My main source of data is IPG’s SEC filings page, with some info from the Prepared remarks on the Presentations page and the results releases on the Press Releases page. Some “net sales” figures were reported as “revenue” outside of SEC filings, and in previous quarters I’ve confirmed that when both terms were used for the same quantity, they had the same figures.
I’ve also quoted from “IPG Photonics (IPGP) CEO Valentin Gapontsev on Q3 2015 Results – Earnings Call Transcript” Oct. 27, 2015 (www.seekingalpha.com).
I don’t mean to imply that the quarterly twitches matter more than the general trend. The best entry points might be when quarterly results disappoint, although the market is capable of worrying ahead of results. For example recent share price weakness has been attributed to concern about China, see “IPG Photonics up 9.2% following mixed Q3 results, soft Q4 guidance” Oct 27 2015 (seekingalpha.com). The results were reassuring about China, which explains the rise, but that followed a 5% drop (see IPG Photonics misses by $0.03, beats on revenue).
Charts showing guidance are based on this from the prepared remarks:
- “We currently expect revenues for the fourth quarter to be in the range of $215 million to $230 million. We anticipate Q4 earnings per diluted share in the range of $1.00 to $1.15. The mid-point of this guidance represents quarterly revenue growth of approximately 7% and EPS remaining flat, respectively, year-over-year.
The EPS guidance is based upon 53,392,000 diluted common shares, which includes 52,675,000 basic common shares outstanding and 717,000 potentially dilutive options at September 30, 2015.”
Income, revenue and costs
About seasonablity, the 10-K for 2014 has –
- “Historically, our net sales have been higher in the second half of the year than in the first half of the year.”
and from the Prepared remarks –
- “While the book-to-bill was slightly below 1 in Q3 2015 this is not unusual because we typically expect the fourth quarter to be seasonally weaker.”
Taken together, Q3 must be seasonally strong. That’s consistent with the chart above, although there was also a strong Q4 in 2014 due to exceptional orders as pointed out in the middle of this –
- “The Q4 guidance represents about 7% revenue growth at the midpoint over Q4 2014. I want to point out that our guidance range includes double digit growth in Germany, Japan and China. Year over year we expect Q4 revenue in China to grow at about 15%. While this represents a lower rate of growth as compared to the year-to-date it is still pretty good. What is pulling down the overall Q4 expected growth rate is the U.S. which had a very strong Q4 2014 with shipments of several super high-power lasers and a large automotive order. Revenue in the U.S. is more evenly spread between Q3 and Q4 this year rather than being weighted to Q4. In addition, we are expecting a slightly weaker quarter in Turkey and Korea where macro-economic conditions have softened.” (Prepared remarks)
Revenue and costs are affected by currency exchange rates –
- “IPG delivered yet another strong quarter, growing revenues by 22% year-over-year to $243.5 million in the third quarter of 2015. We translated that growth into a gross margin of 54.7% and we reported EPS of $1.18 which includes a $0.06 per share impact of foreign exchange transaction losses. Year-over-year, foreign currency losses reduced our sales by 12 percentage points. In other words, sales would have increased 34% if Q3 2015 exchange rates remained the same as a year ago.” (Prepared remarks)
The only hedge I found was an interest rate swap associated with the U.S. long-term note, worth a notional $11.3 million in 2014, which matured in June 2015. I’ve seen no evidence of currency hedging with derivatives, although the company said they analyze exposure and might use financial hedges. Encouraging faster payment in China was presumably more cost-effective, and also benefits customers rather than giving business to financial counterparties.
Other comprehensive income, exchange rates and dollar debt
As well as affecting how revenue and costs are translated into dollars, exchange rates also affect the dollar value of overseas assets, and the change in the value is recognized in Other Comprehensive Income –
The dollar is probably in long term decline, though with big swings (for the dollar index since 1971, click here then click “Historical” and “Max”). That suggests that in the long term, IPG will accumulate an OCI gain instead of the current accumulated OCI loss of $155.8 million. There’s some risk of further dollar gains before reversion to the trend.
I’ve warned for nearly a year that overseas dollar denominated debt could trigger a flight to safety that could push up the US dollar. The debt problem is explained in “Bond Issuers and Investors Are About to Find Out It’s Not Easy Being Green(back-Denominated)” by Tracy Alloway, August 24, 2015 (bloomberg.com). I don’t have the author’s certainty about it, due partly to a lack of evidence that borrowers don’t earn enough dollars to repay the debt. If it all goes bad, many companies would be affected. I’d rather be holding IPGP with the industry-leading margins, good free cash flow and big stash of cash than many other stocks.
