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Edited Transcript of IPGP earnings conference call or presentation 30-Jul-19 2:00pm GMT

Q2 2019 IPG Photonics Corp Earnings Call

OXFORD Aug 21, 2019 (Thomson StreetEvents) -- Edited Transcript of IPG Photonics Corp earnings conference call or presentation Tuesday, July 30, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James F. Hillier

IPG Photonics Corporation - VP of IR

* Timothy P. V. Mammen

IPG Photonics Corporation - Senior VP & CFO

* Valentin P. Gapontsev

IPG Photonics Corporation - Founder, Chairman & CEO

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Conference Call Participants

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* Andrew Lodovico DeGasperi

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* David Ryzhik

Susquehanna Financial Group, LLLP, Research Division - Associate

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Joseph Helmut Wittine

Edgewater Research Company - Research Analyst

* Mark S. Miller

The Benchmark Company, LLC, Research Division - Research Analyst

* Michael J. Feniger

BofA Merrill Lynch, Research Division - VP

* Nikolay Todorov

Longbow Research LLC - Analyst

* Thomas Lloyd Hayes

Northcoast Research Partners, LLC - MD & Senior Research Analyst

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to IPG Photonics' Second Quarter 2019 Conference Call. Today's call is being recorded and webcast.

At this time, I would like to turn the call over to James Hillier, IPG's Vice President of Investor Relations, for introductions. Please go ahead, sir.

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James F. Hillier, IPG Photonics Corporation - VP of IR [2]

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Thank you, Omar, and good morning, everyone. With us today on IPG Photonics -- our IPG Photonics' Chairman and CEO, Dr. Valentin Gapontsev; and Senior Vice President and CFO, Tim Mammen.

Statements made during the course of this call that discuss management's or the company's intentions, expectations or predictions of the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause the company's actual results to differ materially from those projected in such forward-looking statements. These risks and uncertainties include those detailed on IPG Photonics' Form 10-K for the year ended December 31, 2018, and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors section of IPG's website or by contacting the company directly. You may also find copies on the SEC's website.

Any forward-looking statements made on this call are the company's expectations or predictions only as of today, July 30, 2019. The company assumes no obligation to publicly release any updates or revisions to any such statement. For additional details on our reported results, please refer to the earnings press release and Excel-based financial data workbook posted to our Investor Relations website. We will post these prepared remarks on our Investor Relations website following the completion of the call.

With that, I'll now turn the call over to Valentin.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [3]

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Good morning. Our second quarter results were strong. Driven by improving trends in our China business during April and May, we sold a record number of high-power lasers during the quarter. Although the macroeconomic climate and the pricing environment both remained challenging, we delivered result in the upper half of our guidance range while demonstrating solid traction in new products.

We continue to meet competitive challenges by substantially reducing component and manufacturing costs, while introducing new products that improve productivity and increase flexibility for our customers. As widely reported, the macro economy has softened and the geopolitical climate has become more unstable over the last few months. As a result, we again found ourselves in a more uncertain position with limited near-term visibility to improved -- improving business conditions. Despite the volatile geopolitical and business environment, we continue to invest in new products and application to substantially enhance our competitive position.

IPG remains the clear market leader in fiber lasers with hundreds of megawatts of installed capacity. During the second quarter, our megawatt of total optical power shipped reached a record level. We were able to successfully meet the strong sequential growth in demand for our laser products coming from China with a record shipment into the region. We continue to see aggressive pricing among China-based competition, which intensified towards the end of the second quarter. Nevertheless, we achieved strong sequential growth in high-power laser sales.

We have many laser products and systems that are unique in the industry. Chief among these, we'll continue to produce high-power CW lasers for cutting, welding and other material processing applications at industry-leading power levels, beam stability and wall plug efficiency.

Sales of ultra high-power fiber lasers at 6 kilowatts and greater accounted for nearly 50% of all high-powered laser sales. Sales of lasers at 10 kilowatts or greater grew 16% year-over-year driven by rapid adoption in cutting applications.

We have started shipping our new high-peak power lasers, receiving encouraging feedback from our customers. These new products offer a differentiated solution to catching OEMs, providing us with a distinct advantage in the competitive market.

This unique capability increases piercing speed, improves cut quality, delivers cleaner, more controlled drilling of thicker materials and reduce scrap by enabling closer nesting of parts. We're seeing a compelling customer interest in our new generation of lasers with adjustable mode beam capability that permits a reliable adjustment of the output beam to process. AMB shown to reducing splatter, increase speed and the improved quality in welding application. And our AMB products are being evaluated by leading-edge battery producers.

In the cutting market, OEMs can cut a wide range of material thicknesses using our AMB laser or our standard high-power lasers with our unique family of high-power optical heads.

We delivered excellent progress in new product area outside metal processing. Sales of green pulsed laser used to improve solar cell efficiency increased 150% year-over-year, nearly doubled on a sequential basis. We increased sales of our ultrafast pulsed lasers more than 200% year-over-year and nearly 50% sequentially. We're actively working on more than 50 new products for this laser across a wide range of application in processing glass, ceramic, circuit boards, OLED lithium batteries and solar cells.

