The following information should be read in conjunction with our Consolidated Financial Statements, including the notes thereto, included in Part II, Item 8 of this Annual Report on Form 10-K.
We are a global technology company that designs, develops, manufactures, markets and supports software driven, three-dimensional ("3D") measurement, imaging, and realization solutions for the 3D metrology, architecture, engineering and construction ("AEC"), Operations and Maintenance ("O&M") and public safety analytics markets. We enable our customers to capture, measure, manipulate, interact with and share 3D and 2D data from the physical world in a virtual environment and then translate this information back into the physical domain. Our broad technology set equips our customers with a wide range of 3D capture technologies that range from ultra-high accuracy laser scanner based technology to lower accuracy, photogrammetry based technology. Our FARO suite of 3D products and software solutions are used for inspection of components and assemblies, rapid prototyping, reverse engineering, documenting large volume or structures in 3D, surveying and construction, construction management, assembly layout, machine guidance as well as in investigation and reconstructions of crash and crime scenes. We sell the majority of our solutions through a direct sales force, with an increasing volume being sold through an indirect channel across a range of industries including automotive, aerospace, metal and machine fabrication, surveying, architecture, engineering and construction, public safety forensics and other industries. We derive our revenues primarily from the sale of our measurement equipment and related multi-faceted software programs. Revenue related to these products is generally recognized upon shipment. In addition, we sell extended warranties and training and technology consulting services relating to our products. We recognize the revenue from hardware service contracts and software maintenance contracts on a straight-line basis over the contractual term, and revenue from training and technology consulting services when the services are provided. We operate in international markets throughout the world and maintain sales offices in
Australia, Brazil, Canada, China, France, Germany, India, Italy, Japan, Malaysia, Mexico, the Netherlands, Poland, Portugal, Singapore, South Korea, Spain, Switzerland, Thailand, Turkey, the United Kingdom, and the United States. We manufacture our FARO Quantum Max Armproducts in our manufacturing facility located in Floridafor customer orders from Europe, the Middle Eastand Africa("EMEA"), in our manufacturing facility located in Singaporefor customer orders from the Asia-Pacific region, and in our manufacturing facility located in Floridafor customer orders from the Americas. We manufacture our FARO Focus laser scanner in our manufacturing facilities located in Germanyfor customer orders from EMEA and the Asia-Pacific region, and in our manufacturing facility located in Pennsylvaniafor customer orders from the Americas. We manufacture our FARO Laser Tracker and our FARO Laser Projector products in our facility located in Pennsylvania. Under the manufacturing services agreement dated July 15, 2021and in connection with the Restructuring Plan, Sanmina will provide manufacturing services for the Company's measurement device products currently manufactured by the Company at the aforementioned manufacturing facilities. A phased transition to a Sanmina production facility is expected to be completed by the end of the second quarter of 2022 as part of our cost reduction initiative. We expect all of our existing manufacturing facilities and future third party manufacturing facilities to have the production capacity necessary to support our volume requirements during 2022. We account for wholly-owned foreign subsidiaries in the currency of the respective foreign jurisdiction; therefore, fluctuations in exchange rates may have an impact on the value of the intercompany account balances denominated in different currencies and reflected in our consolidated financial statements. We are aware of the availability of off-balance sheet financial instruments to hedge exposure to foreign currency exchange rates, including cross-currency swaps, forward contracts and foreign currency options. However, we have not used such instruments in the past, and none were utilized in 2021, 2020 or 2019. 31
COVID-19 and impact on our business
Our business is significantly vulnerable to the economic effects of pandemics and other public health crises, including the ongoing novel coronavirus ("COVID-19") pandemic that has surfaced in virtually every country of our global operating footprint. During 2020, we experienced a significant decline in the demand for our products and services across all of our served markets as a result of the impact of the spread of COVID-19. While COVID-19 has negatively impacted demand for our products and services overall, it has provided us with the opportunity to adapt to operating in a virtual environment. We significantly increased the utilization of our existing virtual sales demonstration infrastructure which has enabled ongoing customer product education. We launched an updated web-based learning system with
FARO Academythat has resulted in an increase in the attendance of our virtual training and product information seminars as our customers take advantage of the opportunity to remotely participate and to better understand the capabilities of our products and software offerings.
In 2021, as we saw a recovery in our revenues across our served segments, we continued to assess the continued impact of COVID-19 on our business results and remained committed to taking steps to ensure the health and safety of our employees and customers, as well as the adverse effects of demand disruptions and production impacts, including, but not limited to, the following:
•Operating our business with a focus on our employee health and safety, which includes minimizing travel, implementing remote work policies, maintaining employee distancing and enhancing the sanitation of all of our facilities; •Recommending that our employees receive vaccinations to help protect our colleagues, families, and communities; •Confidentially collecting proof of vaccination from our employees or requiring weekly COVID-19 testing to use certain facilities; •Monitoring our liquidity, disciplined inventory management, and limiting capital expenditures; and •Continuously reviewing our financial strategy to enhance financial flexibility in these volatile financial markets.
