.S. So they end up being booked there. We booked 2, 100-kilowatt lasers at the end of Q3, took a significant order for single-mode lasers that was included in our guidance for the fourth quarter. So you saw sort of a bit more of a consistent rebound outside of China as well. That was a benefit, and that helped us to deliver what was a reasonable guide for Q4 as well. We haven't given an update on -- formally on order flow beyond beginning of October. But in October, we've continued to see some continuing improving trends on a pretty much global basis. I'd say the only place that continues to be weak at the moment or weak through the end of October was Japan. And that economy is certainly a lot more anemic that elsewhere in the world, although, their outlook for 2021 is for a rebound and some strength in that economy. I think it's been weak for so long that it inevitably has to pick up. I think some of the JMTB orders, the domestic data still continues to be a bit weak, but the export data is a lot stronger than it was, particularly in October and November.

Maybe speaking about the data. I mean, we've been seeing reasonably good PMI numbers, China, U.S. Automotive, it looks like it's shown some signs of some recovery, good order flow in durable goods orders, about 6,7 consecutive quarters. You've alluded to the possibility that some people are talking about maybe a better smartphone market, as we all know in '21. So normally, that's a good backdrop for a recovery, but we also had this other issue of the pandemic that is not going away yet. And so I'm just wondering how that's shaping your view of -- the macro view, as you think about the next several months?

So I would agree, I think a lot of the data points to improving trends and even underlying strength. I mean, global PMI is a very strong, the global technology equipment market is one of the fastest-growing sectors at the moment. So that's a big benefit to IPG. I talked about the JMTB orders. I think U.S. manufacturing technology orders in November saw their first year-over-year interest -- increase. Global PMIs, I think were about 54. So everything is pointing to a significant expansion. I agree with you that there's some overhang, perhaps an uncertainty as to how the pandemic plays out over the next few months, but it doesn't seem to be impacting things that much. And I think there's sort of a -- I would characterize it as sort of cautious optimism, but not so much caution. I think the underlying trends and dynamics are pretty positive. And perhaps some of this is also being driven by -- we talked about supply chains becoming more regional because of geopolitical risks and I think that the pandemic has started to focus people on really looking at the risks around their supply chains and where product is being made. And certainly, that may be driving some of the, I think, the ISM in the U.S. as well last week was very strong and the manufacturing indexes. So yes, I think if those trends hold together, it points towards 2021 being a significantly better year than last year. And I think with the rollout of the -- I mean, the vaccine starting at least, that there's at least some light at the end of the tunnel with regard to the impact of the pandemic, I think.

Given IPG's long history in this market. You guys have established and really maintained strong market share. But there's clearly competition. Competition among local -- from local Chinese suppliers. They've managed to gain foothold in the lower mid-range segment of the market. What's your sense as to what market share looks like today, and maybe you have to separate it because you clearly dominate still at the high end?

So our analysis still shows that our total market share is in the range of 60% to 60-plus percent. And that's even when some parts of the market over the last couple of years where we're stronger have been weaker, right? So automotive, traditional automotive welding has been weaker. Additive has been weak as well. You've certainly seen some improvement in things like EV, where we have very, very high market share. You've seen a transition to higher and higher power lasers being used in the high end of the cutting market, and that drives improvements in our total share, even in China, despite claims by the competition that they have, product that is competing with IPG strongly, which it's not. They've got serious issues, we think, around reliability. We've even heard that they're having to adjust some of their warranty periods that they're offering because they can't. I've said this all along, I haven't understood how they've been able to absorb the reliability issues on the P&L with the warranties that they're offering, and we've just got some feedback that they're actually having to shorten those warranty periods, which is an indication that reliability is -- uses pretty much -- a more fundamental. Of course, at the low end of the market, we think in China, we have just about, I think, under 50% share, 40% to 45% share. So that's a part of the market, which is growing very, very rapidly. There's a very high number of lasers sold in the less than 6 kilowatt, particularly in the 1 to 3-kilowatt range. And in that area, there is strong competition, but we still have, as I said, 40-plus percent share in that market. So we're selling thousands of units of lasers there, and we're competing very strongly with the introduction, for example, of our new ultra-low-cost and compact YLR rack-mounted lasers that have a lower cost related to some design changes, not just to the optical components and the benefit of lower diode prices, but even to the electromechanical components. So I think we're actually holding share pretty well even in a competitive market. The dynamics outside China are very different. There are other suppliers that are fairly aggressive in the market, but it's very difficult because they don't give a lot of data around how successful they're actually being. And what's reported at fiber laser sales sometimes includes diodes in the total volume of fiber lasers that they are selling is difficult to pass out. So yes, outside of that area, we have very high share. And then if you get into things like some of these more higher power applications, I mentioned that 200-kilowatt laser, some of the advanced applications, government applications, EV battery applications, we are -- we think we have an exceptionally high share there and compete more with TRUMPF rather than other fiber laser manufacturers in the EV sphere.

