Good morning, and welcome to IPG Photonics' Second Quarter 2019 Conference Call. Today's call is being recorded and webcast. At this time, I would like to turn the call over to James Hillier, IPG's Vice President of Investor Relations, for introductions. Please go ahead sir..

Thank you operator and good morning everyone. With us today is IPG Photonics' Chairman and CEO, Dr. Valentin Gapontsev, and Senior Vice President and CFO, Timothy 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, July 30, 2019. The 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. Our second quarter results were strong. Driven by improving trends in our China business during April and May, we sold a record number of high power lasers during the quarter.

Although the macroeconomic climate and the pricing environment both remain challenging, we delivered results in the upper half of our guidance range, while demonstrating solid traction in new products.We continue to meet competitive challenges by substantially reducing component and manufacturing costs while introducing new products that improve productivity and increase flexibility for our customers.As widely reported, the macro economy has softened and the geopolitical climate has become more unstable over the last few months.

As a result we again find ourselves in a more uncertain position with limited near-term visibility to improving business conditions.Despite the volatile geopolitical and business environment, we will continue to invest in new products and applications to substantially enhance our competitive position.IPG remains the clear market leader in fiber lasers with hundreds of megawatts of installed capacity.

During the second quarter, our megawatts of total optical power shipped reached a record level.

We were able to successfully meet the strong sequential growth in demand for our laser products coming from China, with record shipments into the region.We continue to see aggressive pricing among China-based competition, which intensified toward the end of the second quarter.

Nevertheless, we achieved strong sequential growth in high power laser sales.We have many laser products and systems that are unique in the industry.

Chief among these, we continue to produce high power CW lasers for cutting, welding and other materials processing applications at industry leading power levels, beam stability and wall plug efficiency.Sales of ultra-high power fiber lasers at 6 kilowatts or greater accounted for nearly 50% of all high power laser sales.

Sales of lasers at 10 kilowatts or greater grew 16% year over year, driven by rapid adoption in cutting applications.We have started shipping our new high peak power lasers, receiving encouraging feedback from our customers.

These new products offer a differentiated solution to cutting OEMs, providing us with a distinct advantage in a competitive market.

This unique capability increases piercing speed, improves cut quality, delivers cleaner, more controlled drilling of thicker materials and reduces scrap by enabling closer nesting of parts.We are seeing compelling customer interest in our new generation of lasers with adjustable mode beam capability that permits reliable adjustment of the output beam.

AMB is shown to reduce spatter, increase speed and improve quality in welding applications, and our AMB products are being evaluated by leading edge battery producers.

In the cutting market, OEMs can cut a wide range of material thicknesses using our AMB lasers or our standard high power lasers with our unique family of high power optical heads.We delivered excellent progress in new product areas outside metal processing.

Sales of green pulsed lasers used to improve solar cell efficiency increased 150% year over year and nearly doubled on a sequential basis.We increased sales of our ultrafast pulsed lasers more than 200% year over year and nearly 50% sequentially.

We are actively working on more than 50 new projects for these lasers across a wide range of applications processing glass, ceramics, circuit boards, OLED film, batteries and solar cells.Sales of our newest pulsed lasers, which include those at visible and ultraviolet wavelengths and ultrafast pulse durations, now exceed $10 million per quarter and are growing more than 60% year-over-year.As we expand our portfolio of new pulsed lasers and capitalize on the many application opportunities for our differentiated fiber laser solutions, we expect revenue for these products to grow rapidly over the coming years.Systems sales increased more than 50% year-over-year, excluding Genesis, driven by strong growth in macro systems for welding and other materials processing applications.

In addition, our seam stepper had a record quarter with sales into several large automotive customers.Sales of beam delivery accessories increased 10% year-over-year.

