IPG Photonics Q2 2023 Earnings Call Transcript

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August 1, 2023

There are 8 speakers on the call.

Operator

Morning, and welcome to IPG Photonics Second 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, Mr. Eugene Fedorov, IPG's Senior Director, Investor Relations for introductions. Please go ahead, sir.

Speaker 1

Thank you, Rob, and good morning, everyone. With me today is IPG Photonics' CEO, Doctor. Eugene Cherbakov And Senior Vice President and CFO, Tim Mahmet. Let me remind you that statements made during the course of this call As discussed, management's or the company's intentions, expectations or predictions of the future are forward looking statements. These forward looking statements are subject to risks and uncertainties that could cause the company's actual results to differ materially from those projected in such forward looking statements.

Speaker 1

These risks and uncertainties are detailed in IPG's Photonics Form 10 ks for the period ended December 31, at 2022 and other reports on file with the Securities and Exchange Commission. Copies of these filings may be updated 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, August 1, 2023 only, 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 the earnings press release, earnings call presentation and the financial data workbook posted on the Investor Relations site.

Speaker 1

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 Shebakov.

Speaker 2

Good morning, everyone. I am pleased with our performance this quarter. 2nd quarter revenue came And it is the point of our guidance range. Despite of increased microeconomic uncertainty, which resulted in project delays and impacted sales And outlook in industrial markets across many geographies. We reported another quarter of solid revenue growth in Welding And cleaning applications that were driven by strong sales in eMobility and handheld welding solutions.

Speaker 2

Additionally, revenue improved in 3 d printing and solar cell manufacturing applications as investment in this market increased. Sales in flat sheet cutting applications declined year over year, mostly due to economic uncertainty and increased competition in China and continuing to negatively impact in our results. However, cutting sales were up sequentially in China, North America and Japan. Emerging Growth product accounted for 41% of our total sales in the second quarter. We saw continued growth in A and B lasers, light weld, green and ultrafast lasers as well as the beam delivery.

Speaker 2

But sales declined in medical and advanced applications as well as in laser based system and high power pulsed lasers. We have shipped our first 50 kilowatt AMB laser during the quarter and continue to invest into international sales platforms for LightWealth. As we said on our Q1 conference call, our Medical business was impacted by A large customer working through the inventory. If you use sales in the second quarter, We expect medical sales to return to a more normal level in the Q3 and continue to focus on additional growth opportunities in the medical market. Despite of challenging operating environment, the positive results were And reducing our exposure to low margin and high competitive business.

Speaker 2

We have been focusing on products and applications, which benefits from global investment in e mobility and renewable energy, And this strategy is yielding the good results. IPG had another quarter with a strong sales in e mobility applications, driven by an increase in sales to geographies outside China, primarily in North America, Europe and South Korea. EV related investment in China slowed during the quarter, particularly into traditional prismatic cell batteries. But We are seeing the increased investment into new technologies such as large cylindrical cells and also more investment in Batteries for Storage Applications. Our team is working on new business opportunity in fall cutting applications And Electrical Motor Assembly.

Speaker 2

With continued adoption of on electric vehicles And growth in energy storage globally, demand for batteries should quickly catch up with recent capacity additions And we expect investment in battery manufacturing in China to be stronger next year. Meanwhile, We are seeing the increased investment in EV battery capacity outside of China and expect immobility orders to remain strong in the 3rd Our welded cells are benefiting from growth in innovative applications where our complete solution, which include AMD lasers and welding heads combined with our real time weld monitoring and measuring technology, which has become the industrial standard. LDD's real time measurement can significantly reduce testing time, Scrapcast and failed parts for the customer, making a very strong value proposition An exceptional return on investment, given the yield and cost benefits. LGV also getting great acceptance in outside of batteries, where the final cost of defect can be very high and lead to significant recalls. We are proud to deliver multiple solutions, which can significantly reduce the environmental impact for our Customers, including our high efficiency echo lasers with industrial leading wall plug efficiency over the 50%, Environment Friendly Cleaning Solutions and High Efficiency Laser Diabrhyme and Heating System.

Speaker 2

During the quarter, we continued to see strong results in our laser cleaning solutions in e mobility And other automotive and non automotive applications. Laser cleaning provide substantially benefits to reducing the use of abrasives, Chemicals and Dry Ice Cleaning. Unlike chemicals, abrasive and heat treatment cleaning process, laser cleaning doesn't impact The materials that has been cleaned does not leave toxic waste and also create a safer and cleaner environment for employers. It can be also significantly reduced water consumption. And we are seeing is increasing interest in our laser clean solution for a number of different processes And applications including the paint and corrosion removal.

