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Call Start: 10:00

Call End: 11:04

IPG Photonics Corporation (NASDAQ:IPGP)

Q1 2012 Earnings Call

May 1, 2012 10:00 a.m. ET

Executives

Angelo Lopresti - VP and General Counsel

Dr. Valentin Gapontsev - CEO

Tim Mammen - VP and CFO

Analysts

Zach Larkin - Stephens

Tom Hayes - Thompson Research Group

Mark Douglass - Longbow Research

Jim Ricchiuti - Needham and Company

Krish Sankar - Bank of America Merrill Lynch

Patrick Newton - Stifel, Nicolaus

Joe Maxa - Dougherty and Company

Avinash Kant - D.A. Davidson

Jagadish Iyer - Piper Jaffray

Olga Levinzon - Barclays Capital

Mark Miller - Noble Financial

Jiwon Lee - Sidoti and Company

Arthur Weiss - Lord Abbott

Operator

Good morning, and welcome to IPG Photonics’ First Quarter 2012 Financial Results Conference Call. Today’s call is being recorded and webcast. There will be an opportunity for questions at the end of the call. (Operator Instructions) 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 predictions of the future, are forward-looking statements. These forward-looking statements are subject to known and unknown risks and uncertainties that could cause the company’s actual results to differ materially from those projected in such forward-looking statements. These risks and uncertainties include those detailed in IPG Photonics’ Form 10-K for the year ended December 31, 2011 and other reports on file with the Securities and Exchange Commission.

Copies of these filings may be obtained by visiting the Investors section of IPG’s website at investor.ipgphotonics.com/sec.cfm, or by contacting the company directly. You may also find copies on 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, May 1, 2012. The company assumes no obligation to publicly release any updates or revisions to any such statements.

We will post these prepared remarks on our website following the completion of the call. Please go to www.ipgphotonics.com and select Investors to review these remarks. I’ll now turn the call over to Dr. Valentin Gapontsev.

Valentin Gapontsev

Good morning, everyone. IPG reported another quarter of strong year-over-year growth as we increased revenues by 23% to $123.2 million. Sales momentum for our high-power lasers for material processing applications continued as manufactures increasingly embraced the benefits of high-power laser technology.

In addition, we achieved a record gross margin of 55.8% and grew net income by 30%. Why IPG has enjoyed an impressive growth during the past few years we believe we are still in the early stages of the transition to fiber laser for industrial manufacturing applications. Like, there are new entrants in the fiber laser market trying to compete with IPG our customers continue to recognize the superior technology and reliability of IPG's products. (inaudible) and other benefits of our (inaudible) manufacturing operations.

Not only we are the pioneers in the fiber laser market but we're also the most cost effective, high quality products on the market and we are able to deliver orders in volumes with much shorter lead times than competitors.

Before I turn the call over to Tim for the financial review, I'd like to take a moment to comment on the public offering of 3,250,000 of common stock, which we completed in March 2012. The net proceeds of the offering provide IPG with the financial flexibility to fund capital expenditures and working capital requirements as well as to complete acquisitions of complimentary businesses and technologies. The offering boosted our cash position and we enable the company to capitalize on opportunities as they present themselves over the long term. It provides us with tremendous flexibility as the security of permanent funding.

With that, I'll 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 provide highlights from our income statement and balance sheet and close with our guidance.

First quarter materials processing sales increased 19% year-over-year to $103.2 million. This market accounted for 84% of total sales during the quarter. The industries we serve within the materials processing end markets include automotive, shipbuilding, electronics, consumer, general manufacturing, aerospace and heavy industry.

Materials processing also includes a broad array of applications including marking and engraving, welding, cutting, drilling, cladding, prototyping, scribing, wafer processing, surface cleaning and hardening. The opportunity for fiber laser adoption is expanding as manufacturers increasingly use our technology in a broader range of industrial materials processing applications.

The remaining 16% of sales were from telecom, advanced and medical applications. We see growth opportunities for IPG in these end markets but for (indiscernible) today and going forward we will only break out materials processing in detail since it represents the vast majority of our business.

Sales for these other applications were up 48% year-over-year to $20 million. The growth was driven by the sale of multiple high-power, high-brightness lasers for advanced applications to be used in research. Sales of high-power lasers, which account for just (inaudible) of total revenue increased 42% year-over-year to $63 million. (inaudible) in welding applications have been driving much of the growth of our high-power laser sales.

The benefits for customers using our lasers for cutting and welding include increased accuracy, speed and quality compared with traditional sources.

Sales of (inaudible) increased to $9.6 million or by 28% year-over-year. Much of the growth was driven by specialty cutting and welding applications including thin sheet metal cutting and micro welding as well as printing and centering applications.

Pulse laser sales were down 3% year-over-year to $27.7 million. Pulse lasers are used for marking and engraving applications and general manufacturing where demand is often controlled by general economic trends. We remain optimistic about the long-term opportunity for pulse lasers.

Our low power lasers, which are primarily used for medical applications and micro materials processing generated $3.8 million in sales for the quarter, down 19% year-over-year. We continue to gradually add to our medical OEM customer base. However, this process is lengthy due to the regulator environment.

