IPG Photonics Corporation Second Quarter 2017 Conference Call Prepared Remarks James Hillier: Thank you Christine 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, August 1, 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. Page 1
I'm pleased to report that IPG delivered another record-setting quarter. Our second quarter 2017 revenue and earnings per diluted share were above the high end of our guidance. Demand for our core products, particularly high-power, kilowatt-scale fiber lasers, has never been stronger. Our leadership position within this fast-growing market drove record order activity in the quarter, resulting in a book-to-bill that was above one. Based on these trends and the strength of our current backlog, we believe we are in excellent position to deliver another strong quarter in three months time. We continue to believe the pace at which our fiber lasers are replacing conventional lasers and non-laser-based technologies is accelerating. With fiber laser cutting systems approaching onethird of the installed base, we believe it is becoming increasingly difficult for fabrication shops with CO2 lasers to compete with fiber lasers due to the much faster metal cutting speeds and significantly lower operating costs of fiber vs. CO2 lasers. We are also seeing fiber laser systems begin to replace more non-laser-based technologies for cutting and welding applications. This includes machine presses for punching and stamping of metal, which use inflexible dies for cutting and drilling that wear out and break over time. Fiber laser cutting systems now represent a superior return on investment for many fabrication shops due to their greater flexibility, reliability, and lower operating costs. During the second quarter, we also benefited from accelerating growth in high-power lasers and precision systems for laser-based welding applications. These fiber laser welding systems are increasingly replacing traditional resistance spot, arc welding, e-beam and plasma equipment in automotive, aerospace, nuclear, railway, construction, chemistry and other heavy industries. Page 2
We believe our market leadership continues to expand. There is no company that can produce high-power fiber lasers at our scale, our quality, or our cost. During the second quarter, growth in sales of high-power lasers accelerated to 57% year over year. Our largest OEM customers are migrating to higher-power fiber laser sources of 10 to 15 kilowatts, where IPG has unique and reliable products that help them find new applications and sell higher power systems. We continue to drive adoption through product improvements and cost reductions with a mission to make our fiber lasers the preferred tool of choice across all materials processing applications. This mission was on display at the Laser World of Photonics trade show last month in Munich, where we unveiled the industry's first 120 kilowatt industrial fiber laser. I will remind you that, a few years ago, IPG sold a 100 kilowatt industrial fiber laser in Japan. In addition, we displayed new products that address areas outside core materials processing applications, which we believe can substantially increase our addressable market. We saw strong interest from customers and prospects in our new short picosecond and femtosecond ultrafast lasers. 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 than competing products. We believe the acquisition of OptiGrate in May, with its unique quality chirped volume grating technology, enhances our key technology advantages in ultrafast, and will help in development of new ultrafast products. We also saw strong interest in: our unique ultra-high lumens 3P and 6P low-speckle fiber laser sources for digital cinema and other large screen projection systems; in multi hundred watt green fiber lasers for semiconductor materials annealing and other applications; in our highly- Page 3
efficient family of UV fiber lasers; various new medical fiber lasers; and in our mid-infrared Crand Fe-doped ZnS and ZnSe polycrystal fiber laser pumped family of powerful sources for a wide variety of biophysical, research and advanced applications. During the second quarter, we achieved our first commercial sales of our UV marking laser system, ideal for use in the marking of plastics and micro materials processing applications. In addition, we continue to make substantial progress within urology with the development and introduction of our new 500 watt thulium fiber laser, which has demonstrated decisive advantages in comparison with the current gold standard, holmium lasers, which today dominate the urology market. Earlier this month, we accelerated our expansion into the precision systems market with the acquisition of ILT. ILT has a proven track record producing leading-edge laser-based systems for medical device applications, one of the fastest growing markets for fine welding and cutting applications. ILT adds scale to our existing precision systems business, and we see significant opportunity to expand the addressable market for ILT's products. We are on track to deliver a strong year in 2017. We continue to benefit from the secular growth of fiber lasers within materials processing and other applications. Our capabilities within these markets are unmatched, while the competitive landscape remains very favorable to IPG. Our vertical integration, technical know-how, and industry-leading manufacturing and service scale provide IPG a truly unique set of capabilities within the laser industry. As a result of these crucial advantages, we are the clear fiber laser market leader. Over time, we expect these advantages to drive similar success in other markets and industries including micro materials processing, medical, cinema projection and display, R&D, and defense. We continue to open doors for many Page 4
