IPG Photonics (IPGP) Valentin P. Gapontsev on Q4 2015 Results - Earnings Call Transcript

| About: IPG Photonics (IPGP)

IPG Photonics Corp. (NASDAQ:IPGP)

Q4 2015 Earnings Call

February 12, 2016 10:00 am ET

Executives

Angelo P. Lopresti - Secretary, Senior Vice President & General Counsel

Valentin P. Gapontsev - Chairman & Chief Executive Officer

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

Analysts

Patrick Newton - Stifel, Nicolaus & Co., Inc.

Joe H. Wittine - Longbow Research LLC

Krish Sankar - Bank of America Merrill Lynch

Joe Maxa - Dougherty & Co. LLC

Thomas Hayes - Northcoast Research Partners LLC

Jim Ricchiuti - Needham & Co. LLC

Tom Diffely - D.A. Davidson & Co.

Jagadish Iyer - Redstone Technology Research LLC

Jeremie Capron - CLSA Americas LLC

Mark Miller - The Benchmark Co. LLC

Operator

Good morning and welcome to IPG Photonics' fourth quarter and year end 2015 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.

At this time, I would like to turn the call over to Mr. Angelo Lopresti, IPG's Senior Vice President, General Counsel and Secretary, for introductions. Please go ahead, sir.

Angelo P. Lopresti - Secretary, Senior Vice President & General Counsel

Thank you, and good morning everyone. With us today is IPG Photonics' Chairman and Chief Executive Officer, Dr. Valentin Gapontsev; and Senior Vice President and Chief Financial Officer, Tim Mammen.

Statements made during the course of this conference call that discuss management'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, 2014, and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors section of IPG's website or by contacting the company directly. You may also find copies on the SEC's website. Any forward-looking statements made on this call are the company's expectations or predictions only as of today, February 12, 2016. 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 now turn the call over to Dr. Valentin Gapontsev.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

Thank you, Angelo. Good morning, everyone.

2015 was another record year for IPG as we grew our top line by 17% to $901.3 million and our earnings per diluted share by 20% to $4.53 per share. These results demonstrate our continued leadership position in the fiber laser industry and the operating leverage of our business model. We successfully executed on our strategy to drive growth through the expansion of our established markets, as well as the development of products to address new applications beyond our core applications. These initiatives provide IPG with many exciting opportunities in 2016 and beyond. I will highlight a few of these key new products and market opportunities.

Our recently introduced three-beam fiber laser system for brazing of zinc-coated steel for the automobile industry continued to gain traction. The unique capability of this system is that it delivers three beams to clean the metal surface and to join the metal in one process, which is an advantage for the end user. There is significant opportunity for IPG to grow this three-beam application.

We are encouraged also by potential new volume projects for our laser seam stepper to weld auto the bodies and new opportunities that use our high-power fiber lasers to weld aluminium car parts. As we have said in the past, the trends in the auto industry to use high-strength steel and aluminium alloys toward lighter-weight automobiles drives increase adoption of fiber lasers. Another new IPG product line which should accelerate penetration of different applications is a family of state-of-the-art super high-power 2D and 3D scanners that enables IPG to provide automotive customers with a complete solution for popular remote laser welding and cutting applications. Before customers had to use our lasers with bulky and less perfect scanners from other manufacturers which made hardware and software integration more difficult, significantly increasing complete laser system cost and making service more complex.

Now IPG's solution could simplify these problems by providing customers with a full integrated solution. Sales of our QCW laser for fine processing and welding applications continue to grow as they displace lamp-pumped YAG lasers at an increasing rate. These lasers are used for battery and electronic welding in consumer electronic for medical devices and other consumer products.

It is good news that last year we believe we have passed a breakeven point in adoption of QCW lasers by the market. During previous years potentially large customers only purchased a few units for test preferring to manufacture their own flash pump YAG lasers.

In second half of 2015, a couple of top customers have made a principal decision to turn to our revolutionary new solution, and we have received the first multi-hundred volume orders. We believe that the majority of other customers will follow the trend and our QCW laser share in current and new applications will continue to grow to a much more substantial share of the market. In the past, we have seen similar adoption trends in the 2D cutting market. We expected to have a strong year for battery welding, as demand continues to increase. We have made multiple projects in development with several manufacturers and we believe this will be an application that will perform well in China this year.

Laser cleaning is another growth year for IPG where high-power pulsed laser are employed by our customers to clean parts or molds during the manufacturing process, as well as paint removal in aerospace, ship building and other industries. Our unique multi-kilowatt nanosecond fiber lasers are starting to change the situation in this large market segment. IPG is also focused on driving growth outside of our core material processing application. For example, we are pursuing a very significant market opportunity in the large screen 3D cinema and light shows.

During the fourth quarter we developed and delivered the first prototype of our new unique RGB laser technology platform for cinema projection to a Tier 1 customer. In the first quarter we plan to ship a new production six wavelength or 6P unit with record lumens to that customer. Then in April, IPG will show its new digital laser luminaire at CinemaCon 2016 in Las Vegas, a major show attended by all top cinema operators, Hollywood studios, and projector manufacturers.

The cinema industry needs urgently to improve their 3D movie guest experience by replacing dim bulb light torches with a very high lumen laser light. We believe that IPG's laser luminaire will deliver the brightness and dynamic range that industry is demanding for a new generation of premium large format 3D cinemas. The same platform at a reasonable price would start to enable more rapid displacement of the bulbs currently used as the light source in cinema industry.

Additionally, we have developed and will introduce this year a new line of high-brightness blue diode laser module with an average power up to 200 watts. These unique diode modules are requested by market for use in projector systems, direct imaging systems, biotechnology instrumentation, and a variety of other applications. Next, we are preparing to introduce our low-power UV and ultra-fast fiber lasers to the market in the coming months. The launch of this particular product marks a significant milestone for IPG, as they allow us to penetrate new micro-processing applications.

