IPG Photonics Corporation (NASDAQ:IPGP)
Bank of America Merrill Lynch 2013 Global Technology Conference Call
June 5, 2013 6:15 PM ET
Tim Mammen – Chief Financial Officer
Krish Sankar – Bank of America Merrill Lynch
We have Tim Mammen the CFO is going to make a presentation and then we will open it up for Q&A after this.
Hopefully we have a presentation. Great, thank you. Just before I start, I want to draw your attention to the Safe Harbor statements. Statements in this presentation relates to future plans, eventual performances are forward-looking. These statements involve risks and uncertainties included but not limited to risks associated with the strength or weakness in the industries or geographic markets we serve. Should reference our 10-K and 10-Q to get a more detailed breakdown of some of those risks and these forward-looking statements may or may not happen as we mention them here.
Couple things I’ll talk through this presentation pretty quickly and then open the floor up for questions. Some of you have probably seen it a couple of times. Some of the market data is in the process of being updated. So we still got some of the older numbers in here.
But really, IPG is credited with the company that’s commercialized by the laser technology. We are gaining rapidly share against traditional laser technologies like CO2 and Nd:YAG.
We are also starting to displace non-laser technologies so for example in the welding business, resistance spot welding, wire based arc welding applications and technologies and we believe in other big growth area is some of the deposition technologies.
So for example, historically, cladding applications have used either lot of explosive techniques to cover large pieces of metal or plasma to melt and deposit different kinds of materials on surfaces to harden or strengthen that.
We sell our products to OEMs around the world and systems integrators and as well as end-users that provides us with a nice degree of leverage within our business model. The company has global operations, manufacturing in the United States, Germany and Russia and about 2400 employees around the world
I’ll go through some of the market data but we basically sell laser sources so what that resonator is the light source that goes into laser systems, the market laser sources about $3.8 billion.
The total market for systems is about $10 billion. So systems three times value of the laser source market. The fiber laser market over the last five years is growing about 24% and even in a difficult year, 2011 to 2012, growth was about 19%.
IPG’s got several advantages that I’d like to talk about, we’re obviously the first mover advantage in this market produce a very wide range of products. We are extremely vertically integrated so we have a lot of control over our IP and development cycles and we are one of the lowest cost producers of any type of laser in the market today. So even CO2 YAG lasers.
Despite that low cost, which enables us to penetrate these new applications and given the vertical integration, we do have industry-leading margins both the gross margin level and operating level. We sell into a broad and diverse number of end-markets, both in terms of applications and I’ll talk a bit about those later as well geographies.
Sales in Asia and the Far East about 45%, Europe about 36% and North America about 19%. One piece of information we felt to give is on our last call and this is the first opportunity, but it’s publicly given in a public broadcast is what were our Chinese sales in the first quarter.
People were skeptical that we haven’t given that number, because it was actually weak. Chinese sales in the first quarter about $37.2 million and grew by about 28% year-over-year.
Order flow out of China was very strong in the first quarter and continued to be strong through the end of April and indeed order flow around the world has continued to be pretty strong through the end of May. So that points to continuing bit of momentum in our business as we go through the year, Q2 and then Q3. Seasonally, Q4 can be a little bit weaker.
Another question actually been asked for a couple times, why our sales in North America primarily weaker for the industrials business, so that’s large manufacturing based and that really related to the history of the laser industry. Industrial lasers were primarily used in Europe and Japan. So Asia and Europe in the past.
North American use of lasers tends to be from companies that have developed in the more advanced manufacturing areas, so photolithography and the semiconductor business, some of the biggest laser companies in the medical sector are American based more and more advanced applications in Laser Lift-off or dicing and scribing wafers and particularly also in the R&D markets.
So those are historically been the really strong areas of laser sales in North America. Most of the industrial laser companies actually originated in Europe and that has moved into North America and starting to distribute products there.
