Palladyne AI Corp. (PDYN) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Annual Report. In addition to historical information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in Part I Item 1A Risk Factors and elsewhere in this Annual Report. See also Part I Special Note Regarding Forward-Looking Statements in this Annual Report.
Overview
We are a technology leader in the design, development and manufacture of advanced robotic systems and solutions that redefine human possibilities. Our mission is to increase worker productivity and longevity and prevent injuries through robotics. Our robotic systems are designed to augment and increase human productivity, rather than replace humans, by combining human intelligence, instinct and judgment with the strength, endurance and precision of machines.
Our core systems consist of the Guardian XM, Guardian XT and Guardian Sea Class teleoperated/semi-autonomous systems and the Guardian XO exoskeleton. We adapt these core systems for specific use-cases based on the capabilities and characteristics of each system to create solutions. We may also combine aspects of multiple systems or create a specific system for a particular solution.
Based on feedback from our development customers and potential commercial customers, we have decided to offer our systems and solutions primarily through a sales business model where the customer purchases a system or solution for a one-time, upfront amount. We also plan to offer software upgrades and additional capabilities and to offer for sale add-on hardware components (such as additional interchangeable end-effectors).
Business Combination
On September 24, 2021 (the “Closing Date”), we consummated a business combination (the “Business Combination”) pursuant to the terms of the Agreement and Plan of Merger, dated as of April 5, 2021, by and among Rotor Acquisition Corp. (“Rotor”), Rotor Merger Sub Corp., a Delaware corporation, and a direct, wholly-owned subsidiary of Rotor (“Merger Sub”), and Sarcos Corp., a Utah corporation (“Old Sarcos”) and Amendment No. 1 to the Agreement and Plan of Merger, dated as of August 28, 2021 (the “Amendment” and the Original Merger Agreement, as amended, the “Merger Agreement”), by and among Rotor, Merger Sub and Old Sarcos. Pursuant to the terms of the Merger Agreement, the Business Combination between Rotor and Old Sarcos was effected through the merger of Merger Sub with and into Old Sarcos, with Old Sarcos continuing as the surviving corporation (the “Merger”) and a wholly-owned subsidiary of the Company. On the Closing Date, Rotor changed its name to Sarcos Technology and Robotics Corporation.
The Business Combination was accounted for as a reverse capitalization, with no goodwill or other intangible assets recorded, in accordance with U.S. GAAP. Under this method of accounting, Rotor is treated as the “acquired” company for financial reporting purposes. Accordingly, for accounting purposes, the financial statements of the combined entity represent a continuation of the financial statements of Old Sarcos with the Business Combination being treated as the equivalent of Old Sarcos issuing stock for the net assets of Rotor, accompanied by a recapitalization. The net assets of Old Sarcos and Rotor are stated at historical cost, with no goodwill or other intangible assets recorded. Financial statement information, including results of operations prior to the Business Combination are those of Old Sarcos.
Response to COVID-19
On January 30, 2020, the World Health Organization declared the COVID-19 outbreak a “Public Health Emergency of International Concern” and on March 11, 2020, declared it to be a pandemic. Actions taken around the world to help mitigate the spread of COVID-19 include restrictions on travel, quarantines in certain areas and forced closures for certain types of public places and businesses. COVID-19 and actions taken to mitigate its spread have had and may continue to have an adverse impact on the economies and financial markets of many countries, including the geographies in which Sarcos operates.
We took several actions in response to the COVID-19 pandemic that resulted in significant disruptions to how we operate our business. Our customers and partners adopted similar policies. These actions and policies of ours and our customers and partners are evolving as laws, regulations and recommendations evolve. Although many of these measures are no longer in effect, we have experienced, and may continue to experience, an adverse impact on certain parts of our business as a result of
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measures to mitigate the COVID-19 pandemic and their resulting economic effects. Further, discontinued measures could be reinstituted, for example as a result of government requirements or in response to new variants of COVID-19.
