There was a lot of uncertainty going into IPG Photonics' (NASDAQ:IPGP) third-quarter earnings report. The laser maker signaled last quarter that even in the face of record results, escalating trade tensions with China and softer demand in Europe would hit results, "driven by macroeconomic and geopolitical factors rather than competitive dynamics," and management expected those issues to continue.

Those fears turned out to be well founded, as the company's preliminary results in early October indicated that it would miss even its own muted guidance. The combination of weak demand and foreign currency headwinds conspired to sink IPG, and those forces show no signs of letting up.

Laser on robotic arm cutting metal.

Image source: Getty Images.

Not much to like

Metric Q3 2018 Q3 2017 Year-Over-Year Change
Revenue $356.3 million $392.6 million (9%)
Gross margin 54.8% 57.2% (240 basis points)
Operating income $123.9 million $160.2 million (23%)
Net income $100.5 million $115.6 million (13%)
Diluted earnings per share $1.84 $2.11 (13%)

Data source: IPG Photonics' Third-Quarter 2018 Financial Report.

IPG's revenue fell to $356 million, down 9% year over year, even missing the lower end of the company's guidance issued last quarter. Diluted earnings per share of $1.84 fell 13% compared to the prior-year quarter, and came in near the low end of IPG's forecast. Both numbers were also significantly lower than analysts' expectations prior to the release of the preliminary results in early October. 

Materials processing, which constitutes the lion's share of IPG's business at 94%, fell 11% year over year, as the company sold fewer metal welding, 3D printing, and cutting applications. The remaining sales to other markets increased 22% compared to the prior-year quarter, driven by growth in communications and government applications. High-power CW (continuous-wave) lasers, which helped carry the day last quarter, fell 7% year over year, and accounted for 64% of total revenue. Within that category, fiber lasers helped stem the losses, increasing 10% year over year and commanding 50% of all high-power CW laser sales.

Revenue from other high-power lasers dropped due to weakness in China, where sales fell 9%, and in Europe, which fell 25%, both year over year. Strong sales in North America, which increased 29% compared to the prior-year quarter, weren't enough to offset the declines elsewhere. Foreign exchange rates took a toll as well, reducing revenue by $5 million more than IPG's management had forecast.

It'll get worse before it gets better

IPG isn't pulling any punches, saying things will continue to weaken. "Global macroeconomic and geopolitical headwinds have persisted into the fourth quarter affecting our business along with others in the sector," said CEO Dr. Valentin Gapontsev. He went on to say that the company expects currency headwinds in the fourth quarter to be even worse than the third quarter.

For the fourth quarter, IPG is forecasting revenue in the range of $300 million to $330 million, representing a decline of between 9% and 17% year over year. The company expects earnings per share of between $1.30 and $1.50, which would represent an increase of 35% to 56% compared to the prior-year quarter -- but that needs to be put into perspective.

In fourth-quarter 2017, the Tax Cut and Jobs Act reduced IPG's earnings per share by $0.90 for a one-time tax charge. Adding that back to get an apples-to-apples comparison results in earnings per share that will fall between 19% and 30% year over year. 

Light at the end of the tunnel -- or a train?

Gapontsev highlighted several factors that point to the potential for improvement in 2019. Several of IPG's customers in China have suggested that orders might improve in the first quarter, and the company is anticipating higher spending from its consumer electronics and electric-vehicle battery customers, as well as pickups in other metal welding projects. Management is also seeing increased traction in new products, including micro materials processing applications, telecom, entertainment and display products, and the company's systems business, which are expected to ramp up next year.

However, Gapontsev warned that "Our visibility of a trough in the current downcycle is limited by the uncertainty surrounding the global macroeconomic trade and geopolitical environments."

In other words, until the trade environment improves, uncertainty will remain.

Danny Vena owns shares of IPG Photonics. The Motley Fool owns shares of and recommends IPG Photonics. The Motley Fool has a disclosure policy.