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spk06: Good morning, and welcome to IPG Photonics' third quarter 2021 conference call. Today's call is being recorded in webcast. At this time, I'd like to turn the call over to your host, Eugene Federoff, IPG's Director of Investor Relations, for introductions. Please go ahead, sir.
spk08: Thank you, Robin. Good morning, everyone. With us today is IPG Photonics' Chief Executive Officer, Dr. Eugene Sherbakov, and Senior Vice President and CFO at Team Moment. Statements made during the course of this call that discuss management or the company's intentions, expectations, or predictions of the future are forward-looking statements. These forward-looking statements are subject to risks and assurances that could cause the company's actual results to differ materially from those projected in such forward-looking statements. These risks and assurances include the impact of COVID-19 pandemic on our business and those detailed in IPG photonics Form 10-K for the period ended December 31st, 2020, and our reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the investor 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 2nd, 2021 only. The company assumes no obligation to publicly release any updates or revisions to any such statements. For additional details on the 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'll now turn the call over to Eugene Sherbakov.
spk02: Thank you, Eugene, and good morning, everyone. We are deeply saddened by the passing of the founder and executive chairman of IPG. This is a tremendous loss for our company and the broader photonics community, which benefited greatly from his technical innovations and strategic vision. Because of his vision and relentless work Fiber laser has 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 invest internally in manufacturing and research and development capabilities to make the highest quality components and the most reliable products. At IPG, we are also exploring new markers and applications where fiber lasers can replace existing laser and non-laser technologies by improving efficiency, productivity, or enabling technological breakthrough for our customers. Our technologies are playing well into the major micro trends 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, have been diversified away from the high competitive and more cyclical cutting market in China and our results this quarter demonstrate a successful execution of this strategy. We are pleased to deliver the third quarter revenue and EPS at the top end of our guidance. Results were driven by strong growth and welding marking 3D printing and as well as the cleaning, semiconductors, and a number of other products and applications. Demand for IPG laser continues to improve in North America and Europe, with both welding and cutting applications showing solid growth. We also see increased orders and business activity in Japan. These geographies continue to recover from the pandemic and so increased investment in new factories and automation. We are benefiting from widespread investment in electric vehicles production globally. Our lasers are used in relative welding, foil cutting, and cleaning applications for EV battery manufacturing. We are also seeing opportunity for laser welding in EV motor assembly and body and white applications. These investments are likely to continue for the next three, five years as automotive manufacturers address the need for EV batteries and new technologies in order to meet aggressive global carbon emission standards. We are excited about increased demand. We are seeing it in emerging products. and applications, which contributed just under 30% of our total revenue this quarter, with record sales in AMB lasers and medical, and strong growth in high-power pulse lasers. Both AMB 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 thulium laser and IPG disposable fibers are considered as a new gold standard in the industry. We believe that our medical business will continue to grow significantly, potentially doubling in size over the next two or three years. One of our newest products is handheld laser. which had launched earlier this year, is winning widespread interest and gaining significant traction in welding community. We launched our new and approved version of LightWeld in September. It also has cleaning capability in addition to many preset welding parameters. Some customers may choose LightWeld just for cleaning future. as it can save time, money, and reduce cost considerably. LightWheel was the highlight of our presentation at FAPTEC this year, and we have signed agreements with nationwide distributors that operate hundreds of welding retail stores in the United States. We currently expect to sell tens of thousands of LightWheel systems in the next three to five years. As expected, we saw softer demand condition in China cotton market during the third quarter. The combination 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 cotton 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 and EV battery applications and increased revenue from marketing and 3D printing. In several cases, we saw customers coming back to IPG after low-cost local suppliers didn't meet customer quality and technical support expectations. We continue to benefit from our vertically integrated product model which enabled technological advantage while minimizing the supply chain disruptions. However, we have been seeing some impact on our and our customer operations from ongoing supply chain issues worldwide, which we are able to successfully overcome this quarter. As we announced earlier, the Board selected John Pillar as a 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 CEO and chair roles that started in May 2021, and I look forward to working with John and his new positions. With that, I will turn the call to Tim to discuss financial highlights in the quarter and fourth quarter outlook.
