Good morning, and welcome to IPG Photonics' Fourth Quarter 2018 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.

Thank you, Michelle, 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, 2017 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, February 12, 2019. Company assumes no obligation to publicly release any updates or revisions to any such statements. For additional details on our reported results, please refer to the earnings press release and the 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.

Good morning, everyone. As expected, the fourth quarter was challenging. The macroeconomic climate weakened in our largest markets, reducing demand for our laser products. Despite these challenges, we were able to deliver results in line with the outlook we provided a quarter ago. More importantly, we have made meaningful strides in key new product areas, and undertaken strategic acquisitions that help us capitalize on the long-term growth opportunities for our laser solution. We believe our progress delivering on new growth opportunities: reinforce our industry leadership in fiber laser technology; strengthens our relationships with leading-edge customers; and enables the next-generation of product creation. In China, we saw further weakening in the demand environment in Q4. Higher tariffs have made minimal effect on our production costs, thanks to our diverse global manufacturing footprint and vertically integrated manufacturing. However, the U.S.-China trade war has heightened end customer fear and uncertainty. Continued investment spending on industrial land suggests that Chinese manufacturers likely remain committed to their long-term growth plans. In addition, the Chinese Government has enacted targeted stimulus to address the macro uncertainty and trade war fears of private enterprises. These factors suggest we could see demand begin to stabilize. Near-term, we have seen signs of stabilization in our European business. Unfortunately, the drop in Eurozone manufacturing PMI from more than 60 a year ago to slightly above 50 today, drove a decline in our European business during the second half of 2018. The Eurozone is also affected by softer China demand. There is less certainty among our European customers regarding a pickup in demand, but overall trends do not appear to have worsened. Regardless macroeconomic climate, we remain confident in the longer-term secular growth of fiber laser technology over other lasers and non-laser tools, as well as the continued shift toward higher power…

Thank you, Valentin, and good morning, everyone. Revenue in the fourth quarter declined 9% to $330 million. The acquisition of Genesis, which closed in early December, contributed $8.5 million revenue during the quarter. Foreign exchange headwinds during the quarter, relative to sales assumed in our Q4 guidance, reduced revenue by $2 million. Revenue from materials processing applications decreased 9% year-over-year and revenue from other applications increased 5%, driven by growth in communications, medical, and government applications. For the full, year materials processing revenue increased 3% as strength in the first half was offset by a slowdown in the second half of the year. By region, fourth quarter revenue in China represented approximately 36% of the total and decreased by 19% year-over-year. Strong sales growth into electric vehicle battery applications was more than offset by declines in cutting and micro welding for consumer electronics. Our cutting business remained affected by the current macroeconomic climate in China. During the first quarter, we expect to ship the remaining lasers related to the record Q3 order for battery processing applications. Beyond this order, we do not have near-term visibility into additional orders for this application, but continue to expect a strong contribution from electric vehicle applications this year and over the medium to longer-term. As for micro welding in consumer electronics, recent data points from the smartphone supply chain would now suggest we're unlikely to see this business rebound in 2019. In Europe, revenue decreased 12% year-over-year, primarily relating to softness in cutting, additive manufacturing and welding due to the weaker macroeconomic climate in the region. However, European sales increased 8% on a sequential basis, suggesting that we may have reached a bottom in the current downturn in this business. In North America, revenue increased 32% year-over-year and 14% year-over-year excluding Genesis, driven by…

Thank you. We will now be conducting a question and answer session. In the interest of time, we ask that you please limit yourself to one question and one follow-up and rejoin the queue for any additional. [Operator Instructions] Our first question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed with your question.

Hi. Thank you. Good morning. Just with respect to some of the conversations that you've alluded to with your OEMs in China, it sounds like on the consumer electronics side you're not anticipating much of a pickup and perhaps seeing continued strength in the EV segment of the business. But just more broadly, which areas are you seeing some increased optimism from some of these OEMs in China?

