IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Good afternoon, everyone, or evening, depending where you're dialing in. It is my pleasure to welcome Tim, the CFO of IPG Photonics. This is the first time we've hosted IPG at our Global Industrial Conference. Typically, IPG attends technology conferences. It truly fits the definition of an industrial tech company or better yet, a technology company that services industrial markets. And maybe we can start there, Tim. So could you help people who might be new to the story at our conference with a bit of an overview. What are some industries that are using fiber lasers today? And how you see them displacing manufacturing processes over time.

Good afternoon, Mike. Good to be here and joining you at the Industrial Conference. Yes. I think you're right, yes, we're very much a technology company that's historically been focused on a lot of industrial end markets. There are newer applications opportunities outside of that, which we'll talk about a bit late, hopefully. But lasers are accepted as a pretty fundamental machine tool, right, they're displacing all kinds of different processes used in industrial production of many, many different products. So I have to start with some of the processes and what they displaced and then some of the industries that may help to frame it a bit better. So we think about industrial applications in terms of probably 4 broad categories. The first of which is separating metal, so cutting them or drilling holes. In those applications, you're displacing anything from punches, presses, dyes, mechanical source, plasma cutting systems, anything that's basically separating materials and mechanical drills as well, for example. In joining technology, so a laser basically can weld metal and other materials together. In that example, you're displacing traditional welding applications. So you can understand those used in fabrication and very widely used in many industrial manufacturing processes, whether it be in automotive, agricultural equipment, heavy equipment manufacturing, manufacturing of consumer durable goods, elevators, railcars, ships. I mean weldings are very, very highly widely used applications. In joining you also display, for example, riveting, which is -- which has been used for joining of reflective materials together such as aluminum. So the benefit of a laser is that you can also weld different types of materials and reflective materials, and you can also displace things like adhesives that are used as well as a joining mechanism. The fourth area we kind of think about laser processing in is ablative processes. So here instead of penetrating the material you're working on you're removing layers of material from it, the oldest application there is marking and engraving, so displacing traditional marking engraving technologies that may have used inks or chemicals to actually engrave. So what are the mechanical processes that would have actually engraved. So the laser is a noncontact process that produces a permanent mark and can produce very sophisticated marks on different types of materials. Those ablative processes are expanding into other areas such as cleaning applications. So you're starting to see lasers use the prepare metals for welding, cleaning, coatings of things, cleaning corrosion off services, cleaning production molds or storage vessels and tanks. So all of those are ablative processes where the laser is burning either an intentionally laid down material or a material that's a contaminant there. And then the final area we think about industrial process is really on deposition technology. So for example, cladding applications, you are taking a metal substrate and, say, steel and laying down titanium because you want a harder surface on it or you're taking additive manufacturing processes and taking metal powder and melting it together in a laser sintering process to build a complex part. In that example, you're displacing reductive processes such as machining or ultimately, you could also be getting into producing more complex shapes and parts than costing can produce. So explaining those applications, I think you can understand you address a very, very wide variety of industries that range from automotive to aerospace to fabrication and shipbuilding furnitures, furniture manufacturing, light fixtures, refrigerators, microwaves, other transportation manufacturing and making buses, railcars, construction industry, to name a few. Consumer electronics and smartphone manufacturing within the automotive industry, the shift towards EV vehicles is a beneficiary of the laser -- benefits the laser industry, not just from a significant benefit from battery manufacturing, where in fact, 3 applications are used: welding, cutting and cleaning applications. So the end industries and applications in the industrial markets are very diverse, and we haven't yet touched upon some of the nonindustrial markets there. You may be less interested in, but we're very interested.

No. I think we'll touch on that, and we'll definitely touch on the EV battery manufacturing side after what we've heard this week from VW. But I guess the first question I want to get into is, you guys are headquartered in Massachusetts, and China is your biggest region with nearly 40% to 50% of sales, depending on the quarter. So for everyone dialing in, why is China your biggest market? How do you protect your IP? And how do you think this as a percent of your mix kind of evolves going forward, Tim?