spk03: 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 three. Revenue in the third 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 4 cents per diluted share, primarily related to the depreciation of the Euro and Chinese Yuan. If exchange rates relative to the U.S. 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 four. Sales of high-power CW lasers decreased 4% year-over-year and represented approximately 47% of total revenue. Sales of ultra-high-power lasers at 6 kilowatts 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 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 ILT and a ramp-up in Lightwell 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 five, 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 continued to gain acceptance. System sales improved in the third 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 third 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 percent, and revenue in the rest of Asia increased 15 percent year-over-year. Moving to a summary of our balance sheet and cash flow on slide six, 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 third 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 have bought approximately another 135,000 shares so far in the fourth quarter. Commenting on outlook for the next quarter, third quarter book to bill remained above one. 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, oil 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 light-well sales continue to gain traction. However, sales in China will be down sequentially in the fourth quarter due to soft demand and 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 fourth quarter of 2021, IPG expects revenue of $330 million to $360 million. The company expects the fourth 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 that 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.
spk06: Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. We ask that you please limit to one question and one follow-up. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the store keys. One moment, please, while we poll for questions. Our first question comes from Jim Rusciutti with Needham & Company. Please proceed with your question.
spk07: Hi. Good morning. I had a question about China. If we exclude the cutting business in China, Can you give us some senses 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.
spk03: No, 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're 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 and engraving applications, which are increasingly being used in automated production lines, and 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're good.
spk02: But for cutting applications also, we have to see the lower end applications, of course. It's some competition from Chinese. But for high end, we have a very good position in comparison to also Chinese competitors.
spk07: And the follow-up question I have is just with respect to light weld. I know it's early days, but 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 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 now
spk02: in early 22 i you know i don't know if there's 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 light welding of course you would like to get the great benefit from this quarter but of course it will take time because a lot of different opportunities and a lot of different customers already participated in this And we have some time to ask the customer to use it. And, of course, we cannot get the first quarter next year. But also, it's very important that we introduce new options for our light weld. And we'll demonstrate in the end of this quarter and beginning of the quarter first next year.
spk07: And this will be – 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 – you're seeing clearly a turn in that part of your business.
spk02: Yes, but talking about catalysis, I don't think so. Because the rest of our business also is growing. And we – optimistic about our prognosis and forecast for the next year, definitely.
spk07: Okay, thanks. I'll jump back in the queue.
spk06: Our next question comes from Nick Tariff with Longbow Research. Please proceed with your question.
spk05: Yeah, and thanks, guys. Good morning. The growth 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 a consistent gross margin despite the decline in China cutting? Are you seeing offsets from new products or are you staying more disciplined in pricing? What are the drivers of the Brazilian gross margin?
spk03: So there's a number of drivers. I think the first thing is the strategy about being disciplined around pricing both in China and globally is really paying dividends in that regard. The second, there's probably two or three 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 You know, we've got sort of strong sales coming out of areas like medical and even some of the semiconductor applications. So, you know, we're exactly trending in the direction that we'd like to see from a mix and diversification perspective, and there is a benefit on the gross margin side from all of those areas.
spk02: Yeah, and also we continue to prolong our special project, which was installed two years ago, about optimization on the manufacturing cost. for our components, for our devices, and this trend also next year, definitely. Okay.
spk05: 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 a double-digit sales growth algorithm. How do you see maybe 2022 relative to that framework? Any comments would be helpful there. Thanks.
spk03: Well, I'm not going to comment on a double-digit growth for next year. I mean, we've provided a medium-term to long-term target of continuing to grow the business at a double-digit growth rate. We're not giving any guidance for next year at this point in time. It would be the wrong point in time to do that. We also 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 major growth drivers that we talked about, sort of macro trends out there with EV battery manufacturing, EV motor manufacturing, body and white applications, new product introductions in the other parts of the welding market with light weld, 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 one and one and a half kilowatts, so transitioning during the course of the year, early on in the year to three and six kilowatt, and then ultimately probably in the second half of the year to eight kilowatt with the ultra-compact device. So there's a whole host of different applications that we think are going to really make next year an interesting and exciting one. Even from a geographic perspective, you continue to see sort of robust applications economic data in North America and Europe, but maybe a little bit of a moderation, but not fundamental shift. And geographically, we're starting to see some recovery in Japan as well, and we'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.
spk02: Yeah, definitely. I would like to add that some customers and also in China and outside of China, they start to ask about the ECA lasers. I mean, ECA lasers are IPG laser which efficiency more than 50%. Nobody could produce such kind of laser today. And this also for us, it will be opportunity to provide very high power laser with such kind of high efficiency. And we would like also demonstrate this product this end of this quarter and also beginning the next quarter. Already we have some potential customers for this.