Sales of our newest pulsed laser, which includes those at visible and ultraviolet wavelengths and ultrafast pulse durations now exceed 10 million per quarter and are growing more than 60% year-over-year. As we expand our portfolio of new pulsed lasers and capitalize on the many application opportunities for our differential fiber laser solutions, we expect revenue for this product to grow rapidly over the coming years.

System sales increased more than 50% year-over-year, excluding the Genesis, driven by strong growth in macro systems for welding and other material processing application. In addition, our seam stepper had a record quarter with sales into several large automotive customers. Sales of beam delivery accessories increased 10% year-over-year.

Toward the end of the quarter, we received a large order for our medical laser solution, addressing the surgical application, enhancing our visibility into strong growth in medical laser solutions this year. Collectively, sales of newer laser products and system into emerging applications grew 12% year-over-year in the second quarter and were 18% in total revenue.

I'm pleased to report that we continue to demonstrate meaningful traction in ultra high-power fiber lasers by investing in new products and applications that expand our addressable market opportunity. While macro factors are creating near-term headwind in our business, our continued focus on developing and enhancing our differentiated laser solution will drive the company's growth for many years. As a reminder, our mission is to make IPG's fiber laser technology the tool of choice in mass production, and I remain confident in our ability to deliver on this mission.

With that, I turn the call over to Tim.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [4]

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Thank you, Valentin, and good morning, everyone. Revenue in the second quarter declined 12% year-over-year to $364 million. Revenue from materials processing applications decreased 12% year-over-year, and revenue from other applications decreased 16%.

Examining performance by region, second quarter revenue in China decreased 19% year-over-year versus a record quarter a year ago and represented approximately 45% of the total. On a sequential basis, sales in China increased more than 40% driven by cutting, welding and marking applications.

Following the escalation of the U.S.-China trade conflict, we have seen a slowdown in order volume growth during the month of June that has continued through the first 3 weeks of July. Unfortunately, we believe this is now likely to delay the recovery that had been underway in China. The pricing environment in China remains intense, affecting the dollar value of units sold.

Our team is focused on further cost reductions throughout the manufacturing process. These cost reductions will only partially offset more aggressive pricing actions taken by the competition, and weaker unit volumes arising from the challenging macroeconomic backdrop will be a headwind to growth during the third quarter.

In Europe, revenue decreased 22% year-over-year primarily due to softness in cutting and additive manufacturing, partially offset by growth in welding. While pricing pressure in Europe has not been as intense in China, the decrease in average selling prices in Europe has been above our historic average of late, affecting revenue during the quarter. Within the region, we have seen a slowdown in Italy, a market which had held up better during the course of 2018. Looking ahead, we believe the persistent macroeconomic weakness throughout Europe is likely to pressure results in the region.

In North America, revenue increased 34% year-over-year driven by the acquisition of Genesis. Excluding Genesis, sales in North America decreased 5% year-over-year with strong growth in welding and cutting, offset by declines in marking, telecom and government applications due to project timing and more challenging comparisons.

Sales in Japan decreased 10% year-over-year on softness in marking, welding and cutting. Sales in Korea decreased 14% year-over-year, though strong bookings suggest improved Q3 performance. And revenue in Turkey decreased 31% year-over-year given macroeconomic pressures in the region.

Turning to performance by product. Sales of high-power CW lasers decreased 20% year-over-year and represented approximately 59% of total revenue. Reduced revenue from high-power CW lasers in cutting, welding and additive manufacturing applications was partially offset by strength in other materials processing applications. Pulsed laser sales decreased 2% year-over-year, with rapid growth in solar cell processing and fine cutting, offset by reduced sales for marking applications.

Medium and low power sales decreased 50% on softness in additive manufacturing and the transition to kilowatt scale lasers in cutting, while QCW sales declined 21% year-over-year due to softness in fine welding for consumer electronics versus the year ago period.

System sales increased 193% year-over-year, including Genesis, and 50% year-over-year excluding Genesis, driven by growth in macro systems for welding and other materials processing applications.

Other product sales decreased 9% year-over-year with growth in beam delivery accessories and service revenue, more than offset by declines in communications and other laser products.

Gross margin of 49.5% declined 726 basis points from the second quarter 2018. Compared with the year ago period, less favorable absorption of manufacturing expenses and foreign exchange reduced gross margin by 150 basis points. The acquisition of Genesis reduced gross margin by 200 basis points and higher inventory provisions reduced gross margin by 150 basis points. Lower product pricing and other factors reduced gross margin by approximately 240 basis points.

Given the renewed uncertainty and increasing price competition, we have limited visibility and less confidence in getting gross margin back above 50% in the near term. Holding other factors constant, we believe that recovery in our core laser business to more than $380 million in quarterly sales would enable us to get gross margin to 50%. Even at that current levels, though, our gross margins are industry-leading.

Second quarter operating income was $91 million or 25% of sales, down 1,430 basis points year-over-year. Excluding a foreign exchange loss of $5 million, operating margin was 26.4%. Excluding foreign exchange, operating expenses as a percentage of sales increased 600 basis points year-over-year due to lower revenue, investments in engineers, sales people and IT systems and the acquisition of Genesis and our Brazilian Submarine Networks Division.

