Good morning and welcome to IPG Photonics' Fourth Quarter 2022 Conference Call. 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 me today is IPG Photonics CEO Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen. Let me remind you that 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 in IPG Photonics' Form 10-K for the period ended December 31, 2022, and our 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, February 14, 2023, 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 were posted on our Investor Relations website. We will post these prepared remarks on the Investor Relations website following the completion of this call. With that, I'll now turn the call over to Eugene Scherbakov.

Good morning everyone. I am pleased to report that we continued to see strong momentum in our focus areas such as e-mobility, welding and medical in the fourth quarter and finished the year with revenue above our guidance range, despite a challenging operating environment and currency headwinds. Our strategy to diversify revenue as evidenced by the performance of emerging growth products and applications is paying off. As we moved through the year, we continued to see record sales in e-mobility, medical and welding, including handheld welding applications. Our team has done an outstanding job diversifying the business and finding growth opportunities. Emerging growth product sales were 46% of our total revenue in the fourth quarter. Demand for many of these products was driven by global investments in e-mobility and renewable energy. IPG is well-positioned to benefit from accelerating global EV battery capacity expansion and our EV sales contributed close to 20% of total revenue in 2022, up from around 10% a year earlier. We believe that the battery capacity build-out will accelerate in North America and Europe and will continue to increase in China in the next several years to support growing EV sales. More recently, customers shifted investments into the U.S. to take advantage of government incentives, which drove higher levels of activity in the region. Our leading position in fiber lasers with a broad range of solutions including welding, cutting, cleaning and process monitoring has allowed us to capture the growth in these markets. We have recently introduced high wall plug efficiency laser drying solutions for use in battery foil manufacturing, the largest CO2 producing process step of battery manufacturing. The solution replaces less efficient infrared bulbs and environmentally unfriendly gas-fired furnaces. It can significantly reduce energy costs and increase drying speeds for our customers. We are particularly…

Thank you, Eugene, and good morning, everyone. My comments generally will 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 fourth quarter was $334 million, down 8% year-over-year due to foreign currency headwinds, which accounted for approximately 7% of the decline. Our divestiture of noncore telecom product lines negatively impacted revenue growth by approximately 2%. We also saw lower sales in general industrial applications in China and Europe, which were nearly offset by strength in emerging growth products. Revenue from materials processing applications decreased 6% year-over-year, and revenue from other applications decreased 23%, with strength in medical offset by weaker advanced application sales and the telecom divestiture. During the quarter, we conducted a review of our Russian operations and recognized significant charges related to inventory, long-lived asset impairments and restructuring. These charges are a result of the lower level of activity we expect given the increasing limitation of sanctions. GAAP gross margin was 18.2%, a decrease of 2,730 basis points year-over-year due to $74 million inventory write-downs and other charges related to our Russian operations. Excluding these inventory-related charges, gross margin was approximately 40%. We provide adjusted results in the appendix on Slide 11 of the presentation. Please note that adjusted results are non-GAAP items and while we believe they may be meaningful, these results should not be considered a substitute for GAAP measures. Gross margin was also negatively impacted by higher inventory provisions in the rest of the world, the strong dollar, scrap, shipping costs and import duties. These were partially offset by increased absorption of manufacturing costs in the quarter as we continue to build our inventories of safety stock. We are working to offset the impact of changes in the…

[Operator Instructions] Our first question comes from Jim Ricchiuti with Needham & Company.

First question I have is just a general question on the EV-related business that you're looking at in '23. I'm wondering how you would characterize the environment broadly? And maybe also whether you see some benefit in this business in the U.S. as a result of the Inflation Reduction Act? Or is that something you might anticipate being more beneficial in 2024?