We continue to maintain a strong capital structure with a cash balance of
Future developments, such as the potential resurgence of COVID-19 in countries that have begun to recover from the early impact of the pandemic and actions taken by governments in response to future resurgence, are highly uncertain. Therefore, the Company is not able to predict the extent to which the COVID-19 outbreak continues to impact the Company's results of operations and financial conditions. See Item 1A, Risk Factors, included in Part I of this Annual Report on Form 10-K for an additional discussion of risks related to COVID-19. Our total sales increased by
$34.0 million, or 11.2%, to $337.8 millionfor the year ended December 31, 2021from $303.8 millionfor the year ended December 31, 2020. Our product sales increased by $32.5 million, or 14.9%, to $251.1 millionfor the year ended December 31, 2021from $218.6 millionfor the year ended December 31, 2020primarily due to the recovery from the economic effect of the COVID-19 pandemic which adversely affected the prior year. Service revenue increased $1.5 million, or 1.8%, to $86.7 millionfor the year ended December 31, 2021remaining fairly consistent with the $85.2 millionfor the year ended December 31, 2020. Also, foreign exchange rates had a positive impact on sales of $4.1 million, or 1.3 percentage points, primarily due to the strengthening of the Euro and the Renminbi relative to the U.S.dollar.
Change in organizational structure and sector reports
As part of our new strategic plan, and based on the recommendation of our CEO, who is also our Chief Operating Decision Maker ("CODM"), in the fourth quarter of 2019, we eliminated our vertical structure in favor of a functional structure. Our new executive leadership team is comprised of functional leaders in areas such as sales, marketing, operations, research and development and general and administrative, and resources are allocated to each function at a consolidated unit level. We no longer have separate business units, segment managers or vertical leaders who report to the CODM with respect to operations, operating results or planning for levels or components below the total Company level. Instead, our CODM now allocates resources and evaluates performance on a company-wide basis. Based on these changes, commencing with the fourth quarter of 2019, we report as one reporting segment that develops, manufactures, markets, supports and sells a suite of 3D imaging and software solutions. In addition to the reorganization of the Company's structure, we evaluated our hardware and software product portfolio and the operations of certain of our recent acquisitions. As a result of this evaluation, we simplified our hardware and software product portfolio and divested our Photonics business and 3D Design related assets obtained from our acquisition of Opto-Tech SRL and its subsidiary Open Technologies SRL (collectively, "Open Technologies") in the second quarter of 2020. 32
February 14, 2020, our Board of Directors approved a global restructuring plan (the "Restructuring Plan"), which supports our strategic plan in an effort to improve operating performance and ensure that we are appropriately structured and resourced to deliver sustainable value to our shareholders and customers. Key activities under the Restructuring Plan have achieved $39.6 millionin annualized Non-GAAP savings that were realized by the end of fiscal year 2021 and included decreasing total headcount by approximately 500 employees upon the completion of the Restructuring Plan. The elimination of our vertical structure allowed us to successfully complete our redefined go-to-market strategy which placed increased focus on our customers and enabled our sales employees, supported by our talented pool of field application engineers, to sell all product lines globally. Our new marketing leadership team has focused its efforts on gaining an increased understanding of customer applications and workflows which enables value-based product positioning while optimizing our customer's total cost of ownership. By strengthening our understanding of customer applications and workflows, we will continue to develop high-value solutions across our product and software platforms. Also, our marketing leadership team has transformed our lead generation process and implemented technology to provide our sales organization with higher quality leads which optimizes the time and effort spent by our newly organized sales team. We continue to focus on organizational optimization and improved decision making throughout the Company. Prior to the execution of the Restructuring Plan, the Company had strong geographic organizations with decentralized decision making. Additionally, the previous vertical structure layered on top of the geographic organization led to an overly complex and costly management structure. The newly formed global functional organization has enabled centralized management and clear process ownership, eliminating redundant resources and increasing the Company's agility and ability to execute the new strategic plan during the COVID-19 global pandemic. We recorded a pre-tax charge of approximately $15.8 millionand paid $13.1 millionduring the year ended December 31, 2020primarily consisting of severance and related benefits, professional fees and other related charges. We have continued to make significant progress in executing the Restructuring Plan during 2021. We recorded a pre-tax charge of approximately $7.4 millionand paid $5.8 millionduring the year ended December 31, 2021primarily consisting of severance and related benefits, professional fees and other related charges and costs. On July 15, 2021, we entered into a manufacturing services agreement (the "Agreement") with Sanmina Corporation ("Sanmina"), in connection with the Restructuring Plan. Under the Agreement, Sanmina will provide manufacturing services for the Company's measurement device products currently manufactured by the Company at the Company's Lake Mary, Florida, Exton, Pennsylvania, and Stuttgart, Germanymanufacturing sites. A phased transition to a Sanmina production facility is expected to be completed by the end of the second quarter of 2022 as part of our cost reduction initiative. The Company expects to pay approximately $4 millionin fiscal year 2022, primarily consisting of severance and related benefits. 33
We continue to evaluate our key initiatives and execution of the Restructuring Plan, and expect to incur additional pre-tax charges in the range of
$6 millionto $10 millionthrough the end of fiscal year 2022.
