Perfect. Maybe just, Tim, to put everyone on the same page, so everyone has a better understanding. Just when we think of IPG Photonics, you know, a manufacturer of fiber lasers, the leader, what end markets do you serve? What's the solutions you're really providing to customers, and really, who are those customers?
So in terms of the end markets we serve, they're, they're very broad. I'll talk about them first in terms of applications. Is that working now?
Can you just say something?
1, 2, 3.
Great.
Okay.
Perfect.
The largest application we've got is welding.
Yes.
That covers a very wide cross-section of different industries, from automotive, including EV, to fabrication, construction, consumer durable goods, consumer electronics, other transportation, so aerospace, rail car manufacturing. So, whatever, wherever you utilize welding, lasers will also be utilized in them. Laser-based welding is more productive. The quality of the welds are better. The cost of it, obviously, given the productivity is improved. You can weld a much more disparate set of materials, so you're not just welding steel, but you can weld copper, aluminum, you can weld copper to aluminum, you can weld titanium. So the laser brings numerous advantages in that application and process. The next largest application we've got is cutting applications.
So cutting's been a somewhat challenged business for us because of the competition in China and really the very significant price reductions that we've seen, which we've chosen. Initially, we competed against the Chinese, but we've stopped competing on price there. The outcome of that really is that the Chinese cutting sales are effectively at a very, very low level, almost nothing at the moment. If we sell lasers for cutting in China, it's often to go into a system that may be exported or into a high-end cutting application in China, say, heavy equipment manufacturing or an automated production line. Outside of China, though, the cutting business, we still have a very significant share in North America, Europe, Japan, and we continue to preserve that. That business at the moment is a bit challenged given the industrial end market demand environment.
Again, it'll address a very, very wide cross-section of industries, similar to any machine tool business that you may look at. Other sort of other applications we're focused on, which are doing very well, we're a significant believer in cleaning applications. So cleaning is a laser-based process where you're displacing chemicals, sort of aqueous-based cleaning processes or abrasives. So if you're, like, blasting a piece of metal that's got corrosion on it, you're utilizing sand or other abrasives to remove the surface of the material and clean the corrosion off it. But it can be used for paint removal, coating removal, cleaning of tanks, storage vessels. Often those processes, because they're using chemicals or abrasives, are very hazardous and environmentally very damaging, right?
That market's very early stages of displacing incumbent processes, so the total market for cleaning, including the complete system, is about $200 million. The market itself is tens of billions of dollars. I mean, this is an application that could be equally as large as cutting and welding. It will become significant given the environmental benefits that the laser-based processes drive. Sometimes it's not even just the reduction in chemicals or abrasives. There can be a significant reduction in the amount of water that's used in a cleaning process. So we've got a customer that their tank cleaning process was consuming about 1 million liters of water for each cycle of cleaning. That was eliminated. The cleanup of the residue, as well, is a lot easier in cleaning processes.
Again, you're dealing with a very, very diverse set of industries. It can cover aerospace, automotive, oil and gas, other manufacturing processes, areas where they're storing liquids or chemicals. So that, that's another growth area. We're also focused on things like drying applications, so utilizing a very electrically efficient laser, either on its own or in combination with ovens and other heat sources. So the benefit of the laser-based drying is that you're presenting a highly electrically efficient source to and you're able to concentrate the energy on a very small surface area, so your drying times are significantly reduced. You've not only got a significant reduction in the electrical consumption, but the speed of the drying process is very significantly improved.
Again, it's a very wide cross-section of industries from the coatings industry, but also food production, pharmaceutical manufacturing are potential end markets there. EV and automotive is another one on drying. And then we've got a sort of microprocessing and medical business, again, you're sort of looking at microprocessing as non-metal-based processes, whether you'd be either you can be ablating the surface of a material, sometimes dicing and scribing. In medical, one of our main applications is lithotripsy, so that's kidney stone removal. You're ablating the kidney stone down to very fine particles. That's a much less invasive process than having surgery to remove a kidney stone. In terms of what we sell, we'll sell standalone lasers.
