James F. Hillier - IPG Photonics Corp. Valentin P. Gapontsev, Ph.D. - IPG Photonics Corp. Timothy P. V. Mammen - IPG Photonics Corp..

Joe H. Wittine - Longbow Research LLC Michael Feniger - Merrill Lynch, Pierce, Fenner & Smith, Inc. James Ricchiuti - Needham & Co. LLC Thomas Robert Diffely - D. A. Davidson & Co. Patrick J. Ho - Stifel, Nicolaus & Co., Inc..

Good morning and welcome to IPG Photonics Third 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, Rob, 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, October 30, 2018. 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 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. Q3 was a challenging quarter as macroeconomic and geopolitical factors reduced demand for our laser products. Despite these challenges, IPG made important progress driving higher power solutions into the market and generating meaningful traction selling our newest product and solutions.

We believe our progress in high power and new products will help us emerge from the current downturn in a stronger competitive position with greater opportunities to address the growing market for laser solutions.

As noted in our preliminary earnings release, we believe tariffs and trade-related headwinds were the primary driver of weaker than expected performance for our business in China and Europe, where China is the main market for perfect European metal processing machines.

Indication from our customers suggest that the purchases of laser system in these regions are being pushed out. We believe uncertainty resulting from the ongoing US-China trade conflict is reducing overall demand for industrial capital equipment purchases, predominantly in China.

In addition, we believe the softening macroeconomic climate in China and Europe, as indicated by lower manufacturing PMI and reduced levels of infrastructure investment, is affecting near-term demand for laser systems. However, we remain confident in the longer term secular growth of fiber laser technology over other lasers and non-laser tools.

During prior business downturns, we have seen customers begin to increase investment in transformational automation and miniaturization technologies that include our laser solutions in order to improve productivity and launch new products.

We continue to expect our solutions to gain share from traditional tools and process technologies due to the superior productivity, flexibility, precision and power of fiber laser systems. We remain the clear market leader in fiber laser technology. That said, competition in continuous wave laser products at less than 4 kilowatts has increased.

Some competitors have also announced continuous wave lasers with power output of up to 10 kilowatts. China remains our largest and most competitive market, unfortunately. As we have previously indicated, we are seeing very aggressive pricing for select products by our competitors in China.

However, we believe our advanced technology, scale and cost advantage over the competition are enabling us to win in the market despite these pricing actions. As our response to the new market situation, during the third quarter we introduced new ultra-compact 1 to 3 kilowatt lasers and other products designed specifically for the market in China.

With the benefit of additional production capacity and these new solutions, we were able to sell several hundred more high-power lasers to OEMs in China that were either exclusively or predominantly buying lasers from our competition.

We have won new business in part because some of these customers have expressed fast-growing concern and frustration with the performance and reliability of competitor products. The revenue impact from these gains has been limited by macroeconomic and geopolitical headwinds, but these early efforts are yielding positive result.

As a reminder, we believe there is no company that can deliver high-power laser solution at our quality, scale, cost and lead time. We continue to drive market acceptance of our ultra-high power fiber laser technology at 6 kilowatts and above, which is now approaching 50% of our high-power laser sales.

We continue to see our largest OEM customers migrating to higher power fiber laser cutting solutions, and Q3 was a record quarter for sales of our unique 12 and 15 kilowatt lasers.

We also introduced the new perfect world's smallest 20 kilowatt cutting laser, further demonstrating IPG's industry leadership in producing the highest power solutions in the marketplace. These ultra-high power lasers are experiencing rapid adoption as they enable faster cutting speeds and improved end-user productivity.

Our new generation super high-power fiber laser is releasing three new technology innovation that will be featured at the upcoming FABTECH trade show in Atlanta.

First, we are introducing new QCV mode (sic) [QCW mode] for our YLS and YLR CW lasers that provides peak power up to 2 times average power, allowing increases in piercing speed, quality and improved piercing of thick material metals.

We reduced heat input in the QCV mode (sic) [QCW mode] result in higher quality cut of intricate parts and cleaner, more controlled drilling of thicker materials. This unique capability is enabled by IPG's QCV diode (sic) [QCW diode] designs – new QCV diode (sic) [QCW diode] designs that provide very high peak power for short duty cycles.

