The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors including, but not limited to, those discussed under Item 1A, "Risk Factors." 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, 2020filed with the SECon 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. We also manufacture and sell complementary products used with our lasers including optical delivery cables, fiber couplers, beam switches, optical processing heads, in-line sensors and chillers. In addition, we offer laser-based and non-laser based systems for certain markets and applications. Our portfolio of laser solutions are used in materials processing, communications, medical and advanced applications. We sell our products globally to original equipment manufacturers ("OEMs"), system integrators and end users. We market our products internationally, primarily through our direct sales force. Our major manufacturing facilities are located in
the United States, Germany, Russiaand Belarus. We have sales service offices and applications laboratories worldwide. 31
We are vertically integrated such that we design and manufacture most of the key components used in our finished products, from semiconductor diodes to optical fiber preforms, finished fiber lasers, amplifiers and complementary products. Our vertically integrated operations allow us to reduce manufacturing costs, control quality, rapidly develop and integrate advanced products and protect our proprietary technology.
Description of our
Net sales. We derive net sales primarily from the sale of fiber lasers, diode lasers, laser and non-laser based systems, amplifiers and complementary products. We sell our products to OEMs that supply materials processing laser systems, communications systems, medical laser systems and other laser systems to end users. We also sell our laser products and laser and non-laser based systems to end users. Our scientists and engineers work closely with OEMs, systems integrators and end users to analyze their system requirements and match appropriate fiber laser, amplifier or system specifications to those requirements. Our sales cycle varies substantially, ranging from a period of a few weeks to as long as one year or more, but is typically several months. Sales of our products are generally recognized upon shipment, provided that no obligations remain and collection of the receivable is reasonably assured. Sales of customized robotic systems are recognized over time. Our sales typically are made on a purchase order basis rather than through long-term purchase commitments. We develop our products to standard specifications and use a common set of components within our product architectures. Our major products are based upon a common technology platform. We continually enhance these and other products by improving their components and developing new components and new product designs. Cost of sales. Our cost of sales consists primarily of the cost of raw materials and components, direct labor expenses and manufacturing overhead. We are vertically integrated and currently manufacture all critical components for our products as well as assemble finished products. We believe our vertical integration allows us to increase efficiencies, leverage our scale and lower our cost of sales. Cost of sales also includes personnel costs and overhead related to our manufacturing, engineering and service operations, related occupancy and equipment costs, shipping costs and reserves for inventory obsolescence and for warranty obligations. Inventories are written off and charged to cost of sales when identified as excess or obsolete. Due to our vertical integration strategy and ongoing investment in plant and machinery, we maintain a relatively high fixed manufacturing overhead. We may not be able to or choose not to adjust these fixed costs to adapt to rapidly changing market conditions. Our gross margin is therefore significantly affected by our sales volume and the corresponding utilization of capacity and absorption of fixed manufacturing overhead expenses. Sales and marketing. Our sales and marketing expense consists primarily of costs related to compensation, trade shows, professional and technical conferences, travel, facilities, depreciation of equipment used for demonstration purposes and other marketing costs. Research and development. Our research and development expense consists primarily of compensation, development expenses related to the design of our products and certain components, the cost of materials and components to build prototype devices for testing and facilities costs. Costs related to product development are recorded as research and development expenses in the period in which they are incurred. General and administrative. Our general and administrative expense consists primarily of compensation and associated costs for executive management, finance, legal, human resources, information technology and other administrative personnel, outside legal and professional fees, insurance premiums and fees, allocated facilities costs and other corporate expenses such as charges and benefits related to the change in allowance for doubtful debt.
Factors and trends that affect our operations and financial results
When reading our financial statements, you should be aware of the following factors and trends that our management believe are important to understanding our financial performance.
