IPG Photonics Corp (IPGP) 2022 Q1 法說會逐字稿

Today's call is being recorded and webcast.

At this time, I'd like to turn the call over to 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 CEO, 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 are detailed at IPG Photonics' Form 10-K for the period ended December 31, 2021, and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors section of IPG's website or by contacting the company directly. You may also find copies on the SEC's website.

Any forward-looking statements made on this call are the company's expectations or predictions as of today, May 3, 2022, only. The company assumes no obligation to publicly release any updates or revisions to any such statements. For additional details on our reported results, please refer to the earnings press release, earnings call presentation and the 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.

Good morning, everyone. We are pleased to report a strong start to the year with the first quarter revenue above the top end of our guidance. Revenue increased 7% year-over-year, benefiting from higher demand in Europe, North America and Japan. We are particularly pleased to see that growth was driven by many emerging applications across all major geographies.

As we stand back, we can identify several macro trends, such as automation and miniaturization, as well as the focus on sustainability, renewable energy and energy efficiency, including EV, which are driving this increased demand.

In the first quarter, we saw strong sales in welding, marking, systems, cleaning, 3D printing, semiconductor and medical applications. Sales outside of China grew 65% (sic) [grew to 65%] of our total revenue, showing our progress in achieving a better geographic balance in our business.

Our welding revenue was a record in the quarter and has become almost as important as our revenue from high-power cutting applications in some regions, or even outgrowing it, as we saw in China. This was driven primarily by opportunities on electric vehicle batteries and automotive production that we are pursuing, as well as an increasing demand for laser welding in general manufacturing, medical devices applications and adoption of our handheld laser for manual welding applications.

Laser enables faster, more precise welding for a wide range of materials, including the thin foils and highly reflective materials, like copper and aluminum, that are difficult or impossible to weld with traditional MIG or TIG welding.

The strong growth in welding, foil cutting, marking and 3D printing applications nearly offset expected drops in high-power cutting applications in China, which stabilized at a low level. As a result, high-power cutting application accounted for a much smaller portion in our revenues in China compared to a year ago.

There are different dynamics in the same applications elsewhere. In Europe and North America, we see increased adoption of laser for -- in cutting application as global manufacturers redirect investment in local supply chains and increase adoption of automation in manufacturing processes. Markets and applications that value of -- our commitment to quality, innovative technology, reliability and global customer support are now IPG's focus.

We are pleased with the growth that we are seeing in medium-power and pulsed lasers, which are primarily driven by higher demand in emerging applications. These lasers are used in foil cutting, 3D printing, solar cell manufacturing, manufacturing of electronics and semiconductor applications. These application requires a high beam stability, quality and stability, and as well as reliable lasers, characteristics for which IPG's devices are known by customers.

In the first quarter, emerging growth product sales were 36% of our total revenue. Many of these products are benefiting from global macro trends, such as automation; miniaturization; as well as the focus of sustainability, renewable energy and energy efficiency. Our lasers are widely used in manufacturing of electronic -- electric vehicles. We are seeing increasing investment by automakers and suppliers in e-mobility worldwide. And continue to see strong growth in demand for our high-power pulsed lasers, adjustable mode beam lasers and real-time welding monitoring capability, that together, can provide a highly customized and engineered solution to address many challenges in these complex manufacturing processes. We expect the investments in e-mobility to continue.

Additionally, manufacturers are increasing spending in automation to address shortages of labor and wage inflation. Laser can provide great productivity, the improvements and significant return on investment. We are seeing an increasing demand for LightWELD because it's easy to use and only requires hours of training for an inexperienced welders. This compares to the month of training for typical MIG and TIG welder.

We have launched a 3rd generation of the device, including the extended range of welding and cleaning capability for more diverse materials. The focus on sustainability and energy efficiency play well into laser cleaning application that can reduce the use of toxic materials. At the same time, high energy costs are driving demand and increasing interest in our premium ECO lasers that provide wall-plug efficiency of greater than 50% and can meaningfully reduce energy consumption in high-power applications.