We have experienced and may continue to experience disruptions in our supply chain, due in part to the global impact of the COVID-19 pandemic. Depending upon the duration of the ongoing COVID-19 pandemic and the associated business interruptions, our customers, suppliers, manufacturers and partners may suspend or delay their engagements with us, which could result in a material adverse effect on our financial condition and ability to meet current timelines. In an effort to manage potential supply chain risks, in particular increasing and unpredictable lead-times, we have accelerated and expect to continue to accelerate purchases of various materials, parts and components for the foreseeable future to support product development and current and future production of our commercial units, which has and will likely continue to increase our use of cash. In addition, the COVID-19 pandemic has affected and may continue to affect our ability to recruit skilled employees to join our team. The conditions caused by the pandemic have adversely affected and may continue to adversely affect, among other things, demand for our products and the ability to test and assess our robotic systems with potential customers any of which adversely affects our business, results of operations and financial condition. The duration and extent of the COVID-19 pandemic and its impacts cannot be accurately predicted at this time, and the ultimate direct and indirect impacts on our business, results of operations and financial condition will depend on future developments that are highly uncertain.
The global impact of COVID-19 continues to rapidly evolve, and we will continue to monitor the situation and the effects on our business and operations closely. We do not yet know the full extent of potential impacts on our business or operations. In particular, the effect of the COVID-19 pandemic may not be fully reflected in our operating results until future periods. Given this uncertainty, we cannot reasonably estimate the impact of the COVID-19 pandemic on our future results of operations, cash flows, or financial condition.
Key Factors Affecting Operating Results
We believe that our performance and future success depend on several factors that present significant opportunities for us but also pose risks and challenges, including those discussed below and in Part I Item 1A Risk Factors of this Annual Report on Form 10-K.
Development, Testing and Commercial Launch of our Core Products
We expect that revenue from the commercial launch of three of our core products, the Guardian XT, Guardian XM and Guardian Sea Class, will determine our near-term financial success. We began initial production of commercial units of the Guardian XM during September 2022 and initial production of commercial units of the Guardian XT during December 2022. We expect that we will have units of both of these systems available for delivery to customers in the first half of 2023. In large part due to significant supply chain disruptions that have limited our supply of parts common to both the Guardian XO and Guardian XT and certain parts pertaining to the Guardian XO, we have prioritized the commercialization of the Guardian XT and Guardian XM and delayed the commercial launch of the Guardian XO. We chose to prioritize the Guardian XT and Guardian XM as we were closer to completing development of commercial units for those products and initial demand for those products appears strong, and our ongoing re-design of the Guardian XO in order to decrease its weight and integrate customer feedback will require additional time to complete. Timelines may be delayed, including due to challenges in recruiting skilled employees, difficulties in securing components and materials, development delays, difficulties relating to manufacturing of the units and other factors discussed under Part I Item 1A Risk Factors “Risks Related to Our Business and Industry.” Such challenges may result in further delay of the anticipated commercial launch of one or more of our products, which would adversely affect our financial condition and operating results.
Financing of Operations
Prior to commercialization, we must complete the development, testing and manufacturing requirements of our products. As a result, we will spend a material portion of our cash on hand to develop our products and fund operations for the foreseeable future. The amount and timing of our future funding requirements will depend on many factors, including the pace and results of our product development efforts, our ability to manufacture, sell and deliver commercial products and thereby recognize associated revenue, capital requirements to build commercial products prior to receiving payments sufficient to cover our costs and our ability to lower product costs as volumes increase. We currently expect to obtain outside financing to help cover production costs for product orders. In addition, although we believe we have sufficient capital to fund our business for at least the next 12 months, we expect to seek additional financing during that time to bolster our cash reserves and ensure our ability to continue to pursue our business objectives. Any delays in the successful completion of the commercialization of our Guardian XT, Guardian XM, Guardian Sea Class and Guardian XO products will negatively impact our ability to generate revenue, our profitability and our overall operating performance.
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Acquisition and Integration of RE2
On April 25, 2022, we acquired RE2, Inc., a Pittsburgh, PA based developer of manipulator arms with human-like performance, intuitive robot interfaces and advanced autonomy capabilities for use in any environment. At closing, we paid approximately $30 million in cash, net of cash acquired, issued approximately 10.8 million shares of Common Stock and assumed certain outstanding options to acquire RE2 common stock which, following such assumption, represent rights to acquire 3.9 million shares of Common Stock. The results presented and discussed below include the activity for RE2 from the acquisition date through December 31, 2022. Our results do not include RE2’s financial information prior to the acquisition.
Customer Demand
Although our Guardian XT and Guardian XM units are not yet commercially available and we have only recently begun production of commercial units in limited quantities, we have received interest from potential customers that have tested or witnessed demonstrations of our pre-commercial units. However, because our robotic systems represent a new product category in markets that currently rely generally on conventional, manual systems, the market demand for our products is unproven, and important assumptions about the characteristics of targeted markets, pricing and sales cycles may be inaccurate. If customer demand does not develop as expected or we do not accurately forecast pricing, adoption rates and sales cycles for our products, our business, results of operations and financial condition will be adversely affected.