Second, we are launching adjustable beam mode capability on our flagship of YLS lasers, which allows programmable adjustment of output beam mode and enables our customer to process a wider range of material thicknesses and improve piercing and cutting quality, as well as optimize welding performance in certain material combinations.

Third, we are introducing an integrated high-power scan head with our recently acquired weld monitoring technology to meet the ever increasing quality monitoring requirement for industries such as automotive, medical, and other.

These three new innovation examples of how IPG is committed to decreasing our customers' cost of ownership and increasing their overall productivity. We also made solid progress in our newest product areas, which is out of metal processing, and will be in future well-dependable from situation Far East, especially in China.

For example, sales of record high-power – super high-power green pulsed lasers used as an ablation tool for improving solar cell efficiency increased near 70% versus the year-ago period.

We achieved a record quarter for our new ultraviolet laser solutions, which are expanding our addressable market for marking and engraving of non-metal and for material ablation.

Our unique new family of picosecond and femtosecond ultrafast pulsed lasers increased sales meaningfully off a small base and are seeing good customer acceptance for micro processing applications.

Sales of systems and beam delivery products increased more than 20% year-over-year, evidence we are becoming a more complete solutions provider within the automotive, aerospace, railway, pipeline, entertainment and medical device industries – and telecom industries.

Collectively, sales of these new products increased approximately 10% year-over-year and now represent more than 10% of total revenue.

We expect during next year that these new applications out of metal processing will reach our target to reach 50% of our total revenue, then it would be more diversified situation, much less dependable from the cycling in one application area.

We remain optimistic about IPG's growth prospects over the medium and longer term given our technology and cost advantages combined with the significant market opportunity for lasers to take share from traditional metal processing technology.

We believe growth in our core industrial market is enabled by the superior performance, productivity, reliability, and cost of ownership of our products over competing solutions.

We expect to augment this growth with advances in new product areas that meaningfully expand our addressable markets in the micro materials processing, medical, silicon, defense, scientific, projection and display industries.

This includes providing more complete system and solution to end users in the aerospace, oil and gas, electric vehicle, railway, and medical device industries and we drive penetration of advanced laser processing.

Despite the challenging macroeconomic and geopolitical backdrop, I remain confident in IPG's multiple growth drivers for the long term, and we deliver on our mission to make our fiber laser technology the tool of choice in mass production. With that, I'll turn the call over to Tim..

Thank you, Valentin, and good morning, everyone. Revenue in the third quarter declined 9% to $356 million. Foreign exchange headwinds during the quarter relative to sales assumed in our Q3 guidance reduced revenue by $5 million. Without this impact, revenue would have been slightly above the low end of our guidance range.

Revenue from materials processing applications decreased 11% year-over-year and revenue from other applications increased 22%. By region, third quarter revenue in China decreased 9% year-over-year and represented approximately 45% of the total.

Modest year-over-year growth in sales of high-power CW lasers for cutting applications was more than offset by declining sales of lasers into welding applications. In macro welding, saw reduced demand from traditional automotive and electric vehicle battery welding applications on a year-over-year basis.

However, during the third quarter, we received the largest order for battery processing applications in the company's history. As such, we believe this business should begin to strengthen in Q4. In micro welding, we continue to see reduced demand related to the consumer electronics investment cycle.

Past investment cycles for consumer electronics have materialized every other year, which would suggest that we should see better performance in 2019. In Europe, revenue decreased 25% year-over-year, primarily due to softness in cutting, additive manufacturing and welding.

As Valentin noted, we believe a weaker macroeconomic climate in the region is the primary driver of reduced demand for lasers serving the cutting market. In addition, we faced a challenging comparison versus the year-ago period when we achieved record sales within cutting applications and record shipments of ultra-high power lasers.

As we noted last quarter, we continue to expect lower sales into European additive manufacturing due to excess inventory at one of our larger customers. In North America, revenue increased 29% year-over-year, driven by strength in cutting, welding and government applications.