Faro Sphere and the Unified Software Environment
FARO Sphere is our new cloud-based platform that is the foundation to our new software and solution strategy. Our objective is to provide differentiated value by offering workflow enhancements which include automated laser scan, data uploads from any location, access to our existing suite of 3D software applications, cloud-based data analysis and global user access as well as ultimately, the ability for our customers to purchase, renew or manage all of their FARO software and hardware assets. FARO Sphere represents the first step into expansion of our cloud-based software offerings that we believe will deliver greater value to our customers and to our shareholders. The FARO Sphere environment could be adopted globally across a wide range of markets, including construction management, facilities, operations and maintenance, robotic simulation and incident preplanning. This potential adoption would lead to an increase in the number of users and thus enable revenue growth of our software and a shift toward increased levels of recurring revenue over time. We anticipate FARO Sphere to be released to our customers within the second quarter of 2022. Revenue from our current software products was
$45.1 million, $38.3 millionand $46.9 millionfor the years ended December 31, 2021, December 31, 2020, and December 31, 2019, respectively. Our recurring revenue which is comprised of hardware service contracts, software maintenance contracts, and subscription based software applications was $64.1 million, $61.2 million, and $56.1 millionfor the years ended December 31, 2021, December 31, 2020, and December 31, 2019, respectively. Acquisition of Holobuilder On June 4, 2021, we acquired all of the outstanding shares of Holobuilder, Inc.("Holobuilder"), a company focused on 3D photogrammetry-based technology for a purchase price of $33.8 millionpaid, net of cash acquired and was paid with cash on hand. We believe this acquisition enables the Company to provide reality-capture photo documentation and added remote access capability for industries such as construction management further expanding the Company's Digital Twin solution portfolio. The results of Holobuilder's operations as of and after the date of acquisition have been included in our consolidated financial statements as of December 31, 2021.
Presentation of information
Amounts reported in millions within this Annual Report on Form 10-K are computed based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. Certain columns and rows within the tables that follow may not add due to the use of rounded numbers. Percentages presented are calculated based on the respective amounts in thousands. 34
Table of Contents Results of Operations 2021 Compared to 2020 Years ended December 31, 2021 2020 Change ($) (dollars in millions) % of Sales % of Sales 2021 vs 2020 SALES Product
$ 251.174.3 % $ 218.672.0 % $ 32.5Service 86.7 25.7 % 85.2 28.0 % 1.5 Total sales 337.8 100.0 % 303.8 100.0 % 34.0 COST OF SALES Product 109.0 32.3 % 98.9 32.5 % 10.2 Service 44.9 13.3 % 45.1 14.8 % (0.2) Total cost of sales 153.9 45.6 % 143.9 47.4 % 10.0 GROSS PROFIT 183.9 54.4 % 159.8 52.6 % 24.1 OPERATING EXPENSES Selling, general and administrative 136.2 40.3 % 131.8 43.4 % 4.4 Research and development 48.8 14.4 % 42.9 14.1 % 5.9 Restructuring costs 7.4 2.2 % 15.8 5.2 % (8.4) Total operating expenses 192.4 57.0 % 190.5 62.7 % 1.9 LOSS FROM OPERATIONS (8.5) (2.5) % (30.7) (10.1) % 22.2 Other expense 0.1 - % 0.1 - % - LOSS BEFORE INCOME TAX EXPENSE (BENEFIT) (8.6) (2.5) % (30.8) (10.1) % 22.2 INCOME TAX EXPENSE (BENEFIT) 31.4 9.3 % (31.4) (10.3) % 62.8 NET (LOSS) INCOME $ (40.0)(11.8) % $ 0.60.2 % $ (40.6)Consolidated Results Sales. Total sales increased by $34.0 million, or 11.2%, to $337.8 millionfor the year ended December 31, 2021from $303.8 millionfor the year ended December 31, 2020. Total product sales increased by $32.5 million, or 14.9%, to $251.1 millionfor the year ended December 31, 2021from $218.6 millionfor the year ended December 31, 2020. The increase in product sales is primarily due to the recovery from the economic effect of the COVID-19 pandemic which adversely affected the prior year. Service revenue increased by $1.5 million, or 1.8%, to $86.7 millionfor the year ended December 31, 2021remaining fairly consistent with the $85.2 millionfor the year ended December 31, 2020. Foreign exchange rates had a positive impact on sales of $4.1 million, or 1.3 percentage points, primarily due to the strengthening of the Euro and the Renminbi relative to the U.S.dollar. Gross profit. Gross profit increased by $24.1 million, or 15.1%, to $183.9 millionfor the year ended December 31, 2021from $159.8 millionfor the year ended December 31, 2020. Gross margin increased to 54.4% for the year ended December 31, 2021from 52.6% in the prior year period. Gross