IPG Photonics Corp (IPGP) 2012 Q1 法說會逐字稿

Good morning and welcome to IPG Photonics' first-quarter 2012 financial results conference call. Today's call is being recorded and webcast. There will be an opportunity for questions at the end of the call. (Operator Instructions). At this time, I would like to turn the call over to Mr. Angelo Lopresti, IPG's Vice President, General Counsel and Secretary, for introductions. Please go ahead, sir.

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

Statements made during the course of this conference call that discuss management's or the Company's intentions, expectations or predictions of the future are forward-looking statements. These forward-looking statements are subject to known and unknown risks and uncertainties that could cause the Company's actual results to differ materially from those projected in such forward-looking statements.

These risks and uncertainties include those detailed in IPG Photonics' Form 10-K for the year ended December 31, 2011 and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors 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, May 1, 2012. The Company assumes no obligation to publicly release any updates or revisions to any such statements. We will post these prepared remarks on our website following the completion of the call. Please go to www.ipgphotonics.com and select Investors to review these remarks. I will now turn the call over to Dr. Valentin Gapontsev.

Good morning, everyone. IPG reported another quarter of strong year-over-year growth as we increased revenues by 23% to $123.2 million. Sales momentum for our high-power lasers for material processing applications continued as manufacturers increasingly embrace the benefits of fiber laser technology.

In addition, we achieved record gross margins of 55.8% and grew net income by 30%. While IPG has enjoyed an impressive growth during the past few years, we believe we are still in the early stages of the transition to fiber laser for industrial manufacturing applications.

While there are new entrants in the fiber laser market trying to compete with IPG, our customers continue to recognize the superior technology and reliability of IPG's product, [their low cost] and [asset] benefits of our [widescale] manufacturing operations. Not only we are the pioneers in the fiber laser market, but we are also the most cost-effective, high-quality product on the market and we are able to deliver orders in volume with much shorter leadtimes than competitors.

Before I turn the call over to Tim for the financial review, I would like to take a moment to comment on the public offering of 3.250 million shares of common stock, which we completed in March 2012. The net proceeds of the offering provide IPG with the financial flexibility to fund capital expenditures and working capital requirements, as well as to complete acquisitions of complementary businesses and technologies.

The offering bolsters our cash position and will enable the Company to capitalize on opportunities as they present themselves over the long term. It provides us with tremendous flexibility and the security of permanent funding. With that, I will turn the call over to Tim Mammen.

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

First-quarter materials processing sales increased 19% year-over-year to $103.2 million. This market accounted for 84% of total sales during the quarter. The industries we serve within the materials processing end markets include automotive, shipbuilding, electronics, consumer, general manufacturing, aerospace and heavy industry.

Materials processing also includes a broad array of applications, including marking and engraving, welding, cutting, drilling, cladding, prototyping, scribing, wafer processing, surface cleaning and hardening. The opportunity for fiber laser adoption is expanding as manufacturers increasingly use our technology in a broader range of industrial materials processing applications.

The remaining 16% of sales were from telecom, advanced and medical applications. We see growth opportunities for IPG in these end markets, but for discussion purposes today and going forward, we will only break out materials processing in detail since it represents the vast majority of our business.

Sales for these other applications were up 48% year-over-year to $20 million. The growth was driven by the sale of multiple, high power, high brightness lasers for advanced applications to be used in research. Sales of high-power lasers, which account for just over 50% of total revenue, increased 42% year-over-year to $63 million. Cutting and welding applications have been driving much of the growth of our high-power laser sales. The benefits for customers using our lasers for cutting and welding include increased accuracy, speed and quality compared with traditional sources.

Sales of medium-power lasers increased to $9.6 million or by 28% year-over-year. Much of the growth was driven by specialty cutting and welding applications, including thin sheet metal cutting and microwelding, as well as printing and sintering applications.

Pulse laser sales were down 3% year-over-year to $27.7 million. Pulse lasers are used for marking and engraving applications and general manufacturing where demand is often controlled by general economic trends. We remain optimistic about the long-term opportunity for pulse lasers.

Our low-power lasers, which are primarily used for medical applications and micromaterials processing, generated $3.8 million in sales for the quarter, down 19% year-over-year. We continue to gradually add to our medical OEM customer base; however, this process is lengthy due to the regulatory environment.

Sales of QCW lasers, which are primarily used for microwelding and cutting applications, more than doubled to $2 million compared with last year. We are excited about the opportunity for additional QCW laser sales. We believe that we can further reduce QCW manufacturing costs, making these lasers an even more attractive option when compared with traditional lamp pumped YAG lasers. This should ultimately translate into incremental marketshare gains and revenue growth for us.

