IPG Photonics Q1 2023 Earnings Call Transcript

Participants

Corporate Executives

• Eugene Fedotoff, Director of Investor Relations
• Eugene A. Scherbakov, Chief Executive Officer and Director
• Timothy P. V. Mammen, Senior Vice President and Chief Financial Officer

Analysts

• Ruben Roy, Stifel, Nicolaus
• Christopher Grenga, Needham & Company LLC
• Mark S. Miller, Benchmark Co.

Presentation

[Operator]

Good morning, and welcome to IPG Photonics' First Quarter 2023 Conference Call.

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 me today is IPG Photonics' CEO Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen. Let me remind you that statements made during the course of this call that discuss management's or the company's 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 are detailed in IPG Photonics' Form 10-K for the period ended December 31, 2022, and our 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, May 2, 2023 only. The company assumes no obligation to publicly release any updates or revisions to any such statements. For additional details on our reported results, please refer to the earnings press release, earnings call presentation or the Excel-based financial data order book 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'll now turn the call over to Eugene Scherbakov.

[Eugene A. Scherbakov, Chief Executive Officer and Director at IPG Photonics]

Good morning, everyone. We are pleased with our results this quarter, which were about our guidance range despite the macroeconomic uncertainty that continue to negatively impact demand in general industrial applications such as cutting and marking. We reported another quarter of solid revenue growth in welding that was driven by record sales in EV applications and an all-time high revenue for our handheld welder, LightWELD. Additionally, we saw the strong results in cleaning and solar cell manufacturing.

Demand for these products is driven by global Macrotrends and increasing investments in renewable energy and eco-friendly solutions. IPG is developing innovative technologies that enable manufacturing of these products and improve speed and efficiency, with benefits to society and environment. Recently, we published our 2023 annual sustainability report on our website providing information on many of these trends and how IPG delivers on our new mission statement, "Applying light in ways that improve life." IPG has been making good progress in diversifying our revenue and reducing our exposure to cyclical and economically sensitive industrial markets.

While these markets and applications still account for a major portion of IPG's revenue, we have been investing our R&D, sales and operating resources to support growth of emerging products and to drive further diversification of our revenues. In the first quarter, emerging growth product sales grew both sequentially and year-over-year and accounted for 45% of total sales. Many of these products are benefiting from global investments in e-mobility and renewable energy. We saw another quarter of record sales in AMB lasers, driven by growth in EV battery welding as global EV battery capacity build-out Continued. We also saw increased demand for our green lasers that are used in solar cell manufacturing applications, improving efficiency of these solar cells.

We expect investments in solar cell capacity globally to drive increasing demand for our green lasers in the future. Additionally, our revenue for lasers used in cleaning applications grew significantly in the first quarter. Laser cleaning solutions provide sustainability benefits by reducing the use of abrasives and harmful chemicals. For example, a customer is evaluating replacing acid etching with our cleaning lasers. In addition to the environmental benefits, laser cleaning can significantly reduce costs of storage, transportation and handling toxic chemicals and eliminate reliance on consumables, which leads to reduced operating expenses.

Our recently introduced laser drying and heating solutions are replacing less-efficient infra-red bulbs. The solutions are well-received by customers and are gaining market acceptance because they cut down on energy consumption and environmental impact. We expect orders for these systems in the second quarter and anticipate a strong demand for drying systems in the future. IPG had another quarter for the second sales of -- record sales for e-mobility applications. We are seeing customers accelerating investment in EV battery capacity in North America, Europe, Japan and Korea in addition to the investments being made in China.

Our e-mobility business in the United States has increased substantially in the first quarter as customers shifted investments into the region to take advantage of government incentives. We offer a broad range of solutions to customers from laser source to complete production lines for existing and emerging battery technologies. Our real-time weld monitoring solutions and adjustable mode beam lasers create an industry leading combination and addresses customers' challenges and provides superior weld quality for hundreds of welds in each battery pack.

We continue to explore additional opportunities for welding components in electrical motor assembly. With the strong pipeline of opportunities we are expecting our global sales force focused on e-mobility applications. We expect the EV investment cycle to continue and e-mobility sales to remain strong in the next three to five years. Although demand can fluctuate depending on the pipeline of projects and regional capacity additions. Our medical business had a good quarter and grew year-over-year driven by continued adoption of our laser system and consumable fibers for urology applications. However, we expect medical sales will be softer in the second quarter as a large customer adjusts its buffer inventory.

