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IPG Photonics Corporation (NASDAQ: IPGP) 2021 Third Quarter 2021 Earnings Conference Call, 10:00 AM Eastern Time, November 2, 2021
Good morning, and welcome to the IPG Photonics third quarter 2021 conference call. Today's call is being recorded and webcast. At this time, I would like to transfer the call to your host, Eugene Fedotoff, IPG Investor Relations Director for an introduction. Please go ahead, sir.
Eugene Fedotoff - Director of Investor Relations
Thank you Rob, good morning everyone. Walking with us today are IPG Photonics CEO Dr. Eugene Scherbakov and Senior Vice President and CFO Tim Mammen. Statements made during this conference call that discuss the intentions, expectations, or future predictions of management or the company are forward-looking statements. These forward-looking statements are subject to risks and uncertainties, which may cause the company's actual results to differ materially from the predicted results in such forward-looking statements. These risks and uncertainties include the impact of the COVID-19 pandemic on our business, as well as those detailed in IPG Photonics' Form 10-K as of December 31, 2020, and other reports filed with the US Securities and Exchange Commission. Copies of these documents can be obtained by visiting the "Investors" section of the IPG website or by contacting the company directly. You can also find a copy on the SEC website. Any forward-looking statements made during this conference call are only the company's expectations or forecasts as of today, that is, November 2, 2021. The company assumes no obligation to publicly release any updates or revisions in such statements. For more detailed information on the results of our report, please refer to the earnings press release, earnings conference call presentation and Excel-based financial data workbook posted on our investor relations website. After this conference call, we will post these prepared comments on our investor relations website.
With this, I will now forward the call to Eugene Scherbakov.
Eugene Scherbakov - Chief Executive Officer
Thank you. Eugene, good morning everyone. We are deeply saddened by the passing of Valentin Gapontsev, the founder and executive chairman of IPG.
This is a huge loss for the company and the wider photonics community. We have benefited a lot from his technological innovation and strategic rationality. Due to his reasons and the extension of the area, the work eventually becomes a cost-effective, reliable and effective tool, which has a large number of applications in global industrial production, thereby achieving automation, efficiency and the development of new products. He is recognized as the father and great entrepreneur of the fiber laser industry. Following his footsteps, we will continue to focus on innovation and provide the highest quality components and the most reliable products in terms of in-house manufacturing and R&D capabilities. At IPG, we are still exploring new markets and applications. By improving efficiency and productivity or achieving technological breakthroughs for our customers, fiber lasers can replace existing laser and non-laser technologies. Our technology has performed well in major micro brands, including investments in electric vehicles and renewable energy, as well as concerns about energy efficiency, industrial automation, and miniaturization that are changing the way products are created. As part of our strategy, we have been diversifying from the fiercely competitive and more cyclical Chinese cutting market. Our quarterly performance proves the successful execution of this strategy. We are very happy to take the third quarter revenue and earnings per share as the highest end of our guidance. The results were driven by strong growth in the soldering market, 3D printing, and the number of semiconductors and other products and applications. The demand for IPG lasers in North America and Europe continues to grow. This does indeed show strong growth in welding and cutting applications. We have also seen an increase in orders and business activities in Japan. These areas continue to recover from the pandemic, thus increasing investment in new factories and automation. We are benefiting from extensive global investment in electric vehicle production. Our lasers are used in a variety of welding, cutting and printing applications for electric vehicle battery manufacturing. We have also seen opportunities for laser welding to be widely used in electric vehicle motor components and car bodies. As automakers meet their needs for electric vehicle batteries and newer technologies to meet stringent global carbon emission standards, these investments may continue in the next three to five years. We are excited about the increased demand for measurement products and applications, which accounted for less than 30% of our total revenue this quarter, record sales in the laser and medical fields, and strong growth in high-power pulsed lasers. Both A&B and high-power pulsed lasers have benefited from increased global investment in electric vehicle battery capacity. Our medical products are rapidly gaining adoption, and our lasers and IPG disposable optical fibers are both regarded as the industry’s new gold standard. We, our medical business, we will continue to grow significantly, and in the next two to three years, our size may double. One of our newest products is a handheld laser, which was launched earlier this year and has aroused widespread interest and gained great attention in the welding industry. We launched a new and improved version of LightWELD in September. In addition to the percentage welding