Sales of QCW lasers, which are primarily used for micro welding and cutting applications more than doubled to $2 million compared with last year. We are excited about the opportunity for additional QCW laser sales. We believe that we can further reduce QCW manufacturing costs making these lasers and even more attractive option when compared with traditional lamp pump YAG lasers.

This should ultimately translate into incremental market share gains and revenue growth for us. Sales of other products, which include amplifiers, diode lasers, green lasers, mid-IR lasers and certain components were $7.7 million and service, parts, lease and other revenue totaled $9.5 million.

Now, looking at our performance by geography. European sales increased to $41.9 million or by 11% year-over-year. We had a solid quarter there due to the delivery of multiple high-power lasers for advanced applications. That growth was partially offset by a weak order in Russia. However, we anticipate a stronger Q2 in that market.

North American sales increased to $25.6 million or by 48% on a year-over-year basis. Again, much of this growth is a result of high-power laser sales for material processing applications, such as cutting, welding, braising and cladding.

Asian sales, which include Western Asia and the Middle East increased to $55.1 million or by 23% year-over-year with demand particularly strong for battery welding and 2D cutting applications. China performed well recovering much faster than anticipated due to demand for specialty cutting and welding applications as well as higher value add marking applications for the consumer electronics market.

Cutting application sales to Turkey, which is reported as a component of Western Asia, also increased meaningfully. While Japan underperformed during Q2, we anticipate growth to return there as order flow increases for cutting and welding opportunities, particularly as customers who have recently qualified our lasers start to ramp demand.

Now, turning to the income statement. Total sales in Q1 increased 23% year-over-year to $123.2 million. Gross margins were 55.8% compared with 53.7% in Q1 2011. Gross margin includes stock based compensation charges of $460,000 and $521,000 in the first quarters of 2012 and 2011 respectively.

Sales and marketing expenses were $5.1 million or 4.2% as a percentage of sales, down from 5% in the year-ago quarter. We expect to invest in more demo units in 2012 and in our application labs to ensure that we have new products on hand for customers to test. In addition, we plan to add to our sales staff around the world.

General and administrative expenses increased 22% to $9.9 million but were flat as a percentage of sales at 8% compared with the year-ago quarter. R&D expenses increased year-over-year on a real dollar basis by 25% to $7.1 million due to increased spending on R&D materials. As a percentage of sales, R&D was 5.8% of total revenues, which was flat with the first quarter of 2011.

In total, operating expenses for the first quarter of 2012 excluding foreign exchange losses increased (inaudible). Operating expenses include stock based compensation charges of (inaudible) and $2,086,000 in the first quarters of 2012 and 2011 respectively.

First quarter operating income was $45.2 million or 36.7% of sales compared with $34 million or 34.1% of sales in the first quarter of last year. In Q1 2012, other expense includes $1.1 million for final payments related to a contingent consideration agreement for a prior acquisition. Net income attributable to IPG for the first quarter increased 30% to $29.9 million.

On a per-diluted-share basis we reported $0.61 in Q1 2012 compared with $0.47 a year ago. We estimate that if exchange rates had been the same as one year ago, sales in Q1 2012 would have been $900,000 higher, gross profit would have been $500,000 higher and operating expenses would have been $200,000 higher.

Now, turning to the balance sheet. In the first quarter cash and cash equivalents including short-term investments increased by $189.8 million to $395.5 million. This was primarily due to the closing in March 2012 of the public offering of 3,250,000 shares, which contributed $168.3 million after operating expenses.

At March 31, 2012 inventory was $123.4 million and increase of (inaudible) from year-end 2011. Approximately $3.5 million or 2.8% of in the increase in inventory related to the translation affect of the appreciation of the euro and rubel exchange rates versus the US dollar. While our current level of inventory on hand amounts to 206 days and is now above the top of our target range of less than 180 days. Given further sales growth and continued improvement in inventory planning and management, we hope to reduce the number of days outstanding in the future.

However, we continue to see a competitive advantage to holding a large balance of inventory to be able to respond to customers in Asia and around the world with short lead times. Accounts receivable were $88.4 million at the end of the first quarter or 65 days sales outstanding compared with $75.8 million at December 31, 2011 or 56 days sales outstanding.

Accounts receivable was higher than normal at the end of Q1 due to the timing of shipments in the quarter. 78% of revenue was shipped in February and March, with sales in China ramping after the Chinese New Year, Korean customers deferring shipments from the US until after March 16 when the new (inaudible) was reduced to zero and the delivery of high ASP, high-power lasers for advanced applications in March.

Cash generated from operations during the quarter was $27 million. Capital expenditures for the quarter totaled $13.8 million, which is consistent with our target range of (inaudible) to $60 million for the year. We are investing in new manufacturing facilities and capacity expansion in high growth regions, particularly in the US, Germany and Russia.

Some of the facilities that have been under construction will become operational before the end of 2012 including buildings in Germany and Russia.

And now for our expectations for the upcoming quarter. The book-to-bill ratio was greater than one in the first quarter and we are optimistic that our order flow will continue to be strong. It has been in April. Geographically, we are performing well across the globe. North American manufacturers are adopting fiber lasers for a broader range of industrial materials processing applications.

