IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us here this morning at Stifel's Cross Sector Industry Conference. We're fortunate today to spend some time with IPG Photonics. And with us today is CFO, Tim Mammen.

Tim, maybe just a great place to start, I think, would be just maybe taking a step back and thinking about the broader demand environment right now. Maybe we could start by sort of looking at China and then maybe we'll go rest of world. But maybe if you can just talk a little bit about the demand environment right now in China? Obviously, you've worked your way up to focus a bit more on the programmable and the higher power end of the market. But just maybe overall, sort of how the demand trends are there? Tim, can you hear us?

Hang on a second. [Technical Difficulty]

Thanks, everyone, for your patience. We're having a couple of problems there with the webcast. I think we've got it worked out now. Tim, I'm just going to assume that the introduction went okay. And maybe if we could just start with a little bit of an overview of the demand environment? Maybe what you're seeing in China right now, both in terms of overall demand and maybe where some of that competition stands right now within that China market?

Sure, John. Good morning, and thank you for having us here. So we haven't given any updates beyond our first quarter call. But in general, we've seen fairly robust global recovery and demand across all of our major geographies. So beginning last year in Q2, China really started to pick up. We continue to gain momentum during the year. We saw a good start to the year in Q1 with revenue basically flat over Q4 when China can be down given Chinese New Year. Strong demand coming from, obviously, EV investment cycle, there's 3 applications there that we deal with foil cutting. [Technical Difficulty]

Thanks, everyone, for your patience. And sorry for some of the challenges we're having this morning. Tim, you were talking a little bit about the overall China market. And then -- sorry that we cut you off there.

So yes, I was commenting on the very strong demand we're seeing on some of the EV applications, the good recovery we've seen and continued demand for both the low and high end of the cutting market. So the low end of the cutting market has continued to perform relatively well. That's an area where we have still got a meaningful amount of share as compared to some of the Chinese competitors. We've also got a lot of share, we sell thousands of units into that end of the market. The shift towards higher power lasers is clearly benefiting us. We're seeing demand for 20, 30 and even 40-kilowatt lasers. Outside of China, I was particularly pleased with some of the performance in Europe in the first quarter. So the overall demand profile there continued to gain some traction. It's still below peak levels of demand, but both in Northern and Southern Europe. Our demand out of North America was pretty good. And Korea also has recovered from the pandemic. So the only area that continues really to be very weak is Japan, and it kind of has is challenges, but I think we see in our business that are similar to experiences of everybody else out there. There does seem to be a bit of stability in the market, and Japan had a better forecast for bookings in Q2, which would drive revenue in the second half of the year. So they appear to be seeing some, at least, stabilization and recovery there. But I'd say that's the remaining significant industrial economy that needs to recover.

Got it. Got it.

One other thing that's interesting, by the way, John, on Q1, I just forgot to mention was that our revenue was basically flat in China, which we're pleased with. Whereas one of the major competitors there, their sequential revenue was down 35%. So certainly, relative to them, and this may be due to the different areas where we're significantly stronger than them in more of the advanced processes. We had a significant pickup in share against that one competitor. They may also have lost share against one of the other competitors, that's a private company and doesn't release data there. But we are pleased with that comparative performance in China as well.

And Tim, one of the -- I think investors concern, certainly more on a longer-term basis, but would just appreciate your perspective here is the ability of some of those lower power sort of indigenous China competition to not just move up in power relative to where they are today. But to get to a quality or consistency level where they could start to export on a more global basis. And just curious to get your perspective of where that competition is, I guess, more from a technical capability and less so just from a pricing capability?