Toward the end of the quarter, we received a large order for our medical laser solution addressing a surgical application, enhancing our visibility into strong growth in medical this year.Collectively, second quarter sales of newer laser products and systems into emerging applications grew 12% year-over-year in the second quarter and were 17% of total revenue.I am pleased to report that we continue to demonstrate meaningful traction in ultra high power fiber lasers while investing in new products and applications that expand our addressable market opportunity.While macro factors are creating near-term headwinds in our business, our continued focus on developing and enhancing our differentiated laser solutions will drive the company's growth for many years.As a reminder, our mission is to make IPG's fiber laser technology the tool of choice in mass production, and I remain confident in our ability deliver on this mission.With that, I'll turn the call over to Tim..

lower revenue; investments in engineers, salespeople and IT systems; and the acquisitions of Genesis and our Brazil submarine networks division.Net income was $72 million and earnings per diluted share were $1.34. Foreign exchange losses reduced EPS by $0.08. If exchange rates relative to the U.S.

Dollar had been the same as one year ago, we would have expected revenue to be $18 million higher and gross profit to be $10 million higher.

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

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

Capital expenditures were $54 million, as we continue to invest in new plants and equipment to meet demand for our products over the next several years.During the quarter we repurchased 15 thousand shares for $2 million.

We expect share repurchases to increase in the back half of 2019 and remain committed to offset dilution from equity issuance.Turning to guidance, data points relating to the health of manufacturing economies in our largest regions have weakened over the last three months.

Our second quarter book-to-bill ratio was above one, but below normal seasonality as order volumes weakened in June. Furthermore, the competitive environment remains challenging, due in part to the recent slowdown in industry demand levels.As a result, we expect pricing headwinds related to the competitive environment to continue.

We expect growth in our innovative new products, accessories and complete systems to partially offset softness in our core business as these solutions gain further acceptance in the market.Based on these factors, for the third quarter 2019 we expect revenue of $325 million to $355 million. We expect our third quarter tax rate to be approximately 25%.

We anticipate delivering earnings per diluted share in the range of $1.05 to $1.35.Escalation of the US-China trade conflict and further macro softness have reversed the market recovery we had expected to strengthen in the second half of 2019.

Our largest machine tool OEM customers have not provided us with expectations beyond the next few months given the weaker macroeconomic and geopolitical climate.As a result, we do not have the necessary conviction to provide an outlook beyond the current quarter.

However, we believe strength in new products and ongoing enhancements to our core laser portfolio will enable us to better capitalize on the eventual rebound in end market demand.As discussed in the Safe Harbor passage of today's earnings press release, actual results may differ from our guidance due to factors including, but not limited to, product demand, order cancellations and delays, competition, tariffs, trade policies and general economic conditions.Our guidance is based upon current market conditions and expectations, assumes exchange rates referenced in our earnings press release, and is subject to risks outlined in the company's reports with the SEC.With that, Valentin and I will be happy to take your questions..

[Operator Instructions]. Our first question comes from the line of Michael Feniger, Bank of America Merrill Lynch. Please proceed with your question.

Yes thanks guys for taking my question. Just help us understand the pricing comments.

I believe at a conference Tim, it was I think two months ago, you mentioned how pricing stabilizing somewhat sequentially it sounds like things changed in June, so can you just remind us how much does pricing typically fall every year, I think it’s like 5% to 10%, how much did we see that fall in 2018 and now what are your expectations now for as we think of the rest of 2019 there?.

No typically you’ll see pricing go down 5% to 15% historically. More recently on average pricing if you look from a year-over-year basis has been 30% or even slightly higher than that from certain product lines.

The issue that has really become a power within the market is as soon as the macro environment weakens the competitors try and hold on to or increase share by decreasing pricing aggressively. So its very closely tied.

We are seeing changes and the demand environment with the way that the competitors respond to that.Having said that, the pricing is it continues to be a challenge.

We've had a lot of discussions internally at IPG about being certainly more selective and very strategic about how we're going to respond to these sort of reaction removed by the competition.There are even some OEMs where we're looking at not responding to pricing in the way that they're demanding because we believe, we do have a significantly better quality product both in terms of just for example, electrical efficiency reliability service and support specifications warranty.

And those are advantages that we believe people should be paying for.