Before I turn the call to Tim, let me provide an update on the conflict in Ukraine, which we all hope will come to a peaceful resolution soon. To help with this humanitarian crisis, IPG allocated $0.5 million to provide financial aid to our employees who helped refugees from Ukraine. We are proud to hear that many of our employees have opened their homes to refugees and provided clothes, food and temporary housing.

In response to the current situation, IPG stopped all new investment in Russia and already terminated some existing projects. As we announced on March 3, we are executing on our contingency plans, increasing the manufacturing and inventories of critical components in United States and Western Europe.

In the first quarter, we started hiring additional employees, allocated work space for increasing production and running second shift in the United States, Germany and Italy. We have also been qualifying the third-party suppliers for certain components. This activity, which will accelerated during the second and third quarter this year, would significantly reduce IPG's reliance on Russian components by year-end.

We are using this situation as an opportunity to introduce the new production technologies and automation to increase yield and productivity. We recognize the risk of operation in the region as the escalation of sanctions will potentially have a significant impact on our business because the large capacity for critical components that many of our lasers rely on is currently in Russia.

As we are making these decision, we are doing our best to protect the interest of our employees and their families.

I will turn the call over to Tim to discuss financial highlights in the quarter.

Thank you, Eugene, and good morning, everyone. My comments will generally 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 first quarter was $370 million, up 7% year-over-year, driven by growth in most of our key product lines and geographies, and increased 2% sequentially mainly due to higher revenue in China. Revenue from materials processing applications increased 7% year-over-year, and revenue from other applications increased 9%.

First quarter GAAP gross margin was 46.4%, a decrease of 110 basis points year-over-year due to increased shipping charges, higher cost of products sold and higher inventory reserves, partially offset by reduced manufacturing expenses as a percent of sales.

Excluding foreign currency gains, operating expenses increased slightly year-over-year, primarily in sales and marketing, to support higher revenues. GAAP operating income was $93 million, and operating margin was 25.2%. Net income was $70 million or $1.31 per diluted share. The effective tax rate in the quarter was 25%.

During the quarter, we recognized a foreign exchange gain of $6 million primarily related to the balance sheet impact as a result of the depreciation of the Russian ruble and the euro as compared to the U.S. dollar. If exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $10 million higher and gross profit to be $4 million higher.

Moving to Slide 5. Sales of high-power CW lasers decreased 2% and represented approximately 45% of total revenue. Sales of ultra-high power lasers above 6 kilowatt represented 49% of total high-power CW laser sales.

Pulsed laser sales increased 21% year-over-year with continued growth in high-power pulsed lasers used in EV battery manufacturing and increased demand in cleaning applications. System sales increased 28% year-over-year, driven by growth in laser systems and higher sales of LightWELD.

Medium-power laser sales increased 49% on growth in welding, 3D printing, electronics and semiconductor applications. QCW laser sales were down 6% year-over-year. Other product sales increased slightly year-over-year, driven by higher sales in medical, which were offset by lower sales in telecom and advanced applications.

Looking at our performance by region on Slide 6. Revenue in North America increased 5%, driven by growth in cutting and welding revenue, as well as increased revenue in medical applications and systems.

We saw strong revenue growth in Europe this quarter. Sales increased 27% in the region as a result of higher demand across many different applications, including cutting, welding, cleaning, solar cell manufacturing and advanced applications. We believe that about 10 percentage points of this growth was attributed to pull-forward of demand from the second quarter as customers were securing supply.

Revenue in China decreased 7% year-over-year. As expected, revenue in high-power cutting applications stabilized at a lower level. But we saw strong growth in welding, foil cutting, marking and 3D printing in China.

Other Asia benefited from increased sales in cutting applications in Japan and good growth in Korea this quarter.

Moving to a summary of our balance sheet on Slide 7. We ended the quarter with cash and cash equivalents and short-term investments of $1.4 billion and total debt of $33 million. Cash provided by operations was $16 million during the quarter. And capital expenditures were $25 million in the first quarter.

