Annual Statements Open main menu
  1. Annual Statements
  2. » Companies
  3. » IPG PHOTONICS CORP
  4. » Quarter Report: 2014 June (Form 10-Q)

IPG PHOTONICS CORP - Quarter Report: 2014 June (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 June 30, 2014
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 July 29, 2014, there were 52,124,557 shares of the registrant’s common stock issued and outstanding.


TABLE OF CONTENTS
 
 
Page
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
 
June 30,
 
December 31,
 
2014
 
2013
 
(In thousands, except share
and per share data)
ASSETS
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
483,432

 
$
448,776

Accounts receivable, net
124,144

 
103,803

Inventories
178,925

 
172,700

Prepaid income taxes and income taxes receivable
19,706

 
15,996

Prepaid expenses and other current assets
32,634

 
30,836

Deferred income taxes, net
15,251

 
14,232

Total current assets
854,092

 
786,343

DEFERRED INCOME TAXES, NET
8,139

 
4,799

GOODWILL
455

 
455

INTANGIBLE ASSETS, NET
8,472

 
9,564

PROPERTY, PLANT AND EQUIPMENT, NET
268,122

 
252,245

OTHER ASSETS
19,106

 
7,810

TOTAL
$
1,158,386

 
$
1,061,216

LIABILITIES AND EQUITY
CURRENT LIABILITIES:
 
 
 
Revolving line-of-credit facilities
$
2,724

 
$
3,296

Current portion of long-term debt
12,000

 
1,333

Accounts payable
15,059

 
18,787

Accrued expenses and other liabilities
63,379

 
59,336

Deferred income taxes, net
3,187

 
2,109

Income taxes payable
16,823

 
15,218

Total current liabilities
113,172

 
100,079

DEFERRED INCOME TAXES AND OTHER LONG-TERM LIABILITIES
21,354

 
21,835

LONG-TERM DEBT, NET OF CURRENT PORTION
—

 
11,333

Total liabilities
134,526

 
133,247

COMMITMENTS AND CONTINGENCIES (NOTE 12)

 

IPG PHOTONICS CORPORATION STOCKHOLDERS’ EQUITY:
 
 
 
Common stock, $0.0001 par value, 175,000,000 shares authorized; 52,121,222 shares issued and outstanding at June 30, 2014; 51,930,978 shares issued and outstanding at December 31, 2013
5

 
5

Additional paid-in capital
551,885

 
538,908

Retained earnings
479,571

 
390,757

Accumulated other comprehensive loss
(7,601
)
 
(1,701
)
Total IPG Photonics Corporation stockholders’ equity
1,023,860

 
927,969

TOTAL
$
1,158,386

 
$
1,061,216

See notes to consolidated financial statements.

1
Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands, except per share data)
NET SALES
$
192,204

 
$
168,171

 
$
362,779

 
$
310,023

COST OF SALES
87,977

 
78,249

 
169,268

 
144,460

GROSS PROFIT
104,227

 
89,922

 
193,511

 
165,563

OPERATING EXPENSES:
 
 
 
 
 
 
 
Sales and marketing
8,047

 
6,845

 
15,212

 
12,713

Research and development
13,362

 
10,483

 
26,146

 
19,281

General and administrative
13,124

 
12,829

 
26,040

 
24,639

Loss (gain) on foreign exchange
945

 
(110
)
 
(425
)
 
(591
)
Total operating expenses
35,478

 
30,047

 
66,973

 
56,042

OPERATING INCOME
68,749

 
59,875

 
126,538

 
109,521

OTHER INCOME (EXPENSE), Net:
 
 
 
 
 
 
 
Interest expense, net
—

 
(35
)
 
(139
)
 
(88
)
Other income (expense), net
239

 
(239
)
 
573

 
(169
)
Total other income (expense)
239

 
(274
)
 
434

 
(257
)
INCOME BEFORE PROVISION FOR INCOME TAXES
68,988

 
59,601

 
126,972

 
109,264

PROVISION FOR INCOME TAXES
(20,705
)
 
(17,881
)
 
(38,158
)
 
(32,417
)
NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION
$
48,283

 
$
41,720

 
$
88,814

 
$
76,847

NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION PER SHARE:
 
 
 
 
 
 
 
Basic
$
0.93

 
$
0.81

 
$
1.71

 
$
1.49

Diluted
$
0.92

 
$
0.80

 
$
1.68

 
$
1.47

WEIGHTED AVERAGE SHARES OUTSTANDING:
 
 
 
 
 
 
 
Basic
52,068

 
51,462

 
52,019

 
51,435

Diluted
52,769

 
52,385

 
52,747

 
52,357

See notes to consolidated financial statements.


