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IPG PHOTONICS CORP - Quarter Report: 2013 September (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________
FORM 10-Q
__________________________________________
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-33155 
IPG PHOTONICS CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
04-3444218
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
 
 
50 Old Webster Road,
Oxford, Massachusetts
01540
(Address of principal executive offices)
(Zip code)
(508) 373-1100
(Registrant’s telephone number, including area code)
__________________________________________ 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ý    NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ý    NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer
ý
  
Accelerated Filer
¨
Non-Accelerated Filer
¨
  
Smaller Reporting Company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  ý
As of November 5, 2013, there were 51,680,453 shares of the registrant’s common stock issued and outstanding.



TABLE OF CONTENTS
 
 
Page
EX-12.1 STATEMENT RE COMPUTATION OF EARNINGS TO FIXED CHARGES
 
EX-31.1 CERTIFICATION OF CEO PURSUANT TO RULE 13a-14(a)
 
EX-31.2 CERTIFICATION OF CFO PURSUANT TO RULE 13a-14(a)
 
EX-32 CERTIFICATION OF CEO AND CFO PURSUANT TO SECTION 1350
 
EX-101.INS XBRL INSTANCE DOCUMENT
 
EX-101.SCH XBRL TAXONOMY EXTENSION SCHEMA
 
EX-101.CAL XBRL TAXONOMY EXTENSION CALCULATION LINKBASE
 
EX-101.LAB XBRL TAXONOMY EXTENSION LABEL LINKBASE
 
EX-101.PRE XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE
 
EX-101.DEF XBRL TAXONOMY EXTENSION DEFINITION LINKBASE
 



Table of Contents

PART I-FINANCIAL INFORMATION

ITEM 1. UNAUDITED INTERIM FINANCIAL STATEMENTS

IPG PHOTONICS CORPORATION
CONSOLIDATED BALANCE SHEETS
 
September 30,
 
December 31,
 
2013
 
2012
 
(In thousands, except share
and per share data)
ASSETS
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
398,355

 
$
384,053

Accounts receivable, net
120,640

 
96,630

Inventories
171,268

 
139,618

Prepaid income taxes and income taxes receivable
17,326

 
13,071

Prepaid expenses and other current assets
30,072

 
18,639

Deferred income taxes, net
11,547

 
12,948

Total current assets
749,208

 
664,959

DEFERRED INCOME TAXES, NET
6,100

 
2,107

GOODWILL
455

 
2,898

INTANGIBLE ASSETS, NET
10,131

 
7,510

PROPERTY, PLANT AND EQUIPMENT, NET
236,507

 
210,563

OTHER ASSETS
7,395

 
7,461

TOTAL
$
1,009,796

 
$
895,498

LIABILITIES AND EQUITY
CURRENT LIABILITIES:
 
 
 
Revolving line-of-credit facilities
$
1,547

 
$
2,442

Current portion of long-term debt
1,333

 
1,505

Accounts payable
14,293

 
17,783

Accrued expenses and other liabilities
59,553

 
51,451

Deferred income taxes, net
2,050

 
9,831

Income taxes payable
27,031

 
42,443

Total current liabilities
105,807

 
125,455

DEFERRED INCOME TAXES AND OTHER LONG-TERM LIABILITIES
16,635

 
13,102

LONG-TERM DEBT, NET OF CURRENT PORTION
11,667

 
14,014

Total liabilities
134,109

 
152,571

COMMITMENTS AND CONTINGENCIES (NOTE 12)

 

IPG PHOTONICS CORPORATION STOCKHOLDERS’ EQUITY:
 
 
 
Common stock, $0.0001 par value, 175,000,000 shares authorized; 51,604,568 shares issued and outstanding at September 30, 2013; 51,359,247 shares issued and outstanding at December 31, 2012
5

 
5

Additional paid-in capital
526,481

 
511,039

Retained earnings
354,162

 
234,977

Accumulated other comprehensive loss
(4,961
)
 
(3,094
)
Total IPG Photonics Corporation stockholders’ equity
875,687

 
742,927

TOTAL
$
1,009,796

 
$
895,498

See notes to consolidated financial statements.

1

Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except per share data)
NET SALES
$
172,152

 
$
156,379

 
$
482,175

 
$
417,498

COST OF SALES
79,339

 
70,420

 
223,799

 
187,945

GROSS PROFIT
92,813

 
85,959

 
258,376

 
229,553

OPERATING EXPENSES:
 
 
 
 
 
 
 
Sales and marketing
6,801

 
5,785

 
19,514

 
16,771

Research and development
11,501

 
7,762

 
30,782

 
22,131

General and administrative
13,175

 
10,609

 
37,814

 
29,294

Loss (gain) on foreign exchange
1,563

 
1,796

 
972

 
(272
)
Total operating expenses
33,040

 
25,952

 
89,082

 
67,924

OPERATING INCOME
59,773

 
60,007

 
169,294

 
161,629

OTHER INCOME (EXPENSE), Net:
 
 
 
 
 
 
 
Interest income (expense), net
63

 
55

 
(25
)
 
541

Other income (expense), net
218

 
205

 
49

 
(981
)
Total other income (expense)
281

 
260

 
24

 
(440
)
INCOME BEFORE PROVISION FOR INCOME TAXES
60,054

 
60,267

 
169,318

 
161,189

PROVISION FOR INCOME TAXES
(17,716
)
 
(17,832
)
 
(50,133
)
 
(48,357
)
NET INCOME
42,338

 
42,435

 
119,185

 
112,832

LESS: NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS

 

 

 
2,740

NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION
$
42,338

 
$
42,435

 
$
119,185

 
$
110,092

NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION PER SHARE:
 
 
 
 
 
 
 
Basic
$
0.82

 
$
0.83

 
$
2.32

 
$
2.20

Diluted
$
0.81

 
$
0.81

 
$
2.28

 
$
2.16

WEIGHTED AVERAGE SHARES OUTSTANDING:
 
 
 
 
 
 
 
Basic
51,495

 
51,090

 
51,474

 
50,204

Diluted
52,367

 
52,102

 
52,346

 
51,281

See notes to consolidated financial statements.


2

Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
(In thousands)
Net income
$
42,338

 
$
42,435

 
$
119,185

 
$
112,832

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Translation adjustments
11,892

 
10,479

 
(2,094
)
 
3,676

Unrealized gain on derivatives
53

 
24

 
227

 
130

Total other comprehensive income (loss)
11,945

 
10,503

 
(1,867
)
 
3,806

Comprehensive income
54,283

 
52,938

 
117,318

 
116,638

Comprehensive income attributable to noncontrolling interest & redeemable noncontrolling interest

 

 

 
1,908

Comprehensive income attributable to IPG Photonics Corporation
$
54,283

 
$
52,938

 
$
117,318

 
$
114,730

See notes to consolidated financial statements.


