IPG Photonics' CEO Discusses Q3 2011 Results - Earnings Call Transcript

Nov. 1.11 | About: IPG Photonics (IPGP)

IPG Photonics Corporation (NASDAQ:IPGP)

Q3 2011 Earnings Call

November 1, 2011 10:00 AM ET

Executives

Angelo Lopresti – VP and General Counsel

Valentin Gapontsev – Chairman and CEO

Tim Mammen – VP and CFO

Analysts

Tom Hayes – Piper Jaffray

Olga Levinson – Barclays Capital

Paul Thomas – Bank of America Merrill Lynch

Mark Douglass – Longbow Research

Avinash Kant – D.A. Davidson and Company

Ajit Pai – Stifel, Nicolaus

Joe Maxa – Dougherty & Company

Mark Miller – Noble Capital

Jiwon Lee – Sidoti & Company

Jim Ricchiuti – Needham & Company

Joseph Gartner – Emilton Associates

Operator

Good morning and welcome to IPG Photonics Third Quarter 2011 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 Vice President and Chief Financial officer, Tim Mammen.

Statements made during the course of this conference call that discuss Management's or the Company’s intentions, expectations or prediction 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 includes those details in IPG Photonics Form 10-K for the year ended December 31, 2010 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 @investor.ipgphotnocis.com/sec.cfm or by contacting the Company directly. You may also find copies on the SEC's website at www.sec.gov.

Any forward looking statements made on this call are the Company's expectations or predictions only as of today, November 1, 2011. The company assumes no obligation to publicly release any updates or revisions to any such statements. We will post these prepared remarks on our website following the completion of the call. Please go to www.ipgphotonics.com and select Investors to review these remarks.

I will now turn the call over to Dr. Valentin Gapontsev.

Valentin Gapontsev

Thank you. Good morning, everyone. We are pleased to report that IPG delivered another quarter for the record books. Our third quarter revenues grew by 62% year-over-year to $129.1 million. Also our EPS came in at an all-time high of $0.66.

Demand for high power lasers for material processes and applications primarily drove the sales increase and we demonstrated trends across nearly all geographies and applications. Marking, cutting and welding applications continue to be the most popular application for our fiber-lasers and are primarily being use within the general manufacturing and automotive industries.

As we enter the final quarter of 2011 it is safe to say that more and more customers across the world recognizes IPG’s fiber-laser technology can reduce their cost and improves their efficiency in product manufacturing.

The tipping point has been reached in key applications and it is quite evident that we have a clear role ahead to capture and increase in share of the laser market. Of course, we’re planning to continue to leverage our technology to develop new products and processes that delivers superior benefits for our customers. Recently, we have introduced or about to introduce several new products. This includes 2 kilowatt laser specially designed for welding in dry environments.

Ultra compact lasers without good power up to 1 kilowatt and 20 and 30 watts green lasers. We believe this high power will improve the adoption of the green fiber-lasers. In addition, we have obtained excellent result processing plastics, cardboard and paper using our Thulium laser, which will enable us to continue [ph] directly with the laser process in these types of materials.

We were very pleased (inaudible) the Michigan jury in our five year litigation with IMRA America decided that IPG's fiber-lasers and amplifiers do not infringe IMRA's 630 [ph] which concern single mode amplifiers based on multi-mode active fibers.

I am proud of our team and our lawyers for their dedication and hard work that they put into proving our non-infringement. IPG has in fact in viewing the future aggressively defend against intellectual property claims, as well as protect our growing the state of lasers [ph].

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

Tim Mammen

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

Materials processing which accounted for approximately 89% of total sales increased 69% year-over-year and 6% from the sequential second quarter to $114.3 million. Cutting and welding sales for the automotive industry were particularly strong, as well as marking and engraving applications for microelectronics manufacturing.

We estimate that IPG will have between 20% and 25% of the lasers source cutting market, doubling from one year ago. Sales for the telecommunications market increased 41% year-over-year and 25% sequentially to $7.4 million. The Long-Haul broadband access and cable TV markets continue to drive telecom sales.

Medical sales were up 74% year-over-year and 25% sequentially to $2.4 million. Our OEM customer base is growing, however, it does take time for OEMs in this end market to obtain regulatory approvals and generate significant orders.

Advanced application sales were down 12% year-over-year and 20% sequentially to $5 million. As we had anticipated government funding for research and development is softer in 2011 than in 2010. The timing and amount of funding available can caused advance application revenue to vary from period to period.

As Valentin mentioned, sales of high-power lasers, which continue to be our leading product line increased to 131% year-over-year and 5% sequentially to $58 million. High-power lasers are largely being used for cutting and welding applications and we’re seeing increasingly strong demand from auto manufacturers and Tier 1 suppliers particularly in Germany, Japan, China and the U.S. These customers appreciate the beam quality and flexibility of our fiber-laser, which create meaningful gains in productivity.

Sales of our Laser Seam Stepper system which is a welding system that combines our fiber-laser with the welding apparatus continues to perform well. In Q3 we sold an additional seven systems to a major German automaker and other customers have ordered this system as well. In addition to the Laser Seam Stepper sales, we completed the delivery and installation of a $2.6 million pipeline welding system in Russia.

Other laser systems sold in 2011 were for applications like welding locomotive engines, medical device manufacturing and battery welding which shows that we are having some success building this part of our business.

Sales of medium power lasers increased to $10.1 million or by 95% year-over-year and 20% sequentially. Sales of these lasers were for printing and micro welding and was strong during the third quarter. We’ve also seen a pickup in sales in China for medium power lasers used for thin sheet and foil cutting in the manufacturer of a variety of trim and decorations.

Pulsed laser sales increased to $33.4 million, an increase of 10% year-over-year but were down 4% on a sequential basis. Marking applications for microelectronics continue to help drive sales of our pulsed laser during the quarter, as well as other materials processing applications. The sequential decline is the result of some softness that we’re seeing in China.

Low power laser sales of $4.1 million increased 4% year-over-year but were down 12% sequentially. Low power lasers are primarily used for medical and micro materials processing applications.

Sales of QCW lasers which are used for consumer and micro processing applications were up 249% compared with last year and 11% sequentially. This product was launched in the spring of 2010.

Since that time we have attracted significant interest from a number of OEMs and end users looking to upgrade or replace high power Flash Lamp-pumped YAG Lasers. Among other applications we’re seeing demand for, the QCW lasers are being used for ceramic cutting. Sales of other products, which include amplifiers, diode lasers and certain components, were $10 million and service parts lease and other revenue totaled $8.6 million.

Our geographic performance was strong in all major regions during the third quarter. European sales increased to $54 million or by 63% year-over-year and 14% on a sequential basis. North American sales increased to $21.8 million or by 46% on a year-over-year basis but were down 14% from the sequential second quarter. The sequential decline was primarily due to the timing of shipments.

Asian sales increased to $56.2 million or by 67% year-over-year and 8% sequentially. China had another record quarter with sales growing 144% year-over-year and 4% sequentially. The only regions where we experienced year-over-year declines were in the other Asian markets which include countries like Singapore and Thailand.

Now turning to the income statement. Total sales for Q3 increased 62% year-over-year and 6% sequentially to $129.1 million. Gross margins improved to 54.6% from 50% in Q3, 2010, and remained consistent with Q2, 2011.

Our General and Administrative Expenses increased by 41%, mostly as a result of an increase in compensation expenses due to an increase in bonus accruals and stock compensation and an increase in legal expenses.

The IMRA trial and trial preparation took place in Q3, but wrapped up in early October. We will incur some expenses related to the trail in Q4 and for post-trial work. I want to note however that a formal judgment has not yet been entered and the District Court will need to decide numerous motions that we expect IPG and IMRA to file.

Near term post-trial expenses are uncertain at this time because IPG will have to respond to IMRA’s post-trial motions in any appeal. However based upon what we know today, we anticipate that our legal expenses related to IMRA’s litigation claims will have peaked in Q3 and Q4 of this year.

R&D expenses increased year-over-year on a real dollar basis by 31% to $6.5 million, but were down as a percentage of sales to 5% of total revenues versus 6% for the third quarter of 2010. In total, operating expenses for the third quarter of 2011 excluding foreign exchange gains or losses increased to 34% to $23.2 million.

Third quarter operating income was $49.2 million or 38% of sales compared with $20.5 million or 26% of sales in the third quarter of last year. Operating income includes stock based compensation charges of $1.879 million and $914,000 in the third quarters of 2011 and 2010 respectively.

Stock based compensation increased because of an increase in the fair value of options in restricted stock units issued in 2011 primarily due to an increase in the price of IPG stock. We expect quarterly stock based compensation to be at about the same level in Q4.

Net income attributable to IPG came in as a record high increasing 149% to $32.9 million. On a per diluted share basis, we reported $0.66 in Q3 2011 compared with $0.28 per share a year ago. We estimate that if exchange rates have been the same as one year ago, sales in Q3 2011 would have been $7.3 million lower, gross profit would have been $3.4 million lower and operating expenses would have been $0.9 million lower.

Now turning to the balance sheet. Our cash and cash equivalents increased by $8.4 million sequentially to $196.6 million at the end of the third quarter of 2011. At September 30th, inventory was $117.3 million, up 62% from year end 2010 including the translation effect of foreign exchange.

Our current level of inventory on hand amounts to 182 days and is slightly higher than the top of our target range of less than 180 days. Accounts receivable were $80.4 million at the end of the third quarter or 56 days sales outstanding compared to $55.4 million at December 31, 2010 or 49 days sales outstanding.

Cash generated from operations in the first nine months was $56 million. Capital expenditures for the first nine months for 2011 totaled $34.7 million and are on track for our target of $50 million for the year.

CapEx spending in 2011 is focused on building new fiber facilities, expanding capacity in several high growth regions and enhancing our sales and service infrastructure. Early next year, we’ve planned to add front end diode capacity in the U.S. and to continue expansion of manufacturing in Russia.

That leads us to our expectations going forward. As we enter the final quarter of 2011, we expect that our momentum will continue and we will report strong year-over-year top and bottom line growth.

Looking further ahead, our prospects are equally bright. As Valentin mentioned at the outset, our fiber-lasers are now widely accepted by customers. This provides us with a tremendous competitive advantage for the foreseeable future and the ability to grow revenues and profits for the long term.

Our technology development engine will continue full speed ahead in order to maintain our market leadership. Our key component of our R&D focus will be to move further up the value chain with an increasing amount of lasers systems and we will invest in capacity expansion so that we are able to capitalize on the significant opportunities before us.

With that as background, let me provide you with our guidance for the upcoming quarter. Our guidance takes into consideration, the lack of visibility into and uncertainty around the global economy.

Within that context IPG Photonics expects revenues in the range of $123 million to $135 million. The company anticipates earnings per diluted share in the range of $0.60 to $0.71 that is based on 48,747,000 diluted common shares, which includes 47,483,000 basic common shares outstanding and 1,264,000 potentially dilutive options at September 30, 2011.

This 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 want to attempt to forecast gains and losses related to exchange rates.

And with that, we’ll open the call up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is coming from Tom Hayes from Piper Jaffray. Mr. Hayes, please proceed with your question.

Tom Hayes – Piper Jaffray

Tim, I was just wondering, you did call out some slowing in China related to the pulsed lasers. So I was just wondering is there any specific end market that’s driving that slowing.

Tim Mammen

Just the general manufacturing, their [ph] pulsed lasers in China are used in a variety of marking and engraving applications that include the microelectronics industry for personal devices but also some more basic marking and engraving applications for examples that are decorative items. We haven’t got any specific information on which of those end markets is the weakest, because we don’t deal directly with the customers out of there.

Tom Hayes – Piper Jaffray

Okay. I guess shifting gears a little bit, last quarter in your prepared remarks, you had identified that your goal is to sell 1,000 lasers for cutting this year. Just wondering how you’re progressing on that target?

Tim Mammen

I think we’re doing pretty well. I was actually just looking at these numbers with Dr. Gapontsev last night. I think we're over 800 year-to-date and probably heading for about 1,100 cutting lasers for 2011. So we estimate that anywhere between 20% and 25% of the cutting market is now being serviced by our fiber-lasers and that represents probably a doubling of where we were from a year ago.

Tom Hayes – Piper Jaffray

Okay. I know in the third quarter guidance you had indicated there was about $2 million of legal expenses build into your guidance for last quarter. Can you just give us some more visibility what legal came into this quarter and what’s kind of baked into the fourth quarter numbers?

Tim Mammen

I think legal was a bit higher than the $2 million we had forecasted. I think it was around $2.6 million and we’re probably factoring in just over $1 million still in Q4, but we don’t have a lot of visibility into that. It could be a little bit more than that. I don’t expect it to be less than that.

Tom Hayes – Piper Jaffray

Okay. Just lastly, could give the revenue number for China for the quarter?

Tim Mammen

It was around $30 million. I don’t have the exact number in front of me here. It's about $30 million, $29 million or $30 million.

Operator

Thank you. Our next question is coming from Olga Levinson from Barclays Capital. Ms. Levinson, please proceed with your question.

Olga Levinson – Barclays Capital

I was wondering if you can talk about what sort of gross margin you are embedding within the December quarter guidance and how you think about the trajectory there going forward given your DOI has trended above your target range?

Tim Mammen

For Q4 we’re still in the range of sort of 53.5 to 54.5 in terms of the guidance we've given. DOI is slightly above where it should be. Not all of that increase in inventory is related to absorption. There are some long lead-time items that we’ve also purchased for inventory. So we are focused on looking at inventory and getting it below that 180 day limit but I’m not factoring in any significant impact on gross margins in Q4 in relation to changes in inventory.

There are other ways that we can by the way adjust capacity. For example, you reduce overtime within the company, that reduces the amounts of costs that you have to absorb because you’re paying less in overtime and it reduces production. So you are able to reduce some of the inventory of components that you’re manufacturing.

There are other ways that we can get to that without necessarily impacting gross margin. If you take a very hard look at inventory and suddenly decide you want to reduce it by a very significant amount, that would impact gross margin because you’d reduce absorption but we’re not at that point yet, Olga.

Olga Levinson – Barclays Capital

Got it. And then in terms of the individual sub-segments i.e. high power, medium power and pulsed into the December quarter; are you anticipating similar type of slowdown within medium, low and pulsed and growth in high power or is the mix going to be different?

Tim Mammen

The primary slowdown and weakness in Q4 is on the pulsed side. The medium and high power backlog and forecast for Q4 is still holding up pretty well. Even in China, you’ll notice that in China, some of the weakness in Q3 on pulsed was there but China was actually up sequentially and that’s a reflection of shipments of high-power lasers.

Olga Levinson – Barclays Capital

Got it. And just the final question. What was your book-to-bill for the quarter?

Tim Mammen

It was slightly below one. Again very slight below. We don’t give that specific number. How those offset that I’ll say that the bookings in the quarter were a record and they were up about 8% from Q3. So book-to-bill is slightly below one, but we had a record quarter in total bookings.

Operator

(Operator Instructions). Our next question is coming from Paul Thomas from Bank of America Merrill Lynch. Mr. Thomas, please proceed with your question.

Paul Thomas – Bank of America Merrill Lynch

I guess we talked a little bit about high power and low power. In terms of markets that you have more confidence in, could you talk a little bit about that with respect to 4Q? Does auto still look pretty stable? You talked about pulsed being a little bit weak but are there other markets that you have more visibility into at this point?

Tim Mammen

I think that overall the order flow kind of was a little bit weak coming into the last two or three weeks in September and we got a bit nervous about it. But in the first three weeks of this quarter in the U.S. and Germany, Japan in particular, and even Italy, order flow has been pretty reasonable. Compared to a year ago, it’s actually increased quarter-to-date. It’s up about 8% to 10% in the first three weeks.

So, those key economies, Northern Europe, U.S., Italy where we’ve got a lot of OEMs on cutting and welding applications, still are pretty resilient. We've got a good quarter for Japan forecast in terms of revenue and a reasonable quarter for Russia, which is going to be up significantly year-on-year. So it really is the softness in China around some of the pulsed and probably in Q4 we’ll see some softness on cutting lasers in China.

Paul Thomas – Bank of America Merrill Lynch

Okay. And you talked in the past about cutting and welding, the total market being around may be $1.2 billion to $1.3 billion. How much of that is in China and do you think your market share in those segments in China is about the same and if it is elsewhere, do you think it’s higher or lower?

Tim Mammen

I’m not sure exactly how much of that $1.2 billion to $1.3 billion is in China. It's clearly a growing amount. Our market share in China is similar to the rest of the world and may be a little bit higher. Most of our cutting and welding applications though continue to be in Northern Europe, Italy, places like Turkey, the U.S.

We got a lot of new cutting customers in Japan which we think will help to drive traction in Japan next year. They’re not relieved and coming on stream in Q4 of ‘11. And we will wait and see what plays out in China. There’s not a lot of information on that at the moment.

Paul Thomas – Bank of America Merrill Lynch

Okay. Then may be looking ahead little bit, I know you just gave 4Q guidance. But I guess at this point, is it still reasonable to think 1Q is going to be seasonally down from 4Q?

Tim Mammen

Yeah it nearly always is. I know that there’s a sort of very large advanced application order that's expected in Germany, which should help the first quarter, but Q1 is always soft overall, generally the softest quarter of the year for us.

Operator

Thank you. Our next question is coming from Mark Douglass from Longbow Research. Mr. Douglass, please proceed with your question.

Mark Douglass – Longbow Research

Tim, as we look into automotive, what is the breakdown right now between welding and cutting there? I assume it’s mostly welding. Are we talking like 80:20, anything like that?

Tim Mammen

We don’t have the exact number, because we don’t know where a lot of our cutting OEMs are selling stuff. I would actually think that no; it’s probably 60:40 or even 50:50. A lot of the cutting stuff that we're selling into OEMs we understand is going into the automotive side.

Mark Douglass – Longbow Research

Oh, really, okay.

Tim Mammen

So automotive is not dominated by welding. Welding is a strong application there but it's not that imbalanced as you're mentioning.

Mark Douglass – Longbow Research

Is that body cutting?

Tim Mammen

Yeah, all kinds of materials they're cutting there, both of them, the end user on the tier one parts components.

Mark Douglass – Longbow Research

Okay. And then Japan you're mentioning revenues are doing pretty well there. Again is that a combination of infiltrating their OEMs there and the traction cutting as well as auto, or is it more one than the other?

Tim Mammen

Japan is really continued to be driven, the fourth quarter by a lot of welding and automotive applications for welding application both for automotive and general industrial. The real traction on the cutting has only just started. We expected it to be a good driver of growth next year in Japan.

Mark Douglass – Longbow Research

Okay. So you're still early in the game with them there?

Tim Mammen

Yeah. The other thing Japan, we've actually had a lot of orders for recently which go into the beginning of next year and the end of this year is the marking and engraving business with our main OEM. They’ve given us a lot of orders in the last couple of weeks.

Mark Douglass – Longbow Research

Okay. And finally a lot of excess cash with the trial now out of the way, again, congratulations on that; are you thinking about buybacks, maybe in the dividend? How are you thinking about your cash? It seems like you have more than enough for your CapEx needs?

Tim Mammen

We’re not thinking about at this point in time starting to return stuff to shareholder through buybacks or dividends. I think that they may look like a lot of cash, but really the balance sheet, we’ve done a lot of work to transform it over the last 18 to 24 months. 24 months ago we had a lot less cash.

So I think we're still a good 18 months away from deciding if we have surplus to be returned to shareholders. I think the next 12 to 18 months will see us looking at some smaller to medium size technology acquisitions and add-ons and that may use some of the cash we’ve got there, particularly where we think we can get a very significant return on that capital.

Operator

Thank you. Our next question is coming from Avinash Kant from D.A. Davidson and Company. Please proceed with your question.

Avinash Kant – D.A. Davidson and Company

Question on automotive business. In terms of where you are as far as the penetration is concerned, where do you think you are and how far can you go especially in the welding and cutting market for automotive applications?

Tim Mammen

I think we’re still relatively early in the welding. You still haven’t seen anybody for a good seven or eight years fully outfits a factory for welding with lasers. The last time that happened was back in 2002 and 2003 and not totally successfully.

I’ve mentioned that we had got I think seven orders for the Seam Stepper that was shipped in the third quarter. So that’s starting to gain some traction. But really in order to penetrate welding fully you’ll see in a quarter maybe several hundred lasers going into welding. We are ways off from getting to that point in time. On the cutting side, I don’t know how far fiber is penetrated there. It’s just very difficult to get detailed information on it.

Avinash Kant – D.A. Davidson and Company

But would you say it’s still very early?

Tim Mammen

We believe the adoption of fiber continues to be relatively early across a lot of applications. I mean we’re saying, we’ve got between 20% and 25% of the cutting market. That stills gives us a very significant runway for growth in cutting whether it be automotive or otherwise, just to get to 50% of that.

Avinash Kant – D.A. Davidson and Company

And in terms of competition, are you starting to see more people and in which markets, at this point?

Tim Mammen

We’re not really seeing anybody on the competitive front at the high power level despite numerous claims made by just about everybody in the laser industry. I haven’t heard of us lose a high power laser order to a kilowatt fiber-laser competitor yet.

Avinash Kant – D.A. Davidson and Company

Okay and quick question on the pricing. Where do you stand competitively to the gas laser pricing out there at this point?

Tim Mammen

We’re absolutely comparable. I’ve read a couple of articles recently that have been put out that state there is really no difference in pricing between CO2 and fiber. So people can start to realize the cost benefits from fiber almost immediately.

Avinash Kant – D.A. Davidson and Company

Okay. And I may…

Valentin Gapontsev

Our price is now per kilowatt power for fiber cheaper than gas laser price.

Avinash Kant – D.A. Davidson and Company

Okay. And Tim, I may have missed a few numbers. The European sales number and the other, what was the number, Europe and other?

Tim Mammen

Avinash, I have to go back into the script. You can call me afterwards. I'll give you those numbers.

Operator

Thank you. Our next question is coming from Ajit Pai from Stifel, Nicolaus. Mr. Pai, please proceed with your question.

Ajit Pai – Stifel, Nicolaus

A couple of quick questions and then one housekeeping question. The first one is you talked about adding front end capacity for diodes. Is this capacity going to be any different from the traditional capacity as it's more vertically integrated than historically been?

Tim Mammen

No, it’s basically very similar. But the advantage is on some of the new equipment we’re buying is for example, the MBE reactor got a greater number of wafers that we can grow. So we’re actually adding a lot of wafer capacity very cost effectively. There is no fundamental change in the technology that I’m aware of is that, that's true.

Valentin Gapontsev

Our own concerns for diode growing very positive. That year we produced total optical power of diode power of above 4.5 megawatt. This year it would be more than 13 megawatt of optical power. It’s still not enough for our sales. So we need to double this capacity to produce next year with more than 25 megawatt of optical power. Only for IPG consumption, not for sell diode separately in the market.

Ajit Pai – Stifel, Nicolaus

Right. And about five years ago, you talked about potentially selling you’re diodes in the merchant market, but right now as Valentin just mentioned the focus is primarily for captive consumption, has anything changed in terms you’re considering selling your diodes in the merchant market or is the focus now?

Valentin Gapontsev

It started to sell more but the sales small in other market there, the total demand except for IPG is small enough but with that the sale but our own need for diode increased much process then we even projected. So we did not have any opportunity to sell to other people with top ten (inaudible) sales because it wasn’t enough diode for our sales.

Ajit Pai – Stifel, Nicolaus

Got it. And then just looking at the September quarter, you had a book-to-bill slightly below one, but Tim, seasonally isn't the September quarter your softest book-to-bill when you look back over the past 10 years.

Tim Mammen

I know that July and August can be week, surprisingly this year July and August were very strong and then we had a strong couple of weeks in September at the beginning and then the end of September was weak normally the end of September is a pretty strong period, so that's what gave us a little bit of – but overall Q3 was pretty good actually it was a record quarter in bookings. I think it was actually up about 8% sequentially from Q2, so it wasn't bad. It was just a little bit volatile at the end.

Ajit Pai – Stifel, Nicolaus

And going into October, I mean – in November right now is October particularly weaker just to what business is like compared to 3Q.

Tim Mammen

At the beginning of October has actually being very reasonable in terms of water flow. I mentioned there is some stuff that have come in even for Q1 compared to a year ago, the current data that I have is actually for the first three weeks. Orders were up about 8% on a year ago. So it was a pretty reasonable start. I mean for Q4 to be a staler quarter you want to see orders up 20% plus, but it's good to see that they're actually up year-over-year rather than down in the first three weeks.

Ajit Pai – Stifel, Nicolaus

Got it. And then advance applications – I think few years ago there were some pretty high power lasers do, the U.S. Navy and then after that you still had some applications and some dialogue over there and be on the defense side, could you give us some indication as to whether that’s business that’s given what’s happening with budgets et cetera, whether that something that is still a material opportunity for IPG or its not?

Tim Mammen

Relatively small opportunity in the near term, I know there is a – for example 10 kilowatt single mode in the U.S. that which is negotiating a sale of its actually an upgrade of a 5 kilowatt single mode, there are some actually interesting things in Europe happening with some of the single mode lasers, we believe we are just about to get a very significant order in Q1 for several 10 kilowatt single modes, so it’s not that material, it’s still every uneven, I think it’s still several years away from really understand whether this technology is going to viable and cost effective as a defensive mechanism.

Ajit Pai – Stifel, Nicolaus

And then the house keeping question, could you just give us a breakdown of the stock based comp how it goes on the various line items?

Tim Mammen

We normally put that, I’ll have to provide that later, the total was 1.8 million, I don’t have it by – I don’t have it by the line items, but I can give that later and we can…

Tim Mammen

Okay. Thank so much.

Operator

Thank you. Our next question is coming from Joe Maxa from Dougherty & Company. Mr. Maxa, please proceed with your question.

Joe Maxa – Dougherty & Company

Thank you. I was just wondering if you could expand on your Russian sale from selling pretty large sale and your opportunity is moving forward.

Tim Mammen

I think, there is a lot of work going on in Russia, Valentin can speak in a little bit more detail, I will tell you about the pipeline loadings system it was a $2.6 million system that was delivered in Q3, but there are lot of other significant opportunities on particularly cuttings systems that we’re looking at. I know VG has been working on.

Valentin Gapontsev

In the Russia, now the work we’ve done value a large projects with together with where big state companies and we have fast growing demand for the complete systems and we have built special facility to manufacture all kinds of these complete integrating system macro and micro in Russia for us and we estimate this market will grow very fast for multiple increase in sales during next couple of years.

Joe Maxa – Dougherty & Company

So, wonder we think we can be a $10 million type per quarter market, is that a few years away?

Tim Mammen

For industrial it was a whole Russian market.

Joe Maxa – Dougherty & Company

For your sales to Russia?

Valentin Gapontsev

Russia, we have more than 10 million sales now for month.

Joe Maxa – Dougherty & Company

It’s pretty close and in Q3 it was like over nine and I think in Q4 it will around 10?

Valentin Gapontsev

Last year total sales was 56 million this year, it would be more than off about 100 million.

Joe Maxa – Dougherty & Company

Where do you include that in your geographic breakdown?

Tim Mammen

Within the European.

Joe Maxa – Dougherty & Company

Okay. All right. Thank you.

Operator

Thank you. Our next question is coming from Mark Miller from Noble Capital. Mr. Miller, please proceed with your question.

Mark Miller – Noble Capital

Yes. I’m just wondering we’ve had some reports or some of the other laser company non-fiber that they saw some softening last quarter and in orders this quarter for microelectronics customers, I’m just wondering what you think?

Tim Mammen

We haven’t – in the softness we talked about where we are seeing it Mark and I’ve tried to give some anecdotal stuff around general order flow and general trends. The microelectronics probably it’s in China around maybe some of the personal device production, but I don’t have any more detail on that. A lot of our customers deal much more directly with these end market and through OEMs and they may have more visibility into specific customers.

Mark Miller – Noble Capital

So in the current situation, do you feel it's been impacted we’ve heard other equipment areas not so in lasers, but credit card needs to have an impact especially in smaller firms, any color on that?

Tim Mammen

A little bit. Yes I think it’s impacting some of the smaller sized cooperation to find the access to capital a bit difficult. Some of that slack is being picked up by the bigger people who have access to credit lines and cash, but I’d just say yes, there is some impact on that.

Mark Miller – Noble Capital

Is that the marking area basically?

Tim Mammen

Primarily in some high-power units that are going through like smaller customers.

Mark Miller – Noble Capital

And finally I was wondering if you could break out what the IMRA expenses were, legal expenses for the September quarter?

Tim Mammen

Our total legal is about 2.5 million.

Mark Miller – Noble Capital

For the September quarter?

Tim Mammen

Yes.

Mark Miller – Noble Capital

Thank you.

Operator

(Operator Instructions). Our next question is coming Jiwon Lee from Sidoti & Company. Mr. Lee please proceed with your question.

Jiwon Lee – Sidoti & Company

Thank you. First off, I don’t think a lot of laser companies can claim that, the European sales grew sequentially, but I just wanted to drill down a little bit on how much of the revenue gain is gaining against the legacy lasers and cutting versus gain new customers?

Tim Mammen

It's primarily being driven by legacy lasers gains in cutting, but I mentioned that we’ve sold seven units of seam stepper for example, so that’s a welding opportunity that continues to grow in Europe. It’s both the welding and cutting so we’re clearly getting a lot of market share gains from legacy technologies.

Valentin Gapontsev

I think Q2 is our European customers most of them integrated. So, if I know machine which they making use in our lasers, (inaudible) worldwide so as most of them go into to Paris, to Brazil, to Mexico in other countries but despite its they are making these machines in Europe.

Jiwon Lee – Sidoti & Company

So, if I think about the mix between cutting for instance welding overall how they roughly breakdown is that roughly 50-50 or is that still little more towards welding or cutting?

