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

Q1 2019 IPG Photonics Corp Earnings Call

OXFORD May 6, 2019 (Thomson StreetEvents) -- Edited Transcript of IPG Photonics Corp earnings conference call or presentation Tuesday, April 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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* Alex Chang

Citigroup Inc, Research Division - VP

* 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

* 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 First Quarter 2019 Conference Call. Today's call is being recorded and webcast.

At this time, I'd 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, Doug, and good morning, everyone. With us today is 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 in 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, April 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, everyone. We were pleased to deliver first quarter results in line with our guidance during the challenging macroeconomics, geopolitical and competitive [environment]. During the quarter, business trends improved in China, driving sequential growth in order. More importantly, we have made competitive challenges head-on, [have potentially reduced income] and manufacturing costs. We have also introduced a [made-to-order]product features that improve [synergies], flexibility and quality for our customers.

IPG always seeks to gain advantage during times of market threat. If properly [mitigated], these challenging times can be a catalyst for (inaudible) investment that result in a stronger competitive position on which excess returns can be earned.

We remain the clear market leader in fiber laser with hundreds of megawatts of installed capacity. In the first quarter, we [fit] more than 11 megawatts of total optical power, up year -- 10% year-over-year. High-power megawatts increased even more year-over-year, 15% year-over-year.

Also we have seen a greater pricing among China-based competition of [our porfolio of optimizers] serving the mobile [cost-cutting] market. We increase sales of our [head-mounted] optimizers sequentially with even stronger unit growth. The pricing environment has affected the dollar value of units ever since March. However, our ability to actually reduce cost has limited the growth margin impact, from such 200 basis points year-over-year.

Last year, we reduced the cost of diodes essentially and some other components by more than 15% and have started the mass production of new diodes in Q1. This year, we have visibility into further cost reduction and product enhancement that we believe extend our competitive lead.

In the last quarter, we have developed, and a couple of weeks ago, have started to sell to customers new unique 2 to 4 kilowatts CW lasers with cables [gig] power additional pulse capability. That innovation essentially enhanced our competitive position in the cutting market. The lasers increased piercing speed, improved (inaudible) cut quality, delivering cleaner, more-controlled -- control drilling of thicker materials while reducing scrap. It's a lower (inaudible) to compare to competitive ways of other (inaudible) guide (inaudible) big improvement in sales this year.

At other high-power sectors, our multiple IPG customers will fortunately be launching their first [multi kilowatt] cutting system, raising the bar for speed and flexibility in process in (inaudible), metals (inaudible) non-laser technologies.

In addition, we see continued customer interest in our new generation of high-power laser with adjustable mode and beam capability that permit reliable adjustment of our beam to process a wider range of material thickness for cutting applications, while reducing its spatter and improving quality in welding applications. We also made solid progress in our newest product areas outside metal processing.

Sales of green power lasers, for example, used for (inaudible) efficiency more than doubled year-over-year. We also made the fast growth of sale of our red, blue, UV and other new products. We increased sales of our ultrafast pulse lasers nearly 3x compared with prior year. And actually we're actively working on more than 50 new projects for this laser across a wide range of application.

System sales increased more than 200%, and the execution of Genesis of outside digital (inaudible) laser processing within the transportation, agriculture, aerospace and industrial and mining. Sales of beam delivery accessories increased more than 70% year-over-year. We increased sales of our laser-based cinema projection system more than 150% year-over-year as our solution has been adopted at 3 of the leading providers of cinema projection technology.

We also have visibility into strong growth of -- in medical laser solutions this year. Collectively, sales for newer laser products and system into emerging application grew at double-digit rate in the first quarter and provide 15% of total revenue.

We continue to demonstrate meaningful traction in ultra-high-power fiber lasers while investing in new products and application. We believe this progress substantially expands our addressable market and opens up opportunities that will drive the company's growth for many years.

The mission is to make IPG's fiber laser technology the foremost choice in mass production for many years ahead. I am confident in our ability to execute on this mission and deliver our strategic returns.

With that, I'll 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 first quarter declined 12% year-over-year to $315 million. Revenue from materials processing applications decreased 11% year-over-year, and revenue from other applications decreased 32% due to the timing of orders in our advanced applications and communications businesses.

By region, first quarter revenue in China decreased 24% year-over-year and represented approximately 36% of the total. Macro-driven softness in cutting and marking applications was partially offset by growth in macro welding. Within China, sales of ultra-high-power CW lasers grew by a double-digit percentage but were more than offset by declining sales of lasers for lower-power applications. In Europe, revenue decreased 24% year-over-year primarily due to softness in cutting and additive manufacturing, partially offset by growth in welding.

In Europe, total sales of $88 million were consistent with the Q3 '18 level, which supports our previous assertion that revenue in the region appears to have stabilized. However, continued macroeconomic softness in the region, as evidenced by the decline in Eurozone manufacturing PMI, makes project -- predicting an eventual rebound in Europe more challenging.

In North America, revenue increased 65% year-over-year driven by the acquisition of Genesis. Excluding Genesis, sales in North America increased 1% year-over-year with slight declines in cutting, welding and marking, offset by strength in other products and applications.