We can combine the lasers with optical delivery, so in many of the welding, we're not selling a complete system, but a subsystem, where you're combining the laser with a high-speed scanner or, and a measuring capability, which will tell you about the quality of the weld as it's done. And then you go from subsystems to complete systems. So, for example, we've sold complete systems for cleaning, welding applications, cutting. The medical system for lithotripsy is a complete system. The handheld welder is also a complete system, so it's a small system, but it includes all the programming, the optical head, all of the safety that's combined within that. So, in terms of the products, it'll go from the resonator or the engine, which is the laser, up to a complete system.
As you know, you're a product-driven company with a lot of technology, just for the audience and for investors, how can we think of that in terms of how it drives the model? So is there any rule of thumb, Tim, when we think of GDP is X, industrial production X, and you guys can grow Y because of the high addressable market, because of the penetration opportunity? Just what's a good rule of thumb for investors to think about IPG on a three-cycle basis, what the top-line growth kind of looks like?
Yeah, in many of those markets where you're still under-penetrated compared to some of the legacy applications, right? So it's basically everything above from marking and engraving and cutting applications. You know, the average growth rates for those applications is in... like welding, is probably in the 10%-12% growth rate. For cleaning and drying applications, you're potentially in, you know, much stronger double-digit growth rates. The medical and microprocessing businesses, particularly for surgical applications, again, growing at probably the 10%-15% rate. The cutting market is more of a GDP rate of growth, I'd say. So some of the market, like in China, which we don't participate in, is quite highly penetrated, but the rest of the world is still relatively under-penetrated in cutting.
But we think the cutting market probably grows more in the 3%-5%. You know, even at that level, it would be accretive to us. We've seen significant headwinds around that. Marking and engraving, I'd say again, is really GDP capacity utilization driven, and we'll still sell fairly basic lasers for marking and engraving, particularly where they're used in high volume throughput. People don't want to use an unreliable device in an automated production system because, you know, a day of downtime on an automated production system is far in excess of the value of the, of the laser.
And Tim, why, just for—to help us contextualize this, why do you feel like laser penetration in industrial applications took off in China? And when do you feel like that happens in U.S. and Europe? I know you—obviously, these are still big markets for you, but from what I understand, the penetration rate's a little higher in China, the adoption of your fiber laser technology compared to the U.S. Do you feel like, Tim, that's on the come? Is that something that we could look in 5, 10 years, and we kind of see that curve accelerate?
Yeah, I think you're gonna see it accelerate in the rest of the world, not in five or ten years, but even in the nearer term. So there's a couple of things with the China market, right? There was a lot of greenfield investment that drove China's investment in production capacity over the last 20 years, and a lot of that accelerated, say, over the last 10 years. A lot of the investment, for example, in smartphone subcontract manufacturing happened in China, and with that, a high-tech kind of manufacturing operation. They didn't really look at legacy welding, right? It. They were utilizing different types of materials that were very fine. The materials were particularly suited to laser-based processing. So you've had certain investments in industries that have driven that adoption.
They've had a significant investment in EV battery manufacturing capacity that exceeds the rest of the world. Again, there you've got very complex, high-speed welding with complex materials as well, that you can't really weld with traditional technologies. And then, you know, the other side of it is that, that greenfield, because they're developing a lot of greenfield sites, they weren't really broad-based users of some of the incumbent technologies. And there's a certain dynamism that exists there, where they're pretty open to evaluating newer technologies. Some of that's driven, I think, by government support as well, right? The risk isn't entirely sitting on all of these individual company balance sheets. So there's a benefit that's perhaps given to them there.
There's somewhat of an innate conservatism in Europe and North America and some of these other markets, where traditional welding technologies have been used for 100 years, right? They understand them, even if the quality isn't great. The cost of welding isn't a pain point necessarily, even though... So even if you're bringing the cost of welding down with a laser, like spot welding with vehicles is still done with electric spot welding, 'cause the cost, the entire cost of welding a car is probably $450, right? The focus point has not been trying to take 20% out of that cost, even though spread over 60 million vehicles, it's huge. People have been looking to add all kinds of other bells and whistles to vehicles, right?