Tim Mammen

No, I think this year it’s going to be 50-50. I think it’s difficult to bring that number down exactly. The analysis we have is showing about 50-50.

Jiwon Lee – Sidoti & Company

And what the expectation sort of kind of moving forward next year between cutting and welding.

Tim Mammen

I would hope to remain retail that that balance so that we’d be growing both of those businesses fairly significantly most of welding growth will come from displacing potentially non-laser technologies in the cutting growth will come from continuing to displays the existing legacy laser technologies.

Jiwon Lee – Sidoti & Company

Okay. That’s helpful. And then on the Japan side since the spring imposed the IMRA litigation, I understand that you did gain one very significant clean customers there. But, so could you kind of highlight how that revenue outlook may change next year?

Tim Mammen

Yes, I didn’t quite catch the question of here.

Jiwon Lee – Sidoti & Company

I was mentioning about the Japan post the IMRA trial and spring time, whether your revenue outlook next year changes?

Tim Mammen

I don’t know IMRA had affected any of the Japanese sales and performance we have seen, it's not pretty good improvement in Japan performance throughout this year and we expect as I mentioned the qualification of new cutting customers in Japan, new welding customers is not driven or affected by what is going on with the litigation.

Valentin Gapontsev

Unit is farther off and owner of IMRA both are buying from us lasers.

Jiwon Lee – Sidoti & Company

I see. And the Tim, did you mentioned there has no significant changes in your pricing environment across the board?

Tim Mammen

We don’t see anything material, no pressure, I mean we are considering to as mentioned we want to fiber-laser in the cost to what basis the low the gas lasers, but we are not seeing coming out and putting pressure on us to do. I mean we are doing this as primarily as people buy quite of volume of lasers we provide then with the discount.

Valentin Gapontsev

I can't say for them, step up step systems we introduce market qualifies this year only for one automaker but now we are starting into area of shipment, it's just beginning it's we support these only separate system would be in many countries you will need to only indiscernible] next year to ship the market.

Also it can says that not only high power our QCV QC double your laser, now we have introduced also the UV lasers in market, (inaudible) laser. We support growth of laser next year wouldn’t be you would much higher than growth of high power sales. So they will cut their shares the market in our sales will increase that are marking. And also regarding marking ways the only recently week ago we receive huge order for one of the (inaudible) customer not Chinese customer but it very huge order for next year.

Operator

Thank you. Our next question is coming from Jim Ricchiuti from Needham & Company. Mr. Ricchiuti, please proceed with your question.

Jim Ricchiuti – Needham & Company

Thank you. Just with respect to your last comment Valentin, the change in mix as you look out in 2012 does that have any implications for gross margins.

Valentin Gapontsev

No it's worth; you wouldn’t care more margins that are high power margin now. So should improve also, our growth margin will grow farther we suppose only because we more and more part making and how to a decrease also the part, we call – we use all the metal parts from the outside, two of that is now installed last year, this year with, 10 million is the deduction now 90 percent of population is produced, (inaudible).

Now we install also internal production over (inaudible) it's also mining and also help us to us to increase marginal our product, gross margin.

Jim Ricchiuti – Needham & Company

Okay. Thank you, and then…

Tim Mammen

And then as listening, we are only providing discounts for orders of a 1,000 or more.

Jim Ricchiuti – Needham & Company

Okay. Tim, can you remind the seasonal decline or sequential decline that you had seen the last two years and selling expense, what is the issues there that play out, is it just timing of commissions or there is some other issues that cause that?

Tim Mammen

First of all, yes, sometimes the timing is the way that we’re occurring the bonuses. We’re trying and do it fairly evenly related to performance during the year. The other side of it is the timing, we don’t book any of our trade shows and their expenses into prepaid and advertising, we basically recognize that expense whenever we have those shows and Q3 is pretty light on trade fairs. It can be affected by demo unit inventory and associated depreciation increases or decreases in that as well. And then on occasions we sort of rationalized the sales force also, with increased headcount or decrease for people who are not performing particularly well. So there is probably a number of different priorities for that to come into play Jim.

Jim Ricchiuti – Needham & Company

Okay. Now looking at your OpEx as a percent of revenue I guess last quarter Q3 we are on 18%, Q2 we are on 17%, I think in the last call if I understood you correctly, longer term you actually see your OpEx creeping up as a percent of revenue and maybe is there anything you can say about that is to how we should think about your OpEx next year, I know it’s a function clearly of revenues, but just in general terms?

Tim Mammen

I think we would like to see it at around 20%, so that we can continue to invest in the business. I think 17%, 18% is little bit low. I think we are just getting at tremendous kind of leverage of it is if you look at every single one of those line items they are up significantly and I think operating expense were up 34% year-over-year in Q3. So we are inventing it’s just to raise of growth of revenue at the moment is ahead of that curve. But I think a sustainable operating expense should be around 20%.

Jim Ricchiuti – Needham & Company

Okay. And a final question for me just with respect to R&D, you are talking about R&D increasing as you move up to value chain with more systems. In the past, you have talked about this, but you also have been careful to point out that you are not, yes sir we are going head-to-head with some of your larger OEMs. Is there any additional color that you can provide on what you are doing in terms of systems development?

