IPG PHOTONICS CORPORATION
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes included in this Annual Report on Form 10-K. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of certain factors including,
but not limited to, those discussed under Item 1A, "Risk Factors."
Overview
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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 , Russia and Belarus . 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.
Description of Our Net Sales , Costs and Expenses
Net sales. We derive net sales primarily from the sale of fiber lasers, diode
lasers, laser and non-laser based systems, amplifiers and complementary
products. We sell our products to OEMs that supply materials processing laser
systems, communications systems, medical laser systems and other laser systems
to end users. We also sell our laser products and laser and non-laser based
systems to end users. Our scientists and engineers work closely with OEMs,
systems integrators and end users to analyze their system requirements and match
appropriate fiber laser, amplifier or system specifications to those
requirements. Our sales cycle varies substantially, ranging from a period of a
few weeks to as long as one year or more, but is typically several months.
Sales of our products are generally recognized upon shipment, provided that no
obligations remain and collection of the receivable is reasonably assured. Sales
of customized robotic systems are recognized over time. 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.
Cost of sales. Our cost of sales consists primarily of the cost of raw materials
and components, direct labor expenses and manufacturing overhead. We are
vertically integrated and currently manufacture all critical components for our
products as well as assemble finished products. We believe our vertical
integration allows us to increase efficiencies, leverage our scale and lower our
cost of sales. Cost of sales also includes personnel costs and overhead related
to our manufacturing, engineering and service operations, related occupancy and
equipment costs, shipping costs and reserves for inventory obsolescence and for
warranty obligations. Inventories are written off and charged to cost of sales
when identified as excess or obsolete.
Due to our vertical integration strategy and ongoing investment in plant and
machinery, we maintain a relatively high fixed manufacturing overhead. We may
not be able to or choose not to adjust these fixed costs to adapt to rapidly
changing market conditions. Our gross margin is therefore significantly affected
by our sales volume and the corresponding utilization of capacity and absorption
of fixed manufacturing overhead expenses.
Sales and marketing. Our sales and marketing expense consists primarily of costs
related to compensation, trade shows, professional and technical conferences,
travel, facilities, depreciation of equipment used for demonstration purposes
and other marketing costs.
Research and development. Our research and development expense consists
primarily of compensation, development expenses related to the design of our
products and certain components, the cost of materials and components to build
prototype devices for testing and facilities costs. Costs related to product
development are recorded as research and development expenses in the period in
which they are incurred.
General and administrative. Our general and administrative expense consists
primarily of compensation and associated costs for executive management,
finance, legal, human resources, information technology and other administrative
personnel, outside legal and professional fees, insurance premiums and fees,
allocated facilities costs and other corporate expenses such as charges and
benefits related to the change in allowance for doubtful debt.
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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
ongoing COVID-19 pandemic and therefore remain uncertain at this time. Economic
indicators show some improvement from the severe contraction experienced earlier
in 2020, which has led to an improvement in the recent demand environment in
certain regions. It is difficult to predict whether the improvement in some
macro-economic indicators will be sustained if there are additional restrictions
imposed as a result of a resurgence in COVID-19 infections. This uncertainty
continues to make forecasting our business challenging in the near to
medium-term.
Currently, our four major production facilities in United States , Germany ,
Russia and Belarus remain open and are operating normally. 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 COVID-19 become more severe than we have
experienced to date or if there was significant absenteeism as a result of
COVID-19 or resurgence in the places where we operate, it could impact our
internal supply chain. 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 may face some supply chain restraints related to
logistics, including available air cargo space and higher freight rates if there
is a COVID-19 resurgence. 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
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 guidelines from relevant authorities becomes more
restrictive 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.
Net sales. Our annual revenue growth rates have varied from year to year. Net
sales decreased by 9% and 10% in 2020 and 2019, respectively, and increased by
4% in 2018. In 2020, the decline in net sales was driven by decreased demand for
our products related to the COVID-19 pandemic that extended and deepened the
weak macroeconomic environment prevailing at the end of 2019. In 2019, the
decline in net sales was driven by decreased demand for our products related to
the trade war between the U.S. and China that weakened macroeconomic conditions
in the second half of 2019. In addition to these factors, sales were affected by
declines in average sales prices related to competition. These reductions in
sales were partially offset by the introduction of new products, including high
power and ultra-fast pulsed lasers, optical heads and other accessories and the
development of new applications for our products some of which displace
non-laser technologies.