Would you characterize the pricing environment in these sectors as stable or at least what you'd expect in terms of being able to take costs out, the way you have?

I think because the market has been a bit more resilient across the board, pricing has been a bit more stable over the last 6 to 9 months than it has been previously. In some of those areas where we have a clear advantage, pricing is a lot more resilient. But you have to also imagine that in the high end of the cutting market, we have an advantage. Yes, of course, you can price those lasers at a premium. But because the cutting market looks at things on a dollar per watt basis, it's not as though you can price it 20 or 30-kilowatt laser on a per kilowatt basis at a significant premium to the low end of the market, but there is a total ASP benefit because there's just so much more power delivered with that later.

The cutting market has been such a core market for you guys. It's also a market that is somewhat more mature. Is this a high single-digit growth market for you guys in a decent economy, is that the way to think about it?

Yes. I think cutting is -- if you look at the data on it in terms of unit volumes over the last 8 to 10 years, it's quadrupled in size, right? So it has grown very, very rapidly. And as the cost of laser technology has come down, it's displaced on a separation processes. But I would say, I concur with that in -- growing that in the mid- to high single digits. I don't think would -- it's not unreasonable. And I think it's actually in terms of an investment, this is actually a pretty strong underlying growth rate because it's a 2x GDP. I think if you also look at that, you can look -- you can frame the opportunity by looking at what the total machine tool market is. And Laser's total share of that is still less than 15%, it's 10%, 11%. If you then eliminate some of the machine tools where we potentially can't displace them. So some of the reductive processes are still more difficult compared to additive. But so if you look at the separation process, the punches, presses, dyes, even now starting to see displacement of plasma cutting systems. And particularly for cutting thicker materials. So maybe the addressable market is 30%, 35% of that $70 billion, though, it still means that the laser penetration is still only 30%. So there's a huge amount of metal that's still separated using other processes.

Of course, the area that I think a lot of folks are looking at, including some of your competitors have also talked about it is, is the welding market and the opportunity there. Does this look like this is their next -- I don't know if you want to call it a greenfield, it's not exactly greenfield. But clearly, there's some drivers. You mentioned a couple of EVs and whatnot. What are you guys looking at in terms of opportunities in welding?

