QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2022
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-23081
FARO TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Florida
59-3157093
(State or other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
250 Technology Park,
Lake Mary,
Florida
32746
(Address of Principal Executive Offices)
(Zip Code)
(407) 333-9911
(Registrant’s Telephone Number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $.001
FARO
Nasdaq Global Select Market LLC
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,”
“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No x
There were 18,278,511 shares of the registrant’s common stock outstanding as of August 1, 2022.
Common stock - par value $0.001, 50,000,000 shares authorized; 19,651,715 and 19,588,003 issued, respectively; 18,275,364 and 18,205,636 outstanding, respectively
20
20
Additional paid-in capital
306,119
301,061
Retained earnings
55,283
73,544
Accumulated other comprehensive loss
(32,369)
(17,374)
Common stock in treasury, at cost - 1,376,351 and 1,382,367 shares held, respectively
(30,657)
(30,792)
Total shareholders’ equity
298,396
326,459
Total liabilities and shareholders’ equity
$
442,949
$
479,740
The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(in thousands, except share and per share data, or as otherwise noted)
NOTE 1 – DESCRIPTION OF BUSINESS
FARO Technologies, Inc. and its subsidiaries (collectively “FARO,” the “Company,” “us,” “we” or “our”) design, develop, manufacture, market and support 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.
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 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.
During 2022, we continue to mitigate the ongoing impact of COVID-19 on our business results and we remain committed to taking actions to mitigate both the impact on the health and safety of our employees, as well as negative business effects resulting from demand disruption, material availability and potential production and shipment challenges, 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;
•Isolating our production environment from non-essential personnel, to minimize the risk of COVID-19 exposures;
•Recommending that our employees receive vaccinations and vaccine boosters to help protect our colleagues, families, and communities;
•Aggressively pursuing required raw materials to ensure continuity of supply and minimize material cost increases;
•Aggressively pursuing alternative logistics paths when intermittent government-ordered shutdowns affect current logistics paths;
•Monitoring our liquidity, disciplined inventory management, and scrutinizing our capital expenditures while executing our strategic plan; 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 $102.0 million and no debt as of June 30, 2022. We believe that our liquidity position is adequate to meet our projected needs in the reasonably foreseeable future.
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 new 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.
NOTE 2 – PRINCIPLES OF CONSOLIDATION
Our condensed consolidated financial statements include the accounts of FARO Technologies, Inc. and its subsidiaries, all of which are wholly owned.All intercompany transactions and balances have been eliminated. The financial statements of our foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at period-end for assets and liabilities and average exchange rates during each reporting period for results of operations. Adjustments resulting from financial statement translations are reflected as a separate component of accumulated other comprehensive loss. Foreign currency transaction gains and losses are included in net loss.
The accompanying unaudited condensed consolidated financial statements and notes thereto have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These condensed consolidated financial statements include all normal recurring accruals and adjustments considered necessary by management for a fair presentation in conformity with U.S. GAAP.Preparing financial statements 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 revenues and expenses during the reporting period. Actual results could differ materially from those estimates. The condensed consolidated results of operations for the six months ended June 30, 2022 are not necessarily indicative of results that may be expected for the year ending December 31, 2022 or any future period.
The information included in this Quarterly Report on Form 10-Q, including the interim condensed consolidated financial statements and the accompanying notes, should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. The accompanying December 31, 2021 condensed consolidated balance sheet has been derived from those audited consolidated financial statements.
Stock-based compensation expense is allocated to the applicable departmental cost in our condensed consolidated financial statements. The following table summarizes total stock-based compensation expense for each of the line items on our condensed consolidated statements of operations:
NOTE 4 – IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Impact of Recently Adopted Accounting Standards
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 condensed 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 in 2021 at its book value of approximately $4.0 million.
The following tables present our revenues by sales type as presented in our condensed consolidated statements of operations disaggregated by the timing of transfer of goods or services:
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2022
2021
2022
2021
Product sales
Product transferred to customers at a point in time
$
54,178
$
56,674
$
105,659
$
107,544
Product transferred to customers over time
5,524
3,601
10,774
7,366
Total product sales
$
59,702
$
60,275
$
116,433
$
114,910
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2022
2021
2022
2021
Service sales
Service transferred to customers at a point in time
$
8,620
$
9,602
$
17,322
$
19,599
Service transferred to customers over time
11,595
12,233
22,818
23,932
Total service sales
$
20,215
$
21,835
$
40,140
$
43,531
The following table presents our revenues disaggregated by geography, based on the billing addresses of our customers:
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2022
2021
2022
2021
Total sales to external customers
Americas (1)
$
34,667
$
33,702
$
71,344
$
66,251
EMEA (1)
21,555
26,474
43,691
51,928
APAC (1)
23,695
21,934
41,538
40,262
$
79,917
$
82,110
$
156,573
$
158,441
(1) Regions represent North America and South America (the “Americas”); Europe, the Middle East, and Africa (“EMEA”); and Asia-Pacific (“APAC”).
For revenue related to our measurement and imaging equipment and related software, we allocate the contract price to performance obligations based on our best estimate of the standalone selling price. We make this allocation estimate utilizing data from the sale of our applicable products and services to customers separately in similar circumstances. 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 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. Software arrangements generally include short-term maintenance that is considered post-contract support (“PCS”), which is considered to be product transferred to the customer over time and a separate performance obligation. We generally establish a standalone sales price for this PCS component based on our maintenance renewal rate. Maintenance renewals are recognized on a straight-line basis over the term of the maintenance agreement. Payments for products and services are collected within a short period of time following transfer of control or commencement of delivery of services, as applicable.
Further, customers frequently purchase extended hardware service contracts with the purchase of measurement equipment and related software. Hardware service contracts are considered a performance obligation when services are transferred to a customer over time, and, as such, we recognize revenue on a straight-line basis over the contractual term. Hardware service contracts include contract periods that extend between one month to three years.
We capitalize commission expenses related to deliverables transferred to a customer over time and amortize such costs ratably over the term of the contract. As of June 30, 2022, the deferred cost asset related to deferred commissions was approximately $3.4 million. For classification purposes, $2.3 million and $1.1 million are comprised within the Prepaid expenses and other current assets and Other long-term assets, respectively, on our condensed consolidated balance sheet as of June 30, 2022. As of December 31, 2021, the deferred cost asset related to deferred commissions was approximately $3.5 million. For classification purposes, $2.3 million and $1.2 million were comprised within the Prepaid expenses and other current assets and Other long-term assets, respectively, on our condensed consolidated balance sheet as of December 31, 2021.
