FARO TECHNOLOGIES, INC.
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.
Overview
We are a global technology company that designs, develops, manufactures, markets
and supports software driven, three-dimensional ("3D") measurement and imaging
solutions. This technology permits high-precision 3D measurement, imaging and
comparison of parts and complex structures within production and quality
assurance processes. Our devices are used for inspection of components and
assemblies, rapid prototyping, reverse engineering, documenting large volume or
structures in 3D, surveying and construction, as well as for investigation and
reconstruction of accident sites or crime scenes. We sell the majority of our
products through a direct sales force across a broad number of customers in a
range of manufacturing, industrial, architecture, surveying, building
information modeling, construction, public safety forensics, cultural heritage,
and other applications. Our FaroArm®, FARO ScanArm®, FARO Laser TrackerTM, FARO
Laser Projector, and their companion CAM2®, BuildIT, and BuildIT Projector
software solutions, provide for Computer-Aided Design ("CAD") based inspection,
factory-level statistical process control, high-density surveying, and
laser-guided assembly and production. Together, these products integrate the
measurement, quality inspection, and reverse engineering functions with CAD and
3D software to improve productivity, enhance product quality, and decrease
rework and scrap in the manufacturing process, mainly supporting applications in
the automotive, aerospace, metal and machine fabrication and other industrial
manufacturing markets. Our FARO Focus and FARO ScanPlan laser scanners, and
their companion FARO SCENE, BuildIT, FARO As-BuiltTM, and FARO Zone public
safety forensics software offerings, are utilized for a wide variety of 3D
modeling, documentation and high-density surveying applications primarily in the
architecture, engineering and construction and public safety markets. Our FARO
ScanArm® and its companion SCENE software also enable a fully digital workflow
used to capture real world geometry for the purpose of empowering design,
enabling innovation, and speeding up the design cycle.
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 extended warranties on a straight-line basis over the
term of the warranty, 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 FaroArm® and FARO ScanArm® products in our manufacturing
facility located in Switzerland for customer orders from Europe , the Middle East
and Africa ("EMEA"), in our manufacturing facility located in Singapore for
customer orders from the Asia-Pacific region , and in our manufacturing facility
located in Florida for customer orders from the Americas . We manufacture our
FARO Focus in our manufacturing facilities located in Germany and Switzerland
for customer orders from EMEA and the Asia-Pacific region , and in our
manufacturing facility located in Pennsylvania for customer orders from the
Americas . We manufacture our FARO Laser TrackerTM and our FARO Laser Projector
products in our facility located in Pennsylvania . We expect all of our existing
manufacturing facilities to have the production capacity necessary to support
our volume requirements during 2020.
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 2019, 2018 or 2017.
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Executive Summary
Our total sales decreased $21.9 million , or 5.4%, to $381.8 million for the year
ended December 31, 2019 from $403.6 million for the year ended December 31,
2018 . Our product sales decreased $30.9 million , or 9.6%, primarily driven by a
softening in many of our served markets, with particular softness in the
automotive and broader Asian markets. Our service revenue increased $9.0
million , or 10.9%, as we continued to capitalize on the growth of our global
installed, serviceable base and focused sales initiatives to maintain customer
relationships after the purchase of our measurement devices. Also, foreign
exchange rates had a negative impact on sales of $13.0 million , decreasing our
overall sales by approximately 3.2%, primarily due to the weakening of the Euro
and Chinese Yuan relative to the U.S. dollar.
Change in Organizational Structure and Segment Reporting
Since the fourth quarter of 2016, we had operated in five verticals-3D
Manufacturing, Construction Building Information Modeling ("Construction BIM"),
Public Safety Forensics, 3D Design and Photonics-and had three reporting
segments-3D Manufacturing, Construction BIM and Emerging Verticals. As discussed
in our Quarterly Report on Form 10-Q for the third quarter of 2019, our new
management team, led by our new Chief Executive Officer ("CEO"), formulated and
began to implement a new comprehensive strategic plan for our business. As part
of our strategic planning process, we identified areas of our business that
needed enhanced focus or change in order to improve our efficiency and cost
structure. In the fourth quarter of 2019, we reassessed and redefined our
go-to-market strategy, refocused our marketing engagement with our customers and
re-evaluated our hardware product portfolio. We have also begun to focus on
other organizational optimization efforts, including the simplification of our
overly complex management structure.
