IPG Photonics Q3 2021 Earnings Call Transcript

Participants

Corporate Executives

• Eugene Fedotoff, Director of Investor Relations
• Eugene Scherbakov, Chief Executive Officer
• Tim Mammen, Senior Vice President & Chief Financial Officer

Analysts

• Jim Ricchiuti, Needham & Company LLC
• Nik Todorov, Longbow Research
• Michael Feniger, Bank of America Co.
• Paretosh Misra, Berenberg Bank
• Joe Wittine, Edgewater Research
• Mark Miller, Benchmark Co.

Presentation

[Operator]

Good morning and welcome to IPG Photonics 3rd Quarter 2021 Conference Call. Today's call is being recorded and webcast. At this time, I'd like to turn the call over to your host, Eugene Fedotoff, IPG's Director of Investor Relations for introductions. Please go ahead, sir.

[Eugene Fedotoff, Director of Investor Relations at IPG Photonics]

Thank you, Rob and good morning everyone. With us today is IPG Photonics' Chief Executive Officer, Dr. Eugene Scherbakov and Senior Vice President and CFO, Tim Mammen. Statements made during the course of this call that discuss management's or the company's intentions, expectations, or predictions of the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause the company's actual results to differ materially from those projected in such forward-looking statements. These risks and uncertainties include the impact of COVID-19 pandemic on our business and those detailed in IPG Photonics' Form 10-K for the period ended December 31, 2020 and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors section of IPG's website or by contacting the company directly. You may also find copies on the SEC's website. Any forward-looking statements made on this call are the company's expectations or predictions as of today, November 2, 2021 only. The company assumes no obligation to publicly release any updates or revisions during such statements. For additional details on our reported results, please refer to the earnings press release, earnings call presentation, and Excel-based financial data workbook posted on our Investor Relations website. We will post these prepared remarks on our Investor Relations website following the completion of this call.

With that, I will now turn the call over to Eugene Scherbakov.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Thank you. Eugene, and good morning everyone. We are deeply saddened by the passing of Valentin Gapontsev, the Founder and Executive Chairman of IPG.

This is a tremendous loss for the company and the broader photonics is community. We have benefitted greatly from his technical innovations and strategic reason. Because of his reason and area lengthens work finally have become cost effective, reliable, and effective tools that have mass applications in global industrial production enabling automation, efficiency, and development of new products. He was recognized as a father of the fiber laser industry and a great entrepreneur. Following his footsteps, we will continue to focus on innovation and internally in manufacturing and research and development capabilities the highest quality components and the most reliable products. At IPG, we are also exploring new markets and applications where fiber laser can replace existing laser and non-laser technologies by improving efficiency and productivity or enabling technological breakthrough for our customers. Our technology is playing well in the major micro brands and include investments in electrical vehicles and renewable energy as well as focus on energy efficiency, industrial automation and miniaturization which are transforming the way products are created. As a part of our strategy, we have been diversifying the way from the high competitive more cyclical cutting market in China and our results this quarter demonstrated successful execution of this strategy. We are pleased to deliver as a 3rd-quarter revenue and EPS at the top end of our guidance. Results were driven by strong growth in welding market, 3D printing, and as well as the a semiconductors and number of other products and applications. Demand for IPG laser continued to improve in North America and Europe. This does welding and cutting applications showed strong growth. We have also seen increased orders and business activities in Japan. These geographies continue to recover from pandemic and so increased investment in new factories and automation. We are benefiting from widespread investments in electric vehicles production globally. Our lasers are used in a variety of welding for cutting and printing applications for EV battery manufacturing. We are also seeing opportunity for laser welding in EV motor assembly and body in wide applications. These investments are likely to continue for the next three, five years as automotive manufacturers address they need for EV batteries and newer technologies in order to meet aggressive global carbon emission standards. We are excited about the increased demand we are seeing in the measures product and applications which contributed just under 30% of our total revenue this quarter with record sales in lasers and medical and strong growth in high power pulse lasers. Both A&B and high power pulse lasers are benefiting from increased investment in EV battery capacity worldwide. Our medical products are rapidly gaining adoption and both our laser and IPG disposable fibers are considered as the new gold standard in the industry. We, that our medical business, we will continue to grow significantly potentially doubling the size over the next two to three years. One of our newest products is hand-held laser which gets launched earlier this year with widespread interest and gaining significant traction in welding community. We launch our new and improved version of LightWELD in September. It also has cleaning capability in addition to percent welding parameters. Some customers may choose LightWELD just for clean feature, as it can save time, money, and reduce cost of consumables. [Indecipherable] highlight of our presentation [Indecipherable] this year. And we have signed agreements with nationwide distributors that catering hundreds of welding retail stores in the United States. We expect to sell thousands of lightWELD system in the next three to five years. As expected, we saw softer demand conditions in China cutting markets during the 3rd quarter. The continuation of moderated demand environment driven by widespread supply chain issues, high shipping cost, and power shortage as well as a more aggressive price competition from local manufacturers negatively impacted demand for cutting applications in China during this quarter. At the same time, we are seeing record demand in welding in China as a result of strong sales in EV battery applications and increase in the near from market in the 3D printing. In several cases, we saw customers are coming back to IPG after lower cost local suppliers did not meet customer quality and technical support expectations. We continue to benefit from our vertically integrated product model which enables technological advantage while minimizing the supply chain disruptions. Currently, we have been seeing some impact on our and our customer duration from ongoing supply chain issues worldwide, which we were able to successfully overcome this quarter. As we announced earlier, the board selected John Peeler as the Non-Executive Chair. John has served as lead and Independent Director since 2017, and his appointment provides continuous stability as we have worked together well over the years. This appointment continues to separate [Indecipherable] that started in May 2021, and I look forward to working with John and his [Indecipherable]. With that, I will turn the call to Tim to discuss financial highlights in the quarter and 4th quarter outlook.