So we are now starting to see the automotive and general manufacturing industries increasingly use industrial grade lasers whereas they had lagged the rest of the world diode a little bit.
I mentioned that the total markets the laser sources was about $3.8 billion, that’s expected we have reasonable GDP growth to grow at about 5% to 7%, maybe a 4% GDP growth you might get to 9% growth on the underlying laser market.
The growth rate for fiber lasers from 2011 through 2015 is expected to be in excess of 20%. Fiber had penetrated about 15% of the total laser market a year ago. It’s expected to get to about 30%. We believe that as we introduce new products of different wavelengths, we should see that penetration actually exceed those levels.
One of the reasons it’s fairly liked today though is that we’ve been primarily focused on the materials processing market which is about $2.8 billion and within that materials processing market, IPG’s strength for the last 10 years has been on processing metals.
The metal part of the market is only about $1.8 billion and probably grew a little bit last year so it maybe a little bit larger than that exiting 2012. Our sales into the materials processing market last year about $500 million.
So total penetration into the metal materials processing is starting to approach 30%. It’s a little bit below that level. We think and it’s now widely accepted by the industry that penetration at least into the materials processing for meta l will approach the level of 50% to 60% over the next two to three years.
IPG’s belief is that once you get to that level there is no reason for adoption not to carry on to 70% or 80% given the advantages of the technology. Some of the older technologies will probably continue to reside in more specific applications, for example of processing of textiles, some of the strength that they have on the plastics.
The two slides, the two columns rather on the right hand side of this slide are about $1 billion of opportunity in materials processing still, but what’s called we call fine processing and non-metal processing. The fine processing market is primarily green and UV lasers.
They are most widely deployed in photolithography, which is over half of the $800 million. The remaining part of that $845 million market is a fast-growing segment that uses UV and green lasers for different types of processing.
Examples of that includes via hole drilling in PC boards, dicing and scribing wafers in semiconductor, Laser Lift-off and ablation processes for example within LED or the solar application.
There is also a large part of marking and engraving that uses UV lasers to mark plastics. So for example marking of white plastics as well as marking of plastic cabling in the aerospace industries predominantly done with UV. Aerospace cables are heavily marked in very, very short intervals for identification purposes.
IPG is being really pushed to introduce our UV lasers as fast as possible to the market. Because we know that we’ll be able to get to market the lower cost than the existing devices.
Gaining rapidly share and hopefully spanning the total universe that our lasers are being used in. So we are trying to get UV laser introduced within the next six months or so. We made recently an acquisition that strengthens our ability to convert our existing lasers to UV and complement some of the technology we had in-house.
That acquisition hopefully will enable us to get a more reliable device at a higher power level into the market earlier than otherwise. We would be very pleased over the next couple of years of that non-lithographic market which I said is about $300 million to $400 million.
If you get the 20% of that market, so anything from 60 plus million of revenue adds quite significantly to our overall opportunity and then over time we’d like to see our lasers grow much more deeply into that end-market.
Talked a bit of already about the potential growth of fiber lasers over time, the next two to three years the market is expected to get to approximately $1.4 billion. In terms of the applications that we address, materials processing is actually now more than 90% of IPG’s sales, and again it’s a reflection of the size of the markets that we address.
We sell into many different industries, automotive being a large part of us. For example, in the automotive industry the transition to high strength steels to reduce weight, improve fuel efficiency, the increasing use of aluminum in vehicles.
These all play into our hands, because you need lasers to cut high strength steels, high strength steels are not welded, particularly well with traditional resistant spot welding. So the quality and strength of the weld that can be achieved with the laser is increased, has that strength has increased the number of welds that is required is reduced and also the amount of overlapping material to make the welds could be reduced as well.
In general manufacturing, you’ll see our lasers going to anything from consumer products, to making elevators, buses, outside of the traditional cars and light trucks, heavy industries like ship building, store a nice pick up in aerospace sales in the first quarter of this year.