So we're looking at a lot of the integration of lasers in automated processes and looking at [ pewter ] welding as well as hybrid welding processes, often you can integrate the laser within an automated system with some of the traditional capability and there's fundamental improvements in quality and productivity there. We have a couple of examples that are very specific to that where people have been able to improve productivity and even simplify the design of what they're manufacturing. And that in turn has enabled very rapid returns on investment to be achieved. Welding of different types of materials is very important. So some of the alloys, if you look at aluminum or even titanium welding are areas where we're doing a lot of work on them. Welding different types of materials together or thicker materials together is another area. I think, overall, though, I'd say that the penetration into traditional welding is still a long way behind where it could be because lasers are capable of doing every single different type of welding, right? But those older welding technologies tend to be quite low cost. Welding itself, as a process, is not a fast process, even if it's done with a laser. So you don't get these huge productivity gains that you see with cutting applications. But you do get a cost advantage, but the cost advantage is perhaps not as fundamental. So it takes a longer time to displace things. The interesting thing I would say is that, in newer industries where they haven't necessarily been beholden to those older technologies or they haven't been using those older technologies. And let's think that those technologies have been used for decades, right? It's not as though they've just been around for 20 years and lasers come along. Resistant spot welding has been out there for 100 years and MIG and TIG and ARC processes for many, many decades. But new industries tend to adopt laser welding much more rapidly. In part because they're more aggressive, less conservative, in part because they're not beholden to those older technologies and in part because sometimes the welding that they're doing is a lot more complex, both in types of material that they're joining together. So within batteries, you've got, again, many different types of alloys. You've got thinner materials. You've got thousands of welds, that are having to be done very, very rapidly. You got many different types of welding processes within the battery application. And there are also other laser applications that can be integrated into the production lines too, whether it be the cutting of thin foils very, very quickly or even cleaning application. So the welding, with the lasers kind of fits in some of the other laser-based applications there. I think if you also look at consumer electronics. It's another area where welding penetration is much higher than it is in some of the more traditional industries. So and over the last decade or so, the amount of welding that's done within smartphones has increased quite substantially. So it's interesting to look at that bifurcation between some of the more leading edge industries and some of the more traditional industries that are out there. I think the final part to say on the welding there is that, we think that the handheld welder that we've introduced to the market is really a potentially over the near to medium-term, a much more fundamental game changer for lasers within the welding market. It's an extremely simple device to use. It comes with tens of difference of preprogrammed recipes, if you like, for welding different types of materials and different thicknesses of materials. The work that we've done with it shows that it enables less skilled welders also to perform processes, and that's a huge cost saving there. The quality of the weld done is extremely high. The device will also be shortly introduced with a wire feeding capability. So that where you need wire to fill joints. The wire when you weld with the lasers and often uses the joining mechanism, it's used more as a filling capability. You're going to have that capability incorporated with the handheld device. And even at -- the device is going to be 1.5 kilowatts with some high peak power capability system sort of almost QCW capability to get to the higher peak power levels at it. The processes for even welding thicker materials with multiple passes and runs will be similar to -- that's required for traditional technologies. So I think it will be interesting to see how the handheld welder changes some of the dynamics in the more traditional part of the welding industry, right? The manual processes, which are still very, very dominant.

And that product is just one of -- a number of products that, I think, were introduced in over the past call it, year, 1.5 years and really beginning to, I think, you're adding some new features to their portfolio, differentiating yourself from some of the competitors. But I wonder, yes, and as we think about new processes because your revenue base is fairly large. How do we think about some of these emerging growth opportunities. Yes, if we were to look at them in total, say, for the first 9 months and of the year. How meaningful is it? And in the aggregate, as we think about these new products and applications, they have the potential to move their revenue needle in the next 1 to 2 years for you?