Sales of other products, which include amplifiers, diode lasers, green lasers, mid-IR lasers and certain components, were $7.7 million and service, parts, lease and other revenue totaled $9.5 million.

Now looking at our performance by geography, European sales increased to $41.9 million or by 11% year-over-year. We had a solid quarter there due to the delivery of multiple high-power lasers for advanced applications. That growth was partially offset by a weak quarter in Russia. However, we anticipate a stronger Q2 in that market.

North American sales increased to $25.6 million, or by 48% on a year-over-year basis. Again, much of this growth is a result of high-power laser sales for materials processing applications such as cutting, welding, brazing and cladding.

Asian sales, which include Western Asia and the Middle East, increased to $55.1 million, or by 23% year-over-year, with demand particularly strong for battery welding and 2D cutting applications. China performed well recovering much faster than anticipated due to demand for specialty cutting and welding applications, as well as higher value add marking applications for the consumer electronics market.

Cutting application sales to Turkey, which is reported as a component of Western Asia, also increased meaningfully. While Japan underperformed during Q1, we anticipate growth to return there as order flow increases for cutting and welding opportunities, particularly as customers who have recently qualified our lasers, start to ramp demand.

Now turning to the income statement, total sales for Q1 increased 23% year-over-year to $123.2 million. Gross margins were 55.8% compared with 53.7% in Q1 2011. Gross margin includes stock-based compensation charges of $460,000 and $521,000 in the first quarters of 2012 and 2011 respectively.

Sales and marketing expenses were $5.1 million, or 4.2% as a percentage of sales, down from 5% in the year-ago quarter. We expect to invest in more demo units in 2012 and in our application labs to ensure that we have new products on hand for customers to test. In addition, we plan to add to our sales staff around the world.

General and administrative expenses increased 22% to $9.9 million, but were flat as a percentage of sales at 8% compared with the year-ago quarter. R&D expenses increased year-over-year on a real dollar basis by 25% to $7.1 million due to increased spending on R&D materials. As a percentage of sales, R&D was 5.8% of total revenues, which was flat with the first quarter of 2011.

In total, operating expenses for the first quarter of 2012, excluding foreign exchange losses, increased 20% to $23.5 million. Operating expenses include stock-based compensation charges of $1.538 million and $2.086 million in the first quarters of 2012 and 2011 respectively. First-quarter operating income was $45.2 million, or 36.7% of sales compared with $34 million, or 34.1% of sales in the first quarter of last year.

In Q1 2012, other expense includes $1.1 million for final payments related to a contingent consideration agreement for a prior acquisition. Net income attributable to IPG for the first quarter increased 30% to $29.9 million. On a per diluted share basis, we reported $0.61 in Q1 2012 compared with $0.47 a year ago. We estimate that if exchange rates had been the same as one year ago, sales in Q1 2012 would have been $900,000 higher. Gross profit would have been $500,000 higher and operating expenses would have been $200,000 higher.

Now turning to the balance sheet, in the first quarter, cash and cash equivalents, including short-term investments, increased by $189.8 million to $395.5 million. This was primarily due to the closing in March 2012 of the public offering of 3.250 million shares, which contributed $168.3 million after operating expenses.

At March 31, 2012, inventory was $123.4 million, an increase of 6% from year-end 2011. Approximately $3.5 million, or 2.8% of the increase in inventory, related to the translation effect of the appreciation of the euro and ruble exchange rates versus the US dollar.

While our current level of inventory on hand amounted to 206 days and is now above the top of our target range of less than 180 days, given further sales growth and continued improvements in inventory planning and management, we hope to reduce the number of days outstanding in the future. However, we continue to see a competitive advantage to holding a large balance of inventory to be able to respond to customers in Asia and around the world with short leadtimes.

Accounts receivable were $88.4 million at the end of the first quarter, or 65 days sales outstanding compared with $75.8 million at December 31, 2011, or 56 days sales outstanding. Accounts receivable was higher than normal at the end of Q1 due to the timing of shipments in the quarter. 78% of revenue was shipped in February and March with sales in China ramping off to the Chinese New Year, Korean customers deferring shipments from the US until after March 16 when the new tariff rate was reduced to zero and the delivery of high ASP, high-power lasers for advanced applications in March.

Cash generated from operations during the quarter was $27 million. Capital expenditures for the quarter totaled $13.8 million, which is consistent with our target range of $55 million to $60 million for the year. We are investing in new manufacturing facilities and capacity expansion in high-growth regions, particularly in the US, Germany and Russia. Some of the facilities that have been under construction will become operational before the end of 2012, including buildings in Germany and Russia.

And now for our expectations for the upcoming quarter. The book-to-bill ratio was greater than 1 in the first quarter and we are optimistic that our order flow will continue to be strong. It has been in April.