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 in 2020 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.
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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.
In the recent years, our net sales have been negatively impacted by tariffs and
trade policies. New tariffs and other changes in U.S. trade policy could trigger
retaliatory actions by affected countries, and certain foreign governments.
We are also susceptible to global or regional disruptions such as political
instability, geopolitical conflicts, acts of terrorism, significant fluctuations
in currency values, natural disasters, macroeconomic concerns and particularly
the impact of the COVID-19 outbreak that affect the level of capital
expenditures or global commerce. With respect to the COVID-19 outbreak
specifically, our 2020 financial results were negatively impacted. In addition,
as of the time of this Annual Report on Form 10-K, we expect that COVID-19 could
continue to negatively impact our businesses beyond 2020, but the extent and
duration of such impacts over the longer term remain uncertain and dependent on
future developments that cannot be accurately predicted at this time, such as
the severity and transmission rate of the coronavirus, the extent and
effectiveness of containment actions taken, the approval, effectiveness, timing
and widespread inoculation of the global population with new vaccines, and the
impact of these and other factors on our customer base and general commercial
activity.
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 can experience additional competition which tends to
decrease average selling prices and affects gross margin;
•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
lower prices 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 finally,
•Gross margin on systems and communication components can be lower than margins
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 levels of gross margins by growing sales, by
taking market share in existing
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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. For instance, despite the decreases in sales in 2020 and 2019,
manufacturing levels remained high and our facilities increased production as we
manufactured more optical power products at lower average selling prices.
We invested $87.7 million , $133.5 million and $160.3 million in capital
expenditures in 2020, 2019 and 2018, respectively. Most of this investment
relates to expansion of our manufacturing capacity and, to a lesser extent,
research and development and sales-related facilities.
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, 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 are 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 $45.4 million , $38.9 million and $13.0 million in 2020, 2019 and 2018,
respectively.
Selling and general and administrative expenses. In the past, the Company has
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. We incurred $0.7 million and $2.5 million of non-cash
impairment charges related to long-lived assets during the years ended
December 31, 2020 and 2019, respectively. There were no impairment charges
recognized during the year ended December 31, 2018 .
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. If our analysis indicates potential impairment to goodwill in one or
more of our reporting units, we may be required to record charges to earnings in
our financial statements, which could negatively affect our results of
operations.
As a result of the continued negative impact of COVID-19 on order flow for our
Genesis custom system business, we performed an impairment analysis of the
goodwill during the third quarter of 2020. We performed a quantitative
assessment using the discounted cash flow method under the income approach as
well as the guideline public company analysis and guideline transaction analysis
under the market approach to estimate the fair value of the custom systems
business. As a result of this and to a lesser extent the overall performance of
the business since its acquisition in 2018, we recognized a non-cash impairment
loss of $44.6 million , which was equal to the carrying amount of goodwill prior
to its impairment. The analysis considered internal forecasts of sales,
profitability and capital expenditures, as well as valuation multiples of
comparable public companies and valuation multiples of transactions of
comparable companies. If the business impacts of COVID-19 carry on for
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an extended period, it could cause us to recognize additional impairments for
goodwill and certain long-lived assets, including amortizable intangible assets
or right-of-use assets in one or more of our reporting units, 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. 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 annual net sales were 24%, 21% and 26% in 2020, 2019 and 2018,
respectively. Our largest customer accounted for 8%, 9% and 12% of our net sales
in 2020, 2019 and 2018, respectively. The same customer accounted for 21% and
24% of our net accounts receivable as of December 31, 2020 and 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. We generally do not enter into agreements
with our customers obligating them to purchase a fixed number or large volume of
our fiber lasers or amplifiers. If any of our significant customers were to
substantially reduce their purchases from us, our results would be adversely
affected.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States ("GAAP") requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of net sales and expenses. By
their nature, these estimates and judgments are subject to an inherent degree of
uncertainty. We base our estimates and judgments on our historical experience
and on other assumptions that we believe are reasonable under the circumstances,
the results of which form the basis for making the judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results could differ from those estimates, which may materially
affect our operating results and financial position. We have identified the
following items that require the most significant judgment and often involve
complex estimation: revenue recognition, inventory valuation, warranty,
accounting for income taxes and goodwill and long-lived asset impairment.