parameters, it also has cleaning capabilities. Some customers may choose LightWELD just for the cleaning function, because it can save time, money and reduce the cost of consumables. [Unrecognizable] This year we introduce the highlights of [Unrecognizable]. And we have signed agreements with national distributors that provide services to hundreds of welding retail stores in the United States. We expect to sell thousands of lightWELD systems in the next three to five years. As expected, we saw weak demand in the Chinese cutting market in the third quarter. Driven by extensive supply chain issues, high transportation costs and power shortages, as well as more intense price competition from local manufacturers, the demand environment continued to slow down, which had a negative impact on the demand for cutting applications in China this quarter. At the same time, due to the strong sales of electric vehicle battery applications and the growth of the 3D printing market, we have seen China's welding demand hit a record high. In several cases, we have seen customers return to IPG after low-cost local suppliers failed to meet customer quality and technical support expectations. We continue to benefit from our vertically integrated product model, which can achieve technological advantages while minimizing supply chain disruption. At present, we have seen the continuing supply chain issues on a global scale have some impact on the duration of us and our customers, and we have successfully overcome these issues this quarter. As we previously announced, the board of directors chose John Peeler as the non-executive chairman. John has been a leader and independent director since 2017, and his appointment provides continued stability because we have worked well together for many years. This appointment continues to separate the [Unrecognizable] that began in May 2021, and I look forward to working with John and his [Unrecognizable]. With this, I will forward the call to Tim to discuss the financial highlights of this quarter and the fourth quarter outlook.
Tim Mammen - Senior Vice President and Chief Financial Officer
Thank you. Eugene, good morning everyone. My comments usually follow the earnings conference call presentation provided on our website. I will start with the financial review on Slide 3. Revenue in the third quarter was US$379 million, a year-on-year increase of 19% and a month-on-month increase of 2%. GAAP gross profit margin in the third quarter was 49%, a year-on-year increase of 100 basis points. Compared with the same period last year, the increase in gross profit margin was mainly due to the decrease in inventory provision and the decrease in unabsorbed manufacturing expenses as a percentage of sales. GAAP operating income was $102 million and operating profit margin was 26.9%. Net income for the third quarter was US$75 million or diluted earnings per share of US$1.40. The effective tax rate for the quarter was 26%. As a reminder, last year's performance was negatively affected by the $45 million goodwill impairment charge. In this quarter, we confirmed an after-tax foreign exchange earnings of US$2 million or diluted earnings per share of US$0.04, which was mainly related to the depreciation of the euro and the renminbi. The exchange rate relative to the U.S. dollar is the same as a year ago, and we expect revenue to decrease by 9 million U.S. dollars and gross profit to decrease by 6 million U.S. dollars. Turning to slide 4, sales of high-power continuous lasers fell 4% year-on-year, accounting for about 47% of total revenue. The sales of ultra-high-power lasers of 6 kW or higher accounted for 51% of the total sales of high-power continuous wave. Due to the growth of cutting, welding, 3D printing and semiconductor applications, sales of mid-power lasers increased by 109%. Due to increased demand for marking, engraving and drilling applications, QCW laser sales increased by 8% year-on-year. Sales of pulsed lasers, including high-power pulsed lasers, increased by 69% year-on-year, including strong growth in electric vehicle battery manufacturing, foil cutting applications for solar cell applications, and increased sales of our infrared lasers for marking and cleaning. System sales increased by 56% year-on-year, of which Genesis and IoT revenue increased, and lightWELD sales increased. Sales of other products increased by 58% year-on-year, benefiting from sales growth in medical and beam delivery. Checking our performance by region on Slide 5, North America’s revenue increased by 55% year-on-year, driven by increased sales of materials processing, welding growth, and high-power lasers for cutting applications. As our products continue to gain recognition, we have also seen record quarterly revenues in the medical sector. System sales improved in the third quarter, with strong revenue growth for laser and non-laser systems. In Europe, revenue increased by 50% year-on-year due to accelerated demand for cutting and welding applications and strong growth in marking and additive applications. In the third quarter, our revenue in China fell by 7% year-on-year and accounted for approximately 36% of total sales. Soft sales of high-power lasers in cutting applications offset the increased demand for welding applications, high-power pulsed lasers for foil cutting, and marking and additive applications. Sales in Japan increased by 11%, and revenue in the rest of Asia increased by 15% year-on-year. Go to the balance sheet and cash flow summary on Slide 6. At the end of the quarter, our cash, cash equivalents, and short-term investments were $1.5 billion, and our total debt was $35 million. The strong operational execution power resulted in