IPG Photonics ( Nasdaq - IPGP ) -- Q2 Outlook Stronger than Expected

IPG Photonics appears on track to produce excellent Q2 results.  Performance could exceed our previous expectation, which already was good.  Three large shipments slipped out of the March quarter due to customer delays in accepting the products.  Those revenues will be recognized in the June period.  A lot of times when there's a delay like that new sales are impacted, as resources are diverted.  That doesn't appear to have been the case with IPG.  Business has remained robust despite the peaked economy.  The laser industry is expanding as manufacturers continue their automation drive.  The company's share of the market is expanding.  New applications have been developed to address new segments of the laser industry, and adjacent areas where lasers were never used before.  Average order sizes are rising, enabling IPG to reduce prices while preserving high profit margins.  OEM partners continue to integrate IPG's fiber lasers into a wider range of applications.

Performance of the systems keeps improving, moreover, opening even more opportunities.  Competitors are trying gallantly to develop fiber lasers of their own, but to little avail.  The gap between IPG's systems and the rest of the industry is widening rather than closing, which is the normal pattern.  Growth probably will stay below potential due to economic factors.  But sustained above average growth is likely, nonetheless.  Leverage could be generated if IPG spends part of its accumulating cash flow on niche acquisitions, with the idea to ramp them up with its well established manufacturing base and distribution system.

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Cognex ( Nasdaq - CGNX ) -- Difficult Q2 Comparison

Cognex (CGNX $44.50) appears on track to produce solid June quarter results.  But a significant improvement over the year earlier period will be difficult.  Cognex is a leading provider of machine vision systems.  The high potential logistics business finally is gaining some momentum.  Cognex has developed a series of bar code readers that worked faster and under tougher conditions than existing technologies.  The potential market in package delivery and business to business shipping is large.  Companies have been reluctant to adopt the technology, though, due to the disruption it might create plus the incremental cost.  Business has picked up but it remains behind Cognex's original plan.  The core factory automation line is continuing to carry the freight.  Growth in that segment has stayed below target, as well, primarily the result of weak economic conditions.  The surface inspection and semiconductor units are likely to exhibit sequential improvement in the June quarter.  Both of those segments are relatively small, though.  And neither has shown evidence of a sustained improvement.  Despite the pick-up in solar installation activity most panel makers haven't lifted capital spending to date.  The medical testing equipment business remains in an early stage of development, moreover.  That unit holds sizable long term potential but it will take time for Cognex's machine vision to be designed into new systems, and for those systems to roll out.

Excitement about the "Google car" and other futuristic robotic applications have bolstered the share price.  Cognex is familiar with the opportunities and in fact pursued machine vision for autos nearly a decade ago.  Those technologies are unlikely to materialize for another 2-3 years at best.  Even if that happens, volume production probably wouldn't occur for another 2-3 years.  The long term outlook remains positive.  The potential downside is that competition could intensify as a result of the robotic hype and increase in venture capital investments.  Still, Cognex is positioned to fare well.  The stock is somewhat elevated at present, although it could be supported in the near term by higher dividends and buybacks.  Still, earnings growth is muted for a stock trading at such a lofty P/E multiple.  Near term appreciation may prove limited unless the underlying fundamental picture gathers steam.

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World Energy Solutions ( Nasdaq - XWES ) -- New Accounting Approach Camouflages Growth

World Energy Solutions (XWES $3.90) reported good Q1 results.  The company is the leading provider of electricity procurement services for large and mid-size companies and government agencies.  It features a unique computer based auction system that pits multiple energy vendors against each other, resulting in more competitive pricing than traditional broker relationships.  World Energy collects a share of the recurring payment stream on those deals.  In the past the company booked its entire commission up-front on small transactions to simplify to bookkeeping work.  A new accounting interpretation required World Energy to adopt the same delayed recognition method it uses on large contracts.  That restatement took effect in 2012, which reduced reported revenue while preserving the full cost impact.  The resulting mis-match between costs and revenue caused margins and earnings to decline significantly.

Bookings activity has remained at above average levels.  World Energy also operates an energy efficiency subsidiary that comes on site and makes its customers' operations more efficient.  Cross marketing efforts to electricity buyers is amplifying that unit's performance.  Auction procurement services also are provided for natural gas consumers.  That segment stalled in the most recent quarter as natural gas prices rose.  Despite that, backlog and deferred revenue improved by 27% in the March quarter (10%-15% exclusive of acquisitions).  Investments in sales and marketing are continuing, laying the foundation for continued above average growth in upcoming periods.  We have reduced our estimates somewhat to reflect a better understanding of the new accounting format.  Our view of the real business remains unchanged.  Cash flow is poised to expand in 2013, enabling World Energy to repay debt associated with recent acquisitions.  As those obligations are satisfied more money will be ploughed into organic growth.  Only a fraction of the United States currently allows competitive energy markets.  Arizona and Michigan are moving to open up in the intermediate term.  Longer term, if any kind of carbon trading system is enacted World Energy will be ideally positioned to run the show.