Revenue Recognition. Revenue is recognized when transfer of control to the
customer occurs in an amount reflecting the consideration that we expect to be
entitled. In order to achieve this core principle, we apply the following five
step approach: (1) identify the contract with a customer, (2) identify the
performance obligations in the contract, (3) determine the transaction price,
(4) allocate the transaction price to the performance obligations in the
contract, and (5) recognize revenue when a performance obligation is satisfied.
We allocate the transaction price to each distinct product based on its relative
standalone selling price, as more fully described in Note 1, "Nature of Business
and Summary of Significant Accounting Policies - Revenue Recognition," in our
consolidated financial statements. Revenue is generally recognized when control
of the product is transferred to the customer (i.e., when our performance
obligation is satisfied), which typically occurs at shipment, but which can
occur over time for certain of our systems contracts. We also recognize revenue
over time for sales of extended warranties. When goods or services have been
delivered to the customer, but all conditions for revenue recognition have not
been met, deferred revenue and deferred costs are recorded on our consolidated
balance sheet. We enter into contracts to sell customized robotic systems, for
which revenue is generally recognized over time, depending on the terms of the
contract. Recognizing revenue over time for these contracts is based on our
judgment that the customized robotic system does not have an alternative use and
we have an enforceable right to payment for performance completed to date.
Recognizing revenue over time also requires estimation of the progress towards
completion based on the projected costs for the contract.
Inventory. Inventory is stated at the lower of cost (first-in, first-out method)
or market value. Inventory includes parts and components that may be specialized
in nature and subject to rapid obsolescence. We maintain a reserve for excess or
obsolete inventory items. The reserve is based upon a review of inventory
materials on hand, which we compare with historic usage, estimated future usage
and age. In addition, we review the inventory and compare recorded costs with
estimates of current
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market value. Write-downs are recorded to reduce the carrying value to the net
realizable value with respect to any part with costs in excess of current market
value. Estimating demand and current market values is inherently difficult,
particularly given that we make highly specialized components and products. We
determine the valuation of excess and obsolete inventory by making our best
estimate considering the current quantities of inventory on hand and our
forecast of the need for this inventory to support future sales of our products.
We often have limited information on which to base our forecasts. If future
sales differ from these forecasts, the valuation of excess and obsolete
inventory may change and additional inventory provisions may be required.
Because of our vertical integration, a significant or sudden decrease in sales
could result in a significant change in the estimates of excess or obsolete
inventory valuation.
Warranty. We maintain an accrual for warranty claims for units sold that are
subject to warranty. We estimate this accrual considering past claims
experience, the number of units still carrying warranty coverage and the average
life of the remaining warranty period. A change in the rate of warranty repairs
or when warranty is generally incurred during the warranty period could change
our estimated warranty accrual and associated warranty expense.
Income Taxes and Deferred Taxes. Our annual tax rate is based on our income,
statutory tax rates and tax planning opportunities available to us in the
various jurisdictions in which we operate. We file federal and state income tax
returns in the United States and tax returns in numerous international
jurisdictions. We must estimate our income tax expense after considering, among
other factors, if inter-company transactions have been made on an arm's length
basis, differing tax rates between jurisdictions, allocation factors, tax
credits, nondeductible items and changes in enacted tax rates. Significant
judgment is required in determining our annual tax expense and in evaluating our
tax positions. As we continue to expand globally, there is a risk that, due to
complexity within and diversity among the various jurisdictions in which we do
business, a governmental agency may disagree with the manner in which we have
computed our taxes. Additionally, due to the lack of uniformity among all of the
foreign and domestic taxing authorities, there may be situations where the tax
treatment of an item in one jurisdiction is different from the tax treatment in
another jurisdiction or that the transaction causes a tax liability to arise in
another jurisdiction.
We provide reserves for potential payments of tax to various tax authorities
related to uncertain tax positions and other issues. Reserves recorded are based
on a determination of whether and how much of a tax benefit taken by us in our
tax filings or positions is "more likely than not" to be realized following
resolution of any potential contingencies present related to the tax benefit,
assuming that the matter in question will be raised by the tax authorities.
