IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Good afternoon to everyone. I know it's been a very busy day for everyone joining us. Long conference. Appreciate your attendance. I'm Michael Feniger, I'm the machinery, engineering and construction analyst here at BofA. And I'm grateful to host IPG Photonics, one of the most interesting unique companies, I think, at the conference in terms of a blend between industrial technology. I'm just going to have Tim introduce himself so you get a little bit of background on Tim, and then I'll pass it to me, and we'll join some Q&A. Over to you, Tim.

Mike, thank you very much.

Perfect. And maybe just, Tim, to put everyone on the same page, so everyone has a better understanding. Just when we think of IPG Photonics, a manufacturer of fiber lasers, the leader, what end markets do you serve? What's the solutions you're really providing to customers? And really who are those customers?

In terms of the end markets we serve, they're very board, first in terms of applications [indiscernible]. So the largest application we've got is welding. That covers a very wide cross-section of different industries from automotive, including EV to fabrication; construction; consumer durable goods; consumer electronics; other transportation, so aerospace, railcar manufacturing. So the very -- I mean, whatever -- wherever you utilize welding, lasers will also be utilized in them. Laser-based welding is more productive; the quality of the weld is better; the cost of it, obviously, given the productivity is improved. You can weld a much more disparate set of materials, so you're not just welding steel, but you can weld copper, aluminum, you can weld copper to aluminum, you can weld titanium. So the laser brings numerous advantages in that application and process. The next largest application we've got is cutting applications. So cutting has been a somewhat challenged business for us because of the competition in China and really the very significant price reductions that we've seen, which we've chosen, initially, we competed against the Chinese, but we've stopped competing on price there. The outcome of that really is that the Chinese cutting sales are effectively at a very, very low level, almost nothing at the moment. If we sell lasers for cutting in China, it's often to go into a system that may be exported or into a high-end cutting application in China, say, heavy equipment manufacturing or an automated production line. outside of China, though, the cutting business, we still have a very significant share in North America, Europe, Japan, and we continue to preserve that. That business at the moment is a bit challenged given the industrial end market demand environment. Again, it will address a very, very wide cross-section of industries, similar to any machine tool business that you may look at. Other -- sort of other applications we're focused on, which are doing very well, we're a significant believer in cleaning applications. So cleaning is a laser-based process where you're displacing chemicals, sort of aqueous-based cleaning processes or abrasives. So if you're like blasting a piece of metal that's got corrosion on it, you're utilizing sand or other abrasives to remove the surface of the material and clean the corrosion of it. But it can be used for paint removal, coating removal, cleaning of tanks, storage vessels. Often those processes because they're using chemicals or abrasives are very hazardous and environmentally very damaging, right? That market is very early stages of displacing incumbent processes. So the total market for cleaning, including the complete system is about $200 million. The market itself is tens of billions of dollars. I mean this is an application that could be equally as large as cutting and welding. And it will become significant given the environmental benefits that the laser-based processes drive. And sometimes, it's not even just the reduction in chemicals or abrasives, there can be a significant reduction in the amount of water that's used in a cleaning process. So we've got a customer that their tank cleaning process was consuming about 1 million liters of water for each cycle of cleaning that was eliminated. The cleanup of the residue as well is a lot easier in cleaning processes. Again, you're dealing with a very, very diverse set of industries, it can cover aerospace, automotive, oil and gas, other manufacturing processes, areas where they're storing liquids or chemicals. So that's another growth area. We're also focused on things like drying applications, so utilizing a very electrically efficient laser either on its own or in combination with ovens and other heat sources. So the benefit of the laser-based drying is that you're presenting a highly electrically efficient source to -- and you're able to concentrate the energy on a very small surface area. So your drying times are significantly reduced. You not only got a significant reduction in the electrical consumption but the speed of the drying process is very significantly improved. Again, it's a very wide cross-section of industries from the coatings industry, but also food production, pharmaceutical manufacturing are potential end markets there. EV and automotive is another one on drying. And then we've got a sort of micro processing and medical business. Again, you're sort of looking at microprocessing as nonmetal-based processes, whether you'd be either -- you can be ablating the surface of a material sometimes dicing and scribing. In medical, one of our main applications is lithotripsy so that's kidney stone removal. You're ablating the kidney stone down to very fine particulate. It's a much less invasive process than having surgery to remove a kidney stone. In terms of what we sell, we'll sell stand-alone lasers. We can combine the lasers with optical delivery. So in many of the welding, we're not selling a complete system, but a subsystem where you're combining the laser with a high-speed scanner or -- and measuring capability, which will tell you about the quality of the weld as it's done. And then you go from subsystems to complete systems. So for example, we've sold complete systems for cleaning, welding applications, cutting. The medical system for lithotripsy is a complete system. The handheld welder is also a complete system. So it's a small system, but it includes all the programming, the optical head, all of the safety that's combined within that. So in terms of the products, it will go from the resonator or the engine, which is the laser up to a complete system.

