IPG Photonics Corporation (NASDAQ:IPGP) Barclays Capital Global Technology, Media and Telecommunications Conference Call May 22, 2012 10:45 AM ET
Tim Mammen – Chief Financial Officer
Olga Levinzon – Barclays Capital
Olga Levinzon – Barclays Capital
Good morning everyone. Thank you for joining us. I’m Olga Levinzon display and lighting analyst of Barclays. And this morning, it’s my pleasure to introduce Tim Mammen, CFO of IPG Photonics the leading fiber laser company in the world. And I’ll turn over to Tim.
Great, thank you, Olga. Just want to draw your attention first of all to our Safe Harbor statements and the fact that we will be making forward-looking statements during the course of this presentation. Actual results could differ from those forward-looking statements and I also just want to draw your attention to the risk factors that are outlined in our quarterly filings with the SEC.
Having said that, I'll move on to talking about the company. IPG released credit suite with being the company that commercialized this unique fiber laser technology. The company was started about 20 years ago and has grown very rapidly particularly over the last three or four years as fiber lasers have become more and more widely accepted. We are replacing traditional technologies. The laser market itself also is growing as new technologies are being developed the used lasers and also lasers displays non-laser technologies in them as primarily in the machine tool business.
We have a very nicely leveraged business model. We sell our product to OEMs and end users who when they qualify our lasers for using their systems results in multiple units being sold on a going forward basis. The company really is truly global with over 2000 employees and major manufacturing facilities around the world. We really are very proud of the fact that we are the leader and most profitable company not only in the fiber laser market, but the most profitable company in the entire laser sector altogether.
The laser market is significant. We currently are really focused on selling products into the laser source, so the laser source is the engine that drives the laser systems. That market is about $3.8 billion and I've got a slide to breakdown for you provides more information to that. The laser market is growing at about 7% to 9% per year. The estimates are it will grow at about two times GDP and that’s really a reflection of the fact that lasers are becoming more and more widely deployed in different application, in particular the ease-of-use and cost of the devices comes down and fiber is driving most of the changes.
The fiber market grew about 27% from 2006 to 2011 and then last year at almost 60% as we started to rapidly penetrate into applications like cutting or significant growth in welding applications in the automotive industry. The company has many competitive advantages. A couple of the more significant ones are that we are very deeply vertically integrated. So, we don’t just produce the laser that we have a very deep venture of optical components that we manufacture internally, very deep skill sets, know-how processes, invest in manufacturing and capacity in many of those optical components.
The IP portfolio is very deep. It encompasses not only our semiconductor diodes and the way that we package them, but a lot of the optical components for the use to combine the light from the diodes into the optical fibers. And the vertical integration surrounds the optical components and then the final manufacturing of the laser is what helps us to drive the stellar margins that we have. In 2011, our average gross margin was just about 54%, Q1 of this year, it was approaching 57%.
One of the things I liked about the business is its diversity. I mentioned a couple of applications welding, cutting, there are more esoteric applications out there, for example, 3-D prototyping. We sell product into the microelectronics industry for marketing and graving and newer applications, for example, people doing research into using lasers to drill oil and gas wells. So, on top of the applications, there you have tremendous geographic diversity as well with sales spread around the world in Asia, Europe and North America.
The following slides really look a bit more the existing laser markets and fiber share and how that has changed over the last four years. So, the laser source market itself has grown from about $3.4 billion to $3.8 billion and fiber share has gone from just under $200 million of about – to about $600 million in 2011. The average growth rate over that period above 31%.
Looking further forward, the market analysis that exists and that's really around the currently deployed products that we have, we don’t think that this captures opportunities, for example, the more recently introduce QCW laser into the replacement for a solid state laser and also the ability for IPG to start producing laser different wavelengths like green and UV has not really captured in this analysis here. But what you can see is the overall laser market continues to grow very strongly approaching just under $5 billion in 2015 and fiber grows at an average rate of about 23% to about $1.4 billion. If IPG can maintain its market share, which is very strong at the movement, we have a very strong belief that we can grow the company to more than $1 billion in revenue.
Looking at the laser source market, the largest part of it is materials processing and that makes up 85% of our sales. We break that down and the industry also breaks it down into five different areas. First of all is the high power macro processing for welding and cutting, that’s about $1 billion market. Fiber has grown to about 20% of that or $220 million. IPG is really the leader in producing high-power lasers. Few companies are starting to introduce products to compete with us. We think our share of the high power business continues to be above 90%.