Another significant medium to long-term growth opportunity is in medical applications. We recently created a separate company, IPG Medical. We have quite an experience to key scientists in this field who are working with our Russian company and leading medical researchers developing new medical applications using our fiber laser. For example, we have been working in the urology market, where we have been testing successfully our new unique high-power energy thulium laser, fiber laser, which could replace traditional one member YAG lasers for breaking up kidney stones by enabling much faster and simpler medical procedures. We are also working successfully on another meaningful innovation in dental, aesthetics, hair removal and other medical applications.

Last year we continued with intensive development in complete laser materials processing systems for a variety of applications and developed new process and technologies, sophisticated software and hardware solutions. Our focus was mainly on new application in that field, where lasers are not used up to now. We have achieved very impressive result in some of them. For example, we have developed broad processes and complete equipment and fast verification for welding of oil pipes directly in oil drilling stations is achieved.

Now we are working on a large project for welding large-diameter gas pipelines also directly in the field. Other successful projects include development of technology and complete laser system for welding of large structures of thick titanium or aluminium alloys. We plan to ship the first such unique system to a customer in Q1.

We'll continue investments in sales and production facilities. In Q4 we opened a new office in Wuhan, China and in Czech Republic. Wuhan is recognized as the economic financial transportation capital of central China with automobile heavy industry, electronics, photonics, pharmaceutical, chemical, food and beverage industries being well represented. We hope that the new offices in Wuhan and Czech Republic will help to develop new OEM customers and improve our business with existing customers.

Looking ahead, we continue to be optimistic for 2016, and I'm managing the company to achieve double-digit growth for the year. Our optimism is granted in our strong core product, our work in many new product introductions done during the year. Our core fiber laser product will continue moderately to our 2016 growth. In addition, we expect continued strong growth for some of our recently introduced products. The growth will be supported by our rich product pipeline. At this time, most of our OEMs continue to expect to see growth for their applications and systems in this year and for the most part remain upbeat. Their feedback is not as moving as is the emotional sentiment in the financial market.

With this, I will turn the call over to Tim.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

Thank you, Valentin, and good morning, everyone.

Fourth quarter revenue grew 8% to $223.6 million from $207.4 million a year ago. Materials processing sales increased 9% year over year to $209 million, accounting for approximately 94% of total sales during the quarter. The lower than traditional growth rate primarily reflects lower sales in Russia and Turkey and single-digit growth in Europe. However, as I will discuss later, North America, China, and Japan each had double-digit growth in the quarter.

Sales to other markets, including advanced applications, telecom, and medical applications, which accounted for approximately 6% of IPG's total revenue, decreased by approximately 11% to $14.6 million. Strong growth in medical and to a lesser extent telecom was more than offset by lower sales in advanced applications, which are typically large and uneven from quarter to quarter. Growth in the medical area was driven by increased demand from core customers in the skin rejuvenation and the aesthetic markets. The increase in telecom sales was primarily due to demand for products for last-mile fiber for U.S. cable TV access.

High-power laser sales, which accounted for 55% of total revenue, increased 6% year over year to $122.6 million. This growth was driven by a 10% increase in core materials processing applications, including cutting and welding, offset by decreases in advanced applications and micro-processing applications.

Pulse laser sales decreased by 13% year over year to $27.8 million due to lower year-over-year demand for marking and engraving applications as a result of increased competition and also pricing pressure in China. We should note that we've been seeing pricing competition for both lasers moderating in China in recent quarters.

Medium power laser sales increased 13% year over year to $24 million, or 11% of total revenues. This growth continues to be driven by sales for fine-processing, additive manufacturing which includes laser sintering applications.

Sales of QCW lasers, which are mostly used for fine welding and cutting increased by 62% year-over-year to $10.9 million and accounted for 5% of total revenues. QCW lasers are continuing to displace lamp-pumped YAG lasers at an accelerating rate as Valentin mentioned. Revenue from low power lasers increased 13% to $3.6 million due to an increase in medical applications.

Sales of other products, which include amplifiers, diode lasers, green lasers, mid-IR lasers, integrated laser systems and certain components increased by 64% year-over-year to $15.7 million, primarily as a result of higher telecom and laser system sales, as well as sales related to the laser display project that Valentin mentioned earlier.

Service, parts, lease, and other revenue, including accessories, totaled $19 million, an increase of 3% from $18.5 million last year. This increase includes $3.8 million of deferred revenue recognized in 2015 compared with $2.9 million recognized in Q4 2014.

Now looking at our performance in Q4 by geography. Sales in Asia increased to $111.6 million, or by 14% year-over-year. Within that region, China sales increased 13% to $69.1 million. Growth in China was primarily related to strong demand for welding and brazing applications using high power and QCW lasers, and solid growth for cutting applications using high and medium power lasers. This growth was partially offset by the decline in sales for marking and engraving applications that I mentioned earlier.

In Japan, sales increased 39% year-over-year to $23.3 million, reflecting the continued penetration of cutting OEMs in this geography. European sales increased 2% year-over-year to $70.8 million. We saw good growth in Germany, particularly for welding and laser sintering applications. The growth was partially offset by lower sales in the rest of Western Europe and Russia.

North American sales grew 2% year-over-year to $39.9 million. In North America, we had double-digit growth sales in materials processing applications, with particularly good growth in cutting and welding. However, growth in materials processing was offset by a decline in advanced application sales, resulting in a more modest overall growth for the U.S. despite a good performance in materials processing.

Now, working our way down the income statement. Gross margins of 54.6% were at the high end of our range of 50% to 55% as a result of the good absorption of manufacturing costs due to high levels of production. Some of this was added to inventory during the quarter mostly in the diode area. Our inventory of diodes was operating with only a few weeks supply on hand. As we have brought on some of the additional chip and packaging capacity, we have managed to build about three months supply of diodes.