Cash generation was negatively impacted by a further increase in strategic inventory during the quarter to offset ongoing supply chain constraints for electronic components and to build inventories of critical optical components outside of Russia.

We expect 2022 capital expenditures will be in the range of $130 million to $140 million for the full year. 2022 CapEx includes facilities and capacity expenditure to support additional capacity for critical components in Europe and the U.S. CapEx previously budgeted to be spent in Russia will now be spent on investments to derisk our internal supply chain.

During the quarter, we repurchased over 600,000 shares for a total of $79 million, a record quarterly share repurchase number for the company. Since the end of the quarter, we repurchased an additional 675,000 shares for $66 million.

Moving to our outlook on Slide 9. First quarter book-to-bill was above 1. And we're pleased with the order flow across all regions, which was in part driven by customers placing orders with requested delivery days -- dates that extend beyond the second quarter.

While our ability to ship products was not impacted in the first quarter, there are ongoing supply chain constraints worldwide that may impact us or our customers. In China, COVID-19 outbreaks and restrictions to control the spread of COVID-19 have resulted in a weaker economic outlook. There are also trade restrictions and economic sanctions on Russia in general that impact our operations there.

The risk of a full Western embargo on Russia, the probability of which we cannot assess, continues to represent a material downside risk to the financial results and operations of the company until new capacity for critical components is built in Europe and the U.S. While we are managing through the current situation, we expect higher import duties and tariffs on Russian-sourced components as well as ongoing elevated shipping costs to negatively affect our margins.

Looking at the global demand environment. Macroeconomic indicators have been moderating globally. And despite strong indicators from the U.S. and Europe, we saw the March PMI in China indicate a contraction. That makes forecasting our business challenging in the medium term, and our second quarter guidance remains subject to significant uncertainties, including the impact on the global business environment from geopolitical events, trade restrictions and sanctions, COVID-19, economic trends, growth from emerging product revenue competition and the lack of long-term binding order commitments.

With that said, we feel optimistic as we continue to benefit from growth opportunities created by major macro trends, such as automation, miniaturization and sustainability, that drives growth for electric vehicle battery manufacturing, LightWELD and medical sales.

In the second quarter of 2022, IPG expects revenue of $355 million to $385 million. The company expects the second quarter tax rate to be approximately 26%. IPG anticipates delivering earnings per diluted share in the range of $0.95 to $1.25 with 53 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 company's reports with the SEC.

With that, we'll be happy to take your questions.

(Operator Instructions) Our first question comes from Nik Todorov with Longbow Research.

Can you hear me, guys? Sorry about that.

Congrats on great results given all the uncertainty and headwinds out there. A question on China. It sounded like -- I think I heard some comments suggesting that the EV sales are -- have gained significant traction there and then become a larger percentage of your sales in China. Maybe can you help us understand, currently, what portion of your China sales are now coming from high-power cutting? I know historically, that has been a little bit over 50% of the China business, but where it is today? And maybe where do you see it going from here on?

Yes. Nik, we haven't given a specific number on that. It's come down. The traditional cutting, when you exclude the specialty foil cutting, it's come down fairly meaningfully from that 50% level. So the real growth and performance in China is being driven by these other emerging areas, such as EV or even the additive, cleaning applications. Continue to see good demand from consumer electronics and other areas. So we're very pleased with the diversification of the business there.

Okay. And as a follow-up question, Tim, can you give us some sense of what is the implied gross margin in the second quarter guidance? I think we're getting to anywhere from 44% to 45%.

And maybe help us understand the puts and takes. You talked about the duties and the higher logistics cost.

And also, is that the full impact of the gross margin, given the situation with the headwinds with getting products in and out of Russia? Because I know you have secured inventory there. So do you anticipate to see incremental headwinds potentially into 3Q as you may have to rebuild inventory from China -- from Russia into United States and Europe?

Yes. So in the presentation, Nik, you see on Slide 9, the gross margin that we've used on the guidance is 44% to 46%, so slightly higher at the top end of the range than you had.