Europe and China are performing better than expected considering the macroeconomic factors in each region. And we are optimistic about our long-term prospects in Japan. Operationally, we are focused on identifying new opportunities for expansion including developing specialized laser (inaudible) to meet customers needs and penetrating more deeply into the fine processing market with new QCW, green, UV, near infrared and ultra fine lasers and also entering new geographies.

We have a strong balance sheet, which will allow us to make the necessary investments to build out our infrastructure and continue to execute upon our growth strategy.

With that as a context, IPG Photonics expects Q2 revenues in the range of $128 million to $138 million. The company anticipates Q2 earnings per diluted share in the range of $0.60 to $0.70. That is based on 52,103,000 diluted common shares, which includes 50,967,000 basic common shares outstanding and 1,136,000 potentially dilutive options at March 31, 2012.

The basic common shares outstanding include the 3,250,000 common shares issued as a result of the follow-on offering in Q1 2012. This guidance is subject to the risks we outlined in our reports with the SEC and assumes that exchange rates remain at present levels. I want to reiterate that we do not attempt to forecast gains or losses related to exchange rates.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from Zach Larkin with Stephens. Please proceed with your question.

Zach Larkin - Stephens

Hey, good morning, gentlemen. Congrats on the quarter and thanks for taking my call.

Tim Mammen

Morning, Zach.

Zach Larkin - Stephens

First off, obviously strong quarter, stellar gross margins. Could you comment a little bit on the margins and what you expect or thinking about as we go into Q2 and move through the year. What we saw in 1Q something that's sustainable or should we expect a little bit of contraction as we go forward?

Tim Mammen

In the first quarter, gross margins did benefit from shipments and sales of quite a number of high-brightness, high-power lasers with a significantly higher ASP. That benefit was probably about 100 basis points. So if you excluded that gross margin would be right in line with our target of around 55%. So in Q2 we're not expecting a significant number of those shipments although there are other orders expected, which from quarter to quarter may benefit gross margin a little bit in the second half of the year. But that's the real reason there's a bit of benefit on product mix on gross margin there.

Zach Larkin - Stephens

All right. Thanks. That's very helpful. And then as you look at the past quarter and orders, are there specific industries that you're seeing strength. I'd assume auto is doing well (inaudible) and then also maybe if there's any that's a little bit weaker than you might have anticipated?

Tim Mammen

Auto is clearly a driver particularly in North America where we've got increasing number of orders and sales from just about every single major manufacturer in the Tier 1. Cutting continues to be a strong growth driver both in Europe through our Italian OEMs and with a recovery in China. The consumer electronics industry with the subcontract manufacturing in China, we're seeing actually ramping demand there for medium power lasers and also pulse and QCW lasers.

The benefits to come in the second half of the year I think really are in Japan where we're expecting the cutting customers who've developed equipment to start purchasing in Q2 and Q3 and also some increase in demand from the major automotive manufacturers there who have qualified us for welding applications.

There are no real specific areas of weakness. Europe on the materials processing side is a little bit sluggish and we've benefited that a little bit by the advanced application sales there. And we're actually expecting some more advanced stuff to come out of Europe, which should help the year there even if materials processing continues to be a little bit weak.

Valentin Gapontsev

And for the second and third quarter within (inaudible) huge orders for pulse laser, new generation of pulse laser, which we introduced to the market at the end of last year from China and from (inaudible).

Zach Larkin - Stephens

Okay. Thanks very much. And also wondered, we've got a little bit of a soft patch for 2Q just based upon the year-over-year growth. Is there any change in your guys outlook longer-term for the continued 20% type top line opportunities as we get through the current macro malaise?

Tim Mammen

I think we're pretty comfortable in all of the market forecasts. This is how we talk about it, are the fiber (inaudible) to penetrate all of these different applications. And if we can grow to 60% to 70% of different applications by 2015, the underlying growth rate assumed there would actually be a little bit above 20%. Maybe closer to 23%. I think you may have again quarters where growth exceeds that with adoption into different end markets or geographies. But the underlying sustainable growth rate for the company we believe is in tack.

Zach Larkin - Stephens

Thank you very much. Congrats again on the quarter.

Tim Mammen

Thank you, Zach.

Operator

Our next question comes from the line of Tom Hayes of Thompson Research Group. Please proceed with your question.

Tom Hayes - Thompson Research Group

Thank you. Good morning, gentlemen. Congratulations on the start to the year. I guess my first question is kind of on the (inaudible) that some of your expansion projects should be up and running this year. Just wondering if maybe you could touch on a little bit on what kind of capacity that will provide you. Is it in the 10% to 15%, 25% range of additional capacity that'll provide you?

Tim Mammen

It depends what you talk about – we talk about this in different ways. If you're adding to processes for example, any additional wafer growth machines that we're putting in for the diode area will double wafer growth capacity. Then you need to add on the downstream side of chip production to build up to that but it's more manageable once you've got the wafer growth in.

The new buildings will provide the space to add headcount to ramp manufacturing of components in Russia, in Germany and in the US as demand grows. So I think that for every dollar of CapEx that you spend you're able to generate on an annual basis $3 to $4 of revenue.

