IPG Photonics Corp (IPGP) 2012 Q3 法說會逐字稿

Good morning, and welcome to IPG Photonics' third-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). And as a reminder, please limit yourself to one question and one follow-up. 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.

Think 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, October 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'll now turn the call over to Dr. Valentin Gapontsev.

Thank you, Angelo. Good morning, everyone. For the third quarter of 2012 we achieved record results once again on both the top and bottom lines. Our revenues increased 21% and net income was up 29% from the prior year.

Our growth is attributable to our ability to continue to execute well on our strategy and to displace existing laser technologies across a wide range of applications in material processing and to ensure that we maintain our sales leadership. Our leadership position is strengthening, even as several companies claim that they might have a viable and competing fiber laser solution.

In certain specialty marketing applications, we believe we have gain share against competing fiber and non-fiber laser suppliers. We have been successful in penetrating material processing applications such as cutting, welding, cladding, marking and engraving, by displacing traditional methods. We believe we are close to seeing more widespread adoption of fiber lasers for the high-speed drilling and trepanning of holes in the aerospace industry, an application we have been working on for several months.

To continue our success, we are expanding our current offerings through new products that improve our ability to serve customer needs in the fine processing, as well as unique applications in different industries. We continue to add to the list of applications and systems for which IPG lasers are qualified and designed into.

In addition, we have been selectively pursuing entry into the laser systems business. We do not intend to compete with our existing OEM customers because their focus will be on becoming qualified to develop systems for new and specialized value-added applications in welding, cladding, micro-electronics processing and ablation, or to penetrate the geographic areas not currently well served by existing suppliers of cutting systems.

This is an important strategic plan that we are pursuing and our recent acquisition of JPSA Laser is a step in this direction. Another step we have taken is to accelerate the introduction of integrated macro-fiber laser systems in Russia, a market where we have advantages because of our large operations there and our familiarity with the market and culture.

There we have taken orders for several large systems which will modernize a large automotive facility in Russia. We have signed a recently strategic operation agreement with Gazprom and are preparing similar agreement with some other largest Russian industrial holdings.

We are also leveraging our existing technologies to help customers solve problems and become qualified for new applications. For example, one IPG partner has proven the concept of delivering our fiber laser beam several kilometers into the earth in order to drill oil and gas wells more efficiently and at lower cost. We have found some other applications for ultrahigh-power lasers that have significant commercial potential, also.

We are continuing to build on our product portfolio and we will be launching several new exciting projects during the current fourth quarter. First, we have received an order for a 100-kilowatt fiber laser from a Japanese customer for deep penetration welding and other applications. This would be the highest power industrial laser which has ever built worldwide and it would be delivered in Q1 or beginning Q2, next year.

Last week, in cooperation with Volkswagen at the EuroBLECH show, we introduced the world's first handheld laser welder based on our seam stepper. We believe this unique device could be a further catalyst for welding in automotive and other industries. The EuroBLECH was also noticeable for the dozens of OEMs demonstrating cutting systems using our fiber lasers. It was not a few people now, it is dozens, up to 20 different companies.

We have also recently extended our unique [QCV] family of lasers to higher power end, by introducing a new member with 12, 15 and 18-kilowatt peak power for the aerospace and other industries.

In further development of our green laser line, we have recently received an order for two 100-watt visible-UV green lasers for the semiconductor industry. We are working hard to introduce a new family of low cost, compact and efficient ultraviolet lasers in the coming quarters that will compete successfully with legacy lasers on the market segments.

In particular, we are finishing the qualification and plan to introduce in Q4 of this year a 350-nanometer pulsed laser for marking plastic and other applications. Several others [perhaps] UV laser we plan to launch in the Q1 and Q2 next year.

Also, I am pleased to report that we have introduced new optical switches, scanners, and various laser heads for high-power applications that improve the performance and operation of our KW-class fiber laser, essentially. With that, I'll turn the call over to Tim Mammen, our CFO.

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 provide highlights from our income statement and balance sheet, and close with our guidance.

Third-quarter materials processing sales increased 21% year over year to $137.4 million, accounting for 88% of total sales during the quarter. The materials processing applications that drove much of our growth in the third quarter include marking and engraving, cutting and welding, predominantly for use in automotive, general manufacturing, and heavy industries.