The unearned service revenue liabilities reported on our condensed consolidated balance sheets reflect the contract liabilities to satisfy the remaining performance obligations for extended warranties, subscription-based software and software maintenance. The current portion of unearned service revenues on our condensed consolidated balance sheets is what we expect to recognize as revenue within twelve months after the applicable balance sheet date relating to extended warranties, subscription-based software and software maintenance contract liabilities. The unearned service revenues less the current portion on our condensed consolidated balance sheets is what we expect to recognize as revenue extending beyond twelve months after the applicable balance sheet date relating to extended warranties, subscription-based software and software maintenance contract liabilities. Customer deposits on our condensed consolidated balance sheets represent customer prepayments on contracts for performance obligations that we must satisfy in the future to recognize the related contract revenue. These amounts are generally related to performance obligations which are delivered in less than 12 months. During the three and six months ended June 30, 2022, we recognized $9.5 million and $20.4 million of revenue that was deferred on our condensed consolidated balance sheet as of December 31, 2021. During the three and six months ended June 30, 2021, we recognized $9.6 million and $21.6 million of revenue that was deferred on our condensed consolidated balance sheet as of December 31, 2020.
The nature of certain of our contracts gives rise to variable consideration, primarily related to an allowance for sales returns. We are required to estimate the contract asset related to sales returns and record a corresponding adjustment to Cost of Sales. Our allowance for sales returns for June 30, 2022 and June 30, 2021 were both approximately $0.2 million.
Shipping and handling fees billed to customers in a sales transaction are recorded in Product Sales and shipping and handling costs incurred are recorded in Cost of Sales. We exclude from Sales any value-added sales and other taxes that we collect concurrently with revenue-producing activities.
NOTE 6 – ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
As of June 30, 2022
As of December 31, 2021
Accounts receivable
$
73,144
$
80,754
Allowance for credit losses
(2,229)
(2,231)
Total
$
70,915
$
78,523
Activity related to the allowance for credit losses was as follows:
Six Months Ended June 30, 2022
Beginning balance of the allowance for credit losses
$
(2,231)
Current period provision for expected credit losses, net of recoveries
(80)
Charge-offs of amounts previously expensed
82
Ending balance of the allowance for credit losses
$
(2,229)
NOTE 7 – INVENTORIES
Inventories are stated at the lower of cost or net realizable value using the first-in first-out (FIFO) method. We have three principal categories of inventory: 1) manufactured product to be sold; 2) sales demonstration inventory - completed product used to support our sales force for demonstrations and held for sale; and 3) service inventory - completed product and parts used to support our service department and held for sale. Shipping and handling costs are classified as a component of Cost of Sales in our condensed consolidated statements of operations. Sales demonstration inventory is held by our sales representatives for up to three years, at which time it would be refurbished and transferred to finished goods as used equipment, stated at the lower of cost or net realizable value. We expect these refurbished units to remain in finished goods inventory and sold within 12 months at prices that produce reduced gross margins. Service inventory is used to provide a temporary replacement product to a customer covered by a premium warranty when the customer’s unit requires service or repair and as training equipment. Service inventory is available for sale; however, management does not expect service inventory to be sold within 12 months and, as such, classifies this inventory as a long-term asset. Service inventory that we utilize for training or repairs and which we deem as no longer available for sale is transferred to fixed assets at the lower of cost or net realizable value and depreciated over the remaining life, typically three years.
Basic net loss per share is computed by dividing net loss by the weighted average number of shares outstanding. Diluted net loss per share is computed by also considering the impact of potential common stock on both net loss and the weighted average number of shares outstanding. Our potential common stock consists of employee stock options, restricted stock units and market-based awards. Our potential common stock is included in the diluted earnings per share calculation when adding such potential common stock would not be anti-dilutive. Market-based awards are included in the computation of diluted earnings per share only to the extent that the underlying conditions (and any applicable market condition) (i) are satisfied as of the end of the reporting period or (ii) would be considered satisfied if the end of the reporting period were the end of the related contingency period and the result would be dilutive under the treasury stock method. When we report a net loss for the period presented, the calculation of diluted net loss per share excludes our potential common stock, as the effect would be anti-dilutive.
For the three and six months ended June 30, 2022, there were approximately 582,595 shares issuable upon the exercise of options, the vesting of time-based restricted stock and the contingent vesting of market-based restricted stock units that were excluded from the dilutive calculations, as they were anti-dilutive. For the three months and six months ended June 30, 2021, there were approximately 425,455 issuable upon the exercise of options that were excluded from the dilutive calculations, as they were anti-dilutive.
A reconciliation of the number of common shares used in the calculation of basic and diluted net loss per share is presented below:
Activity related to accrued warranties was as follows:
Six Months Ended
June 30, 2022
June 30, 2021
Balance, beginning of period
$
1,880
$
1,683
Provision for warranty expense
1,497
1,284
Fulfillment of warranty obligations
(1,512)
(1,351)
Balance, end of period
$
1,865
$
1,616
NOTE 10 – FAIR VALUE MEASUREMENTS
Our financial instruments include cash and cash equivalents, accounts receivable, customer deposits, accounts payable and accrued liabilities. The carrying amounts of such financial instruments approximate their fair value due to the short-term nature of these instruments.
Liabilities measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations:
As of June 30, 2022
Level 1
Level 2
Level 3
Liabilities:
Contingent consideration (1)
$
—
$
—
$
938
Total
$
—
$
—
$
938
As of December 31, 2021
Level 1
Level 2
Level 3
Liabilities:
Contingent consideration (1)
$
—
$
—
$
1,028
Total
$
—
$
—
$
1,028
(1)Contingent consideration liability represents arrangements to pay the former owners of certain companies we acquired based on the attainment of future product release milestones and is reported in Other long-term liabilities. We use a probability-weighted discounted cash flow model to estimate the fair value of contingent consideration liabilities. These probability weightings are developed internally and assessed on a quarterly basis. The remaining undiscounted maximum payment under these arrangements was $1.0 million as of June 30, 2022. We expect to make payments earned by former owners under these arrangements on August 31, 2023.
In the first quarter of 2020, our Board of Directors approved a global restructuring plan (the “Restructuring Plan”), which is intended to support our strategic plan in an effort to improve operating performance and ensure that we are appropriately structured and resourced to deliver increased and sustainable value to our shareholders and customers. Key activities under the Restructuring Plan include a continued focus on efficiency and cost-saving efforts, which included a planned decrease of total headcount by approximately 500 employees upon the completion of the Restructuring Plan.
On July 15, 2021, we entered into a manufacturing services agreement (the “Agreement”) with Sanmina Corporation (Nasdaq: SANM) (“Sanmina”), in connection with the Restructuring Plan. Under the Agreement, Sanmina will provide manufacturing services for the Company’s measurement device products previously manufactured by the Company at the Company’s Lake Mary, Florida, Exton, Pennsylvania, and Stuttgart, Germany manufacturing sites. This phased transition to a Sanmina production facility was substantially completed at the end of the second quarter of 2022 as part of our cost reduction initiative. The facilities which previously housed our manufacturing function are currently under evaluation for a reduction in occupancy. All of these facilities are mixed-use spaces with our service, research and development, or sales teams, and are in use for those functions.