Geographically, we are performing well across the globe. North American manufacturers are adopting fiber lasers for a broader range of industrial materials processing applications. Europe and China are performing better than expected considering the macroeconomic factors in each region. And we are optimistic about our long-term prospects in Japan.

Operationally, we are focused on identifying new opportunities for expansion, including developing specialized laser systems to meet customers' needs and penetrating more deeply into the fine processing market with new QCW, green, UV, near infrared and ultrafast lasers and also entering new geographies.

We have a strong balance sheet, which will allow us to make the necessary investments to build out our infrastructure and continue to execute upon our growth strategy. With that as a context, IPG Photonics expects Q2 revenues in the range of $128 million to $138 million. The Company anticipates Q2 earnings per diluted share in the range of $0.60 to $0.70. That is based on 52.103 million diluted common shares, which includes 50.967 million basic common shares outstanding and 1.136 million potentially dilutive options at March 31, 2012.

The basic common shares outstanding include the 3.250 million common shares issued as a result of the follow-on offering in Q1 2012. This guidance is subject to the risks we outlined 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'll open the call up for your questions.

(Operator Instructions). Zach Larkin, Stephens.

Good morning, gentlemen. Congrats on the quarter and thanks for taking my call.

Good morning, Zach.

Hey, first off, obviously strong quarter, stellar gross margins. Could you comment a little bit on the margins and what you expect or are thinking about as we go into Q2 and move through the year? Is what we saw in 1Q something that is sustainable or should we expect a little bit of contraction as we go forward?

In the first quarter, gross margins did benefit from shipments and sales of quite a number of high brightness, high-power lasers with a significantly higher ASP. That benefit was probably about 100 basis points. So if you excluded that, gross margin would be right in line with our target of around 55%. So in Q2, we are not expecting a significant number of those shipments; although there are other orders expected, which, from quarter to quarter, may benefit gross margin a little bit in the second half of the year. But that is the real reason it is a bit of benefit on product mix on gross margin there.

All right, thanks. That is very helpful. And then as you look at kind of the past quarter and orders, are there specific industries that you are seeing strength? I would assume auto is doing well, but then also maybe if there is any that is a little bit weaker than you might have anticipated?

Auto is clearly a driver, particularly in North America where we have got increasing number of orders and sales from just about every single major manufacturer in the Tier 1. Cutting continues to be a strong growth driver both in your Europe through our Italian OEMs and with a recovery in China. The consumer electronics industry with the subcontract manufacturing in China, we are seeing actually ramping demand there for medium-power lasers and also pulsed and QCW lasers.

The benefits to come in the second half of the year I think really are in Japan where we are expecting the cutting customers who have developed equipment to start purchasing in Q2 and Q3 and also some increase in demand from the major automotive manufacturers there who've qualified us for welding applications.

There are no real specific areas of weakness. I mean Europe on the materials processing side is a little bit sluggish and we have benefited that a little bit by the advanced application sales there and we are actually expecting some more advanced stuff to come out of Europe, which should help the year there even if materials processing continues to be a little bit weak.

And for the second and third quarter, we have received very huge orders for pulsed laser, new generation of pulsed laser, which we introduced to the market end of last year from China and from Apple.

Okay, thanks very much. And also wondered -- we've got a little bit of a soft patch for 2Q just based upon the year-over-year growth. Is there any change in your guys' outlook longer term for the continued 20% type top-line opportunities as we get through the current macro malaise?

I think we are pretty comfortable that, in all of the market forecasts -- this is how we talk about it -- are that fiber should continue to penetrate all of these different applications. And if we can grow to 60% to 70% of different applications by 2015, the underlying growth rate assumed there would actually be a little bit above 20%, maybe closer to 23%. I think you may have again quarters where growth exceeds that with adoption into different end markets or geographies. But the underlying sustainable growth rate for the Company we believe is intact.

Okay, thank you very much. Congrats again on the quarter.

Thank you, Zach.

Tom Hayes, Thompson Research Group.

Thank you. Good morning, gentlemen and congratulations on the start to the year. I guess my first question is kind of on the expansion. You touched on it, Tim, that some of your expansion projects should be up and running this year. Just wondering if maybe you could touch on a little bit on what kind of capacity that will provide you. Is it in the 10% to 15%, 25% range of additional capacity that that will provide you?

It depends what you talk about; we talk about this in different ways. If you're adding to processes, for example, the additional wafer growth machines that we are putting in for the diode area will double wafer growth capacity. Then you need to add on the downstream side of chip production to build up to that, but it is more manageable once you have got the wafer growth in.

