You should read the following discussion in conjunction with our condensed
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, manufacture and sell high-performance fiber lasers, fiber amplifiers
and diode lasers that are used for diverse applications, primarily in materials
processing. We also manufacture and sell complementary products used with our
lasers including optical delivery cables, fiber couplers, beam switches, optical
processing heads, in-line sensors and chillers. In addition, we offer
laser-based and non-laser based systems for certain markets and applications.
Our portfolio of laser solutions are used in materials processing,
communications, medical and advanced applications. 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. Our major manufacturing facilities are located in the United States,
Germany and Russia. We have sales service offices and applications laboratories
worldwide.
We are vertically integrated such that we design and manufacture most of the key
components used in our finished products, from semiconductor diodes to optical
fiber preforms, finished fiber lasers, amplifiers and complementary products.
Our vertically integrated operations allow us to reduce manufacturing costs,
control quality, rapidly develop and integrate advanced products and protect our
proprietary technology.
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.
COVID-19 Update. Global demand trends have been impacted adversely by the
COVID-19 pandemic and therefore remain uncertain at this time. While we have
seen a rebound in demand in China in the second quarter, this was partially
offset by weakness in both Europe and North America. We believe demand trends
will continue to be impacted by how significantly COVID-19 is affecting various
regions of the world. This uncertainty continues to make forecasting our
business challenging in the near to medium-term.
Currently, our three major production facilities in United States, Germany, and
Russia remain open. We have implemented employee safety and sanitization
protocols that have impacted productivity and efficiency. We have vertically
integrated manufacturing, and many of the components one facility supplies to
another facility are single sourced internally and not available from third
party suppliers, for example our semiconductor diodes manufactured in Oxford,
Massachusetts. While we have attempted to build safety stock of critical
components at our various locations, if government restrictions to address the
COVID-19 outbreak become more severe than we have experienced to date or if
there was significant absenteeism as a result of a COVID-19 outbreak or
resurgencein the places where we operate, it could impact our internal supply
chain. We have implemented certain payroll and sick time policies to help
support our employees impacted by COVID-19. These measures have and will
continue to increase the cost of our operations but the magnitude and length of
time of this impact is difficult to quantify at this time and may continue to be
difficult to estimate in the future. If our revenues are reduced for an extended
period or if our production output falls because of government restrictions or
absenteeism, we may be required to reduce payroll-related costs and other
expenses in the future through layoffs, furloughs or reduced hours, even though
we have not done so to date.
We have not experienced significant supply disruption from third party component
suppliers; however, we face some supply chain restraints primarily related to
logistics, including available air cargo space and higher freights rates.
Available cargo space on flights between the U.S. and Europe and Europe and Asia
is limited as a result of COVID-19, increasing shipping time and cost. We may
experience delays in the future if resurgences are experienced and governments
implement new restrictions. We believe we have the ability to meet the near-term
demand for our products, but the situation is fluid and subject to change.
We continue to monitor the rapidly evolving conditions and circumstances as well
as guidance from international and domestic authorities, including public health
authorities, and we may need to take additional actions based on their
recommendations. The measures implemented by various authorities related to the
COVID-19 outbreak have caused us to change our business practices including
those related to where employees work, the distance between employees in our
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facilities, limitations on in person meetings between employees and with
customers, suppliers, service providers, and stakeholders as well as
restrictions on business travel to domestic and international locations or to
attend trade shows, investor conferences and other events. To date, we have been
able to accommodate these changes to our business operations and continue to
meet customer demand. If the guidance from relevant authorities becomes more
restrictive in the future due to a resurgence of COVID-19 in a particular
region, the effect on our operations could be more significant.
The COVID-19 pandemic has increased economic uncertainty and decreased demand
for our products in many markets we serve and could continue for an unknown
period of time. In these circumstances, there may be developments outside of our
control, including the length and extent of the COVID-19 outbreak and
government-imposed measures that may require us to adjust our operating plans.
As such, given the dynamic nature of this situation, we cannot reasonably
estimate the future impacts of COVID-19 on our financial condition, results of
operations or cash flows. However, we do expect that it will have an adverse
impact on our revenue as well as our overall profitability and may lead to an
increase in inventory provisions, allowances for credit losses, and a volatile
effective tax rate driven by changes in the mix of earnings across the Company's
markets. Additionally, if the business impacts of COVID-19 carry on for an
extended period, it could cause us to recognize impairments for goodwill and
certain long-lived assets including amortizable intangible assets or
right-of-use assets. In particular, the outbreak of COVID-19 has negatively
affected new order flow in North America for our custom systems business. We are
monitoring this business and if order flow does not improve in the near term, it
may become a triggering event which causes us to evaluate the carrying value of
goodwill related to that business.
Net sales. Our net sales have historically fluctuated from quarter to quarter.
The increase or decrease in sales from a prior quarter can be affected by the
timing of orders received from customers, the shipment, installation and
