IPG Photonics Corp (IPGP) 2014 Q2 法說會逐字稿

Good morning, and welcome to IPG Photonics second-quarter 2014 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 Senior Vice President and Chief Financial Officer, Tim Mammen. Statements made during the course of this conference call that discuss management 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, 2013 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 or by contacting the Company directly. You may also find copies on the SEC's website.

Any forward-looking statements made on this call are the Company's expectations and predictions only as of today, July 29, 2014. The Company assumes no obligation to publicly release any update or profession to any such statements. We will post these prepared remarks on our website following the completion of the call.

I'll now turn the call over to Dr. Gapontsev.

Thank you. Good morning, everyone. It is a pleasure for us to report today that IPG's second-quarter 2014 results demonstrate continued strong fiber laser adoption. This result (inaudible) above or at our guidance range for revenue and earnings per share, respectively. We continue to penetrate existing applications and materials (inaudible) and are now starting to gain increasing acceptance of fiber laser technologies for new applications.

Key financial highlights from the quarter include were 14% revenue growth primarily due to 18% growth in material processing applications offset by the declines in other applications. (inaudible) 17 basis point year-over-year increase in gross margins to 54.02%. That 16% growth on the bottom line demonstrating some leverage in our operating model.

Our book to bill in the quarter was also much greater than one. Coming off a strong quarter, this bodes well as we entered the second half of 2014. We continued to penetrate and increase sales in metal cutting, welding, coagulant (inaudible), and cleaning applications. Also saw growth in 3-D printing, glass cutting, glass welding, and microprocessing.

These are positive trends. This should translate into near- and long-term growth opportunities for IPG. We were pleased to achieve this result, based mostly upon our established Ytterbium fiber lasers product lines. Without a meaningful contribution from the new families of green, red, UV, and mid-infrared as well as ultra-short bounced waves.

We expect these new families to be introduced to the market in the coming months, and which should benefit growth in 2015 and 2016. Sales of high-power lasers with more than 500 volts continued to perform well, with unit sales of approximately 1200 units and more than 2.4 megawatts of optical power shipped per reported quarter. This corresponds to a three-year CAGR for kilowatts shipped of shipped power of more than 45%. Moreover, the growth opportunities in the core high-power material processing applications of cutting, welding, and cladding still have a significant runway ahead.

The metal cutting market is growing at a rate 5% to 7% annually, while the market for other material processing -- including welding, cladding, hardening, and cleaning -- is growing much faster. We believe that fiber as a technology is a major catalyst for the faster growth for these other applications and could ultimately increase the size of this market to be comparable and even higher to the cutting market.

As we mentioned in Q1, the electrical efficiency of our high-powered now approaches 42% to 45%, which is two times the efficiency of other fiber and disk lasers now available on the market.

The electrical efficiencies (inaudible) substantially better than the direct diode lasers currently being offered by certain competitors. We do not believe that our -- we are losing any share to direct diode laser. To the contrary, given the improvement in electrical efficiency and development of automotive (inaudible) and applications, we see an opportunity to potentially displace these technologies. In (inaudible) applications, for example, is proof (inaudible).

While the mobile, power-pulse, fiber-laser market is both more mature than our high-powered applications, it also has more competition. Despite this, we are pleased to see that our pulse laser sales increased sequentially due to our new low-cost pulse fiber lasers and meaningful growth in sales of the new families of peak circuit and super high-power pulse fiber lasers, which were recently launched.

These pulse lasers have peak power of up to 1 megawatt and average power up to (inaudible) 5 kilowatts, respectively. They have started to gain traction in cleaning abrasion, deep engraving, and traditional marketing applications. In addition to this, sales of green lasers, while still small, also grew by more than 100% compared to year ago for application in semiconductor, substrate (inaudible), solar, cell edge deletions and inter diamond applications.

We continue to make progress developing these unique technologies and have both increased in availability and peak power, which have been obtained from these technologies.

Of peak power of their -- our UV technology is now more than 100 kilowatts, and average power has reached a record level of 200 volts. We are much closer to launching these products for mass application.

We are finishing to build specialized new production line for these lasers, which is expected to begin operation in Q4. When investing in IPG's worldwide infrastructure and technology to capitalize on these customer demand trends, IPG has a number of significant advantages, including the scale that we have in our manufacturing and the depths of our technology across a wide spectrum of optical components from which the lasers are assembled.

We continue to develop products at new wavelengths, power levels, and pulse durations as well as a variety of laser bait systems that we believe will open up new markets and applications and be incremental to our overall growth. In addition, we are working hard to further reduce the cost of our existing products, which expands the benefits already enjoyed by our customers and further distances us from our competition.