I think we've been pretty adamant that not even at high power, but even at lower power levels, they're not where we are on a technical reliability, form factory, electrical efficiency basis. The weaknesses that they have at the lower level become more pronounced at higher power levels with degradation in power output going down. Beam quality and electrical efficiency, obviously, being key areas there. In terms of the ability to compete on the global market, you see them in some of the lower end countries, if you like, more developing economies, but very, very little headway and progress being made in more of the advanced areas. And given the relatively low quality of the product that they produce, I think that's going to be the major challenge that they have in trying to sell product outside of China, I think as well, they find it difficult to support -- I mean, support product and sales and service and support. Safety is another issue where we've heard that their product lags behind even the requirements in more of the global markets. The main thing is here that the product architecture they use is significantly different from the one that IPG uses. Nobody has yet managed to really replicate what we do in terms of product architecture. And that doesn't just -- even if you can buy diodes on the open market, the quality of the glass fiber, the way you get the energy transferred into the glass fiber, the way you combine different modules together to increase power output, those are all critical areas where we just do things differently. Nobody copies us or has been able to replicate what we do.

Got it. Got it. And then maybe shifting gears a little bit to the welding opportunity. A lot obviously has been made over the last couple of years, particularly around EV welding -- or EV battery welding, excuse me, and some of the advantages of the programmability aspects of the lasers are there. But could you also maybe spend a minute on that, but also some of this -- the newer opportunity that's emerged with the new handheld welders and what you're seeing in that market and how that may be develops over the next couple of years for you?

So certainly, things like the AMB, which is the adjustable mode beam capability, enhances significantly weld quality. So for example, thinner materials reduces spatter fairly -- very, very dramatically. There's other applications we've got -- or systems we've got. We've got a slightly different process, which is basically, it's an ability to stir the world as it happens, it improves weld quality. You've got the real-time weld monitoring capability. So that's actually the device that assesses the quality of the weld on the fly rather than having to move the part to a new fixture to test it. And then if you've got a poor quality well, move it back to redo the weld. All of those capabilities are enhancing our ability to address a larger part of the welding market. In addition to that, you've got things like the ability to combine that with the higher power scanning systems. So that, again, improves welding productivity. And that's all more on the automated side. And you've got -- that would traditionally be -- traditional automotive. There's a lot of demand coming from welding on the EV processes. And then in the last quarter -- first quarter, we started to sell the handheld welder having introduced it a couple of months beforehand. The response to that product has been very, very positive. We've -- in terms of order flow, it's probably been, in my experience -- in terms of ramping -- it's still very -- it's moderate volumes at the moment. It's not thousands of units of water flow that we're getting out of it. But in terms of the ramp into sort of demand for several hundred units of this product, it's been as quick as we've seen when we've introduced new product to the market. So that product enables better weld quality, faster welding and also critically is a much easier product to use. So the skill level of the welder is reduced. So if you can reduce -- welders are expensive, particularly highly skilled welders are very expensive, almost artist, right? So if you can save on your hourly cost on a welder $5 to $10 an hour, you get payback on the system in less than a year. In addition to that, we've even had experience where people because they're now using laser-based welding instead of traditional welding, they've even been actually able to change the materials they're using in some of their welding processes and save cost on the material, in one instance, reducing the thickness of the material that they were using. And that's a cost saving in itself. So there's numerous advantages being identified with the system. We're starting to introduce that system with more features. So for example, software add-ons that add capability around cleaning, improving the recipes that we're including in the system, adding a wire feeder and other accessories to the device. So that will add and enhance the value proposition of that. Overall, in the first quarter, the total demand for welding was one of our best quarters since 2017. That market, for us, has been a little bit of a laggard and underperformer through the '19 and '20 when it started to recover. '18 and '19, it certainly had underperformed relative to our expectations.

Sticking with that, welding, just for a minute and maybe shifting gears a little bit more on the competitive side of it. It was one of the areas that I know Coherent was trying to make some inroads in on its own. And I'm just curious with the pending acquisition of II-VI, how do you think about, I guess, competition overall, not just within welding, but does that make that combination, does that change the outlook materially as you think about that combined entity from a competitive standpoint?