Sales in Japan increased 4% year-over-year with a continued rebound in cutting, offset by declines in welding and marking and engraving. Sales in Korea were consistent with the prior year, and revenue in Turkey decreased 29% year-over-year, which is not surprising given the recent economic turmoil in that country.

Turning to performance by product, high-power laser sales decreased 7% year-over-year to $227 million in the quarter and represented more than 64% of total revenue. Reduced sales of lasers for welding, cutting and additive manufacturing were partially offset by strength in sales to government applications.

Sales of fiber lasers at 6 kilowatts and above increased more than 10% year-over-year and now account for nearly 50% of all high-power laser sales, driven by strong adoption in cutting applications. Sales of other high-power lasers declined year-over-year due to the weaker demand environment in China and Europe that Valentin cited.

We are seeing aggressive pricing for select products by our competitors in China, most notably 1 to 3 kilowatt lasers serving the cutting market. Pricing pressures in this business are being exacerbated by softening demand trends.

However, with the benefit of additional production capacity and new ultra compact high-power laser solutions, we are more aggressively targeting OEM accounts in China that were either exclusively or predominately buying lasers from competition.

Early progress in these efforts has helped to offset some of the pricing and demand-driven pressure in our high-power cutting business and contributed more than $10 million in additional revenue during the quarter.

Pulsed lasers sales decreased 11% year-over-year, with rapid growth in green, ultraviolet and ultrafast pulsed lasers, offset by reduced sales of other pulsed products. Medium power laser sales decreased 48% on softness in additive manufacturing and cutting.

QCW sales of $18 million declined 23% year-over-year due to the expected reduction in demand related to the consumer electronics investment cycle, partially offset by strong growth in higher power QCW sales into welding and aerospace drilling applications.

Other product sales increased 10% year-over-year due to strong sales growth in systems and beam delivery accessories. Gross margin of 54.8% declined 242 basis points from Q3 2017 and was at the high end of our guidance range of 50% to 55%.

The decline in gross margin was largely attributable to the lower revenue in the third quarter of 2018 versus the year ago period, and as a result, less favorable absorption of manufacturing costs. However, we were able to partially offset this impact with continued cost reductions and favorable product mix.

Third quarter operating income was $124 million, or 34.8% of sales, down 605 basis points from Q3 2017. Excluding a foreign exchange loss of $2 million, operating margin was 35.2%.

Operating expenses as a percentage of sales increased 410 basis points year-over-year as we continue to make necessary investments in sales, engineering and administrative talent, as well as in IT systems. On a sequential basis, operating expenses increased 250 basis points as a percentage of sales.

Net income was $101 million and earnings per diluted share were $1.84. Foreign exchange losses reduced EPS by $0.03. If exchange rates relative to the U.S. dollar had been the same as one year ago, we would have expected revenue to be $8 million higher and gross profit to be $4 million higher.

The effective tax rate in the quarter was 21%, which included certain discrete tax items that benefited EPS by approximately $0.14. Included in these items, we now expect a net benefit from Global Intangible Low Taxed Income and net of Foreign Derived Intangible Income deductions in the U.S.

tax act due to clarification from the IRS on how these taxes should be calculated. Excluding discrete items, the effective tax rate was 27.5%. We ended the quarter with cash, cash equivalents, and short-term investments of $1.12 billion and total debt of $46 million. During the quarter, we repatriated $116 million in cash from Europe into the U.S.

Having now repatriated $522 million from Europe, U.S. cash and investments now represent 78% of the total. Cash provided by operations was $72 million during the quarter and was $280 million on a year-to-date basis. Capital expenditures were $37 million during the quarter and were $133 million on a year-to-date basis, up 34% year-over-year.

We continue to invest in new facilities and equipment to meet demand for our products over the next several years. In Q3, we repurchased 371,000 shares for $61 million, representing nearly half of the new $125 million repurchase authorization we announced in August.

Turning to guidance, global macroeconomic and geopolitical headwinds have persisted into the fourth quarter, affecting our business along with others in the sector. As a result, order flow has continued to soften.

