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spk02: Good morning, and welcome to IPG Photonics' third quarter 2023 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 Fedorov, IPG Senior Director, Investor Relations, for introductions. Please go ahead with your conference.
spk01: Thank you, Rob, and good morning, everyone. With me today is IPG Photonics CEO, Dr. Eugene Shcherbakov, and Senior Vice President, CFO, Tim Mahmoud. Let me remind you that 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 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 end of December 31st, 2022, and our reports on file with the Securities Exchange Commission. Copies of these filings may be obtained by visiting the investor section of the IPG's website or the SEC's website. Any forward-looking statements made on this call are the company's expectations or predictions as of today, October 31st, 2023, and 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 earnings press release, earnings call presentation, and the financial data workbook posted on the Industrial Relations website. We will also post these prepared remarks on the website following the completion of this call. With that, I'll now turn the call over to Eugene Shcherbakov.
spk04: Good morning, everyone. Our third quarter revenue was negatively impacted by softer demand in industrial market and further decline in sales in China. Lower demand from industrial customer and reduced demand of immobility applications drove revenue declines in cutting, welding, and marking applications. We also continued to see strong competition in addition to soft demand in the flat street cutting market in China. But even with low revenue, we are pleased with our operating performance this quarter and deliver gross margin improvement and earning per share at the high end of our guidance. While the uncertainty in market economic conditions continue to await on capital equipment spending, customers in Europe, North America, and Japan are increasingly using the high power laser for cutting. We believe that laser adoption in these geographies is significantly behind China. And this market remains the last competitor with IPG, holding a strong market position. We're also seeing the adoption of laser welding technology in automotive and general industrial markets across many geographies. Laser welding provides high speed, precision, and accuracy as well as a low heat input and ability to join dissimilar materials. Our real-time weld measurement system is a great complementary technology to adjustable mode beam in V-lasers and IPG welding head that provides a fast and reliable welding solutions for a broad range of applications across many different industries. Immersion growth product sales accounting for 42% of total revenue in the third quarter. We saw a decline in EMB and high-power power supplies related to low-demand and immobility applications due to decreased investment in EV battery capacity in China. We said in the past that EV battery investment is likely to fluctuate quarter to quarter. a production expansion project can be very large in size and provide some lumpiness in our immobility cells. As a result, some quarter of even years may be better than others. However, we expect EV investment cycle to continue, providing a great opportunity for IPG in the next three to five years. Adoption of electric vehicles still grows in China, Europe, and North America, and battery manufacturers will need to build additional capacity to support higher EV sales. Also, energy storage is growing and may potentially require even more batteries to support the transition to sustainable energy future. Our handheld welder sales continue to grow, driven by rollout in Europe, And LightWeld has up in four times the speed of traditional MIG and TIG welders and does not require extensive training. We are seen as a high interest in the welding community and held five simultaneous live demonstrations of the device at the Fabtech show this year to satisfy this interest. We are also still early on adoption curve and continue to promote light weld in the welding market in the US and other geographies. We're also seeing a significant increase in demand for our lasers and 3D printing applications. Industry reports suggest that technology is being tested for manufacturing of consumer electronic devices. Growth in metal 3D printing technology has been shown that many had anticipated, but it seems Like there is a new catalyst that can potentially drive further adoption. 3D printing is using high quality lasers to melt metal powder to create parts. And APG has a strong position in this market, providing the lasers with high stability beam characteristics. We are recently introducing a new AM laser designed especially for additive manufacturing. This laser has an adjustable mode and can move from single mode to fine structure to multimode output for up to six times higher build-up rates. Finally, sales in our medical business improved as expected after the inventory reduction by a large customer in the prior quarter. Growth in medical continues to be driven by adoption of our laser system. and consumable fibers, which we are considering the gold standard in urology applications. We are also seeing a strong growth in aesthetic applications, which is much larger market. And our fiber laser technology is significantly more advanced compared to the traditional lasers used in medical and aesthetic applications. And our goal is to gain market share by replacing these older technologies. 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 summary, I am optimistic about the growth driven for our products and continued diversification of IPG revenue in the long term. We have introduced a new product products for laser cleaning and drying applications this year, and promote our high-efficiency ecolasers that help reduce the environmental impact for our customers. I would like to thank our employers for their strong contribution in the quarter, and I will now turn the call over to Tim to discuss financial highlights.
