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IPG Photonics Corporation (NASDAQ:IPGP)

Q3 2013 Earnings Call

November 1, 2013 10:00 AM ET

Executives

Angelo Lopresti – VP, General Counsel and Secretary

Valentin Gapontsev – Chairman and CEO

Tim Mammen – SVP and CFO

Analysts

Patrick Newton – Stifel

Jagadish Iyer – Piper Jaffray

Krish Sankar – Bank of America Merrill Lynch

Joe Maxa – Dougherty & Company

Jim Ricchiuti – Needham & Company

Avinash Kant – DA Davidson & Company

Tom Haynes – Thompson Research

Mark Douglass – Longbow Research

Mark Miller – Noble Financial Capital Market

Jiwon Lee – Sidoti & Company

Operator

Good morning and welcome to IPG Photonics’ Third Quarter 2013 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.

Angelo Lopresti

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 discusses 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, 2012, 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 copy on the SEC’s website.

Any forward-looking statements made on this call are the company’s expectations or predictions only as of today, November 1, 2013. 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.

I’ll turn the call over to Dr. Valentin Gapontsev.

Valentin Gapontsev

Good morning, everyone. As we have published it today in third quarter IPG reached record high revenue of $172.2 million or 10% more than $156.4 million a year ago. The year-over-year growth rate [indiscernible] than usual for IPG however we have to remind you the year ago primary result was improved essentially by watch one time order in advanced application field. Sales for advanced applications in the recent quarter were lower related last year due to lighter government spending in several countries year-to-date. Further, we experienced weak telecom medical demand in Q3 of this year. Due to peak sales in our traditional material processing segment which represent today 95% of our revenue it grew by approximately 19%. Additionally, we have to note the year-ago quarter was benefited from very much single time pulsed laser sales for consumer electronics giant. Due to this order our sales in high power fiber lasers increased by 42% year-over-year.

So once again our results demonstrate IPG’s strong fiber laser technology leadership position and ability to capitalize from growing demand for several key material process and application. As these numbers show we continue to make good progress in penetrating industrial end market particularly cutting, welding, cladding, cold drilling, marking and engraving.

In additional smaller and fewer market such as additive manufacturing and ceramic cutting have starting to contribute more meaningfully into growth. Fiber lasers continue to gain sales and increasing number of OEMs deploy them more widely in their system to displace existing laser and non-laser technology. A positive trend for IPG is a shift towards using higher power fiber laser for several applications including cutting and adhesive manufacturing. So this is driven by the need to process larger parts plastic and metals and mark different material with higher energy. Not only are the selling prices of these units higher but this trend also benefit us from a competitive standpoint because it is more difficult for others to manufacture reliable and high performance high-power laser.

Laser with high power of up to 60 kilowatt have been using in cutting application widely now and up to 10 kilowatt for additive manufacturing as customer need, customer need higher power to fabricate larger parts at faster speeds. Another example of this trend is increasing customer interest in super high power lasers for multiple [indiscernible] awards for non-laser application such as construction, illumination, oil and gas exploration and even ice breaking for shipping and art.

With the opportunities for processing new material such cutting tough wires, glass and other reach uses in the growing number of multiples, in addition QCW lasers continued to gain traction over variety of application. I am pleased to report the QCW sale grew our 200% from last year. After receiving safety certification for our Laser Seam Stepper and Seam Stepper family we are now selling this system worldwide for both automotive and non-automotive applications. The feedback from customers for the Stepper is extremely positive and we are optimistic for this product.

Year-to-date R&D spending is up by 39%, as IPG expands development of new products such UV, ultra flat fiber laser, hybrid mid-infrared laser and many other which can open new market for us and present additional large opportunity for IPG. We also continue to investment to reduce the cost of and improve fuel efficiency of existing high-power lasers.

We reached very fantastic new results in this direction. Improvement like this will increased our fiber laser in direct diode competition. In addition, we expect the investment we make in developing variety of high power systems for the Russian market to benefit sales in the geographies beginning in quarter four this year. In addition the development of new laser welding, cutting and cladding kits as well as high power scanners is nearing completion and are now undergoing customer tests. As we done with other product complementary to our fiber lasers the new optical delivery system will provide our customer a more complete IPG solution and better performance at a cost effective price.