In real dollars, sales and marketing expenses increased to $8.6 million from $7.9 million a year ago while they were flat as a percentage of sales at 3.9%. This is an area where we plan to invest in 2016 by expanding in new geographic locations such as Czech Republic, Mexico, and Brazil and hiring new sale specialists to cover some of our new products and application introductions.

Research and development expenses increased to $17.8 million from $13.8 million a year ago. As a percentage of sales R&D increased to 7.9% from 6.7% of sales in the same quarter last year. The increase in R&D spending related to higher personnel expenses and costs of materials used in R&D development projects. R&D continues to focus on improving existing products, developing new manufacturing processes and launching innovative new products in order to strengthen our technology lead and allow us to penetrate new markets.

General and administrative expenses decreased to 6.6% of total sales compared with 7.3% one year ago. General and administrative spending in total dollars decreased to $14.7 million from $15.1 million a year ago, reflecting lower consulting costs and collections of previously reserved accounts receivable.

Operating expenses for the fourth quarter were $39 million, including a foreign exchange gain of $2.1 million, compared with $34.3 million a year ago, which included a foreign exchange gain of $2.6 million.

Fourth quarter operating income was $83 million, or 37.1% of sales, compared with $79.6 million, 38.4% of sales in the fourth quarter of last year. Excluding foreign exchange, operating margins were 36.2% and 37.2% in 2015 and 2014 respectively.

Our tax rate in the fourth quarter was 26.5%. We had a benefit of $0.04 per share from the reenactment of the U.S. R&D tax credit which was signed permanently into law at the end of the fourth quarter as compared to a benefit of $0.02 per share in Q4 2014 when it was just reenacted for that year. The change should allow for a more consistent effective quarterly tax rate in 2016.

Net income for the fourth quarter increased by 7.6% to $60.7 million. On a diluted per share basis, we reported $1.14 for the fourth quarter compared with $1.07 a year ago. In Q4 2015 the foreign exchange gain increased EPS by $0.03 while in the same quarter last year it benefited EPS by $0.04. Excluding the benefit related to foreign exchange transaction gains and the lower effective tax rate during the quarter, EPS was $1.07 as compared to $1.01 for Q4 2014.

If exchange rates relative to the U.S. dollar had been the same as one year ago, which were on average: €0.80; RUB 48; ¥115; and CNY 6.14 respectively, we would have expected revenue to be $15 million higher, gross profit to be $7.6 million higher and operating expenses would have been $2.7 million higher.

Now turning to the balance sheet, we continue to maintain a strong balance sheet, ending the year with $582.5 million in cash and cash equivalents, $106.6 million in short-term investments and $19.7 million in debt.

At December 31, 2015, inventory was $203.7 million, up 19.1% from $171 million at yearend 2014. I mentioned earlier we had good absorption of manufacturing cost and some of the absorption wound up in inventory. Our current level of inventory on hand amounts to approximately 184 days compared with our target range of less than 180 days. Accounts receivable were $150.5 million at the end of the fourth quarter or 62 days sales outstanding compared with $143.1 million at December 31, 2014, or 63 days sales outstanding.

Cash provided by operations during the quarter was $60.7 million. Capital expenditures for the quarter totaled $19.4 million and with $70.6 million for 2015 in total. This was above the $60 million to $65 million range we previously provided due to the timing of payments related to a cogeneration electricity plant in Oxford, Massachusetts. We expect CapEx for full year 2016 to be in the range of $100 million to $110 million for facilities and equipment to increase our capacity and support our future growth. We intend to seek financing for one or more of the facilities that might reduce cash expenditures to between $80 million and $90 million.

The end of Q4 we had backlog of $442.5 million, a 38% increase from yearend 2014. This includes shippable orders of $185.1 million and frame agreements of $257.4 million, which increased by 6% and 76% respectively as compared to yearend 2014.

And now for our expectations for the upcoming year. As Valentin mentioned we continue to be optimistic for 2016 on managing the company to achieve double-digit growth for the year. Our optimism is grounded in our strong core products, our backlog and many new product introductions planned during the year. Further, backlog in China is up 27% over last year and indicates that the demand for our unique and leading products is less gloomy than the macro news everyone hears daily about China.

As Valentin discussed, our core fiber laser products will contribute moderately to our 2016 growth. In addition, we expect continued strong growth from some of our recently introduced products including the QCW lasers, high power pulse lasers, as well as the trifocal brazing laser. From an application perspective we expect stronger growth from high power and fine welding applications for automotive and battery welding, as well as laser sintering, cleaning and ablation applications and moderate growth from cutting applications. The growth will be enhanced by our rich product pipeline. New product introductions for 2016 include new industrial laser systems, laser projection systems, ultrafast pulse lasers and UV lasers.

In addition, I'd like to provide some more color about opening backlog. Japan is up by about 33% year-over-year and as already mentioned opening backlog in China is up by approximately 27%. In other locations such as Europe and the USA, it is slightly lower. Our frame order backlog has increased by 76% from a $146 million to $257 million. In Q4 we reviewed this frame agreement backlog with our customers. While we cannot assert with 100% certainty that this entire frame agreement backlog will result in shippable orders, it supports the forecasts we are receiving from our main OEMs that they still expect to see growth in 2016. So while the midpoint of guidance calls for a slow start to the year, we are still targeting double digit growth with increased sales in subsequent quarters based on several factors.

First a substantial proportion of Japanese backlog is scheduled by customers for Q2 and Q3 delivery. In 2015 a different dynamic was at play. In Q1 2015 Japanese revenue was strong due to the change in consumption tax rates that accelerated deliveries into Q1 2015.

While we expect Chinese revenue to continue to show growth year-over-year, in Q1 2016 revenue in Europe and USA is flat compared to a year ago. It is positive that order flow in China continues to hold up nicely while in Europe and in U.S. order flow has started to improve during this quarter.