2
Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
(In thousands)
Net income
$
48,283

 
$
41,720

 
$
88,814

 
$
76,847

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Translation adjustments
6,683

 
(4,358
)
 
(5,983
)
 
(13,986
)
Unrealized gain on derivatives
44

 
91

 
83

 
174

Total other comprehensive income (loss)
6,727

 
(4,267
)
 
(5,900
)
 
(13,812
)
Comprehensive income attributable to IPG Photonics Corporation
$
55,010

 
$
37,453

 
$
82,914

 
$
63,035

See notes to consolidated financial statements.


3
Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Six Months Ended June 30,
 
2014
 
2013
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
88,814

 
$
76,847

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
17,088

 
14,885

Deferred income taxes
(4,893
)
 
(3,385
)
Stock-based compensation
7,172

 
5,472

Unrealized gains on foreign currency transactions
(2,225
)
 
(591
)
Other
335

 
460

Provisions for inventory, warranty & bad debt
12,207

 
10,255

Changes in assets and liabilities that (used) provided cash:
 
 
 
Accounts receivable
(20,720
)
 
(21,212
)
Inventories
(14,988
)
 
(23,814
)
Prepaid expenses and other current assets
436

 
(1,503
)
Accounts payable
(2,684
)
 
2,508

Accrued expenses and other liabilities
(170
)
 
(880
)
Income and other taxes payable
(1,071
)
 
(32,412
)
Tax benefit from exercise of employee stock options
(2,426
)
 
(2,356
)
Net cash provided by operating activities
76,875

 
24,274

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of and deposits on property, plant and equipment
(45,781
)
 
(34,263
)
Proceeds from sales of property, plant and equipment
254

 
166

Acquisition of businesses
—

 
(5,555
)
Other
42

 
407

Net cash used in investing activities
(45,485
)
 
(39,245
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from line-of-credit facilities
15,376

 
11,971

Payments on line-of-credit facilities
(15,911
)
 
(12,591
)
Principal payments on long-term borrowings
(667
)
 
(2,186
)
Exercise of employee stock options and issuances under employee stock purchase plan
3,379

 
2,177

Tax benefit from exercise of employee stock options
2,426

 
2,356

Net cash provided by financing activities
4,603

 
1,727

EFFECT OF CHANGES IN EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
(1,337
)
 
(1,325
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
34,656

 
(14,569
)
CASH AND CASH EQUIVALENTS — Beginning of period
448,776

 
384,053

CASH AND CASH EQUIVALENTS — End of period
$
483,432

 
$
369,484

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for interest
$
223

 
$
165

Cash paid for income taxes
$
41,525

 
$
61,308

Non-cash transactions:
 
 
 
Demonstration units transferred from inventory to other assets
$
1,318

 
$
2,410

Inventory transferred to machinery and equipment
$
1,030

 
$
—

Additions to property, plant and equipment included in accounts payable
$
1,209

 
$
605

See notes to consolidated financial statements.

4
Table of Contents

IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY
 
 
Six Months Ended June 30,
 
2014
 
2013
 
(In thousands, except share and per share data)
 
Shares
 
Amount
 
Shares
 
Amount
COMMON STOCK
 
 
 
 
 
 
 
Balance, beginning of year
51,930,978

 
$
5

 
51,359,247

 
$
5

Exercise of stock options
172,786

 
—

 
144,891

 
—

Common stock issued under employee stock purchase plan
17,458

 
—

 
13,913

 
—

Balance, end of period
52,121,222

 
5

 
51,518,051

 
5

ADDITIONAL PAID-IN CAPITAL
 
 
 
 
 
 
 
Balance, beginning of year
 
 
538,908

 
 
 
511,039

Stock-based compensation
 
 
7,172

 
 
 
5,472

Exercise of stock options and related tax benefit from exercise
 
 
4,784

 
 
 
3,815

Common stock issued under employee stock purchase plan
 
 
1,021

 
 
 
718

Balance, end of period
 
 
551,885

 
 
 
521,044

RETAINED EARNINGS
 
 
 
 
 
 
 
Balance, beginning of year
 
 
390,757

 
 
 
234,977

Net income attributable to IPG Photonics Corporation
 
 
88,814

 
 
 
76,847

Balance, end of period
 
 
479,571

 
 
 
311,824

ACCUMULATED OTHER COMPREHENSIVE LOSS
 
 
 
 
 
 
 
Balance, beginning of year
 
 
(1,701
)
 
 
 
(3,094
)
Translation adjustments
 
 
(5,983
)
 
 
 
(13,986
)
Unrealized gain on derivatives, net of tax
 
 
83

 
 
 
174

Balance, end of period
 
 
(7,601
)
 
 
 
(16,906
)
TOTAL IPG PHOTONICS CORPORATION STOCKHOLDERS’ EQUITY
 
 
$
1,023,860

 
 