spk06: 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 third quarter was 301 million, a decline of 14% year over year. Foreign currency headwinds reduced revenue growth by approximately 2%. Revenue from materials processing applications decreased 15% year over year, while revenue from other applications was nearly flat. Gap gross margin was 44.1%, an increase of 100 basis points year over year, which was driven by lower inventory provisions, reduced shipping costs and tariffs, as well as an improvement in absorption of manufacturing costs as a percentage of sales. On a sequential basis, gross margin continued to improve on lower revenue as we focused on reducing costs, managing inventory, and improving manufacturing efficiency. Despite the headwinds to our revenue from a challenging operating environment and reduced capital equipment spending worldwide, I am pleased with the resilience of our financial model and the company's ability to improve margins and to continue to generate ample cash flow from operations to support current and future investments. FX headwinds also had a negative impact in the quarter. If exchange rates relative to the US dollar had been the same as one year ago, we would have expected revenue to be $6 million higher and gross profit to be $4 million higher. GAAP operating income was $56 million and operating margin was 18.5%. Net income was $55 million or $1.16 per diluted share. The effective tax rate in the quarter was 19% and benefited from certain discrete items. Foreign currency transaction gains related to re-measuring foreign currency assets and liabilities to period end exchange rates had a small positive impact on operating income of $400,000 or one cent per share. I'd like to remind you that last year's results benefited from $22 million, or $0.32 per diluted share gain, on the sale of the telecom transmission business. Excluding the currency transaction gain, asset impairment, and recovery of a restructuring charge related to our Russian operations, as well as the gain on the sale of telecom business last year, operating expenses were nearly unchanged year over year. Sequentially operating expenses increased primarily in research and developments in sales and marketing as we invested in resources to drive future growth while still controlling expenses. Moving to slide five, sales of high-power CW lasers decreased 22% and represented approximately 40% of total revenue. Sales of ultra-high-power lasers above 6 kilowatts represented 46% of total high-power CW laser sales. The decline in revenue was primarily due to lower demand in flat sheet cutting applications in China and Europe. We continue to see customers outside of China adopting laser technology, but demand has been impacted by the economic uncertainty with OEMs delaying purchasing and reducing inventories. Pulse laser sales decreased 25% year-over-year due to lower sales in marking and solar cell applications. System sales increased 4% year-over-year, with growth in light weld offsetting a decline in non-laser systems. Medium power laser sales increased 1%, driven by increased demand in welding and higher sales in 3D printing applications. QCW laser sales were down 4% year-over-year, and other product sales decreased due to lower revenue in advanced and telecom applications. Looking at our performance by region on slide six, revenue in North America decreased 13%. We saw a strong growth in welding and cleaning applications, as well as higher parts and service sales. However, this growth was more than offset by lower sales in cutting, medical, advanced, and telecom applications. In Europe, sales increased 3%, and the region continued to perform well given weak the weak macroeconomic environment. Revenue growth was driven by welding and semiconductor applications. Revenue declined in cutting, marking, and cleaning applications, which were impacted by lower industrial demand and destocking by some OEM customers. Revenue in China decreased 28% year over year as demand declined across most industrial applications, including cutting, welding, and marking. Additionally, revenue was negatively impacted by competition in the flat sheet cutting market and lower demand in e-mobility applications due to a decline in new battery projects and delayed capacity expansions. Moving to a summary of our balance sheet and cash flow on slide seven, we ended the quarter with cash, cash equivalents, and short-term investments of $1.1 billion and no debt. Our inventories continue to decrease sequentially, and we target further reductions in inventories in the fourth quarter. Cash provided by operations was $86 million, and capital expenditures were $26 million during the quarter. We sold two buildings in the quarter, realizing $29 million in proceeds, which means net capital expenditures are just under $55 million year-to-date. well below the same period last year. While maintaining a strong balance sheet, we have