Obviously the macroeconomic environment is more uncertain than a year ago. It could turn more negative during the year which would impact our current expectations. In addition, the growth in revenue from new product introductions is predicated on successfully introducing them to the market, gaining acceptance from end customers, displacing incumbent technologies and finding new applications. In addition, our outlook can change due to changes in foreign exchange rates, competition, pricing, the timing, and shipments of orders. In short the risks of the current environment are more difficult to predict than they have been for the last couple of years. In the meantime, we will manage for long-term growth including investing in R&D and infrastructure, to take advantage of the historical shift in laser usage that IPG fiber lasers initiated.

We currently expect revenues for the first quarter to be in the range of $200 million to $215 million. We anticipate Q1 earnings per diluted share in the range of $0.88 to a $1.03. The midpoint of this guidance represents quarterly revenue growth of approximately 4% and a relatively flat EPS respectively year-over-year.

The EPS comparison takes into consideration the foreign exchange gain that benefited the EPS by $0.11 per share in Q1 2015. This EPS guidance is based upon 53,434,000 diluted common shares, which includes 52,714,000 basic common shares outstanding and 720,000 potentially dilutive options at December 31, 2015. Guidance is based upon current market conditions and expectations and is subject to the risks we outlined in our reports with the SEC. It also assumes exchange rates relative to the U.S. dollar of: €0.92; RUB 75; ¥120, and CNY 6.6 respectively. I want to reiterate that we do not attempt to forecast transaction gains or losses related to changes in exchange rates.

And with that, Valentin and I will be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. Our first question comes from the line of Patrick Newton with Stifel. Please go ahead with your questions.

Patrick Newton - Stifel, Nicolaus & Co., Inc.

Thank you, good morning, Valentin and Tim. I guess I really wanted to focus on the growth outlook. You spoke to managing the business for double-digit growth. You talked about strength in the core portfolio and several ways that you believe that you can grow in the back half of the year. I just wanted to put a finer point on this and help understand if the double-digit growth rate is actually taking down or still within the target range of your prior 10% to 15% metric that you put out post 3Q earnings?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So the double digit is double digit. We're not providing an update to that 10% to 15% growth range. And we've chosen to frame it in this way, Patrick. So there isn't an additional finer point to really put on it. We do remain very confident for the year as a whole. As I mentioned, even the core products orders in Asia are very strong. We talked about North American and European opening backlog being a bit weaker. I'd like to point out that we've actually had a couple of large automotive orders in the last week or so both in North America and in Germany that indicate some continuing improvement in those geographies as well. So I don't want to get drawn on any more finer points. Overall, I think we set ourselves a good target for the year, and it's a target that we are actively and proactively managing the company to attain.

Patrick Newton - Stifel, Nicolaus & Co., Inc.

And then just a clarification on your backlog, I just want to understand the difference between the firm shipments and then the frame agreement. Firm shipments are pretty straightforward. But the frame agreement, are those associated with the minimum purchase orders that you have for your larger customers, or are those some other type of backlog metric?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So frame agreements are – they're not quite long-term contracts but they're the equivalent of indicated total purchases that customers will make during the year that they give us in order to obtain, for example, price breaks. If they don't achieve those anticipated volume purchases, they don't get the price breaks. In addition to that, in certain geographies, for example in China, the frame agreements that we take are taken along with a relatively small deposit that adds some teeth to them. So they don't have a firm delivery date attached to them. But they are tied to pricing. They're tied to, in some instances, some deposits. And then they get called off during the year, and when they get called off they get translated into shippable orders. We only report them in shippable orders when they're called off, and we only would report bookings as they translate out of frame agreements into the shippable orders.

One other point I'd like to make is the growth in backlog that I mentioned specifically for Japan and China relates to growth in shippable backlog. That is not just the growth in the combined shippable and frame agreement backlog.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

The frame agreement in many cases is connected with the estimated time when the people will get license, export license, but sometimes they wait for some months. And so they apply for frame agreements, and it gives them chance immediately to apply for license.

Patrick Newton - Stifel, Nicolaus & Co., Inc.

And then if I can just sneak one more in, just on the adoption rate in Japan because that seems to be a really good growth area, and then also QCW which put up impressive numbers. Can you help us understand? What is the fiber penetration rate in Japan? And then how much has QCW displaced in the YAG lasers to this point?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

The penetration rates on Japan on the cutting – on welding, Japanese penetration has always been pretty good on the high-power side. There's always been good adoption from the major automotive manufacturers.

With our main OEM customers on the cutting side, we're still probably in relatively early stages. We've maybe tracked up from low – mid-single digits to 20% penetration. And that, as we've articulated before, over the next 12 months to 18 months is expected to get to 60% based upon the feedback we've heard from two of the three main OEMs that we deal with there. So there's still over the next 18 months potentially significant growth coming out of the cutting applications in Japan.

In terms of QCW penetration, it's a bit more difficult to understand exactly where we stand because it's really tied to what's the total volume of YAG lasers that are sold in the world each year. We think that probably more than 10,000 YAG lasers are sold each year, and that would put our penetration into that market at 15% or so. If the total market for YAG lasers each year is a bit higher, the QCW penetration at this point in time is potentially a little bit lower.

Operator

Thank you. And our next question comes from the line of Joe Wittine with Longbow Research. Please go ahead with your questions.

Joe H. Wittine - Longbow Research LLC

Hi, good morning. I appreciate the disclosure of the backlog in China. Tim, I think that was helpful relative to investor concern for today. So at this point, is it safe to say you actually feel better about China in 2016 than you did 90 days ago and that your technology remains a priority investment, or is that too aggressive of a view today as visibility in the second and third quarter orders are still murky?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

I think one of the comments that I've mentioned the thing – you've got to bifurcate your emotional reaction or hype to everything that's going and really look at what the facts of the situation are. So you have strong frame agreement order. You've got strong shippable backlog order. We're receiving positive feedback from all of the main OEMs in all the core product introductions. You've got definite projects and growth coming out of the battery welding, which will be strong in China and even in other parts of the world. And then you've got the consumer electronics cycle that's going to go through probably an investment phase this year that benefits our marking and QCW lasers. One of the other companies that sells automation and sensing equipment that announced yesterday is also expecting to benefit from that cycle driven by the major consumer electronics manufacturers.

