IPG Photonics Corp (IPGP) 2011 Q3 法說會逐字稿

Good morning, and welcome to IPG Photonics' third-quarter 2011 conference call. Today's call is being recorded and webcast. 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, 2010, 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 also 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, 2011. 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'll now turn the call over to Dr. Valentin Gapontsev.

Thank you, Angelo. Good morning, everyone. We are pleased to report that IPG delivered another quarter for the record books.

Our third-quarter revenues grew by 62% year over year to $129.1 million. Also, our EPS came in at an all-time high of $0.66. Demand for high power lasers for materials processing applications primarily drove the sales increase and we demonstrated strength across nearly all geographies and applications. Marking, cutting and welding applications continue to be the most popular applications for our fiber lasers and are primarily being used within the general manufacturing and automotive industries.

As we enter the final quarter of 2011, it is safe to say that more and more customers across the world recognize that IPG's fiber laser technology can reduce their costs and improve their efficiency in product manufacturing. The tipping point has been reached in key applications, and it is quite evident that we have a clear road ahead to capture an increase in share of the laser market. Of course we plan to continue to leverage our technology to develop new products and processes that deliver superior benefits to our customers.

Recently we have introduced, or are about to introduce, several new products. These include a 2 kilowatt air cooled laser, specifically designed for welding in dry environments, ultra-compact lasers with output power up to 1 kilowatt and a 20- and 30-watt green lasers. We believe that higher power will improve the adoption of the green fiber laser.

In addition, we have obtained excellent results processing plastics, cardboard and paper using our thulium laser, which will enable us to compete directly with CO2 lasers processing these types of materials.

We were very pleased last month that the Michigan jury in our five-year litigation with IMRA America decided that IPG's fiber lasers and fiber amplifiers do not infringe IMRA's US's 630 patent, which concerns single-mode amplifiers based on multi-mode active fibers. I am proud of our team and outside lawyers for their dedication and hard work that they put into proving our non-infringement.

IPG has in the past and will in the future aggressively defend against intellectual property claims, as well as protect our growing estate of patents.

With that, I'll turn the call over to Tim Mammen.

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

Materials processing, which accounted for approximately 89% of total sales, increased 69% year-over-year and 6% from the sequential second quarter to $114.3 million. Cutting and welding sales for the automotive industry were particularly strong, as well as marking and engraving applications for microelectronics manufacturing. We estimate that IPG will have between 20% and 25% of the laser source cutting market, doubling from one year ago.

Sales for the telecommunications market increased 41% year-over-year and 25% sequentially to $7.4 million. The long haul, broadband access and cable TV markets continue to drive telecom sales.

Medical sales were up 74% year-over-year and 25% sequentially to $2.4 million. Our OEM customer base is growing. However, it does take time for OEMs in this end market to obtain regulatory approvals and generate significant orders. Advanced applications sales were down 12% year-over-year and 20% sequentially to $5.0 million.

As we had anticipated, government funding for research and development is softer in 2011 than in 2010. The timing and amount of funding available can cause advanced application revenue to vary from period to period.

As Valentin mentioned, sales of high power lasers, which continue to be our leading product line, increased 131% year-over-year and 5% sequentially to $58 million. High power lasers are largely being used for cutting and welding applications, and we're seeing increasingly strong demand from auto manufacturers and Tier 1 suppliers, particularly in Germany, Japan, China and the US. These customers appreciate the beam quality and flexibility of our fiber laser which create meaningful gains in productivity.

Sales of our Laser Seam Stepper system, which is a welding system that combines our fiber laser with the welding apparatus, continues to perform well. In Q3, we sold an additional seven systems to a major German auto-maker, and other customers have ordered the system as well.

In addition to the Laser Seam Stepper sales, we completed the delivery and installation of a $2.6 million pipeline welding system in Russia. Other laser systems sold in 2011 were for applications like welding locomotive engines, medical device manufacturing and battery welding which shows that we are having some success building this part of our business.

Sales of medium power lasers increased to $10.1 million or by 95% year-over-year and 20% sequentially. Sales of these lasers were for printing and micro welding and were strong during the third quarter. We've also seen a pickup in sales in China for medium power lasers used for thin sheet and foil cutting in the manufacture of a variety of trim and decorations. Pulsed laser sales increased to $33.4 million, an increase of 10% year-over-year, but were down 4% on a sequential basis. Marking applications for microelectronics continued to help drive sales of our pulsed lasers during the quarter, as well as other materials processing applications. The sequential decline is the result of some softness that we're seeing in China.

Low power laser sales of $4.1 million increased 4% year-over-year, but were down 12% sequentially. Low power lasers are primarily used for medical and micro materials processing applications.

Sales of QCW lasers, which are used for consumer and micro-processing applications, were up 249% compared with last year and 11% sequentially. This product was launched in the spring of 2010. Since that time, we have attracted significant interest from a number of OEMs and end users looking to upgrade or replace high-power flash lamp pumped YAG lasers.

Among other applications we're seeing demand for, the QCW lasers are being used for ceramic cutting.

Sales of other products, which include amplifiers, diode lasers and certain components were $10 million; and service, parts, lease and other revenue totaled $8.6 million.

Our geographic performance was strong in all major regions during the third quarter. European sales increased to $50.4 million or by 63% year-over-year and 14% on a sequential basis. North American sales increased to $21.8 million or by 46% on a year-over-year basis, but were down 14% from the sequential second quarter. The sequential decline was primarily due to the timing of shipment. Asian sales increased to $56.2 million, or by 67% year-over-year and 8% sequentially. China had another record quarter, with sales growing 144% year-over-year and 4% sequentially.

The only regions where we experienced year-over-year declines were in the other Asian markets, which include countries like Singapore and Thailand.

Now, turning to the income statement. Total sales for Q3 increased 62% year-over-year and 6% sequentially to $129.1 million. Gross margins improved to 54.6% from 50% in Q3 of 2010 and remained consistent with Q2 2011.

Our general and administrative expenses increased by 41.0%, mostly as a result of an increase in compensation expenses due to an increase in bonus accruals and stock compensation and an increase in legal expenses. The IMRA trial and trial preparation took place in Q3, but wrapped up in early October. We will incur some expenses related to the trial in Q4 and for post-trial work.

I want to note, however, that a formal judgment has not yet been entered and the district court will need to decide numerous motions that we expect IPG and IMRA to file. Near term, post-trial expenses are uncertain at this time because IPG will have to respond to IMRA's post-trial motions and any appeal. However, based upon what we know today, we anticipate that our legal expenses related to IMRA's litigation claims will have peaked in Q3 and Q4 of this year. R&D expenses increased year-over-year on a real-dollar basis by 31% to $6.5 million but were down as a percentage of sales to 5% of total revenues versus 6% for the third quarter of 2010.

In total, operating expenses for the third quarter of 2011, excluding foreign exchange gains or losses, increased 34% to $23.2 million.

Third-quarter operating income was $49.2 million, or 38% of sales, compared with $20.5 million, or 26% of sales, in the third quarter of last year. Operating income includes stock-based compensation charges of $1.879 million and $914,000 in the third quarters of 2011 and 2010, respectively.

Stock-based compensation increased because of an increase in the fair value of options and restricted stock units issued in 2011, primarily due to an increase in the price of IPG's stock. We expect quarterly stock-based compensation to be at about the same level in Q4.

Net income attributable to IPG came in at a record high, increasing 149% to $32.9 million. On a per diluted share basis, we reported $0.66 in Q3 2011 compared with $0.28 per share a year ago.

We estimate that if exchange rates had been the same as one year ago, sales in Q3 2011 would have been $7.3 million lower, gross profit would have been $3.4 million lower, and operating expenses would have been $0.9 million lower.

Now, turning to the balance sheet, our cash and cash equivalents increased by $8.4 million sequentially to $196.6 million at the end of the third quarter of 2011. At September 30, inventory was $117.3 million, up 62% from year-end 2010, including the translation effect of foreign exchange. Our current level of inventory on hand amounts to 182 days and is slightly higher than the top of our target range of less than 180 days.

Accounts receivable were $80.4 million at the end of the third quarter, or 56 days sales outstanding, compared to $55.4 million at December 31, 2010, or 49 days sales outstanding.

Cash generated from operations in the first nine months was $56.0 million. Capital expenditures for the first nine months of 2011 totaled $34.7 million, and are on track for our target of $50 million for the year. Capex spending in 2011 is focused on building new fiber facilities, expanding capacity in several high-growth regions, and enhancing our sales and service infrastructure.

Early next year, we plan to add front end diode capacity in the U.S. and to continue expansion of manufacturing in Russia.

That leads us to our expectations going forward. As we enter the final quarter of 2011, we expect that our momentum will continue, and we will report strong year-over-year top- and bottom-line growth.

Looking further ahead, our prospects are equally bright. As Valentin mentioned at the outset, our fiber lasers are now widely accepted by customers. This provides us with a tremendous competitive advantage for the foreseeable future and the ability to grow revenues and profits for the long term.

Our technology development engine will continue full speed ahead in order to maintain our market leadership. A key component of our R&D focus will be to move further up the value chain with an increasing amount of laser systems. And we will invest in capacity expansion so that we are able to capitalize on the significant opportunities before us.

With that as background, let me provide you with our guidance for the upcoming quarter.

Our guidance takes into consideration the lack of visibility into and uncertainty around the global economy. Within that context, IPG Photonics expects revenues in the range of $123 million to $135 million. The Company anticipates earnings per diluted share in the range of $0.60 to $0.71. That is based on 48,747,000 diluted common shares, which includes 47,483,000 basic common shares outstanding and 1,264,000 potentially dilutive options at September 30, 2011.

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 for your questions.

(Operator Instructions). Tom Hayes from Piper Jaffray.

Thank you. Tim, I was just wondering, you had called out some slowing in China related to the pulsed lasers. I was just wondering is there any specific end market that is driving that slowing?

Just the general manufacturing that pulsed lasers in China are used in a variety of marketing and engraving applications that include the microelectronics industry for personal devices, but also some more basic marketing and engraving applications for examples that are decorative items. It's -- we have not got any specific information on which of those end markets is the weakest because we don't deal directly with the customer there, but --.

Okay. I guess shifting gears a little bit, last quarter in your prepared remarks you had identified that your goal was to sell 1,000 lasers for cutting this year. Just wondering how you are progressing on that target?

I think we're going pretty well. I was actually just looking at these numbers with Dr. Gapontsev last night. I think we are over 800 year to date and probably heading for about 1,100 cutting lasers for 2011. So we estimate that anywhere between 20% and 25% of the cutting market is now being serviced by our fiber lasers; and that represents probably a doubling of where we were from a year ago.

I know in the third quarter guidance you had indicated there is about $2 million of legal expenses built into your guidance from (technical difficulty). Can you just give some more visibility with legal came into this quarter and what kind of baked into the fourth-quarter numbers?

I think legal was a bit higher than the $2 million we forecasted. I think it was around $2.6 million and we are probably factoring in just over $1 million still in Q4, but we don't have a lot of visibility into that. It could be a little bit more than that. I don't expect it to be less than that.

Just last thing. Could you just -- the revenue number for China for the quarter?

It was around $30 million. I don't have the exact number in front of me here. It will be in the -- it's about $30 million, $29 million or $30 million.

All right, thanks, I'll get back into queue.

[Olga Levinson] from Barclays Capital.

I was wondering if you could talk about what sort of gross margin you are embedding within the December quarter guidance and how you think about the trajectory there going forward given your DOI is -- has trended above your target range?

So Q4, we are still in the range of [53.5 to 54.5] in terms of the guidance we've given. DOI is slightly above where it should be. Not all of that increase in inventory is related to absorption, there are some long lead time items that we have also purchased for inventory. So we don't -- we are focused on looking at inventory and getting it below that 180-day limit.

But I'm not factoring in any significant impact on gross margins in Q4 in relations to changes in inventory.

There are other ways we can, by the way, adjust capacity. For example you reduce overtime within the company, that reduces the amounts of costs that you have to absorb because you are paying less than over time and a reduces production, so you are able to reduce some of the inventory of components that you are manufacturing. There are other ways that we can get that without necessarily impacting gross margin.

And if you take a very hard look at inventory and suddenly decide you want to reduce it by a very significant amount, that would impact gross margin because that you would reduce absorption. But we are not at that point yet, Olga.

Got it. And then in terms of the individual subsegments, i.e., high power, medium power, and all into the December quarter. Are you anticipating similar type of slowdown within medium, low, and pulsed and growth in high power? Or is the mix going to be different?

The primary slowdown in weakness in Q4 is on the pulsed side. The medium and high-power backlog and forecast for Q4 is still holding up pretty well. Even in China, you will notice that in China some of the weakness in Q3 on pulse is there, but China was actually up sequentially and that is a reflection of shipments of high-powered lasers.

Got it and just a final question. What was your book to bill for the quarter?

It was slightly below 1 again. Very slightly below. We don't give that specific number and, however, to offset that, I will say that the bookings in the quarter were a record and they were up about 8% from Q3. So book to bill was slightly below 1, but we had a record quarter at total bookings.

Thank you.

(Operator Instructions). Paul Thomas from Bank of America Merrill Lynch.

I guess we talked a little bit about high-power and low-power. In terms of markets that you have more confidence in, could you talk a little bit about that with respect to 4Q? Does auto still look pretty stable? You talked about pulsed being a little bit weak, but are there other markets that you have more visibility into at this point?

I think that overall the auto flow, and it kind of was a little bit weak coming into the last two or three weeks in September and we got a bit nervous about it -- but in the first three weeks of this quarter in the US and Germany, Japan in particular, and even Italy, order flow has been pretty reasonable. Compared to a year ago it's actually increased quarter to date. It's up about 8% to 10% in the first three weeks. So it's really that those key economies northern Europe, US, Italy, where we have got a lot of OEMs on cutting and welding applications, they look pretty resilient.

We have got a good quarter for Japan forecast in terms of revenue. You know, a reasonable course for Russia which is going to be up significantly year on year. So it really is the softness in China around some of the pulsed; and probably in Q4 we will see some softness on cutting lasers in China.

And you've talked in the past about cutting and welding, total marketing around maybe [1.2 billion or 1.3 billion]. How much of that is in China and do you think your market share in those segments in China is about the same as it is elsewhere? Do you think it is higher or lower?

I'm not sure exactly how much of that 1.2 billion, 1.3 billion is in China, it is clearly a growing amount. Our market share in China is probably similar to the rest of the world, it may be a little bit higher. Most of our cutting and welding applications to continue to be Northern Europe, Italy, places like Turkey, the US. We have got a lot of you cutting customers in Japan which we think will help to drive traction in Japan next year. They are not relieved and coming on stream in Q4 of 2011. And we just, we are waiting to see what plays out in China. There's not a lot of information on that at the moment.

Maybe looking ahead a little bit. I know you just gave 4Q guidance, but I guess at this point, is it still reasonable to think 1Q is going to be your -- seasonally down from 4Q?

Yes. It nearly always is unless some anecdotal -- anecdotally I know that there's sort of a very large advanced application order that's expected in Germany which should help the first quarter. But Q1 is always softness in the world. Generally the softest quarter of the year for us.

Mark Douglass from Longbow Research.

Mark Douglass Good morning, gentlemen. Tim, as we look into automotive, what is the breakdown right now between welding and cutting there? I assume it is mostly welding. But are we talking about 80/20, anything like that?

I don't think it's -- we don't have the exact number because we don't know where a lot of our cutting OEMs are selling stuff. I would actually think that no, it's probably 60/40 or even the DTD. A lot of the cutting step that we are selling into OEMs, we understand is going into the automotive side. So --.

Really, okay.

It is not dominated -- automotive is not dominated by welding. Welding is a strong application but it is not that imbalanced as you're mentioning.

Is that body cutting?

Yes, all kinds of materials that they're cutting now. Both the end-user and the Tier 1 parts components.

And then Japan you're mentioning revenues are doing pretty well there. Again, is that a combination of infiltrating their OEMs there in the selection cutting as well as auto? Or is it more one than the other?

Japan is really -- continues to be driven in the fourth quarter by a lot of welding and automotive applications, both welding applications for automotive and general industrial. The real traction on the cutting has only just started. We expect it to be a good driver of growth next year in Japan.

So you are still early in the game with them there?

Yes, the other thing in Japan we have actually had a lot of orders more recently which go into the beginning of next year and the end of this year is the marketing and engraving business with our main OEM. They have given us a lot of orders in the last couple of weeks.

Then finally, a lot of excess cash with the trial now out of the way, and congratulations on that, are you thinking about buybacks making the dividend? How are you thinking about your cash? Seems like you have more than enough in your CAPEX needs.

We are not thinking about this point in time starting to return stuff to shareholders through buybacks or dividends. I think that that may look like a lot of cash, but really the balance sheet, we have done a lot of work to transform it over the last 18 to 24 months, 24 months ago we had a lot less cash. So I think we are still a good 18 months away from deciding if we have surplus to be returned to shareholders.

I think the next 12 or 18 months will see us looking at smaller to medium size technology acquisitions and add-ons, and that may use some of the cash we got there, particularly where we think we can get a very significant return on that capital.

Thank you.

Avinash Kant from DA Davidson & Co.

Good morning. Question on automotive business. In terms of where you are as far as the penetration is concerned, we think you are and how far can you go especially in the welding and cutting market for automotive applications?

I think we're still relatively early in the welding. I mean, you still haven't seen anybody for a good seven or eight years fully outfits a factory for welding with lasers. The last time that happened was back in 2002 and 2003 and not very successfully.

You know I mentioned that we had got I think seven orders for the Steam Stepper that we shipped in the third quarter so that's starting to gain some traction; but really in order to penetrate welding fully, you'll say in the quarter maybe several hundred lasers going into welding. We are a ways off from getting to that point in time.

On the cutting side, I don't know how far fiber is penetrated there, it's just very difficult to get detailed information on it.

But would you say it is it is still very early?

We believe the adoption of fiber continues to be relatively early across a lot of applications. I mean, we are saying we've got between 20 and 25% of the cutting market. That still gives us a very significant runway for growth and cutting, whether it be automotive or otherwise, just to get 50% of that.

And in terms of competition, are you starting to see more people and in which markets at this point?

We are not really seeing anybody on the competitive front at the high power levels, despite numerous claims made by just about everybody in the laser industry. I haven't heard of us lose a high-power laser order to a kilowatt fiber laser competitor yet.

Okay. And quick question on the pricing. Where do you stand comparatively to the gas laser pricing out there at this point?

We are absolutely comparable. I think there's numerous -- I have read a couple of articles recently that have been put out that state there is really no difference in pricing between CO2 and fibers. So people can start to realize the cost benefits from fiber almost immediately.

Okay and I --

Our prices now [both reward for fiber cheaper than gas] laser price.

Okay and Tim, I may have missed a few numbers. The European sales number and the other, what was the numbers? Europe and other?

Avinash, I haven't got -- I have to go back into the script. You can call me afterwards, I'll give you those numbers.

Okay, perfect, thanks.

Ajit Pai from Stifel Nicolaus.

Good morning. Couple of quick questions and then one housekeeping question. The first one is, you talked about adding front end capacity for diodes. If this capacity going to be any different from the traditional capacity or is it more [vertically than created] historically then?

No, I think it's basically very similar. The advantage is on some of the new equipment we are buying is, for example, the MBE reactor has got a greater number of wafers that we can grow. So we are actually adding a lot of wafer capacity, very cost-effectively. There is no fundamental change in the technology that I am aware of. Is that true, Valentin?

Our (inaudible). Last year, we produced total optical power of diode power of about 4.5 MW. This year it wouldn't be more than 15 MW vertical power. It is still not enough for [ourselves]. So we need to double this capacity to produce next year. We put in more than 25 MW of optical power. Only for IPG consumption. Not for sale, diodes separately [in the market].

Right, and about five years ago, you talked about potentially selling your diodes in the merchant market, but right now as Valentin just mentioned, the focus is primarily for captive consumption. Has anything changed in terms of your considering selling your diodes in the emerging market? Or is the focus now --?

We started to sell small, but the sales are small and in our market, the total demand for the exact IPG is smaller now. But we started to sell, but our own need for diodes increased much a process than we even projected. So we did not have any opportunity to sell for other people. We took temporary orders to sell, it wasn't enough diodes for our sales.

Got it. Then, just looking at the September quarter, you had a book to bill slightly below 1. But, Tim, seasonally, isn't the September quarter your softest book to bill when you look back over the past 10 years?

I know that July and August can be weak. Surprisingly, this year July and August were very strong and then we had a strong couple of weeks in September at the beginning and at the end of September was weak and normally the end of September is a pretty strong period. So that is what gave us a little bit of nerves. But overall, Q3 was pretty good.

I heard it was a record quarter in bookings. I think it was actually up about 8% sequentially from Q2. So it wasn't bad. It was just a little bit volatile at the end.

And going into October, I mean in November right now was October particularly weak to what business is like compared to 3Q?

No, the beginning of October has actually been very reasonable in terms of auto flow. I mentioned there is some stuff that has come in even for Q1 compared to a year ago that the current data that I have has actually been the first three weeks. Orders were up about 8% on a year ago. So it was a pretty reasonable start.

I mean for Q4 to be a stellar quarter you would want to see orders up 20% plus. But it's good to see that they are actually up year on year rather than down in the first three weeks.

And then advanced applications, I think a few years ago you sold some pretty high-powered lasers to the US Navy and then after that you still had some applications and some dialogue over there on the defense side. Could you give us some indication as to whether that business that's given what's happening with budgets, etc., whether that is something that is still a material opportunity for IDG or it's not?

It's a relatively small opportunity in the near term. I know there's a, for example, a kilowatt single mode in the US that we are just negotiating a sale of it actually and operator of a 5 kilowatt single mode.

There are some actually interesting things in Europe happening with some of the single mode lasers. We believe we are just about to get a very significant order in Q1 for several 10 kilowatt single mode. So it's not that material, it is still very uneven. I think we are still several years away from really understanding whether this technology is going to be viable and cost-effective as a defensive mechanism.

And then the housekeeping question, could you just give us a break down of the stock-based comp, how it goes on the various line items?

We normally put that in. I will have to provide that later, it was -- total was $1.8 million. I don't have it by the line items, but I can give that later and we can -- (multiple speakers)

Okay, thank you so much.

Joe Maxa from Dougherty & Co.

Thank you. I was just wondering if you could expand on your Russian sale from selling pretty large sale and then, your opportunities moving forward.

I think there is a lot of work going on in Russia. Valentin can speak in a little more detail. I will tell you about the pipeline loadings system. It was a $2.6 million system that was delevered in Q3, but there are a lot of other significant opportunities on particularly cuttings systems that we're looking at, and I know VG has been working on.

In Russia, now the work we've used large projects with together with where (inaudible) state companies and we have fast growing demand for the complete systems and we have built for this special facility to manufacture all kinds of these complete integrated system macro and micro in Russia for us. And we estimate this market will grow very fast for multiple increase in sales during the next couple of years.

So, when do we think we can be a $10 million type per quarter market? Is that a few years away?

For industrial, it was the whole Russian market.

For your sale to Russia?

For Russia, we have more than $10 million sales now for month.

It's pretty close. In Q3, it was like over $9 million and I think in Q4, it will be around $10 million.

In Russia, last year its total sales was $56 million. This year, it [would be more than about $100 million].

Where do you include that in your geographic breakdown?

Within the European.

Thank you.

Mark Miller, Noble Capital.

Yes. I'm just wondering. We've had some reports for some of the other laser companies non-fiber that they saw some softening last quarter and in orders this quarter for microelectronics customers. I'm just wondering what you think.

We haven't heard -- you know, in the softness we've talked about where we are seeing it -- and I've tried to give some anecdotal stuff around general order flow and general trends. The microelectronics, probably, it's in China around maybe some of the personal device production, but I don't have any more detail on that.

A lot of our customers deal much more directly with these end market than through OEMs and they may have more visibility into specific customers.

So, in the China situation, do you feel it's being impacted? We've heard other equipment areas, not so in lasers, but credit type means having an impact especially in smaller firms. Any color on that?

A little bit, yes. I think it's impacting some of the smaller-sized operations who are finding access to capital a bit difficult. Some of that slack is being picked up by the bigger people who have access to credit lines and cash. But I'd say yes, there is some impact on that.

Is that the marking area basically?

Primarily, and some high-power units that are going to like smaller customers.

And, finally, I was wondering if you could break out what the IMRA expenses were, legal expenses for the September quarter?

Our total legal was about $2.5 million.

For the September quarter.

Yes.

(Operator Instructions). Jiwon Lee, Sidoti & Company. Mr. Lee, please proceed with your question. Ms. Lee, excuse me.

Thank you. First off, I don't think a lot of laser companies can claim that their European sales grew sequentially. But just wanted to drill down a little bit on how much of the revenue gain is gaining against the legacy lasers and cutting versus gaining new customers?

It's primarily being driven by legacy lasers gains in cutting, but I mentioned that we've sold seven units of the Steam Stepper, for example. So that's a welding opportunity that continues to grow in Europe. It's both the welding and cutting so we're clearly getting a lot of market share gains from legacy technologies.

And in Q2 is our European customers most of them integrated. So, final machine which they making use in our lasers worldwide so as most of them as we know, go into Paris, also to Brazil, to Mexico and other countries but despite this they are making these machines in Europe.

So, if I think about the mix between cutting, for instance, welding overall, how would they roughly break down? Is that roughly 50-50 or is that still skewed a little more towards welding or cutting?

No, I think this year it's going to be 50-50. It's difficult to bring that number down exactly. The analysis we have is showing about 50-50.

And what's the expectation moving forward next year between cutting and welding?

I would hope to retain that -- that balance so that we'd be growing both of those businesses fairly significantly, most of the welding growth will come from displacing potentially non-laser technologies and the cutting growth will come from continuing to displace the existing legacy laser technologies.

Okay. That's helpful. And then on the Japan side, since the spring and post the IMRA litigation, I understand that you did gain one very significant [clean] customers there. But, could you kind of highlight how that revenue outlook may change next year?

I didn't quite catch the question here.

I was mentioning about the Japan -- post the IMRA trial and since the spring time, whether your revenue outlook next year changes?

I don't think IMRA affected any of the Japanese sales and performance we have seen. It's some pretty good improvements in Japan performance throughout this year and we expect, as I mentioned, the qualification of new cutting customers in Japan, new welding customers is not driven or affected by whatever was going on with the litigation.

[U&I still way is farther of --] and owner of IMRA also buying from us lasers.

I see. That's helpful. And Tim, did you mention there has no significant changes in your pricing environment across the board?

We don't see anything material, no pressure. I mean, we are considering to as I also mentioned we want to get the fiber laser in a cost per watt basis, below the gas lasers, but we are not seeing coming out and putting pressure on us to do it. I mean, we are doing this as primarily as people buy a greater volume of lasers we provide then with the discount.

I can say also for them, [step of laser where only separate systems] we introduced market only qualifies this year only for one automaker but now we are starting into area of shipment. It's only just beginning, it's -- while we support these only separate system would be in many countries you will need to only [make the deal next year] we will ship to the market.

Also I can say that not only high power high power, [no or see, UV] if you see that (inaudible) green ways we also introduce also is the UV lasers in market, meet in laser. We support growth of laser next year would be much higher than growth of high power sales. So they will cut their shares in the market and our sales will increase the [micros]. And also regarding marking ways that only recently, a week ago, we receive huge order for one of the [Paris] customer, not Chinese customer. But a very huge order for next year.

Jim Ricchiuti from Needham & Company.

Okay. Thank you, just with respect to your last comment, Valentin, the change in mix, as you look out in 2012 does that have any [indications] for gross margins?

That would be in mobile (inaudible) more margins at high power now. So should improve also, our growth margin will grow farther we suppose only because we more and more part making and how to decrease also the part, we hopefully will use all the metal parts from the outside -- two of that is now installed last year, this year with, $10 million is the deduction now 90 percent of population is produced inhouse. It's also [kind of problematical], also this part.

Now we install also internal production only (inaudible) total, will say, money and also help us to us to increase marginal -- our product, gross margin.

And then others listening, we are only providing discounts for orders of 1,000 or more.

(laughter). Okay. Tim, can you remind the seasonal decline or sequential decline that you -- we have seen the last two years in selling expense, what are the issues there that play out? Is it just timing of commissions or -- there's some other issues that cause that?

First of all, yes, I'm sorry. The timing is the way that we're occurring the bonuses. We try and do it fairly evenly related to performance during the year. The other side of it is the timing. We don't book any of our trade shows and pay fare expenses into prepaid and advertising, we basically recognize that expense whenever we have those shows. And Q3 is pretty light on trade fairs. It can be affected by demo unit inventory and associated depreciation increases or decreases in that, as well.

And then on occasions, we sort of rationalize the sales force or we increase headcount or decrease it for people who are not performing particularly well. So there is probably a number of different priorities for that to come into play.

Okay. Now looking at your OpEx as a percent of revenues, I guess last quarter, Q3 around 18%, Q2 around 17%. I think in the last call if I understood you correctly, longer term you actually see your OpEx creeping up as a percent of revenue? And maybe, is there anything you can say about that as to how we should think about your OpEx next year? I know it's a function clearly of revenues, but just in general terms.

I think we would like to see it at around 20%, so that we can continue to invest in the business. I think 17%, 18% is a little bit low. I think we are just getting a tremendous kind of leverage off it is, if you look at every single one of those line items they are up significantly. And I think operating expense were up 34% year on year in Q3.

So we are investing. It's just the rate of growth of revenue at the moment is ahead of that curve. But I think a sustainable operating expense should be around 20%.

Okay. And a final question for me, just with respect to R&D. You are talking about R&D increasing as you move up the value chain with more systems. In the past, you have talked about this but you also have been careful to point out that you are not necessarily going head-to-head with some of your larger OEMs.

Is there any additional color that you can provide on what you are doing in terms of systems development?

Let me continue. Valentin mentioned the same step and the opportunities there which doesn't go really head-to-head with anybody. Some cutting applications in Russia. There is a lot of work we want to do on QCW systems because a lot of the existing micro-electronic manufacturers have their own pulsed high power [lump] pump YAG and they often don't want to cannibalize that business and put a fiber-laser in, so we believe the way to really grow the QCW business is to compete directly with them. They are not customers of ours at the moment. So those are a couple of different directions we are focused on going in.

Okay and if I may, you mentioned the timing of shipments in North America was the big factor in the sequential decline. Did those shipments go this quarter -- Q4? And so you can tell, say, what vertical that was from?

I can't really give you any more specific stuff on that than evidenced at hand. I think we had like some [signing] in the Q3, sorry -- Q2 and Q1 benefited from some 10 kilowatt single-mode lasers going out. There was a 17 kilowatt laser that did not ship at the end of the quarter, but went out in Q4.

That was for advanced applications, so it was a very high quality beam laser. That was the main item in the North Americas.

Arthur Weiss, from Lord Abbett.

Yes, thank you. The question is on the --- when you're taking market share on the cutting laser side, do you think that the lasers are going into new factories? Are they going into end of life replacements or are they ripping out CO2 lasers, [midlife], and replacing them with the fiber-lasers?

Well, a number of ways, (inaudible) metal drop shops, for example, worldwide especially in China, in other countries. So they all -- they use our laser now. We can win your reference now, you will see official papers when you are receiving from end user and we are not working with still within the user, we are only compliant to integrate and integrate the supply and cutting machine to -- and in Europe.

But we haven't done that from end user and the days part so one fiber ware that you play two, you want three, give somebody cutting, get cutting systems. And they're so happy that you're absolutely happy. More and more people recognize this normal advantage with a fiber cut against a CO2 custom [fit]. So it's you and the small guys, and of course, big fabs -- we are in a (inaudible) one time this system only. But before the -- only a year ago, the most people will -- a user was sure that the fiber-cutting system only good for thin metal, they will go 5 millimeter thickness now due in this year all people will be cutting out, even prove confirm that very good cuttings going now up to 20 millimeter, even [Broom] confirmed recently one conference only one week ago in Florida.

So the open door for all cutting application now to deal with fiber it's an enormous jump ahead, so it's now we're sure what we might [mix] in five years fiber-laser will dominate in the cutting market.

Thank you. Joseph Garner from Emerald Associates -- Emerald Advisers.

Thank you, good morning. I was wondering if you could a talk a little bit about where you stand in terms of your production capacity initiatives and when you expect some of those to come online?

Most production new capacity were $1 billion now is for final in the user integrated system special in Russia we're building such capacity to make final end user systems. Also increased our production capacity towards core components like fiber, like diodes, for example in US. We have built new platform for diodes and will triple our capacity for diode product, not the biggest on the whole capacity but it's not in our -- now we improved, we've built new facilities.

In Russia, we're building second fiber product. We have now the big perfect fiber PREP in Germany; new fiber PREP would be the same quality in Russia, and similar development.

Also, Joe, I don't think we're having troubling meeting these increases in demand that we're seeing out there. We have added the tremendous modern capacity in Germany and the US over the last year. So we are not seeing constraints within our internal supply chain. I think it's actually more the opposite. I'm trying to get the production people focused on managing inventory rather than just producing it.

Right. Can you talk about the efficiency of the new capacity as you brought it on line? Is it performing as well as you would like?

Yes. For example, they are producing, I think, 40 high-power lasers a month in the US. They were doing less than 10 a year ago. Module production in the US is something like over 250 modules a month capability. There's very little difference between the efficiency of that and where we produce modules anywhere else in the world.

I mention on the front end on the diode side there's a new MBE machine which will grow three or four times the number of wafers that the existing machines would do. The entire machine is not very expensive, so as you grow into capacity it should see the wafer growth efficiency actually improve. We've redesigned some of the designs on the diode packages to reduce costs.

So we're pretty happy with the way that the efficiency of the capacity that we're adding.

It's a new capacity also they exist in the improvement for more [dimension]. We have now only in diode would decrease price per watt twice only during the last 18 months, two times cheaper now with price per watt. We have other opportunities to drop again during the next couple of years.

Right. Terrific. Thank you very much.

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

Thank you. Thank you for joining us today. We'll look forward for speaking with you at the end of our fiscal year for close in spite of now it's not stable economic situation where we reach new record at the time.

Thank you, everyone.

Thank you and that does conclude our teleconference today. Thank you for joining us and have a wonderful day.