Sales in Japan decreased 20% year-over-year on softness in marking, welding and cutting. However, strong bookings in the region adjust improved performance in Japan during the second quarter.

Sales in Korea increased 4%, and revenue in Turkey decreased 36% year-over-year but improved sequentially.

Turning to performance by product. High-power CW laser sales decreased 22% year-over-year and represented approximately 57% of total revenue. Reduced sales of high-power CW lasers for cutting and additive manufacturing were partially offset by strength in welding applications. Sales of ultra-high-power fiber lasers at 6 kilowatts or greater accounted for nearly 50% of all high-power laser sales driven by rapid adoption in cutting applications.

Sales of lasers at 10 kilowatts or greater increased more than 40% year-over-year, while sales of other high-power lasers declined year-over-year due to the weaker demand environment in China and Europe and more aggressive price reductions on select products.

Pulsed laser sales decreased 18% year-over-year with rapid growth in green and ultrafast pulse lasers, offset by reduced sales of other pulse products. Medium and low-power laser sales decreased 39% on softness in additive manufacturing and the transition to kilowatt-scale lasers in cutting.

QCW laser sales declined 13% year-over-year but increased 17% on a sequential basis as lower sales into consumer electronics applications was partially offset by increased sales of higher-power QCW lasers into other applications.

System sales increased 245% year-over-year due to the acquisition of Genesis. Excluding Genesis, system sales increased nearly 20% year-over-year driven by growth in macro systems for welding, drilling and ablation applications along with the initial acceptance of our laser-based cinema projection system, with the leading providers in cinema projection technology.

Other product sales increased 6% year-over-year driven by growth in beam delivery accessories and service revenue. Gross margin of 47.3% declined 920 basis points from the first quarter 2018. Compared with the year ago period, less favorable absorption of manufacturing expenses reduced gross margin by nearly 500 basis points.

Lower-than-expected absorption of manufacturing expenses and a higher inventory provision resulted in gross margin coming in slightly below the low end of our expected Q1 range. In addition, acquisitions reduced gross margin by more than 200 basis points, and lower product pricing and foreign exchange headwinds reduced gross margin by a further 200 basis points approximately.

All the other factors constant, we believe that recovery in our business to approximately $380 million in quarterly sales would enable us to get close to the midpoint of our long-term gross margin guidance of 50% to 55%.

First quarter operating income was $68 million or 21.7% of sales, down 1,750 basis points from the first quarter 2018. Excluding a foreign exchange loss of $2 million, operating margin was 22.2%. Excluding foreign exchange, operating expenses as a percentage of sales increased 630 basis points year-over-year due to lower revenue, investments in engineer, salespeople and IT systems, higher R&D material costs and higher-than-normal legal expenses.

Net income was $55 million, and earnings per diluted share were $1.02. Slightly lower than expected absorption of fixed manufacturing costs and higher inventory provision reduced EPS by $0.04 relative to guidance. In addition, higher R&D material expenses, legal cost and foreign exchange losses reduced EPS by $0.04. If exchange rates relative to the U.S. dollar had been the same as 1 year ago, we would have expected revenue to be $15 million higher and gross profits to be $8 million higher. In fact, 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 $1.03 billion and total debt of $44 million. Cash provided by operations was $46 million during the quarter. Operating cash flow was reduced by cash tax payments that totaled more than $50 million relative to a Q1 tax provision of $17 million. These payments were primarily related to the timing of cash taxes paid in Germany with the filing of our 2017 tax return in Q4 2018.

Capital expenditures were $33 million, which included approximately $21 million for the purchase of a new facility in Massachusetts as we continue to invest in new plants and equipment to meet demand for our product over the next several years.

Turning to guidance. We have seen further signs of improving business conditions in China, our largest region, with sequential growth in orders and good momentum through the first 3 weeks of the second quarter. Our first quarter book-to-bill ratio was above 1, in line with normal seasonality, albeit off a lower base given the weaker macroeconomic environment. If this momentum in China is maintained, it should continue to drive better performance.

Performance in Europe is generally stable but down from peak levels, reflecting reported economic trends in the region.

We expect pricing headwinds relative to competition in China to continue. We believe our innovative new products, accessories and complete solutions would provide customers with a superior value proposition that will cement and enhance our market leadership position.

Based on these factors, for the second quarter 2019, we expect revenue of $340 million to $370 million. Expect our second quarter tax rate to be approximately 25%. We anticipate delivering earnings per diluted share in the range of $1.25 to $1.55.

Commentary from our largest machine tool OEM customers continues to improve, but we do not yet have clear visibility into their full year order plans. As such, we do not believe it is appropriate to provide full year revenue guidance at this time.

As a reminder, we would expect year-over-year trends to improve in the back half of 2019 driven by market recovery and strength in new products and our solutions.

As discussed in the safe harbor passage of today's earnings release, actual results may differ from our guidance due to factors including but not limited to product demand, order cancellation 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.