The new buildings will provide the space to add headcount to ramp manufacturing of components in Russia, in Germany and in the US as demand grows. So I estimate that for every dollar of CapEx that you spend, you are able to generate on an annual basis $3 to $4 of revenue.

I guess second question maybe is just on your -- some pretty positive comments on China. I was just wondering is their activity level back to a level where you saw kind of before the downturn we have been talking about the last couple of quarters?

In Q2, they recovered very nicely. I mean they were right up -- not quite as high as Q3 of last year, but the momentum we have got going into Q2 -- the Vice President we have got in China and the Asian operations is very optimistic about Q2 and certainly the orders that we have had in hand and the order flow through April has been very strong. So we are expecting a good quarter out of China there.

And I want to reiterate again that we talked about the work we were doing in deepening relationships in China with existing OEMs and new OEMs, introducing new products for new applications. Valentin mentioned the unique pulsed lasers that we have introduced there. The QCW offering, which is not only driving sales in China, but also in Korea. We have hired sales people in China with a lot of experience in that market.

So the combination of those three things -- a deepening of relationships, the introduction of new products, which address new applications and the expansion of the salesforce -- means that we think we have actually got a much more solid foundation to the business there than we had even 18 months ago. So there is a lot of work that the Company has done in all of these areas.

We can say more that April bookings is fantastic.

And China represents about what percentage of your revenue, Tim?

This quarter, they were probably about [23.6%] (corrected by company after the call).

Okay. I guess just last question, maybe your thoughts on the annual (inaudible) for the non-controlling interest.

I am factoring in about $1.2 million for Q2 and then if Russia continues to [expect] this strong then, it would ramp a little bit each quarter after that, maybe 20% a quarter.

20% increase per quarter over Q2 levels?

Yes.

Okay. Great, thank you, guys.

(Operator Instructions). Mark Douglass, Longbow Research.

Hi, good morning, gentlemen. Tim, you talked about inventories. Is a lot of the inventory growth here -- is it still in finished goods? It's what it sounds like. Just because you want that as a competitive advantage is that -- rather than WIPs?

Well, it is finished components, as well as finished goods. So we keep on hand finished packaged diodes, finished fiber blocks, modules and then also at the subsidiary. So for example, in Japan or Korea, Italy, China, they will have finished product to enable (inaudible) because they have got orders that need to ship early in the quarter or in order to respond quickly to customer demand, they will hold some finished product inventory. So the components you could think about as WIP even though they are finished and then there is the finished product.

Oh, okay.

You can build a laser if you have the modules and the parts available very quickly in response to leadtimes extremely quickly.

Right. Then on the op expenses line, I think some of us were expecting a more significant drop and fall-off in general and admin. What are you thinking about op expenses going forward? I mean 19% I think is a little higher than what was anticipated. Should that be floating back down as the year progresses?

So the total of 19% includes the $1.2 million of FX losses. If you exclude those, I think operating expenses were just under 18%. G&A was higher than a year ago because of a little bit on salaries and benefits, not too much. There was tax, legal and accounting fees, all of it related to transfer pricing and other matters that came through. Travel was a little bit higher, but the other item in there was we had a $350,000 increase in reserves related to accounts receivable whereas a year ago, that was flat. We will provide reserves on stuff that is getting older even though we may recover it. Our history is that we tend to recover those amounts, but we will provide those reserves on the balance sheet to be prudent.

Okay. So you think 18% is more normal and even some leverage available?

We grow revenue -- I think there will be some leverage on OpEx. You have to take out that there was $1.2 million of FX to get to the real OpEx that we paid out.

Okay, thank you.

Jim Ricchiuti, Needham & Company.

Hi, thank you. I was wondering if you could comment on how you see the new QCW scaling up as you go through the year. It sounds like you have adequate capacity. Is it a case of just putting more sales, marketing resources, getting the customers to understand the technology a little more?

With QCW introduced, [one] have here a (inaudible) the device from this [family]. It is a very big family of devices that (inaudible) of different power, peak power. Now we increase the (inaudible). First, we introduce 1.5 kilowatt peak power. Now a new version, we increase up to 18 kilowatts peak power. A big range of laser, different laser, which cover all applications, which (inaudible) that people use.

And there is huge potential for such lasers because they absolutely cover all parameters in order of value better than (inaudible). And also we now have the developed special diodes for such lasers, which allow us to provide both the price benefit to customers. So (inaudible) a very big business. We consider in two or three years we will -- sales of such lasers will increase a minimum five times to compare with current sales. This year, we got a contribution to the revenue contribution. We will compete with contribution from high-power lasers.

And the primary applications for this in terms of the vertical markets that you address?