Speaker 2

Another recently introduced laser solution which is replacing the less efficient Infrared bubbles for the drying and heating is gaining interest and we have booked our first order for EV battery applications, which will be shipped in the Q3. The dryer solution are well received by customers and are gaining market Acceptance because they significantly cut down energy consumption and reduce the environment impact on legacy processes. And today, I am happy to announce that the Board of Directors has elected Colin Kennedy is a new Director of the company. I'm looking forward to working with Colin and believe She will be a great contributor to IPG's strategy, particularly with our growth in medical applications, Given her 25 years of experience in the medical system manufacturing industry, I would like to thank our employees Well, there is a strong contribution in the quarter. And we will now turn the call over to Tim to discuss financial highlights.

Speaker 3

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 4. Revenue in the second quarter was $340,000,000 A decline of 10% year over year, partially due to foreign currency headwinds, which accounted for approximately 2% of the decrease And the telecom divestiture that reduced revenue by approximately 1%. Revenue from materials processing applications decreased 8% year over year, while revenue from other applications decreased 23%.

Speaker 3

GAAP gross margin was 43.4%, a decrease of 2 30 basis points year over year due to higher cost of Products sold and charges for scrap, which were partially offset by lower inventory reserves, 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 as we focused on reducing costs and improving manufacturing efficiency. We also benefited from slightly lower inventory provisions and shipping costs. As mentioned before, FX headwinds also had a negative impact in the quarter. If exchange rates relative to the U.

Speaker 3

S. Dollar had been the same as 1 year ago, We would have expected revenue to be $9,000,000 higher and gross profit to be $5,000,000 higher. GAAP operating income was $72,000,000 and operating margin was 21.2%. Net income was $62,000,000 or $1.31 per diluted share. The effective tax rate in the quarter Was 24% and was benefited by certain discrete items.

Speaker 3

Foreign currency transaction expense Related to remeasuring foreign currency assets and liabilities to period end exchange rates had a negative impact on operating income of $1,000,000 But net of a tax benefit had no material impact on earnings per share. Excluding the currency transaction loss Under restructuring charge, operating expenses declined year over year, primarily in research and development And general administrative categories as we reduce spending on telecom product developments, implement a tighter cost controls and reduced expenses. Moving to Slide 5. Sales of high power CW lasers decreased 10% and represented approximately 43% of total revenue. Sales of ultra high power lasers above 6 kilowatt Represented 50% of total high power CW laser sales with customers outside of China moving to higher powers.

Speaker 3

The decline in revenue was primarily due to lower demand in flat sheet cutting applications as a result of softer demand and competition in China. Pulse laser sales decreased 24% year over year as strong growth in cleaning And solar cell applications was offset by lower demand in foil cutting and marking applications. System sales declined 1% year over year with growth in Lightwell offset by a decline in other laser and non laser systems. Medium power laser sales increased 18%, driven by increased demand in welding and 3 d printing applications, While QCW laser sales were down 2% year over year, other product sales decreased due to lower revenue in medical and advanced applications. Looking at our performance by region on Slide 6.

Speaker 3

Revenue in North America decreased by 11% with strong growth in welding and cleaning applications, offset by lower sales in advanced and medical applications, lower cutting revenue and the divestiture of the telecom business. In Europe, sales increased 4% driven by growth in welding and cleaning applications despite overall uncertainty in the economy. At the recent laser show in Europe, the tone of our business was muted with most customers expecting a slowdown in the second half of twenty twenty three. Revenue in China decreased 28% year over year as demand declined across most markets and applications compared to the prior year with the exception of cleaning and 3 d printing. Moving to a summary of our balance sheet and cash flow on Slide 7.

Speaker 3

We ended the quarter with cash, cash equivalents and short term investments of $1,100,000,000 and repaid $16,000,000 of debt in the quarter. Cash provided by operations was $67,000,000 And capital expenditures were $26,000,000 during the quarter. We now expect capital expenditures to be between $130,000,000 $140,000,000 this year. Our inventories decreased slightly, and we continue to target further reduction in inventories during the second half of the year. While maintaining a strong balance sheet, we have been returning a significant amount of capital to shareholders over the last year and in the Q1.

Speaker 3

We did not repurchase shares in the Q2. As previously reported, the Board announced a new $200,000,000 share repurchase authorization in May, And we have a new 10b18 repurchase plan in place. We intend to repurchase opportunistically. Moving to our outlook on Slide 9. 2nd quarter book to bill was below 1.

Speaker 3

We continue to see uncertain macroeconomic condition and soft orders in all major manufacturing regions. Leading indicators in North America and Europe point to contraction in the industrial markets, while the timing of demand recovery in China remains uncertain. However, despite the weaker business conditions overall, the e mobility sector was not affected in Europe and North America, And we're still seeing solid activity in orders in eMobility for the Q3. Furthermore, we expect to see normalizing demand in medical And Advanced Applications as well as the Systems business, which should help to offset headwinds in the rest of the business. For the Q3 of 2023, IPG expects revenue of $300,000,000 to $330,000,000 Company expects Q3 gross margin to be between 40% 42%.