been returning a significant amount of capital to shareholders through opportunistic share repurchases. We spent $46 million on share repurchases in the third quarter and approximately $160 million this year. Moving to our outlook on slide nine, third quarter book to build was below one with macroeconomic uncertainty resulting in project delays and reduced orders in all major manufacturing regions. Leading manufacturing indicators in Europe are trending to the lowest level since the 2008 recession. While economic indicators in China are mixed, we believe the Chinese cutting market is down 20% to 30%, and the timing of an overall recovery in demand remains uncertain despite some government stimulus. Competition from Chinese manufacturers remains stiff. Additionally, project delays related to battery capacity expansion in China provide further uncertainty to the outlook. Although we have limited visibility into orders beyond the fourth quarter, we continue to believe the battery investment in China should restart in 2024 as electric vehicle sales continue to increase. Investment in battery capacity outside of China is in the early stages and should increase in the next several years as well. We also expect some benefits from government spending and onshoring activities to benefit industrial activity in the US. For the fourth quarter of 2023, we expect revenue of $270 million to $300 million. The fourth quarter gross margin estimate is between 41% and 43%. We anticipate delivering earnings per diluted share in the range of $0.80 to $1.10, with approximately 47 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'll be happy to take your questions.
spk02: 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. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Ruben Roy with Stifel. Please proceed with your question.
spk07: Thank you. Dr. Shcherbakov, thanks for the comments. I wanted to start on China, and Tim just mentioned that at this point it sounds like there's a lot less visibility. I wanted to make sure I was understanding that commentary right, because Tim said that, you know, potentially battery investment should restart in 2024. I think 90 days ago, you know, the tone of your call and your commentary was a little more positive in terms of when you thought we would get a catch up on some investment for batteries in China, and it sounds like that's probably weakened from 90 days ago, and there's a lot less certainty. So maybe if you could just walk us through how you're thinking about that, maybe for the first half of 2024 to start, that would be helpful.
spk04: Thank you for your questions. But you know, during this 90 days, I have the ability to visit China and discuss with our potential and existing customers. for many applications. And, of course, our main questions about this immobility application. And total opinion that definitely now battery manufacturing production is saturated, temporarily, it's clear. And forecast, of course, it's not 100% forecast, but Forecast preliminary forecast that it will be also a little bit low in the first half of the year, next year, and will increase in the second half. Of course, it will strongly depend on the environment conditions, what kind of political situations and so on. But in total, definitely, it's not so optimistic about the today activity for EV applications in China.
spk07: OK. Well, that's helpful. Thank you. And then, Tim, I think you mentioned the cutting market was down 20% to 30% in aggregate. I think your cutting exposure in China is a lot lower than that. I just wanted to make sure I had that right. And if you can give us an actual number, that would be helpful.
spk06: So we talk about 20% to 30% as the overall decline in the total Chinese cutting market, right? And I think that's shown in some of the numbers that have been reported by other Chinese public companies who had a weak Q3. Our China flat sheet cutting sales are still well below 10% of our total consolidated sales. This quarter, having seen that relatively stable in Q1 and Q2, it was a little bit down in Q3. But really, the weaker performance in China On a year-over-year basis, it's still showing up on the cutting side. But really, some of the EV demand had softened as reflected in our original guidance and didn't really strengthen during the quarter at all. So tonally, I'd say that kind of covers it.
spk07: Yeah, absolutely. And if I could sneak in a last question here, it's great to see the gross margins holding up in lieu of the lower revenue run rate and even with the guidance. And, you know, some of the inputs there, Tim, that you talked about, you know, didn't have too much to do, I don't think, yet with getting some of the factory utilizations and the new factories and the expanded factory in Germany up. Maybe you could just walk us through, you know, maybe medium-term gross margin thinking from here as revenues rise. potentially start to recover next year.