COVID-19 Update. 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 main production facilities in
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. Net sales. Our annual revenue growth rates have varied from year to year. 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. In 2019, the decline in net sales was driven by decreased demand for our products related to the trade war between the U.S.and Chinathat weakened macroeconomic conditions in the second half of 2019. 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. Although applications within materials processing are broad, the capital equipment market in general is cyclical and historically has experienced sudden and severe downturns. For the foreseeable future, our operations will continue to depend upon capital expenditures by end users of materials processing equipment and will be subject to the broader fluctuations of capital equipment spending. In 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. These decreases result from factors such as increased competition, decreased manufacturing costs and increases in unit volumes. We may also reduce selling prices in order to penetrate new markets and applications. Furthermore, we may negotiate discounted selling prices from time to time with certain customers that place high unit-volume orders. The secular shift to fiber laser technology in large materials processing applications, such as cutting applications, had a positive effect on our sales trends in the past such that our sales trends were often better than other capital equipment manufacturers in both positive and negative economic cycles. As the secular shift to fiber laser technology matures in such applications, our sales trends are more susceptible to economic cycles which affect other capital equipment manufacturers broadly and the machine tool and industrial laser industries more specifically. 33
Gross margin. 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.Dollar. Many of these factors are not under our control. The following are examples of factors affecting gross margin:
•As our products mature, we may face additional competition which tends to drive down average selling prices and affects gross margin;
•Our gross margin can be significantly affected by product mix. Within each of our product categories, the gross margin is generally higher for devices with greater average power. These higher power products often have better performance, more difficult specifications to attain and fewer competing products in the marketplace;
•Higher power lasers also use more optical components, improving the absorption of fixed overhead and allowing economies of scale in manufacturing;
•The gross margin of certain specialty products may be higher because there are fewer or sometimes no equivalent competing products;
•Customers that purchase devices in greater unit volumes generally are provided lower prices per device than customers that purchase fewer units. In general, lower selling prices to high unit volume customers reduce gross margin although this may be partially offset by improved absorption of fixed overhead costs associated with larger product volumes, which drive economies of scale;
• Gross margin on communications systems and components may be lower than gross margin on our laser sources and amplifier, depending on 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.
We have invested
A high proportion of our costs is fixed so costs are generally difficult to adjust or may take time to adjust in response to changes in demand. In addition, our fixed costs increase as we expand our capacity. If we expand capacity faster than is required by sales growth, gross margins could be negatively affected. Gross margins generally decline if production volumes are lower as a result of a decrease in sales or a reduction in inventory because the absorption of fixed manufacturing costs will be reduced. Gross margins generally improve when the opposite occurs. If both sales and inventory decrease in the same period, the decline in gross margin may be greater if we cannot reduce fixed costs or choose not to reduce fixed costs to match the decrease in the level of production. If we experience a decline in sales that reduces absorption of our fixed costs, or if we have production issues, our gross margins will be negatively affected. We also regularly review our inventory for items that are slow-moving, have been rendered obsolete or are determined to be excess. Any provision for such slow-moving, obsolete or excess inventory affects our gross margins. For example, we recorded provisions for slow-moving, obsolete or excess inventory totaling
$34.3 million, $45.4 millionand $38.9 millionin 2021, 2020 and 2019, respectively. Selling and general and administrative expenses. In the past, the Company has invested in selling and general and administrative costs in order to support continued growth in the Company. As the secular shift to fiber laser technology matures, our sales growth becomes more susceptible to the cyclical trends typical of capital equipment manufacturers. Accordingly, our future management of and investments in selling and general and administrative expenses will also be influenced by these trends, although we may still invest in selling or general and administrative functions to support certain initiatives even in economic down cycles. Certain general and administrative expenses are not related to the level of sales and may vary quarter to quarter based primarily upon the level of acquisitions and litigation. 34
Research and development expenses. We plan to continue to invest in research and development to improve our existing components and products and develop new components, products, systems and applications technology. We believe that these investments will sustain our position as a leader in the fiber laser industry and will support development of new products that can address new markets and growth opportunities. The amount of research and development expense we incur may vary from period to period. 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, 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. Our ability to adjust the foreign currency selling prices of products in response to changes in exchange rates is limited and may not offset the impact of the changes in exchange rates on the translated value of sales or costs. In addition, if we increase the selling price of our products in local currencies, this could have a negative impact on the demand for our products. Major customers. While we have historically depended on a few customers for a large percentage of our annual net sales, the composition of this group can change from year to year. Net sales derived from our five largest customers as a percentage of our annual net sales were 19%, 24% and 21% in 2021, 2020 and 2019, respectively. Our largest customer accounted for 22% and 21% of our net accounts receivable as of December 31, 2021and 2020, respectively. We seek to add new customers and to expand our relationships with existing customers. We anticipate that the composition of our significant customers will continue to change. We generally do not enter into agreements with our customers obligating them to purchase a fixed number or large volume of our fiber lasers or amplifiers. If any of our significant customers were to substantially reduce their purchases from us, our results would be adversely affected.