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

Thank you, Valentin, and good morning, everyone. With Valentin having provided the business highlights, I'll get right into the sales drivers for the quarter.

Materials processing sales increased 18% year over year to $185.3 million, accounting for more than 96% of total sales during the quarter. Within materials processing, cutting is our largest application, and we continue to see strong growth in this application due to increased sales with their existing OEM customers and development of new OEM customers.

We also saw growth in welding applications where, for example, fiber displaced CO2 lasers and transmission welding, as well as seeing growth in remote welding and, to a lesser degree, spot welding applications. In addition to these applications, we are experiencing growth in some newer and up-and-coming applications including 3-D printing, ablation in cleaning of different materials, as well as glass cutting, polymer welding, polysilicon wafer annealing, and other processes.

For glass cutting, we're seeing an increasing opportunity in sapphire glass cutting applications, which is being used in a growing number of smart phones.

Another fast-growing materials processing market for IPG is additive manufacturing of metal parts, or 3-D printing. Historically, much of the growth in additive manufacturing has come from plastics. Today, industrial applications using metal are driving demand for fiber lasers to produce complex parts in volume and not just as prototypes.

The increasing complexity and volume of parts that are likely to be made means that metal processing with fiber lasers could ultimately represent a large opportunity. As complexity, size, and volume of part production increases, productivity gains will likely come from either using a greater number of medium-power lasers in tandem or higher power fiber lasers in the kilowatts scale.

Sales for other markets including advanced applications, telecom, and medical, which account for less than 4% of IPG's total revenue, decreased by approximately 34% or by $3.6 million.

Looking at our results by product line, high-power laser sales, which accounted for 54% of total revenue, increased 22% year over year to $104.1 million. High-power laser sales continue to grow as fiber lasers gain further market acceptance within established applications like cutting and welding and also with new applications.

We have been successful thus far in penetrating these new applications that there remains significant opportunity to gain traction with our existing OEMs and end users and with those that have yet to adopt our technologies.

As we've discussed before, we are seeing high-power OEM cutting customers purchase higher-power units from us as they qualify our lasers to cut faster and thicker-gauge metals.

Pulse laser sales decreased 19% year over year to $32.4 million. This was expected due to continued competition for low-power pulse lasers for marketing and engraving applications in China. However, we are encouraged that pulse laser sales increased 12% from the sequential first quarter thanks in part to growing sales of our new generation of low-cost, low-power pulse lasers in China. These new lasers began shipping in Q2.

We are also seeing increased sales of our high average power and high peak power pulse lasers, which are more complex and less harder for low-end manufacturers to compete with. High-power pulse lasers are being used for higher-end applications such as deep engraving of metal, cleaning of molds and tools used in manufacturing, and surface ablation.

Sales of medium-power lasers rose 38% to $21.6 million, or 11% of total revenues, as demand continues to suddenly grow for thin metal cutting and micro welding, particularly in the consumer electronics industry.

QCW laser sales, which are mostly used for glass cutting, turbine blade drilling, and welding applications, increased to $8.1 million, or by 44% year over year, accounting for 4% of total revenues. Sales of low-power lasers were down 13% year over year to $3.1 million, primarily due to softer sales for medical applications.

Sales of other products which include amplifiers, diode lasers, green lasers, mid-IR lasers, integrated laser systems, and certain components, were $6.7 million, up 8% year over year. Service, parts, lease, and other revenue including accessories totaled $16.2 million, an increase of 39% from last year.

Now looking at our Q2 performance by geography. Sales in Asia increased to $101.7 million, or by 12% year over year. Within that region, China sales increased 12% to $65.6 million. The business in China is diverse across a variety of applications including cutting, welding, marking, engraving, glass cutting. And we are making progress in growing our OEM customer base in that region.

In Korea, we are seeing increased demand for high-power and QCW lasers, and we continue to be successful in penetrating the cutting OEMs in Turkey. All of these factors helped to offset the year-over-year decline in pulse laser sales in China.

European sales were up 36% year over year to $64 million. Growth in Europe was primarily due to continued penetration of cutting OEMs for general manufacturing, increased demand for additive manufacturing applications, and automotive sales to a major German automotive manufacturer which had shipped in Q1 but had been deferred pending installation. In Poland, where we recently opened up a sales office, we have seen strong demand from local OEMs, and orders increased by more than 300%.