Hi, Jim. It's Tim here. So we remain very optimistic about the EV business globally in 2023 and expect that to continue to grow. If you look at the sort of medium to longer-term trends in terms of battery capacity additions, we don't have final numbers for last year, but between 2022 to 2025 we're expecting to see a tripling of battery capacity and then another doubling of it beyond then. So we remain optimistic about that. With regard to the second question around the Inflation Reduction Act, we've actually seen some significant order that was delivered in Q4 that went into the U.S. and may have gone into another geographic region if that hadn't or part of it they're going into another geographic region without the act. And even in the first quarter of -- the first few weeks of this quarter, we've actually booked some significant EV-related orders in North America. So there's certainly some -- the Inflation Reduction Act has seen, you can point to some specific evidence of orders strengthening in the U.S. They may not be solely related to that, but certainly in some to some degree.

I would like to add something. For us, EV application is very important. Why? Because for such kind of applications, our customers is not only one of our second to products from IPG, no. As a lot of product, including the different kind of laser, CW, QCW, pulse lasers, which are using for different kind of production, for example, welding, battery, cutting foils, cleaning and so on. This is why, for us, it's very important because we can present to our customer a different kind of product, again, different lasers, different kind of subsystems and primary systems.

Got it. A follow-up question just relates to China with the reopening there, I'm wondering how much of a benefit do you see in the legacy business? Or are you looking at the improvement in -- from reopening being more of a tailwind that comes from the emerging areas of the business in China?

With the reopening, you will see some improvement in the legacy business, right? We still participate in the higher end of the cutting market, which is not necessarily defined by power, right? So the investments on that side, on the general industrial side have been pretty weak over the last 18 months or so. So we expect to see some improvement in that. But really, in addition to that, we want to see and drive -- continue to drive strong performance from the other applications where we clearly have a significant advantage and where the competitive dynamics are less. So the major outperformance or improvement probably coming from non-legacy but legacy contributing to some degree on that, the cutting business is at a very low level in China in Q4.

Our next question is from Ruben Roy with Stifel.

Tim, I guess, just a follow-up right on that point. Can you give us an idea of where cutting is as a percentage of your China revenue? And with China reopening -- I guess this is a question that also incorporates sort of the restructuring in Russia. So China reopening, cutting, where is it today and kind of how you see that playing out through the course of the year? And then that combined with Russian ops and as that impacts gross margin, I guess, is the real question for the year, how you're looking at your gross margin flowing through 2023 would be helpful?

China cutting was well below 1/3 of total revenue in Q4 and you saw China cutting revenue, was only about 34% of the total. So there's exposure to the consolidated basis, it's slightly less than 10%. So that's both a positive and a negative, right? You've got a lot of diversification away from it. We obviously like that business to be a bit stronger because it provides a foundation or formwork on the baseline of revenue. In terms of the cost structure and gross margin, there's a lot of different aspects to that question. Maybe not just the China supply chain. We've started to already supply a significant number of the lasers that were produced in Russia, the lower power levels. We're really supplying the medium power to lower power kilowatt lasers to China. We're already supplying a significant quantity of those out of Europe. We're already supplying at the lower power level the ultra-compact laser that has a significantly reduced bill of material costs. We're transitioning that up to not just 1.5 and 3 kilowatts, but already started almost 6 kilowatt, and we'll go to the 8 kilowatts. So you get some cost benefit out of that there. Overall, rather than just talking about it on the cutting side, all of the analysis we've done on gross margin despite this crisis that we've faced shows us that the cost structure of the business, and I said that I'd be able to talk about this more clearly this quarter. When we get into the second half of the year assuming some increase in revenue, we actually see a good improvement in gross margins from this point forwards as long as the macro stays relatively positive. And we actually don't see a fundamental shift in the gross margin cost structure related…

Well, thank you, Tim, for all that detail. That's great to hear. I guess just a quick follow-up then. You mentioned lower level of activity, which is kind of obvious with the Russian operations. Can you give us sort of a rough idea of where Russia stands today as a percentage of production kind of -- is there more to do? How low is you going to get? Is it going to get shut down? I mean any sort of longer-term detail around the activity there would be helpful.

