IPG Photonics Corp (IPGP) 2007 Q3 法說會逐字稿

Good morning, and welcome to IPG Photonics Third Quarter 2007 Conference Call. Today's call is being recorded and webcast. At this time, I would like to turn the call over to Angelo Lopresti, IPG's Vice President and General Counsel and Secretary, for introduction. Please go ahead.

Thank you and good morning, everyone. With us today is IPG Photonics Chairman and Chief Executive Officer, Dr. Valentin Gapontsev and Vice President and Chief Financial Officer, Tim Mammen.

Statements made during the course of this conference 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 known and unknown risks 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 details in IPG Photonics Form 10-K for the year ended December 31, 2006. In other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investor Relation section of IPG's website at www.iptphotonics.com or by contacting the company direction.

Any forward-looking statements made on this call are the Company's expectations or predictions only as of today, November 6, 2007. The Company assumes no obligation to publicly release any updates or revisions to any such statement. We will post these prepared remarks on our website after the completion of the call. Please go to www.ipgphotonics.com to view these remarks. I'll now turn the call over to Dr. Gapontsev.

Good morning. Once again, we reported (inaudible - highly accented) revenue and net income. These were in line with our guidance. Sales from material processing application continue to be a key growth driver with (inaudible - highly accented) application also gaining momentum.

Additionally, we are seeing Telecom application starting to recover. Most of these Telecom are coming from Russia, but we are starting to see opportunities in other areas of the world. Before I turn the call over to Tim Mammen, let me review highlights for the quarter.

Third quarter revenues increased 32% to $47.9 million. Our sales growth also continues to translate into strong bottom line performance. Net income increased 80% to $8.6 million and diluted EPS increased to $0.19 from $0.12 last year. I will now turn the call over to Tim Mammen.

Thank you Valentin and good morning, everyone. I'll start with some operational remarks and I will then review our financial highlights. Let me start by discussing some of the areas where we are seeing increasing traction for our high-power fiber lasers.

We continue to make progress penetrating the automotive market, particularly among automotive integrators. Again, this quarter, we have shipped several kilowatt lasers to numerous US, European and Asian automotive and component manufacturers. Applications include welding fuel injectors, tailored blanks and mufflers.

In addition, we continue to make progress in penetrating different heavy industry applications, such as shipbuilding, pipeline construction and nuclear power station repair and dismantling.

In shipbuilding, our lasers are being used for cutting, welding, and (inaudible). One positive trend that we are seeing with welding applications is a greater acceptance of our products from integrators. In fact, at the upcoming FABTECH International and AWS Welding show this month, numerous integrators are going to be demonstrating IPG lasers, both remote welding and also cutting.

One integrator will demonstrate both cutting and welding on two separate robots using a single laser with a beam switch. Last quarter we mentioned that our new pulsed laser product lines were opening up new opportunities for IPG and deep engraving, solar panels and display panels.

During the third quarter we saw increased orders for pulse lasers for solar panel processing in North America and we are continuing to work on new opportunities with customers in the US, Europe and Asia.

We see this as a strong growth area for us going forward. Cutting applications also continued to be a solid growth area for us. We received several repeat and new orders in Europe and India for cutting applications from smaller integrators who were starting to build volume and we see growing interest from other integrators, as well.

A key part of our growth strategy is to displace Legacy lasers, as well as non-laser technologies in sophisticated materials processing applications, continue to make progress in this quarter on that effort.

For example, during the quarter, we continue to sell our fiber lasers to customers for the welding of aluminum in train cars, these customers who previously used non-laser techniques taking advantage of the maneuverability of our lasers' flexible delivery cable.

We are also seeing our fiber lasers displacing traditional lasers in electronics welding for lithium batteries. In addition, a new OEM customer in Germany that previously used a competitors' lamp pumped yag laser is now using our fiber lasers for 3-D robotic welding. This application represents the opportunity for multiple future orders.

We've continued to expand certain manufacturing capacity. We took delivery of the second of three new MBE wafer growth machines, expanded burning facilities for testing diode chips and added capacity for packing our new high-powered diodes.

Burning and packaging are two areas where we were approaching capacity limits. In Germany, we moved into new general manufacturing facilities for low and medium power lasers.

Now I'll turn to the financial results. Let me start by giving you some key highlights for the quarter. Revenue for the third quarter was $47.9 million and represented an increase of 32% year-on-year primarily driven by an increase in sales by our materials processing segment of 37%.

Dollar sales of high power lasers increased by 41% compared to one year ago. Gross margin was 45% compared with 48% in Q3 2006. Operating expenses at 19% were at the low end of our target range. Operating income increased by 24% compared to the same period one year ago.

And as Valentin mentioned, earnings per share were $0.19 which represented a 58% increase year-on-year. Now, let me provide you with some more information about how we performed in the four markets that we target.

