IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

We're going to start the clock now. And thank you, everybody, for sticking around for the last session of the day. My name is Ruben Roy. I cover Applied Technologies at Stifel, and I'm really excited to have IPG with us again this year with what I consider a special guest, no offense to Tim, but Tim Mammen, the CFO of IPG is to my right, but Trevor Ness, who I haven't had the opportunity to have a panel with is here as well SVP Sales and strategic business development. And I really enjoyed talking to Trevor just to get that sort of sell side of the viewpoint as well and in the audience here, as Eugene Fedotoff from IR. So great to have you here. Trevor, since you're here, maybe just you can kick it off with a little bit of an overview of IPG, if that's okay, Tim, for some of the folks that might not be as familiar with the customer.

Yes. Yes, sure. Trevor can answer all the financial questions as well.

Thank you for a very kind introduction. So IPG Photonics, we are the world leader in fiber laser technology. We don't just produce lasers as a large part of our business. We also produce systems, and those systems run the gamut of medical systems through to complex industrial processing systems. So we can make cartesian systems, we make robotic systems, and we also make complete production lines sometimes for different types of customers. And on the laser side, we have an extremely deep technology portfolio. So our lasers span the gamut of wavelength from deep UV all the way up into the mid-infrared. We make lasers from a few milliwatts up to 125 kilowatts in parallel. And in post duration, which is another way we look at lasers, we make lasers from femtosecond all the way through to pure CW. So very, very broad technology portfolio. We're an interesting company as well because we are very vertically integrated. We have our own diode fab here in Massachusetts. So we make all of our own diodes that we package, and they are the pump light for our lasers that excites the ytterbium, which causes the leasing effect for our ytterbium high-power lasers. We make other types of lasers that are not ytterbium, but that's the core business, which is in the 1 micron wavelength.

One of the things, Trevor, before we turn to sort of end markets is that you've also done some acquisitions that have added other technology in software diagnostics into the systems level sort of solution that you can provide to some of your customers? Do you want to spend a second on that area of your portfolio?

Absolutely. The -- on the software side, we had acquired a very interesting company that I think has been a very successful acquisition for us, which is using optical coherence tomography or OCT for in-line weld monitoring in real time. So the technology is supplied with our lasers and our beam delivery and it actually can look into the weld and it can see what's going on in the key hole of the weld. It can do a lot of other things, but we're using it for real-time quality control in applications that are safety critical, like in EV or air bad manufacturing. On the other side, in systems, we grew initially our systems business organically, but to get better leverage and to open up the market capability, we acquired 2 companies. One is based up in Minnesota, in Minneapolis, and we build custom systems and standard systems, which are predominantly used for manufacturing medical devices. So this is a machine, which is typically cartesian with a wide range of lasers for processing all kinds of things that may be going into the body. It could be plastics, could be metals, could be endoscopes, could be stents. And these systems come with very unique software that's providing real-time data transfer to customers' servers often in the cloud. And we are integrating tooling and vision. And we also acquired another company in Davenport, Iowa, who was called Genesis, and they're making robotic systems. So we have the capability to do cartesian and robotics. And the robotics business, we are predominantly moving in welding and in cleaning, which is quite an interesting area for us. So we have a very wide capability in systems from software through to cartesian systems through to robotics.

Thank you, Trevor. That's -- I think you've hit on a lot of the probably most interesting aspects of the company and kind of the go-forward strategy in that answer for me at least. But maybe we'll take a step back to because I think when a lot of investors that I speak to think about IPG and kind of how we got here, the market seems to have been driven at least initially by China with all the industrialization that was going on in China and flat sheet metal cutting. And I always get the question of where are we with the cutting market and how to think about that as a percentage of your revenues? And is that going to be sort of a longer-term headwind ahead of some of these interesting emerging markets ramping. So maybe if we could start there and then we can get kind of more into near to medium-term macro trends, if that's okay.