So we've never really – and outside of your emotional reaction, even 90 days ago we were still confident that China would have a reasonable to a good year in 2016, and we continue to believe that. And that's how I'd characterize it. You've got to strip away your emotional side of the equation and look at what the facts are.

Joe H. Wittine - Longbow Research LLC

Great, that's helpful. And as my follow-up, could you give us some sense or walk us through your profitability expectation for 2016? You've been pretty clear that investors should not expect operating leverage this year. It will be somewhat of a year of investment. You've walked through that. But help us model in gross margin for the year maybe given a combination of a little bit uncertain macro and then you also have these new products scaling which may impact mix, I assume.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So you've got puts and takes on this. In general, we expect to maintain margins in the upper half of the range, so broadly similar to where we've been over the last year. You'll maybe see on the take side a bit more pricing pressure at the lower end of the market. But you'll see some puts and benefits from many of the new product introductions. If you can grow the company even at what for us is a moderate rate, you'll see a continued good absorption of manufacturing costs. So that gives us some comfort at that. There are also levers that we can pull. Hiring at the manufacturing level can be slowed down. It's expected to be slower than it was last year. We can cut for example things like overtime, if necessary. We have some flexibility around some of the other compensation structures not just in manufacturing, but the rest of the P&L. On the operating expense side, I think you'll probably see some leverage out of G&A. Even though we'll have some investment in that. You'll see a little bit of leverage out of R&D. I think the R&D investments will be a bit more moderate. And then higher investments on the selling expense side. The selling investment is absolutely required in order to expand into new geographies, support the new product line introductions. At the bottom that leaves you with probably as I said relatively flat operating margins. We reiterate again this is not a business that you're going to run at 39% or 40% operating margins. And we intend to maintain the business model and invest as we need to, to grow the business.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

Last year, we made enormous drop – to decrease additional cost of our major current products. And when you check the results, the average decrease of costs up to 15% to 20% for most products. We're working (43:43) decrease of costs will support also margin.

Operator

Thank you. Our next question comes from the line of Krish Sankar with Bank of America. Please go ahead with your question.

Krish Sankar - Bank of America Merrill Lynch

Yeah, hi, a couple of quick questions. Tim, can you characterize your customer base in China. What kind of customers are these? Are these like really big guys, small guys, do they have any access to credit issue? The second one follow-up is that I'm kind of struggling to get to your double-digit growth guidance because it seems like your quarterly seasonality is going to be completely different from what you experienced the last four or five years if you had to stick with your guidance. So, I'm kind of curious what gives you the confidence that this year is going to be off seasonal year compared to the last five years? Thank you.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

First of all, on the China question, there's many different customers that we deal with there on the end user market, all the major automotive manufacturers. In consumer electronics with the major manufacturers, consumer electronics and their subcontractors who produce their equipment. And then you've got all the major OEMs who produce equipment, the low macro systems, micro systems, fine processing systems. There are of course some smaller customers that may have less access to credit than some of those larger companies.

In general though, we haven't seen a change in that environment at this point in time. If anything I think there is an attempt by the government to make sure there is sufficient liquidity in the market rather than going through a phase of tightening. So, we haven't seen any significant changes in that. And some of the OEMs by the way are pretty significant companies. The largest customer we've got out there is clearly very big but there are three or four other significant OEMs with a revenue in the range of $200 million a year and have reasonable balance sheets.

In terms of the phasing of the year I think Q1 and Q4 are always the weaker parts of the year. This year we start with a quarter that is down compared to Q4. That's not unusual, Krish. You can never pick whether Q1 is going to be flat, down or up with Q4. And it does depend upon the timing of orders and other dynamics at play. I'd say here we expect to see acceleration of orders particularly now that this is the week of Chinese New Year into next week and the rest of February and March. I'd mentioned that we've got this very strong backlog in Japan that's scheduled for delivery in Q2 and Q3. And there's a different dynamic at play around Q1 in Japan that benefited us last year.

So we expect to still have a very strong Q2, Q3 and then it's a bit early to like talk about where Q4 stands. You've also got the consumer electronics investments cycle this year that's expected to be stronger. That is a Q2, Q3 dynamic. So there are lots of different aspects to this that we try and think about and consider and other elements of actuality that we've also had to consider. But I don't think it's a fundamentally different dynamic. Of course you have to see an improvement in growth rates for the rest of the year otherwise you don't get that double-digit growth rate that we've targeted and that we're managing to.

Krish Sankar - Bank of America Merrill Lynch

Got it. Thank you.

Operator

Our next question comes from the line of Joe Maxa with Dougherty & Co. Please go ahead with your questions.

Joe Maxa - Dougherty & Co. LLC

Hi. Thanks for the color on how you're looking at getting the double-digit growth. I'm wondering how much of that may come from the new products that you're introducing this year. Is it just very minimal or do you expect to see some meaningful growth from these newer products such as the cinema and the ultra-fast lasers and the UV laser.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

We expect over the – sales this year, starting within the UV. Some UV systems we introduced we have demand from the consumer – the system, the manufacturers which provides in large quantity they require from us. They're waiting when we are able to start to provide them this UV and ultra-fast pulses because our solution much more practical, much high efficient, and much less costly than existing. Now we're competitive for any of our products on the market today. So we practically will change the – plan to change situation in this market segment.