acceptance of products at our customers' facilities, the mix of OEM orders and
one-time orders for products with large purchase prices, competitive pressures,
acquisitions, economic and political conditions in a certain country or region
and seasonal factors such as the purchasing patterns and levels of activity
throughout the year in the regions where we operate. Net sales can be affected
by the time taken to qualify our products for use in new applications in the end
markets that we serve. 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. The adoption of our products by a new customer or qualification in a new
application can lead to an increase in net sales for a period, which may then
slow until we penetrate new markets or obtain new customers.
Our business depends substantially upon capital expenditures by end users,
particularly by manufacturers using our products for materials processing, which
includes general manufacturing, automotive, other transportation, aerospace,
heavy industry, consumer, semiconductor and electronics. Approximately 90% of
our revenues for the first half of 2020 and 94% of our revenues for the full
2019 fiscal year were from customers using our products for materials
processing. Although applications within materials processing are broad, the
capital equipment market in general is cyclical and historically has experienced
sudden and severe downturns. For the foreseeable future, our operations will
continue to depend upon capital expenditures by end users of materials
processing equipment and will be subject to the broader fluctuations of capital
equipment spending.
In recent years, our net sales have been negatively impacted by tariffs and
trade policy. New tariffs and other changes in U.S. trade policy could trigger
retaliatory actions by affected countries, and certain foreign governments. The
Chinese government has imposed retaliatory tariffs on a range of U.S. goods
including certain optical and electronic products and components, which has
impacted demand for our products, particularly for materials processing.
The average selling prices of our products generally decrease as the products
mature. These decreases result from factors such as increased competition,
decreased manufacturing costs and increases in unit volumes. We may also reduce
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 place high unit-volume orders.
The secular shift to fiber laser technology in large materials processing
applications, such as cutting applications, had a positive effect on our sales
trends in the past such that our sales trends were often better than other
capital equipment manufacturers in both positive and negative economic cycles.
As the secular shift to fiber laser technology matures in such applications, our
sales trends are more susceptible to economic cycles which affect other capital
equipment manufacturers.
Gross margin. Our total gross margin in any period can be significantly affected
by total net sales in any period, by competitive factors, by product mix, and by
other factors such as changes in foreign exchange rates relative to the U.S.
Dollar, some of which are not under our control. For instance,
•As our products mature, we have experienced an increase in competition which
has decreased average selling prices and reduced gross margin;
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•Our gross margin can be significantly affected by product mix. Within each of
our product categories, the gross margin is generally higher for devices with
greater average power. These higher power products often have better
performance, more difficult specifications to attain and fewer competing
products in the marketplace;
•Higher power lasers also use a greater number of optical components, improving
absorption of fixed overhead costs and enabling economies of scale in
manufacturing;
•The gross margin for certain specialty products may be higher because there are
fewer or sometimes no equivalent competing products;
•Customers that purchase devices in greater unit volumes generally are provided
a lower price per device than customers that purchase fewer units. In general,
lower selling prices to high unit volume customers reduce gross margin although
this may be partially offset by improved absorption of fixed overhead costs
associated with larger product volumes, which drive economies of scale in
manufacturing; and
•Gross margin on systems and communication components can be lower than the
gross margin for our laser and amplifier sources, depending on the
configuration, volume and competitive forces, among other factors.
We expect that some new technologies, products and systems will have returns
above our cost of capital but may have gross margins below our corporate
average. If we are able to develop opportunities that are significant in size,
competitively advantageous or leverage our existing technology base and
leadership, our current gross margin levels may not be maintained. Instead, we
aim to deliver industry-leading gross margin by growing sales by taking market
share in existing markets or by developing new applications and markets we
address, by reducing the cost of our products and by optimizing the efficiency
of our manufacturing operations
A high proportion of our costs is fixed so costs are generally difficult to
adjust or may take time 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, as
experienced during the three and six months ended June 30, 2020, or if we have
production issues, 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 provision for such
slow-moving, obsolete or excess inventory affects our gross margins. For
example, we recorded provisions for slow-moving, obsolete or excess inventory
totaling $6.0 million and $7.9 million for the three months ended June 30, 2020
and 2019, respectively, and $14.4 million and $12.6 million for the six months
ended June 30, 2020 and 2019, respectively.
Selling and general and administrative expenses. In the past, we have invested
in selling and general and administrative costs in order to support continued
growth in the Company. As the secular shift to fiber laser technology matures,
our sales growth becomes more susceptible to the cyclical trends typical of
capital equipment manufacturers. Accordingly, our future management of and
investments in selling and general and administrative expenses will also be
influenced by these trends, although we may still invest in selling or general
and administrative functions to support certain initiatives even in economic
down cycles. Certain general and administrative expenses are not related to the
level of sales and may vary quarter to quarter based primarily upon the level of
acquisitions and litigation.
