IPG Photonics Corp (IPGP) 2021 Q3 法說會逐字稿

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

Thank you, Rob, and good morning, everyone. With us today is IPG Photonics' Chief Executive Officer, Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen. Statements made during the course of this call that discuss management's or the company's intentions, expectations or predictions of the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause the company's actual results to differ materially from those projected in such forward-looking statements.

These risks and uncertainties include the impact of COVID-19 pandemic on our business and those detailed in IPG Photonics' Form 10-K for the period ended December 31, 2020, and our reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors section of IPG's website or by contacting the company directly. You may also find copies on the SEC's website. Any forward-looking statements made on this call are the company's expectations or predictions as of today, November 2. 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 Scherbakov.

Thank you, Eugene, and good morning, everyone. We are deeply saddened by the passing of Valentin Gapontsev, the founder and Executive Chairman of IPG. This is a tremendous loss for our company and the broader photonics community, which benefited greatly from his technical innovations and strategic vision. Because of his vision and relentless work, fibre lasers have become cost-effective, reliable and effective tools that have mass applications in global industrial production, enabling automation, efficiency and development of new products. He was recognized as the 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 markets and applications where fibre lasers can replace existing laser and non-laser technologies by improving efficiency, productivity or enabling technological breakthroughs for our customers. Our technologies are playing well in those major macro trends that include investments in electrical vehicles and renewable energy as well as focus on energy efficiency, industrial automation and miniaturization, which are transforming the way products are created. As a part of our strategy, we have been diversifying away from the highly competitive and more cyclical cutting market in China, and our results this quarter demonstrated successful execution of this strategy.

We are pleased to deliver third quarter revenue and EPS at the top end of our guidance. Results were driven by strong growth in welding, marking, 3D printing and as well as cleaning, semiconductor and a number of other new products and applications.

Demand for IPG lasers continued to improve in North America and Europe, with both welding and cutting applications showing solid growth. We are also seeing increased orders and business activity in Japan. These geographies continues to recover from the pandemic and saw increased investment in new factories and automation.

We are benefiting from widespread investments in electric vehicles production globally. Our lasers are used in a variety of welding, foil cutting and cleaning applications for EV battery manufacturing. We are also seeing opportunities for laser-welding in EV motor assembly and body-in-white applications. These investments are likely to continue for the next 3 to 5 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 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 pulsed lasers. Both AMB and high-power pulsed 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 the new gold standard in the industry. We believe that our medical business will continue to grow significantly, potentially doubling in size over the next 2 to 3 years.

One of our newest product is handheld lasers, which was launched earlier this year, is winning widespread interest and gaining significant traction in the welding community. We launched our new and improved version of LightWELD in September. It also has cleaning capability in addition to many preset building parameters. Some customers may choose LightWELD just for this cleaning feature as it can save time, money and reduce costly consumables. LightWELD was the highlight of our presentation at FABTECH 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 LightWELD systems in the next 3 to 5 years.

As expected, we saw softer demand condition in China cutting market during the third quarter. The combination of a moderated demand environment driven by widespread supply chain issues, high shipping cost and power shortage as well as a more aggressive price competition from local manufacturers negatively impacted demand for cutting applications in China during this quarter. At the same time, we are seeing a record demand in welding in China as a result of strong sales in EV battery applications and increased revenue for marking and 3D printing. In several cases, we saw customers coming back to IPG after lower-cost local suppliers didn't meet customers' quality and technical support expectations.

We continue to benefit from our vertically integrated product model, which enables technological advantage while minimizing supply chain disruptions. However, we have been seeing some impact on our and our customers' operation from the ongoing supply chain issues worldwide, which we were able to successfully overcome this quarter.

As we announced earlier, the Board selected John Peeler as a non-executive chair. John has served as Lead Independent Director since 2017 and his appointment provides continuing stability as we have worked together well over the years. This appointment continues the separate CEO and Chair roles that started in May 2021, and I look forward to working with John in his new position.

With that, I will turn the call to Tim to discuss financial highlights in the quarter and fourth quarter outlook.

Thank you, Eugene, and good morning, everyone. My comments generally will follow the earnings call presentation, which is available on our website. I will start with the financial review on Slide 3.