the cash provided by operations in the quarter of 102 million US dollars. For our cash deployment, the capital expenditure in the third quarter was US$40 million, and we expect the full-year capital expenditure to be between 130 million and 150 million. During the quarter, we repurchased 200,000 shares for US$36 million and purchased approximately 135,000 shares so far in the fourth quarter. When commenting on our outlook for the next quarter, the book balance in the third quarter is still higher than 1. We expect stable demand in North America and Europe, and continue to see growth opportunities in welding and high-power cutting, foil cutting and welding in North America and Europe. The application of EV battery production in many regions, as well as solar cell manufacturing, medical procedures, and advanced applications. Chance. We also see that the sales of lightWELD continue to receive attention. However, due to the weak demand for cutting applications, supply chain issues and power outages that may affect the uncertainty in the demand for our products, as well as continued competitive pressure, sales in China will continue to decline in the fourth quarter. For the fourth quarter of 2021, IPG expects revenue of 330 million to 360 million. The company expects the tax rate for the fourth quarter to be approximately 25%, excluding any discrete items. IPG expects diluted earnings per share to be between US$1 and US$1.30, and the number of diluted shares outstanding is approximately 54 million. I would like to remind you that in light of the COVID-19 pandemic and its related impact on the global business environment, supply chain, public health requirements, and government mandates, the financial guidance provided this quarter will continue to face greater risks and uncertainties. For more detailed information about the risks and uncertainties associated with our forward-looking statements, please refer to the safe harbor paragraph of today's earnings press release. With this, we are happy to answer your questions.
Thank you. At this time, we will conduct a question and answer session. [Operator Instructions] Our first question comes from Jim Ricchiuti from Needham. Please continue with your question.
Jim Ricchiuti - Needham & Company - Analyst
Good morning. I have a question about China. If we exclude the cutting business in China, can you tell us how that business performs in the rest of the portfolio? Do you still see the weakness in China, or whether the business is performing better in China, I have to follow up.
Tim Mammen - Senior Vice President and Chief Financial Officer
In the third quarter, Jim, except for layoffs, the rest of the business was very strong. I mean, obviously, electric vehicle battery applications are a very strong growth driver. We are actually very happy too. We have some good demand from additive applications. These applications have lower power but very high quality lasers and are therefore competitive. This is a very positive trend. I think another good positive trend is in some marking engraving More and more applications are used in automated production lines. Therefore, the quality of the laser is very important there, and it performs well there. Therefore, other applications besides cutting are very powerful, and I would say they are good.
Eugene Scherbakov - Chief Executive Officer
Cutting applications, of course, we must also see lower edge applications in some competitions from China, but for high-end applications, we also have a good position to compare with Chinese competitors.
Jim Ricchiuti - Needham & Company - Analyst
My follow-up question is only related to lightWELD. I know it is still too early, but from FABTECH's interest, yes. I mean, every time I see the booth, it is full of people. People are watching the demo. When will you see the benefits of expanded distribution channels? Will this take a hit in the fourth quarter or will it really start to benefit you in early 22nd? I don’t know if the channel partners have been trained at a high level, but can you tell us what you think of LightWELD?
Eugene Scherbakov - Chief Executive Officer
First of all, I want to get a lot of benefits from this quarter, but of course, it takes time, because there are many different opportunities and different customers involved in this, we must give customers some time to use it, of course, we can be profitable. By the first quarter of next year. But it is also very important that we introduce new options for lightWELD, what we will show at the end of this quarter and early next year.
Jim Ricchiuti - Needham & Company - Analyst
This will be, do you expect this to be a catalyst for your system business, because the rest of the system business seems to be recovering. But when we see this, you will clearly see that part of your business has changed.
Eugene Scherbakov - Chief Executive Officer
Yes. So this is talking about catalysis, I don't think so. Our other businesses will also grow, and we are definitely optimistic about our forecasts and forecasts for next year.
Jim Ricchiuti - Needham & Company - Analyst
OK, thanks. I will jump back into the queue.
Our next question comes from Nik Todorov of Longbow Research. Please continue with your question.
Nik Todorov-Longbow Research-Analyst
Yes, thank you and good morning. Despite the weak layoffs in China, the gross profit margin remains good. So this is obviously different from the previous cycle. Despite the decline in layoffs in China, can you talk about the leverage that allows you to maintain a consistent gross margin? Do you see offsets for new products, or do you see more discipline in pricing? What are the driving factors for flexible gross margins?
