Coherent Corp (COHR) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Coherent's First Quarter Fiscal Year 2018 Financial Results Conference Call hosted by Coherent, Inc. (Operator Instructions) As a reminder, this call is being recorded. I would now like to introduce Bret DiMarco, Executive Vice President and General Counsel. You may begin your conference.

Thank you, Jesse, and good afternoon, everyone. Welcome to today's conference call to discuss Coherent's results from the first fiscal quarter of 2018. On the call, we have John Ambroseo, our President and Chief Executive Officer; and Kevin Palatnik, our Executive Vice President and Chief Financial Officer.

I would like to remind everyone that some information provided during this call may include forward-looking statements, including, without limitation, statements about Coherent's future events, anticipated financial and operating results and business trends. These forward-looking statements may contain such words as expects, will, anticipates, intends or referred to as guidance. These forward-looking statements are only predictions and are subject to risks, uncertainty and assumptions that are difficult to predict and may cause actual results to vary significantly.

These forward-looking statements reflect beliefs, estimates and predictions as of today, and Coherent expressly assumes no obligation to update any such forward-looking statements. For a description of risks and uncertainties which could impact these forward-looking statements, you are encouraged to review Coherent's periodic SEC filings, including its most recent Form 10-K, Form 10-Q and Forms 8-K.

I will now turn the call over to John Ambroseo, our President and Chief Executive Officer.

Thanks, Bret. Apologies for the delayed start. There was a glitch on our end in getting clearance of the press release from NASDAQ.

I'd like to begin with -- provide our perspective on the display market. Before doing so, however, let me just say that our financial results for the last quarter were solid on all aspects, and Kevin will review them in more detail in just a few minutes.

Since sales figures for the iPhone X started to leak several weeks ago, assumptions have been rampant regarding the near- and long-term outlook for OLEDs, leading to very high volatility for related stocks. The operating environment is far less dramatic. A channel check with integrators and panel manufacturers did not identify any changes in delivery cadence or service demand. What's the reason for the disconnect? We think it's rather simple. The leading OLED manufacturer committed its resources to a single customer. Other interested parties, left with no choice, stayed with LCDs.

Turning these customers on requires them to change the display drive electronics, which takes months, not days. So the leading supplier has a short-term glut. Other panel manufacturers continue to invest in technology and capacity as a means to broaden the OLED market and capture share. They have shown no signs of slowing down. The only bump in our road is a short-term supplier-related issue that Kevin will address in his prepared remarks.

Orders for the Semicap market grew well into double digits over the prior quarter on memory demand. The growth was for lasers used in inspection. The industry outlook for the balance of calendar 2018 remains upbeat, memory prices are projected to soften throughout the year, and attention will then shift to the EUV rollout and fab utilization, especially for legacy nodes.

The advanced packaging market was lower following a good Q4. Via drilling is tracking the trend in semicap, particularly for smartphones. Packaging houses are eager to see equipment lead times come down, and tool manufacturers are cautiously increasing the output. These customers are also evaluating the best pathway to drill smaller vias. The potential solutions include carbon monoxide or CO lasers and nanosecond UV lasers, which are both part of our portfolio. The other area that has become very active is flex PCBs, again, for smartphone applications. Nanosecond UV lasers, such as our AVIA NX series, are the solution of choice here.

Although the materials processing market exhibited typical seasonality in the December quarter, there are a number of notable highlights. The first quarter book-to-bill was positive. We secured our first volume order from one of the largest integrators in China for sheet metal cutting. The order was for a combination of 3- and 6-kilowatt fiber lasers. This is a great first step in a large account.

In the overall sheet metal market, more than half our orders were for lasers above 6 kilowatts, which is following the trends in the market. Integrators and end customers are experiencing the usual growing pains in transitioning to higher powers but are confident that the power management issues will be resolved.

Orders for automotive applications were up significantly on a sequential basis from several applications. A Tier 1 supplier ordered high-power fiber lasers for fuel injector welding. Polymer welding for body trim and lighting assemblies was up. And bookings for lasers used -- and lasers and modules used in label printing and marking were also higher on compliance and traceability requirements.