 
$
815,967

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, 2013.
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:
 
June 30,
 
December 31,
 
2014
 
2013
Components and raw materials
$
54,376

 
$
54,539

Work-in-process
67,886

 
64,927

Finished goods
56,663

 
53,234

Total
$
178,925

 
$
172,700

The Company recorded inventory provisions totaling $3,432 and $2,027 for the three months ended June 30, 2014 and 2013, respectively, and $5,812 and $3,556 for the six months ended June 30, 2014 and 2013, 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:
 
June 30,
 
December 31,
 
2014
 
2013
Accrued compensation
$
26,956

 
$
25,727

Customer deposits and deferred revenue
21,213

 
18,489

Current portion of accrued warranty
7,821

 
7,724

Other
7,389

 
7,396

Total
$
63,379

 
$
59,336





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:
 
 
June 30,
 
December 31,
 
2014
 
2013
Revolving line-of-credit facilities:
 
 
 
European overdraft facilities
$
1,883

 
$
1,038

Euro line of credit
841

 
2,258

Total
$
2,724

 
$
3,296

Term debt:
 
 
 
U.S. long-term note
$
12,000

 
$
12,666

Less: current portion
(12,000
)
 
(1,333
)
Total long-term debt
$
—

 
$
11,333

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. There were no drawings on the U.S. line of credit at June 30, 2014 or December 31, 2013.
As of June 30, 2014, the remaining balance of the U.S. long-term note outstanding is considered current because the term of the note expires in June 2015 and is thus due within one year.
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 June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net income attributable to IPG Photonics Corporation
$
48,283

 
$
41,720

 
$
88,814

 
$
76,847

Weighted average shares
52,068

 
51,462

 
52,019

 
51,435

Dilutive effect of common stock equivalents
701

 
923

 
728

 
922

Diluted weighted average common shares
52,769

 
52,385

 
52,747

 
52,357

Basic net income attributable to IPG Photonics Corporation per share
$
0.93

 
$
0.81

 
$
1.71

 
$
1.49

Diluted net income attributable to IPG Photonics Corporation per share
$
0.92

 
$
0.80

 
$
1.68

 
$
1.47

The computation of diluted weighted average common shares excludes options to purchase 57,000 shares and 198,000 shares for the three months ended June 30, 2014 and 2013, respectively, and 81,000 shares and 208,000 shares for the six months ended June 30, 2014 and 2013, 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.
7. DERIVATIVE FINANCIAL INSTRUMENTS
Derivative 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 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.

7
Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


Cash flow hedges – The Company’s cash flow hedge is an interest rate swap under which it pays fixed rates of interest. The fair value amounts in the consolidated balance sheet related to the interest rate swap were:
Notional Amounts1
 
Other Assets
 
Other Current Laibilities2
 
Other Long-Term Laibilities2

June 30,
 
December 31,
 
June 30,
 
December 31,
 
June 30,
 
December 31,
 
June 30,
 
December 31,
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
$
12,000

 
$
12,666

 
$
—

 
$
—

 
$
291

 
$
—

 
$
—

 
$
423

  (1) Notional amounts represent the gross contract/notional amount of the derivatives outstanding.
  (2) As of June 30, 2014, the remaining balance of the U.S. long-term note outstanding is considered current because the term of the note expires in June 2015 and is thus due within one year. Accordingly, the interest rate swap liability has been reclassified.
The derivative gains and losses in the consolidated statements of income related to the Company’s interest rate swap contracts were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Effective portion recognized in other comprehensive loss, pretax:
 
 
 
 
 
 
 
Interest rate swap
$
145

 
$
280

 
$
283

 
$
547

Effective portion reclassified from other comprehensive loss to interest expense, pretax:
 
 
 
 
 
 
 
Interest rate swap
$
(76
)
 
$
(135
)
 
$
(151
)
 
$
(270
)
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.

8
Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


The following table presents information about the Company’s assets and liabilities measured at fair value:
 
 
 
 Fair Value Measurements at June 30, 2014
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Cash equivalents
$
239,860

 
$
239,860

 
$
—

 
$
—

Auction rate securities
1,124

 
—

 
—

 
1,124

Total assets
$
240,984

 
$
239,860

 
$
—

 
$
1,124

Liabilities
 
 
 
 
 
 
 
Contingent purchase consideration
$
357

 
$
—

 
$
—

 
$
357

Interest rate swaps
291

 
—

 
291

 
—

Total liabilities
$
648

 
$
—

 
$
291

 
$
357

 
 
 
 
 
 
 
 
 
 
 
 Fair Value Measurements at December 31, 2013
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Cash equivalents
$
240,159