Net income was $72 million, and earnings per diluted share were $1.34. Foreign exchange losses reduced EPS by $0.08. If exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $18 million higher and gross profit to be $10 million higher.

The effective tax rate in the quarter was 24%, which included certain discrete tax items. We ended the quarter with cash, cash equivalents and short-term investments of $1.04 billion and total debt of $44 million.

Cash provided by operations was $58 million during the quarter. Operating cash flow was reduced by $44 million outflow in accounts receivable related to the increase in revenue during the quarter.

Capital expenditures were $54 million as we continue to invest in new plants and equipment to meet demand for our products over the next several years.

During the quarter, we repurchased 15,000 shares for $2 million. We expect share repurchases to increase in the back half of 2019 and remain committed to offset dilution from equity issuance.

Turning to guidance. Data points relating to the health of manufacturing economies in our largest regions have weakened over the last 3 months. Our second quarter book-to-bill ratio was above 1, but below normal seasonality as order volumes weakened in June. Furthermore, the competitive environment remains challenging due in part to the recent slowdown in industry demand levels. As a result, we expect pricing headwinds related to the competitive environment to continue. We do expect growth in our innovative new products, accessories and complete systems to pass the offset -- softness in our core business as these solutions gain further acceptance in the market.

Based on these factors, for the third quarter 2019, we expect revenue of $325 million to $355 million. We expect our third quarter tax rate to be approximately 25%. We anticipate delivering earnings per diluted share in the range of $1.05 to $1.35.

Escalation of the U.S.-China trade conflict and further macro softness have reversed the market recovery. We had expected it to strengthen in the second half of 2019. Our largest machine tool OEM customers have not provided us with expectations beyond the next few months given the weaker macroeconomic and geopolitical climate. As a result, we do not have the necessary conviction to provide an outlook beyond the current quarter. However, we believe strength in new products and ongoing enhancements to our core laser portfolio will enable us to better capitalize on the eventual rebound in end market demand.

As discussed in the safe harbor passage of today's earnings press release, actual results may differ from our guidance due to factors including, but not limited to, product demand, order cancellations and delays, competition, tariffs, trade policies and general economic conditions.

Our guidance is based upon current market conditions and expectations, assumes exchange rates referenced in our earnings press release and is subject to risks outlined in the company's reports with the SEC.

With that, Valentin and I will be happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Michael Feniger, Bank of America Merrill Lynch.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [2]

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Just to help us understand the pricing comments, I believe at a conference, Tim, it was, I think, 2 months ago, you mentioned how pricing was stabilizing somewhat sequentially. It sounds like things changed in June. So can you just remind us how much has pricing typically fallen every year? I think it's like 5% to 10%. How much did we see that fall in 2018? And now, what are your expectations now for -- as we think of the rest of 2019 there?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [3]

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Typically, you'll see pricing go down 5% to 15% historically. More recently, on average, pricing, if you look on a year-over-year basis, has been 30% or even slightly higher than that on certain product lines. The issue that has really become apparent within the market is as soon as the macro environment weakens, the competitors try and hold onto or increase share by decreasing pricing aggressively. So it's very closely tied. We're seeing changes in the demand environment with the way that the competitors respond to that. Having said that, in our -- and the pricing is, it continues to be a challenge. We've had a lot of discussions internally at IPG about being certainly more selective and very strategic about how we're going to respond to these sort of reaction removed by the competition. There are even some OEMs where we're looking at not responding to pricing in the way that they're demanding because we believe we do have a significantly better quality product, both in terms of just, for example, electrical efficiency, reliability, service and support, specifications, warranty, and those are advantages that we believe people should be paying for. And if everyone is going to be reactionary in this market, particularly in a volatile demand environment, it's really just a chase to the bottom. And our view is that, that is not a way to leverage the value of this technology, which drives tremendous improvements in productivity. And you've really seen this sort of really rapid growth in demand for different applications coming from those improvements in productivity.

So it's certainly a challenging environment, but we're also looking at how we can add value around the lasers, the accessories, the -- for example, in the welding applications, some of the real-time weld monitoring capability within systems, very advanced welding applications like titanium, copper welding, and these are in areas where the competition doesn't really have a lot of expertise or capability in. There are areas where IPG is building a tremendous amount of depth in capability and that's like bringing some of the newer product applications where we're starting to see some nice traction as well, where there's an incremental margin profile that we have of that.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [4]

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And Tim, just can you help us -- I understand the visibility is limited right now, but could we be seeing some type of replacement demand come through? I think systems are 7 to 10 years old. You guys have seen strong growth over the last few years now. I'm just curious if you are seeing maybe some baseline-level replacement demand that has to occur. And then just secondly on that, I'm just hoping if you could give us any more color on the auto market. I know there's a lot of movement there with new EV investments, but also some of the traditional size. We're seeing CapEx maybe start to plateau. Any type of color you can share on that as well?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [5]

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So the first part of the question, certainly, for fiber lasers, you've got some quantity of kilowatt scale and other lasers that are now 10 or more years old. The issue that we face is the real volume of kilowatt-scale fiber lasers start to increase probably in '14 or '15. So you're relatively early in that replacement cycle.