Over time we are targeting to sales at least majority of our high power lasers with these optical delivery system driving incremental revenue. Operationally we have started to move into modern production and administrative facilities in Russia. And we opened a new sales and service office in Poland because of growing demand there. Further we’re substantial expanding diode capacity in Oxford to keep up with the growing expected sales levels. IPG continues to add experienced sales staff and as we seek higher levels of sales and new application for our products.

As I have explained above we have been busy expanding our capacity to meet increased demand, develop a new product technology and application. We believe these investments are essential for augmenting our [brand] and growing our revenue. While this investment have limited spend in growth, we believe we’re at the peak of our current investment cycle and technical expenditure will start to moderate in 2014. Subsequently we expect investment to be a smaller percentage of revenue in future.

With that I am pleased to turn the call over to Tim, who will provide more color on our financial results.

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 statements and balance sheet, and close with our guidance.

As Valentin mentioned third quarter revenue grew 10% to a record high of $172.2 million from a $156.4 million a year ago. Materials processing sales increased 19% year-over-year, to $164 million accounting for 95% of total sales during the quarter. Our initiatives to expand OEM partnership in high power cutting and welding has been successful and is driving much of our material processing growth. It is worth noting that the strong growth in material processing sales this year was achieved despite a very strong quarter for material processing in Q3, 2012. As Valentin mentioned in the year ago quarter, there was a record for pulsed laser for consumer electronics.

Other applications which include telecom, advanced and medical accounted for the remaining 5% of sales. Revenue from these other applications decreased 56% year-over-year to $8.1 million due to lower sales compared to the year ago quarter for advanced applications, a weaker telecom business in Russia and soft demand in medical. Order for advanced applications can be significant to continue to be uneven from quarter-to-quarter as our customers develop an enhanced application for commercial use.

Sales of high-power lasers which accounted for 56% of total revenue increased 42% year-over-year to $95.8 million. We continue to see greater adoption IPG’s high-power fiber lasers for macro processing applications such as cutting, welding and drilling. While automotive and general manufacturing continued to be our strongest industries, we are encouraged by the near term growth potential for additive manufacturing which include laser centering and padding.

Pulsed laser sales decreased 32% year-over-year to $34.4 million due to the tough comparison with Q3, 2012 and accounted for 20% of total revenues. Although sales to the consumer electronics market were not as stronger as they were last year, we believe marking applications pose long- term growth potential for us given the high power and better beam quality of our pulsed lasers. While we do see some increased competition in the Chinese market for lower cost pulsed product from local Chinese vendor, we will shortly introduce a redesign, simpler and less expensive pulsed product for the lower end of that market.

Sales of medium power lasers increased 27% to $14.2 million accounting for 9% of total revenues primarily driven by thin metal cutting and micro welding. We had a record quarter for QCW laser sales which more than tripled to $6.5 million compared with last year and accounted for 4% of total revenues. Our QCW lasers are being used for micro fabrication, to cut and drilling of holes and new applications for glass cutting. We are pleased with the traction that we continue to see for these products. Sales of medium power lasers were down 28% year-over-year to $2.8 million primarily due to the lower sales in medical applications. Sales of other products which include amplifiers, diode lasers, green lasers, medium for red lasers, integrated laser systems in certain component were $8.6 million. Service, parts, lease and other revenues including accessories totaled $9.9 million.

Now looking at our Q3 performance by geography. Asian sales which include to Middle East till Austral Asia increased to $90 million or by 40% year-over-year. Looking just to China sales increased 57% to $56.3 million. We’ve grown our OEM base in China particularly for high power laser, and we will continue to pursue additional OEM partnerships in that region. We are seeing strong interest from the automotive industry in China as well. We also saw solid growth in mid power and QCW lasers in China.