spk06: Yeah, I think, I mean, I've used a little bit of a weaker gross margin in terms of my guidance number. I put 41 to 43%. That's primarily because we're still trying to get inventory down in Q4, so your total absorption may be a little bit lighter in addition to that. I'm being a little bit more conservative on inventory provisions coming into the end of the quarter, but not meaningfully so, right? The top of that range is one and a bit percent below Q3. I think Q3, though, is evidence that the trajectory and ability to get back above 45% and into that 45 to 50% range is coming closer, and particularly if you see a recovery in revenue from the levels they're at. So we've actually achieved two quarters of sequential improvement on gross margin, interestingly, on lower revenue each time. So we are seeing some of the The yield and total volume of product produced in Poland, for example, has increased over the third quarter. Their costs have started to come down. They're still not quite at the target price we want them to be of a fiber block, but they're certainly making a meaningful contribution. So that would be some of the improvement. You know, Italy's done very well in getting their total manufacturing and their costs to an initial level that we wanted them to do so. But there's other work going on at the moment on product cost, initiatives to take significant cost out of some of the higher power lasers in the next six months or so, new generations of diodes. But other stuff, you know, the mix in terms of, yeah, it was weaker in terms of total revenue, but some of the mix related to the medical applications, welding being a good share of total revenue, We had a strong quarter in Korea and Japan where pricing is a lot more resilient. That can help with margins as well. So there's a lot of things that go in there. But I think what this really shows is that you can get back into that higher than 45% gross margin that we haven't walked away from yet.
spk07: Thanks for all that detail, Tim. That's all I had.
spk02: Our next question comes from James with Needham and Company. Please proceed with your question.
spk03: Hi, good morning. Thanks. I would like to follow up a little bit more about what you're seeing in the 3D printing space. It's an area you guys have been talking about more positively over the past year. And I'm wondering, is the demand you're seeing, is this mainly coming from the hardware vendors in China? And are these primarily for consumer electronics applications? At least that's what we seem to be hearing about more.
spk06: So there is, Jim, there's good demand coming out of the hardware vendors in China. The European additive had been fairly good through the first couple of quarters. I think it was sort of flattish in Q3. Nobody has any visibility into any of the consumer electronic stuff at the moment. So a lot of the stuff in China is still aerospace. Dr. Shcherbakov, on his visit, actually saw a very large system with, I think he said, 50 lasers in it.
spk04: Yes, 50 lasers simultaneously used for growing very large parts from metal.
spk06: So we don't have any visibility into the consumer electronics potential demand. I don't think anybody has yet.
spk03: And, you know, a while back, Kim, I have to find it somewhere in my notes, but you guys did size the 3D printing business. And I'm wondering, you know, where are you in relation to where it was at the peak a few years ago when you were seeing quite a bit of activity, at least encouraging activity early on?
spk04: Definitely some years ago it was some peak activity in the 3D printing or manufacturing. But in this time it was definitely overestimated, this market. And then it was, of course, went down. And now I think it's a much more realistic estimation of such kind of technology for future industrial laser applications. And from this point of view, of course, RPG has a very strong position. Why? Because for such kind of applications, the customer has to use a very stable laser. What is stable means? For some parts, they have to use laser more than one month under continuous operations. And it must be absolutely stable, not only this power, but also beam distribution. This is why. because our product is very high quality. Up to now, we have a very strong position also for Chinese market. And especially when we introduce a new AM laser with adjustable mode, adjustable power, and much more stable. And in this case, our customer had opportunity to increase productivity of such kind of technology. But it's very important. Very important. This is why they're using up to 50 simultaneously working lasers. And they couldn't improve, they couldn't only increase power. It's not possible. They're using, as usual, they're using 500, 700 watts of maximum power in single mode regime. Because if you increase power to 1 kilowatt, you can evaporate this metal. It's not an optimal solution. Only optimal solution to use simultaneous and parallel main erasers, main stable high-quality erasers for this application.
