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Item 7. Management’s Discussion and Analysis

2022-02-22 compared with 2021-02-22 · 156 added, 189 removed, 267 unchanged (56% of the section changed)

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This discussion contains forward-looking statements that involve risks and uncertainties.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors including, but not limited to, those discussed under Item 1A, "Risk Factors." The following analysis generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020.

Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 filed with the SEC on February 22, 2021.

We develop, manufacture and sell high-performance fiber lasers, fiber amplifiers and diode lasers that are used for diverse applications, primarily in materials processing.

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COVID-19 Update.

Global demand trends have been impacted adversely by the ongoing COVID-19 pandemic and therefore remain uncertain at this time .

Economic indicators show some improvement from the severe contraction experienced earlier in 2020, which has led to an improvement in the recent demand environment in certain regions.

It is difficult to predict whether the improvement in some macro-economic indicators will be sustained if there are additional restrictions imposed as a result of a resurgence in COVID-19 infections.

Global demand trends have been impacted by the ongoing COVID-19 pandemic and therefore remain uncertain at this time .

While business conditions generally improved from the severe contraction experienced in 2020, it is difficult to predict whether conditions could change if there are additional restrictions imposed as a result of a resurgence in COVID-19 infections.

This uncertainty continues to make forecasting our business challenging in the near to medium-term.

Currently, our four major production facilities in United States, Germany, Russia and Belarus remain open and are operating normally.

We have implemented employee safety and sanitization protocols that have impacted productivity and efficiency.

We have vertically integrated manufacturing, and many of the components one facility supplies to another facility are single sourced internally and not available from third party suppliers, for example our semiconductor diodes manufactured in Oxford, Massachusetts.

While we have attempted to build safety stock of critical components at our various locations, if government restrictions to address COVID-19 become more severe than we have experienced to date or if there was significant absenteeism as a result of COVID-19 or resurgence in the places where we operate, it could impact our internal supply chain.

If our revenues are reduced for an extended period or if our production output falls because of government restrictions or absenteeism, we may be required to reduce payroll-related costs and other expenses in the future through layoffs, furloughs or reduced hours, even though we have not done so to date .

We have not experienced significant supply disruption from third party component suppliers;

however, we may face some supply chain restraints related to logistics, including available air cargo space and higher freight rates if there is a COVID-19 resurgence.

We may experience delays in the future if resurgences are experienced and governments implement new restrictions.

We believe we have the ability to meet the near-term demand for our products, but the situation is fluid and subject to change.

We continue to monitor the rapidly evolving conditions and circumstances as well as guidance from international and domestic authorities, including public health authorities, and we may need to take additional actions based on their recommendations.

The measures implemented by various authorities related to the COVID-19 outbreak have caused us to change our business practices including those related to where employees work, the distance between employees in our facilities, limitations on in-person meetings between employees and with customers, suppliers, service providers, and stakeholders as well as restrictions on business travel to domestic and international locations or to attend trade shows, investor conferences and other events.

To date, we have been able to accommodate these changes to our business operations and continue to meet customer demand.

If guidelines from relevant authorities becomes more restrictive due to a resurgence of COVID-19 in a particular region, the effect on our operations could be more significant.

The COVID-19 pandemic has increased economic uncertainty and decreased demand for our products in many markets we serve and could continue for an unknown period of time.

In these circumstances, there may be developments outside of our control, including the length and extent of the COVID-19 outbreak and government-imposed measures that may require us to adjust our operating plans.

As such, given the dynamic nature of this situation, we cannot reasonably estimate the future impacts of COVID-19 on our financial condition, results of operations or cash flows.

Currently, our four major production facilities in United States, Germany, Russia and Belarus are operating normally with enhanced employee safety and sanitization protocols that have not significantly impacted productivity and efficiency.

We have vertically integrated manufacturing, and many of the components one facility supplies to another facility are single sourced

internally and not available from third party suppliers, for example our semiconductor diodes manufactured in Oxford, Massachusetts.

While we have attempted to build safety stock of critical components at our various locations, if government restrictions to address COVID-19 become more severe or if absenteeism becomes significant as a result of COVID-19 in the places where we operate, it could impact our internal supply chain.

We and our customers are experiencing increased lead times for certain components purchased from third party suppliers;

particularly electronic components.

We, our customers and our suppliers continue to face constraints related to supply chain and logistics, including availability of capacity, materials, air cargo space, sea containers and higher freight rates.

Supply chain and logistics constraints are expected to continue for the foreseeable future and could impact our ability to supply products and our customers' demand for our product or readiness to accept deliveries.

Supply chain constraints have not significantly affected our business but they have moderately increased our freight costs, caused us to carry higher levels of safety stock for certain inventory items, increased the cost of certain electronic components and caused delays in recognizing revenue for certain custom processing systems in our Genesis business due to delays in receiving robots.

Notwithstanding these effects, we believe we have the ability to meet the near-term demand for our products, but the situation is fluid and subject to change if there is a resurgence in COVID-19 or if governments implement new restrictions.

Our annual revenue growth rates have varied from year to year.

Net sales decreased by 9% and 10% in 2020 and 2019, respectively, and increased by 4% in 2018.

Net sales increased by 22% in 2021 and decreased by 9% and 10% in 2020 and 2019, respectively.

In 2021, the increase in net sales was driven by improvement in the macroeconomic environment driven by recoveries from the COVID-19 pandemic.

In 2020, the decline in net sales was driven by decreased demand for our products related to the COVID-19 pandemic that extended and deepened the weak macroeconomic environment prevailing at the end of 2019.

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and China that weakened macroeconomic conditions in the second half of 2019.

In addition to these factors, sales were affected by declines in average sales prices related to competition.

These reductions in sales were partially offset by the introduction of new products, including high power and ultra-fast pulsed lasers, optical heads and other accessories and the development of new applications for our products some of which displace non-laser technologies.