We are starting to penetrate the market for very high speed drilling of holes and turbine blades of fans. That assists with the cooling of those turbine blades and fans, again improving fuel efficiency in the engines because it allows the engines to operate at a higher temperature than at the melting point of alloys that make up those blades in fans.
We do have a small part of the business that goes into the semi and electronic sector. We hope that that would grow in size, we introduced the UV lasers. And on the consumer side, even the razor for example that you may use, the dots on those blades are welded with lasers and primarily done with IPG’s fiber laser.
In terms of our distribution model, one of the things I like to talk about here is that we get a bit of leverage. So, for example, when an OEM qualifies our laser in their system, every time they sell a system after that, we generate a laser sale. So we have a sales force that is really effectively off our balance sheet.
Even on the direct sales side, when we qualify with end-users who are not going through an integrator or an OEM, but choosing to integrate the laser themselves directly in their manufacturing processes will often end up with multiple year relationships and potentially hundreds of lasers sold to the end-user.
So, for example with the razor blades we retrofit about 300 lasers over the last six or seven years. The automotive industry we have with certain German manufacturers up to 70 lasers deployed with just recently obtained a new order from one of the German automotive people for a 100 unit laser that we expect to be deployed over the next 12 months or so.
So even the direct sales results in long term multiple unit relationships. Continued to invest in sales and marketing around the world. Really strengthening sales people who got specific end-market experience.
So, last year for example, we’ve hired a couple of people based on the West Coast who started already working on some of the fine processing applications as we get product to the market. We are actually able to run some of the application works already with the UV lasers even though the laser hasn’t been introduced. Expanded the application laboratory for example in Detroit in North America, invested heavily in China and in Germany and also in Russia and then invested in the headcount as well.
But, it’s again is an area that we see that’s very important future investment areas are different geographies, so for example we are going to do that in South America, try and leverage into the industrial base there. What’s unique really about IPG’s technology is that we have all of the different optical components in-house.
Very deeply vertically integrated, I’ll talk about the benefits of that scale and how that brings cost out a bit later. The actual technology is extremely modular and very scalable. So by way of an example, our competitors are trying to introduce high power lasers are very excited about the one kilowatt lasers that they are bringing to the market.
Within a matter of weeks, IPG builds a 100 kilowatt laser and deliver that to a customer in Japan and marches the highest powered commercially delivered laser that we think that will been sent to the customer. That laser was installed within a matter of days and run up to 100 kilowatts very quickly. So ease of use and scalability of the technology are really very apparent.
Let’s look at from the competitors, we have been looking at some of the spec sheets that our competitors have got out there. They are continuing to use diode bar technology instead of the single emitter technology. It’s much more difficult to scale power out of bars because of the increase in the heat and the reduction reliability.
Some of our competitors are mandating that pressurize air be pumped into the fiber lasers. This leads us to believe that they must be free space optics within the laser. So they are not simply coupling the lights into all of the different components and splice them together because they probably try to stop contamination coming into the laser. So they are probably using some kind of cavity.
The light coming out of the diode bar and then collimating that light in a free space and try to pump the end of the fiber. IPG side pumps all of its fiber. So get all the energy into the sides of fiber. All of the optical components are spliced together and completely monolithic.
One of the people who introduced the fiber laser recently sales to callout what the wall plug efficiency of the device is. Now normally that’s one of the things you really should talk about with the laser, because its key advantages are the electrical efficiency. Our electrical efficiency approaches 35%. Based upon the calculations we are able to do so looking at the kind of power supply that was mandated with our laser.
We estimated the electrical efficiency to anyway about 15%. So you got a device that’s lower electrical efficiency. The beam quality was about 25% worth. Uses diode bars that require much more complex cooling with deionized water systems and having to pump pressurized air into this laser to stop contamination potentially from dirt.
None of that really makes that laser particularly suited in our opinion for used in industrial environment that’s extremely dirty and very dusty. Our lasers are extremely good for used in those environments and indeed can be used in the open air as well very robust. So we are able to scale our power.
