IPG Photonics Corporation (IPGP) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Michael Feniger, the machinery, engineering and construction analyst at Bank of America. Thanks for joining us today and anyone who's on the line. This is the second year in a row we've had IPG Photonics with us. We have Tim, the CFO, with us. I'm going to send it over to Tim just to introduce himself, give a little bit of his background. We're going to just jump into some Q&A and keep this an informal discussion on IPG and really the opportunities that present themselves going forward. So Tim?

Yes. Hi, everybody. I'm Tim Mammen. I'm the CFO at IPG. I've been there for quite a long time, 25-odd years or so. So seeing the company through various growth phases and challenges, and we're hoping to get the company back into consistent growth in the near term with a lot of the investments and strategic initiatives that we've laid out over the last 2 or 3 months under the new CEO, Mark Gitin.

Perfect. And maybe just to bring everybody on the same page, IPG Photonics is really like a technology company, Tim, that services some industrial markets and other markets as well. The founder of IPG kind of is considered to be the godfather of the fiber laser market in some sense. Just maybe you can help everyone who's new to the story. What are the solutions that you guys provide to customers? Who are your customers? What are these end markets that you guys serve?

So probably best step back a little bit on that. And the fundamental strategy that we have as a company is to take legacy applications that will be performed by non-laser processes, right? If you go back into even the market and gravy and cutting arenas, you had inkjet marking is by way of an example or cutting, you've got punches, presses, tool, dyes, saws, mechanical processes, waterjet, welding, obviously, is a very broad-based application with traditional areas in that. Cleaning, right, you use a lot of chemicals, media blast, sand. We've got new application in heating and drying. It's relatively small at the moment, but that's got an opportunity to displace traditional ovens, which are electrically inefficient. So in medical, the same way, you're taking surgical processes, converting them to being used in lasers. So what you've got is a very, very large total available market that covers these different applications that runs to tens of billions of dollars. And strategically, if you can then convert those applications over time to lasers, you increase the SAM for lasers. That's happened very successfully in cutting historically in marking engraving. It started to happen a lot more. It took quite a long time to get there. But on welding applications, we're starting to see it on cleaning. I mentioned things like additive manufacturing is another area where you're actually replacing machining and growing complex parts from powder. So you're basically -- the objective is to grow the SAM from existing large TAMs. Probably a bit more unusually, you may have really a completely new laser-based type of applications that come to the fore more often than not, they may be in like instrumentation or other areas. Typically, our customers are either OEMs who buy the laser or a system and then distribute that add technology around it sometimes and then distribute it. So large companies that produce -- companies that produce large-scale cutting systems, cleaning applications, there are cutting OEMs that produce cleaning systems. And then end users, like a lot of the welding market is more end user driven, so into automotive and other areas. And so yes, your large -- for the OEMs on the industrial side, their large end customers would be in automotive or heavy equipment manufacturing, agricultural equipment manufacturing, elevator manufacturing, furniture, light fixtures. So durable goods, consumer durable goods would be a large users of lasers across a variety of those applications.

So for investors, Tim, what typically drives the demand for these products? I mean what's considered in your view, a good environment for IBGP? Is there any rule of thumb we should think about if GDP or industrial production is X, this might translate to Y in terms of the growth that we can see from the company?

Yes. And sometimes moment you got a GDP growth that's being largely driven by services, right? So -- but typically, if your capital equipment and investment cycles are strong, you've historically grown at 2 to 3x GDP depending upon the application set that you're addressing. I'd say there's 2 phases to this, right? When you're really just a GDP growth, then you -- you're getting into some cyclical applications because you've got the investment cycles that come and go. The other side that's very much a growth driver is the adoption and displacement story. So in applications that are relatively new to penetrating an end market, you will see that displacement even in a weaker environment will drive growth in that, right? And for example, last year, the underlying welding market outside of electric vehicles, which was impacted by the underutilization of capacity, the remaining welding market, actually, it was very stable and maybe even grew a very little bit last year. Medical has grown even because you're going through an adoption phase, that's an area we're targeting significant growth. Micro machining at the moment has started to go through a better performance on a year-over-year basis. That's because we've introduced new technology into that end market that's going through an adoption phase on it and demand has ramped up quite quickly. So I'd say part of it is driven by the underlying industrial and economic demand level, which would be a GDP, would be an indicator there. PMI, perhaps on the capital equipment and manufacturing side is another good indicator. And then with newer applications, you've got an adoption and displacement story. And when those really get legs on them, that's what can drive really accretive growth rates.