Potential interest and penalties associated with such uncertain tax positions is
recorded as a component of income tax expense.
Goodwill and Long-lived Asset Impairment. We perform our annual goodwill
impairment review as of the first day of our fourth quarter, or more frequently
if events or circumstances indicate it is more likely than not that the fair
value of a reporting unit is less than its carrying amount. Such events and
circumstances could include significant and sustained reductions in sales
volume, margin, profitability or cash flows of the reporting unit or changes in
market dynamics, including technology or product changes. We test reporting
units for impairment by comparing the estimated fair value of each reporting
unit with its carrying amount. Intangible assets and other long-lived assets are
also subject to an impairment test if there is an indicator of impairment.
Fair value determinations require considerable judgment and are sensitive to
changes in underlying assumptions, estimates, and market factors. Estimating the
fair value of individual reporting units requires us to make assumptions and
estimates regarding our future plans, as well as industry, economic, and
regulatory conditions. These assumptions and estimates include estimated future
annual net cash flows, income tax considerations, discount rates, growth rates,
royalty rates, contributory asset charges, and other market factors. Assumptions
used in impairment testing are made at a point in time and require significant
judgment; therefore, they are subject to change based on the facts and
circumstances present at each annual and interim impairment test date.
Additionally, these assumptions are generally interdependent and do not change
in isolation. If current expectations of future growth rates and margins are not
met, if market factors outside of our control, such as discount rates, change,
or if management's expectations or plans otherwise change, then one or more of
our reporting units might become impaired in the future.
Definite-lived intangible assets are amortized on a straight-line basis over the
estimated useful life. We review definite-lived intangible assets for impairment
when conditions exist that indicate the carrying amount of the assets may not be
recoverable. Such conditions could include significant adverse changes in the
business climate, current-period operating or cash flow losses, significant
declines in forecasted operations, or a current expectation that an asset group
will be disposed of before the end of its useful life. We perform undiscounted
operating cash flow analyses to determine if an impairment exists. When testing
for impairment of definite-lived intangible assets held for use, we group assets
at the lowest level for which cash flows are separately identifiable. If an
impairment is determined to exist, the loss is calculated based on estimated
fair value.
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Results of Operations
The following table sets forth selected statement of operations data for the
periods indicated in dollar amounts and expressed as a percentage of net sales:
Year Ended December 31,
2020 2019 2018
(In thousands, except percentages and per share data)
Net sales $ 1,200,724 100.0 % $ 1,314,581 100.0 % $ 1,459,874 100.0 %
Cost of sales 661,728 55.1 708,372 53.9 659,606 45.2
Gross profit 538,996 44.9 606,209 46.1 800,268 54.8
Operating expenses:
Sales and marketing 70,583 5.9 77,745 5.9 57,815 4.0
Research and development 126,898 10.6 129,997 9.9 122,769 8.4
General and administrative 110,005 9.2 107,597 8.2 102,429 7.0 Goodwill impairment 44,589 3.7 37,120 2.8 - - Impairment of long-lived assets and other restructuring charges 1,177 0.1 7,130 0.5 -
-
Loss (gain) on foreign exchange (12,915) (1.1) 12,827 1.0 (6,150)
(0.4)
Total operating expenses 340,337 28.4 372,416 28.3 276,863 19.0 Operating income 198,659 16.5 233,793 17.8 523,405 35.9 Interest income, net 6,270 0.5 14,238 1.1 9,057 0.6 Other income, net 763 0.1 345 - 1,933 0.1 Income before provision for income taxes 205,692 17.1 248,376 18.9 534,395
36.6
Provision for income taxes 45,354 3.8 68,115 5.2 130,226 (8.9) Net income 160,338 13.3 180,261 13.7 404,169 27.7 Less: net income attributable to non-controlling interest 766 0.1 27 - 142