What I will say though is there's still a very large installed base of CO2 lasers that needs replacing. One of our competitors and other suppliers in the industry of components will quote that there's more than 70,000 CO2 lasers that are out there that would require replacement over time, we believe, with fiber. Perhaps, the investment cycle towards replacing those is one of the issues that everyone is facing, but a challenge on that has slowed down. When you get to some improvement in sort of the macro climate where you perhaps get some better visibility into what's happening with the geopolitical tensions around the world, that replacement cycle certainly has an opportunity to rebound pretty quickly. And it is, as I said, tens of thousands of CO2 lasers that do require replacement.

The automotive market is, I think, obviously there's a lot of different analysis out there that shows that the automotive investment cycles are relatively low at the moment, and they're perhaps peak. But notwithstanding that, just going back to Q2, we just mentioned that we have the largest supply and purchase order that we supply for our seam stepper applications into major automotive OEMs in Europe. So that was actually a demonstrated change in technologies being invested in, even when the market is relatively low. There's a strong pipeline of automotive business we're working along in the U.S. again driven by technology change and some of the benefits we have from the real-time weld monitoring capability that we're hoping will generate order flow. And then the overall outlook for the EV investment cycle remains very strong, and that's a multi-year investment cycle. It is project driven and it can be uneven from quarter to quarter. But there is certainly different areas of investment within the automotive that we believe that will be drivers for our business over the medium term and, certainly, for the longer term.

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Operator [6]

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Our next question comes from Andrew DeGasperi, Berenberg.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [7]

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I guess one and maybe a follow-up. On the -- first of all, I guess, the $380 million core laser business you mentioned to get to the 50%, just for clarification, was this the midpoint of the 50% to 55% gross margin? Or was this just over 50%?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [8]

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No. Getting back above 50% would be the target of that level that we've talked about previously and on this call. So you'd start to see your absorption rates pick up. I think the thing to do is look at where we were. At $363 million, we're just below 50%. We did have some relatively large inventory provisions in the quarter. So $380 million, it does give us some comfort of being able to get back there. But it is a different scale of the business than the one we're guiding out for Q3, obviously, which is the challenge.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [9]

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Right. And then just on pricing and competition. Is the 6 to 10 kilowatts seeing some pricing pressure because of competition at the lower end? Or are you not seeing competition in that tranche of lasers?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [10]

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Numerous of the competitors have announced product at that level, and they're trying to sell them. If you face it to a certain degree, any customer looks at the average selling price per kilowatt of the laser. And even if there is less competition at the higher levels, you can't price it at premium and you get a very good gross margin on that product. But there's a certain flow through on an ASP per kilowatt across the entire product line is how we like to think about that.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [11]

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As there's more power for competition, it's more and more difficult to compete because they kept even with low power at our knowledge information, where they can see the problem with lifetime or with -- they have to repair very often. With high power, the practical, there are ways they are not able to work in serial. So just more from limited claims they have, but not real sales that we understand.

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Operator [12]

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Our next question comes from John Wittine (sic) [Joe Wittine], Edgewater Research.

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Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [13]

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It's Joe. For -- first off, for high-peak powered QCW, Dr. Gapontsev said you're now shipping. Wondering if you're offering in all geographies and then if you have any rough estimates on, let's say, what portion of the cutting base may realistically adopt HPP-QCW over the next year or so.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [14]

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So we are offering this throughout the world at the moment, Joe. It's still too early to say what proportion of, for example, the lower end of the market will transition to using that high-peak power laser. But there's a lot of evaluation work ongoing. It's probably 1 quarter, if not 2 quarters, early to be able to give more definitive information about the traction that we expect to see from that or, for example, what percentage of the low end of the market would start using a 2-kilowatt HPP or a 4-kilowatt HPP.

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Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [15]

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Okay. Got it. A little bit early. Tim, I know you can't quantify the fourth quarter and that makes perfect sense. But in the event, let's say, headlines kind of stay with the status quo kind of similar to as they are today, would you expect, all else equal, somewhat typical seasonality off the third quarter base, wherever that ends up being?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [16]

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So you know that I can't quantify, but you're asking me to quantify it. We just don't -- I mean, it's one of those extraordinary times where we just -- we need to get through the quarter to work out, see where our order flow ultimately ends up, see where demand in China ends up, see whether there's going to be a bit of budget spent come through. There are certainly some projects around the advance that we're expecting order flow from that would be driven by some project spending. There's a pickup in some of the medical business shipments that will take place in Q3 and Q4. They're still not very material. But you kind of need to see where the trade war ultimately ends up and whether that stabilizes the situation in China. You want to see what happens with the European economic zone over the next 8 to 10 weeks. I mean, you've got this biggest around Brexit with the new Prime Minister in the U.K. being pretty aggressive there. It's an uncertain time. So I'm -- that's the kind of like color I can give you around it, getting drawn into quantifying it at this point in time. If we've been able to quantify, we would've done it.