Medical device manufacturing workstations posted very good results. The driver is an aging population that increasingly requires stents as part of cardiovascular therapy. We have gained share in this area by combining a legacy Rofin workstation with a Coherent laser. Orders for device marking increased significantly, where our lasers are used to print product identification information that resists fading and contamination.

Bookings in OEM components and instrumentation were predictably lower after a record-setting fourth quarter. Timing aside, the market is in good shape. Bioinstrumentation is growing based upon increased clinical adoption of flow cytometry or cell sorting and sequencing. We serve these applications with our OBIS, Sapphire and subsystem solutions. Medical OEM customers are anticipating sustained growth above 10% through the early 2020s for aesthetic, surgical and dental applications. The drivers are well understood: less invasive procedures; faster healing; and delivering what Ponce de Leon couldn't, the fountain of youth.

By contrast, the ophthalmic market is facing some challenges. Western markets have a significant installed base of vision correction tools. Products are very accurate, and the performance enhancements have slowed. To further complicate matters, a series of acquisitions by Big Pharma over the past few years has not delivered the targeted financial results. These assets are back in play, which contributes to market uncertainty.

The aerospace and defense market is rapidly evolving, with several technologies moving from proof of principle to deployment. Directed energy devices are being called upon to dazzle, disable or destroy targets in land, sea and air platforms. The timeline calls for low-power dazzlers to deploy in 2019. We are providing components and modules to primes and sub-primes in this area. We continue to secure large orders -- or orders for large optics, rather, used in satellites and telescopes that we produce alongside ELA optics in our Richmond facility.

Our outlook for fiscal 2018 is unchanged. We expect it to be a record-setting year. Our integration and expansion plans remain on track, and we made another voluntary principal payment of EUR 75 million at the end of December. This brings our total voluntary principal payments to EUR 225 million, and we've repaid about 1/3 of the loan in the first 12 months.

We anticipate sustained strong cash generation. We will continue to invest in growth and pay down the debt. We also want the flexibility to return value to shareholders, and our board has authorized us to repurchase up to $100 million of common stock over the next 12 months. Any buyback will be subject to customary market conditions and limitations.

I'll now turn the call over to Kevin Palatnik, our Chief Financial Officer.

Thanks, John. Today, I'll first summarize fiscal first quarter 2018 financial results then move to the outlook for fiscal Q2. I'll discuss primarily non-GAAP financial results and ask that you refer to today's press release for a detailed description of our GAAP results as well as a reconciliation between GAAP and non-GAAP financial results.

The GAAP adjustments relate to stock-based compensation expense, amortization of intangible assets, restructuring costs, impairment of assets held for sale, the related tax adjustments and the tax adjustments for the Tax Cuts and Jobs Act. The full text of today's prepared remarks and trended GAAP and non-GAAP supplemental financial information will be posted on the Coherent Investor Relations website. A replay of this webcast will also be made available for approximately 90 days following the call.

Fiscal first quarter 2018 financial results for the company's key operating metrics were total revenue of $477.6 million, non-GAAP gross margin of 48.5%, non-GAAP operating margin of 27.8%, adjusted EBITDA of 30.9% and non-GAAP EPS of $3.54. Net sales for fiscal first quarter were $477.6 million, representing growth of 38% year-over-year. As expected, sales came in seasonally weaker in fiscal Q1 when compared with fiscal Q4 of 2017, specifically in the materials processing market, but overall, exceeded the midpoint of our previously guided range.

Our revenue mix by market for fiscal Q1 was microelectronics at 56.2%; materials processing, 26.7%; OEM components and instrumentation, 10.2%; and then scientific and government at 6.9%. Geographically, Asia accounted for 66% of revenues in the fiscal first quarter; the U.S., 15%; Europe, 16%; and rest of world, 3%. Asia includes 2 territories with revenues greater than 10% of total sales.

Other product and service revenues for fiscal first quarter of 2018 were $129 million or approximately 27% of sales, representing an increase of approximately 57% year-over-year. Other product revenue consists of spare parts, related accessories and other consumable products and was 24% of sales. Revenue from services and service agreements were approximately 3% of sales. We had one customer in South Korea related to large flat panel display manufacturing that contributed more than 10% of the fiscal first quarter revenues.