Our business depends substantially upon capital expenditures by end users, particularly by manufacturers using our products for materials processing, which includes general manufacturing, automotive, other transportation, aerospace, heavy industry, consumer, semiconductor and electronics.

In addition to these factors, sales in 2021 were positively affected by growth of new or recently introduced products, including high power pulsed lasers, green pulsed lasers, ultra-fast pulsed lasers, handheld welding systems, optical heads and other accessories and the development of new applications for our products some of which displace non-laser technologies.

The increases in sales were partially offset by decreased demand for high power CW lasers used for cutting due to softer market demand and increased competition in China.

Our business depends substantially upon capital expenditures by end users, particularly by manufacturers using our products for materials processing, which includes general manufacturing, automotive including electric vehicles (EV), other transportation, aerospace, heavy industry, consumer, semiconductor and electronics.

Approximately 91% of our revenues in 2021 were from customers using our products for materials processing.

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For the foreseeable future, our operations will continue to depend upon capital expenditures by end users of materials processing equipment and will be subject to the broader fluctuations of capital equipment spending.

Our net sales have historically fluctuated from quarter to quarter.

The increase or decrease in sales from a prior quarter can be affected by the timing of orders received from customers, the shipment, installation and acceptance of products at our customers' facilities, the mix of OEM orders and one-time orders for products with large purchase prices, competitive pressures, acquisitions, economic and political conditions in a certain country or region and seasonal factors such as the purchasing patterns and levels of activity throughout the year in the regions where we operate.

Net sales can be affected by the time taken to qualify our products for use in new applications in the end markets that we serve.

Our sales cycle varies substantially, ranging from a period of a few weeks to as long as one year or more, but is typically several months.

The adoption of our products by a new customer or qualification in a new application can lead to an increase in net sales for a period, which may then slow until we penetrate new markets or obtain new customers.

In the recent years, our net sales have been negatively impacted by tariffs and trade policies.

New tariffs and other changes in U.S.

trade policy could trigger retaliatory actions by affected countries, and certain foreign governments.

We are also susceptible to global or regional disruptions such as political instability, geopolitical conflicts, acts of terrorism, significant fluctuations in currency values, natural disasters, macroeconomic concerns and particularly the impact of the COVID-19 outbreak that affect the level of capital expenditures or global commerce.

With respect to the COVID-19 outbreak specifically, our 2020 financial results were negatively impacted.

In addition, as of the time of this Annual Report on Form 10-K, we expect that COVID-19 could continue to negatively impact our businesses beyond 2020, but the extent and duration of such impacts over the longer term remain uncertain and dependent on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of the coronavirus, the extent and effectiveness of containment actions taken, the approval, effectiveness, timing and widespread inoculation of the global population with new vaccines, and the impact of these and other factors on our customer base and general commercial activity.

In 2022, inflationary pressures are likely to result in global central banks adopting less accommodating monetary policy that would result in an increase in interest rates.

An increase in interest rates could impact global growth and could lead to a recession that may reduce the demand for our products.

In addition, an increase in interest rates would increase the cost of equipment financed with leases or debt.

We are also susceptible to global or regional disruptions such as political instability, geopolitical conflicts, acts of terrorism, significant fluctuations in currency values, natural disasters, macroeconomic concerns and the impact of the COVID-19 outbreak that affect the level of capital expenditures or global commerce.

With respect to the COVID-19 outbreak specifically, while our financial results for 2021 improved compared to 2020, the possible affect over the longer term remains uncertain and dependent on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of COVID-19 or new variants, the extent and effectiveness of containment actions taken, the approval, effectiveness, timing and widespread vaccination of the global population, and the impact of these and other factors on our customer base and general commercial activity.

The average selling prices of our products generally decrease as the products mature.

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The secular shift to fiber laser technology in large materials processing applications, such as cutting applications, had a positive effect on our sales trends in the past such that our sales trends were often better than other capital equipment manufacturers in both positive and negative economic cycles.

As the secular shift to fiber laser technology matures in such applications, our sales trends are more susceptible to economic cycles which affect other capital equipment manufacturers.

As the secular shift to fiber laser technology matures in such applications, our sales trends are more susceptible to economic cycles which affect other capital equipment manufacturers broadly and the machine tool and industrial laser industries more specifically.

Gross margin.

Our total gross margin in any period can be significantly affected by total net sales in any period, by competitive factors, by product mix, and by other factors such as changes in foreign exchange rates relative to the U.S.

Dollar, some of which are not under our control.

For instance,

Our total gross margin in any period can be significantly affected by a number of factors, including net sales, production volumes, competitive factors, product mix, and by other factors such as changes in foreign exchange rates relative to the U.S.

Many of these factors are not under our control.

The following are examples of factors affecting gross margin:

• As our products mature, we can experience additional competition which tends to decrease average selling prices and affects gross margin;

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• Customers that purchase devices in greater unit volumes generally are provided lower prices per device than customers that purchase fewer units.

In general, lower selling prices to high unit volume customers reduce gross margin although this may be partially offset by improved absorption of fixed overhead costs associated with larger product volumes, which drive economies of scale in manufacturing;

• Gross margin on systems and communication components can be lower than margins for our laser and amplifier sources, depending on the configuration, volume and competitive forces, among other factors.

• Gross margin on systems and communication components can be lower than gross margin for our laser and amplifier sources, depending on the configuration, volume and competitive forces, among other factors, and finally,

• Persistent inflation leading to increases in average manufacturing salaries as well as an increase in the purchase price of components including, but not limited to, electronic components and metal parts could negatively impact gross margin if we are not able to pass those increases on to customers by increasing the selling price of our products.

We expect that some new technologies, products and systems will have returns above our cost of capital but may have gross margins below our corporate average.

If we are able to develop opportunities that are significant in size, competitively advantageous or leverage our existing technology base and leadership, our current gross margin levels may not be maintained.

