IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Greetings, and welcome to IPG Photonics' Fourth Quarter 2020 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 Director of Investor Relations, for introductions. Please go ahead, sir.

Thank you, operator, and good morning, everyone. With us today is IPG Photonics' Chairman and CEO, Dr. Valentin Gapontsev; Chief Operating Officer, Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen. 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 include the impact of the COVID-19 pandemic on our business and those detailed in IPG Photonics' Form 10-K for the period ended December 31, 2019, 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 by contacting the company directly. You may also find copies on the SEC's website. Any forward-looking statements made on this call are the company's expectations or predictions as of today, February 16, 2021, only. The company assumes no obligation to publically release any updates or revisions to any such statements. For additional details on our reported results, please refer to the earnings press release and the excel-based financial data workbook posted on our Investor Relations website. We will post these prepared remarks on our Investor Relations website following the completion of this call. With that, I'll now turn the call over to Valentin.

Good morning, everyone. We are pleased with our fourth quarter results as we delivered revenue that was 10% higher than the fourth quarter 2019 and above our guidance range. In addition, book-to-bill was above 1 in the fourth quarter as we saw the traction in order flow that had started in the third quarter continue during the fourth quarter and into 2021. We're continuing to benefit from the advantages of our leading-edge products, technology differentiation, low-cost production capabilities and the global footprint. We continue to see strong revenue in China, which was significantly higher on a year-over-year basis as volume growth more than offset lower selling prices in the region. We were also pleased to see a sequential improvement in revenue in Europe and strong sequential revenue growth in North America in the fourth quarter. Our systems sales also improved modestly, but continue to be below last year, primarily due to the impact on the economy from COVID-19. We're demonstrating good progress in our core markets, thanks to our technology differentiation and low-cost production capabilities. In high-power lasers, we delivered strong year-over-year growth in both our rack mounted 1 to 4 kilowatt lasers for the high-volume market and our ultra-high power lasers for leading-edge cutting systems as sales of lasers above 6 kilowatt increased 34% compared to the fourth quarter 2019 and were 56% of total high-power sales. At the high end of the market, we are benefiting from an increase in order volumes for our 20 and 30 kilowatt ultra-high power lasers and optical heads. These lasers not only enable 50% to 100% faster cutting speeds than our 15 kilowatt devices, but are capable of processing materials with 20 to 50 millimeters thickness or even greater. This improvement in productivity and flexibility, coupled with superior beam parameters, record wall plug efficiency and reliability is driving the replacement of plasma cutting machine, other nonlaser solutions and lower power laser solutions. We booked the first orders for the new unique ultra-compact rack mounted U series of lasers for low-cost cutting systems, and we expect to start shipping them shortly in volume. Not only do these lasers provide extended optical performance, record power-to-volume ratio and full protection against humidity, they are also significantly evaluating cost to manufacture. As a result, we expect this new design to improve gross margin for these products. We continue to focus on growing sales in other applications that are outside of our traditional cutting and welding markets. Last quarter, we launched our revolutionary and innovative handheld laser welding system and the initial customer response has been extremely positive. We believe this system has a great potential for IPG as it replaces traditional handheld welding products used in metal fabrication like TIG or MIG. The product offers orders of magnitude higher welding quality and speed with much greater precision, flexibility and ease of use to our customers around the world. In addition, for the first time, the product will simultaneously provide the highest quality precleaning and after-cleaning of the weld surface and weld itself, respectively. We have already sold a number of units in the last few weeks only and believe that there are many thousands of customers in the U.S. alone and many tens of thousand worldwide that could be interesting in this unique product. During the fourth quarter, emerging products and application sales were 28% of total revenue, increasing 22%. We are pleased with the performance of a number of products that are the key to the diversification of our revenue. Examples include high-power nanosecond pulsed lasers used for foil cutting and cleaning in electric vehicle battery processing as well as for ablation and cleaning; sales of medical lasers and consumable medical fibers, our gold standard thulium laser solution for urology; and green laser sales for solar cell processing. With record backlog, we expect sales of green lasers to continue to grow fast as our green pulsed lasers are enabling significant improvements in solar cell efficiencies. In addition, high-power lasers for defense application performed well year-over-year. Despite the impact of the pandemic, ultraviolet and ultrafast pulsed lasers into emerging microprocessing applications showed strong growth for 2020. Our Adjustable Mode Beam, AMB, lasers continue to gain traction in the welding industry, most notably in electric vehicle battery welding. And as a result, we received significant orders for AMB lasers in Q4. Our AMB products offer superior speed and weld quality over competing solutions, thanks to broadest range of beam tunability, which enables spatterless welding. The multichannel QCW laser for high-speed spot welding application brings significant cost savings due to an increase in welding productivity and decrease in electrical consumption. Beyond material processing, we continue to develop new soft tissue medical treatment, mid-infrared lasers for molecular-level resolution online spectroscopy, inspection, sensing and biomedical research applications. In addition, we are continuing development of our new generation of analog and coherent digital silicon photonic devices for super high speed and highest volume data processing for telecom, data telecom, many -- and many other advanced future applications. Furthermore, we were extremely pleased by the growth we saw in advanced applications and medical applications. Research and development has been a driving force behind IPG's structure since the company's inception. We spent over 10% of our total revenue on R&D in 2020 and have over 650 people in research and development, including many scientists and engineers who continue to develop new leading-edge solutions for our customers, helping drive efficiency and productivity in their operations and making our fiber laser technology the tool of choice in mass production -- more than 20 years tool of choice in mass production, nobody can compare cost of this absolutely in quality and others. I would like to thank our employees for their strong execution during our fourth quarter despite the continuing challenging operating environment. As a result, the well-being of our employees, their families, our customers, our partners and communities we operate in remains our highest priority. With that, I will turn the call over to Eugene Scherbakov.