In connection with the Restructuring Plan, we paid $2.8 million during the six months ended June 30, 2022, primarily consisting of severance and related benefits. Since the approval of the Restructuring Plan, we have paid $21.7 million, primarily consisting of severance and related benefits. Activity related to the accrued restructuring charge and cash payments during the six months ended June 30, 2022 and June 30, 2021 was as follows:
Severance and other benefits
Professional fees and other related charges
Total
Balance at December 31, 2021
$
3,442
$
477
$
3,919
Additions charged to expense
1,422
510
1,932
Cash payments
(2,016)
(819)
(2,835)
Balance at June 30, 2022
$
2,848
$
168
$
3,016
Balance at December 31, 2020
$
1,481
$
867
$
2,348
Additions charged to expense
1,480
823
2,303
Cash payments
(2,257)
(1,279)
(3,536)
Balance at June 30, 2021
$
704
$
411
$
1,115
Substantially all of our planned activities under the Restructuring Plan are complete and as part of our final steps, we expect to incur remaining pre-tax charges in the range of $1 million to $3 million through the end of fiscal year 2022. We have reduced our total headcount by approximately 390 employees. The Company expects to make concluding cash payments of approximately $4 million in the remainder of fiscal year 2022, consisting of severance and related benefits.
NOTE 12 – COMMITMENTS AND CONTINGENCIES
Purchase Commitments — We enter into purchase commitments for products and services in the ordinary course of business. These purchases generally cover production requirements for 60 to 120 days as well as materials necessary to service customer units through the product lifecycle and for warranty commitments. As of June 30, 2022, we had approximately $60.8 million in purchase commitments that are expected to be delivered within the next 12 months. To ensure adequate component availability, as of June 30, 2022, we also had $1.2 million in long-term commitments for purchases to be delivered after 12 months.
Legal Proceedings — We are not involved in any legal proceedings, including routine litigation arising in the normal course of business, that we believe will have a material adverse effect on our business, financial condition or results of operations.
U.S. Government Contracting Matter — We have sold our products and related services to the U.S. Government (the “Government”) under General Services Administration (“GSA”) Federal Supply Schedule contracts (the “GSA Contracts”) since 2002 and are currently selling our products and related services to the Government under two such GSA Contracts. Each GSA Contract is subject to extensive legal and regulatory requirements and includes, among other provisions, a price reduction
clause (the “Price Reduction Clause”), which generally requires us to reduce the prices billed to the Government under the GSA Contracts to correspond to the lowest prices billed to certain benchmark customers.
Late in the fourth quarter of 2018, during an internal review we preliminarily determined that certain of our pricing practices may have resulted in the Government being overcharged under the Price Reduction Clauses of the GSA Contracts (the “GSA Matter”). As a result, we performed remediation efforts, including but not limited to, the identification of additional controls and procedures to ensure future compliance with the pricing and other requirements of the GSA Contracts. We also retained outside legal counsel and forensic accountants to assist with these efforts and to conduct a comprehensive review of our pricing and other practices under the GSA Contracts (the “Review”). On February 14, 2019, we reported the GSA Matter to the GSA and its Office of Inspector General.
Effective as of February 25, 2021, as a result of the review, we entered into a settlement agreement with the GSA. Pursuant to the settlement agreement, we agreed to, among other things, pay to the GSA $12.3 million in full and final satisfaction of any and all claims, causes of actions, appeals and the like, including damages, costs, attorney’s fees and interest arising under or related to the GSA Matter. As of June 30, 2022, we no longer have any outstanding liability related to this matter.
We have operating and finance leases for manufacturing facilities, corporate offices, research and development facilities, sales and training facilities, vehicles, and certain equipment under which we assume the role of lessee. We do not lease assets as a lessor. Our leases have remaining lease terms of less than one year to approximately ten years, some of which include options to extend the leases for up to fifteen years, and some of which include options to terminate the leases within three months. We do not participate in any material subleasing.
We determine if an arrangement is a lease at inception. Operating leases are included in Operating lease right-of-use (“ROU”) asset, Lease liability, and Lease liability - less current portion in our condensed consolidated balance sheets. Finance leases are included in Property and equipment, net, Lease liability, and Lease liability - less current portion in our condensed consolidated balance sheets.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and lease liabilities are recognized on the commencement date of the lease based on the present value of lease payments over the lease term. Variable lease payments that depend on an index or rate include the variable portion when calculating ROU assets and lease liabilities. Variable lease payments that do not depend on an index or rate are expensed as incurred. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available on the commencement date of the lease to determine the present value of lease payments. We use the implicit rate when readily determinable. The operating lease ROU assets also include any lease payments made and lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option at the time the lease is commenced. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
While we have lease agreements with lease and non-lease components, we account for the lease and non-lease components as a single lease component.
The components of lease expense were as follows:
Three Months Ended June 30, 2022
Three Months Ended June 30, 2021
Six Months Ended June 30, 2022
Six Months Ended June 30, 2021
Operating lease cost
$
1,842
$
1,922
$
3,648
$
3,891
Finance lease cost:
Amortization of ROU assets
29
78
$
77
$
161
Interest on lease liabilities
5
4
$
10
$
10
Total finance lease cost
$
34
$
82
$
87
$
171
We recognize lease payments made for short-term leases where terms are 12 months or less as the payments are incurred. Our short-term lease costs for the three months ended June 30, 2022 and June 30, 2021 were both less than $0.1 million. Our short-term lease costs for the six months ended June 30, 2022 and June 30, 2021 were both $0.1 million.
For the three months ended June 30, 2022, we recorded an income tax expense of $1.3 million compared with an income tax benefit of $0.4 million for the three months ended June 30, 2021. Our effective tax rate was 17.3% for the three months ended June 30, 2022 compared with 25.2% in the prior year period. The tax rate for 2022 reflects a tax expense on a pre-tax loss and the tax rate for 2021 reflects a tax benefit on a pre-tax loss. The change in our income tax expense and our effective tax rate were primarily due to the impact of the capitalization of research and development (“R&D”) expenditures for income tax purposes. The Tax Cuts and Jobs Act (the “Act”) requires the capitalization and amortization of R&D costs incurred after December 31, 2021. We have considered the effects of the Act on the forecasted domestic cash tax payments for the year ending December 31, 2022. Our entity in the United States remains in a full valuation allowance position, hence we were not able to recognize the tax benefits associated with the capitalization of these R&D expenditures.
Our quarterly estimate of our annual effective tax rate, and our quarterly provision for income tax (benefit) expense, are subject to significant variation due to numerous factors, including variability in accurately predicting our pretax and taxable income or loss and the mix of jurisdictions to which they relate, as well as the amount of pretax income or loss recognized during the quarter.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following information should be read in conjunction with the condensed consolidated financial statements, including the notes thereto, included elsewhere in this Quarterly Report on Form 10-Q and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2021.
Amounts reported in millions within this Quarterly Report on Form 10-Q 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.
FARO Technologies, Inc. (“FARO,” the “Company,” “us,” “we” or “our”) has made “forward-looking statements” in this report (within the meaning of the Private Securities Litigation Reform Act of 1995). Statements that are not historical facts or that describe our plans, beliefs, goals, intentions, objectives, projections, expectations, assumptions, strategies, or future events are forward-looking statements. In addition, words such as “may,” “might,” “would,” “will,” “will be,” “future,” “strategy,” “believe,” “plan,” “should,” “could,” “seek,” “expect,” “anticipate,” “intend,” “estimate,” “goal,” “objective,” “project,” “forecast,” “target” and similar words identify forward-looking statements.