And if everyone's going to be reactionary in this market particularly in a volatile demand environment, it's really just to chase to the bottom and our view is that that that's not a way to leverage the value of this technology, which drives tremendous improvements in productivity and you've really seen this sort of really rapid growth in demand for different applications coming from those improvements in productivity.So, it's certainly a challenging environment, but we're also looking at how we can add value around the lasers.

The accessories, the for example in the welding applications some of the real time world monitoring capability within systems very advanced welding applications like titanium, copper welding, and these are in areas where the competition doesn't really have a lot of expertise or capability and there are areas where IPG is building a tremendous amount of depth in capability, and that's excluding some of the newer product applications where we're starting to see some nice traction as well, where there's an incremental margin profile that we have of that..

And Tim, just can you help us, I understand the visibility is limited right now, but could we be seeing some type of replacement demand come through. I think systems are seven to 10 years old. You guys have seen strong growth over the last few years now.

I'm just curious, if you are seeing maybe some baseline level replacement demand that has to occur?And then just secondly on that, I'm just hoping if you'd give us any more color on the auto market I know there's a lot of movement there with new EV investments, but also some of the traditional size we're seeing CapEx maybe start to plateau, any type of color you can you can share on that as well? Thank you..

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

What I will say though is there's still a very large installed base of CO2 lasers that needs replacing one of our competitors and other supplies in the industry of components will pull quote that there's more than 70,000 CO2 lasers that are out there that would require replacement over time, we believe with fiber.

That is part of the investment cycle towards replacing those is one of the issues that everyone's face a bit of challenge on.

That has slowed down, when you get to some improvement in sort of the macro climate or you perhaps get some better visibility into what's happening with the geopolitical tensions around the world, that replacement cycle certainly has an opportunity to rebound pretty quickly, and it is, as I said tens of thousands of CO2 lasers that do require replacement.The automotive market is, I think, obviously there's a lot of different analysis out there that shows that the automotive investment cycles out are relatively low at the moment and have perhaps peaked.

But notwithstanding that, just going back to Q2, we just mentioned that we had the largest supply and purchase order that we supply for our Seam stepper applications into major automotive OEM zone in Europe.So that was actually a demonstrated change in technologies being invested in even when the market is relatively low.

There's a strong pipeline of automotive business we're working long in the U.S.

again driven by technology change and some of the benefits we have from the real time well monitoring capability that we're hoping will generate order flow, and then the overall outlook for the EV investment cycle remains very strong and that's a multi-year investment cycle.

It is project driven, and it can be uneven from quarter-to-quarter.But there are certainly different areas of investment within the automotive that we believe that will be drivers for our business over the medium term, and certainly for the longer term..

Our next question comes from Andrew DeGasperi, Berenberg. Please proceed with your question..

Thanks, good morning. Thanks for taking my question. I guess one and maybe a follow up. On the – first of all I guess the 380 million core laser business you mentioned to get to the 50%.

Just for clarification, was this the midpoint of the 50% to 55% gross margin, or was this just over 50%?.

No getting back over 50% would be the target of our level that we’ve talked about. Previously and on this call, so you've started to see your absorption rates pick up.

I think the thing to do is look at where we were at 363 million, we're just below 50% it has some relatively large inventory provisions in the quarter, the 380 it does give us some comfort of being able to get back there, but it is a different scaled business than one we’re guiding up to Q3 obviously, which is the challenge..

Right.

And then just on pricing and competition, is a 6 to 10 kilowatt seeing some pricing pressure because of competition at the lower end or are you not seeing competition and that's in that tranche of lasers?.

Numerous of the competitors have announced products at that level, and they're trying to sell them.

The issue faces that to a certain degree, any customer looks at the average selling price per kilowatt of a laser and even if there is less competition at the higher levels, you can't price at a premium and you get a very good gross margin on that product.

But there's a certain blows through on an ASP per kilowatt across the entire product line is how we like to think about that..

Got it. Thank you..