Instead, we aim to deliver industry-leading levels of gross margins by growing sales, by taking market share in existing

markets, or by developing new applications and markets we address, by reducing the cost of our products and by optimizing the efficiency of our manufacturing operations.

For instance, despite the decreases in sales in 2020 and 2019, manufacturing levels remained high and our facilities increased production as we manufactured more optical power products at lower average selling prices.

Instead, we aim to deliver industry-leading levels of gross margins by growing sales, by taking market share in existing markets, or by developing new applications and markets we address, by reducing the cost of our products and by optimizing the efficiency of our manufacturing operations.

We invested $123.1 million, $87.7 million and $133.5 million in capital expenditures in 2021, 2020 and 2019, respectively.

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The amount of research and development expense we incur may vary from period to period.

Goodwill and long-lived assets impairments .

We review our intangible assets and property, plant and equipment for impairment when events or changes in circumstances indicate the carrying value may not be recoverable.

Goodwill is required to be tested for impairment at least annually.

Negative industry or economic trends, including reduced estimates of future cash flows, disruptions to our business, slower growth rates, lack of growth in our relevant business units or differences in the estimated product acceptance rates could lead to impairment charges against our long-lived assets, including goodwill and other intangible assets.

We incurred $0.7 million and $2.5 million of non-cash impairment charges related to long-lived assets during the years ended December 31, 2020 and 2019, respectively.

There were no impairment charges recognized during the year ended December 31, 2018.

Our valuation methodology for assessing impairment requires management to make significant judgments and assumptions based on historical experience and to rely heavily on projections of future operating performance at many points during the analysis.

Also, the process of evaluating the potential impairment of goodwill is subjective.

We operate in a highly competitive environment and projections of future operating results and cash flows may vary significantly from actual results.

If our analysis indicates potential impairment to goodwill in one or more of our reporting units, we may be required to record charges to earnings in our financial statements, which could negatively affect our results of operations.

As a result of the continued negative impact of COVID-19 on order flow for our Genesis custom system business, we performed an impairment analysis of the goodwill during the third quarter of 2020.

We performed a quantitative assessment using the discounted cash flow method under the income approach as well as the guideline public company analysis and guideline transaction analysis under the market approach to estimate the fair value of the custom systems business.

As a result of this and to a lesser extent the overall performance of the business since its acquisition in 2018, we recognized a non-cash impairment loss of $44.6 million, which was equal to the carrying amount of goodwill prior to its impairment.

The analysis considered internal forecasts of sales, profitability and capital expenditures, as well as valuation multiples of comparable public companies and valuation multiples of transactions of comparable companies.

If the business impacts of COVID-19 carry on for

an extended period, it could cause us to recognize additional impairments for goodwill and certain long-lived assets, including amortizable intangible assets or right-of-use assets in one or more of our reporting units, which would negatively affect our results of operations.

Foreign exchange.

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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.

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, Russia, and Belarus) 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.

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Net sales derived from our five largest customers as a percentage of our annual net sales were 19%, 24% and 21% in 2021, 2020 and 2019, respectively.

Our largest customer accounted for 8%, 9% and 12% of our net sales in 2020, 2019 and 2018, respectively.

The same customer accounted for 21% and 24% of our net accounts receivable as of December 31, 2020 and 2019, respectively.

Our largest customer accounted for 22% and 21% of our net accounts receivable as of December 31, 2021 and 2020, respectively.

We seek to add new customers and to expand our relationships with existing customers.

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The preparation of financial statements in conformity with accounting principles generally accepted in the United States ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses.

Refer to Note 1, "Nature of Business and Summary of Significant Accounting Policies," in our consolidated financial statements for additional information.

By their nature, these estimates and judgments are subject to an inherent degree of uncertainty.

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We have identified the following items that require the most significant judgment and often involve complex estimation:

revenue recognition, inventory valuation, warranty, accounting for income taxes and goodwill and long-lived asset impairment.

Revenue Recognition.

Revenue is recognized when transfer of control to the customer occurs in an amount reflecting the consideration that we expect to be entitled.

In order to achieve this core principle, we apply the following five step approach:

(1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when a performance obligation is satisfied.

We allocate the transaction price to each distinct product based on its relative standalone selling price, as more fully described in Note 1, "Nature of Business and Summary of Significant Accounting Policies - Revenue Recognition," in our consolidated financial statements.

Revenue is generally recognized when control of the product is transferred to the customer (i.e., when our performance obligation is satisfied), which typically occurs at shipment, but which can occur over time for certain of our systems contracts.

Revenue is recognized when transfer of control to the customer occurs (i.e., when our performance obligation is satisfied) in an amount reflecting the consideration that we expect to be entitled.

For the majority of our revenue, this typically occurs at a point in time such as shipment or delivery date, but can occur over time for certain of our customized robotic systems contracts.

We also recognize revenue over time for sales of extended warranties.

When goods or services have been delivered to the customer, but all conditions for revenue recognition have not been met, deferred revenue and deferred costs are recorded on our consolidated balance sheet.

We enter into contracts to sell customized robotic systems, for which revenue is generally recognized over time, depending on the terms of the contract.

Recognizing revenue over time for these contracts is based on our judgment that the customized robotic system does not have an alternative use and we have an enforceable right to payment for performance completed to date.

Recognizing revenue over time also requires estimation of the progress towards completion based on the projected costs for the contract.

Inventory is stated at the lower of cost (first-in, first-out method) or market value.

Inventory includes parts and components that may be specialized in nature and subject to rapid obsolescence.

Judgments and Uncertainties:

Recognizing revenue at shipment or delivery involves some judgment, particularly when we receive orders with multiple delivery dates.

We allocate the transaction price of the contract to each delivery date based upon the standalone selling price of each distinct product in the contract.

We invoice for each scheduled delivery upon shipment and recognize revenue for such delivery when transfer of control has occurred.

Recognizing revenue over time for customized robotic systems contracts is based on our judgment that these systems do not have an alternative use and we have an enforceable right to payment for performance completed to date.