That's where the engineering focus has been, on safety or sensing, entertainment and displays in vehicles, rather than saying, "Let's take $90 out of the cost of the welding of a vehicle." But with it, where you have an industry that didn't use that, they won't bother looking at the older technologies. So there's an innate conservatism. Sometimes there are standards and certifications that you have to get qualified for, you know, for example, pressure vessel manufacturing or pipeline welding, construction, infrastructure building. There's sort of less laser-based technology that's used in that. But with the handheld and even some of the cleaning, handheld cleaning applications, you can potentially, you know, like taking paint off bridges.
There's some of the areas where, you know, you could see those handheld applications grow, or even welding in the field using a handheld application as well.
Interesting. If I could just zero in on China, one of your regions. IPG's had a very deliberate approach, I think, I feel like to China. You guys don't do any manufacturing there, so to kind of guard your IP, and it feels like the mix of the business within China has kind of evolved from low... You know, from the low end to the high end, more welding, first cutting. Maybe kind of just give us, walk us through what your China business makeup looks like today and what you're seeing there on the ground. We're seeing PMI starting to come up a little bit. There's some talk of stimulus, but we're still kind of waiting for that bazooka, if that ever happens.
Just curious what you're seeing in your portfolio, how that mix has kind of evolved and what you think you're seeing today?
Yeah, I mean, our China business, as we said, the cutting business has become very small. You know, the lasers we still make for cutting are very sophisticated. In one sense, though, the China solution to the fiber laser, which is end pumping the fiber and actually produces a lower quality beam, is in some ways, it's not a disadvantage on cutting applications to have that. As you know, some of the other technologies that have been introduced, like our AMB laser, was originally introduced for cutting applications because we were trying to diverge the beam rather than make it more intense. So if you have a more divergent, less focused beam, it's actually not a detriment in a cutting application.
It's interesting, though, because in additive manufacturing, where the quality of the laser and the quality of the beam are fundamentally important, we're still side pumping the fiber with our special coupling technologies and using very high-quality fibers. That enables, even at lower power levels, a very intense beam. So you'd expect the local manufacturers, in additive, to be competing with us because the lasers are 500 W-1 kW, right? But they really struggle to get to that single-mode beam capability. So the sales in China, really, China, the cutting sales are almost nonexistent. And it's really welding, additive, other fine processing. There's still a marking engraving business there. There's a bit of a medical business that we work with a partner on.
So, it's certainly more value-added applications where process and know-how, but some of it's just driven by this core fundamental difference in the design of the laser. I think the Chinese market has started to stabilize a bit, but it's not really... You know, it's-- there's not yet a lot of traction back in it. You know, we didn't give specific guidance on why we said our book-to-bill was slightly above one for the quarter. I think I mentioned on the call that we'd seen relative stability in China. Our guidance assumed China revenue is relatively flat as well, so we're not seeing a further step down there, which is good to see. I think, you know, of the geographies that's out there, Europe's really still quite challenged, right?
Where China may be stabilizing a bit, and the U.S. has held up better than Europe has over the last six to nine months.
Let me ask you about EVs. You know, you guys have disclosed it's around 20% of your business.
Yeah. Yeah.
And what's interesting to me about EVs is, you know, there's not really a lot of competition. It's really you and maybe one other player that kind of really dominates that market. So I'd just love you to walk us through. It's been such a strong tailwind for you, yet it seems like we're seeing some pauses and pushouts in EVs. So is this more of a China phenomenon that you're seeing the capacity starting to slow or get delayed? What do we need to see to see that greenfield start to come back, and when do you think you will start to see that, Tim?
Yeah. So the EV investment cycle has been a very strong driver of growth for us. You know, 2020, probably started in 2020, 2021, 2022, and then the first half of last year was exceptionally strong. It's quite a diverse set of applications. It's not just welding. Welding is the largest one, but you've got foil cutting, cleaning, and even drying applications in EV. You know, you've seen a slowdown in China halfway through last year. North American investment was still quite strong in the second half of last year, but that has slowed down. I think Europe, the amount of capacity that's added in Europe is still quite limited, so there's a lot of projects that have kind of been announced, and we've been working with a number of companies on the end markets there.