spk05: Got it. Thanks, guys. Good luck.
spk02: Thank you.
spk06: Our next question comes from Michael Fenninger with Bank of America. Please proceed with your question.
spk05: Hey, guys. Yes, and thanks for taking my question. I want to be respectful in how I ask this question. There are a lot of investors wondering, kind of what happens to Valentine, you know, his trust and the voting shares as he's a significant shareholder. In your 10K filing, obviously his ownership position cited as a material risk. We saw yesterday there were some 13D filings that occurred last night. 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 and his trust position at this point?
spk03: So, Michael, there's no material change to the ownership and structure. The estate planning around Dr. Caponso's ownership in IPGP was not only started but completed many years ago. There's no change in the trustees appointed to manage the trust in regard to the UK company. There's no major change there as Dr. Shcherbakov has been managing director and will vote those shares. So I think this sort of transition around this has been thought through and planned pretty well over a sort of decade-long process that we started to look at this at.
spk05: Fair enough, Tim, and I guess on that, I guess this might answer this next question, but Given the circumstances, is there any change in strategic direction for IPG 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 this news on strategy and IPG going forward?
spk03: I think the first statement is if we were going to make a fundamental change on anything, it would be a material announcement that we'd have to make, and we've made all of the announcements around the events of the last couple of weeks. In terms of strategy, we talked about that when Dr. Sherbakov took over as CEO, that at a high level and a broad level, the strategy was developed by Dr. Shcherbakov and Dr. Caponzov and even other members of the executive team over many years. So continuing to pursue the rollouts of fiber laser technologies across multiple applications and end markets. So there's no big change in that direction. Dr. Shcherbakov has mentioned a couple of things. We're 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 that keep us on average at the top end of that range. Of course, there could be some variance depending upon where quarterly revenues fall out. In terms of capital allocation, we've continued to enhance and develop the capital allocation strategy over time where 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, we would have had to articulate them.
spk05: Makes sense. Thanks for that, Tim. And then how do we think about with all these supply chains and the cost inflation With you guys being so vertically integrated, I'm curious how that kind of impacts you with some of these supply chains trying to get certain components. But also, you know, I feel like the expense number was in line with your expectations, around $87 million. Like, how do we think about, you know, are you seeing more cost inflation in the business as you kind of head into the, you know, fourth quarter and into 2022, how we kind of think about those moving parts on SG&A and labor and things like that? Thank you.
spk02: Of course, we see this influence, first of all, for our customers and also for our suppliers. First of all, for electronic chips and so on. But we made some precautions about this. I mean, we have enough in our stock, these components, to organize the stable production of our lasers and not to interrupt uh our customers but of course we have to think about our strategy because you see the price for metal grows dramatically for aluminium 20 percent for copper about 30 percent some chips price also increased not to 20 30 but sometimes for three up to 10 times and in such kind of conditions of course we have to see also some possibility to again just the optimization of the 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.
spk03: And just with regards to the operating expenses, I can address those SG&A and R&D. We're right in line with... what we've guided to for Q3, we're actually running at a bit higher level on some of those objects 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's close to 20% in Q3, 20%. So we're actually slightly ahead of where our budget was, so our variable compensation accruals are slightly higher. You've got some expense coming back from for example, trade shows and fairs on the selling side, so Fabtech. But the variable comp, relatively speaking, next year will probably moderate 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, you know, 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, you know, we've 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.
spk06: As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. One moment while we poll for questions. Our next question comes from Pratash Misra with Barenburg. Please proceed with your question.
spk04: Thank you. Good morning. I guess just going back to that inflation discussion. So, I mean, looking at it a little differently. So some of your competitors have been cutting prices in recent years. So I'm just curious if this inflation in component pricing and trade is making it more difficult for those guys to cut prices. In other words, could this inflation lead to some sort of price stabilization even for the low-powered lasers?
spk03: We can't really talk to how people in the competitive market will behave I think it's interesting, though, 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're certainly being very aggressive around pricing. And with that aggressiveness around pricing, they're 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. Got it.
spk04: 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 you think it could be in the next several years? And also, where exactly are your products used in that whole process?
spk02: It's not only one product, but several products. Unfortunately, I don't know exactly what kind of part of the solar business. But first of all, there is a different kind of pulse laser spot. This, I mean, micrometer region and also green pulse lasers. And for next year, we're also optimistic that I think we have new enough applications for these lasers.
spk01: And we're optimistic, again, about these lasers.