We have great beam quality, very high electrical efficiency, can deliver lasers in multiple different wavelengths, expanding that wavelength both at the lower end of the spectrum and now starting to commercialize our lasers at two microns. The footprints of our laser is much smaller the weight of it is much smaller both compared to legacy technologies as well as some of the competing fiber lasers that the people are claiming and our maintenance and ownership costs are lot lower.
That’s evidenced in numerous examples that we’ve talked about previously where people are able to achieve much higher cutting speeds with the lasers and significantly lower energy consumption. One of the interesting things I think we are seeing this year is, really significant pull through from cutting customers driven by end user acceptance of the technology. So initially in the casting business we were very well recognized on doing thinner materials.
A lot of new Greenfield investments were clearly coming to IPG. The transition we can’t really see is because we are not that close to the end users because we are going through the OEMs but we believe that now we are starting to get into the job shop market much more deeply penetrated. So the acceptance of fiber can cut both thin and thick materials.
It’s much more widely accepted. So even a year ago the ability to cut thick materials was contested even we knew we could do it. That acceptance is getting there. And so you are driving into the job shops. I know a numerous sort of articles that we’ve seen recently about acceptance and job shops and the benefits the people are getting from using the lasers.
I talked about some of the improvements and wealth strength that can be achieved with the laser. Now this is pretty stuck here, so the yellow column shows the wealth strength of a fiber laser in – per square millimeter more than twice as strong as strong as a traditional resistant spot welder.
What this enables an end user do is potentially use 50% use fuel on a vehicle. The average cost about 3.5,000 spot wells, a factory producing 600,000 cars probably have 3000 spot welders. So you get half the number of robots because you can produce fewer welds and you can improve the strength of the weld.
The significant savings that may encourage adoptions with fiber technology despite the fact that the costs are little bit higher. In addition to that, there are significant electrical savings. Those electrical savings are dependent upon the cycle time of the resistant spot wells. So if you got a 100 millisecond resistant spot well, electrical savings are meaningful if the resistant spot wells starts to increase to 300, 400 or 500 milliseconds the electrical savings jumps very, very dramatically and the potential payback for adopting this technology drops.
We are doing a lot of work internally at IPG to really try and understand what the cost of resistant spot weld is we are not experts in that area. The most of the automotive companies won’t disclose that information to us. So we are engaging some consultants to enable us to look at where that cost and where we need to get to. Peak electrical loads on resistant spot welding approaches 70 kilowatts. So that means that the electrical power plants and the electrical infrastructure at the factories have to be extremely sophisticated. Peak electrical loads on seam stepper approached 10 kilowatts.
Another example is the benefit of laser welding versus mig welding. The cost of welding is partly primarily reduced because there is much less wire required. So you go down to about – this is an example given by one of our integrators $0.03 to weld a – compared to $0.27.
The major problem there is that, even though you can replace 6 mig weld at given the highest speed with one laser welder the cost of mig welding systems upfront is extremely low. But even we have to factor in that in and if you take into accent the throughput potentially 50% savings on welding cost.
Now most of the welding companies clearly spend most and earn lot of the money selling the wires, but they are going to vigorously defend this market and there are a couple of other limitations. The wire is also used as – regularly shape parts. So if you are welding very regularly shape parts, the amount of wire saving that you might be able to achieve could be more limited.
But there are clearly very big advantages on welding there. I’d mention high strength steel is a driver of our business. You can see here the growth in high strength steel that’s expected over the next five years. The latest numbers that are available actually show this growing even faster.
So that points towards increasing use of laser to cutting and the automotive industry is well as increasing use of lasers for welding given the difficulty of welding high strength steel with traditional technologies.
A small part of our business, but an interesting application in the first quarter was paint stripping. So this is a removal process, removing layers of paint from aircrafts. They do this every single time they repaint an aircraft because the paint is very heavy. So they don’t want to paint over it. One of our customers developed a completely integrated automated paint stripping system coupled with a vacuum it strips the paint, that the paint removes almost 100% of the residue.