That makes sense. What's interesting is as you mentioned PMIs and PMIs have been kind of stuck in the doldrums below 50 across most regions, really the last year or so. You guys just reported results, your book-to-bill was solidly above 1x. So could you just discuss what you saw there in an environment that has been maybe more sluggish on the capital goods manufacturing side that you guys are seeing a book-to-bill above 1x?

Yes, sure. I think it's been -- it has been a struggle, and it's been a mixed bag, right? I mean -- the U.S. had actually started it recovered to 53% and then dropped back to like just below 51%. So it's still expansionary. Japan had got above 50%, then it's fallen back to sort of 48%. Europe has been down as low as 42% and come back up to 48%. So I think it's very much a mixed bag. Some of the positive momentum we saw in that was not necessarily also -- it didn't have to be tied specifically to the PMI and the -- this comes back to -- you've still got probably an underlying industrial demand environment that is quite weak. So the performance in Q1 with strong book-to-bill in that environment was positive, right? We did see some of our customers on the cutting OEMs say that their overall inventory levels have adjusted down to the levels they want to see them at. So we got actually good order flow from a couple of customers there. But some of the other stuff was on a rebound on EV demand with utilization in battery manufacturing, both actually for EV and storage, picking up significantly. Some of that's demand in additive manufacturing in Europe and China, where we've got very specific capability and perhaps that's not quite tied again to the underlying macro. Very strong order flow on medical, which again is new technology and more adoption. And then we had positive momentum on the micro machining and advanced applications. So I think the positive to take away from Q1 was that it was from a lot of the areas we said we're going to invest in. And it wasn't just -- it wasn't yet a recovery in -- any fundamental recovery in the underlying industrial demand environment, which was probably reflected in the European order flow still being a little bit weak relative to some of the other geographies in Europe, still kind of industrial end market focus with the cutting applications and automotive end markets there being in the doldrums.

Makes sense. And you touched on this earlier, Tim. Last year, you announced a new CEO. He's an outsider. It's usually IPGB has a very rich history. And to see someone come from the outside, it's been kind of a year plus since he's been in the seat. Tim, what is he bringing to the table as someone from the outside? What is kind of changing from your sense for this company, having someone from the outside with a new perspective?

So yes, I mean, Mark, I think it's been a refreshing change, I think, to the organization. The company was -- and Neil talk about this, has got a tremendous depth of technology and capability and still has a tremendous amount of differentiation across many applications and laser capability. Mark has talked about the fact that it was almost -- still operate like a $1 billion start-up, right, where Valentin had built this fantastic company. But Mark is trying to sort of break down some of the silos, improve the communication in the company by way of example, getting, for example, the sales function and the product line management and R&D to really talk and communicate closely so that they're understanding what the customer wants to see on the product solutions, really getting -- I think the role that finance is playing within the organization, for example, has been elevated. So there's a lot more financial -- discipline is the wrong word to use about it, but we're establishing more financial KPIs for departments and areas within the business to operate in. There's a bit more rigor around the financial analysis around the costing side of the business and new product introductions, a gating process within and a proper R&D product development process with gating processes in that so that you're evaluating at different stages, how well you're doing in developing the new product? And are you achieving where you need to be on the cost side of that? Because sometimes you have to make the hard decisions of actually stopping R&D rather than -- and in other instances, you want to actually commit more capital to that, right? So the organizational cross-functional collaborative areas are one of the things he's working on. I think the development and enhancement of what was an original strategic plan, he came in and he didn't find anything fundamentally that we were missing or that he thought we should be doing, but he's put a lot more structure around that. And we presented that to the Board and was rolled out in Q1 to the investment community and some of the investments that we're making are a result of that sort of cohesive strategic plan that's been put out there. So I think Mark's really objective is to take the sort of the gem of the company and the technology that really continues to exist and ensure that it is successful going forward. And some of that's also in areas like focusing on things like ensuring your quality and customer service is world-class as well.

Makes sense. Maybe we could just put some numbers around these opportunities. I mean you referenced before the cutting market, how you guys were able to really drive a penetration story where it was really displacing legacy solutions. What do you feel like is the addressable opportunity when we think of for IPGP in terms of the industrial side, but maybe outside of industrial applications, you have talked a little bit more about medical and some of these other markets. I'm just curious if you guys have any TAMs out there that you guys kind of try to target.