Research and development expenses. We plan to continue to invest in research and
development to improve our existing components and products and develop new
components, products, systems and applications technology. We believe that these
investments will sustain our position as a leader in the fiber laser industry
and will support development of new products that can address new markets and
growth opportunities. The amount of research and development expense we incur
may vary from period to period.
Goodwill and long-lived assets impairments. We review our intangible assets and
property, plant and equipment for impairment when events or changes in
circumstances indicate the carrying value may not be recoverable. Goodwill is
required to be tested for impairment at least annually. Negative industry or
economic trends, including reduced estimates of future cash flows, disruptions
to our business, slower growth rates, lack of growth in our relevant business
units or differences in the estimated product acceptance rates could lead to
impairment charges against our long-lived assets, including goodwill and other
intangible assets.
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Our valuation methodology for assessing impairment requires management to make
significant judgments and assumptions based on historical experience and to rely
heavily on projections of future operating performance at many points during the
analysis. Also, the process of evaluating the potential impairment of goodwill
is subjective. We operate in a highly competitive environment and projections of
future operating results and cash flows may vary significantly from actual
results.
As discussed above, we are also monitoring the effect of the COVID-19 pandemic
on our business and the potential affect it may have on the recoverability of
our long-lived assets. In particular, COVID-19 has negatively affected order
flow for our custom systems business. If order flows continue to be negatively
impacted going forward, the cumulative effect of this reduced demand on backlog
and the future outlook for revenue could be a triggering event which causes us
to evaluate the recoverability of goodwill for this reporting unit. The effects
of COVID-19 may also affect the recoverability of other long-lived assets
including our amortizable long-lived assets or right-of-use assets. If our
analysis indicates potential impairment to goodwill, amortizable intangibles or
right-of-use assets in one or more of our reporting units, we may be required to
record charges to earnings in our financial statements, which would negatively
affect our results of operations.
Foreign exchange. Because we are a U.S. based company doing business globally,
we have both translational and transactional exposure to fluctuations in foreign
currency exchange rates. Changes in the relative exchange rate between the U.S.
dollar and the foreign currencies in which our subsidiaries operate directly
affects our sales, costs and earnings. Differences in the relative exchange
rates between where we sell our products and where we incur manufacturing and
other operating costs (primarily in the U.S., Germany and Russia) also affects
our costs and earnings. Certain currencies experiencing significant exchange
rate fluctuations like the Euro, the Russian Ruble, the Japanese Yen and Chinese
Yuan have had and could have an additional significant impact on our sales,
costs and earnings. The appreciation of the Russian Ruble due to stabilizing oil
prices created a foreign exchange loss in the quarter ended June 30, 2020,
because our Russian subsidiary has certain net assets denominated in U.S.
Dollars. Additionally, the appreciation of the Russian Ruble was the primary
driver of a charge to other comprehensive income during the quarter based on the
translation of Ruble denominated assets and liabilities into U.S. dollars.
Ongoing volatility of foreign exchange rates relative to the U.S. Dollar could
continue to result in significant foreign exchange gains and losses related to
transactions and charges or benefits to other comprehensive income. Our ability
to adjust the foreign currency selling prices of products in response to changes
in exchange rates is limited and may not offset the impact of the changes in
exchange rates on the translated value of sales or costs.  In addition, if we
increase the selling price of our products in local currencies, this could have
a negative impact on the demand for our products.
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 22% for the six months ended June 30, 2020 and
21%, 26% and 28% for the full years 2019, 2018 and 2017, respectively. One of
our customers accounted for 8% and 12% of our net sales for the six months ended
June 30, 2020 and 2019, respectively. The same customer accounted for 26% and
24% of our net accounts receivable as of June 30, 2020 and December 31, 2019,
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
substantially reduced their purchases from us, our results would be adversely
affected.
Results of Operations for the Three Months Ended June 30, 2020 Compared to the
Three Months Ended June 30, 2019
Net sales. Net sales decreased by $67.4 million, or 18.5%, to $296.4 million for
the three months ended June 30, 2020 from $363.8 million for the three months
ended June 30, 2019. COVID-19 was a primary cause of the decline in revenue in
the quarter with reduced sales in Europe, North America and other countries in
Asia, most notably Japan, the Republic of Korea and Turkey. In addition to
reduced demand due to COVID-19, declines in average selling prices for materials
processing products also contributed to the decline in revenue.
The table below sets forth sales by application:
                                                                              Three Months Ended June 30,
                                                                     2020                                                             2019                                         Change
                                                                         (In thousands, except for percentages)
Sales by Application                                                            % of Total                                % of Total
Materials processing                             $        271,708                     91.7  %       $ 345,591                   95.0  %       $ (73,883)           (21.4) %
Other applications                                         24,703                      8.3  %          18,178                    5.0  %           6,525             35.9  %
Total                                            $        296,411                    100.0  %       $ 363,769                  100.0  %       $ (67,358)           (18.5) %