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 and began reorganizing the Company
into a functional structure. Our executive leadership team is now 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, or 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 are now reporting as one
reporting segment that develops, manufactures, markets, supports and sells
CAD-based quality assurance products integrated with CAD-based inspection and
statistical process control software and 3D documentation systems. Our reporting
segment sells into a variety of end markets, including automotive, aerospace,
metal and machine fabrication, architecture, engineering, construction and
public safety.
New Strategic Plan and Restructuring Plan
In addition to the reorganization of the Company's structure, as part of our
strategic planning process, we also evaluated our hardware product portfolio and
the operations of certain of our recent acquisitions. As a result of this
evaluation, we are simplifying our hardware product portfolio, ceasing to sell
certain products and evaluating whether or not we will divest or shut down the
related operations.
We performed our annual goodwill and intangible asset impairment test in
December 2019 in connection with the preparation of our financial statements for
the fourth quarter and year ended December 31, 2019 . As a result of this test,
we recorded an impairment charge of $35.2 million in the fourth quarter of 2019,
which included $21.2 million in goodwill, $10.5 million in intangible assets
associated with recent acquisitions, $1.4 million in intangible assets related
to capitalized patents and $2.1 million in other asset write-downs. See Note 7,
"Goodwill" and Note 8, "Intangible Assets" to the Notes to Consolidated
Financial Statements included in Part II, Item 8 of this Annual Report on Form
10-K for further information. We also recorded a charge of $12.8 million in the
fourth quarter of 2019, increasing our reserve for excess and obsolete
inventory, based on our analysis of our inventory reserves in connection with
our strategy to simplify our hardware product portfolio and cease selling
certain products.
In addition to the implementation of our new strategic plan, on February 14,
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 sustainable value to our shareholders and
customers. Key activities under the Restructuring Plan include a continued focus
on efficiency and cost-saving efforts, which includes decreasing total headcount
by approximately 500 employees upon the completion of the Restructuring Plan.
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These activities are expected to be substantially completed by the end of 2021.
We estimate that the Restructuring Plan will reduce gross annual pre-tax
expenses by approximately $40 million , to be realized in the fourth quarter of
2020 on an annualized basis. We estimate that the implementation of the
Restructuring Plan will result in pre-tax charges of approximately $26 million
to $36 million , which are in addition to the pre-tax charges of approximately
$49 million recorded in the fourth quarter of 2019 in connection with the
implementation of our new strategic plan. We expect $18 million to $22 million
of these additional charges to be in the form of cash charges. Actual results,
including the costs of the Restructuring Plan, may differ materially from our
expectations, resulting in our inability to realize the expected benefits of the
Restructuring Plan and our new strategic plan and negatively impacting our
ability to execute our future plans and strategies, which could have a material
adverse effect on our business, financial condition and results of operations.
GSA 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. Our sales to the Government under the GSA Contracts represented
approximately 4.0% of our total sales for the year ended December 31, 2019 . 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 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 .
As a result of the GSA Matter, for the fourth quarter of 2018, we reduced our
total sales by a $4.8 million estimated cumulative sales adjustment,
representative of the last six years of estimated overcharges to the Government
under the GSA Contracts. In addition, for the fourth quarter of 2018, we
recorded $0.5 million of imputed interest related to the estimated cumulative
sales adjustment, which increased Interest expense, net and resulted in an
estimated total liability of $5.3 million for the GSA Matter, which was based on
our preliminary review as of February 20, 2019 , the date of our Annual Report on
Form 10-K for the year ended December 31, 2018 .