Yes. I think like the cutting business was well talked about. I mean that's not a focus area at the moment. But even on welding applications, we're trying to think about the whole welding market, right? And the capital equipment spend on welding, excluding the wire and the consumable is over a $5 billion market. Lasers are still 15-plus percent penetrated into that, right? There's a lot of older type applications or areas where you have to have a lot of certification like pressure vessel manufacturing or steel tank manufacturing or even in shipbuilding where lasers are still relatively lightly used. The handheld laser has actually enabled us to get into the metal fabrication business a lot more. The other areas in things like the medical, the micro machining, the instrumentation and scientific. The medical is about, just the urology is about a $2 billion market. We sell into the aesthetic market, but as an OEM, we're not doing our own aesthetic systems. That aesthetic market is very large as well. The laser part of it is a subset of it. Micro machining is another market depends -- excluding lithography rights, which we don't play in. It's probably like a $700 million TAM and then instrumentation and other areas add up to make the total opportunity maybe as close to $5 billion. But we're very early stages in some of that, but penetrating even 10% of that opportunity is a very significant runway for the company.

And as CFO, what are the levers you think you could pull to kind of drive that penetration? Is it a different go-to-market strategy than maybe we saw in the past with cutting? Just kind of curious how we can kind of create that penetration displacement a little faster than maybe we've seen in the past.

Yes. I think on the sales and marketing side, there have been significant investments made. Some of these applications continue to be a bit like the OEM market for materials processing, right? In medical, once you qualify with your partners and your OEMs, and we talked about qualifying with a new OEM, in Q1 and starting distribution to them, there's a lot of leverage in that, right? It then becomes more of a technical support. You're not actually out banging on doors, trying to sell another urology system. Your OEMs are doing that for you. On medical, there's quite a lot of value captured by that OEM. Maybe on some of the other applications, we would look at whether we want to do distribution internally ourselves on these. But that's a difficult -- that's really -- you have to have a proper decision made around that because the capability that other people have is very high. I think on the other side of it is on something -- on the welding side, it's not just the sales and marketing, it's actually the investment in the application capability. That application capability is really another differentiator understanding the material science and actually helping customers solve the problems there. So we've continued to invest in our application labs and areas. And then I mean, on the R&D side, it's really that discipline around the stage gating process and the project management and ensuring that you're either pulling back or adding capital. I will say from my perspective as well, one of the things that I think we're continuing to do well and work on is not so much just on the investments there, but really trying to get our gross margins even at lower revenue levels back up so that when we get revenue growth back in, we'll see that accretion come in. And I've said that right now, we're close to 40% on $228 million of revenue. That would mean that we've got 500 basis points still of under absorption. And as we get inventory further under control, you're seeing fewer provisions come through. But I believe you'd be getting close to the mid-40s at revenue that's probably a bit below $300 million, where historically, I said it's a $300 million target. So that whole efficiency on the manufacturing side is also an important area for us to focus on.

And maybe, Tim, just we made it halfway without talking about tariffs, which is probably a record right now at the conference, every fireside chat.

It should have started with that.

We should have probably started with it, to be fair. But we want to talk more about the long-term opportunity. So now we have to talk just about right now in the near term, how are you guys coping with this tariff regime? Do you expect to shift incrementally production around to the U.S. or other areas because of the tariff policy?

Yes. So I mean, you've seen escalation, de-escalation, 90-day pause, I mean I'm not saying anything that probably nobody else has talked about here. For us, I think the developments over the last 24 or 48 hours certainly make the near term a bit easier to navigate, right? You potentially could ship some of the products out of the U.S. with only a 10% tariff plus the original tariffs in China. So sometimes a lot of the lasers had 0. There are some of the accessories that have a 3% to 5%. So your inbound tariff in China now would be 15%. At least in the near term, you may want to use that to satisfy the customers who want the product. But you still got to -- our intention is because this is still a highly uncertain situation is believe that you've got to optimize your manufacturing and capability to best serve regions from different areas geographically. So we're not going to pull back on that optimization strategy and suddenly have in 8 or 12 weeks' time, another ramping up of the tariffs and not be ready to supply product out of Europe or primarily out of Europe for China. The most important thing to understand is that 80% of our product that goes into China is already supplied primarily from Europe, right? And then on the cost side of this, you've got -- obviously, with the lower inbound tariff, you've got the 20% fentanyl and the 10% reciprocal at the moment, that's 30%. You still have actually the original tariffs on whatever the harmonized tariff code would have been for specific products. So the total tariff still inbound is more than the 30% and everyone is talking about the 30% rate. We're halfway through the quarter. We had open POs with our Chinese suppliers. We don't make stuff. So we've had to already pay those tariffs over April and the beginning of May. But we had also already started to move to other suppliers in Southeast Asia and elsewhere for a lot of that product. So there's still going to be a hit in this quarter, but we've already said that we can rebalance this in the second half of the year and substantially offset that impact. It's easier to substantially offset that impact at this point in time given the developments over the last 24 hours or so.