Speaker 3

IPG anticipates delivering earnings per diluted share in the range of $0.85 to $1.15 with approximately 47,500,000 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, Assume 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.

Operator

Thank you. At this time, we'll be conducting a question and answer Our first question comes from Reuben Roy with Stifel. Please proceed with your question.

Speaker 4

Thank you. Good morning all. Tim, I wanted to drill in a little bit further into the commentary around cutting. Demand then competition in China, but can you remind us where kind of as a percentage of revenues in China cutting And was the comment on competition in China broader, meaning that did it encompass EV as well?

Speaker 3

No. The comment on competition in China is really around the cutting market and Not around the EV market, we continue to have a very strong presence on foil cutting, cleaning and welding applications globally. Globally. Cutting within China is certainly a much smaller share of the total sales there now. We had said at the end of last quarter that it was less than 10% of consolidated sales and it remains quite well below that level, the high power cutting Business in China.

Speaker 3

It was pretty stable from Q1 to Q2, but certainly didn't perform well.

Speaker 4

I appreciate that. And as a follow-up, Tim, can we talk a little bit about gross margin and some of the puts and takes? Good quarter here. Obviously, we're going into a little bit of a lower revenue environment in Q3. So thinking through sort of the rest of the year, you've got Potentially some improving productivity coming up in the new factory in Poland and potentially New Hampshire.

Speaker 4

How are you thinking about Gross margin playing out through the rest of the year?

Speaker 3

We were actually very pleased with The sequential improvement in gross margin following the sequential improvement in Q1, so getting back up To a more reasonable level, certainly below our longer term target level still. In Q3, really, the difference is Just on lower revenue levels, the absorption of manufacturing costs will be lower. So going through the remainder of the year, it will really depend upon Where the tone of the business ends up and into next year, hopefully, with an improving outlook, we'd expect to see Gross margins pick up again, but it really is just on the fixed cost base. You start to see some under absorption at the guidance level we're at in Q3.

Speaker 1

Got it. Thank you, Tim.

Operator

Our next question comes from James Ricchiuti with Needham and Please proceed with your question.

Speaker 5

Thank you. Good morning. So it sounds like you're seeing you've seen some Softening in the EV related business in China, I'm wondering if you could talk more broadly about What you're seeing in the market outside of China? And Tim, maybe you can help size this EV Business in Q2, how it's fared just versus Q1 and to the Ken, what that represents of that EV business, how much is battery welding right now?

Speaker 3

Yes. So the soft we are seeing some softness in the demand cycle in China really related to the capacity additions that have already been Built out there. You also started to see a transition for the cylindrical battery investment. We think that's actually going to be a big driver next year As capacity utilization picks up, in the rest of the world, the demand cycle for EV has actually been Pretty robust and strong. I'd say it's strongest in North America and then followed by Europe.

Speaker 3

There's good demand out of South Korea and even in Japan as well, it's still dominated by battery applications. We're diversifying the battery applications again. We've got the first orders for the drying equipment. We're starting to see some demand for additional foil cutting applications. There are some Cleaning applications on some of the main body in mainly in North America that's coming from And there are some complete systems we're selling into that.

Speaker 3

I'd still say though it's still very much battery driven. Motor manufacturing It's still a sort of ancillary application in that area.

Speaker 5

In this reference, roughly, What is your

Speaker 3

Sorry, yes. So it's still well above 20% of sales in Q2.

Speaker 2

Okay. And also We'll see in Europe trend to achieve this production, shift production or better it The final production of cars and you see it definitely for a few, our customers in Europe and also in the United States.

Speaker 5

Got it. And my follow-up question is on the bookings trends. You mentioned book to bill below 1, and I'm wondering if you could If you could provide any more granularity on that and how it may be varying by region and including what you're seeing perhaps in consumer electronics market, which I don't think you mentioned at all in your prepared text?

Speaker 3

Yes. We said that it was softer across All of our major industrial geographies, that would be Europe, U. S. And China. We actually had some Pretty positive order flow out of Japan, which is holding up quite well.

Speaker 3

And South Korea also performed Pretty well too. That's sort of the it's sort of married up to what you're seeing on some of the PMI Data out there. Sorry, Jim, what was the second part of your question?

Speaker 5

Well, just on some of the end markets, mean, I assume that the legacy automotive is slower. I didn't hear any comments about Some of the other end markets, including consumer electronics, which in the past, you've seen some seasonality in terms of orders. What does that market look like for you?