spk04: Okay, thank you.
spk06: Our next question is from Joe Wittine with Edgewater Research. Please proceed with your question.
spk05: Joe Wittine Hey, good morning. My condolences to everyone at IPG. You know, from an investor-facing point of view, I will miss VG's spirited responses to any questions that were focused on competition. You know, clearly showed his technical pride in the products. So, yeah, my condolences. I want to add on China. The prepared remarks, piecing together two separate comments from the prepared remarks. One, I acknowledge that the China competition is continuing. But on the positive side, when discussing gross margin, you mentioned price discipline. So hoping you can kind of expand upon those dynamics. Does that imply you're kind of walking away from certain machines or potentially even customers? Or is anything really changing in those dynamics in the second half of the year?
spk03: I don't think anything's 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 cutting 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 Pyrrhic victory trying to play within the very high volume, low end of the market. What we did say, though, was 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, 6, and ultimately 8 kilowatts 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 AMB laser or the high-power pulse lasers, or even at lower power levels, the single-mode lasers that are being used on on some of the additive and even some welding applications looking at using low-power single mode. We've got very, very clear advantages in all of those areas.
spk05: Thanks. Maybe you could just 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, you know, the core, you know, body and light and tailor-welded blanks type of applications with production being, you know, generally depressed short-term for light vehicle space.
spk03: We're not seeing a very significant investment in that. There's a couple of – there's one North American manufacturer that's actually replaced – started a program to replace some older lasers that were – you know, eight to 10 years old. There's a few orders I've seen coming in in Europe from some of the major manufacturers. There's some recovery in Japan from a major manufacturer there who's looking to roll out some of their more specialized welding processes more broadly for both. A lot of those are sort of on the non-EV side. But no, we've not got major projects that we can point to there. You know, the EV market is really dominating automotive at the moment. Definitely, yes.
spk05: Great. And then finally, just wondering if there are any notable supply chain-driven call-outs this quarter. I think, you know, at least in cutting, your downstream customers' lead times are extending, and it's often due to key components that aren't delays. So I'm wondering if that resulted in any kind of delays to your shipments during the quarter. No.
spk03: Internally, we've managed supply chain very well, but certainly some softness in the yen market. Some of the issues in China, not just around supply chain, but power outages, You know, higher shipping costs are certainly part of the impact on the cutting market in China.
spk02: But nevertheless, all our obligations to our customers will wait. No special delay, no. Our typical lifetime lead time for our product is between six and maximum eight weeks.
spk06: Got it. Thanks very much. Our next question comes from Mark Miller with the Benchmark Company. Please proceed with your question.
spk00: Thank you for the question. In terms of COVID-related costs, you've broken them out previously. How important were they this quarter?
spk03: We haven't really broken out COVID-related costs. Are you getting confused with some other costs, Mark? I'm not sure. There's no real significant impact on the cost structure related to COVID-related Historically, like last year, you had some benefit from lower travel and trade fairs, so you start to see some of those expenses pick up a bit. Of course, there's some cost related to sanitation, sanitizing, and providing PPE, but it's not a material impact on that. We haven't ever broken that out before.
spk00: Sorry. In terms of component shortages, electronic component shortages, how big an impact and in what product areas are you seeing an impact if it is an impact?
spk02: First of all, we have now sufficient quantity of components which we need for our production. And also we're looking for to find the new suppliers, and sometimes also making the redesign of our product to use not components which we used before, but for the new ones. They are flexible enough in this case.
spk08: Thank you.
spk06: Our next question is from Tim Rashudi with Needham & Company. Please proceed with your question.
spk07: Hi, thanks. 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 potentially could even be gaining some share back in China, but certainly Europe was a contributor. How should we think about additive this year?
spk03: I think it peaked back in 2017, maybe the first half of 2018, with the strongest quarters. And certainly since then, the European market has been very weak. The China market is really more new developments, and they're starting to launch product there. And you're starting to see some recovery in the European end markets as well. I think at its peak, it was sort of driving growth. Back at that time, 4% or 5% of revenue, $50 million to $60 million annually.
spk07: And just based on what you're seeing, it sounds like you're optimistic there's some runway for growth in that market.
spk03: I think there's some recovery coming in the market and more players in the market. it's still got a way to go to be like a really fundamental driver in terms of like improving the speed of processes and that kind of thing. But there's certainly some recovery coming back. I think recovering the aerospace market as well will help that because that's an area where quite a lot of additive processes were used.