Thank you, Valentin, and good morning, everyone. The impact of COVID-19 on our production capability continues to be minimal and we are focused on ensuring the safety of our employees with social distancing and enhanced cleaning and filtration measures in place. Otherwise, we're operating normally. Despite the increase in COVID-19 cases in Northern Hemisphere with this fall and winter, production remained fully operational and we managed COVID-related absences effectively. We are very pleased with performance of operations during the fourth quarter as production ramped to meet the increase in demand, enabling us to exceed the top end of our guidance range, and report first quarter of year-on-year growth in more than 2 years. We're proud of the improvement in underlying gross margin driven by an increase in revenue, product cost reduction and product mix improvement. Total SG&A and R&D expenses were $76 million in the fourth quarter and continue to benefit from lower travel and trade show expenses given pandemic-related restrictions. As the business activities start to pick up and some restrictions are lifted and life normalizes in the second half of 2021, we would expect our operating expenses to increase as well. We remain committed to supporting our R&D, while controlling the total operating expenses to drive operating leverage for the company. We continue to benefit from the reducing of the cost of devices, our vertical integrations and from expenses reduction initiative we undertook in the second half of 2019. Examining our performance by region, revenue in China increased 52% year-over-year, represented approximately 42% of total sales. Demand and order flow in China remained resilient during the quarter and order booked in 2021 prior to Chinese New Year have been strong. While we face aggressive competition in the region, we believe that our products have superior performance and reliability and we are seeing the strong growth in demand for our ultra-high power lasers. In Europe, while revenue decreased 5% year-over-year due to the effect of COVID-19, it did grow sequentially. In addition, in Europe, order flow continued to get better despite the increase in restriction in Europe due to lockdowns. Similarly, revenue in North America decreased 11% year-over-year, but grew 37% on a sequential basis with a good improvement in material processing sales for lasers and systems and year-over-year growth in medical and advanced applications. North American bookings continued to be strong even relative to expansion of order flow in Q3 2020. Sales in Japan decreased 29% year-over-year. While economy in the region continues to be negatively impacted by COVID-19, some regional macroeconomic indicators have improved in the recent months. Sales to the rest of Asia increased 3% year-over-year, continuing to recover from the second quarter trough, and also benefited from shipment of green lasers for renewable energy. Sales in Turkey decreased 2% year-over-year and grew 21% sequentially. Economic indicators continue to show improvement from significant contraction earlier in the year, and this is one factor behind the improving direction of our business. In addition, it seems that there is some optimism for an improving investment cycle driven by equipment upgrades related to requirements for the flexible processing, automation and energy efficiency. Our leading-edge fiber laser technology offers significant productivity gains, electrical efficiency and lower cost of ownership over other lasers and nonlaser tools. An increasing focus on the environmental impact and commitment to the net-zero emissions for a large industrial manufacturers is creating additional opportunity for our lasers and bodes well for our long-term growth objective. We're already starting to see it with electrical vehicle and electrical vehicle battery production and are likely to see it with other industries. We believe that efficiency is likely to become a more meaningful driver in displacing processes that are energy intensive, such as plasma cutting or legacy welding processes. Despite the challenging operating environment that we faced in year 2020 due to the COVID-19, we believe that we are well positioned as we enter year 2021. In addition, we continue to believe that the breadth and depth of our product offering, our vast and diversity of advanced materials and components technology platform, our efficient R&D model, our strong balance sheet and free cash flow provide us ample flexibility and respond to business disruptions. With that, I'll turn the call over to Tim to discuss financial highlights in the quarter.

