IPG Photonics Corp (IPGP) 2009 Q3 法說會逐字稿

Good morning, and welcome to the IPG Photonics third quarter 2009 conference call. Today's conference is being recorded and webcast. At this time I would like to turn the call over to Angelo Lopresti, IPG's Vice President, General Counsel and Secretary for introductions. Please go ahead sir.

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 and uncertainties that could cause the company's actual results to differ materially from those projected in such forward-looking statements.

These risks and uncertainties include those detailed in IPG Photonics' Form 10-K for the year ended December 31, 2008, and other reports that are filed with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the investor section of IPG's website at investor.IPGPhotonics.com/SEC.CFM, or by contacting the company directly. You may also find copies at the SEC's website at www.SEC.gov.

Any forward-looking statements made on this call are the company's expectations or predictions only as of today, November 3, 2009. The company assumes no obligation to publicly release any updates or revisions to any such statements. We will post these prepared remarks on our website after the completion of the call. Please go to www.IPGPhotonics.com and select Investors to review these remarks. I'll now turn the call over to Dr. Gapontsev.

Good morning. And thank you for joining us today. IPG delivered. It's a solid quarter compared to the expectations that we set back in August, given the challenging business environment. We exceeded our guidance for revenues as well as EPS. Third-quarter revenues were $45.8 million, down approximately 26% year over year and up 13% sequentially.

We also reported net income of $2.3 million for the quarter, or $0.05 per diluted share. While our year-over-year financial results comparison reflects the global economic downturn, we are cautiously optimistic about our near-term performance due to our sequential improvement in revenues and an improving bookings picture.

An important highlight this quarter was a significant recovery in pulsed laser sales over the prior period, driven primarily by strength in China for marking and engraving applications. This more than offset a small sequential decline in high-power laser sales mainly due to price correction. We are making great progress in developing relationships with OEMs in China for pulsed, low and high power applications, which bodes very well for the future in that geography.

We also saw some recovery in pulsed laser sales in Europe, with the exception of Germany, and some growth in Japan.

Business conditions are still weak domestically, although bookings increased during the quarter in the US, and our level of quote activity is strong.

Looking at our performance by applications -- advanced applications, which grew year-on-year and quarter-on-quarter, was a solid performer in Q3. The medical market has also firmed up and grew moderately quarter-on-quarter but more significantly year-on- year. We expect continued success in our efforts to diversify our customer base in this market.

The materials processing market remains a challenge because of the economy but appears to be showing some signs of improvement. Telecom was soft this quarter, although we are encouraged by our prospects there as well, starting in 2010.

I want to highlight some significant positive developments. The Presidential Committee for Modernization and Technological Development of the Russian Economy recently approved projects aimed at supporting domestic telecom equipment manufacturers in Russia. IRE-Polus, our Russian subsidiary, is recognized as a Russian domestic producer. The driver of the high speed optical network in the projects are state of the art DWDM systems developed and made by us in Russia.

We are now in a pilot project. The revenue opportunity to IPG is significant -- multiple dozen millions of dollars -- if the pilot project is successful. The projects are approved and IPG is ultimately selected.

At an upcoming industrial trade show in China, seven systems integrators will present machines incorporating IPG's high-power fiber lasers. These seven new integrators we developed during a few months only since we started selling high power lasers in China at the end of last year.

We have also made great progress in Korea developing new OEMS and new applications with our products that contributed to the growth of sales in Korea. Our research efforts are resulting in new products that we are starting to ship. I want to talk about a few of them.

First, our long-pulsed fiber lasers with kilowatt levels of peak powers are new products that are competitive in performance and price to traditional flash lamp pump long pulse YAG lasers. With this product introduction, we have expanded our available market into a large segment, hundreds million volts, where we did not compete before because of certain limitation of fiber lasers. These lasers are used in various spot welding applications including battery welding, etc., and the electronics industry.

Second, I am pleased to announce that we have started to ship several of our pulsed green lasers, and we see the demand is fast growing. We have had some delays in development of our continual operation single frequency green laser, which is undergoing internal qualification yet. But we are hopeful that we can offer the green CW laser in Q1 2010.

Third, last quarter we completed internal qualification and started mass production and sale of our own beam switches used in our super power fiber lasers. Also, we are selling now a greater number of IPG-made high power delivery cables and couplers. This is meaningful because we have better margins on these than the ones we purchased before from a sole supplier. The yearly savings due to the result of only -- is -- well, multiple million dollars.

I will now turn the call over to our CFO, Tim Mammen, to review the quarter in more detail.

Thank you Valentin. Good morning everyone.

As Valentin mentioned, we exceeded guidance in the third quarter in both revenue and earnings. We reported a profit of $0.05 in the quarter after recording a loss of $0.03 in the second quarter of 2009. We continued to control costs and capital expenditures, enhanced our already-strong balance sheet and generated $12 million in cash.

With that, let's move right into our discussion of the four markets we serve.

Materials processing, which is IPG's largest market, contributed 76%, or $35 million, of the total revenue we reported in Q3, down 31% year-over-year but up 17% sequentially. Our materials processing business has been hit the hardest by unfavorable market conditions, primarily as a result of lower demand for welding, marking and engraving applications.

The advanced applications market, which includes test & measurement, instrumentation, sensing and defense applications, as well as scientific research & development, performed well in the quarter. Advanced applications represented 15% of total revenue, or $7 million, during the third quarter, increasing more than 33% year-over-year and 22% sequentially. The impressive growth for advanced applications primarily resulted from several high-power laser systems and special pulsed lasers used in sensing applications.