Fiscal first quarter non-GAAP gross profit, excluding stock-based compensation cost, intangibles amortization and restructuring, was $231.5 million. At 48.5% of sales for the quarter, non-GAAP gross margin came in at the midpoint of the previously guided range. Non-GAAP operating margin was 27.8% for the fiscal first quarter and was below the midpoint of the guided range, primarily as a result of the strength of the stock market and its impact on our nonqualified deferred compensation plan liabilities.

We record changes in plan liabilities to cost of sales and operating expenses with a nearly offsetting entry to other income and expense for changes in plan assets. The impact to non-GAAP operating margin was nearly 50 basis points. However, the net impact is virtually 0 to earnings per share. Adjusted EBITDA was 30.9% in fiscal Q1.

With regard to the Tax Cuts and Jobs Act, as expected, we realized a small benefit from the lower tax rates. Our fiscal Q1 pro forma tax rate was 28.8%, a decrease of 50 basis points from fiscal Q4 2017's pro forma tax rate of 29.3%. As a reminder, the significant majority of our income is generated overseas, so the change in tax legislation had a minor effect on our tax rates.

Turning to the balance sheet. Nonrestricted cash, cash equivalents and short-term investments were approximately $423 million at end of fiscal Q1, a decrease of approximately $52 million compared to the end of last quarter. During the quarter, cash from operations generated $65 million. And consistent with our priority of using excess cash flow to delever the balance sheet, as John mentioned, we made a voluntary EUR 75 million payment against our outstanding debt. International cash was $273 million or approximately 65% of the total cash and short-term investment balance. Approximately 45% of total cash and short-term investments is denominated in dollars.

Accounts receivable DSO was 58 days compared to 56 days in the prior quarter. And the net inventory balance at the end of the first quarter was approximately $433 million, an increase of $18 million due to growth needed to support our excimer and high-power fiber laser businesses. Capital spending for the quarter was approximately $24 million or 5% of sales.

Now I'll turn to our outlook for our second fiscal quarter of 2018. Revenue for fiscal Q2 is expected to be in the range of $470 million to $490 million. This range reflects the impact of one of our suppliers being behind on deliveries with a critical component in the manufacture of our Linebeam systems. As a result, we expect we will miss a single system shipment in fiscal Q2. Now given the ASP of this machine is approximately $10 million, this becomes meaningful to the top line. We are in the process of implementing actions to remediate this issue and expect to be back on track with shipments within a quarter's time.

We expect fiscal Q2 non-GAAP gross margin to be in the range of 46% to 49%. Non-GAAP gross margin excludes intangibles amortization of approximately $11.6 million and stock compensation cost estimated at $1.1 million. This range is a sequential decrease to fiscal Q1 results and reflects the continuing strength of the euro. The FX impact included in this range is approximately 70 basis points.

Non-GAAP operating margin for fiscal Q2 is expected to be in the range of 25% to 28%. This excludes intangibles amortization estimated at a total of $14.1 million and stock compensation expense of a total of approximately $8.1 million. This range is also a sequential decrease to fiscal Q1 results and is also impacted primarily by FX. The total FX impact included in non-GAAP operating margin range is approximately 120 basis points.

Other income and expense is estimated to be in the range of $5.5 million to $6.5 million. We expect our overseas income to increase in fiscal Q2 such that our non-GAAP tax rate is expected to be in the range of 29% to 30%. And we're assuming weighted average outstanding shares of approximately 25.1 million for the second quarter.

Finally, I would just like to note that historically, we haven't talked much about FX since it didn't have a material impact on our financial results. However, as a result of the Rofin acquisition, we now have a larger population exposed to the euro. At the current $1.24 rate, the strength of the euro has a projected 120 basis point impact on operating margin, which translates into an impact of $0.16 to non-GAAP earnings per share for fiscal Q2 2018.

I'll now turn the call back over to the operator for a Q&A session.

(Operator Instructions) Our first question comes from Patrick Newton.