The more power for competition, it’s more and more difficult to compete because the even with more power it’s our knowledge information, we have very serious problem with a lifetime or with you have to repay very often with high powered the practical know them way they're not able to walk in serial -- just more from the image they claim they care, but not real sales that we did with them..

Our next question comes from Joseph Wittine, Edgewater Research. Please proceed with your question..

Yes, hey guys. It's Joe.

First off, our high peak power QCW, you said you're now shipping wondering if you're offering in all geographies and then if you have any rough estimates on let's say what portion of the cutting base may realistically adopt HPP-QCW over the next year or so?.

We're offering this throughout the world at the moment Joe, it's still too early to say what proportion of resolve of the lower end of the market will transition to using that high peak power laser.

But there's a lot of evaluation work ongoing, it's probably a quarter if not two quarters early to be able to give more definitive information about the traction that we expect to see from that or.For example, what percentage of the low end of the market would start using an 8 2 kilowatt HPP or a four kilowatt HPP..

Okay, I got it a little bit early.

Jim, I know you can't quantify the fourth quarter and then that makes perfect sense, but in any event let's say headlines kind of stay with the status quo, kind of similar to as they are today would you expect all else equal somewhat typical seasonality off the third quarter base, wherever that ends up being?.

Do you know that I can't quantify, but you're asking me to quantify. Yes I am..

I guess, I am..

We just don't. I mean, it's one of those extraordinary times where we just need we need to get through the quarter to work out you know see where water flow ultimately ends up, see where demand in China ends up, be whether there's going to be a bit of budget spend come through.

There are certainly some projects around the advance that we're expecting in order flow from that would be driven by some budget spending there's a pickup in some of the medical business shipments, that will take place in Q3 and Q4 that's still not very material.

But you kind of need to see where the trade war ultimately ends up and whether that stabilize the situation in China. You want to see what happens with the European Economic Zone over the next eight to 10 weeks. I mean, you got the biggest you now around Brexit with the new Prime Minister in the UK being pretty aggressive there. It's an uncertain time.

So, I'm – that's the kind of like color I can give you around it. But getting drawn into qualifying at this point in time, if we been be able to quantify we would have done..

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

We just got a lower revenue level on relatively high buildup of inventory last year. So you got inventory that just becomes a bit older. It's not -- it's still not a massive in terms of total impact. It's not massively significant.

So I expect them to remain relatively speaking a little bit elevated for two or three quarters as we go through lapping the annual build up in some of the inventory that happened a year ago. But I don't expect to have a much more material impact related to them..

Thank you..

We tried to manage that, Joe, as you know on a constant basis rather than suddenly looking at inventory provisions every two years and having to take a much larger provision. We're trying to look at the realizable value on a regular basis and manage it that way..

Our next question comes from David Ryzhik at Susquehanna. Please proceed with your question..

Hi. Thanks so much for taking my question. Tim, can you maybe elaborate on the base fee declines in Europe. Is that a function of competitive pressures increasing in Europe as well? Then I had a follow-up..

Some of the Chinese are claiming they're selling product in Europe. There's certainly been some of the pulse lasers in Europe they've been trying to get traction on. They are trying to introduce product there. Debates on how much success they've got in that regard given the quality, their ability to support it.

Some of the pricing just transitions through to the OEMs in Europe because they're aware of what's happened in other geographies around the world. Often some of them have JVs for example in China.So they're very aware of what happens to pricing. So the ability to totally differentiate pricing on a standard product across regions is more difficult.

The ability to differentiate pricing on capability and technical specification which is a key strategy that we have is very important, right? So we believe that the HPP lasers, the AMB lasers are going to enable.

We're going to be able to premium price some of that product, selling product with some of the world's monitoring capability and accessories add a tremendous amount of value around it.

But if you're just selling a straight three, four or five kilowatt laser, people understand what's happened to pricing in different regions around the world and unless you've got some other differentiating factor to some degree that pricing migrates.

Understood. Thanks. And then just regarding the 3Q guide, would love to get your assumptions for the new product category embedded in your third quarter guide. It increased nicely from 15% to 18% in Q2.

