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Edited Transcript of IPGP earnings conference call or presentation 13-Feb-20 3:00pm GMT

·43 min read

Q4 2019 IPG Photonics Corp Earnings Call OXFORD Feb 15, 2020 (Thomson StreetEvents) -- Edited Transcript of IPG Photonics Corp earnings conference call or presentation Thursday, February 13, 2020 at 3:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Eugene A. Scherbakov IPG Photonics Corporation - COO, Senior VP of Europe & Director * James F. Hillier IPG Photonics Corporation - VP of IR * Timothy P. V. Mammen IPG Photonics Corporation - Senior VP & CFO * Valentin P. Gapontsev IPG Photonics Corporation - Founder, Chairman & CEO ================================================================================ Conference Call Participants ================================================================================ * James Andrew Ricchiuti Needham & Company, LLC, Research Division - Senior Analyst * John Warren Marchetti Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst * Joseph Helmut Wittine Edgewater Research Company - Research Analyst * Krish Sankar Cowen and Company, LLC, Research Division - MD & Senior Research Analyst * Mark S. Miller The Benchmark Company, LLC, Research Division - Senior Equity Analyst * Michael J. Feniger BofA Merrill Lynch, Research Division - VP * Nikolay Todorov Longbow Research LLC - Analyst * Thomas Robert Diffely D.A. Davidson & Co., Research Division - MD & Senior Research Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good morning, and welcome to IPG Photonics Fourth Quarter 2019 Conference Call. Today's call is being recorded and webcast. At this time, I would like to turn the call over to James Hillier, IPG's Vice President of Investor Relations for introductions. Please go ahead, sir. -------------------------------------------------------------------------------- James F. Hillier, IPG Photonics Corporation - VP of IR [2] -------------------------------------------------------------------------------- Thank you, Darryl, and good morning, everyone. With us today is IPG Photonics' Chairman and CEO, Dr. Valentin Gapontsev; Chief Operating Officer, Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen. 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 include those detailed in IPG Photonics' Form 10-Q for the quarter ended June 30, 2019, 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, February 13, 2020. 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 and Excel-based financial data workbook posted to our Investor Relations website. We'll post these prepared remarks on our Investor Relations website following the completion of the call. With that, I'll now turn the call over to Valentin. -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [3] -------------------------------------------------------------------------------- Good morning, everyone. We delivered fourth quarter revenue slightly above our guidance range on strengths in the U.S. market and new products. The global market economic backdrop, and the competitive landscape in China was the main challenge. However, we are responding with product cost reductions in differentiated new features and accessories for our core products. Furthermore, we're leveraging one of our largest R&D investments in the laser industry to launch leading-edge laser products and systems for new markets. This new solution, which represent about 1/5 of total sales enhance our growth and margin profile and provide greater geographic and end-market diversification. Also weaker microeconomic trends have reduced demand for our core product in the near term. We introduced new lasers and new features that enhance productivity and flexibility for the industry. In 2019, we saw a record number of high-powered lasers, increasing sales of sources at 1 kilowatt and greater by near 23% in total, up to 14,500 units. These numbers include sales growth of laser with power of 1 to 4-kilowatt of YLR type by 60%, and ultrahigh power laser of -- at 10-kilowatt and greater by more than 25%. However, this extremely impressive growth did not compensate our revenue losses caused by very aggressive artificial stimulated growth of fiber with the power price in Chinese market. It's absolutely unfair competition. It's -- but it's -- obviously a different talk. Multiple IPG customers are launching new cutting systems using our 12-kilowatt cutting applications eightfold. Many of these are sold with our new ultra high power cutting sets. In addition, we sold our first laser with high peak power and adjustable mode beam capability. HPP products delivered peak energy, twice the average power of the laser, increasing cutting speed and quality by reducing scrap through converter nesting of parts. Our -- a new AMB laser permit the broadest range of beam tunability, enabling spatterless welding and enhancing the speed of electrical vehicle battery production. When combined with our unique high-power pulse laser for foil cutting and ultra high power CW laser for welding, we see significant opportunity in the electric vehicle battery market this year. Our fiber laser increased customer return on investment by delivering the industry highest power wall-plug efficiency and reliability along with industry-leading beam quality. Competitors' laser often struggle to maintain power even after only several hundred hours of operation. IPG lasers deliver peace of mind and lower lifetime cost, while enhancing end user productivity. IPG also offers the highest brightness through 50-micron core diameter fiber, providing our customers with more than 70% higher productivity in cutting thin metal versus -- which is a competitive -- a competing laser in 100 micron fiber. Augmenting our laser solution with high-power optical head is a key differentiator versus our laser competitors. In 2019, we delivered very good sales of optical heads and other beam delivery accessories, growing sales of this product by 10%. We also shipped our first volume order for LDD process monitoring, our patented real-time welding monitoring solution. LDD enables greater use of laser-based welding in automated production environments, and we are pursuing multiple million dollar plus opportunities with this technology and associated laser product sales. We sold a record number of systems for material growth sales in 2019 with the revenue increasing 33%, excluding Genesis, which we acquired in December 2018. Standard and custom systems for vehicle and battery production, medical device manufacturing, pipe welding, cleaning and inspection application drove systems growth. We plan to leverage Genesis' unique expertise in robotic system integration to accelerate laser processing within the transportation, aerospace and industrial end markets. Product innovation remains core for IPG success. But in 2018, new product sales were 19% of total revenue and 24% in the fourth quarter alone. Sales of green pulse lasers, used to improve solar cell efficiency increased by more than 60% in 2018. Sales of ultrafast pulse lasers