 
$
240,159

 
$
—

 
$
—

Auction rate securities
1,120

 
—

 
—

 
1,120

Total assets
$
241,279

 
$
240,159

 
$
—

 
$
1,120

Liabilities
 
 
 
 
 
 
 
Contingent purchase consideration
$
375

 
$
—

 
$
—

 
$
375

Interest rate swaps
423

 
—

 
423

 
—

Total liabilities
$
798

 
$
—

 
$
423

 
$
375

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.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Auction Rate Securities
 
 
 
 
 
 
 
Balance, beginning of period
$
1,122

 
$
1,114

 
$
1,120

 
$
1,112

Period transactions
—

 
—

 
—

 
—

Change in fair value and accretion
2

 
2

 
4

 
4

Balance, end of period
$
1,124

 
$
1,116

 
$
1,124

 
$
1,116

Contingent Purchase Consideration
 
 
 
 
 
 
 
Balance, beginning of period
$
366

 
$
3,016

 
$
375

 
$
3,023

Period transactions
—

 
—

 
—

 
—

Adjustment for determination of final payment
—

 
(2,457
)
 
—

 
(2,464
)
Change in fair value and currency fluctuations
(9
)
 
—

 
(18
)
 
—

Balance, end of period
$
357

 
$
559

 
$
357

 
$
559

9. GOODWILL AND INTANGIBLES
The carrying amount of goodwill was $455 at both December 31, 2013 and June 30, 2014.


9
Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


Intangible assets, subject to amortization, consisted of the following:
 
June 30, 2014
 
December 31, 2013
 
 
Gross  Carrying
Amount
Accumulated
Amortization
Net  Carrying
Amount
Weighted-
Average  Lives
Gross  Carrying
Amount
Accumulated
Amortization
Net  Carrying
Amount
Weighted-
Average  Lives
 
 
 
 
 
 
 
 
 
Patents
$
4,643

$
(4,099
)
$
544

6 Years
$
4,667

$
(4,091
)
$
576

6 Years
Customer relationships
4,075

(3,507
)
568

5 Years
4,112

(3,324
)
788

5 Years
Production know-how
7,050

(2,245
)
4,805

8 Years
7,063

(1,747
)
5,316

8 Years
Technology, trademark and tradename
4,260

(1,705
)
2,555

8 Years
4,271

(1,387
)
2,884

8 Years
 
$
20,028

$
(11,556
)
$
8,472

 
$
20,113

$
(10,549
)
$
9,564

 
Amortization expense for the three months ended June 30, 2014 and 2013 was $534 and $646, respectively. Amortization expense for the six months ended June 30, 2014 and 2013 was $1,077 and $1,109, respectively. The estimated future amortization expense for intangibles for the remainder of 2014 and subsequent years is as follows:
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
 
Total
$1,066
 
$1,547
 
$1,453
 
$1,453
 
$1,388
 
$1,565
 
$8,472
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 six months ended June 30, 2014 and 2013.
 
 
2014
 
2013
Balance at January 1
$
14,997

 
$
10,714

Provision for warranty accrual
5,936

 
4,984

Warranty claims and other reductions
(4,226
)
 
(2,586
)
Foreign currency translation
(132
)
 
(234
)
 Balance at June 30
$
16,575

 
$
12,878

Accrued warranty reported in the accompanying consolidated financial statements as of June 30, 2014 and December 31, 2013 consist of $7,821 and $7,724 in accrued expenses and other liabilities and $8,754 and $7,273 in other long-term liabilities, respectively.
11. INCOME TAXES
A reconciliation of the total amounts of unrecognized tax benefits is as follows:
 
2014
 
2013
Balance at January 1
$
6,501

 
$
5,392

Reductions of prior period positions
—

 
(63
)
Additions for tax positions in prior period
—

 
—

Additions for tax positions in current period
—

 
313

 Balance at June 30
$
6,501

 
$
5,642

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.


10
Table of Contents
IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except share and per share data)


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. As of June 30, 2014 and through the filing date of these Financial Statements, the Company has no legal proceedings
ongoing that management estimates could have a material effect on the Company's Consolidated Financial Statements.

Russia/Ukraine
Recent events in Ukraine have resulted in the United States and the European Union imposing and escalating sanctions on Russia and certain businesses, sectors and individuals in Russia. The United States and the European Union also suspended the granting of certain types of export licenses to Russia. Russia has imposed its own sanctions on certain individuals in the U.S. and may be considering other sanctions on the U.S. and the European Union or certain businesses or individuals from them. The Company has a large manufacturing facility and research and development operations Russia which supplies components to its U.S. and German manufacturing facilities. In addition, the Company supplies components from its U.S. and German manufacturing facilities to its Russian facility. To date, the Company has not experienced any material disruptions or impact from current sanctions. Should there be disruption of the Company's supplies from or to its Russian operations, or should the United States, the European Union or Russia implement different sanctions, the Company's production and/or deliveries as well as results of operations could be materially impacted.



