IPG Photonics Corp (IPGP) 2010 Q3 法說會逐字稿

Good morning and welcome to IPG Photonics' third-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 the 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 investor.ipgphotonics.com/sec.cfm, or by contacting the Company directly. You may find copies 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, November 1, 2010. The Company assumes no obligation to publicly release any updates or revision 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. Valentin Gapontsev.

Good morning, and thank you for joining us today.

IPG turned in an excellent performance in the third quarter. Revenue grew by 74% year-over-year and 18.7% sequentially. And earnings per share grew by $0.28, from $0.05 a year ago area. Both have demonstrated the strength of our business model, achieving gross margins of 50%, up from 36.5% a year ago and 45.3% in Q2.

The demand for our pulsed laser and high-powered lasers reached -- increased 87.7% and 83.3%, respectively year-over-year; was the chief growth driver for the quarter. We are continuing to see strong demand for high-powered lasers for material power systems applications, which were up 93.1% over the prior year. The result of last quarter reflects the growing market acceptance of high-powered fiber lasers for cutting, which is largest application for high-powered lasers (inaudible). This is indicated in part by the number of high-powered laser cutters and welders displayed at the recent EuroBLECH show in Hannover, Germany, one of the largest fabrication shows in the world. At EuroBLECH alone, 17 companies demonstrated fiber laser cutting systems and, [14 shroud] fiber welding systems and systems for other applications. The growing number of our cutting and welding OEMs shows how the perception of high-powered fiber lasers for material processing applications has changed.

1.5 years ago, IPG highlighted the potential fiber laser for 3 billion (inaudible) cutting market. Our competitors are questioning this (inaudible) on their alleged inferior quality of the metal (inaudible) after fiber laser [cut]. It is clear now that the problem is resolved. Our customers have achieved excellent results even with the (inaudible) of 20 to 35 millimeters. Therefore, with the waves at [their normal technical obstacle] for fiber lasers, to win a substantial share of laser cutting market over the next few years.

[Also], we are working on new partnerships to further our applications' (inaudible). One recent example is our strategic development project for hybrid fiber laser MIG welding solutions with Lincoln Electric, the world's leader in arc welding products. During Q3, other new excellent results with high-powered fiber lasers have been demonstrated, including paint stripping, [large] surface cleaning, solar [telecom] implantations, (inaudible) large scale construction, organic thin film processing for a new generation of large size flatscreen displays and high-speed (inaudible) titanium (inaudible) of metal parts.

In addition, we have delivered (inaudible) stepper welding systems which have been in use in high-volume automotive applications. We believe that this new stepper can have a dramatic impact on automotive welding market. Growth was strong across all of our geographic regions in the quarter with sales in Germany and China both growing at more than 90% compared to one year ago, primarily due to material [processing] demand.

On past calls, I have discussed our expectation for some of our new products. Some of these products have begun to contribute to total revenue in third quarter in a meaningful way, in particular, our high-powered pulsed lasers and [QCW] lasers. We have seen a significant interest from companies in the US to use our QCW laser for retrofitting old (inaudible) [pump] arc welding systems and the use in -- of high-powered pulsed laser in flat panel display manufacturing and deep engraving applications.

The new generation of our state of the art [green] lasers and [mid-infrared] lasers has started to contribute in IPG revenue at Q3 also. It was our (inaudible) efforts to develop a new generation of old (inaudible) [DWDM] telecom systems have started to bring us some [response]. In Q3 telecom sales increased by 160% year-over-year and 144% sequentially. Our new 40G transporters and state of the art line of [max conduct] [multi] (inaudible) and (inaudible) devices have passed field tests and were certified for use by a largest Russian operator, Rostelecom. We saw an essential improvement in US and Japanese telecom sales also.

Finally, I would like to take a moment to discuss our new partnership with the Russian Corporation of Nanotechnologies, or RUSNANO, and our agreement to sell a minority interest in our Russian subsidiary, IRE-Polus, to RUSNANO. RUSNANO was founded under Russian law in 2007 to advance Russia's leadership in the field of nanotechnology. RUSNANO is focused on commercializing nanotechnology projects through its funding by Russian government. According to the agreement, RUSNANO will purchase up to 12.5 ownership in IRE-Polus for $25 million. They kept the right to purchase up to another 12.51% for an equal amount.

This partnership provides two major benefits to IPG that we believe improves our ability to grow sales in the Russian industrial and telecom markets. First, the capital from RUSNANO enables IRE-Polus to make significant investment in R&D and CapEx, further strengthening our position in this market. Second, we believe our partnership with RUSNANO should multiply the number of telecommunications, industrial and other important commercial relationships we have in Russia. At the time of the agreement, IPG will maintain majority ownership and control of IRE-Polus, and IPG has a call option after three years to buy back the minority stake at the [determined] value.