North American sales were $26.2 million for the quarter and decreased 14% year over year. Overall, order flow from materials processing applications in North America are steady. The year-over-year decline is due to the shipment of some large orders for advanced applications and marking engraving in Q2 2013 that created a more challenging year-over-year comparison in the region. North America saw an increase in demand for welding lasers from the prior quarter.

Now working our way down the income statement. Gross margins were within our target range of 54.2% and demonstrate some leverage in our operating model as higher manufacturing activity improved absorption of manufacturing overhead. We continue to invest in advancing our technology, infrastructure, and management talent. Research and development expenses increased to $13.4 million from $10.5 million year ago. As a percentage of sales, R&D was 7%, which is up from 6.2% in the second quarter of 2013.

Our new product development strategy is focused on more broadly covering the optical spectrum including near and mid infrared, invisible and ultraviolet wavelengths, as well as shorter pulse duration products. We expect these products to provide new alternatives to traditional laser and non-laser solutions.

General and administrative expenses increased at a lower rate to $13.1 million, or 6.8% of total sales, compared with $12.8 million, or 7.6% of sales a year ago. Sales and marketing expenses increased to $8 million, or 4.2% of sales, from $6.8 million, or 4.1% of sales a year ago.

Operating expenses for the second quarter of 2014 were $35.5, including a foreign exchange loss of $0.9 million, compared with $30 million a year ago, which included a foreign exchange gain of $0.1 million.

Second-quarter operating income was $68.7 million, or 35.8% of sales, compared with $59.9 million, or 35.6% of sales in the second quarter of last year. Excluding foreign exchange, operating margins were 36.3% and 35.5% in 2014 and 2013, respectively. Our tax rate in the second quarter was 30%.

Net income attributable to IPG for the second quarter increased by 16% to $48.3 million. On a diluted per-share basis, we reported $0.92 for the second quarter compared with $0.80 a year ago.

Now, turning to the balance sheet. We continue to maintain a strong balance sheet, ending the quarter with cash and cash equivalents of $483.4 million and $14.7 million of debt including lines of credit. At June 30, 2014, inventory was $178.9 million, up from $172.7 million at year end. Our current level of inventory on hand amounts to approximately 185 days, compared with our target range of less than 180 days.

Accounts receivable were $124 million at the end of the second quarter, or 59 days sales outstanding, compared with $103.8 million at year end, or 57 days sales outstanding. Cash provided by operations during the quarter was $33.5 million

Capital expenditures for the quarter totaled $34.3 million, which included the purchase of two buildings in Massachusetts that will be used for research and development as well as manufacturing. We estimate CapEx for 2014 of approximately $70 million, although the final amount will depend upon the timing of expenditures.

And now for our expectations for the upcoming quarter. Entering Q3, we remain focused on generating profitable growth, expanding our business with existing OEMs, finding new OEMs, and finding new applications for our fiber- and laser-based products. We will continue to make strategic investments to enhance our product pipeline and expand our worldwide infrastructure while maintaining gross margins within the target range of 50% to 55%.

Order flow in Q2 was strong. And with a book-to-bill ratio of greater than 1, we anticipate sequential and year-over-year revenue growth to the third quarter. As a result, we currently expect revenues for the third quarter to be in the range of $190 million to $205 million. We anticipate Q3 earnings per diluted share in the range of $0.88 to $1.03. The midpoint of this guidance represents quarterly revenue and EPS growth of approximately 15% and 18%, respectively, year over year.

The EPS guidance is based upon 52,769,000 diluted common shares, which includes 52,068,000 basic common shares outstanding and 701,000 potentially dilutive options at June 30, 2014.

The guidance is subject to the risks 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.

With that, Valetin and I will be happy to take your questions.

(Operator Instructions) Krish Sankar, Bank of America.

I had a couple of them. So Tim, I'm kind of surprised to see such strong growth in both China and Europe considering what's going on there. So can you just give some color on to how you expect those two geographies to trend in the September quarter?

Krish, I don't give guidance by quarter, but I think the performance of the business to date in Asia as a whole, China and Europe, has been pretty exceptional. It continues to be driven by penetrating the core applications, particularly in Europe. Tremendous growth in cutting applications, where CO2 is rapidly losing ground. In China as well, cutting and welding and some of the new applications around glass cutting. The cleaning applications with a higher-power pulse lasers.

I think these were trends that we had highlighted would be growth drivers this year, and we are pleased to see that they have materialized, clearly even a bit stronger than we thought they would do so. I think it validates all the investments that the Company has made and really shows that the acceptance of fiber technology is continuing to strengthen within the marketplace.

Got it. That's very helpful. And then one final question. You spoke about using fiber lasers for cutting sapphire. Can you tell like how big you expect that market to be and how you are displacing the diamond cutters? Or is there something else going on? Thank you.