spk03: Got it. Thank you for that, Dr. Sherbakov. And final question, and maybe, Tim, if I could just clarify. On the book to bill, was that similar in all your major regions, or Did it vary a bit in certain regions being a little bit weaker, obviously a little stronger? And then the follow-up is just on the emerging business. Excluding e-mobility, are you seeing the sustainability in the medical, which picked up, and clearly on 3D printing, you're getting some momentum, and just in general, how we should think about emerging going forward? Thanks.
spk05: Yeah, I mean, I think to build
spk06: qualitatively was probably, I'm not saying it's massively weaker, but it was, you know, Europe has got some challenges around it. The cutting business was performing actually very well at the beginning of the year. That certainly softened, even though Europe through Q3 in terms of revenue was quite reasonable. I'd say their bookings have slowed down. China's been a struggle. I'm not sure whether I believe that their PMIs have been at 50%. You know, some of the more positive stuff was in, again, in Japan. Korea actually had very good bookings. Some of that was actually a very large order for some medical aesthetic product. North America, I'd say, it's not got a huge amount of traction behind it, but it's probably a bit stronger than Europe is at the moment in terms of, as expected, right, the North American economy. continues to outperform Europe. Yeah, so qualitatively, that would be my feedback on that. On some of the emerging growth product, I think you highlighted a couple of things, like the medical has rebounded as we said it would do. Light weld in total was up, so that was positive, particularly with some of the rollout on a more global basis. And we continue to work on new versions of light weld and actually looking to expand the distribution network that we've got for that product, take cost out of the product as well, add feature sets to it. Some of the semiconductor advanced applications also performed well. Some of that revenue is in Europe. Within high power pulse, Some of the EV stuff was weaker, but cleaning was actually stronger. Cleaning grew quite well there. So even, you know, the emerging growth products didn't perform particularly well. They were still above 40% of revenue, and there were still some nice product lines within that that performed pretty well. I think I got them all there. That was positive. Okay. Thank you.
spk03: I appreciate it.
spk02: As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. One moment while we poll for questions. Our next question comes from Michael Fenninger with Bank of America. Please proceed with your question.
spk08: Hey, guys. Thanks for taking my questions. Tim, the inventory side, you made some nice improvement. You took out sequentially, and I think you talked about you're really focusing in the fourth quarter on that. Do you think you'll stop and take some out in early 2024 if we stay at this demand level, or do you think you'll be able to get most of that done by the fourth quarter? I'm curious how you're kind of thinking about that.
spk06: No, I mean, this is going to continue to take several quarters to get it down to the level that we'd like to see it at, right? We're still in terms of days running at a high level given the level of activity. So we're going to continue working on it in Q4. It's going to take several quarters, though, to continue to bring that down to the level we want it to be at. Some of that will come from, you know, there's a lot of purchase components in inventory related to electronic parts. And those purchases have certainly started to slow down. There were commitments made when that supply chain was extremely tight. And as you run down that inventory, It's not as though that's an internally produced part. So running down electronic components that are purchased from a third party as you consume them wouldn't lead to like an immediate impact on absorption as you get that under control because it's a third party purchase rather than internally produced component. But yeah, inventory is going to, it's a work in progress. Several quarters to continue to do it. I'm pleased with the way we've, so far managed to at least stabilize it and get it moving in the right direction.
spk08: Made sense, Tim. And just, I know there's a lot of focus on, on the EV build out capacity in China. Just curious on the U S side, how exposed you are to there already, just cause there are some headlines we're seeing, and I'm sure you've seen Tim about Ford pushing out around 12 billion of CapEx right now, GM with a plant Tesla. There seems like there's just a little bit of a pause going on right now based on some EV demand in the US. It could also just be with strikes that were happening there. So just curious what you're seeing there, how critical that is to you now, and if you're seeing that more of a pause rather than anything more indicative going forward. Thank you.