In Western Asia where sales increased by more than a 100% compared to the year ago quarter, we had a strong contribution from Turkish cutting OEMs. European sales were down 15% year-over-year $49.1 million. This was primarily due to lower sales in Germany as a result of lower demand for higher power laser through advanced applications as well as for pulsed laser from marking and engraving in consumer electronics applications. In Russia, the telecom business continuous to be weak as well. As we mentioned, we’ve been working to introduce new products and generate new industrial and telecom customers in Russia, and have added sales capability to support this initiative. Strong contributions both from Italy and Switzerland partially offset the declines in Germany and Russia. North American sales of $32.6 million for the quarter were down 6% year-over-year. A high power in QCW sales performed well in North America during Q3 but the progress it had was offset by the decrease in pulsed laser sales.

Now looking our way down the income statements. Gross margins were 53.9% compared with 55% in Q3 2012. This is within our target range of 50% to 55%. Gross margins did benefit from absorption of labor and overhead manufacturing expenses that were capitalized to inventory but that inventory was not sold during the quarter. We estimate that this benefit increase gross margin by 1.6 percentage point. This benefit though was offset by inventory reserves which totaled $4.2 million or 2.5% of revenue. As Valentin mentioned previously, we continue to invest in advancing our technology, infrastructure and management resources to drive further growth.

As a result, general and administrative expenses increased to $13.2 million and as a percentage of sales were 7.7% compared with 6.8% a year ago.

Research and development expenses increased to $11.5 million from $7.8 million primarily due to the increased headcount and investments in new product development. As the percentage of sales R&D was 6.7% which is up from 5% in the third quarter of 2012, 0.7% of the increase is attributable to acquisitions made in the third quarter of 2012 and the first quarter of 2013.

Operating expenses for the third quarter of 2013 of $33 million include foreign exchange losses of $1.6 million compared with foreign exchange losses of $1.8 million in 2012. Foreign exchange losses reduced earnings per share by $0.02 lesser tax. Third quarter operating income was $59.8 million or 34.7% of sales compared with $60 million or 38.4% of sales in the third quarter of last year. Excluding foreign exchange operating margins were 35.6% and 39.5% in 2013 and 2012 respectively. Our tax rate in the third quarter was 29.5% continue to expect that our rate going forward will be approximately 30%.

Net income attributable to IPG for the third quarter remained relatively flat to $42.3 million and was impacted by the investments that we are making in future growth. On a diluted per share basis we reported $0.81 for the third quarter compared with $0.81 a year ago. We estimate that if exchange rates have been the same as a one year ago in Q3, 2013, sales in gross profit would have been approximately the same and operating expenses would have been $0.1 million lower.

Now turning to the balance sheet. We have a solid balance sheet and ended the quarter with cash and cash equivalents of $398.4 million. At September 30, 2013, inventory was $171.3 million. Our current level of inventory on hand amounts to 190 days compared with our target range of less than 180 days. This is due to several factors including the slowdown of a telecom business, purchase of systems components in Russia for expected sales in the fourth quarter, and a high production levels in components and modules that I mentioned earlier. The foreign exchange rates were the same level at the end of the third quarter of 2013 as they were on September 30, 2012 to translated value of inventory would have been $170.2 million.

Accounts receivable were $120.6 million at the end of the third quarter was 64 days sales outstanding compared with $96.6 million at December 31, 2012 was 60 days sales outstanding. Cash provided by operations during the quarter was approximately $37 million. Capital expenditures and acquisitions for the quarter totaled $14.1 million and were $48.3 million year-to-date. Our expected CapEx for the full year 2013 will be approximately $65 million to $70 million which is lower than we discussed during our last earnings call.

And now for our expectations for the upcoming quarter. Looking ahead, we are optimistic that we can continue to maintain our solid leadership position in the fiber laser market. While we expect full quarter revenue to be seasonally weaker in certain areas and reflected in our guidance, we continue to believe that IPG has significant opportunities for profitable growth which will be driven by existing products and applications and also as we expand our product line which will enable us to address new applications. As I have mentioned, we are making significant investments right now to further our technology, hire great talent, upgrade facilities and add capacity. We are confident that we are executing on the right strategy to drive profitable long-term growth. So looking at Q4, we currently expect revenues in the range of $155 million to $170 million. The company anticipates Q4 earnings per diluted share in the range of $0.68 to $0.82. The midpoint of this guidance represents quarterly revenue and EPS growth of approximately 12% year-over-year. The EPS guidance is based upon 52,367,000 diluted common shares to include 51,495,000 basic common shares outstanding and 872,000 potentially diluted options at September 30, 2013. This guidance is subject to the risks we outlined in our report to the SEC and assumes that exchange rate remain at present levels.