Forward-looking statements are not guarantees of future performance and are subject to a number of known and unknown risks, uncertainties, assumptions, and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Consequently, undue reliance should not be placed on these forward-looking statements. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. We do not intend to update any forward-looking statements, whether as a result of new information, future events, or otherwise, unless otherwise required by law. Important factors that could cause actual results to differ materially from those contemplated in such forward-looking statements include, among others, the following:
•an economic downturn or other adverse changes in the industries that we serve or the domestic and international economies in the regions of the world where we operate and other general economic, business, and financial conditions;
•the effect of the ongoing COVID-19 pandemic, including on our business operations, as well as its impact on general economic and financial market conditions;
•the effect of shipping disruptions caused by COVID-19-related lockdowns and its impact on our ability to deliver our products to customers;
•our inability to realize the intended benefits of reorganizing our business functions to improve the efficiency of our sales organization and to improve operational effectiveness;
•our inability to realize the intended benefits of our undertaking to transition to a subscription-based business model to deliver new and existing software offerings on a cloud-computing-based platform, including but not limited to impairment charges of capitalized expenditures related to the development of Sphere, our cloud-computing-based platform, and our inability to realize the expected benefits;
•our inability to successfully execute our strategic plan and Restructuring Plan, including but not limited to additional impairment charges including existing leasehold improvements and/or higher than expected severance costs and exit costs, and our inability to realize the expected benefits of such plans;
•our inability to realize the anticipated benefits of our partnership with Sanmina and to successfully transition our manufacturing operations to Sanmina’s production facility;
•our inability to reasonably source essential equipment and materials to manufacture our products as a result of global supply shortages;
•the effect of inflationary pressures and its impact on our business operations;
•our inability to successfully realize changes to the pricing of our products and services;
•our inability to achieve and maintain profitability to fully realize the economic benefit of recorded deferred tax assets;
•our inability to further penetrate our customer base and target markets;
•development by others of new or improved products, processes or technologies that make our products less competitive or obsolete;
•our inability to maintain what we believe to be our technological advantage by developing new products and enhancing our existing products;
•risks associated with expanding international operations, such as difficulties in staffing and managing foreign operations, increased political and economic instability, compliance with potentially evolving import and export regulations, and the burdens and potential exposure of complying with a wide variety of U.S. and foreign laws and labor practices;
•changes in trade regulation, which result in rising prices of imported steel, steel byproducts, aluminum and aluminum byproducts and various other raw materials that we use in the production of measurement devices, and our ability to pass those costs on to our customers or require our suppliers to absorb such costs;
•changes in foreign regulation which may result in rising prices of our measurement devices sold as exports to our international customers, our customers’ willingness to absorb incremental import tariffs, and the corresponding impact on our profitability;
•our inability to successfully identify and acquire target companies and achieve expected benefits from, and effectively integrate acquisitions that are consummated;
•our inability to realize the intended benefits of the technology, products, operations, contracts, and personnel of our acquisitions;
•the cyclical nature of the industries of our customers and material adverse changes in our customers’ access to liquidity and capital;
•changes in the potential for the computer-aided measurement market and the potential adoption rate for our products, which are difficult to quantify and predict;
•our inability to protect our patents and other proprietary rights in the United States and foreign countries;
•our inability to defend against a cyberattack or security breach of our systems may compromise the confidentiality, integrity, or availability of our internal data and the availability of our products and websites designed to support our customers or their data;
•our inability to adequately maintain effective internal controls over financial reporting;
•fluctuations in our annual and quarterly operating results and the inability to achieve our financial operating targets as a result of a number of factors including, without limitation (i) litigation and regulatory action brought against us, (ii) quality issues with our products, (iii) excess or obsolete inventory, shrinkage or other inventory losses due to product obsolescence, change in demand for our products, scrap or material price changes, (iv) raw material price fluctuations and other inflationary pressures, (v) expansion of our manufacturing capability, (vi) the size and timing of customer orders, (vii) the amount of time that it takes to fulfill orders and ship our products, (viii) the length of our sales cycle to new customers and the time and expense incurred in further penetrating our existing customer base, (ix) manufacturing inefficiencies associated with new product introductions, (x) costs associated with new product introductions, such as product development, marketing, assembly line start-up costs and low introductory period production volumes, (xi) the timing and market acceptance of new products and product enhancements, (xii) customer order deferrals in anticipation of new products and product enhancements, (xiii) the inability of our sales and marketing programs to achieve their sales targets, (xiv) start-up costs associated with opening new sales offices outside of the United States, (xv) fluctuations in revenue without proportionate adjustments in fixed costs, (xvi) inefficiencies in the management of our inventories and fixed assets, (xvii) compliance with government regulations including health, safety, and environmental matters, and (xviii) costs associated with the training and ramp-up time for new sales people;
•changes in gross margins due to a changing mix of products sold and the different gross margins on different products and sales channels;
•changes in applicable laws, rules or regulations, or their interpretation or enforcement, or the enactment of new laws, rules or regulations that apply to our business operations or require us to incur significant expenses for compliance;
•our inability to successfully comply with the requirements of the Restriction of Hazardous Substances Directive and the Waste Electrical and Electronic Equipment Directive in the European Union;
•the inability of our products to displace traditional measurement devices and attain broad market acceptance;
•the impact of competitive products and pricing on our current offerings;
•the loss of any of our executive officers or other key personnel which may include an inability to competitively address inflationary pressures on employee compensation and flexibility in employee work arrangements;
•difficulties in recruiting research and development engineers and application engineers;
•the failure to effectively manage the effects of any future growth;
•the impact of reductions or projected reductions in government spending, or uncertainty regarding future levels of government expenditures, particularly in the defense sector;
•variations in our effective income tax rate, which makes it difficult to predict our effective income tax rate on a quarterly and annual basis, and the impact of the U.S. Tax Cuts and Jobs Act of 2017 on the global intangible low-taxed income of foreign subsidiaries;
•the loss of key suppliers and the inability to find sufficient alternative suppliers in a reasonable period of time or on commercially reasonable terms;
•the impact of fluctuations in exchange rates on non-U.S. dollar-denominated revenues and expenses which could materially effect our reported financial results;
•the effect of estimates and assumptions with respect to critical accounting policies and the impact of the adoption of recently issued accounting pronouncements;
•the effect of changes in political conditions in the U.S. and other countries in which we operate, including the effect of changes in U.S. trade policies or the United Kingdom’s withdrawal from the European Union, on general market conditions, global trade policies and currency exchange rates;
•the magnitude of increased warranty costs from new product introductions and enhancements to existing products;
•the sufficiency of our plants and third-party resources to meet manufacturing requirements;
•the continuation of our share repurchase program;
•the sufficiency of our working capital and cash flow from operations to fund our short- and long-term liquidity requirements;
•the impact of geographic changes in the manufacturing or sales of our products on our effective income tax rate;
•our ability to comply with the requirements for favorable tax rates in foreign jurisdictions; and
•other risks and uncertainties discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2021, elsewhere in this Quarterly Report on Form 10-Q, and in other SEC filings.