Recognizing revenue over time also requires estimation of the progress towards completion based on the projected costs of the contract.

Sensitivity of Estimate to Change:

Recognizing revenue at a point in time is sensitive to changes in shipping or delivery dates.

Revenue recognition over time is sensitive to the actual costs incurred as compared to the projected total cost of the project.

We monitor the actual and projected costs of these contracts closely.

A change in the projected cost of a project will affect the estimated percentage of completion, the amount of revenue recognized and estimated gross margin.

We maintain a reserve for excess or obsolete inventory items.

The reserve is based upon a review of inventory materials on hand, which we compare with historic usage, estimated future usage and age.

In addition, we review the inventory and compare recorded costs with estimates of current

market value.

In addition, we review the inventory

and compare recorded costs with estimates of current market value.

Write-downs are recorded to reduce the carrying value to the net realizable value with respect to any part with costs in excess of current market value.

Judgments and Uncertainties:

Estimating demand and current market values is inherently difficult, particularly given that we make highly specialized components and products.

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If future sales differ from these forecasts, the valuation of excess and obsolete inventory may change and additional inventory provisions may be required.

Sensitivity of Estimate to Change:

Because of our vertical integration, a significant or sudden decrease in sales could result in a significant change in the estimates of excess or obsolete inventory valuation.

We maintain an accrual for warranty claims for units sold that are subject to warranty.

We estimate this accrual considering past claims experience, the number of units still carrying warranty coverage and the average life of the remaining warranty period.

A change in the rate of warranty repairs or when warranty is generally incurred during the warranty period could change our estimated warranty accrual and associated warranty expense.

We recorded provisions for slow-moving, obsolete or excess inventory totaling $34.3 million, $45.4 million and $38.9 million in 2021, 2020 and 2019, respectively.

Because our calculation of slow-moving, excess or obsolete inventory is based on historical and estimated future use of inventory items, the calculation is affected by sales trends.

In 2020, as sales decreased due to the impact of the COVID 19 pandemic and other factors, our provisions for slow-moving, excess and obsolete inventory reserves increased.

In 2021, as sales increased due to recovery from the impact of the Covid 19 pandemic and other factors, our provisions for slow-moving, excess and obsolete inventory reserves decreased.

Income Taxes and Deferred Taxes .

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We file federal and state income tax returns in the United States and tax returns in numerous international jurisdictions.

We must estimate our income tax expense after considering, among other factors, if inter-company transactions have been made on an arm’s length basis, differing tax rates between jurisdictions, allocation factors, tax credits, nondeductible items and changes in enacted tax rates.

Judgments and Uncertainties:

We must estimate our income tax expense after considering, among other factors, the pricing of inter-company transactions on an arm’s length basis, differing tax rates between jurisdictions, allocation factors, tax credits, nondeductible items and changes in enacted tax rates.

Significant judgment is required in determining our annual tax expense and in evaluating our tax positions.

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Additionally, due to the lack of uniformity among all of the foreign and domestic taxing authorities, there may be situations where the tax treatment of an item in one jurisdiction is different from the tax treatment in another jurisdiction or that the transaction causes a tax liability to arise in another jurisdiction.

Sensitivity of Estimate to Change:

We provide reserves for potential payments of tax to various tax authorities related to uncertain tax positions and other issues.

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Potential interest and penalties associated with such uncertain tax positions is recorded as a component of income tax expense.

Goodwill and Long-lived Asset Impairment.

We perform our annual goodwill impairment review as of the first day of our fourth quarter, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount.

Such events and circumstances could include significant and sustained reductions in sales volume, margin, profitability or cash flows of the reporting unit or changes in market dynamics, including technology or product changes.

We test reporting units for impairment by comparing the estimated fair value of each reporting unit with its carrying amount.

Intangible assets and other long-lived assets are also subject to an impairment test if there is an indicator of impairment.

Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors.

Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions.

These assumptions and estimates include estimated future annual net cash flows, income tax considerations, discount rates, growth rates, royalty rates, contributory asset charges, and other market factors.

Assumptions used in impairment testing are made at a point in time and require significant judgment;

therefore, they are subject to change based on the facts and circumstances present at each annual and interim impairment test date.

Additionally, these assumptions are generally interdependent and do not change in isolation.

If current expectations of future growth rates and margins are not met, if market factors outside of our control, such as discount rates, change, or if management’s expectations or plans otherwise change, then one or more of our reporting units might become impaired in the future.

Definite-lived intangible assets are amortized on a straight-line basis over the estimated useful life.

We review definite-lived intangible assets for impairment when conditions exist that indicate the carrying amount of the assets may not be recoverable.

Such conditions could include significant adverse changes in the business climate, current-period operating or cash flow losses, significant declines in forecasted operations, or a current expectation that an asset group will be disposed of before the end of its useful life.

We perform undiscounted operating cash flow analyses to determine if an impairment exists.

When testing for impairment of definite-lived intangible assets held for use, we group assets at the lowest level for which cash flows are separately identifiable.

If an impairment is determined to exist, the loss is calculated based on estimated fair value.

As of December 31, 2021, we had $19.2 million of unrecognized tax benefits, excluding interest and penalties, recorded in deferred income taxes and other long-term liabilities.

This tax benefit increased by $6.4 million for tax positions taken in the current year offset by reductions of $2.0 million for changes in prior period positions.