Significant Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in
the United States("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses. 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. We base our estimates and judgments on our historical experience and on other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates, which may materially affect our operating results and financial position. We have identified the following items that require the most significant judgment and often involve complex estimation: Revenue Recognition. 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 sheets. 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. Inventory. 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 35
and compare recorded costs with current market value estimates. Write-downs are recorded to reduce the carrying value to net realizable value for any part whose costs exceed 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. We determine the valuation of excess and obsolete inventory by making our best estimate considering the current quantities of inventory on hand and our forecast of the need for this inventory to support future sales of our products. We often have limited information on which to base our forecasts. If future sales differ from these forecasts, the valuation of excess and obsolete inventory may change and additional inventory provisions may be required. 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 recorded provisions for slow-moving, obsolete or excess inventory totaling
$34.3 million, $45.4 millionand $38.9 millionin 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. Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. We file federal and state income tax returns in the United Statesand tax returns in numerous international jurisdictions. 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. As we continue to expand globally, there is a risk that, due to complexity within and diversity among the various jurisdictions in which we do business, a governmental agency may disagree with the manner in which we have computed our taxes. Additionally, due to the lack of uniformity among all of the foreign and domestic taxing authorities, there may be situations where the tax treatment of an item in one jurisdiction is different from the tax treatment in another jurisdiction or that the transaction causes a tax liability to arise in another jurisdiction. 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. Reserves recorded are based on a determination of whether and how much of a tax benefit taken by us in our tax filings or positions is "more likely than not" to be realized following resolution of any potential contingencies present related to the tax benefit, assuming that the matter in question will be raised by the tax authorities. Potential interest and penalties associated with such uncertain tax positions is recorded as a component of income tax expense. As of December 31, 2021, we had $19.2 millionof unrecognized tax benefits, excluding interest and penalties, recorded in deferred income taxes and other long-term liabilities. This tax benefit increased by $6.4 millionfor tax positions taken in the current year offset by reductions of $2.0 millionfor changes in prior period positions. 36
The following table sets forth selected statement of operations data for the periods indicated in dollar amounts and expressed as a percentage of net sales: Year Ended December 31, 2021 2020 2019 (In thousands, except percentages and per share data) Net sales
$ 1,460,860100.0 % $ 1,200,724100.0 % $ 1,314,581100.0 % Cost of sales 764,462 52.3 661,728 55.1 708,372 53.9 Gross profit 696,398 47.7 538,996 44.9 606,209 46.1 Operating expenses: Sales and marketing 78,180 5.4 70,583 5.9 77,745 5.9 Research and development 139,573 9.6 126,898 10.6 129,997 9.9 General and administrative 125,882 8.6 110,005 9.2 107,597 8.2 Goodwill impairment - - 44,589 3.7 37,120 2.8 Impairment of long-lived assets and other restructuring charges - - 1,177 0.1 7,130
(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 (expense) income, net (1,839) (0.1) 6,270 0.5 14,238 1.1 Other income, net 437 - 763 0.1 345 - Income before provision for income taxes 366,481 25.1 205,692 17.1 248,376 18.9 Provision for income taxes 88,615 6.1 45,354 3.8 68,115 5.2 Net income 277,866 19.0 160,338 13.3 180,261 13.7 Less: 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 %