Materials processing which is IPG's largest market contributed 72% of revenues in Q3 and grew by 37% year-over-year. Sequentially, materials processing sales only grew by 2% mainly due to some weakness in Japan. On the sequential quarter basis, we are expecting materials processing sales to grow more strongly in Q4, 2007.

The materials processing segment encompasses several end markets, such as general manufacturing, automotive, aerospace, heavy industry, consumer, semi-conductor and electronics. We have seen growth from each one of these markets for a range of applications.

I've already mentioned some of our successes with welding and cutting applications. We also continue to penetrate marking, printing, centering, and diamond cutting applications during the quarter. We continue to be very encouraged by the growth prospects we see in the materials processing market.

We are also seeing accelerating growth from advanced applications for our fiber laser technology. Advanced applications include test and measurement, instrumentation, sensing, and defense applications, as well as scientific research and development.

The advanced applications segment represented 13% of total revenue during the third quarter. On a year-on-year basis, advanced applications revenue increased by 25%. This growth was driven by sales of kilowatt lasers used in destructive testing, high-powered amplifiers for government applications and continued growth of low-power lasers used in the sensing and mapping of applications.

The recent successful use of our off-the-shelf products in several high-power applications has generated additional interest from the governments and defense industries. We believe the momentum we've established in this segment will continue to build.

We continue to see a robust pipeline of early staged projects that could use our advanced commercial lasers. Features of our fiber lasers, such as high beam quality, robustness, high electrical efficiency, lack of consumables, are key elements for the driving the replacement of non-laser methods with lasers.

Lasers for the medical applications segment comprised 5% of revenue in the third quarter. As we anticipated due to customer order paths and the sales were down 24%, or by $789,000 from the third quarter of 2006. Our sales in this segment continue to be concentrated with one OEM and our goal is to diversify our customer base in this segment in order to reduce the sales volatility we see on a quarter-to-quarter basis.

The communication segment comprised 10% of our revenues in the third quarter. We are starting to see a turnaround in this segment with revenues increasing by 74% year-over-year. The year-over-year quarterly growth should be looked at in context. Telecom sales in the second and third quarter of 2006 marked the low points or the weakness we've experienced in the segments.

The recovery in the communication segment is best reflected by the fact that sales in the third quarter of 2007 were higher than they were for each of the prior six quarters. As Valentin mentioned earlier, most of this growth is driven by demand for integrated systems in Russia.

We are supplying DWDM equipment which includes IPG's fiber amplifiers and transponders for Northwest Telecom's expansion of its already extensive network by 5,000 kilometers connecting 120 locations.

Northwest Telecom is one of Russia's largest Telcos. We are starting to see some indications that our communication sales in North America and other parts of the world should see further recovery in 2008.

Turning to the performance of our laser types in the third quarter, high power fiber lasers, which are primarily used in materials processing and advanced applications continue to be a key to growth driver during the quarter.

On a year-on-year basis, sales of high power lasers increased by nearly 41% and represented approximately 29% or $14 million of total revenue in Q3 2007. Sequentially high power laser sales were up 21% from the second quarter.

The timing of high value and low volume orders received from customers can make high power laser revenue uneven from quarter to quarter. That said, we expect high power laser sales to continue to be a significant growth driver for us in the years ahead.

Sales of medium power lasers were essentially flat for the third quarter of 2006 and represented 9% or $4.1 million of total revenue in Q3 '07. Pulse lasers increased by 41% from the third quarter of 2006. As a percentage of revenue pulse lasers represented approximately 31% of revenue or $14.9 million in Q3 '07.

As I mentioned earlier, we are seeing growing demand for our pulse lasers for the solar panel processing market. In addition, simple and sophisticated market applications continue to help drive sales of our pulse lasers. An example of one of the more sophisticated marking applications is holographic marking of credit and ID cards. We're particularly pleased with the resiliency we continue to see from this product line since it is the line that we have been producing for the longest period.

Turning to our geographic performance during the quarter. We reported 31% of revenue from Asia and Australia, 41% from Europe and 28% from North America. Sales to Europe increased 41% year-over-year, driven primarily by strong growth from Eastern Europe and CIS countries where we are experiencing growth in materials processing and a rebound in Telecom sales.

Sales in Asia and Australia markets increased 28% compared with the third quarter of 2006. Strong sales from our new Chinese office and growth in South Korea contributed to this growth, but overall growth in Asia and Australia was offset by a decrease in Japanese sales.

The volatility related to Japanese sales is in part due to the timing and shipment of high value orders, but could we believe, also be an indication for some economic softness there.

Sales in the US increased 27% over Q3 '06. Overall, we believe the application, geographic and product line diversity of our business model is enabling us to continue to grow revenue, even when one or more of our end markets is experiencing some weakness or volatility.

Gross margin for the third quarter was 45%, which while within our short-term median target range, is a little lower than we would like to see. This compares with 48% gross margin we reported in the third quarter of 2006.

The decrease in margin is primarily the result of a sales mix comprised of higher proportions of high power lasers which have a higher materials content and a slightly lower contribution margin than some of our low-power and pulse lasers and our amplifier products.