Yes, they certainly do. I mean some of them are within the materials processing market, right? And some of them are outside of that in micro materials processing, in medical, in government, in entertainment and display, research and development. In total, those products that we disclose as our emerging products were about 20% of revenue in Q3, and I think pretty similar on a year-to-date basis. So they've become pretty meaningful, right? They are certainly contributing to total revenue. Within those, some of the larger categories that address materials processing of very high-power pulse lasers for cleaning and applications and things like foil cutting, within the 1-micron area, you've got a lot of the government applications as well that address some of the advanced directed energy areas. And then you've got in micro processing, for example, very strong growth driver this year and with new processes that are going to -- new process is going to be quantified very shortly. Green lasers for solar cell manufacturing. The order flow from that has been exceptionally strong and continue to be so through Q4. So that -- the green lasers, if you can start to drive similar adoption for ultrafast lasers and some of the shorter wavelength UV lasers and incorporating the ultrafast technology with some of those shorter wavelengths, you can probably -- you can potentially see some significant transitions in demand, similar to the performance of the green lasers which has really been very exciting. The other area that's been exciting this year has been the rollout of the urology application for medical lithotripsy with kidney stone. The run rate of that business is approaching $30 million a year. 2021 after the initial product launch is going to be more moderate growth, but then as we start to see the displacement of the existing systems, we think 2022 and 2023 are really going to start to drive that business very meaningfully. Interestingly, part of that business uses -- it's the first part of our business that has a consumable element to it. So there's a fiber that's used in each of those procedures, sometimes, particularly in North America and Europe. And even increasingly in some Asian countries, that's a single-use fiber. And if you look at an estimate of, say, one procedure being done a day on these systems, it's over 200 fibers a year and each system generating $20,000 if you have ultimately 1,000 systems deployed, you've got a revenue stream of $20 million from that consumable. Now that's not -- you may look at that and say, that's not that great. But 1,000 systems is only 5% of the estimated number of holmium dusting lasers that are out there. So if you can grow your share within this market from 5% to 10%, 15%, 20%, you could have a consumable fiber business that is significantly greater than that $20 million. And the target is obviously to grow that medical business to $100 million within 2 to 3 years’ time. There are other medical applications we're working on. So soft tissue rejuvenation for cartilage. There's applications that address some of the dermatology. So cleaning and removing lesions and other pigmentation. There are applications that we're working on for varicose veins, which is expected -- that market is expected to grow very rapidly over the next 3 to 4 years. So the medical -- even in things like there may be applications in cardiovascular where you could use the laser. This is very early stages of research and development, but to regenerate heart tissue and strengthen heart tissue -- not in a -- it's not a dissimilar way that you can rejuvenate cartilage, which is basically going through a frac cell type process to create very small, it's difficult to explain, where you can create very, very small distortions in the cartilage, which then heal. And as the healing process happens, it's the rehealing of these micro abrasions, if you like, that actually rejuvenate and strengthen the soft tissue. So I think medical is one of the very exciting areas. And then you've got, obviously, some of the investments we're making on the systems business, which has -- had a bit of a struggle this year, but parts of that have performed very well. So for example, the medical device systems, the systems we use for medical devices where maybe producing stents or cutting metal for medical device manufacturing or welding pacemakers, the demand for that has been pretty strong, even though some of the macro systems that are supplied by Genesis has struggled this year in part as well because the aerospace end market, where they were starting to get some traction has been very, very weak.

If we were to look at all in medical and maybe it does encompass a variety of applications all in medical. What does that represent now? And that has a growth rate that's clearly above the company corporate, right?

Yes. I mean, all in medical is still pretty small. And so it's trending towards about an annual rate of -- well if you include medical devices -- sorry, if you include the systems for medical device manufacturing, you're getting up closer to 5% to total revenue. So if you include medical procedures and systems for medical device manufacturing, you have probably about, a little bit under 5% of the total.

And you alluded to Genesis. And not only commercial aerospace, but they've had historically had some exposure, obviously, the automotive market. And that was an acquisition you did back by the end of 2018. What are your thoughts about that? And how do you think about the Genesis business going forward?

So we're still optimistic about the prospects of that business. In the last year or so, it has -- it's been impacted, not just because of aerospace, but the systems they sell are complex, very high-value automated manufacturing systems, right? These are not $0.5 million systems they can be as -- they can range from $1 million or a little bit below $1 million to $7 million or $8 million. So they are important. When people are making those kind of investments, first of all, there are the things that get pulled back, first. And secondly, they require a significant amount of work to be done when the investments are being made to ensure that the processes that are being implemented can achieve the returns that they're looking for on them. But having said that, the pipeline of business that Genesis has is quite strong. And the pipeline of some of the transition towards laser-based process is also very strong. I'd say the business is actually -- it's relatively stable, and that stability has been reached over the Q3 and even into Q4. The problem is, it's below the level at which we acquired it. So it has to grow back up and then grow from there in order to start to get a more meaningful return on it. I think it's going to take probably, I would look in for some significant and meaningful rebound this year in the business. And then probably see it get back to the level where it was when we acquired it in 2022 and then grow from there. We're still looking to grow that business from the current level back to $100 million then $150 million and above. So it's an important part of the strategy that we have. And it's very much focused on, I said, both laser welding and hybrid-laser welding processes. Some recovery in the aerospace industry would help that as well.