3

Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Nine Months Ended September 30,
 
2013
 
2012
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
119,185

 
$
112,832

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
23,414

 
19,168

Deferred income taxes
(7,591
)
 
2,705

Stock-based compensation
8,604

 
6,358

Gains on foreign currency transactions
972

 
1,484

Other
369

 
38

Provisions for inventory, warranty & bad debt
18,203

 
14,762

Changes in assets and liabilities that (used) provided cash:
 
 
 
Accounts receivable
(26,942
)
 
(36,514
)
Inventories
(43,705
)
 
(17,050
)
Prepaid expenses and other current assets
(3,478
)
 
(3,335
)
Accounts payable
(2,008
)
 
2,170

Accrued expenses and other liabilities
2,734

 
(1,281
)
Income and other taxes payable
(25,186
)
 
19,038

Tax benefit from exercise of employee stock options
(3,610
)
 
(3,870
)
Net cash provided by operating activities
60,961

 
116,505

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property, plant and equipment
(48,333
)
 
(51,715
)
Proceeds from sales of property, plant and equipment
202

 

Proceeds from short-term investments

 
25,452

Acquisition of businesses
(5,555
)
 
(11,596
)
Other
442

 
(313
)
Net cash used in investing activities
(53,244
)
 
(38,172
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from line-of-credit facilities
14,124

 
9,647

Payments on line-of-credit facilities
(15,019
)
 
(11,605
)
Purchase of noncontrolling interests

 
(700
)
Purchase of redeemable noncontrolling interests

 
(55,400
)
Principal payments on long-term borrowings
(2,519
)
 
(1,848
)
Exercise of employee stock options and issuances under employee stock purchase plan
3,228

 
4,275

Tax benefit from exercise of employee stock options
3,610

 
3,870

Proceeds from follow-on public offering, net of offering expenses

 
167,963

Net cash provided by financing activities
3,424

 
116,202

EFFECT OF CHANGES IN EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
3,161

 
(2,200
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
14,302

 
192,335

CASH AND CASH EQUIVALENTS — Beginning of period
384,053

 
180,234

CASH AND CASH EQUIVALENTS — End of period
$
398,355

 
$
372,569

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for interest
$
190

 
$
553

Cash paid for income taxes
$
74,107

 
$
20,967

Non-cash transactions:
 
 
 
Demonstration units transferred from inventory to other assets
$
3,185

 
$
2,098

Amounts related to acquisition of businesses included in accounts payable and accrued expenses and other long-term liabilities
$

 
$
2,444

Additions to property, plant and equipment included in accounts payable
$
679

 
$
545

See notes to consolidated financial statements.

4

Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY
 
 
Nine Months Ended September 30,
 
2013
 
2012
 
(In thousands, except share and per share data)
 
Shares
 
Amount
 
Shares
 
Amount
COMMON STOCK
 
 
 
 
 
 
 
Balance, beginning of year
51,359,247

 
$
5

 
47,616,115

 
$
5

Exercise of stock options
231,408

 

 
385,428

 

Common stock issued under employee stock purchase plan
13,913

 

 
18,654

 

Common stock issued in a public offering

 

 
3,250,000

 

Balance, end of period
51,604,568

 
5

 
51,270,197

 
5

ADDITIONAL PAID-IN CAPITAL
 
 
 
 
 
 
 
Balance, beginning of year
 
 
511,039

 
 
 
332,585

Stock-based compensation
 
 
8,604

 
 
 
6,358

Exercise of stock options and related tax benefit from exercise
 
 
6,120

 
 
 
7,585

Common stock issued under employee stock purchase plan
 
 
718

 
 
 
560

Purchase of redeemable noncontrolling interests ("NCI")
 
 

 
 
 
(7,794
)
Common stock issued in follow-on public offering
 
 

 
 
 
167,964

Premium on purchase of NCI
 
 

 
 
 
(404
)
Balance, end of period
 
 
526,481

 
 
 
506,854

RETAINED EARNINGS
 
 
 
 
 
 
 
Balance, beginning of year
 
 
234,977

 
 
 
122,833

Net income attributable to IPG Photonics Corporation
 
 
119,185

 
 
 
110,092

Adjustments to redemption value of redeemable NCI
 
 

 
 
 
493

Balance, end of period
 
 
354,162

 
 
 
233,418

ACCUMULATED OTHER COMPREHENSIVE LOSS
 
 
 
 
 
 
 
Balance, beginning of year
 
 
(3,094
)
 
 
 
(12,100
)
Translation adjustments
 
 
(2,094
)
 
 
 
3,676

Unrealized gain on derivatives, net of tax
 
 
227

 
 
 
130

Purchase of NCI & redeemable NCI
 
 

 
 
 
(3,243
)
Attribution to NCI & redeemable NCI
 
 

 
 
 
832

Balance, end of period
 
 
(4,961
)
 
 
 
(10,705
)
TOTAL IPG PHOTONICS CORPORATION STOCKHOLDERS’ EQUITY
 
 
875,687

 
 
 
729,572

NONCONTROLLING INTERESTS
 
 
 
 
 
 
 
Balance, beginning of year
 
 

 
 
 
287

Sale of NCI
 
 

 
 
 
(700
)
Other comprehensive income attributable to NCI
 
 

 
 
 
9

Premium on purchase of NCI
 
 

 
 
 
404

Balance, end of period
 
 

 
 
 

TOTAL STOCKHOLDERS' EQUITY
 
 
$
875,687

 
 
 
$
729,572

See notes to consolidated financial statements.

5

Table of Contents

IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared by IPG Photonics Corporation, or “IPG”, “we”, “our”, “its” or “the Company”. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The consolidated financial statements include the Company’s accounts and those of its subsidiaries. All intercompany balances have been eliminated in consolidation. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
In the opinion of the Company’s management, the unaudited financial information for the interim periods presented reflects all adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows. The results reported in these consolidated financial statements are not necessarily indicative of results that may be expected for the entire year.
The Company has evaluated subsequent events through the time of filing this Quarterly Report on Form 10-Q with the SEC.
2. RECENT ACCOUNTING PRONOUNCEMENTS
Accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require
adoption until a future date are not expected to have a material impact on the Company's financial statements upon adoption.

3. INVENTORIES
Inventories consist of the following:
 
 
September 30,
 
December 31,
 
2013
 
2012
Components and raw materials
$
56,738

 
$
53,436

Work-in-process
60,391

 
46,240

Finished goods
54,139

 
39,942

Total
$
171,268

 
$
139,618

The Company recorded inventory provisions totaling $4,286 and $2,486 for the three months ended September 30, 2013 and 2012, respectively, and $7,842 and $6,129 for the nine months ended September 30, 2013 and 2012, respectively. These provisions relate to the recoverability of the value of inventories due to technological changes and excess quantities. These provisions are reported as a reduction to components and raw materials and finished goods.
4. ACCRUED EXPENSES AND OTHER LIABLILITES
Accrued expenses and other liabilities consist of the following:
 
 
September 30,
 
December 31,
 
2013
 
2012
Accrued compensation
$
24,863

 
$
21,972

Customer deposits and deferred revenue
19,929

 
17,174

Current portion of accrued warranty
7,697

 
7,838

Other
7,064

 
4,467

Total
$
59,553

 
$
51,451





6

Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


5. FINANCING ARRANGEMENTS
The Company’s borrowings under existing financing arrangements consist of the following:
 
 
September 30,
 
December 31,
 
2013
 
2012
Revolving line-of-credit facilities:
 
 
 
European overdraft facilities
$
820

 
$
1,135

Euro line of credit
727

 
956

U.S. line of credit

 
351

Total
$
1,547

 
$
2,442

Term debt:
 
 
 
U.S. long-term note
$
13,000

 
$
14,000

Other notes payable

 
1,519

Less: current portion
(1,333
)
 
(1,505
)
Total long-term debt
$
11,667

 
$
14,014

The U.S. and Euro lines of credit are available to certain foreign subsidiaries and allow for borrowings in the local currencies of those subsidiaries.

6. NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION PER SHARE
The following table sets forth the computation of diluted net income attributable to IPG Photonics Corporation per share:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Net income attributable to IPG Photonics Corporation
$
42,338

 
$
42,435

 
$
119,185

 
$
110,092

Adjustments to redemption value of redeemable noncontrolling interests

 

 

 
493

Net income attributable to common stockholders
42,338

 
42,435

 
119,185

 
110,585

Weighted average shares
51,495

 
51,090

 
51,474

 
50,204

Dilutive effect of common stock equivalents
872

 
1,012

 
872

 
1,077

Diluted weighted average common shares
52,367

 
52,102

 
52,346

 
51,281

Basic net income attributable to IPG Photonics Corporation per share
$
0.82

 
$
0.83

 
$
2.32

 
$
2.19

Adjustments to redemption value of redeemable noncontrolling interests

 

 

 
0.01

Basic net income attributable to common stockholders
$
0.82

 
$
0.83

 
$
2.32

 
$
2.20

Diluted net income attributable to IPG Photonics Corporation per share
$
0.81

 
$
0.81

 
$
2.28

 
$
2.15

Adjustments to redemption value of redeemable noncontrolling interests

 

 

 
0.01

Diluted net income attributable to common stockholders
$
0.81

 
$
0.81

 
$
2.28

 
$
2.16

The computation of diluted weighted average common shares excludes options to purchase 31,000 shares and 75,000 shares for the three months ended September 30, 2013 and 2012, respectively, and 210,000 shares and 9,000 shares for the nine months ended September 30, 2013 and 2012, respectively, because the effect would be anti-dilutive.

The Company computes net income per share in accordance with ASC 260-Earnings Per Share. Under the provisions of ASC 260, the Company is required to present basic and diluted earnings per share information separately for each class of equity instruments that participate in any income distribution with primary equity instruments. The Company calculates earnings per share in periods where a class of common stock was redeemable for other than fair value through the application of the two-class method. Until June 29, 2012, the Company had redeemable noncontrolling interests reported in the accompanying consolidated financial statements related to a 22.5% minority interest of the Company's subsidiary, NTO IRE-Polus.


7

Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


7. DERIVATIVE FINANCIAL INSTRUMENTS
The Company’s primary market exposures are to interest rates and foreign exchange rates. The Company uses certain derivative financial instruments to help manage these exposures. The Company executes these instruments with financial institutions it judges to be credit-worthy. The Company does not hold or issue derivative financial instruments for trading or speculative purposes.
The Company recognizes all derivative financial instruments as either assets or liabilities at fair value in the consolidated balance sheets. The Company has used foreign currency forward contracts as cash flow hedges of forecasted intercompany settlements denominated in foreign currencies of major industrial countries. The Company has no outstanding foreign currency forward contracts. The Company has interest rate swaps that are classified as a cash flow hedge of its variable rate debt. The Company has no derivatives that are not accounted for as a hedging instrument.
Cash flow hedges The Company’s cash flow hedges are interest rate swaps under which it pays fixed rates of interest. The fair value amounts in the consolidated balance sheet were:
 
 
Notional Amounts1
 
Other Assets
 
Other Long-Term Liabilities
 
September 30,
 
December 31,
 
September 30,
 
December 31,
 
September 30,
 
December 31,
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Interest rate swap
$
13,000

 
$
14,000

 
$

 
$

 
$
493

 
$
855

Total
$
13,000

 
$
14,000

 
$

 
$

 
$
493

 
$
855

  (1) Notional amounts represent the gross contract/notional amount of the derivatives outstanding.
The derivative gains (losses) in the consolidated statements of income related to the Company’s interest rate swap contracts were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Effective portion recognized in other comprehensive gain (loss), pretax:
 
 
 
 
 
 
 
Interest rate swap
$
186

 
$
219

 
$
733

 
$
667

Effective portion reclassified from other comprehensive gain (loss) to interest expense, pretax:
 
 
 
 
 
 
 
Interest rate swap
$
(101
)
 
$
(140
)
 
$
(371
)
 
$
(436
)
Ineffective portion recognized in income:
 
 
 
 
 
 
 
Interest rate swap
$

 
$

 
$

 
$

8. FAIR VALUE MEASUREMENTS
The Company’s financial instruments consist of cash equivalents, accounts receivable, auction rate securities, accounts payable, drawings on revolving lines of credit, long-term debt and certain derivative instruments.
The valuation techniques used to measure fair value are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy: Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The carrying amounts of cash equivalents, accounts receivable, accounts payable and drawings on revolving lines of credit are considered reasonable estimates of their fair market value, due to the short maturity of these instruments or as a result of the competitive market interest rates, which have been negotiated. If measured at fair value, accounts receivable and accounts payable would be classified as Level 3 and drawings on the revolving lines of credit would be classified as Level 2.
The following table presents information about the Company’s cash equivalents and assets and liabilities measured at fair value:

8

Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


 
 
 
 Fair Value Measurements at September 30, 2013
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Cash equivalents
$
219,248

 
$
219,248

 
$

 
$

Auction rate securities
1,118

 

 

 
1,118

Total assets
$
220,366

 
$
219,248

 
$

 
$
1,118

Liabilities
 
 
 
 
 
 
 
Contingent purchase consideration
$
375

 
$

 
$

 
$
375

Interest rate swaps
493

 

 
493

 

Total liabilities
$
868

 
$

 
$
493

 
$
375

 
 
 
 
 
 
 
 
 
 
 
 Fair Value Measurements at December 31, 2012
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Cash equivalents
$
237,049

 
$
237,049

 
$

 
$

Auction rate securities
1,112

 

 

 
1,112

Total assets
$
238,161

 
$
237,049

 
$

 
$
1,112

Liabilities
 
 
 
 
 
 
 
Contingent purchase consideration
$
3,023

 
$

 
$

 
$
3,023

Interest rate swaps
855

 

 
855

 

Total liabilities
$
3,878

 
$

 
$
855

 
$
3,023

The fair value of the auction rate securities considered prices observed in inactive secondary markets for the securities held by the Company.
The fair value of accrued contingent consideration incurred was determined using an income approach at the acquisition date and reporting date. That approach is based on significant inputs that are not observable in the market. Key assumptions include assessing the probability of meeting certain milestones required to earn the contingent consideration.
During the second quarter of 2013, the Company reduced the fair value of the accrued contingent purchase consideration associated with a 2012 purchase of a manufacturer of laser-based systems by $2,463 as management assessed that there was no possibility that any earn-out amounts included in the purchase agreement with the former owners would be achieved (see Note 9). During the third quarter of 2013, the Company reduced the fair value of the accrued contingent purchase consideration associated with a 2011 purchase of a technology developer by $196. These adjustments are included in total other (expense) income, net.
During the first quarter of 2012, the Company determined a final payment of contingent consideration and other related matters in association with the purchase of a technology company in 2010, increased the liability by $987 and reclassed the revised obligation to accrued expenses. The adjustment was included in total other (expense) income, net. As the payment was then fixed, it was no longer measured at its fair value.
Also, during the nine months ended September 30, 2012, the Company terminated a warrant held by a former investor in NTO IRE-Polus as part of the redemption of the investor's redeemable noncontrolling interest for its fair value of $77.