11
Table of Contents

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. If an OEM has qualified our product for use in their systems or for a certain application the sales cycle will depend upon the end demand for their products and our manufacturing lead times. For other customers the sales cycle can range 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 and by other factors, some of which are not under our control.
Our product mix affects our margins because the selling price per watt, based on the average output power of a laser, is generally higher for low and mid-power devices, high-power pulsed lasers and certain specialty products than for high-power devices and low-power pulsed lasers 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.

12
Table of Contents

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. 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 $3.4 million and $2.0 million for the three months ended June 30, 2014 and 2013, respectively, and $5.8 million and $3.6 million for the six months ended June 30, 2014 and 2013, respectively and $15.1 million, $8.2 million and $6.1 million for the years ended December 31, 2013, 2012 and 2011, 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 was 24% for the six months ended June 30, 2014 and 21%, 16% and 17% for the full years 2013, 2012 and 2011, respectively. Our largest customer accounted for 11% of our net sales for the six months ended June 30, 2014. 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 substantially reduced their purchases from us, our results would be adversely affected.
Results of Operations for the three months ended June 30, 2014 compared to the three months ended June 30, 2013
Net sales. Net sales increased by $24.0 million, or 14.3%, to $192.2 million for the three months ended June 30, 2014 from $168.2 million for the three months ended June 30, 2013.
 
 
Three Months Ended June 30,
 
 
 
 
 
2014
 
2013
 
Change
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
Materials processing
$
185,271

 
96.4
%
 
$
157,618

 
93.7
%
 
$
27,653

 
17.5
 %
Other applications
6,933

 
3.6
%
 
10,553

 
6.3
%
 
(3,620
)
 
(34.3
)%
Total
$
192,204

 
100.0
%
 
$
168,171

 
100.0
%
 
$
24,033

 
14.3
 %
Sales for materials processing applications increased primarily due to higher sales of high-power and medium-power
lasers used in cutting, welding, additive manufacturing, cladding and cleaning applications offset by declines in sales of low-power 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 increasing by displacing gas lasers in systems sold by our OEM customers. QCW laser sales are also increasing due to continued acceptance and by displacing Nd:YAG lasers in applications such as fine-welding, cutting and hole drilling as well as penetrating new applications such as glass cutting. The decrease in sales of pulsed lasers used for marking and engraving applications is due to increased competition and pricing pressure in Asia.
Cost of sales and gross margin. Cost of sales increased by $9.7 million, or 12.4%, to $88.0 million for the three months ended June 30, 2014 from $78.2 million for the three months ended June 30, 2013. Our gross margin increased to 54.2% for the

13
Table of Contents

three months ended June 30, 2014 from 53.5% for the three months ended June 30, 2013. Gross margin increased due to higher absorption of manufacturing overhead costs partially offset by increased provisions for excess or obsolete inventory.
Sales and marketing expense. Sales and marketing expense increased by $1.2 million, or 17.6%, to $8.0 million for the three months ended June 30, 2014 from $6.8 million for the three months ended June 30, 2013, primarily as a result of
increases in personnel, depreciation and premises costs. As a percentage of sales, sales and marketing expense increased to 4.2% for the three months ended June 30, 2014 from 4.1% for the three months ended June 30, 2013.
Research and development expense. Research and development expense increased by $2.9 million, or 27.5%, to $13.4 million for the three months ended June 30, 2014, compared to $10.5 million for the three months ended June 30, 2013, primarily as a result of increases in personnel, material used for research and development, outside research contracts, premises
costs and depreciation. Much of our research and development is focused on developing new applications for fiber lasers
through internal research and partnership with customers and industrial institutes. We are working on the development of new
products including products operating at different wavelengths and with high energy, ultra short pulses in order to address
opportunities in micro-machining applications as well as semiconductor and other non-metal processing. We are also developing complementary products and accessories such as welding and cutting heads and systems including systems used in
macro and micro processing applications. In addition to new products, our research and development focuses on enhancing the
performance of our internally manufactured components and refining production processes to improve electrical efficiency and
reduce the costs of our products. As a percentage of sales, research and development expense increased to 7.0% for the three months ended June 30, 2014 from 6.2% for the three months ended June 30, 2013.
General and administrative expense. General and administrative expense increased by $0.3 million, or 2.3%, to $13.1 million for the three months ended June 30, 2014 from $12.8 million for the three months ended June 30, 2013, primarily as a result of increased personnel, spending on information systems, insurance, depreciation costs and bad debt provisions. As a percentage of sales, general and administrative expense decreased to 6.8% for the three months ended June 30, 2014 from 7.6% for the three months ended June 30, 2013.
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 June 30, 2014 would have been $2.7 million lower, gross profit would have been $0.4 million lower and total operating expenses would have been $0.2 million higher.
Loss (gain) on foreign exchange. We incurred a foreign exchange loss of $0.9 million for the three months ended June 30, 2014 as compared to $0.1 million gain for the three months ended June 30, 2013. The change is primarily attributable to the changes of the U.S. Dollar against the Euro, Russian Ruble, Korean Won, Japanese Yen and Chinese Yuan.
Interest expense, net. Interest expense, net remained relatively flat for the three months ended June 30, 2014 and 2013.
Other income (expense), net. Other income (expense), net was $0.2 million of income compared to $0.2 million of expense for the three months ended June 30, 2014 and for the three months ended June 30, 2013, respectively.
Provision for income taxes. Provision for income taxes was $20.7 million for the three months ended June 30, 2014 compared to $17.9 million for the three months ended June 30, 2013. The effective tax rates were consistent at 30.0% for the three months ended June 30, 2014 and 2013.
Net income attributable to IPG Photonics Corporation. Net income attributable to IPG Photonics Corporation increased by $6.6 million to $48.3 million for the three months ended June 30, 2014 compared to $41.7 million for the three months ended June 30, 2013. Net income attributable to IPG Photonics Corporation as a percentage of our net sales increased by 0.3 percentage points to 25.1% for the three months ended June 30, 2014 from 24.8% for the three months ended June 30, 2013 due to the factors described above.
Results of Operations for the six months ended June 30, 2014 compared to the six months ended June 30, 2013
Net sales. Net sales increased by $52.8 million, or 17.0%, to $362.8 million for the six months ended June 30, 2014 from $310.0 million for the six months ended June 30, 2013.
 