margin from product revenue increased by 1.8 percentage points to 56.6% for the year ended December 31, 2021from 54.8% in the prior year period. This increase in gross margin from product revenue was primarily due to change in product mix, and the favorable impact of the recovery from the economic effect of the COVID-19 pandemic which adversely affected our product fixed cost absorption in the prior year, partially offset by unfavorable price variances of purchased materials in the current year due to global supply shortages. Gross margin from service revenue increased by 1.1 percentage points to 48.2% for the year ended December 31, 2021from 47.1% for the prior year period, primarily due to a reduction in departmental costs as a result of the Restructuring Plan. 35
Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses increased by
$4.4 million, or 3.3%, to $136.2 million, for the year ended December 31, 2021from $131.8 millionfor the year ended December 31, 2020. This increase was driven primarily by an increase in selling commission expense due to higher global sales and an increase in travel expense as there were pandemic stay-at-home orders in the prior year. SG&A expenses as a percentage of sales decreased to 40.3% for the year ended December 31, 2021from 43.4% for the year ended December 31, 2020. Research and development expenses. Research and development expenses increased $5.9 million, or 13.7%, to $48.8 millionfor the year ended December 31, 2021from $42.9 millionfor the year ended December 31, 2020. This increase was primarily driven by higher compensation expense resulting from increased engineering headcount and costs to accelerate new product development. Research and development expenses as a percentage of sales increased to 14.4% for the year ended December 31, 2021from 14.1% for the year ended December 31, 2020. Restructuring costs. In February 2020, we initiated the Restructuring Plan to improve business effectiveness, streamline operations and achieve a stated target cost level for the Company as a whole. Restructuring costs included in operating expenses decreased by $8.4 million, or 53.4% to $7.4 millionfor the year ended December 31, 2021from $15.8 millionfor the year ended December 31, 2020. The decrease was driven primarily by a reduction in severance and related benefit charges from lower headcount reduction in the current year.
Other expenses. Other expenses were
Income tax expense (benefit). Income tax expense for the year ended
December 31, 2021was $31.4 millioncompared with an income tax benefit of $31.4 millionfor the year ended December 31, 2020. Our effective tax rate was (366.8)% for the year ended December 31, 2021compared to 102.0% for the year ended December 31, 2020. The change was primarily due to a $26.5 millionexpense attributable to a valuation allowance against US and certain other jurisdictions deferred tax assets for the year ended December 31, 2021compared to a deferred tax asset benefit of $19.2 millionpursuant to an intra-entity transfer of certain intellectual property rights ("IP Rights"), based on the fair value of the IP rights transferred in December 2020. Net (loss) income. Net loss was $40.0 millionfor the year ended December 31, 2021compared with net income of $0.6 millionfor the year ended December 31, 2020, reflecting the impact of the factors described above. 36
Table of Contents 2020 Compared to 2019 Years ended December 31, 2020 2019 Change ($) (dollars in millions) % of Sales % of Sales 2020 vs 2019 SALES Product
$ 218.672.0 % $ 289.775.9 % $ (71.1)Service 85.2 28.0 % 92.1 24.1 % (6.9) Total sales 303.8 100.0 % 381.8 100.0 % (78.0) COST OF SALES Product 98.9 32.5 % 133.2 34.9 % (34.4) Service 45.1 14.8 % 50.4 13.2 % (5.3) Total cost of sales 143.9 47.4 % 183.6 48.1 % (39.7) GROSS PROFIT 159.8 52.6 % 198.1 51.9 % (38.3) OPERATING EXPENSES Selling, general and administrative 131.8 43.4 % 177.4 46.5 % (45.6) Research and development 42.9 14.1 % 44.2 11.6 % (1.3) Restructuring costs 15.8 5.2 % - - % 15.8 Impairment loss - - % 35.2 9.2 % (35.2) Total operating expenses 190.5 62.7 % 256.8 67.3 % (66.3) LOSS FROM OPERATIONS (30.7) (10.1) % (58.7) (15.4) % 28.0 Other expense 0.1 - % 2.4 0.6 % (2.3) LOSS BEFORE INCOME TAX (BENEFIT) EXPENSE (30.8) (10.1) % (61.0) (16.0) % 30.2 INCOME TAX (BENEFIT) EXPENSE (31.4) (10.3) % 1.1 0.3 % (32.5) NET INCOME (LOSS) $ 0.60.2 % $ (62.1)(16.3) % $ 62.7 Consolidated Results Sales. Total sales decreased by $78.0 million, or 20.4%, to $303.8 millionfor the year ended December 31, 2020from $381.8 millionfor the year ended December 31, 2019. Total product sales decreased by $71.1 million, or 24.5%, to $218.6 millionfor the year ended December 31, 2020from $289.7 millionfor the year ended December 31, 2019. Our product sales decreased due to the unfavorable impact of end market demand softness related to the COVID-19 pandemic and other