RUSNANO has a put option after five years to sell its minority stake to IPG at predetermined value. A (inaudible) deal is offered in place limiting purchases of our common stock via RUSNANO. We expect the transaction to close in 30 to 90 days.

In summary, we believe that this new partnership with RUSNANO will help like IPG to increase our penetration in Russia.

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

Thank you, Valentin, and good morning, everyone. I'll start off with a review of our end markets, products and geographic regions. After that I will follow with a summary of our income statements and balance sheet and close with our guidance.

Our largest market, materials processing, continues to grow at an impressive rate. For the third quarter of 2010 revenues increased by 93.1% year-over-year and 17.9% from a strong Q2 2010. We are seeing a significant increase in demand from several of our major OEM customers for marking and engraving applications, particularly in China and Japan. Worldwide sales for cutting and welding applications have also helped to drive much of the increase in materials processing revenue.

As numerous industries increase their acceptance of fiber laser technology, we have been effective in continuing to penetrate the materials processing market, which is the largest part of the addressable laser market. The telecommunications market delivered the most impressive increase in sales in the quarter, growing 160.5% year-over-year and 144.1% sequentially. After a slow start in the first half of the year due to the timing of orders for long-haul, broadband access and cable TV, we had a stronger Q3 in Russia and also saw an improvement in US and Japanese sales compared to one year ago.

Advanced applications, for which order flow can be more uneven, declined 18.3% year-over-year while growing by 5.6% sequentially. The year-over-year comparison showed a decrease in sales because of a strong Q3 2009, which included shipments of high-value kilowatt lasers to two customers. This market includes test and measurement, instrumentation, sensing and defense applications as well as scientific research and development. We expect advanced applications performance will improve in Q4 as we expect to ship at least one of the 10-kilowatt single-mode lasers that are currently on order. In addition, order flow for advanced applications in Q3 2010 improved, including orders for our proprietary diodes.

Medical sales were down 26.8% year-over-year and 44.4% sequentially. The weaker performance in Q3 2010 was primarily related to the timing of some high-volume orders from a major OEM customer in the US. Overall, even with the year-over-year decline in Q3, sales to the medical market have continued to improve for the year to date compared to the prior year. We have increased sales volume to a major US OEM customer and have been successful in diversifying our customer base, including sales to medical customers in Germany and Russia for surgical applications. We plan to continue to diversify our customer base with new strategic medical device vendors and other OEMs.

From a product line perspective, both pulsed and high-powered fiber laser sales were very strong in Q3. Pulsed laser sales increased 87.7% year-over-year and 33.5% sequentially, and high-power sales increased 83.3% year-over-year and 6.5% sequentially. Demand for marketing and engraving applications for numerous industries continues to drive pulsed laser sales. Industrial manufacturers are increasingly demanding marking systems capable of applying serialized alphanumeric graphic or bar code identifications directly onto their manufactured components to reduce product liability and prevent falsification.

More recent high-power pulsed laser applications sales are for flat panel display manufacturing and deep engraving, including vehicle identification numbering. Orders for cutting and welding applications for general manufacturing and automotive drove much of our high power sales growth. Cutting has been a particularly exciting growth area for IPG. The growth trend in cutting begin in Italy more than one year ago and has led to increased penetration throughout the rest of Europe, China and the US. We have also received orders recently from machine tool customers in Japan for cutting applications.

As mentioned by Valentin, we have now developed a significant number of cutting OEM customers around the world, each of which recognizes fiber lasers as their preferred technology solution. These OEMs lever our sales force at a strong base from which we can further expand our customer base and gross sales of the largest application in materials processing.

In terms of welding, we are seeing growing interest in the US automotive sector for door and other body welding. We have sold many high-powered units to tier one suppliers for welding of high-strength steel for car seats in the US, China and India.

Medium-power laser sales, which primarily consist of microelectronics, printing consumer and sintering applications, increased 82.6% year-over-year and 7% sequentially. Specific sales in the quarter included medium power lasers for micro welding, thin metal cutting and marketing for consumer electronics products.

Low-power laser sales, used mostly for medical and micro materials processing applications, were down slightly year-over-year and 17.7% sequentially. The year-over-year and sequentially declines were primarily related to the timing of orders for medical applications, which I mentioned earlier.

I will now review our major geographic regions. We had strong growth across all major geographic regions during the third quarter, reflecting the rebound in the general economic climate. Europe was up 71.8% year-over-year and 34.3% on a sequential basis. Q3 2009 was particularly weak because the European markets had just reached the bottom due to the recession.

With that said, during the past year we have made significant progress in penetrating the market for cutting applications; and that business, which I discussed earlier, has been very strong. In addition, European sales have been helped by growth in marking and engraving, welding and printing.