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

Thank you. Eugene, and good morning everyone. My comments generally will follow the earnings call presentation which is available on our website. I will start with the financial review on Slide 3. Revenue in the 3rd quarter was $379 million, which increased 19% year-over-year and 2% sequentially. Third quarter GAAP gross margin was 49%, an increase of 100 basis points year-over-year. Compared with the year ago period, the increase in gross margin was driven primarily by lower inventory provisions and a reduction of unabsorbed manufacturing expenses as a percent of sales. GAAP operating income was $102 million, and operating margin was 26.9%. Third quarter net income was $75 million or $1.40 per diluted share. The effective tax rate in the quarter was 26%. As a reminder, last year's results were negatively impacted by a goodwill impairment charge of $45 million. During the quarter, we recognized an after-tax foreign exchange gain of $2 million or $0.04 per diluted share, primarily related to the depreciation of the Euro and Chinese yuan. Exchange rates relative to the US Dollar had been the same as one year ago, we would have expected revenue to be $9 million lower and gross profit to be $6 million lower. Moving to Slide 4, sales of high power CW lasers decreased 4% year-over-year and represented approximately 47% of total revenue. Sales of ultra high power lasers of 6 kW or greater represented 51% of total high-power CW sales. Medium power laser sales increased 109% on growth in cutting, welding, 3D printing, and semiconductor applications. QCW laser sales increased 8% year-over-year on a higher demand for marking, engraving, and drilling applications. Pulse laser sales including high power pulse lasers increased 69% year-over-year with strong growth in foil cutting applications for EV battery manufacturing, solar cell applications as well as higher sales of our infrared lasers for marking and cleaning. System sales increased 56% year-over-year with improved revenues for Genesis and IoT and a ramp up in lightWELD sales. Other product sales increased 58% year-over-year, benefiting from higher sales in medical and beam delivery. Examining our performance by region on Slide 5, revenue in North America increased 55% year-over-year driven by materials processing with growth in welding and increased sales of high-power lasers for cutting applications. We also saw record quarterly revenue in medical, as our products continue to gain acceptance. System sales improved in the 3rd quarter with both laser and non-laser systems posting strong revenue growth. In Europe, revenue increased 50% year-over-year driven by accelerated demand in cutting and welding applications as well as strong growth in marking and additive applications. Our revenue in China decreased 7% year-over-year in the 3rd quarter representing approximately 36% of total sales. Soft sales of high-power lasers in cutting applications more than offset higher demand in welding applications, high power pulse lasers for foil cutting and growth in marking and additive applications. Sales in Japan were up 11% and revenue in the rest of Asia increased 15% year-over-year. Moving to a summary of our balance sheet and cash flow on Slide 6. We ended the quarter with cash, cash equivalents, and short-term investments of $1.5 billion and total debt of $35 million. Strong operational execution resulted in cash provided by operations of $102 million during the quarter. For our cash deployment, capital expenditures were $40 million in the 3rd quarter and we expect capital expenditures to be between 130 million and 150 million for the full year. During the quarter, we repurchased 200,000 shares for $36 million and bought approximately another 135,000 shares so far in the 4th quarter. Commenting on our outlook for the next quarter, 3rd quarter book to bill remained above 1. We expect stable demand in North America and Europe and continue to see growth opportunities in welding and high-power cutting in North America and Europe, foil cutting and welding applications for EV battery production across many geographies as well as opportunities in solar cell manufacturing, medical procedures, and advanced applications. We also see lightWELD sales continue to gain traction. However, sales in China will be down sequentially in the 4th quarter due to soft demand in cutting applications, uncertainty due to supply chain issues and power outages that may impact demand for our products as well as ongoing competitive pressures. For the 4th quarter of 2021, IPG expects revenue of 330 million to 360 million. The Company expects the 4th quarter tax rate to be approximately 25% excluding any discrete items. IPG anticipates delivering earnings per diluted share in the range of $1 to $1.30 with approximately 54 million diluted shares outstanding. I would like to remind you the financial guidance provided this quarter continues to be subject to greater risk and uncertainty given the COVID-19 pandemic and its associated impacts to the global business environment, supply chain, public health requirements, and government mandates. Please refer to the Safe Harbor passage of today's earnings press release for more details on risks and uncertainties associated with our forward-looking statements. And with that, we'll be happy to take your questions.