So in sapphire cutting, you're seeing, for example, the lenses over the cameras transitioning to sapphire; some of the readable on-off buttons. I think the real opportunity on sapphire is very difficult to quantify until some of the end users of some smart phones determine exactly how much sapphire glass they intend to use in future generations of product. And that's not particularly clear at the moment.

It's a growing opportunity. If the transition to greater quantity of glass coverage continues, I think it will continue to be a driving opportunity for the Company. But it's not clear. I don't think anybody has any real clear idea in the market as to how large it could become.

Thanks, Tim.

Mark Douglass, Longbow Research.

Good results. Tim, did any orders pull into the quarter sooner than expected? Just a little more detail as to what was the positive surprise to you versus your expectations going into the quarter.

I think we always (multiple speakers) -- there's a certain amount of orders that book and bill during the quarter. Nothing was pulled into the quarter. Everything was delivered in accordance with customer requirements. I think what really drove the quarter coming out of April and into May and even earlier on in June was just a strengthening of overall order flow in Europe and Asia. You saw strong performance out of China, Korea, and Northern European countries.

So it's just a general improvement in the tone of the business, I would say. There was nothing specific. There was no big order that we pulled in. Clearly, we recognized some revenue on one of the major German automotive manufacturers, but that wasn't 5% revenue; it was less than 2% of revenue.

Okay. And then on cutting sales, in our channel checks, we picked up an acceleration in the adoption of high-powered cutting. Did you see that across the board, just an acceleration in the adoption rate? Or was that more driven by people just moving up the power levels to four and six kilowatts versus two and three maybe a year ago?

No, our major customers are going with higher power. Yes, it's right. Up to 61.8 kilowatts, it's also helped us to increase sales. But quantity of lasers (inaudible) for cutting applications also growing very fast still. You see (inaudible) in units growth up to 40%, it's much higher than in revenue due to some correction with prices in the volume also discount. But in units it's really -- sees the (inaudible) very fast growth. It's the same rate it was two or three years ago, up to more than 40% per year.

Okay.

No, it's still far from saturation.

Okay. And then just finally on the CapEx. $34 million -- I believe you did not change your CapEx expected rate for 2014. There was just a big chunk of it in the quarter. Can you discuss what your -- where you're adding capacity? And I assume some of that is from the UV laser.

Yes, of course. The timing of the CapEx was actually something we called out on the last call, where we are expecting a big outflow in Q2. So you've had quite a lot of investment in facilities, the purchase of two buildings in Marlborough. You've had a significant deposit made on a building in Moscow. And then you have had continued investment, for example, on the UV manufacturing; continued investment on diode production expansion; completion of some systems; manufacturing buildings. So it's across optical components; it's finished product manufacturing; it's some R&D. But the timing of those CapEx with Q2 being very strong on CapEx is something that I had highlighted in the last call. So it's kind of right in line with expectations.

Okay. Thank you.

Joe Maxa, Dougherty & Company.

I wanted to get an update on the seam stepper. You talked last quarter about the number of auto OEMs testing it. I just wanted to see where they're at and what your outlook is.

Everyone continues to evaluate the seam stepper. We continue to roll it out. We did ship a few units during the quarter. I can't remember exactly to. But not only is it automotive. There continues to be evaluation by people, for example, in manufacture of appliances. We mentioned previously there was a company that makes aluminum boats that had bought a seam stepper. It's seen substantial improvement in the quality and the speed of the welding.

Train, high-speed wagons, and so on or many other applications. Very successful testing with the weld. New technology based on seam stepper. For example, automotive -- it's really (inaudible) very future for seam stepper, but it takes time to introduce it to the market. The qualifications and so on.

How long would you anticipate the qualifications take on a product like that?

We expect next year very fast growth sales of seam stepper.

Got it, okay. And then I wanted to ask if you're seeing any effect or impact from the ongoing events in Russia. Maybe give a little color on any impact to your business.

First of all, so maybe just address some of the more specific issues. The sanctions announced so far have not and do not have a material effect on IPG. We clearly are continuing to monitor those sanctions. But from recent press reports, that clearly focused on the financial energy and military sectors which are not the focus of our business.

The other important thing to note is that the supply of optical components, both into and out of Russia, is not yet -- were not yet but not affected by any of these sanctions that's not covered by dual use or any import or export licenses.

No, clearly there were some concerns that the sanctions are creating a weakening of the Russian economy in general. That is a thing we're monitoring and a concern of ours, particularly availability of liquidity. I think the issue though is that Russian sales are still less than 5% of our total revenue.