Tim Mammen - Senior Vice President and Chief Financial Officer
So there are many drivers. I think the first thing is that the strategy around pricing in China and globally does indeed bring benefits in this regard. The second one may have 2 or more drivers. Therefore, since the sales of cutting applications in China have slightly decreased, while the sales of other applications are higher, we usually benefit from it. In addition, some of your strong sales in cutting and other applications in Europe and North America have also brought geographically mixed benefits, which is also a benefit, and then we have obtained strong sales in fields such as medical and even some semiconductor applications. Therefore, from a hybrid and diversified perspective, we are moving in the direction we want to see, and the gross margins in all these areas are beneficial.
Eugene Scherbakov - Chief Executive Officer
Yes. In addition, we will continue to extend the special items that were installed two years ago regarding the optimization of manufacturing cost components or equipment this year and the trend next year. really.
Nik Todorov-Longbow Research-Analyst
As a follow-up, Tim, can you provide preliminary comments on 2022? I know that you will not specifically guide, but I think you talked about the double-digit sales growth algorithm last quarter. What do you think of 2022 relative to this framework? Any comments will be helpful. thanks.
Tim Mammen - Senior Vice President and Chief Financial Officer
I will not comment on the double-digit growth next year. What I mean is that we have provided a mid-to-long-term goal of continuing to grow the business at a double-digit growth rate. We currently do not provide any guidance for next year. It would be a wrong point in time to do so. We don’t have to decide whether to provide annual guidance. In general, although we are still very optimistic about next year. You have gained the main growth momentum. We talked about the macro trends of EV battery manufacturing, EV motor manufacturing, body-in-white applications, new product launches in other parts of the welding market, and growth in medical applications. The global and Chinese high-power cutting market is growing Transition to higher power levels. We will start rolling out our ultra-compact lasers at power levels above 1 kW and 1.5 kW to allow the transition in the middle of the year. At the beginning of the year, it will reach 3 kW and 6 kW, and will eventually reach 8 kW through ultra-compact equipment in the second half of this year. Therefore, we believe that there are a large number of different applications that will make next year an interesting and exciting application. Perhaps from a geographic perspective, you will continue to see strong economic data in North America and Europe, and perhaps a slight slowdown, but there is no fundamental change in the region. We are also beginning to see some recovery in Japan, and you are in South Korea. There are many opportunities in other Southeast Asian markets. Therefore, at this point in time, we are completely optimistic about next year.
Eugene Scherbakov - Chief Executive Officer
Of course, I would like to add some customers as well as Chinese and foreign customers to ask questions about this type of laser and IPG lasers with an efficiency of more than 50%. No one will produce this product today. So this is also an opportunity for us to provide such a high-efficiency high-power laser, which will also be demonstrated at the end of this quarter and the beginning of the next quarter. We already feel some professional customers for this.
Nik Todorov-Longbow Research-Analyst
understood. Thank you and good luck.
Tim Mammen - Senior Vice President and Chief Financial Officer
Our next question comes from Michael Feniger of Bank of America. Please continue with your question.
Michael Feniger-Bank of America-Analyst
Hello everyone. Yes, thank you for asking-for asking my question. I want to maintain respect and how I asked this question. There are many investors who want to know what will happen to Valentin is trust in voting shares. Since you are only an important shareholder in your 10-K file, his ownership position is clearly regarded as a significant risk. We saw yesterday that some 13D files occurred last night. I just because it does appear with investors. Given these documents, can you provide an update? At this point, what is the status of his ownership of this trust position?
Tim Mammen - Senior Vice President and Chief Financial Officer
So, Michael. There are no major changes in ownership and structure. The estate planning around IPG [Indecipherable] ownership not only started to be completed many years ago. The trustee appointed to manage the trust has not changed, and your idea of paying the company has not changed significantly, because Dr. Scherbakov will be the managing director and will vote for these shares, so I think we have considered this transition and planned well. The process of decades has led us to focus on the center.
Michael Feniger-Bank of America-Analyst
very fair. I think I think this might answer the next question. But in view of this situation, will there be any changes in IPG's strategic direction after the incident? Is there any change in the capital allocation of large cash balances? Is there any change in management that we should pay attention to? We see the new executive chairman. But just curious, will there be any changes after the press release on strategy and IPG?
