IPG Photonics Corp (IPGP) 2012 Q2 法說會逐字稿

Good morning. Welcome to IPG Photonics' second-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 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, July 31, 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 delivered another successful quarter with record revenues of $138 million, gross margins of 54.3% and net income of $37.7 million which increased by 23% year over year. High-power fiber laser sales for materials processing applications continue to drive IDG's topline growth. We also reported a record quarter for pulsed laser sales and solid growth in medium power and QCW laser sales.

Our sales growth continues to be driven by three factors. The first is the adoption of fiber lasers over other laser technologies. I have discussed many times before the efficiency, superior performance, and cost benefits of the fiber laser.

The second factor is the overall use of lasers in an increasing number of applications. This is due to new types of materials used in manufacturing, the growing use of automation continued and the need for precision and speed that only lasers can handle.

The third factor is the strong demand we are seeing in several of our key industries that is currently holding up despite prevailing economic concerns. For example, automotive OEMs are using new materials such as high-strength steel in manufactured advanced manufacturing techniques, and fiber lasers are the best solution to cut or weld these materials.

We believe that meaningful transition to laser processing is just starting for some of these applications. As a consequence, the fiber laser is continuing to make significant market share gains across applications. These factors also explain why IPG is doing well in geographies like China and Europe, despite slower macroeconomic growth.

Looking to the future, we are conducting internal research and working with industrial institutes and other strategic partners to develop new applications and new products in applications where lasers have not been widely used before. We plan to further leverage our leadership position by pursuing large-scale, higher-margin applications including welding and cladding with high-power lasers, microprocessing, and ceramic cutting with QCW lasers as well as processing of non-metals, micro processing, scribing and marking with high-power green lasers.

In addition, we are expanding our geographic footprint to meet customer demand. In Q2, we opened an office in Turkey to service the numerous OEM material processing customers we have there.

Finally, we remain focused on developing specialized laser-based systems to meet the specific needs of manufacturers whose requirements are not currently met by standard systems or in certain geographic areas where fiber laser systems are not currently available.

We are also improving the flexibility of our existing products. For example, we have developed a 2 kilowatt air-cooled laser for use in dry environments and an ultra-compact 1 kilowatt fiber laser for use in applications requiring a small footprint.

We are continuing to make the necessary investments to support the increasing demand for our products and meet the needs of our customers as well as identify opportunities to expand and grow our business.

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 statements and balance sheet and close with our guidance.

Second-quarter materials processing sales increased 16% year-over-year to $124.6 million. This market continues to drive our growth and accounted for 90% of total sales during the quarter. The most significant materials processing applications for fiber lasers are cutting, welding, and marking and engraving. We are also seeing growth from applications such as cladding, drilling, brazing, annealing, and rapid prototyping.

Other applications which include telecom, advanced and medical, accounted for the remaining 10% of sales. Revenue from these other applications decreased 5% year-over-year to $13.3 million.

Sales in these end markets can be uneven due to the timing of orders. The year-over-year decline in Q2 was due to a particularly strong second quarter of 2011.

Sales of high-power lasers, which account for 45% of total revenue increased 13% year-over-year to $62 million. We continue to see demand for high-power lasers used for cutting and welding particularly in the automotive and in heavy industries.

Sales of medium power lasers increased to $11.1 million or by 32% year-over-year. These lasers benefited from an increase in demand from developers of consumer electronics for thin sheet metal cutting and welding. IPG is a proven qualified vendor to multiple consumer electronics integrators displacing other vendors and we look forward to continuing to expand upon these relationships.

Pulsed laser sales had a record quarter at $38.2 million, which accounted for 28% of total revenues and was an increase of 10% compared with last year. The increased demand for pulsed lasers can be attributed to growth in the consumer electronics market.

Low-power sales were $4.2 million for the quarter, down 11% year-over-year. The medical end market accounts for the majority of our low-power laser sales and we are seeking to diversify our customer base in that area.

Sales of QCW lasers, which are primarily used for micro-welding and cutting applications increased 16% to $2.1 million compared with last year. QCW unit sales increased by 79% as deployment increased following the selling price reductions we implemented earlier this year. Demand for QCW lasers is steadily increasing as we adjusted our pricing and customers now have a cost-effective fiber-based alternative to flash lamp high peak power pulsed lasers.