On July 15, 2019 , we submitted a report to the GSA and its Office of Inspector
General setting forth the findings of the Review conducted by our outside legal
counsel and forensic accountants. Based on the results of the Review, we reduced
our total sales for second quarter 2019 by an incremental $5.8 million sales
adjustment, reflecting an estimated aggregate overcharge of $10.6 million under
the GSA Contracts for the period from July 2011 to March 2019 . In addition, we
recorded an incremental $0.8 million of imputed interest related to the
estimated cumulative sales adjustment during 2019, which increased Interest
expense, net and resulted in a $6.6 million total incremental increase in the
estimated total liability for the GSA Matter. As of the date of the filing of
this Annual Report on Form 10-K, we have recorded an aggregate estimated total
liability for the GSA Matter of $11.9 million . This estimate is based on the
information we have as of the date of this Annual Report on Form 10-K and is
subject to change based on discussions with our outside legal counsel and the
Government.
Presentation of Information and Reclassifications
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.
Depreciation and amortization expenses are being reported in our statements of
operations to reflect departmental costs. Previously, those expenses were
reported as a separate line item under operating expenses. Amounts related to
depreciation and amortization expenses for years ended December 31, 2018 and
2017 have been restated throughout this Annual Report on Form 10-K to reflect
this reclassification of depreciation and amortization expenses and to conform
to the current period presentation.
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Selling and marketing expenses and general and administrative expenses are now
being reported in the accompanying statements of operations together in one line
as Selling, general and administrative. Previously, those expenses were reported
as two separate line items under operating expenses. Amounts related to selling,
general and administrative expenses for the years ended December 31, 2018 and
2017 have been restated throughout this Annual Report on Form 10-K to reflect
this reclassification of selling, general and administrative expenses and to
conform to the current period presentation.
Software maintenance revenue is now being reported in the accompanying
statements of operations as a component of product sales. Previously, these
revenues were reported in service sales. Amounts related to software maintenance
revenue for the years ended December 31, 2018 and 2017 have been restated
throughout this Annual Report on Form 10-K to reflect this reclassification of
software maintenance revenue and to conform to the current period presentation.
Software maintenance cost of sales is now being reported in the accompanying
statements of operations as a component of product cost of sales. Previously,
these cost of sales was reported in service cost of sales. Amounts related to
software maintenance cost of sales for the years ended December 31, 2018 and
2017 have been restated throughout this Annual Report on Form 10-K to reflect
this reclassification of software maintenance cost of sales and to conform to
the current period presentation.
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Results of Operations
2019 Compared to 2018
Years ended December 31,
2019 2018 Change
(dollars in millions) % of Sales % of Sales 2019 vs 2018
Product $ 289.7 75.9 % $ 320.6 79.4 % $ (30.9)
Service 92.1 24.1 % 83.0 20.6 % 9.0
Total sales 381.8 100.0 % 403.6 100.0 % (21.9)
Product 133.2 34.9 % 130.9 32.4 % 2.4
Service 50.4 13.2 % 51.2 12.7 % (0.8)
Total cost of sales 183.6 48.1 % 182.1 45.1 % 1.6
Gross profit 198.1 51.9 % 221.6 54.9 % (23.4)
Operating expenses
Selling, general and administrative 177.4 46.5 % 169.7 42.0 % 7.7
Research and development 44.2 11.6 % 46.1 11.4 % (1.9)
Impairment loss 35.2 9.2 % - - % 35.2
Total operating expenses 256.8 67.3 % 215.8 53.5 % 41.0
Other expense 2.4 0.6 % 1.2 0.3 % 1.2
Income tax expense (benefit) 1.1 0.3 % (0.4) (0.1) % 1.5
Net (loss) income $ (62.1) (16.3) % $ 4.9 1.2 % $ (67.0)
Consolidated Results
Sales. Total sales decreased by $21.9 million , or 5.4%, to $381.8 million for
the year ended December 31, 2019 from $403.6 million for the year ended
December 31, 2018 . Total product sales decreased by $30.9 million , or 9.6%, to
$289.7 million for the year ended December 31, 2019 from $320.6 million for the
year ended December 31, 2018 . Our product sales decrease reflected lower unit
sales primarily driven by continuing softness in many of our served markets,
with particular softness in the automotive and broader Asian markets. Service
sales increased by $9.0 million , or 10.9%, to $92.1 million for the year ended
December 31, 2019 from $83.0 million for the year ended December 31, 2018 ,
primarily due to an increase in warranty and customer service revenue driven by
the growth of our global installed, serviceable base and focused sales
initiatives to maintain customer relationships after the purchase of our
measurement devices. Foreign exchange rates had a negative impact on sales of
$13.0 million , decreasing our overall sales by approximately 3.2%, primarily due
to the weakening of the Euro and Chinese Yuan relative to the U.S. dollar.