But stepping back a bit, I mean, fundamentally, you've just got to look at what global utilization of battery capacity is and estimate the total installed capacity. We think there's about 1.5 TW of installed capacity. A lot of the market data will say it's 2 TW. We just don't... Well, there's, just none of it adds up. I mean, even if you look at what CATL says their capacity is, and they've got, a very significant share of it, and you add up some of the other, you just don't get to 2 TW. I think there may have been 2 TW announced, but the actual build-out is probably around 1.5 TW.
I mean, you take that, you look at 14 million EV vehicles sold, and you use an average of 50-60 kWh, you can work out the total amount of battery capacity that's needed, then CATL made an interesting comment on their public stuff, that 20% of global demand is actually storage now, and that grew very robustly last year. So you basically need. We think that the average utilization across the industry is 55-60% at the moment. Some of the larger players saying they're at 70% utilization. Total EV vehicle sales are supposed to go from 14-18 million this year, so that's another 25% increase.
If you see continued increase in demand for storage, you probably see capacity getting up to that 70% level overall, that we think starts to drive an improvement in a pickup in the investment cycle. We don't think people will leave until they get to 80% utilization because there's a lag between bringing that capacity on and demand continuing to increase. You know, I think by region, you've still got strong EV push in China, Europe. The U.S. has got a number of different issues that are sort of swirling around it, that include like political, politicization of the EV trends. U.S. sales, only 9% are EVs. Europe's at 25%. China's at 35%. I think Japan is a bit of an open question mark.
You know, there's several leaders in the automotive industry there who think that the hybrid approach is more suited to the transition and achieves a lot of the advantages of it. We still think that for every gigawatt of battery capacity that's added, it drives about $1 million of laser-based investment. So, you know, a shift from 1.5 TW to, say, 3 TW implies a very, very significant demand for laser-based processes, and we think we have about 60% share of that, as compared to one of the other main suppliers in the market.
And Tim, let me just pull that thread a little bit with your market share in EV, which seems like that's the long-term opportunity. The pushback I hear from investors sometimes is, while in the cutting market, IPG own the market, and then the Chinese players, at least in China, started to come up, develop products, and undercut that market. How do you feel about your technology and your product for the EV market? Are they way behind? Are they catching up? Is that a threat at all, or do you feel secure with how that EV market's playing out for you guys?
No, at the moment, we feel that we have significant technological advantages in it. It's a little bit binary, right? Because as I said, the architecture that they use is different from ours, and even within the additive market, which is relatively low power, they can't get to these very high beam qualities that are needed for some of these applications, particularly the welding side of it. The foil cutting side, there is some competition at the lower end, but we're going to higher and higher power lasers there. The cleaning is driven by very, very high power pulse lasers, where we've got unique capability in it. Are they gonna sit still and do nothing? No.
But do we still have a very core advantage, not only in the laser, but the measuring technologies, the beam delivery, even the processes, and not just on, like, welding, but even in cleaning, there are some real nuances around the cleaning processes. If you're trying to clean different types of metals and how you maintain the corrosion resistance of different types of metals, there's a lot of know-how that's built into that. So at the moment, we feel pretty positive about the core capability that we have in these more complex... not just welding, but these other complex processes. But they're not gonna sit still. I mean, we're silly to think that we're gonna sit still and not expect them to try and catch up in those areas.
I think the other side to it is that Western automotive companies don't wanna rely on capacity that is China-based, right?
That's a good point.
Some of them are utilizing Chinese technology when they're building factories outside, but a lot of other companies are relying on other battery manufacturing technology if they're putting... You know, particularly in North America, you've seen less of an investment by some of the major Chinese battery manufacturers. It's more of the South Koreans who've been putting in that investment. So there's gonna be a bit of a fight around this, sort of from a geopolitical perspective and trade perspective as well.