The North American market grew by 73.1% on a year-over-year basis but was down slightly on a sequential basis by 5.6%. Much of the growth came through materials processing for welding, marking and engraving applications and cutting. In addition, the telecommunications business in the US improved slightly in Q3 2010. The sequential decline in North American sales was the result of a decrease in medical sales and a decrease in welding sales due to the fact that Q3 opening backlogs in the US was a little weak. It should be noted that North American bookings in Q3 2010 were the strongest they have been for at least the past two years.

Asia and Australia grew by 76.7% year-over-year and 20.2% sequentially. China had particularly strong growth in Q3 due to the economic rebound and expansion of our existing low-power and pulsed business for marking and engraving applications. In addition to OEMs in China purchasing lasers, we believe a number of our European customers are exporting our lasers in their systems to China. Asia and Australia sales growth was also helped by stronger Japanese sales, which grew by 43.4% year on year, and by 43.5% sequentially. Marking and engraving and welding applications were, in particular, strong performers in Japan. We also sold a 25-kilowatt laser in Japan for testing with copper welding and nuclear facility decommissioning applications.

In other Asian regions, we are seeing sales growth in Korea and in India driven, again, by marking and engraving and welding. Over the year-to-date sales in Singapore, Taiwan and Malaysia have also improved. The rest of the world, which represents less than 1% of our business, increased by 126.4% year-over-year but was down 33.1% sequentially.

Now turning to the income statement, total sales of $79.8 million increased 74.2% year-over-year and 18.7% sequentially and exceeded our guidance for the quarter of $69 million to $75 million. Gross margins improved to 50% for the third quarter compared with 36.5% in Q3 2009 and 45.3% in Q2 2010. Several factors have driven this improvement in gross margin. First, our total cost of sales only increased by 37.1% from Q3 2009, while sales increased by 74.2%, due to the fact that absorption of manufacturing expenses has significantly improved with an increase in capacity utilization.

Second, lower-cost, higher-power packaged diodes developed in 2009 are now being used widely in our products, particularly in high-power lasers. Third, product mix benefited from sales of medium power lasers in new products, which include high-power pulsed lasers and QCW lasers. The cost of these high-value-adding devices relative to their sales prices is lower. Fourth, the volume of our lower cost, internally-produced, high-powered laser accessories, which we previously sourced from outside vendors, have increased. In addition, gross margin benefited from the fact that part of the increase in absorbed manufacturing expenses related to products that were placed in inventory and not sold in the quarter.

I'd like to mention that as part of the management and utilization of our worldwide manufacturing capacity, we have enhanced our capacity in Germany by shifting the manufacturing of certain components and products to the US and Russia. Russia is now manufacturing pulsed lasers in volume, and the US is manufacturing more pulsed lasers as well as key components using the assembly of high-power lasers that were previously made in Germany.

SG&A expenses in Q3 were $12.3 million, or 15.4% of sales, compared with $8.5 million or 18.7% of sales in the third quarter of last year. Operating expenses include a $2.1 million net foreign exchange loss during the quarter compared with a $40,000 net foreign exchange gain during the same period last year. While SG&A expenses decreased as a percentage of sales, in absolute terms SG&A expenses increased, primarily due to an increase in salaries and benefits and accounting and legal expenses. Salaries and benefits increased due to the accrual of performance-related bonuses, while accounting and legal expenses were higher in Q3 2010 compared to Q3 2009, due to litigation expenses related to the IMRA trial. The IMRA trial did not begin on August 24, 2010, as originally scheduled. At this point the court has not issued a Markman order on plane construction, and it has not set the dates for a summary judgment motion hearing or the trial. Although good amounts of pretrial work has been done, we expect to incur significantly higher legal expenses when activity in this case picks up again, as we rigorously defend IPG against the claims in this lawsuit.

R&D expenses were up slightly year-over-year on a real dollar basis, but down as a percentage of sales at $5 million or 6.2% of total revenues versus $4.6 million or 10% of total revenues for the third quarter 2009. Our research and development efforts are focused on designing and introducing new and improved products by increasing power levels, improving beam quality and electrical efficiency, decreasing the footprint and lowering the cost per watt of our lasers.

Total operating expenses for the third quarter of 2009 were $19.4 million compared with $13.1 million for the same period last year and include the $2.1 million foreign exchange loss mentioned above. We estimate that, if exchange rates had been the same as one year ago, sales in Q3 2010 would have been $1.7 million higher, gross profit would have in $0.2 million higher and operating expenses in total would have been $0.3 million higher.

Third quarter operating income was $20.5 million or 25.7% of sales compared with $3.6 million or 8% of sales in the third quarter of last year. The foreign exchange loss mentioned was 2.6% of sales. Operating income includes stock-based compensation charges of $914,000 and $783,000 in the third quarters of 2010 and 2009, respectively. In the third quarter of 2010, $272,000, $530,000 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 2010 was 33%. We expect our full-year effective tax rate to be approximately 33%.