And 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 the line of Jim Ricchiuti from Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [2]

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Tim, when you talked about the 200 basis points impact on gross margins from acquisitions, was that all Genesis-related?

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

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Yes.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [4]

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Okay. So Genesis was about $21 million of revenues in the quarter?

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

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We said $24 million in the press release. So that line there then.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [6]

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Okay. Just as it relates to what you're seeing in the market in China, are you hearing anything from your customers that give you any view of a pickup or, on the other hand, weakness in consumer electronics-related revenues?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [7]

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We're not hearing anything that's going to drive a very significant pickup, but there is some demand for consumer electronics applications. We're seeing some order flow for some of the micro welding applications with our QCW lasers. We've been asked to deliver some products very short lead times for that, continuing to work on some of the higher-power applications for welding, the frame around different phones.

But yes, this week -- this year, I don't think it's going to be a significant consumer electronics revenue driver as some of the biannual cycles are, and I think there's another company that reported last night that reflected that as well. So there's some order flow, but it's certainly not a bullish tone around consumer electronics in general.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [8]

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Understood. And then just a clarification and I'll jump back in the queue. The book-to-bill of 1.0, were you are referencing China? Or were you talking about book-to-bill across the various regions?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [9]

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In total. China was also above 1 there as well.

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Operator [10]

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Our next question comes from the line of Tom Diffely from D.A. Davidson.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [11]

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I was curious. You talked about how you've been able to offset some of the pricing with some of the new features. I'm curious what type of features is the most successful. Is it speed, reliability or specific tech specs? What do you find the most successful in fighting off some of the pricing pressure?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [12]

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So first of all, I think really what has offset some of the pricing pressures is being this very significant reduction in components and subassembly costs with the new generation of diodes, and they're relative to the pricing pressure we've seen. We're only seeing 200 basis points in margin degradation related specifically to pricing, I think, is really quite extraordinary.

In terms of some of the product features we've introduced in -- for the cutting applications, I think the QCW feature, with the 2x peak power, because of the improvement in piercing speed, quality of piercing, the fact that the cutting can then start closer to the edge of the metal and reduce scrap is going to be a very fundamentally important feature to have with the lasers.

And on the adjustable mode beam, I think there's good work being done with customers. I said there's a lot more excitement around the QCW feature, which is actually good for us because that's very unique to IPG. Several other customers offer the variable beam capability, but QCW is really unique to IPG.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [13]

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And then maybe getting back to the cost reduction side. I mean you guys have been very good over the last decades of reducing the costs. Is this a continuous opportunity for you? Or at some point, do you run out of ways to reduce the costs?

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

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I mean, Valentin keeps driving everybody every year to get to cost reductions. And if you just looked at, say, the cost of an individual component, you might be reaching a greater limit on being able to reduce that. But if you can then take that and get more power out of individual components, that is much as anything else can bring your cost per watt down.

As you get more power out of components, it can also simplify the product architecture, reduce the number of splices, for example, that are required in the manufacturing process, reduces the form factor of the lasers. That, in itself, takes cost out. So every year, we take cost out and think it's going to become more difficult, and then we succeed yet again to take a significant amount of cost out.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [15]

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And then finally, when you talked about the pricing...

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

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Valentin will add a comment around that. Just before you go ahead.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [17]

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I can say with diodes for example. For the last 6 years, we decreased cost of 1 watt of diode, decreased more than 10x. During 6 years, 10x decrease cost of diode. Now nobody can compete with [the cost of this]. It's a fantastic result, which 10 years ago, the biggest scientists could dream only about a possible future per-watt. We reached such a number.

And we've produced now, I would tell you about -- it's more than 70-megawatt of optical power, 70 megawatts, [ask around] added together who produce diodes, may be only few megawatts only. We've produced 70 megawatts.

We're able to compete in quantity for how many years we need to invest to reach such number, but without the diode, nobody can [practically compete] with us, to replace us in the market. Nobody able even to close us in the margin, such number. Only diodes, but other components for that quantity of different kinds of lasers only poses now competition, [Chinese] and so on. It's only for a couple of lasers, 1 micron laser for more power up to 2, 3 kilowatt quality, no question at all (inaudible). But even quantity, never able to reach now our number.

This price correction was then made artificially, of course. It's damaged the market, very [central] price. But when you talk about quantity, for them, a laser, high-power laser, 1 kilowatt -- watts to increase -- each year, we increase up to 20% up to now. Every year, we increased [22] units.

Price, the decrease of price, you take one time, aggressive 1 year, 2 years, and then finish, and whereas they could not grow their price up to you. And now they're making artificial with this, without -- [with losing your moving] margin practical, but they have to stop. But quantity, every year we increase quantity, 15%, 20% up to now. We did not lost market share. Over time, we increased market share.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [18]

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Great. And finally, Tim, when you look at the pricing pressure that you've seen, is that you responding to market pricing? Or is it you getting aggressive on pricing to regain or retain share?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [19]

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Market pricing has been very aggressive, as Valentin has referenced. We think that -- well, we can see that it started to stabilize a bit. To a degree, we have to respond to it, but we're still pricing at a premium to the market given our improved quality and performance of the lasers.