 
Six Months Ended June 30,
 
 
 
 
 
 
2014
 
2013
 
Change
 
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
Materials processing
 
$
347,996

 
95.9
%
 
$
290,663

 
93.8
%
 
$
57,333

 
19.7
 %
Other applications
 
14,783

 
4.1
%
 
19,360

 
6.2
%
 
(4,577
)
 
(23.6
)%
Total
 
$
362,779

 
100.0
%
 
$
310,023

 
100.0
%
 
$
52,756

 
17.0
 %

14
Table of Contents

Sales for materials processing applications increased primarily due to higher sales of high-power and medium-power
lasers used in cutting, welding, additive manufacturing, cladding and cleaning applications offset by declines in 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 increasing by displacing gas lasers in systems sold by our OEM customers. QCW laser sales are also increasing due to continued acceptance and by displacing Nd:YAG lasers in applications such as fine-welding, cutting and marking/engraving as well as penetrating new applications such as hole drilling and glass cutting. The decrease in sales of pulsed lasers used for marking and engraving applications is due to increased competition and pricing pressure in Asia.
Cost of sales and gross margin. Cost of sales increased by $24.8 million, or 17.2%, to $169.3 million for the six months ended June 30, 2014 from $144.5 million for the six months ended June 30, 2013. Our gross margin decreased slightly to 53.3% from 53.4% for the six months ended June 30, 2014 and 2013, respectively. Gross margin decreased due to increased provisions for excess or obsolete inventory partially offset by increased absorption of manufacturing overhead costs.
Sales and marketing expense. Sales and marketing expense increased by $2.5 million, or 19.7%, to $15.2 million for the six months ended June 30, 2014 from $12.7 million for the six months ended June 30, 2013, primarily as a result of
increases in personnel, travel, insurance, premises costs and depreciation. As a percentage of sales, sales and marketing expense increased to 4.2% for the six months ended June 30, 2014 from 4.1% for the six months ended June 30, 2013.
Research and development expense. Research and development expense increased by $6.9 million, or 35.6%, to $26.1 million for the six months ended June 30, 2014, compared to $19.3 million for the six months ended June 30, 2013, primarily as a result of increases in personnel, material used for research and development, outside research contracts, premises
costs and depreciation. Much of our research and development is focused on developing new applications for fiber lasers
through internal research and partnership with customers and industrial institutes. We are working on the development of new
products including products operating at different wavelengths and with high energy, ultra short pulses in order to address
opportunities in micro-machining applications as well as semiconductor and other non-metal processing. We are also developing complementary products and accessories such as welding and cutting heads and systems including systems used in
macro and micro processing applications. In addition to new products, our research and development focuses on enhancing the
performance of our internally manufactured components and refining production processes to improve electrical efficiency and reduce the costs of our products. As a percentage of sales, research and development expense increased to 7.2% for the six months ended June 30, 2014 from 6.2% for the six months ended June 30, 2013.
General and administrative expense. General and administrative expense increased by $1.4 million, or 5.7%, to $26.0 million for the six months ended June 30, 2014 from $24.6 million for the six months ended June 30, 2013, primarily as a result of increased personnel, spending on information systems, insurance, depreciation costs, bad debt provisions and loss on disposal of equipment. As a percentage of sales, general and administrative expense decreased to 7.2% for the six months ended June 30, 2014 from 7.9% for the six months ended June 30, 2013.
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 six months ended June 30, 2014 would have been $3.3 million lower, gross profit would have been $0.6 million lower and total operating expenses would have been $0.7 million higher.
Loss (gain) on foreign exchange. We incurred a foreign exchange gain of $0.4 million for the six months ended June 30, 2014 as compared to $0.6 million gain for the six months ended June 30, 2013. The change is primarily attributable to the changes of the U.S. Dollar against the Euro, Russian Ruble, Korean Won, Japanese Yen and Chinese Yuan.
Interest expense, net. Interest expense, net remained relatively consistent at $0.1 million of expense for the six months ended June 30, 2014 and 2013.
Other income (expense), net. Other income (expense), net increased to $0.6 million of income for the six months ended June 30, 2014 compared to $0.2 million of expense for the six months ended June 30, 2013. The expense amount in the six months ended June 30, 2013 included a $2.9 million goodwill impairment charge partially offset by a $2.5 million reduction in contingent consideration related to prior year acquisitions.
Provision for income taxes. Provision for income taxes was $38.2 million for the six months ended June 30, 2014 compared to $32.4 million for the six months ended June 30, 2013, representing an effective tax rate of 30.1% and 29.7% for the six months ended June 30, 2014 and 2013, respectively. The increase in the provision for income taxes was primarily
the result of increased income before provision for income taxes. The increase in effective rate was due to differences in
recognition of research and development tax credits available in the United States. The American Taxpayer Relief Act
of 2012 (the “Act”) was signed into law on January 2, 2013 which retroactively reinstated research and development tax credits
for 2012 and authorized them for 2013 as well. Accordingly, all of the 2012 credits were recognized in the first quarter of 2013.