In addition, mid-power lasers comprised a greater proportion of sales in the third quarter of 2006. We also saw the trend of better absorption of fixed and semi-variable manufacturing costs flatten this quarter, as we brought on more capacity and additional human resources in manufacturing.

Inventory write-downs in Q3 '07 totaled $392,000. SG&A was $6.5 million or 14% of sales compared with $5.3 million or 15% of sales in the third quarter of 2006. SG&A as a percentage of sales was lower than our target range for the short-term of 15% to 18% primarily due to a gain on exchange rates of $610,000. We are still targeting an SG&A range of 13% to 16% of sales in the longer term and we hope to generate some additional operating leverage towards the end of 2008.

R&D expenses were $2.4 million or 5% of third quarter revenues. This compares with $1.7 million or 5% of revenues in Q3 '06. In absolute terms, R&D expenses increased by 39% year-on-year. Our target range for R&D is 5% to 7% of revenue in the short to median term.

Our sharp focus on targeted R&D objectives, combined with rapid development cycles and our results driven culture have kept IPG's R&D expenditures low as a percentage of revenue. Operating income increased by 24% compared to the same period last year. IPG generated operating income of $12.8 million or 27% of revenue compared with operating income of $10.3 million or 29% of revenue in the third quarter of 2006.

Operating income includes charges related to stock-based compensation of $396,000 and $190,000 in the third quarter of 2007 and 2006 respectively. In the third quarter of 2007, $81,000, $233,000 and $82,000 of stock-based compensation charges related to cost of sales, SG&A and R&D respectively.

Our tax rate for the third quarter of 2007 was 26.3%. The tax rate benefitted from legislation passed during the quarter that will reduce our effective German tax rate in 2008 to approximately 30% from 38% in 2007. As a result of reevaluating our German deferred tax liabilities to the new enacted rate, we had a tax benefit of $982,000 in the third quarter.

The underlying effective rate for the full year 2007 is expected to be 36% slightly lower than the 37% we are estimating at the end of the second quarter. Excluding the benefits of the third quarter the underlying effective rate for Q3 was 34%. For 2008 we have estimated that the change in enacted rates should reduce our overall effective rate to approximately 32%.

Net income for the third quarter of 2007 increased to $8.6 million or $0.19 per diluted share compared with net income of $4.7 million or $0.12 per diluted share for the third quarter of 2006.

Let me now turn to our balance sheet, which continues to be strong. Cash and cash equivalents at September 30, 2007 stood at $44.8 million compared with $75.7 million on December 31, 2006. As we mentioned on previous calls, in January, we repaid $18.2 million of the remaining bank term debt in the US and Germany leaving a balance of $20 million related to subordinated notes outstanding.

We also increased our liquidity with two new credit lines, one obtained in Q3 and the other in October. Year-to-date 2007 capital expenditures totaled $26 million and were primarily related to completing our expenditures on facilities in the US and Germany for diode, fiber and other production, as well as the acquisition of equipment.

During the first nine months of the year, there was a negative net cash flow from operations of $0.5 million. This compares with cash flows from operations of $9.9 million for the same period of 2006. The decrease primarily resulted from an increase in several working capital items primarily inventory and taxes offset by an increase in net income.

We believe that the increase in working capital license such as inventory is consistent with present and expected sales growth. We also continue to maintain strategic stock levels of certain critical inventory components such as diodes.

We have paid $17.5 million in cash taxes through the first nine months of 2007 as compared to $1.4 million in the same period of 2006. As a result of net overpayments in Germany for 2006, we expect a tax refund in the fourth quarter.

Even excluding this repayment, we are expecting operating cash flow to improve in the fourth quarter. With regard to our line of credit facilities as of September 30, we had a total of $17.6 million available on our US, German and Japanese credit facilities.

We will continue to use these facilities from time to time in order to finance our short-term working capital requirements. These funds do not include a new $15 million Euro or $21 million unsecured revolving credit facility that we entered into in October. This new credit facility offers us better terms, a longer term committed line and also additional liquidity.

Before we take your questions, I would like to provide you with our guidance for the fourth quarter of 2007. For the fourth quarter, IPG Photonics expects revenues in the range of $51 million to $54 million. The company anticipates earnings per diluted share in the range of $0.17 to $0.20.

That is based on 45,731,000 diluted common shares, which includes 43,362,000 basic common shares outstanding and 2,369,000 potentially diluted options, and compares to a share count of 34,550,000 common shares used to calculate earnings per share for the fourth quarter of 2006.

In summary, we continue to report solid financial results in line with our guidance. We also continue to execute well on our growth strategy positioning IPG to leverage our superior technology, to capitalize on significant growth opportunities across many diverse markets. With that, we'll open the call up for your questions.

Thank you. (OPERATOR INSTRUCTIONS). We'll go first to John Harmon at Needham & Company.

Hi, good morning.

Hi, John.