And as you -- you're a product-driven company with a lot of technology, just for the audience and for investors, how can we think of that in terms of how it drives the model? So is there any rule of thumb, Tim, when we think of GDP as x, industrial production as x, and you guys can grow y because of the high addressable market because of the penetration opportunity, just what's a good rule of thumb for investors to think about IPG on a through-cycle basis what the top line growth kind of looks like?

Yes, in many of those markets where you're still underpenetrated compared to some of the legacy applications, right, so it's basically everything [ above ] from marking and engraving and cutting applications, the average growth rates for those applications is in -- like welding is probably in the 10% to 12% growth rate. For cleaning and drying applications, you're potentially in much stronger double-digit growth rates. The medical and micro processing businesses, particularly for surgical applications, again, growing at probably the 10% to 15% rate. The cutting market is more of a GDP rate of growth, I'd say. So some of the market like in China, which we don't participate in is quite highly penetrated, but the rest of the world is still relatively underpenetrated in cutting, but we think the cutting market probably grows more in the 3% to 5%. Now even at that level, it would be accretive to us, we've seen significant headwinds around that. Marking and engraving, I'd say, again, is really GDP capacity utilization driven, and we'll still sell fairly basic lasers for marking and engraving, particularly where they're used in high-volume throughput. People don't want to use an unreliable device in an automated production system because a day of downtime on an automated production system is far in excess of the value of the laser.

And Tim, why just for -- to help us contextualize this, why do you feel like laser penetration in industrial applications took off in China? And when do you feel like that happens in U.S. and Europe? I know you -- obviously, these are still big markets for you. But from what I understand, the penetration rate is a little higher in China, the adoption of your fiber laser technology compared to the U.S.? And do you feel like, Tim, that's on the come? Is that something that we can look in 5, 10 years, and we kind of see that curve accelerate?

I think you're going to see it accelerate in the rest of the world in 5 or 10 years, but even in the nearer term. So there's a couple of things with the China market, right, there's a lot of greenfield investment that drove China's investment in production capacity over the last 20 years, and a lot of that accelerated, say, over the last 10 years. A lot of the investment, for example, in smartphone, subcontract manufacturing happened in China. And with that a high-tech kind of manufacturing operation, they didn't really look at legacy welding, right? They were utilizing different types of materials that were very fine, the materials were particularly suited to laser-based processing. So you've had certain investments in industries that have driven that adoption. They've had a significant investment in EV battery manufacturing capacity that exceeds the rest of the world. Again, there, you've got very complex, high-speed welding with complex materials as well that you can't really weld with traditional technologies. And then the other side of it is that, that greenfield because they're developing a lot of greenfield sites, they weren't really broad-based users of some of the incumbent technologies. And there's a certain dynamism that exists there where they're pretty open to evaluating newer technologies. Some of that's driven, I think, by government support as well, right? The risk isn't entirely sitting on all of these individual company balance sheet. So there's a benefit that's, perhaps, given to them there. There's somewhat of an innate conservatism in Europe and North America and some of these other markets where traditional welding technologies have been used for 100 years, right? They understand them even if the quality isn't great, the cost of welding isn't a pain point necessarily even though -- so even if you're bringing the cost of welding down with a laser like spot welding with vehicles is still done with electric spot welding because the cost -- the entire cost of welding a car is probably $450, right? The focus point has not been trying to take 20% out of that cost even though it's spread over 60 million vehicles. It's huge. People have been looking to add all kinds of other bells and whistles to vehicles, right? That's where the engineering focus has been on safety or sensing, entertainment and displays in vehicles rather than saying, let's take, $90 out of the cost of the welding of a vehicle. But where you have an industry that didn't use that, they weren't bother looking at the older technologies. So there's an innate conservatism. Sometimes there are standards and certifications that you have to get qualified for and for example pressure vessel manufacturing or pipeline welding, construction infrastructure building, there's sort of less laser-based technology that's used in that. But with the handheld and even some of the cleaning -- handheld cleaning applications, you can potentially like taking paint off bridges, there's some of the areas where you could see those handheld applications grow even welding in the field using a handheld application as well.

Interesting. If I could just zero in on China, one of your regions. IPG has had a very deliberate approach, I feel, like, to China. You guys don't do any manufacturing there, so to kind of guard your IP. And it feels that the mix of the business within China has kind of evolved from low end to the high end, more welding versus cutting. Maybe kind of just give us -- walk us through what your China business makeup looks like today? And what you're seeing there on the ground? We're seeing PMI starting to come up a little bit. There's some talk of stimulus, but we're still kind of waiting for that [ Bazooka ] if that ever happens. So just curious what you're seeing in your portfolio, how that mix has kind of evolved and what you think you're seeing today.