For example, with electrical efficiency, the size, the general reliability of the product. And now with new feature sets, we believe some of these features will enable us to add value around the product and enhance that pricing a little bit relative to where the competition is.

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Operator [20]

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Our next question comes from the line of Patrick Ho with Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [21]

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Tim, maybe first off just following up on the strong performance you had in the ultra-high-powered segment on a year-over-year basis. From -- I guess from a big picture basis, where do you believe we're in, in the industry transition to these higher-powered lasers particularly for the cutting market?

Are we still at the very early stages, say, like first or second inning? Or are we kind of halfway through, I guess, this industry shift?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [22]

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We're still at relatively early stage. I think it depends on what power level you're talking about. In the 6- to 10-kilowatt range, the first use of those lasers started a couple of years ago. In the 10 to 15, it's only really that transition happened -- it started to happen over the last year.

And in 20 kilowatts, as you referenced, people are only just starting to introduce cutting systems at that kind of power level. So as the higher power you get, the most recent the transitions are to utilizing higher-power scale devices.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [23]

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Great. And as my follow-up question, in terms of the improved outlook that you're starting to see in China, the -- is part of that related to a better inventory situation therein where they worked off maybe some of the excess laser inventory they have? Or is it being driven by, I guess, a turn in demand?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [24]

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So we don't think that there's, at anytime, a huge amount of inventory that sits with the OEMs. In part, that's because the way we manage the business, right? We have very short lead times. We don't force product on people when they see fluctuations in demand.

So what we're seeing here, there may be a little bit of an inventory adjustment, but it's not -- I do not believe it's the primary driver. The primary driver has been a shift in the demand cycle coming back, and we referenced that even in Q1. So we started to make a bit of a call on our first quarter earnings announcement.

The bookings forecast for China in Q2 would -- it doesn't just reflect an inventory adjustment. That reflects a very definitive pickup in demand. And that reflects, I think, the effect of some of the stimulus and other actions that are being taken locally to get to, I think, is a softer landing than might otherwise have happened.

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Operator [25]

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Our next question comes from the line of David Ryzhik from Susquehanna.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [26]

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So regarding the 6 kilowatt or above high-powered lasers in your prepared remarks, I guess the numbers would shake out to around flat year-over-year growth in Q1, and China grew double digits in this segment. So that would suggest the rest of the world declined year-over-year. I just wanted to get your sense on what are the demand trends for a 6 kilowatt and above ex-China and what you saw there in Q1. And then I have a follow-up.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [27]

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Yes. No. Absolutely. I mean, it's clear that relative peak revenue in Europe was actually in Q1 a year ago, and a lot of that was coming off the initial transition towards more than 6-kilowatt power lasers. So Europe, as we've said, compared to that peak, continues to be weak, but it has stabilized at least, right?

Revenue is tracking along over the last 3 quarters at relatively the same level, but it's still significantly off the peak demand that we saw at the beginning of the year. That would be the main driver.

In Q1, Japan was also a little bit weak, but order flow from some of the main OEMs started to pick up at the end of the quarter, and we're going to see an improvement in high-power laser demand in Japan in Q2 and their bookings forecast is also good. So that trend should happen into Q3.

Korea was okay with high-power lasers, but cutting applications, not brilliant, but they've got a good forecast as well for the second quarter.

So ex-China, particularly the largest market where we serve is Europe, that certainly is off from -- continues to be off from peak demand a year ago.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [28]

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Okay. And just regarding ultrafast, you talked about sales up 3x. You're working on more than 15 new products. I would love to -- for -- perhaps you can expand upon your strategy there, how you view the market opportunity, perhaps what kind of revenue run rate you think you can get to over the next few years. I would really appreciate that.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [29]

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So it's actually we're working on about 50, 5-0, projects with different customers, and we believe we've got a very -- an excellent device that is compact.

It has a very fast startup time from a [coal]. It has very good electrical efficiency. We're working on continuing to improve the amount of energy and the average power that we can get out of the device so that we can address more and more applications at a very high level. I think that's the main strategy. And then really pushing the product out to customers for evaluation in processing of many different types of materials.

It's certainly a product that's got a lot of very positive feedback from customers. Without getting back into a specific run rate around ultrafast pulse laser, if you look at the microprocessing and look at ultrafast and UV and some of the visible product offerings, the total revenue around that is actually starting to approach a -- just below a $10 million orderly run rate, so getting up towards a $40 million annual run rate, and that's really starting to get to be more meaningful.

Therefore, so 2% or 3% of revenue, we've said, get to 5% and 10% of revenue first and then gain another 500 basis points a share. You can quickly see yourself heading towards now $100 million to $150 million of total revenue quite quickly.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [30]

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And I can tell you with ultrafast lasers, we will introduce market [press laser] all fiber with a reasonable power source, first laser. All other customers have provided very bulky, expensive and not flexible solid-state solution. It is not fiber solution. We provide now a 50-watt home fiber placed in the market.