Hi, Jim.

Hi.

Clearly, the business in China is still very much significantly focused on cutting applications. So a rebound there really requires that business to come back. And what we've seen is solid order flow through the end of December. And I'm actually very pleased with what we've seen in January from that business. On the consumer electronics side, there are some applications. There's a newer application on welding some of the frames of the metal that we expect to be a driver, but it's probably not going to offset some of the weakness given the data points that you've seen on consumer electronics, for example in other areas. And then on the EV, we said that we expect the overall trends on the investment in EV to continue during the year. We're also starting to see some increasing interest toward some of the micro processing applications from picosecond and ultrafast lasers, with many customers getting further along with their evaluation processes. But clearly, the rebound in China, at this point in time, is dependent on the cutting business and that's where we've seen some strengthening in the demand trends. Our largest OEM, we had a meeting with them just these last few days. There were a couple of people in the U.S. and they're actually pleased that we're back to quite the level they were at, but they were pleased with the order flow that they saw in January for cutting systems.

Okay. And, Tim, just looking out at the balance of the year. It sounds like you're also seeing increased traction from some of the newer products. How important is that part of the business going to be to you showing the kind of growth in the second half of the year that maybe some of us are looking for?

I mean, from the perspective, you break it down by different product lines, you'd want to see that there's definitive revenue we can see coming from the entertainments and projection and display, the continued growth obviously the system side of the business and that would very important. The ultrafast is going to be important. We've got a good revenue forecast there. I'd say that you have balance this still with a relative size of those businesses compared to the core business, so we still need to see a rebound in the core business. And if we get that, the newer product introductions with that good margin structure will add a layer of icing on that cake, I'd say. Its still, in total demand, relatively early in penetrating some of those new applications, but certainly gaining some nice traction in them. I think we said on the call that in Q4, the newer products are now about 20% of total revenue, which was good compared to 15% for the full year in 2018. So relatively speaking, you started to see some -- even total contribution relative to total revenue in Q4 was good for those areas. And even outside of just the new products, some of the other applications like Advanced and government continued to perform well in Q4 and the telecom business was also quite strong into the end of the year.

Okay. Going further. In China, in quarter two or quarter three and quarter four our major OEM customers, they have a lot of inventory they will not ship to customers. But now, since January, especially the beginning of February, the inventory finished and we now found we're two, three weeks into a very fast-growing quantity of order. Start of the New Year, Chinese New Year, it was very much a stream of new orders from most OEM Chinese customers. After this New Year finished, this trend will go on, so we will again return to serious -- again, business in China.

Okay. Thank you, Valentin. That’s helpful.

Thank you. Our next question comes from the line of Michael Feniger with Bank of America Merrill Lynch. Please proceed with your question.

Hi, guys. Thanks for taking my questions. Just to be clear, are you assuming gross margins in the first quarter to be down 200 basis points year-over-year? Or do you say that's the Genesis impact to gross margins in the first quarter?

That’s primarily the Genesis impact to gross margin in the first quarter. At the top end of my range, I quote about 50% gross margin and at the bottom end about 48%. Genesis would be about 160% of -- so 160 basis points in total relative to our normal guidance range.

That's helpful. And then on the pricing pressure dynamic, I think you mentioned, it wasn't as bad in the fourth quarter versus the third quarter. So can you kind of elaborate on that? And is that how you're kind of assuming it should sequentially -- that pricing pressure should abate as we enter the start of the year?