Metal marking which we've been selling lasers into for about 15 years is that a market that's just under $300 million and fiber has already grown to about 60% of that. The marking and engraving business has grown very strongly over the last three or four years as more lasers are used, zero number of parts with traceability as an example or the mark and engrave consumer electronic devices. What I like about the marking and engraving business is that 63% I think is a good proxy for how fiber can penetrate into the other parts of the market and demonstrates significant runway that's ahead of the company for example in high power.
The micro-processing fiber has about 21% market share and that’s the market that we think we can start to address a lot more of and I have started to do so with the QCW laser. This is a laser that has a low average power at a high-peak energy as a replacement for a very inefficient lamp-pumped YAG laser. It only has 2% electrical efficiency as compared to IPG's 30% electrical efficiency. Penetrating that market is a very similar story to penetrate in the other markets. We first introduced a product that had all the technological benefits and we then have to bring the cost of that product down to make it competitive with the Nd:YAG laser, so that the people can start to realize the efficiencies and cost savings almost immediately, rather than waiting for them over a four or five-year period.
The newer parts of the market that we are starting to get into, for example, non-metal marking or another $200 million we have a laser in a different wavelength that results for example in welding plastics and marking plastics have been extremely good. We think whereas our sales into that market are virtually at the zero at the moment because we did not have a device that was capable of processing those non-metals. Those should start to grow in the next couple of years. And then into fine processing which is lasers are green and UV applications include the semiconductor industry, LED, OLED, organic LED as well and annealing flat panel displays.
Slide just shows how the fiber laser market is broken down? I said that it's dominated by materials processing and you can see here materials processing will continue to be the major share of the market. There is also there an interesting couple of other interesting parts of our business, the advanced applications business. There are significant opportunities that could develop in that area, for example, in using lasers to destroy other materials, for example, incoming missiles or motor or auxiliary. The use of lasers in drilling oil and gas wells. This is now becoming more of the reality than it ever has been with the lasers softening very hard rock reducing the wear and tear on drill bits and substantially reducing the cost of drilling those wells. Our medical business is pretty small, but there are increasing opportunities that exist there not just in esthetic procedures, but also a more surgical application.
So, I talked a little bit about the diversity of our businesses slide brings us down into some of the end market that we sell into automotive, general manufacturing, 2D cutting, and 3D and 4D cutting as well as marking and engraving applications. Heavy industry we saw lasers into the nuclear industry for welding – welding, oil and gas pipeline, ship building, making locomotive engines.
In aerospace, our lasers are used to weld titanium. We are working on a new application to displace CO2 drilling very fast high-speed percussion drilling of holes in turbine blades and fans to assist the cooling of the fans, which improves the fuel efficiency and reducing the noise of engine. So, lasers are really enabling a lot of these advances in technology that are required not just in the automotive industry, where high stream sales, deals are being deployed, but also in the aerospace industry through fuel efficiency. We do sell lasers into the semiconductor and microelectronics business doing welding and batteries, for example as well as marking and engraving on microelectronic products. And even in the consumer industry, our lasers are used to weld razorblades. If you look at razorblade, it has a series of microdots on it. Those are all laser wells.
I mentioned that the laser itself goes into a system and the following slide really gives an example of the fact that the laser is really estimated anything about one-third of the value of the total system sold to the material process. So, the total laser systems market is actually about $8 billion. IPG has articulated many times that we intent to discretely enter different areas of this market. In particular, where we either don’t compete with our existing OEM selling 2D cutting systems or low value add marking and engraving systems where our existing customers don’t sell in different geographic areas. So for examples, many of our customers do not have much sales will leverage in Russia where we recognized is being a technology that we've started and developed there so, we intent to start selling some cutting systems in Russia.
In other areas of the market though, we are looking really to leverage the use of lasers in welding applications in particular. And the laser is a significant part of the value add in the welding system is made strategic very small acquisitions in Germany to develop a welding head is being qualified by different automobile manufacturers at the moment. So, we are targeting very specific areas of the system business where we think we can leverage the technology, accelerate product line penetration into different end markets. And I’ve already talked about some of the areas on non-metal processing and the micro and fine processing market as well.
I mentioned briefly the leverage that exists in our business model. So, one of the interesting things about the laser industry is once you qualify your product with a customer whether it be an end user or an OEM who will put the laser into their own system. That initial qualification will of course result in an initial sale it's what happens down the road that's very interesting, because as those customers increase the use of their lasers in their manufacturing facilities, they will buy more and more lasers from us.