It does bake into account some import duties and tariffs. They've increased in the U.S., but they have actually not increased in Europe. It takes into account continued sort of relatively high inventory provisions, given the amount of strategic inventory that we're holding and have held over time through this supply chain crisis that has been ongoing through COVID. So we saw relatively high inventory provisions in the second quarter. It also takes into account some higher shipping costs.

In the near term, does it bake in all of the potential costs? It does not because Q3, Q4 would depend upon what happens with import duties and tariffs in Europe. And then as we transition into making more of these components outside of -- in Europe and North America, obviously, your import duties and tariffs will go down. But in the near term at least, some of your other costs related to salaries go up.

Over time, though, as we continue to bring on better quality components that can handle more power, increase automation, improve yields, we're not walking away from our overall gross margin target of 45% to 50%, even though in the near term, we're likely to be struggling a little bit. We're consistently getting into that.

Our next question comes from Chris Greg with Needham & Company.

Congrats on the quarter. Are you able to quantify the headwind on gross margins during the quarter in connection with reducing the Russian manufacturing operations? And could you talk about the types of workaround measures that you're taking, and any associated costs?

On the first quarter, I'll deal with the cost side of it. And Dr. Scherbakov can look at -- discuss the plans that are being implemented.

There wasn't really much impact on gross margin in Q1 related to that. We were starting to implement the different strategies and contingencies to derisk that. The main impact to gross margin on Q1 were the elevated inventory provisions. To a certain degree, the shipping cost is partly related to the challenges that are faced. But those shipping costs were even elevated in Q4 due to all of the supply side and logistics constraints coming out of COVID, right?

We were hoping that some of the shipping would ameliorate at the beginning of this year, but that's kind of been overtaken by where fuel costs, for example, are. And then some of the logistics challenges of moving product into Europe and the U.S. from Russia.

In terms of some of the contingency planning and shifting our production, Dr. Scherbakov can talk about how we're progressing there.

First of all, we're starting -- installed, in Germany or the United States, additional shifts for production of this kind of very important components for us, of course. And also not only second shift, but also in some places, third shift. For these components, of course, it also increased our labor cost. It's clear. But according to our plan, we'll introduce a complete production for some components. I'm not talking about all component. But first of all, for example, fiber blocks and some isolators.

I think we will be less reliant on Russia in third and fourth quarter, definitely. And for some components, like fiber block, I think will be absolutely independent to the end of this year. But up to now, of course, we are working hard to reduce this and increase our inventories in different countries. You'll see what will be the final results. But we are seeming optimistic.

Got it. And in terms of the impact from COVID-related disruptions in China, what are you seeing there in light of the lockdowns vis-a-vis revenue and gross margins in the quarter? And what are your expectations there for Q2?

It's difficult to say because Shanghai closed approximately 1 month, completely locked down. The same -- not the same, but the approximately the same situation in Shenzhen. What will be the next action from the China government? We don't know exactly. But definitely, in some cases, it will be the low-activity production. And also, we'll be using our lasers in China. But situation is now uncertain. And to make then any forecast, any predictions, it's very difficult today.

In terms of like the guidance, the overall number given by China is actually fairly robust, and that's factored into the sort of top end of the range. We did even get a low-end forecast assuming shutdowns become more pervasive. And the demand there was -- assumed they could continue shipping. And it wasn't a catastrophic fallout of revenue, right? It wasn't that the expected activity to come to a standstill. But the bottom end of our range kind of factors in some of that uncertainty there.

Got it. And then just last one for me and I'll hop back in the queue. But any color on the book-to-bill by region would be helpful.

Yes. I think that was actually really interesting in terms of look at the source of the bookings in Q1, which were very strong. We mentioned that there's a number of different orders that we've got to give us visibility into second, third and fourth quarter order flow. So that's kind of the first sort of structural change a little bit on the bookings.