Just wondering what you expect for the third quarter?.

We don't give specific guidance around different elements of the revenue streams in the third quarter. We continue to expect good traction around the green lasers, the ultrafast lasers, pick up in some of the shipments, the cinema applications continued strength in some of the laser systems business. So we're looking for growth from those areas.

We don't give specific guidance around those numbers and we're looking for growth to drive the business forward not just in Q3 but Q4 and the medium term from those newer applications.There'll be a pick up in some of the medical shipments as well based upon the order that we got.

So we're actually pleased with some of the diversification in this business. When you look at these all areas we worked on for a long time and they're now starting to generate not the level of revenue we want, but they've got they've got some nice traction in revenue coming from these leading edge new products.

And if we can continue executing with them we're going to have a much more diverse business within 18 to 24 month period..

Okay. Thanks, Tim..

Our next question is from Jim Ricchiuti, Needham & Company. Please proceed with your question..

All right. Thank you. Good morning. I'm wondering if there are any regions geographic regions where perhaps the bookings have held up somewhat better, sounds like it's been a – you're clearly seeing some slowing in bookings in July in China.

Where are you seeing other areas of weakness and where are you seeing some signs where it's holding up better?.

So, in China, Jim, actually bookings were relatively strong for the quarter. It's just -- there's some uncertainty about whether people are going to take that demand now, so their revenue guidance is weaker. Order flow in Korea was actually very strong even though the macro date out of Korea isn't that good.

But that's again being – that lot of that development of some of the new product introductions and orders yet from DMV there specifically, but they've been doing a lot of work for example the DMV on welding applications, but a lot of the ultra far some of the UV, some of those newer applications in the welding business in Korea with strong.Japan order flow was not great, but they're expecting a pickup in revenue from Japan in Q3.

The US is continuing to hold up reasonably well, so that that continues to be a more resilient area into the macro. Also the U.S. business is a bit more diverse, right? You've got the emerging medical business. You've got the advanced business which was revenue wise was a bit weak, but there's a lot of different projects being worked on that.

We've got an order for a 60 kilowatt laser in the last couple of weeks out of the U.S..

Two orders..

Two orders with 60 kilowatts..

Yes..

So that would be for an advanced research application. Other areas – I mean, Europe as a whole it is pretty weak and China is volatile, right.

There is some underlying demand that exist in China, but its getting switched on and off as business uncertainty either gets switched off when business uncertainty declines and it comes back when there's some confidence in the business environment. So I wouldn't say there is no demand for ladies in China, it just volatile at the moment.

And that's the challenge that we're dealing with..

Thanks for clarifying..

We have still month value of fast growth of business in China. But after the new increase of tariff immediately quantity ordered from China drop minimum three times. Now our customers remain with that, but before they order by five, 10 even fifty hundred units per one order now quantity orders is the same will be practically quantity per day.

But instead of 10, 15 or hundred of each order now will only one or two pieces. So they pull on order, but waiting [Indiscernible] what happened later now they hold practical problem in quantity volume what they need all they purchase, but [Indiscernible] to purchase..

That's helpful. On the system side of the business x Genesis, I'm surprise if the business is been holding up and you're showing the kind of growth that you have that you're showing in this kind of macro environment.

Are you -- is it just because it's a relatively small business and you have new applications you're going after?.

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

The ILC business which is shipping into the medical device manufacturing industry had had a good quarter in Q2. It's going to have another -- it's going to have a better quarter in terms of shipments in Q3.

Their total order flow is also held up.And then we did deliver quite a lot of higher power specialized -- some of these are fairly specialized systems. There was one system for welding batteries that was delivered to the UK, Jim.

There's another system for welding batteries in a consumer product that will be delivered or revenue will come through on Q3. So some of those more specialized systems, we could get some revenue off.

And then for example the system that was sold for the battery welding is actually going to result in good order flow for some lasers for the battery welding application in the future. So, yes, the systems business X Genesis for lasers performed pretty well..