Thank you, Eugene, and good morning, everyone. Revenue in the fourth quarter was $337 million and increased 10% year-over-year, driven by growth from most of our key product lines. Revenue from materials processing applications increased 10% year-over-year and revenue from other applications increased 12%. Sales of high-power CW lasers increased 17% and represented approximately 55% of total revenue. Sales of ultra-high power lasers above 6 kilowatts represented 56% of total high-power CW laser sales. Pulsed laser sales increased 55% year-over-year, with strong growth driven by our high-power nanosecond pulsed lasers used in EV battery manufacturing, green pulsed lasers used in solar cell manufacturing as well as higher sales of our new UV and ultrafast pulsed lasers, which were partially offset by lower sales of low-power pulsed lasers for marking applications. Systems sales decreased 20% year-over-year due to COVID-19, but did improve sequentially. Medium power laser sales increased 25% as there was some recovery in additive manufacturing and other fine processing applications. QCW laser sales decreased 16% year-over-year due to lower sales for aerospace drilling applications. Other product sales decreased 11% year-over-year primarily due to lower telecom sales. Q4 gross margin was 44%, which increased 310 basis points year-over-year. The additional inventory charge reduced gross margin by 410 basis points. Excluding this impact, gross margin benefited from lower cost of products and a decrease in unabsorbed costs as a percentage of sales as compared to the year ago period. The additional inventory charge of $14 million was related to optical components that have been replaced by components with better performance. Fourth quarter GAAP operating income was $65 million and operating margin was 19%. During the quarter, we recognized a foreign exchange loss of $5 million, primarily related to the depreciation of the U.S. dollar versus the euro. Q4 net income was $49 million or $0.92 per diluted share. The additional inventory charge and foreign exchange loss reduced EPS by $0.27. The effective tax rate in the quarter was 24%. If exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $12 million lower and gross profit to be $8 million lower. We ended the quarter with cash, cash equivalents and short-term investments of $1.4 billion and total debt of $38 million. Strong operational execution resulted in cash provided by operations of $85 million during the quarter. Capital expenditures were $26 million in the fourth quarter. We expect 2021 capital expenditures will be in the range of $150 million to $160 million for the full year. Total capital expenditures in 2020 were significantly below our initial budget as we delayed some projects and some of these projects are now rescheduled for 2021. 2021 CapEx includes facilities and equipment expenditure for production, R&D and sales activity to support our future growth. During the quarter, we did not repurchase any shares. In total, fourth quarter book-to-bill was above 1, and we were pleased with order flow across all of our main geographic regions. Geographically, most areas continue to show improvement with the only area that remains weak being Japan. For the first quarter of 2021, IPG expects revenue of $310 million to $340 million. Company expects the first quarter tax rate to be approximately 25%. IPG anticipates delivering earnings per diluted share in the range of $0.90 to $1.20, with 53.2 million basic common shares outstanding and 53.9 million diluted common shares outstanding. The improvement in macroeconomic indicators is now more broad-based and, if sustained, gives us optimism for 2021. However, we're a little cautious given the resurgence of COVID-19 in Europe and North America as well as the uncertainty surrounding vaccination rollout and return to normalcy is unclear at this time. These uncertainties continue to make forecasting our business challenging in the medium term. And our first quarter guidance remains subject to significant uncertainties, including the impact on the global business environment and expected recovery from COVID-19, economic trends, growth from emerging product revenue, competition and the lack of long-term binding order commitments. That said, we continue to benefit from near-term growth opportunities in ultra-high power cutting, electric vehicle battery processing, renewable energy, microprocessing, medical procedures and advanced applications. We believe the strides we are making in higher power products within our core materials processing business and new solutions are enhancing our competitive position. As discussed in the safe harbor passage of today's earnings press release, actual results may differ from our guidance due to factors, including, but not limited to, goodwill and other impairment charges, product demand, order cancellation and delays, competition, tariffs, trade policies, health epidemics and general economic conditions. 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 company's reports with the SEC. With that, Valentin, Eugene and I will be happy to take your questions.