I guess, John, you kind of alluded to this in your prepared remarks, but I think it was last quarter you'd spoke to the need to increase capacity in FY '19 to satisfy demand in your flat panel display business given work with many manufacturers across multiple geographies. And so I think there's clearly a fear in the market that OLED adoption trends have changed.

Given that you're closer to the source, are there any changes in your planned capacity expansions? Or I guess asked differently, have you seen a shift in customer appetites or potential OLED market opportunities from an order perspective?

So Patrick, I'm going to refer back to my prepared remarks. We've gone through and spoken with customers both on the integrator side as well as the panel manufacturer side, and the short-term turbulence has not impacted their plans as we see them today. So we are going to continue with our planned expansion. Again, the size and dollars involved are nominal. If we don't do that, we won't be able to live up to our commitments.

Great. And I guess a couple quarters ago, you also talked about 3 major fabs being discussed in the market, one that had been confirmed, another in Korea and another in China. And you had stated at the time that there are virtually no orders from those fabs in your June quarter backlog.

So I'm curious, as we sit here today, are any of those 3 fabs a meaningful contributor to either what you reported exiting FY '17 or the current quarter?

So I'm not in a position where I'm going to update you. We don't discuss detailed orders. We certainly don't discuss what's coming from specific customers. But I'll go back to my previous statement. If we're planning to move forward with our plans, it means that we have good visibility into what customers are going to need and when they're going to need it.

Okay, that's helpful. And then just -- could you provide us a little bit more details on this shortage of a critical Linebeam component? It sounds like it's for a 1000 system. I'm curious, is this a component that goes into all of your systems, and you just happen to be one short?

And then should we anticipate that in your -- I guess in the June quarter, that we should see somewhat of a snapback as you maybe overship by one Linebeam?

Yes, Patrick, it's Kevin. So I was a little bit elusive in the prepared remarks, but I think both John and I have been very consistent over the handful of quarters that optics is probably the long pole when it relates to Linebeams. And so that is the critical component. We're working with a number of suppliers to correct that, to remediate that, and we will snap back within a quarter.

Your next question comes from Jim Ricchiuti.

John, just wanted to ask you regarding the utilization rates. Just given what we're seeing and hearing in the market, isn't it somewhat surprising that we're still seeing the same kind of utilization rates of your equipment?

So Jim, the thing to bear in mind is that even customers that are not producing product as they go through qualification and fab spin-up are still burning through tubes.

But would this include customers that are -- have been ramping for some time? Are you seeing any kind of change in utilization rates among those customers?

I understand the question, and we can't -- given our position in these fabs, we can't comment on a situation that might refer back to a single customer. I certainly understand the reason you're interested in the information, but I can't provide any color on it. I'm sorry.

Okay. Let me just switch over to one other area, the microelectronics business. And it does tie in, I think, as well to just the concerns people have about smartphone demand, particularly the newer products.

Have you noticed any change in either -- you mentioned -- you called out the flex PCB area is an area, I believe, of strength in advanced packaging. Have you seen any change in the demand environment there just in light of what's been happening the last couple of weeks?

We have not.

Okay. And then one final question, and I'll jump back in the queue. Congrats on the momentum you're seeing on the fiber laser side of the business. Can you talk a little bit about how competitive this win was for you with this Chinese machine tool company?

Would you characterize either pricing or margins? Was it in line with your expectations? Or is this just potentially going to be a more competitive business as you start to ramp it?

We are not -- we're not trying to buy share in this market. We're trying to sell at competitive prices with respect to competitors, and by definition, all of these sales are competitive. There is a -- the leader in the space is extremely confident. They build a great product, and they set the standard, which everybody else has to meet.

We feel that we've done that here, or else we wouldn't have won the business. But we are not doing it -- we're not chasing the business. We certainly don't have any interest in starting a price war.

And then just let me slip one more in, just the environment that you're seeing in materials processing, particularly in China. How would you characterize the overall level of demand that you're seeing there?

It has continued to be quite active and quite good. The customers are becoming more and more sophisticated in terms of their interactions with companies. They understand how to play people off against one another to the best of their abilities.