We are working on multiple new opportunities to broaden our medical portfolio and to further grow the business so it becomes a more meaningful contributor to IPG sales in the next two to three years. I would like to thank our employees for their dedicated work. We believe that an engaged and diverse workforce is a great strength of our organization. IPG has always focused on inclusion and employs a large number of women and workers from diverse backgrounds. To further improve our diversity, for the first time, we announced targets in our recent CSR report to increase gender diversity and minority representation in the global workforce and management roles. We strongly believe that an inclusive workplace creates a better future for our company and the communities we operate in.

I'll now turn the call over to Tim to discuss financial highlights in the quarter.

[Timothy P. V. Mammen, Senior Vice President and 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 investor relations website. I will start with the financial review on slide four. Revenue in the first quarter was $347 million, a decline of 6% year-over-year due to foreign currency headwinds, which accounted for approximately 4% of the decline and telecom divestiture that reduced revenue by approximately 1%. Revenue from materials processing applications decreased 8% year-over-year, while revenue from other applications increased 10%. GAAP gross margin was 42.3%, a decrease of 410 basis points year-over-year, due to increased manufacturing costs, higher inventory reserves as well as higher shipping costs and tariffs, which was partially offset by an improvement in absorption as a percentage of sales. On a sequential basis, gross margin did show some improvement. FX also had a negative impact in the quarter.

If exchange rates relative to the U.S. dollar had been the same as one year ago, we would have expected revenue to be $15 million higher and gross profit to be $8 million higher. GAAP operating income was $75 million and operating margin was 21.7%. Net income was $60 million or $1.26 per diluted share. The effective tax rate in the quarter was 28% and was impacted by certain discrete items. Foreign currency transaction gains related to remeasuring foreign currency assets and liabilities to period-end exchange rates, had a positive impact on operating income of $3 million and positively benefited earnings per share by $0.06.

Excluding the currency transaction gain and a small restructuring charge, operating expenses declined year-over-year, primarily in research and development as we reduced spending on telecom product development as well as reduced expenses from the sale of the corporate aircraft last year. Moving to slide five. Sales of high power CW lasers decreased 8% and represented approximately 44% of total revenue. Sales of ultra-high power lasers above six kW represented 42% of total high power CW laser sales.

The decline was primarily due to lower demand in high power cutting applications due to softer demand and competition in China, which was only partially offset by growth in welding. Pulsed lasers sales decreased 16% year-over-year as strong growth in cleaning and solar cell applications was offset by lower demand in cutting and marking applications. Systems sales increased 20% year-over-year driven by growth in laser-based systems and LightWELD. Medium power laser sales decreased 42% while QCW laser sales were down 12% year-over-year, negatively impacted by lower sales to consumer electronics applications.

Other product sales increased driven by strong medical sales and increased revenue in advanced applications. Looking at our performance by region on slide six, revenue in North America decreased by 1%, due to the telecom divestiture. Growth in welding, cleaning, advanced applications and medical applications was strong in the quarter and offset lower cutting revenue.

In Europe, sales decreased 7% as a result of difficult comparisons as some growth in the first quarter of the prior year was attributed to pull forward of demand from the second quarter due to supply chain concerns. However, European revenue increased sequentially despite overall uncertainty in the economy. Revenue in China decreased 22% year-over-year as growth in welding for EV battery applications and cleaning applications was offset by continued softness in the cutting market and lower demand in marking applications. Moving to a summary of our balance sheet on slide seven, we ended the quarter with cash, cash equivalents, and short-term investments of $1.1 billion and total debt of $16 million. Cash provided by operations was $37 million during the quarter and capital expenditures were $33 million in the quarter.

First quarter cash provided by operations is typically low due to bonus and tax payments. Our inventories stabilized in the quarter and we continue target a reduction in inventories during the year. While maintaining a strong balance sheet, we have been returning a significant amount of capital to shareholders over the last year and continued to do so in the first quarter. During the first quarter, we repurchased shares for a total of $113 million completing our existing authorization.

Today, we announced a new $200 million share repurchase program, another commitment in our efforts to enhance shareholder value by returning capital. IPG has returned a significant amount of capital since the beginning of 2022, repurchasing over $600 million in shares outstanding. Moving to outlook on slide nine, first quarter book-to-bill was 1. We continue to see uncertain macroeconomic conditions and soft demand in general industrial markets.