We are seeing aggressive pricing for select products, as previously mentioned by our competitors, particularly in China, and we expect currency headwinds to be greater in the fourth quarter than in the third quarter.

However, we have made strides competitively selling several hundred more high-power lasers during the third quarter to manufacturers of laser cutting systems in China that were exclusively or predominantly buying lasers from our competition. We are encouraged by this progress and the strength in new products and the performance in some other regions.

Based on these factors, for the fourth quarter 2018, we expect revenue of $300 million to $330 million. We expect our third quarter tax rate to be approximately 26%, excluding effects relating to equity grants. We anticipate delivering earnings per diluted share in the range of $1.30 to $1.50.

Based on this guidance, we now expect full-year revenue growth for 2018 will be in the range of 1% to 4%, down from our prior outlook of 7% to 9%. We believe there are some encouraging signs for 2019. Indications from several customers in China suggest that order flow may improve in the first quarter.

We expect spending on consumer electronics, electric vehicle battery and other metal welding projects to increase in 2019 over 2018.

In addition, we believe our early traction in new product areas will drive increasing contributions next year from micro materials processing applications, telecom, entertainment and display products, and our systems business.

However, our visibility of a trough in the current downcycle is limited by the uncertainty surrounding the global macroeconomic trade and geopolitical environment.

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

Our guidance is based upon current market conditions and expectations, assumes exchange rates referenced in our earnings press release, and is subject to risks outlined in the company's reports with the SEC. With that, Valentin and I will be happy to take your questions..

Thank you. Thank you. The first question comes from the line of Joe Wittine with Longbow Research. Please go ahead with your questions..

Hi. Thank you. So, we've seen a slowdown here and competition is creating a little bit more pressure than in the past. Yet, the gross margin is holding up, I believe, better than most would have expected.

So, can you discuss maybe a little bit further how you're defending the GM, including precisely where you are in realizing those cost savings from the diode efficiencies? I want to say that full benefit is beginning in the fourth quarter but won't be fully realized until the first? Thanks..

So, Joe, as you alluded to, we continue to focus on taking cost out of the entire bill of material. Diode is obviously an area we focused on. We are now producing a significant quantity in the U.S. exclusively of the new diode types and packages with the new chip design.

So, you are – as you come into Q4 seeing a significant proportion of cost of sales running with those diodes. There's still some of the older packages being produced in Russia, but it's a pretty low quantity of that.

The other things that we focused on in the third quarter, which has certainly helped gross margin is that total manufacturing expenses are also down substantially compared to the second quarter. Absorption, unfortunately, is also down, and it's down significantly enough that it hasn't fully offset the unabsorbed manufacturing expenses.

But I was actually very pleased to see the total reduction in manufacturing expenses and albeit a lower absorption rates on the lower revenue level which would be expected. So, that puts a focus on the bill of material as well as actually a focus on manufacturing expenses. For example, overtime is being drastically reduced.

Headcount increases are very much limited at the moment. And then the throughput of expenses on some of the processes is also down as total throughputs on manufacturing processes like the chip manufacturing are also reduced. So, at a high level, I think that's a good summary of the way we're managing through this at the moment..

Okay. Great.

And then on China, can you discuss any further those potential green shoots that certain Chinese customers that you referenced? How much confidence do you have? Is the tone actually improving or are you skeptical at all if that could merely be kind of typical out quarter or next year optimism? How can we handicap the likelihood of that uptick materializing? Thanks..

So, the tone right now is certainly not improving, but the general feeling is that there is likely to be a pick-up in demand just because of the way the CapEx cycle functions.

I think some of the Chinese companies are looking for greater stimulus to the private sector from the government, which will give the private sector more confidence in their ability to make CapEx decisions. From what we're hearing, a lot of the government support so far has been more to the public sector.

The private sector is optimistic that some of that support and confidence may come in the near term and would give them some sense that they'd see some improvement into the first half of next year. But it really is more just a reflection of their sentiments and thinking rather than anything definitive at this point in time..

That's great. And finally, for me....

According to our situation and our Chinese competitors in many case price is cheaper than material cost. And so who can say the difference how they reports on profit, we don't understand at all. Or cover their expenses..