Manufacturing of Our Products
To the extent we obtain commercial orders for our products, we will need to manufacture and deliver them to our customers. We have recently entered into an agreement with a third-party contract manufacturer and expect to generally outsource manufacturing of our products over time. However, engaging with a manufacturing partner will likely require significant time, ramp-up, testing and coordination before high-volume production capability by the partner is achieved. We currently do not anticipate high-volume production by a contract manufacturing partner to be in place until at least the end of 2023. We expect that this contract manufacturing partner will initially focus on helping us produce sub-systems for the Guardian XT. We expect that in 2023 we will have the internal capability to manufacture a total of between 300 – 500 systems, depending on the mix. However, we do not believe that we will use all of that capacity in 2023. For additional information around the risks associated with contract manufacturing see Part I Item 1A Risk Factors “Our expected transition to an outsourced manufacturing business model may not be successful, which could harm our ability to deliver products and recognize revenue.”
Continued Investment and Innovation
We are a pioneer in the robotic systems industry and benefit from lessons learned over 30 years and significant investment in research and development in our proprietary technologies and our extensive patent portfolio. However, our financial performance is significantly dependent on our ability to maintain this leading position and further dependent on the investments we make in research and development. It is important that we continually identify and respond to rapidly evolving customer requirements, develop and introduce innovative new products, enhance and service existing products and generate active market demand for our robotic systems. If we fail to do this, our market position and revenue may be adversely affected, and our investments into these technologies will not be recovered.
Geopolitical and Macro-economic Environment
Geopolitical and macro-economic factors, such as inflation, rising interest rates, oil prices, unemployment rates, the war in Ukraine, volatility in the stock market and political or social unrest, can have significant impacts on economic activity, which in turn could affect demand for our products or our ability to cost-effectively develop, sell and manufacture our products. Among other things, these and similar factors can affect our supply chain, our ability to hire qualified personnel, our labor and materials costs, the prices we charge for our products and the budgets of our customers and their expected return-on-investment from the purchase of or subscription for our products. Many of these factors are outside of our control but can have a significant impact on our business success and operating results. If we are unable to manage our business successfully in response to any such factors, our business and results of operations would be adversely affected.
Basis of Presentation
Currently, we conduct business through one operating segment. All long-lived assets are maintained in, and all losses are attributable to, the United States of America. See Note 14, Segment Information, in the accompanying consolidated financial statements for more information about our operating segment.
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Components of Results of Operations
Revenue, net
We derive our revenue from two sources. First, we enter into research and development agreements primarily relating to the commercialization of our products. Second, we sell our products and related parts and repair services. Product development contract revenue consists of revenue arising from different types of contractual arrangements, including cost-type contracts and fixed-price contracts. Product revenue primarily consists of sales of the Company’s products.
Product Development Contract Revenue
Cost-type contracts – Research, development and/or testing service contracts, including cost-plus-fixed-fee and time and material contracts, relate primarily to the development of our robotics systems and related technology. Cost-type contracts are generally entered into with the U.S. government. These contracts are billed at cost plus a margin as defined by the contract and Federal Acquisition Regulation (“FAR”). The FAR establishes regulations around procurement by the government and provides guidance on the types of costs that are allowable in establishing prices for goods and services delivered under government contracts. Revenue on cost-type contracts is recognized over time as goods and services are provided.
Fixed-price contracts – Fixed-price development contracts relate primarily to the development of technology in the area of robotic systems. Fixed-price development contracts generally require a significant service of integrating a complex set of tasks and components into a single deliverable. Revenue on fixed-price contracts is generally recognized over time as goods and services are provided. To the extent our actual costs vary from the fixed fee, we will generate more or less profit or could incur a loss. In accordance with Accounting Standards Codification 606, for fixed price contracts, we will recognize losses at the contract level in earnings in the period in which they are incurred.
Product Revenue
Product revenue relates to sales of our products, and certain miscellaneous parts, accessories and repair services. We provide a limited one-year warranty on product sales. Product warranties are considered assurance-type warranties and are not considered to be separate performance obligations. Product revenue is recognized at the point in time when ownership of the goods is transferred, generally at the time of shipment to the customer. At the time product revenue is recognized, an accrual is established for estimated warranty expenses based on historical experience as well as anticipated product performance.