Yes, that's an interesting question. Historically, the laser market for industrial applications was more dominated by European and Japanese machine tool manufacturers, right, if we went back, say, 10 to 15 years or so. Those companies would more -- they may have exported equipment to China, but they're also servicing, for example, the machine tool industry, and laser machine tool industry in North America is relatively small so they'll be also supplying lasers into North America and Southeast Asia as well. The real change you've seen over the last 10 or 15 years is the laser-based systems' capability, and demand for laser-based systems in China is growing enormously. And they've been very, very aggressive adopters of, in particular, fiber laser technology given its advantages. So not only do many of those foreign machine tool companies either export systems to China or have set up joint ventures there. There are many home grown companies that have developed in China that produce cutting systems and marking systems and integrate welding capability there. So they've advanced tremendously, and for a long period of time China has been the manufacturing part of global industrialization, right? I mean, I think we may see some changes coming up in terms of more regional supply chains given the challenges thrown up by the pandemic and even the trade war, the impacted business in 2018 and '19. But it's really a sort of acceptance of laser technology. China is also, obviously, with the advanced manufacturing 2025 vision is very rapidly adopting any technology manufacturing in Houston, potentially is more aggressive and has been more aggressive around it than even some of the other regions around the world. So as a result of that, adoption and investment and capacity additions in China across multiple different industries, it's become a very important market for IPG. In terms of how we protect our IP, we actually don't make anything in China at all. Everything is made in North America, Germany. And our low-cost manufacturing is actually based in Russia and Eastern Europe, where we have a very competitive manufacturing cost but also don't have a lot of IP leakage, right? You don't have people trying to set up making fiber lasers in their garage, generally speaking, and you're not subject to the same IP threats that you perhaps have in China. And to address the last part of your question, China is going to remain a very important part of the market for us. It's had its challenges given some of the increase in competition there. A lot of the strategies we're pursuing at the moment are to diversify the business. Many of those applications have broader-based demand globally, if it's medical applications or microprocessing applications or advanced applications indeed wouldn't have any demand in China, but if those -- their diversification strategy is successful. For example, I mean, people in China getting kidney stones, you're going to try and install kidney stones removal equipment in China. But there's obviously also very strong demand for that equipment in North America and Western Europe as well and the dynamics around some of those emerging businesses were a bit different in terms of competitive dynamics and qualification periods. So yes. Our target is to recognize the importance of China, but also to, over time, diversify the revenue streams to make them less reliant perhaps on China going forward.

That makes sense. And I don't think it's a secret that China is your biggest region, and I think China is home to the most amount of robots in manufacturing. And I guess I just would like to help investors on the call. We have automation players at this conference from Siemens to EVB to Rockwell. There's well-known robotic players like FANUC. I mean can you help everyone understand where fiber laser technology and processing kind of fits in with the robotics and automation processes? Is there any room for partnership or synergistic opportunities between a fiber laser system and robotics? Any help on that?

Yes. There's tremendous opportunity for synergies between that. So the fiber laser with its flexible delivery is very easily integrated with any robotic system. And the laser can be used in multiple dimensions. Obviously, cutting applications has been primarily used on an XY axis in only 2 dimensions, but there are welding and cutting and many other applications that operate in multiple dimensions that are enabled by the flexible fiber delivery. We don't often get very rarely accepted. We're using them internally to build our own systems involved in -- designated a specific robotic supplier. We're rather agnostic, right? Different companies have their own favorite suppliers and there's nothing that limits an IPG laser from being used on any robot. So -- and they are used on and deployed very broadly with all of those manufacturers that you just mentioned. So we're just not in that -- we're not part of that kind of decision-making process, right? An industrial company or an automotive company has their preferred supply of robots or multiple supply of robots, and they would make that decision and then the integration of the laser with the robot would happen afterwards.

Perfect. And just because we're on the China topic, China was really first in first out in terms of the COVID downturn, the impact to orders and the recovery. So I'm just curious with what you saw with China, is the recovery more of just a rebound from the downturn? Or do you think we're in the start of a more sustainable investment cycle going forward there?