Just a couple of questions. First of all, you probably explained it last quarter, but just talk about why you saw lumpiness in your medical quarters, and then secondly more of a technology question, some other companies in the CO2 laser space have been talking about fiber lasers having difficulty making inroads versus CO2 due to the cut quality; I'd like you to comment on that.

I'll just answer the medical question, then I'll pass the cut quality on to Valentin. On medical, we are still very reliant on one main OEM who do adjust their purchasing patterns from quarter to quarter depending upon their own demand and inventory levels.

So that continues to lead to some volatility in that segment. We also continue to work with several other potential OEMs. I would say it is taking a bit longer to develop those OEM relationships in the medical area, but we are seeking to diversify that business.

As far as the question related to cut quality on fiber versus CO2, Valentin, perhaps you can address that.

And that's regarding sheet metal, please.

First regarding medical, I would like to (inaudible - highly accented) qualification between our customers, so we try and have (inaudible - highly accented) during the quarter for end of first quarter of next year, so I believe the medical business or medical growth is very essential.

Regarding the cuts different in quality cuts by CO2 and fiber laser, it is not true some people speak of latencies, but it is the study of the (inaudible - highly accented) cuts quality with CO2 lasers more than 25 years. With fiber laser, it's less than two years, but to do it was very big progress achieved during the time and quality is now become comparable. It's our own application center, which is very good result.

We simply wanted (inaudible - highly accented) reported but I can run off institute excellent result in total in full range of cut from thin metal up to 20mm thick. (inaudible - highly accented) of CO2, but still it should be further improvement, so we don't see any principal problem in speed of cutting with fiber laser it's three times higher so for example, it's so we need three times less power for the thin metal than with CO2 laser, so it's compared to fiber laser is extremely complex during this application.

Thank you.

We'll move next to Antonio Antezano at Bear Stearns.

Good morning.

Hi, Antonio.

I was to understand, regarding your outlook for gross margin, what is what you are embedding in your guidance for Q4 and as we go into 2008 what kind of gross margins you expect?

Gross margin guidance is the range between 45% and 49%. As I mentioned, I think we were a little bit lighter where we wanted to be in Q3, probably about 1% or so. In Q4, we expect to see some improvement, and I think that in 2008 we should start to get towards the top end of the range 45% to 49%.

Okay, and then in China, now that you have an office there, what is the growth that you're seeing in that region and what are your expectations also going forward?

In China, might be a problem, still some limitation, physical limitations due to the export control (inaudible - highly accented) why they need such control, but we expect it would be some change in the regulation, at least to open up much more opportunities in this case. Now, we are selling in China only very low (inaudible - highly accented) and (inaudible - highly accented) lasers could not go off of a 50-watt, but we expect shortly it will be improvement in this. We're working very hard in this direction, so we will double, triple our business very shortly, which will resolve the problem with export control.

Thank you. I'll go back to the queue. Thank you.

We'll move next to John Lau at Jefferies & Company.

Great thanks. I wanted to focus on to a different area for advanced application. I was wondering if you could comment to us on the work that you're doing on some of the military projects that you're doing, and specifically comment upon the technical advantages.

Is it the beam quality, or what is the edge that fiber lasers have in some of these new destructive applications? Thank you.

(inaudible - highly accented) upon military sources, what's been enormous multi-billion dollars as we know, but the results is very limited. There were limited up to date. The fiber laser in our opinion was unpractical and [inaudible-heavily accented] performance and practical and people find they could use these with the, for the most targets.

From the knowledge, this application of (inaudible - highly accented). Due to the compact variable, this is easy to use and also the excellent beam quality is not for what people dream of (inaudible - highly accented), but (inaudible - highly accented) final target, but for many applications now it's ready to use.

And the other key thing, Valentin, is just the scalability of the power. Nobody can even combine up to the power levels, John.

Okay in terms of the reliability and the quality of beam is that because the beam quality is finer and can reach the target better than the CO2 lasers? Is that the key --

(inaudible - highly accented) most military targets because of wavelengths and (inaudible - highly accented). Fiber (inaudible - highly accented) much better beam quality than CO2; it's compact and it's a mobile device, so it really corresponds to most of the requirement of such application.

And one final follow-up, you mentioned, Tim, that Japan was weaker, some issues there maybe with the economy there. Are you seeing the corresponding pick-up in the United States or what areas are picking up for that short fall? Thank you.

I think it's definitely some of the advanced applications order flow in the US, I think as well, that the US actually for us continues to be fairly resilient. We haven't seen any fall-off in materials processing orders. We're starting to see some nice growth in the US. I think where a lot of work at the high power level has been done with a lot of integrators and numerous other end users.

So overall, I'd say the US is more robust and we're quite pleased with overall performance here.

Great. Thank you very much.

We'll go next to Ajit Pai at Thomas Weisel Partners.

Yeah, good morning.

Hi, Ajit.

A couple of quick question. I'll first begin by just revisiting a gross margins. For 270 basis point decline, but sequentially a year-over-year I think about 70 basis points of that is in inventory. Could you give us some color as to what that inventory write-down was?