The communications market comprised 4%, or $2 million, of our total revenues in the third quarter, decreased by about 54% year-over-year. Telecom sales were particularly weak in the US.

The momentum that had been building in Russia during the past few quarters for telecom products for broadband access and cable TV slowed in the third quarter due primarily to customer timing and budget issues. We remain encouraged about our prospects for telecom in Russia and are currently being considered for some large projects building optical networking system solutions.

Sales for the medical application market comprised 4% of total revenue, or $1.9 million, an increase of approximately 24% year over year and were relatively flat on a sequential basis. Medical application sales are beginning to stabilize, primarily due to growing demand in the US for low powered lasers.

In addition, a growing number of OEMs worldwide are purchasing lasers for medical applications on a more consistent basis. We continue to focus on diversifying our medical business customers by prospecting for new OEMs.

Now, let's look at the business in terms of product lines.

Pulsed lasers, our top selling product line in Q3, taking the lead over high power fiber lasers, with sales of $16.2 million and representing 35% of revenues. While these sales were down approximately 23% year over year, we were encouraged that sales were up by more than 63% sequentially. The sequential growth in pulsed lasers was driven primarily by strength in China, and parts of Europe, mostly for marking and engraving applications. Much of the year-over-year decline can be attributed to the solar applications business, which was very strong in the comparable quarter in 2008.

Sales of our high power fiber lasers decreased by 24% year-over-year in Q3 to $13.7 million and represented 30% of total revenue, primarily due to weaker sales for welding applications, partially offset by stronger sales for cutting applications. Sales for high power lasers were down about 12% sequentially from Q2 '09 as a result of slower sales in the US.

Geographically, we are beginning to sell more high power lasers in China, India and Russia. We are also hopeful our new rep in Brazil will gain some traction. Late last year, we initiated a new strategy in China to sell our high power lasers into OEM systems manufacturers. The benefit of this strategy is that our new partners have many salespeople marketing the system instead of our reps marketing our lasers to one customer at a time. This strategy is beginning to gain some noticeable traction, and we have already begun selling to some large Chinese OEM systems manufacturers, as Valentin mentioned.

We also recently recorded several large high-power laser sales in Russia for industrial applications, such as welding and cutting. High power laser sales became a larger portion of revenues in Russia, which have been predominantly telecom-related over the past several quarters.

Sales of medium power lasers decreased 65% in Q3 2009 from Q3 of 2008 to $2.8 million. Sequentially, medium power lasers fell about 34%. Much of the weakness in Q3 came from soft orders in microelectronics, printing and sintering. However, we did record several new medium power orders for welding and cutting applications in Russia.

Our low power lasers, which are primarily used for medical applications and micro materials processing, were down 19% year over year to $4 million, but up 41% on a sequential basis and accounted for about 9% of total revenue. Much of the sequential growth in low power lasers was from sales for medical applications.

From a geographic perspective, we reported 42% of total revenues from Asia and Australia, 39% from Europe, and 19% from North America. We are seeing significantly improved performance in Asia driven by returning strength in China, Japan and Korea. China is becoming a much stronger market for us than it has been in the past, primarily due to the new sales strategy that I just mentioned and the strong Chinese economy in Q3. We are developing many new relationships in that market that will be beneficial to us in the future.

With the exception of Germany, the rest of Europe performed well. Southern Europe was particularly strong, primarily as a result of growing demand from our cutting OEMs. As you may recall, earlier this year we qualified with a few cutting machine OEMs, who are marketing their new systems with our lasers.

We reported weak performance in the US, partly due to some revenue timing issues. While bookings shippable within one year in the US were strong in the quarter, a number of these orders will not be fulfilled until Q1 or even Q2 of next year. In addition, the solar market in the US remains soft. It is also important to note that we had a strong quarter for the US in Q3 2008.

Turning now to the income statement -- sales for the quarter were down 26% year-over-year to $45.8 million but up by more than 5% (sic - see prepared remarks), or 13% on a sequential basis. We estimate that if exchange rates had been approximately the same as one year ago, our sales would have been $0.2 million higher.

Gross margins were 36.5% in the third quarter of 2009 compared with 47.4% in Q3 '08. Gross margin was negatively affected by lower absorption of manufacturing costs as a result of lower sales, product mix due to fewer sales of medium power lasers, and the impact of pricing pressure on average selling prices. Despite the reduction in our cost structure on an absolute dollar basis, manufacturing costs were higher as a percentage of sales. We estimate that if exchange rates had been approximately the same as one year ago, our Q3 gross profit of $16.7 million would have been $600,000 higher.

While our gross margin is lower than we would like, with an improvement of 7.4 percentage points from the second quarter of 2009, we have demonstrated the ability to generate some positive momentum in gross margins when revenues begin to pick up again. As we increase our absorption rates as a result of higher sales, margin growth should continue to accelerate.

SG&A expenses were $8.5 million or 18.7% of sales in Q3 2009 compared with $9.8 million or 15.8% of sales in Q3 2008, as we have continued to control discretionary spending related to consultants and accounting and legal. In addition expenses related to bad debt were lower in Q3 2009. We estimate that if exchange rates had been approximately the same one year ago, our Q3 '09 SG&A expenses would have been $0.1 million higher.

I want to update you on recent activity involving our pending patent litigations since they have a direct bearing on our legal expenses. We previously reported that the Patent and Trademark Office confirmed the patentability of all the claims in the IMRA America patent over the prior art cited in the re-examination, as well as the new claims added during the re-examination. The stay on the litigation was lifted recently, and this litigation has recommenced. The trial has been set to begin in August 2010. As a result, we expect to incur higher legal expenses in the coming quarters.

The lawsuit with CardioFocus remains in re-examination at the Patent and Trademark Office. The Patent and Trademark Office has cancelled most of the claims. For two of the three patents in question the patent owner has abandoned those claims. The third patent remains under re-examination.

Although the litigation stay has expired, IPG asked the court to extend the stay for a year. This request is pending.

R&D expenses were $4.6 million or 10% of revenues in Q3 2009. This compares with $4.1 million or 6.7% of revenues in the third quarter of 2008. In the coming quarters we anticipate R&D expenses to stabilize at these levels or slightly decline as production picks up and consumes labor resources now being focused on R&D.

Our Q3 '09 exchange rate gain on transactions and the revaluation of financial assets and liabilities was only a $40,000 gain in Q3 '09 compared to a gain of $1.6 million in Q3 '08.

IPG's operating income in the third quarter of 2009 was $3.6 million compared with operating income of $17.1 million in Q3 of last year, yet significantly improved from the operating loss of $1.3 million in Q2 of '09.

Operating income includes stock based compensation related charges of $783,000 and $461,000 in the third quarter of 2009 and 2008, respectively. In the third quarter of 2009, $164,000, $506,000 and $113,000 of stock-based compensation charges related to cost of sales, SG&A and R&D, respectively.

Our tax rate for the third quarter of 2009 was 31.5%. We estimate an overall tax rate of 31.5% for the year. The effective rate for 2008 was 32%.

Our third quarter net income attributable to IPG was $2.3 million or $0.05 per diluted share, compared with net income of $10.9 million or $0.23 per diluted share for the third quarter a year ago.

Year-to-date cash generated from operations has exceeded the amount spent on investing activities by more than $28 million.

Capital expenditures were $1.9 million for the third quarter and $9.6 million year-to-date. As you know from past conference calls, we have been targeting CapEx of less than $15 million for the year.

In the third quarter, using the cash generated this year, we repaid $17 million of our outstanding credit lines.

Our cash and cash equivalents net of debt at the end of the third quarter of 2009 were $42.5 million, compared with $12.2 million at December 31, 2008. Cash and cash equivalents improved from year end by $25.0 million to $76.3 million at the end of the quarter. Not included in cash and cash equivalents are $1.3 million in auction rate securities at September 30, 2009, which are included in other long-term assets.

Cash flow from operations in the third quarter was $13.9 million. Cash used in investing activities was $1.7 million, and cash used by financing activities was $14.9 million.

Accounts receivable decreased to $29.8 million at September 30, 2009 from $41.8 million at December 31, 2008.

Days sales outstanding were 59 days at the end of Q3 compared to 65 days at the end of 2008. The lower DSO at September 30 reflects the timing of sales made during the quarter with more sales shipped earlier in the quarter as compared to the quarter ended December 31, 2008.

Finally on the balance sheet, inventory decreased to $59.2 million at September 30, 2009 from $72.6 million at year-end 2008, in part due to the reserves we have booked this year but also due to consumption of inventory and managing production and purchasing.

As mentioned in our news release this morning, we expect to file with the SEC shortly a universal shelf registration statement that will allow the company to register up to $130 million in securities including $30 million in secondary shares. The proceeds of any future offering could be used for a variety of purposes. At this time, we have no immediate plans to issue securities under the shelf, but it will provide us with the financial flexibility to do so at the appropriate time. The filing is nothing more than proactive capital structure planning.

This leads us to our expectations going forward. In the second quarter of this year we reported more than $40 million in revenue and had a book to bill of more than 1. That drove a 13% sequential increase in revenue to $45.8 million in Q3. In the third quarter on revenues of just over $45 million, we have a book to bill also greater than 1. A number of the recent bookings are up for Q1 and Q2 of next year, however. While we performed very well from a revenue standpoint in Asia in Q3, corporate buyers are still cautious in the US and in Europe -- especially Germany. So we believe that we may have seen the worst of the macroeconomic environment. However, we'll offer the caveat that like everyone, we don't know where the market will end up in the short term and beyond.

So let me now provide you with the specific guidance. For the fourth quarter, IPG Photonics expects revenues in the range of $44 million to $49 million. The Company anticipates earnings per diluted share in the range of $0.04 to $0.09. That is based on 46,695,000 diluted common shares which include 45,573,000 basic common shares outstanding and 1,122,000 potentially dilutive options.

This guidance is subject to the risks we outline in our reports with the SEC and assumes that the exchange rates remain at present levels. I want to reiterate that we do not attempt to forecast gains or losses related to exchange rates.

Before we go to Q&A, let me summarize five key points.

First, we performed better than our guidance in the third quarter, generating a $0.05 profit and growing revenue sequentially by 13%.

Second, we were able to increase gross margins sequentially in the quarter, showing the leverage in our business model. Also, we continued to control costs and reduce capital expenditures.

Third, we saw a recovery in pulsed lasers, driven primarily by strength in China, where we continue to build our presence in several product lines. The overall strength in China is offsetting weakness in the United States, although the bookings picture in the United States is improving.

Fourth, we have a strong balance sheet and have demonstrated excellent cash generating ability.

And finally, customers continue to see the value in IPG's laser and technology, which can lower their costs and improve the way they manufacture their products. Despite the weakened demand due to the economy, IPG is winning many competitive bids with competing laser technologies because our customers recognize the benefits of our technologies, and fiber lasers are now becoming widely accepted.