Questions and Answers

[Operator]

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jim Ricchiuti with Needham and Company. Please proceed with your question.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

Hi, good morning. I had a question about China. If we exclude the cutting business in China, can you give us some sense as to how the business performed across the rest of the portfolio? Are you still seeing weakness in China or did that business perform better ex cutting in China and I have a follow-up.

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

In Q3, Jim, excluding cutting, the rest of the business was very robust. I mean, clearly EV battery applications are a very strong driver of growth. We are actually really pleased as well. We've got some good demand coming from additive applications there which are with lower power, but very high quality lasers, so competitively, that's been a very positive trend and the other good positive trend I think was on some of the marking engraving applications which are increasingly being used in automated production lines. So therefore, where the quality of the laser is very important that also performed well there. So other applications outside of cutting were more than robust, I'd say they are good.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Cutting applications, also we have to see the lower edge applications of course in some competition from Chinese but for high-end, we have a very good position comparison also Chinese competitors.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

The follow-up question I have is just with respect to lightWELD. I know it's early days, but yeah, judging by the interest at FABTECH. I mean, every time I saw the booth, it was packed. People looking at the demonstration of that. At what point are you, will you see the benefit of the expanded distribution channels? Will that hit in Q4 or is that something that really begins to benefit you in early '22? I don't know if there is a high level of training that goes on with the channel partners, but can you give us a sense as to how you're thinking about lightWELD?

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Firstly, I would like to get is a great benefit from this quarter but of course, it will take time because a lot of different opportunities and different customers participated in this and we have to give some time to customer to use it and of course we can have benefit will get to the first quarter next year. But also it's really important that we introduce new options for our lightWELD, and we will demonstrate in the end this quarter and beginning of the what I've just next year.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

And this will be is, do you anticipate this is going to be a catalyst for your systems business because the rest of the systems business also seems to be recovering. But as we look at that you're seeing a clearly a turn in that part of your business.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Yes. So that's talking about catalysis, I don't think so. It will be that's out rest of our business also will grow, and we are optimistic about our prognosis and forecast for the next year definitely.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

Okay, thanks. I'll jump back in the queue.

[Operator]

Our next question comes from Nik Todorov with Longbow Research. Please proceed with your question.