fluctuations in market conditions. Service sales decreased by $6.9 million, or 7.5%, to $85.2 millionfor the year ended December 31, 2020from $92.1 millionfor the year ended December 31, 2019, primarily due to the unfavorable impact of end market demand softness related to the COVID-19 pandemic and other fluctuations in market conditions. Foreign exchange rates had a positive impact on sales of $0.7 million, reducing our overall sales decline by approximately 0.2 percentage points, primarily due to the strengthening of the Euro relative to the U.S.dollar. Gross profit. Gross profit decreased by $38.3 million, or 19.3%, to $159.8 millionfor the year ended December 31, 2020from $198.1 millionfor the year ended December 31, 2019. Gross margin increased to 52.6% for the year ended December 31, 2020from 51.9% in the prior year period. Gross margin from product revenue increased by 0.8 percentage points to 54.8% for the year ended December 31, 2020from 54.0% in the prior year period. This increase in gross margin from product revenue was primarily due to 2019 including a $12.8 millionincrease in our reserve for excess and obsolete inventory recorded in connection with our strategic decisions to simplify our hardware and software product portfolio and cease selling certain products. Gross margin from service revenue increased by 1.8 percentage points to 47.1% for the year ended December 31, 2020from 45.3% for the prior year period, primarily due to a reduction in departmental costs as a result of the Restructuring Plan. 37
Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses decreased by
$45.6 million, or 25.7%, to $131.8 million, for the year ended December 31, 2020from $177.4 millionfor the year ended December 31, 2019. This decrease was driven primarily by decreased salaries and wages and other cost savings initiatives to reduce non-personnel costs that resulted from the Restructuring Plan. Additionally, a decrease in selling commission expense and travel expense was driven by reduced global sales and pandemic stay-at-home orders, respectively. SG&A expenses as a percentage of sales decreased to 43.4% for the year ended December 31, 2020from 46.5% for the year ended December 31, 2019. Research and development expenses. Research and development expenses decreased $1.3 million, or 2.9%, to $42.9 millionfor the year ended December 31, 2020from $44.2 millionfor the year ended December 31, 2019. This decrease was mainly driven by a decrease in purchased technology intangible amortization expense as a result of the impairment of certain intangible assets in connection with the Restructuring Plan. Research and development expenses as a percentage of sales increased to 14.1% for the year ended December 31, 2020from 11.6% for the year ended December 31, 2019. Restructuring costs. In February 2020, we initiated the Restructuring Plan to improve business effectiveness, streamline operations and achieve a stated target cost level for the Company as a whole. Restructuring costs included in operating expenses for the year ended December 31, 2020were $15.8 millionprimarily consisting of severance and related benefits charges. Impairment loss. As a result of our annual goodwill and intangible asset impairment test performed in the prior year, we recorded an impairment loss of $35.2 millionin the fourth quarter of 2019, which included $21.2 millionin goodwill, $10.5 millionin intangible assets associated with recent acquisitions, $1.4 millionin intangible assets related to capitalized patents, and $2.1 millionin other asset write-downs. There were no similar impairments in 2020. Other expense. Other expense was $0.1 millionfor the year ended December 31, 2020compared to $2.4 millionfor the year ended December 31, 2019. This decrease was primarily driven by the impairment charge related to our equity investment in present4D GmbH("present4D") recorded in the second quarter of 2019 and the impairment charge related to our note receivable due from present4D recorded in the fourth quarter of 2019. Income tax (benefit) expense. Income tax benefit for the year ended December 31, 2020was $31.4 millioncompared with an income tax expense of $1.1 millionfor the year ended December 31, 2019. Our effective tax rate was 102.0% for the year ended December 31, 2020compared to 1.9% for the year ended December 31, 2019. The change in income tax (benefit) expense was primarily due to the Company completing an intra-entity transfer of certain intellectual property rights ("IP Rights") which resulted in the Company establishing a deferred tax asset benefit of $19.2 million, based on the fair value of the IP rights transferred in December 2020. Net income (loss). Net income was $0.6 millionfor the year ended December 31, 2020compared with net loss of $62.1 millionfor the year ended December 31, 2019, reflecting the impact of the factors described above.