It doesn’t require any chemicals which produce toxic sledge to remove the paint or plastic bead so the other methodology that is used is actually the bombard plane with very small plastic beads to remove the paint. Manual paint stripping for example of team requires about four people. The C130 Calgary plane will require a 16 to 18 people to strip that paint. So, this system can do it much more quickly and also in a much more environmentally friendly manner with one or two, I think one person can run the whole system.
IPG has a blue chip customer base around the world. I won’t go over customers one-by-one but they are in the presentation. Talks about one of the reasons, many of the reasons why IPG’s customers choose our fiber lasers, the vertical integration, so I maybe spend a little bit of time on. They will just reduce cost that the slide in this presentation that shows we – dive cost down from over $80 and down to between $2 and $2.50 ramping the scale of our production our well.
We can control quality. Can focus our R&D. So we have a huge amount of test data that’s been accumulated within the company over the last 15 years. Hundreds of millions of hours of test days around diode performance for example. Very short lead times, so our supply chain is in internal for the company and crucially this limits the spread of trade secrets.
So nobody they’ve been able to build significant volume within the supply chain to compete with IPG or enable IPG’s customers to compete with us. And what that drives is industry-leading gross margins and operating margins.
Slide just shows different areas of the integration that we got to, can reference this. So the diode is on the optical components. Increasingly the delivery systems of the laser. So the processed fibers, the beam switches, welding and cutting heads for example we developed scanning systems as well to enable high speed welding.
Very strong IT portfolio. Vertically integrated business model and another defensive part of our business is the manufacturing scale that we have. The ability to supply thousands of lasers, sometimes at very short lead times, last year we ramped up a production line for pretty specific type of pulse laser for the consumer electronics industry.
We ramped that production line in a matter of weeks, supplying over $5 million of products to a customer. I do not believe anybody else in the industry would have been able to do so. This year we’ll probably shift 2500 high power lasers. Our customers are trying to shift 10, 15 high power lasers a quarter. So, the difference in manufacturing scale between IPG and then the competition that are trying to get to where we are is enormous.
This slide just shows how we ramped up both the scale of our diode production in terms of chips producing more than 1.2 million chips last year and brought the cost down in 2012 between $2 and $2.50 that cost is not even fully backed into all of the bills and materials as of the end of Q1, for that 70% of the lasers that we are using at lowest cost diodes.
So this further benefit that will come through. Global manufacturing I mentioned as earlier in the presentation. And the financial review I won’t spend much time. I am sure you’ve all read about the financial read about the financial results from the first quarter.
If you look at our gross margins, here one thing I will talk about, just in to our distinction there is a lot of –there is a sort of back haze out there about IPG. This has been our margins are unsustainable. They are going to collapse by 1000 basis points and we believe that we are the price leader in the market we are the lowest cost manufacturer.
Gross margins have been a little bit unstable over the last few quarters, but I think what people need to understand you have to draw a distinction between whether that’s competitively driven or a little bit driven by where IPG is in its investment cycle. So last year we invested about $60 million in CapEx. It’s up to another $70 million that needs to spend this year.
As that CapEx come on stream the fixed cost will increase a little bit. As the business grows we have to absorb those fixed cost. We are investing in R&D to ensure get the UV product introduced. So, little bit of an impact on operating margins. Continuing to invest in sales and marketing. Again as the business grows, we are making those investments to grow the business and we’ll start to get a little bit of re-leveraging in the model.
And potentially those investments slow down. So you get through another phase of growth in 2014 maybe into 2015 where the amount of CapEx you are having to spend relative to revenue is lower than it has been for the last couple of years. So it’s very important to draw a distinction between where we are in our investment phase, both on CapEx and R&D and trying to get new products to the market and whether the sort of margin volatility is being driven by competition, it is not being driven by competition.