[Operator Instructions] Our first question comes from John Marchetti with Stifel.

Tim, Valentin, I was wondering if maybe you could just talk about some of the puts and takes on the longer-term view. I know you mentioned that the underlying fundamentals continue to get a little bit better here. But as we're looking out through the course of the year, all else being equal, would you expect that we're back to sort of getting back in line with a double-digit revenue growth range, maybe off of '19 as opposed to '20 given that '20 was such a challenging year?

Yes. We're not going to comment on annual guidance or targets there. So except for your last comment, John, I think talking about puts and takes, there were a number of them articulated in the script. First of all, the continuing shift to higher power lasers for cutting applications, a lot of new product introductions. We're very optimistic about the handheld welder and growth in revenue from that. All of our emerging products in Q4 performed really exceptionally well across a pretty broad portfolio of items that are starting to drive incremental growth. So whether it's the green lasers, the high-power nanosecond pulse lasers for EV, some increasing traction for ultrafast and UV. Medicals performed very well during the whole course of the year with the lithotripsy application. Other newer product introductions, the multichannel QCW for displacing YAG lasers in spot welding. We had good orders for AMB. So we continue to see traction and momentum across what is now a pretty broad-based and diverse set of products and applications, and we continue to see improvement in -- we referenced again some of the key macroeconomic indicators that we follow. Certainly this year looks like it could be set up for being significantly better than the last 2 years we've been through. I mean the key issue will be to get out of some of the volatility that we've seen that sometimes impacted the second half of a year as happened in 2019 or as resulted in a slow start to the year as the pandemic did last year. So the main target is to get out of more of the volatility and get to sort of consistent year-over-year growth on a quarterly business, and we've got significant drivers for that.

Got it. And so maybe just as a follow-up on the gross margin side. As we're looking out over the next several quarters, any expectations that we should assume maybe some additional charges like we saw this quarter? Or really treat that more as a one-off here in 4Q, and we're back to a more normalized environment for gross margin as we're looking out over the first half and into '21?

Yes, I'm much more definitively expecting a normalized gross margin print over the coming year. We've -- during the course of the year, not just in Q4, given some of the volatility related to the pandemic, we have had significant inventory provisions and charges. And the last -- the final charge in the end of the quarter, I think, positions us well for a more normalized operating position going forward. So I think we've got a good start to the year in that context as well. And on the other side on gross margin, we've got other benefits coming through from some of the product mix as we continue to grow revenue, better absorption of fixed costs and then, for example, the ultra compact laser starting to generate more meaningful revenue, there's a meaningful improvement in gross margin we expect from that. And then even taking the design changes on the ultra compact and rolling them into higher power lasers up to, I think, 7 or 8 kilowatts -- up to 8 kilowatts not going to be used in. So there's a lot of other initiatives on cost reductions as well that we're optimistic about.