Yes. So in terms of pressure on pricing in Q4 it had abated. The issue that we had was that we had to absorb the full quarter of pricing that you saw in Q3 into the business model and that had a bigger impact in Q4 than it had in Q3. Pricing remains relatively less pressurized at the moment, I'd say. And then, we also have a some benefits and there're a couple of things I'd like to call out. In Q4, even though we had a very strong success with the sale of the 12 to 15 kilowatt lasers, there were some also mix issues around gross margins. So we actually had, relatively speaking, on the low cost-cutting side, a smaller decrease in sales of our rack mounted lasers. And that's good to see, because that's where there's the most competition. So that shows that we have good execution around that. But even though the 12 to 15 kilowatts grew very well and even our core YLS 1 to 5 kilowatts, which are very profitable. At the higher end of the cutting market, we saw demand for those lasers more impacted. So there's some mix issues. You also saw the QCW revenue down in Q4 compared to Q3. So there's a lot of different things on gross margin going on, not just around the pricing, but also the mix. And my view on gross margin overall is that I'd like to get the core laser business back to like a $350 million run rate and then the systems business with Genesis on top of that. And I think at that point we'd be out of the woods, relatively speaking, and targeting being back in the upper half of our 50% to 55% range. The final thing I'd like to say on it is that, we've talked about some of the lower diode cost feeding through. And there's a package diode which is basically being used across the product line. But it's actually a new package diode design that is going to be introduced as well and the cost of that package actually is about 8% or 9% lower than even the existing package. And that's going to start to be used more fully during the second quarter this year. So we haven't stood still around any of these different areas. We continue to make improvements and drive cost down.

And Tim just...

I can explain one for you. Regarding our target for Genesis, take in mind, last year it's only one month and they include the result only during one month, or the result based on all the products which they made, their business model was without IPG. This year we've turned -- our target to turn the most products from Genesis. It would be new products which based on technology developed in IPG. And now we have a realization the real system would be made with the participation of Genesis. This product should be much more profitable than the old products which Genesis made, let's say, with using their own only technology. And our target on this new system product mix with margin is not a big difference for our margin of laser itself. But just recall, it would be a much more marginal product, our target. Second regarding QCW laser. When we're talking about QCW, what is this QCW laser, we developed three, four or five years ago in Brazil's market. For now, we introduced new QCW laser, much more efficient and much more competitive and more profitable than old lasers, which we sell before. As this new QCW laser have to replace some lasers -- older lasers and open new opportunity would be much more competitive than former lasers. So the same situation. And we have to return increase again sales of new QCW lasers, we hope would be very profitable growth for sales again.

Thank you.

Thank you. Our next question comes from the line of David Ryzhik with Susquehanna Financial Group. Please proceed with your question.

Hi. Thanks so much for taking the question. Just wanted to drill down on Q1 guidance, ex Genesis it appears that the guide is around down 11% Q-over-Q overall revenue. Given that you're pleased with some of the order flows thus far this quarter just wanted to know, is there some conservatism baked into the guide? Or what else is driving that Q-over-Q decline given that you're seeing some constructive order flow in January and early February? And I have a follow-up.

So I think two things on that. First of all, there's a lot of orders that are coming in for shipment in the second quarter. So the order flow improvement doesn't necessarily just flow through to the bottom line immediately. The second thing is that, January is always a very weak revenue month and it's very difficult to just make that up even if order flow strengthens and you have a great March relatively speaking. So I'd say, those are the two main things we've taken into consideration in determining guidance for Q1. I'd say overall, the 11%, 10% down for the laser business is right in line with where you'd see opening shippable backlog on a year-over-year basis as well.

Great. Thanks. And do you mind giving the growth rate in the six kilowatt and above fiber lasers I think I may have missed it on the call.

Haven't got that at hand. We'll give that to you after. We did put it in the script somewhere.

Okay. Sure. And…

The 12 and 15 was up more than 50% the six kilowatt and above – I've got that data point somewhere I'll give it to after.

Sure. And just wanted to drill down on QCW, to what extent is this – will this become relevant in the pricing pressure you're seeing in the 1 kilowatt to 4 kilowatt segment? Do you believe that the differentiation here will help you preserve or maybe regain some share that you've lost over the past year in that competitive environment in China?