Finally, increased sales, manufacturing efficiencies as well as relatively flat costs in other operating expenses increased third quarter net income to $13.2 million or $0.28 per diluted share compared with $2.3 million or $0.05 per diluted share for the third quarter a year ago. The $2.1 million net foreign exchange expense during the third quarter negatively affected earnings by $0.03 per share after tax.

In Q3 the German tax authorities completed their examination for the years 2003 to 2008. The tax settlement amounts related to agreed order findings was less than the amount accrued for uncertain German tax positions and had no material impact on the Company's financial results.

Now turning to the balance sheet, our cash and cash equivalents increased by $6 million sequentially to $96.6 million at the end of the quarter. For the third quarter of 2010, inventory was $64.9 million, up 22.8% from year end, including the translation effect of foreign exchange. The increase in inventory is less than the increase in sales. We continue to invest in building our inventory in order to accommodate rising demand and unit sales.

Accounts receivable were $53.7 million at the end of the third quarter, or 61 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 higher levels of shipments at quarter end, which also negatively affect days sales outstanding. Despite the increase in inventories in accounts receivable, for the year-to-date we were able to generate cash from operations of $29.6 million and reduce our credit lines and long-term debt by $2.5 million. Cash generated from operations in the third quarter was $6.2 million.

I'd also like to mention that in Q3 we extended our existing $55 million credit facility with Bank of America to June 2015. Before the amendment, the $35 million line of credit expired in June 2011 and the original $20 million term loan expired in August 2013. The outstanding balance on the term loan is $17.7 million as of September 30, 2010.

Capital expenditures and acquisitions of businesses totaled $17.8 million for the first nine months of 2010, including $5.1 million related to acquisitions of businesses, and we remain on target to spend approximately $25 million in capital expenditures for the full year 2010 -- sorry -- including $5.1 million in Q3 of the $17.8 million.

Before I sum up and turn to guidance, I would also like to note that going forward, the initial minority investment by RUSNANO in IRE-Polus that Valentin discussed earlier will initially result in approximately $0.02 per share reduction to earnings on a quarterly basis of starting in Q1 2011, assuming a close date of January 1. This estimate has been calculated with reference to the following benefits and costs that we will have to account for. An increase in interest income in relation to the investment proceeds offset by the following three items -- changes in the value of the RUSNANO put and IPG call attached to the RUSNANO rights to acquire an additional 12.51% of IRE-Polus, changes in net income attributable to the minority interest and accretion and interest relating to the RUSNANO put on the original 12.5% investment.

In the future we expect that the increase in revenue and net income IRE-Polus achieves as a result of the strategic advantages of this partnership would more than offset this initial dilution. The sales growth that we have achieved thus far in 2010 is the result of our continued focus on driving the proliferation of fiber lasers in existing and new applications while further extending our leadership position in the markets we serve. We expect that the sales momentum we have been building will continue through the end of the year and into 2011. Demand for our fiber laser technology is growing, and our outlook is positive. We will continue to focus on maintaining the high quality of our laser products while volumes continue to ramp up globally. And as sales grow, we expect to benefit from the significant leverage in our business model.

Now let me provide you with our guidance for the upcoming quarter. For the fourth quarter 2010, IPG Photonics expects revenues in the range of $80 million to $86 million. The Company anticipates earnings per diluted share in the range of $0.30 to $0.35. That is based on 47.7 million diluted common shares, which includes 46,533,000 basic common shares outstanding and 1,167,000 potentially diluted options. This guidance is subject to the risk we outline in our report with the SEC and assumes that 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 for your questions.

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

Quick question -- could you talk a little bit about the capacity that you have overall at this point and the capacity utilization (inaudible)? Given your revenue growth, I was trying to figure out what kind of revenue growth can you achieve without requiring much capital investment in the near-term.

So, right now, on average, for the year-to-date capacity utilization is between 70% and 75%. In the fourth quarter I would say that it's getting above 75%. We are now at the level where, a year or so ago, we said we would need to start investing again in capacity, approximately $80 million of quarterly revenue. We expect to make those investments, first of all, next year in Russia, where we will build a new facility. We will make some investments in Germany, to a lesser degree, and some investments probably on the diode fab in the US.

In addition to that, we plan to buy a new building in Italy which will help with some of the manufacturing capacity for telecom products. So we are at the point in time now where we start to need to look at those capacity investment decisions.

So, Tim, in that regard, would you have some idea about the CapEx that you could have for the next year? How should we model that?

We have not established a formal budget at the moment. I think we've discussed spending in the region of $35 million to $45 million, but that's subject to a final budget.

Okay, and did you give out the bookings number for the quarter, and could you talk a little bit about the book-to-bill that you had? And what do you expect in Q4 also, in terms of bookings?