Despite relaxing COVID restrictions in China, demand remains relatively muted. However, we are still seeing solid activity and orders in e-mobility and renewable energy across all geographies. Despite all of the uncertainty, IPG continues to benefit from growth opportunities created by major macrotrends such as electric vehicle battery manufacturing and renewable energy. Furthermore, LightWELD has been gaining traction in the U.S., Europe and Asia. We believe these trends and continuing efforts to diversify our revenues will make IPG more resilient and drive our growth. For the second quarter of 2023, IPG expects revenue of $325 million to $355 million.

The Company expects the second quarter gross margin to be between 41.5% and 43.5%. IPG anticipates delivering earnings per diluted share in the range of $1.05 to $1.35, with approximately 47.5 million diluted common shares outstanding. As discussed in the "Safe Harbor" passage of today's earnings press release, our guidance is based upon current market conditions and expectations, assumes exchange rates referenced in our earnings press release, and is subject to risks outlined in the "Safe Harbor" and the company's reports with the SEC.

With that, we will be happy to take your questions.

Questions and Answers

[Operator]

My first question comes from Ruben Roy with Stifel. Please proceed with your question.

[Ruben Roy, Analyst at Stifel, Nicolaus]

Hi. Thank you. Tim, I was wondering if you could expand a little bit on the commentary around demand in China remaining relatively muted. Recently, you characterized some of those applications in China that have been weak like cutting as sort of near or at trough level. And I'm just wondering, at this point, if you think there might be a further lag down based on what you're seeing from the order environment or with reopening. I know there's been some mixed PMI data recently. But as you think about the second half, do you think that we might see a little bit of improvement off of what potentially could be at trough level?

[Timothy P. V. Mammen, Senior Vice President and Chief Financial Officer at IPG Photonics]

I mean I think at the moment, demand remains relatively muted, as we've said, the expected traction from a recovery is taking longer to really crystallize. I still think we're running relatively speaking on some of the older industrial applications like cutting and marking and engraving at that sort of trough level but continuing to perform very well on EV and some of our precision applications, which now are a dominant part of our overall revenue there. I think our commentary is in line with what other people are seeing, right? You're not just seeing a very strong rebound post COVID restrictions being lifted. The PMI data is not particularly strong. But for example, in Q1 relative to our guidance, China did outperform a little bit. So that was a positive. So there was some evidence of a little bit of strengthening and the Q2 guidance is reasonable. It doesn't show any material pickup compared to Q1, it's relatively flat, but it does point to stability. I think it's way too early to say where the second half of the year really ends up at this point in time.

[Ruben Roy, Analyst at Stifel, Nicolaus]

Understood. That's helpful. As a quick follow-up, I wanted to touch on some of the emerging markets, which obviously are doing very well and specifically around EV and how to think about that marketplace. You doubled revenues 2021 to '22. Order rates continue to remain very strong. Eugene talked about a little bit of a slowdown in medical as one of your large customers adjust against buffer inventory. I'm wondering how to think about EV and the order book going forward? Do you think some of the new applications that you're addressing are going to continue to drive momentum or new customer diversity, etc? Or is there a period that we might see coming up where you have some equipment utilization and pause in spend in that market? Just kind of wondering how we should think about that for the rest of this year?

[Timothy P. V. Mammen, Senior Vice President and Chief Financial Officer at IPG Photonics]

So overall, the EV demand environment remains really quite strong, right? I think the benefit is that where you might see weakness in one area, it's going to be picked up in other areas. So we're seeing a lot of demand coming out of North America at the moment. Some of that's being driven by some of the benefits that came out of the Inflation Reduction Act. You're starting to see increased investments in Europe as well. China remains quite resilient in that area. But even if there is a bit of a slowdown in one of those geographies, we expect it to be -- continue to be strong in some of the other areas. This demand we're expecting and we're seeing in some of our other areas in Southeast Asia as well, like South Korea and even in Japan. The other benefit is that I think we're going to start to see orders for the drying equipment materialized during the second quarter, and that should continue to diversify that revenue stream. So I think we have to look at it more on a global basis rather than just specific geographies, and we believe that the puts and takes around that will make this still a very sustainable revenue driver for the company.

[Eugene A. Scherbakov, Chief Executive Officer and Director at IPG Photonics]

Also, I would like to add we have very strong growth for revenue, it's for past later applications, first of all, for cleaning. But for us, it's much more important that we are not selling only just lasers, but also final system of cleaning including our lasers, scanners, in some cases, our laser monitor and other options. And selling for such kind of product, it's also the good opportunity for us to penetrate to many, many different markets a year related to the cleaning applications.

