Good morning, and welcome to IPG Photonics' Second Quarter 2023 Conference Call. Today's call is being recorded and webcast. At this time, I'd like to turn the call over to your host, Mr. Eugene Fedotoff, IPG's Senior Director, 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, Timothy 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 updated 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, August 1, 2023, only. And 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 financial data workbook posted on the Investor Relations site. We will post these prepared remarks on our 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 with our performance this quarter. Second quarter revenue came and is the point of our guidance range. Despite of increased macroeconomic uncertainty, which resulted in project delays and impacted sales and outlook in industrial markets across many geographies. We reported another quarter of solid revenue growth in welding and cleaning applications. Now that were driven by strong sales and e-mobility and handheld welding solutions. Additionally, revenue improved in 3D printing and solar cell manufacturing applications as investment in these markets increased. Sales in flat sheet cutting applications declined year-over-year, mostly due to economic uncertainty and an increased competition in China, and continued to negatively impact on our results. However, cutting sales were up sequentially in China, North America and Japan. Emerging Growth product accounting for 41% of our total sales in the second quarter. We saw continued growth in AMB lasers, LightWELD, green and ultrafast lasers as well as the beam delivery, but sales declined in medical and advanced applications as well as in laser-based system and high-power pulse lasers. We have shipped our first 50-kilowatt AMB laser during the quarter and continue to invest in the international sales platforms for LightWELD. As we said on our first quarter conference call, our medical business was impacted by a large customer working through the inventory, which reduced sales in the second quarter. We expect medical sales to return to a more normal level in the third quarter and continue to focus on additional growth opportunities in the medical market. Despite a challenging operating environment, the positive results were driven by our progress in diversifying revenue and reducing our exposure to low-margin and highly competitive business. We have been focusing on products and applications, which benefits from global investment in e-mobility and renewable energy, and this…

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 second quarter was $340 million, a decline of 10% year-over-year, partially due to foreign currency headwinds, which accounted for approximately 2% of the decrease and the telecom divestiture that reduced revenue by approximately 1%. Revenue from materials processing applications decreased 8% year-over-year while revenue from other applications decreased 23%. GAAP gross margin was 43.4%, a decrease of 230 basis points year-over-year due to higher cost of products sold and charges for scrap, which were partially offset by lower inventory reserves, reduced shipping costs and tariffs as well as an improvement in absorption of manufacturing costs as a percentage of sales. On a sequential basis, gross margin continued to improve as we focused on reducing costs and improving manufacturing efficiency. We also benefited from slightly lower inventory provisions and shipping costs. As mentioned before, FX headwinds also had a negative impact in the quarter. If exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $9 million higher and gross profit to be $5 million higher. GAAP operating income was $72 million, and operating margin was 21.2%. Net income was $62 million or $1.31 per diluted share. The effective tax rate in the quarter was 24% and was benefited by certain discrete items. Foreign currency transaction expense related to remeasuring foreign currency assets and liabilities to period-end exchange rates had a negative impact on operating income of $1 million, with net of a tax benefit had no material impact on earnings per share. Excluding the currency transaction loss and a restructuring charge,…

[Operator Instructions]. Our first question comes from Ruben Roy with Stifel.

Tim, I wanted to drill in a little bit further into the commentary around cutting. It sounded like the weakness was sort of weighted more towards the softer demand than competition in China. But can you remind us where -- kind of as a percentage of revenues in China cutting stat stands? And was the comment on competition in China broader, meaning that did it encompass EV as well?

No, the comment on competition in China was really around the cutting market and not around the EV market. We continue to have a very strong presence on foil cutting, cleaning and welding applications globally. Our cutting within China is certainly a much smaller share of the total sales there now. We had said at the end of last quarter that it was less than 10% of consolidated sales, and it remains quite well below that level, the high-power cutting business in China. It was pretty stable from Q1 to Q2, but it certainly didn't perform well.

I appreciate that. And as a follow-up, Tim, can we talk a little bit about gross margins and some of the puts and takes? Good quarter here. Obviously, we're going into a little bit of a lower revenue environment in Q3. So thinking through sort of the rest of the year, you've got potentially some improving productivity coming up in the new factory in Poland and potentially New Hampshire. How are you thinking about gross margin playing out through the rest of the year?

Yes. We were actually very pleased with the sequential improvement in gross margin following the sequential improvement in Q1. So getting back up to a more reasonable level, certainly below our longer-term target level still. In Q3, really, the difference is just on lower revenue levels, the absorption of manufacturing costs will be lower. So going through the remainder of the year, it will really depend upon where the tone of the business ends up and into next year, hopefully, with an improving outlook, we'd expect to see gross margins pick up again. But it really is just on the fixed cost base. You start to see some under-absorption at the guidance level we're at in Q3.

Our next question comes from James Ricchiuti with Needham & Company.

So it sounds like you're seeing -- you've seen some softening in the EV-related business in China. I'm wondering if you could talk more broadly about what you're seeing in the market outside of China. And Tim, maybe you could help size this EV business in Q2, how it fared just versus Q1? And to the extent you can, what that represents of that EV business, how much is battery welding right now?

Yes. So the -- we are seeing some softness in the demand cycle in China really related to the capacity additions that have already been built out there. You also started to see a transition more of the cylindrical battery investment. We think that's actually going to be a big driver next year as capacity utilization picks up. In the rest of the world, the demand cycle for EV has actually been pretty robust and strong. I'd say it's strongest in North America and then followed by Europe. There's good demand out of South Korea and even in Japan as well. It's still dominated by battery applications. We're diversifying the battery applications. Again, we've got the first orders for the drying equipment. We're starting to see some demand for additional foil cutting applications. There are some cleaning applications on some of the main body in -- mainly in North America, that's coming from, and there are some complete systems. We're selling into that. I'd still say, though, it's still very much battery-driven motor manufacturing is still a sort of ancillary application in that area.