Tim Mammen - Senior Vice President and Chief Financial Officer
I think that if we are going to make a fundamental change or anything for the first time, it will be an important announcement that we will make. We may make all announcements around the events of the past few weeks and the past few weeks. In terms of strategy, we talked about when Dr. Serbakov took over as CEO. At a high level, this strategy was formulated by Dr. Serbakov and Dr. Gapontsev and other executive team members over the years. Therefore, we will continue to introduce fiber laser technology in a variety of applications and end markets. So there is no big change in that direction. Dr. Scherbakov mentioned a few things and will continue to try to optimize our manufacturing footprint and efficiency there. We will not change the 45% to 50% gross margin guidance range, although internally, we are increasingly willing to achieve the high end of this range and take measures to keep us at the high end of this range on average. Of course, there may be some differences, depending on where the quarterly revenue drops. In terms of capital allocation, as time goes by, we continue to strengthen and develop capital allocation strategies. We regularly execute the existing $200 million repurchase and complete the previous repurchase quickly and quickly. Therefore, there are no fundamentals. Otherwise, you Will have to clarify them.
Michael Feniger-Bank of America-Analyst
make sense. Thanks for that. Tim. Then what do you think of all supply chains and cost inflation, you will be so vertically integrated? I’m curious as to how this affects some new supply chains that are trying to acquire certain components, but I think the cost figures are in line with your expectations, about 87 million US dollars, such as how we consider you to see more costs when you enter 2022 Will companies experience inflation in the fourth quarter? How do we think about those activities on SG&A, as well as labor and things like that? Thank you. Of course, you will see the impact of this impact on our customers and many of our suppliers. High but some components, but they are all electronic chips and so on, but we have manufactured some-about this revenue [unrecognizable] issue and our inventory of these components. I want to trade our lasers steadily, not to disturb our customers. But of course we must consider our strategy, because metal prices have risen sharply, aluminum 20%, copper well 30%, and some chip prices have also risen instead of 30%. But sometimes 3 to 10 times, there is some flexibility in this case, so we optimize our costs again and discuss future operations with our existing and potential customers. Of course there are some uncertainties, but we believe that next year will definitely be Will be more stable conditions.
Tim Mammen - Senior Vice President and Chief Financial Officer
As far as operating expenses are concerned, I can solve those SG&A and R&D. We are consistent with our guidance in the third quarter. We actually operate at a higher level than a year ago on some of these operating expenses. First of all, because of our availability Variable compensation accruals, taking into account the overall performance growth so far this year, the third quarter is close to 20% and 20%. So it's actually slightly higher than our budget, so our variable compensation should be slightly higher. For example, you get some expenses from the seller’s trade shows and exhibitions, so FabTech is variable. Relatively speaking, we may ease next year, depending on our performance relative to next year’s budget. So in fact, no fundamental changes have been seen. We also hope to optimize these costs in terms of operations, unlike anything else. So of course I hope to be very self-disciplined in the way we manage. But we must also ensure that, for example, in sales and R&D, we focus on hiring enough sales staff to develop the business and carry out sufficient marketing activities. At the same time, we also focus on R&D and get the key projects and product drives that we think can really be achieved. Revenue growth is complete.
[Operator Instructions] Our next question comes from Paretosh Misra and Berenberg. Please continue with your question.
Paretosh Misra - Berenberg - Analyst
Thank you and good morning. I want to return to that inflation discussion. So I mean, look at it differently. Therefore, some of your competitors have been cutting prices in recent years. So I am curious whether this kind of inflation and parts pricing and trade make it more difficult for these people to cut prices. In other words, even for low-power lasers, will inflation lead to some kind of price stability?
Tim Mammen - Senior Vice President and Chief Financial Officer
I mean we can’t really talk to our employees, the competitive market will perform well, if you look at the results of one of the competitors announced last week, I think it’s very interesting, even if compared to the first quarter, Their gross profit margin is also declining, I think it is close to 600 basis points. Therefore, they must be very aggressive in pricing, and because of this enthusiasm, pricing will certainly not reduce the cost base because of the impact on gross margins. I cannot say how they will perform strategically in the future.
Paretosh Misra - Berenberg - Analyst
understood. As a follow-up, maybe you can talk more about your solar business. Any thoughts on how big it is now and how big do you think it might be in the next few years and where exactly is your product used throughout the process?
Eugene Scherbakov - Chief Executive Officer
It is not only a product, but a variety of products. Unfortunately, I don’t know if you can, which part of the solar business today, but first of all, there are different kinds of pulsed lasers, I mean micron area, and green pulsed lasers. Next year and we are also very optimistic, I think We are very optimistic about the application of lasers, and we are again optimistic about this laser.