Yes. And the issue with China has been not just the recovery and it came out of last -- the pandemic down -- driven downturn, very, very strong. Demand overall and on average on China has been strong for a number of years. The problem is it's been volatile and it's also been impacted by competition rate. So there's been a huge increase in the quantity of lasers sold in the total optical power that's supplied in China over the last 2 years. The issue is that the pricing adopted by some of the Chinese competitors has been very, very aggressive. So the -- not only have you had a bit of economic volatility, the total dollar value of the market has not grown to quite the extent that it could otherwise have done so, right? Pricing had been a little bit more rational. There could have been a huge incremental amount of value creative. This current up cycle has been pretty robust. I think the economic data in China is pretty positive. I think globally, it's starting to look a lot more robust. So PMI is a positive, much more broadly than they have been. Global GDP forecasts are positive. That will help the Chinese to a certain extent, particularly with their export-driven markets, but they're also pursuing a strategy, as I said, of advanced manufacturing, the 2025 vision. They're trying to increase local demand. They're making themselves less reliant upon being an export economy. So over time, I think those are all positive factors for us. I'd like to see growth continue to recover elsewhere as well, right? I'd like to see as much growth driven this year from European, North American and Japanese and other Southeast Asian sales, and it not necessarily is to be just driven by China. The general outlook at the moment is that the credit may not be as expansionary as last year, but continues to be available, and it continues to be available, particularly for advanced manufacturing. There continues to be infrastructure spending going on. Some projects were delayed last year that are being -- we started this year as some of the anecdotal feedback that we have heard there.

And Tim, do you see with the comments around the up cycle, you mentioned PMI is recovering, you've seen the machine tool orders recover. With this up cycle, are you seeing a shift in mix, meaning you guys have high market share in a higher end of the market. Are we seeing a shift for investments to more of the higher -- stronger demand for the higher end of the market now as we start -- the recovery starts to broaden out and pick up steam?

Yes. You're certainly seeing that happen within the cutting market where technology transitions are driving to higher and higher power cutting systems, and that's adding to the flexibility of the end user because they can cut thin and think on materials. They can cut the thin materials, they can cut thicker materials as the higher power they have, the advances being made. And the cut quality they have means that starting to displace plasma, which has some forecast quality and may even with thick materials require machining afterwards, right, and then the cost of the plasma system relative to a laser system is still low. But there's other ownership costs related to consumable and even labor that mean that transitioning towards a fiber laser can get you to a payback within, say, 2 years even those high power levels. You're seeing some mix benefits in terms of like the EV investment cycle globally, with more sophisticated lasers used for welding including ink delivery, which would include scanners, welding heads, real-time weld monitoring capability, which is a key advantage that we have. The foil cutting application uses a very advanced high end pulse laser with high average power in it. That same type of lasers used in the cleaning applications. So there's lots of positive drivers there in terms of mix in the second half of last year. We saw a lot of positive mix benefit from some of the single-mode lasers for advanced applications in North America. We've sold a couple of hundred kilowatt lasers last year as well. That's all there. But the low end of the market is also pretty resilient at the moment, and we are continuing to be participants in that, right, with our ultra compact laser for less than 4-kilowatt laser cutting capabilities. That laser has a lower bill of material costs. So we're hoping to improve the margins a bit on that low end of the cutting market. So you can't discount the low end of the market, as much as things move to higher and higher power levels. There's an awful lot of applications that use lasers in like the 1-8 kilowatt range. And there will always be very important power. It's not that everything is transitioning to 20 kilowatt, as much as we wish it may be.

Fair enough. And maybe we can move to the EV discussion. Maybe give a broad overview of how the auto industry, even traditional, kind of embrace laser technology, where it fits on an ICE. And now with a transition to EV, it seems like that would be accretive. Maybe you can give us a rule of thumb of where laser processing technology fits in? We hear these headlines on EV manufacturing, particularly when it comes to batteries.