9

Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Auction Rate Securities
 
 
 
 
 
 
 
Balance, beginning of period
$
1,116

 
$
1,108

 
$
1,112

 
$
1,104

Period transactions

 

 

 

Change in fair value
2

 
2

 
6

 
6

Redeemed by issuers at par

 

 

 

Balance, end of period
$
1,118

 
$
1,110

 
$
1,118

 
$
1,110

Contingent Purchase Consideration
 
 
 
 
 
 
 
Balance, beginning of period
$
559

 
$
597

 
$
3,023

 
$
999

Period transactions

 
1,847

 

 
1,847

Adjustment for determination of final payment

 

 

 
987

Change in fair value
(184
)
 

 
(2,648
)
 
28

Reclass of determined final payment

 

 

 
(1,417
)
Balance, end of period
$
375

 
$
2,444

 
$
375

 
$
2,444

Warrant
 
 
 
 
 
 
 
Balance, beginning of period
$

 
$

 
$

 
$
77

Period transactions

 

 

 
(77
)
Change in fair value

 

 

 

Balance, end of period
$

 
$

 
$

 
$

9. GOODWILL AND INTANGIBLES
The following table sets forth the changes in the carrying amount of goodwill for the nine months ended September 30, 2013:
 
Amounts
Balance at January 1
$
2,898

Adjustment
(95
)
Impairment
(2,803
)
Total goodwill arising from acquisition
455

 Balance at September 30
$
455

Intangible assets, subject to amortization, consisted of the following:
 
 
September 30, 2013
 
December 31, 2012
 
 
Gross  Carrying
Amount
Accumulated
Amortization
Net  Carrying
Amount
Weighted-
Average  Lives
Gross  Carrying
Amount
Accumulated
Amortization
Net  Carrying
Amount
Weighted-
Average  Lives
 
 
 
 
 
 
 
 
 
Patents
$
4,667

$
(4,066
)
$
601

6 Years
$
4,664

$
(4,193
)
$
471

6 Years
Customer relationships
4,054

(3,101
)
953

5 Years
3,993

(2,363
)
1,630

5 Years
Production know-how
7,029

(1,494
)
5,535

8 Years
2,514

(656
)
1,858

9 Years
Technology, trademark and tradename
4,249

(1,207
)
3,042

8 Years
4,229

(678
)
3,551

8 Years
 
$
19,999

$
(9,868
)
$
10,131

 
$
15,400

$
(7,890
)
$
7,510

 
On March 13, 2013, the Company acquired the working capital and long term assets of Mobius Photonics Inc., a manufacturer of high-power pulsed ultra-violet ("UV") fiber lasers for micro-machining and fine processing applications. As a result of the acquisition, the Company recorded intangible assets of $4,480 of which all related to technology and know-how. Additionally, the Company recorded $455 of goodwill related to expected synergies for the Company's expansion of product offerings with UV and short pulsed fiber lasers.

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IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)



Amortization expense for the three months ended September 30, 2013 and 2012 was $596 and $572, respectively. Amortization expense for the nine months ended September 30, 2013 and 2012 was $1,705 and $1,669, respectively.The estimated future amortization expense for intangibles for the remainder of 2013 and subsequent years is as follows:
2013
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
$596
 
$2,047
 
$1,637
 
$1,451
 
$1,451
 
$2,949
 
$10,131
In accordance with ASC 350-Intangibles-Goodwill and Other, the Company assesses the impairment of its long-lived assets including its definite-lived intangible assets and goodwill, at least annually for goodwill, and whenever changes in events or circumstances indicate that the carrying value of such assets may not be recoverable. During each reporting period, the Company assesses for factors that may be present which would cause an impairment review.
 During the second quarter of 2013, the Company undertook an impairment analysis of long-lived assets and goodwill related to IPG Microsystems ("IPGM"), the assets of which were acquired in September 2012. The Company undertook the analysis because of certain qualitative factors including a decline in sales and bookings due to underlying weakness in the markets IPGM serves.
The Company performed an impairment analysis to assess whether there was impairment of long-lived assets of IPGM including identifiable intangibles included in the table above using the guidance in ASU 360-10-35. The Company concluded that no impairment existed as the undiscounted cash flows from IPGM are forecasted to be greater than the carrying value of identified long-lived assets.
The Company carried out the two-step goodwill impairment test in accordance with the provisions of ASU 350-20-35. That analysis indicated that the fair value of IPGM, based on a discounted cash flow analysis, was less than the carrying value. The implied value of goodwill, as measured in step 2, was zero. Accordingly, the Company adjusted the value of goodwill associated with IPGM to $0. The adjustment was included in total other (expense) income, net.
10. PRODUCT WARRANTIES
The Company typically provides one to three-year parts and service warranties on lasers and amplifiers. Most of the Company’s sales offices provide support to customers in their respective geographic areas. Warranty reserves have generally been sufficient to cover product warranty repair and replacement costs. The following table summarizes product warranty activity recorded during the nine months ended September 30, 2013 and 2012.
 
 
2013
 
2012
Balance at January 1
$
10,714

 
$
8,631

Provision for warranty accrual
7,867

 
6,548

Warranty claims and other reductions
(4,977
)
 
(4,775
)
Foreign currency translation
136

 
(14
)
 Balance at September 30
$
13,740

 
$
10,390

Accrued warranty reported in the accompanying consolidated financial statements as of September 30, 2013 and December 31, 2012 consist of $7,697 and $7,838 in accrued expenses and other liabilities and $6,043 and $2,876 in other long-term liabilities, respectively.
11. INCOME TAXES
A reconciliation of the total amounts of unrecognized tax benefits is as follows:
 
 
2013
 
2012
Balance at January 1
$
5,392

 
$
4,509

Reductions of prior period positions
(63
)
 

Additions for tax positions in prior period

 

Additions for tax positions in current period
293

 
556

 Balance at September 30
$
5,622

 
$
5,065


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IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


Substantially all of the liability for uncertain tax benefits related to various federal, state and foreign income tax matters, would benefit the Company’s effective tax rate, if recognized.
12. COMMITMENTS AND CONTINGENCIES
From time to time, the Company may be involved in disputes and legal proceedings in the ordinary course of its business. These proceedings may include allegations of infringement of intellectual property, commercial disputes and employment matters. In August 2013, the Company was sued for misappropriation of certain trade secrets, unfair trade practices, and correction of inventorship on a patent owned by the Company related to beam couplers and beam switches. The plaintiff seeks damages in an unspecified amount, double damages for misappropriation of trade secrets and treble damages for unfair trade practices. The Company has filed to dismiss the trade secret misappropriation claims. The Company intends to vigorously defend the claims. At this time, no loss is deemed probable and no amounts have been accrued in respect of this contingency.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward looking statements that are based on management’s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements. See “Cautionary Statement Regarding Forward-Looking Statements.”
Overview
We develop and manufacture a broad line of high-performance fiber lasers, fiber amplifiers and diode lasers that are used in numerous applications, primarily in materials processing. We sell our products globally to original equipment manufacturers ("OEMs"), system integrators and end users. We market our products internationally primarily through our direct sales force.
We are vertically integrated such that we design and manufacture most of our key components used in our finished products, from semiconductor diodes to optical fiber preforms, finished fiber lasers and amplifiers. We also manufacture certain complementary products used with our lasers, including optical delivery cables, fiber couplers, beam switches, optical heads and chillers. In addition, we offer laser-based systems for certain markets and applications.
Factors and Trends That Affect Our Operations and Financial Results
In reading our financial statements, you should be aware of the following factors and trends that our management believes are important in understanding our financial performance.
Net sales. We derive net sales primarily from the sale of fiber lasers and amplifiers. We also sell diode lasers, communications systems, laser systems and complementary products. We sell our products through our direct sales organization and our network of distributors and sales representatives, as well as system integrators. We sell our products to OEMs that supply materials processing laser systems, communications systems and medical laser systems to end users. We also sell our products to end users that build their own systems which incorporate our products or use our products as an energy or light source. Our scientists and engineers work closely with OEMs, systems integrators and end users to analyze their system requirements and match appropriate fiber laser or amplifier specifications. Our sales cycle varies substantially, ranging from a period of a few weeks to as long as one year or more, but is typically several months.
Sales of our products generally are recognized upon shipment, provided that no obligations remain and collection of the receivable is reasonably assured. Our sales typically are made on a purchase order basis rather than through long-term purchase commitments.
We develop our products to standard specifications and use a common set of components within our product architectures. Our major products are based upon a common technology platform. We continually enhance these and other products by improving their components and developing new components and new product designs.