Paretosh Misra - Berenberg - Analyst
Our next question comes from Joe Wittine of Edgewater Research. Please continue with your question.
Joe Wittine-Edgewater Research-Analyst
Hi, good morning. I extend my condolences to IPG from an investor-oriented perspective, and I will miss VG’s enthusiastic response to any questions we focus on competition. We clearly showed that his technology broadened the product. So yes, my condolences. I want to ask about China. Yes. The prepared comments put together the key individual comments in the prepared comments. A comment on Chinese competition is still going on, but on the positive side, discussing gross margin you mentioned price discipline. So have we expanded on these dynamics. Does this mean that you are moving away from certain machines or even potential customers, or are there any real changes in these dynamics in the second half of this year?
Tim Mammen - Senior Vice President and Chief Financial Officer
I don't think anything has really changed fundamentally. There are a lot of low-end markets, and they actually only buy at price. Then, continue to have higher, this is in the overwhelming aspect of things, there is still a high-end market, usually serving higher-volume manufacturing and automated manufacturing systems, where reliability is very critical to the system. So, for example, in a production line, if you have a few hours or even a day of downtime, the cost of downtime will far exceed the cost of the laser. right. Therefore, it is precisely in those areas that we continue to focus on, our share is still high, trying to play a role in the very high low-end market is a bit triumphant. But what we do say is that as we expand the supply of ultra-compact and low-cost lasers, when we reach 3 kW, 6 kW and finally 8 kW, there is definitely an opportunity to increase our share, and then in the rest of the Chinese market, you are To handle more complex applications, our competitive products are significantly better. Therefore, whether it is A&B lasers or high-power pulsed lasers, they are all single-mode lasers with lower power levels. These lasers are used for some additives, and even some welding applications that seek to use low single-mode. We have obtained very, very good results. All these areas have obvious advantages.
Joe Wittine-Edgewater Research-Analyst
thanks. Maybe just give us a comment on car investment, except for electric cars, I think this is understandable. But I just want to know if it will have any impact on the interest in investing in core bodywork in white and Taylor welded blank type applications, while the light vehicle sector is generally sluggish in the short term?
Tim Mammen - Senior Vice President and Chief Financial Officer
Yes, we have not seen a very important investment in this area. As a couple, a North American manufacturer actually replaced it and started a plan to replace some 8-10 year old lasers, because I see After some orders came from some major manufacturers in Europe, and some major manufacturers in Japan recovered from a major manufacturer today, they hope to introduce more professional welding processes more widely, many of which belong to non-electric vehicles. But no, we have no major projects that can be pointed out today. At present, the electric vehicle market does dominate the automotive industry.
Eugene Scherbakov - Chief Executive Officer
Joe Wittine-Edgewater Research-Analyst
great. Finally, just want to know if there are any noteworthy supply chain-driven recalls this quarter. I think at least in terms of reducing downstream customers, delivery time is being extended, which is usually caused by not a key component of the laser. So I wonder if this will cause any delay in your shipment this quarter?
Tim Mammen - Senior Vice President and Chief Financial Officer
Do not. Internally, we manage the supply chain very well, but there is definitely some weakness in the terminal market and some problems in China. Not only the supply chain is out of power, the absence of transportation costs is definitely part of the impact on the Chinese cutting market.
Eugene Scherbakov - Chief Executive Officer
However, despite this, all our obligations to customers do not delay our typical life cycle, but delay the delivery date of our products. It is between 6 weeks and a maximum of 8 weeks.
Joe Wittine-Edgewater Research-Analyst
understood. thank you very much.
Our next question comes from Mark Miller of The Benchmark Company. Please continue with your question.
Mark Miller-Benchmark Company-Analyst
Thank you for your question. In terms of COVID-related costs, you have broken them down before. How important is this quarter?
Tim Mammen - Senior Vice President and Chief Financial Officer
we do not have. So we have not really broken down the costs associated with COVID. If you are confused about other expenses, Mark, I'm not sure. We have no real significant impact on the cost structure associated with COVID. Historically, just like last year, you benefited from lower travel and trade shows, so you start to see some of these expenses increase. Of course, there are some sanitation-related costs-disinfection and not providing personal protective equipment, but this is not the case, and this has no substantial impact. We have never broken this situation before.
Mark Miller-Benchmark Company-Analyst
Of course, I’m sorry. In terms of component shortages and electronic component shortages, how does this have an impact? I mean, if there is an impact, which product areas will you see affected?