Sincerely speaking, we expect that this year, our gross margin will return back to our usual frames above 50%. But we're very careful with forecasting because the situation over quarter 3, quarter 4 is not setting at all. So quarter 1, quarter 2, absolutely promising on the puts, however. But of course, you know definitely our guidance is so very, very careful, very considerate.

Our next question comes from Tom Diffely with D.A. Davidson.

When you look at the strong activity, it sounds like you had pre-Chinese New Year in China on the order front. Do you expect China to grow as a percentage of the order book over the next couple of quarters? Or is that being matched by growth in some of the other regions?

Tom, relative to like Q1 last year, when China order flow slowed down dramatically and then it really picked up in April and May, I would expect, in total, China order flow to remain relatively consistent as a percentage of the total because the growth in Europe and North America was also starting to recover more meaningfully. There's the growth in some of the emerging products as well that are not just strong in China, but are strong elsewhere. So totally, we expect more of an even contribution and a rather less China-centric focus perhaps on revenue for the year. But notwithstanding that, China order flow has really been very strong prior to Chinese New Year. For example, not just of shippable orders, but even the frame agreements has been very, very good. And those are generally placed to get licenses, so that shipment can take place during the course of the year.

And remarkable, the most frame orders, the normal quality of frame orders is practically doubled compared to last year or last 2 quarters. But the major of these orders is for high-power above 10, 15 kilowatt, when they're asking for license to get license. It's a normal growth of high power from that point. So we expect -- nobody can supply them that wattage. Nobody -- it's only we can supply working more than 15 -- 10, 15 kilowatts working [indiscernible] all the time for IPG, all China done for IPG today. It's a lot. It's Europe and America is much more neutral here. Very much less still because major integrator -- cutting system integrators in Europe and the U.S., they don't have all high-power lasers, don't have. So -- and they're stocking 10-kilowatt range level. But China, extremely 15 to 30-kilowatt level.

Okay. That's helpful. And then as a follow-up, how big is the EV battery market right now for lasers? And where do you think that goes over time?

I think it's -- I don't have a definitive number on that in terms of where it is today. The message we give on it is that it is a potential decade-long investment cycle. And if EV vehicle production is going to get to the levels that are expected, people are talking about 25%, 40%, even 50% of total vehicle sales over 10 or 15 years, it will drive hundreds of millions of dollars of laser-based investment for EV battery manufacturing and even laser-based investment for EV auto vehicle manufacturing itself. So it's a long-term significant opportunity with hundreds of millions of dollars of laser-based processing required for that. Even some of -- I've noticed some of the battery tech -- all the battery technologies like cylindrical, which were not using much laser-based processing, seem to be evaluating lasers more and more now.

Our next question comes from Nik Todorov with Longbow Research.

Tim, in the last up cycle, you guys had -- we've been very consistent on putting about 60% incremental gross margin. I understand guiding sales is difficult, but how should we think about the incremental gross margin? You highlighted multiple cost initiatives. Should we think about that 60% as a base case? Or you could see some upside? And also can you talk about what are the limitations of rolling that ultra compact design above 8 kilowatt? And then I have a follow-up.

I think some of the incremental gross margins are probably not far off where we were historically, maybe a little bit below that 60%. The one thing below the line we're cautious on is as we get into a more normal environment, we try to call this out on the script is that operating expenses, you get more travel and trade shows and other activity in a more normal environment. OpEx will probably pick up in the second half of the year a little bit. So that drop-through won't be straight to the bottom line. In terms of the other question about migrating the design of the ultra compact to higher power lasers, perhaps, Eugene, you'd like to talk about that and a potential rollout over time?

