IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Good morning, this is Tom. I appreciate everyone participating this morning. We have Tim Mammen and Eugene Fedotoff from IPG Photonics. About 35 minutes for the webcast here. Just as a reminder, if you are watching the webcast, you do want to ask a question, you'll need to type it into the ask a question box on the webcast page, and then I'll work it into the conversation. But Tim, and Eugene, I appreciate you guys taking the time today. Maybe, Tim, you kind of starting off and level setting us as we left Q2 and your Q2 earnings call into Q3. Maybe just kind of remind us how you saw the end market and the conditions for the -- for IPG out there.

Sure. So thank you, everybody. Yes, in Q2 into Q3, bookings have been a bit weaker than we would have liked to see in Q2, we normally have a book-to-bill that's above 1. We said it was slightly below 1. That drove overall weaker guidance and we would like to see in the Street was expecting some negative reaction to that. So we were starting to see some macro headwinds related spending on lasers. There was also a bit of softness on total EV Investments in Q3. That's obviously going to come back. But at a high level, things like the cutting business, which have performed very well, actually in Europe and North America. In Japan in the first half of the year, we're showing some softness European PMIs were as weak as I've seen them in, I don't know, maybe 20 years, I think the European PMI was at 39%, there are concerns about Germany being in recession. Other PMI data is a bit more robust. So the U.S. is pumping on slightly above 50% as is Japan, allegedly, the China number is [ 48%, 49% ], that depends on whether you believe it or not. So there is certainly some areas of softness. Overall, though, we still think we've got a tremendous opportunity given some of the thematic investment cycles, the energy transition the ability of the laser technology to continue to displace non-laser welding applications, welding grew by 40% in 2022. The total size of our welding sales is equal to cutting coming into the end of the year, you're seeing some renewed interest in things like additive manufacturing has been some announcements, we don't have a lot of data on this or detail on it other than what's been publicly talked about additive potentially being used on making certain consumer electronic devices. Cleaning has continued to perform very well across the world. Medical was a bit weak in Q2, but we're expecting that to come back in Q3. So Medical is another business, if you can continue to diversify the applications, both within surgical and potentially in an [ ecstatic ] is an exceptionally large market that's still using very old laser technologies, right? There hasn't been a drive to change those laser technologies. And we think with our longer wavelength lasers and given our improved electrical efficiency and later even in the 2 to 5, 2 to 10-micron range, we could be very disruptive over time in that area, introducing improvement to the processes. So Yes, clearly, Q3 was a weaker guide than we would like to see in the there's certainly some softness out there on some of the CapEx and markets from our perspective.

Okay. So that's great. I just going to kind of level set everyone since it's been a little while -- since you guys you obviously released those [ hammer stuff ]. Shifting gears a little bit, Eugene and I, a really good meeting at [indiscernible] year last week. And I think the energy that I took out of the meeting was fairly positive. One of the things that you guys had for us and center, I'm going to go through a couple different topics coming out of FABTECH, but certainly, you had 5 LightWELD demos up and running and that looks busy for the couple of days. I was there. Maybe just kind of talk about through the progress that you're seeing on the product line and kind of where you see it going over the next year or 2.

Yes. I mean we're still exceptionally optimistic about the ability of that handheld welder to displace traditional welding technologies. It's got significant advantages in the speed with which someone can be trained to well, the actual seat of the welding, which is significantly positive than traditional technologies, the different types of materials that could be joined. So you can join reflective materials, copper or aluminum together, you can join different types of materials together steel or copper for example. We've introduced our device with higher power levels. We've introduced it with cleaning applications in it. You can also integrate it with a Cobalt and when we first introduced the FABTECH, I think we had 1 or 2 demos running and it was totally overwhelmed. We couldn't actually not many people to get their hands on the device last year, we increased that 3 and this year, we increased it to 5 stations. And from what I heard, I couldn't go to FABTECH, but Eugene told me that all 5 of those stations were very busy. So the total market for handheld welder is maybe $2 billion, $1 billion of it is perhaps very, very low-end systems and about $1 billion of it is more addressable by our handheld solution. And our target is to try and get 20% of our total market, which would represent a $200 million product line. We haven't given the competitive reasons exactly where we stand on progress in that direction, but LightWELD has continued to perform very well. We've introduced it more broadly in Europe this year after getting CE marks that take up in Southeast Asia and Japan and Korea continue to be positive. We're not really selling our product in China some competing products in China were just not choosing to go up again. But yes, the overall assumption of the product continues to be quite positive. You got here a lot of work we're doing. We've got launching some demo traders that are going to enable us to go out around the country and other areas demonstrating the product and even ultimately training people on the product and even providing service and support as the total installed base increases. We're looking at other distributors to work with. I think is a product that particularly well suited if you can ramp sales and put in place e-commerce selling as well, selling directly off for e-commerce matter. We started to do that albeit in a limited basis.