And with that, we will open the call up for your questions

(Operator Instructions). James Ricchiuti, Needham & Company.

I wonder if you could comment on the outlook for the high power laser business just based on the bookings profile that you have in the quarter. Do you see that part of the business beginning to pick up again in Q4? Or is that more early next year? Thank you.

So the detailed information we don't disclosed specifically, but our guidance process that we go through shows that the high power lasers will pick up again in the fourth quarter, and at the top end of our guidance they pick up fairly materially.

I can add that you see we don't have their [open set] sales high power in optical power in the unit quantities. That's a smaller decrease -- decline in the revenue, also due to correction of price. Now we continue this correction, so -- but in optical power we saw this year -- deploys very, very few -- it's higher than a point -- nine months, it's higher than last year and much higher than a we -- from our major competition. In total during this -- with (inaudible) fiber laser total optical power of up to 4 megawatts of power. Our nearest competition with disk lasers (inaudible) they did not publish correct data, but a rough estimate for it, we won competition in high power (inaudible).

That's helpful. Just a follow-up question, the improvement that you are anticipating in Q4 in high power, it sounded like you had a better bookings quarter in the US. Is that a contributing factor? And is China the other major factor that's driving that?

I would say less -- a little bit of contribution from the US, and some of the high power laser we've taken for orders in the US are probably for Q1 delivery. They're some of the very special, high-power lasers we have. But the major contribution in Q4 will come from improved high-power laser sales in China. Japan is also showing some renewed traction there where they have been a little bit weak. We will take revenue on one of our first high-power laser systems in India as well. There's some additional traction I think, and it's going to continue to flow through, in southern Europe in particular. And also in Germany our sales guys are forecasting some orders that have been probably a bit delayed given the economic situation coming in in the fourth quarter.

So the overall outlook on the high-power laser side is across the world, I would say. It's not just sort of strength in China. It really is seeing an improvement across the board.

During the quarter, it was made mainly in Europe, this development -- a new application with potential very large OEM customers. For example recently Mitsubishi having (inaudible) publish press release when they qualified first to use our fiber laser for ship industries to (inaudible) first time in Japan. It's a (inaudible) certified for such hybrid welding application for ship industry. It's very potential with serious market also. Also in Korea is our laser qualified by several, these very serious OEM customers for other applications. So the profits (inaudible) deployment introduction the fiber lasers were new in new application is going very well.

Thank you. I'll jump back in the queue.

Mark Douglass, Longbow Research.

Can we talk about the gross margins a little bit? Considering the beat on the sales line, I was under the impression before that maybe the gross margins should have been a little bit higher. Can you talk about that a little bit?

No, I mean, I think gross margins have come in almost exactly in line where we would've expected them. Previously we'd said that at $45 million of revenue we would expect about 35% on gross margin, with that trending as revenues tend to $50 million in revenue to 40% gross margin. So reporting 36.5 at just over 45 million is basically in line with our expectations.

We still continue -- and it's in line with our expectations given where we stand on trying to manage inventory, so we've seen inventory come down again. We continue, as you -- last year we built quite a lot of inventory. Some of those high (inaudible) in inventory are now getting -- they haven't been used, a little bit older, so we continue to have some inventory write-downs. So those totaled about $1.3 million during the quarter.

So even with those inventory write-downs, we're actually pretty reasonably happy with the traction the model is showing on gross margins relative to the change in revenue and the overall decline in inventory which we've continued to consume.

So you still have some or write-downs. I figured they were mostly done, which is maybe why the margins did expand the way they did.

I'll reiterate again, we previously said that at $45 million in revenue we would target 35% in gross margins, at $50 million in revenue, 40% in gross margins and then trending up to 45% as revenue continues to increase to about $55 million to $57 million. So we are not disappointed with the margin leverage we have attained in the quarter.

With the high-power laser sales to the Chinese OEMs, would you expect that the margin profile there is slightly worse than say sales to more mature markets?

No, I wouldn't say so. I would say the pricing strategy and policy that we have pursued around the world applies to China. So we have seen the prices of in particular 1 to 4 kilowatt lasers come down in order to ensure continued market penetration. The pricing policies with the using in China are not fundamentally different from those that we apply with OEMs in Italy or Korea in particular. So we do not expect worse margins on high-power laser sales in China at this point in time.

Okay. And then finally, on the capital structure, what is it that you think you would be shooting for? I mean, is it that you're necessarily looking to raise capital from equity rather than debt. I know you just mentioned a variety of purposes would be a -- your use for the shelf registration of shares, but just describe a little bit about what you are thinking and the reasoning behind the shelf registration?

Sure. First of all we want to provide ourselves with some flexibility. We are subject to SEC review given the relative size of the company, and there's obviously a time frame behind that. So we want to drive flexibly using the shelf should the value of the company approach a level which we think it is reasonable to raise money.

Clearly the company is generating a reasonable amount of cash at the moment, and from an operations perspective the need for additional capital is not probably that great. What we find we do not have a lot of flexibility around is having sufficient cash available for -- to use for any nice add-on technological acquisitions we would like to make. So if we find some smaller companies around the world we may want to acquire for $10 million or $20 million, clearly we with still only 60 -- $42 million of net cash on the balance sheet, there's not a lot of flexibly we have in order to pursue those kind of strategic acquisitions.