It is mode application and material processing for single -- for fine processing and it is a lot of applications. Now, it is not new markets; it is existing markets, white market, just a replacement of the (inaudible) pump YAG by this new generation diode pumps, highest-quality lasers. We don't see any competition in the market (inaudible) because price cost depends absolutely from (inaudible) diode power. Diode power in the case, our case, we decreased dramatically. Nobody able to compete there.

So would you assume that this revenue ramps significantly on a sequential basis as you go through the year?

We estimate the market for such type of laser by $0.5 million, so it will be dominated in this market with (inaudible) revenue we expect.

Okay, thank you.

I think the target is, Jim, in the near term, we have got to double those sales this year at a minimum.

Or double, what you doing (inaudible)?

No, no. Just this year.

No, no, it's much more --.

Double the sales this year over --.

To deal with many customer, now the testing and found it is an enormous benefit of this and now the changed design of their final working stations. It takes some time for (inaudible) use of such phrases. But we hear from many customers very optimistic for (inaudible) volume.

Thank you.

Krish Sankar, Bank of America Merrill Lynch.

Yes, hi, thanks for taking my question. I had two of them. Number one, either Valentin or Tim, can you talk a little bit of the competitive situation? One of your peers just spoke about one of your fiber lasers, one kilowatt being adopted because it is insensitive to back reflection. I was just trying to get a sense of if you can talk a little bit about your fiber laser situation and the competition. I just had a follow-up after that.

We are still not seeing any real increase in competition despite multiple announcements by other laser companies around the world. Particularly on the high-power side where we continue to have a tremendous quality and price advantage and even on pulse lasers where we believe we have gained marketshare because of our ability to deliver in volume with a pretty unique product range and also at a very competitive price and quality.

So people have got a very long way to catch up. There is one customer who has claimed that one of the benefits I think is the back reflection benefit. But Valentin can explain in more detail the advantage of our laser in that regard.

Back reflection that was invention [occur]. One of our major competitors, very big guy, was very clean only to save them a share in the market they claim on both (inaudible) gains of 20 fiber laser, but all was absolutely wrong, did not for their -- when they tried to make own something similar, they had a big problem with it, but we resolve problem with back reflection by six, seven years ago and never have any problem with it. It's stupid talk about back reflection. It is a game of some people only.

So we don't see any area with competition market and what year is outflow that we raised our sales of fiber laser at 60% when the total market for fiber laser grew only well over 40%. So our share of the market growing in spite of the competition. Not -- we are not giving the market to other people. This year, we also will increase our share in this market very seriously.

Thank you. That is very helpful. And then just a follow-up for Tim. Tim, clearly your cash flow generation seems to be improving now, but if I look over the last several years, it has kind of been all over the map. So I'm just trying to get a sense of when I look ahead, do you have a certain metric? Do you have like what kind of cash flow you are looking at or like should it be over a certain percentage of revenue? Do you have any such metric or is it going to be pretty lumpy?

At least in the near term, it will be -- if you are talking about the cash flow after capital expenditures, it is likely to be a bit lumpy as capacity is expanded or once that capacity has been expanded, you grow into it and you are not spending so much capital on CapEx. That is the main lumpiness on it. I think we clearly are trying to manage working capital well. I explained a little bit on receivables, but our target is -- traditionally I think in the Company receivables has been down below 60 days historically on an average basis.

The inventory, we are continuing, there is more and more focus on that. I think we went through a period last year with sales growing very rapidly where we build inventory out. I have looked at the overall trend on inventory growth in the last three quarters and it has stabilized even though days are a little bit volatile, so we are generating more. That is not eating up so much working capital from cash flow generation, but because of these different elements, particularly around the CapEx, we don't have any specific targets that we set ourselves.

I obviously like to see operating cash flow as close to net income as possible. I think that shows you are running the Company well and I think we had $27 million of operating cash flow in Q1 and net income was $29 million. I think that is a pretty good target to be at and I think there are benefits we can get out of that still further a little bit.

Great, terrific, guys. Thanks a lot and congrats on the good result.

Patrick Newton, Stifel Nicolaus.

Yes, good morning, Tim and Valentin. Congrats on the quarter. So I wanted to touch base on the medium-power lasers. They increased very nicely sequentially in Q1. Can you discuss visibility with these lasers and should we expect to see the growth rate accelerate on a year-over-year basis from current levels?

We don't talk about specific visibility by productline. Some of that growth came out of China again from microprocessing applications, thin metal cutting and in general, the forecast out of China continues to be strong for that. Some of the other applications on medium power are , which is a deposition technology. That continues to be a growth area for the Company, some printing applications.

But you should note that overall that the medium-power lasers in the CW format were not really addressing a very large part of the microprocessing market, which is why we introduced the QCW to really compete with the lamp of YAG. And the real significant growth over the next couple of years, as Valentin articulated, will come really from QCW. We expect the medium-power CW to perform well, but the real growth is from the QCW side of things I think.