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The table below sets forth sales by type of product and other revenue:

Three Months Ended June 30,


                                                                          2020                                                             2019                                         Change
                                                                              (In thousands, except for percentages)
Sales by Product                                                                     % of Total                                % of Total
 High Power Continuous Wave ("CW") Lasers             $        157,478                     53.1  %       $ 213,411                   58.7  %       $ (55,933)           (26.2) %
 Medium Power CW Lasers                                         10,692                      3.6  %          15,415                    4.2  %          (4,723)           (30.6) %
 Pulsed Lasers                                                  42,577                     14.4  %          40,813                   11.2  %           1,764              4.3  %
 Quasi-Continuous Wave ("QCW") Lasers                           13,708                      4.6  %          15,967                    4.4  %          (2,259)           (14.1) %
 Laser and Non-Laser Systems                                    24,942                      8.4  %          39,383                   10.8  %         (14,441)           (36.7) %
 Other Revenue including Amplifiers, Service,
Parts, Accessories and Change in Deferred
Revenue                                                         47,014                     15.9  %          38,780                   10.7  %           8,234             21.2  %
Total                                                 $        296,411                    100.0  %       $ 363,769                  100.0  %       $ (67,358)           (18.5) %


Materials processing
Sales for materials processing applications decreased due to lower sales from
high power lasers, medium power lasers, QCW lasers, laser and non-laser systems,
and other laser products and service, offset by increased revenue from pulsed
lasers. Sales for material processing applications were generally negatively
affected by the COVID-19 pandemic. Although we benefited from sequential
improvement in our China-based business, the effect of COVID-19 reduced sales in
Europe, North America and other countries in Asia, most notably Japan, the
Republic of Korea and Turkey during the quarter ended June 30, 2020. Although we
believe that COVID-19 was a primary cause of the decline in revenue in the
quarter, we also continue to experience declines in average selling prices due
to competition, particularly for high power laser products in China.
•The decline in high power lasers related to the decrease in sales of lasers
used for metal cutting and welding. Within cutting applications, decreased sales
were attributable to a weaker global demand environment primarily in N. America
and Europe and continued competition affecting average selling prices. Part of
the decline in average selling prices for high power lasers is due to the
adoption of more compact or rack mounted "YLR" series lasers, which are
displacing 1 to 3 kilowatt "YLS" series lasers that are larger and cannot be
rack mounted. These more compact YLR lasers are less expensive to manufacture
and are sold at prices lower than the YLS series lasers they are displacing. The
decrease in sales of high power lasers used in welding applications was driven
by lower sales into general manufacturing industries.
•The decrease in medium power sales related to ongoing transition to kilowatt
scale cutting lasers and decreased demand in laser sintering for metal-based
additive manufacturing.
•The increase in pulsed laser sales was due to growth in sales of high power
pulsed lasers used for ablative and battery processing applications, partially
offset by decreased demand of pulsed lasers used for marking and engraving
applications.
•QCW laser sales decreased due to lower demand for fine processing and consumer
electronics applications.
•The decrease in laser and non-laser systems sales was due to lower demand of
non-laser systems in the transportation and aerospace sectors.
•Other Revenue for materials processing decreased due to lower demand of parts
and service.
Other applications
Sales from other applications increased due to higher demand for lasers used for
medical procedures, government applications, and semiconductor applications.
Cost of sales and gross margin. Cost of sales decreased by $23.5 million, or
12.8%, to $160.0 million for the three months ended June 30, 2020 from $183.5
million for the three months ended June 30, 2019. Our gross margin decreased to
46.0% for the three months ended June 30, 2020 from 49.5% for the three months
ended June 30, 2019. Gross margin decreased mainly due an increase in unabsorbed
manufacturing expense as a percentage of revenue in the second quarter of 2020
versus the year ago period.
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Sales and marketing expense. Sales and marketing expense decreased by $3.4
million, or 16.4%, to $17.3 million for the three months ended June 30, 2020
compared with $20.7 million for the three months ended June 30, 2019. This
change was primarily a result of decreases in personnel, travel, trade fair and
exhibits and demo unit depreciation. As a percentage of sales, sales and
marketing expense increased to 5.8% for the three months ended June 30, 2020
from 5.7% for the three months ended June 30, 2019.
Research and development expense. Research and development expense decreased by
$3.3 million, or 9.5%, to $31.6 million for the three months ended June 30,
2020, compared to $34.9 million for the three months ended June 30, 2019. This
change was primarily a result of decreases in R&D materials, personnel and
travel. Research and development continues to focus on developing new products,
enhancing performance of existing components, improving production processes and
developing manufacturing of new components such as crystals and refining
production processes to improve manufacturing yields and productivity. New