Moreover, new risks and uncertainties emerge from time to time, and we undertake no obligation to update publicly or review the risks and uncertainties included in this Quarterly Report on Form 10-Q, unless otherwise required by law.
Overview
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.
Prior to the end of the second quarter of 2022, we manufactured our FARO Quantum Max Arm products in our manufacturing facility located in Florida for customer orders from North America and South America (the “Americas”) and Europe, the Middle East and Africa (“EMEA”), and in our manufacturing facility located in Singapore for customer orders from the Asia-Pacific region (“APAC”). We manufactured our FARO Focus laser scanner in our manufacturing facilities located in Germany for customer orders from EMEA and APAC, and in our manufacturing facility located in Pennsylvania for customer orders from the Americas. We manufactured our FARO Laser Tracker and our FARO Laser Projector products in our manufacturing facility located in Pennsylvania.
Under the manufacturing services agreement dated July 15, 2021 and in connection with the Restructuring Plan described below, Sanmina now provides manufacturing services for our measurement device products previously manufactured by us at the aforementioned manufacturing facilities. The phased transition to a Sanmina production facility was substantially completed at the end of the second quarter of 2022 as part of our cost reduction initiative. The facilities which previously housed our manufacturing function are currently under evaluation for a reduction in occupancy. All of these facilities are mixed-use spaces with our service, research and development, or sales teams, and are in use for those functions. We expect our third party manufacturing facilities to have the production capacity necessary to support our volume requirements for the remainder of 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 or the six months ended June 30, 2022. We may not use such instruments in the future.
Restructuring Plan
In the first quarter of 2020, our Board of Directors approved a global restructuring plan (the “Restructuring Plan”), which is intended to support our strategic plan in an effort to improve operating performance and ensure that we are appropriately structured and resourced to deliver increased and sustainable value to our shareholders and customers. Key activities under the Restructuring Plan include a continued focus on efficiency and cost-saving efforts, which included a planned decrease of total headcount by approximately 500 employees upon the completion of the Restructuring Plan.
On July 15, 2021, we entered into a manufacturing services agreement (the “Agreement”) with Sanmina Corporation (Nasdaq: SANM) (“Sanmina”), in connection with the Restructuring Plan. Under the Agreement, Sanmina will provide manufacturing services for the Company’s measurement device products previously manufactured by the Company at the Company’s Lake Mary, Florida, Exton, Pennsylvania, and Stuttgart, Germany manufacturing sites. This phased transition to a Sanmina production facility was substantially completed at the end of the second quarter of 2022 as part of our cost reduction initiative. The facilities which previously housed our manufacturing function are currently under evaluation for a reduction in occupancy. All of these facilities are mixed-use spaces with our service, research and development, or sales teams, and are in use for those functions.
Substantially all of our planned activities under the Restructuring Plan are complete and as part of our final steps, we expect to incur remaining pre-tax charges in the range of $1 million to $3 million through the end of fiscal year 2022. Since the approval of the Restructuring Plan, we have paid $21.7 million, primarily consisting of severance and related benefits and have reduced our total headcount by approximately 390 employees. We expect to make concluding cash payments of approximately $4 million in the remainder of fiscal year 2022, consisting of severance and related benefits.
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 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 in the expansion of our cloud-based software offerings that we believe will deliver greater value to our customers and to our shareholders. The FARO Sphere platform can be adopted globally across a wide range of markets, including construction management, facilities, operations and maintenance, robotic simulation and incident preplanning. If FARO Sphere is adopted widely, we would expect this to 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 launched FARO Sphere to the market on April 12, 2022.
Revenue from our current software products was $10.5 million and $10.2 million for the three months ended June 30, 2022 and June 30, 2021, respectively, and $20.8 million and $20.4 million for the six months ended June 30, 2022 and June 30, 2021, respectively. Our recurring revenue which is comprised of hardware service contracts, software maintenance contracts, and subscription-based software applications was $17.1 million and $15.8 million for the three months ended June 30, 2022 and June 30, 2021, respectively, and $33.6 million and $31.4 million for the six months ended June 30, 2022 and June 30, 2021, respectively.
Research and development costs incurred relating to the development of internal-use software and website development, including software used to upgrade and enhance our websites and applications to be sold as a service are capitalized in the period incurred and amortized over 1 year to 5 years. These costs include external direct costs of materials and services and internal costs such as payroll and benefits of those employees directly associated with the development of new functionality in internal use software to be sold as a service. The amount of costs capitalized relating to internally developed computer software to be sold as a service was $1.7 million and $1.2 million for the three months ended June 30, 2022 and June 30, 2021, respectively, and $3.2 million and $1.4 million for the six months ended June 30, 2022 and June 30, 2021, 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 million, net of cash acquired. This acquisition enables us to provide reality-capture photo documentation and added remote access capability for industries such as construction management further expanding our Digital Twin solution portfolio. The results of Holobuilder’s operations as of and after the date of acquisition have been included in our condensed consolidated financial statements as of and for the period ended June 30, 2022.
The following table sets forth, for the periods indicated, our unaudited results of operations expressed as dollar amounts and as a percentage of total sales.
Three months ended June 30,
Six months ended June 30,
(dollars in thousands)
2022
% of Sales
2021
% of Sales
2022
% of Sales
2021
% of Sales
Sales
Product
$
59,702
74.7
%
$
60,275
73.4
%
$
116,432
74.4
%
$
114,910
72.5
%
Service
20,215
25.3
%
21,835
26.6
%
40,141
25.6
%
43,531
27.5
%
Total sales
79,917
100.0%
82,110
100.0%
156,573
100.0
%
158,441
100.0
%
Cost of sales
Product
28,169
35.2
%
25,455
31.0
%
52,504
33.5
%
50,259
31.7
%
Service
11,311
14.2
%
11,173
13.6
%
22,607
14.4
%
22,293
14.1
%
Total cost of sales
39,480
49.4
%
36,628
44.6
%
75,111
48.0
%
72,552
45.8
%
Gross profit
40,437
50.6
%
45,482
55.4
%
81,462
52.0
%
85,889
54.2
%
Operating expenses
Selling, general and administrative
36,018
45.1
%
33,594
40.9
%
71,508
45.7
%
66,942
42.3
%
Research and development
12,042
15.1
%
11,760
14.3
%
24,170
15.4
%
23,733
15.0
%
Restructuring costs
1,333
1.7
%
779
0.9
%
1,932
1.2
%
2,303
1.5
%
Total operating expenses
49,393
61.8
%
46,133
56.2
%
97,610
62.3
%
92,978
58.7
%
Loss from operations
(8,956)
(11.2)
%
(651)
(0.8)
%
(16,148)
(10.3)
%
(7,089)
(4.5)
%
Other (income) expense
Interest (income) expense, net
(12)
—
%
39
—
%
(4)
—
%
49
—
%
Other (income) expense, net
(1,636)
(2.0)
%
883
1.1
%
(1,649)
(1.1)
%
(732)
(0.5)
%
Loss before income tax benefit
(7,308)
(9.1)
%
(1,573)
(1.9)
%
(14,495)
(9.3)
%
(6,406)
(4.0)
%
Income tax expense (benefit)
1,266
1.6
%
(397)
(0.5)
%
3,766
2.4
%
(2,009)
(1.3)
%
Net loss
$
(8,574)
(10.7)
%
$
(1,176)
(1.4)
%
$
(18,261)
(11.7)
%
$
(4,397)
(2.8)
%
Consolidated Results
Three Months Ended June 30, 2022 Compared to the Three Months Ended June 30, 2021
Sales. Total sales decreased by $2.2 million, or 2.7%, to $79.9 million for the three months ended June 30, 2022 from $82.1 million for the three months ended June 30, 2021. Foreign exchange rates had a negative impact on total sales of $4.7 million, or 5.7%, primarily due to the weakening of the Euro and the Japanese Yen relative to the U.S. dollar in the current period as compared to the change in foreign exchange rates applicable in the prior period. Total product sales decreased by $0.6 million, or 1.0%, to $59.7 million for the three months ended June 30, 2022 from $60.3 million for the three months ended June 30, 2021. Increased product sales due to the global demand of our new Quantum Max Arm and Focus Laser Scanner products were completely offset by the negative impact on sales related to the weakening of the Euro and the Japanese Yen relative to the U.S. dollar during the three months ended June 30, 2022. Service sales decreased by $1.6 million, or 7.4%, to $20.2 million for the three months ended June 30, 2022 from $21.8 million for the three months ended June 30, 2021.
