NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business — IPG Photonics Corporation (the “Company”) is the leading developer and manufacturer of a broad line of high-performance fiber lasers, fiber amplifiers and diode lasers that are used for diverse applications, primarily in materials processing. Its world headquarters are located in Oxford, Massachusetts. It also has facilities and sales offices elsewhere in the United States, Europe and Asia.

Principles of Consolidation — The Company was incorporated as a Delaware corporation in December 1998. The accompanying financial statements include the accounts of the Company and its majority-owned subsidiaries. All intercompany accounts and transactions have been eliminated.

Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates.

Foreign Currency — The financial information for entities outside the United States is measured using local currencies as the functional currency. Assets and liabilities are translated into U.S. dollars at the exchange rate in effect on the respective balance sheet dates. Income and expenses are translated into U.S. dollars based on the average rate of exchange for the corresponding period. Exchange rate differences resulting from translation adjustments are accounted for directly as a component of accumulated other comprehensive income (loss).

Cash and Cash Equivalents and Short-Term Investments — Cash and cash equivalents consist primarily of highly liquid investments, such as bank deposits, marketable securities with original maturities of three months or less with insignificant interest rate risk and marketable securities with remaining maturities of three months or less at the date of acquisition. Short-term investments consisted primarily of similar highly liquid investments, such as bank deposits and marketable securities with remaining maturities greater than three months.

Inventories — Inventories are stated at the lower of cost or market on a first-in, first-out basis. Inventories include parts and components that may be specialized in nature and subject to rapid obsolescence. The Company periodically reviews the quantities and carrying values of inventories to assess whether the inventories are recoverable. Because of the Company’s vertical integration, a significant or sudden decrease in sales activity could result in a significant change in the estimates of excess or obsolete inventory valuation. The costs associated with provisions for excess quantities, technological obsolescence, or component rejections are charged to cost of sales as incurred.

Property, Plant and Equipment — Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation is determined using the straight-line method based on the estimated useful lives of the related assets. In the case of leasehold improvements, the estimated useful lives of the related assets do not exceed the remaining terms of the corresponding leases. The following table presents the assigned economic useful lives of property, plant and equipment:



Category		Economic Useful Life
Buildings		30 years
Machinery and equipment		5-7 years
Office furniture and fixtures		3-5 years

Expenditures for maintenance and repairs are charged to operations. Interest expense associated with significant capital projects is capitalized as a cost of the project. The Company capitalized $524, $142 and $46 of interest expense in 2013, 2012 and 2011, respectively.

Long-Lived Assets — Long-lived assets, which consist primarily of property, plant and equipment, are reviewed by management for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In cases in which undiscounted expected future cash flows are less than the carrying value, an impairment loss is recorded equal to the amount by which the carrying value exceeds the fair value of assets. No impairment losses have been recorded during the periods presented.

Included in other long-term assets is certain demonstration equipment. The demonstration equipment is amortized over the respective estimated economic lives, generally 3 years. The carrying value of the demonstration equipment totaled $5,524 and $4,931 at December 31, 2013 and 2012, respectively. Amortization expense of demonstration equipment for the years ended December 31, 2013, 2012 and 2011, was $2,725, $2,797 and $2,920, respectively.

Goodwill — Goodwill is the amount by which the cost of the acquired net assets in a business acquisition exceeded the fair values of the net identifiable assets on the date of purchase. Goodwill is not amortized which is in accordance with the requirements of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 350, Intangibles-Goodwill and Other (“FASB ASC 350”). Goodwill is assessed for impairment at least annually, on a reporting unit basis, or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. If the book value of a reporting unit exceeds its fair value, the implied fair value of goodwill is compared with the carrying amount of goodwill. If the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recorded in an amount equal to that excess. As more fully described in Note 13, the Company incurred an impairment loss of $2,803 in 2013, which is included in other income (expense) in the accompanying consolidated statements of income.

Intangible Assets — Intangible assets result from the Company’s various business acquisitions. Intangible assets are reported at cost, net of accumulated amortization, and are amortized on a straight-line basis either over their estimated useful lives of five to ten years or over the period the economic benefits of the intangible asset are consumed.