And you touched on another opportunity that a lot of laser and photonics companies have been talking about for a while now, but certainly in the past year, there's directed energy and on the defense side. Any update as to what you're seeing in that market and you're feeling in general about the competitive landscape?

Yes. So it's generally been a -- it was a very strong year for that application. We sold numerous single-mode lasers. We had another order for the single-mode lasers in Q3, that I mentioned, that would -- incorporated in our guidance for Q4 delivery with 2, 100-kilowatt lasers that we took orders for last year continue to deliver some diodes and amplifiers for other applications within that. So our focus is really on continuing to supply the optical component of that, the energy source, right? We're not getting involved in doing the beam combining and building these complex tracking systems, that's not where our inherent skill set is, right? And we continue to believe that on the optical side of it, we have, by far and away, the greatest advantage, both in terms of beam quality and the ability to scale power and also even whether coherently combining amplifiers that are of a lower power level in producing the highest quality of those amplifiers as well as producing the diodes. So I think you really have to -- when the competitors talk about it really assess their capability versus ours in terms of that reliability, scalability of power and beam capability. And then you have to look at what they're actually doing within the industries because some of them are seems to be more focused on the actual delivery of the light and the beam tracking capability, which we think -- I mean there's tens of people trying to do that within the defense subcontracting and defense part of the industry, right? There's -- you mention or think about any of the names out there, and they're all developing that combining and tracking technology. And so we don't think that's where the core element of value we can deliver is, it's really around the laser itself. There's still talk within the industry, for example, you'll see these articles that will come out about chemical lasers, which do have some capability to produce very, very good beam quality and high-power levels, but they're very, very difficult lasers to use in even a laboratory environment. They're not reliable. They require a lot of downtime before they -- after they've been fired to get them up and running again. And so things like even chemical lasers have not got the commercial viability to address that market.

Yes. We're running out of time. I wanted to ask you one final question, if I may. Genesis was the last acquisition of significance, you guys did. You've got quite a significant cash position, over $1 billion in cash and investments. How should we think about acquisitions and capital deployment?

So we're continuing to look at potential acquisitions. There's clearly a host of different markets that we're trying to get into, and we've developed technology and products for. So that broadens the opportunity of areas for us to look at acquisitions, whether it be, for example, in micro processing or in the medical area. I think over the last year, although, also there's been so much -- not just volatility in the market, but we've had to really focus on internally managing the business through this very, very difficult time. And I'd say that's put -- maybe potentially to focus on acquisitions a little bit on hold, and it's also been important to make sure that we -- what we've acquired is being fully integrated and that we're getting a return on that. But there's still a pipeline of things we're looking at. I -- clearly -- we could support much more meaningfully sized acquisitions on the balance sheet. But the other side, the capital allocation is not just the acquisition side. I think we've become more mature and we've enhanced and developed our capital allocation strategy. We have an anti-diluted buyback and a pure buyback that's approved by the Board of Directors. We try to do those on a pretty disciplined -- the anti-dilutive just gets done on a weighted average basis, but the other pure buyback, we'd like to manage that on a fairly disciplined basis where we're looking at what the our internal analysis of the fair value of the company is. And relative to that, where the stock is trading and accelerating or decelerating the share repurchases there. I think the other side of the equation is that the strength of the balance sheet in itself has been attractive to a large part of the investor base over the last year or so, they see a tremendous amount of stability in that. So we're not -- as I said, we're not here to necessarily financially leverage the company, we're here to execute around the technology fundamentally.

Terrific. Tim, thank you. We're going to close it off there. Thanks very much for joining us today.

Great, Jim. Good to see you. Thanks a lot. Bye.

Bye-bye.