Sales of other products which include amplifiers, diode lasers, green lasers, mid-IR lasers, integrated laser systems, and certain components were $10.3 million and service, parts, lease, and other revenue totaled $10 million.

Now looking at our performance by geography, European sales increased 11% year-over-year to $47.2 million. Growth was driven by a record revenue quarter in Russia where both telecom and materials processing performed well.

North American sales decreased to $22.7 million or by 10% on a year-over-year basis. The decline from the prior year is primarily due to the timing of shipments as order volume in North America was strong during the quarter and we are anticipating significant growth in Q3.

Asian sales, which include Western Asia and the Middle East, increased to $67.6 million or by 26% year-over-year. China and Japan delivered solid quarters particularly from the general manufacturing, automotive, and consumer electronics end markets. In China, we are expanding our presence and taking market share from our competitors.

As Valentin mentioned in his introduction, despite slower economic growth, China is performing well primarily due to market share gains in cutting applications, strength in microelectronics, and growth in welding applications. In Western Asia, we also saw strong growth from Turkey as a result of increased sales to cutting OEMs.

Now turning to the income statement, total sales for Q2 increased 13% year-over-year to a quarterly record of $138 million. Gross margins were on target at 54.3% compared with 54.7% in Q2 2011. Gross margin includes stock-based compensation charges of $568,000 and $363,000 in the second quarters of 2012 and 2011 respectively.

Sales and marketing expenses were $5.9 million or 4.2% as a percentage of sales in line with the year-ago quarter.

General and administrative expenses increased 5% to $8.7 million but were relatively flat as a percentage of sales at 6% compared with the year-ago quarter.

R&D expenses increased year-over-year on a real dollar basis by 9% to $7.2 million. As a percentage of sales, R&D was 5.2% of total revenues, which was flat with the second quarter of 2011. Our R&D efforts are focused on designing and introducing new and improved standard and customized products and the mass production of components.

Operating expenses for the second quarter of 2012 include foreign exchange transaction gains of $3.4 million or $0.04 per share net of tax. Excluding the foreign exchange gain, total operating expenses increased by 5% to $21.8 million. Operating expenses include stock-based compensation charges of $1.633 million and $1.330 million in the second quarters of 2012 and 2011 respectively.

Second-quarter operating income was $56.4 million or 40.9% of sales compared with $46.1 million or 37.8% of sales in the second quarter of last year. Operating margin excluding the foreign exchange transaction gains was 38.7%.

Net income attributable to IPG for the second quarter increased 23% to $37.7 million. On a diluted per share basis, we reported $0.72 for the quarter compared with $0.63 a year ago. Net income attributable to redeemable noncontrolling interests during Q2 was $2.1 million or $0.04 per diluted share.

We regained complete control of our Russian subsidiary just prior to the close of the second quarter, purchasing the minority interest for $55.4 million in cash and expect that the transaction will be accretive from the current third quarter as there will be no income attributable to the noncontrolling interest in that and subsequent periods. There was no impact to EPS as the purchase price approximated the fair value of the noncontrolling interests share in our Russian subsidiary.

We estimate that if exchange rates had been the same as one year ago, sales in Q2 2012 would have been $4.3 million higher, gross profit would have been $2.3 million higher, and operating expenses would have been $0.7 million higher.

Now turning to the balance sheet, at the end of the second quarter, cash and cash equivalents including short-term investments had increased by $149.7 million to $355.3 million. This was primarily due to the closing in March 2012 of the public offering of 3.250 million shares which contributed at $168.3 million after operating expenses.

At June 30, 2012, inventory was $122 million, an increase of 4% from year-end 2011. Our current level of inventory on hand amounts to 174 days and is now below our target range of less than 180 days. We strive to strike a balance between holding a lower number of days outstanding while maintaining a sufficient balance of inventory to fulfill customer orders around the world with short lead times. If foreign currency exchange rates were at the same level at the end of the second quarter as they were on December 31, 2011, the translated value of inventory would have been $124.5 million.

Accounts receivable were $86.1 million at the end of the second quarter or 56 days sales outstanding compared with $75.8 million at December 31, 2011 or 56 days sales outstanding.

