IPG Photonics Corp (IPGP) 2010 Q2 法說會逐字稿

Good morning and welcome to IPG Photonics' second-quarter 2010 financial results conference call. Today's call is being recorded and webcast. There will be an opportunity for questions at the end of the call. (Operator Instructions). At this time, I would like to turn the call over to Mr. Angelo Lopresti, IPG's Vice President, General Counsel, and Secretary, for introductions. Please go ahead, sir.

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 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, 2009, and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the investor section of IPG's website at investors@IPGPhotonics.com/SEC.cfm or by contacting the Company directly. You may also find a copy on 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, August 3, 2010. 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 following the completion of the call. Please go to www.IPGPhotonics.com and select investors to review these remarks.

I will now turn the call over to Dr. Gapontsev.

Good morning and thank you for joining us today. The financial results that we reported during the first quarter further improved in the second quarter of 2010. Despite some underlying uncertainties in the global market environment in the second quarter, many of our end markets are benefiting from this secular recovery.

IPG reported record revenue in $67.3 million, up nearly 67% over the same quarter last year, 31.4% over the first quarter of 2010. Reported revenue and earnings per share exceeded our guidance range, essentially.

Three factors contribute to our robust quarterly performance. First, strong growth across material processing applications. Second, outstanding results from China, and third, IPG vertical integration which drives operating leverage in the response to increasing of unit volumes.

I will briefly touch of each of these. Material processing represented approximately 85% of our quarterly revenue and grew by more than 90% year over year. Increase in demand for high power and pulse laser underscored this vibrant growth as customers continued their adoption of fiber laser given the distinct advantages, including greater performance, superior beam quality, reliability, [profitability], high efficiency, and lower maintenance costs.

In fact, Q2 represents a record quarter for IPG's pulse lasers and the second highest level of quarterly high-powered lasers sales. To put these numbers in perspective, the unit growth of high-power and low-power lasers each more than doubled this quarter versus Q2 2009, and the unit growth of pulse laser more than tripled.

In addition, we set a record for this quarter for optical power in the unit quantity shipped.

China experienced tremendous growth during the second quarter, driven by customer demand for high power and pulse lasers. Chinese revenue more than tripled versus Q2 2009, and China counted again for more than 10% of our revenue during the quarter.

Our OEMs in China continue to see strong end demand for 2D and 3-D high-power cutting and welding applications. This new greenfield built -- by the way, this seems to be preferred white source for material processing applications. We are also replacing a group [pinyada] and CO2 lasers, given our superior product performance, reliability, and efficiency.

We haven't experienced a slowdown in the Chinese equipment, and the demand for our products is robust. However, we see that availability of certain components and [berate in the even] export licenses, so the potential constraint in the future given the particular growth of these region.

Our second quarter gross margin of 35.3% reflects the strong growth in our higher ASP product lines in combination with leveraging IPG fixed core structure due to higher vertical integration strategies. [Killer also] high-powered lasers sold by IPG nearly doubled this quarter versus the same quarter last year, benefiting margins.

By leveraging the advancements we can make in diode performance and component cost, we can now target gross margins that are still able to preserve pre-recession levels. This quarter, gross margin also benefited from lower inventories and reserves, related to the third quarter a year ago.

Now, for a new product update. Whereas (inaudible) encouraged [buy] contribution from a new product such as TCV laser, lasers which generated almost $1 million revenue in its initial release quarter, QCW lasers will be directly competitive with existing legacy [lead] pump solid-state lasers. Green pulse lasers are in [varying] reduced stage also, with some large potential for intermobile -- module customers. Green CW lasers are in the final internal testing stage and I expect it to be in the customer's hand before the end of the year.

We have an increasing book of quotes and customer inquiries for our unique single frequency tunable lasers, leveraging our acquisition of Photonics Innovations in January.

And finally, we are pleased to report that we have fully integrated the previously announced Cosytronic acquisition. The total pipe refining [months still are] for lasers still [separate], integrated high-power [varientals] are progressing very well.

In conclusion, I would like to mention that we believe that the recent announcement by our competitors of an increased focus on fiber laser development will only benefit IPG sales. IPG helped pioneer the field of fiber lasers for high-powered [can award] applications in metals processing for almost a decade, and with competitors only now turning their attention to this opportunity, we believe this will help validate the commercial market opportunity and help IPG distinguish itself with superior products offering versus the potential competitors.

Fiber lasers continue to gain traction and have a distinct advantage to cut materials such as aluminum, copper, brass, stainless steel, and nonmetal that cannot be cut effectively with traditional CO2 lasers. IPG collaborates with many OEMs and integrators worldwide to deliver best-in-class processes and systems for many applications.

With that, I will turn the call over to Tim.