At this time we have not identified any. I'll tell you we've done some research on acquiring companies in Europe, where it's difficult for us to use stock, so that's definitely one purpose ultimately of raising cash, would be provide us a lot more flexibility on those technology type acquisitions where we would not be able to use cash. Let's say that's the primary outlook for us.

And then there are some other issues that we understand are out there. We want to try and improve the float and the trading liquidity of the shares. Those are more peripheral. We are not going to do an offering simply to do that.

That's very helpful. My final question is just what are you hearing in the flat sheet cutting markets in general with their expectation 2010? And in particular with fiber lasers trying to gain more traction there. Or is this something we're just kind of waiting for FABTECH and other trade shows to get a better handle on that? Thank you.

I would say right now it's very difficult to provide any outlook on 2010 specifically. What I will say is the number of cutting OEMs for standard flat sheet metal applications that we've developed in this year runs to probably three or four in Italy alone, seven in China, several in Germany and the US. And where we are seeing is they appear to be getting quite a lot of market share and rapid penetration because the view that we have at least into Q4, which is where we have the most visibility, for those OEMs is strong.

In terms of 2010 I would agree with you. Probably you have to wait until -- even after FABTECH I'm not sure whether anybody has a good enough picture into 2010. But we believe we are gaining a lot of market share there.

Yes. In cutting applications the major problem was before the people with the users have opinions that fiber with one micron laser was fiber and disk quality of cutting much [better than] with CO2 laser. Now during (inaudible) year the situation improve dramatical with several practical quality of cutting becoming the same with [wet C02] lasers in wide range of thickness of metals.

From other side (inaudible) power for a C02 laser was (inaudible) fiber laser. We also now have made correction of price, and now the price per watt in fiber lasers now is even better than for a typical CO2 laser from laser manufacturers. So with this bad year we have overcome. And taking account also of it to make -- to cut with the same speed the fiber laser needs less power than C02 laser practical up to two, sometimes even three times. So practical fiber laser becoming a very prospective for cutting application.

We expect during the next two, three years much replacements of CO2 cutting -- cutters with fiber cutters worldwide. And also with (inaudible) markets very serious market is (inaudible) market because of auto when they use all cutters machine with C02 laser which needs now to be replaced, and many of the users are looking to replace not by the new C02 but for -- by fiber lasers.

Thank you.

Avinash Kant, D.A. Davidson & Co.

A few questions. Of course we are starting to see some sort of recovery in the revenue levels that you have had. Now, could you maybe talk a little bit about how much of it is driven by just overall economic recovery? How much of it is driven by more penetration in newer applications? And how much is from you taking market share from other laser-based applications?

So maybe the best way to look at that is just to look at it on a product line basis. In Q3 I would say that quite a lot of the recovery was economically driven, given the improved outlook in China and some of the far east. And that is evidenced by the fact that pulsed laser sales were up by almost 60%.

In terms of market penetration, I think we've gone through just a bit of a volatile quarter in terms of welding, and the specific applications Valentin's mentioned, that we've made tremendous progress on some hybrid welding applications. Mitsubishi has made this public announcement. That was a little bit weak in Q3, but in terms of market share gains the cutting was very strong.

In terms of the economic side of it, I think that's still continuing to drive through some weakness on the medium power lasers, particularly in the microelectronics business. But offsetting that we for example have got a couple of new laser ordered in Q4, the medium power lasers for some welding applications for the razor blades, so that was a really good indication of some -- even though it's not a very material order, it's just nice to see that order come back.

On the medical side, which is clearly driving the low power, a lot of that is market share gains, new applications, displacing one of our main competitors, we think SPI in Korea, getting into even a new OEM in China. Interestingly in Germany we also have one of the first orders and multiple unit orders for some surgical applications from a new customer there. So again, that's like newer applications, newer market share, so it's across the board. You have to dissect and look at it on a product line and geographic and application basis.

And I believe in the previous quarters you have talked about expecting a decent size order, I believe a $4 million to $5 million order from Europe. Did you get that already? Was it in the bookings in the third? Or are you expecting it in the fourth quarter?

No. We've talked a lot about this very high-power laser. It's still in the pipeline there. The sales people have spoken, it's going to come in in Q4. It will not be for shipment this year. It's an ultra-high-power laser for some material processing R&D. It has not gone away, that's the only insight we really have on it at this point in time.

And if you could talk a little bit about the pricing environment? Of course you were seeing a lot of pricing pressure from different players in last quarter. Has it gotten a bit better? Or --?

I would say we've reached a level on pricing where they've stabilized, and the pressure had diminished somewhat, and strategically we believe that both of the high-power lasers in the 1 to 4 kilowatt range and on the pulsed lasers, the strategy we followed does not need -- it's not going to be a sort of quarterly basis, that those declines are going to continue to have to be made. So it's more stability in Q3 on pricing in general across all the product lines.

And CapEx, you have said you were targeting less than $15 million in the year. How should we think of going forward in the next year?

So next year clearly if there's a recovery here, there's -- we will -- in Germany and the US still the requirements for capital expenditure is relatively limited. There is if the business in Russia picks up, we have not invested a lot in Russia over the last two or three years. There's a little bit of investment gone there. But as the business picks up there, we know we need to invest in our manufacturing and R&D facilities there. That next year -- well, it's difficult to say over a one-year period, but we may need $15 million there.

We know we've got to build a little -- a small building in Japan and Korea, we have an issue whereby not many landlords like to lease us buildings because we test lasers in them, and some of their tenants don't really like it very much. So even though there is no safety issue from our perspective, but we know for example we want to buy and build our own facility in Japan, that may be like $1.2 million.