Tom Hayes - Thompson Research Group

Great. I guess second question maybe is just on your pretty positive comments on China. I was just wondering is their activity level back to (inaudible) where you saw kind of before the downturn we've been talking about the last couple of quarters?

Tim Mammen

In Q2 they recovered very nicely. They were right up not quite as high as Q3 of last year but the momentum we've got going into Q2, the Vice President we've got in China and the Asian operations is very optimistic about Q2 and certainly the orders that we have in hand and the order flow through April has been very strong. So we're expecting a good quarter out of China.

And I want to reiterate again that we talked about the work we were doing in deepening relationships in China with existing OEMs and new OEMs introducing new products for new applications. Valentin mentioned the unique new pulse lasers that we've introduced there. The QCW offering, which is not only driving sales in China but also in Korea. We've hired sales people in China with a lot of experience in that market.

So a combination of those three things, the deepening of relationships, the introduction of new products, which address new applications and the expansion of the sales force means that we think we've actually got a much more solid foundation to the business there than we had even 18 months ago. So there's a lot of work that the company has done in all of these areas.

Valentin Gapontsev

And you can say more that April bookings is fantastic.

Tom Hayes - Thompson Research Group

And China represents about what percentage of revenue, Tim?

Tim Mammen

This quarter they were probably about 27%.

Tom Hayes - Thompson Research Group

Okay. I guess just last question. Maybe your thoughts on the annual amount for the non-controlling interest.

Tim Mammen

I am factoring in about $1.2 million for Q2. And then if Russia continues to expect to be strong then, it would ramp a little bit each quarter after that. Maybe 20% a quarter.

Tom Hayes - Thompson Research Group

20% increase per quarter over Q2 levels?

Tim Mammen

Yes.

Tom Hayes - Thompson Research Group

Okay. Great.

Operator

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

Mark Douglass - Longbow Research

Hi. Good morning, gentlemen.

Tim Mammen

Morning, Mark. How are you?

Mark Douglass - Longbow Research

Fine. How are you?

Tim Mammen

Good thanks.

Mark Douglass - Longbow Research

Good. Tim, you talked about inventories is a lot of the inventory growth here, is it still in finished goods is what it sounds like? Just because you want that (inaudible) rather than WIPs.

Tim Mammen

Well it's finished components as well as finished goods, so we keep on hand finished packaged diodes, finished fiber blocks, modules. And then also at the subsidiary. So for example, in Japan or Korea, Italy, China, they will have finished product to enable themselves – either because they've got orders they need to ship earlier in the quarter or in order to respond quickly to customer demand, they'll hold some finished product inventory.

So the components you could think about as WIP even though they're finished and then there's the finished product. You can build a laser if you have the modules and the parts available very quickly and respond to lead times extremely quickly.

Mark Douglass - Longbow Research

Right. And then on the OpEx expenses line, I think some of us were expecting a more significant drop and fall-off in general and admin. What are you thinking about OpEx expenses going forward. I mean, 19% I think is a little higher than what was anticipated. Should that be floating back down as the year progresses?

Tim Mammen

The total of 19% includes the $1.2 million of FX losses. If you exclude those, I think operating expenses were just under 18%. G&A was higher than a year ago because of a little bit on salaries and benefits, not too much. There was tax, legal and accounting fees. Some of it relates to transfer pricing. And other matters that came through. Travel was a little bit higher but the other item in there was we had a $350,000 increase in reserves related to accounts receivable, whereas a year ago that was flat. And we'll provide reserves on stock that is getting older even though we may recover it.

Our history is that we tend to recover those amounts but we will provide those reserves on the balance sheet to be prudent.

Mark Douglass - Longbow Research

Okay. So do you think 18% is more normal and even some leverage available?

Tim Mammen

We grow revenue – I think there will be some leverage on OpEx. You have to take out the $1.2 million of FX to get to the real OpEx that we paid out.

Mark Douglass - Longbow Research

Okay. Thank you.

Operator

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

Jim Ricchiuti - Needham and Company

Hi. Thank you. I was wondering if you could comment on how you see the new QCW scaling up as you go through the year. It sounds like you have adequate capacity. Is it a case of just putting more sales, marketing resources? Getting the customers to understand the technology a little more?

Valentin Gapontsev

With QCW introduced (inaudible) power, peak power. Now we increased the (inaudible). It's 1.5 KW peak power. Now in new version we increased up to 18 KW peak power. Big range of (inaudible) which cover all applications. Which before (inaudible) the people use. And there's huge potential for such (inaudible) because they absolutely (inaudible). And also we announced this with special diodes for such lasers, which allow us to provide also the price benefit to customers. So it's a very big business. We consider during two, three years we will – the sales of such lasers will increase five times to compare with current sales. It will be a contribution to the revenue contribution. We’ll compete with contribution from high power lasers.

Jim Ricchiuti - Needham and Company

And the primary applications for this in terms of the vertical markets that you address?