I want to reiterate that we do not attempt to forecast gains and losses related to exchange rate.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Patrick Newton with Stifel. Please proceed with your question.

Patrick Newton – Stifel

Tim, hi, number one, something struck me on your guidance is that you widening your revenue and EPS guidance range for the first time I think in the history since you guys went public. I would love your thoughts on was there a process behind this, whether you see increased volatility in your end markets or what drove the widening of guidance.

Tim Mammen

First of all, it’s the second time we widened guidance since we went public so when the company was significantly smaller we increase our range from I think about $5 million to $10 million, this quarter again the company is got larger so part of that reasoning is the increased scale of the company. But also coming into the end – the year in Q4 a little bit more variability around revenue and certainly seasonality in some areas so we just wanted to be a little bit more cautious on that. The bottom of the range well-adjusted to the total orders in hand is pretty conservative number. So we are confident about the range we have given. But yes we have broadened our range a little bit.

Patrick Newton – Stifel

So sounds like you have more broaden the down side just based on that orders commentary.

Tim Mammen

No comments is whether the downside is broaden versus the upside, when we decided to go with a wider range and the guidance has been generated on a similar basis to that that we use each quarter.

Patrick Newton – Stifel

Okay, great. And some details on expansion of your manufacturing capabilities between Oxford [ph], Germany and Russia. Could you help us understand how much capacity you have actually brought on line perhaps quantify in terms of quarterly revenue. And then you also note in your prepared remarks that net income was flat year-over-year largely from investment activities, and I was wondering if you could quantify the impact force given this investment phases virtually coming to an end.

Tim Mammen

In terms of facilities that we have been constructed because you can’t build half a building, now we could so well and excess of $200 million in quarterly revenue, over time though we will continue to add equipment and ramp up headcount as revenue grow so investment phase that has been entered into over the last 12 to 18 months and will come to conclusion through next year really positioned us very strongly for the next two to three years of revenue growth. I terms of operating expense, a very significant investment in R&D and G&A partly related to acquisition also related to specific headcount, next year we expect operating expenses to increase a slower rate than revenue, we haven’t given any specific guidance around that but I would hope to get some leverage back into the model as we access the investment phase of the company and hopefully positioned our self-returning cash and profitability particularly on some of the R&D with new product introduction. So we have been suffering the cost of that R&D without getting any revenue benefit this year really.

Patrick Newton – Stifel

All right and then just Tim, one more on product commercialization, I guess can you update us on your pipeline for advanced application and just thought process on how that particular product line will there in 2014 and are you still roughly 18 months away from commercialization and I might have missed but any update on the timing of your UV product when enter in the market.

Tim Mammen

On the advanced applications we work with different end customers around the world. There is no clear indication, some of the government applications will reach commercialized position next year, there is some smaller applications that they are going to get there, but there is nothing meaningfully that we have to discuss around that. Only UV, I think that’s question that Valentin should really address because he is much closer on that and I think we are all optimistic the UV product is getting close to introduction.

Valentin Gapontsev

Now we are continue some qualification product in the right step and so we prepare manufacturing facility for next year so that must production penetration different market application, it is a new our product family to ultra-fast [ph] laser, beam laser, , green laser, it’s fantastic to compare with current situations in the market both in performance and price. We believe merit of this product minimum ten times better than all existing product in the market now.

Operator

Thank you. Our next question comes from the line of Jagadish Iyer with Piper Jaffray. Please proceed with your question.

Jagadish Iyer – Piper Jaffray

Yes, thanks for taking my question. Two questions. First question is a two part question. Why did the pulsed laser decline and why were sales in North America down given the fact that orders were still pretty strong. Can you elaborate on that Tim please?