[Ruben Roy, Analyst at Stifel, Nicolaus]

Thank you, Eugene. Thank you, Tim, for all the detail.

[Timothy P. V. Mammen, Senior Vice President and Chief Financial Officer at IPG Photonics]

No problem.

[Operator]

Our next question is from Jim Ricchiuti with Needham & Company. Please proceed with your question.

[Christopher Grenga, Analyst at Needham & Company LLC]

Hi, good morning. This is actually Chris Grenga on for Jim. Europe and Germany, in particular, saw sequential revenue growth. Could you provide some additional color on what you're seeing in that region?

[Timothy P. V. Mammen, Senior Vice President and Chief Financial Officer at IPG Photonics]

Yes, I think actually, Europe was performed very well in the first quarter, given the challenges that, that area has faced. I think you started to see really the energy issues that were a key headwind in the middle and third quarters and even into the end of last year has started to abate. So the overall demand environment was quite strong. Some of that was EV, but there was also good demand from some of the cutting applications, particularly in Southern Europe, which helped some of that outperformance. So yes, I think the economic data has really stabilized. PMIs are still not very strong there, but at least the underlying demand was certainly stronger than we'd expected, and the overall tone in the business for the first quarter was quite positive, and that carries on even in the second quarter with the guidance that we received from the individual entities.

[Eugene A. Scherbakov, Chief Executive Officer and Director at IPG Photonics]

And especially for EV applications, we see such kind of trend that our main potential customer for battery production. They're shifting this production close to the real manufacturing -- car manufacturing. And of course, for us, it's much more advanced because we are using all our portfolio for different kind of laser options for such kind of production.

[Christopher Grenga, Analyst at Needham & Company LLC]

Got it. Great. And with respect to the battery applications. Is there any carryover overlap with stationary battery storage that would be in use in like a residential or like a utility scale solar application? Or is it mostly relevant for EV batteries?

[Eugene A. Scherbakov, Chief Executive Officer and Director at IPG Photonics]

Of course, EV battery now has the first place, but battery for storage also is very important, especially for Europe because it's solar applications that maybe not so active now. But definitely, it will be growing in the future. Laser wise, the storage battery is a very important part of this production. But of course, on the first time now, it's on the first place, of course, definitely, it's battery for electrical cars.

[Timothy P. V. Mammen, Senior Vice President and Chief Financial Officer at IPG Photonics]

EV application set would be very similar, whether it's on the welding, cleaning, all of that, it's basically pretty standard across those.

[Christopher Grenga, Analyst at Needham & Company LLC]

Got it. And just perhaps one more. So with respect to the migration of the production of components that were formally in Russia, just could you provide a status update on where that stands and perhaps any of the large remaining items on that effort?

[Eugene A. Scherbakov, Chief Executive Officer and Director at IPG Photonics]

First of all, it's not my migration of production, expanding our production in Germany because it's our standard product for many, many years. By the way, we introduced from Germany to Russia, this production for some simple blocks. All technology is we are keeping in Germany. Yes, we -- first of all, we increased our production in Germany, but also we installed a new manufacturing place in Poland and also in Italy. And from this manufacturing, now we'll have visibility to eliminate any reliance to the Russian production, many different kinds of components, including the final block, fibers and other -- specially fiber-based components.

[Christopher Grenga, Analyst at Needham & Company LLC]

Thank you very much.

[Operator]

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

[Mark S. Miller, Analyst at Benchmark]

Could you discuss the automotive market, excluding EV?

[Eugene A. Scherbakov, Chief Executive Officer and Director at IPG Photonics]

What do you mean excluding EV? Now EV is a substantial part of this production. All investment by the way, all investments, for example, European car production companies, mainly going to EV production, not the standard car production.

[Mark S. Miller, Analyst at Benchmark]

And -- excuse me.

[Eugene A. Scherbakov, Chief Executive Officer and Director at IPG Photonics]

Go ahead.

[Mark S. Miller, Analyst at Benchmark]

And merchant applications, was that roughly 45% of sales last quarter?

[Timothy P. V. Mammen, Senior Vice President and Chief Financial Officer at IPG Photonics]

Yes.

[Mark S. Miller, Analyst at Benchmark]

Okay. Thank you.

[Operator]

We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Eugene Fedotoff for closing comments.

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

Thank you for joining us this morning and your continued interest in IPG. We will be participating in a number of investor events this quarter, and we're looking forward to speaking with you over the coming weeks. Have a great day, everyone.

[Operator]

[Operator Closing Remarks]