IPG Photonics Catches a Break

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You might not guess it from the stock price, but Motley Fool Rule Breakers recommendation IPG Photonics (Nasdaq: IPGP) dodged a bullet Tuesday.

Sure, the stock is up 11%. And yes, there's good reason for that:

• Q2 sales increased 27% year over year to $56 million.
• Gross margins rose 190 basis points to 48.1%, marking the second straight quarter of improvement.
• Which helped to push profits up 36% to $0.19, "beating by a penny."

But there were still plenty of reasons for a drop for IPG Photonics, which makes fiber-based lasers and amplifiers that are used by, among others, the government and the aerospace industry. For one thing, the company's operating margin continued to erode, dropping about 20 basis points to land at 22.8%. Again, this beats out the numbers that competitors Coherent (Nasdaq: COHR), Rofin-Sinar (Nasdaq: RSTI), Nortel (NYSE: NT), and Newport (Nasdaq: NEWP) are putting up. 

And accounting profits notwithstanding, IPG continues to burn cash. Although management has not released a copy of its cash flow statement, it did provide enough numbers to determine that free cash flow once again ran negative, to the tune of $8.7 million.

This doesn't reflect well on IPG's ability to manage its working capital effectively. Accounts receivable were up 41% year over year. Inventory surged 45%. Neither of those are good numbers relative to sales growth of "only" 27%. And while management addressed the issue of surging inventories, it did so only in passing, and dismissively: "... our margin growth has continued to increase, both sequentially and year-over-year, due to favorable product mix and higher production, part of which resulted in an increase in inventories."

Which it seems to me hurts in two ways. First, IPG admits its inventories are rising -- but doesn't explain why. Instead, it points to the towering piles of unsold goods and exclaims: "Hey, we were really efficient at building stuff we couldn't sell!"

Take a bow
And to wrap all that up with a bow, IPG advised that Q3 sales will likely come in around $59 million, with earnings per share of $0.20 -- both of which numbers fall short of Wall Street's consensus estimates. Honestly, I expected to see a whole lot more red in IPG's shares today.

So I'll say it again: "IPG dodged a bullet."