[Nik Todorov, Analyst at Longbow Research]

Yeah and thanks and good morning. The gross margin is holding pretty well despite the softness in China cutting. So that's obviously a change from the prior cycles. Can you talk about the levers that are allowing you to maintain consistent gross margin, despite the decline in China cutting? Are you seeing offsets from new products or are you seeing more discipline in pricing? What are the drivers of the resilient gross margin?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

So there's a number of drivers. I think the first thing is the strategy around being disciplined around pricing both in China and globally is really paying dividends in that regard. The second there are probably 2 or 3 more drivers. So with slightly lower sales of cutting applications in China and higher sales of other applications, we generally have a mixed benefit from that. In addition, you've got a geographic mixed benefit with some of the stronger sales in Europe and North America around both cutting and other applications, those are also a benefit, and then we've got sort of strong sales coming out of areas like medical and even some of the semiconductor applications. So we are exactly trending in the direction that we would like to see from a mix and diversification perspective and there is a benefit on the gross margin side from all of those areas.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Yeah. And also we continue to prolong our special project reaches installed two years ago about optimization on the manufacturing cost components or devices this year also and the trend also there next year. Definitely.

[Nik Todorov, Analyst at Longbow Research]

As a follow-up, Tim, can you provide any preliminary comments on 2022? I know you're not going to guide specifically, but I think last quarter you talked about double-digit sales growth algorithm. How do you see maybe 2022 relative to that framework? Any comments would be helpful there. Thanks.

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

I'm not going to comment on a double-digit growth for next year. I mean, we provided a medium-term to long-term target of continuing to grow the business with the double-digit growth rate. We're not giving any guidance for next year at this point in time. It would be a wrong point in time to do that. We won't have to make a decision as to whether we provide annual guidance. Overall, though we remain really quite optimistic about next year. You've got the major growth drivers that we talked about sort of macro trends out there with EV battery manufacturing, EV motor manufacturing, Body in White applications, new product introductions in the other parts of the welding market with lightWELD, growth in medical applications, high-power cutting market transitioning to much higher power levels globally as well as in China. We're going to start rolling out our ultra-compact laser at higher power levels than 1 kW and 1.5 kW so transitioning during the course of the year. Early on in the year to 3 kW and 6 kW and then ultimately it will be in the second half of the year to 8 kW with the ultra-compact device. So there is a whole host of different applications that we think are going to really make next year an interesting and exciting one. Maybe from a geographic perspective, you continue to see sort of robust economic data in North America and Europe and maybe a little bit of a moderation, but no fundamental shift in geographically, we're starting to see some recovery in Japan as well, and you've got lots of opportunities in some of the other Southeast Asian markets like Korea. So totally we're sitting here pretty positive about next year at this point in time.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

And definitely, I would like to add some customer and also in China and outside the China, the stuff to ask about this lasers and in IPG laser which has efficiency more than 50%. Nobody will produce such kind of product today. And so this also for us, it will be opportunity to provide very high power laser such kind of high efficiency and it will also demonstrate end of this quarter and also beginning of the next quarter. Already, we feel some professional customers for this.

[Nik Todorov, Analyst at Longbow Research]

Got it. Thank you and good luck.

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

Thank you.

[Operator]

Our next question comes from Michael Feniger with Bank of America. Please proceed with your question.

[Michael Feniger, Analyst at Bank of America]

Hey, guys. Yes and thanks for taking -- taking my question. I want to be respectful and how I asked this question, there are a lot of investors wondering kind of what happens to Valentin is trust in the voting shares. As you just significant shareholder in your 10-K filing obviously his ownership position excited as a material risk. We saw yesterday, there was some 13 D filings that occurred last night. I'm just because it does come out with investors. Could you provide an update given those filings? What is kind of the status on his ownership this trust position at this point?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

So, Michael. There is no material change to the ownership and structure. The estate planning around [Indecipherable] ownership in IPG not only started completed many years ago. There is no change in trustees appointed to manage the trust and your thoughts pay company there is no major change there as Dr. Scherbakov is being Managing Director and will vote those shares, so I think we this sort of transition around this has been thought through and planned pretty well. So sort of decades long process that we started to look at the center.