Revenue in the 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 $0.04 per diluted share primarily related to the depreciation of the euro and Chinese yuan. Exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $9 million lower and gross profit to be $6 million lower.

Moving to Slide 4. Sales of high-power CW lasers decreased 4% year-over-year and represented approximately 47% of total revenue. Sales of ultra-high power lasers 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 from marking, engraving and drilling applications. Pulsed laser sales, including high-power pulsed 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 LightWELD sales. Other product sales increased 58% year-over-year, benefiting from higher sales in medical and beam delivery.

Examining our performance by region on Slide 5. Revenue in North America increased 55% year-over-year, driven by materials processing with growth in welding and increased sales of high-power lasers for cutting applications. We also saw record quarterly revenue in Medical as our products continue to gain acceptance. System sales improved in the 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 and cutting applications more than offset higher demand in welding applications, high-power pulsed lasers for foil cutting and growth in marking and additive applications.

Sales in Japan were up 11%, and revenue in the rest of Asia increased 15% year-over-year.

Moving to a summary of our balance sheet and cash flow on Slide 6. We ended the quarter with cash, cash equivalents and short-term investments of $1.5 billion and total debt of $35 million. Strong operational execution resulted in cash provided by operations of $102 million during the quarter. For our cash deployment, capital expenditures were $40 million in the 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, foil cutting and welding applications for EV battery production across many geographies as well as opportunities in solar cell manufacturing, medical procedures and advanced applications. We also see LightWELD sales continue to gain traction. However, sales in China will be down sequentially in the fourth quarter due to soft demand in cutting applications. Uncertainty due to supply chain issues and power outages that may impact demand for our products as well as ongoing competitive pressures.

For the 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.

(Operator Instructions) Our first question comes from Jim Ricchiuti with Needham & Company.

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

No, in Q3, Jim, excluding cutting, the rest of the business was very robust. And 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 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 are good.

But for cutting applications, also, we have to see the lower end applications, of course, it's some strong competition from Chinese. But for high end, we have a very good position in comparison to also Chinese competitors.

Got it. And the follow-up question I have is just with respect to LightWELD. 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 are you -- will you see the benefit of the expanded distribution channels. Will that hit in Q4? Or is that something that really begins to benefit you in early '22? I don't know if there'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 LightWELD?

Of course, we would like to get the great benefit from this quarter. But of course, it will take time because there are a lot of different opportunities or a lot of different customers already participated in this. And we have to sometimes train these customers to use it. And of course definite benefit will get the first quarter next year. But it's very important that we introduce new options for our LightWELD and we'll demonstrate in the end of this quarter and beginning the quarter first next year.

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?

Yes, about -- talking about catalysts, I don't think slightly. Of course, our rest of our business also will grow. And we optimistic about our prognosis and forecast for the next year, definitely.

Our next question comes from Nik Todorov with Longbow Research.

The gross margin is holding pretty well despite the softness in China cutting. So that's obviously a change from the prior cycles. Can you talk about the levers that are allowing you to maintain consistent gross margin despite the decline in China cutting. Are you seeing offsets from new products? Or are you staying more disciplined in pricing? What are the drivers of the Brazilian gross margin?

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 mix benefit from that. In addition, you've got a geographic mix benefit with some of the stronger sales in Europe and North America around both cutting and other applications, those are also a benefit. And then we've got sort of strong sales coming out of areas like medical and even some of the semiconductor applications. So we're exactly trending in the direction that we 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.

Yes. And also, we have continued to prolong our special project which was installed 2 years ago about optimization on the manufacturing cost for components for our devices, and this is for -- this trend also the next year, definitely.

Okay. 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.

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 LightWELD, growth in medical applications, high-power cutting market transitioning to much higher power levels globally as well as in China. We're going to start rolling out our ultra compact laser at higher power levels than 1 and 1.5 kilowatts. So transitioning during the course of the year, early on in the year to 3 and 6-kilowatt and then ultimately, probably in the second half of the year to 8-kilowatt with the ultracompact 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 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.

Definitely, I would like to add that some customers and also in China and outside of China, they start to talk about the ECO lasers. I mean, ECO lasers or IPG laser's efficiency more than 50%. Nobody would produce such panels lasers today.