increased more than 80% year-over-year off a small base, with more than 50 new projects for these lasers across a wide range of applications as processing glass, ceramic, circuit boards, OLED film, batteries and solar cells. As we enhance the pulse energy, expand the portfolio of new green ultraviolet and ultrafast pulse lasers, we expect revenue of these products to grow rapidly over the coming years and become a more meaningful percentage of total sales. Sales of medical laser increased 80% in 2019, as our thulium laser solution received approval in China and the U.S. We expect sales into urology and other soft tissue applications to ramp over the coming years off a low base. Our medical laser business model include consumable fibers, a continuing revenue stream that benefits as the number of installed system increase. Sales of our RGB Luminaire Laser System for cinema application increased more than 100% in 2018. We continue to invest in transformative new products within new application areas as well, including new medical treatments, mid-infrared lasers for spectroscopy, inspection and sensing application and ultra high power single-mode laser for aerospace and defense. We will rely on our core scientific strengths and strong cash flow to optimize investment in strategic initiatives critical to the long-term success of the company. The initiatives include a greater mix of high-power laser, along with differentiated features and solutions in new markets and applications. We expect to grow faster for these new product areas, enabling IPG to deliver strong growth in revenue and cash flow. I want to thank our talented employees for their hard work during the challenging year. As ever, I remain confident in IPG's ability to execute during this period, delivering on our mission to make our fiber laser technology the tool of choice in mass production. Finally, I will Dr. Eugene Scherbakov, IPG's Chief Operating Officer, to participate in our earnings calls. As many you know, Eugene is a long-serving member of IPG's executive leadership team with extensive operational and technical knowledge of our business. He will be able to provide you with additional insights into IPG's operational performance during this quarter. With that, I will turn the call over to Eugene. -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [4] -------------------------------------------------------------------------------- Thank you, Valentin, and good morning, everyone. I'm pleased to join you today and on future calls to discuss the operational trends in our business. IPG remains the clear market leader in fiber laser with hundreds of megawatts of installed capacity. In 2019, we shipped 52 megawatts of total optical power, increasing 14% year-over-year. We continue to see aggressive prices among China-based competition, which intensified toward to the end of the second quarter last year. Since that time, pricing has been more stable, and for the year, the decline of average price per kilowatt has affected the dollar value of units sold. But our ability to rapidly reduce cost has limited the gross margin impact from these price reductions. Our team is focused on further cost reduction throughout the manufacturing process that we believe will significantly reduce the cost of our high-power laser solutions from 1 up to 6 kilowatts, which accounts for a majority of our high-power units sold. When combined with the full benefit of the cost actions we undertook in the second half of 2019, we believe that these measures will help us sustain our industry-leading margin profile and cash returns. We will continue to manage our cost structure to business environment, targeting gross margin of 45% up to 50%. Excluding inventory provisions, we were at the bottom of this region -- range during the fourth quarter. We executed well in controlling manufacturing expenses, decreasing them by more than 10% from third quarter. This benefit was mostly offset by a reduction of costs absorbed into inventory business lower production level. However, this enabled us to generate cash from inventory as the reduction in the value of inventory on hand was greater than inventory provisions. Examining our performance by region, revenue in China decreased 21% year-over-year and represented approximately 30% of our total sales. As we had expected, performance was impacted by weaker demand due to the U.S.-China trade conflict, slowdown in capital investment and greater than average price declines. In Europe, revenue decreased 17% year-over-year. The demand environment in Europe remains very challenging as the key macroeconomic indicators remain weak in the region. Revenue in North America increased 30% year-over-year driven by acquisition of Genesis. Excluding Genesis sales, North America increased 23% year-over-year with strong growth in welding, surgical and communications applications. Our growth in North America is a testament to our diversified portfolio strategy where increasing adoption of our beam-delivered accessories, and complete laser solution was augmented by growth in advanced applications, communications and medical laser products. Sales in Japan decreased 37% year-over-year. Similar to Europe, the macro economy in Japan remains weak. However, we continue to work in -- of a number of substantial laser welding project in the region. Sales in Korea increased 2% year-over-year on strength and battery welding. And sales in Turkey decreased 80% year-over-year given macroeconomic pressures affecting cutting business in the region. With that, I will turn the call over to Tim to discuss financial highlights in the quarter. -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [5] -------------------------------------------------------------------------------- Thank you, Eugene, and good morning, everyone. Revenue in the fourth quarter declined 7% year-over-year to $307 million. Revenue from materials processing applications decreased 11% year-over-year, and revenue from other applications increased 42%. Sales of high-power CW lasers decreased 15% year-over-year, and represented approximately 51% of total revenue. Reduced revenue from high-power CW lasers in cutting and welding was partially offset by strength in other materials processing applications. Pulsed laser sales decreased 33% year-over-year, with growth in green and ultraviolet pulsed lasers offset by lower sales of pulsed lasers for marking and fine processing applications. System sales increased 69% year-over-year, including Genesis, and increased 43% year-over-year, excluding Genesis. Medium-power laser sales decreased 32% on softness in additive manufacturing and the transition to kilowatt-scale lasers in cutting, while QCW sales increased 14% year-over-year. Other product sales increased 6% year-over-year driven by growth in beam delivery accessories and service revenue. For the full year 2019, revenue declined 10% year-over-year and 10% on an organic constant currency basis. Q4 GAAP gross margin was 40.5%, which declined 1,000 basis points year-over-year. Excluding higher