But the really good thing was that it was made up of order flow in North America, in Europe and other Asian countries. And relatively speaking, if you compared it to a year ago, where bookings out of China were a much higher percentage of revenue, the bookings out of China this quarter was significantly lower as a percentage of the total, and the total was higher.

So for example, in North America, you had very strong bookings on some of the medical applications, materials processing applications. They also had some strong order flow from telecom, which should help with that business a little bit in the second and third quarter. In Europe. It was really broadly about the materials processing across all the different applications. It's good to see some recovery in Japan. And then the Korean business is always quite diverse. We've got some good orders for the solar cell application as well. So that would start to ship in the second and third quarter as well.

I really like the diversity of the backlog that was received and booked, and really, the diversity in the rest of the world, I thought was a real positive.

Our next question is from Tom Diffely with D.A. Davidson.

I was hoping you could talk a little bit about your R&D efforts in Russia, maybe what the percentage of the total effort is there, and the ability to move some of that activity to other regions over time.

About R&D outside Russia, of course, we have a very strong team in the United States and Europe and Italy and some other places. Of course, we now have some dependence, but the dependence is very small in comparison to all our activity in different products. Our main products for emerging applications, we are now developing mainly in Europe and in the United States.

For example, LightWELD, we develop in the United States and demonstrated very good results. High-power pulsed lasers also, we have made such development in Europe, in Germany in particular. For example, one early type of this pulsed laser, about 200, 300 average power, can give us this year about $100 million revenue. It's only one type. And mainly, again, it's very important, in China. But also, we have a very big potential in other countries. And from this point of view again, I would like to underline. Our main development activity now are not in Russia, but outside Russia, in the United States, also in Europe.

Okay. That's very helpful. I appreciate that. And then maybe, Tim, a long-term question. When you look at the growth and perhaps getting back to double-digit growth over time, when you look out a few years, is welding or cutting the bigger driver of that growth?

So in terms of growth rates, I think you're going to have to -- you look at welding and some of the other materials processing applications. Like we're very optimistic on things like cleaning, the additive market, if it can really solve the issues that it has. And so the growth rates of that and the total market, I expect to be higher than the cutting market.

I do think though, the cutting market is quite interesting because whilst it has grown very dramatically in China in terms of unit volumes, when you look at the number of cutting systems that are actually sold in the rest world, it implies that cutting in the rest of the world is still very underpenetrated against some of the historic and legacy machine tools that are used in a similar way, right? Punches, presses, dies. And so there is a very -- plasma cutting, even.

There is, we think, a very considerable runway for cutting systems growth in the rest of the world, particularly if it's even going to be similar in terms of usage to China. So there's an interesting dynamic there where, potentially, if you get to more of a tipping point on that laser adoption, you could actually see the rest of the world cutting market expand more meaningfully.

(Operator Instructions) Our next question comes from Mark Miller with Benchmark Company.

Your margin projection, the midpoint at least, is below last couple of quarters. I'm wondering what's driving the expectations for lower margins in the June quarter.

Yes. Sure, Mark. We mentioned at the beginning of the call a little bit about that. So the major impact in Q2 would be taking into account some higher import duties and tariffs related to product imported into North America. Continuing to see -- expect to have inventory provisions, a little bit higher elevated level shipping costs. They have got continued inflationary headwinds and pressures around basic component costs as well. Those would be the drivers in the guidance number. So there's a number of different challenges out there.

Just a follow-up question. What percent of sales are you attributing the recently introduced products last quarter?

It was 36% last quarter.

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

I apologize if I missed this earlier. So what is the capacity utilization at your Russian facilities today? Are you still producing at that rate in the second quarter? And when does that -- when do we expect that to ramp down?

Our production, again, it depends what kind of components. For some of components, definitely, it will decrease our reliance with Russia in second and third quarter. But to the end of this year, many of our components, we will produce outside. We will produce outside. And also, we are now looking for some additional suppliers from outside, components which we are using in our, for example, small power lasers and so on.

Our projections [such manner, they have to again,] we have to decrease our rely on Russia in third and fourth quarter. Up to now, we are producing some components, not any important products. Some components, yes, they're producing to satisfy requirements from our customers.