They're looking for the best overall performance and value that they can get. Quite frankly, they're doing what they should be doing in an environment where there are multiple vendors capable of supplying their needs.

Your next question comes from Joseph Wolf.

I guess just to come back to that CapEx, should that be the value or the dollars spent in this quarter be the one that continues for the rest of the year? And can you give us some kind of feeling for how much is being spent on the laser business, not the excimer side?

Yes. So Joe, Kevin here. I won't parse it into those pieces, if you will. But overall, I think we've said in the past, talked in the past that as we look into fiscal '18, given the expansion or investment in capacity that we've talked about, the range would be 5% to 6% of sales for the year. So we start out the year at 5% of sales, fiscal Q1.

And then in the ILS segment, I guess on an operating basis turned profitable, but you talked about the euro impacting the translation. Can you talk about just the trajectory of the profitability in the back half of the fiscal year and then into the calendar year?

Yes. Joe, Kevin again. So we've talked about in the past that we will deliver a vertically integrated fiber laser in fiscal '18. That will certainly improve margins. We talked about in-sourcing the semiconductor chip, obviously, which is related to that, which will drive margins. That's probably one of the stronger items that will influence both ILS and Coherent margins going forward.

Okay. But no timing on how we can think about the reversal of some of the FX?

Well, many considerations in that, particularly, obviously, the strength of the euro. And at $1.24, I'm getting varying, I'd say, estimates or forecasts on what the euro is going to do. I'd hasten to say that margins can compensate for that when all of us really don't know the direction of the euro.

For fiscal Q2, we're assuming that $1.24 rate for the remainder of the quarter. That's about as much visibility that I feel confident in in terms of projecting.

Your next question comes from Mark Miller.

On the lasers you're going to be shipping in -- the fiber lasers into China, are the diode bars internally produced?

Kevin just mentioned that's one of the things that we're working on during this year. Those are still sourced from a third party.

Can you give us an update on what you're seeing in the microLED display market? Is it still out there?

There's still a lot of talk going on. I think at CES, one of the more entertaining technologies that was shown was a video wall from, I think, it was Samsung that was 164 inches or something. It was a massive wall. Great color. Not a product that is ready for deployment.

And I don't think much has changed in our view around microLEDs. For small embedded displays in goggles and things like that, yes, it could make sense there and, yes, on these very big displays where you're not limited by the chamber size, they could make sense. But beyond that, we're not seeing much in terms of product flow. We continue to see R&D efforts being -- taking place.

So you still believe they're cost prohibitive for a smartphone application?

I don't think much has changed in the cost calculation in the last 3 months. Three months ago, it was estimated to be about 10x the cost of an OLED display. And I don't -- I'm not aware of any data to suggest that, that has shifted.

Your next question comes from Larry Solow.

Good, just a few follow-ups. Most of my questions have been answered. On the stock repurchase authorization, John. I know you don't take these lightly.

Any reason behind it other than just adding sort of a source of capital allocation and then a way to pay back shareholders? Or does it come at a time when you think your stock is not fairly valued or something? Any comment on that?

Larry, we've had lots of conversation with shareholders. One of the things that they always want to know about is uses of cash, and we said, there are essentially 3 things we can do with the cash. We can invest in the business. We can pay down the debt. Or we can return it to shareholders either through buybacks or dividends.

And we've been very active in paying down the debt, obviously. We're at a point now where we may have the opportunity to use some of the cash for a third purpose, and we can't do that without an authorization. So we put it in for flexibility purposes.

Fair enough. On the fiber laser side, time lines on diodes, obviously, it's not exact science or something you're probably prepared to give. But fair to say by fiscal '19, the majority of your diodes will be internally produced?

So the goal or the targets haven't changed, right. We said we were going to ship vertically integrated product this year. We're on track to do that.

How fast we burn through the inventory of third-party diodes will determine when we're completely independent. I suspect that'll happen -- that we'll burn through all that inventory sometime in '19. Can I pinpoint the date? My crystal ball isn't that good, sorry.

That's fine. But it sounds like that's the plan at least, moving forward. And on that, the fiber laser agreement you announced, by itself, is it actually a needle-mover? Or is it just obviously a good indicator that you're moving forward? And does it potentially open doors for more deals?