Cash and capital resources
Cash and cash equivalents decreased by
$63.6 millionto $122.0 millionat December 31, 2021from $185.6 millionat December 31, 2020. The decrease was primarily driven by net cash used in operating and investing activities. Cash used in operating activities was $13.5 millionduring the year ended December 31, 2021compared to $21.4 millionof cash provided by operating activities during the year ended December 31, 2020. The change was due to changes in working capital accounts, primarily an increase in net accounts receivable from higher sales, a decrease in accounts payable and accrued liabilities driven by the $12.3 millionsettlement of liability related to the GSA matter, as well as an increase in raw material inventories in preparation for our phased transition to our third party contract manufacturer, Sanmina. Cash used in investing activities during the year ended December 31, 2021was $45.7 millioncompared with cash flows provided by investing activities of $13.9 millionduring the year ended December 31, 2020. The change was primarily due to $33.8 millionused in the acquisition of Holobuilder during the year ended December 31, 2021, as compared to the maturity of U.S.Treasury Bills amounting to $25.0 millionduring the year ended December 31, 2020without such activity during the year ended December 31, 2021. Cash flows provided by financing activities during the year ended December 31, 2021was $1.6 millioncompared with $11.1 millionduring the year ended December 31, 2020. The change was primarily due to less proceeds from fewer exercises of stock options during the year ended December 31, 2021as compared to during the year ended December 31, 2020. 38
Of our cash and cash equivalents,
$95.2 millionwas held by foreign subsidiaries as of December 31, 2021. On December 22, 2017, the United Statesenacted the U.S.Tax Cuts and Jobs Act, resulting in significant modifications to existing law, which included a transition tax on the mandatory deemed repatriation of foreign earnings. As a result of the U.S.Tax Cuts and Jobs Act, the Company can repatriate foreign earnings and profits to the U.S.with minimal U.S.income tax consequences, other than the transition tax and global intangible low-taxed income ("GILTI") tax. The Company reinvested a large portion of its undistributed foreign earnings and profits in acquisitions and other investments and intends to bring back a portion of foreign cash in certain jurisdictions where the Company will not be subject to local withholding taxes and which were subject already to transition tax and GILTI tax. On November 24, 2008, our Board of Directors approved a $30.0 millionshare repurchase program. Subsequently, in October 2015, our Board of Directors authorized an increase to the existing share repurchase program from $30.0 millionto $50.0 million. In December 2018, our Board of Directors authorized management to utilize the share repurchase program, beginning January 1, 2019, to maintain the number of our issued and outstanding shares to address the dilutive impact of stock options exercises and the settlement of restricted stock units. Acquisitions for the share repurchase program may be made from time to time at prevailing prices as permitted by securities laws and other legal requirements and subject to market conditions and other factors under this program. The share repurchase program may be discontinued at any time. There is no expiration date or other restriction governing the period over which we can repurchase shares under the program. We made no stock repurchases during the years ended December 31, 2021, 2020 and 2019 under this program. As of December 31, 2021, we had authorization to repurchase $18.3 millionof the $50.0 millionauthorized by our Board of Directors under the existing share repurchase program. We believe that our working capital and anticipated cash flow from operations will be sufficient to fund our long-term liquidity operating requirements for at least the next 12 months.
We have no off-balance sheet arrangements.
Inflation did not have a material impact on our results of operations in recent years. However, we are closely monitoring the current economic climate and its continued impact on our business to adequately respond to price changes which may impact our profitability. In the second half of 2021, we observed raw material cost increases specifically amongst various electronic components we use in our products, and we expect to see the continued pressure on material cost through 2022 to impact our global businesses, worldwide. We have also observed salary pressures on existing and new headcount.
Critical accounting policies
The preparation of our consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as disclosure of contingent assets and liabilities. We base our estimates on historical experience, along with various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Some of these judgments can be subjective and complex and, consequently, actual results may differ from these estimates under different assumptions or conditions. While for any given estimate or assumption made by our management that there may be other estimates or assumptions that are reasonable, we believe that, given the current facts and circumstances, it is unlikely that applying any such other reasonable estimate or assumption would materially impact the financial statements. In response to the
SEC'sfinancial reporting release, FR-60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies," we have selected our critical accounting policies for purposes of explaining the methodology used in our calculation, in addition to any inherent uncertainties pertaining to the possible effects on our financial condition. The critical policies discussed below are our processes of recognizing revenue, the reserve for excess and obsolete inventory, income taxes, the reserve for warranties, goodwill impairment, business combinations and stock-based compensation. These policies affect current assets, current liabilities and operating results and are therefore critical in assessing our financial and operating status. These policies involve certain assumptions that, if incorrect, could have an adverse impact on our operating results and financial position. 39
For arrangements with multiple performance obligations, which represent promises within an arrangement that are capable of being distinct, we allocate revenue to all distinct performance obligations based on their relative standalone selling prices ("SSP"). When available, we use observable prices to determine the SSP. When observable prices are not available, SSPs are established that reflect our best estimates of what the selling prices of the performance obligations would be if they were sold regularly on a standalone basis. Revenue related to our measurement and imaging equipment and related software is generally recognized upon shipment from our facilities or when delivered to the customer's location, as determined by the agreed upon shipping terms, at which time we are entitled to payment and title and control has passed to the customer. Fees billed to customers associated with the distribution of products are classified as revenue. We generally warrant our products against defects in design, materials and workmanship for one year. A provision for estimated future costs relating to warranty expense is recorded when products are shipped. To support our product lines, we also sell hardware service contracts that typically range from one year to three years. Hardware service contract revenues are recognized on a straight-line basis over the term of the contract. Costs relating to hardware service contracts are recognized as incurred. Revenue from sales of licensed software only is recognized when no further significant production, modification or customization of the software is required and when the risks and rewards of ownership have passed to the customer. These software arrangements generally include short-term maintenance that is considered post-contract support ("PCS"), which is considered to be a separate performance obligation. We generally establish a standalone sales price for this PCS component based on our software maintenance contract renewals. Software maintenance contracts, when sold, are recognized on a straight-line basis over the term of the contract. Revenue from sales of subscription based software are recognized as such services are performed and are deferred when billed in advance of the performance of services. Revenues resulting from sales of comprehensive support, training and technology consulting services are recognized as such services are performed and are deferred when billed in advance of the performance of services. Payment for products and services is collected within a short period of time following transfer of control or commencement of delivery of services, as applicable. Revenues are presented net of sales-related taxes.