Thank you. Just a clarification point then I'll step aside. Dr. Gapontsev, your prepared remarks mentioned competitive commentary of up to 10-kilowatt competition. Was that referring to China-based competition or was that from the U.S. peer? Thank you..

We don't believe – they claim they have this in (00:33:12) two years ago. It was (00:33:15) Chinese. They have 10 kilowatt. But up to now, we don't believe any (00:33:18) product can provide any (00:33:23) on. And even the low power (00:33:28).

For example, our new products now – even old products which we shipped 5, 10 years ago, demonstrates statistics only one fifth of the lasers that need service for one year. The (00:33:48) don't need service more than one year. But for a new product, for one, two three years.

Only a few percent of lasers need during the year operation service, only a few percent. So, (00:34:01) average lifetime without service up to three, five years. So, regarding this Chinese laser, it's only a few months without service, a typical situation.

We check ourselves their lasers and customer also return customer opinion, Chinese customer in China have many such information, also very concerned about their ability on low power. What about high power (00:34:31) is not possible. But (00:34:34) achievable functionality. Also, there's very limited source.

It – whether it's more than 5 kilowatt breakeven, 4, 5 kilowatt, they're not practical in our opinion..

You get what you pay for..

So, this competition, can they improve during next few years, also very small. They are not able to reach quality of power, not able during the next some years..

Thank you..

The next question is from the line of Michael Feniger with Bank of America. Please proceed with your question..

Hey, guys. Yeah. Thanks for taking my questions. Just the first one, you mentioned, obviously, the biggest weakness. It seems like it's still tariff and trade related. You also cited consumer electronics. I'm just curious what you're seeing on the auto side.

We're starting to see auto sales disappoint in North America, but in China, CapEx for auto seems to be a little bit more stickier than just sales from month to month. I'm just curious if you're seeing CapEx plans on the auto side for your auto customers shifting at all and getting pushed out, and what the dialogues there into 2019..

So, Mike, we've previously said that the automotive in Europe has been weaker this year than it was in 2017 and the same can be said of Japan. Both the traditional and the EV, auto in China as well was weaker, but we're pleased that we've got a significant order.

We've said that's the – it's the largest order for both welding and foil cutting applications for EV in China. So, it's good to see that start to pick up. The North American automotive sales have been reasonable this year and have grown. There continued to be several projects that we're working on.

So, it's – yeah, the automotive cycle is not – certainly has not got a tailwind behind it and it has had a headwind particularly from the traditional side in numerous different geographies. There are several projects that we're working on, some of them in Europe. We'd expect to see some order flow and revenue coming out of them.

But they're not fundamental game changers. They tend to represent changes in the way that the technology is being used by the automotive companies..

That's helpful. And I know you just got asked about the gross margin. I mean this is the first quarter where you're kind of back inside that guidance range, which was expected.

If we don't see that resolution on trade and we continue to see this type of environment, particularly on the price, is IPG – are you guys comfortable maybe going even to that low end of the range to make sure you protect that market share and even win new customers to push back on those more aggressive peers? Thank you..

So, in the short-term, we would be prepared to defend market share with our superior technology and reliability in high-power lasers. And if you've got a lower level of revenue, that may come with a lower gross margin.

If you defend that share and then you get into the recovery or a recovery period with increasing contribution not just from recovery in the metal processing market but also from growth in the new products that we're introducing to the market, we'd expect to then see our gross margin pick up from that.

But yes, we are prepared to defend – we think it's very important to defend market share in the near term. And doing so may lead to some lower gross margin, particularly at the lower end of the 1 to 3 kilowatt range of lasers. It's important to note though as well we continue to take cost out of those devices.

So, we've made significant progress on that which has enabled us to continue to report what we think is stellar gross margins even as pricing has been aggressive in Q3 and Q4..

Tim mentioned that we'll introduce now a new diode, a new fiber module into already much more integrated electronics, a new generation high-power laser from 1 kilowatt up to 50 kilowatt and so on.