We did not give a specific bookings number. The book-to-bill, again, was above 1, and I think that that is also reflected in the guidance that we provided. We are not providing a forecast on what we expect the book-to-bill ratio to be for Q4. The momentum that we are seeing on order flow around the world has continued in October, and that's similar to the update that we provided, I think, on the last call.

Perfect, thank you so much.

And the (inaudible) increase very essentially, and it's enough to support our guidance into Q4 and Q1 next year, our [outlook] (multiple speakers) (inaudible) Q1 next year.

Jim Ricchiuti, Needham & Company.

The question I have is, which expect to selling expense, down sequentially, and yet you showed very strong revenue growth. I wonder if you could just maybe elaborate on that and give us a sense as to where you see selling expense going forward.

It's down sequentially a little bit because of the timing of certain tradeshows and fairs. And, also, we had some demo unit reduction -- a little bit of a reduction in demo unit depreciation. We will continue to invest in those demo units around the world. But it's really a timing on certain of those expenses.

In general, I would expect sales and marketing expenses to increase in absolute terms as we invest in sales personnel around the world, as we expand some of our footprint geographically. But those increases, in general, would be much more moderate than the increase in total sales. I think we've spent a lot of money hiring salespeople with specific specialties in the US, in Germany, in China, in particular, in Italy and in Japan. I think potentially one area where Valentin may invest in sales expenses now will be Russia, as we seek to increase the telecom and, in particular, the industrial sales in Russia.

And Brazil also.

And Brazil as well.

Okay, and while we are talking about geographies, I wonder if you would give us a sense as to how big China represents as a market for you. I guess it was -- was it around 10% last quarter?

China is -- it should be on the geographic sales [map] -- it's almost 17%.

And then final question -- it sounds like you are making very good progress with cutting OEMs. I wonder if you could tell us how many OEMs you have right now in the cutting market and, say, where that was a year ago?

I can't specifically disclose or calculate it exactly, but we've got tens of cutting OEMs, and that continues to increase each quarter. For example, we know that there are four to five companies in Japan who are started to use or lasers and their equipment who are transitioning from CO2. So we must be running at somewhere between 20 and 30 cutting OEMs, major cutting OEMs around the world.

What was the second part of the question?

Well, Tim, I think you've kind of answered it. I was just trying to get a sense that a year ago, that was a much smaller number. And I assume these guys will be ramping up over the course of 2011?

We hope so, yes.

I can say that, year ago, we have not more than 1% or 2% of cutting market, world cutting market. Now we have above 10%, (inaudible) and we hope we can reach with (inaudible) many times is (inaudible).

Paul Thomas, Banc of America/Merrill Lynch.

The question came up earlier about bookings strength, and you mentioned that strength continues through the end of the year and gives support to 1Q. I know you're not going to give any guidance for the beginning of next year, but I'm just wondering at this point, do you guys feel like you're going to be above seasonal growth going into next year, or do you think we'll return to more of a seasonal pattern?

It's very difficult to say at this point in time. I think that, given the we were relatively low on revenue in Q1 2010, the potential increase you will see year on year in Q1 2011 would be more than a normal growth rate. But we still are always a little bit cautious about the first quarter of the year in terms of like sequential growth. Russia can always be very weak in the first quarter and then, as well, certain of the Asian economies with public holidays and other national events can also be a little bit weak.

So I'd actually expect sort of year on year, a bit stronger than normal growth because Q1 2010 was still, relative to Q2 and Q3, a weaker quarter.

Thanks, that's helpful. And then maybe on the pulsed laser side, has the growth there been from existing customers ramping their orders, or have there been new customers coming into the mix?

Primarily existing relationships, some of which have been dramatically expanded this year in Asia, and also, then, a ramp back up of a lot of OEMs, some of whom have been our customers for over a decade. So in Japan, existing relationships saw a big rebound in the third quarter as well as in Germany and the US. I don't think there's like a major new marking and engraving OEM out there. I think most of them have already been our customers for a long period of time, and there are no new entrants into the market.

In Asia we increase -- we double practical quantity of OEM customers. And in total -- in quantity pulsed lasers this year, we tripled production from beginning of the year, practically tripled production and sales.

Joe Maxa, Dougherty & Company.

Tim, I just wanted to talk a little bit about the gross margins. Where do you see that going from here? With a strong Q4, it looks like we might see that expand. What should we think about -- I know it's early, but next year as you start adding capacity? Are we going to be able to stick around this 50% level?

Joe, first of all, I think we do get some benefit in Q3 from inventory growth. The underlying gross margin was a little bit lower. I think, in Q4, given that we are not going to see a big uptick in our cost base, we have an opportunity to at least maintain and potentially improve a little bit the gross margins. But coming into next year, as we've mentioned, with the capacity additions, we remain -- and I don't want to start providing medium-term forecasts about gross margin -- I think we remain optimistic. As long as the business remains where it is, we can still target being at the upper 40s and at that sort of level. There will be a lot of capacity that does start to get added, and it will take us time to start to use that.