And this also for us, it will be opportunity to provide very high power with such kind of high efficiency and we would also demonstrate this product this enter this quarter and also beginning in the next quarter. Already, we have some potential customers for this.

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

I want to be respectful on how I ask this question. There are a lot of investors wondering kind of what happens to Valentine, his trust and the voting shares as a significant shareholder in your 10-K filing, obviously, his ownership position excited at the material risk we saw yesterday, there were some 13 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 trust position at this point?

So Michael, there's no material change to the ownership and structure of the estate planning around Dr. Gapontsev ownership in IPGP was not only started but completed many years ago. There's no change in the trustees appointed to manage the trust and [thoughts of a] U.K. company. There's no major change there, as Dr. Scherbakov 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 -- it's a sort of a decade-long process that we started to look at this.

Fair enough, Tim, I guess on that, is -- I guess this might answer this next question, but given the circumstances, is there any change in strategic direction for IPG following all 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 if there's going to be any changes post this news on strategy in IPG going forward?

I think the first thing is if we were going to make a fundamental change or 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. Scherbakov took over as CEO at a high level and a broad level. The strategy was developed by Dr. Scherbakov and Dr. Gapontsev, and even other members of the executive team over many years. So continuing to pursue the rollout of fiber laser technologies across multiple applications and end markets. So there's no big change in that direction. Dr. Scherbakov 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. We're executing very regularly against the existing $200 million buyback that we have out there and quickly and expeditiously completed the prior one. So no fundamental changes that are out there, otherwise we would have had to articulate them.

Makes sense. And then how do you think about with all the 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 the supply chains trying to get certain components. But also, I feel like the expense number was in line with your expectations around $87 million. Like how do we think about -- are you seeing more cost inflation in the business as you kind of head into the fourth quarter and into 2022? How we can kind of think about those moving parts on SG&A and labor and things like that?

Of course, we see this influence for, first of all, for our customers and also our product suppliers (inaudible) components first of all for electronic chips and so on. But we made some question about this, I mean, we have enough in our stock, these components to organize a stable transaction of our lasers and not to interrupt our customers. But of course, we have to think about our strategy because you see the price from metal grows dramatically for aluminum, 20% or about 30%. Some cheap price also increased not 20% to 30%, but sometimes to 3 up to 10 times. And such kind of conditions of use to see also some possibility to, again, possible optimization of our cost and also to discuss with our existing and potential customer about future preparation. And of course, there is some uncertainty, but we believe that next year or much more stable conditions, definitely.

And then just with regards to the operating expenses, I can address those SG&A. R&D, we were right in line with what we guided to for Q3. We're actually running at a bit higher level on some of those OpEx relative to a year ago, first of all, because our variable compensation accruals given the overall performance of the business, year-to-date growth at close to 20% in Q3, 20%. So we're actually slightly ahead of where our budget was. So our variable comp accruals are slightly high. You've got a slight expense coming back from, for example, trade shows and fares 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 optimization of those expenses on the operating side as much as anything else. So certainly looking to be very disciplined in the way that we manage that. But we'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.

(Operator Instructions) Our next question comes from Paretosh Misra with Berenberg.

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 there's inflation in component pricing and freight 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-power lasers?

But we can't really talk to our people and the competitive market will behave as I think it's interesting that if you look at the results of one of those competitors that was announced last week, even relative to Q1 that 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 mean, I can't say how they're going to behave strategically in the future.

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

It's not only one product or several products. Unfortunately, I don't know exactly what kind of part of the solar business as of today. But first of all, is in different kind of parts later this, I mean micrometer region and also green pulse lasers. And for next year, also, we are optimistic that I think we have now enough applications for these lasers and we're optimistic again now this business.

Our next question is from Joe Wittine with Edgewater Research.

My condolences there IPG. From an investor-facing point of view, I will miss VG's spirited responses to any questions that were focused on competition. Clearly, showed his technical pride in the products, yes, my condolences. I want to ask on China. Yes, the prepared remarks, piecing together two separate comments in the prepared remarks. One of acknowledge of 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.

I don't think anything is 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 the 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 third victory trying to play within the very high-volume low end of the market. What we did say, though, is that as we expand the offering of our ultracompact lower-cost lasers, there's certainly an opportunity to increase our share as we go to 3, 6 and ultimately 8 kilowatt 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 pulsed lasers or even at lower power levels, the single-mode lasers that are being used 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.