new applications where laser technology wasn t used before due to the greater ease-of-use, lower operating costs, and flexibility of our fiber lasers. With that, I'll turn the call over to Tim Mammen. Tim Mammen: Thank you Valentin and good morning everyone. First, let me remind you that I will focus my comments on the key financial highlights of the second quarter. For additional details on our reported results, please refer to the Excel-based financial data workbook posted to our investor relations website in conjunction with today's earnings press release. Revenue in the second quarter grew 46% to a record $369 million, exceeding our guidance of $320 to $340 million. This outperformance was primarily driven by China and to a lesser extent Europe, with robust demand across a variety of applications and industries. Aside from the better-than-expected order flow that Valentin highlighted, we benefited from strong execution in a number of key areas including capacity planning, production and operations management, customer credit management and global administration. Revenue from materials processing applications increased 48% year over year, driven by accelerating growth in cutting and welding, while marking and engraving increased by a high single digit percentage year over year. Revenue from other applications increased 19% year over year from strength in telecom and advanced applications. The contribution to revenue from OptiGrate, which was acquired during the quarter, was not significant. Page 5
Second quarter revenue in our largest region, China, almost doubled year over year and represented half of total revenue. High-power laser sales for cutting and welding applications drove the majority of the nearly $90 million revenue increase in China versus the year-ago period. We also benefited from strength in QCW laser sales primarily related to consumer electronics applications, as well as from high-power pulsed and other laser products. As Valentin noted earlier, we believe the pace at which our fiber lasers are replacing conventional lasers and non-laser-based technologies is accelerating. This trend is especially pronounced within China, where the local machine tool OEMs have been faster to adopt fiber laser technology than other regions. As a result, within cutting and welding applications in China, we are benefiting from the displacement of CO2 and YAG laser systems, machine presses for punching and stamping of metal, and traditional spot and arc welding equipment. In the US, second quarter revenue growth accelerated to 20% year over year, driven by welding applications and a solid contribution from telecommunications. Although auto-related welding sales in the region were down largely due to project-related timing, we saw strong growth in welding lasers and systems sold into the medical, aerospace, and general manufacturing industries. Europe also grew 20% year over year, with notable strength in welding applications into the automotive, heavy industry, and general manufacturing industries. High-power laser sales for cutting applications also grew strongly as our largest cutting OEMs in Europe are moving, as Valentin mentioned, to high-power lasers at 10 kilowatts and above. Sales in Japan declined 3% year over year. Although we remain optimistic about multiple welding-related projects and growing OEM cutting sales in the region, we have yet to see this fully materialize. It Page 6
should also be noted that Japanese cutting OEMs place many orders outside of Japan. We expect a rebound in sales within Japan during the second half of the year. Turning to performance by product, high-power laser sales increased 57% year over year to a record $222 million, contributing more than two-thirds of the incremental revenue we generated in Q2'17 versus the year-ago period. We saw good revenue fiber lasers at 6 kilowatts and above again this quarter as these lasers are increasingly adopted for high-power cutting and welding applications. QCW was another standout in the quarter, with record sales of $29 million growing 82% year over year from strength in fine welding for consumer electronics applications and percussion hole drilling for aerospace applications. Based on historic consumer electronics build cycles, we expect QCW growth rates will begin to moderate during Q3 with the completion of key capacity additions. Medium-power laser sales increased 11% as