Okay. No, that makes a lot of sense. Would you say that the opportunity is roughly equal between North America and Europe, even though Europe is kind of a newer market entrant in this product for you?

Basically going into all handheld welding type applications, right, metal fabrication, job shops, ultimately also in the field applications and potentially areas like construction and other areas. So I think that the fabrication industry, fabrication industry has always been quite regional, right? Fabricating that part next quarter around the world, even the fabrication has been very strong in North America. It's strong in Europe, is strong in Japan and Korea. That kind of metal part was never really to my knowledge like mass produced in China and exported that issues around weight and you're also resolving very -- we are designing and producing parts for very much of a local market there. The benefits of handheld welder, I think, from a cost perspective, make that quite compelling to ensure that those fabricators continue to be very competitive within the local market. It also solves the issue of -- there's a significant shortage of very highly skilled welders that are needed when you're laying down a lot of wire during more complex well processes. And part of the reason we're trying to increase not trying to have increased the power and the devices to do thicker materials as well.

Yes. So I'd second what Eugene said, it seemed to be a very active display. I say, we kind of watched by all 5 seem to be up and running. So that's certainly another positive. Something, Tim, you had talked about for years is just the inherent wall plug efficiency of fiber lasers. And we want the stops on the IPD booth tour this year was our new 50% wall plug efficiency products. And one of the things that kind of came up with the to-do list to being able to sell that wall plug efficiency as kind of a another key catalyst, if you will, to reduce the carbon footprint of the end user. Maybe just talk about briefly the new products. Is that certainly a new threshold for wall-plug efficiency and kind of what you think that brings to the market.

Yes, we've always called out from an ESG perspective, the benefits of fiber laser technology and a lot of the total carbon savings of our customers is articulated in some of our ESG publications. More recently, you're right, we've the ECO laser for cutting has been around for a while. We've seen in terms of particularly at higher power levels where countries of either had shortages of power that you've seen some sales driven from that perspective, you've obviously seen sales -- it's sometimes a little bit difficult to identify specifically somebody who's choosing a 50%-plus efficiency cutting laser specifically for that reason, but it's certainly a benefit to the other system we've introduced at the moment is very efficient drying diode laser for drying applications. So part of that has got opportunity in electric vehicle drying of the foils, but you could also be utilizing at laser to dry other coatings have been some pretty industrial applications out there even utilizing it in cooking of cookies, which the speed for the processing of cookies with dramatically. Would you see replacing very energy inefficient infrared like sources where also the infrastructure around those infrared light sources is quite cumbersome and large as well, whereas with the intensity of the power that you can deliver the diode laser, you actually end up with a much more simple system. A lot of the infrared drying application, I understand and have quite long tunnels through which manufacturing tunnels always to which the parts that are being drier and moved in the delays that you can actually simplify that quite significantly.

Maybe sticking with wood products that were factors I think it is kind of a nice view for us in the industry. And one that we spent some time on and you guys have talked about a little bit is just the EV market and one of the items that we spent some time talking about well, and I'm not sure if it's exactly new, but it's kind of the newer area. Was the adjustable beam laser product kind of aimed at the EV market and kind of going against maybe some of your competitors with the green laser and the ability of not having to go down that technology for your customers are just getting the traditional IR laser. I guess maybe just talk about where you see kind of the larger EV opportunity and kind of see how that's playing out because obviously, it's been a lot around batteries. And you and I have talked about previously, obviously evolving some of the more unique metals that go into the body of the car base, probably speaking, just if you take a potent about the opportunity in EVs.