Results of Operations

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Impairment of long-lived assets and other restructuring charges — — 1,177 0.1 7,130 0.5

Loss (gain) on foreign exchange (12,915) (1.1) 12,827 1.0 (6,150) (0.4)

(Gain) loss on foreign exchange (15,120) (1.0) (12,915) (1.1) 12,827 1.0

Total operating expenses 328,515 22.6 340,337 28.4 372,416 28.3

Operating income 367,883 25.2 198,659 16.5 233,793 17.8

Interest income, net 6,270 0.5 14,238 1.1 9,057 0.6

Interest (expense) income, net (1,839) (0.1) 6,270 0.5 14,238 1.1

Other income, net 437 — 763 0.1 345 —

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Net income 277,866 19.0 160,338 13.3 180,261 13.7

net income attributable to non-controlling interest 766 0.1 27 — 142 —

Net income attributable to IPG Photonics Corporation $ 159,572 13.2 % $ 180,234 13.7 % $ 404,027 27.7 %

Net income attributable to IPG Photonics Corporation per share:

net (loss) income attributable to non-controlling interest (550) — 766 0.1 27 —

Net income attributable to IPG Photonics Corporation common stockholders $ 278,416 19.0 % $ 159,572 13.2 % $ 180,234 13.7 %

Net income attributable to IPG Photonics Corporation per common share:

Basic $ 5.21 $ 3.00 $ 3.40

Diluted $ 5.16 $ 2.97 $ 3.35

Weighted average shares outstanding:

Weighted average common shares outstanding:

Basic 53,410 53,186 53,061

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Comparison of Year Ended December 31, 2021 to Year Ended December 31, 2020

Net sales decreased by $113.9 million, or 8.7%, to $1,200.7 million in 2020 from $1,314.6 million in 2019.

Net sales increased by $260.1 million, or 21.7%, to $1,460.8 million in 2021 from $1,200.7 million in 2020.

The table below sets forth sales by application:

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Materials processing

Sales for materials processing applications decreased due to lower sales of high power lasers, laser and non-laser systems, QCW lasers and medium power lasers, partially offset by increased sales in pulsed lasers.

• High power laser sales for metal cutting and welding applications declined due to the impact of COVID-19 on end market demand, continued reductions of average selling prices and increased competition.

Part of the decline in average selling prices for high power lasers is due to the adoption of more compact or rack mounted "YLR" series lasers which are displacing 1 to 3 kilowatt "YLS" series lasers, which are larger, more complex and more expensive.

These more compact YLR lasers are less expensive to manufacture and are sold at prices lower than the YLS series lasers they are displacing.

• Medium power laser sales decreased due to decreased demand in laser sintering for metal-based additive manufacturing and ongoing transition to kilowatt scale cutting lasers.

• Pulsed laser sales increased due to growth in sales of high power pulsed lasers used for battery processing, ablative processing and solar cell manufacturing applications, partially offset by decreased demand of pulsed lasers used for marking and engraving applications.

• QCW laser sales decreased due to lower demand for fine processing and consumer electronics applications.

• Laser and non-laser systems sales decreased due to lower demand primarily as a result of COVID-19.

The reduction of revenue in laser systems was attributable to lower demand for cutting and welding applications.

The reduction of revenue in non-laser systems was attributable to lower demand in the transportation and aerospace sectors.

• Other Revenue for materials processing decreased due to lower parts and service revenue.

Sales for materials processing applications increased due to higher sales volumes of pulsed lasers, high power lasers, laser and non-laser systems, other laser products and service, medium power lasers, and QCW lasers.

• The increase in high power laser sales related to welding applications partially offset by a reduction in cutting applications.

The increase in sales of high power lasers used in welding applications was driven by higher sales into electric vehicle and E-mobility and general manufacturing industries.

Within cutting applications, the decrease in sales was attributable to softer demand and increased competition in China.

• The increase in medium power sales related to an increase in demand for additive manufacturing, cutting and welding applications.

• Pulsed laser sales, including high power pulsed lasers, increased due to growth in sales for foil cutting and cleaning for EV battery processing applications, marking and engraving applications, other cleaning and stripping applications and green pulsed lasers used for solar cell manufacturing applications.

• QCW laser sales increased due to higher demand in fine processing for consumer electronics applications.

• The increase of revenue in laser and non-laser systems was attributable to higher demand for laser systems used for welding applications including the launch of LightWELD and cutting applications.

• Other revenue for materials processing increased due to higher sales of options and accessories and parts and service.

Other Applications

Sales from other applications increased due to increased demand for lasers used for directed energy, semiconductor, scientific and instrument applications, as well as lasers used in medical procedures, partially offset by lower sales of telecom products.

Sales from other applications increased due to increased demand for lasers used in medical procedures, and advanced applications.

Our net sales were derived from customers in the following geographic regions:

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Cost of sales and gross margin.

Cost of sales decreased by $46.7 million, or 6.6%, to $661.7 million in 2020 from $708.4 million in 2019.

Our gross margin decreased to 44.9% in 2020 from 46.1% in 2019.

Gross margin decreased mainly due to increased manufacturing costs as a percentage of sales due to lower sales, particularly in the first half of the year resulting from the impact of the COVID-19 pandemic.

In addition, provisions for inventory reserves and freight costs were higher.

The increase in freight costs is also primarily attributable to COVID-19.

Expenses related to provisions for excess or obsolete inventory and other valuation adjustments increased by $6.5 million to $45.4 million, or 3.8% of sales, for the year ended December 31, 2020, as compared to $38.9 million, or 3.0% of sales, for the year ended December 31, 2019.

Cost of sales increased by $102.8 million, or 15.5%, to $764.5 million in 2021 from $661.7 million in 2020.

Our gross margin increased to 47.7% in 2021 from 44.9% in 2020.

Gross margin increased mainly due to a reduction of manufacturing costs as a percentage of sales and a decrease in provisions for excess and obsolete inventory as a percentage of sales, while absorption of manufacturing costs and cost of products sold from inventory as a percentage of sales were approximately the same as one year ago.

Expenses related to provisions for excess or obsolete inventory and other valuation adjustments decreased by $11.1 million to $34.3 million, or 2.3% of sales, for the year ended December 31, 2021, as compared to $45.4 million, or 3.8% of sales, for the year ended December 31, 2020.

Sales and marketing expense.