And then of that remaining 200 basis points, how much of it was additional capacity coming online and how much of it was product mix and of that also some color on moving to high power lasers, what the impact on the gross margins is and the Telecom sort of rebounding where that was a negative impact on gross margins, as well.

The Telecom rebounding wasn't a negative impact, I think it was more the lower proportion of medium power lasers just on product mix where our profitability on medium power lasers is very high. You said what was the splits from the remaining 200 basis points between product mix and capacity additions. I'd probably say it was at that level of 1% or 2%. Maybe just over a percent was capacity and a percent was product.

We have added quite a lot of capacity during the course of this year. So probably 1% on product mix, 1% on capacity and then the inventory write-down, so overall of the margin, I think when you all talk about relatively small numbers like that, it isn't overall an issue for us to worry about as something we continue to monitor and keep an eye on and we do expect to see some improvement in that in Q4.

Got it, and looking at the scalability of the diode manufacturing, you're already I think, mentioned you're the largest manufacturer of diodes. Is there still some scale benefit to be gotten there or is it just like capacity additions where when you start your gross margin will fall and then a ramp-up. Is there still some advantage in cost that you can bring down there?

I think yeah on the diode area, we've only just started to expand the chip production through the new machines. What we have noticed is that the yield rates on testing using the new MBE equipment in the last probably six to eight weeks has improved quite nicely and that, as a cost benefit on the diode should start to come through in Q4 and Q1 next year. So while the differences in cost may not be as dramatic as they were in 2004, we do believe we can drive some marginal improvements on diode chip on submetal cost in the nearest term.

We are working very hard, in the usual two degrees of cost of components because we can throw all the quality and cost of components. This year again, we'll have benefits with the degrees of cost of diodes, not only cheap, but also packaged diodes, very essential degrees, so it is the same where we have a degree in the cost of our fiber (inaudible - highly accented), fiber (inaudible - highly accented) and so all core components we use now.

Each year, we'll have benefit and this year also due to better technology with much larger capacity, much better redundancy and the ability to now to direct each machine for special product not to use one machine for many different products, we have improved quality in degrees of cost of the yield.

It's very essential impact for our final manufacturing cost of our product, which in our initial practical, finish optimizing of our prices for most of products including mid power, low power and high power lasers, we try to hold the cost, the price so this product (inaudible - highly accented) project or power or our competition don't (inaudible - highly accented) to do down, but due to improvement from the degrees of costs of components of our margin, we expect we will growth of project we are sure to grow.

Is it fair to assume that the gross margin was not impacted by pricing at all just based on Valentin's commentary right now?

By and large I think that's true, though it's good stability on high power pricing. We did see maybe compared to a year ago an 8% decline on low power prices on average and maybe a 5% on pulse, but the effect of pricing was probably minimal during the quarter.

Got it,

-- and what did you ask what that inventory write-down related to?

Yes.

It was actually a 90% of it was related to some different type of diode we're developing on a different type of mount which after intensive testing we've determined the reliability of those chips was not going to be suitable to go into, but we had been using them in some products, for demo units, but we basically decided we're not going to use those mounts going forward.

Got it. And then just two more quick questions before I get back in queue. I have some other questions, as well. One is about the Navy, orders from the Navy. I think you had mentioned you had finished the delivery of those before the end of the year? So there are two things I noticed. One is I think you didn't comment on the receivables in your sort of prepared remarks. But receivables by much more than they have in the past like two years. So is that to do with most of the orders already having been shipped and recognized as revenue for the Navy order?

No, that really has to do with the fact that the timing of most of our shipments in the third quarter was in the last month of the quarter. We had about 50% of revenue falling into September in part because we shipped part of that Navy order then, but that was really why receivables spiked. It was just because of the timing of shipments and revenue during the quarter.

It's nothing to do with the de-rating quality of your client base?

I would say our client base continues to -- it doesn't deteriorate at all.

Financially, Okay.

We continue, if you say that, for example in Russia where credit control and collection procedures are perhaps not as highly developed as they are here. We continue to have extremely strong credit procedures in Russia where I will try and get pre-payments or letters of credit where we even have had issues of collection in Russia we've actually managed most of the time to resolve those and either by withholding further supplies to a customer, collect cash if they're an integrator. So I would say receivables performance in this company continues to be very, very good.

Okay, I have a few other questions, but I'll get back in queue.

Also add to that, our shipment in Quarter 3 wasn't much higher, but due to some (inaudible - highly accented) revenue recognition we reported the (inaudible - highly accented) for results.

Next we'll go to Thomas Diffely at Merrill Lynch.

Yeah, good morning, could you talk a little bit about the capital spending plans for both the fourth quarter and 2008 and then what the effect on depreciation is going to be?

Hi, Tom. I think CapEx in Q4 probably be around $4 or $5 million. It should be a little bit lighter than it has been in the earlier part of the year. We're still finalizing the CapEx budget for 2008. But I would target a number of around $25 million with a range of let's say up to $30 million.