Gross profit. Gross profit decreased by $23.4 million , or 10.6%, to $198.1
million for the year ended December 31, 2019 from $221.6 million for the year
ended December 31, 2018 . Gross margin decreased to 51.9% for the year ended
December 31, 2019 from 54.9% in the prior year period. Gross margin from product
revenue decreased by 5.2 percentage points to 54.0% for the year ended December
31, 2019 from 59.2% in the prior year period. This decrease in gross margin from
product revenue was primarily due to the $12.8 million increase in our reserve
for excess and obsolete inventory recorded in the fourth quarter of 2019 in
connection with our strategic decisions to simplify our hardware product
portfolio and cease selling certain products, compared to a $4.7 million
increase in our reserve for excess and obsolete inventory recorded in 2018.
Gross margin from service revenue increased by 7.0 percentage points to 45.3%
for the year ended December 31, 2019 from 38.3% for the prior year period,
primarily due to the leveraging effect of higher warranty and customer service
revenue as well as improved efficiencies in our customer service repair process.
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Selling, general and administrative expenses. Selling, general and
administrative ("SG&A") expenses increased by $7.7 million , or 4.5%, to $177.4
million , for the year ended December 31, 2019 from $169.7 million for the year
ended December 31, 2018 . This increase was driven primarily by executive team
transition costs, including the acceleration of stock-based compensation expense
related to the accelerated vesting of stock options and restricted stock units
granted to our prior executive officers and severance costs, professional fees
incurred related to the GSA Matter, and an increase in compensation expenses
related to our increased selling headcount, partially offset by lower commission
expense due to the decrease in product sales. SG&A expenses as a percentage of
sales increased to 46.5% for the year ended December 31, 2019 from 42.0% for the
year ended December 31, 2018 .
Research and development expenses. Research and development expenses decreased
$1.9 million , or 4.1%, to $44.2 million for the year ended December 31, 2019
from $46.1 million for the year ended December 31, 2018 . This decrease in
research and development expenses was mainly due to a decrease in materials and
consulting costs, as well as favorable changes in foreign currencies as the U.S.
dollar strengthened against the Euro, which decreased the compensation cost of
foreign research and development employees. Research and development expenses as
a percentage of sales increased to 11.6% for the year ended December 31, 2019
from 11.4% for the year ended December 31, 2018 .
Impairment loss. As a result of our annual goodwill and intangible asset
impairment test performed in December 2019 , we recorded an impairment loss of
$35.2 million in the fourth quarter of 2019, which included $21.2 million in
goodwill, $10.5 million in intangible assets associated with recent
acquisitions, $1.4 million in intangible assets related to capitalized patents,
and $2.1 million in other asset write-downs. There were no similar impairments
in 2018.
Other expense. Other expense was $2.4 million for the year ended December 31,
2019 compared to $1.2 million for the year ended December 31, 2018 . This
increase 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, partially offset by a favorable
adjustment to the contingent consideration liability from a prior year
acquisition.