products include lasers that operate at different wavelengths such as UV,
visible and mid-IR, lasers with ultrafast pulses, laser based systems for
material processing, projection, display and medical as well as accessories such
as welding and cutting heads. In addition to new products, research and
development is focused on enhancing the performance of our existing products by
improving their electrical efficiency, increasing their average power and making
them more compact. As a percentage of sales, research and development expense
increased to 10.7% for the three months ended June 30, 2020 from 9.6% for the
three months ended June 30, 2019, mainly due to the decrease in sales.
General and administrative expense. General and administrative expense decreased
by $2.1 million, or 7.4%, to $26.4 million for the three months ended June 30,
2020 from $28.5 million for the three months ended June 30, 2019. This change
was primarily a result of decreases in personnel, bad debt expense, travel,
legal and recruitment, partially offset by increases in insurance and
information systems. As a percentage of sales, general and administrative
expense increased to 8.9% for the three months ended June 30, 2020 from 7.8% for
the three months ended June 30, 2019, mainly due to the decrease in sales.
Impairment of long-lived assets and other restructuring charges. We incurred
impairment of long-lived assets and other restructuring charges of $1.2 million
in total for the three months ended June 30, 2020, of which $0.4 million related
to severance and $0.1 million related to lease termination costs as part of
restructuring of our submarine network division. We also incurred $0.7 million
of non-cash long-lived impairments related to machinery and equipment.
Effect of exchange rates on net sales, gross profit and operating expenses. We
estimate that, if exchange rates relative to the U.S. Dollar had been the same
as one year ago, which were on average Euro 0.89, Russian Ruble 65, Japanese Yen
110 and Chinese Yuan 6.82, respectively, we would have expected net sales to be
$8.0 million higher, gross profit to be $4.1 million higher and total operating
expenses to be $1.7 million higher.
Loss (gain) on foreign exchange. We incurred a foreign exchange loss of $12.8
million for the three months ended June 30, 2020 as compared to a $5.1 million
loss for the three months ended June 30, 2019. The foreign exchange loss for the
three months ended June 30, 2020 was primarily attributable to the appreciation
of the Russian Ruble and Euro as compared to the U.S. Dollar. The foreign
exchange loss for the three months ended June 30, 2019 was primarily
attributable to the depreciation of the Chinese Yuan, partially offset by gains
attributed to the appreciation of the Russian Ruble and Euro as compared to the
U.S. Dollar.
Interest income (expense), net. Interest income (expense), net decreased to $1.9
million of income for the three months ended June 30, 2020 as compared to $4.1
million of income for the three months ended June 30, 2019. The reduction in
interest income, net, is due to holding shorter duration investments to increase
liquidity as well as a decrease in yields on shorter duration investments that
resulted in lower market interest rates as compared to rates last year.
Provision for income taxes. Provision for income taxes was $11.1 million (22.5%
of pre-tax income) for the three months ended June 30, 2020 compared to $23.3
million (24.3% of pre-tax income) for the three months ended June 30, 2019.
There were net discrete tax benefits of $3.1 million and $0.6 million for the
three months ended June 30, 2020 and 2019, respectively, primarily related to
the tax deductions for equity-based compensation that exceeded compensation
expense recognized and an investment credit in Russia related to prior years for
which an amended return was filed.
Net income attributable to IPG Photonics Corporation. Net income attributable to
IPG Photonics Corporation decreased by $34.1 million to $38.2 million for the
three months ended June 30, 2020 compared to $72.3 million for the three months
ended June 30, 2019. Net income attributable to IPG Photonics Corporation as a
percentage of our net sales decreased by 7.0 percentage points to 12.9% for the
three months ended June 30, 2020 from 19.9% for the three months ended June 30,
2019 due to the factors described above.
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Results of Operations for the Six Months Ended June 30, 2020 Compared to the Six
Months Ended June 30, 2019
Net sales. Net sales decreased by $133.1 million, or 19.6%, to $545.7 million
for the six months ended June 30, 2020 from $678.8 million for the six months
ended June 30, 2019. COVID-19 was a primary cause of the decline in revenue in
the period with reduced sales in China particularly in the first quarter and
reduced sales in Europe, North America and other countries in Asia, most notably
Japan, the Republic of Korea and Turkey particularly in the second quarter. In
addition to reduced demand due to COVID-19, declines in average selling prices
for materials processing products also contributed to the decline in revenue.
The table below sets forth sales by application:
                                                                          Six Months Ended June 30,
                                                               2020                                                            2019                                         Change
                                                                   (In thousands, except for percentages)
Sales by Application                                                    % of Total                                % of Total
Materials processing                          $    489,782                    89.8  %       $ 646,676                   95.3  %       $ (156,894)           (24.3) %
Other applications                                  55,871                    10.2  %          32,140                    4.7  %           23,731             73.8  %
Total                                         $    545,653                   100.0  %       $ 678,816                  100.0  %       $ (133,163)           (19.6) %