$ 159,57213.2 % $ 180,23413.7 % Net income attributable to IPG Photonics Corporationper common share: Basic $ 5.21 $ 3.00 $ 3.40Diluted $ 5.16 $ 2.97 $ 3.35Weighted average common shares outstanding: Basic 53,410 53,186 53,061 Diluted 53,930 53,785 53,839
Year Ended Comparison
Net sales. Net sales increased by
$260.1 million, or 21.7%, to $1,460.8 millionin 2021 from $1,200.7 millionin 2020. The table below sets forth sales by application: Year Ended December 31, 2021 2020 Change (In thousands, except for percentages) Sales by Application % of Total % of Total Materials Processing $ 1,325,40490.7 % $ 1,082,47890.2 % $ 242,92622.4 % Other Applications 135,456 9.3 % 118,246 9.8 % 17,210 14.6 % Total $ 1,460,860100.0 % $ 1,200,724100.0 % $ 260,13621.7 % 37
The table below shows sales by product type and other revenues:
Year Ended December 31, 2021 2020 Change (In thousands, except for percentages) Sales by Product % of Total % of Total High Power Continuous Wave ("CW") Lasers
$ 687,40647.1 % $ 646,06253.8 % $ 41,3446.4 % Medium Power CW Lasers 80,501 5.5 % 50,796 4.2 % 29,705 58.5 % Pulsed Lasers 240,978 16.5 % 158,448 13.2 % 82,530 52.1 % Quasi-Continuous Wave ("QCW") Lasers 60,668 4.2 % 50,333 4.2 % 10,335 20.5 % Laser and Non-Laser Systems 126,642 8.7 % 93,727 7.8 % 32,915 35.1 % Other Revenue including Amplifiers, Service, Parts, Accessories and Change in Deferred Revenue 264,665 18.0 % 201,358 16.8 % 63,307 31.4 % Total $ 1,460,860100.0 % $ 1,200,724100.0 % $ 260,13621.7 % Materials processing
Sales of materials processing applications increased due to higher sales volumes of pulsed lasers, high power lasers, laser and non-laser systems, other laser products and services, mid-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
•The increase in medium power sales linked 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.
•Sales of QCW lasers increased due to increased demand for precision processing for consumer electronics applications.
• The increase in laser and non-laser systems revenue was driven by increased demand for laser systems used for welding applications, including the launch of LightWELD and cutting applications.
•Other materials processing revenue increased due to higher sales of options and accessories and parts and service.
Sales of 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: Year Ended December 31, 2021 2020 Change (In thousands, except for percentages) Sales by Geography % of Total % of Total North America (1)
$ 314,98421.6 % $ 246,18920.5 % $ 68,79527.9 % Europe: Germany 101,738 7.0 % 65,646 5.5 % 36,092 55.0 % Other including Eastern Europe/CIS 289,136 19.8 % 219,540 18.3 % 69,596 31.7 % Asia and Australia: China 548,348 37.5 % 502,278 41.8 % 46,070 9.2 % Japan 54,077 3.7 % 53,180 4.4 % 897 1.7 % Other 139,148 9.5 % 103,785 8.6 % 35,363 34.1 % Rest of World 13,429 0.9 % 10,106 0.9 % 3,323 32.9 % Total $ 1,460,860100.0 % $ 1,200,724100.0 % $ 260,13621.7 %
(1)The vast majority of sales in
Cost of sales and gross margin. Cost of sales increased by
$102.8 million, or 15.5%, to $764.5 millionin 2021 from $661.7 millionin 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 millionto $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 increased by $7.6 million, or 10.8%, to $78.2 millionin 2021 from $70.6 millionin 2020. This change was primarily a result of an increase of $6.2 millionin 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 increased by $12.7 million, or 10.0%, to $139.6 millionin 2021 from $126.9 millionin 2020. This change was primarily a result of an increase of $9.3 millionin 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. General and administrative expense. General and administrative expense increased by $15.9 million, or 14.5%, to $125.9 millionin 2021 from $110.0 millionin 2020. This change was primarily a result of an increase of $10.3 millionin 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 . Goodwillimpairment. 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 millionin 2020. 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 2021 would have been $45.9 millionlower, gross margin would have been $27.0 millionlower and operating expenses in total would have been $1.0 millionlower. 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, 2020for the respective currencies, which were US$1= Euro 0.88, US$1= Japanese Yen 107, US$1=Chinese Yuan 6.90and US$1= Russian Ruble 72. 39
(Gain) loss on foreign exchange. We incurred a foreign exchange gain of