With the 2 years, we're qualifying and the customer also testing, so on. So (inaudible) request for OEM customers, we've started only 1 month ago, 1 month ago. Therefore, (inaudible) process qualification test and so on.

But the returns from the margin (inaudible) are so excellent. Own people sell their wire much, much better when they use now from other sources. And so it's only the start of sales. So the real growth -- the real -- it would be we expect next year. (inaudible).

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [31]

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And Tim, a quick follow-up. Do you feel like you need to invest in SG&A and R&D? Should we expect some pickup in investments related to this opportunity?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [32]

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On the R&D side, I think we're continuing to invest in R&D and devoting the resources that we need to get the product to market. We haven't seen any decreases in R&D through the downturn.

On SG&A, we've added headcount around that area that's starting to execute. We, of course, look for people who are more specialized in this area as we build the business. But we tend not to go and chase like 100 people to build that market.

We look for the best people who are technically competent and have a deep knowledge based around the different users in the market and leverage them to get a return quickly on the sales cycle for that. And we're not looking to add 100 salespeople to get into the ultrafast market.

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Operator [33]

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Our next question comes from the line of Andrew DeGasperi from Berenberg.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [34]

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First on the welding side, I know that China's cut their subsidies in April for EV. I'm just wondering if there's any impact that you see yet on sales from that end.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [35]

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We haven't seen anything specific related to change in EV demand. We continue to work on different projects. Some of them are not even just related to China demand. They're related to some of the international automotive companies, installing battery capacity in China.

So I think it's too soon to make a call on whether those removal of the subsidies or cutting of them in April, what the impact of them will be. It's certainly not -- we would have liked to see the subsidy stay because it's going to be a bit of a negative.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [36]

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Got it. And then secondly, just on the pricing side as a follow-up is, are you seeing anything in terms of competition moving in the mid-power range?

I mean we've been hearing that your Chinese competitors are trying to improve the reliability of their lasers in the 5 to 6 kilowatt. I'm just wondering if you're seeing anything on that side.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [37]

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Nothing material. I think, of course, they're all trying to get there, but...

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [38]

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They don't have a good chance for this to improve. The -- you have to understand, with increase of power they will deal with the problem growing very fast, but even all our tests could make [personal test] (inaudible) competition or, for example, sure, they will build 2 more -- minimum 2x to 3x batteries per year. We need for 3 years minimum, maximum 1 [sale]. You have 2 or 3, even lower power, 1 kilowatt, 2 kilowatt, 5, 6. And so [they will build] -- well, they're not dramatically with that, so how would they improve nearest time, near 3 years, we don't see any opportunity.

So you know what, we (inaudible) a diode 10x higher than all of them, given their breadth or their (inaudible) creator of high-powered diodes. Now (inaudible) going out of this business because it's not competitive. I would say, not Chinese. Not Chinese.

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Operator [39]

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Our next question comes from the line of Joe Wittine from Edgewater Research.

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Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [40]

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With respect to the full year, we have started to hear some global integrators willing to quantify a 2019 outlook, certainly more than we saw 90 days ago. You obviously aren't hearing enough to publicly quantify a range, which I get, but maybe talk us through any notable forecast you have heard or any regional details you may be hearing.

And for those that are tightlipped, maybe what are they telling you that they're waiting on before giving a more definitive look into the full year? Is it specific down market verticals? Is it geopolitical, et cetera?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [41]

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So I think, yes, Joe, a couple of the OEMs have come up and given some generic information about what they expect for the year. One example of those customers, a large but not even our largest customer although very important, their business is much more one-dimensional than ours. So focused on 2D cutting, whereas we've got a much more diversified set of applications and end markets. I think we look at this, and our annual guidance, even in a less volatile environment, is tricky.

And what we have been saying and continue to see is a nice recovery and even strength in overall bookings.

With a strong bookings forecast for Q2, particularly in China as I referenced, and that's being provided by the sales group, we expect that to continue. Aside from that, I don't want -- it gets a bit difficult to give anything specific. But if you look at Q3, for example, consensus, I think, looks pretty reasonable.

I think RSUs, we just don't have visibility into Q4 yet. We're struggling a little bit. Look at how changeable the macro environment is. 1 month ago, Europe looked like a basket case and yet only today, the data in Europe looks a lot stronger.

So we're certainly seeing some very positive trends on the business. It's just a bit early to get out there and give an annual guidance on it. And we hope to see this momentum continue. If they achieve the bookings forecast they've got for Q2, we're going to see a really nice recovery in the business. So we're waiting on seeing that happening.

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Joseph Helmut Wittine, Edgewater Research Company - Research Analyst [42]

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Okay. Makes sense. And then just a follow-up on China. You kind of presented it as a tale of 2 worlds, ultra high-power CW is up, but then low-power applications are facing some headwinds.

On the ultra high-power CW, can you confirm whether that's 6 and up or 10 and up? And then on the low-power weakness, is that competition-related or is that more demand-related, the declines that you're seeing?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [43]

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On the ultra high-power, we certainly see a lot of strength in 10 and up, a little bit less on 6. The lower end of the market has, in total units, has continued to perform okay, but it's really sort of more of a pricing impact at the lower end of the market that's affecting things.