We have automotive customers, who we qualified with in 2007 and 2008, who bought over the 70 lasers from us. We have OEMs who produced marking and engraving equipment by over 2000 pulse lasers from us and really the very little sales activity required to generate the ongoing revenue that arises from that. So, there is a very nice element of leverage that exists in the distribution model of IPG.
Now, the distribution is held by our global reach. We have major manufacturing facilities in North America, Germany, and Russia in sales and distribution offices all around the world. We’ve invested significantly in headcount since 2008. So, you can see here and also in our application expenses. We held companies and customer sold their application problems. They will come to us with a material if they want to process and we will develop the processes for them, solve their problems, improve the efficiency of what they are doing. Example of that is high-speed drilling of holes in the aerospace industry, where just about every single engine manufacturers working with IPG to protect that process.
We did a lot of the internal work ourselves there. So, the application centers and the expertise that we have in the ability of people who know how to use lasers should not be understated. The renewal applications that come to the floor, for example, high-speed platting, which is a deposition technology that will enable you to take for example a low cost piece of steel and cut it in a rust resistant material. We do much more cost effectively even casting the piece of metal from – early from the corrosion resistant material.
IPG’s technology is very unique I’ve mentioned the vertical integration that we have. We produce all of the components that are used to make a fiber laser and we've invested in the R&D in each of those areas very significantly over the last 10 years. For example, we introduced our diodes to the market in 2000 – at the end of 2003, continued to improve the reliability, the power that we can generate from the diodes, scale to our manufacturing and production and reduce the cost per watt on the diodes. I’ve got a slide later that shows how dramatically that cost per watt has come down. We’ve modified the way that we package the diodes varying from a single semiconductor chip we now package up to 10 semiconductor chips in a very compact device. The diodes are a very efficient way of generating an optical output from an electrical input.
Crucially though you need to take the light that's generated from the diodes and efficiently couple it into the fibers that converts a relatively poor quality light output into a very high quality output. And IPG has whole of that core technology around the coupling as well as around the active fibers, so we draw our own fibers from the glass preforms that we make. We make our own fiber Bragg gratings which are the mirrors that were embedded within the fibers. We’re now also manufacturing a lot of the accessories that go with the lasers. So, for example the process fibers, the optical heads, the beam switches. As we brought our manufacturing in-house, we've been able to improve the profitability on each of those items, some of which can comprise a significant part of the selling price and that’s helped with the profitability of the overall company.
This is very scalable technology. We go produce lasers with the output power loads 5 watts and the largest laser we ever sold is 50,000 watts in output power where the customers wanted 2, 3, 4, 6 or 8 kilowatt lasers very easy for us to scale to that power output. The reason why fiber really is gaining market share is because of the unique advantage of the laser. I’ve mentioned the scalability of the output power. The output beam is very homogenous, so it delivers the energy very uniformly to the work place that enables you to weld with greater quality. Higher the quality of the welds, the pure welds that are required to achieve a certain strength, structural rigidity in the components that you’re building and also the speed of the welds can be improved. The same beam quality drives faster cutting speed.
The electrical efficiency our device is about 30%, comparable electrical efficiency of competing technologies ranges from as low as 2% to the maximum of about 15%, so we’re significantly more electrically efficient. You can build our lasers with different wavelengths, so we are increasingly starting to do that opening up new applications for example, I mentioned welding plastics. And the footprints of our lasers is significantly smaller, it’s a very a compact robust monolithic device. It is vertically maintenance free. The optical components do not require replacement. Our view is that what you want to do is you want to have a laser that has significant uptime driving throughput and productivity the end user and then ultimately when the optical components do degrade they replace the laser rather than continuously repairing it.
And all of that drives lower total cost of ownership, improve productivity. We have examples of customers who have retrofits, fiber lasers on line to what previously using Nd:YAG lasers and they’ve doubled the throughput for example on welding cars and on our production line from 30 units per hour to 60 units per hour. The payback that you get when you deploy fiber can be in a matter of months when those are the productivity gains that are achieved.
This slide just gives you an example of the Blue Chip customer base, the company has, we sell to all the major automotive manufactures around the world, many consumers and electronics device companies and other major users of laser. Customers really chose IPG’s fiber lasers because of those advantages that I’ve chosen or highlighted to you previously. And even compared to other people who are introducing fiber lasers into the market, we believe we continued to have a very, very deep technological advantage that’s driven by the vertical integration, the deep component base that we have. We have a significant selling price advantage over everybody who is trying to introduce laser to the market.
So, competitively we remained well ahead of everybody else and they are trying to build laser that is fundamentally different from any type of laser they tried to build before. There is no similarity between a CO2 laser in the optical component base, on the fiber laser.
Other reasons why customers choose these, I mentioned already improved productivity, the range of materials that you can work on. The lasers are very easy to use and integrate cost. It takes as a matter of hours to install one of our lasers, where CO2 lasers and other systems are much more complicated to implement with mechanical mirrors that have to be aligned.
Vertical integration is a key advantage of the company. I mentioned it helps us to reduce costs crucially also, we control the quality inside the company and we are also able to innovate far more quickly by producing the components internally. If we identify a change that needs to be made to the product, instead of waiting months for that change to happen and having someone on the outside, the IPG is able to drive that change very quickly internally.
These are the key attributes of our defensible position, a very strong IP portfolio, increasing number of patterns that we are filing, to complement the existing patent portfolio we have, vertically integrated business model and also the manufacturing sale and that's really demonstrated here. This slide looks it how diode production has increased since 2003 when we will be producing approximately 25,000 or 30,000 diodes a year. We now produced 1.2 million chips annually and driven the cost per watt of diodes down from about $80 per watt through this year, it's a $3 per watt.
So, really fundamental changes in the cost of the laser that will improve the productivity of the – profitability of the company and also enabled us to reduce the selling price of the laser to make it competitive with CO2 and Nd:YAG lasers. And naturally what's driven some of the tremendous growth we've seen over last two years. People no longer have to wait to realize the cost savings and lower total cost of ownership from using fiber they can start to realize that almost immediately now.
Mentioned the global production facilities, we've invested heavily since the company is being public. We have major manufacturing facilities in the United States, in Germany, and in Russia had investment continues on this year, we will spend between $55 million and $60 million investing in final assembly, component production, and expanding the diode in semiconductor facility we have in the United States. Those are just the couple of examples of where we continue to invest.
I just talked briefly on the financial overview. Last year, revenue grew at about 60%. The average growth rate of the company is being about 27% from the last five years, mentioned how diversify the business model is and I'll show you how the vertically integrated this is all actually benefits gross margins as we get leveraged from manufacturing and also leverage of the sales and R&D functions. You can see here how gross margins have steadily trended up with from 2006 to 2008. 2009 with a decrease in revenue in the middle of the financial crises, we were utilizing capacity much less, the capacity utilization went from about 70% in 2008, down to less than 50% in 2009. But rapidly client backup, we are now utilizing our capacity between 85% and 90% with gross margins up to about 54%, 55%. Medium term range on gross margins is about 53% to 55%. If we do have quarter where we take revenue, you to take inventory down and utilize manufacturing less than a quarter, you may see gross margin a little bit below that, but as soon as you bring the manufacturing backup that will recover.
Coming as a track record of dropping the improvements in gross margins down to the operating line and that evidenced also on the slide here with operating margins approaching 37% at the moment. OpEx is currently running at about 18% of revenue, relatively comfortable with that number in the near-term, three years out that may have to up go as we get into more of the systems business. But this year definitely 18% on OpEx is a pretty reasonable number. 91% of our sales comes from selling five lasers, it's our core strength, the core capability of the company, anybody just trying to get into this business. This is not that core capacity and it's not a core strength they are trying to catch up with it.
The slide just shows how different product lines are developed over the last year. High power laser is growing to be the biggest product line and that's the reflection of the fact that the macro-processing market is the largest opportunity out there and is the cost of the high power laser is come down has been able to compete much more directly with CO2 and the disc laser with lots of our competitors. The pulse business was the largest part of the market until 2009 or largest part of our sales and that’s because we've been in that business for about 15 years. And what we’ll see now is the medium power and QCW business growth as we started to get into more of the micro-processing.
The scale in our manufacturing is exhibited on this slide where total unit volumes have increased dramatically. We sold about 22,000 lasers last year. There is actually a slight error on this slide. The total amount of kilowatt power that we sold was 3,200 kilowatts of power not 2,200 kilowatts with tremendous growth in high-power laser sales.
The company is in the enviable position of having a very strong balance sheet. We have about $380 million of cash and cash equivalents, $70 million of short-term investments, has about total of $395 million. We expect to spend about $55 million to $60 million on CapEx this year as we invest in product manufacturing and developments. And the other thing I’d like to draw your attention to is the return on invested capital is quite high and the return on shareholders’ equity when you take into account the substantial cash power that we have is also very significant.
And with that, I think we’ll – the conclusion on this presentation. I think we do have a breakout session that’s going run for 20 or 25 minutes in one of the other rooms. The next slide, just look at the actual results in the first quarter, but I’ll draw a conclusion here.
Thank you very much everybody.
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