The concern includes China, as in “China’s dollar debts come under pressure” by Michael Mackenzie and James Kynge, August 11, 2015 (ft.com) (you probably have to answer a market research question to see the article). There may be less impact on US firms if the debt is mostly held by local government and real-estate firms (see “China’s Big-Dollar Borrowers Hold Off on Hedging Foreign-Currency Debt” by Fiona Law and Esther Fung, Aug. 28, 2015 (wsj.com)).
I don’t always show a “per share” version, so it’s worth looking at the share count.
DSO and days of inventory
The low value of R-squared for the Days Sales Outstanding trendline indicates that it fluctuates around an average, rather than having any trend (technically, it’s wrong to fit a trend line to a series which puts a third quarter result on the end of annual results). The DSO figure for the latest quarter includes the effect of incentives for early payment in China. While IPG have reduced the average days of inventory during the period, the trendline is not reliable for prediction. IPG hold sufficient stocks of parts to be reasonably sure that assembly can begin as soon as orders are received, and thorough testing before dispatch adds to the inventory.
The next chart adds lines for sales, net income and cash from operations. It isn’t surprising if cash from operations is affected by DSO and days of inventory, but I haven’t tested for it.
I made various tests, with negative results, for relations between the change in sales, and DSO and days of inventory. The tests included the change in next year’s sales, and both the absolute DSO and days of inventory, and the percentage change. The maximum variation explained was 16.4% for the change in inventory and change in next year’s sales. I’d thought that maybe inventory was built up ahead of an expected sales increase (e.g. for product launches), but the figures for the period don’t support that. As well as explaining little of the variation, the trend line sloped the wrong way, as if more inventory predicted lower sales growth. I did not control for management statements, and if it’s ever stated that inventory has been increased in preparation for anticipated sales, my results won’t apply.
My chart of cash from operations against cash used in investment shows good growth of free cash flow. Annual cash flow can be highly variable, and quarterly cash flow is even more variable. The latest jump in cash from operations includes the effect of higher collection in China, as a result of incentives to pay early, motivated by IPG wanting to reduce exposure to the Yuan. A fall back in cash from operations would not be surprising. I have not separated out the effect of changes in working capital (receivables, inventory etc.) which is the most variable component.
The investing cash flow includes cash used for acquisitions. Some companies park cash in short term investments such as securities, with the inflows and outflows swamping the investment flow, but that’s not a problem for IPG except for $25.5 million of “Proceeds from short-term investments” in 2012 which followed “Purchases of short-term investments” for the same amount in 2011. “Property, plant and equipment” generally dominates, with figures of $68.2 million and $53.0 million in 2012 and 2011 (i.e. bigger than the short term investment), $88.6 million and $70.9 million in 2014 and 2013, and $18.2, $18.6 and $14.0 million in Q3, Q2 and Q1 2015 (with Q3 and Q2 calculated). Capex is expected to hold steady, excluding acquisitions which tend to be opportunistic –
- “We’re running, what is it about, 7% to 7.5% of revenue this year. So even that represents a substantial amount of spending activity. I don’t expect to increase as a percentage of revenue in next year at all.” (transcript on Seeking Alpha)
Balance sheet charts
Where I include Q3 2015, there has obviously only been nine months between the quarter’s figures and the end-of-year 2014 figures.
Materials processing and Other applications
In the Prepared remarks the CEO said –
- “In addition, we continue to pursue projects in non-materials processing applications, such as advanced, medical and telecom, because they present significant opportunities for us as evidenced by their strong growth in Q3 when sales for non-materials processing increased by 168% year-over-year.”
The CFO was less upbeat, with –
- “As a reminder, advanced applications sales are typically large and uneven from quarter to quarter.”
I expect he meant all the “Other applications”, having said –
- “Sales to other markets, including advanced applications, telecom and medical applications,”
When “Other applications” decline for a few consecutive quarters, you only get the “typically large and uneven” comment. While it’s possible the segment will see stronger or more even growth, without further information my attitude is that I’ll believe it when I see it.
The annual growth in the number of shares is not shown.
With thanks to Seeking Alpha for their policy about quoting from transcripts, which can be found at the end of the transcript.
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