15
Table of Contents

This benefit reduced our effective tax rate as a discrete item in our tax provision for the first quarter of 2013. The legislation enabling research and development credits expired for 2014 and new legislation has not been enacted. Accordingly, there is no benefit for research and development tax credits recognized for the six months ended June 30, 2014.
Net income attributable to IPG Photonics Corporation. Net income attributable to IPG Photonics Corporation increased by $12.0 million to $88.8 million, or 15.6% for the six months ended June 30, 2014 compared to $76.8 million for the six months ended June 30, 2013. Net income attributable to IPG Photonics Corporation as a percentage of our net sales decreased by 0.3 percentage points to 24.5% for the six months ended June 30, 2014 from 24.8% for the six months ended June 30, 2013 due to the factors described above.
Liquidity and Capital Resources
Our principal sources of liquidity as of June 30, 2014 consisted of cash and cash equivalents of $483.4 million, unused credit lines and overdraft facilities of $62.3 million and other working capital (excluding cash and cash equivalents) of $257.5 million. This compares to cash and cash equivalents of $448.8 million, unused credit lines and overdraft facilities of $61.8 million and other working capital (excluding cash and cash equivalents) of $237.5 million as of December 31, 2013. The increase in cash and cash equivalents of $34.7 million from December 31, 2013 relates primarily to the following:
•
Cash provided by operating activities in the six months ended June 30, 2014 of $76.9 million.
•
Cash provided by financing activities of $4.6 million from the exercise of stock options and their related tax benefit partially offset by payments on long-term borrowings and net payments of line-of-credit facilities.
•
Cash used by investing activities of $45.5 million which mostly relate to capital expenditures.
Our current portion of long-term debt consists of the remaining balance of a $12.0 million secured variable-rate note. 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 June 30, 2014: 
 
 
 
 
 
 
 
 
 
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 ($27.3 million)
 
Euribor + 1.25% or EONIA 1.75%
 
August 2014
 
Unsecured, guaranteed by parent company
Euro Overdraft Facilities(3)
 
Euro 2.0 million
($2.7 million)
 
1.2%-6.5%
 
October 2014
 
Common pool of assets of Italian subsidiary
(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 June 30, 2014.
(2)
$4.8 million of this credit facility is available to our German subsidiary, $20.5 million is available to our Russian subsidiary and $2.0 million is available to our Italian subsidiary. Total drawings at June 30, 2014 was $0.8 million with an interest rate of 1.6%.
(3)
At June 30, 2014, $1.9 million of the $2.7 million was drawn upon with an interest rate of 1.2%.
Our largest committed credit lines are with Bank of America and Deutsche Bank in the amounts of $35.0 million and $27.3 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