The table below sets forth sales by type of product and other revenue:


                                                                         Six Months Ended June 30,
                                                              2020                                                            2019                                         Change
                                                                  (In thousands, except for percentages)
Sales by Product                                                       % of Total                                % of Total
High Power Continuous Wave ("CW")
Lasers                                       $    276,794                    50.7  %       $ 392,430                   57.8  %       $ (115,636)           (29.5) %
Medium Power CW Lasers                             21,945                     4.0  %          31,013                    4.6  %           (9,068)           (29.2) %
Pulsed Lasers                                      74,416                    13.6  %          72,250                   10.6  %            2,166              3.0  %
Quasi-Continuous Wave ("QCW") Lasers               23,581                     4.3  %          30,133                    4.4  %           (6,552)           (21.7) %
Laser and Non-Laser Systems                        43,576                     8.0  %          72,014                   10.6  %          (28,438)           (39.5) %
Other Revenue including Amplifiers,
Service, Parts, Accessories and Change
in Deferred Revenue                               105,341                    19.4  %          80,976                   12.0  %           24,365             30.1  %
Total                                        $    545,653                   100.0  %       $ 678,816                  100.0  %       $ (133,163)           (19.6) %


Materials processing
Sales for materials processing applications decreased due to lower sales of high
power lasers, laser and non-laser systems, medium power lasers, QCW lasers, and
other laser products and services, partially offset by increased sales in pulsed
lasers.
•The decline in high power lasers related to the decrease in sales of lasers
used for metal cutting and welding. Within cutting applications, decreased sales
were attributable to a weaker global demand and continued competition affecting
average selling prices. Part of the decline in average selling prices for high
power lasers is due to the adoption of more compact or rack mounted "YLR" series
lasers which are displacing 1 to 3 kilowatt "YLS" series lasers which are larger
and cannot be rack mounted. These more compact YLR lasers are less expensive to
manufacture and are sold at prices lower than the YLS series lasers they are
displacing. The decrease in sales of high power lasers used in welding
applications was driven by lower sales into general manufacturing industries.
•The decrease in medium power sales related to ongoing transition to kilowatt
scale cutting lasers and decreased demand in laser sintering for metal-based
additive manufacturing.
•The increase in pulsed laser sales was due to growth in sales of high power
pulsed lasers used for ablative and battery processing applications, partially
offset by decreased demand of pulsed lasers used for marking and engraving
applications.
•QCW laser sales decreased due to lower demand for fine processing and consumer
electronics applications.
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•The decrease in laser and non-laser systems sales was due to lower demand of
both laser and non-laser systems. The reduction of revenue in laser systems was
attributable to lower demand for laser systems used for cutting and welding
applications. The reduction of revenue in non-laser systems was attributable to
lower demand in the transportation and aerospace sectors.
•Other Revenue for materials processing decreased due to lower demand of parts
and service.
Other Applications
Sales from other applications increased due to increased demand for lasers used
for medical procedures, government applications, and semiconductor applications,
partially offset by lower sales of telecom products.
Cost of sales and gross margin. Cost of sales decreased by $43.4 million, or
12.4%, to $306.3 million for the six months ended June 30, 2020 from $349.7
million for the six months ended June 30, 2019. Our gross margin decreased to
43.9% for the six months ended June 30, 2020 from 48.5% for the six months ended
June 30, 2019. Gross margin decreased mainly due an increase in unabsorbed
manufacturing costs and a decrease in average selling prices compared to the six
months ended June 30, 2019.
Sales and marketing expense. Sales and marketing expense decreased by $3.9
million, or 9.8%, to $36.0 million for the six months ended June 30, 2020 from
$39.9 million for the six months ended June 30, 2019, primarily as a result of
decreases in expenses related to personnel, travel, trade fairs and exhibits and
marketing. As a percentage of sales, sales and marketing expense increased to
6.6% of sales for the six months ended June 30, 2020 from 5.9% for the six
months ended June 30, 2019, mainly due to the decrease in sales.
Research and development expense. Research and development expense decreased by
$4.0 million, or 5.9%, to $63.4 million for the six months ended June 30, 2020,
compared to $67.4 million for the six months ended June 30, 2019, primarily as a
result of a decrease in expenses related to materials used for research and
development projects, personnel, consultants, travel and training. Research and
development continues to focus on developing new products, enhancing performance
of existing components, improving production processes and developing
manufacturing of new components such as crystals and refining production
processes to improve manufacturing yields and productivity. New products include
lasers that operate at different wavelengths such as UV, visible and mid-IR,
lasers with ultrafast pulses, laser based systems for material processing,
projection, display and medical as well as accessories such as welding and
cutting heads. In addition to new products, research and development is focused
on enhancing the performance of our existing products by improving their
electrical efficiency and increasing their average power. As a percentage of
sales, research and development expense increased to 11.6% for the six months
ended June 30, 2020 from 9.9% for the six months ended June 30, 2019, mainly due
to the decrease in sales.
General and administrative expense. General and administrative expense decreased
by $2.3 million, or 4.1%, to $53.5 million for the six months ended June 30,
2020 from $55.8 million for the six months ended June 30, 2019, primarily as a
result of decreases in expenses for bad debt, travel, legal, personnel,
recruitment and consultants, partially offset by increases in insurance,
depreciation, and information systems. As a percentage of sales, general and
administrative expense increased to 9.8% for the six months ended June 30, 2020
from 8.2% for the six months ended June 30, 2019, mainly due to the decrease in
sales.
Impairment of long-lived assets and other restructuring charges. We incurred
impairment of long-lived assets and other restructuring charges of $1.2 million
in total for the six months ended June 30, 2020, of which $0.4 million related
to severance and $0.1 million related to lease termination costs as part of
restructuring of our submarine network division. We also incurred $0.7 million
of non-cash long-lived impairments related to machinery and equipment.
Effect of exchange rates on net sales, gross profit and operating expenses. We
estimate that, if exchange rates relative to the U.S. Dollar had been the same
as one year ago, which were on average Euro 0.89, Russian Ruble 65, Japanese Yen
110 and Chinese Yuan 6.79, respectively, we would have expected net sales for
the six months ended June 30, 2020 to be $13.4 million higher, gross profit to
be $6.7 million higher and total operating expenses would have been $2.5 million
higher.
(Gain) loss on foreign exchange. We incurred a foreign exchange gain of $6.8
million for the six months ended June 30, 2020 as compared to a loss of $6.7
million for the six months ended June 30, 2019. The gain for the six months
ended June 30, 2020 was primarily attributable to depreciation of the Russian
Ruble, partially offset by the depreciation of the Chinese Yuan as compared to
the U.S. Dollar. The loss for the six months ended June 30, 2019 was primarily
attributable to the appreciation of the Russian Ruble and depreciation of the
Chinese Yuan as compared to the U.S. Dollar.
Interest income (expense), net. Interest income (expense), net, decreased to
$4.9 million of income for the six months ended June 30, 2020 as compared to
$8.0 million of income for the six months ended June 30, 2019. The reduction in
interest
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income, net, is due to holding shorter duration investments to increase
liquidity as well as a decrease in yields on shorter duration investments that
resulted in lower market interest rates as compared to rates last year.
Provision for income taxes. Provision for income taxes was $22.4 million for the
six months ended June 30, 2020 compared to $40.6 million for the six months
ended June 30, 2019, representing an effective tax rate of 23.0% and 24.2% for
the six months ended June 30, 2020 and 2019, respectively. For the six months
ended June 30, 2020 and 2019, the net discrete tax benefits were $5.9 million
and $2.9 million, respectively, primarily related to the tax deductions for
equity-based compensation that exceeded compensation expense recognized and for
an investment credit in Russia related to prior years for which an amended
return was filed during the six months ended June 30, 2020.
Net income attributable to IPG Photonics Corporation. Net income attributable to
IPG Photonics Corporation decreased by $52.8 million to $74.6 million for the
six months ended June 30, 2020 compared to $127.4 million for the six months
ended June 30, 2019. Net income attributable to IPG Photonics Corporation as a
percentage of our net sales decreased by 5.1 percentage points to 13.7% for the
six months ended June 30, 2020 from 18.8% for the six months ended June 30, 2019
due to the factors described above.
Liquidity and Capital Resources
The following table presents our principal sources of liquidity:
                                                                         June 30,          December 31,
                                                                           2020                2019
                                                                                 (In thousands)
Cash and cash equivalents                                              $ 747,859          $    680,070
Short-term investments                                                   501,040               502,546
Unused credit lines and overdraft facilities                             129,909               105,469