The average selling prices of our products generally decrease as the products mature. These decreases result from factors such as decreased manufacturing costs and increases in unit volumes, increased competition, the introduction of new products and market share considerations. In the past, we have lowered our selling prices in order to penetrate new markets and applications. Furthermore, we may negotiate discounted selling prices from time to time with certain customers that purchase multiple units.
Gross margin. Our total gross margin in any period can be significantly affected by total net sales in any period, by product mix, that is, the percentage of our revenue in the period that is attributable to higher or lower-power products, by sales mix between OEM customers and other customers, by mix of sales in different geographies and by other factors, some of which are not under our control.
Our product mix affects our margins because the selling price per watt is generally higher for low, mid-power devices and certain specialty products than for high-power devices sold in large volumes. The overall cost of high-power lasers may be partially offset by improved absorption of fixed overhead costs associated with sales of larger volumes of higher-power products because they use a greater number of optical components and drive economies of scale in manufacturing. Also, the profit margins on systems can be lower than margins for our laser and amplifier sources, depending on the configuration, volume and competitive forces, among other factors.
The mix of sales between OEM customers and other customers can affect gross margin because we provide sales price discounts on products based on the number of units ordered. As the number of OEM customers increases and the number of

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units ordered increases, the average sales price per unit will be reduced. We expect that the impact of reduced sales price per unit will be offset by the manufacturing efficiency provided by high unit volume orders, but the timing and extent of achieving these efficiencies may not always match the mix of sales in any given time period.
A high proportion of our costs is fixed so they are generally difficult or slow to adjust in response to changes in demand. In addition, our fixed costs increase as we expand our capacity. If we expand capacity faster than is required by sales growth, gross margins could be negatively affected. Gross margins generally decline if production volumes are lower as a result of a decrease in sales or a reduction in inventory because the absorption of fixed manufacturing costs will be reduced. Gross margins generally improve when the opposite occurs. If both sales and inventory decrease in the same period, the decline in gross margin may be greater if we cannot reduce fixed costs or choose not to reduce fixed costs to match the decrease in the level of production. If we experience a decline in sales that reduces absorption of our fixed costs, or if we have production issues or inventory write-downs, our gross margins will be negatively affected.

We also regularly review our inventory for items that are slow-moving, have been rendered obsolete or determined to be excess. Any write-off of such slow-moving, obsolete or excess inventory affects our gross margins. For example, we recorded provisions for inventory totaling $4.2 million and $2.5 million for the three months ended September 30, 2013 and 2012, respectively, and $7.8 million and $6.1 million for the nine months ended September 30, 2013 and 2012, respectively, and $8.2 million, $6.1 million and $2.7 million for the years ended December 31, 2012, 2011 and 2010, respectively.
Sales and marketing expense. We expect to continue to expand our worldwide direct sales organization, build and expand applications centers, hire additional personnel involved in marketing in our existing and new geographic locations, increase the number of units for demonstration purposes and otherwise increase expenditures on sales and marketing activities in order to support the growth in our net sales. As such, we expect that our sales and marketing expenses will increase in the aggregate.
Research and development expense. We plan to continue to invest in research and development to improve our existing components and products and develop new components, products and systems. The amount of research and development expense we incur may vary from period to period. In general, if net sales continue to increase we expect research and development expense to increase in the aggregate.
General and administrative expense. We expect our general and administrative expenses to increase as we continue to invest in systems and resources to support our worldwide operations. Legal expenses vary from quarter to quarter based primarily upon the level of litigation and transaction activities.
Major customers. While we have historically depended on a few customers for a large percentage of our annual net sales, the composition of this group can change from year to year. Net sales derived from our five largest customers as a percentage of our net sales were 23% for the nine months ended September 30, 2013 and 16%, 17% and 19% for the full years 2012, 2011 and 2010, respectively. We seek to add new customers and to expand our relationships with existing customers. We anticipate that the composition of our significant customers will continue to change. If any of our significant customers were to substantially reduce their purchases from us, our results would be adversely affected.
Results of Operations for the three months ended September 30, 2013 compared to the three months ended September 30, 2012
Net sales. Net sales increased by $15.8 million, or 10.1%, to $172.2 million for the three months ended September 30, 2013 from $156.4 million for the three months ended September 30, 2012.
 
 
Three Months Ended September 30,
 
 
 
 
 
2013
 
2012
 
Change
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
Materials processing
$
164,101

 
95.3
%
 
$
137,725

 
88.1
%
 
$
26,376

 
19.2
 %
Other applications
8,051

 
4.7
%
 
18,654

 
11.9
%
 
(10,603
)
 
(56.8
)%
Total
$
172,152

 
100.0
%
 
$
156,379

 
100.0
%
 
$
15,773

 
10.1
 %
Sales for materials processing applications increased primarily due to higher sales of high-power, medium-power and QCW lasers used in cutting and welding applications, offset by decreased sales of pulsed lasers used in marking and engraving applications. We continue to see increased acceptance of the advantages of fiber laser technology. A growing number of OEM customers have developed cutting systems that use our high-power lasers and sales of these systems are gaining sales from gas laser systems. In addition, new welding processes using fiber lasers have been developed, increasing sales of lasers for this application, which are replacing traditional laser and non-laser welding technologies. Among other factors contributing to sales

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growth, QCW lasers are displacing lamp pumped YAG lasers with our OEM customers. Lower pulsed laser sales were attributable to high consumer electronics demand a year ago and increased competition for certain models of pulsed lasers. The decrease in other applications sales relates primarily to a decrease in sales of lasers for advanced applications in the current year following fulfillment of a large order a year ago and lower telecommunications sales in Russia and North America. Orders for certain advanced applications can be uneven and of high unit value so that they can both benefit and impact sales depending on their timing.