[Michael Feniger, Analyst at Bank of America]

Fair enough. I guess on that is I guess this might answer this next question. But given the circumstances, is there any change in strategic direction for IPG following, following the events? Any change in capital allocation with the significant cash balance? Any change that we should be aware of management? We saw the new Executive Chairman. But just curious, is there going to be any changes post news on strategy and IPG going forward?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

I think the first time if we were going to make a fundamental change or anything, it would be a material announcement we to make and we may all of the announcements around the events of the last couple of, last couple of weeks. In terms of strategy, we talked about that when Dr. Scherbakov took over as CEO that at a high level on a broad level this strategy was developed by Dr. Scherbakov and Dr. Gapontsev and even other members of the executive team over many years. So continuing to pursue the the rollout of fiber laser technologies across the multiple applications and end markets. So there is no big change in that direction. Dr. Scherbakov has mentioned a couple of things are going to continue to try and optimize the manufacturing footprint and efficiencies that we have there. We're not changing our gross margin guidance range of 45% to 50% although internally, we're getting increasingly comfortable of achieving the top end of that range and pursuing initiatives to keep us on average at the top end of that range. Of course there could be some variance depending upon where and a quarterly revenues fall out. And in terms of capital allocation, we have continued to enhance and develop the capital allocation strategy over time, we're executing very regularly against the existing $200 million buyback that we have out there and quickly and expeditiously completed the prior one, so no fundamental changes that are out there otherwise, you would have to articulate them.

[Michael Feniger, Analyst at Bank of America]

Makes sense. Thanks for that. Tim. And then how do you think about with all the supply chains and the cost inflation would you guys being so vertically integrated? I'm curious how that kind of impacts you with some new supply chains trying to get certain components but also I feel like the expense number was in line with your expectation, around $87 million, like how do we think about are you seeing more cost inflation in the business as you kind of head into the 4th quarter 2022? How we kind of think about those moving parts on the SG&A, and labor and things like that? Thank you. Of course, you see this influence for of our customers and also lot of our suppliers. High but is some components, but they all electronic chips and so on, but we made some -- the question about this earning [Indecipherable] enough and our stock this components to. I'm going to stable transaction of our lasers and not to interrupt our customers. But of course we have to think about our strategy, because the price for metal grows dramatically for aluminum 20%, for copper well 30%, some chip price also increased, not 30%. But sometimes 3 up to 10 times and in such kind of conditions is also some flexibility so again that's optimization our cost and also to discuss with our existing and potential customer about future operation and of course there is some uncertainty, but we believe that next year it will be much more stable conditions, definitely.

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

And just with regard to the operating expenses, I can address those SG&A and R&D, we were right in line with what we guided you for Q3, we're actually running at a bit higher level on some of those OpEx relative to a year ago first of all, because our variable compensation accruals, given the overall performance of the business year to date growth that so close to 20% in Q3 and 20%. So actually slightly ahead of where our budget was so our variable comp accruals are slightly higher. You got some expense coming back from, for example, trade shows and fairs on the selling side so FabTech but it is variable comp, relatively speaking, next year we'll probably moderates a bit depending upon how we perform relative to next year's budget, so not seeing actually any fundamental shift in that. We're also looking for no optimization of those expenses on the operating side as much as anything else. So certainly looking to be very disciplined in the way that we manage that. But we also got to make sure that for example on things like selling and R&D that we're focused on hiring enough salespeople to grow the business and doing sufficient marketing activity and also focusing on R&D and getting key projects and products that we think will really drive revenue growth completed.

[Operator]

[Operator Instructions] Our next question comes from Paretosh Misra with Berenberg. Please proceed with your question.

[Paretosh Misra, Analyst at Berenberg Bank]

Thank you and good morning. I think just going back to that inflation discussion. So I mean, looking at it will differently. So some of your competitors have been cutting prices in recent years. So I'm just curious if this inflation and component pricing and trade is making it more difficult for those guys to cut prices. In other words, could be inflation lead to some sort of price stabilization, even for the low power lasers?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

I mean we can't really talk to our people and the competitive market will behave, I think it's interesting if you looked at the results of one of those competitors that was announced last week, even relative to Q1, their gross margins are down, I think by almost 600 basis points. So they have certainly been very aggressive around pricing and with that aggression, It's around pricing there certainly not getting their cost base down because of that impact to the gross margin. I can't say how they're going to behave strategically in the future.

[Paretosh Misra, Analyst at Berenberg Bank]

Got it. And as a follow-up, maybe just if you could talk a bit more about your solar business. Any thoughts on how big is that right now and how big do you think it could be in the next several years and also where exactly are your products used in that whole process?