A little bit of an issue on the first quarter around the revenue number that was reported that was really related to the dynamics on the quarter and the ability to turn orders. So it’s a very strong ramp in order flow through first quarter. Book-to-bill significantly above one, order flows stayed strong through April, it stayed strong through May.
And that adds a good tone for the business as we look forward in the year. So again, I just want to make it very clear and you got to draw distinctions between where we are and really how much of this is being influenced by the competition rather sort of the challenges that we faced over the last six months with Europe and then seen this big ramp up in orders.
One person on the investment side said to me well, if course your book-to-bill was above 1 because your revenues were $8 million low where the street was at $150 million in Q1. Even if revenue be at the $150 million, book-to-bill would still have been substantially above 1. So contextualizing things like that helps a little bit.
That slide just looks at our total percentage of sales of fiber which about 90% and this breaks out our product line sales high power is by far the largest scale of the manufacturing and then finally sort of the strength of the balance sheet which probably everyone is pretty well aware of and try and quickly bring that to a conclusion so that open the floor up for any questions.
Krish Sankar – Bank of America Merrill Lynch
Great, thanks a lot Tim. And I think, thanks for the China number too. Appreciated and definitely a very interesting presentation. Learnt few newer things. Now you kind of highlighted that the order activity was strong through May, can you just refine about which geographies are you seeing lot more activity pick up given that Europe has been still little depressed, China seems to be coming off of bottom. Can you just give some color around the different geographies raising order activity?
So, it’s all pretty reasonable. I think, Europe actually is continuing to be strong. Europe was strong in Q1 lot of pull through on demand for cutting applications both in Northern Europe and Italy. It seems that actually some strength on the welding business in Europe.
So that has been very weak through the second half of last year and even in right into the beginning of Q1. In Asia, order flow in China continues to be strong.. So I think we are seeing adoption there I think our penetration into the Chinese market is probably ahead of some of the other markets both for cutting and welding applications.
And people are not quite so – holding to the older to CO2 technology because they hadn’t been deployed that for as long – as a large part of the market use the arc lasers, there is a less entrenched CO2 supply base there and people seem to transition towards fiber technology a bit more readily.
We have talked about some of the investments we made in Korea in terms of headcount and Japan. Our Korean business last year was about $24 million, $25 million. That performed very well in the first quarter. I expect the run rate on that business to double by the end of this year. Japan, with good order flow continues out of Japan.
Again, we’ve invested heavily in the sales force. Some new management there. So that’s starting to take effect. Also the other thing in Japan is we called out historically. We were not selling any fiber lasers into the cutting business in Japan. Now four companies qualified our fiber lasers and introduced cutting systems in the second half of last year primarily in July and August they introduced them.
So we are starting to see some ramping demand from those customers as well. North America, the advanced business is a little bit weak in North America and Europe, so just because the normal quarter than historically. No it’s right in Q1 it’s more like our 2012, 2011 quarters. It’s much more linear.
You are obviously looking at some very large markets on the industrial side. Could you give me some color in terms of the – specifically the spot welding market, very large broad based market. The cost of the laser spot welders are expensive or the rate which those comes down and what percentage of the cost of those welders is in the laser source? So how much control do you have over the speed at which the cost of those comes down to compete with the traditional markets?
So, we control the cost almost. So we supply both the laser as well as the unique welding head that basically mimics at normal spot welder and clamps on to the metal and then fires the laser within the mini enclosure. You are not having to really invest anymore on R&D or selling expense to achieve that sale.
So you pick up some of that gross margin deleveraging on the operating side and then lastly, even if you got a lot of margins on that, the return on capital employed is just so high that you’ll be full – not to take that business even at lower gross margin. It’s just, if and when it arises we have to communicate it.
Krish Sankar – Bank of America Merrill Lynch
It seems this is lot of time. Thanks a lot Tim, I appreciate the presentation and your time.
Great, thanks Krish.
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