For the customer that I referred to in China, we got a very small portion of their total buy, right. Which is the way these things start out. You do the development work. You prove out the product. They'll take some, see how they go in the field. If they meet all of the requirements or all the expectations, then you have an opportunity to compete for a large part of the business.

For our fiber laser business, it's obviously a pretty important first step. For the overall business, obviously, this is still very small numbers. But the trend line I would say is what's encouraging to us that we're getting these opportunities.

Okay, great. And then could you just clarify on the advanced packaging market? I don't think things change that fast. I know last quarter, you spoke to adding capacity in the via drilling in the direct imaging sides of your business. So it sounds like orders were good there. I believe you even talked about record orders at the end of last year.

So is the slowdown you cited this quarter more of a temporary thing and just an order flow? Or any other color on there will be great.

So I don't think that I talked about expanding capacity in either of those areas. I said demand was up -- last quarter, I did say demand was up in both areas, but we were able to handle that with the existing resources.

As far as the trend lines, it's not uncommon that things in API slow down in the December quarter because most of the manufacturers put capacity in place earlier so that they can have devices on the shelves for the holiday shopping season. I don't think there's anything terribly unusual here. Overall handset demand hasn't changed in a dramatic way. There's some shift between devices. That more or less always happens.

But I think it's timing based on where we are in the buying cycle for the year. And then, of course, there's always a push when new devices get launched. There's always more capacity that goes into the fabs that are going to build them. So again, pretty much a standard response from what we've historically seen.

Okay. The supplier issue, did that have any impact in this quarter? And is it sort of -- it sounds like it's isolated to one big-ticket item. But is there a trickle effect, down effect? Does it hurt margins at all other than a little leverage you may get on that one sale?

Yes, Larry, Kevin here. It's a fiscal Q2 concern. A single system as I mentioned on the prepared remarks, $10 million. Obviously, that has up-and-down impact to the P&L. I'm not going to get into margins because we're not going to isolate that on a single machine and convey margins to that. But clearly, it had an impact with -- or impact on guidance.

Got it. And then just last question on the tax rate, Kevin. Obviously, the lower (inaudible) survey doesn't benefit you guys too much. The slightly lower going forward or at least for next quarter. Does that include an adjustment for the repatriation of funds that I guess you have spread out over 8 years or whatever?

Yes. So actually that's the actual cash payment for the repatriation. We have to basically accrue all that and identify that into the tax rate as a discrete item. That's been done for Q1. If you look at the GAAP rate versus the pro forma rate, right, there's a pretty significant difference.

But as we look into Q2, as we make up the shipment, we'll generate more of our income overseas at higher tax rates, and that's why the 28.8% pro forma tax rate for Q1, we guided 29% to 30% for fiscal Q2.

Okay. So it sounds like we'll sort of stay in that high 20%s to 30% range for the foreseeable future at least. Is that...

At least for Q2, yes.

Your next question comes from Mehdi Hosseini.

I only have a few questions, no 5-part question. Going back to flat-panel display, how would you characterize opportunities for Coherent when comparing rigid to plastic OLED? You can either tell me about the TAM or from a pixel count.

But it seems like there's a lot of noise out there, and when it comes to smartphone market, maybe some of the confusion has more to do with the rigid versus plastic. And any color here would be really appreciated.

What matters to us or what matters to our business is the square meters per month that are produced. Whether it's rigid or flex is irrelevant. It's the same hardware. It's almost an identical process.

Right, right, right. Okay. Now -- so to that extent, and if you are so confident about underlying business momentum and the long-term growth prospect, why not help us. Perhaps you can tell us about where these systems are shipped to -- maybe shipment by geography, especially with your nonflat display business in China growing, that could help diversify outside of Korea.

Is there any metric or any way you can help us better understand longer-term opportunity rather than being so preoccupied by the daily noise?

Yes, Mehdi, Kevin here. Frankly, we can't parse it down to that granular level. As you know, there's still pretty much a single dominant supplier out there. And if we were to talk about some of those numbers or calibrate it that way, it would just correlate right back to that single dominant player. They don't like that. We don't like that.