Regarding the cinema, it's similar – or platform. It's new and very hot. All the top operators in their field are waiting. They don't have other serious solution, only our one solution. They get a diode solution, but it's much less stable, and they're also much more costly today. So all practical operators working the field are now waiting. We will start extremely – we'll start to open door for shipments to them. Special customer will finish qualification. And one of the diode customer and already also is support our sales to other people. We don't have any limitation here for – exclusivity right for this customer.

So we expect this year sales with multi tens of million sales also luminaire products and others. So in total, I would say, we expect more than up to $50 million to $100 million additional sales from new product this year. Also, we plan this year to dramatically increase our sales of laser material processing systems. We expect total 400% growth this year. We'll start seriously get return from system business.

Joe Maxa - Dougherty & Co. LLC

Let me just clarify. Did you say you expected $50 million to $100 million of revenue this year from the newer products? Does that include the QCW and once they've been in the market...

Valentin P. Gapontsev - Chairman & Chief Executive Officer

QCW is not newest product. QCW product we introduced about six years ago. But only last year we've got breakeven. Typically, beginning the first year, typically new product going very slow. The situation not very hot. In the QCW, the situation was all people they replaced YAG solid-state lasers, all practically give us integration and produce own YAG system for them. To switch from own to new product was very difficult, and it was long test and so on. But for last year this, sorry, 2015 pressed when two of the top customers switched to us in spite they produce own YAG very large quantity switched to our laser QCW because much more perfect, provides final integrated system, much higher quality and so on. Now all the other (51:33) the same way because we don't have any competition with exclusivity of products within the market.

We do not believe somebody will enter in the market with similar product to QCW laser near this year. And this product provides new performance for final on marker and precision system. So with this year, it should grow very fast but it's not very old. It was introduced in market six years ago. We are talking now of new product which only this year we introduced in the market. Some applications are very hot and we expect a very impressive option (52:15) even this year.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

Just to clarify, Joe, some of the newer product includes not only the QCW, the trifocal brazing, the higher power pulse lasers which are relatively new to the market. And then you've got the systems which we started to introduce, and then you've got the really new product that's coming to the market as well.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

Ultra fast pulse (52:35) and mid-infrared even as a medical device is also a system, materials processes for macro systems and some micro system. In macro system we have bigger line of customers waiting when we will ship them this product. But there's still some time needed to spend for certification, documentation and so on, each of these products is customized. But we'll do some of the product, many million dollars, each of them.

Operator

Okay, thank you. And our next question comes from the line of Tom Hayes with Northcoast Research. Please go ahead with your question.

Thomas Hayes - Northcoast Research Partners LLC

Good morning, gentlemen. First question, Tim, on the increased spending on sales and marketing. Just wondering as far as the pace of growth of that, have the expenses already been added, or are they kind of should be layered in over the year? And my follow-up was just kind of on the timing of the new Wuhan and Czech Republic facilities on when you plan on opening those?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So the sales and marketing was the investment that we wanted to make last year, for various reasons didn't happen. We've just hired for example the new General Manager in Brazil and in Mexico. We've hired the new sales person in the Czech Republic. The Czech Republic is not a major expense. You've got a specialist sales guy who's going in there. So the sales and marketing investment is expected to happen during the course of this year because we didn't quite get to where we wanted to last year. In terms of the new offices the Czech office is very small. It's up and running. The Wuhan office has also opened.

Thomas Hayes - Northcoast Research Partners LLC

Great. Thank you.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

A year ago, we opened office in Poland and now it's going well, pretty well. So that we have also to split sales in East Europe also to the Czech Republic and other countries because somebody (54:37) sales between these countries.

Operator

Okay, thank you. And our next question comes from the line of Bobby Burleson with Canaccord Genuity. Please proceed with your question. Bobby Burleson your line is live. Please check if you're muted. Okay. Then our next question comes from the line of Jim Ricchiuti with Needham & Company. Please go ahead with your question.

Jim Ricchiuti - Needham & Co. LLC

Thanks. Good morning. You seem to be suggesting a pick-up in the consumer electronics business. Are these orders you already have in backlog for Q2, Q3 delivery or are you anticipating the orders are going to come in? It sounds like you have pretty good line of sight for this.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

We'll anticipate it at this point in time. Jim, we don't have the orders in hand but we've got indications from the two of the main OEMs that supply into that market. That they are expecting a strong year for sales due to that investment cycle. They rarely give us orders a long way ahead of time for that. They don't in fact get those orders from their end customer until much closer to when the investment happens.

Jim Ricchiuti - Needham & Co. LLC

And if you were, Tim, to look at 2015 what kind of year was it in that particular segment of the business?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

2015 was more moderate. I think the last cycle that you had was some investment in 2014. 2015 wasn't bad but it wasn't a big investment cycle. We saw some pick-up, more in a change in applications there that drove the QCW for the fine welding rather than it being a penetration of an application, rather than it being driven by a significant capacity spend. I think this year people are expecting a capacity benefit not just a application penetration benefit.

Operator

Thank you. And our next question comes from the line of Tom Diffely with D.A. Davidson. Please go ahead with your question.

Tom Diffely - D.A. Davidson & Co.

Good morning. Tim, first on China you said that you saw less pricing pressure recently. Could you expand a little on that?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So certainly at the lowest end of the pulse laser product line, pricing has in the last couple of quarters stabilized a bit more than it has historically. That's driven by the fact that the low-cost suppliers in China really cannot afford to go down any further on pricing. They have brought themselves, we believe, to the limit, and that limit is actually starting to affect their financial performance. There are rumors in the market that one of them may not even be particularly financially stable at the moment. So that whole strategy has an end gain to it that is not in our opinion particularly sustainable for these smaller companies, even as they try to grab share initially when they introduce product.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

(57:49) from mainly to power Chinese customers that our competition in China now practically near the bottom, so they practical don't have any margin at all. They could not more drop down even to survive long time. So they expect for this next year many of them will disappear from the market. But we still in spite we compete with them. We also dropped price. We still have very reasonable margin from our product.

Tom Diffely - D.A. Davidson & Co.