-
Net income attributable to IPG Photonics Corporation $ 159,572 13.2 %$ 180,234 13.7 %$ 404,027 27.7 % Net income attributable toIPG Photonics Corporation per share: Basic $ 3.00$ 3.40 $ 7.55 Diluted $ 2.97$ 3.35 $ 7.38 Weighted average shares outstanding: Basic 53,186 53,061 53,522 Diluted 53,785 53,839 54,726 Comparison of Year EndedDecember 31, 2020 to Year EndedDecember 31, 2019 Net sales. Net sales decreased by$113.9 million , or 8.7%, to$1,200.7 million in 2020 from$1,314.6 million in 2019. The table below sets forth sales by application: Year Ended December 31, 2020 2019 Change (In thousands, except for percentages) Sales by Application % of Total % of Total Materials Processing$ 1,082,478 90.2 %$ 1,229,211 93.5 %$ (146,733) (11.9) % Other Applications 118,246 9.8 % 85,370 6.5 % 32,876 38.5 % Total$ 1,200,724 100.0 %$ 1,314,581 100.0 %$ (113,857) (8.7) % 38
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The table below sets forth sales by type of product and other revenue:
Year Ended December 31,
2020 2019 Change
(In thousands, except for percentages)
Sales by Product % of Total % of Total
High Power Continuous Wave ("CW") Lasers $ 646,062 53.8 % $ 734,745 55.9 % $ (88,683) (12.1) %
Medium Power CW Lasers 50,796 4.2 % 56,625 4.3 % (5,829) (10.3) %
Pulsed Lasers 158,448 13.2 % 137,675 10.5 % 20,773 15.1 %
Quasi-Continuous Wave ("QCW") Lasers 50,333 4.2 % 56,440 4.3 % (6,107) (10.8) %
Laser and Non-Laser Systems 93,727 7.8 % 141,647 10.8 % (47,920) (33.8) %
Other Revenue including Amplifiers, Service,
Parts, Accessories and Change in Deferred
Revenue 201,358 16.8 % 187,449 14.2 % 13,909 7.4 %
Total $ 1,200,724 100.0 % $ 1,314,581 100.0 % $ (113,857) (8.7) %
Materials processing
Sales for materials processing applications decreased due to lower sales of high
power lasers, laser and non-laser systems, QCW lasers and medium power lasers,
partially offset by increased sales in pulsed lasers.
•High power laser sales for metal cutting and welding applications declined due
to the impact of COVID-19 on end market demand, continued reductions of average
selling prices and increased competition. 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, more complex and more expensive. These more compact
YLR lasers are less expensive to manufacture and are sold at prices lower than
the YLS series lasers they are displacing.
•Medium power laser sales decreased due to decreased demand in laser sintering
for metal-based additive manufacturing and ongoing transition to kilowatt scale
cutting lasers.
•Pulsed laser sales increased due to growth in sales of high power pulsed lasers
used for battery processing, ablative processing and solar cell manufacturing
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.
•Laser and non-laser systems sales decreased due to lower demand primarily as a
result of COVID-19. The reduction of revenue in laser systems was attributable
to lower demand 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 parts and service
revenue.
Other Applications
Sales from other applications increased due to increased demand for lasers used
for directed energy, semiconductor, scientific and instrument applications, as
well as lasers used in medical procedures, partially offset by lower sales of
telecom products.
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Our net sales were derived from customers in the following geographic regions:
Year Ended December 31,
2020 2019 Change
(In thousands, except for percentages)
Sales by Geography % of Total % of Total
North America (1) $ 246,189 20.5 % $ 280,886 21.4 % $ (34,697) (12.4) %
Europe :
Germany 65,646 5.5 % 81,365 6.2 % (15,719) (19.3) %
Other including Eastern Europe/CIS 219,540 18.3 % 249,871 19.0 % (30,331) (12.1) %
Asia and Australia:
China 502,278 41.8 % 491,890 37.4 % 10,388 2.1 %
Japan 53,180 4.4 % 71,757 5.5 % (18,577) (25.9) %
Other 103,785 8.6 % 121,586 9.2 % (17,801) (14.6) %
Rest of World 10,106 0.9 % 17,226 1.3 % (7,120) (41.3) %
Total $ 1,200,724 100.0 % $ 1,314,581 100.0 % $ (113,857) (8.7) %
(1) The substantial majority of sales in North America are to customers in the
United States .