Operating Expenses
Cost of Revenue
Our cost of revenue consists of direct and overhead expenses related to either the sale of our products or our product development contract revenue. Direct expenses include direct labor used in the production of a product or in our product development contracts, benefits expense associated with direct labor and materials directly tied to our product sale or product development contracts. Overhead expenses include allocable supervisory labor, benefits expense associated with supervisory labor, allocation of facilities expense including rent and utilities and allocation of IT labor support and equipment. Overhead expenses not allocated to cost of revenue are expensed across research and development, general and administrative and sales and marketing expenses, as applicable.
Research and Development
Research and development expenses are mainly comprised of costs from the continuing development and refinement of our existing robotic systems and the continuing research and development costs associated with our future products. These expenses include labor and related benefit expenses, materials and supplies used in our laboratories, patent expenses and related overhead expenses. Our research and development expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.
General and Administrative
Our general and administrative expenses consist primarily of employee-related costs for our finance, legal, people success and other administrative teams, as well as certain executives. In addition, general and administrative expenses include insurance,
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public company compliance related costs, including outside legal and accounting expenses, other professional fees, facilities and IT expense not allocated to other operating expense categories, and related overhead expense.
Sales and Marketing
Our sales and marketing expenses arise from our activities relating to our efforts to market and sell our products and services. The expenses consist primarily of labor, benefits and employee-related costs, marketing programs and events, customer service, lead generation fees, product marketing expense, public relations fees and travel associated with sales generation and marketing support and related overhead expense.
We plan to continue to invest in sales and marketing to grow our customer base and increase our brand awareness. The trend and timing of sales and marketing expenses will depend in part on the timing of the commercial launch of our products and their reception by the market. As our product sales grow, we expect that sales and marketing expenses will increase in absolute dollars in future periods; however, we expect our sales and marketing expenses to decrease as a percentage of our revenue over the long term, although our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.
Intangible Amortization Expense
Amortization of intangible assets primarily consists of amortization of identified finite-lived trade name and trademarks, developed technology, and customer relationship assets that were allocated a portion of the purchase price from the acquisition of RE2. These costs are amortized on a straight-line basis over 5 to 9 year useful lives and, as a result, amortization expense on these assets is expected to increase slightly next year and then remain stable over the coming years.
Goodwill Impairment
Goodwill represents the excess of consideration transferred over the fair value of tangible and identifiable intangible net assets acquired and the liabilities assumed in a business combination. All of our goodwill was recognized from the acquisition of RE2. Goodwill is tested for impairment at the reporting unit level annually or more frequently if events or changes in circumstances indicate that it is more likely than not that the fair value of the reporting unit is less than its carrying amount.
We currently operate as a single reporting unit. When testing goodwill for impairment, we have the option of first performing a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If we elect to bypass the qualitative assessment, or if a qualitative assessment indicates it is more likely than not that carrying value exceeds its fair value, we perform a quantitative goodwill impairment test. Under the quantitative goodwill impairment test, if our reporting unit’s carrying amount exceeds its fair value, we will record an impairment charge based on that difference. During the fourth quarter of 2022, due to the sustained decreases in our publicly quoted share price and market capitalization, we performed a quantitative goodwill impairment test. Based on the results of the quantitative goodwill impairment assessment we concluded that the carrying value of the single reporting unit exceeded its fair value and that our goodwill was fully impaired as of December 31, 2022. We recorded a $70.2 million non-cash goodwill impairment charge during the twelve months ended December 31, 2022.
Other Income (Loss)
Interest Income (Expense), net
Interest income consists primarily of interest received or earned on our cash and marketable securities balances. Portions of our cash resided in money market investments and in U.S. Treasury securities at various points during the year. Interest expense is primarily due to interest paid on leased equipment used for our software platforms.
Gain (Loss) Warrant Liability
Gain (loss) on warrant liability consists of the change in fair value of the private placement warrants we assumed as part of the Business Combination.
Gain on Forgiveness of Notes Payable
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Gain on forgiveness of notes payable consists of gains recognized as a result of the forgiveness of our loans received under the Paycheck Protection Program (“PPP”).
Other Income, net
Other income, net consists primarily of other miscellaneous non-operating items such as proceeds from the CARES Act employee retention credit.
Income Tax Benefit (Expense)
Income taxes consist of taxes currently due plus deferred income taxes related primarily to differences between the tax bases and financial reporting bases of assets and liabilities. The deferred income taxes represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.