Working capital (excluding cash, cash equivalents, restricted cash and short-term investments)

                                         506,341               522,114


Short-term investments at June 30, 2020, consist of liquid investments including
corporate notes, commercial paper and certificates of deposit with original
maturities of greater than three months but less than one year. We also hold
long-term investments, included in other assets on the condensed consolidated
balance sheets, which consist of auction rate securities totaling $0.6 million.
See Note 5, "Fair Value Measurements" in the notes to the condensed consolidated
financial statements for further information about our short and long-term
investments.
The COVID-19 pandemic is likely to reduce cash generated from operations as
compared to previous levels due to a decrease in net income and because we may
choose not to or be able to reduce working capital. Investment in working
capital might need to be maintained or increased due to a need to maintain a
higher level of inventory because of supply chain disruptions and an increase in
accounts receivable days if customers delay payments. In addition, cash from
operations could be affected by various risks and uncertainties, including, but
not limited to, the effects of the COVID-19 pandemic and other risks detailed in
Item 8.01 of the Current Report on Form 8-K filed with the SEC on May 5, 2020
and "Management's Discussion and Analysis - Factors and Trends that Affect our
Operations and Financial Results" in this Quarterly Report on Form 10-Q.
Although we expect the COVID pandemic to adversely affect our cash flow from
operations, we believe that our existing cash, cash equivalents and investment
balances, anticipated cash flows from operations and available credit facilities
will be sufficient to meet our working capital and operating resource
expenditure requirements for the next twelve months. We also expect to continue
investments in capital expenditures, to assess acquisition opportunities and to
repurchase shares of our stock in accordance with our repurchase program,
although the extent and timing of such expenditures may be adjusted in response
to the impact of COVID-19 on our operations, cash flow and other factors. Our
future long-term capital requirements will depend on many factors including our
level of sales, the impact of the economic environment on our growth, global or
regional recessions, the timing and extent of spending to support development
efforts, expansion of the global sales and marketing activities, government
regulation including trade sanctions, the timing and introductions of new
products, the need to ensure access to adequate manufacturing capacity and the
continuing market acceptance of our products.
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The following table details our line-of-credit facilities and long-term notes as
of June 30, 2020:
         Description                  Total Facility/ Note              Interest Rate                 Maturity                   Security
U.S. Revolving Line of Credit             $75.0 million              LIBOR plus 0.80% to             April 2025                 Unsecured
(1)                                                                  1.20%, depending on
                                                                       our performance
Euro Credit Facility                    Euro 50.0 million           Euribor plus 0.75% or            July 2023                  Unsecured,
(Germany) (2)                            ($56.1 million)              EONIA plus 1.00%                                     guaranteed by parent
                                                                                                                            company and German
                                                                                                                                subsidiary
Other Euro Facility (3)                 Euro 2.0 million            Euribor plus 0.89% to          September 2020             Common pool of
                                         ($2.2 million)                     1.78%                                           assets of Italian
                                                                                                                                subsidiary
Long-term Secured Note (4)                $20.8 million                Fixed at 2.74%                July 2022                Secured by the
                                                                                                                            corporate aircraft
Long-term Unsecured Note (5)              $19.0 million              1.20%

above LIBOR,               May 2023                  Unsecured
                                                                       fixed using an
                                                                    interest rate swap at
                                                                       2.85% per annum