It's good to hear. And Tim, on the call, you guys discussed a shift in an order for a customer. I think it was like $50 million you guys quantified. Can you just let us know what happened there? Is this a delay? Is this -- was this a cancellation? Just kind of help us understand as you're navigating a tariff regime and policies, what kind of happened there with that customer? And do we see that come back in the third quarter?

Yes. No, it's not just one customer. There are 2 or 3 customers. It was different products. They were not cancellations. These are products that the customers want. The problem was there are 2 or 3 of these product lines that we only made in the U.S. They were developments of technology that have happened here, and we've continued to make them here rather than quite a lot of our products we make both in Europe and in the U.S. It just happens that these 2 or 3 product lines were made exclusively in the U.S. So the problem was that if you started to ship that product out of the U.S., you had 170% -- it was actually not even 145% -- it was 170% -- actually, I'm getting confused -- it was 135% into China. And these are lasers that are anything from $20,000, $30,000 and accessories that are $12,000 or $15,000, right? That's a huge incremental cost. So we were -- we basically talked and negotiated with the customers to delay delivery of those until we ramped up manufacturing in Europe. We did that -- we've done that pretty quickly. I think we started shipping some of those units out of very low volumes in the last few days even out of Europe and going to try and ship some more and ramp up that volume through the end of the quarter and then deliver the rest of it in Q3. So yes, they're absolutely not cancellations, product the customer wants, which is you can't take a $20,000 laser and $25,000 a tariff on top of it.

Get a little pushback on that one. But with the tariff conversation, Tim, I am curious just when we think of the competitive dynamic, right? Because I think when it comes to your -- you have a business in China, you guys have diversified even outside of China. I know there's the high end of the laser, the low end. I am kind of curious when we think of the tariff policy, has that created any barriers to entry? Does it make it harder for low-cost suppliers to enter certain markets? Are you seeing that as that coming up in conversations with customers?

Yes. I think it will. In certain geographies like in the U.S., the penetration of the low-cost suppliers was relatively limited, right? People were averse to buying. But certainly, even with a 50% tariff, that's a significant increase in their cost. A lot of them running with margins that are ranging from 15% to 20% per quarter gross, right? And kind of breakeven. So this cost increase is pretty significant even with the revised tariffs, I should think, certainly at the higher level, it was a massive increase to them. In Europe, I think there's a lot of -- in many of these areas, we're still very technologically differentiated, right? So in Europe, there isn't a significant tariff on like cutting systems, for example, coming from China. I think the other side of the equation is that there's just a lot of uncertainty around this and the impact of it will be ultimately, you're probably going to have more localized manufacturing, reshoring -- reshoring in Europe, even though there's not a lot of -- there's no tariff war per se. I think customers even may be looking at -- not customers, but companies looking at -- we've never made any stuff in China. I don't think we're going to make stuff in China, but would we use subcontract manufacturing in Asia as another lever that we could pull to help meet customer demand with less of a cost impact.

And there's a high degree of laser cutting when it comes to the auto market, yet also you guys are positioned when it comes to welding side for that EV penetration story as well. So maybe we could just talk broadly where do you guys serve the auto market? And then we kind of touch on that on where like the EV, e-mobility side and the potential there comes to play.

We -- I mean the auto market is a pretty broad-based set of applications, right? There are -- there's a lot of cutting -- cutting OEMs sell into the automakers for cutting panels, tailor-welded blanks. On the welding side, we do a lot of seatback welding, for example, specialized welding of airbag detonators, some welding on the body and white, but there's still a lot of electrical welding done with the spot welding on that. On the EV side, you actually see an increase in welding obviously related to the battery. It doesn't change of a seatback or an airbag detonator right, or the main body. There's no fundamental difference there. But so you see a big increase related to welding on EV related to battery and electric motors. On the other area actually where on traditional automotive lasers have been adopted quite significantly, was on welding of transmissions. Obviously, that is a decrease, but the increase relative to EV, if you eliminate transmissions is a multiple higher. And then I mean there's some marking engraving done on the vehicle as well. But that would basically be -- there's some -- actually, there's cleaning applications, too. So whether they're using resins or sometimes resins are used in the joining or used as a damper for sound. There's often either coatings or resins that have to be removed. So we're using lasers with the customers are using lasers with their coatings removal as well.

Well, Tim, I pull on this thread a little bit. I'm just curious with your position with the auto industry and then the opportunity in EV. Do you feel like the transition is a positive for IPG Photonics as we kind of transition away from ICE to EV based on your penetration opportunity, the competitor set, but how much actual work you're doing on the EV relative to what a traditional vehicle would look like?