Yes, sure. I think if we step back and look at this clearly cutting and other older applications such as marketing grading core drivers of IPG 6 over the last 20 years or so. The cutting market has become fundamentally more competitive in China. And then over the last year or so, the really weak industrial demand has also impacted the cutting business outside of China and the rest of the world. So our OEM business in Europe, for example, is really quite weak at the moment. All of our analysis points to that genuinely being the macro rather than a competitive issue. I think people are going to debate that with us until we see a recovery and the extent to which we participate in that recovery. One of the ways today actually, we kind of breaking that down is if you look at the total cutting business, last year, it was 25% of consolidated sales. If you add in the more basic market engraving applications, that's about another 10%. So 35% of our business in total is kind of core legacy applications, whereas 65% of it covers the welding, cleaning, microprocessing, medical and now the drying applications additive manufacturing. So markets that are either more nascent or growing more robustly, total welding sales were approaching 40% of our sales last year. Within cutting, we stated that the headwinds around China have been so significant that the China cutting sales are really a very small share of total sales. So they're actually less than 5% of our considerably less even than 5% of consolidated sales. So there's not much more of a downside to the cutting market in China. And we think that as the global economy recovers rather than the rest of the world cutting sales bring a headwind they could actually start to increase and recover and then would complement some of these other growing applications more meaningfully in an upside thing.

Do you think -- it seems like the Chinese adopted laser technologies for cutting rather quickly and perhaps in some other geographies we're still not there yet, maybe kind of given rates of adoption, et cetera. Is that the right way to think about it? Is there more upside just from TAM expansion as potentially your technologies take over from legacy technologies? Or is it more of just macro coming back, driving revenue growth?

I'll leave that to Trevor, because he got a lot of insight on what happened with the Chinese cutting market and how that grew and developed.

Yes. So in China, the market probably 10, 12 years ago, was actually quite small. So if you looked at cutting globally, let's say it was somewhere in the 5,000 to 6,000 machines. What happened is, in China, they didn't adopt other types of cutting technology. They went straight to laser, and we were able to benefit hugely from that. So one of the things about the fiber laser is that we made it very simple to integrate into machines. And so it attracted a very large number of new OEMs into the marketplace, well over 100. And our success in that market then attracted a lot of Chinese competition, which pushed the prices of the lasers down. And of course, it pushed the prices of the machines down. So what's happened is that if you look at the kind of the pyramid of the cutting market, the bottom of the pyramid has become very, very large. So perhaps the total size of the market is 60,000 to 70,000 machines today, but the bulk of those are very low-cost machines being sold in emerging markets and in China, and that's the market where we've lost a lot of share to Chinese competition, in the mid-range and the high end, where the customer is looking for a higher quality or higher reliability, higher beam core quality. Those are the areas where we've continued to excel. So we still have business with Chinese OEMs, but of course, a lot of long-standing relationships with OEMs in other parts of the world in Japan, in Europe and even in United States.

Interesting. So let's move on from that jumping point to kind of what Tim said earlier about sort of cutting as a percentage of revenues having come down, certainly in China. And then you've got what we are categorizing as emerging market areas, welding, some of the new areas, client cleaning drying. But within that, EV is very important, right? So Tim, you've broken out EV as a percentage of sales. And maybe we can walk through the EV market, and wherever you are, from your perspective, sort of clearly, we've had a tough and challenging environment over the last several quarters and how you see EV emerging, we could drill down into some of the other markets from there?

Yes. So we stated last year that EV in the second half of the year was quite challenging, grew moderately, actually slightly and ended up being slightly above 20% of total sales. If you went back 2 or 3 years, it was less than 5% of sales, right? So that was one of the really robustly performing end markets that helped to offset some of the headwinds around the cutting business. There was a significant amount of capacity built out over that period of time. And one of the challenges that we run into is that the utilization of that capacity despite continued robust growth in total EV sales has been quite low over the, say, last 12 months or so. So our estimate is that there's probably 1.5 terawatts of actual installed capacity. Some market data would point to that being as high as 2 terawatts. We think that's more total announced capacity, and it does take into account projects that have either been deferred or delayed. If you then try and work back from that, and we do a lot of work just looking at total EV vehicle unit sales and using an average of the amount of kilowatt hours per vehicle, which if you're combining it with the hybrid, maybe an average of 50-kilowatt hours per vehicle to get into higher-end vehicle with, say, 300-plus mile range. It could be as high as 100-kilowatt hours per vehicle, right? So last year, you had 14 million EVs sold globally, grew by more than 30% in China and Europe actually grew quite strongly in the U.S., although just off a very small base. You get back to about 800 gigawatt hours of total battery being consumed just on automotive. The other thing that you have to factor in also now is that storage capacity and production is growing quite quickly. So some of the data out there shows that total storage battery production was around 200 gigawatt hours last year and grew by about 50%. That implies that utilization is somewhere around between 60% and 70%. So as that continues to pick up, so I think the latest data out of China and Europe showed pretty good robust sales for EVs in April. I think total EV sales as a percentage of the total market was approaching 40%. Europe was quite strong. In the U.S., you've got a fight going on between where EVs are going to land within the ecosystem of hybrid, ICE and EV. So there's certainly a lag here in continued adoption. But as that utilization starts to pick up towards that 70% or 75%, you're going to see capacity start to be built out again, we're still not certain we think that's sort of probably not the second half of this year, maybe a bit of a pickup into the end of this year, but '25 and '26 should see that pick up. So we kind of look at a lot of that data at a more macro level. And then obviously, Trevor and his sales team have a lot of insight into what's happening more at the ground leverage with customers and projects as well.