Just at this conference, inventories is a topic of conversation. I'm curious where you feel your customers are in terms of inventory digestion this cycle, where IPGP feels they are with their inventories, and what this could look like by the end of 2024. Is there a scenario where we could see customers actually having to add inventories back in and replenish, or is that more of a 2025 story?
I think at the moment, we still see inventory within the cutting OEM supply chain. Outside of that, not very... I've not heard of any significant inventory issues on, on the welding side, for example. The cutting business, though, is really challenged. So if you looked at some of the results of some of the cutting customers, you know, they're down 40% year-over-year. So it's taking them time, and they often don't carry much inventory, which is the interesting thing. So they were really caught out with the slowdown in demand.... We think they're starting to work through that during the course of this year. Whether it results in, Well, first of all, they never really carried a significant amount of inventory, right? The laser is like the engine that goes into the system.
You install it at, you know, almost the last piece of the system that gets installed. So I don't think you're gonna see a big rebound in them replenishing inventories, except if there was, like, a big rebound in demand, and nobody's-
Seeing that.
Seeing that at this point in time, right? So you'll probably get, relative to their current demand level, a more normalized takeoff from them, but it would still be... If, if they're down year-over-year, you're not gonna be recovering to normal levels of demand from the cutting industry until it rebounds back up to standard utilization and capacity.
Yes, and so a few weeks ago, Tim, you guys announced a new CEO. He's an outsider, which I thought was very interesting, as IPGP is the founder and the creator really, of the fiber laser industry. So you have a rich history of just being a product-driven company. There's a culture there. I'm curious why the company went to an outsider, and really what investors can kind of expect what a new CEO could bring in-house.
So first of all, I think, again, the board, looking at this sort of from a step back a bit, has done a great job with, like, the succession planning around this. You know, Dr. Scherbakov has retired from the business, will retire from the business in a couple of weeks' time. So they ran a very complete process. We used an executive search firm. We considered external and internal candidates. But coming back, I think, to your question on the culture of it, what the board really liked that Mark brings is the fact that he is a laser scientist, right? So, he has that scientific background and knowledge. He's a Ph.D. He's worked in the laser industry for his entire career, really.
So from that product, scientific, cultural basis, that was a key attribute that he had. And then he's also, though, a very seasoned business person, right? He's run sales organizations during his career. He's run R&D functions, which is different from doing R&D. You know, there's a commercial aspect to running R&D, marrying your technical capability with the market requirements. He's run a you know a fairly complex business over the last five years that covers different end markets and successfully done so. So that sort of strategic commercial aspect to it, coupled with his scientific background, was really you know what the board, I think, liked about his capability. Had it taken another six, nine months to find somebody, it would have taken six or nine months to find somebody. There was no particular rush around this.
I think he'll bring... In terms of what he'll bring to the company that may be a bit different, is exactly a reflection of what I've described. He's both scientific as well as very commercially oriented and strategically driven. He's a very financially focused person. I've had, you know, I've met him a couple of times already, very financially focused person, wants to understand the KPIs that we track within the business and looking at, like, you know, where's our manufacturing efficiency and absorption, and why is absorption at this level? You know, the kind of questions that you all ask about the business as well.
Well, maybe on, on top of that, Tim, the most common question that we get is on the gross margin. So, you know, right now, your gross margin's a little bit below your target range. Obviously, we've been in a really, a downturn with demand. Just help us understand what can get us back into that gross margin range. What are the levers to get us back up there? Is it strictly just the macro needs to improve? Anything to kind of flesh that out, because it's been a big topic of conversation.
Yeah, I said on the Q1 call, actually, that, you know, I kind of break gross margin down to looking at what the gross margin of the product was, and then, you know, look at some of the period costs, whether they're like inventory provisions or scrap, and then I look at utilization. And what was good about Q1, and even the second half of last year, was that our product gross margin has been relatively stable, even improving a little bit, which implies we're getting some cost down on components, for example. We're also, you know, perhaps on a mix basis, I said in Q1, had some benefit there. We had some very high-value single-mode lasers that we sold that helped.