Tim Mammen

We can continue, Valentin mentioned the same step and the opportunities there which doesn’t go really head-to-head with anybody. Some cutting applications in Russia. There is a lot of work we want to do on QCW systems because a lot of the existing micro-electronic manufactures have their own pulsed high power lamp pump YAG and they often don’t want to cannibalize that business and put a fiber-laser in, so we believe the ways have really grow the QCW business is to compete directly with them they are not customers of ours at the moment. So those are couple of different directions we are focused on going.

Jim Ricchiuti – Needham & Company

Okay. And if I may do you mention the timing of shipments in North America was the big factor in the sequential decline. Did those shipments go this quarter Q4 and as you can tell say what vertical that was from?

Tim Mammen

I can’t really give you any more specific stuff on that than evident at hand. I think k we had like some timing in the Q3, sorry Q2 and Q1 benefited from some 10 kilowatt single mode lasers going out. There was a 17 kilowatt laser that did not ship at the end of the quarter, but went out in Q4 that was good advanced applications, so it was a very high quality beam laser. That was the main item in the North Americas.

Operator

Thank you. Our next question is coming from (inaudible). Mr. Wife [ph], please proceed with your question.

Unidentified Analyst

Yes, thank you. The question is on the – when you're taking market share on the cutting laser side, do you think that the lasers are going into new factories or they going into end of life replacements or they ripping out CO2 lasers, midlife and replacing them with the fiber-lasers.

Valentin Gapontsev

There are a number of ways, metal drop shops for example worldwide especially in China, in other countries, so they all they use our laser now. We can when you reference you will see official papers when you are receiving from end user and we are not working with within the user, we only stop to integrate and supply cutting machine in Europe.

But we haven’t done that from end user and the (inaudible) one five of it is that you play two, you want three give somebody cutting, get cutting systems and it's so crappy that you absolutely.

Much more and more people cut (inaudible) if it's normal it's advantage with a fiber cut against a CO2 so it's you and the small guys and of course big fabs we are in North South, one time this system only but before the only year ago the most people will user was sure that fiber cutting system only good for thin metal they will go 5 millimeter thickness now due to in this year old people will be cutting even proof confirm that very good catching going now up to 20 millimeter even (inaudible) confirmed recently when conference only one week ago in Florida.

So with the open door for all cutting application how to deal with fiber its enormous jump ahead, so it’s now we’re sure what we might next in five years fiber-laser we will dominate in the cutting market at all.

Operator

Thank you. We have time for one more question from the Joseph Gartner from Emilton Associates. Emilton Advisors, Mr. Gartner, please proceed with your question.

Joseph Gartner – Emilton Associates

Thank you and good morning. I was wondering if you could a talk a little bit about where you stand in terms of your production capacity initiatives and when you expect some of those to come online.

Valentin Gapontsev

Most production new capacity were 1 billion now is for final in the use integrated system special in Russia we’re building such large capacity to make final end user system. Also increased our production capacity towards the core components like fiber, like diodes for example in U.S. we have built new PREP for diodes it will triple our capacity for diode product, not the biggest on the whole capacity but it's not awfully -- now we improve we’ve build new facilities.

In Russia, we’re building second fiber product we have now the big fiber product in Germany new fiber PREP would be the same quality in Russia, in development.

Tim Mammen

Also, Joe, I don’t know we’re having troubling meeting these increases and demand that we’re seeing out there. We have added the tremendous modern capacity in Germany and the U.S. over the last year. So we don’t seeing constraints within our internal supply chain. I think it’s actually more the opposite. I’m trying to get the production people to be focused on managing inventory rather than just producing it.

Joseph Gartner – Emilton Associates

Right. Can you talk about the efficiency of the new capacity as you brought it on line, is it performing as well as you would like?

Tim Mammen

Yes. For example, they are producing I think 40 high power lasers a month in the U.S. they were doing less than 10 a year ago. Module production in the U.S. is something like over 250 modules a month capability. There’s very little difference between the efficiency of that and where we produce modules anywhere else in the world. I mentioned on the front end on the diode side there’s a new MBE machine which will grow three or four times of wafers of the existing machines would do. In tire machine is not very expensive, so as you grow into capacity it should see the wafer growth efficiency actually improve. Now we’ve redesign some of the designs on the diode packages to reduce costs, so we’re pretty happy with the way that the efficiency of the capacity that we’re adding.

Valentin Gapontsev

The new capacity also they exist in the improvement for more dimension. We have now only in diode will decrease price per watt only during the last 18 months two times cheaper now price per watt. We have other opportunities to drop again during the next couple of years.

Joseph Gartner – Emilton Associates

Right. Terrific thank you very much.

Operator

Thank you everyone. At this time we have reached the end of the Q&A session. I would now turn the conference back over to Dr. Gapontsev for any closing and additional remarks.

Valentin Gapontsev

Thank you. Thank you for joining us today. We’ll look forward for speaking with you at the end of our fiscal year for close in spite of now it's not safe conversation situation where it reached new record at the time.

Tim Mammen

Thank you everyone.

Operator

Thank you. And that does conclude our teleconference today. Thank you for joining us and have a wonderful day.

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