inventory reserves, Q4 gross margin would have been 45.2%, and normalizing for a full bonus accrual, gross margin would have been 44.1%. Compared with the year-ago period, higher inventory reserves reduced gross margin by 570 basis points, less favorable absorption of manufacturing expenses reduced gross margin by 250 basis points, and the acquisition of Genesis reduced gross margin by 180 basis points. Fourth quarter GAAP operating income was $243,000, and operating margin was 0.1%. Excluding higher inventory reserves, foreign exchange and charges related to asset impairment and restructuring, Q4 operating margin would have been 20.9%. And normalizing for a full bonus accrual, operating margin would have been 17.8%. As a reminder, our fourth quarter expenses did not include an accrual for employee bonuses because of 2019 underperformance relative to our budget. For modeling purposes, you should assume quarterly bonus expense of approximately $4 million in cost of sales, and $5 million operating expenses in 2020. Net loss was $4 million or $0.08 per diluted share. Higher inventory reserves and charges related to impairment of goodwill and other long-lived assets and restructuring reduced EPS by $0.99. In addition, foreign exchange losses reduced EPS by a further $0.08, and discrete tax items benefited EPS by $0.08 as well. If exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $4 million higher and gross profit to be $2 million higher. The effective tax rate in the quarter was 245%. The effective tax rate was increased by nondeductible charges related to impairment of goodwill and other long-lived assets and restructuring and decreased by certain discrete benefits in the quarter. On a non-GAAP basis, excluding these effects, the underlying fourth quarter tax rate was approximately 27%. We ended the quarter with cash, cash equivalents and short-term investments of $1.18 billion, and total debt of $42 million. More than 60% of our cash is held in the U.S. with most of the remaining cash balance in Germany. Effective operational execution resulted in cash provided by operations of $130 million during the quarter. Capital expenditures were $26 million in the quarter, and $134 million for the year versus our revised target of less than $150 million. During the quarter, we repurchased 105,000 shares for $15 million. For the full year 2019, we repurchased $41 million worth of stock and have $84 million remaining on our current buyback authorization. We ended the year with $285 million of shippable backlog, down 16% year-over-year, and total backlog, including frame agreements of $693 million, down 3% year-over-year. Fourth quarter book-to-bill was 1, in line with normal seasonality. Turning to guidance. We believe we have significant long-term growth opportunities in laser welding, fine processing, electric vehicle batteries and our portfolio of new products addressing opportunities in micro-processing, medical systems and beam delivery solutions. Current demand for our leading-edge laser solutions remains mixed, with strength in North America and emerging regions, such as India and Southeast Asia offset by ongoing macro softness in Europe and Japan. Prior to the government-extended Lunar New Year holiday, there were signs that business in China was firming, with order flow having picked up in December and January. However, ongoing business disruption related to the novel coronavirus outbreak makes forecasting our business in China and the impact on global demand very challenging at this point. China is a large and important market for IPG with repercussions for other markets, and we continue to monitor the situation closely. For the first quarter of 2020, IPG expects revenue of $220 million to $250 million. The company expects the first quarter tax rate to be approximately 26%. IPG anticipates delivering earnings per diluted share in the range of $0.00 to $0.30, with 52.9 million basic common shares outstanding and 53.6 million diluted common shares outstanding. This guidance assumes approximately $45 million in reduced revenue and $0.45 lower EPS from business disruption related to the novel coronavirus outbreak. This estimate is based upon the facts and understandings we have at this time. As discussed in the safe harbor passage of today's earnings press release, actual results may differ from our guidance due to factors, including, but not limited to, goodwill and other impairment charges, product demand, order cancellation and delays, competition, tariffs, trade policies, health epidemics and general economic conditions. Our guidance is based upon current market conditions and expectations, assumes exchange rates referenced in our earnings press release, and is subject to risks outlined in the company's reports with the SEC. With that, Valentin, Eugene and I will be happy to take your questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Our first questions come from the line of John Marchetti of Stifel. -------------------------------------------------------------------------------- John Warren Marchetti, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [2] -------------------------------------------------------------------------------- I was hoping we could just spend a minute on some of the commentary that you talked about seeing some strength in the order book, obviously, in December and January, out of China. Recognizing that, that's likely very much up in the air right now given everything that's going on there, but just hoping you could spend a couple of minutes talking about where you were seeing some of that strength. And then maybe as we look out a little bit further into 2020, you may be looking around, maybe geographically, where you see some of the bright spots and some of the risk points ex-China as we go through the year? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [3] -------------------------------------------------------------------------------- I think there's been a general pickup in demand in China in terms of order flow, a little bit, we saw that in December. It helped the book-to-bill equal 1. And then certainly, in January before the Lunar New Year and the Coronavirus disruptions, the order flow in China has really been pretty positive across OEMs for cutting applications. I haven't had a chance to look at the detail of where that was really coming from yet, but we've looked at the total number, so we'd have to pass that through in a bit more detail. But it was certainly a good start to the year, and we're showing significantly better tone than we've seen over the previous 4 or 5 months. In terms of the rest of the geographic regions, I mean, we look at the same macroeconomic data that you would, and we continue to see that the underlying strength in the local economies is largely driven by strength in the U.S., which continues to hold up well. Sentiment perhaps isn't quite as strong as it was a year ago, but we've also got the benefit in the U.S. with a much more diverse product line with new applications coming on-stream, referenced some