China being 25% of sales and the cutting business being weaker would have helped on the mix side of things as well, 'cause some of the cutting stuff is lower margin. We're trying to drive the margins up on some of the systems businesses by developing a more standard platform and also the process, moving away from being like an... You know, there are enough integrators out there who combine the laser with the robot and deliver it to the end customer. We want to differentiate ourselves on the system side by having a more standard platform, but also delivering the process and the know-how to the end customer. And then, so in Q1, there's still elevated inventory provisions because our inventory's been running at a high level. It was interesting talking to Mark, the new CEO, about that.
He was, like, saying, you know, he's had to deal with exactly the same things on the electronic supply chain, and turning that spigot off has been difficult for us to do. So you know, you can get if those inventory provisions start to come down, then it's down to absorption, and I could see where absorption was. Even though we've brought manufacturing costs down relative to this level of revenue, our absorption was off by... I actually didn't give a number on the call. But you know, relative to our more efficient quarters, I can see a pathway back at a reasonable revenue level. I'm not talking like $350, but even, you know, back up at $300 million, at 43%-44%.
And then if you can grow back from that, you'll be getting into the range that we've talked about. So there's nothing fundamentally wrong when I look at the model and the way things are performing that level. The other levers we can pull are that if you continue to get cost reduction out of the actual product, so we've talked about taking up to 20% out of the high-power laser cost this year. That's really around new diode designs, but the new diode design actually changes the whole form factor of a laser, 'cause you're producing, you know, making fewer diodes, so you're building a higher power module. You're combining fewer modules together. The form factor of the laser goes down. The manufacturing and assembly processes become more efficient as well.
So that would be a, you know, that would help the product gross margin line, even if your absorption stays relatively below efficient, most efficient levels. And then, as we get inventory more under control, we wanna try and get inventory down to 200 days. It's a slow process to get that down, given where revenue is as well, right? You're trying to take inventory down while revenue's got a headwind against it. But I always think it's very important to focus on these sort of downturns on managing the balance sheet. You know, generate a lot of cash out of receivables in Q1. But underlying cash flow, 'cause we paid bonuses in Q1, if you take the bonuses and the AR, they offset each other.
The underlying cash flow generated, even at this revenue level, was sort of $45 million-$50 million for the quarter, which was really good to see. But yeah, there's nothing that worried me unduly about the gross margin, the structure of cost of sales relative to revenue, that didn't give me good visibility into a recovery in that as you absorb your manufacturing cost base better.
Perfect, and you know, you touched on the cash flow. You know, you have this new CEO coming in. You have over a $1 billion net cash position. Just... I've never viewed you guys as a very acquisitive company. Do you think that starts to change? Is it to add to new verticals, to consolidate the market? How do you guys kinda look at that cash balance and the landscape and what we think we can expect going forward?
Yeah, so we've continued to maintain a very strong balance sheet. We get applauded for that. You know, we have returned a lot of capital. Before I get into the acquisition strategy, we've returned a lot of capital to shareholders over the last year, over $1 billion, taking the share count down from, like, 53 million to 45.5 million. Got another $300 million buyback that's approved. We'll continue to execute that opportunistically. Given what we did in Q1, you can assume that we see some value in where the stock's trading at the moment. Now, the issue on, like, acquisitions one is that, you know, first, I think valuation expectations have been elevated. Two, we were dealing with moving all of our manufacturing out of Russia, right?
This has not been an easy last couple of years that the company's been through, aside from the downturn more recently in some of the end markets. But we've got a pipeline of stuff we've been looking at. I haven't spent enough time with the new CEO to determine whether we're fundamentally gonna change that or not. I think we're looking at this not from a consolidation perspective. It's really smaller type, bolt-on, programmatic approach to acquisitions, really to enable us to execute into some of these end markets that we think have got significant opportunities in them, and it, from a technology or distribution side, would be areas we're really focused on.
Great! Well, we're gonna wrap it up there. I wanna thank Tim for coming and the IPG Photonics team, and hopefully we'll see you guys again next year. Thank you.
Thank you very much, everybody.