Very helpful. I guess we'll shift then from EV over to some of these other markets, Trevor, cleaning, drying, welding outside of EV. You guys have a very interesting handheld molding family of products that I'd like to get into. But when you think about some of these areas and maybe want to throw medical devices into that mix, what are you most excited about in terms of these new sort of applications for fiber lasers?

I'm excited about all of them to be honest with you. I'm very excited about all of them. So I'm excited about welding. And as Tim said, we've grown welding tremendously. It became the largest share of our business last year. And our business is very diversified in welding. So we can work in all kinds of welding from medical devices I was explaining through to EV. We have all kinds of lasers that can be tuned and customized to the application, our application expertise in welding is world class. It's a big part of our selling pipeline. We have a huge number of applications, labs and engineers around the world that work directly with customers, which is a very strong value proposition that we bring to the end customer to provide a solution, and we're not just supplying the laser. We're supplying the beam delivery. So we're providing welding heads, very sophisticated scanning heads for welding or high-speed cleaning, the software or complete systems. So welding is great. The handheld we can come on to a little later. The cleaning is a great opportunity. It's like a virgin market, which is just prime for new technology adoption, which is giving you a very strong ROI, which is environmentally just fantastic compared to the incumbent technologies, which are typically solvents, chemicals or abrasives. And so we've been very successful already in different types of cleaning applications. We're seeing double-digit growth every year, and we're doubling down on the NPI and building out the product portfolio to enable us to get good leverage from that in the future. Drying is an interesting one. It's early stage. We're still exploring it. So it's areas like coating, food and beverage, drying of battery foils. And medical is another one, which is very exciting for us. We have a medical business today that we've grown almost completely organically. We have become very strong in urology, and we've actually technology, we've transformed the technology being used in urology. So we're using 2 micron thulium laser. We're giving practitioners and surgeons the capability to actually dust stones. One of the big issues was that you couldn't get rid of the stones completely. So they are actually recurring and coming back after a period of time. With our laser technology, we've been able to turn them to dust. So they're completely passed, and we have a very deep portfolio of products in the pipeline that we're planning to bring to market over the coming years. So that's a market that we think over the next 3 to 4 years, we can double or triple.

I think you've had TAM assumptions across a lot of these markets historically. I don't know if we've seen an update, but can you maybe segment out sort of your initial discussions with your customers? I mean, these are big TAMs, I understand. But the laser portion of it? Have you been able to sort of pinpoint down some assumptions at this point of what the opportunity might be?

I can talk about the clean market runs to tens of billions of dollars, right? The total laser based, if you include the system in it, so there's a number of OEMs that we sell lasers too. We're doing our own cleaning systems that's still very small. It's like a $200 million market. It's expected to grow at 12-plus percent a year. Even at that rate, even in 3 or 4 years, it's going to dramatically increase in size, but it's still going to be a very, very small share of the total opportunity that's out there. I think likewise, the drying market as well runs into several billion dollars. As Trevor said, that's a very nascent market. So it's going to take probably 2 or 3 years to get some real traction and momentum into it, but it could also become a pretty fundamental application for the lasers, complementing things like the welding in particular and the cleaning as well. So they're just huge markets, but they're sort of so nascent. It's a little bit -- it's impractical to talk about the total size of the market. I think look at the laser size and the expected growth rates. But those are markets that we'll be growing at a significantly stronger rate than, say, for example, the cutting market and even the welding market is sort of expected to be a double-digit growth market, but some of these earlier stage ones could be growing even more quickly.