Income tax expense (benefit). Income tax expense for the year ended December 31,
2019 was $1.1 million compared with an income tax benefit of $0.4 million for
the year ended December 31, 2018 . Our effective tax rate was 1.9% for the year
ended December 31, 2019 compared to (8.2%) for the year ended December 31, 2018 .
The change in income tax expense (benefit) was primarily due to $8.5 million of
income tax expense recorded in the year ended December 31, 2019 resulting from
our determination that it is more likely than not that certain foreign deferred
tax assets will not be fully realized and the establishment of a valuation due
to a history of cumulative losses in related jurisdictions. Additionally, the
year-over-year change in our income tax expense (benefit) and our effective tax
rate was partially due to a pretax book loss during the year ended December 31,
2019 as compared with pretax book income in the year ended December 31, 2018 , as
well as provision-to-return adjustments recorded in 2019 and 2018.
Net (loss) income. Net loss was $62.1 million for the year ended December 31,
2019 compared with net income of $4.9 million for the year ended December 31,
2018 , reflecting the impact of the factors described above.
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2018 Compared to 2017
Years ended December 31,
2018 2017 Change
(dollars in millions) % of Sales % of Sales 2018 vs 2017
Product $ 320.6 79.4 % $ 287.2 79.6 % $ 33.4
Service 83.0 20.6 % 73.7 20.4 % 9.4
Total sales 403.6 100.0 % 360.9 100.0 % 42.7
Product 130.9 32.4 % 115.8 32.1 % 15.1
Service 51.2 12.7 % 46.5 12.9 % 4.7
Total cost of sales 182.1 45.1 % 162.2 45.0 % 19.8
Gross profit 221.6 54.9 % 198.7 55.0 % 22.9
Operating expenses
Selling, general and administrative 169.7 42.0 % 152.3 42.2 % 17.4
Research and development 46.1 11.4 % 41.1 11.4 % 5.0
Total operating expenses 215.8 53.5 % 193.4 53.6 % 22.4
Other expense (income) 1.2 0.3 % (0.5) (0.1) % 1.7
Income tax (benefit) expense (0.4) (0.1) % 20.3 5.6 % (20.7)
Net income (loss) $ 4.9 1.2 % $ (14.5) (4.0) % $ 19.4
Consolidated Results
Sales. Total sales increased by $42.7 million , or 11.8%, to $403.6 million for
the year ended December 31, 2018 from $360.9 million for the year
ended December 31, 2017 . Our sales increase was primarily driven by increases in
both unit sales and average selling prices and growth in hardware warranty
revenue, partially offset by the $4.8 million reduction of our total sales
recorded in the fourth quarter of 2018 as a result of the GSA Matter (the "GSA
cumulative sales adjustment"). Total product sales increased by $33.4 million ,
or 11.6%, to $320.6 million for the year ended December 31, 2018 from $287.2
million for the year ended December 31, 2017 . Our product sales increase was
primarily driven by increases in both unit sales and average selling prices,
partially offset by the GSA cumulative sales adjustment. Service
revenue increased by $9.4 million , or 12.7%, to $83.0 million for the year
ended December 31, 2018 from $73.7 million for the year ended December 31, 2017 ,
primarily due to an increase in warranty and customer service revenue driven by
the growth of our installed, serviceable base and focused sales initiatives,
partially offset by the GSA cumulative sales adjustment. Foreign exchange rates
had a slightly positive impact on sales of $2.5 million , increasing our overall
sales growth by 0.7 percentage points, primarily due to the strengthening of the
Euro, Japanese Yen and Chinese Yuan relative to the U.S. dollar.
Gross profit. Gross profit increased by $22.9 million , or 11.5%, to $221.6
million for the year ended December 31, 2018 from $198.7 million for the year
ended December 31, 2017 . Gross margin decreased to 54.9% for the year
ended December 31, 2018 from 55.0% for the year ended December 31, 2017 . This
decrease was primarily due to the GSA cumulative sales adjustment recorded in
the fourth quarter of 2018 and a $4.7 million inventory charge recorded in the
third quarter of 2018 resulting from an analysis of our inventory reserves in
connection with our new product introductions and acquisitions, increasing our
reserve for excess and obsolete inventory, partially offset by higher average
selling prices of our measurement solutions due to new product introductions,
improved manufacturing efficiencies and higher gross margin from service
revenue.