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

It's not only one product, it's several products. Unfortunately, I don't know if you could, what's kind of part of the solar business today, but first of all, there is different kinds of pulsed laser stuff this I mean micrometer region and also getting green pulse lasers and for next year and also we are optimistic that I think we you applications for lasers, we are optimistic, again about this lasers.

[Paretosh Misra, Analyst at Berenberg Bank]

Okay, thank you.

[Operator]

Our next question is from Joe Wittine with Edgewater Research. Please proceed with your question.

[Joe Wittine, Analyst at Edgewater Research]

Hey, good morning. My condolences IPG from an investor facing point of view, I will miss VG's spirited responses to any questions that we're focused on competition. We are clearly showed his technical broaden the products. So yeah, my condolences. I want to ask on China. Yeah. The prepared remarks piecing together key separate comments in the prepared remarks, one in regard with the China competition is continuing, but on the positive side, discussing gross margin you mentioned price discipline. So are we kind of expand upon those dynamics. Does that imply you're kind of walking away from certain machines or potentially even customers or has anything really changing in those dynamics in the second half of the year?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

I don't think anything has really fundamentally changing. There is a high-volume low-end of the market that really only buys on price. And then, there continues to be a higher, this is on the crushing side of things, there continues to be a high-end of the market that generally serves higher volume manufacturing and automated manufacturing systems where reliability is very key to the system. So for example, in a production line, if you have downtime of even a few hours not even a day, the cost of that downtime will be way in excess of the cost of the laser. Right. So it's in those areas that we continue to focus on where our share continues to be very high, it's kind of a bit of a victory trying to play within the very high volume low-end of the market. What we did say though is that as we expand the offering of our ultra-compact lower cost lasers, there's certainly an opportunity to increase our share as we go to 3 kW, 6 kW and ultimately 8 kW there and then in the rest of the China market, you're dealing with much more sophisticated applications and where our competitive products are significantly better. So whether it's the A&B laser or the high power pulse lasers were even at lower power levels of single mode lasers that are being used on on some of the additive and even some welding applications looking at using low by single mode, we got very, very clear advantages in all of those areas.

[Joe Wittine, Analyst at Edgewater Research]

Thanks. Maybe just give us comment on automotive investments as well, beyond electric vehicles, which I think is understood. But I'm just wondering if there's any impact to appetite to invest for the core body in white and Taylor welded blanks type of applications with production being generally depressed short term for for the light vehicle space?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

Yeah, we're not seeing a very significant investment in that, as a couple of, there is one North American manufacturer that's actually replace it started a program to replace some older lasers 8 to 10 years old as a few orders I've seen coming in in Europe from some of the major manufacturers, some recovery in Japan from a major manufacturer today who is looking to roll out some of their more specialized welding processes more broadly that both that a lot of those are sort of on the non-EV side. But no, we have not got major projects that we can point today. The EV market is really dominating automotive at the moment.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Definitely, yes.

[Joe Wittine, Analyst at Edgewater Research]

Great. And then finally, just wondering if there are any notable supply chain driven call-outs this quarter. I think at least in cutting your downstream customers lead times are extending and it's often due to key components that aren't the laser. So I'm wondering if that resulted in any kind of delays to to your shipments during the quarter?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

No. Internally, we managed supply chain very well, but certainly some softness in the end market and some of the issues in China, not just around supply chain power outages, no shipping costs is certainly part of the impact on the cutting market in China.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

But nevertheless, all our obligation to our customers delayed not our typical lifetime and to be a lead time for our products. It's between 6 and maximum 8 weeks.

[Joe Wittine, Analyst at Edgewater Research]

Got it. Thanks very much.

[Operator]

Our next question comes from Mark Miller with The Benchmark Company. Please proceed with your question.

[Mark Miller, Analyst at Benchmark]

Thank you for the question. In terms of COVID related costs, you have broken them out previously and how important will be this quarter?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

We haven't got any. So we haven't really broken out COVID related costs. If you kind of confused with some other cost, Mark, I am not sure. We have had no real significant impact on the cost structure related to COVID. Historically, like last year you had some benefit from lower travel and trade fairs so you starting to see some of those expenses picked up a bit. Of course there is some some cost related to sanitation -- sanitizing and no providing PPE, but it's not, it's not a material impact on that. We haven't ever broken that out before.