Revenue Recognition — The Company recognizes revenue in accordance with FASB ASC 605. Revenue from orders with multiple deliverables is divided into separate units of accounting when certain criteria are met. These separate units generally consist of equipment and installation. The consideration for the arrangement is allocated to the separate units of accounting based on their relative selling prices. The selling price of equipment is based on vendor-specific objective evidence and the selling price of installation is based on third-party evidence. Applicable revenue recognition criteria are applied separately for each separate unit of accounting. Revenue for laser and amplifier sources generally is recognized upon the transfer of ownership which is typically at the time of shipment. Installation revenue is recognized upon completion of the installation service which typically occurs within 30 to 90 days of delivery. For laser systems, which may carry customer specific processing requirements, revenue is recognized at the latter of customer acceptance date or shipment date if the customer acceptance is made prior to shipment. Returns and customer credits are infrequent and are recorded as a reduction to revenue. Rights of return generally are not included in sales arrangements.

Accounts Receivable and Allowance for Doubtful Accounts — Accounts Receivable include $17,679 and $8,526 of bank acceptance drafts at December 31, 2013 and 2012, respectively. Bank acceptance drafts are bank guarantees of payment on specified dates. The maturity of these bank acceptance drafts is less than 90 days. The Company maintains an allowance for doubtful accounts to provide for the estimated amount of accounts receivable that will not be collected. The allowance is based upon an assessment of customer creditworthiness, historical payment experience and the age of outstanding receivables.

Activity related to the allowance for doubtful accounts was as follows:



	2013			2012			2011
Balance at January 1	$	2,173		$	1,605		$	2,143
Provision for bad debts, net of recoveries	323			642			(219		)
Uncollectable accounts written off	(31		)	(170		)	(309		)
Foreign currency translation	8			96			(10		)
Balance at December 31	$	2,473		$	2,173		$	1,605

Warranties — The Company typically provides one to three-year parts and service warranties on lasers and amplifiers. Most of the Company’s sales offices provide support to customers in their respective geographic areas. The Company estimates the warranty accrual considering past claims experience, the number of units still covered by warranty and the average life of the remaining warranty period. The warranty accrual has generally been sufficient to cover product warranty repair and replacement costs.

Activity related to the warranty accrual was as follows:



	2013			2012			2011
Balance at January 1	$	10,714		$	8,631		$	6,917
Provision for warranty accrual	11,363			8,112			6,701
Warranty claims and other reductions	(7,405		)	(6,542		)	(4,692		)
Foreign currency translation and other	325			513			(295		)
Balance at December 31	$	14,997		$	10,714		$	8,631

Accrued warranty reported in the accompanying consolidated financial statements as of December 31, 2013 and December 31, 2012 consists of $7,724 and $7,838 in accrued expenses and other liabilities and $7,273 and $2,876 in other long-term liabilities, respectively.

Advertising Expense — The cost of advertising is expensed as incurred. The Company conducts substantially all of its sales and marketing efforts through trade shows, professional and technical conferences, direct sales and our website. The Company’s advertising costs were not material for the periods presented.

Research and Development — Research and development costs are expensed as incurred.

Income Taxes — Deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the financial statement carrying amounts and tax basis of assets and liabilities and net operating loss carryforwards and credits using enacted rates in effect when those differences are expected to reverse. Valuation allowances are provided against deferred tax assets that are not deemed to be recoverable. The Company recognizes tax positions that are more likely than not to be sustained upon examination by relevant tax authorities. The tax positions are measured at the greatest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement.

The Company provides reserves for potential payments of tax to various tax authorities related to uncertain tax positions and other issues. The reserves are based on a determination of whether and how much of a tax benefit taken by it in its tax filings or positions is more likely than not to be realized following resolution of uncertainties related to the tax benefit, assuming that the matter in question will be raised by the tax authorities.

Concentration of Credit Risk — Financial instruments that potentially subject the Company to credit risk consist primarily of cash and cash equivalents, auction rate securities and accounts receivable. The Company maintains substantially all of its cash and marketable securities in six financial institutions, which it believes to be high-credit quality financial institutions. The Company grants credit to customers in the ordinary course of business and provide a reserve for potential credit losses. Such losses historically have been within management’s expectations (see discussion related to significant customers in Note 15).