Yes. So on that point, let's drill into the handheld welding a bit here, which I think you do have some ideas on sort of standard inert gas welders, take a kind of classic welders. And I know you're not going to address the entire market structural steel welding, et cetera. However, it does seem like you're getting some validation. You signed a contract, a distribution contract with Miller Electric last fall, which I think is really interesting. And so maybe you can just comment on that specific piece.

Sure, I could take that one. Yes. So handheld laser welding is a revolutionary technology. We can train anybody in the room to weld...

Welding day, by the way. In about 10 minutes, I'm not good with my hands but...

Well, I will congratulate, we proved it. Look, there's a tremendous shortage of welders out in the United States and in developed economies. And so the handheld laser welder is really a technology box, which is not only giving you a laser beam, it's giving you all of the application processing parameters. So you determine what kind of weld you want, the thickness, the materials, you dial in the application presets and the laser does it for you. It's also very easy to use because often, it's -- we're using wire feed with it. So it's pushing you at the right speed for your well. So all you've got to do is hold that gun correctly. It's able to weld pretty thick material up to 4-millimeter steel, when we can also clean with it. It's not a pure laser cleaner, but we can do pre and post weld laser cleaning. So we're seeing a lot of rapid adoption in particularly developed markets. It gives a lot of productivity and a very good quality of weld and the relationship with Miller is something we're really proud of. They're a fantastic company. They're a world leader in MIG and TIG. We've been working with them since 2022. And they just launched on May 1, and congratulate them on their product launch. They've approached it fantastically. We're very impressed with the way in which they manage their business, have gone to market with the product and in the way in which we cooperate with them. So we're proud to be a partner for them. Of course, what Miller brings is several things. They're bringing all of their deep technology know-how, application know-how. They're bringing a channel and a huge marketing machine. So they sell through distribution. They have a tremendously strong distribution network, which they've now trained and are setting up to sell the product. They also bring obviously, excellent reference. So now with a company like Miller saying, yes, this is a good technology. This is something that is going to enable you to increase your productivity, perhaps use employees that are not as skilled or not as time served as 20-year thick welders. So having them give us that recommendation to the product is something which is really fantastic. And we think it's going to be a multiyear success story with them as we continue to launch a series of products together.

Yes. When we read the press release last fall, it was really interesting. We have a fellow here, a colleague, Nathan Jones, who covers the space. And it's a traditional sort of list of distributors that he looks at, and it's tough for them to embrace new technologies. So again, it seems like a strong validation of what you guys are working on I've been hogging up all the questions we're getting down to the last 5 or 6 minutes. So are there any questions in the audience? All right. I'll keep going then. I guess if we can spend a few minutes, Tim, on the model. And just obviously, it's been rough ago the last several quarters, and revenues have come down quite a bit from the peak. And you have a longer-term margin target, which I wanted to talk about. But how are you thinking about gross margins, operating expenses as we kind of work through this challenging environment?