16
Table of Contents

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 June 30, 2014.
Operating activities. Net cash provided by operating activities increased by $52.6 million to $76.9 million for the six months ended June 30, 2014 from $24.3 million for the six months ended June 30, 2013, primarily resulting from:
•
A decrease in income and other taxes payable of $1.1 million in the six months ended June 30, 2014 compared to a decrease of $32.4 million in the six months ended June 30, 2013, which included cash payments for corporation tax in Germany of approximately $32 million for fiscal year 2011 and revised estimated payment for fiscal year 2012.
These payments would typically have been made in the fourth quarter of 2013. Also;
•
An increase in inventory of $15.0 million in the six months ended June 30, 2014 compared to an increase of $23.8 million in the six months ended June 30, 2013;
•
An increase in cash provided by net income after adding back non-cash charges of $118.5 million in the six months ended June 30, 2014 as compared to $103.9 million in the same period in 2013; partially offset by
•
A decrease in accounts payable of $2.7 million in the six months ended June 30, 2014 compared to an increase of $2.5 million in the six months ended June 30, 2013.
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, investment in inventories was required to support historic and future growth rates and to enable 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 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 $45.5 million and $39.2 million in the six months ended June 30, 2014 and 2013, respectively. The cash used in investing activities in 2014 related to the construction and purchase of new buildings in the United States, Germany and Russia as well as purchases of machinery and equipment. The cash used in investing activities in 2013 related to the construction of new buildings in the United States, Germany and Russia and an acquisition during the first quarter.
We expect to incur approximately $70 million in capital expenditures, excluding acquisitions in 2014, as we continue to upgrade facilities and add capacity worldwide 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 $4.6 million and $1.7 million in the six months ended June 30, 2014 and 2013, respectively. The cash provided by financing activities in 2014 was primarily related to the cash provided by the exercise of stock options, sales of shares under our employee stock purchase plan and the related tax benefits of the exercises partially offset by the payments on our long-term borrowings and net payments of line-of-credit facilities. The cash provided by financing activities in 2013 was primarily related to the cash provided by the exercise of stock options, sales of shares 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.
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

17
Table of Contents

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, 2013. 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.
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 an interest rate swap agreement. 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 Russian Ruble, the Japanese Yen and Chinese Yuan. Loss on foreign exchange transactions totaled $0.9 million for the three months ended June 30, 2014. Gain on foreign exchange transactions totaled $0.1 million for the three months ended June 30, 2013. 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 June 30, 2014. 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

18
Table of Contents

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.

19
Table of Contents

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, 2013, and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014.
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, 2013, and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, 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, including the following:

Russia/Ukraine

Recent events in Ukraine have resulted in the United States and the European Union imposing and escalating sanctions on Russia and certain businesses, sectors and individuals in Russia. The United States and the European Union also suspended the granting of certain types of export licenses to Russia. Russia has imposed its own sanctions on certain individuals in the U.S. and may be considering other sanctions on the U.S. and the European Union or certain businesses or individuals from them. The Company has a large manufacturing facility and research and development operations Russia which supplies components to its U.S. and German manufacturing facilities. In addition, the Company supplies components from its U.S. and German manufacturing facilities to its Russian facility. To date, the Company has not experienced any material disruptions or impact from current sanctions. Should there be disruption of the Company's supplies from or to its Russian operations, or should the United States, the European Union or Russia implement different sanctions, the Company's production and/or deliveries as well as results of operations could be materially impacted.
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
January 1, 2014 — January 31, 2014
 
—
 
(1
)
 
$
—

 
$
—

 
$
—

February 1, 2014 — February 28, 2014
 
—
 
(1
)
 
—

 
—

 
—

March 1, 2014 — March 31, 2014
 
2,639
 
(1
)
 
71.10

 
—

 
—

April 1, 2014 — April 30, 2014
 
—
 
(1
)
 
—

 
—

 
—

May 1, 2014 — May 31, 2014
 
—
 
(1
)
 
—

 
—

 
—

June 1, 2014 — June 30, 2014
 
2,785
 
(1
)
 
68.64

 
—

 
—

Total
 
5,424
 
 
 
$
69.84

 
$
—

 
$
—

 
(1)
In 2012, 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 in 2014.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
(a) Exhibits
 

20
Table of Contents

Exhibit
No.
 
Description
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


21
Table of Contents

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: August 5, 2014
 
By:
/s/ Valentin P. Gapontsev
 
 
 
Valentin P. Gapontsev
 
 
 
Chairman and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
 Date: August 5, 2014
 
By:
/s/ Timothy P.V. Mammen
 
 
 
Timothy P.V. Mammen
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)


22