Cost of sales and gross margin. Cost of sales decreased by $46.7 million , or
6.6%, to $661.7 million in 2020 from $708.4 million in 2019. Our gross margin
decreased to 44.9% in 2020 from 46.1% in 2019. Gross margin decreased mainly due
to increased manufacturing costs as a percentage of sales due to lower sales,
particularly in the first half of the year resulting from the impact of the
COVID-19 pandemic. In addition, provisions for inventory reserves and freight
costs were higher. The increase in freight costs is also primarily attributable
to COVID-19. Expenses related to provisions for excess or obsolete inventory and
other valuation adjustments increased by $6.5 million to $45.4 million , or 3.8%
of sales, for the year ended December 31, 2020 , as compared to $38.9 million , or
3.0% of sales, for the year ended December 31, 2019 .
Sales and marketing expense. Sales and marketing expense decreased by $7.1
million , or 9.1%, to $70.6 million in 2020 from $77.7 million in 2019. This
change was primarily a result of decreased spending on trade fairs and exhibits,
travel and personnel costs partially offset by an increase in depreciation. As a
percentage of sales, sales and marketing expense was 5.9% in 2020, unchanged
from 2019.
Research and development expense. Research and development expense decreased by
$3.1 million , or 2.4%, to $126.9 million in 2020 from $130.0 million in 2019.
This change was primarily a result of decreases in R&D materials, consultants
and travel partially offset by increases in personnel costs. As a percentage of
sales, research and development expense increased to 10.6% in 2020 from 9.9% in
2019. We expect to continue to invest in research and development and that
research and development expense will increase in the aggregate.
General and administrative expense. General and administrative expense increased
by $2.4 million , or 2.2%, to $110.0 million in 2020 from $107.6 million in 2019.
This change was primarily a result of increases in personnel costs, loss on
disposal of fixed assets, insurance, information systems, and premises partially
offset by decreases in expense for travel, bad debt provision, legal, and
consultants. As a percentage of sales, general and administrative expense
increased to 9.2% in 2020 from 8.2% in 2019.
Goodwill impairment, impairment of long-lived assets and other restructuring
charges. During the third quarter of 2020, we concluded that declines in revenue
and order flow for the Genesis custom systems business caused by
pandemic-related decreases in capital spending in the aerospace and
transportation industries were a triggering event requiring a goodwill
impairment evaluation. As a result of the analysis, we incurred a non-cash
goodwill impairment loss of $44.6 million in 2020. In 2019, we incurred non-cash
goodwill impairment losses of $37.1 million related to impairments of our
transceivers reporting unit and our submarine network division.
We incurred impairment of long-lived assets and other restructuring charges of
$1.2 million in 2020, of which $0.4 million related to severance and $0.1
million related to lease termination costs that resulted from the restructuring
of our submarine network division. We also incurred $0.7 million of non-cash
long-lived impairments related to machinery and equipment. In 2019, we incurred
impairment of long-lived assets and other restructuring charges of $7.1 million ,
of which $5.3 million related to non-cash impairment losses of long-lived assets
and $1.8 million were charges related to global restructuring programs.
Effect of exchange rates on sales, gross margin and operating expenses. We
estimate that if exchange rates had been the same as one year ago, sales in 2020
would have been $2.5 million lower, gross margin would have been $3.7 million
lower and
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operating expenses in total would have been $6.2 million higher. These estimates
assume constant exchange rates between fiscal year 2020 and fiscal year 2019 and
are calculated using the average exchange rates for the twelve-month period
ended December 31, 2019 for the respective currencies, which were US$1 =Euro
0.89 , US$1 =Japanese Yen 109 , US$1 =Chinese Yuan 6.91 and US$1 =Russian Ruble 65 .
Loss (gain) on foreign exchange. We incurred a foreign exchange gain of $12.9
million in 2020 as compared to a loss of $12.8 million in 2019. The gain was
primarily attributable to the depreciation of the Russian Ruble and the
appreciation of the Chinese Yuan as compared to the U.S. Dollar, which was
partially offset by a loss attributed to the appreciation of the Euro and
depreciation of the Brazilian Real as compared to the U.S. Dollar.