I would target something in the region at this point in time, $15 million to $20 million for CapEx next year, maybe a little bit more. If we get revenue to above $50 million, I would hope to be generating $10 million to $12 million in operating cash flow and generate another $20 million in free cash flow next year, if we manage working capital appropriately.

So number of caveats out there, but I think we can continue to generate say good amounts of free cash flow next year, even with potentially a little bit higher CapEx as we invest in some new geographic areas.

Is that fair Valentin?

Yes. You forgot only to say if our (inaudible) product in India, we are looking to expand our facility in India, a very prospective market which have now very good engineering team in India, but we have to add to them additional (inaudible) and some equipment because it's -- we have -- working [with] there would be (inaudible) nearest, couple of years fast growth of business.

I may have missed the medical and communications revenues. What were they in the quarter?

Communications was $2 million and medical was $1.9 million.

Perfect, thank you so much.

Jiwon Lee, Sidoti & Company.

Back to the pricing issue, did I hear correctly that the pricing has stabilized across the board, especially on the high-power area? And then what would have to happen for pricing to kind of start walking the other way?

Going up?

Yes.

So first of all, you asked -- to the question is, yes, in general we've seen much better price stability in high-power and across the board in Q3.

In terms of pricing going up, it's an interesting question. The way the prices -- first of all I'll address it the other way. Strategically at IPG we have a vision that in order to really penetrate a much higher percentage of the machine tool business including non-laser applications, in general the price of lasers to become -- has to come down, not go up, for them to be more widely adopted. So any desire that you might see for the widely deployed pulse lasers, high-power lasers, medium power lasers, pricing suddenly go up by 20% is unlikely to ever happen. In fact our strategy is to continue to make lasers more cost effective to people who use other machine tools and to drive the laser penetration of the machine tool market from hopefully 2% or 3% to initially 5% and maybe in five years time up to 10%.

Where we will see pricing benefits and higher margins is on the newer, very leading-edge technology projects that we introduce, so for example, the very, very high power, single mode lasers, or potentially on some of the other lasers as well. But in general the thesis and philosophy of the company is to really penetrate much -- many more applications using fiber and bring the benefits to the end-user. Is that fair, Valentin?

Yes, I agree.

That's fair and helpful. And can we quantify the telecom opportunities that you see for next year? And another one, if you could talk also a little bit about were the auto percentage sales stood? And what do you see from the auto market for next year?

On the telecom side, as we've mentioned, we have been approved and qualified by major government institutions in Russia as a local supplier of integrated systems. We believe, as Valentin mentioned on the call, those opportunities extend -- I think he used the phrase "multiple dozens of millions of dollars." It's very unclear at this point in time what the timing on that revenue is, but we would hope that it's going to drive significant growth in Russia next year, and that would also drive some of the capital expenditure that we need to make in Russia.

Think also in the US to a lesser extent, though, we believe we've qualified newer, higher level and more integrated product with a number of different OEMs here. And whilst they continue to have a lot more volatile purchasing at the moment, we think we can get into increasing revenues on the telecom side even in the US next year.

And with telecom, you know before we started in (inaudible) OEM business was in telecom arena, we produced at the time and delivered to money (inaudible) key customers and integrators so they were core high-power amplifiers, to now with breadth in the world in high-powered amplifiers, but you know after 2002, 2003 the telecom market collapsed, prices and so on (inaudible) it's new -- and so the new situation is to sell just components in (inaudible) in telecom, now a low profit business.

But during the last five years, we come with the way where it's now practical, a fully integrated system. Forget about (inaudible) solution. Now this year, end of this year, beginning next year we introduce full complete solution we can supply for one distance in the broadband application (inaudible) complete solution, compete with such company like Alcatel (inaudible) in full volume. So it's in (inaudible) now (inaudible) telecom business an absolutely new integrated level, and we believe during this next five years the telecom business will return back to us, it will -- we will be one of the biggest business in IPG again. It's however instead of tens millions -- tens -- a few tens millions this year or last year, we were looking really down back to hundred -- many hundreds millions business -- our target in telecom arena.

That's helpful. If you could talk about the auto business for this year? And where do you see the opportunities for next year?

This year, if you look at the auto business, we've continued to have some order flow, some of the more standard applications and parts for the auto industry, so we have had orders from both end users in the US -- Ford, GM. We've had some one or two unit orders in Germany as well, the upgraded laser for Peugeot Citroen. We've sold a couple of lasers to BMW, had some order flow in Japan as well. Tends to be a little bit uncertain right now given the economic situation.

On some of the other areas we've made progress, for example, in newer auto applications, and significant progress. So battery welding is the main one that comes to mind. Again in Q3 some of the order flow on the battery welding side was a little bit light.

In terms of the perspective on that for next year, we continue to have been told by a number of these major customers that their requirements run to multiple tens of units of lasers. And that's from the German manufacturers. I think we are hoping to make some significant progress with Toyota. Hyundai is currently we believe evaluating a much, much wider deployment of fiber lasers in Korea, having very successfully used five or six units of our lasers four years in Korea. So they're looking at a much wider deployment.

We've got a couple of units that are going into some Ford facilities over here.

So it's -- the perspective for next year is, it goes to multiple tens of units of lasers. We cannot quantify it exactly now, but we would expect a significant improvement and much less volatility next year in terms of the auto sector.