Cash generated from operations during the quarter was $51.5 million. Capital expenditures for the quarter totaled $22 million. We still expect capital expenditures to be $55 million to $60 million for the year. In addition to expanding diode capacity, we are adding to manufacturing capacity in Germany and Russia and investing in our international sales and service locations to respond to our customers' needs.

Recently we opened a new application development center for cutting and welding in Russia as well as a sales and service office in Turkey. We are considering increasing our presence in additional countries with further infrastructure investments.

Now for our expectations for the upcoming quarters. IPG continues to benefit from our market-leading products, superior fiber laser technology, global scope, and first mover status. The increased number of fiber offerings from competitors has not adversely affected our business given our product performance, reliability, and pricing advantages and may ironically help to drive acceptance of and expand the market for fiber lasers as our competitors educate more end users about the benefits of fiber laser technology.

We are confident in our prospects for growth and profitability in the coming quarter despite potential macroeconomic headwinds driven by the three factors which are driving demand that Valentin discussed at the outset of the call.

The second quarter was a record quarter for order bookings and the book to bill was greater than one. That momentum continued into the first few weeks of July. We expect the top line to grow on a sequential and year-over-year basis in Q3.

IPG Photonics currently expects Q3 revenues in the range of $145 million to $155 million. The Company anticipates Q3 earnings per diluted share in the range of $0.74 to $0.84. That is based on 52.175 million diluted common shares which includes 51.066 million basic common shares outstanding and 1.109 million potentially dilutive options at June 30, 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.

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

(Operator Instructions). Zach Larkin, Stephens Inc.

Good morning, gentlemen. Congratulations on a great quarter. First off, I wondered if you could talk about the guidance and maybe go through what some of your key assumptions are that underpin the guidance and perhaps what some of your expectations are by product category?

First of all, the assumptions that we have used to derive guidance are the same as -- and the methodology is the same that we have used over the last five years since we have been public. So we look at the total backlog and orders in hand at the beginning of the quarter, factor in how bookings have run during the first weeks of the quarter, and then also factor in an element of orders that would book and bill.

So the ratio of orders in hand relative to guidance is equivalent to where we've been in prior quarters at about 70% to 75%. It may even be a little bit higher than that.

In terms of specifics -- on product lines, we haven't really previously given any specific date on that and I won't do it now. I will do a little bit on geographies where we expect a nice pickup in the US going into the third quarter. A reasonable and probably a fairly nice pickup in Japan and then China will perform relatively well. We don't expect to see the same pickup from Q1 to Q2 in Q3 in China, but it will still have a strong quarter.

Then in Europe for example, order flow has been good in July. We've actually had some advanced application orders in for the 10 kilowatt single mode lasers and 3 kilowatt single mode lasers so that will also help European sales in Q3. So some of the advanced application orders that I talked about at the beginning of Q2 were booked in July so that was nice to see and we have also had some solid orders from microelectronics in Europe and also the automotive industry.

We are also starting to get the benefit from a new product we introduced end of last year, beginning of this year. For example, this is a very good return from the new nanosecond, one nanosecond pulse the way that we introduced into the year and this only for three months before end of [what] quarter and for this quarter where we see a huge order from one [Taiwan] customer. It's more than 2000 units, north of about 30 million orders only [provides this new] laser we introduced recently.

So also now I expect a very good benefit from our QCW laser in the next two quarters. We expect a green laser which we introduced also in the last year now with the upgrade with much more power. Also going very well, so the implementation in the field is the way this will give us future return, we expect it in this year -- already in this year.

We are now in quarter three, quarter four we are going to introduce market -- a lot of new products, more than 10 new products which can revolutionize some new applications which we still don't have good position currently.

Thank you very much for all of that color. Then as you talk about the new entrants expanding the focus on fiber lasers. Are you seeing any of these new players in the fiber laser arena doing anything kooky with pricing, trying to come in and buy market share to anything or anything Draconian like that?

I think they have become more aggressive on pricing. The view, our view is that they are still above our prices and not really able to compete. And then given I think first of all, the quality of our product and reliability of it and the volumes that we can produce on with short lead times, we are not really seeing a huge impact from that increased competition in terms of product offering.