Interest income, net. Interest income, net decreased to $6.3 million of income
in 2020 compared to $14.2 million of income in 2019. The reduction in interest
income, net, is primarily due to a decrease in yields on shorter duration
investments that resulted in lower market interest rates as compared to rates
last year. In addition, our initial response to the COVID-19 pandemic included
holding shorter duration investments to increase liquidity, which also reduced
yields.
Provision for income taxes. Provision for income taxes was $45.4 million in 2020
compared to $68.1 million in 2019, representing an effective tax rate of 22.0%
in 2020 and 27.4% in 2019. The lower effective tax rate was primarily due to
increased benefit from discrete adjustments. Discrete adjustments in 2020
resulted in a $10.6 million reduction in tax expense, which includes (i) $9.7
million for equity-based compensation deductions for tax in excess of the
deductions reflected in book income, (ii) $3.2 million for an investment credit
in Russia requested in amended returns filed for prior years and (iii) $1.2
million for prior year provision to return adjustments, offset by an increase to
tax expense for a $3.6 million impact of losses in subsidiaries for which no tax
benefit was taken. Discrete adjustments in 2019 were $1.3 million and include a
decrease to tax expense for (i) $5.1 million related to equity-based
compensation deductions for tax in excess of the deductions reflected in book
income and (ii) $4.8 million for prior year provision to return adjustments,
offset by an increase to tax expense of $10.0 million for goodwill impairments
losses which were not deductible for tax.
Net income attributed to IPG Photonics Corporation . Net income attributable to
IPG Photonics Corporation decreased by $20.6 million to $159.6 million in 2020
from $180.2 million in 2019. Net income attributable to IPG Photonics
Corporation as a percentage of our net sales decreased by 0.4% to 13.3% in 2020
from 13.7% in 2019 due to the factors described above.
Liquidity and Capital Resources
The following table presents our principal sources of liquidity:
As of December 31,
2020 2019
(In thousands)
Cash and cash equivalents $ 876,231 $ 680,070
Short-term investments 514,835 502,546
Unused credit lines and overdraft facilities 132,048 105,469
Working capital (excluding cash and cash equivalents and short-term investments)
542,433 522,114
Short-term investments at December 31, 2020 consist of liquid investments
including corporate bonds, commercial paper, U.S. Treasury and agency
obligations and municipal bonds with original maturities of greater than three
months but less than one year. See Note 3, "Fair Value Measurements" in the
notes to the consolidated financial statements for further information about our
short-term investments.
We expect to continue investments in capital expenditures, to assess acquisition
opportunities and to repurchase shares of our stock in accordance with our
repurchase program. The extent and timing of such expenditures may vary from
period to period. 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 including any ongoing impact of the COVID-19 pandemic on certain
global or regional economies, global or regional recessions, the timing and
extent of spending to support development efforts, expansion of 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 December 31, 2020 :
Description Total Facility/ Note Interest Rate Maturity Security
U.S. Revolving Line of $75.0 million LIBOR plus 0.80% to April 2025 Unsecured
Credit (1) 1.20%, depending on our
performance
Euro Credit Facility Euro 50.0 million Euribor plus 0.75% or July 2023 Unsecured, guaranteed
(Germany) (2) ($61.3 million ) EONIA plus 1.00% by parent company and
German subsidiary
Other Euro Facilities (3) Euro 2.0 million Euribor plus 0.94% to March 2021 Common pool of assets
($2.5 million ) 2.02% of Italian subsidiary
Long-term Secured Note (4) $19.6 million Fixed at 2.74% July 2022 Secured by the
corporate aircraft
Long-term Unsecured Note (5) $18.4 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 December 31, 2020 , there were no amounts drawn
on this line, however, there were $3.3 million of guarantees issued against the
line which reduces total availability.
(2) This facility is available to certain foreign subsidiaries in their
respective local currencies. At December 31, 2020 , there were no drawings,
however, there were $3.4 million of guarantees issued against the line which
reduces total availability.
(3) At December 31, 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 $61.3 million (or €50,000 as
described above), respectively, and neither of them is syndicated. 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. 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
December 31, 2020 .