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Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $17.4 million , or 11.4%, to $169.7 million ,
for the year ended December 31, 2018 from $152.3 million for the year
ended December 31, 2017 . This increase was due to higher compensation expense
from headcount increases, primarily driven by our global sales force headcount
increase, an increase in commission expense driven by increased sales and an
increase in global system expenses associated with implementing the European
Union's General Data Protection Regulation. SG&A expenses as a percentage of
sales were 42.0% for the year ended December 31, 2018 compared with 42.2% for
the year ended December 31, 2017 .
Research and development expenses. Research and development
expenses increased $5.0 million , or 12.2%, to $46.1 million for the year
ended December 31, 2018 from $41.1 million for the year ended December 31, 2017 .
This increase in research and development expenses was mainly due to higher
compensation expense resulting from increased engineering headcount and higher
amortization of intangible assets related to acquisitions and new production
tooling for the manufacture of our products.
Other expense (income). Other expense was $1.2 million for the year ended
December 31, 2018 compared to other income of $0.5 million for the year ended
December 31, 2017 . This change was primarily driven by the $0.5 million of
imputed interest expense recorded in the fourth quarter of 2018 related to the
GSA cumulative sales adjustment and the effect of foreign exchange rates on the
value of the current intercompany account balances of our subsidiaries
denominated in other currencies.
Income tax (benefit) expense. Income tax benefit for the year ended December 31,
2018 was $0.4 million compared with income tax expense of $20.3 million for the
year ended December 31, 2017 . This change was primarily due to the higher income
tax expense for the year ended December 31, 2017 related to the U.S. Tax Cuts
and Jobs Act of 2017 (the "U.S. Tax Cuts and Jobs Act").
On December 22, 2017 , the United States enacted the U.S. Tax Cuts and Jobs Act,
resulting in significant modifications to existing law. We followed the guidance
in Securities and Exchange Commission ("SEC") Staff Accounting Bulletin 118
("SAB 118"), which provided additional clarification regarding the application
of Financial Accounting Standards Board ("FASB") Accounting Standards
Codification ("ASC") Topic 740, Income Taxes ("FASB ASC Topic 740"), if a
company did not have the necessary information available, prepared or analyzed
in reasonable detail to complete the accounting for certain income tax effects
of the U.S. Tax Cuts and Jobs Act for the reporting period in which the U.S. Tax
Cuts and Jobs Act was enacted. As a result, in accordance with the U.S. Tax Cuts
and Jobs Act, we recorded a provisional amount of $19.4 million of additional
income tax expense in the fourth quarter of 2017, the period in which the
legislation was enacted. The portion of this $19.4 million provisional amount
that related to the transition tax on the mandatory deemed repatriation of
foreign earnings was $17.4 million based on our best estimate and guidance
available at that time.
As additional guidance was released during the SAB 118 remeasurement period, we
completed our transition tax analysis, which resulted in an income tax benefit
of $1.0 million and a $1.8 million decrease of our deferred tax assets recorded
in the fourth quarter of 2018 related to adjustments to the transition tax on
mandatory deemed repatriation of foreign earnings.
Net income (loss). Net income was $4.9 million for the year ended December 31,
2018 compared with a net loss of $14.5 million for the year ended December 31,
2017 , reflecting the impact of the factors described above.
Liquidity and Capital Resources
Cash and cash equivalents increased by $24.9 million to $133.6 million at
December 31, 2019 from $108.8 million at December 31, 2018 . The increase was
primarily driven by net cash provided by operating activities and financing
activities, partially offset by net cash used in investing activities.