Valentin Gapontsev

It's multiple application. Material processing for single or for fine processing. It's a lot of applications. It's not new markets, it's existing markets, wide markets. Just a replacement for the (inaudible). It's new generation diode pumps. Highest quality lasers. And we don't see any (inaudible) because it's cost depends absolutely from cost of (inaudible) Diode power in the case, our case would decrease dramatically. Nobody would be able to compete there.

Jim Ricchiuti - Needham and Company

So would you assume that this revenue ramps significantly on a sequential basis as you go through the year, Valentin?

Valentin Gapontsev

We estimate the market for such kind of laser – $0.5 billion. It will be – we'll be dominating this market, what's estimate what the revenue should be expected.

Tim Mammen

I think the target is, Jim, is to in the near-term we've got to double those sales this year at a minimum.

Jim Ricchiuti - Needham and Company

Double the sales this year over –

Valentin Gapontsev

(inaudible) many customer now they are testing and found its enormous benefit of this and now they change the design of their final working stations. It takes some time for – to start mass volume use of (inaudible) is what we hear from many customers. Very optimistic for a (inaudible).

Jim Ricchiuti - Needham and Company

Thank you.

Operator

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

Krish Sankar - Bank of America Merrill Lynch

Hi. Thanks for taking my question. I have two of them. Number one, either Valentin or Tim, can you talk a little bit about the competitive situation. One of your (inaudible) just spoke about one of your fiber lasers, 1 KW being adopted because it is insensitive to back reflection. I'm just trying to get a sense of – if you can talk a little bit about the old fiber laser situation and the composition. And I just had a follow-up after that.

Tim Mammen

We're still not seeing any real increase in competition despite multiple announcements by other laser companies around the world, particularly on the high power side where we continue to have a tremendous quality and price advantage. And even on pulse lasers where we believe we've gained market share because of our ability to deliver in volume with a pretty unique product range and also a very competitive price and quality.

So people have got a very long wait to catch up. There is one customer who's claimed that one of the benefits I think is that back reflection benefit. But, Valentin, can explain in more detail the advantage of our laser in that regard.

Valentin Gapontsev

(inaudible) that was invention of one of our major competitors. Very big guy. They claim only to save their share of the market they claim a lot of (inaudible) disadvantage of fiber laser. But what (inaudible) did not (inaudible). When they tried to make something similar they had big problem with this. But we resolved problem with back reflection like six, seven years ago. We never have any problem with it. (inaudible) talk about back reflection. It's a game of some people only. So we don't see any real competition market and (inaudible) show that we raised our sales of fiber laser at 60% when the total market of fiber laser grew only less than 40%. So with our share in the market growing it's quite (inaudible) competition. We're not giving the market to other people. This year we also increased our share in this market (inaudible).

Krish Sankar - Bank of America Merrill Lynch

Thank you. That's very helpful. And just a follow-up for Tim. Tim, clearly your cash flow generation seems to be improving now. But if I look over the last several years it's kind of been all over the map. I'm just trying to get a sense of when I look ahead, do you have some metrics, do you have like what kind of cash flow you're looking at? Or should be all of a sudden a certain percentage of revenue? Do you have any such metric or is it going to be pretty lumpy?

Tim Mammen

At least in the near-term it'll be, if you're talking about the cash flow after capital expenditures, it's likely to be a bit lumpy as capacity is expanded or once that capacity has been expanded you grow into it and you're not spending so much capital on CapEx. That's the main lumpiness on it. I think we clearly are trying to manage working capital well. Explained a little bit on receivables but our target is – traditionally I think in the company receivables has been down below 60 days historically on an average basis.

The inventory, we're continuing – there's more and more focus on that. I think we went through a period last year with sales growing very rapidly where we built inventory out. I've looked at the overall trend on inventory growth in the last three quarter s and it has stabilized even though days are a little bit volatile. So we're generating more. That's not eating up so much working capital from cash flow generation.

But because of these different elements (inaudible) we don't have any specific targets that we set ourselves. I'd obviously like to see operating cash flow as close to net income as possible. I think that shows you're running the company well and I think we had $27 million of operating cash flow in Q1 and net income was $29 million. I think that’s a pretty good target to be at and I think there are benefits we can get out of that still further a little bit.

Krish Sankar - Bank of America Merrill Lynch

Great. Terrific (inaudible). Thanks a lot and congrats on the good results.

Tim Mammen

Thank you, Krish.

Operator

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

Patrick Newton - Stifel, Nicolaus

Good morning, Tim and Valentin. Congrats on the quarter.

Tim Mammen

Good morning, Patrick.

Patrick Newton - Stifel, Nicolaus

I wanted to touch base on the medium power lasers. They increased very nicely sequentially in Q1. Can you discuss visibility with these lasers and should we expect to see the growth rate accelerate on a year-over-year basis from current levels?

Tim Mammen

We don't talk about specific visibility by product lines. Some of that growth came out of China. Again, for the micro processing applications in metal cutting and in general, the forecast out of China continues to be strong for that. Some of the other applications on medium power, centering, which is a deposition technology. That continues to be a growth area for the company. Some printing applications.

But you should note that overall the medium power lasers in the CW format, we're not really addressing a very large part of the micro processing market, which is why we introduced the QCW to really compete with the lamp pump YAG. And the real significant growth over the next couple of years as Valentin articulated will come really from QCW.