Okay. Thank you..

Our next question is from Patrick Ho, Stifel. Please proceed with your question..

Thank you very much. Jim, maybe first off you talked about some additional cost cutting efforts on your end, given how you're already the lowest cost supplier in the industry.

Are these additional cost cuts coming on the manufacturing side of the supply chain? Can you just give a little more color and details of where you can extract additional cost savings?.

It continues to come from the core optical components that we use. The size is obviously one that we talk about a lot there.

Increasing the power that you can get out of an individual fiber block, there are even some mechanical components where we're going to -- some of these are design changes, right? So for example, some of the heat sink designs we're looking at that are used in the modules, we're going to improve the quality of the cost aluminum in that to enable those heat sinks to more rapidly remove heat that will enable us to produce modules of higher power level and increase reliability.That's something in the medium to near term that we're looking at that isn't going to roll into the building material for a few months.

But that would be an example of something that we think about and it's a bit more of a lateral way of thinking about it. And then you've got to look at where we adding value around the accessories which grew a 10% year-over-year.

There's a lot of value added around the accessories that we produce relative to the cost of an accessory and the selling price. The newer products where we're taking cost out of the bills and materials, for example, the cinema products continuing to ramp the demand for ultrafast pulse trying to get the cost of the green lasers down a bit more.

There's some of the newer products you'll see improving margin there as well. It's a pretty broad based. As I always said, part of it -- the strongest part of IPG's DNA is not just the technology..

And very important before that we had introduced diode beginning at this year a new product which much more powerful and also cheaper per watt very [Indiscernible] only introduced in the market couple of months ago. So the return work from this diode we expect this year next year would be much return from the market with these diodes..

Great. That's helpful. Maybe its my follow up question. I think as Jim mentioned, Genesis has held up very well in this overall environment.

How do you see expanding Genesis from kind of its core North American base? How do you I guess expand its opportunities into other regions? And how you look at that on a going forward basis?.

This Genesis before work on the American market, they don't have an opportunity, they have opportunity to work worldwide. Now we have extent the activity worldwide.

So Europe, even for Asia market for example, Korea, in the Japan and many others [Indiscernible] become worldwide and we expect and second also -- now we redesign products using the way that before the quantity or system they produce always only very small quality.

Now the most new product now based laser technology its take some time to redesign and so on. So we have very serious, very much products now, some in U.S., some in other country, and we prepare now is very much products that sold and they [Indiscernible] and components here and laser is also part of final system.

It would be major our internal integrated all customers with whom we're working who discuss serious problem. They have the practical with Genesis, and very excited now to reach that [Indiscernible] integrated and very much in the market..

Great. Thank you very..

It will take time starting from [Indiscernible] of this new core production line. [Indiscernible] part like very unique accessories now, now we'll produce not even production sale which still some of them were able to make out Before.

Now with Genesis we are now going to production wise portfolio and change technology [Indiscernible] company, full technology provide where they could provide new product, provide new solution and full solution in core production line. It’s absolutely new approach, IPG take some time but very successful we are going in to this new business..

Thank you..

Our next question comes from Tom Diffely, D.A. Davidson. Please proceed with your question..

Yes. Good morning. Just a follow up on Jim's question on the systems side.

Does that mean that pricing is holding out better on systems versus the kind of core fiber laser market?.

It’s a different dynamic. Tom, it depends how much where you are adding a lot of technology and you're adding a lot of value and you're delivering complete processes. The relative price versus cost is strong. In some parts of the market where there's more competition the relative price to cost is lower.

So it really depends upon what the application and solution you're delivering is in some of these core areas where we're seeing some growth, for example, we're doing some of the medical device manufacturing applications, the average selling price of those systems because you're delivering software as well as technology, traceability for example within the manufacturing process.

Certainly pricing is not being impacted in the way that it has in the other parts of the market. But it really comes down to the completeness of the technology and the solution that you're offering..

Okay. That's helpful.

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

So, what was the last part of the question, Tom?.