Okay. That's very helpful.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

This people cost of this Chinese competitors cost is much higher than IPG cost for general product and we also have good performance our product much better. So we are sure we'll stay in this market and wouldn't be much more price situation this especially next year.

Tom Diffely - D.A. Davidson & Co.

Okay and then just quick clarification. Tim, you noted $100 million in short-term investments, does this market differ in investment strategy for your cash?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

On the balance sheet, yes, we're trying to get a little bit more yield out of the cash that's sitting there. It's not a huge amount, so we put some into shorter-term investments have a weighted average maturity of less than a year given that interest rates were supposed to go up we hadn't put much into that that side of it. And the yield is still not great, but I think it's averaging something like 60 basis points as compared to close to zero on straight less than 90-day Treasuries or even negative on that. So yes, there is that $100 million that is in there, Tom.

Operator

Thank you. And our next question comes from the line of Jagadish Iyer with Redstone. Please go ahead with your question.

Jagadish Iyer - Redstone Technology Research LLC

Thanks for taking my question, two questions, Tim. First on the QCW lasers, I just wanted to understand the kind of growth that we should be looking at for this year. And given what you had mentioned particularly in China that you see competition on the low end, do you see competition on the QCW? And what kind of growth rate should we be thinking about for the QCW for this year? And then I have follow-up.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

For QCW we don't see any competition. Nobody can produce such quality lasers now and to sell with such price for them cost would many times higher than our cost so this way. So even somebody will produce, try for them in order watching the time try to reproduce but not successful and could not have compete with price for that. So as I've said today already that we don't see any competition for QCW in next, at minimum for three years. For component growth of QCW market, it's as you know net (01:00:55) lamp-pumped YAG market more than 10,000 units. So it still can grow three to five times without any problem. It's going to this year grow more than 50% again.

Jagadish Iyer - Redstone Technology Research LLC

Okay, good. That's helpful, Valentin. And then as a follow-up, Tim, just as clarification on the higher CapEx that you had said for this year. What kind of capacity we should be looking at in terms of this incremental CapEx that you're going to be spending over the next say 12 to 18 months in terms of quarterly run rates that you can sustain with this kind of capacity spend expansion that you're doing? Thank you.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So I see a lot of the CapEx is going to come through this year. Let's talk about it at a high level. First of all, related to manufacturing and facilities directly that add capacity, probably 75% as it relates to that. Some of it relates to sales, service, and application buildings around the world. Most of the facilities will only come on stream towards the end of the year, and some of them are only being started now. So in terms of depreciation and actually benefiting capacity, there's not going to be a huge amount of that benefit coming in early on in the year. It's more looking forward to supporting 2017 and 2018. So while this has a bit of a negative impact on cash, there's actually not a big impact on depreciation this year. And even when those buildings are brought on stream, they probably only affect depreciation by about $0.5 million a quarter.

In terms of some of the equipment, the diode area for example, new MBE reactors, again, those are only expected to be delivered in the second half of the year, and then they have to be qualified and brought up to speed. So I mentioned that we've already invested in diode capacity, and we saw some of that benefit come through in Q4. The additional investment in diode capacity is again longer term. So I think those are the main things. There's a substantial amount going into also electrical cogeneration capacity in Oxford, Massachusetts. We'll get some rebates on that, and then that will drive down one of the highest P&L costs that we have on the manufacturing side, which is actually burning in our diodes for long-term test. That cogeneration capacity will help to reduce the cost of electrical burning related to diodes. So there will be ultimately a cost benefit from that that comes through when we get that capacity up and running.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

And you have to take in mind that the growth, 17% growth in the revenue, but in physical units we've grown practical with physical 30% to last year. Thirty was physical unit, 30% more than 2014 for some of the core product within high-power lasers and kilowatt laser we increased throughout the year. Again in optical power, we produced 40% more than 2014. three years second, each year we increased for 40% total for optical power high-power laser, because a different laser from 1 kilowatt to 10 kilowatt, 50 kilowatt would count not in physical units, but optical power. So optical power last year produced 40% more than 2014. So it's a such increase in practical 50% year-over-year capacity. Every year you have to increase. You could not produce the same such and provide such big growth. So each year we invest in how we increase. We not only in some ways increase productivity but also increase our capacity and, agreement, facility and so on. We would like to increase our revenue to double-digit.

Operator

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

Jeremie Capron - CLSA Americas LLC

Hi, good morning. Thanks. I was wondering that we've talked about the company landscape for pulse laser in China. I wonder if you could give us an update on your core market of high-power lasers. Some competitors are coming up with higher power units. And I wonder how this translates in terms of the pace of price declines for your product, especially in the context of a slower cutting market.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

The market tricks when the people clear more. We have more higher-power units, more deals, and so on. And market tricks, the reality you have to provide reliable ways, but as you know we might – as you know we might even 10 kilowatt from one channel 10 kilowatt or the 2 kilowatt, 2.5 kilowatt, some of them they basically they claim today. We all the time are making optimum of modules. Our time to provide not to provide reliable power, provides lasers that will work many years without service. So they need to have redundancy and we've built optimal large (1:08:23) with sub-optimum quantity of module. But power lasers as you know are much cheaper we have in a very high margin to compare. Other people, they are working variable margin. Some of them even recognize this. So what it sounds, no problem to make 2.55 kilowatt for one module, but for what? It would be much less reliable, much less practical and so on. So we don't see any sense to make this. So it's a commercial trick to claim we have higher power; that's how it is, but it doesn't tell them the real competition in the market.