Thank you, Valentin, and good morning, everyone. Our results for the second quarter reflect an improvement in our end markets; growth within materials processing; excellent Chinese results; growth in Europe, the U.S., and the rest of Asia, excluding Japan; and continued adoption of our fiber lasers, which still only represent approximately 10% of the total materials processing laser market, according to Optech Consulting.

Furthermore, the operational leverage and profitability that IPG demonstrated this quarter is evidence of our differentiated laser technology, strategic pricing strategy, and vertically-integrated business model.

I will review our end markets, products, and applications next. Afterwards, I'll follow with a summary of our income statement and balance sheet, and close with our guidance.

Materials processing reported an outstanding second quarter, growing revenue 90.8% on a year-over-year basis and 34% on a sequential basis. In total, materials processing, which is IPG's largest market, contributed 85.1%, or $57.3 million, to the second quarter's consolidated revenue.

Within this segment, IPG serves manufacturing, automotive, heavy industrial, aerospace, consumer, and electronics end markets. Growth in demand for high-power lasers for cutting and welding and pulse lasers for engraving and marking applications were the major drivers behind this period's robust performance.

For the second quarter, the advanced applications market, which includes test and measurement, instrumentation, sensing and defense applications, as well as scientific research and development, represented 8% of total revenue, or $5.4 million. Revenue decreased 5.3% year over year and increased 15% sequentially.

As we have stated previously, orders are less predictable in this market. We do continue to have a number of 10 kW single mode lasers -- laser orders in hand that, when shipped to customers later this year, will meaningfully contribute to revenue.

Medical sales comprised 3.7% of total revenue, or $2.5 million. Sales to the medical application market grew by 31.9% on a year-over-year basis and 28.6% sequentially. This solid performance comes on the heels of the first quarter where medical sales more than doubled on a year-over-year basis.

We have had some success in diversifying our medical customer base, driving sales of low-power lasers. We will continue to seek inroads with strategic medical device vendors and other OEMs.

For the second quarter, sales to the telecommunications market decreased 24.2% year over year and grew 15% on a sequential basis. This segment comprised 3.2%, or $2.1 million, of our total revenues. We continue to experience weakness in Russia due to the timing of orders for long-haul, broadband access, and cable TV resulting from the merger between Ross Telecom and seven regional telecom operators, which received shareholder approval at the end of the quarter.

However, sequentially the telecommunications sales improved, and we did receive a sizable Japanese telecom order in July and look forward to additional orders in the coming quarters. The catalyst for growth in this sector will depend on our ability to sell complete 10 gig and 40 gig DWDM systems in the CIS region.

From a product line perspective, high-power fiber lasers rebounded nicely from the first quarter, coming in at $23.6 million, or 51% year-over-year growth, and reflecting a 39% sequential improvement from Q1 2010. Strength across materials processing, including cutting applications, underscored these results and did our -- as did our exceptional performance in China, with added strength in Europe and Latin America.

We had a very strong quarter for pulse lasers with sales of $22.8 million, driven by the improving demand for materials processing applications, particularly marking and engraving. Pulse laser sales grew 129% year over year and 34% sequentially. As Valentin mentioned earlier, we are pleased to report that second-quarter sales of pulse lasers represents an all-time record for IPG.

Our low-power lasers, which are primarily used for medical applications and micro materials processing, were up 70% year over year to $4.8 million, and increased 7% on a sequential basis.

Medium-power laser sales, at $4.8 million for the second quarter, grew by 12% year over year and 19% sequentially. Micro electronics, printing, and centering applications continued to support performance of this product line.

All of our geographies posted stronger results against the backdrop of an improving macro economy. Asia and Australia contributed 41.7% to total revenue. The region's revenues increased on both a year-over-year basis and a sequential basis, by 112.7% and 40.3%, respectively.

China, in particular, generated exceptionally strong results, driven by high-power hand pulse lasers used throughout materials processing activities to support that country's double-digit economic growth. Keep in mind that IPG started selling high-power lasers in China only in 2009, and therefore the prior-year results reflected lower sales volumes of high-power lasers.

We do remain a bit cautious on Japan, which underperformed the overall Asian geography due to continued malaise in Japan's overall economy.

Europe represented 34.3% of overall revenue during the second quarter. Revenue increased 52.3% on a year-over-year basis and 29.7% sequentially after a soft first quarter of 2010. Germany and Italy continued to deliver consistently solid results.

Our North America market grew by 31.4% on a year-over-year basis and 18.6% sequentially. Amounting to 23.5% of IPG's sales, growth in materials processing, and specifically high-powered cutting lasers and pulse lasers for marking and engraving, contributed to this quarter's performance.

As with Japan, we continue to remain a bit cautious with the United States given continued macro headwinds, although recent order flow have improved and we are waiting on a few significant orders. In the advanced applications, ongoing projects, R&D, and the timing of funding has limited activity in 2010.