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

So, the transaction FX losses in Q2 were primarily renminbi versus dollar driven, a little bit to a lesser extent on the Euro. We try and -- the natural hedges are pretty much the same.

Sometimes those natural hedges don't work as effectively if exchange rates go in the same direction, so a weakening renminbi and a weakening euro, you're not for hedges just don't work. If you have a weakening euro and a strengthening renminbi those natural hedges work better.

I continue to be, particular with the cost of hedging some of the renminbi exposures skeptical about whether you just end up smoothing the losses.

So we tend not to go into using the FX forward contracts for that.On the other side of it if you look at the impact on revenue on a translation basis, the two biggest exchange rates that have moved over the last year again are the renminbi is depreciated from a high of 630 almost, If you go back to Q2 a year ago. It touched lows approaching seven.

So that's a 10% depreciation and the Euro probably a year ago is 1.18 1.19 and is anywhere in the range of 1.11, 1.12. The ruble which is also an exposure we have is properly traded between 57 and 63 and over the last year. And those would be the three main currencies that were affected by..

Okay. Thank you..

Our next question comes from Nick [ph] Todorov, Longbow Research. Please proceed with your question..

Thank you. Good morning guys. So, just to go back on the pricing headwind comment.

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

Yes. I mean I'd said that inevitably there is a knowledge about what goes on in China from the cutting equipment manufacturers in different regions around the world, so that you can isolate price changes in one region for another. And the second thing is that people tend to think about pricing in terms of the cost per kilowatt.

So, if you see decreases in one region they tend to migrate to the other regions to a greater or lesser extent.

And it depends also upon-- if you go to the higher power levels it tends to be less so because there's less competition as an advantage that the cutting equipment manufacturers get in terms of productivity.Some of the electrical efficiency benefits have become more and more important as you go to higher and higher power levels right.

A laser that operates at 20% electoral efficiency at one kilowatt, it's perhaps – its certainly not as important when you have 20% electrical efficiency competing against an IPG laser that has 50% electrical efficiency at 10 or 15 or 20 kilowatts.

So, as you go up in power there's certain performance advantages that IPG delivers that are not matched by the competition, but you see pricing migrate around the world just because people understand what's happened in China. Several of the OEMs I mentioned have joint ventures in China.

They've got intelligence on the ground about what the cost of a one, two, four, six, eight or 10 kilowatt laser is..

Okay..

Don't forget, Europe for example with like 70% to 80% is only expert, but user not inside of Europe, mainly in Asia and China. So as they look in China mainly. So if China [Indiscernible] didn't change, it immediately [Indiscernible]..

[Indiscernible] this well, probably 25, you just looked at average selling prices, first of all, its about 25% of the total change is related to the FX that I addressed in the previous question just on a translation basis with renminbi having depreciated 10% and the Euro having depreciated 5% or 6%.

If you saw the dollar start to weaken and some of those currencies strengthen there'll be some recovery against that. So there's a view that the dollar may weaken if interest rates are moved down by the Fed tomorrow..

Yes. Got it. And then you talked about demand being very volatile in China kind of related to changes in the headlines.

Is it strictly demand being volatile or you're seeing also the same on the pricing front or prices have been kind of getting progressively weaker as we get into the – as we get into May and June?.

I said at the beginning of the call that the demand volatility that tends to drive price volatility, right, particularly from the competition.

I think the industry has to learn to become less reactionary to this because it's just going to be a rush to the bottom and we're certainly being more selective and strategic about looking at pricing and the value that the lasers deliver.

But the demand volatility unfortunately the moment drives a reactionary response on pricing from particularly two or three of the competitors, because they're just trying to fight for any revenue they can get.

That's a very short term view to have in our opinion around the markets and one of the reasons why we're looking to be more strategic and selective..

Got it. And last question from me. Last couple of quarters you talked about some strength in aerospace and defense. Can you give us update and then, I didn't hear anything in this quarter. And I think you mentioned some volatility and probably in advanced products.

Is that related to maybe some just temporary drop in demand in that end market or is there something else?.