This year, we will (inaudible) some qualification. We will start to sell a lot of new lasers, which we claim in the and/or second half of last year demonstrates (inaudible) of flow and new one, it is -- the UVM laser, for example, there are short pulse lasers to very high energy quick pulse and average power of nanosecond lasers. So it is a lot of different kinds of lasers, which each of them have contributed essentially starting from this year additional to our traditional lasers.

Okay. And is it fair to say that the QCW lasers have a similar gross margin profile to your traditional CW lasers?

Yes, they will do -- at the moment, the pricing is a little bit higher. We are bringing the pricing down as we bring the diode cost down with this unique new diode that we have developed and then the pricing policy we will use for the QCW will be the same as all the other lasers. So we expect to generate very similar gross margin off that product.

Okay. And then shifting gears to China, thanks for the details on China in the quarter and you commented about order flow strong across all geographies. But can you characterize Chinese order flow relative to the total Company? I guess the reason I am interested is, especially in the month of April, we had a weaker Chinese Flash PMI and it sounds like you are not seeing any hiccup there. So if you could just discuss China in a little bit more detail.

I can say you (inaudible). As I mentioned today, in February, we had fantastic booking and more than 50% of this from China.

Okay, that's helpful. And then one last one on your manufacturing capacity expansion. If these facilities do come online in Germany and Russia by the end of the year, Tim, how should we think about the impact to your gross margin profile as this capacity ramps?

Well, the intention obviously is to be growing into that capacity and we can continue to do that. We have seen a nice year-on-year improvement in revenue in Q1. That can be sustained during the year. I wouldn't expect to see a meaningful impact on gross margin through the year.

One thing you should know is a lot of the investment we put in is primarily on facilities. If you look at the ratio of facilities relative to equipment, it is -- the amount of facilities is quite high and facilities get depreciated over a 30-year period. So you can absorb quite a lot of CapEx without that necessarily impacting gross margin dramatically.

Thank you for taking my questions.

(Operator Instructions). Joe Maxa, Dougherty & Company.

Thank you. Most have been answered, but I did want to address the pulsed lasers. It has been a little bit weak. I am just wondering if you are seeing any pickup or turnaround in that productline.

I think we have had some good orders coming out for the new applications in the consumer electronics side both with some customers in Europe who supply stuff into the manufacturing operations. There are subcontractors in China, as well as orders in China. Clearly the thing to note, Joe, is that the pulsed laser business is one of our most mature productlines. We have been in that business for 16 years I think we've signed up and started working with our first main OEM in Japan. Fiber already has more than 60% marketshare there.

The desire to go after the remaining 40%, which can be very low value add and relatively low-quality lasers, it is not really the most strategically advantageous business decision. We are better off focused on growing some of the other productlines up to 60% marketshare in the total laser market.

So we have always said that we believe that we are going to be the leader in the pulsed laser business and we can satisfy everybody's requirements and solutions. There has been some benefit in order flow at the end of the quarter for some of those consumer electronics applications. But that is our -- the caveat to it is it is the most mature productline that we do have.

All right. Thank you. That was helpful.

Avinash Kant, D.A. Davidson.

Good morning, Valentin and Tim. Could you talk a little bit about the average diode cost per watt that you had in 2011? And you had given some targets earlier about 2012. So if you could give us some idea of where you are in terms of achieving those targets and when should we see the average net diode cost per watt in 2012?

I think we gave a target of getting below $3 and we are already there on the diode used in the CW lasers and when we introduce the new diode for the QCW where we can drive a lot more power on short pulses through the diode. The cost will be even lower than that.

And could you talk a little bit about some of the opportunities you are seeing in oil and gas drilling?

There seems to be some progress being made with using high-power lasers in conjunction with drillbits to soften rock and substantially reduce the pressure that is required on the drillbit to penetrate very heavy rock. There is some stuff out there on the web about it that it really is improved as a workable solution to using fiber -- delivery fibers that are several kilometers, so thousands of meters in length. We are expecting to see some additional orders from those applications in Q2 as people continue their -- the main customers we have got continue their research into it.

They've told us that if this continues to be as successful as it is, the potential will ramp to tens, if not hundreds of units. It makes the viability, the economic viability of wells that, until now, were very expensive to drill much more economically viable because it reduces considerably the wear and tear on the drillbit. It also reduces vary significantly the amount -- the number of times and the amount of time spent on pulling drillbits out of the ground to replace them when they are worn.