$15.1 millionin 2021 as compared to a gain of $12.9 millionin 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.Dollar. Interest (expense) income, net. Interest (expense) income, net was $1.8 millionof expense in 2021 compared to $6.3 millionof 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 millionin 2021 compared to $45.4 millionin 2020, representing an effective tax rate of 24.2% in 2021 and 22.0% in 2020. The increase in tax expense was due to an increase in pre-tax income. Discrete adjustments in 2021 resulted in a $9.1 millionreduction in tax expense, which includes (i) $5.4 millionfor equity-based compensation deductions for tax in excess of the deductions reflected in book income, (ii) $2.4 millionfor prior year provision to return adjustments and (iii) $2.0 millionfor 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 millionfor 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 millionand include a decrease to tax expense for (i) $9.7 millionrelated to equity-based compensation deductions for tax in excess of the deductions reflected in book income (ii) $3.2 millionfor an investment credit in Russiarequested in amended returns filed for prior years and (iii) $1.2 millionfor prior year provision to return adjustments, offset by an increase to tax expense of $3.6 millionfor losses in subsidiaries for which no tax benefit was taken. Net income attributed to IPG Photonics Corporation. Net income attributable to IPG Photonics Corporationincreased by $118.8 millionto $278.4 millionin 2021 from $159.6 millionin 2020. Net income attributable to IPG Photonics Corporationas 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.
Cash 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 Ukraineand 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 main sources of liquidity:
As of December 31, 2021 2020 (In thousands) Cash and cash equivalents
$ 709,105 $ 876,231Short-term investments 805,400 514,835 Unused credit lines and overdraft facilities 128,772 132,048
Working capital (excluding cash and cash equivalents and short-term investments)
519,745 542,433 Short-term investments at
December 31, 2021consist of liquid investments including corporate bonds, commercial paper, U.S. Treasuryand agency obligations and municipal bonds with original maturities of greater than three months but less than one year. See Note 3, "Fair Value Measurements" in the notes to the consolidated financial statements for further information about our short-term investments. 40
The following table details our line-of-credit facilities and long-term notes as of
December 31, 2021: Description Total Facility/ Note Interest Rate Maturity Security U.S. Revolving Line of $75.0 millionLIBOR plus 0.80% to April 2025 Unsecured Credit (1) 1.20%, depending on our performance Euro Credit Facility Euro 50.0 millionEuribor plus 0.75% or July 2023 Unsecured, guaranteed (Germany) (2) ( $56.7 million) EONIA plus 1.00% by parent company and German subsidiary Other Euro Facilities (3) Euro1.5 million Euribor plus 2.02% June 2022 Common pool of assets ( $1.7 million) of Italian subsidiary Long-term Secured Note (4) $16.9 millionFixed at 2.74% July 2022 Secured by the corporate aircraft Long-term Unsecured Note (5) $17.2 million1.20% above LIBOR, May 2023 Unsecured fixed using an interest rate swap at 2.85% per annum (1) This facility is available to certain foreign subsidiaries in their respective local currencies. At December 31, 2021, there were no amounts drawn on this line, however, there were $2.5 millionof guarantees issued against the line which reduces total availability. (2) This facility is available to certain foreign subsidiaries in their respective local currencies. At December 31, 2021, there were no drawings, however, there were $2.2 millionof guarantees issued against the line which reduces total availability. (3) At December 31, 2021, there were no drawings. This facility renews annually. (4) At maturity, the outstanding note balance will be $15.4 million. (5) At maturity, the outstanding note balance will be $15.4 million. Our largest committed credit lines are with Bank of America N.A. and Deutsche Bank AG in the amounts of $75.0 millionand $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.revolving line of credit and long-term debt facility. These covenants, tested quarterly, include an interest coverage ratio and a funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio. The interest coverage covenant requires that we maintain a trailing twelve-month ratio of EBITDA to interest on all obligations that is at least 3.0:1.0. The funded debt to EBITDA covenant requires that the sum of all indebtedness for borrowed money on a consolidated basis be less than three times