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Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [17]

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All right. Understood. And then last for me. Could you remind us on what's driving the outsized inventory provisions on a year-over-year basis? And what do you assume there within the third quarter guide?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [18]

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You just got a lower revenue level on relatively high buildup of inventory last year, so you got inventory that just becomes a bit older. It's not -- it's still not a massive -- in terms of total impact, it's not massively significant. So I expect them to remain, relatively speaking, a little bit elevated for 2 or 3 quarters as we go through lapping the annual buildup in some of the inventory that happened a year ago. But I don't expect to have a much more material impact related to them. We try to manage that, Joe, as you know, on a constant basis rather than suddenly looking at inventory provisions every 2 years and having to take a much larger provision. We're trying to look at the realizable book value on a regular basis and manage it that way.

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Operator [19]

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Our next question comes from David Ryzhik, Susquehanna.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [20]

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Tim, can you maybe elaborate on the base fee declines in Europe? Is that a function of competitive pressures increasing in Europe as well? Then I had a follow-up.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [21]

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Some of the Chinese are claiming they're selling product in Europe. It'd certainly been some of the pulsed lasers in Europe they have been trying to get traction on. They are trying to introduce product there. You base on how much success they've got in that regard given the quality and their ability to support it. Some of the pricing just transitions through to the OEMs in Europe because they're aware of what's happened in other geographies around the world. Often, some of them have JVs, for example, in China. So they are very aware of what happens to pricing. So the ability to totally differentiate pricing on a standard product across regions is more difficult. The ability to differentiate pricing on capability and technical specification, which is a key strategy that we have, is very important, right? So we believe that the HPP lasers, the AMB lasers are going to enable -- we're going to be able to premium price some of that product. Selling product with some of the weld monitoring capability and accessories add a tremendous amount of value around it. But if you're just selling a straight 3-, 4- or 5-kilowatt laser, people understand what's happened to pricing in different regions around the world. And unless you got some other differentiating factor, to some degree, that pricing migrates.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [22]

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Understood. And just regarding the 3Q guide, would love to get your assumptions for the new product category embedded in your third quarter guide. It increased nicely from 15% to 18% in 2Q. Just wondering what you expect for the third quarter.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [23]

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We don't give specific guidance around different elements of the revenue streams in the third quarter. We've continued to expect good traction around the green lasers, the ultrafast lasers, a pickup in some of the shipments for cinema applications, continued strength in some of the laser systems business. So we're looking for growth from those areas, but we don't give specific guidance around those numbers. And we're looking for growth to drive the business forward not just in Q3, but Q4 and the medium term from those newer applications. They'll be a pickup in some of the medical shipments as well based upon the order that we've got. So we're actually pleased with some of the diversification in this business. When you look at these all areas we worked on for a long time, and they're now starting to generate not the level of revenue we want, but they've got some nice traction in revenue coming from these leading-edge new products. And if we can continue executing with them, we've got to have a much more diverse business within an 18 to 24-month period.

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Operator [24]

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Our next question is from Jim Ricchiuti, Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [25]

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Wondering if there are any regions -- geographic regions where, perhaps, the bookings have held up somewhat better. It sounds like it's been -- you're clearly seeing some slowing in bookings in July in China. Where are you seeing other areas of weakness? And where are you seeing some signs where it's holding up better?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [26]

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So in China, as you imagine, bookings were relatively strong for the quarter. It's just there's some uncertainty about where the people are going to take that demand now, so their revenue guidance is weaker. Order flow in Korea was actually very strong, even though the macro days that are out of Korea isn't that good. But that's again being -- that a lot of development and some of new product introductions. Some orders yet from AMB there specifically, but, I mean, you're doing a lot of work, for example, at the AMB on welding applications. But a lot of the ultrafast, some of the UV, some of those newer applications and the welding business in Korea were strong. Japan order flow was not great, but there's expecting -- we're expecting a pickup in revenue from Japan in Q3.

The U.S. is considering to hold up reasonably well, so that continues to be a more resilient area into -- of the macro. Also the U.S. business is a bit more diverse, right? You've got the emerging medical business, you've got the advanced business, which was, revenue-wise, is a bit weak, but there's a lot of different projects being worked on that. We've got an order for a 60-kilowatt laser in the last couple of weeks out of the U.S. so...

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [27]

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2 orders.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [28]

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2 orders for 60 kilowatts.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [29]

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Yes.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [30]

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So that would be for an advanced research application. The other areas -- and Europe as a whole is pretty weak, and China is volatile, right? There is some underlying demand that exists in China, but it's getting switched on and off as business uncertainty either gets switched off when business uncertainty declines and it comes back when there's some confidence in the business environment. So I wouldn't say there is no demand for lasers in China. It's just volatile at the moment, so that's the challenge that we're dealing with.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [31]

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And for the past 2 months we have fast growth of business in China, but after the new increase of tariff, immediately, quantity orders from China dropped minimum 3x. Now our customer remain with us, but they -- before, they order by 5, 10, even 50, 100 units per 1 order, now brought down quantity of orders -- is the same as before practically, quantity per day. But instead of 10, 50 or 100 each order, now, only 1 or 2 pieces. So they probably want to order, but waiting for the events, what happens later and now they order practical brought down in quantity, only what they need or they purchase, but brought down the purchase.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [32]

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It's helpful. On the system side of the business, ex Genesis, I'm surprised that the business has been holding up. And you're showing the kind of growth that you have that you're showing in this kind of macro environment. Are you -- is it just because it's a relatively small business and you have new applications you're going after?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [33]

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As you think some of the systems, especially the multiaccess and the small form cutting machine, which is primarily sold in the U.S., right, does benefit from the U.S. economy being relatively stronger. There's also a relatively old capital equipment in terms of age in the U.S. So that investment cycle, potentially, if the macro holds up, is stronger.