And you know that it's a very -- the -- a good trend for us and sign that all German carmakers, major carmakers now (inaudible) practical with IPG. The most of them now, they qualify IPG fiber laser for use in main production line. Before they were oriented there, our competition, German competition, but now with situation change in full practical. It's a very good sign if German car industry even now in bad economics situation start to purchase from IPG in quantity, impressive quantity -- BMW. But now all other practically, so if IPG practical, we (inaudible) and again, car industry, it [down to] fiber technology.

You know (inaudible) experience with former use of the YAG lasers. This -- it was -- some were skeptical (inaudible) bought it in current, that is special German for laser technology at all. Now after (inaudible) alone, Europe and the good field result with Hyundai and the BMW, now people start again to believe in fiber technology in main car line assemblies and so on. IPG now is the main driver in this direction.

That's helpful. If I may, two more questions. When you talk about integrated products or systems level, is the focus mainly on the telecom side? Or is there any other opportunities over the next year or two?

Well, the focus isn't just on the telecom side, it is -- we've mentioned this before on many occasions -- either targeting specific geographic areas where customers require much more of a one-stop shop and they just don't want to buy a laser and have to find another integrator. And it's also on specific applications where -- which we may identify are not adequately covered by existing OEMs in the market.

So in particular our focus at the moment is Russia on some systems integration and India. The good news is on the laser side we actually have now shipped the first welding system in India to our customers using a 4 kilowatt laser. It's a dual welding system. We believe the initial production runs that they have had, they are showing very, very significant increases in productivity, both using the laser system and also based upon some of the design and engineering work that the Indian development team achieved. So that's a nice milestone for us.

We've also shipped an integrated cutting system in Russia -- or a couple of cutting systems in Russia whereby we integrated the system ourselves, we didn't actually build the cutting system.

So just two examples there in geographic regions. It's still early -- it's very early stages in terms of our systems development process right now, and over the next year I would say we should keep a close eye on how it continues to fall and track. I know in India they've also got a second order for another welding system that's already in-house.

I'll yield the floor for now, thank you.

Joe Maxa, Dougherty & Company.

I just wanted to understand the guidance a little bit better. Based on what you've been saying, it sounds like you're expecting your product lines to maintain very similar from Q3 levels with the high-end or potential upside coming from success with high-power. Is that the way we should be thinking about it?

Yes. We are seeing actually some -- a little bit of -- a nice recovery in high-power, a little bit of recovery even in the medium power, and some also good improvement on the low power level. And hopefully pulse will continue to perform reasonably well. There's a little bit of -- we wait upon customers to issue their releases against their orders, so a little bit of lack of visibility into how strong pulse will be. But it's not just high-power, it's nice to see some of the medium power stuff coming back a little bit in Q4 as well.

So if everything is growing a bit, either there's concern on the pulse or you should be able to come in at that higher end?

We do not make any comments about where in the range we are going to come in. We provided a range that we think adequately covers the risks out there.

One of the issues -- yes, there's a little bit of lack of visibility into pulse, but also there is a lot of high-power stuff that's going into China that requires export licenses. There's a couple of other high-power lasers going around the world which also require some export licenses, and typically on some of the high-power lasers if it's newer applications, we do run into timing -- not so much on the shipping side, but just acceptance issues. So we try and factor those things in when we make the sliding calculation.

So there's quite a -- there's a methodology we use that we don't change quarter on quarter.

That's helpful. Did you guys have any 5% or 10% customers in the quarter?

No.

And on the multi-kilowatt side of the pipeline, can you give us a look into that?

What do you mean?

Your multi-kilowatt, your 20-plus multi mode, your five, 10 single mode lasers. What's the pipeline look like?

The pipeline on those areas, particularly on the 10 kilowatt single mode lasers has improved quite nicely. We probably have three orders in-house already for 10 kilowatt single mode lasers.

Some of the applications using 20 kilowatt lasers -- on the directed energy stuff there's probably a little bit of a delay on those. On some of the other materials processing applications people are continuing to do development work, so we sold a laser in March for -- it was both for nuclear -- research into nuclear welding and also turbine blade work, welding of wind turbines. We know that project is continuing along, we don't expect necessarily another 20 kilowatt laser to be ordered there.

Some indication on another application for a clean energy thermal application, they're trying to use the laser for drilling deep into the ground, that we may see some additional order flow on that in the nearer term.

But the main focus at the moment -- it's very difficult to predict those 20 kilowatts and 30 kilowatt systems at the moment. A lot of them are budget driven where the people get approvals on them. We know one of our 10 kilowatt single mode lasers, it actually had to go up to the CFO for the Fortune 500 company for approval before that order was placed with us. So there's a lot of scrutiny given to this when people are spending significant amounts of money on us.

But it's special -- this is still experiment for -- in such applications. But 20 kilowatt now to 30 kilowatt lasers becoming the working force for such high hybrids where we're dealing with thick metal materials [incipient] or in the (inaudible) thin -- thick pipe (inaudible) and so now we have very big progress and direction, and we believe next year we start to ship such laser, not by one piece in the can, by 10 piece in the can for (inaudible) OEM and for (inaudible) with serious new industrial applications, not just for special projects and so on.

What is the time frame for when you get one of these orders as far as shipping it?

We are shipping now. This quarter we are shipping, next quarter we are shipping. We have order fixed. Not one but multiple orders now. But it ship (multiple speakers)

The three orders you have in-house you will ship this quarter?