So I think what we look at is here, the growth in the systems business would clearly be potential upside to expectations. But it's -- yes, we are monitoring all of that as much as anybody else is, and there continues to be some geopolitical risk around that.

The main concern from our business, aside from growing Russian business, would be a severe weakening of the Russian economy.

But take in mind that more than 75% of Russian business is export to other -- so German, American companies now with our fast-growing export directly to Russian customers -- to Chinese customers. So share of sales directly in Russia is not much enough. And in any case, we remain but maybe some in part but very small in part because the most business of Russian company is export.

Great. Thank you. That's very helpful.

Patrick Newton --

No sign from Russian authorities that you can make some contract sanction, which can impact our business. No signs, no intention as we know.

Patrick Newton, Stifel.

Congratulations on the quarter. I guess the first one is on additive manufacturing and glass sapphire cutting. You talked about this several times in your prepared remarks and thus far in the Q&A. Although not really perhaps the size of market given a lot of the changes on sapphire, can you at least help us understand the contribution of revenue from each product line at this point?

Yes. In general terms, I'll talk about that, Patrick. Glass cutting grew by more than 100%. It's still less than 2% of revenue. And on the additive manufacturing, again, that grew by more than 100%. It's probably around 2.5% of revenue or something like that.

So I think we targeted last year focusing on additive manufacturing and seeing that business double. We are on target to see that happen. And the drivers there are increased volume, size, and complexity of parts that I drew attention to.

My view on this market is that if you get to 1000 systems sold for additive manufacturing, the laser source could grow to $70 million or $80 million. And at the moment the total number of systems sold in additive manufacturing for metals is probably somewhere -- if we look at the total number of lasers we sell, it is probably less than 200. And even 1000 systems is relatively small if additive metal manufacturing really takes hold in volume processes within industrial applications.

For both these applications, cutting or glass cutting and for additive manufacturing, we have two kinds of business. First, we sell fast-growing sales of laser for other people for integrators who use our lasers in both these applications.

Second, we develop own technology for cutting and this additive manufacturing, own technologies with machine who will support our technology. And if we are not successful, the director will start to sell such machine to other customers. For example, cutting machines, they were open site what test -- tested one that was a key customer in this and very quality and speed would demonstrate much faster than existed in the market machine from other integrators.

In additive manufacturing, also very interesting. The results and hope to in future to sell our own system machine, not only lasers.

Is there any timing on that, Valentin, to potentially enter in that market?

First, machine for this cladding and for the growing some parts, metal parts, we shipping now to customers.

Okay. That's helpful.

And I guess shifting gears, Tim, on the service parts lease and other. You specifically said something about add-ons, and perhaps I missed that in the past. But I wanted to know is there reclassification of revenue in this segment, or are you just calling out add-ons because that's a big part of what allowed that segment to double sequentially?

No, there's no reclassification. I called it out because the accessories were a growth driver of that segment. We will work on breaking out accessories. The accessories include things like the optical hedge that we targeted to bring to the market and had identified as being a potential source of revenue growth, and that has started to happen in the second quarter.

And those are, if I recall, margin accretive.

They are very good margin product, the optical edge.

Okay. And then I guess, given some of the new products entering the market, you have your lower-cost pulse laser that's being adopted that should help your margin mix. Is it possible that we could see gross margin exceed the high end of your 50% to 55% range in Q3 or within the next few quarters for at least a short period of time?

We continue to maintain the range that we've given. I think there are so many puts and takes around gross margin, it's not just driven by absorption. Clearly, if you get some of the UV product into the market, you continue to grow the high-power pulse product. You see some transitions on cutting to higher power levels. Those would benefit gross margins. But you've also got to be cautious about continued pricing pressure within China, for example, at the lower end; potentially increased competition.

So, no, I think we would like to get to the top end of that range. But beyond that, I don't want to give any other indication. We've identified that range as a reasonable range within which the Company should grow on a medium-term basis. And that's how I think I'd like to leave the message.

We can demonstrate more than 60% easily even now. But in the case we have to decrease our investment for future growth because we are looking strategically at what we -- how it situated and what would be our position in income through the next five years. And now we have to invest -- we invest in very hard to create both new products and the technologies and facilities and so on. So we think 50% to 55% (inaudible) gross margin, we all that our income we will have to invest more very aggressively for future.

Avinash Kant, DA Davidson.

I have two quick questions, actually. The first one was on the pulse laser. As you have been introducing your new products in the pulse lasers, on the pulse laser side, in China, do you see better margins than what you had previously on this product?