Absolutely. I think the customer response actually – initially that QCW-CW feature there's a distinction. Valentin was talking about a pure new QCW design. There's also the ability to deliver the QCW feature with the CW. It is extremely compelling from both our internal application work and some of the feedback we're getting at early stages from customers both in terms of improving the quality of the piercing, reducing the time of the piercing, and even using the QCW feature to enhance the cutting of more complex parts. So when you're cutting just in a straight line you can deliver CW power on a constant basis. The ability to modulate the energy as you start to cut around curves and corners, with more complex parts actually enhances the quality of the cutting. And if you've got a 12 kilowatt laser you can actually modulate that laser piercing with very high energy. When – in the 1 to 6 kilowatt range having the QCW feature you've got 1 kilowatt laser to generate 2 kilowatts of power or 4 kilowatts to generate 8 kilowatts of power, gives you a significant change in the processing capabilities. So we think this is actually a very unique capability and really does enhance the laser's capability even at those lower-power levels.

Okay great. And then just last one from me, if I can. Do you mind just sizing the telecom opportunity? You've been a little bit more vocal. You've talked about Menara. You made an undersea cable acquisition. Just we'd love to hear what you're – what kind of revenue run rate are you targeting this business. And perhaps, can 5G even driver some upgrade – some business maybe over the next few years? Thanks so much.

Our target during the couple of years is increase our telecom revenue a million -- a couple hundred million dollars per year. And next year we hope to reach such numbers.

Okay.

Our next question comes from the line of Tom Diffely with D.A. Davidson. Please proceed with your question.

Yes, good morning. First a clarification on the gross margin question. So, the 200 basis point impact from the recent acquisition, is that -- can we view that as kind of a permanent impact? Or is that due to onetime items in the quarter?

No. I mean at the moment that's where the Genesis business model stands. As Valentin has described the overall target over time and it will take time is to really leverage their systems more onto the laser side and to reduce -- using our technologies and capabilities to reduce the cost of the laser relative to them. I think it's also very important to understand the value proposition that's being delivered because when you often get into these more advanced laser processing and even whether it be welding or cladding particularly welding of different and diverse materials, the total productivity gains and reduction in cost the laser system delivers would be captured more in the average selling price of these systems as well as reducing the cost of them. But in the near term, we can't change that business Tom in two or three months. It's going to take a little bit of time to do it. And I'd say right now and for the foreseeable future the impact overall on the business is about 150 to 200 basis points on gross margin.

And we're talking about system business, of course, system business to improve profitability and margin into our new partners, of course, it takes time. It's not possible to make during a few months only, half year, one year total. We're looking for essential improvement for systems business these -- like Genesis and so on, IoT next year. But take in mind up to now the gross margin, total IPG doesn't -- a very small impact from these guys because it shows more share of total business and so on. But maybe gross margin define our standard products it's taken months. Last year we decreased practically our major -- this cost power major components like laser diodes new generation of laser diodes, fiber modules and the many other parts components we decreased by -- decreased cost by 20% even 30%. So it's very essential decrease of cost on this part. As a result total gross margin, total company integrated gross margin will grow very essentially. It will compensate some growth. You can say that a price of a more-power laser for a mid-power laser in the quarter for introduction of some -- was perfectly up to now with the beginning systems. But in total we have very essential benefit now in gross margin. It compensates growth, which we have temporarily -- we hold temporarily with the new products.

Okay. No, that's helpful. And then as a follow-up, when you look at the benefits from the QCW-CW combination is that in lieu of beam shaping or in conjunction with beam shaping to increase the productivity when you have different types of cutting to do at the same time?