Maybe if 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 the core body and white and tailor-welded blanks type of applications with production being generally depressed short term for the light vehicle space.

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

Definitely, yes.

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

No.

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

But nevertheless, all our obligation to our customers will make it not special delay. Our typical last time -- lead time for our product, it's between 6, maximum 8 weeks.

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

In terms of COVID-related costs, you've kind of broken them up previously. How important were they this quarter?

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

Sorry. In terms of component shortages, electronic compartment shortages, how big an impact and in what product areas are you seeing that impact, if it is an impact?

First of all, we have now a sufficient quantity of components which we need for our production and also looking for to find the new suppliers and sometimes also making a redesign of our product to use not companies which we used before, but for the new ones. We are flexible enough in this case.

Our next question comes from Jim Ricchiuti with Needham & Company.

Tim, you had called out in a couple of areas, additive manufacturing. 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?

I think it peaked back in 2017, maybe the first half of 2018...

'17.

Was the strongest quarters and certainly since then, the European market has been very weak. The China market is really more new developments and started 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 -- back at that time, 4% or 5% of revenue, $50 million to $60 million annually.

And just based on what you're seeing, it sounds like you're optimistic there's some runway for growth in that market.

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 the recovery in the aerospace market as well will help that because that's an area where quite a lot of additive processes were used.

Excuse me, for this 3D applications are now uses much more sophisticated machine before as usual, they use for one machine one lasers. Now up to 12 lasers, they use for one machine to produce big enough components from metal, from other materials. And this is just for us.

Got it. And the other area that we do get questions on a lot just because there's seems to be a fair amount of activity is in directed energy. Is there -- 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.

There's no really particular updates at the moment. I think really the shipping for the people looking for 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 like the beam tracking and the delivery of the beam. We're looking at being a light source in certain -- broad set of those applications there. So we're not -- our customers are the ones who do the beam tracking and delivery capability. So we're not so much on that competitive end.

Up to now, there is not big competition for example, for high power single mode lasers. We produced and we demonstrated the 10 kilowatts single mode lasers more than 10 years ago. Up to now, nobody can produce such kind of lasers.

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

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 an inventory provision, fixed cost absorption. Can you just bucket that for us again?

Inventory provisions and basically your unabsorbed manufacturing costs as a percentage of sales were down. Relative to a year ago, your core gross margin was relatively stable over the main areas.

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 -- 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 the low-end cutting?

So the first part of the question, I think, for us, the China market like elsewhere, is becoming more diversified and we're benefiting from certain tailwinds that are driven by the EV investment cycles. We talked about additive, we talked about some of the companies coming back to us on the market in (inaudible) Undoubtedly, though, the cutting market is weak at the moment, and the supply chain is used. There's the power outage issues. They've got a bit of the [Evergrande] and 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 I've got reference 2 or 3, the ECO lasers, a 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 the 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.

And also important that for high-power as well, creating not only source, I mean, lasers, contested. In many cases, our optical heads and some other components. And in this case, we can compete much more successfully.

Our next question comes from Nik Todorov with Longbow Research.

I have just on China, again. How do you guys explain this bifurcation of demand in China? I think EV demand is obviously idiosyncratic, I 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?

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 on a -- in an automated environment, the downtime on a production line even for one hour or 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 versus -- 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.

I would like to present you some examples. For example, some automotive customer, which we have some experience. The reaction time -- it must be if your laser installed in the production line, reaction time must be less than 20 minutes. Can you imagine what kind of always come up and what kind of training we have to supply, what kind of support we have to supply to our customer? The problem is not the supply laser reliable base. Of course, it's very important, but to organize a service and support to customers, It's also very, very important. And in many cases because we are using our experience to work with practically all automotive customers in the world, we have enough experience also to support our customers in other applications.

Yes, that's very helpful. I think my question was more so from a macro perspective. Why do you think in China cutting demand is soft while your side in strength in marking and 3D 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.

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 mean, actually look to 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 pulsed lasers sold into that. But we're kind of one of the reasons and expect -- one of the reasons the positive performance that we'll be gaining share back for the automated processes. And then on EV, that's a well-understood macro tailwind, right?

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

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.

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