And the obvious in EMEA are very significant, right? I mean you maybe got somewhere over a terawatt and installed battery capacity, maybe approaching 1.4 terawatt if you expect the energy transition to happen just from a vehicle basis if you exit 70% of vehicles being electrified and make an assumption on a gigawatt basis of total power that's needed per vehicle, you arrive at a capacity of somewhere around approaching 6 terawatts and to that, you can add some of the storage capacity as well, which would be incremental. It perhaps is it factoring in other transportation as well. . So we think there's a very significant runway for laser opportunity within EV, it is basically dependent upon the total amount of capacity that's being added each year, but you can also expand the number of applications to example if you're adding the drying application or you're cutting different types of oils within that, you're replacing some of the mechanical processes. On the welding side, we think our infrared solution. The AMB is exceptionally good at producing [ spatuals ]. We introduced that with a single mode being combined with a multimode ring. We combine that with the LDD, the laser debt dynamics, real-time weld monitoring capability, high-speed, scanners, other welding heads. So you're delivering a much more complete solution with often helping the customers even in developing the welding processes for the different materials are doing. So there are a lot of capability, you're not just delivering the laser. In certain instances, we're also integrating our optical subsystem, if you like, with the laser, the LDD, the scanner into a complete system for welding within EV processes. The combined solution, particularly you're looking at the AMB combined with the LDD, which is the well measuring technology we've seen not just actually an EV, but in other areas, very significant improvements in yield. One customer had maybe a 40% scrap rates on some of the battery production, they brought that down to 10%. Non-EV application [indiscernible] was running at like a 2% scrap rate that came down to 20 basis points. And in dollar terms, it reduced their scrap value by almost $20,000 a day and the payback on implementing the LDD system in there was exceptionally short. So the pretty wide variety of applications the welding the largest coil cutting there's also cleaning applications in EV, a lot of kidney applications outside of EME the drying application as well. And then you've got the non -- first, we've got non-vehicle batteries, as I said, storage applications. But then you've also got applications within the vehicle manufacturing that are not fundamentally different from an ICE vehicle you lose some of the transmission world, but you pick up a huge amount of battery that way offset anything on transmission. But the rest of the world in around things like seat backs or airbags nature or some of the tailor-welded blanks for the body and white applications continue to expand as well. There's another recall around airbags. Again, the quality of welding on airbags is very, very critical and we think we can bring some improvement in that with our suite of technologies and help some of the end customers resolve some of those issues. But this is...

Would you say -- and there seems to be a good amount of news [indiscernible], are you seeing a lot of the new battery capacity come on domestically here?

There's only been a significant ramp-up in battery capacity in North America and the IRA has partly been driving that right there big announcements of capacity that's going to be added elsewhere, which is be now put into North America, where you're seeing investments in Europe as well in the first half of the year, the China investment cycle relatively okay. It wasn't that strong material compete last year, they've got some capacity they're waiting to grow into our China capacity, which is expected to pick up next year and then you continue to expect to see an acceleration of North American and European battery investment.

Is there a way to think about the laser investment required for each terawatt of battery capacity.

Yes. I saw the data that was initially out there was somewhere per gigawatt like $1 million of laser-based technology. If you look at the total capacity that was added last year and the fact that our sales were about 20% of our total sales clearly those numbers are far off -- there's continued analysis going into the -- we don't think changes in battery design probably the battery becomes more efficient, maybe you need battery where the laser content may go up and on the welding and cutting applications and cleaning applications. But we've got to do -- it's always ongoing work looking at what that total opportunity is...

Okay. One of the things that found interesting at FABTECH again was -- and I think broadly speaking in the laser industry is transitioning to pick up an opportunity is just on cleaning, whether it's removing paint oil or grease, I think, obviously, the sand blasting has shown environmental issues and I think this is a bit of a newer area for you guys, but one that seems to be growing of interest in warrants, maybe you touch on that a little bit.