So comparing EV to ICE, there are some applications that would be very similar, right? So whether you're -- both lines of vehicles have seats and airbag detonators. And they've got tailor welded blanks that form the basis of the vehicle body. All of that would be pretty similar. Some of the structural components with an EV may be a bit more complex that may also drive a bit more laser-based welding. In some of that structural integrity, light-weighting in EVs would also help adopt with lasers, right, because you're then with something like aluminum, you're competing against riveting because it's very difficult to weld aluminum with traditional technologies. That would be a driver. Within the internal combustion engine itself, there's very little laser technology used like an engine block [indiscernible]. There's some small laser applications for drilling fine holes in fuel injectors and things like that. The big difference would be that you'd see a reduction in lasers demanded for welding transmissions and gearboxes because that's an area where lasers have been used quite extensively because transmissions have become more complex. They've gone to 8 speeds. They're trying to reduce weight. The welding is very complicated. The stresses of a gear is subject too. So that was quite complex welding where lasers have been used, that would obviously go down, but then you have this huge increase in laser applications related to batteries, and potentially even in electric motor manufacturing, welding copper within motor manufacturing is the evaluating lasers for that. Within batteries, there are 3 main applications. I think I've mentioned these already. Welding, the cleaning and the cutting applications. The cutting is both for very thin foils using pulse lasers, but also all the casing in the metal that's millimeter thick has to be cut using probably flatter process as well. For us, EVs historically are anywhere. I mean, there are quarters where you have very levy sales. But let's say, on average, 3% to maybe 10% of sales in a very strong quarter. We think the EV investment cycle is at least a decade. It will be more than a decade-long if the adoption is going to happen in the way that people say. So you're right. There's an announcement by one of the major automotive manufacturers, yes, they have about a huge order for batteries that they're placing and also a new factory that they're going to 6 factories. I think they're talking about investing in between now and 2030 and primarily in Europe. So the interesting thing about EV as well is this is not just going to be a China-related demand cycle. We've already supplied lasers in Europe and North America. We had a good order we received in Q4 of last year that's going to be supplied mostly in Q1 of this year to one of the Tier 2 automotive companies in North America. We've got other orders on the books for European companies as well. So yes, the EVs is the societal change that potentially has too benefit for the laser industry.

That's great. And as you know, there's headlines around reshoring, Biden has an initiative to bring manufacturing back to America. There's a lot of discussion around dual supply chains. I'm curious if you're observing this in your order book or conversation with customers? In a meeting earlier, you mentioned Genesis, this business you acquired a few years ago that was weak in 2020, and it's seeing the pipeline build. I'm curious if you kind of flesh that out for us, help us understand what you're seeing in America, if you do see that trend playing out? And why laser technology to make the cost benefit dynamic a reality to bring back supply chains?

So, I mean, I think what you see at the moment, it's all relatively new, right, the sort of regionalization of supply chain. What you hear at the moment is more anecdotal rather than fundamental shifts. I think it's going to going to take time for people to make those decisions. Certainly, I think that the regionalization of the battery supply chain is a prime example of that, right? Historically, maybe those investments would have been made in China because of the cost. How lasers benefit? This is relatively easy to talk about, right? Lasers are a very -- we've mentioned all of this on the call already, they are a flexible tool. They're very productive. They're easily integratable within automated production systems. By way of an example, even on the manual side, we recently launched handheld welder. It is very easy to use. It's also very flexible because it can weld different types of materials, but most importantly, somebody can be trained to use that handheld welder within a few hours, right? It's probably spending months at welding school, and you can get to very high-quality welding with that device, where historically, welders are basically artists. And a very highly qualified welding is an extremely well-paid fabricator. You can get to payback with the handheld welding system, if you can even save $5 to $10 an hour, in what you pay a welder of whom there are shortages, right? It's very difficult to find welders. You get payback on that welding system within a year with those kind of savings. So lasers are very well positioned for enabling reshoring initiatives given productivity, flexibility, and automation capability, ease of use as well with the fiber laser.

That makes sense, Tim. And with that backdrop, can you just help us understand IPGV's, like algorithm? We're seeing GDP numbers that could potentially approach 5%, 6%, 7%. So with that in mind, what's a good marker for me to think, if you're in that type of backdrop, what type of sales growth IPG could see? And then how to think of the gross margins within that range?

Yes. And I'm not going to answer this question in terms of like guidance for this year, right? I think maybe quite a [indiscernible]. And generally speaking, we've looked at this. And historically, the industrial laser market has grown up to 2x GDP because you tend to see adoption of lasers, you see stronger investment cycles, particularly as capacity utilization gets out there. I think that's a reasonable proxy to continue to base that upon. I mean one of the challenges we've had has been the volatility of the end markets for the better part of 3 years, right, driven by different things. It would be great to get out of that volatility in a more steady-state growth driven by stronger GDP and underlying other economic indices that we follow like PMI technology, machine tools, general machine tool orders globally. Then layered on top of that is sort of some of the benefits that you may get from faster investment cycles in emerging industries like EV or really the growth that we look for comes from some of those areas of diversification that I was talking about before in micro processing, medical, renewable energy investments, advanced applications. And those would enable us if we can succeed in those areas. And you have, say, an industrial market, that's growing 5% to 10% depending on where GDP is. Now our target is clearly to get back into a longer-term growth rate in the double digits, where we've really struggled in particularly the last 18 months or so given the thing going on.