of the cinema and medical opportunities are expected to grow very strongly. So I think the U.S. is a reflection of where we'd like to see the whole business flow globally with that diversification. Some of the medical will also -- we were selling some of the medical lasers, for example, in India and China. Starting to sell them in China, so that should be a bit of a benefit there. I'd say, globally, Europe looks more -- at least it was looking a lot more stable, and order flow in Europe at the beginning of the year has been reasonable. Europe is obviously a key. They rely on a lot of export-driven industries, so it's going to be interesting to see whether some of the impact to China, which is really uncertain at the moment, offsets some of the stabilization, if not even a bit of strength in Europe. I was quite pleased to see where European order flow had been in the first 6 weeks of the quarter. Japan remains weak, but orders in January were reasonable there. Korea was reasonable. I think macroeconomic-wise, Japan is the other weak area at the moment. -------------------------------------------------------------------------------- Operator [4] -------------------------------------------------------------------------------- Our next questions comes from the line of Tom Diffely of D.A. Davidson. -------------------------------------------------------------------------------- Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [5] -------------------------------------------------------------------------------- So I was curious on the orders that picked up in December and early January. Have you since seen those quarters pushed out or canceled? Or is it just a lack of new orders filling the void? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [6] -------------------------------------------------------------------------------- We haven't had -- I mean, in relation to the shutdown, Tom, over the last 2 weeks in China? -------------------------------------------------------------------------------- Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [7] -------------------------------------------------------------------------------- Correct. Yes. -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [8] -------------------------------------------------------------------------------- So no, we just don't have any indication of whether they're just going to be pushed out or delayed and taken later. It's a very fluid and changing situation with people back in our major offices only on Monday. So we don't know whether it's going to lead to a big pickup in Q2 because demand recovers or whether it is a permanent push out for the year. We also have not had any orders canceled, and the general theory -- I mean, one of the comments from our general manager in China is that people are keen to get back to work to offset the losses they're incurring. Whether that can happen or not is an open question, right? This is a very changing situation. Even overnight, there's a bit more negativity around the way they're diagnosing the virus, and certainly, that's having an impact on the U.S. market today and Europe. So it's just such a changeable situation. It's not really possible to give you anything more definitive than the estimates we've made as of today. -------------------------------------------------------------------------------- Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [9] -------------------------------------------------------------------------------- Okay. And that's helpful. And then as a follow-up, just a little bit more maybe on the battery, the auto battery market, what type or size of laser is used in that space? And what do you think the long-term prospects are from a market point of view? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [10] -------------------------------------------------------------------------------- There's a wide variety of lasers used in battery processes. Dr. Scherbakov knows a lot about this. So he'll cover some of that. -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [11] -------------------------------------------------------------------------------- Yes, there is a different kind of applications for battery . Battery welding is one of the applications. The second one, it's weldings -- also case for battery. And for these applications, our customers using different kind of lasers. But the last lasers we should supply to our existing and some potential customer, with these options, ABB, MBB options, adjustable mode beam diameter. And the first result demonstrates a very good result. Just experiments demonstrates very good results. And from this point of view, we see a good future for our high-power lasers, first of all. -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [12] -------------------------------------------------------------------------------- For us, growing demand for thin foil cutting, I would say, it's very special, very super high-speed cutting, and they use our green laser now, I would say, a special fiber product will require, but so when we will meet this requirement. But it's a real fast growing business. And also system business for automation of the production of battery production, also, we're talking with some major Tier 1 players in this market. -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [13] -------------------------------------------------------------------------------- And also important that such kind of battery are now using the different automotive customers. And for example, we received a very big -- enough orders for other lasers, and together, with our online monitor, produced by LDD. In this case, it's very important applications, and we see that also big interest in for such kind of combinations. I mean our lasers, online monitor, welding monitor, especially for battery production. -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [14] -------------------------------------------------------------------------------- And then Tom, the other part of your question was, this is -- continues to be a decades long -- a decade-long -- decades, perhaps, long investment cycle. It's really the transition to electric vehicles is going to happen in the volumes that everyone is expecting. If you're going to get to 25% or 30% of vehicles, there's probably over $1 billion of laser-based investment that's required over a 10-year period. So that still hasn't changed at all at this point in time. -------------------------------------------------------------------------------- Operator [15] -------------------------------------------------------------------------------- Our next questions come from the line of Jim Ricchiuti of Needham & Company. -------------------------------------------------------------------------------- James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [16] -------------------------------------------------------------------------------- So one of the things that I was kind of struck by in the quarter was the strength you're seeing in the ultra high power segment of the market. And