In principal, we have several generation of compact lasers, starting -- I'm talking about high-power lasers, of course, with power more than 2, 3 kilowatt. And the first stage was already demonstrated, and we already shipped thousands of such kind of lasers. The next step was to use a rack mounted compact laser for high-power applications, I mean, with power more than 1, 2, 3 and 4 kilowatt. Again, such kind of lasers already supplied to our customer effectively for -- first of all, for cutting and also for better welding application. The next-generation, which we are introducing this year, is much more compact with output level up to 8 kilowatt. It will be the next stage. And the first results demonstrated very good performances. And we're absolutely sure that it will be the next generation of ultra compact rack mounted laser, first of all, for cutting applications. And very important that based on this design, we can dramatically reduce our cost of production and, of course, to propose to our customer better price. Such kind of situation is compact and ultra compact lasers.

Okay. Very helpful. And just a follow-up. Maybe can you guys talk about the adoption curve that you expect for the handheld welding laser? It sounds like you guys have received -- you mentioned extremely positive feedback. How much do you think do you have to educate the customer or to kind of prove your point? It seems like they're seeing the benefits outright. I'm just trying to see what are you thinking in terms of the adoption curve.

VG, do you want to take it?

Our estimation is enormous. Only United States that we investigated, more than 24,000 only small drop shops, which uses this manual welding tool instrumentation. 24,000 only U.S., but also watch OEM where I got a motive now that it was also used. But even they -- each of them will buy only 1 unit is 24,000 units. 24,000 units was $300 million. Only 1 unit, but typically the small shops spend not 1, 2 by 10. It's all that U.S. count, minimum 5x more, so it's 100,000 shops. Each from the -- we now provide for testing for this estimation, more than 70 -- only U.S., more than 70 such drop. They still think it's fantastic devices. Let's imagine only speed of welding. Speed of welding increased 6 to 7x -- 6 or 7x quality of welding, much, much higher than with regular, but also simultaneously clean -- immediately clean surface and pre-welding and after-welding. Now with TIG and MIG regular, they have to use chemicals then to clean this, in any case, quality of final surface, not were very sufficient. Now they don't need to make [indiscernible] and thus for one time put by laser beam in additional mode operation the same way the beam [indiscernible]. So the people with slow fantastic improvement, so they only waiting, waiting with the way -- delivery only due to some formal bureaucratical qualification for electrical emissions. So now we have a ship in U.S. of this emission, started only of -- a few weeks, started to ship first unit to be able to sell to customer before we cover due to order falls. So with new year, this year only, we'll sell some welding unit. Next year, it would be 10,000 units. So it's very fasting production market, and we don't see competition can make simmer during next 1 or 2 years. Even later would be difficult because we have very innovative new technology, which any Chinese, nobody have today.

On the other point, actually it's easier to use as well. So it's easier to use. So the training of the welder and the skill of the welder...

Yes, very easy to use. If the normal welder, you have to train many months, even more it should be some tailwind. Here, you don't need any person, any student. After only few hours of demonstration, presumably production can go out immediately. So practically, it's available to everybody today. It's also enormous benefit, because quantity of professional welders now decrease and decrease.

Our next question comes from Jim Ricchiuti with Needham & Company.

On the topic of the handheld laser, so I'm wondering are you going to market any differently with this product offering, just given the size of the market and the price points? And how are the gross margins on this product?

So in terms of going to market at the moment, we're rolling it out in a phased manner with some of the key -- we had a lot of job shops coming to evaluate it. And we're also looking at potentially some distribution arrangements, but we potentially also have to expand some of the sales force as volumes ramp up to support what is a much broader-based customer list compared to our typical OEM base. So we're continuing to evaluate how best to get to that efficient model around it, Jim. But -- and typically, we've invested in a stuff as we've grown the revenue on it to get that return simultaneously. We may use a few more distributors around this as well. And the gross margins, by the way, on the product are very good, benefiting from some of the design improvements around the ultra compact lasers.

Okay. And the follow-up question is, you showed a nice recovery in the U.S., at least in North America, at least on a sequential basis. And I'm wondering you look at that business over the next couple of quarters, how sustainable do you think it is? Is it broadly based? And are you feeling comfortable that, that recovery in the U.S. is sustainable?