our trailing twelve months EBITDA. Funded debt is decreased by our cash and available marketable securities not classified as long-term investments in the U.S.in excess of $50 millionup to a maximum of $500 million. We were in compliance with all such financial covenants as of and for the three months ended December 31, 2021. The financial covenants in our loan documents may cause us to not take or to delay investments and actions that we might otherwise undertake because of limits on capital expenditures and amounts that we can borrow or lease. In the event that we do not comply with any one of these covenants, we would be in default under the loan agreement or loan agreements, which may result in acceleration of the debt, cross-defaults on other debt or a reduction in available liquidity, any of which could harm our results of operations and financial condition.
See Note 11, “Funding Arrangements” in the Notes to the Consolidated Financial Statements for more information on our facilities and term debt.
The following table summarizes our material cash commitments at
December 31, 2021and 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 Total(2) $ 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 treasury activities:
December 31, 20212020 (In thousands)
Cash flow from operating activities
Cash used by investing activities
(416,282) (99,574) Cash used by financing activities (125,066) (10,080) Operating activities. Net cash provided by operating activities increased by
$104.4 millionto $389.7 millionin 2021 from $285.3 millionin 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. Accruals and payables for personnel costs including bonuses and income and other taxes payable are largely dependent on the timing of payments for those items. The increase in cash flow from operating activities in 2021 primarily resulted from:
•an increase in cash provided by net income after adding 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 material tax jurisdictions,
• an increase in liquidity provided by accrued liabilities and accounts payable due to higher premiums payable, increased customer deposits and timing of payments,
•a decrease in cash used by debtors due to the improvement in pending sales; partially offset by,
• an increase in cash used by inventory, including an increase in the number of days of 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 millionand $99.6 millionin 2021 and 2020, respectively. The cash used in investing activities in 2021 primarily related to $293.1 millionof net purchases of short-term investments and $123.1 millionfor property, plant and equipment. The cash used in investing activities in 2020 primarily related to $87.7 millionfor property, plant and equipment, $12.3 millionof net purchases of investments and $0.4 millionfor the acquisition of a business during 2020, net of cash acquired.
In 2022, we expect to hire approximately
support anticipated revenue growth, increase vertical integration, increase redundant manufacturing capacity for critical components and enhance research and development capabilities. The timing and extent of any capital expenditures in and between periods can have a significant effect on our cash flow. If we obtain financing for certain projects, our cash expenditures would be reduced in the year of expenditure. Many of the capital expenditure projects that we undertake have long lead times and are difficult to cancel or defer to a later period. 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 millionand $10.1 millionin 2021 and 2020, respectively. The cash used in financing activities in 2021 was primarily related to the purchase of $134.9 millionof treasury stock, $3.8 millionof principal payments on our long-term borrowings and $2.6 millionof payment of a purchase price holdback from a business combination; partially offset by net proceeds of $16.3 millionfrom 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 millionof treasury stock, $3.7 millionof principal payments on our long-term borrowings, and $1.7 millionof payments of a purchase price holdback from a business combination; partially offset by net proceeds of $33.2 millionfrom 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
See Note 1, "Nature of Business and Summary of Significant Accounting Policies" in the notes to the consolidated financial statements for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our consolidated financial statements contained in Part IV of this Annual Report.
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