Tim Mammen

Yes, hi, Jagadish. The pulsed laser decline was caused out by for the last – almost the last year I say so, a year ago we had very strong sales of pulsed laser into the consumer electronic applications primarily related to new product introduction.

Valentin Gapontsev

It was one very large order one order in consumer electronics order; it is only but very much first order for during three months we said to deliver some thousand lasers to this customer is what unique situation not repeated every year.

Jagadish Iyer – Piper Jaffray

Okay, on the North American orders being low, despite the –

Tim Mammen

It’s same driver there so –

Valentin Gapontsev

It’s order was not to one integrate, we did not shipped directly to end user, we ship through four different integrator, some of the integrator first in China, other integrator in the U.S. and all these integrate provide for the same application towards the same customer, final manufacture facility was in China

Jagadish Iyer – Piper Jaffray

Just as a follow up, what should be thinking, how should we be thinking about the OpEx now that your investment cycle is over for now? How should we think about OpEx as we look into 2014? Thank you.

Tim Mammen

As I just articulate this well I think the rate of growth of OpEx will be lower than the rate of growth of revenue in 2014. And certainly R&D is not going to go down because we’ve hired talented scientist and PhD people but the rate of growth of that and G&A should be much more moderate and I hope to get some leverage back into the model on the OpEx side, if we get some reasonable revenue growth next year.

Operator

Thank you. Our next question comes from Krish Sankar with Bank of America Merrill Lynch. Please proceed with your question.

Krish Sankar – Bank of America Merrill Lynch

Hi, thanks for taking my question. And I have a couple of them. Number one, Tim, when I look into Q4, can you help us understand which segment of you laser product would be down sequentially, would it be high power in pulsed or you expecting other segments going down to.

Tim Mammen

We don’t really get into giving guidance around specific product line, the main seasonally weaker area is going to be China, and that would be around some of the pulsed and cutting application there, that will be offset by there is some increasing strength in Europe, their order flows for the first three weeks have been pretty reasonable. Increased system sales and, pressure and high power laser sales in Russia and then if you order flow in Japan so particularly high power laser primarily in cutting and welding application has improved, so the seasonality and weakness is really again coming we pulled out pretty frequently relates to China. But we don’t get into specific product line guidance.

Valentin Gapontsev

The most of the quarter would be as you know higher risk in the revenue recognition given we sit in – ready to ship product order for this but some customer usually shipped payment for next year and there can some problem with revenue recognition risk of this.

Krish Sankar – Bank of America Merrill Lynch

All right and then if you look at your pulsed laser business, what percentage of your pulsed laser goes into consumer electronics this year.

Tim Mammen

I didn’t give a specific number on that. There is a wide variety of end market, some of the pulsed laser sales in consumer electronics actually better in Q2; I don’t have a specific percentage on that. We don’t get a lot of huge amount of insight into where the OEMs are putting the product. It’s a more of general trend that we understand unless there is a very large specific order.

Valentin Gapontsev

In consumer electronics it was around – there are only few what you watch customers. And already know where the watch customer and then they making you introduce new product or you know iPod for example that sooner I think is very – by cycling so for each new product they making new production line with new equipment but it’s not regular order as going by cycling, it’s open bottom we are watching for many application for such customers and we expect very watch order sending, but as process [indiscernible] each and so on so it’s not smooth quarter per quarter growth or the cycling to convert bottom all time.

Operator

Thank you. Our next question comes from the line of Joe Maxa with Dougherty & Company. Please proceed with your question.

Joe Maxa – Dougherty & Company

Thank you and good morning. Wondering on the North America, what kind of growth option that you see in North America in the coming year?

Tim Mammen

Continue to see the automotive business I think tracking well, there are lot of different projects around that particularly on welding application, introduction of the same steps to North America and then major growth opportunities around some of the micro processing applications as we get new product introduced. Cutting continues to perform well here with OEMs that are both based in North America as well as have presence here but are based in Europe. And I think that is the main areas of growth in North America.

Joe Maxa – Dougherty & Company

And regarding the auto market, how do you see that longer terms, I mean are those sales have been strong in the U.S. and China? You got the larger OEMs say they are going to undertake their largest manufacturing expansion take the years, so I just want to know how you think about the auto market moving forward?

Tim Mammen

The general trends on automotive a new material that continue to be used in the manufacture of vehicles to reduce weight and improve fuel efficiency. Primary example of that is high strain steel, high strain steel, has to be cut with laser because machine tool dies wear out too rapidly. And that trend continues, our OEMs continue to forecast that 3D cutting will be firmly growth driver for automotive application. On the welding side, it’s important to reiterate that welding applications tend to have been the most specialized application to date. So for example seat back, transmissions, air bag detonators, the use of laser welding in building the main car body is still very, very thinly penetrated and that continuous to be target market for us for example with the C stepper or the introduction of our integrated laser loading system with the scanner, that’s an area where IPG has been a little bit weaker and where we have lost orders to competition. So the greater integrated system we can have on the welding side, we think we can drive some sales out of that. So the general trends on automotive towards new material to product lighter and more fuel efficient cars over the longer term benefit the laser industry as a whole.

Operator

Thank you. Our next question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed with your question.

Jim Ricchiuti – Needham & Company

Hi, thank you. Good morning. The large customers you have been alluding is in the midst of pretty significant launch of refreshed product, you anticipate potentially participating in some pick up and sales of the pulsed laser over the next quarter or two.

Valentin Gapontsev

We are working for some projects and very successful up to now but still process of the rail fund qualification of technology.

Jim Ricchiuti – Needham & Company

Okay and question that you called out additive manufacturing a couple of times. Is that getting to the point where it is closing in on 5% of revenues or is it still below that? And do you see that as potentially a good growth driver with a next year for you?

Tim Mammen

It’s still below 5% of revenues, Jim, it’s certainly up by almost a 100% year-on-year, so the interesting thing there are so to yes it’s definitely a growth driver, secondly I think on the additive manufacturing side, a lot of the historic rate came out of plastics additive manufacturing. The increasing trend now is towards growth in metal, additive manufacturing and the other trends that we think which we think is particularly interesting is a trend towards higher power laser, I mentioned that we have had customer buy laser with up to 10 kilowatt of output power so some of the additive manufacturing applications, the other side of that market is interesting and very nascent though we think will drive growth is cutting and there are high speed cutting technology that we have been working with. For example a major university in the U.K. around will develop systems that will be brought to market in the next year or so. So yes I think the additive manufacturing, I certainly hope to see that get up to more than 5% of revenue and probably put a time frame on it but I think it will be a major application for us.

Valentin Gapontsev

I can say the additive manufacturer now is special for metal, part for metal power dust and the most current now integrated for using system for such application, new IPG laser, in principle we even don’t know how many power customer use for such application because not all only our customer for what application they buy now laser. I think 5% is very conservative estimation of laser with such application.

Jim Ricchiuti – Needham & Company

And if I may just slip on the UV laser, if you continue to make the kind of progress that you are seeing with that, can you give us any sense as to when we might see commercial launch next year and potentially how we might think about this in terms of adding growth to the company.

Valentin Gapontsev

We started to sell some of product to the market for evaluation for testing so nobody buying volume before more test, design system manufacturing system with new laser, so it take process going only year for minimum [indiscernible] market new product so difficult to expect immediate during one quarter-to-quarter would jump and it’s – we hope our product have so many serious advantage that their processor and implementation would be much shorter than a year but in any case it will take one to year north of few months. But you will be to see essential contribution to our revenue.

Operator

Thank you. Our next question comes from the line of Avinash Kant with DA Davidson & Company. Please proceed with your question.

Avinash Kant – DA Davidson & Company

Good morning, Valentin and Tim. So my question is more related to the ASP trends that you are seeing and may be if you could give us some idea about pricing trends both in different segments of the market and also different regions especially Asia.