No. I mean, our view is that I don't like to necessarily talk about competitors specifically. Nobody has made any significant progress in competing with us. So some of our competitors have some sales in certain markets where they have some distribution strength related to other applications, and that may be applicable to Coherent in certain countries in Southeast Asia. But we don't -- as I said, there's a fundamental difference in the architecture, for example, it's not just the diode quality where it's important. So II-VI has its own source of semiconductor chips and diodes that is something they've been selling into the market, so they have that. But it's not massive. The only important thing here, much more critical in our opinion, is the way that you pump the light into the glass fiber, the quality of the glass fiber that you use, the combining technologies to combine different power levels of modules together to get the higher power levels. We have our AMB technology. I talked about some of the core advantages and capability that we've already had on that. In the industrial laser welding market, our competitor has really been the large industrial private company in Germany, TRUMPF, not any of the other laser companies. So -- and we've made significant headway in improving the complete system. And I don't mean just the automated system as in that Genesis delivers, but the laser combined with the optics that we deliver and beam delivery capability that we have with our accessories have made us far more competitive in the really advanced areas of the welding market. There's a lot of process, know-how and technology that has to be combined with the laser to succeed in laser welding.

Got it. And Tim, you mentioned some of the newer areas that you've been focused on. Can you talk a little bit about how things like green lasers or the high powered pulse or the ultra -- those newer applications are starting to maybe open up a different avenue of growth rather than just sort of cutting and welding, which I think is certainly still the largest today. And I think where a lot of people are focused on still with the company's demand profile?

So yes, we've been really pleased with the traction we've got across our fairly broad portfolio of emerging products. And sometimes, you might characterize them as like emerging higher power products that are creating emerging applications. So some of that benefit has obviously come from the real traction we've seen in the EV investments like, right? So these are not -- there's some material processing applications in there that are fairly specialized, things like the foil cutting and cleaning applications. The cleaning market is forecast to become significantly larger. You're displacing very environmentally unfriendly processes there, whether it be solvents or abrasives or other media blasts, chemicals. But you're referencing some of the more non-materials processing areas that have also seen some very good growth in the last 18 months or so. Clearly, the green laser has got a lot of traction in solar cell applications and renewable energy. It's interesting there, we're actually not so much driving productivity in the manufacturing process as in improving the efficiency of the solar cells themselves, which is really critical. We've got 2 applications that are driving each of them about 100 basis points improvement in solar cell efficiency. That's massive. There's another green laser application that's usually going to use a higher power green laser that could be driving 150-plus basis points improvement in solar cell efficiency, right? So that's a very important dynamic there and has really led to the strong growth in green lasers. In one instance there, we actually displaced and replaced a competitor in another application who is an entirely newly qualified application. You started to see a bit better performance from the micro -- other microprocessing applications with ultrafast and UV. So if you combine that with the green, you're approaching $50 million of annual business there within microprocessing applications, perhaps like 10% share of -- excluding lithography and annealing. Other strong growth drivers, we've been very pleased with the performance of the medical business, which went from a very, very low, we were less than $5 million a year in medical last year, to it's approximately $30 million. We target is in -- to grow that -- double that sort of into 2022 and then really grow that business to $100 million and then try and get to 20% share of the medical business. The interesting part of the medical applications is that there's a significant part of that, that could be -- is being driven by consumable fiber. So each of these procedures, single-use fiber applications within lithotripsy and other soft tissue surgical applications that we're going to introduce the revenue that you can see even with one procedure a day being performed on a system can amount to almost 50% of the system's value. So you can understand that as you get more and more systems deployed there, the consumable elements of this could become significantly higher. Even in developing markets, the fibers are, even though they're multiple use and they're sterilized between applications, it's not that they're used 100x over when they say the multiple uses sort of 5x or so. The other area that we've seen very strong performance from has been advanced applications last year. So government and directed energy applications. We've sold single-mode lasers, 100-kilowatt lasers, 30- and 50-kilowatt lasers. So those advanced applications processing of destructive capability on materials and even thicker materials outside of cutting, that was a very strong driver of growth. We've got good backlog on advance. But the beginning of the year is always a bit weaker. Although Q1 was reasonable in terms of revenue, but we've got good backlog for those advanced applications. So there's a number of different drivers on those emerging products that have been quite positive.