Offsetting that, though, will be an increase in sales of some of the newer products that I mentioned have a lot of value-add attached to them and good pricing. And if volumes continue to increase, we certainly do not expect a deterioration in gross margins in the near-term.

Got it, then just on this IMRA lawsuit, is that in your Q4 guidance, if that were to pick back up?

No. At the moment, because there's just no information out there about the trial and a trial date and absolutely nothing that we've received when that will happen. We actually have relatively low legal expense numbers estimated for Q4, just because we don't think there will be much activity. I think it's unlikely at this point in time that suddenly there will be a trial date set in the beginning of December, particularly coming up to the holiday season. It may happen, but we think it's unlikely.

And last thing -- can you give us a -- has there been a change in the, let's call it, the end market verticals over the last year, or what has the change been? I'm just thinking of -- if we think about auto manufacturers or solar customers, as far as if you can tell who the end users and what shift you may have seen, maybe, say, your top handful?

I don't think we've seen any real shift in terms of end use, we've just seen a continued expansion of a lot of the relationships that we have, whether it be in the automotive, in general manufacturing, particularly in the diversification of the cutting OEMs, the rebound in marking and engraving. I think there are more and more applications that lasers are being used in, even in some of the more simple applications like marking and engraving. You are now getting into deep engraving for vehicle identification numbering; that's a newer application. You're seeing the pulsed lasers used in, certainly, initial stages of more diverse solar applications as well as this flat panel display opportunity. So you are seeing a diversification of some of the applications, no real fundamental shift in the source of the business. So you haven't got millions of dollars being generated from an industry that we didn't have last year.

Mark Douglass, Longbow Research.

You were talking about EuroBLECH. What was the tone of EuroBLECH, if you can kind of flesh that out? You talked about the increased number of OEMs incorporating your lasers. Was there a pickup of orders at the show, or are people still being relatively cautious just in general about ordering high-power cutting systems?

I don't actually have much specific feedback from the show. I haven't had a chance to get (inaudible) have any of the salespeople spoken to you, Valentin, about it?

Just typical, we do not sign any immediate with a big contract, but it's very huge interest in this (inaudible) development of continued businesses that we have, and the EuroBLECH and now with the new show, which would be (inaudible) [fab tech] show next week; it's two major shows which really impact more than the business growth and our sales growth.

On the sales and marketing side of things, Tim, can you talk about -- I mean, it was mentioned before -- it decreased sequentially, and some of that was just due, you said, to depreciation and the like. But how much of your sales are commission-based? Is this not that high of a percentage, such that it really doesn't grow substantially with sales growth?

We have a program here which is more based upon growing sales. We don't generally reward people by commissions; they get more of a bonus-based program based upon the growth rates that they achieve. And those accruals and payments in relation to that had already substantially got to the maximum amounts halfway through the year, so there was no sudden fundamental pickup in that amount in Q3.

I do note, though, that the year to date, even though there's a little bit of a decline sequentially, selling expenses are up about 30% for year-to-date. So there's a little bit of a dip in Q3; shouldn't be taken as a trend.

Right, but then would you think anything incremental in 4Q, there shouldn't, again, then, be a large step up because of (multiple speakers) bonus accruals --

No, the variable part of the compensation plans is all being accrued at the full amount for the salespeople and was paid out halfway through the year. So it just didn't result in a big pickup in the third quarter because they had already started to perform extremely well through the first half of the year.

Right, and then that resets beginning of fiscal '11, then?

Yes.

Okay, that's helpful.

Some of the other variable comps did pick up a little bit in Q3 because of the improved performance, though, so that's where it went to the G&A amount, G&A lines.

Okay, but we're still looking at $17 million, a little bit higher, maybe, in 4Q operating expenses, then?

I think it would be pretty similar to Q3, yes.

Yes, it's Q3. Yes, it seems to be implied in your guidance. And again, your incremental margins were 65%, and your guidance looks to assume, again, very, very high incremental margins. Incremental margins assumed are, it looks like, 65% in 4Q. What kind of sustainability -- probably not that sustainable, but still, that's a pickup from 3Q; that's kind of surprising.

You know, we targeted before incremental margins, I think, in around the 60% range. There was a little bit of benefit because you saw some utilization of capacity to build inventory. But anywhere from 55% to 60% at this point in time is pretty reasonable. When we start add capacity next year, those incremental gross margins will come down a little bit for every dollar of revenue added.