Okay, and have you seen a depreciation ramping over the next few quarters?

Obviously I think that some of the CapEx next year will relate to facilities that will only come on stream in the second half of the year. I think that the facilities that are being built out over the last year are now basically on stream and the depreciation started to come through in Q3. There'll be a little bit more of an impact in [Q2] or 4. Some equipment will obviously be purchased through the first half of next year, so I would say, if you're talking about how you see some steady step-ups in depreciation quarter on quarter at the moment.

Okay, and could you just --

That's difficult question to answer. I'm sorry I'm being vague.

That's fine. Can you give some sort of sense as to what your capacity then is end of '07 and what you project at the end of '08?

Where we are on capacity?

Yes.

I think that we continue to look at that in three or four different areas. First of all, with the expansion of our new chip manufacturing plant, we'll probably only be at around 40% capacity there. When we get the new third MBE in which will be partly for redundancy and then having an MBE be cleaned while another one's functioning, we' think that we can probably get to doubling revenue without significant addition on MBEs.

On fiber, the fiber facilities that was running at full capacity could draw thousands of kilometers of fibers but we just draw very, very specialist fiber in small quantities, so on the fiber equipment, we're relatively low capacity level. I wouldn't think we'd have to even double in revenue invest significantly in fiber.

On the area where we work money in high capacity, we were essentially consuming all packaged diodes, continuing to invest in the diode packaging, I mentioned that, so we probably brought capacity down from where was it 80%, 90% to maybe 70% or we continue to invest in the packaging, and then burning of chips, as well, is an area where we continue to invest. The other aspects of capacity related to assembly and manufacturing will add incrementally as we go forward.

Okay.

And we are next year we have to finish our plan of developing with water capacity was for components and for assembly and to [make the way with] (inaudible - highly accented) stock for couple of years because the capacity which we'll be ahead of next year which we'll win out for (inaudible - highly accented) business $.5 million.

Do you have a sense on what just the study, say, capital study would be if you weren't expanding?

Actually I could not answer that question off the top of my head. It would probably be somewhere around $11 million.

Okay, great. Thank you.

And we'll go next to C.J. Muse at Lehman Brothers.

Hi, this Olga Levinzon Everson is calling in for C.J. A couple of questions, I guess you mentioned that you're seeing nice growth and that you lost orders across most of the applications. Are you seeing any macro concerns on extendings or decision-making time on many of your customers or geographies just overall in looking at 2008?

In the US I think we're presently surprised by the robustness we're seeing here. I think that we're also seeing some opportunities arise in the US just because of the additional productivity in some instances where people are using, for example, helium gas, accelerated pay-back times they can get by converting to our lasers.

So we haven't seen macro conditions in the US affect things. I think the one area potentially where we are seeing it is in Japan where we have a lot of high power laser business.

But to a degree we have only one quarter so far in Japan for to see what happens in Q4 and maybe something to do with just the timing of orders or the development cycles they're going through in developing new applications and processes. But definitely Japan is the one area where macro-wise our feeling is that it's affecting us.

Now our booking for Quarter 4 and Quarter 1 is much higher than it was for previous quarters, so we feel confirmed that our expectation is really realistic.

Okay, and I know you don't usually talk about specific numbers for your backlog, but can you kind of talk about the level relative to your revenue guidance for December and what kind of visibility you have right now?

Visibility continues to be pretty good. I'd say that 90% of our guidance is basically in confirmed orders.

Okay, so shifted to the next one quarter, one to two quarters?

I mean that doesn't include other backlogs. I'm saying that in terms of the guidance we've given, probably around 90% of it is available to be, is already ordered in-house.

Okay, got 'ya. Okay, and then looking out, you talked about in terms of the gross margin, part of it was extended capacity, what kind of impact, is that impact going to be start diminishing after you get past the December quarter or will that still sort of be a light downward drop in margin?

I think we do have gross margins to increase in Q4 and that should be maintained even given some of the seasonality in the business in Q1 and then to get to the top end of our target range in the second half of 2008.

Okay. And then one final question, given that SG&A was slightly lower than what you had guided to in the last quarter in terms of the near-term, how should we think about SG&A in the next two to three quarters?

If you look at SG&A and just take out the exchange rate, transaction exchange rate benefit of $610,000, you get back to a more normal state of SG&A there. Even with that $610,000 added back it was kind of at the low end of our range due to some benefits on assorted expenses. I will still say that we're targeting in the median term 16% to 18% range.

Yeah, I think 16% to 18% is what you said. Okay, and I guess one final question. You had, I think it's an advanced application, revenues went up by about 57% quarter over quarter, was that mean a couple of bulk orders was that penetration of a lot of different customers? How should we think about that growth going forward?

Now, having some of the benefit on advanced came through from the big Navy order, so we shipped part of that order and part of it we'll ship in Q4.