Results of Operations
The discussion below regarding our results of operations for the twelve months ended December 31, 2022, includes the financial results of RE2 beginning on the acquisition date of April 25, 2022 through December 31, 2022. Our results do not include RE2’s financial information prior to the acquisition.
Comparison of the Year Ended December 31, 2022, and 2021
Revenue, net
The following table presents our revenue for the twelve months ended December 31, 2022 and 2021:
| Year Ended December 31, | 2022 vs. 2021 Change | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) | 2022 | 2021 | Change | % Change | ||||||||||||
| Product Development Contract Revenue | $ | 14,239 | $ | 3,584 | $ | 10,655 | 297 | % | ||||||||
| Product Revenue | 330 | 1,491 | (1,161 | ) | (78 | )% | ||||||||||
| Revenue, net | $ | 14,569 | $ | 5,075 | $ | 9,494 | 187 | % |
Revenue increased by $9.5 million, or 187%, from $5.1 million in the twelve months ended December 31, 2021, to $14.6 million in the twelve months ended December 31, 2022, as explained below.
Product Development Contract Revenue
Revenue derived from product development contracts increased by $10.7 million, or 297%, from $3.6 million for the twelve months ended December 31, 2021 to $14.2 million for the twelve months ended December 31, 2022. The increase was primarily due to revenue recognized by RE2 from the acquisition date through December 31, 2022 pertaining to ongoing product development contracts. We expect future revenue from product development contracts to increase on a year over year basis due to the inclusion of RE2 product development contract revenue for the full year and as we bring on additional development contracts that support our commercialization efforts. As we focus on initial commercial product sales of our core product portfolio, our product development contract revenue will decrease as a percentage of total revenue.
Product Revenue
Revenue derived from product sales decreased by $1.2 million, or 78%, from $1.5 million for the twelve months ended December 31, 2021 to $0.3 million for the twelve months ended December 31, 2022. The decrease was a result of reduced sales of our legacy products to focus on the commercialization of our core product portfolio.
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Operating Expenses
The following table presents our operating expenses for the twelve months ended December 31, 2022 and 2021:
| Year Ended December 31, | 2022 vs. 2021 Change | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) | 2022 | 2021 | Change | % Change | ||||||||||||
| Operating expenses: | ||||||||||||||||
| Cost of revenue | $ | 11,614 | $ | 3,867 | $ | 7,747 | 200 | % | ||||||||
| Research and development | 34,144 | 17,516 | 16,628 | 95 | % | |||||||||||
| General and administrative | 63,480 | 58,059 | 5,421 | 9 | % | |||||||||||
| Sales and marketing | 9,949 | 6,624 | 3,325 | 50 | % | |||||||||||
| Intangible amortization expense | 2,184 | — | 2,184 | *NM | ||||||||||||
| Goodwill impairment | 70,236 | — | 70,236 | *NM | ||||||||||||
| Total operating expenses | $ | 191,607 | $ | 86,066 | $ | 105,541 | 123 | % |
*NM - Not Meaningful
Cost of Revenue
Cost of revenue increased by $7.7 million, or 200%, from $3.9 million for the twelve months ended December 31, 2021, to $11.6 million for the twelve months ended December 31, 2022. Cost of revenue increased significantly mainly due to the increase in revenue from the inclusion of RE2's product development contract revenue and the costs associated with that revenue beginning April 25, 2022.
Research and Development
Research and development expenses increased by $16.6 million, or 95%, from $17.5 million for the twelve months ended December 31, 2021, to $34.1 million for the twelve months ended December 31, 2022. The increase was driven primarily by an increase in labor and overhead expense as a result of increased headcount (due in part to the RE2 acquisition) and third-party service provider costs as we focused on the development and commercialization of our Guardian XT, Guardian XM, Guardian Sea Class and Guardian XO products. We expect research and development expenses to decrease slightly during 2023 on a year-over-year basis as we continue to develop and refine our existing products and further enhance our efforts on our future products and software.
General and Administrative
General and administrative expenses increased by $5.4 million, or 9%, from $58.1 million for the twelve months ended December 31, 2021, to $63.5 million for the twelve months ended December 31, 2022. General and administrative expenses increased due to increased legal expenses, business insurance expenses, increased headcount (due in part to the acquisition of RE2) and related expenses. With the exception of stock-based compensation expense, we expect our general and administrative expenses to increase slightly during 2023 on a year-over-year basis as we work on our commercialization pathway and maintain public-company compliance requirements, but to decrease as a percentage of revenue.