Cost of sales and gross margin. Cost of sales increased by $8.9 million, or 12.7%, to $79.3 million for the three months ended September 30, 2013 from $70.4 million for the three months ended September 30, 2012. Our gross margin decreased to 53.9% for the three months ended September 30, 2013 from 55.0% for the three months ended September 30, 2012. Gross margin decreased due to geographical mix of sales and an increase in sales volume to OEM customers which earn volume sales discounts. Product mix reduced gross margin due to lower sales of high brightness lasers in the quarter. High brightness lasers have a higher average selling price per watt than other products.
Sales and marketing expense. Sales and marketing expense increased by $1.0 million, or 17.6%, to $6.8 million for the three months ended September 30, 2013 from $5.8 million for the three months ended September 30, 2012, primarily as a result of increases in personnel costs and trade shows to support the increase in revenue. As a percentage of sales, sales and marketing expense increased to 4.0% for the three months ended September 30, 2013 from 3.7% for the three months ended September 30, 2012.
Research and development expense. Research and development expense increased by $3.7 million, or 48.2%, to $11.5 million for the three months ended September 30, 2013, compared to $7.8 million for the three months ended September 30, 2012, primarily as a result of increases in personnel costs and costs of material used for research and development. Of the total increase in research and development expense, $1.8 million is associated with the ongoing research and development costs of acquisitions made in the third quarter of 2012 and first quarter of 2013. Research and development continues to focus on developing new products at different wavelengths including ultra-violet ("UV"), green and mid-infrared, new pulsed products, enhancing the performance of our internally manufactured components, refining production processes to improve manufacturing yields, developing new accessories and achieving higher output powers. As a percentage of sales, research and development expense increased to 6.7% for the three months ended September 30, 2013 from 5.0% for the three months ended September 30, 2012.
General and administrative expense. General and administrative expense increased by $2.6 million, or 24.2%, to $13.2 million for the three months ended September 30, 2013 from $10.6 million for the three months ended September 30, 2012, primarily as a result of increased personnel costs, consulting costs, depreciation and premises costs and increased reserves for bad debt. Of the total increase in general and administrative expense, $0.8 million is associated with the ongoing general and administrative costs of acquisitions made in the third quarter of 2012 and first quarter of 2013. As a percentage of sales, general and administrative expense increased to 7.7% for the three months ended September 30, 2013 from 6.8% for the three months ended September 30, 2012.
Effect of exchange rates on net sales, gross profit and operating expenses. We estimate that, if exchange rates had been the same as one year ago, net sales for the three months ended September 30, 2013 would have been approximately the same, gross profit would have been approximately the same and total operating expenses would have been $0.1 million lower.
Loss (gain) on foreign exchange. We incurred a foreign exchange loss of $1.6 million for the three months ended September 30, 2013 as compared to $1.8 million loss for the three months ended September 30, 2012. The change is primarily attributable to the changes of the U.S. Dollar against the Euro, Russian Ruble, Korean Won and Chinese Yuan.
Interest income (expense), net. Interest income (expense), net remained consistent at $0.1 million of income for the three months ended September 30, 2013 and for the three months ended September 30, 2012.
Other income (expense), net. Other income (expense), net remained consistent at $0.2 million of income for the three months ended September 30, 2013 and for the three months ended September 30, 2012.
Provision for income taxes. Provision for income taxes was $17.7 million for the three months ended September 30, 2013 compared to $17.8 million for the three months ended September 30, 2012. The effective tax rates were 29.5% and 29.6% for the three months ended September 30, 2013 and 2012, respectively.
Net income attributable to IPG Photonics Corporation. Net income attributable to IPG Photonics Corporation decreased by $0.1 million to $42.3 million for the three months ended September 30, 2013 compared to $42.4 million for the three months ended September 30, 2012. Net income attributable to IPG Photonics Corporation as a percentage of our net sales

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decreased by 2.5 percentage points to 24.6% for the three months ended September 30, 2013 from 27.1% for the three months ended September 30, 2012 due to the factors described above.
Results of Operations for the nine months ended September 30, 2013 compared to the six months ended September 30, 2012
Net sales. Net sales increased by $64.7 million, or 15.5%, to $482.2 million for the nine months ended September 30, 2013 from $417.5 million for the nine months ended September 30, 2012.
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
2013
 
2012
 
Change
 
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
Materials processing
 
$
453,199

 
94.0
%
 
$
365,525

 
87.6
%
 
$
87,674

 
24.0
 %
Other applications
 
28,977

 
6.0
%
 
51,973

 
12.4
%
 
(22,996
)
 
(44.2
)%
Total
 
$
482,176

 
100.0
%
 
$
417,498

 
100.0
%
 
$
64,678

 
15.5
 %
Sales for materials processing applications increased primarily due to higher sales of high-power, medium-power and QCW lasers used in cutting and welding applications, offset by decreased sales of pulsed lasers used in marking and engraving applications. We continue to see increased acceptance of the advantages of fiber laser technology. A growing number of OEM customers have developed cutting systems that use our high-power lasers and sales of these systems are gaining sales from gas laser systems. In addition, new welding processes using fiber lasers have been developed, increasing sales of lasers for this application, which are replacing traditional laser and non-laser welding technologies. We also increased sales of QCW lasers used for cutting and welding thin sheet metal because of higher demand in consumer electronics applications and from increased OEM demand driven in part by the displacement of lamp pumped YAG lasers. Lower pulsed laser sales were attributable to high consumer electronics demand a year ago and increased competition for certain models of pulsed lasers. The decrease in other applications sales relates primarily to a decrease in sales of lasers for advanced applications in the current year following fulfillment of large orders a year ago and lower telecommunications sales in Russia and North America. Orders for certain advanced applications can be uneven and of high unit value so that they can both benefit and impact sales depending on their timing.
Cost of sales and gross margin. Cost of sales increased by $35.9 million, or 19.1%, to $223.8 million for the nine months ended September 30, 2013 from $187.9 million for the nine months ended September 30, 2012. Our gross margin decreased to 53.6% from 55.0% for the nine months ended September 30, 2013 and 2012, respectively. Gross margin decreased due to product and geographical mix of sales and an increase in sales volume to OEM customers which earn volume sales discounts. Product mix reduced gross margin due to lower sales of high brightness lasers in the nine months ended September 30, 2013. High brightness lasers have a higher average selling price per watt than other products.
Sales and marketing expense. Sales and marketing expense increased by $2.7 million, or 16.4%, to $19.5 million for the nine months ended September 30, 2013 from $16.8 million for the nine months ended September 30, 2012, primarily as a result of an increase in personnel costs, advertising and trade shows to support the increase in revenue. As a percentage of sales, sales and marketing expense remained relatively flat at 4.0% for the nine months ended September 30, 2013 and for the nine months ended September 30, 2012.
Research and development expense. Research and development expense increased by $8.7 million, or 39.1%, to $30.8 million for the nine months ended September 30, 2013, compared to $22.1 million for the nine months ended September 30, 2012, primarily as a result of increases in personnel costs and costs of material used for research and development. Included in the increase are $3.5 million of research and development costs associated with the ongoing research and development costs of companies which were acquired in the third quarter of 2012 and first quarter of 2013. Research and development continues to focus on developing new products at different wavelengths including UV, green and mid-infrared, new pulsed products, improving the electrical efficiency of high power products, enhancing the performance of our internally manufactured components, refining production processes to improve manufacturing yields, developing new accessories and achieving higher output powers. As a percentage of sales, research and development expense increased to 6.4% for the nine months ended September 30, 2013 from 5.3% for the nine months ended September 30, 2012.
General and administrative expense. General and administrative expense increased by $8.5 million, or 29.1%, to $37.8 million for the nine months ended September 30, 2013 from $29.3 million for the nine months ended September 30, 2012, primarily due to increased personnel costs, accounting and legal, travel and premises expenses. General and administrative costs increased $2.4 million due to the additions of general and administrative costs for companies acquired in the third quarter of 2012 and the first quarter of 2013. As a percentage of sales, general and administrative expense increased to 7.8% for the nine months ended September 30, 2013 from 7.0% for the nine months ended September 30, 2012.