Customer needs are not more your customer needs final, reliable, highest commodity product very high efficiency, and so on. All that people claim we have now also (01:07:11) ask them the data, efficiency, total wall-plug efficiency with laser. We now run with 50%, 45% to 50% efficiency. Nobody of them yield efficiency more than 20%, 25%, two times with you and three times worth, but they have to talk about this, not power module and so on. And the situation is also different. Our parts ways and our competition in China and other with low cost, absolutely different way as they part sort of joint application power, but performance, quality and so on absolutely not comparable. The same we will see that in the low cost of this commodity cost. But it is also different we're talking about different product.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So, Jeremie, on the pricing side as well there are a couple of things there, I think that maybe the medium power, there's a bit more competition on high power. I think Trevor has said himself most of the core applications to try and maintain pricing. If there are significant volume opportunities that come out the welding market for example in order to crystallize and accelerate those opportunities, we're always flexible to make sure we can drive laser penetration. So it's always a question of supply and demand.

With the rest of the competitive position in the market, I would like to just mention a couple of things. One of our main competitors that has a high power laser that sells into the cutting market in Asia actually had I think a down year on sales for their customer and didn't have a successful year certainly as our cutting applications grew. One of the other competitors had a reasonable year but it is still only, in terms of the total number of high power lasers we sell is less than 5% of the market. And then the other main people that talk about high power lasers we don't see them meaningfully in the market at the moment. And certainly whether you look at the high power pulsed applications, virtually no competition. We get into our high power pulse. The QCW Valentin mentioned as well. The performance in cost of the diode is absolutely fundamental to that laser. So there is a lot of talk but the facts when you come back to them not just the sort of scientific and technical aspect that Valentin called out, the facts if you look at the penetration, people are getting into the market is still relatively limited.

Jeremie Capron - CLSA Americas LLC

Thanks. And if I may, I have one more on...?

Valentin P. Gapontsev - Chairman & Chief Executive Officer

You'll see we'll now this year or last year we shipped kilowatt laser, sell more than 7,000 pieces, 7,000 by one year. In total optical power to 12 megawatt of optical power, 12 megawatt ask other people how much power, total for fiber laser they are making per year. A few ten – a few hundred kilowatt only. With 12 megawatt of optical power, you need for this to make this unique for this to produce only diode pump, high power diode, not one chip, multi-chip diode module. We produced last year of about million such diode module, each 50 watts, 60 watts with very high lifetime. 50 watts, 60 watts million piece, ask other people what capacity they have. To develop such capacity, you need five to 10 years. Nobody can even waste any money if you're not able (01:10:51) to increase and produce in short time.

(01:10:54) support serious competition. We could not expect because not serious, nobody have such capacity as they are useful. It's only diode but many other components also you have to produce also very high volume high quality and so on. To make few pieces 10 pieces, 100 even pieces is not too difficult. To make 10,000 pieces high power per year is enormous. Not only investment but many years, steps, and development people trained in equipment, especially on automation. (01:11:32)

Jeremie Capron - CLSA Americas LLC

Understood. And on the balance sheet aspect here, you've made some good progress in terms of working capital and fixed asset turnover in the last two years. Now we have a slower year ahead of us, do you think we should expect similar trends, similar improvement or any change here, Tim? Thanks.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

We continue to be focused not on just generating great margins but also managing working capital. I'm not forecasting any fundamental shift in days sales outstanding. I think we've managed that pretty well. Inventory days, I think, will fluctuate a bit during the year depending on where demand peaks and troughs. So for example you may see inventory days exiting Q1 a little bit higher because we're expecting very strong demand in Q2 and Q3 and then inventory days lower by the end of Q3. So there will be some fluctuations around inventory. I think that we're going to have to manage. For the rest of the balance sheet, I think, as you point out in pretty good shape. And I don't think there's going to be anything detrimental around that. We're certainly managing to ensure that we don't have anything detrimental.

Operator

Thank you. And our next question comes from the line of Mark Miller with The Benchmark Company. Please go ahead with your question.

Mark Miller - The Benchmark Co. LLC

I just had a question. You said sales grew 13% year-over-year in China but they were down significantly sequentially. I just was wondering what drove the sequential decline.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

Mark, they're nearly always down sequentially in China Q3 to Q4. So the first thing that drives it is just simple seasonality. And so, you always have to look at China just on a quarter-over-quarter basis compared to the previous year to look at what the business trends are. There was nothing unusual that drove that sequential shift this year.

Mark Miller - The Benchmark Co. LLC

And then I'm wondering if you could estimate what percent of sales recently have come via replacement sales and how do you expect that to grow in the years ahead?

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

By replacement, do you mean displacing an incumbent laser technology?

Mark Miller - The Benchmark Co. LLC

On a customer who's been using your lasers and these lasers in time need to be replaced.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

So there is still about – yes, if you look at the real acceleration if you take the high power or the QCW, right, most of these lasers are in terms of the volume of sales less than five or six years old. So, we think a laser in a laser. It's also important to understand that the age of the system that the laser goes into like a typical cutting system has a life of eight years to 10 years depending upon the duty cycle it's put through, a welding system because the duty cycle is a bit low, it's potentially a bit of a longer life.

So, you're not into like the replacement cycle yet. What you do have though is if you look at the total number of cutting systems that's installed around the world, there are more than probably 50,000 high-power cutting systems. By our estimation, fiber's penetration into the total installed base is you can look at net up our high power sales and total units, it's probably somewhere over 20%. There is still a huge potential opportunity as those older CO2 cutting systems reached their replacement cycle to grow into the installed base even though we've grown substantially into the annual demand and that's a very important thing to note. It's not that fiber is already 80% of the installed base. It's still relatively early stages in that. And similarly, for QCW on displacing YAG lasers, it's relatively early stages into the installed base of many of these older laser systems.

Operator

Thank you. This concludes today's question-and answer-session. I'd like to turn the floor back to management for closing remarks.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

Okay. Thank you for joining us this morning. Again, we look forward for speaking with you on next quarter's call. Have a great day.

Timothy P. V. Mammen - Chief Financial Officer & Senior Vice President

Thank you, everyone.

Valentin P. Gapontsev - Chairman & Chief Executive Officer

Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.

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