(1) This facility is available to certain foreign subsidiaries in their
respective local currencies. At June 30, 2020, there were no amounts drawn on
this line; however, there were $1.2 million of guarantees issued against the
line which reduces total availability.
(2) This facility is also available to certain foreign subsidiaries in their
respective local currencies. At June 30, 2020, there were no drawings on this
facility; however, there were $2.3 million of guarantees issued against the line
which reduces total availability.
(3) At June 30, 2020, there were no drawings. This facility renews annually.
(4) At maturity, the outstanding note balance will be $15.4 million.
(5) At maturity, the outstanding note balance will be $15.4 million.
Our largest committed credit lines are with Bank of America N.A. and Deutsche
Bank AG in the amounts of $75.0 million and $56.1 million (or 50.0 million Euro
as described above), respectively, and neither of them is syndicated. On April
22, 2020, we amended the Euro credit facility with Deutsche Bank AG, extending
its maturity through July 31, 2023. We plan to seek amendments of our credit
agreements and notes to modify LIBOR and Euribor reference rates as these rates
are phased out as borrowing rates.
We are required to meet certain financial covenants associated with our
U.S. revolving line of credit and long-term debt facility. These covenants,
tested quarterly, include an interest coverage ratio and a funded debt to
earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio.
The interest coverage covenant requires that we maintain a trailing twelve-month
ratio of EBITDA to interest on all obligations that is at least 3.0:1.0. The
funded debt to EBITDA covenant requires that the sum of all indebtedness for
borrowed money on a consolidated basis be less than three times our trailing
twelve months EBITDA. Funded debt is decreased by our cash and available
marketable securities not classified as long-term investments in the U.S.A. in
excess of $50 million up to a maximum of $500 million. We were in compliance
with all such financial covenants as of and for the three months ended June 30,
2020.
The financial covenants in our loan documents may cause us to not make 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.
See Note 10, "Financing Arrangements" in the notes to the condensed consolidated
financial statements for further information about our facilities and term debt.
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The following table presents cash flow activities:
                                                   Six Months Ended June 30,
                                                   2020                   2019
                                                        (In thousands)
Cash provided by operating activities        $    130,256             $

101,779


Cash used by investing activities                 (35,204)

(106,258)


Cash used by financing activities                 (23,471)

(4,143)




Operating activities. Net cash provided by operating activities increased by
$28.5 million to $130.3 million for the six months ended June 30, 2020 from
$101.8 million for the six months ended June 30, 2019. In 2020, net sales and
net income decreased by 20% and 41%, respectively. As there were decreases in
net sales and net income, cash provided by net income after adding back non-cash
charges decreased. This decrease has been offset by a decrease in the amount
invested in working capital. Our largest working capital items typically are
inventory and accounts receivable. Items such as accounts payable to third
parties, prepaid expenses and other current assets and accrued expenses and
other liabilities are not as significant as our working capital investment in
accounts receivable and inventory because of our vertically integrated
structure. Accruals and payables for personnel costs including bonuses and
income and other taxes payable are largely dependent on the timing of payments
for those items. The increase in cash flow from operating activities in 2020
primarily resulted from an increase in cash provided by accounts receivable, a
decrease in cash used by inventory and a decrease in cash used by income and
other taxes payable; partially offset by a decrease in cash provided by net
income after adding back non-cash charges.
Investing activities. Net cash used in investing activities was $35.2 million
for the six months ended June 30, 2020 as compared to cash used in investing
activities of $106.3 million in 2019. The cash used in investing activities in
2020 related to $37.4 million of capital expenditures, partially offset by $1.6
million of net proceeds of short-term investments. The cash used in investing
activities in 2019 related to $86.5 million of capital expenditures, $15.1
million for acquisition of business and $5.1 million of net purchases of
short-term investments.
We expect to incur approximately $100 million in capital expenditures, excluding
acquisitions, in 2020. Capital expenditures include investments in facilities
and equipment to add capacity in selected countries, add redundancy in
specialized manufacturing and support our research and development efforts. The
timing and extent of any capital expenditures in and between periods can have a
significant effect on our cash flow. If we obtain financing for certain
projects, our cash expenditures would be reduced in the year of expenditure.
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 used in financing activities was $23.5 million
for the six months ended June 30, 2020 as compared to net cash used of $4.1
million in 2019. The cash used in financing activities in 2020 was related to
the purchase of treasury stock of $28.2 million, $1.9 million of principal
payments on our long-term borrowings and $1.7 million of payment of a purchase
price holdback from a business combination, partially offset by $8.3 million
from the exercise of stock options net of amounts disbursed in relation to
shares withheld to cover employee income taxes due upon the vesting and release
of restricted stock units. The cash used in financing activities in 2019 was
related to the purchase of treasury stock of $2.3 million and $1.8 million of
principal payments on our long-term borrowings.
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" of Part I of
the Form 10-K for the year ended December 31, 2019 (the "Annual Report") and in
the Current Report on Form 8-K, filed on May 5, 2020, with the SEC (the "May 5
Current Report"). 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
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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
See Note 2 in the Notes to Condensed Consolidated Financial Statements for a
full description of recent accounting pronouncements, including the respective
dates of adoption or expected adoption and effects on our condensed consolidated
financial statements contained in Item 1 of this Quarterly Report.

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