so what does that reflect, just this shift in demand within China to move at an accelerating pace to ultra high power? -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [17] -------------------------------------------------------------------------------- Of course, there are some trends, first of all, in China, because in China, this customer, much more flexible in comparison to the other countries. And some of these customers already used our, for example, 20-kilowatt laser for cutting applications. They produce special machines. But for us, it's much also very interesting because we are not supplying on the lasers, it's supplying our optical heads for these high power lasers. And in this combination, there is also special produced fiber, we can generate a good revenue. But also some customers now start to ask about 35-kilowatt laser for cutting applications. And such kind of trends also we saw in Japan and with some delay also in Europe. -------------------------------------------------------------------------------- James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [18] -------------------------------------------------------------------------------- Got it. And Tim, if I may. Just with respect to the Q1 guidance, I assume there's going to be a considerable headwind from underutilization impacting gross margins in Q1. Is there any way to think about gross margins in the near term? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [19] -------------------------------------------------------------------------------- Yes. I mean, unfortunately, this quarter is probably one of the most difficult quarters that we will have had since 2009. So the gross margin that we're factoring in, in that guidance is below to 40%. We're using operating expenses that will be a bit higher than they were in Q4 in the sort of $76 million to $78 million. If you exclude the impact related to the reduction in demand for China, gross margin would have been closer to the 45%. It would have been slightly below at the top end of the range, 45%. And at the bottom end of the Q1 range, it would have been about 40%. So Q1, even if you add back in the impact of coronavirus, it was obviously going to be a difficult quarter for us. We would have expected that, if the order trends had held up, to really transition into a stronger Q2 based upon what we'd seen on order flow. So it is a difficult Q1, and probably, as I said, one of the more difficult quarters we've had for the last 10 years in that context. -------------------------------------------------------------------------------- James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [20] -------------------------------------------------------------------------------- Got it. And last question for me is just with respect to the U.S. business, ex-Genesis, was there anything unusual in terms of larger pieces of business that contributed to that growth? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [21] -------------------------------------------------------------------------------- There were some battery welding projects we talked about that went into -- ultimate custom was a European automotive entity, that was a nice order that we took. It was with the LDD that Eugene mentioned. U.S., generally, we'll see a pickup into Q4, right? So you had that benefit in a similar way that we had it before. That was probably the largest single order I can reference. You had some benefit coming from a pickup in medical, but that's going to carry on. We've already got a significant large order that was booked in January for the medical business for this year. Those are the 2 things I can think of. We had a 100-kilowatt laser order in the U.S. that didn't actually ship, it's going to ship in January. And one of the other benefits, by the way, on the ultra high power was the -- talking about the overall ultra high power, the 120-kilowatt in Germany, by the way, did ship. So that benefited some of the ultra high power numbers as well. -------------------------------------------------------------------------------- Operator [22] -------------------------------------------------------------------------------- The next question is coming from the line of Michael Feniger of Bank of America Merrill Lynch. -------------------------------------------------------------------------------- Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [23] -------------------------------------------------------------------------------- Just first off, Tim, could you just help us? I know you talked about order flows picking up in December and January. Obviously, it's difficult to forecast. I'm just -- is that something that you sequentially see? Can you help us understand what gave you comfortability there to -- I know it's reassuring that order flows were firming. I'm just curious, is that like how we -- is that seasonally just how the business typically trends? Or did you feel like there was actually some pickup more than seasonality, given the depressed markets before that? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [24] -------------------------------------------------------------------------------- That's an interesting question. Normally, January is a weak month for order flow. In the last 2 years, so the beginning of '18, coming off a depressed -- sorry, the beginning of '19, coming off a depressed end to '18, we also had quite strong order flow in January in China and other areas. That drove the overall strength in the business in the first half of last year, which then obviously tailed off when you got to the end of June. So you saw a similar strength, if not even a bit more positive, I think, than last year overall in the first few weeks of this year. Honestly, you're latching on a little bit to this positivity or we are -- you want to see those trends carry on. We want to see those trends carry on through Q1 and into Q2, and we wouldn't want to see, obviously, a slowdown halfway through the year. We want to maintain this momentum, but the general tone was pretty good. -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [25] -------------------------------------------------------------------------------- Specifically this January, we have absolutely a record order flow, much higher than any other before. But what fourth quarter was a practical [stock order] in total. We expect that January would be a way bigger [plus] order compared to any other years. -------------------------------------------------------------------------------- Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [26] -------------------------------------------------------------------------------- That's helpful. And just, if I understand, Q1 is difficult just with the cost savings that's occurring now, we can all try to have our own forecast on the macro. But with how you're managing the business, just with the cost savings you're trying to achieve, if we see a revenue base of $350 million and we're through the inventory charges, Tim, how can we think about maybe a gross margin range at that type of revenue number? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [27] -------------------------------------------------------------------------------- So $350 million, I'm comfortable of being back into the midpoint of the 45% to 50%. If you can get back up to like the $400 million, which seems a long way off at the moment, it's closer to 50%. And then operating expenses at that level would probably be around $80 million a quarter. So a bit above 20% in operating margins trending to slightly around 25%, I should think. But we're comfortable with -- at this point in time with that. I think the big caveat around that is so long as there isn't a massive change in pricing again, and we continue to make some cost reductions that we've got rolling into the business model over the next 2 quarters or so. -------------------------------------------------------------------------------- Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [28] -------------------------------------------------------------------------------- And that is the -- if I could squeeze one more in, just on inventories. I think you mentioned, I believe, for the quarter, it was over a 550 million -- 550 basis points hit to gross margins on inventories. Are you -- with where you are now, obviously, there's no crystal ball on the macro. But like how are you feeling with your inventory position right now? And how we -- or do you think we're through some of those charges? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [29] -------------------------------------------------------------------------------- Yes. We went through a really detailed review of inventory, not just in Q4, but you saw -- you've seen elevated provisions even in Q2 and Q3 compared to normal. We believe that we've dealt with potentially excess items, and certainly, the slow-moving items that we'd identified, and we'll be targeting being more in a normal range of 1% to 1.5% provisions per quarter. Of course, if demand doesn't come back, it -- you have to caveat that statement with relative to where demand was. But if you're getting back to like $300 million to $350 million, or $330 million to $350 million in revenue, I'd be very comfortable with where we stand on inventory. I think the other good thing was it wasn't just the inventory provisions that took inventory down, there was really good execution by the manufacturing groups around the world so that we actually generated $20 million of cash from inventory in the quarter, which was a great thing to see. -------------------------------------------------------------------------------- Operator [30] -------------------------------------------------------------------------------- Our next question comes from Joe Wittine of Edgewater. -------------------------------------------------------------------------------- Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [31] -------------------------------------------------------------------------------- Just some product questions for me, trying to understand how much a tailwind rising power levels could be in 2020. It sounds like the 12s are finally coming to market in the west, it's been a while coming. And then in China, wondering if you're seeing a continued extension at kind of the highest end of ultra high power, 20s, et cetera? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [32] -------------------------------------------------------------------------------- A question about the shift -- continuing shift, and how much a benefit it can be. -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [33] -------------------------------------------------------------------------------- Yes. Benefit -- definitely there is a economic benefit for us. And first of all, in the end, there are no competition for such kind of high powered lasers, it's clear. And if -- and also for different kind of applications. I already talked about cutting applications, but also for welding applications, special material welding applications also. As much as possible, they use only high-power lasers. It's high efficiency and so on. And from different kind of applications, high-power trend definitely will give us additional benefits. -------------------------------------------------------------------------------- Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [34] -------------------------------------------------------------------------------- Okay. And then on high-peak power... -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [35] -------------------------------------------------------------------------------- Let me tell you, (inaudible) the time when this year, we expect serious growth in high-power demand for advanced applications. They have much more budget. Potential customer with whom we're working, received this year much better -- higher budget than before it went for the volume introduction to the use -- practical use, high-power different solutions we are working for. -------------------------------------------------------------------------------- Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [36] -------------------------------------------------------------------------------- And what are those advanced applications? Could you elaborate further? Are those within macro, cutting and welding, still? -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [37] -------------------------------------------------------------------------------- No, no, no. It's other applications. -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [38] -------------------------------------------------------------------------------- And special material process areas. -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [39] -------------------------------------------------------------------------------- Aerospace mainly as application, not material processing. -------------------------------------------------------------------------------- Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [40] -------------------------------------------------------------------------------- Understood. Then switching gears to high peak power QCW, the [quals] there, I would assume, are still underway. And I think you said you shipped one. So I'm assuming you have some more insights into the market acceptance. So as that product is fully commercialized, what sort of kind of kind of penetration are you expecting throughout the broad cutting business? I mean could that product be half of your cutting sales in the future once fully rolled out, more or less? Any help there would be great. -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [41] -------------------------------------------------------------------------------- So I think on HPP, there continues to be a number of different customers that are evaluating the product within their cutting applications. It's still relatively unclear as to what percentage of total sales it can end up being, Joe. I think we'll have more clarity on that as we go through this year and customers start to introduce product, incorporating