So that market hasn't gone -- it's not 20% down. It's more on a pricing issue there. The competition is also a lot stronger at that level. So we think, again, some of these new features, particularly the QCW feature on the lasers, will be a substantial enhancement. A smaller form factors of these lasers also would be a benefit to the end market relative to the Chinese competition.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [44]

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Not only it's smaller, but also it is much more functionality for that. Much more and much more efficient, but much more additional functionality by property and so on, for which you know this, people only claim that they have the 5- or 10-kilowatt laser, our competitor. But if they compare, we don't see any in the exhibition.

We don't see your own laser. You should have done it, so on and so on. Where is this laser? Where are we seeing the customers who use these lasers? It's only a while, more than marketing tricks. It's not serious you want to talk about. We have produced 10 kilowatt laser now of about 1,000, 1,000 lasers. And they, how many they produce? Maybe less than 10. It's only for a while (inaudible). It's only a marketing -- it's only marketing tricks more clearly. When we're in (inaudible) and ask which (inaudible) exhibition sold. What they sold, it's not 10 kilowatts at all. Absolutely, when asked, it's not 10. We've got -- you've got heating. They need water, 5 times more water only to heat -- to cool them. But they don't have any cables, even pipes is all for this, so even 5 pipes, maybe you can hold only 2, 3 kilowatts, but not 10, never 10.

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Operator [45]

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Our next question comes from the line of Mark Miller with The Benchmark Company.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [46]

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I don't want to overdo in this, but in terms of the ultra high-power, some people have announced products recently. And are you seeing any increased competition? Or is that still your own playing field?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [47]

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Well, Valentin gave a very definitive answer on his view of what their capabilities in that area just now. So there's nothing else to add. We just don't believe that they're anywhere close to us.

But yes, they announced up, but they just don't have competing product that is getting any meaningful traction in the market.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [48]

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And you mentioned ultrafast and green lasers did well last quarter. Can you estimate what percent of sales are coming from new products last quarter?

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

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Yes. In total, new sales -- new products are driving about 15% of sales and grew at a double-digit rate, and there's a whole variety of new products in there, including the ultrafast, green, the visible, some of our higher-power pulse systems, accessories, which includes the beam delivery stuff, so about 15% of total revenue.

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

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Take in mind, only green lasers. But first, no -- now more than 15 different kinds of [actual] lasers with different functionality. Most of them unique, nobody able to reproduce and to provide the same quality, the same performance at all.

It's unique version of lasers. And more and more people started to take this, and they found it fantastic laser. Now TRUMPF also started to make green lasers because they thought big opportunities claim about. We don't see any competition. Only a (inaudible) some application in TRUMPF.

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Operator [51]

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Our next question comes from the line of Alex Chang with Citigroup.

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Alex Chang, Citigroup Inc, Research Division - VP [52]

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I have one question regarding to China sales. Actually, we have seen the major customer in China deliver around 26% y-o-y sales in the first quarter. Also your major competitors in China also deliver about 20% revenue growth.

But your revenue from China was 20% decline. How can we understand this? I mean, how much is from the changing impact? How much is from ASP or unit sales?

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

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So Alex, this is a relatively easy question to answer. I've done my research into it. We actually had a very strong quarter in Q1 2018 in China with our main OEMs.

And if you looked at the main OEM revenue, most of them went from Q1 to Q2 with a doubling of revenue. So their sales from IPG were in the prior quarter ahead of that growth. So we had a really exceptional quarter.

So relative to that, our Q1 this year looks weaker, but we're starting to see improving demand trends. I mean, the main OEM out there the -- is our largest customer. Their reported revenue doubled from Q1 to Q2, and that was their peak.

They don't -- they're buying lasers ahead of that for us. So of course, there's some impact on it on pricing, but we referenced that the unit -- total unit sales across the board performing quite nicely. We're starting to get real traction at 10 kilowatts and more, but it's really -- it's a timing difference.

That appears to create an anomaly between the way they're performing or not. So they had a relatively weak Q1 a year ago, and they'll show some more solid performance relative to that. So we've got a very different timing difference to deal with.

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Alex Chang, Citigroup Inc, Research Division - VP [54]

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Understood. My follow-up question is about your new product with QCW feature. As you mentioned, the QCW is mainly for the consumer electronics applications. So how much contribution from this new product do you expect for this year? And apart from the consumer electronics, what other applications would this new product in for?

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

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I just want to be clear. The older QCW generation of lasers was an exclusively QCW feature that was targeting the micro-cutting and welding applications in consumer electronics. The new QCW feature where we get 2x the energy out of a CW laser incorporates and combines that feature with a normal, continuous wave laser.

The additional peak power is what really helps within the cutting applications, so reducing piercing time, improving the quality of the piercing as well as with the -- enabling the OEM to start cutting nearer to the edge of the metal reducing scrap. So it's an entirely different feature that's enabled by IPG's new generation of diodes, which can run both in CW and QCW feature or mode rather. We can explain that to you a bit more detail afterwards if you aren't clear on it.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [56]

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Yes. In terms of the new family of QCW laser, it's not the same we had before. It's much more powerful in an area we'll provide, good improvement and cutting it all.

[The way we build], the way we operate, Chinese not able to make something similar at all. And not only now, but year-over-year. But one reason we used our diodes, they work with 5x more peak power, than able to work diode from any other source, not only from Chinese-made, but made by any other customer manufacturing worldwide. Our diodes provide so unique properties. Only with such diodes can make efficient such kind of fiber laser.

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Operator [57]

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Our next question comes from the line of Tom Hayes with Northcoast Research.

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Thomas Lloyd Hayes, Northcoast Research Partners, LLC - MD & Senior Research Analyst [58]

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I just wanted to follow-up. You have mentioned several times in your prepared remarks on the weakness in the additive manufacturing space. I just wanted to get some thoughts on kind of that market and the outlook for the year.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [59]

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It started to improve a little bit, but it hasn't got the same traction it had in the end of '17 and into the first 2 or even the first quarter 2018. So the order is starting to pick up, but certainly not at the level it was a year ago yet.

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Thomas Lloyd Hayes, Northcoast Research Partners, LLC - MD & Senior Research Analyst [60]

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Okay. And then just maybe on North America. I think you said when you factor Genesis out, the North American revenue is up about 1%. Anything strikingly as far as that outlook?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [61]

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So some of the other business in North America, the advanced applications and the telecommunications are just primarily here. It was probably the weakest part of that. The interesting there is on advanced applications.

We had very strong orders in Q1 for a couple of the applications there. So that revenue will start to pick up. The communications outlook has a bit more of an improvement coming into Q2. But I'd say we were actually really pleased with the advanced application order flow in Q1. So it's really more of a timing issue there.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [62]

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In the one application, we made in [10th year] development of laser devices for (inaudible) Europe. Now they have started to ask, so they will now invest some practical applications. So volume and set few units start to grow by 10, by 100 (inaudible) in revenue. It would be a bigger loss. And we, many years, started them for this development. Now so in a way I expect both the (inaudible) both are for real, practical, for field use.

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Operator [63]

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Our next question comes from the line of Michael Feniger with Bank of America Merrill Lynch.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [64]

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Tim, just a point of clarity. The $380 million of quarterly sales against the midpoint of gross margin, does that include Genesis or exclude Genesis?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [65]

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No, including. So you're kind of getting back about $350 million with the laser business.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [66]

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Okay. Tim, can you help frame the puts and takes for us in terms of this gross margin trajectory? So I believe in the second half of last year, you had some significant headwinds. There's currency, the price reset, utilization rates were moving lower. Like, how should we think about moving into the second half?

Where are utilization rates kind of trending now? Can we see diode savings flow through the P&L more so in the second half? And maybe talk currency.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [67]

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So even with the first generation of the new type of diode, you saw some benefit in that last year. As I referenced, I think it's actually -- it's amazing that when you look at the model, only 200 basis points of the margin degradation really specifically relates to pricing. The cost of the bill of materials has come down already very significantly.

Balance in reference, there is the next generation of this higher-power diode coming onstream that started to be used in the first quarter. We started to use it, not exclusively, so that will continue to benefit the cost of product through the year. So that's still got to fully flow through. So that should help a little bit with gross margin.

The key thing outside of that is really to get back to an absorption -- a better absorption rates on fixed cost because that, as I mentioned, is 500 basis points of the difference relative to our year ago gross margins.

So recovering that puts you closer to the midpoint of the 50% to 55% range. It would actually put the laser revenue, if you exclude the acquisition, in the upper half of that range because the acquisition is a bit of a dilutive impact to that. So that would be very good.

Right now, exchange rates are still a bit of a headwind. We referenced that they took $15 million out of revenue for the first quarter. The Chinese yuan is still at a lower level than it was in Q1 and Q2 when it kind of peaked at CNY 6.3 and it's CNY 6.6, I haven't look in the last couple of days, but it's CNY 6.7.

The euro is weaker than it was a year ago. It's at $1.12 this morning. So it's off from $1.17 to $1.20 that it was in the first half of last year. So FX is still a bit of a headwind we're dealing with.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [68]

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Fair enough. And this is -- this question is not necessarily on Q2, but if credit improves, the trade tensions ease and the macro just stabilizes, do you see some signs of a replacement cycle for laser systems in the second half or 2020 that can kind of provide a support of revenue?

I know growth has been weak the last 3 quarters, but if we take a step back, you've grown revenue at a 25% CAGR over the last decade. Is there signs that the installed base is aging and we could see some replacement?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [69]

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I don't have enough data specifically to give you a definitive answer on that. Certainly, some of the higher-power devices are more than a decade old, so we're probably seeing some replacement cycle.

The real increase in high-powered volume though started 5 years ago. So there's still a couple of -- we've always had a couple of years off from a real ramp potentially in a replacement cycle for that. I mean 2014, '15 was when we started to see very significant growth in high-power lasers. So those lasers are not yet at the end of their life cycle.