Tim Mammen

General trends on ASP

Valentin Gapontsev

It’s euro level prices much cheaper than competition in high-power laser but for them it’s difficult to compete with from the point at all. And with [indiscernible] future positive we need to stop competition but now we are in a level and don’t need to go further decrease our price so increasing our project for in high power is essentially for our growth margin for high power is sales growing of that. Regarding the pulsed laser situation, in pulsed laser it is not one two pulsed if you say, it’s different kind of laser with different specification, with a more green pulsed laser, not a second range, situations now is still much strong competition from Chinese customers, Chinese manufacturers for more and very simple major for primary marking business in other people don’t need high performance, for them the most important price. Now Chinese company drop price practically with eyes to compare only one year ago two years ago price in this Chinese market biggest market. So we are ready to meet such challenge and we are prepared with the new balance sheet and more grade, grade better than Chinese but price would be similar and cheaper and so we don’t like to give to Chinese this market segment. For other side, we are developing new family, a very high grade, high end pulsed laser which penetrate now very fast to the market, it replace will grade for OEM customers, consumer customers for example or the customer for many others. This penetration we feel very serious advantage to any competition both in quality and price so we don’t worry about this and we are ready for our future sales the most revenue we will generate with high end laser. But low end we will also don’t like to give to the Chinese manufacturer. All other manufactures, European, American are not able to compete in this market at all.

Operator

Thank you. Our next question comes from the line Tom Haynes with Thompson Research. Please proceed with your question.

Tom Haynes – Thompson Research

Thanks, good morning, gentleman. Tim, you mentioned large sales to Turkey, just wondered may be if you could talk about that – it was that couple sales that were pent up with shipped out previous quarters and that for Turkey

Tim Mammen

No real timing issues around, Turkey in Q2 was also very strong in Turkey where it grew by more than a 100% again; we’ve got three large OEMs on the costing side there. A couple of customer itself pulsed laser to Turkish market and economy has grown fairly dramatically there. They are fairly advanced from manufacturing, both on automotive but even for example there is smaller aerospace industry there. The OEMs in Turkey given their cost basis, supply a lot of product into Eastern Europe, they even sold product down for cutting systems and sort of laser that we deliver down on Africa, South America, so that business is not really timing issue. I think it is growing so strongly that it is not going to grow by 100% next year; you are getting some more moderate growth for Turkey next year and general secular trends rather than accelerating growth.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Mark Douglass with Longbow Research. Please proceed with your question.

Mark Douglass – Longbow Research

Okay, important question then. Tim, can you talk about the growth in China, that the breadth it is lot of due to high-power or I guess now you know the way we look at how much is the high-power growth is – overall high power growth is coming from China.

Tim Mammen

Yeah, China has performed very well on high-power for cutting and welding application this year. Other areas of growth in China though have been on the QCW applications. The mid power applications for micro welding and cutting, the pulsed laser this year in China have been a bit weaker. They are pretty diverse set of end market that we are addressing there. And to look into other side of the equation the high power is not all being driven by China, high-power sales for example, if you exclude the defense business but in Europe have been very strong for cutting applications in North America year-to-date high power laser sales have been strong as well for cutting and welding application. The high power business in Japan has actually picked up a little bit this years both for welding and cutting application too. So year-to-date in Korea high power has been a little bit weaker but they are actually now starting to get some traction there in the high power business in Korea should be stronger in the fourth quarter.

Valentin Gapontsev

I disagree with Tim or carefully correct it. Our sales for pulsed laser in China are not going down in quantity of unit, they increase again and Korea is right its 15% to 20% compare to last year in quantity. Question is pricing, revenue, revenue because price drop very essential so revenue is but units we sell more than a year ago.

Operator

Thank you. Our next question comes from the line of Mark Miller with Noble Financial Capital Market. Please proceed with your question.

Mark Miller – Noble Financial Capital Market

Thank you for taking my question. I am just wondering that as you develop on especially on installed base, what is the outlook in terms of the replacement opportunity and in terms of replacement whether sales from replacement now versus new opportunities and where that might be in two years.