And so until the supplying or the industry broadens out, we're still going to be -- have to be elusive with how we characterize shipments and so forth. We just can't go there.

Sure. Sure. How long will it take for you to scale this fiber laser opportunity in China?

That really depend on -- with this -- the one that I mentioned, you mean, with the single customer?

Yes.

So that's going to be dependent on the customer somewhat because they're going to -- they've ordered a bunch of devices from us. They'll put those in the field and evaluate both short- and long-term performance.

And if we check all those boxes, then we have an opportunity to compete for a larger portion of their business. I can't tell you if that's a 3-month process or a 6-month process or a 1-year process. I think it's going to be very dependent on how the customer -- how and where the customer deploys those products.

Sure, okay. And my last follow-up has to do with insourcing components as it relates to Rofin. Given all the variability that you have to deal with in the flat-panel display and new product ramp, why not accelerate the insourcing of component for Rofin?

And why not try to perhaps reach that inflection point with Rofin gross margin, which could have a positive impact on the blended gross margin?

The process of insourcing follows a pretty predictable pathway. And as I mentioned in previous calls, we did a design rev on an existing product. That went through testing. We wanted to dial it in a bit further so there was a tweak.

And then you go through another growth phase and growth mean a net tax so growth is actually making the devices. And once you have them made and packaged, you can start to put them through testing.

Now some of the testing, you could do in an accelerated fashion and some of the testing, you just have to let them cook because you're trying to develop long-term reliability data before you put these things out into the field in mass quantities.

We're at a point where the time line is probably somewhat incompressible around the data collection. But again, it's completely in sync with what we told people to expect that we'd ship vertically integrated product this year. And if all those things pass the checklist, then we could take it across the portfolio.

And I apologize, Mehdi, I'm repeating myself again, but just to make sure it's clear, we do have some inventory of these third-party diodes. We're going to want to burn through all of those first before we go to a completely internal supply. It's underway. I can't give you an exact date because we haven't finished the data collection yet.

Your next question comes from the line of Joe Wittine.

First off, as it relates to OLED application development, so you obviously have some visibility of what's happening at the device level, certainly better visibility than I do.

So John, what applications excite you today as potential kind of near-term needle-movers, be it in smartphones or beyond? And then what are your updated thoughts on the smartphone adoption curve as you've positioned it before through 2020, et cetera?

Sure. So again, I'm going to go back to comments that we've made in the recent past. What we're hearing in the marketplace is OLEDs broadening beyond smartphones. There's discussion of it being brought into tablets, and that probably becomes more of a reality as more vendors come into play on the OLED side.

And then people have very polarized opinions about a foldable phone. Some of them were demonstrated at CES a little over a month ago. There was the full spectrum of reviews and opinions on them. But if you look at a device that can be a game-changer from a user perspective, that's probably one of them.

They're -- and I'm going to sound terribly biased, and I don't -- well, I'm going to sound terribly biased. A lot has been decided -- seemingly decided about this market based on the performance of a single smartphone.

The momentum that is behind OLED seems to be quite strong and quite sustainable over a long period of time. And one of the things that we keep talking about is, you have to look at the overall costs in the long term, where you have a tremendous difference in the material costs between OLEDs and LCDs, and you have a pretty significant performance gap between OLEDs and LCDs.

The conversion is going to happen. We could argue exactly when it's going to happen, but it's going to happen. And that view on our part hasn't changed. And apparently, based on what we're hearing from customers, it -- not much has changed from their standpoint in terms of continuing to make investments to develop the technology and to expand capacity.

That's very helpful. And I'm glad you pointed out the current device. I mean, I think it's pretty commonly accepted that the demand-related problem for the X is principally price related.

So on that, do you get the sense that the cost of the panel is kind of functioning as the key part of the bill of materials that necessitates those high prices? And second, do you get any sense from the supply chain that we will see lower device prices to counter weak demand in the near term or from where you see it? Are the device makers content with maintaining devices at the current price point for -- call it, calendar '18?

So Joe, great questions. And while I love to opine on things that are above my pay grade, it's difficult for me to tell you exactly what's driving the pricing decisions on the handset. I think what you hear in the marketplace is that the display is about 2x the cost of a high-end LCD.