We expect the medium power CW to perform well but the real growth from the QCW side of things I think.

Valentin Gapontsev

And this year we will (inaudible) we will start to sell a lot of new lasers, which we (inaudible) enter second half of last year demonstrate (inaudible) a new one. The UVM laser for example, they are short pulse lasers, very high energy per pulse and the average power of nanosecond lasers. So it's a lot of different kinds of laser, which each of them have contributed (inaudible) starting from this year in addition to our traditional lasers.

Patrick Newton - Stifel, Nicolaus

Okay. And is it fair to say that the QCW lasers have a similar gross margin profile to your traditional CW lasers?

Tim Mammen

Yes. They will when we – at the moment the pricing is a little bit higher. We're bringing the pricing down as we bring the diode cost down with this unique new diode that we developed. And then the pricing policy we use for the QCW will be the same as all the other lasers. So we expect to generate very similar gross margin off that product.

Patrick Newton - Stifel, Nicolaus

Okay. And then shifting gears to China. Thanks for the details on China in the quarter and you commented about order flows strong across all geographies. But can you characterize Chinese order flow relative to the total company. And I guess the reason I'm interested is especially in the month of April we had a weaker Chinese flash PMI and it sounds like you're not seeing any hiccup there. So if you could just discuss China in a little bit more detail.

Valentin Gapontsev

I can (inaudible). As I mentioned today (inaudible) we have fantastic bookings and more than 50% of this from China.

Patrick Newton - Stifel, Nicolaus

Okay. That's helpful. And then one last one on your manufacturing capacity expansion. If these facilities do come online in Germany and Russia by the end of the year, Tim, how should we think about the impact here gross margin profile as this capacity ramps?

Tim Mammen

The intention obviously is to be growing into that capacity and we can continue to do that. We've seen a nice year-on-year improvement in revenue in Q1. That can be sustained during the year. I wouldn't expect to see a meaningful impact on gross margin through the year. One thing you should note is a lot of the investment we put in is primarily on facilities.

If you look at the ratio of facilities relative to equipment, the amount of facilities is quite high and facilities get depreciated over a 30-year period. So you can absorb quite a lot of CapEx without that necessarily impacting gross margin dramatically.

Patrick Newton - Stifel, Nicolaus

Thank you for taking my questions.

Operator

(Operator Instructions) Our next question comes from the line of Joe Maxa with Dougherty and Company. Please proceed with your question.

Joe Maxa - Dougherty and Company

Thank you. Most have been answered but I did want to address the pulse lasers. Been a little bit weak. I'm just wondering if you're seeing any pickup or turnaround in that product line?

Tim Mammen

I think we've had some good orders coming out for the new applications in the consumer electronics side both with some customers in Europe who supply stuff into the manufacturing operations. Subcontractors in China as well as orders in China. Clearly the thing to know, Joe, is that the pulse laser business is one of our most mature product lines. We've been in that business for 16 years I think we signed up and started working with our first main OEM in Japan. And fiber already has more than 60% market share there.

The desire to go after the remaining 40%, which can be very low value add and relatively low quality lasers, it's not really the most strategically advantageous business decision. We're better off focused on growing some of the other product lines up to 60% market share in the total laser market. So we've always said that we believe that we're going to be the leader in the pulse laser business and we can satisfy everybody's requirements in solutions. There have been some benefit in order flow at the end of the quarter for some of those consumer electronics applications. But that is our – the caveat to it is, it's the most mature product line that we do have.

Joe Maxa - Dougherty and Company

All right. Thank you. That was helpful.

Operator

Our next question comes from the line of Avinash Kant with D.A. Davidson. Please proceed with your question.

Avinash Kant - D.A. Davidson

Good morning, Valentin and Tim. Could you talk a little bit about the average diode cost per watt that you had in 2011 and you had given some targets earlier about 2012. So if you could give us some idea of where you are in terms of achieving those targets and where should we see the average diode cost per watt in 2012?

Tim Mammen

I think we gave (inaudible) getting below $3 and we're already there on the diode used in the CW lasers. And when we introduce the new diode for the QCW (inaudible) where we can drive a lot more power on short pulses through the diode, the cost will be even lower than that.

Avinash Kant - D.A. Davidson

And could you talk a little bit about some of the opportunities you are seeing (inaudible) drilling?

Tim Mammen

There seems to be (inaudible) being made with using high power lasers in conjunction with drill (inaudible) to soften rock and substantially reduce the pressure that's required on the (inaudible) to penetrate very heavy rock. There's some stuff out there on the web about this that it really is being proved as a workable solution to and using fiber – delivery fibers that are several kilometers. So thousands of meters in length.

We're (inaudible) to see some additional orders from those applications in Q2 as people continue – the main customers we've got continues their research into it. And they told us that if this continues to be as successful as it is, the potential will ramp to tens if not hundreds of units. It makes the viability, the (inaudible) viability of wells that until now we're very expensive to drill much more economically viable. Because it reduces considerably the wear and tear on the drill bit. It also reduces very significantly the number of times and the amounts of time spent on pulling drill bits out of the ground to replace them when they're worn.