[Mark Miller, Analyst at Benchmark]

Sure, sorry, in terms of component shortages, electronic component shortages, how that been an impact, I mean what product areas are you seeing an impact if it is an impact?

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

First of all, we have, we have now sufficient quantity of components, which we need for our production and also looking for so far in the new suppliers and sometimes also make uncertainty redesign of our products to use not components is where it was before, but for the new ones. We are flexible enough in this case.

[Mark Miller, Analyst at Benchmark]

Thank you.

[Operator]

Our next question Jim Ricchiuti with Needham and Company. Please proceed with your question.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

Hi, thanks. Yeah, Tim, you had called out in a couple of areas additive manufacturing. I wonder if you could remind us if we went back prior years where that business may have peaked and what you're seeing in the market, it sounds like you you're potentially could even be gaining some share back in China. But certainly, Europe was a contributor, how should we think about additive this year?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

Like it peaked back in 2017, maybe the first half of 2018 with the strongest quarters and certainly since then, in the European market has been very weak. The China market is really more new developments and that started to launch product and you're starting to see some recovery in the European end markets as well. I think it is peak it was sort of driving but back at that time, 4% or 5% of revenue $50 million to $60 million annually.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

And just based on what you're saying, it sounds like you're optimistic there is some runway for growth in that market?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

I think there is some recovery coming in the market and more players in the market. It's still got a way to going to be like a really fundamental driver in terms of like improving the speed, the processes, and I think that that's recovery coming back. I think recovery the aerospace market as well will help that because that's an area where quite a lot of management processes where used.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Excuse me, of course, 3D applications are now using much more sophisticated machine. If before as usual they used for one machine, one lasers. Now up to 12 lasers they use one machine to produce components from metal from other materials and this is very fast.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

Got it. And the other area that we do get questions on a lot just because there is, it seems to be a fair amount of activity is in directed energy is there, are there any, any updates you can provide whether it's visibility into projects, anything you can say along those lines, because this is obviously an area of the market where it's a little bit more competitive.

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

There's no really particular update at the moment, I think, really that tipping point and people are looking for some commercialization of these different technologies that are a couple of things that have been launched by people, not seeing material ramping in volume yet, there's a lot of ongoing R&D projects. We continue to ship lasers in those, the business is pretty stable at the moment. It's still pre-commercialization. On the competitive side, I will say that we play in a very different part of market. We're not trying to do like to beam tracking and delivery of the beam. We're looking at being the light source in certain, not broad set of those applications, so we're not. Our customers are the ones who do the, the beam tracking in delivery capability, so we're not so much on that competitive end.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

Up to now that exist, not be competition for example for high polish in the market lasers, reproduced and [Indecipherable] 10 kW lasers more than 10 years ago. Up to now, nobody can produce such kind of lasers.

[Jim Ricchiuti, Analyst at Needham & Company LLC]

Thank you. Thanks very much.

[Operator]

Our next question is from Michael Feniger with Bank of America. Please proceed with your question.

[Michael Feniger, Analyst at Bank of America]

Yeah. Thanks for squeezing me back in. Tim, the gross margin of 100 bps year-over-year to 49%. Apologies, I think you might have already broke some of this out but what were the main drivers there, I think there is like inventory provision, fixed cost absorption. Can you just talk at that for us again?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

Yeah, the inventory provisions and basically or unabsorbed manufacturing costs as a percentage of sales were down relative to a year ago. Your gross margin was relatively stable. I, the main, the main, the main areas.

[Michael Feniger, Analyst at Bank of America]

Okay. And Tim, I think at a conference in August you felt that the China market was not as dire and in a dire situation as it was in obviously 2019. Is that, is that kind of still the case, given some of the other tailwinds you're seeing there? And just on the China pricing, is it that the market has already taken a step down and you're just not following it down there or is it just, if it does go down, you're not, you're not willing to match and fall there because you guys are are diversifying a little bit away from some of the low-end cutting?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