Got it. And your inventories, which are at a record -- I mean, they were up 23% year-over-year. Your revenue was up 7%. I recognize you're building a lot of stock. Just help us understand, Tim. Are you comfortable with these inventory levels? Do we continue to build upon these levels to -- because we think demand will accelerate? Like help us understand the buildup of the inventories and how to think about that throughout this year?

So a lot of different aspects to that question. I think the opportunity -- so first of all, it's -- there's numerous different supply chain issues and challenges that the company has faced, both external and internal, right? In particular on the external side, PC boards and PC board components and electronic parts. So when we look and analyze inventory, you can see that some of the increase relates to investments in that area of our inventory and would relate to external supply chain issues.

So we've built some inventory of diode and diode chips, for example, in Russia that enable them to continue to produce products locally for China. And then we're building inventory of a lot of the other optical components to derisk that supply chain and ensure that we can meet the demand from our customers.

So of course, if you look at this from a purely financial perspective, and you can say that inventory turns are below 2, you don't like that as a financial person. But if you look at the opportunity cost and the risk around that we're trying to deal with, I think that, that investment at this point in time is very much not only warrantied, it's actually needed. And I think that it is very much justified in that way.

So it's more also looking at like the intent and the planning behind that and how we're managing it within our contingencies that's most important. And I think we're doing that pretty well. I think even if you go back through the whole COVID supply chain issue, right? We -- I think we had 1 quarter where we couldn't ship a few million dollars worth of product due to supply chain. But the rest of the time, we managed through that supply chain issue on COVID pretty well.

So it's very difficult, on that opportunity/risk basis, to quantify the benefit. The benefit is very significant on inventory. The downside risk is that you're going to run some potentially higher inventory provisions over a period of time until you get through this. That's kind of how I look at it.

Of course, as a CFO, I'd like to see inventory lower. But there's an operation -- a very much an operational and risk slant to this as well.

Yes. But from the point of CEO, of course, we have to, first of all, to minimize risk to delay our product to our customers. This is why we are guaranteeing our shipment in time. Our typical -- I would like to remind, our typical shipment, about 4 up to 6 weeks after placing the order. This is why we would like to keep in our stock all necessary components.

In some cases, we are buying these components for 1, and some components, for 2 years production. Other way, we couldn't guarantee to our customer with a stable shipment.

But also please take it in mind that price for these components, mainly for chips, increased dramatically during this 1 year. In some components, they increased not only 10% or 20%, up to 3, up to -- some components, up to 10x. Can you imagine? But we have to, if we would like to support our customer, we have to keep this inventory. No other way.

That makes sense. And just lastly, on Europe, obviously, Europe was really strong. You mentioned high demand, but you also mentioned, Tim, some pull-forward, you felt, for customers to secure supply. Just curious what you're seeing maybe just in April like that told you that was a pull-forward. You're seeing headlines about Germany in terms of some implications on the auto sector and truck sector, with Russia, Ukraine. I'm just curious what you're kind of seeing there in your Germany and European markets right now.

So some of the pull forward, I mean it's a bit like us building inventory, right? People want to ensure their components and device supply chains are more secure. So some of it was related to that. We thought it wasn't a massively significant amount.

What are we seeing in Europe after quarter? In general, the tone around the globe is pretty much -- and maybe -- I mean, China, we mentioned, is a little bit weaker. But we're still seeing fairly strong order flow at this point in time. I haven't seen any fundamental shift in like European or North American tone. The rest of Asia remains sort of relatively okay.

Yes. So referring to all the challenges around some of the other energy supply issues and things like that. In fact, over the longer term, I think there's potentially benefit for IPG because cost of electricity in Europe and other energy sources going up dramatically, right? And you're looking at what is one of the most efficient machine tools out there in terms of the fiber laser.

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

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 looking forward to speaking with you over the coming weeks. Have a great day, everyone.

Thank you.

Thank you.

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