But we really are building or using our capacity at about the most efficient level that we have since the middle of 2008. And in 2008 we were continuing to add capacity before the downturn occurred, using the funds from the IPO. So there was a lot of investment that was put into business not just on manufacturing, but selling expenses, and now we are really starting to see the return on that investment come through into the business model. The rate of growth means, though, that we are actually going to have to start investing again. So you will see some of that moderate a little bit coming into 2011.

We are very pleased with it. I can't say anything else other than that. Both gross margins and then operating expenses as a total percent of sales, even though we had to absorb some legal expenses in July and August and a $2 million FX, negative FX impact in Q3, the results that we achieved even with those items, I think, was pretty good.

Yes, those are pretty good incremental margins. Just finally, on working capital, obviously a big step up, certainly if you look at trailing 12-month sales, 43% or so. Would you expect that to trend down? Do you have a target you like to work at for working capital, maybe as a percentage of sales or cash conversion cycle?

The interesting thing is, whilst accounts receivable is up, part of that is due to shipments towards the end of the quarter, so the timing of the accounts receivable can be a little bit skewed because of that. Our accounts receivable days outstanding were actually no different, really, from June, although they are up from December. In the fourth quarter of last year, we actually managed to ship stuff out earlier in the fourth quarter. That benefited the days sales outstanding as of December. But June to September, we've not seen any real change in that number.

Clearly, we are consuming some working capital in relation to inventory. I hope that the increase is in inventory, because we are not seeing such a big step up in sales, will moderate. We also have a lot of finished product that's sitting in China that we hope to ship out in Q4. In total, our cash cycle -- this is interesting, though -- has actually come down because offsetting the increase in accounts receivable and inventory, we've seen some benefit in relation to accruals which have gone up because we haven't paid those out. We actually have some deferred revenue, and we've also collected quite a lot of customer deposits and prepayments, which has helped to finance the inventory side. We do expect some of that to turn over in Q4, in particular in the Far East, where we will ship against some of those customer deposits and prepayments.

So there are two sides to the working capital equation. It's not just the investments in inventory and accounts receivable, but offsetting that has been our management on the liability side, which means that we have actually reduced our cash cycle, the analysis that we've done shows.

Oh, year-over-year, yes, yes. I just wonder if you just have a target that you are trying to work toward.

With inventory, we are trying to target two times per year turning it, and accounts receivable, anywhere from an average of 60 -- if we get accounts receivable down to 50, it's very, very good.

Right, okay, thank you.

[Olga Levinson], Barclays Capital.

I was wondering if you could talk about your current out look for the overall underlying laser market into 2011. Do you expect some level of growth? And, also, where does fiber laser penetration currently stand, and where do you see that moving into next year?

We (inaudible) the market surveys about next year are out. I think, given the overall optimism that all companies are demonstrating and the results that are being reported, there has clearly been a significant rebound in the laser market. I think that, overall, people target a growth rate that is above GDP significantly for the general laser market, anywhere from 7% to 9%, and for fiber to grow at a minimum of 20% within that. We are seeing nothing at the moment that would lead us to believe that that kind of growth rate in 2011 will not continue.

I would estimate that you're going to see fiber penetration probably have increased to between 12% and 15% from, I think, an average of 8% or 9% last year. And there is market analysis out there that shows that fiber laser penetration could get to an average of 30% in the medium term. So none of those trends have really changed.

Got it, and then in terms of your OpEx outlook into 2011, any thoughts as to how that would track relative to your revenue growth?

I think we are pretty much at -- we've targeted maintaining operating expenses in total below 25% of revenue. At the moment, they're at the sort of 20% range. I think that continues to be a reasonable target for the Company. I think we'll have some unevenness on operating expenses, depending upon when the IMRA trial actually occurs. But we are definitely not factoring in an increase in operating expenses that will bring them back above 25% of revenues. Our target -- to make sure that we keep them below that level.

(Operator instructions) Jiwon Lee, Sidoti & Company.

Could you comment a little bit more about the competitive landscape, especially on the high-power front, cutting and welding, whether or not you are seeing some new products or players into this space? And, if you could also comment on the pulsed laser side?

Clearly, people are making announcements about bringing out higher-power fiber lasers. In truth, right now, we have not really seen anything at all from those people who have made those announcements. It remains very unclear as to the price points they can enter the market, the quality and reliability of their products. I think that there is continued and increasing interest in trying to penetrate the fiber laser market because the technology has been fully validated. It continues to be our view that it's going to be very difficult for people to compete with us, given the quality of the light sources that we have and the cost basis that we've achieved, the electrical efficiency, the performance of the lasers.

On the pulsed laser side, I'd say yes, there are more people who claim to be able to compete with us but [fail] to mention that we are seeing a threefold increase in pulsed laser sales. I think that's probably an indication that they are not doing particularly well.

Yes, we do not give the market (inaudible) for pulsed lasers increasing three times maximum of 50% to 70%, but our sales increasing three times practical in quantity. So our market share even increased, not decreased, in spite of about 40 companies which claim they have also pulsed laser -- fiber laser.

Terrific. Some laser companies recently have highlighted some opportunities in the LED space. If you can talk about whether or not you are seeing some traction there, or do how you feel about some potential revenue stream next year and beyond?

That's getting a bit too granular for us, Jiwon. I don't think we've heard anything specific about the LED market opportunity. I think, in Korea, in a different market sector where we are more optimistic about stuff as this -- well, it is the OLED market for flatscreen display manufacturing. We are not sure about any manufacturers. We are speaking to or using lasers for mass manufacturing of LEDs, although they may be out there.

LED market, it's absolutely different; it's becoming a commodity market, quite a huge volume, very low prices. It's not our field of activity. We make high-power [dies]. It's absolute different technology than LED technology.

People who may be using our lasers -- we don't know if people who are using our lasers on this --

No, no, no; absolutely different.

Okay, that's helpful, thank you.

Ajit Pai, Stifel Nicolaus.

Good morning and congratulations on a very solid quarter. A couple of quick questions. I think the first one is just about the telecommunications sales. How sustainable is that rebound that you're seeing? And you talk about both Russia and the US, so what's going on in the US?

I think there's a diversification of some of the customer base introduction of new products, improvement in sales to some of our main -- outside of the US, to our main OEM in Japan; those are the two main markets that we have. In Russia we are seeing, really, some initial penetration from these new products that we've developed and the deepening of our relationships there.

And absolutely different, for us, market approach in the US and in Russia and some other countries. In the US, we still sell the unique but high-power amplifiers, the other new kinds of amplifiers (inaudible) sources and so on. It's all parts of the telecom fiber optic system.

In Russia, we are developing and implementing the market for complete solution, complete system, and to which we will (inaudible) and now becoming very competitive with bigger system manufacturers, like Alcatel, Huawei and so on. We are working now, starting our process to implement such system also by geographical market, for example, South America into what we have prepared (inaudible) project (inaudible).

So are you comfortable with us modeling the telecom business going up sequentially in the next four to five quarters?

Really, I think the only quarter which can be weak is Russia in Q1, and there's still not absolute clarity on that. In general, on an annualized basis, yes.

In annual, we feel it will go to multiple, many times our sales in telecom next year in total, but not this quarter.

But the plan will be an improving one on a sequential basis, other than Q1? Do you expect that? At least from these elevated levels, you will still continue to see growth?

Yes. I think we're going to be disappointed if we don't continue to execute in this matter purely given the improvements that we've seen.

Okay, and then the next question is just on the advanced applications. Can you give us some color as to when you expect some of the high-power, more defense-related lasers? Do you expect any more of those to ship over the next four to six quarters?

Well, we've got several orders on hand that we hope to ship, at least one of which, maybe more in Q4. There are odd orders that still come in; they are just -- that market is still not big for us, and there's still a lot of R&D that's required in it. It's not in a situation where you're suddenly going to see sales of 20 units a quarter or anything like that. There are still orders expected, and we continue to work with a fairly diverse number of customers in that area.

Got it, thank you.

Mark Miller, Noble Financial.

I'm just wondering if you can just -- I don't need exact figures, but just give us a little more color about bookings. I think you mentioned North America was strong for the September quarter. Any other color you can give us about geography or products or application area would be beneficial.

(inaudible), I'd like to think, overall, we continue to see very strong bookings around the world. It was pleasing to see the US have its best quarter in bookings for a long time, that I mentioned. We also saw across different applications some improvement, in general, in the advanced application business compared to where it had been during the first six months of the year. And then all of the other geographies -- Europe, China, Japan, India off a small base -- it's really across the board. Everything else has continued to be improving.

You mentioned high powered diode cost coming down was a driver of your margin improvement. Do you feel there's still a lot more coming? I know that was one of your hopes for the coming quarters, that you are going to be able to grab continued significant reduction in your diode costs, which are a major part of your product cost.

Yes; we've seen that cost come down this year, and there are additional strategies that run out not just into the next two or three quarters, but there is a longer-term target to drive the cost of the diodes that we use internally down. And as we ramp volumes, we think we can continue to achieve significant milestones in that regard. We don't want to put any targets out there about that, but I think we've demonstrated an ability already to be pretty effective in that regard.

Of course, the (inaudible) of diode depends from volume. This year we are -- we have reached 6 megawatts of -- produced 6 megawatts of total diode power. It's practical two times more than last year. It's -- and cost of diodes very strongly depends from volume, which is partly increase of volume of diode right now, it's the cost will have opportunity to drop price per watt very essentially additional.

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 in February next year, when we report our fourth-quarter and full-year results.

Thank you, everyone.

Thank you, everybody.

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