The rest of the world made up 0.6% of total sales.

Now turning to the income statement, total sales of $67.3 million increased nearly 67% year over year and 31.4% sequentially, and exceeded our guidance for the quarter of $57 million to $62 million. Gross margins improved to 45.3% for the second quarter, compared with 29.1% in Q2 2009 and 40.1% in Q1 2010. Gross margins benefited from an increase in sales and production, part of which was placed in inventory, as well as lower inventory reserves compared to the same quarter in 2009.

In addition, we are starting to benefit from improved margins on new products and accessories, which we are manufacturing in greater quantities.

SG&A expenses in Q2 were $12.3 million, or 18.3% of sales, compared with $8.8 million, or 21.8% of sales, in the second quarter of last year. Though IMRA patent litigation expenses were lower in the second quarter than in the first quarter of 2010, these legal costs increased year over year. I have mentioned before this elements of our expenses can vary from quarter to quarter based on the level of activity.

Furthermore, with IPG's improving financial performance, we continue to accrue for performance-related bonuses as compared to 2009 when we did not. Keep in mind that we did not accrue for performance-related bonuses in 2009. We had a $2.3 million net foreign exchange gain during the quarter, compared with a $0.5 million net foreign exchange gain during the same period last year.

With regard to the IMRA litigation, the Markman hearing was held in early -- held early in June 2010, but to date, the District Court has not issued a decision on the claim constructions asserted by IPG and IMRA. As such, there has been no court action on any substantial matter so far.

The trial is still on track to begin on August 24, 2010. We continue to expect to incur significantly higher legal expenses this year, especially in Q3, related to this case as we vigorously defend IPG against the claims in this lawsuit.

We are pleased to report that IPG has settled all patent infringement claims made against the Company by CardioFocus, as well as IPG's counterclaims against CardioFocus by mutual agreement. The settlement did not and will not have any impact on IPG's financial statements or condition. The settlement brings to a close the claims filed against IPG in February 2008.

R&D expenses were consistent year over year at $4.7 million, or 7% of total revenues, versus $4.7 million, or 11.7% of total revenues, for the second quarter 2009. The two reporting periods are comparable on an absolute dollar basis, as IPG continues to invest in new products and internally-developed complementary accessories.

Total operating expenses for the second quarter of 2010 were $14.8 million, compared with $13.1 million for the same period last year. Again, incrementally-higher litigation costs, bonus accruals, and selling expenses contributed to this increase. We continue to expect quarterly operating expenses to be approximately [$17 million in Q3 2010 including legal expenses] (corrected by company after the call).

We estimate that if exchange rates had been the same as one year ago, sales in Q2 2010 would have been $2.6 million higher, gross profit would've been $1.4 million higher, and operating expenses in total would've been $0.1 million higher.

Second-quarter operating income was $15.7 million, or 23.4% of sales, compared with an operating loss of $1.3 million in the second quarter of last year. Operating income includes stock-based compensation charges of $793,000 and $635,000 in the second quarters of 2010 and 2009, respectively. In the second quarter of 2010, $151,000, $520,000, and $122,000 of stock-based compensation charges related to cost of sales, SG&A, and R&D, respectively.

Our tax rate for the second quarter of 2010 was 33.2%. The slight increase in the effective tax rate is due to the settlement of prior-year taxes related to a change in the registered status of our Chinese subsidiary. We expect our full-year effective tax rate to be approximately 32.5%.

Finally, we are pleased to report second-quarter net income of $10.3 million, or $0.22 per diluted share, compared with a net loss of $1.2 million, or $0.03 per share, for the second quarter a year ago. The $2.3 million net foreign exchange gain during the second quarter benefited diluted earnings per share by $0.03 after tax.

Now turning to the balance sheet, our cash and cash equivalents increased by $6.2 million sequentially to $90.7 million at the end of the second quarter. Cash generated from operations in the second quarter was $15.6 million. For the second quarter of 2010, inventory was $54 million, up 2% from year end, excluding the impact of foreign exchange.

As IPG continues to see improving global demand for our products, we will incrementally add to inventory to meet the needs of our customers. Accounts Receivable were at $39.9 million at the end of the second quarter, or 59 days sales outstanding, compared to $30.4 million at December 31, 2009, or 50 days sales outstanding. The Accounts Receivable increase is due to higher sales this quarter and the timing of the shipments at quarter end.

Capital expenditures totaled $12.8 million for the first half of 2010, including the Korean building that we acquired during the first quarter for $2.5 million to aid with the selling of high-power fiber lasers throughout Asia. While we continue to target capital expenditures of approximately -- for 2010 of approximately $25 million, including a portion for acquisitions, this amount could increase slightly towards the end of the year if sales growth continues and capacity utilization improves further.