Cash flows from operating activities provide our primary source of liquidity. We
generated positive cash flows from operations of $32.5 million during the year
ended December 31, 2019 compared to $6.3 million during the year ended
December 31, 2018 . The increase was mainly due to the non-cash impairment
charges recorded in the fourth quarter of 2019, as well as changes in working
capital, primarily comprised of a decrease in accounts receivable, an increase
in GSA liability and unearned service revenue; partially offset by an increase
in inventory.
Cash flows used in investing activities during the year ended December 31, 2019
were $9.3 million compared with $55.8 million during the year ended December 31,
2018 . The change was primarily due to cash paid for acquisitions of $27.1
million , for our $1.8 million equity investment in Present4D, and for the net
purchase of $14.0 million in U.S. Treasury Bills during the year ended December
31, 2018 , compared to no such activity in the year ended December 31, 2019 .
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Cash flows provided by financing activities during the years ended December 31,
2019 and December 31, 2018 were $2.2 million and $19.8 million , respectively.
The decrease was primarily driven by a reduction in proceeds from the issuance
of stock relating to the exercise of stock options during the year ended
December 31, 2019 compared to the prior year, increased contingent consideration
paid in connection with our recent acquisitions in the year ended December 31,
2019 , and increased payments for taxes related to the net share settlement of
equity awards in the year ended December 31, 2019 .
Of our cash and cash equivalents, $89.3 million was held by foreign subsidiaries
as of December 31, 2019 . On December 22, 2017 , the United States enacted 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. Despite the changes in US tax law, our current intent is to
indefinitely reinvest these funds in our foreign operations, as the cash is
needed to fund ongoing operations.
On November 24, 2008 , our Board of Directors approved a $30.0 million share
repurchase program. Subsequently, in October 2015 , our Board of Directors
authorized an increase to the existing share repurchase program from $30.0
million to $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, 2019 , 2018 and 2017 under this program. As of December
31, 2019 , we had authorization to repurchase $18.3 million of the $50.0 million
authorized 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.
Contractual Obligations and Commercial Commitments
We are party to capital leases on equipment with an initial term of 36 to 60
months and other non-cancellable operating leases. These obligations are
presented below as of December 31, 2019 (dollars in thousands):
Payments Due by Period
Contractual Obligations Total < 1 Year 1-3 Years 3-5 Years > 5 Years
Operating lease obligations $ 22,173 $ 7,188 $ 7,065 $ 5,549 $ 2,371
Capital lease obligations 799 355 401 43 $ -
Purchase obligations 54,169 52,640 1,529 - -
Transition tax liability 12,247 1,166 2,333 5,103 3,645
Other obligations 733 733 - - -
Total $ 90,121 $ 62,082 $ 11,328 $ 10,695 $ 6,016
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 December 31, 2019 , we
had approximately $52.6 million in purchase commitments that are expected to be
delivered within the next 12 months. To ensure adequate component availability
in preparation for new product introductions, we also had $1.5 million in
long-term commitments for purchases to be delivered after 12 months. During the
fourth quarter of 2017, we recorded a provisional amount of $17.4 million
related to the increase to our taxes payable pursuant to the U.S. Tax Cuts and
Jobs Act associated with the mandatory deemed repatriation of the earnings of
our foreign subsidiaries, or transition tax. During the fourth quarter of 2018,
we decreased the provisional estimate of the one-time transition tax by $2.8
million upon completing our analysis of earnings and profits of our foreign
subsidiaries and utilization of foreign tax credits. $1.8 million of the
decrease related to a change in our deferred tax assets, and $1.0 million was an
income tax benefit recorded in the fourth quarter of 2018. We made our first two
transition tax payments in 2018 and 2019 and will pay the remaining liability
over the next six years. Other obligations included in the table primarily
represent estimated payments due for acquisition related earn-outs of $0.7
million .
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Inflation
Inflation did not have a material impact on our results of operations in recent
years, and we do not expect inflation to have a material impact on our
operations in 2020.