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Effect of exchange rates on net sales, gross profit and operating expenses. We estimate that, if exchange rates had been the same as one year ago, net sales for the nine months ended September 30, 2013 would have been $1.7 million higher, gross profit would have been $0.9 million higher and total operating expenses would have been $0.2 million higher.
Loss (gain) on foreign exchange. We incurred a foreign exchange loss of $1.0 million for the nine months ended September 30, 2013 as compared to $0.3 million gain for the nine months ended September 30, 2012. The change is primarily attributable to the changes of the U.S. Dollar against the Euro, Russian Ruble, Chinese Yuan and Korean Won.
Interest income (expense), net. Interest income (expense), net decreased to $0.1 million of expense for the nine months ended September 30, 2013 compared to $0.5 million of income for the nine months ended September 30, 2012. The decrease is the result of lower interest bearing deposits as compared to the prior period.
Other income (expense), net. Other income (expense), net increased to $0.1 million of income for the nine months ended September 30, 2013 compared to $1.0 million of expense for the nine months ended September 30, 2012. Included in other income (expense), net for the nine months ended September 30, 2013 were $2.9 million goodwill impairment charge partially offset by a $2.7 million reduction in contingent consideration related to prior year acquisitions. For the nine months ended September 30, 2012, $1.1 million of expense is included related to final payments on a contingent consideration agreement from a prior acquisition.
Provision for income taxes. Provision for income taxes was $50.1 million for the nine months ended September 30, 2013 compared to $48.4 million for the nine months ended September 30, 2012, representing an effective tax rate of 29.6% and 30.0% for the nine months ended September 30, 2013 and 2012, respectively. The increase in the provision for income taxes was primarily the result of increased income before provision for income taxes. The decrease in effective rate was due primarily to the mix of income earned in various tax jurisdictions as well as the benefit of 2012 research and development credits included in the American Taxpayer Relief Act of 2012 (the “Act”) which was signed into law on January 2, 2013. Because a change in tax law is accounted for in the period of enactment, certain provisions of the Act benefiting our 2012 U.S. federal taxes, including the research and experimentation credit, could not be recognized in our 2012 financial results and instead were reflected in our first quarter 2013 financial results.
Net income attributable to IPG Photonics Corporation. Net income attributable to IPG Photonics Corporation increased by $9.1 million to $119.2 million, or 8.3% for the nine months ended September 30, 2013 compared to $110.1 million for the nine months ended September 30, 2012. Net income attributable to IPG Photonics Corporation as a percentage of our net sales decreased by 1.7 percentage point to 24.7% for the nine months ended September 30, 2013 from 26.4% for the nine months ended September 30, 2012 due to the factors described above.
Liquidity and Capital Resources
Our principal sources of liquidity as of September 30, 2013 consisted of cash and cash equivalents of $398.4 million, unused credit lines and overdraft facilities of $63.1 million and working capital (excluding cash and cash equivalents) of $245.0 million. This compares to cash and cash equivalents of $384.1 million, unused credit lines and overdraft facilities of $61.4 million and working capital (excluding cash and cash equivalents) of $155.5 million as of December 31, 2012. The increase in cash and cash equivalents of $14.3 million from December 31, 2012 relates primarily to cash provided by operating activities in the nine months ended September 30, 2013 of $61.0 million. Cash provided by financing activities of $3.4 million was partially offset by cash used in investing activities of $53.2 million which mostly relate to investments in fixed assets and an acquisition during the first quarter.
Our long-term debt consists primarily of a $13.0 million secured variable-rate note, of which $1.3 million is the current portion. This debt matures in June 2015, at which time the outstanding debt balance would be $10.7 million. The variable interest rate was fixed by means of an interest rate swap instrument.
We believe that our existing cash and marketable securities, our cash flows from operations and our existing lines of credit provides us with the financial flexibility to meet our liquidity and capital needs, as well as to complete certain acquisitions of complementary businesses and technologies. Our future long-term capital requirements will depend on many factors including our level of sales, the impact of economic environment on our sales levels, the timing and extent of spending to support development efforts, the expansion of the global sales and marketing activities, the timing and introductions of new products, the need to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products.
The following table details our line-of-credit facilities as of September 30, 2013: 

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Description
 
Available Principal
 
Interest Rate
 
Maturity
 
Security
U.S. Revolving Line of Credit (1)
 
Up to $35.0 million
 
LIBOR plus 1.125% to 1.625%, depending on our performance
 
June 2015
 
Unsecured
Euro Credit Facility (Germany)(2)
 
Euro 20.0 million ($27.0 million)
 
Euribor + 1.25% or EONIA 1.75%
 
June 2014
 
Unsecured, guaranteed by parent company
Euro Overdraft Facilities
 
Euro 1.9 million
($2.6 million)
 
1.3%-6.5%
 
October 2014
 
Common pool of assets of German and Italian subsidiaries
(1)
$14.1 million of this revolving credit facility is available to our foreign subsidiaries in their respective local currencies, including India, China, Japan and South Korea. There were no drawings at September 30, 2013.
(2)
$17.6 million of this credit facility is available to our German subsidiary, $4.0 million is available to our Russian subsidiary and $5.4 million is available to our Italian subsidiary. Total drawings at September 30, 2013 was $1.5 million with an interest rate of 1.3%.
Our largest committed credit lines are with Bank of America and Deutsche Bank in the amounts of $35.0 million and $27.0 million, respectively, and neither of them is syndicated.
We are required to meet certain financial covenants associated with our U.S. revolving line of credit and long-term debt facilities. These covenants, tested quarterly, include a debt service coverage ratio and a funded debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) ratio. The debt service coverage covenant requires that we maintain a trailing twelve month ratio of cash flow to debt service that is greater than 1.5:1. Debt service is defined as required principal and interest payments during the period. Cash flow is defined as EBITDA less unfunded capital expenditures. The funded debt to EBITDA covenant requires that the sum of all indebtedness for borrowed money on a consolidated basis shall be less than two times our trailing twelve months EBITDA. We were in compliance with all such financial covenants as of and for the three months ended September 30, 2013.
The financial covenants in our loan documents may cause us to not take or to delay investments and actions that we might otherwise undertake because of limits on capital expenditures and amounts that we can borrow or lease. In the event that we do not comply with any one of these covenants, we would be in default under the loan agreement or loan agreements, which may result in acceleration of the debt, cross-defaults on other debt or a reduction in available liquidity, any of which could harm our results of operations and financial condition.
Operating activities. Net cash provided by operating activities decreased by $55.5 million to $61.0 million for the nine months ended September 30, 2013 from $116.5 million for the nine months ended September 30, 2012, primarily resulting from:
A decrease in income and other taxes payable of $25.2 million in the nine months ended September 30, 2013 compared to an increase of $19.0 million in the nine months ended September 30, 2012, which includes cash payments for corporation tax in Germany of approximately $32 million for a final payment of fiscal year 2011 and revised estimated payment for fiscal year 2012 which both became due when we filed our fiscal year 2011 German tax return;
An increase in inventory of $43.7 million in the nine months ended September 30, 2013 compared to an increase of $17.1 million in the nine months ended September 30, 2012; offset by
An increase in accounts receivable of $26.9 million in the nine months ended September 30, 2013 compared to an increase of $36.5 million in the nine months ended September 30, 2012;
An increase in cash provided by net income after adding back non-cash charges of $163.2 million in the nine months ended September 30, 2013 as compared to $157.3 million in the same period in 2012.
Given our vertical integration, rigorous and time-consuming testing procedures for both internally manufactured and externally purchased components and the lead time required to manufacture components used in our finished products, the rate at which we turn inventory has historically been comparatively low when compared to our cost of sales. Also, our historic growth rates required investment in inventories to support future sales and enable us to quote short delivery times to our customers, providing what we believe is a competitive advantage. Furthermore, if there was a disruption to the manufacturing capacity of any of our key technologies, our inventories of components should enable us to continue to build finished products for a reasonable period of time. We believe that we will continue to maintain a relatively high level of inventory compared to

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our cost of sales. As a result, we expect to have a significant amount of working capital invested in inventory. A reduction in our level of net sales or the rate of growth of our net sales from their current levels would mean that the rate at which we are able to convert our inventory into cash would decrease.
Investing activities. Net cash used in investing activities was $53.2 million and $38.2 million in the nine months ended September 30, 2013 and 2012, respectively. The cash used in investing activities in 2013 related to the construction of new buildings in the United States, Germany and Russia as well as purchases of machinery and equipment and an acquisition during the first quarter of 2013. The cash used in investing activities in 2012 related to the construction of new buildings in the United States, Germany and Russia. These expenditures were partially offset by the proceeds from the maturity of short-term investments of $25.5 million.