This leads us to our expectations going forward. We exit the first half of 2010 with solid momentum in most of our end markets, product lines, and geographies, underscored by a book to bill greater than one and over 500 kW of high-power lasers sold.

Global adoption for fiber lasers continues to favorably impact our pipeline of opportunities, while pricing has been more stable. IPG business model is well positioned to meet the increasing global demand for fiber lasers, introduce new and innovative lasers, penetrate complementary markets, service our installed customer base, and, as always, capitalize on new opportunities to expand our customer base and displace existing laser and non-laser technologies in a wide range of applications.

Now, let me provide you with our guidance for the upcoming quarter. For the third quarter of 2010, IPG Photonics expects revenues in the range of $69 million to $75 million. The Company anticipates earnings per diluted share in the range of $0.19 to $0.25. That is based on 47,333,000 diluted common shares, which include 46,220,000 basic common shares outstanding and 1,113,000 potentially dilutive options.

The EPS guidance includes higher planned legal expenses related to the upcoming IMRA America patent trial. 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.

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

(Operator Instructions). Avinash Kant, D.A. Davidson & Co.

First question, about China. Clearly China has seen a very strong growth. Could you give us a little bit of color about whether that growth has been a bit gradual or has it been a result of some recent wins that you've had over the past quarter or so?

Clearly, it's not gradual. The rate of growth there has accelerated. I would say that there are several main OEMs who have substantially increased their purchasing of both high-power lasers for cutting and welding applications, and also pulse lasers for marking applications. We have signed large agreements for multiple hundred unit orders of pulse lasers, and that has helped to really propel the results from that area forward.

So, Tim, if you were to say, your design and wins have been much stronger lately in China?

The design wins?

Yes, or the wins at the customers have accelerated?

Yes, I think the penetration overall in China has really started to gain traction. Don't forget as well that we only started selling the high-power lasers there in the last year or so.

So, there's a lot of process development work that our customers have been doing. There's a lot of R&D being -- going on in relation to that, and as we've expanded the service and support and sales people, we've been able to penetrate quickly in the last six months or so the high-power laser market, as well as see a rapid rebound in increased growth of pulse lasers.

So would you say that the growth in China is driven primarily by high power or pulse, or both at this time?

It's right across the -- all the product lines. It's high power, it's pulse lasers, it's the new QCW lasers. And there are also significant orders for some of the medium-power lasers as well.

One thing we have started to make progress with is obtaining blanket order export permits and licenses for certain customers, so that has enabled us to ship more frequently, although there are a number of export licenses for other customers we are still waiting on.

We [have a mortal steel connecticut wad] we are still awaiting licenses. So it's only to cut the growth in China sales.

And any color on adoption at the key automotive manufacturers? I know you were expecting some meaningful orders or expansion at some of the European guys. Any color on that?

I think the automotive sector had a solid quarter in Q2. There is no 20- or 30-unit sales out there. But our traction and penetration across the board, whether it be in Europe, in the U.S., at both the final assembly plants, the Tier 1 and Tier 2 suppliers, and indeed in China and Japan, continue apace. We're not going to report on any specific customers.

Paul Thomas, BoA Merrill Lynch.

So, on the September quarter guidance, that $72 million at the midpoint. In the past, you've talked about gross margin targets that would've been in the high 40s, maybe 48%, 49% range. What sort of range should we be thinking here? And then, in addition to that, I guess, what would get us kind of up into that 48%, 49% range? Is it further ASPs or is it more inventory turns or what might make that happen?

First of all, I'd like to say I think we are really pleased to get the margins back up above 45%. I think it's quite remarkable, given some of the ASP declines we've seen over the last 18 months. So, it's very pleasing.

I think the cost initiatives that Valentin had put in place to reduce the cost of diodes, improve the efficiency of the diodes, so we can use fewer of them, and develop the accessories has really driven that, and then we've seen capacity utilization improve.

Of course, in the near term as revenues step up, we would expect and hope that gross margins will improve beyond the 45%. I'm not going to provide specific guidance or a target of 48% or 49%. I think we'd like to see some incremental improvements as revenue grows, and then, one thing I will caution about coming into next year and afterwards is we may have to start adding a little bit of capacity because, clearly, our utilization levels are improving.

But if you want to model, as I said on the last call, on the current cost base, of course you can see gross margins coming up to 47%, 46%. And then, the near term, we would hope to get up to that level.

Again, as well, there were some issues around product mix can change from quarter to quarter if we suddenly see a ramp-up in medium-power lasers sales, which have a nice margin profile to them. We could see some benefit to that. So, it's a real mix and it's -- a number of different factors go into it.

Okay, and then maybe on the utilization rate. You commented about having to expand capacity. Where is your utilization rate at right now and at what level would you think about adding more capacity?