spk06: Our view is that there is a bit of a pause, right? You've seen several announcements that have come even in the last couple of weeks. But if the transition towards electric vehicles is going to continue and reach a much more meaningful level, the total investments will have to pick up. I mean, our view is that if they're starting to have to start looking at capacity for 25 and 26, the second half of next year should see some improvement on that. You know, our exposure in North America, on some quarters, it can be quite high. You've got projects where we've delivered significant amount of welding and other equipment for EV. There's some revenue for EV in North America in Q4 guidance, but it's not. I mean, our business in North America isn't totally dependent upon EV, but it clearly was a meaningful driver for us, and we do need a rebound in that EV investment to happen, and hopefully that will happen in 2024 with a view to capacity that's needed in 25, 26.
spk04: And for America, EV applications for us is interesting because it's not only requirements on not only for lasers or some components. We also start to supply to our customers a complete system. For example, for cleaning applications, one of the biggest EV manufacturers that start to use our cleaning applications was a new product. So they received two, and in pipeline state, There's some additional orders for this. For us, it's very important to demonstrate our new technologies.
spk06: Sorry, Mike. The other thing is that we are expanding the application, so the drying, the first meaningful amount of drying revenue will come in Q4. The overall feedback from the market on that is very important, not just for EV, by the way. It costs a whole bunch of different applications where that laser can be used on drying, whether it's for coatings or even more esoteric areas. And then we're looking at some other cutting applications within battery as well that are more specialized. So the application set is continuing to expand, and customers are working with us on different applications as well.
spk08: That's helpful, Collar. I guess maybe following up on that, Tim, with expanding the application set – it seems like you guys are making progress on the gross margin given some of the changes in production. I'm curious though, if you got big picture, if you think maybe taking the margin range down, would that unlock more growth in some ways, since that was kind of a lever, at least on the pricing side, uh, historically, just curious how you kind of think about that too, would that reinvigorate or be a catalyst to drive higher growth if, if, if you made that type of shift.
spk06: I think the overall pricing of lasers and integrated beam delivery systems drives a huge amount of productivity benefit for the end customers, right? In a lot of these, even on the EV side, when you combine it with LDD and even non-EV applications, the welding is really driving significant returns on investment We highlighted, for example, on light-welded, you know, compared to mingle tickets, four times faster. So I don't think, you know, the issue on the pricing is if you're going to try and compete with the Chinese, it's not like a 10% price reduction. It's, you know, magnitudes greater than that. And the cost of lasers overall has come down very dramatically over the last three to four years. So we don't think This isn't really a pricing issue. The value proposition of the technology overall continues to be very significant. Having said that, we are looking at taking a lot of cost out of some of the higher power lasers, and we will be able to be a bit more aggressive around pricing whilst actually increasing margin if we achieve those cost decreases over the next couple of quarters as well.
spk04: This is very important. Of course, we are following this cost initiatives, cost reduction initiatives. It's very important. But also, very important that we start to introduce a new technological platform for the standard, I mean, not standard, but new lasers for welding, cutting, other applications. It will be a significant cost reduction in manufacturing of such kind of lasers. And we will introduce the next two, three quarters to the market.
spk05: Thank you.
spk02: Our next question comes from Mark Miller with the Benchmark Company. Please proceed with your question.
spk00: Just wondering what drove the sequential improvement in other sales?
spk06: Rebound in the medical business and then some of the other advanced applications around semiconductor were quite strong. Those would probably be the two main drivers, Mark.
spk00: Okay. Emerging products. Green lasers continue to do well there. What else is doing well in terms of products?
spk06: Sorry, in which products?
spk00: Emerging products. Green lasers are still strong there.
spk06: Actually, green was a little bit weaker this quarter, but we're working on a whole bunch of new projects for green, so hopefully see a recovery. The strong performance on emerging was, again, the medical... Some of the advanced applications, light weld performed well. Within high power pulse, cleaning did very well. Welding in general was strong, even though it was a bit weaker quarter on welding.
spk05: Thank you.
spk02: We have reached the end of the question and answer session. I'd now like to turn the call back over to Eugene Federoff for closing comments.
spk01: Thank you for joining us this morning and for your continued interest in IPG. We will be participating in a number of investor events this quarter and are looking forward to speaking with you again soon. Have a great day, everyone.
spk02: This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.
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