On the defense side is still very much. There's some commercialized applications, but they're only developing right. So a lot of it tends to be very project driven and you'll have very strong quarters and then the revenue can be uneven because order flow will be lower and people will be working on utilizing lasers they bought.

There's one application that's been developed commercially at lower power single mode lasers where we're expecting to see some increase in demand in the second half the year.

We referenced that we got two orders for 60 kilowatt lasers that are going to restart, so that business is just uneven and expected to be stronger in the in the second half of the year. A couple was the first part of the question I remember it..

No. I think you answered it. I think you answered it correctly..

It cannot be a poor mainly about the same for this application laser, but now we're going for the production sell even system for this market. It absolutely different approach and much more valuable and so on and its going very successful is for the same, for example, to aerospace and high energy market. It's one for oil and gas market so on.

We're going to pull complete solution, unique process. We have developed that process. Now we materialize in the full system. Some system platform [Indiscernible] so on. But its not easy process to introduce in this market, but it can take some years and so on.

But we're going very successful for some products but very difficult application, going extremely and huge potential, very large order business..

Got it. That's helpful. Thank you, guys. Good luck..

Our next question is from Tom Hayes, Northcoast Research. Please proceed with your question..

Good morning. Thanks for taking my question. I'll try to be brief.

Tim, I just wonder if you may provide any other color as it relates to mix within your China sales as it kind of relates to move in up and down the power scale?.

We would provide a little bit. Yes. I mean the ultra high power and the greater than 10 kilowatts performed very well in the quarter. That had rebounded strongly in April and May. So that was a bit of a benefit. The lower end of the market in units was relatively strong. I mean that's the really high level stuff in terms of the high power.

There's some -- some of the welding applications in China at high power as well were performed reasonably well..

Great. Thanks for the color..

Our next question is from Mark Miller, The Benchmark Company. Please proceed with your question..

Thank you for the question.

I'm just wondering about programmability, is that becoming a bigger part of the laser sales? You've seen growth in demand for programmable applications?.

Programmable, you mean the adjustable mode of the mark-up, an area that we're working on with for example customers both in cutting and welding applications. In welding, there's a substantial reduction in splatter with the programmability of it you can also then cut varying thicknesses of material.

It's important but it's talked about a lot in terms of marketing materials by different companies around the world.

Our view on it is actually the program ability is probably going to be more of an enhancement for welding applications that is necessarily for enhancing thick cutting applications.Some of the quality people are getting to with our Higher Power cutting head for example is achieving adequate cut quality when you're cutting materials of one, two-inch thickness as you don't require jigsaw quality cuts.

That sometimes is just the perception of the quality of the cut. If that's what you mean about programmability, it's going to have some niche applications particularly in welding. It's not going to be an overall dominant type of laser that's sold for materials processing..

You're starting for example application. When people talk about fiber laser also very thin metal sheet like one, two millimeters and so on then CO2 we can provide much thicker processing much thicker material. Now people forget about it because fiber laser provide only one centimeter and so on.

Now with the technology to cut up to five watt centimeter with high quality cutting, nobody still have this technology, nobody have this, only we have it. It's not only – and cut very specific, so also process it and so it's also priority.Now with it produce it technology to the market, nobody can compete with that today so on.

It thickness so far three to six even more centimeters cutting very high speed, high quality and so on, nobody can make this cut for example, the best way, 10 kilowatts, 12 kilowatt they try to develop cutting process so one. We provide now with 20 kilowatt.

In process, it's also [Indiscernible] because its not power it also special solutions to how to deliver this power and so and optical [Indiscernible] so everything nobody cannot provide today to the market. And it’s a process also know how. But this business would be a little [Indiscernible] cutting still. We have this [Indiscernible]..

Thank you..

And also, copper cutting for example and so on also and when people Indiscernible] very high generator for example for very powerful [Indiscernible] problem with this even copper provide excellent [Indiscernible] discuss provide for them I don't like to make but.

Thank you..

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

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

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