No, we're not able to talk in detail about that at this point in time. We've got this review ongoing. Part of that review, obviously, the level of activity in that operation is going to be significantly lower. So that review incorporated a significant and substantial restructuring plan, which we've made really good headway on even in the last 8 weeks or so. The restructuring plan goes through Q1 and Q2, and then we're continuing to evaluate different options for that business, but we're really -- we don't have any options right now because we need to get through the restructuring. But really, the view point is that because of the restrictions on what you can do into and out of Russia is that business has to be self-sustaining on its local sales. At the moment, they can supply some basic medical devices to some of our regions around the world. But the whole plan that we looked at was to make it a self-sustaining business based upon local sales. And given that level of sales, we feel optimistic about increasing, but the total capacity that's needed there is going to be adjusted, and is being adjusted.

Our next question is from Mark Miller with The Benchmark Company.

I'm just looking at your backlog. Can you estimate what percent of sales are EV related in the backlog?

It wouldn't be dissimilar to our total revenue that we reported last year. So probably about 20% of it. I mean it will depend upon the timing of shipments as well. I know, for example, in the last couple of weeks, we've had a significant order for some EV-related products. So it wouldn't be dissimilar to the total share of EV on revenue last year, Mark.

In terms of how the backlog rolls out during the year, were you expecting an improving margin picture based on the current backlog?

Yes, that's because you've got some of the -- we continue to expect not just the current backlog but future order flow as well, right? We've talked about having a strong year on EV applications. We're rolling out the ultra-compact lasers at higher power levels. We're expecting obviously that given the improvements in the China business and generally speaking, we're optimistic about growing revenue during the year. So you get some scale back in the business that would also drive an improvement in gross margins. You've got other cost reduction initiatives that we're working on and things like the automation area that I talked about. So as I said, overall, it's interesting. You go through these crises, but when you come out of them, the degree and depth of work that's done actually sometimes leads you to certainly a much stronger organization. And coming into the second half of the year, we believe that we're going to see some meaningful improvements in gross margin.

And the emerging products typically carry above-average margins. Is that correct?

Yes, in general, you've got all the AMB, the high-power pulse, green lasers have got good margin. The medical has got good margin. LightWELD margins have improved a lot over since the product was first introduced both with new options and capability on that product and reduction in the bill of materials. So the LightWELD margin has improved. We expect our margin on our laser systems business, excluding LightWELD to improve. So for example, the margin on the cleaning systems, which is a much more standard system, that should have an improving margin profile as compared to historical one-off type systems that were sold for primarily welding applications. Actually the other thing out there is that we expect some better performance on advanced applications this year. Last year was a pretty weak year on advanced applications, we got a good pipeline of potential orders there and advanced applications have a good margin profile to them as well.

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

Tim, when we think of that manufacturing footprint, the full transition as you said, we'll see -- it'll become more clear, it seems like in the second half. Is it ramping up more in Poland, in Germany or U.S. just speaking about that second half, like how much of a percentage increase are we seeing in those areas versus where we were in Q4 right now by regions? Or any sense to see which one capacity is ramping up higher than where we were a year ago?

About components. First of all, of course we have transferred production in different areas in Poland, in Italy and Germany and also expanding our production in the United States. Comparison is difficult because we are producing different components in different areas. For example, in the United States, we produce components, especially for U.S. markets, for U.S. applications. In Europe, it's much more broader because in Italy and Poland also they produce different kind of components. It's not the same than in Germany. And from this point of view, of course, we have a good opportunity to optimize production. First of all, taking in mind the much more optimal process to introduce a lot of automation. It's one of the primary goals for organizing this production, first of all, components; but also in some cases, final devices. And from this point of view, we have a good opportunity to increase our production outside Russia, much more effective -- much more cost effective and much more productive.