Eugene Scherbakov - Chief Executive Officer
First of all, we have, we now have a sufficient number of components, which are what we need for production, and are currently still looking for new suppliers, sometimes we are not sure to redesign our products to use components that are not the previous ones, but for new. In this case, we are flexible enough.
Mark Miller-Benchmark Company-Analyst
Our next question is Jim Ricchiuti and Needham and Company. Please continue with your question.
Jim Ricchiuti - Needham & Company - Analyst
Hello, thanks. Yes, Tim, you have put forward requirements in several areas of additive manufacturing. I want to know if you can remind us that if we go back to where the business might have reached its peak in previous years and what you saw in the market, it sounds like you might even gain some share in China. But what is certain is that Europe is a contributor. How should we view additives this year?
Tim Mammen - Senior Vice President and Chief Financial Officer
Just as it peaked in 2017, perhaps the strongest quarter in the first half of 2018, of course, the European market has been very weak since then. There are indeed more new developments in the Chinese market, starting to launch products, and you are also beginning to see some recovery in the European terminal market. I think it is the peak period, but at that time, 4% or 5% of the annual income of 50 million to 60 million US dollars.
Jim Ricchiuti - Needham & Company - Analyst
Based on what you said, it sounds optimistic that you have some growth runways in this market?
Tim Mammen - Senior Vice President and Chief Financial Officer
I think there will be some recovery in the market, and there will be more participants in the market. In terms of improving speed, process, etc., it still has a way to become a true basic driver. I think that is a return to recovery. I think the recovery of the aerospace market will also help, because this is an area that uses a lot of management processes.
Eugene Scherbakov - Chief Executive Officer
Sorry, of course, the machines used by 3D applications are much more complicated now. If as usual, they use one machine, one laser. There are now as many as 12 lasers, and they use one machine to produce parts from metals of other materials, and they are very fast.
Jim Ricchiuti - Needham & Company - Analyst
understood. In another area, we did receive a lot of questions, because it seems that a considerable amount of activities are directed energy, you can provide any updates, whether it is visibility of the project, whatever you can say, because this is obviously a fierce competition Market area.
Tim Mammen - Senior Vice President and Chief Financial Officer
There is no really special update at the moment. I think it is really the turning point. People are looking for the commercialization of these different technologies. This is something that people have already launched. We haven’t seen an increase in the number of materials. There is a lot of ongoing research project. We continue to ship lasers, and our business is fairly stable at the moment. It is still pre-commercialized. In terms of competition, I would say that we play a role in a very different part of the market. We are not trying to track and transmit the beam. We are thinking of being a light source in certain applications, rather than a broad collection of these applications, so we are not. Our customers are those who do beam tracking in delivery capabilities, so we don't have that many on this competitive end.
Eugene Scherbakov - Chief Executive Officer
So far, there is no competition, such as the highly polished lasers on the market, copied over 10 years ago and [unrecognizable] 10 kW lasers. So far, no one has been able to produce such a laser.
Jim Ricchiuti - Needham & Company - Analyst
Thank you. thank you very much.
Our next question comes from Michael Feniger of Bank of America. Please continue with your question.
Michael Feniger-Bank of America-Analyst
Yes. Thank you for squeezing me back. Tim, gross profit margin increased by 100 basis points year-on-year to 49%. Sorry, I think you may have solved some of these problems, but what are the main driving factors there? I think there is inventory preparation and fixed cost absorption. Could you repeat that?
Tim Mammen - Senior Vice President and Chief Financial Officer
Yes, inventory reserves and basic or unabsorbed manufacturing costs as a percentage of sales have decreased compared to a year ago. Your gross profit margin is relatively stable. Me, main, main, main area.
Michael Feniger-Bank of America-Analyst
OK. Tim, I think at a meeting in August, you felt that the Chinese market was not as scary and scary as it was in 2019. Considering some other unfavorable factors, is this still the case? Where to watch? As far as China’s pricing is concerned, is the market already going down, you just didn’t follow it, or just, if it does go down, you are not, you are unwilling to match and fall there because you are moving away from some low-end cutting diversification?