And maybe tying all that together for a second, Tim, on the margin front, is there a noticeable difference between, say, cutting, welding and then some of these newer application areas? Or are we still in a situation where the largest overall driver of margins from here in terms of an improvement is still going to be driven by volume increases?

No. There's a certain benefit we think we can still get from volume increases, as we've said in our guidance for the second quarter. Our range on gross margins was sort of 47% to 49%. There's -- I referenced like a couple of hundred basis points of improvement on volume. Certainly, if you can grow some of the other applications where we have fundamental competitive advantages and particularly getting to higher power levels across different applications and markets, there's a margin benefit there. The continued challenges, though, even though pricing has been stable, is what are the dynamics going to be on the competitive -- more competitive cutting market, even as you go to higher power levels there. Because when prices change, they tend to change on a per kilowatt basis. And it will gravitate even to the areas where we have competitive advantage because people know what the price per kilowatt is at the low end, and they know that it's really a question of just combining more optical components together to get to the higher power lasers. The other aspect of it is, though, that even at those higher power levels, if pricing had been where it was, you wouldn't see, for example, like 30-kilowatt lasers or 40-kilowatt lasers starting to displace plasma cutting. There's certainly the price decrease that has gravitated to those high levels has made those higher power cutting systems much more competitive versus plasma and even other thicker metal cutting processes, right? So there's many different ways to look at it. But I'd say that the main challenge continues to be really around the cutting market and the pricing dynamics there with benefit coming from higher-end applications in the areas that we've talked about this morning across those multiple different areas.

And you mentioned there, Tim, on that potential plasma cutting opportunity or displacement opportunity. How does, I guess, that opportunity compare to what maybe we've already seen in terms of displacing some of the older technologies and cutting as they move to fiber laser? Is that a similar-sized opportunity? Is it a much smaller subset because you're only dealing with some of the thickest materials? Just curious how you kind of size that plasma displacement opportunity over time?

We think it's significant. I mean it's difficult to break out the total plasma margin between high power and low power. This is probably an installed base, people estimate there are like 200,000 plasma systems around the world. So just on the basis of where CO2 had got to, right, that's 3x larger than the CO2 market. In terms of installed base and in terms of life cycle, I think a plasma system is similar to a CO2 system at lower power levels, 5 years at a high power level like 8 to 10 years in terms of life cycle. There's a large part of our plasma market, though, that is at the lower end, lower power level. And I think that some of the growth you've seen on low power cutting systems has already and for several years been displaced in plasma at the low end of the market, right? Whereas a lot more price has -- to what you are seeing was the transition towards higher power levels is lasers moving up to compete against thicker cutting plasma systems where we're able to -- those plasma systems are still quite cheap. But as the cost of these high-end systems with 20 and 30 -- 15, 20 and 30 kilowatts and even now going to 40 kilowatts has cut down. You're certainly starting to see a ramp in demand to replace those. It's difficult to gauge what percentage of the installed base of 200,000 really addresses the thicker part of the market, but it may be 10% to 25% of it. So you're talking 20,000 to 50,000 systems, which would be about at the high end, you get to the same size of the total CO2 installed base for higher power systems at the low end, it's a bit smaller. But if you're talking about selling 10,000, 20-kilowatt lasers to displaced plasma, that's a huge quantity of very high-power lasers for that end of the market.

Right. Okay. Okay. Well, unfortunately, Tim, we are out of time. And I apologize, everyone, for some of the technical difficulties we had. But thank you very much, Tim. Appreciate the update. And best of luck. We'll talk soon.

Thanks, John. Thank you, everybody.