Reserve for Excess and Obsolete Inventory
Because the value of inventory that will ultimately be realized cannot be known with exact certainty, we rely upon both past sales history and future sales forecasts to provide a basis for the determination of the reserve. Inventory is considered potentially obsolete if we have withdrawn those products from the market or had no sales of the product for the past 12 months and have no sales forecasted for the next 12 months. Inventory is considered potentially excess if the quantity on hand exceeds 12 months of expected remaining usage. The resulting obsolete and excess parts are then reviewed to determine if a substitute usage or a future need exists. Items without an identified current or future usage are reserved in an amount equal to 100% of the first-in first-out cost of such inventory. Our products are subject to changes in technologies that may make certain of our products or their components obsolete or less competitive, which may increase our historical provisions to the reserve. We review these assumptions regularly for all of our inventories which include sales demonstration and service inventories.
We review our deferred tax assets on a regular basis to evaluate their recoverability based upon expected future reversals of deferred tax liabilities, projections of future taxable income, and tax planning strategies that we might employ to utilize such assets, including net operating loss carryforwards. Based on the positive and negative evidence of recoverability, we establish a valuation allowance against the net deferred assets of a taxing jurisdiction in which we operate, unless it is "more likely than not" that we will recover such assets through the above means. Our evaluation of the need for the valuation allowance is significantly influenced by our ability to achieve profitability and our ability to predict and achieve future projections of taxable income. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of operating a global business, there are many transactions for which the ultimate tax outcome is uncertain. We establish provisions for income taxes when, despite the belief that tax positions are fully supportable, there remain certain positions that do not meet the minimum probability threshold as described by FASB ASC Topic 740, which is a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority. In the ordinary course of business, we are examined by various federal, state, and foreign tax authorities. We regularly assess the potential outcome of these examinations and any future examinations for the current or prior years in determining the adequacy of our provision for income taxes. We assess the likelihood and amount of potential adjustments and adjust the income tax provision, the current tax liability and deferred taxes in the period in which the facts that gave rise to a revision become known. 40
Reserve for guarantees
We establish at the time of sale a liability for the one-year warranty included with the initial purchase price of our products, based upon an estimate of the repair expenses likely to be incurred for the warranty period. The warranty period is measured in installation-months for each major product group. The warranty reserve is included in accrued liabilities in the accompanying consolidated balance sheets. The warranty expense is estimated by applying the actual total repair expenses for each product group in the prior period and determining a rate of repair expense per installation-month. This repair rate is multiplied by the number of installation-months of warranty for each product group to determine the provision for warranty expenses for the period. We evaluate our exposure to warranty costs at the end of each period using the estimated expense per installation-month for each major product group, the number of units remaining under warranty, and the remaining number of months each unit will be under warranty. We have a history of new product introductions and enhancements to existing products, which may result in unforeseen issues that increase our warranty costs. While such expenses have historically been within expectations, we cannot guarantee this will continue in the future.
Impairment of goodwill
Goodwillrepresents the excess cost of a business acquisition over the fair value of the net assets acquired. We do not amortize goodwill; however, we perform an annual review each year, or more frequently if indicators of potential impairment exist (i.e., that it is more likely than not that the fair value of the reporting unit is less than the carrying value), to determine if the carrying value of the recorded goodwill or indefinite lived intangible assets is impaired. Each period, we can elect to perform a qualitative assessment to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. If we believe, as a result of our qualitative assessment, that it is not more likely than not that the fair value of a reporting unit containing goodwill is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary. If we elect to bypass the qualitative assessment option, or if the qualitative assessment was performed and resulted in the Company being unable to conclude that it is not more likely than not that the fair value of a reporting unit containing goodwill is greater than its carrying amount, we will perform the quantitative goodwill impairment test. We perform the quantitative goodwill impairment test by calculating the fair value of the reporting unit using a discounted cash flow method and market approach method, and then comparing the respective fair value with the carrying amount of the reporting unit. If the carrying amount of the reporting unit exceeds its fair value, we impair goodwill for the excess amount of the reporting unit compared to its fair value, not to be reduced below zero. Management concluded there was no goodwill impairment for the years ended December 31, 2021and 2020. However, during 2019 as a result of this test and under our historical reporting unit structure, the estimated fair value of each of the Photonics reporting unit, which included goodwill recognized with the Instrument Associates, LLCd/b/a Nutfield Technology("Nutfield"), Laser Control Systems Limited("Laser Control Systems") and Lanmark Controls, Inc.("Lanmark") acquisitions, and the 3D Design reporting unit, which included goodwill recognized with the acquisition of Opto-Tech SRL and its subsidiary Open Technologies SRL (collectively, "Open Technologies"), were determined to be significantly less than the carrying value of such reporting unit, indicating a full impairment. This impairment was driven primarily by historical and projected financial performance lower than our expectations and changes in our go-forward strategy in connection with our new strategic plan. Business Combinations We allocate the fair value of purchase consideration to the assets acquired and liabilities assumed based generally on their fair values at the acquisition date. The excess of the fair value of purchase consideration over the fair value of the assets acquired and liabilities assumed is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing intangible assets include, but are not limited to, expected future cash flows, which include consideration of future growth rates and margins, customer attrition rates, future changes in technology and brand awareness, loyalty and position, and discount rates. Critical estimates are also made in valuing contingent considerations, which represent arrangements to pay former owners based on the satisfaction of performance criteria. Fair value estimates are based on the assumptions management believes a market participant would use in pricing the asset or liability. Amounts recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisition, as additional information about conditions existing at the acquisition date becomes available.