Overall, because of the laser content on the battery and the motors, yes, it's definitely a net positive. It's important also on the battery to note that a large amount of battery demand is not even EV driven now, it's storage, right, which is serving a whole host of different industries and end markets. So net-net, EV transition has been a significant driver and benefit to us in terms of total automotive sales. And I think it's interesting, some of the data out there is actually showing like even North American electric vehicle sales are forecast to grow at 15% this year. Europe is coming back with a bit of rebound. China is already half the vehicles sold are EV. So I think there's -- I read somewhere in the article that most people who buy an EV actually are not unhappy with it. They kind of actually think that the solution is pretty positive, whatever the geopolitical debate is around it.

And maybe, Tim, just because you are a CFO, I'm sure you look at a lot of other companies and benchmark. The question we get sometimes is because you are a technology company that services the industrial markets, it's a very unique company. What do you look like as -- when you think about peers? What are some companies that you look at in terms of what they're reporting, what trends they're discussing that maybe we, on this side aren't paying attention to. And I'm wondering if it's robotic companies, automation companies, just what other companies out there or subsectors do you kind of look at as the CFO to say, that's how we should benchmark or those trends are relevant to us based on our unique product servicing and our end market mix?

Yes, I think that's a good question because a lot of the traditional laser companies, if you look at the Coherent or Lumentum, MKSI, where [indiscernible] have become like they're much more diversified. They've got very big telecom businesses, right? They're doing the data storage, data transmission. So we'll look at the subset of their welding business and what they're saying about that, but not the whole entity. We'll track sort of what Cognex's tone is about the business because they're very -- they don't do lasers, but their end markets are industrial and other tech areas. I think, yes, the robotic companies are interesting ones to follow. Some of the other industrial -- I mean many of the other companies are so big compared to us. It's more sort of like looking at what they're stating about the end markets that are out there. Obviously, we worked with Miller, part of Illinois Tool Works. But yes, it's a difficult -- the laser companies were a bit more laser specific, and they're less so at the moment. So I think the industrial tech universe is what we kind of look at, but a lot of them are a lot bigger than us, right? So that's where Cognex perhaps fits in a bit more directly.

And you've been in a process, Tim, of getting your cost down, working down your inventories, which we saw a lot of progress the last few quarters. And it seems like you're kind of waiting for those volumes to come back to really get that absorption with the factories and with the company. Just what are some of the indicators you're keeping an eye on? I mean, in this conversation, you mentioned PMIs. I think you also mentioned maybe utilization rates when you look at some of the EV battery players. I'm just kind of curious what data points you're following that would make us feel more comfortable as we kind of head into 2026.

Yes. We look at I mean, underlying macro trends and commentary, GDP, I mean, you mentioned the PMI machine tool data from different places around the world, right? The Japanese machine tool data is always good to look at. There's German machine tool data, although there's a -- Eugene was reminding me there's like a 3- or 4-month lag on that. Robotics sales, we look at a lot of the PMI data and the underlying tone that you're hearing from -- and utilization, we're try and find like battery utilization or just looking at where EV total sales are, trying to find data on battery storage applications. The medical is less -- it's not a discretionary medical spend, like if you've got a kidney stone you generally want to move quickly.

Not looking at the PMIs on that one. Tim, as we wrap up, an interesting conversation that we have with investors is actually on your balance sheet. You guys have a large net cash position. You kind of discussed that. You just recently acquired a business was last year, clean laser. Just help us understand with such a large cash position, what as a CFO, are you monitoring and how you're kind of thinking about using that cash going forward?

So I mean, what we've said is that we want to have a more balanced approach to capital allocation than we've had over the last 3 years when we've returned a very significant amount of capital to shareholders. I think last year, $350 million and the last 3 years, over $1 billion. We want to maintain firepower to execute, I think more on a programmatic, strategically driven acquisition plan. We're going to continue doing opportunistic buybacks, but just probably in a more balanced way rather than at the level we were operating at before. I think Clean laser was a really good example of an acquisition that fits very closely with IPG. They were sourcing lasers from us. They were utilizing some of their own lasers internally. They were a leader in terms of process and know-how for cleaning-based systems and the core technologies around that, right? We're able to build upon that with our global distribution, for example. So I think that was a very good example of like a bolt-on that was very complementary to an area of growth that we were prioritizing, and I think we're looking at similar types of acquisitions there. You probably want to do things with a little bit more scale on them so you get a bit more incremental revenue and hopefully, margin out of it because we're looking at profitable companies. Makes sense.

All right. Tim, thank you. I just want to thank Tim and Eugene for coming to the conference today. Always great checking with you guys and learning more about the company and the journey. So thanks, everyone.

Great. Michael, thank you very much.