Gross profit. Gross profit decreased by $5.1 million, or 11.1%, to $40.4 million for the three months ended June 30, 2022 from $45.5 million for the three months ended June 30, 2021, and gross margin decreased by 4.8 percentage points to 50.6% for the three months ended June 30, 2022 from 55.4% for the three months ended June 30, 2021. Gross margin from product revenue decreased by 5.0 percentage points to 52.8% for the three months ended June 30, 2022 from 57.8% for the prior year period primarily due to changes in product mix and unfavorable price variances due to global supply shortages. Gross margin from service revenue decreased by 4.8 percentage pointsto 44.0% for the three months ended June 30, 2022 from 48.8% for the prior year period, primarily due to the aforementioned decrease in service sales with relatively consistent fixed costs.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by $2.4 million, or 7.2%, to $36.0 million for the three months ended June 30, 2022 from $33.6 million for the three months ended June 30, 2021.
This increase was primarily driven by higher personnel costs resulting from additional headcount obtained primarily from our Holobuilder acquisition and base compensation increases. Selling, general and administrative expenses as a percentage of sales increased by 4.2 percentage points to 45.1% for the three months ended June 30, 2022 from 40.9% for the three months ended June 30, 2021. Our worldwide period-ending selling, general and administrative headcount increased by 25, or 3.3%, to 776 at June 30, 2022, from 751 at June 30, 2021.
Research and development expenses. Research and development expenses increased by $0.2 million, or 1.7%, to $12.0 million for the three months ended June 30, 2022 from $11.8 million for the three months ended June 30, 2021. This increase was primarily driven by higher compensation expense resulting from increased engineering headcount and costs to accelerate new product development and from our acquisition of Holobuilder. Research and development expenses as a percentage of sales increased to 15.1% for the three months ended June 30, 2022 from 14.3% for the three months ended June 30, 2021.
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 increased by $0.5 million to $1.3 million for the three months ended June 30, 2022 from $0.8 million for the three months ended June 30, 2021 primarily consisting of additional severance and related benefits charges as part of our phased transition to our third party contract manufacturer, Sanmina.
Interest (income) expense, net. We recorded net interest income of less than $0.1 million for the three months ended June 30, 2022 and net interest expense of less than $0.1 million for the three months ended June 30, 2021.
Other (income) expense, net. For the three months ended June 30, 2022, other income was $1.6 million compared with other expense of $0.9 million for the three months ended June 30, 2021. This change was primarily driven by the effect of foreign exchange rates on our non-U.S.dollar-denominated balance sheet.
Income tax expense (benefit). For the three months ended June 30, 2022 we recorded an income tax expense of $1.3 million compared with an income tax benefit of $0.4 million for the three months ended June 30, 2021. Our effective tax rate was 17.3% for the three months ended June 30, 2022 compared with 25.2% in the prior year period. The tax rate for 2022 reflects a tax expense on a pre-tax loss and the tax rate for 2021 reflects a tax benefit on a pre-tax loss. The change in our income tax expense and our effective tax rate were primarily due to the impact of the capitalization of research and development (“R&D”) expenditures for income tax purposes. The Tax Cuts and Jobs Act (the “Act”) requires the capitalization and amortization of R&D costs incurred after December 31, 2021. We have considered the effects of the Act on the forecasted domestic cash tax payments for the year ending December 31, 2022. Our entity in the United States remains in a full valuation allowance position, hence we were not able to recognize the tax benefits associated with the capitalization of these R&D expenditures.
Our quarterly estimate of our annual effective tax rate and our quarterly provision for income tax expense (benefit) are subject to significant variation due to numerous factors, including variability in accurately predicting our pretax and taxable income or loss and the mix of jurisdictions to which they relate, as well as the amount of pretax income or loss recognized during the quarter.
Net loss. Our net loss was $8.6 million for the three months ended June 30, 2022 compared with net loss of $1.2 million for the prior year period, reflecting the impact of the factors described above.
Six Months Ended June 30, 2022 Compared to the Six Months Ended June 30, 2021
Sales. Total sales decreased by $1.8 million, or 1.2%, to $156.6 million for the six months ended June 30, 2022 from $158.4 million for the six months ended June 30, 2021. Foreign exchange rates had a negative impact on total sales of $6.9 million, or 4.3%, primarily due to the weakening of the Euro and the Japanese Yen relative to the U.S. dollar in the current period as compared to the change in foreign exchange rates applicable in the prior period. Total product sales increased by $1.5 million, or 1.3%, to $116.4 million for the six months ended June 30, 2022 from $114.9 million for the six months ended June 30, 2021 due to global demand of our new Quantum Max Arm products. Service sales decreased by $3.4 million, or 7.8%, to $40.1 million for the six months ended June 30, 2022 from $43.5 million for the six months ended June 30, 2021.
Gross profit. Gross profit decreased by $4.4 million, or 5.2%, to $81.5 million for the six months ended June 30, 2022 from $85.9 million for the six months ended June 30, 2021 and gross margin decreased by 2.2 percentage points to 52.0% for the six months ended June 30, 2022 from 54.2% for the six months ended June 30, 2021. Gross margin from product revenue decreased by 1.4 percentage points to 54.9% for the six months ended June 30, 2022 from 56.3% for the prior year period, primarily due to changes in product mix and unfavorable cost variances due to global supply shortages. Gross margin from service revenue decreased by 5.1percentage pointsto 43.7% for the six months ended June 30, 2022 from 48.8% for the prior year period, primarily due to the aforementioned decrease in service sales with relatively consistent fixed costs.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by $4.6 million, or 6.8%, to $71.5 million for the six months ended June 30, 2022 from $66.9 million for the six months ended June 30, 2021. This increase was primarily driven by higher personnel costs resulting from additional headcount obtained primarily from our Holobuilder acquisition and base compensation increases. Selling, general and administrative expenses as a percentage of sales increased by 3.4 percentage points to 45.7% for the six months ended June 30, 2022, compared with 42.3% of sales for the six months ended June 30, 2021. Our worldwide period-ending selling headcount increased by 25, or 3.3%, to 776 at June 30, 2022, from 751 at June 30, 2021.