Sales and marketing expense decreased by $7.1 million, or 9.1%, to $70.6 million in 2020 from $77.7 million in 2019.

This change was primarily a result of decreased spending on trade fairs and exhibits, travel and personnel costs partially offset by an increase in depreciation.

As a percentage of sales, sales and marketing expense was 5.9% in 2020, unchanged from 2019.

Sales and marketing expense increased by $7.6 million, or 10.8%, to $78.2 million in 2021 from $70.6 million in 2020.

This change was primarily a result of an increase of $6.2 million in personnel and related costs, mainly from bonus expense for having achieved 2021 bonus targets.

The remaining change was due to other sales and marketing expenses.

As a percentage of sales, sales and marketing expense decreased to 5.4% of sales in 2021 from 5.9% in 2020.

Research and development expense.

Research and development expense decreased by $3.1 million, or 2.4%, to $126.9 million in 2020 from $130.0 million in 2019.

This change was primarily a result of decreases in R&D materials, consultants and travel partially offset by increases in personnel costs.

As a percentage of sales, research and development expense increased to 10.6% in 2020 from 9.9% in 2019.

Research and development expense increased by $12.7 million, or 10.0%, to $139.6 million in 2021 from $126.9 million in 2020.

This change was primarily a result of an increase of $9.3 million in personnel and related costs, mainly from bonus expense for having achieved 2021 bonus targets.

The remaining change was due to other research and development expenses.

As a percentage of sales, research and development expense decreased to 9.6% in 2021 from 10.6% in 2020.

We expect to continue to invest in research and development and that research and development expense will increase in the aggregate.

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General and administrative expense increased by $15.9 million, or 14.5%, to $125.9 million in 2021 from $110.0 million in 2020.

This change was primarily a result of increases in personnel costs, loss on disposal of fixed assets, insurance, information systems, and premises partially offset by decreases in expense for travel, bad debt provision, legal, and consultants.

As a percentage of sales, general and administrative expense increased to 9.2% in 2020 from 8.2% in 2019.

Goodwill impairment, impairment of long-lived assets and other restructuring charges .

This change was primarily a result of an increase of $10.3 million in personnel and related costs mainly from bonus expense for having achieved 2021 bonus targets.

The remaining change was due to increases in other general and administrative expenses, partially offset by a reduction in losses on disposal of fixed assets.

As a percentage of sales, general and administrative expense decreased to 8.6% in 2021 from 9.2% in 2020 .

Goodwill impairment .

There was no impairment of goodwill in 2021.

During the third quarter of 2020, we concluded that declines in revenue and order flow for the Genesis custom systems business caused by pandemic-related decreases in capital spending in the aerospace and transportation industries were a triggering event requiring a goodwill impairment evaluation.

As a result of the analysis, we incurred a non-cash goodwill impairment loss of $44.6 million in 2020.

In 2019, we incurred non-cash goodwill impairment losses of $37.1 million related to impairments of our transceivers reporting unit and our submarine network division.

We incurred impairment of long-lived assets and other restructuring charges of $1.2 million in 2020, of which $0.4 million related to severance and $0.1 million related to lease termination costs that resulted from the restructuring of our submarine network division.

We also incurred $0.7 million of non-cash long-lived impairments related to machinery and equipment.

In 2019, we incurred impairment of long-lived assets and other restructuring charges of $7.1 million, of which $5.3 million related to non-cash impairment losses of long-lived assets and $1.8 million were charges related to global restructuring programs.

Effect of exchange rates on sales, gross margin and operating expenses.

We estimate that if exchange rates had been the same as one year ago, sales in 2020 would have been $2.5 million lower, gross margin would have been $3.7 million lower and

operating expenses in total would have been $6.2 million higher.

We estimate that if exchange rates had been the same as one year ago, sales in 2021 would have been $45.9 million lower, gross margin would have been $27.0 million lower and operating expenses in total would have been $1.0 million lower.

These estimates assume constant exchange rates between fiscal year 2021 and fiscal year 2020 and are calculated using the average exchange rates for the twelve-month period ended December 31, 2020 for the respective currencies, which were US$1=Euro 0.88, US$1=Japanese Yen 107, US$1=Chinese Yuan 6.90 and US$1=Russian Ruble 72.

Loss (gain) on foreign exchange.

We incurred a foreign exchange gain of $12.9 million in 2020 as compared to a loss of $12.8 million in 2019.

The gain was primarily attributable to the depreciation of the Russian Ruble and the appreciation of the Chinese Yuan as compared to the U.S.

Dollar, which was partially offset by a loss attributed to the appreciation of the Euro and depreciation of the Brazilian Real as compared to the U.S.

Interest income, net.

Interest income, net decreased to $6.3 million of income in 2020 compared to $14.2 million of income in 2019.

The reduction in interest income, net, is primarily due to a decrease in yields on shorter duration investments that resulted in lower market interest rates as compared to rates last year.

In addition, our initial response to the COVID-19 pandemic included holding shorter duration investments to increase liquidity, which also reduced yields.

(Gain) loss on foreign exchange.

We incurred a foreign exchange gain of $15.1 million in 2021 as compared to a gain of $12.9 million in 2020.

The gain was primarily attributable to the depreciation of the Euro and the appreciation of the Chinese Yuan as compared to the U.S.

Interest (expense) income, net.

Interest (expense) income, net was $1.8 million of expense in 2021 compared to $6.3 million of income in 2020.

The change in interest (expense) income, net, was due to a reduction in yields on cash equivalents and short term investments that resulted in lower market interest rates as compared to prior year rates.

Provision for income taxes .

Provision for income taxes was $88.6 million in 2021 compared to $45.4 million in 2020, representing an effective tax rate of 24.2% in 2021 and 22.0% in 2020.

The lower effective tax rate was primarily due to increased benefit from discrete adjustments.