Speaker 3

Yes. I mean that would be reflected mostly in the QCW sales, which were down slightly year over year. So there's no great traction in consumer electronics. The other And in consumer electronics. The other positive areas on applications were really cleaning and then Additive manufacturing was actually cleaning was very strong globally.

Speaker 3

Additive manufacturing was okay in Europe and was actually very strong In China, with a couple of the OEMs that we work very closely with there and additive there, we have been qualified because of the Quality and the reliability of the lasers.

Speaker 2

And cleaning applications for us is very important because we are shipping not only a pulsed laser or CW laser for Such kind of applications, but final systems for cleaning. Thank you.

Operator

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

Speaker 6

Thanks guys for fitting me in. The inventory came down 3% quarter over quarter. I know that's been a target of you guys to make improvements there. With book to bill less than one times and some of these PMIs low, I'm just curious to how you're thinking about inventories in the back half. Do we need to take out more?

Speaker 6

Are you trying to position to get to a certain level to get to position yourself for 2024? Any way to kind of think about that in the back half?

Speaker 3

Yes. We continue to be very focused on managing inventory, and We're not seeing some of the same supply chain issues that we had experienced for the last couple of years. So we continue to Target bringing inventory down during the second half of the year and generating cash out of that. In the medium term, let's say, we want to get down to less 200 days inventory on hand and ultimately get back to a more normalized inventory level, which would be Somewhere around 180 days, but that may take a bit longer to get to. But yes, we're definitely looking to Take some additional cash out of inventory and are pleased with the progress that we've made to date this year.

Speaker 3

And certainly, it's a significant change as compared to the investment in inventory we felt that was necessary last year.

Speaker 6

Great. And Tim, just following up on the question around the production footprint, it sounds like What's weighing on the gross margin among other things is the under absorption that you kind of talked about the volumes. Are you still confident with the change with Poland and raising production in the U. S. That with your cost base, as we think about those gross margin targets, maybe not for obviously Q3 or Q4, just maybe longer term.

Speaker 2

Definitely, it's our goal to optimize our cost, first of all, for production of some of components like fiber blocks and others for our lasers. And of course, we are working hard this way. By the way, in Poland, we will increase our production Dramatically and we will increase further to the end of this quarter. The same situation in Italy. We also increased our production for these components and also in Germany.

Speaker 2

And every time we have of course, it's under our control to the cost These components because it's influenced finally, you know exactly our gross margin. Situation in the United States much more Rather because it's expensive country, but nevertheless, we are looking forward to make final optimization our cost, First of all, for fiber components production.

Speaker 6

Great. Thanks for that. And then just On Europe, Europe, we're hearing from other industrial companies that kind of flagging a weakening in Germany and The last month or so, your growth was pretty resilient, even up a little bit in Germany. Just curious what you're kind of seeing there With the underlying demand versus your ability to offset that it looks like in some areas.

Speaker 3

Yes. I mean, certainly, during the quarter, Europe was performed pretty reasonably and particularly compared to a year ago. The weaker guidance reflects some of the softness that other people are seeing. For us, that's translating into Q3. There are positives and negatives, right?

Speaker 3

Some of the industrial OEM business is a bit weaker, where some of the welding applications Have held up quite well and things like cleaning are also performing well in Europe. But yes, I mean, the PMIs in Europe are 43, they're some of the weakest they've been for quite a long time. And I think that the German economy is quite weak at the moment. So we'll have to see how long it takes for that to turn around.

Speaker 2

Thank you.

Operator

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

Speaker 7

Thank you for the questions. You mentioned there was a large customer inventory adjustment in the U. S. Could you give a little more color what type of industry was that from?

Speaker 3

Yes. Mark, obviously, medical applications, which we'd called out on Q1, would be weaker in the Q2, and now we're expecting a Recovery and medical application sales in Q3, the customers worked through their inventory adjustment that they Signal to us would happen in the Q2.

Speaker 7

Any opportunities such as in the consumer electronics area Related to AI you see coming up?

Speaker 3

I mean there's some announcements out there that there's one of the major smartphone manufacturers is going to be using more additive manufacturing In their processes, that would be an opportunity for us given The strength that we have within the additive manufacturing processes around the world, I think, I mean, that would be one of the more significant This is being talked about. As you mentioned, the consumer electronics investment cycle overall with QCW lasers and even pulse lasers being Relatively, anemic is not strong outside of that right now.

Speaker 7

Thank you.

Operator

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

Speaker 1

Thanks for joining Thank you this morning and for your continued interest in IPG. We will participate in a number of investor events this Order and are looking forward to speaking with you over the coming weeks. Have a great day everyone.

Operator

This concludes today's conference. You may disconnect your lines at this time and we thank you

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