Research and development expenses. Research and development expenses increased by $0.5 million, or 2.1%, to $24.2 million for the six months ended June 30, 2022 from $23.7 million for the six months ended June 30, 2021. This increase was primarily driven by higher compensation expense resulting from increased engineering headcount and costs to accelerate new product development and from our acquisition of Holobuilder. Research and development expenses as a percentage of sales increased to 15.4% for the six months ended June 30, 2022 from 15.0% for the six months ended June 30, 2021.
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 $0.4 million to $1.9 million for the six months ended June 30, 2022 from $2.3 million for the six months ended June 30, 2021 primarily driven by the reduction of severance and related benefits.
Interest (income) expense, net. For the six months ended June 30, 2022, we recorded interest income of less than $0.1 million compared with interest expense of less than $0.1 million for the six months ended June 30, 2021.
Other (income) expense, net. For the six months ended June 30, 2022, other income was $1.6 million compared to other income of $0.7 million for the six months ended June 30, 2021. This change was primarily driven by the effect of foreign exchange rates on our non-U.S.dollar-denominated balance sheet.
Income tax expense (benefit). For the six months ended June 30, 2022, we recorded an income tax expense of $3.8 million compared with income tax benefit of $2.0 million for the six months ended June 30, 2021. Our effective tax rate was 26.0% for the six months ended June 30, 2022 compared with 31.4% in the prior year period. The tax rate for 2022 reflects a tax expense on a pre-tax loss and the tax rate for 2021 reflects a tax benefit on a pre-tax loss. The change in our income tax expense and our effective tax rate were primarily due to the impact of the capitalization of research and development (“R&D”) expenditures for income tax purposes. The Tax Cuts and Jobs Act (the “Act”) requires the capitalization and amortization of R&D costs incurred after December 31, 2021. We have considered the effects of the Act on the forecasted domestic cash tax payments for the year ending December 31, 2022. Our entity in the United States remains in a full valuation allowance position, hence we were not able to recognize the tax benefits associated with the capitalization of these R&D expenditures.
Our quarterly estimate of our annual effective tax rate and our quarterly provision for income tax expense are subject to significant variation due to numerous factors, including variability in accurately predicting our pretax and taxable income or loss and the mix of jurisdictions to which they relate, as well as the amount of pretax income or loss recognized during the quarter.
Net loss. Our net loss was $18.3 million for the six months ended June 30, 2022 compared to $4.4 million for the prior year period, reflecting the impact of the factors described above.
Cash and cash equivalents decreased by $20.0 million to $102.0 million at June 30, 2022 from $122.0 million at December 31, 2021. The decrease was primarily driven by net cash used in investing activities.
Cash used in operating activities was $3.3 million during the six months ended June 30, 2022, compared to $12.3 million of cash used in operating activities during the six months ended June 30, 2021. The decrease was due to changes in working capital accounts, primarily consisting of a decrease in inventory in the current year from the sale of our raw materials at cost to our third party contract manufacturer, Sanmina and the settlement of the GSA Liability in the prior year.
Cash used in investing activities during the six months ended June 30, 2022 was $9.0 million compared to cash used in investing activities of $37.8 million during the six months ended June 30, 2021. The decrease was primarily due to the acquisition of Holobuilder in the prior year and purchases of property and equipment and cash paid for technology development, patents, and licenses during the six months ended June 30, 2022, compared to lower purchase activity of property and equipment and cash paid for technology development, patents, and licenses during the six months ended June 30, 2021.
Cash used in financing activities was $1.3 million during the six months ended June 30, 2022 compared to cash provided by financing activities of $1.2 million for the six months ended June 30, 2021. The decrease was primarily due to lower proceeds from the issuance of stock related to stock option exercises during the six months ended June 30, 2022, compared to during the six months ended June 30, 2021.
Of our cash and cash equivalents, $97.3 million was held by foreign subsidiaries as of June 30, 2022. On December 22, 2017, the United States enacted the U.S. Tax Cuts and Jobs Act, resulting in significant modifications to existing tax 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. We have reinvested a large portion of our undistributed foreign earnings and profits in acquisitions and other investments and intends to bring back a portion of foreign cash in certain jurisdictions where we 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 million share repurchase program. 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. 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. In October 2015, our Board of Directors authorized an increase to the existing share repurchase program from $30.0 million to $50.0 million. We made no stock repurchases during the six-month period ended June 30, 2022 under this program. As of June 30, 2022, we had authorization to repurchase $18.3 million remaining under the repurchase program.
We believe that our working capital and anticipated cash flow from operations will be sufficient to fund our short- and long-term liquidity operating requirements for at least the next 12 months.
We have no off-balance sheet arrangements.
Contractual Obligations and Commercial Commitments
We enter into purchase commitments for products and services in the ordinary course of business. These purchases generally cover production requirements for 60 to 120 days as well as materials necessary to service customer units through the product lifecycle and for warranty commitments. As of June 30, 2022, we had $60.8 million in purchase commitments that are expected to be delivered within the next 12 months. We also had $1.2 million in long-term commitments for purchases to be delivered after 12 months. Other than as described in the preceding sentences, there have been no material changes to the contractual obligations and commercial commitments table included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021.
The preparation of our condensed 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. A discussion of our critical accounting policies is included in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the Securities and Exchange Commission on February 16, 2022. As of June 30, 2022, our critical accounting policies have not changed from those described in our Annual Report on Form 10-K for the year ended December 31, 2021.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Exchange Exposure
We conduct a significant portion of our business outside the United States. As of and for the six months ended June 30, 2022, 58% of our revenue was invoiced, and a significant portion of our operating expenses and manufacturing costs were paid, in foreign currencies, and 38% of our assets were denominated in foreign currencies. Fluctuations in exchange rates between the U.S. dollar and such foreign currencies may have a material effect on our results of operations and financial condition and could specifically result in foreign exchange gains and losses. The impact of future exchange rate fluctuations on the results of our operations cannot be accurately predicted due to our constantly changing exposure to various currencies, and the fact that all foreign currencies do not react in the same manner in relation to the U.S. dollar. Our most significant exposures are to the Euro, Japanese Yen, Swiss Franc, Chinese Yuan and Brazilian Real. To the extent that the percentage of our non-U.S. dollar revenues derived from international sales increases in the future, our exposure to risks associated with fluctuations in foreign exchange rates may increase. 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 or the six months ended June 30, 2022. We may not use such instruments in the future.
Global Inflation Exposure
General inflation in the United States, Europe and other geographies has risen to levels not experienced in recent decades. General inflation, including rising prices for our raw materials and other inputs as well as rising salaries negatively impact our business by increasing our cost of sales and operating expenses. General inflation also negatively impacts our business by decreasing the capital for our customers to deploy to purchase our products and services. Inflation may cause our customers to reduce or delay orders for our goods and services thereby causing a decrease in sales of our products and services. The impact of future inflation fluctuations on the results of our operations cannot be accurately predicted.