Sales and Marketing
Sales and marketing expenses increased by $3.3 million, or 50%, from $6.6 million for the twelve months ended December 31, 2021, to $9.9 million for the twelve months ended December 31, 2022. This increase was driven by an increase in professional service fees due to the engagement of a third-party vendor utilized in data management of our products and services, and increased headcount expenses, including increased stock-based compensation expense and increased expenses related to additional headcount due in part to our RE2 acquisition. We expect our sales and marketing expenses to increase during 2023 on a year-over-year basis as our revenue increases.
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Intangible Amortization Expense
Intangible amortization expenses increased by $2.2 million, from $0.0 million for the twelve months ended December 31, 2021, to $2.2 million for the twelve months ended December 31, 2022. The increase in intangible amortization expense is due to the recognition of amortization expenses for the identified intangible assets recorded as part of the RE2 acquisition.
Goodwill Impairment
We fully impaired our goodwill and recorded a non-cash goodwill impairment of $70.2 million for the twelve months ended December 31, 2022 compared to no impairment for the twelve months ended December 31, 2021. The non-cash goodwill impairment was primarily driven by the sustained decrease in the Company’s publicly quoted share price and market capitalization.
Other Income (Loss)
The following table presents other income (loss) for the twelve months ended December 31, 2022 and 2021:
| Year Ended December 31, | 2022 vs. 2021 Change | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) | 2022 | 2021 | Change | % Change | ||||||||||||
| Other income (loss) | ||||||||||||||||
| Interest income (expense), net | $ | 1,831 | $ | (34 | ) | $ | 1,865 | (5,485 | )% | |||||||
| Gain (loss) on warrant liability | 13,442 | (4,927 | ) | 18,369 | (373 | )% | ||||||||||
| Gain on forgiveness of notes payable | — | 4,394 | (4,394 | ) | (100 | )% | ||||||||||
| Other income, net | 743 | 51 | 692 | 1,357 | % | |||||||||||
| Total other income (loss) | $ | 16,016 | $ | (516 | ) | $ | 16,532 | (3,204 | )% |
Other income was $16.0 million for the twelve months ended December 31, 2022, as compared to other loss of $0.5 million for the twelve months ended December 31, 2021, as a result of the increase in unrealized mark-to-market gain on our outstanding private placement warrants and increased interest income, partially offset by the gain on forgiveness of notes payable recorded in the prior year period in connection with the forgiveness of our PPP loans.
Income Tax Benefit (Expense)
Income tax benefit increased to $3.9 million for the twelve months ended December 31, 2022, compared to $0.0 million in income tax expense for the twelve months ended December 31, 2021. The income tax benefit recorded during the twelve months ended December 31, 2022 is due to the removal of a portion of our previously recorded valuation allowance on our net deferred tax assets associated with net deferred tax liabilities recorded as part of the acquisition of RE2, resulting in an income tax benefit recognized during the period. The future reversal of the net deferred tax liabilities is a source of taxable income to be considered by us when determining whether a valuation allowance is needed for our existing net deferred tax assets.
Liquidity and Capital Resources
Prior to the closing of the Business Combination, Old Sarcos financed its operations through private placements of redeemable convertible preferred stock, from the limited sale of Guardian S units and other commercially available products and by providing product development contract services and as a subcontractor for prime contractors working with the U.S. Department of Defense.
Upon the closing of the Business Combination, we retained approximately $228.8 million in cash proceeds, net of fees and expenses related to the Business Combination, including $220 million from the PIPE Financing.
We currently use cash to fund operations and capital expenditures and meet working capital requirements. As of December 31, 2022, we had $114.5 million in cash, cash equivalents and marketable securities. We believe that our cash, cash equivalents and marketable securities on hand will be sufficient to support operations, working capital and capital expenditure requirements for at least the next 12 months from the date of this report; however, we may need to secure additional financing prior to achieving positive operating cash flows, which we do not expect to occur until 2025 at the earliest.
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The amount and timing of our future funding requirements will depend on many factors, including the pace and results of our product development efforts, our ability to manufacture and deliver commercial products and thereby recognize associated revenue, capital requirements to build commercial products prior to receiving payments sufficient to cover our costs and our ability to lower product costs as volumes increase. Any delays in the successful completion of the commercialization of our products will negatively impact our ability to generate revenue, our profitability and our overall operating performance.
In addition, we may enter into arrangements to acquire or invest in complementary businesses, services and technologies, which may require acquisition capital as well as operational capital for these acquisitions or arrangements. We may be required to seek additional equity or debt financing to facilitate these arrangements. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when desired, our business, results of operations and financial condition would be materially and adversely affected.