Discrete adjustments in 2020 resulted in a $10.6 million reduction in tax expense, which includes (i) $9.7 million for equity-based compensation deductions for tax in excess of the deductions reflected in book income, (ii) $3.2 million for an investment credit in Russia requested in amended returns filed for prior years and (iii) $1.2 million for prior year provision to return adjustments, offset by an increase to tax expense for a $3.6 million impact of losses in subsidiaries for which no tax benefit was taken.

Discrete adjustments in 2019 were $1.3 million and include a decrease to tax expense for (i) $5.1 million related to equity-based compensation deductions for tax in excess of the deductions reflected in book income and (ii) $4.8 million for prior year provision to return adjustments, offset by an increase to tax expense of $10.0 million for goodwill impairments losses which were not deductible for tax.

The increase in tax expense was due to an increase in pre-tax income.

Discrete adjustments in 2021 resulted in a $9.1 million reduction in tax expense, which includes (i) $5.4 million for equity-based compensation deductions for tax in excess of the deductions reflected in book income, (ii) $2.4 million for prior year provision to return adjustments and (iii) $2.0 million for the reduction in tax reserves as a result of the close of the statute of limitations for the year in which the tax reserve was established.

The discrete benefits were offset by $1.2 million for an increase to tax expense for the tax impact of losses in subsidiaries for which no tax benefit was taken.

Discrete adjustments in 2020 were $10.6 million and include a decrease to tax expense for (i) $9.7 million related to equity-based compensation deductions for tax in excess of the deductions reflected in book income (ii) $3.2 million for an investment credit in Russia requested in amended returns filed for prior years and (iii) $1.2 million for prior year provision to return adjustments, offset by an increase to tax expense of $3.6 million for losses in subsidiaries for which no tax benefit was taken.

Net income attributed to IPG Photonics Corporation.

Net income attributable to IPG Photonics Corporation decreased by $20.6 million to $159.6 million in 2020 from $180.2 million in 2019.

Net income attributable to IPG Photonics Corporation as a percentage of our net sales decreased by 0.4% to 13.3% in 2020 from 13.7% in 2019 due to the factors described above.

Net income attributable to IPG Photonics Corporation increased by $118.8 million to $278.4 million in 2021 from $159.6 million in 2020.

Net income attributable to IPG Photonics Corporation as a percentage of our net sales increased by 5.8% to 19.0% in 2021 from 13.2% in 2020 due to the factors described above.

Liquidity and Capital Resources

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.

We expect to continue making investments in capital expenditures, to assess acquisition opportunities and to repurchase shares of our stock in accordance with our repurchase program.

The extent and timing of such expenditures may vary from period to period.

Our future long-term capital requirements will depend on many factors including our level of sales, the impact of the economic environment on our growth including any ongoing impact of the COVID-19 pandemic on certain global or regional economies, global or regional recessions, the timing and extent of spending to support development efforts, expansion of global sales and marketing activities, government regulation including trade sanctions, the timing and introductions of new products, the need to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products.

As of December 31, 2021, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

With respect to the current geopolitical situation involving Ukraine and Russia, the imposition of sanctions against Russian banks or international bank messaging systems could impact our ability to access company cash in Russia, but would not materially disrupt our liquidity as a whole.

We attempt to keep only amounts that are needed for working capital there.

A substantial majority of our cash and cash equivalents are located outside of Russia.

The following table presents our principal sources of liquidity:

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See Note 3, "Fair Value Measurements" in the notes to the consolidated financial statements for further information about our short-term investments.

We expect to continue investments in capital expenditures, to assess acquisition opportunities and to repurchase shares of our stock in accordance with our repurchase program.

The extent and timing of such expenditures may vary from period to period.

The following table details our line-of-credit facilities and long-term notes as of December 31, 2021:

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Euro 1.5 million

($2.5 million) Euribor plus 0.94% to 2.02% March 2021 Common pool of assets of Italian subsidiary

($1.7 million) Euribor plus 2.02% June 2022 Common pool of assets of Italian subsidiary

Long-term Secured Note (4)

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Our largest committed credit lines are with Bank of America N.A.

and Deutsche Bank AG in the amounts of $75.0 million and $61.3 million (or €50,000 as described above), respectively, and neither of them is syndicated.

We plan to seek amendments of our credit agreements and notes to modify LIBOR and Euribor reference rates as these rates are phased out as borrowing rates.

and Deutsche Bank AG in the amounts of $75.0 million and $56.7 million (or €50.0 million as described above), respectively, and neither of them is syndicated.

We plan to seek amendments of our credit agreements to modify LIBOR and EONIA reference rates as these rates are phased out as borrowing rates.

We do not plan to amend our long-term unsecured note as it matures prior to the final phase-out of LIBOR.

We are required to meet certain financial covenants associated with our U.S.

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See Note 11, "Financing Arrangements" in the notes to the consolidated financial statements for further information about our facilities and term debt.

The following table summarizes our material cash commitments at December 31, 2021 and the effect such commitments are expected to have on our liquidity and cash flow in future periods.

We intend to use our existing cash, cash equivalents and short term investments as well as cash generated from operations as sources of funds for these material commitments.

Payments Due in

Total Less Than 1 Year

(In thousands)

Operating lease obligations $ 27,399 $ 6,307

Purchase obligations 19,880 14,222

Long-term debt obligations (including interest) (1)

35,078 18,860

Contingent consideration 1,371 1,371

$ 83,728 $ 40,760

(1) Interest for long-term debt obligations was calculated including the effect of our fixed rate amounts.

The weighted average fixed rate amount was 2.80%.

See Note 11, "Financing Arrangements" to the consolidated financial statements for additional details.

(2) Excludes obligations related to ASC 740, reserves for uncertain tax positions, because we are unable to provide a reasonable estimate of the timing of future payments relating to the remainder of these obligations.

See Note 17, "Income Taxes" to the consolidated financial statements.

The following table presents cash flow activities:

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Operating activities.