Certainly some of the stuff in 2010 or '11. I mean our electrical efficiency back then was significantly below where it is now. Our form factor was a lot bigger. The quality of the device, even though it was very good, doesn't match what we have today. So there's some replacement probably going on, it's not a huge amount.

We would be looking for a continued displacements of nonlaser applications as the investment cycle picked up, right? As people look to invest in new equipment, they would consider a laser-based system now where historically they may have been looking at a nonlaser-based application.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [70]

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Yes. Before the people -- when they asked, for example, for very thick metal, (inaudible) the plasma cutting and the laser cutting, where the cutting was better but still not for thick metal.

Now we provide them with a [significant] metal cutting worth opportunity. And cost per meter is now (inaudible) much cheaper than plasma. So they start (inaudible) to request plasma also water cutting in many other. They replace now only -- also only start to replace e-beam and fusion (inaudible), e-beam welding, for example. Now we -- the way we process for laser cuttings and welding of this many metals, thick metals and also even titanium and so on.

It's got an often excellent fantastic new opportunities, it's all instead of e-beam, but people are going where it's going, but it's really where you [match] market would be near us 3, 5 years.

Revenue match market. If only IPG developed now a new generation this year, we introduced a new generation 10- to 20-kilowatt laser, 2x cheaper than before and much more compact, easy-to-use, very simple at all for operator.

Now, never before it was, even 1 year ago, we have much more bulky and much more expensive maintenance. Now we produce very nice quality, very compact, efficient, easy-to-use where you might -- where is that immediate where many people from plasma and [other status] each from laser.

But nobody able to provide the same at all. Nobody would be able, not even Chinese, never -- nor TRUMPF, no [criteria]. Nobody other who try to make fiber laser and high-power. Nobody of them able to make the same.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [71]

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Michael, the other point to take on that is that there is still tens of thousands of CO2 lasers that require replacing in the market. The installed base of CO2 laser is still at 60,000 or 70,000 lasers despite the penetration of fiber into the market. And as you see the global economy, if it does stabilize or even improve and credit cycles improve, that may be a source of demand that would be of benefit over the next 12 to 18 months.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [72]

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Got you. Tim, that's about -- yes. That makes sense. And just lastly, I mean, you mentioned like when someone asked before about consumer electronics, it's -- you mentioned it's usually a biannual cycle.

So 2018, last year, was a very difficult year and you even hinted this year and some of -- some peers this year is going to be challenged as well. So that's kind of 2 years of a down cycle there. So how far is your consumer electronics business kind of down from that 2017 level?

And then if you think of 2020, with some introductions of models, a potential recovery in smartphones, I'm just trying to gauge, do you think laser processing in that application could increase kind of cycle-over-cycle?

Do you see room for that to kind of improve if we do see 2020, that type of recovery that some people expect in that market?

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [73]

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With consumer electronics, you'd expect this year because of the biannual product cycle to be stronger. We're just not -- we just don't have any visibility into that demand. Yes, in each iteration of different smartphones, there is more and more laser processing done, whether it be some of the welding applications around the frame or different materials being used, there's increasing use of ultrafast pulsed lasers, not just sort of focused on the metal processing side of things. So...

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [74]

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UV and so on.

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Timothy P. V. Mammen, IPG Photonics Corporation - Senior VP & CFO [75]

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Yes, the UV. So yes, the applications have broadened, and that market does see a bit of a rebound with new product introductions. We would certainly hope to be at the vanguard of benefiting from that.

We just don't have any visibility into it, meaningful at the moment. And so I mentioned the stuff we've seen as orders coming through.

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Valentin P. Gapontsev, IPG Photonics Corporation - Founder, Chairman & CEO [76]

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Even medical lasers, now in some application medical is recognized worldwide -- recognized, for example, for (inaudible), for phone, removal and so on for [tissue]. It's now practical all the (inaudible) and doctors in the world, in America, Europe.

And now in China, we'll open also now the safe where we're seeing qualification for [LGA] qualification in some countries. And after 1, 2 years, it practical [it would be many years out] where it [implements] now both in scientific and many other, who before, dominated the market now all replaced with our thulium lasers. It's a new revolution.

Now our sale is grow already by hundred, but in the future, we'll be by many thousands because this lasers is much more costly than material processing where they bought 1 thulium [like 10] is the Chinese lasers cost. So it's still a very big business.

We expect -- and we now introduced many other applications, also medical ways of new generation of fiber, first time fiber instead of this really old laser they use up to now, but they vow not to use -- not practical at all.

And doctors now practical found what it's fiber, what is the real new innovation. And (inaudible) in medical application, where will it provide big companies right now making hundreds of millions of dollars in this market.

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Operator [77]

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That is all the time we have for questions. I'd like to hand the call back to management for closing comments.

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James F. Hillier, IPG Photonics Corporation - VP of IR [78]

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So 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 our next quarter's call. Have a great day, everyone.

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Operator [79]

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Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.