Overall, utilization has moved up from just above 50% to closer to 70%. We previously said that as revenue tends to about $80 million a quarter, we'll need to start planning to add capacity.

At the moment, we have some plants which are operating at higher capacity and others at lower capacity. So our first strategy, which has already been implemented, has been to move production out of -- a little bit out of Europe and into the U.S. where capacity utilization is lower to meet that demand, so we're going to start producing some of the product for Asia over here, for example.

So, the immediate plan is to improve the efficiency of those plants that are underperforming a little bit and take some of the stress off those plants at the moment that are having to supply product. I would say that coming into the end of this year, you will see our CapEx plans for next year step up from where they are right now. We cannot at this time provide specific numbers or even an estimate of where we think that will go to.

Mark Douglass, Longbow Research.

Nice quarter. You're already back above prior peak. Tim, I assume orders were tracking through July similarly to what they were like in the second quarter.

We have not seen any significant change in order flow through July and we mentioned, actually, that we've actually seen some improvement in the U.S. through the first four to five weeks of the quarter, and, yes, no significant changes in trends around the rest of the world.

Where in the U.S. are you seeing it pick up? Is the lack of credit also hampering these things just overall, sales to laser-cutting OEMs?

No, I wouldn't say that. I think first of all, in answer to your question, it's across the board, the pick up in the U.S. again is across all of the product lines -- pulse lasers, low-power lasers. There are opportunities out there for medium-power lasers and also the high-power lasers.

The other part of it is that some of our European OEMs, which we don't see this as coming into the U.S., but there's a lot of cutting equipment coming from some of the European OEMs directly into North America.

I wouldn't say that -- I haven't heard of anybody say that a lack of access to credit has delayed an order. I think people potentially were remaining a little bit cautious through the second quarter. (Multiple speakers) any hearsay in the market about people not having credit or access to credit lines for leasing.

That's helpful. And then, also in the U.S., do you think people are [just within terms] are kind of waiting for the trade shows to kind of see what's out there and when people place orders? Do you hear a buzz that people might be kind of delaying plans to the back half of the year and it should really pick up in the U.S.?

We haven't heard anything specific. I think part of it was just the timing of stuff in the second quarter, with projects taking a little bit longer -- a few more weeks to get approved. We haven't heard of anything that's been delayed by four or six months. I think it's more just a process issue in terms of ordering.

Okay, thank you.

I don't think they're waiting for the trade shows.

I can add only that we now are working very hard to develop new products, new applications. We are very successful in the very high-volume applications where some of them were developed for U.S. customers, so we expect the next couple of quarters very serious new orders from these customers.

Jim Ricchiuti, Needham & Company.

Tim, did you actually give a dollar number for the legal expense you are anticipating for Q3? I wasn't sure if you provided that for Q2.

We did not provide it for Q2 and we did not update the number for Q3 for various reasons. I won't be giving a number right now.

But you expect it to be up significantly and it's basically in your guidance?

Yes.

Just with respect to the bookings strength that you are seeing, you mentioned that you are seeing a pick-up in the U.S. It sounds like China continues to be strong. What are you seeing in Europe, just in light of some people's concerns about the macro economy over there?

No real change in Europe. I think that the whole credit crisis and eurozone problems really have not affected day-to-day manufacturing in Europe. I think also Europe, given, in particular with Germany, the export nature of the economy, it's continuing to benefit from the strength in the Far East. So we really haven't seen any significant change in trends in Europe either.

Okay, and then, you made a comment about price stability. Is that pricing -- is pricing stable both in the high-power laser as well as pulse?

Yes, I think that the overall pricing strategy that we've implemented has remained stable as we see unit volumes to some of these OEMs step up. I mentioned there are a couple of OEMs that were shipping probably -- or ramping up to ship 500 units a quarter on pulse lasers, and on the high-power lasers they've got customers who are taking five to 10 units a month. There is, because of those higher unit volumes, slightly lower ASPs. But then, we offset that, as we've always hoped to do so, by improving the absorption by increasing output.

Great. Thanks a lot. Congratulations on the quarter.

Jiwon Lee, Sidoti & Company.

Now, you've made two acquisitions this year. Remind us again how do you expect those acquisitions to help to expand product line, and I think you were expecting some meaningful revenue contributions from this side sometime in next year. Are we on target?

We expected from this acquisition very serious in Korea, in [bit] sales, even this year we started such [first all that we see] from our very potential or very prospective customers. So [ultimate] very high, so next year we expect very high return from these two [boss] acquisition, especially from acquisition of Cosytronics acquisition.

That's helpful. Since you are still gunning for more acquisitions, what is on the horizon for you?

We haven't specifically talked about any other acquisitions. Our overall strategy remains to look at companies that we can easily integrate that have a technology that we could use with our light source.

