ipg photonics corporation third quarter 2017 conference...

IPG Photonics Corporation

Third Quarter 2017 Conference Call Prepared Remarks

Operator:

Good morning, and welcome to IPG Photonics' third quarter 2017 conference call. Today's call is

being recorded and webcast. At this time, I would like to turn the call over to James Hillier, IPG's

Vice President of Investor Relations, for introductions. Please go ahead sir.

James Hillier:

Thank you operator and good morning everyone. With us today is IPG Photonics' Chairman and

CEO, Dr. Valentin Gapontsev, and Senior Vice President and CFO, Tim Mammen.

Statements made during the course of this conference 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 known and unknown 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 those detailed in IPG Photonics' Form 10-K for the year

ended December 31, 2016 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

only as of today, October 31, 2017. The Company assumes no obligation to publicly release any

updates or revisions to any such statements. We will post these prepared remarks on our

website following the completion of the call. I'll now turn the call over to Dr. Valentin Gapontsev.

Valentin Gapontsev:

Good morning everyone.

IPG Photonics delivered record quarterly results with 48% year over year revenue growth and

with revenue and EPS above the high end of our guidance. We have been able to meet

customer requirements by increasing production faster than revenue growth and fulfilling orders

with no meaningful change in lead time. This achievement is a testament to our operational

excellence and strong execution in the quarter. It also highlights our philosophy to make laser

technology more accessible by reducing its cost. Our vertically-integrated business model

enables us to more rapidly scale production, reduce costs, and deliver innovation than the

competition. In short, there is no company that can produce high-power fiber laser solutions at

our scale, our quality, our schedule or our cost.

The secular shift to high-power products across our largest applications and geographies

continues to drive outperformance. Our fiber lasers enable faster processing speeds and

superior productivity and flexibility at a lower cost. These advantages only increase at higher

power levels. During the third quarter, sales of high-power CW lasers increased 60% year over

year with even higher growth in units. Sales of ultra high-power solutions at 6 kilowatts and

above more than doubled year over year. Our largest OEM customers are migrating to higher-

power fiber laser sources of 10 to 15 kilowatts, where IPG has unique solutions in the

marketplace.

We are also seeing customer migrate from low- and mid-power laser solutions up to higher-

power fiber technology. The market for cutting systems ranging from 700 watts to 1.5 kilowatts in

China has increased dramatically this year, with unit volumes more than double last year's level.

We estimate some quantity of these China-produced systems are being exported to meet

demand in emerging economies in Southeast Asia, India, Eastern Europe, and Latin America.

These fiber-laser-based cutting systems are replacing non-laser technologies including machine

presses for punching and stamping of metal that use inflexible dies for cutting and drilling that

wear out and break over time.

We are benefiting from rapid growth within our other product categories as well. Sales of QCW

lasers increased more than 100% year over year driven by consumer electronics investments.

Sales of high-power, 100 watt and above, nanosecond pulsed fiber lasers nearly doubled from

the year-ago period. Market acceptance of these products is occurring across a diverse set of

applications including foil sheet cutting and terminal cleaning for batteries, solar cell scribing and

drilling, and laser trimming for displays. Sales of green pulsed lasers used as an ablation tool for

improving solar cell efficiency also grew strongly both sequentially and year over year. We

continue to see encouraging interest from customers in evaluating our new ultrafast picosecond

and femtosecond pulsed laser family. As a reminder, our ultrafast lasers offer much higher wall-

plug efficiency, a smaller footprint, more consistent energy per pulse, a faster cold-start time and

significantly lower cost of ownership as well as investment than competing products. These

products meaningfully expand our addressable market opportunity within the micro materials

processing, medical, and scientific markets.

In addition to developing new unique laser sources, we are now producing corresponding optical

accessories and fully integrated systems to drive new applications for laser technology. Sales of

accessories, including welding and cutting heads, scanners, collimators, beam switches,

process fibers, smart power supplies and chillers, increased 50% year over year. Our organic

systems business complemented by the newly-acquired ILT business was a strong contributor in

the quarter. We are no longer just a supplier of lasers, but we are also a qualified supplier of

complete system and application solutions into major markets such as the automotive,

aerospace, railway, pipeline, and medical industries.

The rapid growth across our product portfolio drove record operating cash flow of $164 million in

the third quarter, and our total cash balance now exceeds $1 billion. Let me take a moment to

discuss our capital allocation strategy. We are committed to allocating capital in a manner that

maximizes returns and increases shareholder value. There are few companies that possess the

growth opportunity, balance sheet strength, and free cash flow generation of IPG, providing us a

unique opportunity to deploy capital to enhance and accelerate this growth opportunity.

We believe organic investment in our business will continue to deliver the greatest return to

shareholders, and this remains our highest priority. We also recognize that we cannot capitalize

on our tremendous growth opportunity through organic investment alone. Maintaining a strong

balance sheet provides us maximum flexibility to pursue value-creating acquisitions that

accelerate time to market, as well as transformative deals during times of market disruption. In

addition to these investment areas, we have a $100 million stock repurchase authorization in

effect.

We are poised to deliver our strongest annual growth in six years driven by accelerating

adoption of our fiber laser technology within our core markets. Looking ahead, we see excellent

opportunity to leverage these advantages and substantially expand our addressable market with

the launch of new fiber-based laser sources and systems for the micro materials processing,

medical, cinema projection and display, scientific, and defense industries. We continue to

execute on our mission to drive adoption of our leading-edge technology through product

improvements and cost reductions, making our fiber laser technology the tool of choice in mass

production.

With that, I'll turn the call over to Tim Mammen.

Tim Mammen:

Thank you Valentin and good morning everyone. I will review the key financial highlights of the

third quarter. For additional details on our reported results, please refer to the Excel-based

financial data workbook posted to our investor relations website.

Revenue in the third quarter grew 48% to a record $393 million, exceeding our guidance of $350

million to $375 million. This outperformance was across multiple regions, applications, and

products. In order to meet record demand, we demonstrated strong operational execution

across our global manufacturing organization. During the quarter currency movements benefited

sequential revenue by approximately $6 million. Revenue from materials processing applications

increased 52% year over year, driven by rapid growth in lasers sold for cutting and welding

applications, and a record quarter for lasers sales for 3D printing applications. Revenue from

other applications decreased 9% year over year as softness in communications and government

business relative to challenging comparisons a year ago offset strength in medical.

By region, third quarter revenue in China increased over 70% year over year and represented

approximately 45% of total. Sales of high-power CW lasers for cutting and welding applications

drove the vast majority of the revenue increase in China versus the year-ago period, and we

also benefited from strength in QCW laser sales primarily related to consumer electronics

welding applications. Growth in Europe accelerated to 50% year over year, driven by strength in

high-power lasers for cutting and welding applications, medium-power lasers for 3D printing

applications, pulsed laser sales for marking and engraving, and high-power pulsed lasers for

marking, engraving, and solar cell manufacturing.

In the US, third quarter revenue increased 13% year over year, as strength in systems and high-

power pulsed lasers offset lower sales of high-power lasers into automotive welding applications

while the acquisition of ILT benefited systems revenue in the US. Project timing can lead to

some variability in US automotive sales.

Sales in Japan declined 10% year over year due to ongoing softness at our largest customer in

the region. We have seen a meaningful sales increase this year among our largest Japanese

OEMs within other regions, most notably China. As a result, we estimate sales to Japan-based

OEMs in all regions increased by a mid-single-digit percentage year over year.

In other regions, sales in Turkey reached a record level this quarter on rapid growth in high-

power lasers for cutting applications and accessories sales. Korea remains on track for a record

year, with third quarter revenue growth exceeding our corporate average on strength in

automotive and battery welding, marking and engraving, and applications related to

semiconductor, electronics, and display manufacturing.

Turning to performance by product, high-power laser sales increased 60% year over year to a

record $244 million, contributing more than 70% of the incremental revenue we generated in the

third quarter 2017 versus the year-ago period. Revenue from fiber lasers at 6 kilowatts and

above more than doubled from the year ago period. QCW sales of $24 million increased more

than 100% year over year from strength in fine welding for consumer electronics applications.