Other applications, which include telecom, advanced and medical, accounted for the remaining 12% of sales. Revenue from these other applications increased 26% year over year to $18.7 million.

Sales of high-power lasers, which accounted for 43% of total revenue, increased 16% year over year to $67.1 million. Our high-power lasers are primarily used for cutting and welding applications. During Q3, we began to see demand from the aerospace market using our lasers for drilling applications. On a smaller scale, we also sell into niche applications that include cladding, annealing and ablation technology. In addition, Q3 benefited from $4.5 million of sales of high-brightness lasers used in advanced applications.

Pulsed lasers sales had another record quarter with sales of $50.4 million, which accounted for 32% of total revenues and increased 51% compared with last year. We benefited from significant demand in the consumer electronics markets during the quarter. Marking in consumer electronics is an application in which we have gained share from other fiber and non-laser suppliers with our introduction of pulsed lasers with higher power and better beam qualities.

While sales in Q4 for this application will be lower because of completion in Q3 of several major projects, we believe that this is an application that will benefit our sales in the longer term as end-user capacity and new product introductions pick up in the future.

From these recently-completed projects, we now have important expertise and credibility in this market with our cost-effective and reliable products. In addition, we have a diverse and cost-effective pulse laser product line that we can manufacture in high volume. We believe we will continue to see these products qualified by new customers and new applications.

Sales of medium-power lasers increased to $11.2 million, or by 11% year over year. Medium-power lasers sales were driven by thin metal cutting and welding in micro-processing. Thin metal cutting applications are likely to continue to be a growth driver for these lasers because our lasers are compact, air-cooled and very efficient.

Sales of low-power lasers were down 7% year over year to $3.8 million. Sales of QCW lasers decreased 9% to $1.8 million compared with last year. Our QCW lasers are primarily used for micro-welding and cutting applications. We continue to work with several OEMs to qualify them for larger-volume shipments and, once qualified with more OEMs, we expect these lasers to become a larger part of our business over the long term.

Sales of other products, which include amplifiers, diode lasers, green lasers, mid-IR lasers, integrated laser systems and some certain components, were $7 million. Service, parts, lease and other revenue, including accessories, totaled $14.6 million.

Now looking at our performance by geography. European sales increased 14% year over year to $54 million. The growth in Europe was mainly driven by strong demand for high-power lasers for automotive and advanced applications, as well as pulsed lasers for marking and engraving in consumer electronics manufacturing. In the automotive area we have made some progress gaining welding business in France, historically a stronghold of a large competitor. However, our strength in Europe was partially offset by a weaker quarter in Russia after a strong second quarter there.

North American sales increased to $34.4 million, or by 57% on a year-over-year basis, primarily driven by strong sales for automotive, welding, cutting for general manufacturing, and consumer electronics.

Asian sales, which include Western Asia and the Middle East, increased to $67.6 million, or by 14% year over year, supported by our recent entry into Turkey as well as solid contributions from China and Japan.

Now, turning to the income statement, total sales for Q3 increased 21% year over year to a quarterly record of $156.4 million. Gross margins were on target at 55% compared with 54.6% in Q3 2011. Gross margin benefited from the sales of specialty high-power lasers, but some of this benefit was offset by higher inventory reserves. Gross margin includes stock-based compensation charges of $563,000 and $419,000 in the third quarters of 2012 and 2011, respectively.

Sales and marketing expenses were $5.8 million, or 3.7% as a percentage of sales, down from 4.4% as a percentage of sales in the year-ago quarter. General and administrative expenses decreased slightly to $10.6 million and were down as a percentage of sales to 6.8% from 8.5% in the year-ago quarter. The decrease is primarily related to lower compensation and legal-related expenses compared with the prior year, partially offset by an increase in accounts receivable reserves.

R&D expenses increased year over year on a real-dollar basis by 19% to $7.8 million. As a percentage of sales, R&D was 5% of total revenues, which was flat with the third quarter of 2011. We continue to make investments in advancing our technology as well as hiring valuable talent. In addition, there was a slight increase in our R&D materials expense during the quarter.

Operating expenses for the third quarter of 2012 include a foreign exchange transaction loss of $1.8 million, or $0.02 per share net of tax. Excluding the foreign exchange loss, total operating expenses increased by 4% to $24.2 million. Operating expenses include stock-based compensation charges of $1,596,000 and $1,460,000 in the third quarters of 2012 and 2011, respectively.

Third-quarter operating income was $60 million, or 38.4% of sales compared with $49.2 million, or 38.1% of sales in the third quarter of last year. Operating margin, excluding the foreign exchange transaction loss, was 39.5% of sales. Net income attributable to IPG for the third quarter increased 29% to $42.4 million. On a diluted per-share basis, we reported $0.81 for the quarter compared with $0.66 a year ago.

We estimate that if exchange rates had been the same as one year ago, sales in Q3 2012 would have been $9.2 million higher; gross profit would have been $5.9 million higher; and operating expenses would have been $1.8 million higher.

Now turning to the balance sheet. Our balance sheet remains strong. At the end of the third quarter, cash and cash equivalents, including short-term investments, had increased by $17.2 million to $372.6 million. At September 30, 2012, inventory was $135.1 million, an increase of 18% from the year end 2011 amount of $116.9 million. Our current level of inventory on hand amounts to 175.1 days compared with our target range of less than 180 days.

If foreign currency exchange rates were at the same level at the end of the third quarter as they were on December 31, 2011, the translated value of inventory would have been $136.5 million. At the end of the third quarter, $7.2 million of the increase in inventory relates to amounts purchased from JPSA and includes $1.8 million of purchase accounting value attributable to that inventory. Excluding this and the effects of exchange rates, our inventory increased by $5.4 million compared to June 30, 2012.

Accounts Receivable were $110.6 million at the end of the third quarter, or 64 days sales outstanding, compared with $75.8 million at December 31, 2011, or 56 days sales outstanding. This is primarily due to the timing of shipments in the quarter and cash receipts against bank notes which secure some sales in China. A significant amount was collected against maturing bank notes during the first few weeks of the quarter, reducing days sales outstanding.

Cash generated from operations during the quarter was $38 million, part of which was used to fund our acquisition of JPSA Laser. You should note that operating cash flow in the fourth quarter will be reduced by cash payments for corporation taxes in Germany. These payments relate to taxes for 2011 that will become due when we file our 2011 German tax return and interim tax payments for 2012, which will increase when we submit last year's return. In Q4 we expect cash payments for corporation tax in Germany to be more than $30 million as compared to $7.4 million for the year to date.

Capital expenditures for the quarter totaled $16 million, bringing us to approximately $52 million year to date. We are expecting to end the year at the higher end of our CapEx target range of between $55 million and $60 million.

During the quarter we opened a new manufacturing facility in Germany to expand our capacity for tooling and high-power assembly. In Russia we opened a new machine shop as well as a new demonstration center. These are the first of several new buildings on our campus that will ultimately add significant capacity to our manufacturing and research capabilities, totaling approximately 380,000 square feet of new space.

The machine shop allows us to decrease costs and duplication by doing our own metal work with better assembly facilities. We will begin to take occupancy of other buildings on the Russian campus later this year and next year. Here in the US, we opened a building for the manufacture of fiber-laser systems and to assemble printed circuit boards in house. Our new PCB capability allows us to control the times and lower costs on this important component.

And now for our expectations for the upcoming quarter. We expect to report year-over-year growth in the fourth quarter as we continue to capitalize on the fundamentals that are driving our business. At the same time, we will face some challenges in the fourth quarter, including seasonality in China, lowers sales of products for consumer electronics and macroeconomic headwinds in Europe and China with the potential to spread to our business in the US.

IPG Photonics currently expects Q4 revenues in the range of $140 million to $150 million. The Company anticipates Q4 earnings per diluted share in the range of $0.65 to $0.75. The midpoint of this guidance represents growth in revenue and net income of 18% and 17%, year over year, respectively.

The EPS guidance is based on 52,102,000 diluted common shares, which includes 51,090,000 basic common shares outstanding and 1,012,000 potentially dilutive options at September 30, 2012. The basic common shares outstanding include the 3,250,000 common shares issued as a result of the follow-on offering in Q1 2012. This guidance is subject to the risk we outlined in our reports with the SEC and assumes that exchange rates remain at present levels. I want to reiterate that we do not attempt to forecast gains or losses related to exchange rates.

Looking further ahead, we maintain a positive outlook. The benefits of fiber laser technology are clear. They provide greater productivity; the ability to work on a wide for IT of materials; a smaller footprint; and more efficient electrical consumption. Fiber lasers will continue to displace incumbent technologies and we are adding OEM customers as we become qualified for more applications. This gives us confidence that IPG will continue to deliver profitable growth for the long term, despite current political and economic uncertainties and macroeconomic challenges.

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

(Operator Instructions). Zach Larkin, Stephens.

Congratulations on another great quarter. First off, I just wondered if you could talk about any specific or what you thought were the most significant design wins that you had in the quarter. Valentin talked about a lot of different new product introductions. And I'm just wondering which ones you guys view as the most significant as we're looking forward.

I think one of the more significant ones is the continued development of the aerospace drilling application, which we think will be a growth driver next year. The second one is continued development of QCW customer relationships. The indications from several end users are that they will ramp significantly demand in 2013. And then some of the semiconductor applications at shorter wavelengths next year.

I disagree with Tim. Number one is for -- go towards the highest expectation, the [CUV] in ways of which we will now -- we will start to introduce in market. We did not particularly participate in this market initially to our [Russian house] and in ways of which (inaudible) to introduce much later, we hope will change situations there for Q3 and Q4, because big demand for current legacy lasers do not meet the customer requirements. All ways that we will meet all requirements of the large quantity of customers.

[QCV], number two, because QCV we developed to introduce two years ago and now with the fate of the test from different supplies qualification, going very well. So next year would be a real mass introduction for OEMs, many OEMs.

Thank you very much for that color. And then, as you look at guidance, I wondered if you could comment a little bit how much of the sequential declined is driven mainly off of -- if you can quantify the consumer impact, and then also give us a sense for the margin profiles that are assumed in the varying ranges of the guidance.

Some of it is the consumer electronics. I'd say more of it is the seasonality in China. This is the second year that we've experienced this. And as the China business has got bigger, this seasonality has changed, where historically we used to have a stronger Q4 and a weaker Q1.

In terms of the margins, at the top end of the range my gross margins are at around 54% or slightly higher and operating margins at 38%. And at the bottom of the range, they are slightly lower than that.

I think, if people are looking at their models for next year, this impact of the seasonality for Q4 should be taken into account to a greater degree. But also, what is clear is that Q2 and Q3 actually benefit a little bit from stronger growth than we've historically had. So, I think those are the key takeaways from this at the moment.

Also, some imports we have -- you got some with very serious orders which we plan to ship into Q4 custom house to ship delivery to the beginning of next year, just to their program. This is also -- to create some (inaudible) with our guidance.

Patrick Newton, Stifel Nicolaus.

Thanks, Tim and Valentin, for taking my questions. Pertaining to the margin outlook that you just gave, Tim, is that more an impact of you moving into the systems level business? Or is it the lack of having some of this high brightness in the quarter? Because it seems like a pretty significant step down on a sequential basis. So, if you could help us flush out what's driving that gross and operating margin outlook.

Well, I don't think it's that significant a step down. I think part of it is, obviously, slightly lower sales of the high brightness but with lower revenue activity, you have slightly lower absorption of fixed costs. That is the primary driver. It's not really an impact of the systems business. And I really don't think it's a significant decrease in margin profile given a slightly lower revenue number.

I guess that's fair. And then, Tim, to dive into the revenue guidance expectation, you are clearly alluding to the pulsed laser business taking a breather in 4Q. But can you walk us through what your expectations are for the high-power business? And the reason I ask is, it seems like over the last six years you've averaged more than a 30% sequential growth rate in 4Q for your high-power fiber laser business.

Even last year, we had a very challenged macro environment and tough trends in China, you were still able to grow that business nearly 12% sequentially. So can you walk us through how we should think about that high power business in Q4?

We don't give specific guidance around that. The high power business will not be as weak as the pulse business in the fourth quarter. You'll have some sales -- lower sales of the higher brightness which will impact the high power. We just don't go into that kind of granularity around that, I think. It will be a reasonable quarter on high power but a weaker quarter on pulsed.

As Valentin mentioned, there's actually a series of orders due for delivery in Japan, including the 100-kilowatt laser, which is actually going to be in Q1. We were hoping to get that out in Q4.

There is another significant order that is coming, Japan as well, for over 50 kilowatts of different types of lasers. That will be in Q1, so we're missing a little bit of that seasonality on high-power in the fourth quarter, too.

And now we see a very essential orders for a system in Russia but, unfortunately, we did not have enough space to make this in quarter four in spite of customer asked us to ship in quarter four. But now we -- when we [operate] the new facility ready for [behavior] in a few weeks and we will start already serious help manufacturing capacity and so on, we will -- this order Q1 and Q2.

Joe Maxa, Dougherty & Company.

Could you just elaborate a little more and where you're seeing the macro weakness and specifically by geography? Any area more than the other?

(Multiple speakers) the seasonality in China. That is not as bad as it was last year when it was also a combination of macro, but the China revenues will be down in Q4. Europe is clearly not that strong at the moment, either. That's been pretty well articulated, I think, by everybody in the industry.

North America is actually continuing to track along quite reasonably. Order flow, even through October, has been pretty nice in North America. And even in Russia we're expecting a stronger Q4 then we had in Q3.

Japan, I'd say a little bit of weakness in third quarter orders with some delays in orders into October, but then Japanese orders have been good in the first few weeks of this quarter. But the issue there is that a lot of the deliveries in Japan are being requested for Q1, not in Q4 this year.

Places like Korea are pretty normal; there's nothing unusual to report there. And Turkey continues to track strongly. So, it's China and really Europe that are the weaker areas right now.

Okay. And I know you're not giving outlook for next year yet, Q1 tends to be flattish with Q4, last couple of years, for example. You have a few orders pushed to Q1, is that a reasonable expectation?

Well, we've had orders, I don't know whether you could call them pushed, they been requested to be delivered in the first quarter, particularly in Japan. I don't really understand your question, Joe.

I was just wondering if we should be looking at Q1 being roughly in line with Q4.

It's way too early to talk about Q1. We don't give guidance for Q1 on our Q3 conference call.

Jiwon Lee, Sidoti.

Just, first off, wanted to ask about your near- to mid-term strategies, especially with the JPSA. You highlighted some opportunities in Russia with the Gazprom. Outside of that, how do you see that business trending in terms of the revenue and margin profile? Thank you.

JPSA, not only revised their product portfolio and application we introduced there, but we are doing some additional with these other applications. So maybe next year the contribution of JPSA would be very essential. They have to double or triple their business compared to this year.

But not only JPSA, because we have created during the last couple of years, we have very powerful system team also in Russia and here in Oxford. So, in total now, during a very short time we created for systems manufacturing and development, we create team more than 80 high-quality professionals including JPSA, Russia, again and US Oxford.

We are now negotiating and here we're creating many very [enriched] products for systems, especially in Russia but not only in Russia. Also in America now that we start to sell [attempts] of system for American customers. So, we hope next year our business -- system business will grow very fast.

Great. And my follow-up question is, given the order trends that you saw in the third quarter and so far in the fourth quarter, how comfortable are you about your fourth-quarter revenue guidance?

The methodology I've used on the fourth quarter is exactly the same as the methodology I've used historically. So, at the top end of the range we have about 75% of orders in hand. And at the bottom of the range, about 80%. So that's a very similar proportion to the one I've used historically.

But this methodology works very well typically but for the first quarter situation. Often it's very different, because at the end of the year a lot of people stop -- have not -- still have money like to get, spend it exactly where it wants delivered in quarter four.

So, we can expect it will (inaudible) have a good chance to expect additional orders to compare what Tim calculated revenue based on usual methodology. But we could not put into the forecasts that -- and not conform with it.

Krish Sankar, Bank of America Merrill Lynch.

I had a few of them. Tim, so you highlighted about the seasonality you're seeing in China. I'm curious, are there any other geographies where you see seasonality? Or is China the only one where you typically see seasonality?

In the fourth quarter, China is normally the only one where we've seen seasonality these last two years. I think you have some macro headwinds in Europe this year as well. The other seasonality you see is, generally in the first quarter, it is a very slow start in Russia. We've always highlighted that one.

The first four to five weeks of Q1 can also be -- continue to be weak in China until you get through Chinese New Year. And then things pick up very quickly. And then, as budgets get firmed up, you tend to see order flow pick up in North America by about the end -- the middle of February through March.

So, historically, the weaker quarters we've had are Q1 and Q4 has been stronger. But now, as the Chinese business has grown to be a lot larger, this seasonality is the second year that we've really seen this. I think 2010 is a little bit of an anomaly because we're coming off a very weak 2009 and there was the very strong recovery that the whole laser industry experienced.

I think if you look at some of the other laser companies, our seasonality is beginning to mirror theirs more closely, particularly with Q4.

Got it. Okay, that's helpful. And then, what was sales to China and Russia in Q3?

China was about $34 million; Russia was about $9.5 million.

Jagadish Iyer, Piper Jaffray.

Two questions, Tim. First, can you just give us an update on where you are in terms of your cost reduction of your laser diodes, by -- now that it's -- by the end of the year? And what do you think you can project for next year? And then I have a follow up, please.

I think we continue to make very good progress. We've actually achieved all of the cost reductions that we had discussed at the beginning of the year. That is now starting to flow through into the bills of material on a fuller basis. So, for example, the new PLD-40, the new PLD-120 for the QCW.

In certain instances, the cost per watt is down at $2 or less. On some of the -- the CW for the PLD-40, it's below $2.50. So, all of those targets have already been achieved in terms of the product. And then as we use older inventory and transition more fully to using the newer diode, that will start to flow through more fully during -- starting in Q3, and more fully in Q4 and then into Q1.

But how should we think about, on a year-over-year basis, like this time next year? Is there some kind of color that you can give in terms of -- what kind of cost reduction targets you have in mind for the laser diodes?

Not at this point in time. I think we've just made a huge step going from over -- I talked about last September we were at over $3.50 a watt, and now we're down at $2. That's a pretty significant step. I don't think we're ready to articulate going down to $1.25 or $1.50 quite yet. I think we have to get this fully implemented first.

I will say that there are other areas, but I ought to mention we just brought on-stream the PC board manufacturing. There will be costs that are reduced on that. Some of the other accessories and components, the switches; the cost starts to come down there.

We are working very hard to decrease costs on the growth for the (inaudible) improve performance. Many critical components, not only diodes; we're working also on PCB, as Tim mentioned. That will give us additional -- to make the savings per year like $5 million to $7 million.

We now are starting to make own power supplies for high power and now the [talks] additional $6 million to $10 million savings before we use. Up to now we use from our outsourced power supplies, the quality and performance and surprised what one -- to hit our new expectation and how we will develop own much better and cheaper.

We also develop new generation of the output accessories, optical for high power. But again, much, much cheaper than before. As we starting to sell our own optical sales for cutting, drill, welding and other applications; also very big savings. So in total, our savings program we hold next year will net us additional savings up to $20 million to $50 million on minimum, is my expectation.

Regarding diodes, we now -- up to now we practically did not sell diodes separately, in spite of a lot of requests. The main reason was, we did not have enough for our demand, of own demand for diodes. We worked higher than we produced, in spite of how we increased dramatically the manufacturing of that.

But no, we did not have enough space for packaging. Now we finishing new facilities here in Oxford for packaging. Is new facility, 60,000 square feet. Then we can double in our assembly team. If so, we can open door for [JF] sales for diodes to our other customers. Also can sell, give us additional essential revenue.

Thanks for the color -- just one --

Volume also -- depends on volume. With more power we will produce more diodes (inaudible) for each, for what goes over -- down farther. This year, we'll make over -- about 18 megawatts of optical power. The next year we can make 30% more.

Just on a follow-up, just two parts on this one. First on the China, I don't know whether you have given enough clarity on this one, Tim. Which subsegment is weaker in Q4? Is it the consumer side or is it the auto side? Can you give us some color, please?

I think it is generally across the board. Part of it is consumer. You also see some of the cutting customers, they reduced a little bit of their inventory coming into the end of the year. Their total take is also down, so it's, in general, across the board.

Our automotive business, by the way, in China, is only just starting to really gain a significant amount of traction. We won a couple of orders in Q3 and we've also identified tens of millions of dollars of potential business next year that we expect to be a strong growth driver in China. And we're at a much earlier stage of identifying that and working with the end customer. So, our general manager and vice president in Asia is extremely optimistic that we'll actually build significantly on the automotive business in China next year.

So, automotive has not yet been a real strong growth driver for us in China. It's been a reasonable one, but there's a lot of new opportunities that we are at an early stage of identifying, that gives us actually a great degree of optimism for that next year.

During the last months we have many meetings with our top Chinese customers. They all -- they have problems this last quarter in certain fourth quarter this year. They still have much inventory. But they are very optimistic about next year, all of them.

Mark Miller, Noble Financial Capital Markets.

Just wanted to pursue a little more about China. Rofin-Sinar indicated they had seen, in July, some weakness from machine tool customers. You are saying it is kind of across the board. I was just wondering if machine tool was impacting you also.

All of our customers -- the laser is used in basically machine tool applications, whether it's cutting or welding or drilling, across a fairly wide variety of industries. I'm not sure I get the specificity of the question, Mark.

Okay, well, let's -- the other question I want was about linearity of orders. I believe August is typically weaker for you and I was just wondering how linear orders were or how normal the order pattern was last quarter.

August, September in here, it was not good months. But October going very well. We are in good hopes November, December also will go very well.

(Operator Instructions). Jim Ricchiuti, Needham & Company.

I was wondering if you could help us with the pulsed laser business. What portion of that now is consumer electronics related? And how much is that up for you, year over year?

Well, from the point -- we have very much order during the last three months with order delivery from [Apple] family. It is very much whether it was ordered and delivered and now we have finished the delivery and so when they're waiting, they promised us the new orders in the beginning of next year which will -- over about 3000 lasers was delivered only during the last three months of such application.

It's probably about 25% of the total pulsed business for the year, Jim.

But it is now -- we introduced -- we have introduced new laser, not typical pulsed labor for market. This new laser, immediate call a special request of this [Apple]. And they start to only start it first. We can watch orders for this much more perfect. We've thought about very high-quality lasers. Now, the orders, this family of new pulsed lasers, we only starting it will be -- be accepted different, new -- much more perfect pulsed laser, which don't have any competition yet in the market.

Tom Hayes, Thompson Research Group.

I was just wondering, we've talked about it on previous calls, the strength that you've seen in the automotive sector. We touched briefly on it, what you're seeing in China, but I just -- more globally, if you could talk about what you saw in the third quarter and the expectations for the fourth quarter.

We had actually a strong quarter in automotive, particularly in North America in the third quarter. We really highlighted that that was going to be a growth driver coming into the end of Q2. We took a strong order flow in Q2 and then we said we'd have a big pickup in North America, so that was very good. We've identified, as I mentioned, some of these opportunities in China for next year, but we actually won some smaller orders for the first time in China.

In Europe, we won a couple of orders, I mentioned, in France, which was very important. Even though, again, not so big in size but they are an area where one of our largest competitors has been particularly strong. The rest of the European business we haven't turned in a 100-unit order this year from any of the major customers.

They been deploying smaller units through this year, given some of their headlines that they've had in Europe. The automotive was really strong in North America. It's very pleasing to see that.

But we, until -- I come with you now, we are now going into a new phase when we shipping not just lasers, we are starting to ship full welding systems. We developed a unique welding system which helps so much (inaudible) -- we are able now to mass replacement over the spot welders in the [radio device] assembly in service and so on.

It's first time such a system is developed in both a Class I system, which can work without any (inaudible) and so on, enormous savings. The first we developed this and worked with Volkswagen as Volkswagen qualify [in pool] and start to use current generation of this new welders in their production lines first in parts -- here in Germany, then now in China and Mexico, and so what did all this start.

We developed now doing full time, only during one quarter, second to third generation, much better. Now we will open door for all other customer. We have here combined with four main automotive customer, all they require for immediate deliveries to start to test this system. We believed that here we would -- a very change in this welding application for automotive.

We developed, we introduced at EuroBLECH, for demonstrating manual systems because our robotic system, which we use only for Volkswagen production lines which produced more than 1000 cars per day. But the most production line for by had much weight to it, some 100 cars per day. But they don't use practically the robotic welders, they use manual. Before, manual ways of welding did not exist at all. Now with the welding demonstrated and qualified a manual laser welder. But this, our consultant from automotive (inaudible) it would be a huge demand for such system. Our first reaction at first exhibition, EuroBLECH, all automotive companies will visit us, all the required for tests, all very tight.

Avinash Kant, D.A. Davidson.

So expanding a little bit on the automotive opportunity, I don't know if you gave the overall revenue percentage from automotive in the current quarter. And what I was more interested in finding out is Japan -- how are you doing on the automotive side in Japan? And when do you think the adoption date is going to kick in or start to ramp?

We are -- Japan is -- all of the automotive companies in Japan use our lasers but in limited quantity. The biggest of them now report us, that for many years qualification, they make final decisions start with IPG lasers. Before, they tried to use a Japanese-made legacy lasers. But now they have principle decisions, start with IPG lasers. I received a message, I could not mention the names, but the top Japanese companies. And we start to get from them first -- orders start to run from Japanese [hedge] companies.

Total next year will be double, triple, maybe even much more, and later we will ship to Japanese automotive.

Mark Douglass, Longbow Research.

First question is, how much of Q4 do you have baked in for Sercel on the top line and bottom line?

It's still a pretty small contribution in the fourth quarter. Their run rate is about $2 million to $3 million a quarter. It will depend upon -- at the top end of that range, there is a couple of systems that will have to be shipped in December; at the bottom end, there's a couple less. So $2 million to $3 million top and bottom end of the range. At the bottom end of the range, they still lose a couple of cents; at the top end of the range they just about break even.

Olga Levinzon, Barclays.

Just as a follow up on the JPSA contribution and how we should be thinking about the impact to OpEx going forward, at the current -- if we assume sort of a mid-150s range -- so in line with what you reported for the September quarter, what's the target OpEx range? And within that, you talked about the sale percentage of the overall revenues declining year on year. Can you talk about the drivers there? And now that JPSA is within the mix, how we should think about that going forward?

At the top end of the range, the numbers I gave included JPSA in them. So my gross margin number for the top end of the range is about 54.5% on gross margin, and 38% at OpEx. I think, on G&A, they add about $0.5 million a quarter. And on selling and R&D, it's a little bit less. I'll have to check the specific numbers; they're not particularly material. So the top of the range on the guidance and the gross margin and operating margin are 54.5% and 38% already include JPSA in them.

Is that clear, Olga?

Going forward, especially assuming your business continues to ramp including JPSA, should we be thinking that SG&A should be in the 11% to 12% range as a percentage of your total sales? Or what are the drivers there?

SG&A in this quarter was -- let me check the numbers in total. It's not going to fundamentally change, as revenue continues to increase, because the JPSA numbers are just not that big. So it's 7%, just under 7%, on G&A this quarter. And selling was 4%. So, you're at 11% -- yes, 11% to 12% is perfectly reasonable, if we can continue to see some nice growth in the business overall next year. So there's not going to be any material change in headcount, for example, related to JPSA. They already have a well built-out headcount infrastructure both around R&D and general administrative and also their manufacturing.

We're actually continuing to hold that team together because we believe that pretty quickly we can drive their revenue back up. But we also don't need to add a tremendous amount of headcount to execute on their systems. We may have to add a couple of, for example, salespeople specific to their technology and applications in Asia, who would be based in our offices. But we don't need to guard and hire 50 people to support the JPSA business.

Regarding machine business, our new machine business, we've been saying we don't win JPSA in the main part. The main business we will make with our Russian team, in Russia and other neighbor countries. And all quarter, which we are talking about is very intense project with this year's project now and development there. All of this (inaudible) was based on the gross margin is the same, wherever what we have on sales of lasers. More than 50% is minimum.

And we are able to make heavy in-house all these laser source, all these fiber core parts of systems, motion systems to install, when we're able to make very profitable machine business.

Thank you. And 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. After the questions are done, thank you for participating on our call today. We look forward to reporting our Q4 results next year. I hope they will be successful.

Thank you, everybody.

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