The ILT business, which is shipping into the medical device manufacturing industry, has had a good quarter in Q2. It's going to have another -- it's going to have a better quarter in terms of shipments in Q3. Their total order flow is also held up.

And then we did deliver quite a lot of higher power specialized -- some of these were fairly specialized systems. There was one system for welding batteries that was delivered to the U.K., Jim. There's another system for welding batteries and a consumer product that will be delivered, where revenue will be -- will come through on Q3.

So some of those more specialized systems, we did get some revenue of. And then, for example, the system that was sold for the battery welding is actually going to result in good order flow for some lasers for that battery welding application in the future. So yes, the systems business ex Genesis for lasers has performed pretty well.

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Operator [34]

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Our next question is from Patrick Ho, Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [35]

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Tim, maybe first off, you talked about some additional cost cutting efforts on your end. Given how you're already the lowest cost supplier in the industry, are these additional cost cuts coming on the manufacturing side of the supply chain? Can you just give a little more color and details of where you can extract the additional cost savings?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [36]

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It continues to come from the core optical components that we use, the size is obviously one that we talk about a lot there, increasing the power that you can get out of an individual fiber block. There are even some mechanical components where we're going to -- some of these are design changes, right? So for example, some of the heatsink designs we're looking at that are used in the modules, we're going to improve the quality of the cast aluminum in there to enable those heatsinks to more rapidly remove heat. That will enable us to produce modules of higher power level and increase reliability. That's something in the medium to near term that we're looking at that isn't going to roll into a bit of material for a few months, but that would be an example of something that we think about. And it's a bit more of a lateral way of thinking about it.

And then you've got to look at where we're adding value around the accessories, which grew at 10% year-over-year. There's a lot of value added around the accessories that we produce relative to the cost of an accessory and the selling price. The newer products where we're taking cost out of the bills of materials, for example, the cinema products continuing to ramp the demand for ultrafast pulse, trying to get the cost of the green lasers down a bit more. So some of the newer products, you'll see improving margin there as well. So it's a pretty broad based. And I always said, part of the -- the strongest part of IPG's DNA is not just the technology. It's really this ability to take costs out of product.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [37]

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And very important before we introduced laser beginning this year, a new diode which is much more powerful and also cheaper to work, very essential where they only produce in the market only a couple of months ago, practically. So the -- we've returned work from the diodes, we expect end of this year, next year would be much return from the market with these diodes.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [38]

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Great. That's helpful. And maybe as my follow-up question, I think as Jim mentioned, Genesis has held up very well in this overall environment. How do you see expanding Genesis from kind of its core North American base? And how do you, I guess, expand its opportunities in other regions and how you look at that on a going-forward basis?

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [39]

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Genesis before worked only for American market. They don't have enough opportunity there to work worldwide. Now we will extend the activity worldwide, to Europe, even for Asian markets for them, for South Korea, in Japan and many other. And so it's really become a worldwide player. And we expect -- and second also, now with these designs product they are using in laser, before the quantity of systems they produced before with the laser only when it's more quantity. Now for the most new product or when -- now based on the laser technology, it takes some time to redesign and so on.

But we've got -- we see this very much project now that some in the U.S., some in other country, when we prepare now with very large projects that sell with these. They were the major player. Now it's a new integrator would be now a company for our food chain from the parts and components here. But laser is also part of fine ore system. Genesis would be major -- our internal integrator. All customer with whom we are working who just got to see this progress, they're happy practically, one of them is Genesis, they are absolutely very excited now to switch the work of Genesis system laser integrator for many ways into the market.

It takes time with starting from 3D modeling of these new whole production line. Before we start providing all the parts of the laser, now there's also some other parts, like very unique accessories, optical accessories, now we provide not even production cell, which still some of them, we're able to make ourselves before. Now with Genesis, we now go into production lines portfolio and change technology mainly for large companies, full technology where we could provide new process, provide new solution and full solution in a full production line. It's absolutely new approach for IPG. It takes some time, but various success will go into this new business.

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Operator [40]

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Our next question comes from Tom Diffely, D. A. Davidson.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [41]

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Just to follow up on Jim's question on the system side. Does that mean that pricing has hold up better on systems versus the kind of core fiber laser market?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [42]

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It's a different dynamic, Tom. It depends how much -- the way you're adding a lot of technology and you're adding a lot of value and you're delivering complete processes, the relative price versus cost is strong. In some parts of the market, though, where there's more competition, the relative price the cost is lower. So it really depends upon what the application and solution you're delivering is. In some of these core areas where we're seeing some growth, for example, we're doing some of the medical device manufacturing applications, the average selling price of those systems, because you're delivering software as well as technology, traceability, for example, to the manufacturing process, certainly, pricing is not being impacted in the way that it has in the other parts of the market. It really comes down to the completeness of the technology and the solution that you're offering.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [43]

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Okay. That's helpful. And then Tim, when you look at the FX impact in the quarter, what region is driving most of that impact? And what do you have in place as far as natural or synthetic hedges right now?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [44]

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So what's the last part of the question, Tom?