You've got to draw a distinction between the standard multi mode lasers and the single mode lasers. 20 kilowatt multi mode laser -- we'll give an eight to 12 week delivery time and build it out very quickly and even deliver it in a shorter period of time. On the very leading edge 10 kilowatt single mode lasers, which Valentin mentioned, are still a very leading-edge product. Those delivery times go out to probably four to six months (multiple speakers)

Our 1210 kilowatt single mode will ship in this quarter. We have two orders that we have to ship this quarter, we will be -- we will fulfill this schedule.

Thank you very much guys.

Ajit Pai, Thomas Wessel.

A couple of quick questions. I think the first I think you addressed only partially in the last question, which is, you talked about your directed energy applications. I think in the third quarter of 2007 you had shipped a bunch of your -- I think four separate lasers that had been put together for a defense-related application. So it's been about two years now, and at that point you expected to start seeing the orders about two years out. So could you give us some color as to in military applications what kind of progress you've made? How sizable that opportunity could be? And the directed energy application you talked about in answering the last question, whether that was for a military application or for a non-military application?

We are a commercial company, we (inaudible) lasers (inaudible) we are not participate any special project for military application and don't target to participate in such projects. What people buy and for what they use, it's their -- confidential. We don't know exactly for what they use it.

There is something. On the four systems that was bought by the Navy, they successfully shot down a UAV using those four lasers in this last quarter, it was a very successful trial I think. They are continuing to be pleased with the performance of those lasers. There is some indication from them that they are looking at purchasing a higher power level unit, we don't know when it is going to happen.

There is this -- a lot of the orders for the 10 kilowatt single mode lasers that come in are just -- those are -- we believe some of those are directed energy applications. And then one of our major customers in Europe on the directed energy, we were hoping for some orders in the second half of this year. We don't have a lot of visibility. But we've had one order, but it's for lower power laser from them.

So I think there's a lot of -- to summarize, a lot of progress made on the processes in beam combining and beam tracking technologies by everybody. Successful shoot-downs of UAVs, not just by the Navy, but a couple of our other customers. And it's still a little bit of a wait and see out there for improved orders from 10 kilowatt single mode for that application.

Got it. But then when you get your orders, do you expect them -- to get them directly from the Navy or the military? Do you expect them to get them from the large defense contractors? Are you in conversations with multiple defense contractors?

We get them from all of those sources. And yes, we are in conversations with multiple defense contractors.

Got it. And then when you look internally at the operating leverage you've talked about -- and you also mentioned that one of the things that would help a lot in terms of your margins would be sort of scaling your diodes and being a merchant provider of diodes. Could you give us some color as to whether there's been any progress in being a significant merchant provider?

So we have made some progress during the year. The overall level of sales is still relatively low. Last year if you include diode lasers and also just straight PLD components, the total number of sales is probably around $600,000 and year-to-date about $2.1 million, so relatively speaking, not too bad a performance in that area to leverage some of the fixed cost base. We'd like to see it get up to above $5 million and ultimately hopefully run at somewhere like $10 million. But definitely some progress, probably not quite as much as we wanted to see during the year.

What's the obstacle then to the (multiple speakers)

I can tell you that we receive (inaudible) request from major was a player of people provide to Walker to [pump] the fiber laser. But we had made decision, did not tell to our competition at all. So we are only looking for application which is not connected with pump of fiber laser in competitive to us in lasers. So (inaudible) special (inaudible) new products for their touch applications, and so its medical application, material process and (inaudible) application for example (inaudible) plastic welding, to printing and many others. It takes time to work with this for a year, and we have many contacts in the projects with OEM customers and the new materials (inaudible) direction, but it takes time to develop serious OEM business, a long test, and also they have to fulfill all contracted to each to IPG a supplier. But we think tens million dollars we will make without pump diodes. Only for in other application. Pump diodes we won't sell in the open market.

Got it. Thank you.

C.J. Muse, Barclays Capital.

This is Olga calling in for C.J. First on the -- you've given the relatively solid backlog that you mentioned that you have right now that's shippable in the first quarter. Do you expect to see seasonal declines in the March quarter that's in line with typical seasonality? Or do you see potential for better than seasonal 1Q?

We don't provide specific guidance going out into the following quarter. But I think you should continue to -- if you're looking at this from a modeling perspective, to continue to mirror some of the trends that we've seen historically. Given some of the visibility that we are seeing for the first quarter, maybe it won't be quite as severe, and also the fact that we appear to be at this point in time in a little bit of a recovery. But other than that, I won't provide any more guidance to you on that.

I guess on the -- can you give us a breakout for your fourth Q guidance between gross margin and the OpEx? And then also how you see SG&A trending into 2010, given the legal expenses?

So on the gross margin side, we've talked quite a lot about $45 million of revenue. We would expect about 35% gross margin as you tend to $50 million of revenue, gross margin should pick up to 40%. The overall drop-through a something like -- I think it's about $750,000 to $800,000 per million.

On the operating side I would say that we are budgeting for litigation expense in Q4 around $500,000. So that would be an increase in SG&A of that amount. R&D should be flat. Overall, if we trend to $55 million in quarterly revenue, our operating expenses should be tending towards -- or trending towards about 25% and operating margin overall, given hopefully gross margins picking up from -- to the mid-40s, then hopefully operating margin in the range of like 19% to 20% for 2010. The general sort of modeling direction -- if that's what you're looking for.

Okay, thank you.

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.

Okay. Thank you for joining us today. We look forward for speaking with you again when we report our fourth-quarter results early next year. I -- we hope -- we are sure we will report you new good news.

Thank you everyone.

Thank you ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time.