So the first part of the question. I think for us the China market like elsewhere is becoming more diversified and is benefiting from certain tailwinds that are driven by the EV investment cycles. We talked about additive, we talked about some of the customers coming back to us on the briefing, not only though the cutting market is weak at the moment in the supply chain issues, there is that power outage issues, they have got a bit the Evergrande. I mean, none of these things are things we can control. Right. We can continue to compete very strongly in that market. In terms of no opportunities there even on the cutting, Dr. Scherbakov referenced 2 or 3, the echo lasers moved towards even higher power on cutting. And then the ultra-compact laser, which gives us an opportunity to compete at the the non-cost part of the market. On pricing, the competitive, the competitive dynamics have taken many steps down on pricing and we have now been much more disciplined in our strategy around pricing standing by value proposition of the technology that we deliver for well over a year now. So we've been and we're really pleased with the way that's transitioned into our business model, as evidenced by performance in this quarter.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

And also important that high-power lasers the strict in not only source. I mean lasers. Also, in many cases, our optical heads and some other components and in this case we can compete much more successfully.

[Operator]

Our next question comes from Nik Todorov with Longbow Research. Please proceed with your question.

[Nik Todorov, Analyst at Longbow Research]

Yeah, thanks for the follow-up, on follow-up questions. I have just on China again. How do you guys explain this bifurcation of demand in China? I think EV demand is obviously idiosyncratic we understand that the capacity needs to be added, but how do you explain the divergence and in cutting versus marking and treated printing, given the backdrop of supply chains, power outages and things of that nature that you have highlighted.

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

Relatively easy to explain where anyone is using lasers in a highly automated or high-volume production environment, they really want reliability and quality because if a production line goes down on a, in an automated environment the downtime on a production line even for 1 hour, 2 hours forget about one day, it far exceeds the cost of the laser. Whereas if you go into like some of the job shop applications, a job shop can be down for a day and wait for a replacement laser to be supplied by a competitor and it doesn't impact them from a cost perspective in that way and because they're paying so much less for the laser, they're prepared to put up with that and it's really, I mean I you described is the opportunity cost of versus of automation versus very low-end type applications where people may be processing metal, for example. I don't know, furniture or live fixtures or that kind of thing. So that's really in my mind add to sort of so we real nub of the issue.

[Eugene Scherbakov, Chief Executive Officer at IPG Photonics]

I would like to do is going to some examples, for example, for some automotive, a customer you shrink that in some experience the reaction time. It might be. If you're a laser installed on the production line, reaction time actually must be less than 20 minutes and as I mentioned what kind of lasers come up installed and what kind of training w have to supply. What kind of support we have to supply to our customers. The problem is not to supply laser, reliable laser, of course it's very important, but organize a service and support to customer is also very important and in many cases because we're are using the our experience the workers, practically all automotive customers in the world, we have enough experience to also to support our customers in other applications.

[Nik Todorov, Analyst at Longbow Research]

Yeah. That very helpful. I think my question was more so from a macro perspective, why do you think in China cutting demand is soft, while you're citing strength in market printing and some of the other areas. I understand from your perspective, you know why there is the bifurcation between high end and low-end and you explained that perfectly, but just from a macro perspective, why is cutting demand softer versus 3D print and marketing being stronger given the backdrop of supply chain and power outages and everything?

[Tim Mammen, Senior Vice President & Chief Financial Officer at IPG Photonics]

I think additive is an emerging business there and it's starting to support the more nascent aerospace industry. So that's a driver. And it's really at the beginning of that, not just in aerospace, but the additive is being rolled out I think at a really a relatively early stage and the marking engraving there's some areas for example where you're supporting things like consumer electronics where we've gained share back. So the market itself. I mean as you looked at trying to understand whether where the total marketing and engraving market is, but it's also a very, very large market. There are tens of thousands of pulse lasers sold into that, but we kind of one of the reasons, and one of the reasons positive performance that we be gaining share back for the automated processes and then on EV that's a well-understood macro tailwind right?

[Nik Todorov, Analyst at Longbow Research]

Right. Okay, that's all I was looking for. Thanks. Appreciate it.

[Operator]

We have reached the end of the question and answer session. I would now like to turn the call back over to your host, Eugene Fedotoff. Thank you.

[Eugene Fedotoff, Director of Investor Relations at IPG Photonics]

Thank you for joining us this morning and where your continued interest in IPG, we'll look forward to speaking with you over the coming weeks and we'll be participating in a number of virtual investor events this quarter. Have a great day, everyone. [Operator Closing Remarks]