(inaudible) will now begun in the (inaudible) logistic market in the future because it (inaudible) smoothly, but when the market will need hundreds of the multi-tens kilowatt lasers, it is really (inaudible) in terms of the future. Now the wells are going to go in much faster. We are working this area (inaudible) about eight years with customers. But (inaudible) still just an idea now becoming practical. So we -- now it's years, very serious potential for the future.

Jagadish Iyer, Piper Jaffray.

Yes, thanks for taking my question. Two questions. Tim, can you basically give us an idea of how much was sales to the automotive segment in Q1 and where do you see the automotive segment trending at the end of the year? Can you give us some numbers for '12 versus '11? And then I have a follow-up.

We don't give that out specifically. What we have talked about before is the stuff that we can identify and then there is a lot of stuff that we can't. I would estimate that automotive sales were about 35% of total sales.

Okay, and where do you see that for '12 versus '11, please?

It is growing. I mean in the US, it will grow. I think there is -- as a percentage of the total, I think it will remain relatively consistent. It is early stages of adoption in that industry, early stages of qualification. You are seeing ramping demand in the US from all the major manufacturers and Tier 1s. We are still in early stages with most of the German manufacturers as they look to more widely embrace fiber. And the same holds for the Japanese.

So again, it is a -- we are changing the way that people are making cars and processing materials within the auto industry to enable better fuel efficiency and improved safety. None of those parameters have changed and people are going to have to move in that direction to meet their MPG requirements that have been mandated by law.

Okay. And just on the -- just as a follow-up, post your offering, can you help us in giving us some details about where are you in terms of trying to find adjacencies to your segment? Can you give us an update on that? Thank you.

There isn't a huge amount to update you on. As we talked about previously, we are clearly the leader in the market. We get a lot of people approaching us. Some of them better quality than others and we evaluate those opportunities as they arise. We look at opportunities in different geographies. There continues to be nothing specific to announce in that regard.

I mean I think when we do have something specific and tangible, we will make an announcement about it. But the basic thing is that we are either targeting opportunities that can accelerate our existing productline penetration into end markets, can help us to expand geographically and accelerate sales or accelerate into markets where we are lightly penetrated, for example in the fine processing at shorter wavelengths or into plastics processing where our thulium laser has proven to be a good wavelength to process plastics at. So the strategy is I think fairly well-articulated and you will see us hopefully execute on that in the next couple of years.

Olga Levinzon, Barclays Capital.

Hi, thank you for taking my question. I wanted to follow up on a couple of the sort of new and expanding market opportunities that you outlined, specifically welding and then the QCW lasers. I guess what is the current ASP premium or gap that you have between fiber lasers and the YAG pump lasers within the QCW segments? And then also for fiber laser welding systems versus non-laser systems that are currently serving the market?

So QCW a year ago was probably fairly significant. Right now, the pricing on QCW is directly competitive with YAG, so that is a very similar strategy that we pursued in penetrating the cutting market. And that is why we believe we are on the verge of being able to substantially increase those sales. An even start -- this is a huge installed base of lamp pump YAG lasers, which we believe people can now seriously consider retrofitting with our QCW. So we believe that is going to start in the next year and gather momentum.

In terms of welding applications, you have to look at the total cost of welding with different technologies and that includes not only if you are using manual processes, the annual cost of paying a skilled welder. You also have to look at the consumption of wire, so it is not just the upfront cost of a MIG or TIG welder compared to a laser. All of the cost analysis when you look at that compared to electrical consumption, wire consumption, decrease in manual labor because fiber enables you to automate processes in shipbuilding, in oil pipeline manufacturing, in other areas of assembly.

The laser is increasingly basically much more cost effective or not only cost effective, but provides a better quality weld so you can process welds faster and reduce the number of welds that are required. The issue that you face there is that these markets are dominated by players who have been in the welding business for 100 years. We have got entrenched customer relationships with applications that are well-recognized. So you have to go and change the view of these different industries to get lasers to be accepted and that is pretty much the similar process we had to go through with the cutting.

So you are not going to see a sudden change in adoption that is going to drive tremendous 100% plus growth in one quarter. The big welding companies are not going to give up the welding industry very easily. They make a lot of their money from selling the wire, for example, as a consumable.

And fiber laser also green technology. (inaudible) come in much more and more valuable in the market and also it is also much more precise (inaudible) fiber laser allowed to build very special materials, which are very difficult to weld with spot welding. For example, now in automotive with (inaudible) steel, which is very difficult to weld by spot welding. Much more strength steel. For example, aluminum and so on. So it has opened multiple opportunities to use absolutely new materials in this -- in many industries.

Mark Miller, Noble Financial.

I wonder if you can provide us with any more updates. You talked about entering the specialty systems business and thoughts about what acquisitions, what you might have to add to do that?