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 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's financial 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.
Revenue Recognition
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 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. We
separately sell extended warranties. Extended warranty revenues are recognized
on a straight-line basis over the term of the warranty. Costs relating to
extended warranties are recognized as incurred. Revenue from sales of 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
maintenance renewal rate. Maintenance renewals, when sold, are recognized on a
straight-line basis over the term of the maintenance agreement. 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.
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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.
Income Taxes
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.
Reserve for Warranties
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.
Goodwill Impairment
Goodwill represents 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.
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We changed the timing of our annual test of goodwill during 2019 to align with
our updated strategic plan and annual budgetary process. Accordingly, we
performed our annual quantitative test for impairment of our recorded goodwill
as of December 10, 2019 . As a result of this test, the estimated fair value of
each of the Photonics reporting unit, which included goodwill recognized with
the Instrument Associates, LLC d/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.
Each period, and for any of our reporting units, 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, 2018 and 2017.
Business Combinations
We allocate the fair value of purchase consideration to the assets acquired and
liabilities assumed based 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 earn-outs, 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.
Stock-Based Compensation
We measure and record compensation expense using the applicable accounting
guidance for share-based payments related to stock options, restricted stock,
restricted stock units and performance-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 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.
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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.
Also, beginning in October 2018 , 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
In February 2016 , the FASB issued Accounting Standards Update ("ASU") No.
2016-02, Leases (Topic 842) ("ASU 2016-02"), which is intended to increase
transparency and comparability among organizations by recognizing lease assets
and lease liabilities on the balance sheet and disclosing key information about
leasing arrangements to enable users of financial statements to assess the
amount, timing and uncertainty of cash flows arising from leases. ASU No.
2018-11, Leases (Topic 842): Targeted Improvements, was issued by the FASB in
July 2018 and allows for a cumulative-effect adjustment transition method of
adoption. We adopted ASU 2016-02 effective as of January 1, 2019 utilizing the
cumulative-effect adjustment transition method of adoption, which resulted in
the recognition on our consolidated balance sheet as of December 31, 2019 of
$18.4 million of right-of-use assets for operating leases, $19.6 million of
lease liability for operating leases, $0.8 million of property and equipment,
net for finance leases and $0.8 million of lease liability for finance leases
under which we function as a lessee. We elected certain practical expedients
available under the transition provisions to (i) allow aggregation of non-lease
components with the related lease components when evaluating accounting
treatment, (ii) apply the modified retrospective adoption method, utilizing the
simplified transition option, which allows us to continue to apply the legacy
guidance in FASB ASC Topic 840, including its disclosure requirements, in the
comparative periods presented in the year of adoption, and (iii) use hindsight
in determining the lease term (that is, when considering our options to extend
or terminate the lease and to purchase the underlying asset) and in assessing
impairment of our right-of-use assets. The adoption of ASU 2016-02 also required
us to include any initial direct costs, which are incremental costs that would
not have been incurred had the lease not been obtained, in the right-of-use
assets. The recognition of these costs in connection with our adoption of this
guidance did not have a material impact on our consolidated financial
statements.
In January 2017 , the FASB issued ASU No. 2017-04, Intangible - Goodwill and
Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"),
which is intended to simplify the subsequent measurement of goodwill by
eliminating Step 2 from the goodwill impairment test. Under the new guidance, we
perform our goodwill impairment test by comparing the fair value of a reporting
unit with its carrying amount. An impairment charge is recognized for the amount
by which the carrying amount exceeds the reporting unit's fair value up to the
amount of the goodwill allocated to the reporting unit. The new guidance also
eliminates the requirements for any reporting unit with a zero or negative
carrying amount to perform Step 2 of the goodwill impairment test if it fails
the qualitative assessment. We adopted this guidance in connection with our
annual impairment test for the fiscal year ended December 31, 2019 . The adoption
of this guidance did not have a material impact on our consolidated financial
statements.
Impact of Recently Issued Accounting Standards
In 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.
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