Valuation of the stock has become a challenge due to the accounting change.  Assuming World energy's natural profit margin remains intact investors probably will focus primarily on bookings (sales plus the increase in backlog and deferred revenue).  Based on software companies that employ similar accounting techniques the rule of thumb might be 2x if organic growth is 10%; 3x @ 20%; 4x @ 30%; and so on.  At today's metrics that would put the stock at $7-$9 a share.

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Cognex ( Nasdaq - CGNX ) -- Product Pipeline Powers Up

Cognex (CGNX $40.00) reported good Q1 results.  Performance continued to be impacted by weak results in a number of ancillary markets -- solar, electronics, semiconductors, and surface inspection.  Demand remained robust in the primary factory automation segment.  And volume started to perk up in the high potential logistics area.  A series of new logistics products reinforced that momentum and laid the groundwork for the company to penetrate a wider range of applications beyond.  Sales rose 4% to $80.9 million.  Income climbed 8% to $.42 a share.

Growth is poised to speed up.  The logistics segment -- machine vision equipment that can read bar codes and other data at high speed at difficult angles -- got off to a slow start in 2012 as prospective customers underwent lengthy trials.  Performance was superior, though, and the technology now is rolling out in higher volume.  More versions of the technology have been introduced to segment the market.  And a 3-D version was launched, as well, opening up further opportunities.  The surface inspection business dipped in Q1 but appears on track to regain its trend line in the June period.  The electronics and semiconductor unit showed improvement, albeit off a low base.  That area is bound to jump significantly at some point but a big move may not materialize until overall economic conditions stabilize.  Factory automation remains solid.  Long term leverage could be provided by greater robotics use.

Our estimates are fairly conservative.  A stronger performance is possible if the logistics business ramps up more rapidly or some of Cognex's secondary lines regain momentum.  Acquisitions could provide additional impetus.  New products are rolling out more efficiently than in the past, moreover, providing a steadier drumbeat of incremental revenue.  Margins are likely to remain at above average levels due to the company's superior product performance.

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IPG Photonics ( Nasdaq - OPGP ) -- Turns the Screw

IPG Photonics reported good Q1 results.  Performance was slightly below potential due to delays associated with a handful of shipments.  Even so, sales advanced 15% to $141.9 million.  Earnings increased 13% to $.71 a share.  Margins narrowed a bit as a result of quantity discounts on several large orders.  IPG Photonics has been cultivating the market for its high performance fiber optic lasers over the last 3-4 years.  Most customers still have a large installed base of co-2 and yag crystal machines, older technologies that fiber has begun to leapfrog.  In the past fiber was a niche category because it couldn't generate the same amount of power as the older formats.  IPG Photonics overcame that hurdle in the 2009-2010 time frame.  Since then the company's fiber systems have made broad inroads because of their other advantages, including lower power consumption, less maintenance, smaller form factors, and easier wave length control.  Substantial penetration was realized in several major industries, like automotive.  But a lot of potential customers hedged their bets, retaining existing systems while experimenting with IPG Photonics's innovative lines.  The rate of adoption has begun to accelerate, reinforced by further price reductions that have resulted from engineering improvements.  Competitors with co-2 and crystal laser mainstays have been rushing to develop their own fiber systems.  End users with longstanding relationships have given those companies a chance to catch up with IPG Photonics.  The company appears to have extended its price performance advantage, however, bolstered by internal trade secrets and vertical integration of key components.  Order volumes are beginning to expand.  IPG Photonics is helping the process along by offering attractive pricing.  Financial results throughout the rest of the laser industry have stalled as the company has put its foot on the gas.

The book to bill ratio exceeded 1.0x by a wide margin in the March quarter.  Weak economic conditions in Europe held back the order rate.  But average order size expanded.  In addition to replacing existing laser technologies, IPG Photonics has started to displace adjacent technologies that lasers never addressed before.  Small acquisitions are helping the company reach some of those markets.  The acquired products are being supplanted by lasers, leveraging the customer relationships that were obtained in the deals.  Internals sales and marketing expansion is underway, too, to exploit smaller geographic segments.  And R&D efforts continue to expand, lifting product performance while addressing new applications.

Our estimates are conservative.  About one third of the world's population lives in advanced economies.  Tremendous long term potential exists as the rest catches up.  That process is stymied for now by ineffective policies in the developed countries.  IPG Photonics's sales likely will remain below potential this year and in 2014 as a result.  Solid growth is expected, nonetheless, as the company wins market share and penetrates new applications and geographies.  Margins may dip modestly as more large quantity orders are delivered.  But profitability promises to stay at superior levels.  Growth could accelerate once free enterprise is allowed to flourish again and today's central bank manipulations end.

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