I mentioned previously even at the lower power levels and the pulse lasers, we actually think we've probably increased our market share over the last year to year and a half and certainly not seen any meaningful degradation in high power. I would expect our high-power market share to be very high still.

Yes, it is [on both worlds] we are now at the quarter, very good in increase of sales. In total, it is a revenue increase 13% in (inaudible) but one year in both ways it's quantity. It is now for them, last month 40% more than a year ago. We produced, shipped lasers and pulse lasers 40% more. So the same kilowatt laser with 15 units, we will ship 23% more than last year and take in units and power and we expect the increase up to 36% next quarter -- this quarter.

So a very big increase in quantity. We still are making some optimization of pricing and of course we are going to -- during this quarter, we got very good improvement, a decrease in the quarter. Our major product for example and 4 kilowatt laser we decreased the cost by more than 20%, Q2, we will raise it more than 30% decrease the quarter, a distribution of opportunities to win competition and to control the price we are saving [very good] gross margins.

Krish Sankar, Bank of America Merrill Lynch.

Thanks for taking my question. I had two of them. Tim, can you talk a little bit about the linearity of bookings you saw in the June quarter and the strength you have seen so far in July -- do you expect it to continue for the rest of the September quarter?

In terms of flow, Q1 was pretty strong. We had a book to bill above 1. That trend continued through Q3 and then the beginning of July has continued in the same vein. We are not really seeing any indications from customers of any significant pullback or change.

I would say that some of the improvements we have seen at the beginning of -- end of June and beginning of July is actually a substantial increase from certain customers of lasers for cutting applications in Europe who have previously been more focused on CO2. That was a very pleasing transition so the trend on orders is generally pretty good.

Got you. All right, that's helpful. Then as a follow-up, then just trying to get a sense of when you guys go and displace an incumbent, or if a customer is trying to second source someone besides you, what is the timeline it takes to qualify a second source typically?

Do you mean a fiber competitor?

Yes.

We don't know what that timeline is. I will say that most people who have tried to qualify a second source in most of the instances we know have actually reverted back to abandoning that second source and using IPG solely or have substantially ramped up their call offs from IPG. So the implication being that they are not being terribly successful in qualifying other people.

In the pulse laser side, the qualification if they wanted to use someone else probably would not be that long because the lasers operate at the same wavelength, so it's dependent upon their ability to believe in more the reliability and ability of the customer to deliver.

Tom Hayes, Thompson Research.

Thank you. Good morning, gentlemen. Congratulations on the quarter. Just wondering on the business in Russia, it sounds like it was a pretty solid quarter and you expect a good growth for the balance of the year. You mentioned the telco and the material processing segments. I was just wondering if you could provide a little color of is there one that is outperforming the other and your thoughts on those areas for the balance of the year?

I don't think one is up on the other. We have previously talked about the fact that we hope Russia will grow both of those end markets. For telco, it is our biggest market. The industrial market in China -- in Russia, sorry, continues to grow fairly strongly. There is this move to reinvest in the manufacturing base and capability there. We've done a lot of work with major industrial companies ranging from automotive manufacturing to shipbuilding to the aerospace industry, locomotive and train building, and are we believe making very good progress of being at the forefront of helping them improve the way that they are manufacturing product.

And we think that in the future one of the areas where we are focused on developing complete systems and solutions and where that will take off fairly quickly is in Russia over this probably next 18 months or so.

Okay, on the last call, you indicated that you had a new diode in the works for the QCW lasers. I was just wondering if -- it sounds like that came to fruition as you were able to lower your costs if I understood it right by about 30% on those lasers.

Yes, the new diode, new diode -- and not really new package but the higher power diode is qualified and being used in the QCW and actually some of that R&D innovation has been carried over to new package and higher, slightly higher power level diodes for some of the QCWs, so it's actually a good example of leveraging the benefits that you drive from one product into another product as well.

We continue qualification of these diodes for example. We started March production so this in June, we produce in large quantities the diode to start to deploy in our product. And QCW finally we in June of this quarter, we upgrade pretty dramatically before we stocked with basic model of 1.5 kilowatts now with new module much more (inaudible) 3 kilowatt power.