Potential other acquisitions may be to expand our global reach, and also forward integration of both the acquisitions we made this year fall into those categories with the COSY Seam-Stepper providing us with an entree into the welding market and the Photonics Innovations expanding the product line [viday] into different wavelengths.

We do not envisage at this point in time making a large channel-type acquisition because we think they're difficult to integrate. There are cultural issues around that. So, we want to make a success of these two acquisitions, and then hopefully identify other value-adding propositions out there.

That's helpful. And on pricing, obviously the ASP year over year is on a down trend. But given the demand outside of the volume discount you're giving out on large orders, has it stabilized?

Yes, the pricing has basically stabilized within the discount parameters that we give. We have not seen a need to reduce those prices any further. We believe, furthermore, that the value that we're now providing with the technology, high-power lasers being priced between $50 and $70 depending upon the final output power, has really driven some of the acceleration in adoption. And then, given the lower maintenance costs and lower total cost of ownership, it's a particularly propelling -- particularly compelling case that we can present to potential customers now.

Okay. On the competitive landscape, in the past there were some competitions on the pulse laser side. Could you talk a little bit about that competitive landscape changes at all, and/or anything on the high-power horizon?

So I think those pulse laser customers are still out there. The only way they can try and compete is on price, but we are sort of -- they can't really compete on price because we've got all the volume manufacturing and ability to price our product and make a profit on it. So, they are out there, but I'd say that a lot of our customers have continued to buy from us because we're the only people who can meet the total unit volumes and the quality and reliability of the product.

And this year, we expect increasing sales of pulse laser minimal three to four times to compare to 2009, twice higher than it was 2008 when we have the peak sales.

It's -- we decreased the rate of cost -- decreased a little price of this laser. It's now practical out of competition at all. But the decrease of price wasn't -- not for account or for a lower margin. It was a result of very hard work to decrease costs, manufacturing costs of such powerful lasers. We [felt] very good decreased saving last year and this year, so it practically -- we're seeing the same margin, very high margin, but we won't market so. Now our share in the market pulse laser increased very essential this year.

Great. And lastly for me, in the past within materials processing, you've given some insight as to which end markets are showing strengths or weaknesses. Could you sort of provide similar colors within your materials processing, especially with the cutting and welding in mind?

So, general trends, in terms of sectors, the automotive, general manufacturing are all strong, and then it's really cutting, welding, and marking and engraving that are the key drivers of the growth.

That's helpful. Thank you.

Joe Maxa, Dougherty & Company.

Tim, you mentioned you expect OpEx levels to remain around $15 million per quarter. Does that include the legal expenses?

Yes, it does.

So with $15 million and gross margins around your 45%, I'm just looking at the model, you're going to have -- I'm coming up mid to higher end of your guidance, am I -- there was some thought that, or some talk, that your gross margins could expand from 45 in the near term. Are we looking at we should be near the high end?

Of what?

Of your guidance. What would get you down to the lower end, I guess?

Joe, I can't make any determinations on where you should be building your model at the higher or lower end. (Multiple speakers) There's product mix, there's -- it depends how much inventory is added or consumed, because that will drive the absorption rates. You know, we clearly are adding some indirect labor. It depends how quickly they become efficient or not efficient. So, there is a number of different factors in there.

Are you looking at typical -- are you expecting a typical fourth-quarter seasonality this year?

There's nothing at the moment to assume that it will be any different, unless the whole economy blows up like it did in Q3 2008. Typically, we see increased traction in the CIS and then some budget spending throughout the world, so there's no reason to think that that would not happen at this point in time.

Right. Also wanted to ask on your new products, you touched on them briefly, million dollars in one of the product lines, I think. Can you give us an overall update of how those new products are tracking, again? Maybe refresh what you said earlier.

So, the QCW lasers, which are a low average power laser with a high peak power that runs into the kilowatts, that is probably the most successful product launch in the first quarter. That's the one that had grown to almost $1 million in sales.

There were a lot of applications there in the microprocessing arena that should quickly displace Lamp Pump YAG lasers, which are particularly inefficient. So we're very hopeful that that's going to track quickly, and then, we've got -- the pulse green laser is released. There's a few unit sales of that that have occurred, but there's ongoing testing.

And on the continuous-wave green laser, that's close to completion. With one of the acquisitions, we just heard we've got a small order, a nice ASP order for -- it's a -- one of the new products at the lower power, special [science], single frequency, two watt single-frequency lasers. So, some of those new products are clearly performing better than others, but we're hopeful that they would all, over the next 12 months, start to improve dramatically.

Ajit Pai, Stifel Nicolaus.

Good morning and congratulations on the prior quarter. A couple of quick questions, actually three. The first one is on China. You saw some pretty significant strength there. Could you discuss your China channel strategy a little bit, about what's changed over there in terms of the mix?