I think we've had a nice growth on even some of our lower prior applications like sensing and topographic mapping, as well as good sales of some specialized high power amplifiers for government use and also some rather high power lasers being used by universities and other applications. So that business is a good business for us and I think it'll continue to grow.

By the way, consider (inaudible - highly accented) slow, very slow business but we're working very closely with the most of major customers this year.

Okay, great. Thank you very much.

Our next question comes from Jiwon Lee at Sidoti & Company.

Morning.

Morning, Jiwon.

Morning.

Let's start with your fourth quarter guidance. Your guidance sales of $61 million to $64 million and when I look at your four products from high power all the way down to medical, what type of mix assumption did you put in to this fourth quarter guidance?

We are forecasting some strong growth in the high power area, continued growth obviously on the amplifiers and Telecom in Russia.

Not only Russia, now some of our [inaudible - highly accented] we installed our now first in India and Bahaman Islands and now we're working with South America and India. We now participate in a big, very big order. It's our new [inaudible - highly accented] solution very effective way. GSM now qualified for more and more customer qualifies for [inaudible - highly accented].

And then on the other areas, we do expect pulse to grow a little bit and some growth in medium, so I would say the main drivers of growth will be coming from the amplifiers and the high power in Q4.

Okay, and I think Valentin mentioned that our of Japan, it seems like you're a little bit cautiously optimistic for the fourth quarter into the first quarter, that a lot of it is order timing with the development cycle issues. But in the third quarter, out of Japan, which area in terms of your in-market, did you see particular weakness?

Our main OEM there [inaudible] was a little bit weaker than they had actually told us they were going to be on the sort of annual guidance they've given us.

Some of the other more highly developed applications where we saw strong sales in 2006 appeared to be taking some time to gain some traction, sort of in the welding and some of the other nuclear industry applications, so I think they're-marking was a bit disappointed in Japan in Q3.

Great. In terms of your infrastructure, you have spent through obviously some of those sales and support, especially overseas, how further along are you, or you're sort of done for building for '08 target?

Are you talking about general capacity with sales and service centers?

Sales and service; sorry about that.

Did you want to talk about in terms of Japan and [inaudible]?

Service Center (inaudible-highly accented) now going to the new big highest quality service center in (inaudible-highly accented) in Japan we have this (inaudible-highly accented), so the south of Japan. In the US now we are building very big applications center in the highest quality in Detroit. We're also increasing our (inaudible-highly accented) three service centers in Russia, the applications centers in Moscow, (inaudible-highly accented).

So (inaudible-highly accented) excellent new results, for example, (inaudible-highly accented) record results in the first time with weather, we built 2 inch steel with highest quality [inaudible-highly accented ] metals in for example for pipe welding for gas and oil industry, the same with shipbuilding and so on. It's absolutely new opportunities for us (inaudible-highly accented) full sensation of this (inaudible-highly accented). It's (inaudible-highly accented) our own applications centers, this is [inaudible].

Just to address that, I think that in Japan, we've actually just moved into the new office and application center there. In China, the new building is --

So it's 14,000 square feet and so building in Beijing, so it's really well for us.

So the two areas that we'll develop in 2008 are Detroit and also the demo facility which we're building in Oxford, so those are really the two big investments.

In Russia.

In Russia as well.

I see. Okay. That's fair, and the final question is you're sequential inventory rule, I think is about $8 million, could you give us a little more color in what's in your inventory?

We've done a thorough review again, on the end of the quarter on inventory. I think that we're actually reduced finished goods a little bit. Most of the growth has come out of work in process. So some of that is an increase in the strategy supply of diodes to build out of fiber modules.

Our raw materials inventory after it took a step up in the first half of the year has broadly stabilized, so it's really sort of work in process to build out for Q4, and we continue to have a lot of focus on inventory.

Our [inaudible] we're very focused on that. We've done a thorough review of any slow-moving stuff attain at the end of the quarter. So we're not, of course, we'd like to see our turns where we get up about two times. We're comfortable with where we are at the moment on that.

Great. That's all for me. Thank you.

Our next question comes from Jeffrey Lin of Global Crown Capital.

Good morning. First I was wondering if you could comment on the timeframe of your current manufacturing expansion initiative. So when do you expect to take delivery of your third MBE reactor, how do you see expansion of burn-in and packaging capacity going forward and so forth?

Okay, with MBE reactor we have installed (inaudible-highly accented) qualifies (inaudible-highly accented) come in December of this year. This year this reactor will provide for us full advantage because before we had only one, the multi-wafer for reactor and to small reactor, we're all (inaudible-highly accented) from each of the (inaudible-highly accented) profits and we never know when the reactor will provide the same performance before we've (inaudible-highly accented) our reactor.

Now (inaudible-highly accented) forwarded (inaudible-highly accented) allow us to make up to 5 million chips per year, to lower (inaudible-highly accented), and now (inaudible-highly accented) to introduce new products that is to start to sell some type of product to the open market for me. Before we use (inaudible-highly accented) all diodes.