Valentin Gapontsev

(inaudible) market in the future because the (inaudible) but when the market will need hundreds of the multi (inaudible) kilowatt lasers. It's really a big potential for the future. And now the well (inaudible) growing much faster. (inaudible) about eight years with customers, the point was still just an idea. Now it's becoming practical so we now see this potential for the future.

Operator

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

Jagadish Iyer - Piper Jaffray

Thanks for taking my questions. Two questions. Tim, can you basically give us an idea of how much was sales to the automotive segment in Q1. And where do you see the automotive segment trending at the end of the year? Can you give us some numbers for 2012 versus 2011? And then I have a follow-up.

Tim Mammen

We don't give that out specifically. What we talked about before is the stuff that we can identify and then there's a lot of stuff that we can't. I would estimate that automotive sales were about 35% of (inaudible).

Jagadish Iyer - Piper Jaffray

Okay. And where do you see that for 2012 versus 2011 please?

Tim Mammen

It's growing. In the US it'll grow I think – as a percentage of the total I think it will remain relatively consistent. Early stages of adoption in that industry. Early stages of qualification. You're seeing ramping demand in the US from all the major manufacturers in Tier 1. We're still at early stages. Most of the German manufacturers as they look to more widely embrace fiber. And the same holds for the Japanese.

So again it's a – we're changing the way that people are making cars and processing materials within the auto industry to enable better fuel efficiency and improved safety. None of those parameters have changed and people are going to have to move in that direction to meet their MPG requirements that are being mandated by law.

Jagadish Iyer - Piper Jaffray

Okay. And just as a follow-up. Post your offering, can you help us and give us some details about where are you in terms of trying to find adjacencies to your segment? Can you give us an update on that? Thank you.

Tim Mammen

There's not a huge amount to update you on. As we talked about previously we're clearly the leader in the market. We get a lot of people approaching us. Some of them better quality than others. And we evaluate those opportunities as they arise. We look at opportunities in different geographies. There continues to be nothing specific to announce in that regard. I think when we do have something specific and tangible we will make an announcement about it.

But the basic thing is that we're either targeting opportunities where we can accelerate our existing product line penetration into end markets, can help us to expand geographically and accelerate sales. Or accelerate into markets where we're lightly penetrated. For example in the fine processing, at shorter wavelengths or into plastics processing where our (inaudible) laser has proven to be a good wavelength to process plastics at.

So the strategy I think is fairly well articulated. And you'll see us hopefully execute on that in the next couple of years.

Operator

Our next question comes from the line of Olga Levinzon with Barclays Capital. Please proceed with your question.

Olga Levinzon - Barclays Capital

Hi. Thank you for taking my question. Wanted to follow-up on a couple of the new and expanding market opportunities that you outlined, specifically welding and then the QCW lasers. I guess what is the current ASP (inaudible) or gap that you have between fiber lasers and the YAG pump lasers within the QCW segment? And then also for fiber laser welding systems versus non-laser systems that are currently serving the market?

Tim Mammen

So QCW a year ago was probably fairly significant. Right now the pricing on QCW is directly competitive with YAG so that's a very similar strategy that we pursued in penetrating the cutting market. And that's why we believe we're on the verge of being able to substantially increase (inaudible) sales. And even start – there's a huge installed (inaudible) of lamp pump YAG lasers, which we believe people can now seriously consider retrofitting with our QCW.

So we believe that's going to start in the next year and gather momentum. In terms of welding applications you have to look at the total cost of welding with different technologies. And that includes not only if you're using manual processes, the annual cost of paying a skilled welder. You also have to look at the consumption of wire. So it's not just the upfront cost of a mig or tig welder compared to a laser.

All of the cost analysis, when you look at that compared to electrical consumption, wire consumption, decrease in manual labor because fiber enables you to automate processes in shipbuilding, in oil pipeline manufacturing, in other areas of assembly the laser is increasingly basically much more cost effective or not only cost effective but provides a better quality weld. So you can process welds faster and reduce the number of welds that are required.

The issue that you face there is that these markets are dominated by players who have been in the welding business for 100 years. You've got a (inaudible) customer relationships with application that are well recognized. So you have to go and change the view of these different industries to get lasers to be accepted. And that's pretty much the similar process we had to go through with the cutting. So you're not going to see a sudden change in adoption that’s going to drive tremendous (inaudible) 100%-plus growth in one quarter.

The big welding companies are not going to give up the welding industry very easily. They make a lot of their money from selling the wire for example as a consumable.

Valentin Gapontsev

And fiber laser, also green technology is also becoming much more (inaudible) available in the market and it's also much more precise for them welding. Fiber welds allow to weld very special (inaudible) which is very difficult to weld with spot weld is for them now (inaudible). New steel, which is very difficult to weld by spot welding. (inaudible) steel or for them aluminum and so on. So that open a lot of opportunity to use absolutely new materials in many industries.

Operator

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

Mark Miller - Noble Financial

I wonder if you can provide us with any more updates. You talked about entering the specialty systems business and thoughts about what acquisitions, which you might have to add to do that.