We are responsible for establishing and maintaining disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to provide reasonable assurance that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (the “SEC”) rules and forms. Disclosure controls and procedures also include, without limitation, controls and procedures that are designed to provide reasonable assurance that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objective. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that our management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of June 30, 2022. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2022 to provide reasonable assurance that information required to be disclosed in this Quarterly Report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
During the quarter ended June 30, 2022, there was no change in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
We are not involved in any legal proceedings, including routine litigation arising in the normal course of business, that we believe will have a material adverse effect on our business, financial condition or results of operations.
Item 1A. Risk Factors
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed under “Risk Factors” in this Item 1A and in our Annual Report on Form 10-K for the year ended December 31, 2021 as filed with the SEC, before deciding to invest in, or retain, shares of our common stock. These risks and uncertainties could materially and adversely affect our business, financial condition, and results of operations. The risks described in our Annual Report on Form 10-K for the year ended December 31, 2021 and in subsequent periodic reports filed with the SEC are not the only risks we face. Our operations could also be affected by additional factors that are not presently known by us or by factors that we currently consider to be immaterial to our business. There have been no material changes in our risk factors from those set forth in our Annual Report on Form 10-K for the year ended December 31, 2021, other than as set forth below.
The risk factors entitled “Because a significant portion of our revenues and expenses are denominated in foreign currencies, we face significant exposure to foreign exchange rate risk” and “Increases in the cost and constraints in the availability of raw materials or components used in our products could negatively impact our business and profitability” have been updated to read as follows:
Because a significant portion of our revenues, expenses, and assets are denominated in foreign currencies, we face significant exposure to foreign exchange rate risk.
We conduct a significant portion of our business outside the United States and consequently much of our revenues, expenses and assets are denominated in foreign currencies, most notably the Euro, Japanese Yen, Swiss Franc, Chinese Yuan and Brazilian Real. Our results of operations are affected by fluctuations in exchange rates, which have caused, and may in the future cause, significant fluctuations in our quarterly and annual results of operations. Fluctuations in exchange rates may have a material adverse effect on our results of operations and financial condition and could result in potentially significant foreign exchange gains and losses. The impact of future exchange rate fluctuations on the results of our operations cannot be accurately predicted due to our constantly changing exposure to various currencies, and the fact that all foreign currencies do not react in the same manner in relation to the U.S. dollar. Additionally, currency fluctuations could require us to increase prices to foreign customers, which could result in lower net sales by us to those customers. If we do not adjust the prices for our products in response to unfavorable currency fluctuations, we could be forced to sell our products at a lower margin or at a net loss. To the extent that the percentage of our non-U.S. dollar revenues derived from international sales increases in the future, our exposure to risks associated with fluctuations in foreign exchange rates will increase. 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 may not use such instruments in the future.
Increases in the cost and constraints in the availability of raw materials or components used in our products could negatively impact our business and profitability.
Our products contain various raw materials, including steel, steel byproducts, aluminum, aluminum byproducts, resin products and various electronic components. We use raw materials directly in manufacturing and in components that we purchase from our suppliers. These raw materials are subject to extensive laws, governmental regulations, policies, including tariffs and other import restrictions, inflationary pressures, exchange rate fluctuations and supply shortages. Some of the raw materials are obtained from suppliers outside the United States, and to the extent that the quantity or proportion of materials derived from such foreign suppliers increases in the future, our exposure to tariffs and other import restrictions, supply chain disruptions and exchange rate fluctuations may increase. The occurrence and impact of future changes in laws, governmental regulations, policies, inflationary pressures, exchange rate fluctuations and supply shortages cannot be accurately predicted. Changes to the laws, governmental regulations and policies governing these raw materials, including tariffs and other import restrictions, have increased and could continue to increase the cost of such raw materials and, correspondingly, the cost of manufacturing our products. Further, interruptions in global supply chains, inflationary pressures and exchange rate fluctuations have increased and could continue to increase the cost of such raw materials, and have constrained and could continue to constrain the availability of such raw materials. If the costs of our raw materials further increase, whether due to changes in laws, governmental regulations, policies, supply shortages or for other reasons, we may not be able to pass on these costs to our
customers, which could have a material adverse effect on our business, results of operations and financial condition. Even in the event that increased costs can be substantially passed through to our customers, our gross margin percentages would decline.
The following risk factor has been added:
Inflation in the global economy could negatively impact our business and results of operations.
General inflation in the United States, Europe and other geographies has risen to levels not experienced in recent decades. General inflation, including rising prices for our raw materials and other inputs as well as rising salaries negatively impact our business by increasing our operating expenses. General inflation also negatively impacts our business by decreasing the capital for our customers to deploy to purchase our products and services. Inflation may cause our customers to reduce or delay orders for our goods and services thereby causing a decrease in sales of our products and services.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Recent Sales of Unregistered Securities
On May 27, 2022, pursuant to our 2022 Equity Incentive Plan, which was approved at our 2022 annual meeting of shareholders (the “annual meeting”), and our Company’s Non-Employee Director Compensation Policy, each of our non-employee directors was automatically granted restricted stock units equal to an aggregate total of 37,884 shares of the Company’s common stock in connection with our annual meeting (the “Annual Director Grants”). Additionally, Rajani Ramanathan was automatically granted restricted stock units equal to an aggregate total of 3,189 shares of the Company’s common stock in connection with her appointment to our Board of Directors on July 25, 2022 (the “Initial Director Grant”). The Annual Director Grants shall vest on the day prior to the 2023 annual meeting of shareholders and the Initial Director Grant shall vest on July 25, 2025, each subject to the director’s continued service on our Board of Directors as of such date.
During the quarter ended June 30, 2022, we also issued restricted stock units equal to an aggregate total of 1,986 shares of the Company’s common stock to certain employees (the “Employee Grants”). The Employee Grants shall vest in three equal annual installments on the anniversary dates of each respective grant.
The restricted stock units were granted in accordance with Section 4(a)(2) of the Securities Act of 1933, as amended. The shares underlying these restricted stock units will be registered on a Form S-8 registration statement prior to the vesting event applicable to such awards.
Purchases of Equity Securities by the Issuer Under the Share Repurchase Plan
On November 24, 2008, our Board of Directors approved a $30.0 million share repurchase program. 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. 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. In October 2015, our Board of Directors authorized an increase to the existing share repurchase program from $30.0 million to $50.0 million. We made no stock repurchases during the six month period ended June 30, 2022 under this program. As of June 30, 2022, we had authorization to repurchase $18.3 million remaining under the repurchase program.
Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101.*)
* - The certifications attached as Exhibit 32.1 and 32.2 that accompany this Quarterly Report on Form 10-Q are deemed furnished and not filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of the Registrant under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FARO Technologies, Inc.
(Registrant)
Date: August 3, 2022
By:
/s/ Allen Muhich
Name: Allen Muhich
Title: Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