And Michael, I think given your question, the benefit on like the Polish -- lower-cost Polish manufacturing is not -- that's really starting to ramp now, right? We didn't have any benefit from that in Q4 that was meaningful. The expansion, we did have some benefit from Italy, but that's going to be expanded. So a lot of the additional capacity that was initially put in because the capability existed there was in North America and Germany, and we expect these other areas to view the benefit going forward. I do want to be clear a bit that we go through -- continue to go through the restructuring of the operations in Russia. The first half of the year is going to have potentially some small additional charges, but we're also, for example, carrying some extra cost at the moment in Russia. We expect the restructuring process to take up until about May. So that's why I say that you come into -- the underlying gross margins in Q1 and Q2 will be able to explain pretty clearly. There may be some -- the word I'm looking for a bit of murkiness around the reported margins. And then when you get into the second half of the year, you've adjusted the cost structure in Russia and you've got the sort of full benefit from some of the Polish and Italian operations coming through and some of the other cost reduction initiatives.

Very helpful. And just welding in EV is obviously a very strong areas for you guys. Can you just help us understand the competitive dynamics there? Has there been any change there in the last one to two years when we think of welding in the EV space?

Yes, definitely. In the initial stage, we certainly are able to start to introduce our lasers for EV applications. Our first introduction of different kinds of lasers for welding, including our latest development -- developed laser was AMB, adjustable mode beam parameter laser. But now situation is different because for such kind of application we deliver not only lasers, but also our monitoring system, our scanners or special welding fence. And also now we are working to introduce to our customer the full integration solution, including all these components largely integrated with the same design and the same software. And for the future also see to penetrate to the EV market, not only by producing some components like lasers or some other subsystems to our customer. Our main goal to introduce and to deliver to our customer subsystem and systems for welding applications but also for cutting applications, but also very promising applications, cleaning applications also for EV market. And we have good opportunity using our high-power pulsed lasers and also our system based on these high-power pulsed lasers for cleaning applications for EV market.

Comparatively, it's really no competition still in China from anybody on the welding side. The company who will compete with most on EV continues to be the large German manufacturer. So the competitive dynamics haven't changed in that end market. On LightWELD, globally, that's really continues to be a very leading edge product. If you look online, you'll see there are some handheld welders advertised in China, but they're pretty large devices. They've got different cooling requirements. They're not really even equivalent to what we're producing.

They all accept only one important parameter, very low price in comparison to our product.

Perfect. And I guess just lastly, like you guys have done a lot of -- like you said, Tim, there's been a lot of work being done in diving deep into how you guys have handled a lot of these challenges. Is there any product -- I know this was touched on earlier, but is there any products you guys think about longer term, maybe shifting more your capacity towards the U.S.? Or I know it came up earlier about servicing the cutting market, the low end in China. Just curious with how you guys have transformed or transitioned away from Russia? Is there a different profile that you guys maybe will service going forward? Has that come into the picture?

I quite didn't get the question, but I mean there's a lot of -- for example, all of our diode manufacturing has been always and always will be -- not always will be, but it is still primarily in the U.S., right, all the semiconductor, most of the packaging. There is no specific. On the finished product is you're basically assembling different components together. So you can even change that depending on where your demand is. If we had excess capacity in the U.S. and wanted to supply a greater number of lasers to China from the U.S. because European demand for finished product was very strong, we could easily do that. The finished product side is very flexible as to where you actually make the end product. I'd say the U.S. does a lot. Obviously, they're producing all the LightWELD products at the moment. They produce all the green lasers for the solar cell and other applications. So a little bit a newer product, is coming more primarily out of North America, but we're not also -- we don't -- we're not holding to that. You could add capacity elsewhere on that finished product. So it's really the component side of it that we've been looking at over the last few months and all the different things we've been talking about on that to offset some of the capacity that we're losing in Russia. But there's a lot of flexibility on finished products as to where you produce them.

And based on this visibility, it’s very simple because manufacturing of fiber laser, final assembly or final manufacturing is a very easy process. We can easily install at any facility. It's not a problem. The main know-how -- our main know-how is, first of all, of course, in components. And this is why we are producing components in selected area, for example, diodes product is produced only in the United States. No reason to expand this production for the other countries because already installed the automation production, very effective, just cost per 1 watt is much less in comparison to all others. And the same for other components. Fiber components, of course, is not any sense to produce outside of Germany because again, it's installed, stable production and now introduce the automated production for these components.

Our next question is from Jamie Wang with Citigroup Hong Kong.

I have two quick questions here. First, regarding the Russia impairment. Are those impairment and charge one-offs, and that we won't see this expenses this year or going forward? And second question is regarding China. We recently talked to your corporate partner in China Han's Laser and they said this year it’s likely to go back to 2021 level. So that's about 15% a year growth. I just want to ask Tim, are you seeing...

Jamie, can you just speak up? We can't really hear your question at the moment. I didn't get either of those questions. Could you just talk a bit more -- talk a bit louder? The first question was on...

Yes. Is it better now?

No, not really but.

Okay. Never mind. Forget about those questions. Sorry, there is something wrong with the microphone. Yes, sorry.

Okay, there’s a problem.

Jamie, are you still there?

Yes. But can you guys hear me well now?

It's a little bit better. We'll try -- let's try one more time.

Yes. Sorry, yes.

Let's stay with one question first and then the second one after that, yes. So the first question was on restructuring charges, I think.

Okay. Okay. So Tim, I want to ask. The first question, regarding the Russia impairment, loss impairment charge is one-off, so that we won't see these expenses this year and going forward?

There may be some smaller restructuring charges related to severance and things like that. But in terms of like the impairment of long-lived assets and the inventory, we think we did a very, very thorough review of those, and that would be the only -- we don't expect any significant charges related to that.

Okay. Thank you. Okay. The second question is regarding China business. Recently, we talked to your corporate partners in China, Han's Laser. And they say that it's likely, revenue in the industry is likely to go back to 2021 level. So that was about 15% a year growth. I just want to understand, would you guys are seeing the similar metrics of revenue recovery in China? Yes, just want to understand your follow-up recovery in China.

You're saying Han's has said they expect revenue to go back to 2021 levels?

Yes.

Which is about a 15% recovery from 2022?

Roughly, roughly. And they are particularly positive on the high-power recovery -- recovery from the high-powered laser equipment for your reference.

We expect -- we're not giving specific guidance on China, but Q4 and Q1 revenue of China is at a pretty low point. You saw last quarter it was 34% of revenue, less than $100 million. So we are -- our half forecast during the year expects a meaningful pickup in China revenue. Whether we get back to peak levels is probably a bit unlikely because we still do have the competitive dynamics around the cutting business, right? We're driving a lot of that growth from other applications. We don't expect cutting to be 40% or 50% of China revenue going forward. But we do expect a recovery in China during the rest of the year.

Got it. Okay. That's clear. Thank you very much. No more questions from me.

I think Han's -- by the way, Han's' outlook points to the fact that people are optimistic that overall the China's economy is going to see a recovery in the year.

Yes. The give-ups are -- yes, the rough guidance did say that despite the fact that the visibility -- although the visibility is quite low right now, particularly from their [outflow processing], particularly from the PCB business, but they expect their revenue to recover maybe from the second quarter or second half of this year in China.

[Operator Instructions] Next question comes from the line of Jim Ricchiuti with Needham & Company.

Just a follow-up on the EV market. You cited some of the market data out there, which is fairly bullish. And you've certainly shown strong growth in this market. Would you be -- because you, I assume, have some line of sight to this business, would you assume this business is capable of growing 25%, 30% this year or more?

Of course, significant -- I mean I'm not going to give a number on it, Jim, because that kind of like ends up in sort of annual guidance on it. But we're expecting meaningful growth out of that business and it to be geographically, globally based, not just sort of China-based but strong growth in North America and Europe as well.

Okay. And on LightWELD, I know you made some commentary earlier in the call, but I think you've suggested that it was at last quarter, I think, of $40 million or so run rate business that you thought could grow 80%. Is that still the kind of expectations you have for the business?

We've got very strong expectations of that business and now rolling it out in Europe more broadly. We're not actually focused really on China on it, but we've got very good demand out of Japan and Korea for that business and continue to expect it to grow extremely robustly going forward.

We have 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 your continued interest in IPG. As usual, we will be participating in a number of investor events in this quarter, and I am looking forward to speaking with you soon. Have a great day, everyone.

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