Tim Mammen - Senior Vice President and Chief Financial Officer
So the first part of the question. I think for us, the Chinese market is becoming more diversified, just like other places, and benefiting from some tailwinds driven by the electric vehicle investment cycle. We talked about additives, we talked about some customers who came back to us at the briefing. Not only the current cutting market is weak on supply chain issues, but there are also power outages. They have already got some Evergrande. I mean, these things are beyond our control. right. We can continue to compete very fiercely in this market. For no chance even when cutting, Dr. Scherbakov mentioned 2 or 3, the echo laser moves towards higher power when cutting. Then there is the ultra-compact laser, which gives us the opportunity to compete in the non-cost part of the market. In terms of pricing, the fiercely competitive dynamics have taken many measures in terms of pricing. We are now more self-disciplined in the strategy surrounding pricing. We have provided a technology value proposition for more than a year. Therefore, as evidenced by the performance of this quarter, we have been and are very satisfied with this approach to our business model.
Eugene Scherbakov - Chief Executive Officer
It is also important that high-power lasers are not only strict at the source. I mean laser. In addition, in many cases, our optical heads and some other components, in this case, we can compete more successfully.
Our next question comes from Nik Todorov of Longbow Research. Please continue with your question.
Nik Todorov-Longbow Research-Analyst
Yes, thank you for your follow-up questions. I just returned to China. How do you explain this divergence of demand in China? I think the demand for electric vehicles is obviously special. We know that we need to increase capacity, but given the supply chain, power outages, and your background of that nature, how do you explain the difference between cutting and marking and processing printing? highlight.
Tim Mammen - Senior Vice President and Chief Financial Officer
It is relatively easy to explain where anyone uses lasers in a highly automated or mass production environment, they really need reliability and quality, because if the production line fails, the downtime of the production line in an automated environment is even 1 hour, 2 hours counts as a day , This far exceeds the cost of the laser. However, if you enter like some processing shop applications, the processing shop may be down for a day, waiting for competitors to provide alternative lasers, and will not affect them from a cost perspective in this way, because they pay much less for lasers , They are ready to live with this, it really, I mean I mean you describe the opportunity cost of automation and very low-end types of applications where people might handle metals, for example. I don’t know, furniture or live devices. So this really added some in my mind, so we really solved the problem.
Eugene Scherbakov - Chief Executive Officer
What I want to do is to give some examples. For example, for some cars, a customer, you have shortened the reaction time in certain experiences. possible. If you are a laser installed on a production line, the response time must actually be less than 20 minutes. As I mentioned, what kind of laser is installed and what kind of training must be provided. What kind of support do we have to provide customers. The problem is not to provide lasers. Reliable lasers are of course important, but it is also important to organize service and support for customers. In many cases, because we are using our experience, workers, and almost all automotive customers in the world, we have enough Experience to support our customers in other applications.
Nik Todorov-Longbow Research-Analyst
Yes. That's very helpful. I think my question is more like from a macro perspective, why do you think China's cutting demand is weak, and you mentioned the strength of market printing and some other areas. I understand from your perspective, you know why there is a divergence between the high-end and the low-end, you explained it well, but from a macro perspective, why cutting demand in the context of supply is stronger than 3D printing and marketing chain and power outages And everything?
Tim Mammen - Senior Vice President and Chief Financial Officer
I think additives is an emerging business there, and it is starting to support the emerging aerospace industry. So this is a driver. This is really at the beginning, not only in the aerospace field, but also additives are being launched. I think at a relatively early stage and there are some areas of marking engraving, for example, where you support consumer electronics, we regained share. . So the market itself. I mean, when you try to understand where the entire marketing and engraving market is, it is also a very, very large market. There are tens of thousands of pulsed lasers being sold, but we are one of the reasons and one of the reasons for our positive performance in regaining share in the automated process. Then in electric vehicles is this a well-understood macro tailwind?
Nik Todorov-Longbow Research-Analyst
right. Okay, this is what I have been looking for. thanks. Appreciate it.
We have reached the question and answer session. I now want to turn the call back to your host Eugene Fedotoff (Eugene Fedotoff). Thank you.
Eugene Fedotoff - Director of Investor Relations
Thank you for joining us this morning and your continued interest in IPG. We look forward to talking with you in the coming weeks. We will participate in some virtual investor events this quarter. I wish you all a good day. [Closing speech by the operator]
Eugene Fedotoff - Director of Investor Relations
Eugene Scherbakov - Chief Executive Officer
Tim Mammen - Senior Vice President and Chief Financial Officer
Jim Ricchiuti - Needham & Company - Analyst
Nik Todorov-Longbow Research-Analyst
Michael Feniger-Bank of America-Analyst
Paretosh Misra - Berenberg - Analyst
Joe Wittine-Edgewater Research-Analyst
Mark Miller-Benchmark Company-Analyst
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