Medium-power laser sales increased 22% driven by a substantial increase in demand from 3D

printing customers and growth in fine welding which offset the decline in medium power cutting

attributable to the shift by OEMs to 1 and 1.5-kilowatt-scale lasers that Valentin discussed.

Pulsed lasers sales grew 16% year over year. As Valentin noted, we saw strong growth in sales

of our newer green and high-power pulsed lasers across a diverse set of applications. These

products represent nearly half of our pulsed laser sales. Sales of low-power pulsed lasers for

marking and engraving applications were up by a low single digit percentage. Finally, sales of

other products increased 31% year over year due to strong sales growth in systems and

accessories.

Gross margin of 57.2% was up 280 basis points from Q3 2016 and above our guidance range of

50% to 55%. We were able to more than offset declines in average selling prices with improved

manufacturing efficiency, cost reductions, and favorable product mix. Q3 operating income was

$160 million, or 40.8% of sales, well above Q3 2016. Excluding foreign exchange losses,

operating margins increased to 41.8% from 36.5% in Q3 of 2016, above our guidance range as

we leveraged our costs over higher sales volume. We were able to achieve positive leverage in

sales and marketing, R&D, and G&A while continuing to invest in product development and the

expansion of our global sales force and administrative footprint. Our third quarter tax rate was

28.0%, including a $3 million benefit from stock options exercised and RSUs released during the

quarter. These tax benefits increased EPS by $0.06.

Net income for the second quarter was $116 million, increasing 67% from Q3 2016. Earnings

per diluted share were $2.11 for the second quarter compared with $1.29 a year ago, and above

our Q3 guidance range of $1.50 to $1.70. Foreign exchange decreased EPS by $0.05 versus

the year-ago period decrease of $0.04.

If exchange rates relative to the U.S. Dollar had been the same as one year ago, we would have

expected revenue to be $5 million lower, gross profit to be $3 million lower and operating

expenses to be $1 million lower.

We ended Q3 with cash, cash equivalents, and short-term investments of $1.05 billion and total

debt outstanding of $50 million. Our current level of inventory on hand amounts to approximately

155 days, which is below our target range of 2 turns or approximately 180 days. Days sales

outstanding were 53 at quarter-end, compared with 55 a year ago.

Cash provided by operations during the quarter was $164 million. Third quarter capital

expenditures were $56 million, of which $28 million reflects the gross purchase amount of our

new corporate aircraft. As a reminder, we sold our previous aircraft for $15 million during the

second quarter. Through the first nine months of the year, capital expenditures are $84 million,

net of proceeds from the sales of the previous aircraft. In order to help ensure sufficient future

capacity, we now expect capex for the full year to be in the range of $100 to $110 million,

approximately 8% of revenue, up from $90 to $100 million previously. Looking ahead to 2018,

we believe capex is more likely to be at the higher end of our 8% to 12% target range given the

accelerating growth within our business this year. During the third quarter we repurchased 17

thousand shares for $3 million as part of our antidilutive repurchase program and have now

repurchased 319 thousand total shares for $36 million since the program began last July.

Turning to guidance, based on our third quarter outperformance and current backlog, we are

now targeting approximately 37% to 39% revenue growth for the full year, up from 32% to 34%

previously. This would represent our strongest annual revenue growth in six years as Valentin

mentioned, and is a testament to our leadership in providing cost-effective high-power laser

solutions to our customers. For the fourth quarter, we expect revenue growth in the range of

18% to 27% year over year or $330 million to $355 million. Our revenue outlook reflects the

expected slowdown in spending related to the consumer electronics investment cycle and

typical seasonality in China, factors that resulted in a Q3 book-to-bill below 1.

In Q4 we expect the tax rate to be approximately 29% excluding effects relating to equity grants

and anticipate earnings per diluted share in the range of $1.55 to $1.80, which reflects earnings

growth in the range of 12% to 30% year over year. As discussed in the "Safe Harbor" passage

of today's earnings press release, actual results may differ from our guidance due to factors

including, but not limited to, product demand, order cancellations and delays, competition and

general economic conditions. Our guidance is based upon current market conditions and

expectations, assumes exchanged rates referenced in our earnings press release, and is

subject to risks outlined in the Company's reports with the SEC.

With that, Valentin and I will be happy to take your questions.

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