spk02: Excuse me. For these 3D applications, they are now using much more sophisticated machines. Before, as usual, they used for one machine, one laser. Now, after 12 lasers, they're used for one machine to produce big enough components from metal or from other materials. And this is too fast.
spk07: Got it. And the other area that we do get questions on a lot just because there seems to be a fair amount of activity is in directed energy. Are there 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.
spk03: There's no really particular updates at the moment. I think really the tipping point that people are looking for is some commercialization of these different technologies. There 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'll say that we play in a very different part of the market. We're not trying to do the beam tracking and delivery of the beam. We're looking at being the light source in certain broad sets of those applications there. Our customers are the ones who do the beam tracking and and delivery capability. So we're not so much on that competitive end.
spk02: Up to now, there is no big competition, for example, for high-power single-motor lasers. We produced and we demonstrated the 10 kilowatt single-motor lasers more than 10 years ago. Up to now, nobody can produce such kind of lasers.
spk07: Thank you. Thanks very much.
spk06: Our next question is from Michael Fenninger with Bank of America. Please proceed with your question.
spk05: Yes, 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's like inventory provision, fixed cost absorption. Can you just bucket that for us again?
spk03: Yeah, inventory provisions and basically your unabsorbed manufacturing costs as a percentage of sales were down. Relative to a year ago, your product price margin was relatively stable over the main area of service.
spk05: Okay. And Tim, I think at a conference in August, you felt that the China market was not as dire in a dire situation as it was in, obviously, 2019. 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, you know, if it does go down, you're not willing to match and follow there because you guys are diversifying a little bit away from some of that low-end cutting?
spk03: So the first part of the question is, I think for us, the China market, like elsewhere, is becoming more diversified and benefiting from certain tailwinds that are driven by, you know, the EV investment cycles. We talked about additive. We talked about some of the companies coming back to us on the market and craving. Now, undoubtedly, though, the cutting market is weak at the moment, and there's supply chain issues. There's the power outage issues. You know, they've got a bit of the Evergrande crash. 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 opportunities there, even on the cutting, Dr. Sherbrooke referenced two or three, the echo lasers, the move towards even higher power on cutting, and then the ultra-compact laser, which gives us an opportunity to compete at the lower cost part of the market. On pricing, the competitive dynamics have taken many steps down on pricing, and We have now been much more disciplined in our strategy around pricing and standing behind that 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.
spk02: And also important that for high power lasers, we are shipping not only source, I mean lasers, but also shipping In many cases, our optical heads and some other components. And in this case, we can compete much more successfully.
spk06: Our next question comes from Nick with Longbow Research. Please proceed with your question.
spk05: Yeah, thanks for the 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 in cutting versus marking and traded printing, given the backdrop of supply chains, power outages, and things of that nature that you highlighted?
spk03: It's actually 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 in an automated environment, the downtime on a production line, even for one hour, two 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 don't know how you describe it, it's the opportunity cost of automation versus very low-end type applications where people may be processing metal, for example, for, I don't know, furniture or light fixtures, that kind of thing. That's really, in my mind, that's the sort of the real nub of the issue.
spk02: I would like to present you some examples. For example, some automotive. a customer which had some experience. The reaction time, it must be, if your laser is installed on the production line, reaction time must be less than 20 minutes. Can you imagine what kind of lasers must be installed and what kind of training we have to supply, what kind of support we have to supply to our customer? The problem is not to supply laser, reliable lasers. Of course, it's very important. But to organize a service and support the customer, It's also very, very important. And in many cases, because we are using our experience to work with practically all automated customers in the world, we have enough experience also to support our customer in other applications.
spk00: Yeah, that's very helpful.
spk05: 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 marketing and creative printing and some of the other areas? I understand from your perspective, you know, why there's 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 printing and marking being stronger given the backdrop of supply chain and power outages and everything?
spk03: I think the 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 at a relatively early stage. On the marking and 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 haven't actually looked at trying to understand where the total marking and engraving market is, because it's also a very, very large market. There's tens of thousands of pulse lasers sold into that. But we kind of, one of the reasons, One of the reasons for positive performance, though, would be gaining share back for the automated processes. And then on EV, that's a well-understood macro tailwind, right? Right. Yeah. Yeah. Okay. That's all I was looking for. Thanks. Appreciate it.
spk06: 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 Federoff. Thank you, Eugene.
spk08: Thank you for joining us this morning and for your continued interest in IPG. We 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.
spk06: This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.
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