Yes. I mean our China business, as we said, the cutting business has become very small. The lasers we still make for cutting are very sophisticated. In one sense, though, the China solution to the fiber laser, which is end pumping the fiber and actually produces a lower quality beam is, in some ways, it's not a disadvantage on cutting applications to have that. Some of the other technologies that have been introduced, like our AMB laser was originally introduced for cutting applications because we were trying to diverge the beam rather than make it more intense. So if you have a more divergent, less-focused beam, it's actually not a detriment in a cutting application. It's interesting, though, because in additive manufacturing, where the quality of the laser and the quality of the beam are fundamentally important, we're still side pumping the fiber with our special coupling technologies and using very high-quality fibers that enables even at lower power levels, a very intense beam. So you'd expect the local manufacturers in additive to be competing with us because the lasers are 500 watts to a kilowatt, right? But they really struggle to get to that single-mode beam capability. So the sales in China really -- the cutting sales are almost nonexistent and it's really welding, additive, other fine processing, there's still a marking and engraving business there. There's a bit of a medical business that we work with a partner on. So it's certainly more value-added applications where process and know-how. But some of it is just driven by this core fundamental difference in the design of the laser. I think the Chinese market has started to stabilize a bit, but it's not really -- there's not yet a lot of traction back in it. We didn't give specific guidance on why we said our book-to-bill was slightly above 1 for the quarter. I think I mentioned on the call that we've seen relative stability in China. Our guidance assume China revenue is relatively flat as well. So we're not seeing a further step down there, which is good to see. I think one of the geographies that's out there, Europe is really still quite challenged, right, where China may be stabilizing a bit and the U.S. has held up better than Europe has over the last 6 to 9 months.

And let me ask you about EVs. You guys have disclosed around 20% of your business. And what's interesting to me about EVs is there's not really a lot of competition, it's really you and maybe one other player that kind of really dominates that market. So I'd just love you to walk us through. It's been such a strong tailwind for you, yet it seems like we're seeing some pauses and pushouts in EV. So is this more of a China phenomenon that you're seeing the capacity starting to slow or get delayed? What do we need to see that greenfield start to come back? And when do you think you will start to see that, Tim?

Yes. So the EV investment cycle has been a very strong driver of growth for us, probably started in 2020, '21, '22 and then the first half of last year was exceptionally strong. It's quite a diverse set of applications. It's not just welding. Welding is the largest one, but you've got foil cutting, cleaning and even drying applications in EV. You've seen a slowdown in China halfway through last year. North American investment was still quite strong in the second half of last year but that has slowed down. I think Europe, the amount of capacity that's added in Europe is still quite limited. So there's a lot of projects that have kind of been announced, and we've been working with a number of companies on the end markets there. But stepping back a bit, I mean, fundamentally, you just got to look at what global utilization of battery capacity is and estimate the total installed capacity. We think there's about 1.5 terawatts of installed capacity. A lot of the market data will say it's 2 terawatts. We just don't -- none of it adds up. I mean if you look at what CATL says their capacity is, and they've got a very significant share of it and you add up some of the other, you just don't get to -- I think they may have been 2 terawatts announced, but the actual build-out is probably around 1.5 terawatts. I mean you take that, you look at 14 million EV vehicles sold and you use an average of 50 to 60-kilowatt hours, you can work out the total amount of battery capacity that's needed, then CATL made an interesting comment on their public stuff that 20% of global demand is actually storage now and that grew very robustly last year. So you basically need -- we think that the average utilization across the industry is 55%, 60% at the moment. Some of the larger players saying they're at 70% utilization. Total EV vehicle sales are supposed to go from 14 million to 18 million this year. So that's another 25% increase. If you see continued increase in demand for storage, you probably see capacity getting up to that 70% level, overall, that we think starts to drive an improvement in a pickup in the investment cycle. We don't think people will leave until they get to 80% utilization because there's a lag between bringing that capacity on and demand continuing to increase. I think by region, you still got strong EV push in China, Europe, the U.S. has got a number of different issues that are sort of swirling around it that include like politicization of the EV Trends. U.S. sales only 9% of EVs; Europe's at 25%; China is at 35%. I think Japan has a bit of an open question mark. There's several leaders in the automotive industry there, who think that a hybrid approach is more suited to the transition and achieves a lot of the advantages of it. We still think that for every gigawatt of battery capacity that's added, it drives about $1 million of laser-based investment. So a shift from 1.5 terawatts to, say, 3 terawatts implies a very, very significant demand for laser-based processes. And we think we have about 60% share of that as compared to one of the other main suppliers in the market.