Fair Value of Financial Instruments — The Company’s financial instruments consist of cash equivalents, accounts receivable, auction rate securities, accounts payable, drawings on revolving lines of credit, long-term debt, certain derivative instruments and contingent consideration.

The valuation techniques used to measure fair value are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy: Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The carrying amounts of cash equivalents, accounts receivable, accounts payable and drawings on revolving lines of credit are considered reasonable estimates of their fair market value, due to the short maturity of these instruments or as a result of the competitive market interest rates, which have been negotiated.

The following table presents information about the Company’s assets and liabilities measured at fair value:



			Fair Value Measurements at December 31, 2013
	Total		Level 1		Level 2		Level 3
Assets
Cash equivalents	$	240,159	$	240,159	$	—	$	—
Auction rate securities	1,120		—		—		1,120
Total assets	$	241,279	$	240,159	$	—	$	1,120
Liabilities
Contingent purchase consideration	$	375	$	—	$	—	$	375
Interest rate swap	423		—		423		—
Total liabilities	$	798	$	—	$	423	$	375



			Fair Value Measurements at December 31, 2012
			Fair Value Measurements at December 31, 2012
	Total		Level 1		Level 2		Level 3
Assets
Cash equivalents	$	237,049	$	237,049	$	—	$	—
Auction rate securities	1,112		—		—		1,112
Total assets	$	238,161	$	237,049	$	—	$	1,112
Liabilities
Contingent purchase consideration	$	3,023	$	—	$	—	$	3,023
Interest rate swaps	855		—		855		—
Total liabilities	$	3,878	$	—	$	855	$	3,023

Auction rate securities and contingent consideration are measured at fair value on a recurring basis using significant unobservable inputs (Level 3). The fair value of the auction rate securities was determined using prices observed in inactive secondary markets for the securities held by the Company. The auction rate securities are considered available-for-sale securities. They had a cost basis of $1,450 at December 31, 2013 and December 31, 2012. Other-than-temporary impairments recorded in other income (expense), net were $0, $0 and $49 in 2013, 2012 and 2011, respectively.

The interest rate swaps are designated as cash flow hedges the fair value of which was estimated based on quoted market prices or pricing models using current market rates. Fair value at December 31, 2013 and December 31, 2012 for the interest rate swaps considered prices observed in inactive secondary markets for the securities held by the Company.

The fair value of contingent consideration was determined using an income approach at the respective business combination dates and at the reporting date. That approach is based on significant inputs that are not observable in the market and include key assumptions such as assessing the probability of meeting certain milestones required to earn the contingent consideration. The business combinations that give rise to contingent consideration are more fully described in Note 12.

During the second quarter of 2013, the Company reduced the fair value of contingent consideration related to the Company's subsidiary, IPG Microsystems LLC's ("IPGM") acquisition of certain working capital and long-term assets from JP Sercel Associates Inc. ("JPSA") to $0 because management assessed that there was no possibility that milestones in the earn-out agreements would be achieved. Additionally, the Company reduced other contingent consideration for other agreements by $196. Accordingly, $2,659 is included in other income (expense) in the accompanying Consolidated Statements of Income.

During the year ended December 31, 2012, the Company terminated a warrant held by a former investor in the Company's Russian subsidiary NTO IRE-Polus ("IPG Russia") as part of the redemption of the investor's redeemable noncontrolling interest for its fair value of $77.

The following table presents information about the Company’s movement in level 3 assets and liabilities measured at fair value:



	2013			2012
Auction Rate Securities
Balance, January 1	$	1,112		$	1,104
Change in fair value and accretion	8			8
Balance, December 31	$	1,120		$	1,112
Contingent Purchase Consideration
Balance, January 1	$	3,023		$	999
Period transactions	—			2,444
Adjustment for determination of final payment	—			987
Change in fair value and currency fluctuations	(2,648		)	10
Settlements and payments	—			(1,417		)
Balance, December 31	$	375		$	3,023
Warrant
Balance, January 1	$	—		$	77
Period transactions	—			(77		)
Balance, December 31	$	—		$	—

Comprehensive Income — Comprehensive income includes charges and credits to equity that are not the result of transactions with stockholders. Included within comprehensive income is the cumulative foreign currency translation adjustment and unrealized gains or losses on derivatives. These adjustments are accumulated within the consolidated statements of comprehensive income.