Tim Mammen

We continue to evaluate it. We talked about this. Again we've articulated I think a very clear strategy. First of all we're not going to start to compete with basic systems. You mentioned the specialty systems. We're not going to go in and actually do marking machines or cutting machines. We are going to compete with customers. There are geographies where we may look at doing cutting machines in for example Russia. On the specialty laser system side the integration of a QCW in a micro processing machine, which we've already developed for cutting and welding is another area where we're looking to go into. And then on the specialty welding equipment there are also developments there. We've supplied numerous systems already. For example into the locomotive engine casing manufacturing. Into one of the automotive manufacturing (inaudible) where we retrofit a YAG laser system for roof welding.

That was an integrated system supplied by IPG's group here. It actually resulted in the throughput of vehicles on that production line doubling from 30 cars to 60. So it's really focused on different welding and specialty applications. There are systems using thulium for processing plastic that we've also developed internally. The key things I think to understand, Mark, some of this also is driven by our customers and it's also driven by IPG.

We develop a lot of these applications. And we don't see why we should sort of hand over the secret sauce of the applications to integrators within the industry and allow them to make an (inaudible). We think that we can enhance and more fully develop the technology within the company so that it doesn't just reside within the optical components but it continues to be expanded in the applications and other specialty areas around motion technology or (inaudible) handling.

Valentin Gapontsev

And the (inaudible) companies prepare to have these complete solution and don't like to (inaudible) the project to many subcontractors. They prefer to get complete solution including installation from one supplier. And we're ready to work with such large customers and we have now many products that require (inaudible) and we ready now to meet their requirements and expectations.

Operator

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

Jiwon Lee - Sidoti and Company

Thank you and good morning. Just looking at your Asian sales, the sequential improvement there seems to be driven by the recoveries in China. And as the order rate continues to rise there would the June quarter revenue expectation be kind of the all time high? And I have a quick follow-up question.

Tim Mammen

I have not given specifically whether China is going to be an all time high. Are we going to continue to see a continued improvement in growth sequentially in (inaudible). I haven't given any specific guidance as to whether it will be a record quarter or not there, Jiwon.

Jiwon Lee - Sidoti and Company

Okay.

Tim Mammen

It'll be one of the components that drives the improvement in revenue reflected in the guidance range but it's not the only one.

Jiwon Lee - Sidoti and Company

And how should we be thinking about the potential threat from high power direct (inaudible)?

Tim Mammen

We continue to believe that direct diode lasers have an inferior beam quality and reliability to our fiber laser primarily because they're pumped by diode bars. There's a lot of talk and there has been a lot of talk in the industry for the last two years that direct diode lasers are going to be a growing area. Most of the people who test a diode laser against an IPG laser find that the better beam quality and improved performance of the fiber means that the processing speeds and cost savings they can achieve are substantially improved.

So we think that this is an overstated benefit of diode lasers. The beam quality even though it continues to improve a little bit just doesn’t enable the processing speeds and quality that can be achieved with fiber. Most people who like to talk about diode lasers talk about them because they're not capable of producing fiber lasers.

Valentin Gapontsev

And I can say we produce both fiber laser and diode laser. We (inaudible) with a diode system, direct diode system than any manufacturer out there today. But fiber for us to compare to diode much, much better (inaudible) including efficiency the same. Including price – no price benefit from diode. We don't see ourselves because we can compare. We have both of them and we advise all our customers to use fiber not diode but if they insist, we will also ship them diode. But fiber is much better. Fiber (inaudible) if fiber is much better. It's our position in the market.

Operator

Our final question comes from the line of Arthur Weiss with Lord Abbott. Please proceed with your question.

Arthur Weiss - Lord Abbott

Yes. I apologize if you've covered this but if there's a country that is in need of high efficient fiber lasers it's Japan. And it didn't sound like what I would expect would be greater demand there is showing its head yet. Can you comment on that?

Tim Mammen

I think we had a particularly strong quarter a year ago as a comparative. The actual outlook for Japan for the remainder of the year is pretty strong, Arthur. There are a lot of I think five OEM customers producing cutting equipment who have recently qualified the fiber laser. Not many of them have actually introduced their equipment yet.

That's expected to happen in Q2. There are a lot of research projects. Example, we just got an order for a 30-KW laser ongoing for materials processing. We also expect demand into the automotive industry, the large manufacturers there to ramp (inaudible) braising and welding applications.

You're absolutely right though, fiber with the electrical efficiency and performer benefits of that and particularly at high power, it's been one of our strongest markets over the last eight years since we introduced the high power lasers there. So Q1 is not necessarily reflective of the expectations going forward. Our sales and general manager in Japan put in actually an aggressive budget for total sales growth this year.

Valentin Gapontsev

And our sales here in Japan was $41 million (inaudible) support or (inaudible) to double the sales in Japan with (inaudible) such numbers.

Operator

We have reached the end of the Q&A session. I will now turn the conference back over to Dr. Gapontsev for any closing or additional remarks.

Valentin Gapontsev

Okay. I want to thank you again for participating in our conference call and your interest in IPG. We look forward to reporting continued growth at the end of Q2. Have a good day and good-bye.

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