And will – next year, will contain these new components, and cost of these components, cost per 1 kilowatt or 1 horsepower, 25%, 30% (00:39:36) components we use now. So, we expect (00:39:39) have very serious impact improvement of fast growth of gross margin. But the production of them, the new generation, very efficient and more powerful diodes.

We started only this October, so impact of this (00:39:58) margin we expect next year..

Perfect. Thanks, guys..

The next question is from the line of Jim Ricchiuti with Needham & Company. Please proceed with your question..

Hi. Good morning. Tim, you alluded to a large win in the EV market. You also talked about winning some share back from competition in China.

Is that all related or is that EV win that you discussed in addition to the share gains that you think you've managed to capture in China?.

No. That's completely discrete relationships and EV battery orders are separate from the wins that we've had on the cutting, the sort of Tier 2 and Tier 3 cutting customers..

Got it.

And can you talk a little bit about how you saw push-outs in both Europe and China as you progress through the quarter? Was this broadly based or was it concentrated among a handful of customers?.

On a year-over-year basis, if you looked at the performance within China, you'd actually see some OEMs growing, who, for example, made significant gains. There are leaders at the higher power level who performed strongly. In other parts of the customer base, you'd see their sales are down year-over-year.

I'd say that coming into the end of the quarter and into the beginning of Q4, that tone has softened across the board for the cutting applications. Offsetting that a little bit is the win on the battery welding side.

In Europe, on a year-over-year basis, basically because of weakness on cutting, welding and additive for the reasons we've articulated, there's a significant decline in revenue. I'd say the European order flow is basically much more stable and our expectations for Q4 are in Europe more stable than they are in China.

And then, we're expecting, for example, outside of those two areas, some growth sequentially in Japan and solid performance in the U.S., which would probably show year-over-year growth but sequentially a stable situation.

So, the way I'd characterize it, outside of China, we're seeing, I think, some better sense of stability, whereas China continues to be soft and has softened a bit since the end of Q3..

So your overall book-to-bill was below 1.

It was weakest in China, closer to 1 in Europe, and was it around 1 in the U.S.?.

Jim, we don't get into giving book-to-bill by specific region. I think that my tonal comments about that by geography are the ones that you should reference..

Okay. Thanks a lot..

Thank you..

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

Yes. Good morning. One more question on the Chinese market.

So, the slowdown there that you're seeing, is it just nervousness or are they actually having an issue with access to capital or can you tell?.

So, I think one of the issues, Tom, is that the Chinese government had been through a period of tightening during the first half of the year. That then has got compounded by the definite uncertainty related to investment decisions that has come out of the increasingly aggressive stance on the trade war.

And now you're actually in a period where, I'd say, it's more the macro than the credit access that's the – and the uncertainty around the macro that's impacting things. At the same time, I think you're starting to see the Chinese loosen credit policy. And let's see where they go with that.

I think they have to also do some stuff on the infrastructure side to give the private sector some comfort about the decision-making process on future investments, but I'd say that the tightening process got overshadowed with the very increased uncertainty around the CapEx investment cycle driven by the trade war.

I don't think that's the primary driver of the weakness we're seeing at the moment..

Okay. That makes sense. And then if you look at China in general – go ahead..

I'd like to say even without this trade war, the policy of Chinese government to help anyway to the Chinese companies to get in to the fiber laser market. They include in the list of the strategic technology fiber laser 10 years ago. 10 years Chinese customer try to make copies of these products and tools and to install some production.

And Chinese government up to now helped their own manufacturer anyway to win this market. It is strategic (00:45:45), you could not stop the changing situation. Now they start to make even (00:45:48) product that have huge help by any means from Chinese government state-owned companies and so on.

It's the same happened in the electronics many years ago. Then all the budget electronics they won, now it's all moved to China. All the high-end electronics still remain in Western countries, but these most electronics now it's in China. They (00:46:20). The same situation now attempt to get the fiber laser technology strategic to China.

To control this, we see it here with such strength that they will go with (00:46:33). We still have very good (00:46:34), much high quality. It's a huge gap between poor quality with these guys, but it's a situation, nobody can change this. That's why trade war, no trade war, but we have to fight for this technology..