We measure and record compensation expense using the applicable accounting guidance for share-based payments related to stock options, restricted stock awards, restricted stock units and market-based awards granted to our directors and employees. The fair value of stock options, including performance awards, without a market condition is determined by using the Black-Scholes option valuation model. The fair value of restricted stock units and stock options with a market condition is 41
estimated, at the date of grant, using the Monte Carlo Simulation valuation model. The Black-Scholes and Monte Carlo Simulation valuation models incorporate assumptions as to stock price volatility, the expected life of options or awards, a risk-free interest rate and dividend yield. In valuing our stock options, significant judgment is required in determining the expected volatility of our common stock and the expected life that individuals will hold their stock options prior to exercising. Expected volatility for stock options is based on the historical and implied volatility of our own common stock while the volatility for our restricted stock units with a market condition is based on the historical volatility of our own stock and the stock of companies within our defined peer group. The expected life of stock options is derived from the historical actual term of option grants and an estimate of future exercises during the remaining contractual period of the option. While volatility and estimated life are assumptions that do not bear the risk of change subsequent to the grant date of stock options, these assumptions may be difficult to measure, as they represent future expectations based on historical experience. Further, our expected volatility and expected life may change in the future, which could substantially change the grant-date fair value of future awards of stock options and, ultimately, the expense we record. The fair value of restricted stock, including performance awards, without a market condition is estimated using the current market price of our common stock on the date of grant. We elect to account for forfeitures related to the service condition-based awards as they occur. We expense stock-based compensation for stock options, restricted stock awards, restricted stock units and performance awards over the requisite service period. For awards with only a service condition, we expense stock-based compensation using the straight-line method over the requisite service period for the entire award. For awards with both performance and service conditions, we expense the stock-based compensation on a straight-line basis over the requisite service period for each separately vesting portion of the award, taking into account the probability that we will satisfy the performance condition. Furthermore, we expense awards with a market condition over the three-year vesting period regardless of the value that the award recipients ultimately receive. Our non-employee directors may elect to have their annual cash retainers and annual equity retainers paid in the form of deferred stock units pursuant to the 2014 Equity Incentive Plan and the 2018 Non-Employee Director Deferred Compensation Plan. Each deferred stock unit represents the right to receive one share of our common stock upon the non-employee director's separation of service from the Company. We record compensation cost associated with our deferred stock units over the period of service.
Impact of recently adopted accounting standards
June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13, and subsequent related amendments to ASU 2016-13, replace the existing incurred loss impairment model with an expected loss model that requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. We adopted ASU 2016-13 effective as of January 1, 2020, and the adoption of the new guidance did not have a material impact on our consolidated financial statements. In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes which amends and aims to simplify accounting disclosure requirements regarding a number of topics including: intraperiod tax allocation, accounting for deferred taxes when there are changes in consolidation of certain investments, tax basis step up in an acquisition and the application of effective rate changes during interim periods, amongst other improvements. We adopted ASU 2019-12 effective as of January 1, 2021, and the adoption of the new guidance did not have a material impact on our consolidated financial statements. In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Asset and Contract Liabilities from Contracts with Customers which intends to simplify the accounting for acquired revenue contracts with customers in a business combination and to also remove inconsistencies in this topic related to recognition of an acquired contract liability and payment terms and their effect on subsequent revenue recognized by the acquirer. ASU No. 2021-08 allows an acquirer to recognize and measure contract assets and contract liabilities acquired in a business combination in a similar manner to how they are recorded on the acquiree's financial statements at book value. Early adoption is permitted and we early adopted ASU No. 2021-08 in the fourth quarter of 2021. As a result of the early adoption of ASU No.2021-08 we recorded the deferred revenue associated with the acquisition of Holobuilder at its book value of approximately $4.0 million. 42
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