that feature within it. There's a bit more clarity, I'd say, over AMB, particularly for welding applications, where there's a lot of acceptance of that. We've always said the AMB would be a very strong performer on welding, given the reduced splatter and improvement in quality there. -------------------------------------------------------------------------------- Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [42] -------------------------------------------------------------------------------- Okay. Great. And then, finally... -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [43] -------------------------------------------------------------------------------- , In the second quarter, we introduced new families of the mid-power laser with HPP option. It's an absolute new level competing in performance to compare existing current laser to our competition, nobody from China, so don't want to have nothing similar. So the deal with HPP will still grow very fast. It's HPP option for a new generation of the mid-powered lasers, including -- but also new performance and new quality of laser (inaudible) HPP option. And also much more [quals] than exist in the lasers also will allow us to increase the gross margin very essentially for mid-power lasers to [yield] a return to very high profitability, which was in spite of the drop of price. -------------------------------------------------------------------------------- Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [44] -------------------------------------------------------------------------------- Interesting. Finally for me, on the consumer electronics portion of your business, especially the fine welding piece. Have you received any indication on orders for the mid part of the year related to smartphones prior to the holiday and quarantine? I'm trying to assess how prudent it is for our models to assume an uptick in those investments in that part of the supply chain, given I think everyone believes it's going to be a stronger year for smartphone production from a unit perspective, coming off of a few quiet years. -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [45] -------------------------------------------------------------------------------- No, we don't have any indication yet on likely orders. The general view is from the laser supply side it's probably going to not be a huge catalyst in terms of a typical biannual, there should be some pickup, but it's not going to be a massive driver as it was in '17. For example, they continue to repurpose some of the existing lasers into production lines, even for newer phones. So it's not as though it's going to drive like doubling of QCW sales or anything like that this year, Joe. -------------------------------------------------------------------------------- Operator [46] -------------------------------------------------------------------------------- Your next question comes from the line of Mark Miller of The Benchmark Company. -------------------------------------------------------------------------------- Mark S. Miller, The Benchmark Company, LLC, Research Division - Senior Equity Analyst [47] -------------------------------------------------------------------------------- Just wanted to look at -- looking at the backlog and framing agreement went up year-over-year, but orders were down. Can you provide some color on that? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [48] -------------------------------------------------------------------------------- No, I think the total backlog, Mark, was down 3%. So including frame agreements, it points to being a reasonable start to the year, but still a little bit uncertain. I think we focus a lot on the shippable side. So there's still some underlying demand there in terms of the frame agreements. There's a lot of frame agreements that have been put, for example, to get particularly higher power and ultra high power licenses. So there's clearly, if the economy stabilizes, I think that the biggest trend that could come out of that is that you'll see the demand cycle for those ultra high power lasers which require licenses increase. That will be the biggest read through I would go with on the frame agreement side of it. But it still requires more certainty on the macro, and clearly, resolution on -- not resolution, but some stability in relation to the current situation in China. I think where we were more focused on rather than what the closing backlog, the bookings in Q4 were, the book-to-bill was 1. So that was reasonable given that we're at slightly above our guidance range. Our real focus on bookings, though, had been on the positive trends we've seen in January and even the first week of February, excluding China, obviously. -------------------------------------------------------------------------------- Mark S. Miller, The Benchmark Company, LLC, Research Division - Senior Equity Analyst [49] -------------------------------------------------------------------------------- In terms of the backlog, too, in terms of the mix, is this a higher margin mix or similar to what you've seen? And can we expect some improvements from the backlog in terms of margins? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [50] -------------------------------------------------------------------------------- I referenced that some of the frame agreement backlog will be driven by licenses getting for ultra high power lasers in the 10, 12, 20 and even in China moving towards potentially higher balances. That's all got a margin benefit to us in Q4. You actually, I think, saw -- and Valentin referenced this as well, the low end of the cutting market remained relatively stable in Q3 and Q4, that would have been a margin impact to us. So you see a recovery in ultra high power, then you see some orders coming from some of these other advanced applications at ultra high power, that has a margin benefit. We're selling more AMB lasers into the battery welding application, that has a benefit. And we're combining for the welding with the LDD, that has a benefit. And then key to everything as well is driving growth of ultrafast technology in green lasers, which also have extremely high-margin on them. They wouldn't be significant volumes of those in backlog at the moment, but growth of those business during the year is a target for the company. -------------------------------------------------------------------------------- Operator [51] -------------------------------------------------------------------------------- Our next questions come from the line of Nick Todorov of Longbow Research. -------------------------------------------------------------------------------- Nikolay Todorov, Longbow Research LLC - Analyst [52] -------------------------------------------------------------------------------- Tim, you highlighted the strength in welding. Can you talk about mix within that? Maybe I'm assuming it's more AMB with lasers. But is it systems or lasers? Can you give us any color on mix in welding? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [53] -------------------------------------------------------------------------------- There's some benefit on systems, but there was also the significant order I mentioned for battery processing in the U.S. that benefited welding. That wasn't actually AMB, but it was order that was supplied with the LDD, the real-time weld monitoring and welding heads as well. There is some pickup in QCW in Q4 that would have been outside of systems, that would have been a driver as well as some of the welding performance. In the fourth quarter, there was some revenue recognized on some other welding systems, though, as well, which benefited stuff. A lot of the stuff that goes through Genesis, though, is obviously welding-based applications, not exclusively, but largely welding-based applications. -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [54] -------------------------------------------------------------------------------- Agriculture. -------------------------------------------------------------------------------- Nikolay Todorov, Longbow Research LLC - Analyst [55] -------------------------------------------------------------------------------- Okay. I understand that in other markets like Europe and China, it's difficult to forecast. But North America seems a little bit more stable. Are you willing to take a hit on what is the outlook you can see from North America, particularly in the core cutting markets for 2020? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [56] -------------------------------------------------------------------------------- I think I referenced that earlier in the call that we continue to see a reasonably robust demand environment, not just across the core cutting applications, but across numerous different applications in the U.S. And we're targeting reasonable growth on the U.S. for this year across all of these, not just the cutting and welding, but some of the newer applications, such as medical, semiconductor, advanced applications, deposition technologies, for example, like high-power cladding applications. And then the systems business as well is largely focused, even outside of the acquired business, the organic systems business -- the medical devices, for example, performed very well last year. There's a new system that's being introduced, stent cutting, which we think enhances our competitive dynamics in that market as well. So there's a lot of diversity in the U.S. business that would be helped by a stronger macro environment here compared to the rest of the world. -------------------------------------------------------------------------------- Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [57] -------------------------------------------------------------------------------- And now until end of last year, second half last year, made a great drop. Now we go into a new level of cooperation in the implementation of welding -- laser welding technology to the many segment of industry. We signed now with very serious long term agreement with very big Tier 1 plays in aerospace and transportation. And so we become the real long-term partner in mainly -- in the development, the joint development of the new welding processes, including full -- not only to sell lasers before for them, but provide them full complete solution, new process for special for each kind of the welding of material parts and so on. Then full automation system in providing and identifying ready production lines. It's a long-term cooperation with more and more such large -- the Tier 1 in the corresponding segment of market -- plays in the market. In the U.S., in the Europe, and so on. In material -- in auto, not only metal processing welding, but also in the material -- auto material processing, and also one. It's not just a retail sales of long-term cooperation, where you see this partnership with biggest players in the market. It's open for us to work on the opportunity. -------------------------------------------------------------------------------- Operator [58] -------------------------------------------------------------------------------- Our final question comes from the line of Krish Sankar of Cowen & Company. -------------------------------------------------------------------------------- Krish Sankar, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [59] -------------------------------------------------------------------------------- I had two quick questions. One is, Tim, on your commentary on gross margin, I understand the biggest impact to gross margin is today from under absorption. So when you look at the revenue range of $300 million to $400 million on a quarterly basis, gross margin were up 45% to 50%. Is the inherent assumption service systems a similar percentage of the total revenue than it is today? And then a quick follow-up for Dr. Scherbakov. Is the EV opportunity mainly on the welding side? -------------------------------------------------------------------------------- Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [60] -------------------------------------------------------------------------------- So in terms of gross margin, in terms of the recovery to $350 million or $400 million, you'd actually expect the laser business to perhaps recover a bit more quickly than proportion of growth in systems, even though we're targeting very strong growth in systems. So there'll be a little bit of a margin benefit, but the systems would still be a drag relative to the top end of that range, like on a -- an equivalent basis compared to where we were before. If you excluded the systems, you'd be above 50% -- slightly above 50%. -------------------------------------------------------------------------------- Eugene A. Scherbakov, IPG Photonics Corporation - COO, Senior VP of Europe & Director [61] -------------------------------------------------------------------------------- Okay. Of course, applications are not only connected to battery welding or cutting of foil, also there exists some big opportunity to use our high-power laser for welding body and wide welding for a vehicle. And from this point of view, also we see a very good perspective for our lasers. -------------------------------------------------------------------------------- Operator [62] -------------------------------------------------------------------------------- At this time, I will turn the call back to James Hillier for closing remarks. -------------------------------------------------------------------------------- James F. Hillier, IPG Photonics Corporation - VP of IR [63] -------------------------------------------------------------------------------- Thank you for joining us this morning and for your continued interest in IPG. We're looking forward to speaking with you over the next few weeks and our next quarter's call. Have a great day, everyone. -------------------------------------------------------------------------------- Operator [64] -------------------------------------------------------------------------------- This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.