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [45]

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What kind of natural hedges through operations or synthetic hedges might you have in place for FX?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [46]

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So the transaction FX losses in Q2 were primarily renminbi versus dollar driven, a little bit, to a lesser extent, on the euro. We try and -- the natural hedges are pretty much same. Sometimes, those natural hedges don't work as effectively if exchange rates go in the same direction. So a weakening renminbi and a weakening euro, your natural hedges just don't work. If you have a weakening euro and a strengthening renminbi, those natural hedges work better.

I continue to be, particularly with the cost of hedging some of the renminbi exposures, skeptical about whether you just end up smoothing the losses, so we tend not go into using the FX forward contracts for that.

On the other side of it, if you look at the impact on revenue on a translation basis, the 2 biggest exchange rates that have moved over the last year again are the renminbi has depreciated from a high of CNY 6.30 almost if you go back to Q2 a year ago. It's touched lows approaching CNY 7, so that's a 10% depreciation. And the euro, probably a year ago, was EUR 1.18, EUR 1.19. And it's anywhere in the range of EUR 1.11, EUR 1.12. The ruble, which is also an exposure we have, has probably traded between RUB 57 and RUB 63 as shown over the last year. Those would be the 3 main currencies that we're affected by.

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Operator [47]

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Our next question comes from Nick Todorov, Longbow Research.

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Nikolay Todorov, Longbow Research LLC - Analyst [48]

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So just to go back on the pricing headwind comments. So obviously, most of the headwinds are centered in China, but can you guys talk about if you're seeing anything in Europe or in North America? We just picked up some commentary from the supply chain that some OEM cutting tools, the manufacturers have become aggressive as well. And from what we know, they're not your customer. So just wondering if you're seeing any more aggressive discounts in Europe and in North America?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [49]

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Yes. I've said that, inevitably, there is a knowledge about what goes on in China from the cutting equipment manufacturers in different regions around the world. So that you can't isolate price changes in one region for another. And the second thing is the people tend to think about pricing in terms of the cost per kilowatt. So if you see decreases in one region, they tend to migrate to the other regions to a greater or lesser extent. That depends also upon -- if you go to the higher-power levels, it tends to be lesser because there's less competition. That's an advantage that the cutting equipment manufacturers get in terms of productivity.

Some of the electrical efficiency benefits have become more and more important as you go to higher and higher-power levels, right? A laser that operates at 20% electrical efficiency at 1 kilowatt, it's -- perhaps, it's more certainly not as important when you have 20% less efficiency competing against an IPG laser that has 50% electrical efficiency at 10 or 15 or 20 kilowatts. So as you go up in power, there are certain performance advantages that IPG delivers that are not matched by the competition.

But you see pricing migrate around the world just because people understand what's happened in China. Several of the OEMs I mentioned have joint ventures in China. They've got intelligence on the ground about what the cost of a 1, 2, 4, 6, 8 or 10 kilowatt laser is.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [50]

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Don't forget that Europe, for example, is like 70% to 80%, it's only export, not inside of Europe, but mainly in Asia and China. So as they work in for China mainly. So if the China situation pricing change, it immediately impacts all the situation. Europe, they have also the sales related to sales position in China that they have to work also to correct the prices for the equipment.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [51]

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Maybe I'll add, Nick, on this as well is that probably, 25 -- you just looked at average selling prices across the border, about 25% of the total change is related to the FX that I addressed in the previous question, just on a translation basis where the renminbi having depreciated 10% and the euro having depreciated 5% or 6%. If you saw the dollar start to weaken and so those currencies strengthen, there will be some recovery against that. So there's a view that the dollar may weaken if interest rates move down by the Fed tomorrow.

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Nikolay Todorov, Longbow Research LLC - Analyst [52]

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Yes. Got it. And then you talked about demand being very volatile in China kind of related to changes in the headlines. Is it strictly demand being volatile? Or are you seeing also the same on the pricing front or prices have been kind of getting progressively weaker as we get into the -- as we get into May and June?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [53]

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I'd said at the beginning of the call that the demand volatility, that tends to drive price volatility, right, particularly from the competition. So I think the industry has to learn to become less reactionary to this because there's just going to be a rush to the bottom. And we're certainly being more selective and strategic about looking at pricing and the value that the lasers deliver. So the demand volatility, unfortunately, at the moment, drives a reactionary response on pricing from particularly 2 or 3 of the competitors because they're just trying to fight for any revenue they can get. That's a very short-term view to have, in our opinion, around the markets and one of the reasons why we're looking to be more strategic and selective.