Then a multiple combination of such module now has to deliver energy (inaudible) up to 200 joules or it's 20 kilowatt peak power system is absolutely new situation in this market today.

Joe Maxa, Dougherty & Co.

Thank you, you mentioned three key verticals cutting OEMs, auto manufacturers, and consumer electronics applications. I wonder if you can break out how much those areas account for your total revenues?

We had mentioned this. We only for a few months or the future whether few months counts up to $30 million only first quarter. So here we will qualify as the one of the major customers in the world for such applications and so (inaudible) you start to supervise them in the vast quantity up to 1400 per month shipment.

The other side, we don't break that down. We've mentioned that our automotive sales that we can identify range in any given quarter from sort of 10% to 15% of sales and then there is a significant part of sales that go to cutting OEMs and other people who produce welding systems that probably end up in the automotive industry maybe as high as 25% to 30% of sales.

The problem with trying to break this out by end markets more specifically is that we do not have access to that information and could not provide very reliable information about it.

Now (inaudible) talk of automotive companies in main production manufacturing facilities for five of the previous automotive companies (inaudible) with 35 hour user for use in their production while it's in Germany and the US and Japan. Five top automotive companies. Now there's a forward quality, 35 of their official document certifications of documents from these companies.

I also wanted to follow up on the advanced application orders you mentioned. So would that suggest we should be seeing an uptick in the gross margin like we saw in Q1?

So it benefited a little bit but not dramatically. As a percentage of sales, it will be relatively small. Some of those will ship in Q3 and some of them will ship in Q4. But the point I think you are making is that the gross margin on those products because of the relatively high selling price given our unique advantage with those products is a bit higher. It won't be a meaningful difference. There may be a little bit of a benefit.

Jim Ricchiuti, Needham & Company.

Good morning. Thank you, Tim, can you say whether the business in Europe excluding Russia was up?

It was -- Germany actually performed relatively well. Germany was up by 4% or 5% year on year. The rest of Europe was up by about 5%, so clearly 10% overall was driven a bit more strongly by Russia, but Europe was -- given all the headwinds and problems there, actually performed relatively well.

Okay and with respect to QCW, I think in the past you've talked about potentially doing as much as $12 million or so of revenue in 2012. Given where you are through the first six months of the year and given the demand you are seeing in the market, do you feel that is still reasonable or is there potentially upside to that?

I would think that's a sort of reasonable number. It's going to depend how much more traction we get in Q3 and Q4. There are a lot of tremendous number of inquiries and people talking about large contracts. It just depends when they materialize, whether they come through in the second half of this year or really drive into next year. But we are talking about high-volume orders with significant dollar value against that. So our expectation is for that product line to become probably after high-power and pulse the third most important product line over time.

The (inaudible) qualification for us at the customer qualification, they have to make change upgrades in system and qualify test procedures and so on. The typical one or two years profits is going before they even start to making volume. We introduce year end (inaudible) growth but the units indicate it is a process -- (inaudible) top customers are going very well and they are very optimistic when they start.

Patrick Newton, Stifel Nicolaus.

Thank you. Good morning, Valentin and Tim. Congratulations on the quarter.

Thank you, Patrick. Good morning.

Tim, I guess on the gross margin front, how should we think about gross margin inventory as we move into the September quarter? I would think we should expect a sequential increase in pulse given that you burned inventory in the June quarter and are now below your long-term days target and likely need to restock. I guess is that a fair assumption?

No, I think we've got a lot more focus on inventory and managing the days, so I don't think we are in a position where we would have to restock. We have actually in terms of finished product built some finished product in China for Q3 supply. They have a little bit of finished product in Japan so we're actually in a pretty good position there.

I would say that gross margin will come towards the top of our range of 53% to 55% given where revenue is forecast to be and it may be a little bit above that with some benefit from the single mode high brightness lasers that we expect to ship. But we're not fundamentally changing the expectation on gross margin. I think it will be another very solid quarter there.

Thank you, that's helpful. I guess on the QCW laser, a two-part question. Do you anticipate another leg down in pricing to drive more unit adoption or should we see relatively stable pricing at current levels as you've reached a competitive cost threshold?

And I guess secondly on the unit side, do you anticipate that the year-over-year growth rate will be sustainable or possibly even accelerate relative to growth year-over-year that you put up in the June quarter?