We continue to evaluate it. We talked about this again. We have articulated I think a very clear strategy. First of all, we are not going to start to compete with basic systems. You mentioned the specialty systems. We are not going to go in and naturally to marking machines or cutting machines where we are going to compete with customers.

There are geographies where we may look at doing cutting machines in for example Russia. On the specialty laser system side, the integration of a QCW in a microprocessing machine, which we already developed for cutting and welding, is another area where we are looking to go into. And then on the specialty welding equipment, there are also developments there. We've supplied numerous systems already, for example, into the locomotive engine casing manufacturing, into one of the automotive manufacturers in the US where we retrofit a YAG laser system for roof welding. That was an integrated system supplied by IPG's group here. It actually resulted in the throughput of vehicles on that production line doubling from 30 cars per unit to 60.

So it is really focused on different welding and specialty applications. There are some systems using thulium for processing plastic that we have also developed internally.

One of the key things I think to understand is some of this also is driven by our customers and it is also driven by IPG. We developed a lot of these applications and we don't see why we should sort of hand over the secret sauce of the applications to integrators within the industry and allow them to make and add value off that. We think that we can enhance and more fully develop the technology within the Company so that it doesn't just reside within the optical components, but it continues to be expanded into the applications and other specialty areas around motion technology or materials handling.

And these watch companies prepare to have this complete solution. Don't provide to us (inaudible) the project from many subcontractors. They prefer to get a complete solution, including installation from one supplier. And we are ready to work with such large customers and we have now many projects with (inaudible) and such and we are ready now to meet that requirement expectation.

Jiwon Lee, Sidoti & Company.

Thank you and good morning. Just looking at your Asian sales, the sequential improvement there seems to be driven by the recoveries in China. And as the order rate continues to rise there, would the June quarter revenue expectation be kind of the all-time high? And I have a quick follow-up question.

I have not given specifically whether China is going to be an all-time high. We are going to continue to see a continued improvement in growth sequentially in China revenue. I haven't given any specific guidance as to whether it will be a record quarter or not though.

Okay, fair enough.

It will be one of the components that drives the improvement in revenue reflected in the guidance range, but it is not the only one.

And how should we be thinking about the potential threat from high-power direct diode lasers?

We continue to believe that dialectic diode lasers have an inferior beam quality and reliability to our fiber laser primarily because they are pumped by diode bars. There is a lot of talk and there has been a lot of talk in the industry for the last two years that direct diode lasers are going to be a growing area. Most of the people who test a diode laser against an IPG laser find that the better beam quality and the improved performance of the fiber means that the processing speeds and cost savings they can achieve are substantially improved.

So we think that this is an overstated benefit of diode lasers. The beam quality, even though it continues to improve a little bit, just doesn't enable the processing speeds and quality that can be achieved with fiber. Most people who like to talk about diode lasers talk about them because they are not capable of producing fiber lasers.

And I can say we produce both. In fiber laser and diode laser, we can provide better diode system -- direct diode system than any manufacturer as of today. But fiber, for us, to compare to diode, much, much better compared to (inaudible) in all parameters, including infusion is the same, including price -- no price benefit from diode. So we don't see ourselves because we can compare, we have both of them and we advise our customers to use fiber, not diode. But if they insist, we also ship in diode, but the fiber is much better. Why we have to lie to customers to buy diodes if fiber is much better. It is our position (inaudible).

Arthur Weiss, Lord Abbett.

Yes, I apologize if you covered this, but if there is a country that is in need of high efficient fiber lasers it is Japan. And it didn't sound like what I would expect would be greater demand there is showing its head yet. Can you comment on that?

We had a particularly strong quarter a year ago as a comparative. The actual outlook for Japan for the remainder of the year is pretty strong. There are a lot of -- I think five OEM customers producing cutting equipment who have recently qualified for fiber laser. Not many of them have actually introduced their equipment yet. That is expected to happen in Q2. There are a lot of research projects. For example, we just got an order for a 30 kilowatt laser ongoing for materials processing. We also expect demand into the automotive industry, the large manufacturers there, to ramp for brazing and welding applications.

You're actually right though. Fiber with the electrical efficiency and performance benefits of that and particularly at high power has been one of our strongest markets over the last eight years since we introduced the high-power lasers there. So Q1 is not necessarily reflective of the expectations going forward. Our sales and general manager in Japan put out actually an aggressive budget for total sales growth this year.

And now our sales last year in Japan were $41 million. This year, we will support our target to double the sales in Japan. We have already reached those numbers.

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, I want to thank you again for participating on the call and your interest in IPG. We look forward for reporting continued growth at the end of Q2. Have a good day. Goodbye.

Thank you, everyone.

And that concludes our conference call. Thank you for joining us today.