It can be used in conjunction with beam shaping. So for example, if you've got the unit core of the laser and you're running a certain amount of power through the inner core, not the outer ring you can actually incorporate the QCW function within that and that will be an intention to go forward on that direction. Actually our competitors sort of looked at our beam shaping and say, well only half of the energy goes through the core and half of the energy goes through the ring. The reality is, if you combine that with the QCW offset that alleged weakness of the solution. And the other thing is the beam shaping has also had some positive application results both on improved cut quality as well as -- not just on cutting, but on welding application. So in some of the -- there's a reduction in splatter around some of the welding applications. The other benefit of our solution on that beam shaping side, we believe quite strongly in this is that we're not stressing the fiber. And we believe the competitive solutions are stressing mechanically the fiber. And interestingly, we've also heard from one of the companies that produces optical heads that there is energy leaking into the cladding of the fiber that has actually necessitated a redesign of -- a costly redesign of the optical head. So I think really people needs to start parsing out these differences in technology a bit more specifically and with greater understanding of the benefits and disadvantages of different approaches.

Okay. That’s helpful. Appreciate it.

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

Thank you very much. Maybe as a follow-up to some of the questions already on China. Based on the order pickup activity that you've seen and the conversations with your customers, do you believe your customers have a view of an improving macro environment in the region? Or do they believe that a stimulus package is on the way that's giving them confidence to kind of pick up the order flow once again?

I think, there's two or three things. I think Valentin said, some of the slightly higher levels of inventory have been worked through. The general feedback we're getting is that the demand is there and people would still just want some resolution of some of the uncertainty around trade war. They're starting to see that maybe move forward a little bit at least in some of the discussions from the U.S. government and their desire to get that result. And the third thing I think there is some benefit coming from the stimulus that is being put into the market which has been both on the infrastructure. Some of it is a bit more fiscal right, so tax rebates which we haven't really seen before reduction in VAT is another one. Yes, if you looked at the straight economic data, it would perhaps belie what we're seeing. But we kind of saw this downturn sooner than everybody else. And hopefully we are going to have a bit more conviction of seeing by the time we get to the end of this quarter a recovery sooner than other people. So two or three things Patrick I think that we've heard.

Great. That's really helpful. And maybe as a follow-up question on the gross margin profile and the impact of Genesis. It sounds like longer term you still are committed to that the 50% to 55% range you've talked about in the past. As we look at 2019 as a whole obviously a pickup in revenues will help gross margins from that level. But will product mix and the mix shift as the year progresses to some of your new products and maybe high-powered lasers how big of an influence, do you think that'll be to the overall gross margin profile as 2019 progresses?

I think it'll be a nice benefit. So I think I have mentioned the total pickup in revenue just on the laser business, if you can get back sort of the $340 million, $350 million, $360 million range you start to see us leveraging the business model much more – much better and more efficiently than we're able to at these levels. Secondly, a pickup in revenue around the core business at that level would be – would require the higher-margin product to recover strongly as well. So that drives some of that benefit. We believe that the new features, we're introducing with the QCW, CW and the beam mode will also enable a little bit of premium pricing. It's not necessarily going to be massive, but it also is competitively better. And then you've got the newer product, the ultrafast lasers have very high margins on them. Some of the projection and display products has high margin. And as you mentioned medical, but we've got good order from some of the lithotripsy applications that's already in hand that we'll start shipping in April. So clearly, yes some of the new laser products would help us. And we've always said this that, we're going to see competition at certain ends of the market, but we always try and run ahead of the game by taking costs down and introducing new leading-edge product, with clearly having to deal with many different dynamics in the business at the moment. But right now, I actually think we'll get back into the upper half of that range, if we can get the core laser business back to $350 million. Obviously, at that revenue level, I think this comes back to Tom's question the share of for example Genesis even in this year would be lower as a percentage of total revenue than it is at the core laser business being at $300 million. So the impact of Genesis would be less – or the impact of the systems business would be less.