Yes, sure. So on the last call talked about gross margin in a little bit of detail, right, and said that I was pretty comfortable with the underlying dynamics of the model, not withstand in fact that volumes are impacting gross margins. So I pointed out that gross margin actually of the products sold was really quite good in Q1. There was some mix benefit on that. We had a little bit of sales into the directed energy area. So those are sort of very specialized single-mode lasers, which have got good margin on them. The China and global cutting business being a bit weaker will have been a bit of a mix benefit for us. But I was actually quite pleased with the outcome on the gross margin of the product. So then as we went through cost of sales, the 2 or 3 things that impacted us were, first of all, we still got quite a high scrap rate as we've been ramping up production outside of Russia because we lost that capacity. That scrap rate is starting to moderate a bit. So we're starting to see some improvement in yield in some of the newer manufacturing locations. Inventory provisions were still elevated. They've impacted us by more than 100 basis points on a year-over-year basis. Again, as we now get inventory more under control, we're really trying to get some cash freed up from the investment in inventory working capital taken inventory down by about $70 million over the last 2 quarters or so. Some of that has been the provisions, but some of it is actual real cash generated from it. We want to get inventory days down to about 200 and ultimately target turning inventory at least 2x per year. That implies that the kind of current run rate, you've got to take $80-plus million further out of inventory. But as you get more discipline into inventory and you get the focus on it, you -- what I find is you then see the provisions come under control as well, right, because you're not dealing with the planning to improve your excess quantities, your obsolescence comes down as well. So that focus on inventory will help us flip the provision impact, I think, over the next 6 to 9 months. And then the other fundamental impact on gross margins relative to, say, Q1 even a year ago was the under absorption of the fixed cost base was 500 to 600 basis points. So if you take that and add that back to the reported gross margin, you're really back at like for 44%, 45%. And that was what we reported at a $300 million level in Q3 last year. So even though we had significantly reduced manufacturing expenses, the under-absorption was still significant. And part of that is not just the lower revenue, it's trying to get inventory down as well, right? So it's a double whammy on that side of things. At the moment, we're still investing in and intending to maintain operating expenses is kind of in the range of where we've guided, so we're not looking to take them down. We think it's very important in the downturns to -- particularly given some of the market opportunities we're evaluating right emerging, nascent areas, trying to maintain a leadership position in the EV and the welding market in general. So important to continue to invest in the sales and marketing side of the business, but also very important to continue to invest on R&D. Some of the R&D is taking cost out of existing products, so that will help gross margin during a recovery. So it won't just be the leverage, but if we can get the cost of the product down and keep some of that within our model rather than just pass it on to the customer that should help us. And then you got new product introductions. So in the medical arena, Trevor talked about new applications we're launching there, trying to improve our capability in things like micro processing, launching a new weld measurement system. So it's going to be hopefully lower cost, lower bill of material costs that will potentially expand the opportunity and the available TAM for that application. So quite a lot of new product, while the cost we're trying to get taken out of product, new higher-power pulse lasers, for example, as well for the cleaning applications. So we don't want to take our foot off the accelerator at this point in time. I mean if the business continued to be challenged, and the environment remain weak beyond, say, the near to medium term, we do have opportunities where we can start to more fundamentally adjust the cost structure as maybe.

Right. I think I have time for 1 more question unless anybody else has a question. All right. To finish up then, Tim, all sounds really good to me and you also have the benefit of having a very, very strong balance sheet. Last I checked, I'd say, $25 per share in net cash. Can you talk just a little bit about capital allocation policy and given where we are in the cycle? I mean, are there opportunities out there that might be more aggressive about -- thinking about from an M&A perspective?

Yes. So first of all, I think on capital allocation, we're still running with quite a high level of CapEx, right? This year, we're having to replace a fiber facility that we lost in Russia. I expect once that is done, and there's a significant building in Oxford that's also close to completion. CapEx is really going to come down to a sort of replacement level, right? So I think about replacement just in terms of total depreciation, which is about $60 million per year or lower. So we're going to see some benefit in free cash flow generation from that lower level of CapEx. In terms of the other areas, we're continuing to buy back stock, right? We've got another $300 million program that was approved in February, we completed the last one. We're repurchasing stock under the new program. And then in terms of acquisitions, I mean, our new CEO starts tomorrow. We're still T-1, as I called it earlier in details.

I didn't even get this. Yes, I will talk about that.

So I think we're looking at -- I was going to look at that whole acquisition strategy and probably develop and enhance what we're going to do over the coming months. But we've been looking at that more on a programmatic basis. So looking at opportunities either with technology that fits well with what we do or distribution that can really leverage us into some of these emerging end markets. We're still very much not considering ourselves to be a consolidator in the industry. We're not intending to lever up the balance sheet and do that. But on a programmatic basis, you're generating a certain amount of cash and doing relatively -- we would consider deals with $200 or $300 million may be slightly larger in revenue but not like the $1 billion sales level, but we're also looking at stuff that's really nascent technologies that are even significantly slower than that but add to our capability and potentially leverage our finished products and to the end market at a faster rate.

Makes sense. I think Trevor would like that. I went a little bit over on this one. But thank you so much for joining me today. Very interesting. Thanks, everybody.

Thank you, everyone.

Thank you.