increased demand for fine welding, wafer inspection, and 3D printing offset softness in cutting. Within lower end cutting applications, we continue to see many OEMs transition away from medium-power, adopting high-power lasers at 1 kilowatt and above. Pulsed lasers sales grew 12% year over year. Sales of high-power pulsed lasers used in marking and engraving as well as ablative, cleaning and stripping applications increased more than 50%, being partially offset by a decline in low-power pulsed laser sales. Finally, sales of other products increased 53% year over year due to strong sales growth in systems and accessories. Working our way down the income statement, gross margin of 55.9% was up 140 basis points from Q2 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 Page 7
favorable product mix. Q2 operating income was $141 million, or 38.2% of sales, up 60 basis points from Q2 2016. Excluding foreign exchange losses, operating margins increased to 40.2% from 37.0% in Q2 of 2016, well above our guidance range as we leveraged our costs over higher sales volume. We were pleased to have achieved leverage in sales and marketing, R&D, and G&A despite higher spending related to product development, new applications and manufacturing processes, and the expansion of our sales force and global service capabilities. Our tax rate in the second quarter was 26.5%, including a $3 million benefit from stock options exercised and RSUs released during the quarter and a $2 million benefit due to the release of reserves related to uncertain tax positions upon the conclusion in Q2 of prior period audits. These tax benefits increased EPS by $0.10. In Q3 we expect the tax rate to be approximately 30% excluding any effects relating to equity grants. Net income for the second quarter was $104 million, increasing 55% from Q2 2016. Earnings per diluted share were $1.91 for the second quarter compared with $1.25 a year ago, and above our Q2 guidance range of $1.50 to $1.70. Foreign exchange loss decreased EPS by $0.10 versus the year-ago period increase of $0.02. If exchange rates relative to the U.S. Dollar had been the same as one year ago, we would have expected revenue to be $11 million higher, gross profit to be $8 million higher and operating expenses to be $1 million lower. We ended Q2 with cash, cash equivalents, and short-term investments of $930 million and total debt outstanding of $23 million. Our current level of inventory on hand amounts to approximately Page 8
145 days, which is below our target range of 2 turns or approximately 180 days. Days sales outstanding were 58 at quarter-end, compared with 55 a year ago. Cash provided by operations during the quarter was $82 million. Capital expenditures totaled $22 million for the quarter, and we continue to expect $90 million to $100 million of capex for the full year including approximately $15 million to upgrade our corporate aircraft, net of proceeds from selling the existing one. During the second quarter we repurchased 91 thousand shares for $12 million as part of our antidilutive repurchase program and have now repurchased 301 thousand total shares for $33 million since the program began last July. Turning to guidance, for the third quarter of 2017, we expect revenues to be in the range of $350 million to $375 million. We anticipate Q3 earnings per diluted share in the range of $1.70 to $1.90. The mid-point of this guidance represents quarterly revenue and EPS growth of approximately 36% and 40%, respectively, year over year. Year-to-date bookings have exceeded our expectations, pointing to strong revenue growth in 2017. Based on first half outperformance and current backlog, we are now targeting approximately 32% to 34% revenue growth for the full year. Our fourth quarter performance will be driven by order activity through the end of the third quarter and during the fourth quarter, for which our visibility is low. Given the magnitude of outperformance during the first half of the year, we believe it is prudent to assume a lower growth rate in the fourth quarter due to more challenging comparisons and an expected slowdown in spending related to typical seasonality in China and the consumer electronics investment cycle. Should this anticipated spending slowdown fail to materialize at a level consistent with historic trends, this could result in upside to our full year guidance range. Page 9
As discussed in more detail in the "Safe Harbor" passage of our news release today, actual results may differ from both our full year and quarterly guidance due to various factors including, but not limited to, product demand, order cancellations and delays, competition and general economic conditions. This guidance is based upon current market conditions and expectations, and is subject to the risks outlined in the Company's reports with the SEC, and assumes exchange rates relative to the U.S. Dollar of Euro 0.88, Russian Ruble 59, Japanese Yen 112 and Chinese Yuan 6.77, respectively. As a reminder, we do not attempt to forecast changes foreign exchange rate. With that, Valentin and I will be happy to take your questions. Page 10