And what is the addressable -- on the industrial side, and then we'll get to the nonmetal process. But on the industrial side, Tim, what's the TAM? What's the addressable market? Where are laser systems fitting now? And what do you think is realistic to try to capture over the next few years?

Yes, yes, this is an interesting question because it's difficult to -- we've had to work out if we're here to try and frame it, right? And inevitably, when you do these things at a very high level, but it does provide some context to it, and this is in our investor presentation. Laser systems are anything for industrial applications, they're $11 billion to $12 billion in total sales. Yes. The machine tool industry is $70 billion to $80 billion. So we talk about laser penetration being 15% or so. Not all of those applications are addressable by lasers. So a huge amount of metal processing is across those 4 different ways that we think about, right, separating, joining, ablating and depositing materials in different degrees that they are at different stages of penetration. So additive and ablative processes are well behind some of the joining processes and even joining is a long way behind cutting. But if you look at what the addressable market would be, maybe 40% of the machine tool industry could use a laser-based application at the moment. So laser systems then would be not 15% of the addressable market or maybe closer to 30% or 35%, still representing -- growing from 35% to 50% of that would be increasing laser-based system sales from $12 billion to $18 billion, and laser sources are typically 25% of that. So yes, you're talking about $1.5 billion of laser source increases, and the total laser source market for industrial applications is anywhere from $2.5 billion to $3 billion at the moment.

And Tim, there's a biding war clearly going on with coherent, which touches the laser technology area. I mean what do you think this says about laser technology in general? And maybe to relate this, as the CFO, with a robust balance sheet, net cash, how does IPGP view its M&A strategy? Are you a consolidator? Are you going to be looking to get more outside of industrial to grow that area? Maybe you can touch about that broadly.

Yes. We've been very clear that we don't view ourselves as a consolidator within the industry. Our M&A strategy is very much focused on looking at technologies that can be accretive to our sales. So our strategy over the last 3 or 4 years with the acquisitions we've done is really references that, whether it be acquiring a company that does real-time weld monitoring capability or another company that is specialist in compressing energy within glass that enables some of our ultrafast offerings or acquiring a systems company that are specialist in medical device manufacturing, smaller acquisition we did was our medical group. Genesis is obviously a company that specialized in automated laser welding and other welding systems. So we will look at things much on from a technology perspective rather than just a consolidation and financial perspective. We've deployed $300 million of cash in that regard. Other areas that we may look at here, some of the areas you referenced, maybe in micro processing or instrumentation in medical. So you have some of these areas that you have to be a bit careful of. Like a lot of medical companies, they spend a huge amount of sales to marketing because they're involved, not so much on the surgical side of the things, but on the [indiscernible] sector, which tends to be a more discretionary expenditure, right? If you're talking about things like hair removal or tattoo removal, skin rejuvenation technologies where we're developing more surgical type applications, which we think are less discretionary spending. If you've got a kidney stone, you kind of want that kidney stone out. And there's probably a more significant barrier to entry around some of those applications than there are in aesthetic areas. So -- but yes, there is a potentially areas where we'd look at doing acquisitions.

And Tim, I have to ask like the founder and CEO, Valentin, I mean he's certainly a pioneer. He's the largest shareholder. He's also over 80 years old. So I'm curious how we should view the next few years for IPG Photonics? Is there a succession plan in place? Is he more open to selling once he feels he's ready to retire? How involved is he still on the ongoing day-to-day? This is kind of a question that's coming up more and more, I find with investors right now.