Tim Mammen

It depend which product line you are looking at, Mark. So for example on pulsed lasers there has been a replacement market that exist today for several years in some of the application interesting on pulsed laser, you will find product being replaced even after three to four years. So the cycle time and the quality of delays were improved to the degree that when people install a new production line they are not transferring existing pulsed laser over. So replacement market on high power is probably starting to begin in the first high-power laser in volume or in store by IPG in 2005-2006. So that just starting, I think the more interesting question is to really look at what our penetration into the installed base of cutting systems as that fiber penetration, in the installed base of cutting systems it has been quoted as being as high 70,000 units I think that includes a lot of lower power level lasers. Our view is the installed base of high-power cutting system is probably about 45,000-55,000 units around the world. The total number of high-power fiber laser sold still is less than 10% so it’s probably more meaningful to look at where we are in the cycle of replacing the installed base of existing CO2 and despite of strong growth we think we are still relatively early in that cycle.

Operator

Thank you. Our next question comes from the line of Jiwon Lee with Sidoti & Company. Please proceed with your question.

Jiwon Lee – Sidoti & Company

Thank you. You highlighted some upcoming strength from the Russian high-power systems. Could you talk a little bit more about what that outlook might be within and outside of Russia?

Valentin Gapontsev

During one year we create very strong team for development and introducing the marking systems and during the time we develop [indiscernible] our sales in quantity now, we started sales for such system now in quarter four now we see very much order, very much multi million order per quarter proceed that system the one of the Russian customer is only just start next year. We expect good win many customer base prepare bed sheet for such order for IPG so next year would be very interesting growth sale of full complete system, for cutting, welding, for additive manufacturing some hole drilling and it’s not one, two system it is full express order, we have taken 14 different full complete system to one customer, 14 different system. Also we might in seven that to sell for micro for machine system here in U.S. We have some unit business, we also sell this year, we expect within $6 million to $8 million only income U.S. our unit. Its customized system, each system has different specification or complete target for different customers. Some customer repeat and serious customer, normal customer repeat after first test and use first test, for minimum three customers that too by some units additionally, so it’s really just – plus soon we are experience serious contribution to our revenue.

Operator

Thank you. Our next question comes from the line of Jeremie Capron with CLSA Americas. Please proceed with your question.

Jeremie Capron - CLSA Americas

Good morning and thanks for taking my question. On the competitive environment you talked about the situation for pulsed lasers in China but what about higher power among your conventional laser competitors, is there any company that you see is a potentially becoming more of a threat?

Tim Mammen

We haven’t really seen anybody make significant progress against IPG and there has been lot of product announcement based upon our initial reading and some of the published results by public I mean they trying to get into this market, they really haven’t made any meaningful progress on the high power level in the last year or so. Particularly, even one and two kilowatt, but now as you see that the end market trend a little bit more towards as we mentioned cutting systems going to 6 kilowatts, welding applications to the higher power level, those high-power lasers are even more difficult for people to build. So their ability to compete both technically and on prices is limited.

Valentin Gapontsev

You can compare for example this year we expect a minimum 1,000, we will be able to sell high-power laser more than last year, this year minimum 1,000 total would be above 3,000 laser with compare or rather people reporting, it is not comparable, a tall number 43% growth only during one year, 43% growth.

Operator

Thank you. Our next question comes from the line of Patrick Newton with Stifel. Please proceed with your question.

Patrick Newton – Stifel

Yes, thank you, just two quick follow ups for you, Tim. One is, why would the inventory reserves is so big in the September quarter? And would it repeat in December? And two is, should we expect that gross margins will be up sequentially in to December quarter?

Tim Mammen

We’ve mentioned some of the areas that we’ve had business tracking a little bit slower on, so we took pretty hard look at some of the telecom inventory, we don’t give guidance about inventory reserves specifically so no commentary about Q4. And then on gross margin at the bottom end of our guidance range, given the lower absorption that you would expect, I used about 51.5% gross margin of the top end of the range assuming about 54% and gross margin we’ve highlighted that we target gross margin to be in the 50% -55%, we are not trying to chase them up to 56%-57%, we believe it’s much more important to continue to grow the business as a whole and increase in installed base.

Operator

Thank you. At this time, we have reached at the end of our Q&A session. I would now like to turn the conference back over to Dr. Valentin Gapontsev for any closing or additional remark.

Valentin Gapontsev

Thank you for joining us. We look forward to speaking with you next quarter.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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