And this where [indiscernible] is roughly -- what is your rough...

Yes. So we're still well above 20% of went above 20% of sales in Q2.

And also we'll see in Europe trend to achieve this production, shift production or better it to the final production of cars. And you see it indefinitely for a few of our customers in Europe and also in the United States.

Got it. And my follow-up question is on the bookings trends. You mentioned book-to-bill below 1, and I'm wondering if you could provide any more granularity on that. And how it may be varying by region and including what you're seeing perhaps in the consumer electronics market, which I don't think you mentioned at all in your prepared text?

Yes. We said that it was softer, of course, all of our major industrial geographies that would be Europe, U.S. and China. We actually had some pretty positive order flow out of Japan, which is holding up quite well. And South Korea also performed pretty well too. That's sort of the -- sort of married up to what you're seeing on some of the PMI data out there. Sorry, James, what was the second part of your question?

Well, just on some of the end markets, I mean, I assume that the legacy automotive is slower. I didn't hear any comments about some of the other end markets, including consumer electronics, which in the past, you've seen some seasonality in terms of orders. What does that market look like for you?

Yes. I mean that will be reflected mostly in the QCW sales, which were down slightly year-over-year. So there's no great traction in consumer electronics. The other positive areas on applications were really cleaning and then additive manufacturing was actually -- cleaning was very strong globally. Additive manufacturing is okay in Europe and was actually very strong in China with a couple of the OEMs that we work very closely with there, and additive there, we've been qualified because of the quality and the reliability of the lasers.

And cleaning application for us is very important because we are shipping not only pump laser or CW laser for the size kind of applications, but final systems for cleaning.

[Operator Instructions]. Our next question comes from Michael Feniger with Bank of America.

The inventories came down 3% quarter-on-quarter. I know that's been a target for you guys to make improvements there. But with book-to-bill less than 1x and some of the PMIs low, I'm just curious to how you're thinking about inventories in the back half? Do we need to take out more? Are you trying to position to get to a certain level to get -- just to position yourself for 2024, any ways to kind of think about that in the back half?

Yes, we continue to be very focused on managing inventory. And we're not seeing some of the same supply chain issues that we had experienced for the last couple of years. So we continue to target bringing inventory down during the second half of the year and generating cash out of that. In the medium term, let's say, we want to get down to less than 200 days inventory on hand and ultimately get back to a more normalized inventory level, which would be somewhere around 180 days, but that may take a bit longer to get to. But we're definitely looking to take some additional cash out of inventory and are pleased with the progress that we've made to date this year. And certainly, it's a significant change as compared to the investment in inventory we felt that was necessary last year.

Great. And Tim, just following up on the question around the production footprint. It sounds like what's weighing on the gross margin, among other things, is the under-absorption that you kind of talked about the volumes. Are you still confident with the change with the Poland and raising production in the U.S. that -- with your cost base as we think about those gross margin targets, maybe not for obviously Q3 or Q4, just maybe longer term?

Definitely, our goal to optimize our cost. First of all, for production of some of components like fiber blocks and others for our lasers. And of course, working [indiscernible] this way. By the way, in Poland, we will increase our production dramatically and we will increase further to the end of this quarter. The same situation in Italy. We also increased our production for these components and also in Germany. And every time we -- of course, it's under our control to cost of these components because it's influenced finally exactly to our gross margin. Situation in the United States, much more farther because it's an expensive country. But nevertheless, we are looking forward to make the final optimization of our cost first of all, for fiber components production.

Great. And then just on Europe, Europe, we're hearing from other industrial companies that kind of are flagging a weakening in Germany and Europe, the last month or so. Your growth was pretty resilient, even up a little bit in Germany. Just curious what you're kind of seeing there with the underlying demand versus your ability to offset that it looks like in some areas?

Yes. I mean, certainly, during the quarter, Europe was performing pretty reasonably and particularly compared to a year ago. The weaker guidance reflects some of the softness that other people are seeing. For us, that's translating into Q3. There are positives and negatives, right? Some of the industrial OEM business is a bit weaker, where some of the welding applications have held up quite well and things like cleaning are also performing well in Europe. But yes, I mean the PMIs in Europe are at 43%. They're some of the weakest they've been for quite a long time. And I think that the German economy is quite weak at the moment. So we'll have to see how long it takes for that to turn around.

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

You mentioned there was a large customer inventory adjustment in the U.S. Could you give a little more color what type industry was that from?

Yes. Mark, obviously, medical applications, which we'd called out on Q1 would be weaker in the second quarter, and now we're expecting a recovery in medical application sales in Q3, the customers worked through their inventory adjustment that they've signaled to us would happen in the second quarter.

Any opportunities such as in the consumer or consumer electronics area related to AI UC coming up?

I mean there's some announcements out there that there's one of the major smartphone manufacturers -- is going to be using more additive manufacturing in their processes. That would be an opportunity for us, given the strength that we have within the additive manufacturing processes around the world. I think -- I mean that would be one of the more significant opportunities that's been talked about. As you mentioned, the consumer electronics investment cycle overall with QCW lasers and even pulse lasers being relatively anemic is not strong outside of that right now.

We have reached the end of the question-and-answer session. I would now like to turn the call back over to Eugene Fedotoff for closing comments.

Thanks for joining this morning and for your continued interest in IPG. We will participate in a number of investor events this quarter and are looking forward to speaking with you over the coming weeks. 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.