Sorry [indiscernible] because it's not really a newer area for us. It's an area we have been working on for several years. We have got some OEMs that sell into the market. We have actually also developed our own cleaning more complete cleaning systems and we've booked last year several orders for those if you start into the OEMs, utilizing much higher power pulse rates than you'd use even for certainly for marking engraving and much higher power even than for foil casting applications. So there's a unique capability that we have on. And that, as I said, we've introduced the handheld with containing capability both preprocessing and actually seeing the wells offer. But I think it's potentially a massive opportunity. I mean, the cleaning market is even a bit difficult to quantify some of the numbers I've seen out there. It runs obviously the billions of dollars than amount of cleaning with chemicals, solvents, abrasives you think about the oil and gas industry or shipbuilding manufacturing processes where you have to remove a coating or you're cleaning storage tanks, vessels, molds. It's a really significant opportunity for the laser industry. There's other cleaning applications like dry ice cleaning, which has also got a huge energy input where you're freezing carbon oxide gas. You also got an environment at a you're not talking carbon oxide gas as being the output from that process and it is a much cleaner process from both in terms of trying to dispose of hazardous chemicals but also from an operating perspective. Cleaning with a laser is significantly safer from a health and safety perspective of the operator. So we think it's a very significant opportunity. That performed very well in first half of this year compared to the first half of last year and grew significantly last year. I think you're starting to see some giant acceleration around cleaning applications for the laser industry.

Okay. Appreciate the color. Maybe shifting gears a little bit to kind of some geography-based questions. Obviously, with the challenges in Russia, you opened up some new production in Poland, an area where I don't believe you previously had production capabilities. And that's -- I think you mentioned like Q2 to still continue to ramp up. Maybe any color there and as the opportunity to continue to move your best-in-class manufacturing around.

Yes. So Poland was obviously a greenfield site for manufacturing for us. They've made great progress through the first half of this year. They're still meaningfully below the total production level that they want to achieve and their yields are improving. But given where the yields are, their costs are higher than the target level, we expect to continue to make very good progress with that through Q3 and Q4. That's very important, the total cost of production, whether it be direct labor or even overhead is certainly comparable to where our costs were in Russia. In other areas in Italy where costs are higher than lower than Germany, they've made very good progress to ramping up their production there. The other focus that we'd be looking at is automation of different assembly processes of optical components. And we're starting to introduce some of that automation into production. That's obviously is something that will take a bit more time to get cemented in. But we actually go some -- that basically develops systems that are not being deployed quite but very close to being deployed in some of the fiber block manufacturing, some of the fiber couple of manufacturing and even the module the modules where you combine the fiber block with the diodes, there's relatively easy ways of utilizing pick-and-place technologies to significantly reduce labor input on some of those optical subassemblies that are currently quite labor-intensive. So progress in that area would be equally as good as display to a lower cost manufacturing area. Automatization yields significantly that a cost benefit and yield benefit than necessarily producing the low-cost manufacturing area.

You can just remind me because I know I believe that a lot of the products that you guys used to ship into China was made in your Russian facility. Is that now coming out of the Poland and Italy? Or are you coming out of kind of a combination of your other plants as well?

No. So some of those products will be produced initially by and large, a lot of the other product for China is coming out of Germany. The only thing that the Russian facility is continuing to supply some medical product into China and India, some very low power pulse lasers when we disclosed, I think, in the first half of the year, though the total sales from Russia into China were below $15 million. China and India were well below $15 million compared to -- i don't remember actually what they were in the prior year but much, much higher than that last year.

Okay. Shifting gears to China a little bit. Obviously, the cutting market has been a bit of a challenge. But certainly, you've talked previously about the other markets within China where it's well being additive even some consumer electronics, maybe just kind of talk about where you guys are would sign because obviously, it used to be the largest market as a percentage of revenue has changed a little bit, but you are expanding your thoughts going forward in China.

Q2 in China was in total below 30% of total revenue. So the concentration in China has certainly come down a lot. Part of that is in around the cutting business and we said that the cutting business was less than 10% of consolidated sales, less than 30% of total sales in China. We've seen good performance out of these other areas, EV, additive, cleaning, consumer electronics where that investment cycle is stronger. We see good sales of QCW lasers for fine welding applications there. Strategically, China obviously remains very important there earlier, adopters of technology often aggressive adopters of technology. But we'd like to see growth from all of these other areas of these other applications on a much more global basis, so we're very pleased with the performance for example of cutting in Europe in the first of the year and has gone into a bit of a headwind on a macro basis. Cutting business in Japan grew strongly the welding business on a global basis has been a strong performer. But yes, the strength we've seen in China has been around those emerging applications and growth areas as well, right, whether it be welding cleaning applications. It's a lot of investment going on additive manufacturing in China, a couple of the OEMs have developed some strong capability there. Medical line are also starting to grow the applications that are growing are not dissimilar around the world, we tend to be strong globally on an application, and you'll get strong sales for that same application in China as well.