And on China itself, you talked about getting open orders for certain customers where you can ship much faster and not for other customers. So, could you give us some color as to the significant orders? I think you mentioned hundreds of units from one customer, whether -- an OEM there, whether -- what kind of OEM is it? And also, you know, Han's Laser, whether you consider them more of a competitor or more of a customer in China, and then I have two other questions.

This is not hundreds, but thousands of lasers in one [sense]. So, we have such big orders, and they are growing very fast. And Han's Laser, we compete with him, but also are very serious customer.

I think your first part of the question, Ajit, was what sort of changed? First of all, we did make a management change in China a year ago and brought on somebody, as we did in Japan, who's been in the laser industry for 20 years. They have built out substantially the sales and service and support, and also used their knowledge and industry experience to really drive us forward as a serious supplier of lasers in that country.

I think, on top of that, there is a lot of development and process work for different applications that's happened over the last six to nine months, and often when those developments in process come to an end, you do see an initial step up in revenue as people start ordering multiple units.

And the last side of the strategy has to be -- has been to start selling the high-power lasers, where for a couple of years we were only selling pulse lasers. So it's a combination, I think, of all of those issues and strategies reaping benefits.

Got it. The second question would be sort of looking at the advanced application side. I think while on a year-over-year basis your revenues were down, on a sequential basis it was up. I think Valentin has talked about a couple of very large high-power orders over there. Have those orders shipped already and what -- the potential of further sort of momentum in this particular area, especially for defense applications, what's the probability of something happening over there in 2011?

The answer to the first part of the question is the single-mode high-power lasers have not shipped yet. We are expecting or hoping to ship one of them this quarter and the remaining two, or maybe three in backlog, by the end of the year. So, that should help the advanced application revenue in the second half of the year.

I think that our forecast at the beginning of the year was more of a year of consolidation around advanced. There is no clear visibility into anything in 2011 at the moment. I think there are some funding constraints and ongoing R&D. There is a -- one multiple kilowatt opportunity. It's below 20 kW that I think we'd hope to get an order for before the end of this year. But there's nothing specific we can provide about multiple 10-unit orders for 2011 at this point in time. (Multiple speakers)

That's where advanced application, for us it's [sight] work. We need to in our business plan, we never take in account that [one] application business, in serious.

Got it. But it has potential to become very material if you start getting defense-oriented orders, right, as a percentage of your business, when they start coming in, and right now they haven't started coming in in high volume. The question is do you expect them to start coming in in the next 18 to 24 months? Or you think that the timeline is going to be greater than that?

I just don't know we can say at this point in time as to when it will be. It would hopefully increase that advanced applications revenue. But the largest part of the market that we can address continues to be materials processing, which is already a multibillion dollar market. So we have to continue to execute on penetrating that.

You are right that if you suddenly get 10-unit orders for single-mode kilowatt lasers, that should increase the advanced side. But I don't think advanced will ever get up to 40% or 50% of our revenue. At least, we can't even make that determination right now.

Got it. Then the last question is just looking at the cost structure. There were two initiatives that you talked about over the past couple of years in improving our margins. One initiative was increasing the wattage per diode, and there were transitions going on over there, so could you give us some idea of the pipeline and the mix right now in terms of 9 W versus other diodes, as well as in the future, whether there are already even higher-powered diodes that are on the calendar for 2011-2012, and whether they save costs or they don't.

And the second initiative you talked about was integrating the number of components that you are buying externally, trying to produce them in house. So I wanted to get some color as to whether most of the initiatives have already -- that you had on your plate have already sort of been reflected in margins or they are going to continue to be reflected in margins going forward?

On the diode side, I think we've transitioned now for the pulse lasers to the new chip, which is being packaged into a 10 W package, and then on a high-power lasers we've now moved up from the 22 W to the 30 W.

I think Valentin's view is that 30 W is probably optimum for all of CW high-power lasers. For example, on the QCW lasers, we are planning on using the newer PLD 60. So the 60 W diode, so that transition is coming to a full implementation. We were still using some of the older PLD 20s during the first half of the year, but the proportion has come down significantly.

In terms of the other accessories, we really are seeing those start to flow through into the business model, let's say, we're using 80% of our own accessories now? Probably something like 80% of our own accessories at this point in time.

And with diodes, also take in mind that with increase of volume, price per watt are going down very essentially. This year, we will produce two times more diodes than last year. In terms of price per watt, we [won] maybe 30% down compared to last year.

It's not -- we still have enough reserve [and] probably grow the volume also would give us a very big benefit in costs in the margin. Other parts in -- also components in the parts we produce in house also margin depends and cost depends strongly from volume. So, we increase the volume, margins have to go up very essential.