We expect our operating and capital expenditures to increase as we increase headcount, expand our operations and grow our customer base. If additional funds are required to support our working capital requirements, for acquisitions or for other purposes, we may seek to raise funds through additional debt or equity financings or from other sources. We currently expect to obtain outside financing to help cover production costs for product orders. In addition, although we believe we have sufficient capital to fund our business for at least the next 12 months, we may seek additional financing during that time to bolster our cash reserves and ensure our ability to continue to pursue our business objectives. We are satisfied with our liquidity and currently have no plans to do an equity financing in 2023. We will continue monitoring our liquidity, financial and business results and outlook and market conditions, and could change our plans if we determine it to be necessary or advisable. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our equity holders could be significantly diluted and these newly issued securities may have rights, preferences or privileges senior to those of existing equity holders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility and would also require us to incur additional interest expense. Additional financing may not be available at all or, if available, may not be available on terms favorable to us or that we find acceptable.
As of December 31, 2022, our total minimum lease payments are $17.2 million, of which $1.5 million are due in the next 12 months. Additionally, as of December 31, 2022, we had unconditional purchase commitments of $36.0 million, of which $8.0 million is due in the next twelve months. For detail regarding our lease obligations and unconditional purchase commitments refer to Note 4 Leases and Note 13, Commitments and Contingencies, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Cash Flows
The following table summarizes our cash flow data for the periods presented:
| Year Ended December 31, | 2022 vs. 2021 Change | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) | 2022 | 2021 | Change | % Change | ||||||||||||
| Net cash provided by (used in): | ||||||||||||||||
| Net cash used in operating activities | $ | (65,391 | ) | $ | (42,103 | ) | $ | (23,288 | ) | 55 | % | |||||
| Net cash used in investing activities | (109,045 | ) | (4,688 | ) | (104,357 | ) | 2,226 | % | ||||||||
| Net cash (used in) provided by financing activities | (7,519 | ) | 230,241 | (237,760 | ) | (103 | )% | |||||||||
| Net (decrease) increase in cash and cash equivalents | $ | (181,955 | ) | $ | 183,450 | $ | (365,405 | ) | (199 | )% |
Net Cash Used in Operating Activities
Cash flows used in operating activities during the twelve months ended December 31, 2022, increased by $23.3 million to $65.4 million from $42.1 million during the same period in 2021. The increase to net cash used in operating activities was primarily attributable to a $75.6 million increase to net loss, an $18.4 million increase to gains on warrant liability revaluation and a $7.5 million decrease in stock-based compensation, partially offset by goodwill impairment of $70.2 million and $6.0 million of other non-cash expenses. Additionally, net cash used in operating activities related to changes in operating assets and liabilities decreased by $2.0 million, driven mainly by decreases prepaid expenses, partially offset by decreases in accrued liabilities and other non-current liabilities and increases in inventory and billed and unbilled receivables.
Net Cash Used in Investing Activities
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Our net cash used in investing activities increased by $104.4 million. The increase in cash used in investing activities is due to the purchase of marketable securities during the twelve months ended December 31, 2022 of $77.9 million, net of maturities, and $29.7 million of net cash used as part of the purchase consideration for the RE2 acquisition.
Net Cash (Used In) Provided by Financing Activities
Our overall cash provided by financing activities decreased by $237.8 million. The decrease was due mainly to the cash proceeds from the Business Combination and PIPE Financing of approximately $228.8 million, net of expenses and fees, which was completed during the third quarter of 2021 and $2.0 million of proceeds from loans received under the PPP for the twelve months ended December 31, 2021. During the twelve months ended December 31, 2022, $8.1 million was used to repurchase shares of common stock that were withheld for payment of tax withholding obligations upon the vesting of equity awards, partially offset by proceeds from the exercise of stock options.
Emerging Growth Company Status
Section 102(b)(1) of the Jumpstart our Business Startups Act of 2012 (the “JOBS Act”) exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can choose not to take advantage of the extended transition period and comply with the requirements that apply to non-emerging growth companies, and any such election to not take advantage of the extended transition period is irrevocable.