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Nikolay Todorov, Longbow Research LLC - Analyst [54]

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Got it. And last question from me. The last couple of quarters, you talked about some strength in aerospace and defense. Can you give us an update? And then I didn't hear anything in this quarter, and I think you mentioned some volatility and probably in advanced products. Is that related to maybe some just temporary drop in demand in end market? Or is there something else?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [55]

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No. On the defense side, it's still very much -- there's some commercialized applications that are already developing, right? So a lot of it tend to be very project driven, and you'll have very strong quarters and then the revenue can be uneven because order flow will be lower and people will be working on utilizing the lasers they bought. There's 1 application that's being developed commercially at lower power, single-mode lasers where we're expecting to see some increasing demand in the second half of the year. We referenced that we got 2 orders for 60-kilowatt lasers that are going into research. So that business is just uneven and expected to be stronger in the second half of the year. I can't -- what's the first part of the question? I can't remember it.

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Nikolay Todorov, Longbow Research LLC - Analyst [56]

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No, I think you answered that correctly.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [57]

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And so we cannot be -- mainly about the same for this application, just laser. But now, we're going for -- to the sales -- production sale even system for this market. That's a different approach and much more valuable. And so on going very successful for the same, for example, for -- to aerospace and high-energy market and so on for oil and gas market, so on, so the volume with whole complete solution, unique process. We have developed that process, now we materialize in this full system with some systems parts 150, 130 and so on. But it's not easy process to introduce in this market. Well, in case there's some years and so on, but we're going very successful with some projects, but very difficult application going extremely successful in future to have potential would be a very large-volume business.

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Operator [58]

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Our next question is from Tom Hayes, Northcoast Research.

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Thomas Lloyd Hayes, Northcoast Research Partners, LLC - MD & Senior Research Analyst [59]

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I'll try to be brief. Tim, I was just wondering if you may provide any other color as it relates to mix within your China sales? Does it kind of relates to moving up and down the power scale?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [60]

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I think we'll provide a little bit -- yes, I mean, the ultra high power and the greater than 10 kilowatts has performed very well in the quarter. That has rebounded strongly in April and May, so that was a bit of a benefit. The lower end of the market in units was relatively strong. I think that -- really, that's a high-level stuff in terms of the high-power. Some of the welding applications in China are high-power as well, where we performed reasonably well.

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Operator [61]

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Our next question is from Mark Miller, The Benchmark Company.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [62]

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I'm just wondering about programmability. Is that becoming a bigger part of the laser sales? Have you seen growth in demand for programmable applications?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [63]

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By programmable, you mean the adjustable mode beam, Mark, that scenario that we're working on with, for example, customers both in cutting and welding applications and welding, there's a substantial reduction in splatter. With the programmability of it, you can also then cut varying thicknesses of material.

It's important, but it's talked about a lot in terms of marketing materials by different companies around the world. Our view on it is, actually, the programmability is probably going to be more of an enhancement for welding applications than it is necessarily for enhancing thick cutting applications. Some of the quality people are getting to it, our higher power cutting head, for example, is achieving adequate cut quality when you're cutting materials of 1, 2-inch thicknesses. You don't require jigsaw quality cuts there. Sometimes, it's just the perception of the quality of the cut. If that's what you mean about programmability, it's going to have some niche applications, particularly in welding. It's not going to be an overall dominant type of laser that's sold for materials processing.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [64]

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You start in, for example, application. When you hear people talk of fiber laser or the very thin metal sheets, like 1, 2 millimeters and so on, then CO2 can provide much thicker, processing much thicker materials. Now people forget about this because fiber laser provides for the 1 centimeter and so on. Now with the way with technology to cut up to 5 watt centimeter, the way with high-quality cutting, nobody still would care for this technology, nobody cares for this. Only we care. It's not only -- and hardware, very special and so -- also process it all and know it and so with all the (inaudible).

Now we produce this technology at those markets. Nobody can compete with us today and so on. It's taking us up to 3 to 6, even more, centimeters cutting very high speed, high quality and so on. Nobody can make the cut, for example. The best ways, 5 -- 10 -- even 10 kilowatts, 12 kilowatts, they tried to develop on cutting -- cut and process and so on. We provide now with 20, 21 kilowatt and process it. So also in ways, special technology and only can produce this by this old because it's not only power. It's also where is the solution, how to deliver this power and so on and optical heads and so everything, especially nobody can provide today to the market. And so for us, it's a doable know-how. It's -- but this business wouldn't be able to replace pulsed and now it's cutting of thick steel or a stainless steel and so on. We have this product developing inside.

And also copper cutting, for example and so on also and so on. And welding and so on, also them. People are worried they produce very high -- generate and, for example, providing powerful (inaudible) they have serious problem with this unique copper welding. And so we'll provide excellent technology to make this now. We just got to provide for them equipment. I don't like to make, but where it is best made in the world.

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Operator [65]

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At this time, I will turn the call back to James Hillier for closing remarks.

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James F. Hillier, IPG Photonics Corporation - VP of IR [66]

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Thank you for joining us this morning and for your continued interest in IPG. We look forward to speaking with you over the coming weeks and on our next quarter's call. Have a great day, everyone.

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Operator [67]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.