Got it. So, if you've seen this drop in cost and it's not being fully recognized in this quarter, it's going to come through in the third and fourth quarter, and you're talking about stable pricing and you're looking at much higher volumes, there's no reason why your gross margin should be expanding materially over the next couple of quarters, is there?

I think we did say that we would hope to achieve some gains on gross margins. I think we're just cautious about giving specific numbers out there.

As we've always said, with the capital equipment business that we think it's going to be difficult to get up into the upper 40s and then 50s, we don't think on a capital equipment business is necessarily sustainable in the long run. I do think we have done this huge amount of work on the cost side. I think it was Andrew Carnegie that said that if you look at the costs, the rest of the business will look after itself. So, I can give Valentin no higher compliment than he must have been reading some of his books or decided to follow him.

Thank you so much and congratulations again.

Ladies and gentlemen, due to time constraints, we ask that the remaining questioners limit themselves to one question and one follow-up. We thank you for your understanding in this matter.

C.J. Muse, Barclays Capital.

It's Olga calling in for C.J. Thanks for taking the question. I guess because of the limitations, two questions. On the prepared comments, you talked about potentially constrained components in the Chinese end of the market and that might limit the ramp there. Can you talk about which components they are and how you see those limitations getting abated a little bit either through year end or into 2011?

And then, in terms of the Cosytronic acquisition and the production of your new welding tool that's fully integrated, are you seeing any sort of pushback from previous integrators or OEMs you had sold into only from a laser side, now that you are essentially competing in certain parts of the business?

In terms of the components supply chain, I think overall talking about specific components, I think it revolves around trying to manage a ramp-up in production of all of the vertically integrated components that we have.

So, it is clearly a challenge when revenue is growing that quickly to ensure that we don't step in the wrong direction in that management process. There's a big ramp in chip production, there is a big ramp in diode packaging production, the manufacturer of, for example, modulators for the pulse lasers, couplers, isolators. So it's more a question of us having to manage all of that, given our vertical integration.

And then, your second question was about the COSY Seam-Stepper. We haven't heard anything from any of the other OEMs directly. I think we are -- the reason we acquired COSY was it was a newer welding process that had specific applications. And I think it's targeted, really, to displace spot welding more than anything else, rather than necessarily compete directly with some of our OEMs.

We're working in application integration for new solutions, which were in the application when practical now with no competition at all. And we're saving very good relations, that brought our integrator to in the market application which now exists in the market.

Mark Miller, Noble Financial Group.

Just a real quick question. There is a developing opportunity. One laser firm said it's become a sizable market in terms of the LED manufacturing opportunities in China. I was just wondering if any of your newer products will address that market or what's your thoughts about that market in terms of applicability for your firm?

In LED manufacturing. We're not addressing that. (multiple speakers)

(Multiple speakers) different products and different applications. It's commodity products. We're not interested in looking for in the world high-tech. It's an advanced product, that LED is not [a real deal]. It's a commodity product for a big company like Sony and so on.

I was thinking more about the manufacturing process, the scribing application. Just finally, in terms of your growing cash position, I understand you might want to leverage that for your growth opportunities. Is there a point when you start thinking about buying back shares?

We have not contemplated that at this time. I think the rate of growth in the working capital requirements have to be managed first, Mark. So we've got no specific plans to buy back shares at this point in time. (multiple speakers)

On your -- I didn't get your LED question. I think there are some processes, particularly one in China, but in Korea on the OLED, which is being used in the manufacture of some of the new flat-screen TVs where we are supplying equipment into that manufacturing process. I've not heard of anything specifically on the mass manufacture of LEDs in China that we've got any wins there.

I think that's for scribing and dicing applications, what people are focused on, some of the other laser firms.

I Just don't have any insight into it at this time.

Tom Bishop, BI Research.

With regards to the ultra high-powered lasers that -- for defense applications, I was just sort of wondering how the testing is going and are you doing anything up in the 40 and even 50 kW range?

Yes, we have supplied several lasers in the last two to three years in the 40 and 50 kW range. The testing and R&D is ongoing there. We've got a 50 kW laser that's out in the field, and I think it's a 44 kW laser with the Navy.

There is nothing specific to report from that at this point in time. They've had various trials with successfully shooting down drones and unmanned aircraft over the last 18 months or so. I think they're very pleased with the performance of the lasers. We've had reports that they've got more uptime in testing these lasers than they've ever had in the last 10 years. With other technologies.

Nothing with, like, missiles? Or is that too far out there?

It's not our business at all. We (inaudible) in ways that some military people use for some experiment for, wanted for, okay. They buy and pay us money, that's all, but we don't participate in such projects and don't plan to participate in serious in such projects.

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

Okay. Thank you for joining us today. We look forward to speaking with you after the conclusion of third quarter 2010. We hope to report to you great results in this quarter and also at end of year.

Thank you.

That concludes our conference call. Thank you for joining us today.