Yes. I know it's a question we get often as well. So Valentin continues to be involved on a day-to-day basis within the company. I mean, clearly, with COVID and his age, he's spending time -- a lot of time he works from home a lot, right? But he's been in the office as well. He's probably more strategically focused. He is looking at sort of the R&D development and things like pricing strategy with Trevor. Operationally, the company has got the executives who run manufacturing in different locations. And Dr. Scherbakov, who's the COO, he explicably runs U.S. manufacturing. Alex Ovtchinnikov is up on the diode area. We've hired some strategic marketing people. So Valentin has had a lot of bench strength and depth. Since there is a succession plan that the Board has, and they've obviously been developing that over the last couple of years, given in advance is not immortal as much as we'd like to think. There isn't a laser technology that is at that point yet. So yes, there's a succession plan in place, but things continue on as normal within the company at this point in time. In terms of your other questions, and we've not talked about -- Valentin's vision is not to sell the company. He really values it as an independent company. It's kind of like undilutive as it were. It's very focused on what it does. It develops a lot of its own core capability. And his vision is for the company to continue to execute around that capability and vision.

Okay. And we almost went the full time, Tim, without getting asked a question about pricing. I'm getting asked from some of the audience, pricing appeared to be stable in China in the last 3 to 6 months. Is this still the case as demand is stable to recovering? Are you finally starting to see some discipline there? Or at the very least, it's not getting worse compared to where we were the last 3 to 6 months.

Yes. I mean we saw the pricing is -- was stable in the second half of last year. The competitive dynamics has -- have not gone away, right? I mean the Chinese have a lower quality product that they sell into the market at a lower price than we do. I think the market has become very much bifurcated, whether it be at the lower power levels, there's a part of the market and what's a higher-quality product that we sell into. And we're focused on really maintaining share in that part of the market. And when we got a part of the market that's moving certainly towards higher and higher power levels that does help us. Then you've also got the Chinese competitors, selling more lasers at 6 to 8-kilowatt, and trying to get into 10-kilowatt preface. We're having to do that at a lower price point. I think it's as much as whether it's how we manage that strategy, rather than reacting towards the Chinese. I certainly think the Chinese relative to their cost bases are much more limited on what they can do but they do sell at a lower price to IPG. And if IPG wanted to gain share significantly, we'd have to adjust price into do so. But I think that's also been of a fair reflection. We don't want a high-volume, low-margin business. We're really focused on the higher end of the market and continuing to execute on that. We're going to have to watch how that develops over time. And there's a lot of value given the capability of the technology has been transferred to the end user, and that's resulted in a significant increase in volume for different types of applications in China and outside, even, right? I mean the amount of cost we've had to take out of the laser, given the dynamics we've faced over the last couple of years, has meant that we've been able to introduce that handheld welding, where couple of years ago, we wouldn't have been able to price it competitively with the [indiscernible] and gas space welding. [indiscernible] that have come out of this, but it's quite interesting.

Yes. And maybe just to wrap up, Tim. Just maybe outside of industrial, what of those markets do you see the inflection really taking off? There's medical, I think there's a lot of discussion around smartphone manufacturing, considering the first smartphone to where we are now, there has been laser processing, some adoption there. I'm curious when we break down these other nonindustrial markets, what is most exciting to you right now?

I think we're executing well at the exciting ones, right? So we had very strong growth out of medical last year off a small base, right, more than several hundred percent growth. The target is to grow that business from $30 million to $100 million within 2 to 3 years, and then try and get to 20% share of the laser source business within medical and develop a consumable business of that, which I think is very exciting. So the consumable fiber that's used in medical procedures, diversify that medical business outside of lithotripsy kidney stones into things like soft card litter rejuvenation and even more esoteric areas. I think we're starting to see some good traction in micro processing with our shorter wavelength and shorter duration lasers. So combined sales of green UV and ultrafast are approaching a $10 million a quarter, if not higher. At the moment, we're dominated by green going into solar cell, but starting to see some increasing traction in UV and ultrafast. The advanced application, I think, is directed energy continues to be potentially still very difficult to predict when that's going to get commercialized, but if it does get commercialized, the use of lasers in ability to shoot down unmanned aerial vehicles or incoming threats potentially could be a huge driver of laser power and demand and value. But yes, becoming a more prevalent player within the micro processing and the medical industries, even last year, the entertainment, the display lasers, the red, green and blue lasers, surprised me, there were some sales for that even and the cinema industry was basically shut down. So there's some exciting opportunities there that are really 1/4 of the diversification of the company in the future.

Perfect. I think that's a great place to end. I want to thank Tim and Eugene, for coming to our conference. If anyone on the line has any questions, please reach out to me and I'll put you in touch with the company for any further dialogue. Thank you, everybody.

Thanks, Michael.