So $35, $40 to $70 to $80, I mean, those are the numbers that have been thrown around by people who've done the teardown analysis. That's not data that we produced. And I can't comment on its veracity. I'm just parroting what's been out in the marketplace.

But taking a handset from a $700 price point to $1,000 price point, if the only change was in the display, that seems like an awfully big step to take. So there's clearly -- clearly costs have been added somewhere else because, at least if you look at the manufacturer's most recent financial statement, which was unbelievably good, not a big move in gross margin. So if the new device were dramatically higher in gross margin than its predecessor, you would have expected to see some sort of a shift.

So again, I'm drawing a lot of conclusions here based on a limited amount of data, but it would suggest that costs have gone up from multiple components within that build.

Yes, fair points. Okay, and then quickly on the fiber win, congrats by the way, is this your first high-power sale to that OEM? Meaning you or legacy Rofin? And then I just wanted to ask what the power level was. Is it 1 and 2 kilowatts like we're seeing in most of these Chinese integrators today?

No. Well, let me answer the last question first. So in my prepared remarks, I said the order was for a mix of 3- and 6-kilowatt lasers. It is not the first sale that we've made to this customer, but it is the first time that we've taken a volume order from them.

Great. And then finally from me, Kevin, a quick clarification. Thanks for quantifying the euro impact on the margin lines. I just wanted to clarify, is that compared to euro at year-ago levels? Or is that the sequential change you're seeing right now? That'd be helpful.

Yes, Joe. Thanks for that clarifying question. It is the sequential change. Certainly, since January, the rate or the exchange rate has just taken off. And so we will compare it to prior quarter. That's the most immediate impact.

Your next question comes from the line of Jim Ricchiuti.

John, we've been hearing from some of the industry players commenting about some strength in areas of the laser business you don't normally associate with growth: CO2. Are you seeing, hearing any of that?

Our CO2 business actually has been performing quite well, not only for our standard portfolio of a few tens of watts to hundreds of watts. But even the legacy high-power CO2 business that we acquired in the Rofin acquisition has shown signs of life, which is -- it's a pleasant surprise, but not one that we saw coming.

Yes, what do you attribute to that, the strengthening that you're seeing in that area?

So in -- for the low-power applications, I think the drivers are very similar to what we're seeing in the broader markets, whether it's in the microelectronics business or the materials processing business.

For the high-power products, I think this is predominantly repeat business with customers that have an established process that don't want to change the process. So they're seeing growth, and to support that growth, they're just copying what they have.

Okay, that makes some sense. Automotive, sounds like you're seeing reasonably good demand there. You've talked also about opportunities in the battery welding market, which is, clearly, an area that, at least for the fiber laser, suppliers has been an area of real interest. What can you say about that market?

It continues to be a very hot market, attracting lots of investments. It is -- it's still early if you think about the number of batteries that are being produced. It's still small compared to the overall opportunity.

And as a consequence, there's a lot of volatility, order shifting from one quarter to another, manufacturers changing processes. They're trying to optimize things, so that causes pushouts and pull-ins. It's very common for -- I would say from our perspective, it's very common for an early stage market.

Okay. And last question, any follow-on orders in the glass film cutting area? Or maybe can you characterize the pipeline there?

A lot of activity going on with glass cutting particularly for our SmartCleave portfolio. We have seen some good orders there, and I know that we're doing a lot of development -- process development work with customers right now.

I would expect -- I can't tell you this with absolute certainty, but I would expect as new cell phone models come into the marketplace, that's when the opportunities become much larger. When you're in between product launches, you're doing a lot of development work. It's when the product launch, they push the go button is when the orders start flowing pretty quickly.

And at this time, we have no further questions in the queue. I will turn the call back over to John Ambroseo for any additional or closing remarks.

Thanks, Jesse. Again, thank you, everyone, for joining us, and I'm going to apologize, once again, for the late start. We will do everything we can to prevent a repeat of that. Have a good day. We look forward to talking to you, again, soon.

This concludes today's conference call. You may now disconnect.