Yeah. That makes a lot of sense.

So, when you look at the Chinese market down 9% year-over-year, is there any way to quantify how much of that is pricing driven versus unit driven?.

Not definitively. We just don't give that information. So, 80% of it overall was really unit – I'm trying to come up with a reasonable number. I'd say 80% of it was driven by unit volume decreases and then the remaining 20% was being compounded by some pricing declines, particularly at the lower level.

If you look at the high level, you'd also see some pricing declines, but that's actually on the back of very significant volume increases in some of the ultra-high power lasers..

Okay. That's very helpful. Thanks for your time..

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

Thank you very much. Tim, maybe just you could provide a little more color about the comments you made about the tone for the early parts of 2019 that appear to be obviously better relative to what you're seeing today.

Is it coming from a specific market application within China or is it as broad based, where the weakness appears to be much more broad based? Is the potential recovery broad based or is it more in one application?.

I would say some of the comments we've had from companies in the cutting market, conversely some of the other cutting customers are bit more circumspect.

So, one of the comments we've had is that they're looking for a bit more guidance from the government for the private sector and I think that would require some supports around infrastructure spending, a continued loosening on the credit cycles. The broader based aspect of it though is reflected in the orders that we've had for the battery welding.

So, if that investment cycle now continues, you'd expect to see that perform better in 2019 than it has in 2018. And for the consumer electronics cycle, we don't have visibility into anything definitive at the moment. But in general, that is a biannual investment cycle.

So, that's the basis upon which we're reflecting some of the comments from the customers but also how our business cycle has also functioned historically..

Fair enough.

And as my follow-up question, just to go to the gross margin performance, which has been pretty strong given the lower revenues and the pricing pressure you're seeing, how is the product mix shift as you detailed the 6 kilowatts and above are now approximately 50% of your high-powered laser business? How much is that shift helping the overall gross margins stay at relatively elevated levels despite the weaker absorption that you're seeing?.

No, it certainly helps. That's one of the benefits on product mix, so that then some of the higher powered QCW lasers that we sold during the quarter.

I think the QCW lasers actually performed very well given that this was an off cycle from the consumer electronics investment and most of those QCW lasers or a significant numbers of them will have been at the higher power levels.

The continued strength and performance of those higher powered pulsed lasers and also the newer pulsed laser product offerings including the green, the UV, and the ultra-fast would also – if those shifts on product mix can continue, they would also help to sustain the gross margin profile.

So, yeah, product mix is certainly helping us and it's always been part of our strategy to shift the customer base towards these higher performing – higher performance lasers that enable improvements in productivity and drive efficiency..

Great. Thank you very much..

Also say on gross margin in order to (00:51:49) only one way, to generate (00:51:54) once product for new application also to develop and implement. It's only one way. Our policy to run faster than any competition, we're able to make these (00:52:09) new product when we implement, market provides much higher gross margin and so on.

With time, with volume, of course margin going down, it's typical with business law so nobody can change this. And our target, we introduced now for development, we have already now more than 10 new families of product. Next year would be the year when we will do a mass introduction of this product.

Each of this product will cost 10 times more than current product, which now could bring for us revenue with much higher margin. If you first market, then (00:52:54). If you (00:52:57) so margin, of course, would be much less. We have opportunities for these new product and new application.

This year, it was very critical (00:53:10) excellent result this year. And so now we see (00:53:15) with many new applications, very good prospective results with much higher margin than current product, in spite still current product due to our very hard policy to decrease cost, very efficient policies. (00:53:33) still bring for us very good margin.

But up to now in spite of China, our cost of this current product – top current product for us, minimum 3 times cheaper than any competition of manufacturing. It will go and go and decrease and decrease, but very competitive still with all products. New products, (00:53:56) most of them, nobody produce the same today. So, we'd be first in the market..

Great. Thank you very much..

Thank you. At this time, I will turn the floor back to Dr. Gapontsev for closing remarks..

Okay. Thank you for joining us today. We look forward. We are sure that next time we'll provide you much better results. Have a great day..

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