We are an “emerging growth company” as defined in Section 2(a) of the Securities Act, and have elected to take advantage of the benefits of the extended transition period for new or revised financial accounting standards. We will remain an emerging growth company until the earliest of (i) the last day of the fiscal year in which the market value of Common Stock that is held by non-affiliates exceeds $700 million as of the end of that year’s second fiscal quarter, (ii) the last day of the fiscal year in which we have total annual gross revenue of $1.235 billion or more during such fiscal year (as indexed for inflation), (iii) the date on which we have issued more than $1 billion in non-convertible debt in the prior three-year period or (iv) December 31, 2025, and we expect to continue to take advantage of the benefits of the extended transition period, although we may decide to early adopt such new or revised accounting standards to the extent permitted by such standards. This may make it difficult or impossible to compare our financial results with the financial results of another public company that is either not an emerging growth company or is an emerging growth company that has chosen not to take advantage of the extended transition period exemptions because of the potential differences in accounting standards used.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue and expenses at the date of the financial statements. Generally, we base our estimates on historical experience and on various other assumptions in accordance with GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.
Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies and estimates include those related to:
Revenue Recognition
We recognize revenue from the sale of our robotic systems and from contractual arrangements to perform product development contract services that are fully funded by our customers. We recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. Revenue from product development contracts is recognized over time as products and services are provided. For fixed priced contracts we measure progress toward satisfaction of performance obligations using costs incurred to date relative to total estimated costs (“cost-to-cost”). Research and development contracts may last multiple years and estimation of the total transaction price and expected cost requires management’s judgment. Based on the nature of the Company’s research and development contracts, the work to be performed is often complex and may involve new processes, procedures, and tasks which
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creates uncertainty in estimating contract costs. All estimates impacting revenue recognition, including estimates of total expected costs, or Estimates at Completion, are reviewed on a periodic basis, at least quarterly.
For those performance obligations for which revenue is recognized using a cost-to-cost input method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. Changes in judgments with respect to these assumptions and estimates could impact the timing or amount of revenue recognition.
Stock-Based Compensation
We use the fair value approach to account for stock-based compensation in accordance with current accounting guidance and recognize stock-based compensation expenses over the period the recipient is required to provide service in exchange for the award. The Black-Scholes option pricing model is used to estimate the fair value of stock options, which requires the use of a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. The fair value of restricted stock grants is based on the closing market price of our stock on the date of grant less the expected dividend yield. For awards with market based vesting conditions, we estimate the grant date fair value using a Monte-Carlo simulation model or other similar valuation model. These models require the use of assumptions such as the risk-free rate, expected volatility, expected dividends and the correlation coefficient. As we accumulate additional employee stock-based awards data over time and as we incorporate market data related to our common stock, we may calculate significantly different volatilities and expected lives, which could materially impact the valuation of our stock-based awards and the stock-based compensation expense that we will recognize in future periods.
Valuation of Goodwill and Acquired Intangible Assets
Goodwill is initially recorded when the purchase price paid for a business acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. The allocation of the purchase price of the acquired businesses to goodwill and intangible assets requires us to make significant estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets and the appropriate discount rate for those cash flows. Should conditions differ from management’s estimates at the time of the acquisition, material write-downs of goodwill and/or intangible assets may be required.
We evaluate goodwill for impairment at least annually or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The evaluation includes consideration of qualitative factors including industry and market considerations, overall financial performance, and other relevant events and factors affecting the reporting unit. If we determine that a quantitative analysis is necessary, we perform a quantitative analysis which consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. We determine the fair value of our reporting unit based on an income approach. The income approach is based on the present value of estimated future cash flows of the reporting units. If the carrying amount of the reporting unit is in excess of its fair value, the difference between the fair value and carrying amount is recorded as an impairment loss.
An impairment loss on intangible assets with definite useful lives exists when the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. If the carrying amount exceeds the sum of the undiscounted cash flows, an impairment charge is recognized based on the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets.
During the fourth quarter of 2022, due to the sustained decrease in our publicly quoted share price and market capitalization, we performed a quantitative goodwill impairment test. Based on the results of the quantitative goodwill impairment assessment we concluded that the carrying value of the single reporting unit exceeded its fair value and that our goodwill was fully impaired as of December 31, 2022. We recorded a $70.2 million non-cash goodwill impairment charge for the twelve months ended December 31, 2022. During the fourth quarter of 2022 we also tested our intangible assets with definite lives for impairment and found no impairment.
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Recent Accounting Pronouncements
See Note 1, Basis of Presentation and Summary of Significant Accounting Policies, to consolidated financial statements included elsewhere in this Annual Report on Form 10-K for recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted as of the date of this Annual Report on Form 10-K.