I think on the unit side, we will see an acceleration on the units. Then on the pricing I'll leave Valentin to answer that question and the question is whether you need to continue to reduce QCW prices or whether they are now at a reasonable level?

Practical is the main way which we are very competitive now that (inaudible) maturation some major user of such lasers. We don't see a need for further a drop of -- essential drop of price. It depends also from geography. For example in Europe or in the US and Japan, our price is extremely competitive now with (inaudible).

In China, still need some (inaudible) but that depends only from (inaudible) point so already now the top user in China also now this will consider to change, their own production of (inaudible) for our lasers.

Jagadish Iyer, Piper Jaffray.

Thanks for taking the question. Two questions, Tim. First, can you talk about the trends that you are seeing in the automotive segment for the second half versus the first half in terms of the various geographies, North America particularly and Europe as well as China because we are hearing mixed bag on the automotive front, so any color on that will be great and I will have a follow-up.

Okay. We start with North America, the transition to lasers both for cutting and welding of high-strength steel is just beginning and is expected to continue. One of our main OEMs believes that this is not just North America but worldwide there are going to be several thousand cutting systems deployed in the near medium term I'd say for cutting high-strength steel. The adoption of high strength steel in North America and Europe is still at a relatively early stage and at a very early change in China for example.

We are seeing transitions to -- for welding of transmissions continuing and then a relatively new development in North America which follows on from some of the developments in Germany is increasing use of aluminum with a couple of manufacturers announcing a greater content of aluminum in vehicles. The fiber laser is very well suited to welding that and we have been recently qualified with a couple of end users, so that should help sales not just over the next three or four months but we are talking here over the next years as the adoption continues.

In Europe, we have had a couple of reasonable orders from the automotive sector coming into the beginning of this quarter. I would say that Europe despite their battle, we are very well qualified with many people. Europe is a little bit slow in automotive and we are making good progress in China again from this is really from the adoption of new technologies there. So we are not seeing a tremendous change in the desire of the automotive manufacturers to alter the new manufacturing techniques that they want to adopt.

And as well, by the way, we started to see purchasing from some of the larger manufacturers there that we highlighted what happened. That started in Q2 and is expected to continue in Q3.

Just on the Russia side, given the backdrop of your outstanding purchase of the minority interest, how should we think about sales to Russia? I know you kind of alluded earlier, how should we think about sales to Russia in the second half versus the first half and is there a secular growth in Russia over the say the next 12 to 24 months?

So Russia in Q3 will have another good quarter like Q2. I don't expect to see spectacular sequential growth and then I think we will drive into a strong Q4, which is always a good quarter in Russia and I would expect to see some growth there.

Over the next two years, we do believe strongly in the sort of secular growth story from modernization of Russian industry and from fiber laser devices and fiber laser systems being much more widely adopted in manufacturing, so the targets that we have for Russia over the next couple of years are pretty high.

Valentin is a bit close to that. Do you want to add anything to Russia?

In Russia, our target to transfer not just supply and not just related to (inaudible) the supply a complete production sales even production lines. We are working very hard in the direction. We have now agreements with mainly 12 Russian manufacturers that were strategic agreements, commodity agreements for developed jointly supervised in production lines.

(inaudible) lot of space for these three yard for the steel companies and so on. First prototype of some system we have fit to customers and now they are very excited to get local domestic supplier, highest quality domestic supply for them. It's first time in Russia they found that supplier.

We have a very good chance, a unique chance in Russia without any competition from domestic other manufacturers practical only the company which we're able to compete with outside suppliers. (inaudible)

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

Good morning, Valentin and Tim. I had the question about your capacity expansion on the diode side. Could you update us a little bit in terms of where you are in terms of the capacity expansion and are you to the point when you are able to see your yields from the plant and see whether it's in line with what you have had thus far and hopefully they'll add to the -- make the cost actually better going forward?

We have the business plan to [care] for our capacity during the couple of years and what can happen the direction now the new facility we are finishing and also the equipment develop so (inaudible) during 1 1/2 years we believe our capacity will be tripled. But even now we have enough capacity to meet any customer market demand.