Total components of accumulated other comprehensive loss were as follows:



	December 31,
	2013			2012
Foreign currency translation adjustments	$	(1,677	)	$	(2,802	)
Unrealized loss on derivatives, net of tax of $168 and $331	(256		)	(524		)
Change in carrying value of auction rate securities	232			232
Attribution to NCI and redeemable NCI	—			3,292
Purchase of NCI and redeemable NCI	—			(3,292		)
Accumulated other comprehensive loss	$	(1,701	)	$	(3,094	)

Derivative Instruments — The Company’s primary market exposures are to interest rates and foreign exchange rates. The Company uses certain derivative financial instruments to help manage these exposures. The Company executes these instruments with financial institutions it judges to be credit-worthy. The Company does not hold or issue derivative financial instruments for trading or speculative purposes.

The Company recognizes all derivative financial instruments as either assets or liabilities at fair value in the consolidated balance sheets. The Company has interest rate swaps that are classified as a cash flow hedge of its variable rate debt. The Company has no derivatives that are not accounted for as a hedging instrument.

Cash Flow Hedges — The Company’s cash flow hedges are interest rate swaps under which it pays fixed rates of interest. The fair value amounts in the consolidated balance sheets were:



	Notional Amounts¹				Other Assets				Deferred Income Taxes And Other Long-Term Liabilities
	December 31,				December 31,				December 31,
	2013		2012		2013		2012		2013		2012
Interest rate swap(s)	$	12,666	$	14,000	$	—	$	—	$	423	$	855
Total	$	12,666	$	14,000	$	—	$	—	$	423	$	855

(1) Notional amounts represent the gross contract/notional amount of the derivatives outstanding.

The derivative gains and losses in the consolidated statements of income for the years ended December 31, 2013, 2012 and 2011, related to the Company’s interest rate swap contracts were as follows:



	Year Ended December 31,
	2013			2012			2011
Effective portion recognized in other comprehensive income (loss), pretax:
Interest rate swap	$	881		$	944		$	562
Effective portion reclassified from other comprehensive income (loss) to interest expense, pretax:
Interest rate swap	$	(449	)	$	(576	)	$	(629	)
Ineffective portion recognized in income:
Interest rate swap	$	—		$	—		$	—

The Company made no adjustments to the fair value of this derivative as a result of evaluating counterparty risk.

Business Segment Information — The Company operates in one segment which involves the design, development, production and distribution of fiber lasers, laser systems, fiber amplifiers, and related optical components. The Company has a single, company-wide management team that administers all properties as a whole rather than as discrete operating segments. The chief decision maker, who is the Company’s chief executive officer, measures financial performance as a single enterprise and not on legal entity or end-market basis. Throughout the year, the chief decision maker allocates capital resources on a project-by-project basis across the Company’s entire asset base to maximize profitability without regard to legal entity or end-market basis. The Company operates in a number of countries throughout the world in a variety of product lines. Information regarding geographic financial information and product lines is provided in Note 15.

Earnings Per Share — The Company computes net income per share in accordance with ASC 260-Earnings Per Share. Under the provisions of ASC 260, the Company is required to present basic and diluted earnings per share information separately for each class of equity instruments that participate in any income distribution with primary equity instruments. The Company calculates earnings per share in periods where a class of common stock was redeemable for other than fair value through the application of the two-class method. Until June 29, 2012, the Company had redeemable noncontrolling interests reported in the accompanying consolidated financial statements related to a 22.5% minority interest of IPG Russia. The computation of net income per share is provided in Note 9.

Recent Accounting Pronouncements — Accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s financial statements upon adoption.

Subsequent Events — The Company has considered the impact of subsequent events through the filing date of these financial statements.