Yes, we've seen an improvement in margins on those products. Yes.

So overall, you've seen (multiple speakers).

A new product would be much more marginable. With the product which we develop now would finish in qualification and so in production would be much more profitable than products -- low-power products for market convention.

Did it take the overall margins in China better than what it was last year? The same quarter or --

A lot of the pricing pressure, some of it started in Q2. It sort of accelerated Q3, Q4. I'd say we probably recovered a lot of what we'd lost in the second half of last year.

On the longer term, actually, getting back to the services revenues, clearly what kind of opportunity could you see longer-term and how many years from service? Is there a good opportunity that you think as the installed base gets a bit more mature that you could get some meaningful revenues out of services in the fiber laser side?

So the number we gave on servicing included accessories, and we're going to try and breakout accessories coming up in the future. The main growth on that was not services from the accessories on the lasers.

Now, the accessories, we think, have a significant runway of growth. If you're selling 1200 high-power lasers a quarter, transitioning to 5000 high-power devices, just about every single high-power laser either needs a cutting, cladding, welding, some kind of optical head that goes with it. Those optical heads can run in price from -- very basic optical head might be $10,000; a very complex optical head can be tens of thousands of dollars.

So IPG, if we can target getting, say, over time increasing -- half our lasers at least with optical heads, you're talking about 2500 units. If you can transition that to 75% or more of the lasers sold with optical heads and an ASP of $15,000, you can determine a potential revenue stream there that runs to $45 million, $50 million.

This could grow.

(inaudible) it is not a replacement part. Accessory is new additional optics output, optics and so on, which make (inaudible) provide now more complete solution. Not just lasers sort but output optics and so on. Very serious additional business, which we build and now started to mass production. It is for us additional (inaudible). We will add additional launch revenue. It's not replacement parts for service.

This should steadily grow as the installed base grows, right?

As sales of high-power fiber lasers and even QCW lasers for example grow, yes. The sales of those optical accessories will grow.

We install now in Russia very large production line for such optical heads. It would be for expert worldwide -- is not for Russian inside consumption.

Jim Ricchiuti, Needham and Company.

Historically, Q3 has had, in some instances, a heavy component of consumer electronics related revenue to it, which has caused some seasonality in Q4. Can you talk a little bit about how you might anticipate the mix of consumer electronics business in Q3, if it's at all meaningful?

You compare it to last year? So we expect this year, it would be also some decrease in the orders and so on. But our booking in May, June, and July forward is very much better bookings than it was a year ago. So we expect the Q3 minimum and Q4 should be much better and faster grow than it was a year ago. A year ago it was decreased but this year we expect an increase overall.

IN consumer electronics, there is some order flow, particularly in Asia related to consumer electronics. As a percentage of our revenue, if you go back to Q3 2012, that was the really big quarter where there was some significant buildout. It's probably a smaller percentage of revenue.

Nonetheless, given -- it's more the general seasonality in China, Jim, that people should be cognizant of. China revenues generally in Q4 are lower than Q3. And given the relevant size of China to our total revenue, I would still expect seasonality into the fourth quarter.

Got it. And Valentin alluded to the book to bill being much greater than 1. I'm wondering if you could provide a little bit of color on the bookings, book to bill by region. Was there much variability in the order trends by region geographically?

No, I think the order trends generally sort of mirrored the results of the Company. So you had very, very good order flow out of Europe. You saw this very significant pickup, for example, in Poland, which had been relatively small. Turkey continues to hold up nicely through Q2, and then you saw good order flow in China and Korea. Japan, we'd expected it to be a bit weaker, it was a bit weaker. And in the US, the materials processing business is reasonable.

But we actually got a 50-kilowatt laser order for some advanced applications and another 60-kilowatt laser order for some of the oil and gas applications. So we saw some of those ultra-high power orders that we thought would come through come through in North America. The general trends, though, mirrored sort of the results of the Company in terms of revenue.

We expect also in the Q3, Q4 good advanced applications products in the US. So US, we hope (inaudible) signed and our customer promised us very serious improvement in. From other side, we expect also in Q4 would be very good in Russia for (inaudible) system shipment. If we are correct about the orders for this -- correct in our (inaudible) orders for this.

And if I get one final question in. I wonder if you could tell us what is the sweet spot right now in the additive metals, additive manufacturing part of the business in terms of the laser power that you're seeing.

It depends on which customer you are talking about. So you're seeing some of the customers definitely moving towards kilowatt scale. They're probably like at one kilowatt. But there are other customers who are using a slightly different solution. So they're combining multiple 300- to 500-watt lasers together. So by doing that, they think they can maintain the quality of the part produced whilst improving the speed.

I'd say where the quality of the part is not a driving factor -- and speed is more important. People are transitioning towards kilowatts. And then we've seen in some instances lasers as high as 5 kilowatts used on very large parts. We are expecting -- sorry, 10 kilowatts, I think, was one of those orders we had last year. Actually, we're hoping to close some additional orders for the ultra-high-power lasers for additive manufacturing.

So I think the answer to the question is it depends on what the end customer is trying to achieve. It's a balance between quality and speed. And depending on which variable they're trying to solve, it depends upon the solution they are trying to use.

A new application would require much more power. So therefore it was exotic for (inaudible) the 50-kilowatt laser now we -- many customer claim for us they were now (inaudible) start to put laser at 50-plus kilowatt power.

Jeremie Capron, CLSA.

Congratulations on those good results. I wanted to ask about pricing trends. And I guess my question is twofold here. On one side, on the high-power side of things, where I understand that your price point is now pretty much comparable to conventional laser technology. And on the other side, on the pulse laser size, if you could comment also what you're seeing in the Chinese market.

You see what principle price of fiber laser now for the same what I believe much cheaper than price of conventional laser. It's not (inaudible) equal; it's much cheaper. The same CO2 laser. We want cutting market not because of better performance fiber laser compared to CO2 but also because price per kilowatt is essentially cheaper than CO2 lasers.

(inaudible) so the combination of these two factors allow us to really, really aggressively to make such a replacement. So pulse lasers are also much cheaper -- fiber pulse laser much cheaper than any kind of solid-state laser. So it depends; it doesn't matter what kind of pulse laser. So this factor is one of the most important ingredient the market needs.

And we're working very hard to decrease costs of our laser, so saving we decrease some power pricing. Price saving, gross margin saving of this profitability.

Even for the Chinese market, it doesn't mean that we serve low-cost Internet when our Chinese competitors have very low margin. Then our margin remains the same frame as before. Just we more cheap labor, low-cost budget laser. It's not for accounts or less margin. For accounts, with it decrease our manufacturing costs.

Okay.

But our revenue -- but doesn't impact our profitability.

Okay, understood. And then could you give us an update on your M&A pipeline? You called out some potential opportunities earlier in the year. I'm wondering if there's some progress there. And if we could see some uses of this cash pile that's sitting on the balance sheet at this point maybe later in the year?

Yes, I don't think anyone gets very specific on what their M&A pipeline is that we continue to evaluate many different opportunities. The key strategy is not to focus on necessarily a financially-based transaction. We build scale. It's very definitely to look for transactions that can leverage the technology into new end markets or accelerate the adoption of lasers into end markets either by acquiring application know-how, customer relationships.

And then on the other side of it, to a limited degree, backfilling any gaps we think we may have on either the optical components, supply chain, or the vertical integration.

I think the challenges around any acquisition are you've got to find something that achieves those objectives. We often look at companies that have good elements of those characteristics and technologies and benefits, but we also find that they may have other parts of the business that are less desirable.

So it's a pretty fragmented industry. The technologies can be very different -- difficult or different. So we're cautious about what we are doing, but there certainly is a pipeline of things we're looking at. And they range in size from pretty small to large opportunities as well.

Okay. And then the final one from me. Inventories, I think you said inventory days were running around 185. So, we've seen quite a few quarters of inventories essentially trending above your target of 180 days. Could you explain to us what is preventing you from lowering inventory from here?

We continue to hold -- first of all, the entire supply chain is internal to the Company. Secondly, you are seeing I think what I would characterize as a pleasing level of revenue growth from the Company. We continue to improve the processes around inventory. So I think it's important to note that inventories are only up 4% whilst revenue is up 14% this year.

There's been significant gains made in planning and production. We continue, though, to hold inventory because we believe that it is a very important competitive advantage we have in being able to respond very quickly to customer demand with short lead times.

I think, though, I'm pleased to see revenue growth outpacing inventory growth. And in general, total working capital growth I calculate is only about 8% this year on 14% revenue growth. So I think the balance sheet is being managed appropriately. But there are different strategic considerations that come into play around all of these different matters.

But I'd like to intervene again that one of our very powerful weapons against the competition that we have very short lead times. Typical other people three to six months; we have only 4 to 6 weeks. If customer needs very complicated with special customized solution, if they need we can supply even during two weeks only. For this, we need to hold more inventory but provide us a big advantage to compare to our competition.

Mark Miller, Noble Financial.

Congratulations on your quarter. I was just wondering if you could give us a little more color on the UV fiber laser in terms of ramp plans, size of the market opportunity, and how you're going to compete there as an established competitor in that space.

The main problem with the UV fiber laser, not to get some technical (inaudible) and so on, energy per part is a major problem to provide a reasonable lifetime. Because crystal, it's for UV, say, degrades typical very fast.

But the point, it -- but it depends requirement for lifetime depends from application. Our (inaudible) were one (inaudible) very interesting application where people don't need very high -- of course, they need, but they can except with some moderate lifetime. We're making very intensive test. We have very good results but still need to improve crystal such processing and such. So crystal and so on. As other people, not only we that they all UV manufacturers have the same problem.

And we have very good reach, very good results, for example. The 200-volt average power for 355, it is still record data. Nobody reached at this time as we know such numbers. It's this application with such power we can offer a lot of new opportunities, extremely valuable and interesting opportunity.

And we introduced market touch. Nowadays, our product is ready for test by customers. We're starting to provide for test this. So it's going very well. We've also opened now a building facility and start to grow own crystals and have improved quality such crystal for major UV application. And so it's helped us to control quality and so on. So we invest in such products (inaudible) such a way.

Now, by the crystals are you referring to the frequency doubler, or is this something else?

For frequency, yes, for frequency doubling, tripling and the forth harmonics also, yes, for different applications. We will have very good results with green frequency doubling. With green, it's very good to have the ability, very high power, record power. So it's now the more and more very interesting applications.

Then with the (inaudible) also frequency doubling lasers, very high-quality power, direct power, and gem quality.

For UV, it's more difficult from the point lifetime still less, but our test will go on many thousand hours still successful. And acquisition also, which we bought a small company in California, helped us a little with technology of assembly of such optical heads. So then we're going very well in this direction also.

But crystal here for conversion, it's the key issue -- components.

Jake Thompson, [OD].

A couple of questions, really, just on really the driver of your growth in high-powered lasers. Can you just give me some color on your market share versus CO2 and how the market for high-power lasers is sort of displacement versus replacement?

So if you look at the high-power lasers, broadly, can be broken down into three categories, the largest of which is cutting applications. By some estimates, that's $1.1 billion market including the cutting head and potentially also including the chiller from the people I've spoken to put that analysis together. So we use an ASP of about $170,000 that would translate into 6.5 thousand units. We think that has clearly grown over the last two to three years. The estimate previously was that annual volume of cutting systems was about 4,500 to 5,000 units.

And on the basis of that fiber penetration, if you include one of our competitors who's selling and another smaller competitor, is probably 35% to 45% share. So still a significant runway ahead there. The dynamics we've shown in that our cost is no longer or the selling price of fiber is no longer a prohibitive factor in driving consumption.

The increasing need to cut thicker materials and faster materials is driving higher-power lasers to be sold into that market. So we talked about when did this tipping point happen. It actually started to happen probably with some of the major European manufacturers over a year ago; last year Q2, Q3. Some of that growth got a little bit masked given some of the weaknesses in the other business. We continue to see that traction develop over that period of time, and certainly this year it hasn't slowed down much.

So one geography where I think they still lag behind on adoption, which presents an opportunity over the next two to three years, is Japan, where they still use a lot of CO2 lasers because they can buy those CO2 lasers locally from suppliers. We're dealing with many of the OEMs there; are starting to see some increase in purchases. But I'd say the cutting market in Japan has lagged a little bit behind where we've seen it develop in China and Europe.

The other markets are really the welding and cladding and cleaning markets. Welding is the older part of the other high-power market. The welding side is estimated to be about a $320 million market. Fiber is estimated to have about a 50% share there. But fiber is very, very well suited to displacing all other technologies on welding.

We also think that the welding, cladding, and cleaning applications, as we mentioned on the call, have an opportunity to grow at a much faster rate than cutting because it's a less developed market in terms of penetrating and displacing other non-laser applications. For example, like resistance spot welding or arc-based welding or even chemical processes for cleaning explosive technologies for cladding.

So as Valentin mentioned -- and we talk about here multi-year trends. So we're not talking about the next couple of years. But if you wanted to look for a sort of 10-year trend that we might highlight, it's those other high-power applications we believe can become equal to and potentially larger than the cutting market. So it would mean that the growth rate there would be fairly significant.

And then you are seeing growth outside of pure CW high-power. The higher-energy lasers that we are increasingly introducing to the market, as Valentin mentioned, also addressed, for example, some of the ablative processes and deeper engraving products.

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

Thanks for your joining us this morning. We look forward for speaking with you on next quarter's call.

Thank you very much, everyone.

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