We expect to incur approximately $65 million to $70 million in capital expenditures, excluding acquisitions in 2013, as we continue to upgrade facilities and add capacity world wide to support our anticipated revenue growth. The timing and extent of any capital expenditures in and between periods can have a significant effect on our cash flow. Many of the capital expenditure projects that we undertake have long lead times and are difficult to cancel or defer to a later period.
Financing activities. Net cash provided by financing activities was $3.4 million and $116.2 million in the nine months ended September 30, 2013 and 2012, respectively. The cash provided by financing activities in 2013 was primarily related to the cash provided by the exercise of stock options, issuances under our employee stock purchase plan and the related tax benefits of the exercises partially offset by the payments on our long-term debt and line-of-credit facilities. The cash provided by financing activities in 2012 was primarily related to the follow-on public stock offering for which we received $168.0 million, net of offering expenses partially offset by the repurchased 22.5% redeemable noncontrolling interest in our Russian subsidiary of $55.4 million.
Cautionary Statement Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and we intend that such forward-looking statements be subject to the safe harbors created thereby. For this purpose, any statements contained in this Quarterly Report on Form 10-Q except for historical information are forward-looking statements. Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue” or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance, trends in our businesses, or other characterizations of future events or circumstances are forward-looking statements.
The forward-looking statements included herein are based on current expectations of our management based on available information and involve a number of risks and uncertainties, all of which are difficult or impossible to accurately predict and many of which are beyond our control. As such, our actual results may differ significantly from those expressed in any forward-looking statements. Factors that may cause or contribute to such differences include, but are not limited to, those discussed in more detail in Item 1, “Business” and Item 1A, “Risk Factors” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2012. Readers should carefully review these risks, as well as the additional risks described in other documents we file from time to time with the Securities and Exchange Commission. In light of the significant risks and uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that such results will be achieved, and readers are cautioned not to rely on such forward-looking information. We undertake no obligation to revise the forward-looking statements contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Recent Accounting Pronouncements
Accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require
adoption until a future date are not expected to have a material impact on our financial statements upon adoption.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk in the ordinary course of business, which consists primarily of interest rate risk associated with our cash and cash equivalents and our debt and foreign exchange rate risk.
Interest rate risk. Our investments have limited exposure to market risk. To minimize this risk, we maintain a portfolio of cash, cash equivalents and short-term investments, consisting primarily of bank deposits, money market funds and short-term government securities. The interest rates are variable and fluctuate with current market conditions. Because of the short-term nature of these instruments, a sudden change in market interest rates would not be expected to have a material impact on our financial condition or results of operations.

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We are also exposed to market risk as a result of increases or decreases in the amount of interest expense we must pay on our bank debt and borrowings on our bank credit facilities. Our interest obligations on our long-term debt are fixed by means of interest rate swap agreements. Although our U.S. revolving line of credit and our Euro credit facility have variable rates, we do not believe that a 10% change in market interest rates would have a material impact on our financial position or results of operations.
Exchange rates. Due to our international operations, a significant portion of our net sales, cost of sales and operating expenses are denominated in currencies other than the U.S. Dollar, principally the Euro, the Japanese Yen, the Russian Ruble, and Chinese Yuan. As a result, our international operations give rise to transactional market risk associated with exchange rate movements of the U.S. Dollar, the Euro, the Japanese Yen, the Russian Ruble, and Chinese Yuan. Loss on foreign exchange transactions totaled $1.6 million for the three months ended September 30, 2013. Loss on foreign exchange transactions totaled $1.8 million for the three months ended September 30, 2012. Management attempts to hedge these exposures by partially or fully off-setting foreign currency denominated assets and liabilities at our subsidiaries that operate in different functional currencies. Foreign currency derivative instruments can also be used to hedge exposures and reduce the risks of certain foreign currency transactions; however, these instruments provide only limited protection and can carry significant cost. We have no foreign currency hedges as of September 30, 2013. We will continue to analyze our exposure to currency exchange rate fluctuations and may engage in financial hedging techniques in the future to attempt to minimize the effect of these potential fluctuations. Exchange rate fluctuations may adversely affect our financial results in the future.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision of our chief executive officer and our chief financial officer, our management has evaluated the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). Based upon that evaluation, our chief executive officer and our chief financial officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective.
Changes in Internal Controls
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are party to various legal proceedings and other disputes incidental to our business. There have been no material developments to those proceedings reported in our Annual Report on Form 10-K for the year ended December 31, 2012, and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013.
ITEM  1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012, and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Date
 
Total Number of
Shares (or Units)
Purchased
 
 
 
Average Price
Paid per Share
(or Unit)
 
Total Number of
Shares (or Units)
Purchased as Part
of Publicly
Announced Plans
or Programs
 
Maximum Number
(or Approximate
Dollar Value) of
Shares (or Units)
that May Yet Be
Purchased Under
the Plans or
Programs
March 1, 2013 — March 31, 2013
 
48
 
(1
)
 
$
60.11

 
$

 
$

April 1, 2013 — April 30, 2013
 
55
 
(1
)
 
66.41

 

 

June 1, 2013 — June 30, 2013
 
89
 
(1
)
 
59.30

 

 

July 1, 2013 — July 31, 2013
 
55
 
(1
)
 
60.73

 

 

August 1, 2013 — August 31, 2013
 
 
(1
)
 

 

 

September 1, 2013 — September 30, 2013
 
75
 
(1
)
 
53.76

 

 

Total
 
322
 
  
 
$
59.59

 
$

 
$

 
(1)
Our Board of Directors approved “withhold to cover” as a tax payment method for vesting of restricted stock awards for certain employees. Pursuant to the “withhold to cover” method, we withheld from such employees the shares noted in the table above to cover tax withholding related to the vesting of their awards. The average prices listed in the above table are averages of the fair market prices at which we valued shares withheld for purposes of calculating the number of shares to be withheld.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.

ITEM 6. EXHIBITS
(a) Exhibits
 

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Exhibit
No.
 
Description
12.1
 
Statement Re Computation of Earnings to Fixed Charges
31.1
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
31.2
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
32
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 1350
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase
101.LAB
 
XBRL Taxonomy Extension Label Linkbase
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
IPG PHOTONICS CORPORATION
 
 
 
 
 Date: November 8, 2013
 
By:
/s/ Valentin P. Gapontsev
 
 
 
Valentin P. Gapontsev
 
 
 
Chairman and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
 Date: November 8, 2013
 
By:
/s/ Timothy P.V. Mammen
 
 
 
Timothy P.V. Mammen
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)


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