So regarding our test capacity, we're the only company in the world which provides, which makes for 100% all of manufacture it cheap and so before now as our capacity is 14,000 channels simultaneously but what -- next year now we achieve new test facilities and next year we'll have capacity 120,000 channels of test simultaneous testing, (inaudible-highly accented) no one has one tenth of (inaudible-highly accented) diodes would be the first in the world and we'll hold the advantage (inaudible-highly accented).

Now regarding the test capacity, how does the expansion of that capacity, what's the character risks of that? Does that scale incrementally with your business or is it more of a step function such as the production of the chips on the front end with the MBE reactors?

Basically what the answer is on both of the packaging and the test capacity is the facilities are built and as we go through the next 12 months, we would add the equipment, so the equipment that includes all the test channels or the packaging stations, so the expenditure from now on will be more incremental rather than a step function.

With the expense for to build the sales abilities, the degree what we're making ourselves, so it's really a minimal cost, [inaudible].

Okay, thank you. Now, I'm shifting gears a little bit. I was wondering if you could talk a little bit about the solar applications you're seeing, how the fiber laser in these specific applications compared to the direct solid state lasers of CO2 and what kind of penetration do you think that you guys have into this application?

You know, (inaudible-highly accented) compared to diodes, I don't see any future in diodes (inaudible-highly accented) is not far from the (inaudible-highly accented) cheaper than the diodes provided by other manufacturers. From point of performance, fiber laser is a much higher and better for being in other performance than diode.

(inaudible-highly accented),but we don't see any advantage, so the fiber laser universal, do I have profit and can be used for any applications including application with built in qualities, no problem, with the fiber laser is universal for us.

Regarding the compared to the solid state laser, it's specially the most advanced fiber laser with practical application, it's a [inaudible] much cheaper than disk laser today. Our competition with (inaudible-highly accented) wanted to save the share in the market, but this market-- the share per many case, to sell the laser you would have near cost or below cost. We have to - we control prices in the market and we have excellent project even in high end. Regarding the (inaudible-highly accented) also fiber laser (inaudible-highly accented) due to fiber ware due to our own power we would need to provide the same speed of cut. (inaudible-highly accented). We don't see any difference, in some cases it's even cheaper. 1 meter of cutting CO2 laser so it's only timing and the insertion of people. Of course it would also be the development of the final machine (inaudible-highly accented).

I was wondering if you could comment specifically on the competitive advantages of your laser in solar applications specifically.

Solar applications now you know is a (inaudible-highly accented) and we have now more than ten customers (inaudible-highly accented) in the market which now testing and started to use (inaudible-highly accented) in volume fiber lasers instead of the former other kinds of sources they used before.

But what are the benefits they're seeing?

Benefits?

Yeah. Is the quality of cuts, the speed of the cuts?

Quality of cuts and speed also. It's all (inaudible-highly accented)so it's practical, maintenance free devices, and people when they compare this, they select fiber laser, the market application, no practical when they see that the ways for some (inaudible-highly accented) marking business. We have about 100 now OEM customers in the market (inaudible-highly accented) applications.

Okay, Thank you very much.

And our next question comes from Ian Fleischer at FBR Capital Markets.

Hi, good morning. I was wondering if you could comment on the Telecom opportunity in Russia and India over next 12 to 18 months.

How do you see the Telecom opportunity in Russia?

Russia will practical become Number 1 in Russia Telecom market. We'll do optical solution (inaudible-highly accented) and so on. It's (inaudible-highly accented) own qualification. Now the most original operator will now (inaudible-highly accented) operator, and now (inaudible-highly accented) will come to the our solution and to our business growing way fast in our we install now in total our achievements for 17,000 kilometers, 17,000 and we can double that in the next year, so our Telecom business, our target to become Number 1 in Russia Telecom market.

And the resurgence in the US Telecom market, is that with your previous customer?

No, it's new customers.

New customers, and both of new customer regarding the old customer we stopped the (inaudible-highly accented) with hope (inaudible-highly accented) because with our integrators into the business, it's a greater loss to this business, but now we are working with new integrators so we'll hold off for (inaudible-highly accented) business, the (inaudible-highly accented) and now the (inaudible-highly accented) case, so now we're free to use again our own solution with the (inaudible-highly accented) market.

So the US business is definitely becoming more diversified, more customers, the Indian opportunity is for a relatively early stage, but it is significant that we're looking at.

Great, thank you very much.

And at this time, we have reached the end of the Q&A session. I will now turn the conference back over to Mr. Valentin Gapontsev for any closing or additional remarks.

Okay, so in the first quarter of the year, we have positive we have posted strong financial results in the public positioning to IPG is -- on the way the leader in the high performance fiber laser applications. As we enter the final quarter of 2007, we'll move forward to a successful execution of our growth strategy and stating the foundation for an even better 2008. Thank you for joining us today.

Thank you.

And that does conclude today's conference call. Thank you for joining us.