The financial covenants in our loan documents may cause us to not take or to
delay investments and actions that we might otherwise undertake because of
limits on capital expenditures and amounts that we can borrow or lease. In the
event that we do not comply with any one of these covenants, we would be in
default under the loan agreement or loan agreements, which may result in
acceleration of the debt, cross-defaults on other debt or a reduction in
available liquidity, any of which could harm our results of operations and
financial condition.
See Note 11, "Financing Arrangements" in the notes to the consolidated financial
statements for further information about our facilities and term debt.
The following table presents cash flow activities:
As of December 31,
2020 2019
(In thousands)
Cash provided by operating activities
(99,574) (139,975)
Cash used by financing activities (10,080) (37,067)
Operating activities. Net cash provided by operating activities decreased by
$38.2 million to $285.3 million in 2020 from $323.5 million in 2019. In 2020,
net sales and net income decreased by 9% and 11%, respectively. 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
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accounts receivable and inventory because of the amount of value added within
IPG due to 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 decrease in cash flow
from operating activities in 2020 primarily resulted from a decrease in cash
provided by net income after adding back non-cash charges, an increase in cash
used by accounts receivable, an increase in cash used by prepaid expenses and an
increase in cash used by inventory; partially offset by a decrease in cash used
for accrued expenses, a decrease in cash used by income and other taxes payable
and a decrease in cash used by accounts payable.
Investing activities. Net cash used in investing activities was $99.6 million
and $140.0 million in 2020 and 2019, respectively. The cash used in investing
activities in 2020 related to $87.7 million for property, plant and equipment,
$12.3 million of net purchases of investments and $0.4 million for the
acquisition of a business during 2020, net of cash acquired. The cash used in
investing activities in 2019 related to $133.5 million for property, plant and
equipment, and $15.1 million for the acquisition of a business during 2019, net
of cash acquired; partially offset by $7.8 million of net proceeds of
investments.
In 2021, we expect to incur approximately $150 million to $160 million in
capital expenditures, excluding acquisitions. Capital expenditures include
investments in property, facilities and equipment to add capacity worldwide to
support anticipated revenue growth, increase vertical integration, increase
redundant manufacturing capacity for critical components and enhance research
and development capabilities. 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 $10.1 million
and $37.1 million in 2020 and 2019, respectively. The cash used in financing
activities in 2020 was primarily related to the purchase of treasury stock of
$37.9 million , payments on our long-term borrowings of $3.7 million , and $1.7
million of payment of a purchase price holdback from a business combination.
These uses of cash were partially offset by net proceeds 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
and shares issued under our employee stock purchase plan of $33.2 million . The
cash used in financing activities in 2019 was primarily related to the purchase
of treasury stock of $40.7 million and payments on our long-term borrowings of
$3.7 million . These cash uses were partially offset by net proceeds of $7.3
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 and shares issued under our employee stock
purchase plan.
Contractual Obligations and Off-Balance Sheet Arrangements
As of December 31, 2020 , we had no off-balance sheet arrangements that have, or
are reasonably likely to have, a current or future material effect on our
consolidated financial condition, results of operations, liquidity, capital
expenditures or capital resources. The following summarizes our contractual
obligations at December 31, 2020 and the effect such obligations are expected to
have on our liquidity and cash flow in future periods:
Payments Due in
Less Than 1 More Than
Total Year 1-3 Years 3-5 Years 5 Years
(In thousands)
Operating lease obligations $ 27,517 $ 6,452 $ 8,427 $ 4,327 $ 8,311
Purchase obligations 51,730 51,730 - - -
Long-term debt obligations (including
interest)(1) 39,899 4,821 35,078 - -
Contingent consideration 1,963 491 1,472 - -
Total(2) $ 121,109 $ 63,494 $ 44,977 $ 4,327 $ 8,311
(1)Interest for long-term debt obligations was calculated including the effect
of our fixed rate amounts. The weighted average fixed rate amount was 2.79%.
(2)Excludes obligations related to ASC 740, reserves for uncertain tax
positions, because we are unable to provide a reasonable estimate of the timing
of future payments relating to the remainder of these obligations. See Note 17,
"Income Taxes" to the consolidated financial statements.
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Table of Contents Recent Accounting Pronouncements See Note 1, "Nature of Business and Summary of Significant Accounting Policies" in the notes to the consolidated financial statements for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our consolidated financial statements contained in Part IV of this Annual Report.
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