Okay. Maybe a couple of balance sheet questions. I know you've been kind of working on inventory levels and targets. So maybe your kind of thoughts on where you are there? And then kind of on a similar note, just kind of an update on your capital allocation and lots of use of cash longer term?

Yes, we've seen some certainly taken inventory down a little bit through the first half of the year. My view, and I see a lot of focus on this internally is that ultimately, you'd like to get down to -- down to 180 days turning inventory like twice a year, those days are quite elevated still, even though inventory came down a little bit from the end of last year through June -- so there's still -- there still remains work to be done on that, but we want to continue to generate some cash out of inventory in the second half of the year. On the rest of the balance sheet, the balance sheet remains very, very strong. Most of our working capital is it an diode inventory to a lesser extent in accounts receivable. We continue to have over $1 billion of cash on the balance sheet even after returning -- buying back about $600 million of stock in the last 18 months in Q2. We didn't buy back any share we did state that we put in place a new 2018 plan, and we had approved another $200 million buyback. We're not going to probably be doing like quite at the level of $600 million can in the near term. We want to have done the acquisitions recently, so we're really looking at inorganic opportunities in our technological capability to some of these end markets that we're trying to address. We remain very cautious about and do not think of ourselves a consolidator within the industry. We're really looking for technology complementary capability that could grow into some of these other end markets that we've been talking about that we think are significant opportunities. So want to preserve of that, but obviously did approve another $200 million buyback in the April Board meeting and said we put in place 2018 plan that has a bit of a cooling off period...

That's going to be opportunity to talk about buying about.

still.

As we're kind of getting near the end of our time, maybe 2 questions to kind of wrap things up. One, maybe your thoughts on the industry pricing trends? And then secondly, I believe it's always been IPG's philosophy to continue to push prices down and preserve margins through your vertical manufacturing. To that end maybe you could just remind us what revenue run rate do you need to kind of achieve those gross margin targets? So on the pricing front, kind of what does the market look like now? And then on the margin front, what kind of revenue do you need to hit those longer-term targets?

In Q2 we had still some elevated inventory revisions in the level of inventory that we're carrying, they're about 350 basis points of view -- got down to more normalized inventory provision level. I don't think it's all going to happen immediately, but you can get down to normalized inventory provisions of like 150 basis points, you would have actually been closer 40% to 45%. We still have some yield and strategies in the new manufacturing areas if you get down normalized. You're kind of getting back close to the bottom end of that 45% to 50% range, even at that $340 million, $350 million. So if you're getting back above $370 million, closer to $400 million, you see some better performance when it start. And then we're continuing to try to take cost out of product where we talked about the automated manufacturing, trying to improve yield, obviously, an important part of just trying to get more power out of the optical components, simplify the bill of materials. You continue to make progress on that. We would try to maintain more stable pricing because in our line, pricing came down so dramatically for a couple of years, there's a tremendous value proposition to be had from the existing price level that lasers are at. The issues that within China particularly around the cutting market, the Chinese competitors are significantly below where IPG is today, but you've seen what's happened at least probably to the public, they really damaged their gross margins even if they did see some improvement in Q2, but they've almost passed all the value on to the end customer rather than keeping it in the value of the technology and the processing capability advantages themselves. So we really focus on the value proposition of the solutions and solving customer problems, right? You're driving productivity and you've got relatively short payback periods with the technologies should be trying to optimize your pricing whether to that rather than just take it down because you're reducing cost, you're going to become much more focused on the value proposition that you're delivering to the customer. As well as -- I think that has -- really most of it, it's not just pricing, it's the value proposition and solutions that you're growing piling for the end market and the customer.

Okay. I think we've reached end of our time, Tim, Eugene. I appreciate your time as always, there's always good chatting. And I'll circle back up by any follow-up questions. I appreciate the time today.

Thank you [ Tom ], Thanks.