Net cash provided by operating activities decreased by $38.2 million to $285.3 million in 2020 from $323.5 million in 2019.

In 2020, net sales and net income decreased by 9% and 11%, respectively.

Net cash provided by operating activities increased by $104.4 million to $389.7 million in 2021 from $285.3 million in 2020 primarily due to an increase in net income and an increase in cash provided by working capital.

Our largest working capital items typically are inventory and accounts receivable.

Items such as accounts payable to third parties, prepaid expenses and other current assets and accrued expenses and other liabilities are not as significant as our working capital investment in

accounts receivable and inventory because of the amount of value added within IPG due to our vertically integrated structure.

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 decrease in cash flow from operating activities in 2020 primarily resulted from a decrease in cash provided by net income after adding back non-cash charges, an increase in cash used by accounts receivable, an increase in cash used by prepaid expenses and an increase in cash used by inventory;

partially offset by a decrease in cash used for accrued expenses, a decrease in cash used by income and other taxes payable and a decrease in cash used by accounts payable.

The increase in cash flow from operating activities in 2021 primarily resulted from:

• an increase in cash provided by net income after adding back non-cash charges due to net income,

• an increase in cash provided by income and other taxes payable primarily due to a tax refund received in one of our significant tax jurisdictions,

• an increase in cash provided by accrued expenses and accounts payable due to higher bonus accruals, increased customer deposits and timing of payments,

• a decrease in cash used by accounts receivable due to improved days sales outstanding;

partially offset by,

• an increase in cash used by inventory, including an increase in days inventory on hand,

• and an increase in cash used by prepaid expenses and other assets.

Investing activities.

Net cash used in investing activities was $416.3 million and $99.6 million in 2021 and 2020, respectively.

The cash used in investing activities in 2020 related to $87.7 million for property, plant and equipment, $12.3 million of net purchases of investments and $0.4 million for the acquisition of a business during 2020, net of cash acquired.

The cash used in investing activities in 2019 related to $133.5 million for property, plant and equipment, and $15.1 million for the acquisition of a business during 2019, net of cash acquired;

partially offset by $7.8 million of net proceeds of investments.

The cash used in investing activities in 2021 primarily related to $293.1 million of net purchases of short-term investments and $123.1 million for property, plant and equipment.

The cash used in investing activities in 2020 primarily related to $87.7 million for property, plant and equipment, $12.3 million of net purchases of investments and $0.4 million for the acquisition of a business during 2020, net of cash acquired.

In 2022, we expect to incur approximately $130.0 million to $140.0 million in capital expenditures, excluding acquisitions.

Capital expenditures include investments in property, facilities and equipment to add capacity worldwide to support anticipated revenue growth, increase vertical integration, increase redundant manufacturing capacity for critical components and enhance research and development capabilities.

Capital expenditures include investments in property, facilities and equipment to add capacity worldwide to

support anticipated revenue growth, increase vertical integration, increase redundant manufacturing capacity for critical components and enhance research and development capabilities.

The timing and extent of any capital expenditures in and between periods can have a significant effect on our cash flow.

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Many of the capital expenditure projects that we undertake have long lead times and are difficult to cancel or defer to a later period.

We intend to finance our capital expenditures with existing cash, cash equivalents and short term investments as well as with cash generated from operations.

Financing activities.

Net cash used in financing activities was $125.1 million and $10.1 million in 2021 and 2020, respectively.

The cash used in financing activities in 2020 was primarily related to the purchase of treasury stock of $37.9 million, payments on our long-term borrowings of $3.7 million, and $1.7 million of payment of a purchase price holdback from a business combination.

These uses of cash were partially offset by net proceeds from the exercise of stock options net of amounts disbursed in relation to shares withheld to cover employee income taxes due upon the vesting and release of restricted stock units and shares issued under our employee stock purchase plan of $33.2 million.

The cash used in financing activities in 2019 was primarily related to the purchase of treasury stock of $40.7 million and payments on our long-term borrowings of $3.7 million.

These cash uses were partially offset by net proceeds of $7.3 million from the exercise of stock options net of amounts disbursed in relation to shares withheld to cover employee income taxes due upon the vesting and release of restricted stock units and shares issued under our employee stock purchase plan.

Contractual Obligations and Off-Balance Sheet Arrangements

As of December 31, 2020, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

The following summarizes our contractual obligations at December 31, 2020 and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

Payments Due in

Total Less Than 1 Year

1-3 Years 3-5 Years More Than 5 Years

(In thousands)

Operating lease obligations $ 27,517 $ 6,452 $ 8,427 $ 4,327 $ 8,311

Purchase obligations 51,730 51,730 — — —

Long-term debt obligations (including interest) (1)

39,899 4,821 35,078 — —

Contingent consideration 1,963 491 1,472 — —

$ 121,109 $ 63,494 $ 44,977 $ 4,327 $ 8,311

(1) Interest for long-term debt obligations was calculated including the effect of our fixed rate amounts.

The weighted average fixed rate amount was 2.79%.

See Note 17, "Income Taxes" to the consolidated financial statements.

The cash used in financing activities in 2021 was primarily related to the purchase of $134.9 million of treasury stock, $3.8 million of principal payments on our long-term borrowings and $2.6 million of payment of a purchase price holdback from a business combination;

partially offset by net proceeds of $16.3 million from the exercise of stock options net of amounts disbursed in relation to shares withheld to cover employee income taxes due upon the vesting and release of restricted stock units and shares issued under our employee stock purchase plan.

The cash used in financing activities in 2020 was primarily related to the purchase of $37.9 million of treasury stock, $3.7 million of principal payments on our long-term borrowings, and $1.7 million of payments of a purchase price holdback from a business combination;

partially offset by net proceeds of $33.2 million from the exercise of stock options net of amounts disbursed in relation to shares withheld to cover employee income taxes due upon the vesting and release of restricted stock units and shares issued under our employee stock purchase plan.

Recent Accounting Pronouncements

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis