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EX-32 - EXHIBIT 32 - IPG PHOTONICS CORPex-32q32017.htm
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EX-31.1 - EXHIBIT 31.1 - IPG PHOTONICS CORPex-311q32017.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________
FORM 10-Q
__________________________________________
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-33155 
IPG PHOTONICS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
04-3444218
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
 
 
50 Old Webster Road,
Oxford, Massachusetts
01540
(Address of principal executive offices)
(Zip code)
(508) 373-1100
(Registrant’s telephone number, including area code)
__________________________________________ 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ý    NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ý    NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer
ý
  
Accelerated Filer
¨
Non-Accelerated Filer
¨
  
Smaller Reporting Company
¨
Emerging Growth Company
¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  ý
As of November 1, 2017, there were 53,934,506 and 53,615,872 shares of the registrant's common stock issued and outstanding, respectively.



TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 




PART I-FINANCIAL INFORMATION
ITEM 1. UNAUDITED INTERIM FINANCIAL STATEMENTS
IPG PHOTONICS CORPORATION
CONSOLIDATED BALANCE SHEETS
 
September 30,
 
December 31,
 
2017
 
2016
 
(In thousands, except share
and per share data)
ASSETS
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
880,267

 
$
623,855

Short-term investments
165,655

 
206,779

Accounts receivable, net
226,756

 
155,901

Inventories
282,495

 
239,010

Prepaid income taxes
40,639

 
34,128

Prepaid expenses and other current assets
46,727

 
41,289

Total current assets
1,642,539

 
1,300,962

DEFERRED INCOME TAXES, NET
40,547

 
42,442

GOODWILL
51,143

 
19,828

INTANGIBLE ASSETS, NET
49,669

 
28,789

PROPERTY, PLANT AND EQUIPMENT, NET
441,494

 
379,375

OTHER ASSETS
20,673

 
18,603

TOTAL
$
2,246,065

 
$
1,789,999

LIABILITIES AND EQUITY
CURRENT LIABILITIES:
 
 
 
Current portion of long-term debt
$
3,576

 
$
3,188

Accounts payable
34,271

 
28,048

Accrued expenses and other liabilities
134,284

 
102,485

Income taxes payable
10,060

 
24,554

Total current liabilities
182,191

 
158,275

DEFERRED INCOME TAXES AND OTHER LONG-TERM LIABILITIES
58,479

 
36,365

LONG-TERM DEBT, NET OF CURRENT PORTION
46,296

 
37,635

Total liabilities
286,966

 
232,275

COMMITMENTS AND CONTINGENCIES (NOTE 12)

 

IPG PHOTONICS CORPORATION EQUITY:
 
 
 
Common stock, $0.0001 par value, 175,000,000 shares authorized; 53,918,008 and 53,599,374 shares issued and outstanding, respectively, at September 30, 2017; 53,354,579 and 53,251,805 shares issued and outstanding, respectively, at December 31, 2016
5

 
5

Treasury stock, at cost (318,634 and 102,774 shares held)
(35,857
)
 
(8,946
)
Additional paid-in capital
693,337

 
650,974

Retained earnings
1,390,911

 
1,094,108

Accumulated other comprehensive loss
(89,297
)
 
(178,583
)
Total IPG Photonics Corporation equity
1,959,099

 
1,557,558

NONCONTROLLING INTERESTS

 
166

Total equity
1,959,099

 
1,557,724

TOTAL
$
2,246,065

 
$
1,789,999

See notes to consolidated financial statements.

1


IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except per share data)
NET SALES
$
392,615

 
$
266,017

 
$
1,047,834

 
$
726,052

COST OF SALES
168,060

 
121,226

 
459,716

 
329,147

GROSS PROFIT
224,555

 
144,791

 
588,118

 
396,905

OPERATING EXPENSES:
 
 
 
 
 
 
 
Sales and marketing
13,384

 
10,460

 
36,347

 
28,183

Research and development
25,541

 
20,543

 
74,281

 
56,444

General and administrative
21,491

 
16,797

 
59,092

 
46,849

Loss on foreign exchange
3,917

 
2,905

 
15,553

 
6,316

Total operating expenses
64,333

 
50,705

 
185,273

 
137,792

OPERATING INCOME
160,222

 
94,086

 
402,845

 
259,113

OTHER INCOME (EXPENSE), Net:
 
 
 
 
 
 
 
Interest (expense) income, net
(125
)
 
373

 
651

 
835

Other income (expense), net
459

 
194

 
(47
)
 
342

Total other income (expense)
334

 
567

 
604

 
1,177

INCOME BEFORE PROVISION FOR INCOME TAXES
160,556

 
94,653

 
403,449

 
260,290

PROVISION FOR INCOME TAXES
(44,959
)
 
(25,426
)
 
(108,817
)
 
(74,703
)
NET INCOME
115,597

 
69,227

 
294,632

 
185,587

LESS: NET LOSS ATTRIBUTABLE TO NONCONTROLLING INTERESTS

 
(8
)
 
(26
)
 
(33
)
NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION
$
115,597

 
$
69,235

 
$
294,658

 
$
185,620

NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION PER SHARE:
 
 
 
 
 
 
 
Basic
$
2.16

 
$
1.30

 
$
5.51

 
$
3.50

Diluted
$
2.11

 
$
1.29

 
$
5.40

 
$
3.45

WEIGHTED AVERAGE SHARES OUTSTANDING:
 
 
 
 
 
 
 
Basic
53,440

 
53,071

 
53,453

 
53,039

Diluted
54,698

 
53,761

 
54,570

 
53,752

See notes to consolidated financial statements.


2


IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Net income
$
115,597

 
$
69,227

 
$
294,632

 
$
185,587

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Translation adjustments
29,855

 
8,068

 
89,076

 
32,948

Unrealized gain (loss) on derivatives
11

 
(47
)
 
(35
)
 
104

Loss on available-for-sale investments, net of tax reclassified to net income

 

 
298

 

Total other comprehensive loss
29,866

 
8,021

 
89,339

 
33,052

Comprehensive income
145,463

 
77,248

 
383,971

 
218,639

Comprehensive loss attributable to noncontrolling interest

 
(4
)
 
(26
)
 
(17
)
Comprehensive income attributable to IPG Photonics Corporation
$
145,463

 
$
77,252

 
$
383,997

 
$
218,656

See notes to consolidated financial statements.


3


IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Nine Months Ended September 30,
 
2017
 
2016
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
294,632

 
$
185,587

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
46,416

 
37,646

Deferred income taxes
14,534

 
(12,054
)
Stock-based compensation
16,989

 
16,099

Unrealized losses on foreign currency transactions
8,197

 
6,044

Other
699

 
193

Provisions for inventory, warranty & bad debt
34,690

 
33,506

Changes in assets and liabilities that (used) provided cash:
 
 
 
Accounts receivable
(56,416
)
 
(10,853
)
Inventories
(39,697
)
 
(42,814
)
Prepaid expenses and other current assets
(1,560
)
 
(4,102
)
Accounts payable
3,423

 
(9,816
)
Accrued expenses and other liabilities
1,809

 
3,848

Income and other taxes payable
(26,866
)
 
(7,439
)
Net cash provided by operating activities
296,850

 
195,845

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of and deposits on property, plant and equipment
(99,221
)
 
(100,047
)
Proceeds from sales of property, plant and equipment
15,437

 
220

Purchases of short-term investments
(146,585
)
 
(179,374
)
Proceeds from sales of short-term investments
188,143

 
158,808

Acquisitions of businesses, net of cash acquired
(50,594
)
 
(46,527
)
Other
(496
)
 
16

Net cash used in investing activities
(93,316
)
 
(166,904
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from line-of-credit facilities
6,761

 
6,030

Payments on line-of-credit facilities
(6,761
)
 
(6,030
)
Purchase of noncontrolling interests
(197
)
 
(950
)
Proceeds on long-term borrowings
28,000

 
23,750

Principal payments on long-term borrowings
(18,951
)
 
(1,797
)
Proceeds from issuance of common stock under employee stock option and purchase plans less payments for taxes related to net share settlement of equity awards
23,296

 
9,186

Purchase of treasury stock, at cost
(26,911
)
 
(3,483
)
Net cash provided by financing activities
5,237

 
26,706

EFFECT OF CHANGES IN EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
47,641

 
7,379

NET INCREASE IN CASH AND CASH EQUIVALENTS
256,412

 
63,026

CASH AND CASH EQUIVALENTS — Beginning of period
623,855

 
582,532

CASH AND CASH EQUIVALENTS — End of period
$
880,267

 
$
645,558

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for interest
$
1,965

 
$
623

Cash paid for income taxes
$
118,660

 
$
95,539

Non-cash transactions:
 
 
 
Demonstration units transferred from inventory to other assets
$
3,290

 
$
2,916

Inventory transferred to machinery and equipment
$
4,087

 
$
4,056

Changes in accounts payable related to property, plant and equipment
$
(15
)
 
$
(430
)
See notes to consolidated financial statements.

4


IPG PHOTONICS CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY
 
 
Nine Months Ended September 30,
 
2017
 
2016
 
(In thousands, except share and per share data)
 
Shares
 
Amount
 
Shares
 
Amount
COMMON STOCK
 
 
 
 
 
 
 
Balance, beginning of year
53,251,805

 
$
5

 
52,883,902

 
$
5

Exercise of stock options
543,547

 

 
268,198

 

Common stock issued under employee stock purchase plan
19,882

 

 
19,015

 

Purchased common stock
(215,860
)
 

 
(41,800
)
 

Balance, end of period
53,599,374

 
5

 
53,129,315

 
5

TREASURY STOCK
 
 
 
 
 
 
 
Balance, beginning of year
(102,774
)
 
(8,946
)
 

 

Purchased treasury stock
(215,860
)
 
(26,911
)
 
(41,800
)
 
(3,483
)
Balance, end of period
(318,634
)
 
(35,857
)
 
(41,800
)
 
(3,483
)
ADDITIONAL PAID-IN CAPITAL
 
 
 
 
 
 
 
Balance, beginning of year
 
 
650,974

 
 
 
607,649

Stock-based compensation
 
 
16,989

 
 
 
16,099

Proceeds from issuance of common stock under employee stock option plan less payments for taxes related to net share settlement of equity awards
 
 
21,627

 
 
 
10,737

Proceeds from issuance of common stock issued under employee stock purchase plan
 
 
1,669

 
 
 
1,293

Effect of adopted accounting standards
 
 
2,078

 
 
 

Balance, end of period
 
 
693,337

 
 
 
635,778

RETAINED EARNINGS
 
 
 
 
 
 
 
Balance, beginning of year
 
 
1,094,108

 
 
 
833,356

Net income attributable to IPG Photonics Corporation
 
 
294,658

 
 
 
185,620

Effect of adopted accounting standards
 
 
2,145

 
 
 

Balance, end of period
 
 
1,390,911

 
 
 
1,018,976

ACCUMULATED OTHER COMPREHENSIVE LOSS
 
 
 
 
 
 
 
Balance, beginning of year
 
 
(178,583
)
 
 
 
(181,482
)
Translation adjustments
 
 
89,023

 
 
 
32,948

Change in unrealized (loss) gain on derivatives, net of tax
 
 
(35
)
 
 
 
104

Unrealized loss on available-for-sale investments, net of tax
 
 
(240
)
 
 
 

Realized loss on available-for-sale investments, net of tax, reclassified to net income
 
 
538

 
 
 

Balance, end of period
 
 
(89,297
)
 
 
 
(148,430
)
TOTAL IPG PHOTONICS CORPORATION EQUITY
 
 
$
1,959,099

 
 
 
$
1,502,846

NONCONTROLLING INTERESTS ("NCI")
 
 
 
 
 
 
 
Balance, beginning of year
 
 
166

 
 
 
1,137

Purchase of NCI
 
 
(197
)
 
 
 
(950
)
Net loss attributable to NCI
 
 
(26
)
 
 
 
(33
)
Other comprehensive income attributable to NCI
 
 
57

 
 
 
16

Balance, end of period
 
 

 
 
 
170

TOTAL EQUITY
 
 
$
1,959,099

 
 
 
$
1,503,016

See notes to consolidated financial statements.

5


IPG PHOTONICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared by IPG Photonics Corporation, or "IPG", "its" or the "Company". Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). The consolidated financial statements include the Company's accounts and those of its subsidiaries. All intercompany balances have been eliminated in consolidation. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Company's Annual Report on Form 10-K for the year ended December 31, 2016.
In the opinion of the Company's management, the unaudited financial information for the interim periods presented reflects all adjustments necessary for a fair presentation of the Company's financial position, results of operations and cash flows. The results reported in these consolidated financial statements are not necessarily indicative of results that may be expected for the entire year.
The Company has evaluated subsequent events through the time of filing this Quarterly Report on Form 10-Q with the SEC.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09"). ASU 2014-09 supersedes the revenue recognition requirements in "Revenue Recognition (Topic 605)" and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14 "Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date," which defers the effective date of ASU 2014-09 one year to interim and annual reporting periods beginning after December 15, 2017, which would be the Company's fiscal year ending December 31, 2018. In May 2016, the FASB also issued ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," to provide additional clarification of accounting for collections of sales taxes as well as recognition of revenue (i) associated with contract modifications, (ii) for noncash consideration, and (iii) based on the collectability of the consideration from the customer. The guidance also specifies when a contract should be considered "completed" for purposes of applying the transition guidance. The Company has completed its assessment of the new guidance and is in the process of training finance and sales personnel, updating corporate policies, and modifying reporting packages to support the new disclosure requirements. The Company does not expect the standard will have a material impact on the amount and timing of revenue recognized in its consolidated financial statements and has elected to use the modified retrospective application approach for transition to the new standard.
In January 2017, the FASB issued ASU No. 2017-04, "Intangibles—Goodwill and Other (Topic 350)" ("ASU 2017-04"). ASU 2017-04 simplifies the accounting for goodwill impairments by eliminating step 2 from the goodwill impairment test. ASU 2017-04 is effective for public companies for annual reporting periods beginning after December 15, 2020, and interim reporting periods within such period. The amendments should be applied prospectively on or after the effective date and require a disclosure as to the nature of and reason for the change in accounting principle upon transition. Early adoption is allowed for all entities as of January 1, 2017, for annual and any interim impairment tests occurring after January 1, 2017. The Company is currently evaluating the potential impact that the standard will have on its consolidated financial statements upon adoption.
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). ASU 2016-02 requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than twelve months. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. The Company is continuing to evaluate the standard but does not expect that it will have a material effect on its consolidated financial statements upon adoption.
In October 2016, the FASB issued ASU No. 2016-16, "Income Taxes (Topic 740) - Intra-Entity Transfers of Assets other than Inventory" ("ASU 2016-16"). ASU 2016-16 eliminates the current exception that prohibits the recognition of current and deferred income tax consequences for intra-entity asset transfers (other than inventory) until the asset has been sold to an outside party. The amendments will be applied on a modified retrospective basis through a cumulative effect adjustment to retained earnings. Deferred tax assets should be assessed to determine if realizable. Disclosures will be required for the (i) reason for and notice of change, (ii) effect of change on income from continuing operations and (iii) cumulative effect of change on retained earnings. Public entities will apply these changes in annual reporting periods beginning after December 15,

6

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


2017, and interim reporting periods within such period. Early adoption is permitted. The Company is continuing to evaluate the standard but does not expect that it will have a material effect on its consolidated financial statements upon adoption.
3. INVENTORIES
Inventories consist of the following:
 
September 30,
 
December 31,
 
2017
 
2016
Components and raw materials
$
131,920

 
$
93,284

Work-in-process
35,097

 
44,723

Finished components and devices
115,478

 
101,003

Total
$
282,495

 
$
239,010

The Company recorded inventory provisions totaling $4,033 and $6,518 for the three months ended September 30, 2017 and 2016, respectively, and $13,439 and $16,243 for the nine months ended September 30, 2017 and 2016, respectively. These provisions relate to the recoverability of the value of inventories due to technological changes and excess quantities. These provisions are reported as a reduction to components and raw materials and finished components and devices.
4. ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consist of the following:
 
September 30,
 
December 31,
 
2017
 
2016
Accrued compensation
$
60,544

 
$
43,761

Customer deposits and deferred revenue
43,425

 
34,571

Current portion of accrued warranty
20,344

 
15,711

Other
9,971

 
8,442

Total
$
134,284

 
$
102,485

5. FINANCING ARRANGEMENTS
The Company's borrowings under existing financing arrangements consist of the following:
 
September 30,
 
December 31,
 
2017
 
2016
Term debt:
 
 
 
Long-term notes
$
49,872

 
$
40,823

Less: current portion
(3,576
)
 
(3,188
)
Total long-term debt
$
46,296

 
$
37,635

At September 30, 2017, the outstanding principal balance on the two long-term notes was $49,872 of which $3,576 is the current portion. The Company has an unsecured note of $22,266 of which $1,188 is the current portion. The interest on this unsecured note is variable at 1.20% above LIBOR and is fixed using an interest rate swap at 2.85% per annum. The unsecured note matures in May 2023, at which time the outstanding principal balance will be $15,438. The Company has another note that is secured by its corporate aircraft with a outstanding principal balance of $27,606 of which $2,388 is the current portion. The interest on this collateralized note is fixed at 2.74% per annum. The collateralized note matures in July 2022, at which time the outstanding principal balance will be $15,375.
The Company also maintains U.S. and Euro lines-of-credit which are available to certain foreign subsidiaries and allow for borrowings in the local currencies of those subsidiaries. At September 30, 2017 and December 31, 2016, there were no amounts drawn on the U.S. line-of-credit, and there were $109 and $161, respectively, of guarantees issued against the facility which reduce the amount of the facility available to draw. At September 30, 2017 and December 31, 2016, there were no amounts drawn on the Euro lines-of-credit, and there were $985 and $11,999, respectively, of guarantees issued against those

7

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


facilities which reduce the amount available to draw. After providing for the guarantees used the total unused credit lines and overdraft facilities are $110,333 at September 30, 2017.
6. NET INCOME ATTRIBUTABLE TO IPG PHOTONICS CORPORATION PER SHARE
The following table sets forth the computation of diluted net income attributable to IPG Photonics Corporation per share:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income attributable to IPG Photonics Corporation
$
115,597

 
$
69,235

 
$
294,658

 
$
185,620

Weighted average shares
53,440

 
53,071

 
53,453

 
53,039

Dilutive effect of common stock equivalents
1,258

 
690

 
1,117

 
713

Diluted weighted average common shares
54,698

 
53,761

 
54,570

 
53,752

Basic net income attributable to IPG Photonics Corporation per share
$
2.16

 
$
1.30

 
$
5.51

 
$
3.50

Diluted net income attributable to IPG Photonics Corporation per share
$
2.11

 
$
1.29

 
$
5.40

 
$
3.45

For the three months ended September 30, 2017 and 2016, respectively, the computation of diluted weighted average common shares excludes 8,800 and 52,100 common stock equivalents because the effect of including them would be anti-dilutive. The shares excluded for the three months ended September 30, 2017 and 2016, respectively, are comprised of 3,800 and 2,500 restricted stock units ("RSUs") and 5,000 and 49,600 of non-qualified stock options. For the nine months ended September 30, 2017 and 2016, respectively, the computation of diluted weighted average common shares excludes 53,600 and 80,600 common stock equivalents because the effect of including them would be anti-dilutive. The shares excluded for the nine months ended September 30, 2017 and 2016, respectively, are comprised of 14,900 and 20,900 RSUs, 35,900 and 56,400 non-qualified stock options and 2,800 and 3,300 performance stock units.
Under ASU 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" ("ASU 2016-09"), excess tax benefits and deficiencies as a result of stock option exercises and release of RSUs upon vesting are to be recognized as discrete items within income tax expense or benefit in the consolidated statements of comprehensive income in the reporting period in which they occur. The Company recognized excess tax benefits from stock award exercises and restricted stock unit vesting as a discrete tax benefit, which reduced the provision for income taxes for the three months ended September 30, 2017 by $3,361 and for the nine months ended September 30, 2017 by $10,885. The adoption of ASU 2016-09 also increased the calculation of fully diluted shares outstanding for the three months ended September 30, 2017, by 317,835 shares and for the nine months ended September 30, 2017, by 256,938 shares.
On July 28, 2016, the Company announced that its Board of Directors authorized a share repurchase program (the “Program”) to mitigate the dilutive impact of shares issued upon exercise or release under the Company's various employee and director equity compensation and employee stock purchase plans. Under the Program, the Company's management is authorized to repurchase shares of common stock in an amount not to exceed the number of shares issued to employees and directors under its various employee and director equity compensation and employee stock purchase plans from January 1, 2016 through December 31, 2017. The Program limits aggregate share repurchases to no more than $100,000 over a period ending June 30, 2018.
For the three months ended September 30, 2017, the Company repurchased 17,328 shares of its common stock with an average price of $161.55 per share in the open market. Also, for the nine months ended September 30, 2017, the Company repurchased 215,860 shares of its common stock with an average price of $124.67 per share in the open market. The impact on the reduction of weighted average shares for the three months ended September 30, 2017 and 2016 was 9,964 shares and 6,090 shares, respectively, and for the nine months ended September 30, 2017 and 2016 was 136,184 shares and 2,044 shares, respectively.
7. DERIVATIVE FINANCIAL INSTRUMENTS
Derivative instruments The Company's primary market exposures are to interest rates and foreign exchange rates. The Company uses certain derivative financial instruments to help manage these exposures. The Company executes these instruments with financial institutions it judges to be credit-worthy. The Company does not hold or issue derivative financial instruments for trading or speculative purposes.

8

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


The Company recognizes all derivative financial instruments as either assets or liabilities at fair value in the consolidated balance sheets. The Company has no derivatives that are not accounted for as a hedging instrument.
Cash flow hedges The Company entered into a cash flow hedge which is an interest rate swap associated with a long-term note issued during the second quarter of 2016 that will terminate with the long-term note in May 2023. The fair value amounts in the consolidated balance sheet related to the interest rate swap were:
Notional Amounts1
 
Other Assets
September 30,
 
December 31,
 
September 30,
 
December 31,
2017
 
2016
 
2017
 
2016
$
22,266

 
$
23,156

 
$
30

 
$
77

  (1) Notional amounts represent the gross contract/notional amount of the derivatives outstanding.
The derivative gains and losses in the consolidated statements of income related to the Company's interest rate swap contracts were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Effective portion recognized in other comprehensive income, pretax:
 
 
 
 
 
 
 
Interest rate swap
$
(7
)
 
$
(67
)
 
$
(47
)
 
$
172

Effective portion reclassified from other comprehensive income to interest expense, pretax:
 
 
 
 
 
 
 
Interest rate swap

 
(8
)
 

 
(8
)
Ineffective portion recognized in income:
 
 
 
 
 
 
 
Interest rate swap

 

 

 

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

9

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


The following table presents information about the Company's assets and liabilities measured at fair value:
 
 
 
 Fair Value Measurements at September 30, 2017
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Cash equivalents
$
447,555

 
$
447,555

 
$

 
$

Short-term investments
165,602

 
165,602

 

 

Interest rate swap
30

 

 
30

 

Auction rate securities
1,012

 

 

 
1,012

Total assets
$
614,199

 
$
613,157

 
$
30

 
$
1,012

Liabilities
 
 
 
 
 
 
 
Long-term notes
$
49,848

 
$

 
$
49,848

 
$

Total liabilities
$
49,848

 
$

 
$
49,848

 
$

 
 
 
 
 
 
 
 
 
 
 
 Fair Value Measurements at December 31, 2016
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Cash equivalents
$
179,699

 
$
179,699

 
$

 
$

Short-term investments
206,616

 
206,616

 

 

Interest rate swap
77

 

 
77

 

Auction rate securities
1,144

 

 

 
1,144

Total assets
$
387,536

 
$
386,315

 
$
77

 
$
1,144

Liabilities
 
 
 
 
 
 
 
Long-term notes
$
41,351

 
$

 
$
41,351

 
$

Total liabilities
$
41,351

 
$

 
$
41,351

 
$

Short-term investments consist of liquid investments including U.S. government and government agency notes, corporate notes, commercial paper and certificates of deposit with original maturities of greater than three months but less than one year and are recorded at amortized cost. The fair value of the short-term investments considered available-for-sale as of December 31, 2016 was $41,591. This amount included an unrealized loss of $432. There were no short-term investments considered available-for-sale as of September 30, 2017. The fair value of the short-term investments considered held-to-maturity as of September 30, 2017 and December 31, 2016 was $165,602 and $165,025, respectively, which represents an unrealized loss of $53 and $163, respectively, as compared to the book value recorded on the Consolidated Balance Sheets for the same periods.
The fair value of the auction rate securities considered prices observed in inactive secondary markets for the securities held by the Company.
The fair value of accrued contingent purchase consideration incurred was determined using an income approach at the acquisition date and reporting date. That approach is based on significant inputs that are not observable in the market. Key assumptions include assessing the probability of meeting certain milestones required to earn the contingent purchase consideration.

10

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


The following table presents information about the Company's movement in Level 3 assets and liabilities measured at fair value:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Auction Rate Securities
 
 
 
 
 
 
 
Balance, beginning of period
$
1,148

 
$
1,140

 
$
1,144

 
$
1,136

Period transactions
(138
)
 

 
(138
)
 

Change in fair value and accretion
2

 
2

 
6

 
6

Balance, end of period
$
1,012

 
$
1,142

 
$
1,012

 
$
1,142

Contingent Purchase Consideration
 
 
 
 
 
 
 
Balance, beginning of period
$

 
$
20

 
$

 
$
20

Change in fair value and currency fluctuations

 
1

 

 
1

Balance, end of period
$

 
$
21

 
$

 
$
21

9. GOODWILL AND INTANGIBLES
The following table sets forth the changes in the carrying amount of goodwill for the nine months ended September 30, 2017:
 
Amounts
Balance at January 1
$
19,828

Total goodwill arising from acquisitions
31,315

Foreign exchange adjustment

 Balance at September 30
$
51,143

Intangible assets, subject to amortization, consisted of the following:
 
September 30, 2017
 
December 31, 2016
 
 
Gross  Carrying
Amount
Accumulated
Amortization
Net  Carrying
Amount
Weighted-
Average  Lives
Gross  Carrying
Amount
Accumulated
Amortization
Net  Carrying
Amount
Weighted-
Average  Lives
 
 
 
 
 
 
 
 
 
Patents
$
8,114

$
(5,191
)
$
2,923

8 Years
$
8,114

$
(4,926
)
$
3,188

7 Years
Customer relationships
25,718

(4,992
)
20,726

11 Years
12,727

(3,621
)
9,106

9 Years
Production know-how
6,797

(4,816
)
1,981

8 Years
6,618

(4,093
)
2,525

8 Years
Technology, trademark and tradename
30,026

(5,987
)
24,039

8 Years
17,910

(3,940
)
13,970

8 Years
 
$
70,655

$
(20,986
)
$
49,669

 
$
45,369

$
(16,580
)
$
28,789

 
Amortization expense for the three months ended September 30, 2017 and 2016 was $1,725 and $1,252, respectively. Amortization expense for the nine months ended September 30, 2017 and 2016 was $3,958 and $2,696, respectively. The estimated future amortization expense for intangibles for the remainder of 2017 and subsequent years is as follows:
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
 
Total
$1,713
 
$6,786
 
$6,737
 
$6,108
 
$5,934
 
$22,391
 
$49,669
During the third quarter of 2017, the Company acquired 100% of the membership units of Innovative Laser Technologies, LLC ("ILT"). ILT is a Minneapolis, Minnesota based company, which produces high precision laser-based systems for the medical device industry and other end user markets. The Company paid $40,256 to acquire ILT, which represents the fair value on that date. As a result of the acquisition, the Company recorded intangible assets of $11,660 related to customer relationships and $7,480 related to technology, trademark and tradename. Any excess of the acquisition consideration over the fair value of assets acquired and liabilities assumed is allocated to goodwill, which amounted to $22,415. The majority of goodwill arising from this acquisition will not be deductible for tax purposes.

11

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


During the second quarter of 2017, the Company acquired 100% of the shares of OptiGrate Corporation ("OptiGrate"). OptiGrate is located in Oviedo, Florida. OptiGrate is a developer and manufacturer of volume Bragg gratings used in the production of lasers and laser diodes. The Company paid $16,870 to acquire OptiGrate, which represents the fair value on that date. Of the purchase price, $1,849 was held back in escrow for potential post-closing adjustments related to working capital and indemnities provided by the sellers. As a result of the acquisition, the Company recorded intangible assets of $1,010 related to customer relationships and $4,650 related to technology, trademark and tradename. Any excess of the acquisition consideration over the fair value of assets acquired and liabilities assumed is allocated to goodwill, which amounted to $8,900. The goodwill arising from this acquisition will not be deductible for tax purposes.
10. PRODUCT WARRANTIES
The Company typically provides one to three-year parts and service warranties on lasers and amplifiers. Most of the Company's sales offices provide support to customers in their respective geographic areas. Warranty reserves have generally been sufficient to cover product warranty repair and replacement costs.
The following table summarizes product warranty accrual activity recorded during the nine months ended September 30, 2017 and 2016.
 
2017
 
2016
Balance at January 1
$
33,978

 
$
28,210

Provision for warranty accrual
20,284

 
16,098

Warranty claims
(11,746
)
 
(12,273
)
Foreign currency translation
2,459

 
643

 Balance at September 30
$
44,975

 
$
32,678

Accrued warranty reported in the accompanying consolidated financial statements as of September 30, 2017 and December 31, 2016 consisted of $20,344 and $15,711 in accrued expenses and other liabilities and $24,631 and $18,267 in other long-term liabilities, respectively.
11. INCOME TAXES
A reconciliation of the total amounts of unrecognized tax benefits is as follows:
 
2017
 
2016
Balance at January 1
$
6,403

 
$
7,579

Change in prior period positions
(2,240
)
 
(1,876
)
Change for tax positions in current period
1,500

 

 Balance at September 30
$
5,663

 
$
5,703

Substantially all of the liability for uncertain tax benefits related to various federal, state and foreign income tax matters, would benefit the Company's effective tax rate, if recognized.
12. COMMITMENTS AND CONTINGENCIES
From time to time, the Company may be involved in disputes and legal proceedings in the ordinary course of its business.
These proceedings may include allegations of infringement of intellectual property, commercial disputes and employment
matters. As of September 30, 2017 and through the filing date of these Financial Statements, the Company has no legal proceedings ongoing that management estimates could have a material effect on the Company's Consolidated Financial Statements.
13. LONG-LIVED ASSETS
Long-lived assets, which consist primarily of property, plant and equipment, are reviewed by management for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If undiscounted expected future cash flows are less than the carrying value, an impairment loss is recorded equal to the amount by which the carrying value exceeds the fair value of assets. In the fourth quarter of 2016, the Company began assessing the possible sale of its corporate aircraft included within Property, Plant and Equipment, net in its Consolidated Balance Sheets. As a result of this assessment and certain market indications of the aircraft's value if sold, the Company prepared an updated impairment analysis

12

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


of the carrying value of the aircraft as of March 31, 2017. The impairment analysis was probability weighted considering market data available, future cash flows and whether or not the Company would sell the aircraft. Based on that analysis the Company recorded a $162 impairment loss included in general and administrative expense in its Consolidated Statements of Income for the nine months ended September 30, 2017. There were no impairment losses recorded by the Company for the nine months ended September 30, 2016. The corporate aircraft was sold during the three months ended June 30, 2017.

13


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward looking statements that are based on management's current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements. See "Cautionary Statement Regarding Forward-Looking Statements."
Overview
We develop and manufacture a broad line of high-performance fiber lasers, fiber amplifiers, diode lasers, laser systems and optical accessories that are used for diverse applications, primarily in materials processing. We sell our products globally to original equipment manufacturers ("OEMs"), system integrators and end users. We market our products internationally primarily through our direct sales force.
We are vertically integrated such that we design and manufacture most of the key components used in our finished products, from semiconductor diodes to optical fiber preforms, finished fiber lasers and amplifiers. We also manufacture complementary products used with our lasers including optical delivery cables, fiber couplers, beam switches, optical processing heads and chillers. In addition, we offer laser-based systems for certain markets and applications.
Factors and Trends That Affect Our Operations and Financial Results
In reading our financial statements, you should be aware of the following factors and trends that our management believes are important in understanding our financial performance.
Net sales. We derive net sales primarily from the sale of fiber lasers and amplifiers. We also sell diode lasers, communications systems, laser systems and complementary products. We sell our products through our direct sales organization and our network of distributors and sales representatives, as well as system integrators. We sell our products to OEMs that supply materials processing laser systems, communications systems, medical laser systems and other laser systems for advanced applications to end users. We also sell our products to end users that build their own systems, which incorporate our products or use our products as an energy or light source. Our scientists and engineers work closely with OEMs, systems integrators and end users to analyze their system requirements and match appropriate fiber laser or amplifier specifications. Our sales cycle varies substantially, ranging from a period of a few weeks to as long as one year or more, but is typically several months.
Sales of our products generally are recognized upon shipment, provided that no obligations remain and collection of the receivable is reasonably assured. Our sales typically are made on a purchase order basis rather than through long-term purchase commitments.
We develop our products to standard specifications and use a common set of components within our product architectures. Our major products are based upon a common technology platform. We continually enhance these and other products by improving their components and developing new components and new product designs.
The average selling prices of our products generally decrease as the products mature. These decreases result from factors such as decreased manufacturing costs and increases in unit volumes, increased competition, the introduction of new products and market share considerations. In the past, we have lowered our selling prices in order to penetrate new markets and applications. Furthermore, we may negotiate discounted selling prices from time to time with certain customers that purchase multiple units.
Gross margin. Our total gross margin in any period can be significantly affected by total net sales, by product mix, that is, the percentage of our revenue in the period that is attributable to higher or lower-power products and the mix of sales between laser and amplifier sources and complete systems, by sales mix between OEM customers who purchase devices from us in high unit volumes and other customers, by mix of sales in different geographies and by other factors, some of which are not under our control.
Our product mix affects our margins because gross margin is generally higher in each product line for products with higher average output power. Certain specialty products also have higher gross margins. The profit margins on systems can be lower than margins for our laser and amplifier sources, depending on the configuration, volume and availability of competitive products, among other factors.

14


The mix of sales between OEM customers and other customers can affect gross margin because we provide sales price discounts on products based on the number of units ordered. As the number of OEM customers increase and the number of units ordered increases, the average sales price per unit will be reduced. We expect that the impact of reduced sales price per unit will be offset by the manufacturing efficiency provided by high unit volume orders, but the timing and extent of achieving these efficiencies may not always match the mix of sales in any given time period or be realized at all.
We regularly review our inventory for items that are slow-moving, have been rendered obsolete or determined to be excess. Any write-off of such slow-moving, obsolete or excess inventory affects our gross margins. For example, we recorded provisions for inventory totaling $13.4 million and $16.2 million for the nine months ended September 30, 2017 and 2016, respectively, and $22.8 million, $15.4 million and $11.3 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Sales and marketing expense. We expect to continue to expand our worldwide direct sales organization, build and expand applications centers, hire additional sales and marketing personnel at our existing and new geographic locations as well as to support sales of new product lines, increase the number of units for demonstration purposes and otherwise increase expenditures on sales and marketing activities in order to support the growth in our net sales. As such, we expect that our sales and marketing expenses will increase in the aggregate.
Research and development expense. We plan to continue to invest in research and development to improve our existing components and products and develop new components, products, systems and applications technologies. The amount of research and development expense we incur may vary from period to period. In general, if net sales continue to increase we expect research and development expense to increase in the aggregate.
General and administrative expense. We expect our general and administrative expenses to increase as we continue to invest in systems and resources in management, finance, legal, information technology, human resources and administration to support our worldwide operations. Legal expenses vary from quarter to quarter based primarily upon the level of litigation and transaction activities.
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 net sales was 28% for the nine months ended September 30, 2017 and 22%, 25% and 23% for the full years 2016, 2015 and 2014, respectively. One of our customers accounted for 14% of our net sales for the nine months ended September 30, 2017. None of our customers accounted for more than 10% of our net sales for the nine months ended September 30, 2016. 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 September 30, 2017 compared to the three months ended September 30, 2016
Net sales. Net sales increased by $126.6 million, or 47.6%, to $392.6 million for the three months ended September 30, 2017 from $266.0 million for the three months ended September 30, 2016.
 
 
Three Months Ended September 30,
 
 
 
 
 
 
2017
 
2016
 
Change
 
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
Materials processing
 
$
374,725

 
95.4
%
 
$
246,299

 
92.6
%
 
$
128,426

 
52.1
 %
Other applications
 
17,890

 
4.6
%
 
19,718

 
7.4
%
 
(1,828
)
 
(9.3
)%
Total
 
$
392,615

 
100.0
%
 
$
266,017

 
100.0
%
 
$
126,598

 
47.6
 %

15


Sales by Product
 
Three Months Ended September 30,
 
 
 
 
 
 
2017
 
2016
 
Change
 
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
High-Power Continuous Wave ("CW") Lasers
 
$
244,239

 
62.2
%
 
$
153,002

 
57.5
%
 
$
91,237

 
59.6
%
Medium-Power CW Lasers
 
30,423

 
7.7
%
 
25,011

 
9.4
%
 
5,412

 
21.6
%
Low-Power CW Lasers
 
3,138

 
0.8
%
 
2,992

 
1.1
%
 
146

 
4.9
%
Pulsed Lasers
 
39,881

 
10.2
%
 
34,429

 
12.9
%
 
5,452

 
15.8
%
Quasi-Continuous Wave ("QCW") Lasers
 
23,765

 
6.1
%
 
11,660

 
4.5
%
 
12,105

 
103.8
%
Other Revenue including Amplifiers, Laser Systems, Service, Parts, Accessories and Change in Deferred Revenue
 
51,169

 
13.0
%
 
38,923

 
14.6
%
 
12,246

 
31.5
%
Total
 
$
392,615

 
100.0
%
 
$
266,017

 
100.0
%
 
$
126,598

 
47.6
%
Materials processing
Sales for materials processing applications increased due to higher sales of high-power lasers, medium-power lasers, low-power lasers, pulsed lasers, QCW lasers and laser systems.
The increase in high-power laser sales related to growth in cutting and welding/brazing applications. High-power lasers continue to displace CO2 lasers. We believe this transition has also benefited from an accelerated replacement cycle for older CO2 based cutting systems and from displacement of non-laser technologies which has resulted in higher demand for the fiber based cutting and welding systems sold by our OEM customers. Within the cutting applications, we continue to see a migration to lasers with higher output powers which improve processing speeds and enable processing of thicker materials. The shift towards lasers with higher output powers has also benefited sales due to their higher average selling prices.
The increase in medium-power sales related to laser sintering and fine welding applications, partially offset by decreases in fine cutting and semiconductor wafer inspection applications and lower average selling prices.
Low-power laser sales were relatively flat due to an increase in welding and semiconductor applications, partially offset by a decrease in low-power laser sales for printing and marking and engraving applications.
Pulsed laser sales increased due to higher demand for marking and engraving, cleaning and stripping, ablation and solar cell manufacturing applications. Within the pulsed laser category, the increase in sales for high-power and green pulsed lasers were greater than the increases in sales of pulsed lasers with lower average power.
QCW laser sales increased due to the demand for welding and cutting applications. The increase in demand for QCW in welding is primarily related to consumer electronics.
Materials processing sales also increased as a result of higher laser systems and parts and service sales, which are included in Other Revenue in the Sales by Product chart above. The increase in laser systems sales was driven by welding, marking and engraving, and ablation applications as well as from the recent acquisition of ILT.
Other Applications
Sales for other applications decreased due to lower sales of telecom products and advanced applications partially offset by higher sales of medical products. Advanced application sales are typically uneven from quarter to quarter. Sales of telecom products are included in Other Revenue in the Sales by Product chart above.
Cost of sales and gross margin. Cost of sales increased by $46.8 million, or 38.6%, to $168.1 million for the three months ended September 30, 2017 from $121.2 million for the three months ended September 30, 2016. Our gross margin increased to 57.2% for the three months ended September 30, 2017 from 54.4% for the three months ended September 30, 2016. Gross margin increased due to a decrease in the cost of internally manufactured components, increased manufacturing efficiency and product mix which included increased sales of high-power, QCW and pulsed lasers with higher average powers. These increases in gross margin were partially offset by lower average selling prices.
Sales and marketing expense. Sales and marketing expense increased by $2.9 million, or 28.0%, to $13.4 million for the three months ended September 30, 2017 from $10.5 million for the three months ended September 30, 2016. This change was

16


primarily a result of increases in personnel and depreciation expenses. As a percentage of sales, sales and marketing expense decreased to 3.4% for the three months ended September 30, 2017 from 3.9% for three months ended September 30, 2016.
Research and development expense. Research and development expense increased by $5.0 million, or 24.3%, to $25.5 million for the three months ended September 30, 2017, compared to $20.5 million for the three months ended September 30, 2016. This change was primarily a result of increases in personnel, contractors and depreciation expense. Research and development continues to focus on developing new products, enhancing the 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 ultra-violet, visible and mid-infrared; lasers with ultra-fast pulses; laser-based systems for material processing, projection, display and medical; new telecom products including pluggable transceivers; and laser accessories such as scanners, 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 decreased to 6.5% for the three months ended September 30, 2017 from 7.7% for the three months ended September 30, 2016.
General and administrative expense. General and administrative expense increased by $4.7 million, or 27.9%, to $21.5 million for the three months ended September 30, 2017 from $16.8 million for the three months ended September 30, 2016. This change was primarily a result of increases in personnel expense, stock-based compensation, consulting, information systems and recruitment. As a percentage of sales, general and administrative expense decreased to 5.5% for the three months ended September 30, 2017 from 6.3% for the three months ended September 30, 2016.
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 0.90, Russian Ruble 65, Japanese Yen 102 and Chinese Yuan 6.67, respectively, we would have expected net sales to be $4.7 million lower, gross profit to be $2.5 million lower and total operating expenses would have been $0.9 million lower.
Loss on foreign exchange. We incurred a foreign exchange loss of $3.9 million for the three months ended September 30, 2017 as compared to a $2.9 million loss for the three months ended September 30, 2016. Foreign exchange loss for the three months ended September 30, 2017 was primarily attributable to the appreciation of the Euro and Ruble, partially offset by the appreciation of the Chinese Yuan as compared to the U.S. Dollar. Foreign exchange loss for the three months ended September 30, 2016 was primarily attributable to the appreciation of the Euro and Russian Ruble as compared to the U.S. Dollar and the depreciation of the Chinese Yuan as compared to the U.S. Dollar.
Interest (expense) income, net. Interest (expense) income, net, decreased to $0.1 million of expense for the three months ended September 30, 2017 from $0.4 million of income for the three months ended September 30, 2016.
Other income (expense), net. Other income (expense), net, increased to $0.5 million of income for the three months ended September 30, 2017 from $0.2 million for the three months ended September 30, 2016.
Provision for income taxes. Provision for income taxes was $45.0 million for the three months ended September 30, 2017 compared to $25.4 million for the three months ended September 30, 2016. The effective tax rates were 28.0% and 26.9% for the three months ended September 30, 2017 and 2016, respectively. For the three months ended September 30, 2017, the effective tax rate was reduced by $3.4 million of excess tax benefits related to exercise of stock options during the quarter partially offset by an increase in reserves for uncertain tax positions of $1.5 million. Together, these reduced the effective tax rate by approximately 1.1%. Effective as of the beginning of 2017, the accounting standard related to excess tax benefits and deficits changed, and these items are now recognized in the provision for income taxes whereas previously they were accounted for within additional paid-in capital. For the three months ended September 30, 2016, the effective tax rate was reduced by the release of reserves for uncertain tax positions of $1.9 million which reduced the effective rate by approximately 2%.
Net income attributable to IPG Photonics Corporation. Net income attributable to IPG Photonics Corporation increased by $46.4 million to $115.6 million for the three months ended September 30, 2017 compared to $69.2 million for the three months ended September 30, 2016. Net income attributable to IPG Photonics Corporation as a percentage of our net sales increased by 3.4 percentage points to 29.4% for the three months ended September 30, 2017 from 26.0% for the three months ended September 30, 2016 due to the factors described above.
Results of Operations for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016
Net sales. Net sales increased by $321.8 million, or 44.3%, to $1,047.8 million for the nine months ended September 30, 2017 from $726.1 million for the nine months ended September 30, 2016.

17


 
 
Nine Months Ended September 30,
 
 
 
 
 
 
2017
 
2016
 
Change
 
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
Materials processing
 
$
991,921

 
94.7
%
 
$
683,562

 
94.1
%
 
$
308,359

 
45.1
%
Other applications
 
55,913

 
5.3
%
 
42,490

 
5.9
%
 
13,423

 
31.6
%
Total
 
$
1,047,834

 
100.0
%
 
$
726,052

 
100.0
%
 
$
321,782

 
44.3
%
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
2017
 
2016
 
Change
 
 
 
 
% of Total
 
 
 
% of Total
 
 
 
 
High-Power CW Lasers
 
$
634,387

 
60.6
%
 
$
412,628

 
56.8
%
 
$
221,759

 
53.7
%
Medium-Power CW Lasers
 
80,152

 
7.7
%
 
74,739

 
10.3
%
 
5,413

 
7.2
%
Low-Power CW Lasers
 
9,818

 
0.9
%
 
9,053

 
1.3
%
 
765

 
8.5
%
Pulsed Lasers
 
113,442

 
10.8
%
 
99,687

 
13.7
%
 
13,755

 
13.8
%
QCW Lasers
 
74,615

 
7.1
%
 
36,484

 
5.0
%
 
38,131

 
104.5
%
Other Revenue including Amplifiers, Laser Systems, Service, Parts, Accessories and Change in Deferred Revenue
 
135,420

 
12.9
%
 
93,461

 
12.9
%
 
41,959

 
44.9
%
Total
 
$
1,047,834

 
100.0
%
 
$
726,052

 
100.0
%
 
$
321,782

 
44.3
%
Materials processing
Sales for materials processing applications increased due to higher sales of high-power lasers, medium-power lasers, low-power lasers, pulsed lasers, QCW lasers and laser systems.
The increase in high-power laser sales related to growth in cutting, welding, brazing, cladding, cleaning and stripping applications partially offset by decreases in heat treating and annealing, and marking and engraving applications. High-power lasers continue to displace CO2 lasers. We believe this transition has also benefited from an accelerated replacement cycle for older CO2 based cutting systems and from displacement of non-laser technologies which has resulted in higher demand for the fiber based cutting and welding systems sold by our OEM customers. Within cutting applications, we continue to see a migration to lasers with higher output powers which improve processing speeds and enable processing of thicker materials. The shift towards lasers with higher output powers has also benefited sales due to their higher average selling prices.
Medium-power sales increased due to growth in laser sintering, fine welding, cladding and semiconductor inspection applications which was partially offset by decreases in sales for fine cutting applications. Average selling prices for medium-power lasers also declined.
Low-power laser sales increased slightly due to growth in fine welding and semiconductor applications which was partially offset by a decrease in marking and engraving applications.
Pulsed laser sales increased due to growth marking and engraving, cleaning and stripping, solar cell manufacturing, cutting and welding applications which was partially offset by a decrease in ablation applications. Within the pulsed laser category, the rate of sales increases was larger for higher-power pulsed lasers than for pulsed lasers with lower average power.
QCW laser sales increased due to the demand for welding and drilling applications. Welding applications for QCW lasers are primarily related to consumer electronics.
Materials processing sales also increased as a result of higher laser systems and parts and service sales, which are included in Other Revenue in the Sales by Product chart above. The increase in laser systems sales was driven by welding, cutting, marking and engraving, and ablation applications as well as from the recent acquisition of ILT.
Other Applications
Sales for other applications increased due to higher sales for telecom, medical and advanced applications. Telecom sales benefited from an increase in sales of pluggable tranceivers used in data transmission and an increase in amplifier sales used for

18


last mile fiber access to the home applications. For the nine months ended September 30, 2017, the rate of growth of telecom sales benefited from the contribution to sales by Menara, which we acquired in the second quarter of 2016. Sales of telecom products are included in Other Revenue in the Sales by Product chart above. The increase in medical sales was driven by the increase in demand for surgical, dentistry, and other medical applications. Advanced application sales are typically uneven from quarter to quarter. The increase in advanced applications sales was driven by increase in demand from defense, semiconductor and scientific applications across various product lines.
Cost of sales and gross margin. Cost of sales increased by $130.6 million, or 39.7%, to $459.7 million for the nine months ended September 30, 2017 from $329.1 million for the nine months ended September 30, 2016. Our gross margin increased to 56.1% from 54.7% for the nine months ended September 30, 2017 and 2016, respectively. Gross margin increased due to a decrease in the cost of internally manufactured components, increased manufacturing efficiency and product mix which included increased sales of high-power, QCW and pulsed lasers with higher average powers. These increases in gross margin were partially offset by lower average selling prices.
Sales and marketing expense. Sales and marketing expense increased by $8.2 million, or 29.0%, to $36.3 million for the nine months ended September 30, 2017 from $28.2 million for the nine months ended September 30, 2016, primarily as a result of increased expenses for personnel, trade show and exhibitions, travel and depreciation. As a percentage of sales, sales and marketing expense decreased to 3.5% for the nine months ended September 30, 2017 from 3.9% for the nine months ended September 30, 2016.
Research and development expense. Research and development expense increased by $17.8 million, or 31.6%, to $74.3 million for the nine months ended September 30, 2017, compared to $56.4 million for the nine months ended September 30, 2016, primarily as a result of an increase in expenses related to personnel, stock-based compensation, contractors, consultants, materials used for research and development projects and depreciation. 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 ultra-violet, visible and mid-infrared; lasers with ultra-fast pulses; laser-based systems for material processing, projection, display and medical; new telecom products including pluggable transceivers; and laser accessories such as scanners, 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 decreased to 7.1% for the nine months ended September 30, 2017 from 7.8% for the nine months ended September 30, 2016.
General and administrative expense. General and administrative expense increased by $12.2 million, or 26.1%, to $59.1 million for the nine months ended September 30, 2017 from $46.8 million for the nine months ended September 30, 2016, primarily as a result of increased expenses for personnel, stock-based compensation, recruitment, information technology, travel and accounting. As a percentage of sales, general and administrative expense decreased to 5.6% for the nine months ended September 30, 2017 from 6.5% for the nine months ended September 30, 2016.
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 0.90, Russian Ruble 68, Japanese Yen 109 and Chinese Yuan 6.58, respectively, we would have expected net sales for the nine months ended September 30, 2017 to be $16.3 million higher, gross profit to be $12.6 million higher and total operating expenses would have been $2.2 million lower.
Loss on foreign exchange. We incurred a foreign exchange loss of $15.6 million for the nine months ended September 30, 2017 as compared to $6.3 million for the nine months ended September 30, 2016. The loss for the nine months ended September 30, 2017 was primarily attributable to the appreciation of the Euro and Ruble as compared to the U.S. Dollar, which was partially offset by a gain from the Chinese Yuan. The loss for the nine months ended September 30, 2016 was primarily attributable to appreciation of the Russian Ruble as compared to the U.S. Dollar and depreciation of the Chinese Yuan as compared to the U.S. Dollar.
Interest (expense) income, net. Interest (expense) income, net, decreased slightly to $0.7 million of income for the nine months ended September 30, 2017 from $0.8 million for the nine months ended September 30, 2016.
Other income (expense), net. Other income (expense), net decreased to approximately $0 of expense for the nine months ended September 30, 2017 compared to approximately $0.3 million of income for the nine months ended September 30, 2016 as a result of the loss incurred upon sale of available-for-sale-securities being partially offset by net rental income from a building in the United States purchased in the second quarter of 2016 that is partially leased to third parties.
Provision for income taxes. Provision for income taxes was $108.8 million for the nine months ended September 30, 2017 compared to $74.7 million for the nine months ended September 30, 2016, representing an effective tax rate of 27.0% and

19


28.7% for the nine months ended September 30, 2017 and 2016, respectively. The decrease in the effective rate was primarily due to $10.9 million of excess tax benefits related to exercise of stock options and release of restricted stock units which vested during the period. Effective as of the beginning of 2017, the accounting standard related to excess tax benefits and deficits changed, and these items are now recognized in the provision for income taxes whereas previously they were accounted for within additional paid-in capital. The tax effects of the accounting for share-based compensation will increase or decrease our effective rate based upon the difference between our share-based compensation expense and the benefits taken on our tax return which will depend upon the quantity and intrinsic value of RSUs that vest and options that are exercised in the period. Additionally, we recognize excess tax benefits on a discrete basis and we anticipate that our effective rate will vary from quarter to quarter depending upon the factors described above.
Net income attributable to IPG Photonics Corporation. Net income attributable to IPG Photonics Corporation increased by $109.0 million to $294.7 million, or 58.7% for the nine months ended September 30, 2017 compared to $185.6 million for the nine months ended September 30, 2016. Net income attributable to IPG Photonics Corporation as a percentage of our net sales increased by 2.5 percentage points to 28.1% for the nine months ended September 30, 2017 from 25.6% for the nine months ended September 30, 2016 due to the factors described above.
Liquidity and Capital Resources
Our principal sources of liquidity as of September 30, 2017 consisted of cash and cash equivalents of $880.3 million, short-term investments of $165.7 million, unused credit lines and overdraft facilities of $110.3 million and other working capital (excluding cash and cash equivalents and short-term investments) of $414.4 million. This compares to cash and cash equivalents of $623.9 million, short-term investments of $206.8 million, unused credit lines and overdraft facilities of $71.5 million and other working capital (excluding cash and cash equivalents and short-term investments) of $312.1 million as of December 31, 2016. The increase in cash and cash equivalents of $256.4 million relates primarily to cash provided by operating activities in the nine months ended September 30, 2017 of $296.9 million and cash provided by financing activities of $5.2 million. The increase was partially offset by cash used in investing activities of $93.3 million. In addition, the effect of exchange rates increased cash and cash equivalents by $47.6 million.
Short-term investments consist of liquid investments including U.S. government and government agency notes, corporate
notes, commercial paper and certificates of deposit with original maturities of greater than three months but less than one year.
Our long-term debt consists of two long-term notes with a combined total outstanding balance at September 30, 2017 of $49.9 million of which $3.6 million is the current portion. We have an unsecured note with an outstanding principal balance at September 30, 2017 of $22.3 million of which $1.2 million is the current portion. The interest on this unsecured note is variable at 1.20% above LIBOR and is fixed using an interest rate swap at 2.85% per annum. The unsecured note matures in May 2023, at which time the outstanding principal balance will be $15.4 million. We have another note that is secured by our corporate aircraft with an outstanding principal balance of $27.6 million of which $2.4 million is the current portion. The interest on this collateralized note is fixed at 2.74% per annum. The collateralized note matures in July 2022, at which time the outstanding principal balance will be $15.4 million.

The following table details our line-of-credit facilities as of September 30, 2017: 
 
 
 
 
 
 
 
 
 
Description
 
Total Facility
 
Interest Rate
 
Maturity
 
Security
U.S. Revolving Line of Credit (1)
 
Up to $50.0 million
 
LIBOR plus 0.80% to 1.20%, depending on our performance
 
April 2020
 
Unsecured
Euro Credit Facility (Germany) (2)
 
Euro 50.0 million ($59.1 million)
 
Euribor plus 0.75% or EONIA 1.00%
 
July 2020
 
Unsecured, guaranteed by parent company and German subsidiary
Euro Overdraft Facilities (3)
 
Euro 2.0 million
($2.3 million)
 
1.0%-6.5%
 
October 2018
 
Common pool of assets of Italian subsidiary
(1)
This facility is available to certain foreign subsidiaries in their respective local currencies. At September 30, 2017, there were no drawings on this facility, however, there were $0.1 million of guarantees issued against the facility which reduces the amount of the facility available to draw.

20


(2)
This facility is also available to certain foreign subsidiaries in their respective local currencies. At September 30, 2017, there were no drawings on this facility, however, there were $1.0 million of guarantees issued against the facility which reduces the amount of the facility available to draw. During the third quarter of 2017, we entered into a new Euro credit facility, which replaced the old Euro credit facility and increased the available line-of-credit to Euro 50 million from Euro 30 million.
(3)
At September 30, 2017, there were no drawings on these facilities.
Our largest committed credit lines are with Bank of America N.A. and Deutsche Bank AG in the amounts of $50.0 million and $59.1 million (or 50 million Euro as described above), respectively, and neither of them is syndicated.
We are required to meet certain financial covenants associated with our U.S. revolving line of credit and long-term debt facility. These covenants, tested quarterly, include a debt service coverage ratio and a funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio. The debt service coverage covenant requires that we maintain a trailing twelve month ratio of cash flow to debt service that is at least 1.5:1. Debt service is defined as required principal and interest payments during the period. Debt service in the calculation is decreased by our cash held in the U.S.A. in excess of $50 million up to a maximum of $250 million. Cash flow is defined as EBITDA less unfunded capital expenditures. The funded debt to EBITDA covenant requires that the sum of all indebtedness for borrowed money on a consolidated basis be less than three times our trailing twelve months EBITDA. We were in compliance with all such financial covenants as of and for the three months ended September 30, 2017.
We believe that our existing cash and cash equivalents, short-term investments, our cash flows from operations and our existing lines of credit provide us with the financial flexibility to meet our liquidity and capital needs, as well as to complete certain acquisitions of businesses and technologies. We intend to continue to pursue acquisition opportunities based upon market conditions and the strategic importance and valuation of the target company. We may consider issuing debt or equity to finance acquisitions depending on the timing and size of the acquisition. Our future long-term capital requirements will depend on many factors including our level of sales, the impact of the economic environment on our sales growth, the timing and extent of spending to support development efforts, the 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.
Operating activities. Net cash provided by operating activities increased by $101.0 million to $296.9 million for the nine months ended September 30, 2017 from $195.8 million for the nine months ended September 30, 2016. As the business and net income has grown, cash provided by net income after adding back non-cash charges has increased. For the nine months ended September 30, 2017, this increase was partially offset by continued growth in working capital to support the growth of the business. Our largest working capital items 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 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 increase in cash flow from operating activities for the nine months ended September 30, 2017 primarily resulted from:
An increase of $149.2 million in cash provided by net income after adding back non-cash charges to $416.2 million for the nine months ended September 30, 2017 as compared to $267.0 million for the same period in 2016;
A decrease in the cash used for inventory. Cash used for inventory was $39.7 million for the nine months ended September 30, 2017 as compared to $42.8 million for the same period in 2016; partially offset by
An increase in cash used by accounts receivable of $56.4 million for the nine months ended September 30, 2017 as compared to an increase of cash used of $10.9 million for the same period in 2016 due to an increase in sales and the timing of sales in the quarter; and
An increase in cash used for income taxes. Cash used for income and other taxes payable was $26.9 million for the nine months ended September 30, 2017 as compared to cash used for income and other taxes payable of $7.4 million for the same period in 2016.
Given our vertical integration, rigorous and time-consuming testing procedures for both internally manufactured and externally purchased components and the lead time required to manufacture components used in our finished products, the rate at which we turn inventory has historically been comparatively low when compared to our cost of sales. Also, our historic growth rates required investment in inventories to support future sales and enable us to quote short delivery times to our customers, providing what we believe is a competitive advantage. Furthermore, if there was a disruption to the manufacturing capacity of any of our key technologies, our inventories of components should enable us to continue to build finished products

21


for a period of time. We believe that we will continue to maintain a relatively high level of inventory compared to our cost of sales. As a result, we expect to have a significant amount of working capital invested in inventory. A reduction in our level of net sales or the rate of growth of our net sales from their current levels would mean that the rate at which we are able to convert our inventory into cash would decrease.
Investing activities. Net cash used in investing activities was $93.3 million for the nine months ended September 30, 2017 as compared to cash used in investing activities of $166.9 million in 2016. The cash used in investing activities in 2017 related$99.2 million of capital expenditures and $50.6 million, net of cash acquired for the acquisitions of OptiGrate and ILT, partially offset by $41.6 million of net proceeds from sales of short-term investments and $15.4 million of proceeds from sales of property, plant and equipment, which primarily relates to our corporate aircraft. The cash used in investing activities in 2016 related to $100.0 million of capital expenditures, $46.5 million for the acquisition of Menara and $20.6 million of net purchases of short-term investments. 
We expect to incur between $100 million and $110 million in capital expenditures net of proceeds from the sale of our corporate aircraft and excluding acquisitions. Capital expenditures include investments in facilities and equipment to add capacity worldwide to support anticipated revenue growth and the cost to upgrade of our corporate aircraft. In 2018, we expect capital expenditures to increase as a percentage of revenue to support the growth of our business. 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 provided by financing activities was $5.2 million for the nine months ended September 30, 2017 as compared to net cash provided by financing activities of $26.7 million in 2016. The cash provided by financing activities in 2017 was primarily related to proceeds from the exercise of stock options and shares issued under our employee stock purchase plan 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 proceeds on long-term borrowings related to debt issued on the new corporate aircraft purchased during the third quarter of 2017. These cash proceeds were partially offset by the purchase of treasury stock of $26.9 million and payments on our long-term borrowings of $19.0 million, the majority of which related to repayment of the long-term note secured by our previous corporate aircraft. The cash provided by financing activities in 2016 was primarily related to the cash provided by debt issued to finance the purchase of a building, the exercise of stock options, issuances under employee stock purchase plan and shares withheld to cover employee restricted stock taxes partially offset by the payments on our long-term borrowings and net payments of line-of-credit facilities.
Cautionary Statement Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and we intend that such forward-looking statements be subject to the safe harbors created thereby. For this purpose, any statements contained in this Quarterly Report on Form 10-Q except for historical information are forward-looking statements. Without limiting the generality of the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue" or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance, trends in our businesses, or other characterizations of future events or circumstances are forward-looking statements.
The forward-looking statements included herein are based on current expectations of our management based on available information and involve a number of risks and uncertainties, all of which are difficult or impossible to accurately predict and many of which are beyond our control. As such, our actual results may differ significantly from those expressed in any forward-looking statements. Factors that may cause or contribute to such differences include, but are not limited to, those discussed in more detail in Item 1, "Business" and Item 1A, "Risk Factors" of Part I of our Annual Report on Form 10-K for the year ended December 31, 2016. Readers should carefully review these risks, as well as the additional risks described in other documents we file from time to time with the Securities and Exchange Commission. In light of the significant risks and uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that such results will be achieved, and readers are cautioned not to rely on such forward-looking information. We undertake no obligation to revise the forward-looking statements contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Recent Accounting Pronouncements


22


In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09"). ASU 2014-09 supersedes the revenue recognition requirements in "Revenue Recognition (Topic 605)" and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14 "Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date," which defers the effective date of ASU 2014-09 one year to interim and annual reporting periods beginning after December 15, 2017, which would be our fiscal year ending December 31, 2018. In May 2016, the FASB also issued ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," to provide additional clarification of accounting for collections of sales taxes as well as recognition of revenue (i) associated with contract modifications, (ii) for noncash consideration, and (iii) based on the collectability of the consideration from the customer. The guidance also specifies when a contract should be considered "completed" for purposes of applying the transition guidance. We have completed our assessment of the new guidance and are in the process of training finance and sales personnel, updating corporate policies, and modifying reporting packages to support the new disclosure requirements. We do not expect the standard will have a material impact on the amount and timing of revenue recognized in our consolidated financial statements and have elected to use the modified retrospective application approach for transition to the new standard.
In January 2017, the FASB issued ASU No. 2017-04, "Intangibles—Goodwill and Other (Topic 350)" ("ASU 2017-04"). ASU 2017-04 simplifies the accounting for goodwill impairments by eliminating step 2 from the goodwill impairment test. ASU 2017-04 is effective for public companies for annual reporting periods beginning after December 15, 2020, and interim reporting periods within such period. The amendments should be applied prospectively on or after the effective date and require a disclosure as to the nature of and reason for the change in accounting principle upon transition. Early adoption is allowed for all entities as of January 1, 2017, for annual and any interim impairment tests occurring after January 1, 2017. We are currently evaluating the potential impact that the standard will have on our consolidated financial statements upon adoption.
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). ASU 2016-02 requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. We are continuing to evaluate the standard but do not expect that it will have a material effect on our consolidated financial statements upon adoption.
In October 2016, the FASB issued ASU No. 2016-16, "Income Taxes (Topic 740) - Intra-Entity Transfers of Assets other than Inventory" ("ASU 2016-16"). ASU 2016-16 eliminates the current exception that prohibits the recognition of current and deferred income tax consequences for intra-entity asset transfers (other than inventory) until the asset has been sold to an outside party. The amendments will be applied on a modified retrospective basis through a cumulative effect adjustment to retained earnings. Deferred tax assets should be assessed to determine if realizable. Disclosures will be required for the (i) reason for and notice of change, (ii) effect of change on income from continuing operations and (iii) cumulative effect of change on retained earnings. Public entities will apply these changes in annual reporting periods beginning after December 15, 2017, and interim reporting periods within such period. Early adoption is permitted. We are continuing to evaluate the standard but do not expect that it will have a material effect on our consolidated financial statements upon adoption.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk in the ordinary course of business, which consists primarily of interest rate risk associated with our cash and cash equivalents and our debt and foreign exchange rate risk.
Interest rate risk. Our investments have limited exposure to market risk. We maintain a portfolio of cash, cash equivalents and short-term investments, consisting primarily of bank deposits, money market funds, certificates of deposit, corporate notes and government and agency securities. None of these investments have a maturity date in excess of one year. The interest rates are variable and fluctuate with current market conditions. Because of the short-term nature of these instruments, a sudden change in market interest rates would not be expected to have a material impact on our financial condition or results of operations.
We are also exposed to market risk as a result of increases or decreases in the amount of interest expense we must pay on our bank debt and borrowings on our bank credit facilities. Our interest obligations on our long-term debt are fixed either by the underlying agreement or by means of an interest rate swap agreement. Although our U.S. revolving line of credit and our

23


Euro credit facility have variable rates, we do not believe that a 10% change in market interest rates would have a material impact on our financial position or results of operations.
Exchange rates. Due to our international operations, a significant portion of our net sales, cost of sales and operating expenses are denominated in currencies other than the U.S. Dollar, principally the Euro, the Russian Ruble, the Chinese Yuan and the Japanese Yen. As a result, our international operations give rise to transactional market risk associated with exchange rate movements of the U.S. Dollar, the Euro, the Russian Ruble, the Chinese Yuan and the Japanese Yen. The loss on foreign exchange transactions totaled $3.9 million for the three months ended September 30, 2017 and $2.9 million for the three months ended September 30, 2016. Management attempts to minimize these exposures by partially or fully off-setting foreign currency denominated assets and liabilities at our subsidiaries that operate in different functional currencies. The effectiveness of this strategy can be limited by the volume of underlying transactions at various subsidiaries and by our ability to accelerate or delay inter-company cash settlements. As a result, we are unable to create a perfect offset of the foreign currency denominated assets and liabilities. At September 30, 2017, our material foreign currency exposure is net U.S. Dollar denominated assets at subsidiaries where the Euro or the Russian Ruble is the functional currency and U.S. Dollar denominated liabilities where the Chinese Yuan is the functional currency. The U.S. Dollar denominated assets are comprised of cash, third party receivables and inter-company receivables. The U.S. Dollar denominated liabilities are comprised of inter-company payables. A 5% change in the relative exchange rate of the U.S. Dollar to the Euro as of September 30, 2017 applied to the net U.S. Dollar asset balances, would result in a foreign exchange gain of $2.4 million if the U.S. Dollar appreciated and a $2.4 million foreign exchange loss if the U.S. Dollar depreciated.
In addition we are exposed to foreign currency translation risk for those subsidiaries whose functional currency is not the U.S. Dollar as changes in the value of their functional currency relative to the U.S. Dollar can adversely affect the translated amounts of our revenue, expenses, net income, assets and liabilities. This can, in turn, affect the reported value and relative growth of sales and net income from one period to the next. In addition changes in the translated value of assets and liabilities due to changes in functional currency exchange rates relative to the U.S. Dollar result in foreign currency translation adjustments that are a component of other comprehensive income or loss.
Foreign currency derivative instruments can also be used to hedge exposures and reduce the risks of certain foreign currency transactions; however, these instruments provide only limited protection and can carry significant cost. We have no foreign currency derivative instrument hedges as of September 30, 2017. We will continue to analyze our exposure to currency exchange rate fluctuations and may engage in financial hedging techniques in the future to attempt to minimize the effect of these potential fluctuations. Exchange rate fluctuations may adversely affect our financial results in the future.

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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision of our chief executive officer and our chief financial officer, our management has evaluated the effectiveness of the design and operation of our "disclosure controls and procedures" (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of the end of the period covered by this Quarterly Report on Form 10-Q (the "Evaluation Date"). Based upon that evaluation, our chief executive officer and our chief financial officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective.
Changes in Internal Controls
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are party to various legal proceedings and other disputes incidental to our business. There have been no material developments to those proceedings reported in our Annual Report on Form 10-K for the year ended December 31, 2016.
ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2016, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Date
 
Total Number of
Shares (or Units)
Purchased
 
 
 
Average Price
Paid per Share
(or Unit)
 
Total Number of
Shares (or Units)
Purchased as Part
of Publicly
Announced Plans
or Programs
 
Maximum Number
(or Approximate
Dollar Value) of
Shares (or Units)
that May Yet Be
Purchased Under
the Plans or
Programs
January 1, 2017 — January 31, 2017
 
15,300

 
(2)
 
$
99.69

 

 
$
89,529

February 1, 2017 — February 28, 2017
 
12,013

 
(1),(2)
 
119.60

 

 
88,094

March 1, 2017 — March 31, 2017
 
96,583

 
(1),(2)
 
119.40

 

 
78,516

April 1, 2017 — April 30, 2017
 
56,232

 
(1),(2)
 
120.29

 

 
71,752

May 1, 2017 — May 31, 2017
 
20,322

 
(1),(2)
 
135.66

 

 
69,092

June 1, 2017 — June 30, 2017
 
15,000

 
(1),(2)
 
143.28

 

 
66,942

July 1, 2017 — July 31, 2017
 
5,252

 
(1),(2)
 
148.44

 

 
66,163

August 1, 2017 — August 31, 2017
 
13,590

 
(1),(2)
 
166.62

 

 
64,143

September 1, 2017 — September 30, 2017
 

 

 

 

 
64,143

Total
 
234,292

 
 
 
$
124.67

 

 
$
64,143

 
(1)
In 2012, our Board of Directors approved "withhold to cover" as a tax payment method for vesting of restricted stock awards for certain employees. Pursuant to the "withhold to cover" method, we withheld from such employees the shares noted in the table above to cover tax withholding related to the vesting of their awards. For the three months ended September 30, 2017 a total of 1,514 shares were withheld at an average price of $161.63

(2)
In July 2016, the Board of Directors authorized a share repurchase program (the "Program"). Under the Program, the Company's management is authorized to repurchase shares of common stock in an amount not to exceed the number of shares issued to employees and directors under its various employee and director equity compensation and employee stock purchase plans from January 1, 2016 through December 31, 2017. The Program limits aggregate share repurchases to no more than $100 million over a period ending June 30, 2018. For the three months ended September 30, 2017, the Company repurchased 17,328 shares of its common stock with an average price of $161.55 per share in the open market.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES

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Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
(a) Exhibits
 


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
IPG PHOTONICS CORPORATION
 
 
 
 
 Date: November 7, 2017
 
By:
/s/ Valentin P. Gapontsev
 
 
 
Valentin P. Gapontsev
 
 
 
Chairman and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
 Date: November 7, 2017
 
By:
/s/ Timothy P.V. Mammen
 
 
 
Timothy P.V. Mammen
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)


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