And that also -- our business model for system is not in that model. We don't go in to compete with standard application when existed its competition for the metal cutting, strip cutting. It's not our business at all. We – the way we're powered – principally business model we're talking do with absolutely new process at all or new application when nobody still using laser application. We compete not – with not on laser solution and sees a lot of opportunities. And for example, one of this as such for the large pipe gas terrain partition or oil gas partition of pipes to weld with some laser. Up to now nobody making this one, we're first to develop this new technology tools. This technology replace current technology which other people use. It's very expensive and extremely expensive and very complicated technology. For example, for a large gas pipes one only field machine system costs more than $50 million -- $50 million. We developed much better, much more efficient technologies, which is higher -- much higher quality of welded -- with such type we saw. We developed improved in the field. And for us this -- we can sell this technology with very high profit even five times cheaper than this now existing -- only system in that market. Our technology is 10 times cheaper. So we can dictate anywhere with now very high profit. We don't see in a year or two years somebody who can compete with this unique technology at all. To make something similar it takes many years. That's for example. The same example with titanium welding. Nowadays people now use -- to aerospace and NASA they use this technology e-beam welding and vacuum cameras drone or some such cameras for large pipes and so it…

Thank you.

It's absolutely a different business model. Operator: Thank you. Our final question comes from the line of Andrew DeGasperi with Berenberg. Please proceed with your question.

Yes, thanks for taking my question. I guess first, maybe, can you just give us a breakdown of your end markets, where are you seeing pockets of strength, where are you seeing less weakness than you originally did in the last quarter? And then maybe could you discuss the auto industry generally. I know you had a little bit of exposure to that. Could you maybe give us a little more rundown as far as, how's that doing in China and Europe?

So, in general, I think first starting with relatively speaking where the tone is a bit better compared to the beginning of Q4, we've mentioned already the order flow pickup we've seen in China and the different end markets there that are benefiting. I had mentioned that Europe was, even during Q4, was seemed to be reaching at least some point of stability and European orders in -- revenue in Q4 was actually up about 8%. So we're seeing a stabilization. And relatively compared to what it could have been good demand from the OEMs in Europe as opposed in Northern Europe and actually in Italy. North America continues to be performing quite well, good growth in Q4, good reasonable order flow. Q1 is always a little bit slower in North America but reasonable good backlog and our guidance number for Q1 is fairly good for North America. I was pleased with the overall Japanese performance, when you look so some of the Japanese machine tools. Asia and that's been very weak but we grew Japan 4% in Q4 compared to the year ago. Korea was also reasonably good. They've also come into the year with reasonable backlog. But really, I mean, it's a smaller part of the business. But Turkey given the geopolitical dynamics and macroeconomic impacts in Turkey continues to be weak relative to where it was a year ago and a little bit more uncertain. But we're starting to see some order flow even from the OEMs there. It's not going to necessarily turn around dramatically but that would be an area I'd call out for concern. Some of the emerging markets I think have stabilized a bit and that will help the Europeans, right? So you've seen some stabilization in the economic macro environment in South America, Brazil. India for us is a small business at the moment, but we've got a new management team in there and they grew that business very nicely last year and have given us a strong budget for this year. So the emerging markets would be an area where the dynamics I think have improved. We don't necessarily see that directly, but the OEMs see that. Although, if the U.S. dollar continues to strengthen -- I was listening to Bloomberg Radio this morning where that was called out, the continued strength of the U.S. dollar that can be in the future a headwind to emerging markets so we're watching all of that as well.

And sorry just a clarification on the order flow, you mentioned that mostly would show up in the 2Q quarter, or was that potentially -- is it second half related?

No. We've got a lot of backlog for Q2 already. And generally, our terms are within a three to four-month time horizon. So that's why we would need the order flow to continue in February and March because that would drive the shipments in the end of Q2. The orders we've taken in January and February would help to start Q2 stronger than Q1.

Got it. Thank you.

Thank you. At this time, I will turn the call back over to management for any closing remarks.

Okay. Thank you for joining us this morning. We look forward to, again, speaking with you in next quarter's call. Have a great day. Thanks for your time.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.