I think some of these machines are still being qualified, so the multiple wafer, new multiple wafer system is on the verge of being completely qualified. The other way to look at your question is our yields are already very high and there's not a fundamental significant change in manufacturing techniques so we expect to be able to maintain those yields.

Our yield is extremely high so I would say now you get the opportunity to increase the (inaudible) practical (inaudible)

Mark Douglass, Longbow Research.

Talking about Russia and China, what were Russia and China sales in the quarter?

Russian sales were $10.9 million. China was $37.9 million.

So that was significant sequential uptick in China. Was that -- can you talk about how much is related to just end market demand versus new OEMs on board or significant wins with certain customers or is a lot of that driven by electronics customers? Are these new customers for you?

Some of it is the microelectronics but I think we have first of all been pretty clear in articulating that we expected Q2 to be strong and that's on the results of all of the work and investment that we've done in China over the last year strengthening the management and sales teams, improving the distributions that we have qualified new customers.

We have also qualified existing customers with new applications so the cutting business for 2-D has grown significantly compared to a year ago.

In terms of newer applications, very good progress in the microelectronics end market both for very high quality marking as well as for welding applications using our 500 watt medium-power laser. That performed very well in the quarter.

And then development of our macro welding applications with a couple of the OEMs, so it's across the board. I think what we will find is that coming into the end of the year fiber has got pretty significant market share gains in China and particularly IPG's fiber.

Olga Levinson, Barclays Capital.

Thank you for taking my question. I just wanted to touch base on the pulse laser strength that you saw in the quarter. You talked about that being primarily driven by consumer electronics. I was wondering if the consumer electronics seasonality, which would probably mean that equipment orders are strongest in 3Q and then decline into the fourth quarter, does that change the linearity or seasonality of your pulse laser business or do you expect your typical seasonality because of other aspects that play into the pulse business?

I think it's too early to state that but you could see in China it is well known that they invest for example very heavily coming into the Christmas season. We don't know at the moment and we are not providing any information about Q4 because it's too early to do so.

Mark Miller, Noble Financial.

Wondering if you can comment what you are seeing in terms of demand from scientific application customers?

The scientific business is relatively small and stable, no massive growth there. I think the growth and the benefits we have seen in terms of order flow are more on some of the R&D applications using higher power levels, higher power lasers so not necessarily scientific as in R&D and University end markets but people utilizing the lasers. They are trying to develop new applications that are commercially viable, so whether that's in the oil and gas or materials, construction and testing, that's where the R&D focuses on using our lasers.

Last year we forecast for OEM to develop for OEM business. We did not really beneficial to support scientific business but now in new phase, we are getting a return to scientific business and for that we create special separate units which will focus on scientific business. We are now creating such units in Santa Clara.

Thank you.

Jiwon Lee, Sidoti & Company.

Thank you and good morning. Just wanting to kind of hear some updated thoughts about the cash use, first of all.

So I think the thing is that we used $55.4 million to repurchase the minority interest in Russia. That is an accretive transaction for the Company. We are continuing to evaluate acquisition opportunities and the strategy that we have around that is the same as before. It is to either leverage our existing products into new applications or significantly increase their sales and existing applications, so that could be for example high-power lasers used in welding or medium and QCW lasers used in micro welding or micro-cutting.

The other area where we've talked about trying to get some traction into is looking at buying processing applications because we are first of all increasing the power of the green lasers both the pulse and CW. Our UV in Russia now we've increased the power of that and started to improve the reliability so we are going to have a compact, low-cost, very easy to use device at some of the shorter wavelengths. And in the next couple of years, we think that we can increase the sales of those by investing in improved distribution and expertise into that market.

So the basic strategy is to continue to look for opportunities whether synergy comes from leveraging the technology, not necessarily from -- not coming from buying a company and trying to look for cost savings. We really want to leverage product lines and fiber into end markets. That is the intention is to use the cash for smaller scale acquisitions in that area.

The way to get serious here in the near future in defined profits and markets is short power, ultrashort power, [CTUV] and so on and we have in development qualification now many devices for the direction which we believe will make practical these -- a revolution in these applications.

Thank you. 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.

Thank you for listening in on our call. I look forward to reporting to you in our new results through three months. Goodbye.

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