The following information should be read in conjunction with the condensed
consolidated financial statements, including the notes thereto, included
elsewhere in this Form 10-Q and Management's Discussion and Analysis of
Financial Condition and Results of Operations included in our Annual Report on
Form 10-K for the year ended December 31, 2019.
FARO Technologies, Inc. ("FARO," the "Company," "us," "we" or "our") has made
"forward-looking statements" in this report (within the meaning of the Private
Securities Litigation Reform Act of 1995). Statements that are not historical
facts or that describe our plans, beliefs, goals, intentions, objectives,
projections, expectations, assumptions, strategies, or future events are
forward-looking statements. In addition, words such as "may," "might," "would,"
"will," "will be," "future," "strategy," "believe," "plan," "should," "could,"
"seek," "expect," "anticipate," "intend," "estimate," "goal," "objective,"
"project," "forecast," "target" and similar words identify forward-looking
statements.
Forward-looking statements are not guarantees of future performance and are
subject to a number of known and unknown risks, uncertainties, and other factors
that could cause actual results to differ materially from those expressed or
implied by such forward-looking statements. Consequently, undue reliance should
not be placed on these forward-looking statements. We do not intend to update
any forward-looking statements, whether as a result of new information, future
events, or otherwise, unless otherwise required by law. Important factors that
could cause actual results to differ materially from those contemplated in such
forward-looking statements include, among others, the following:

•an economic downturn in the manufacturing industry or the domestic and
international economies in the regions of the world where we operate;
•the effect of the COVID-19 pandemic, including on our business operations, as
well as its impact on general economic and financial market conditions;
•our inability to realize the intended benefits of our undertaking to transition
to a company that is reorganized around functions to improve the efficiency of
our sales organization and to improve operational effectiveness;
•our inability to successfully execute our new strategic plan and restructuring
plan, including but not limited to additional impairment charges and/or higher
than expected severance costs and exist costs, and our inability to realize the
expected benefits of such plans;
•our inability to further penetrate our customer base and target markets;
•development by others of new or improved products, processes or technologies
that make our products less competitive or obsolete;
•our inability to maintain what we believe to be our technological advantage by
developing new products and enhancing our existing products;
•the outcome of the U.S. Government's review of, or investigation into, our
potential overcharging of the U.S. Government under our General Services
Administration Federal Supply Schedule contracts, any resulting penalties,
damages or sanctions imposed on us and the outcome of any resulting litigation
to which we may become a party, loss of future government sales and potential
impacts on customer and supplier relationships and our reputation;
•risks associated with expanding international operations, such as difficulties
in staffing and managing foreign operations, increased political and economic
instability, compliance with potentially evolving import and export regulations,
and the burdens and potential exposure of complying with a wide variety of U.S.
and foreign laws and labor practices;
•changes in trade regulation, which result in rising prices of imported steel,
steel byproducts, aluminum and aluminum byproducts and various other raw
materials that we use in the production of measurement devices, and our ability
to pass those costs on to our customers or require our suppliers to absorb such
costs;
•changes in foreign regulation which may result in rising prices of our
measurement devices sold as exports to our international customers, our
customers' willingness to absorb incremental import tariffs, and the
corresponding impact on our profitability;
•our inability to successfully identify and acquire target companies and achieve
expected benefits from, and effectively integrate, acquisitions that are
consummated, including our recent acquisition of Applied Technical Solutions in
Scandinavia AB;
•the cyclical nature of the industries of our customers and material adverse
changes in our customers' access to liquidity and capital;
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•changes in the potential for the computer-aided measurement market and the
potential adoption rate for our products, which are difficult to quantify and
predict;
•our inability to protect our patents and other proprietary rights in the United
States and foreign countries;
•our inability to adequately establish and maintain effective internal controls
over financial reporting;
•fluctuations in our annual and quarterly operating results and the inability to
achieve our financial operating targets as a result of a number of factors
including, without limitation (i) litigation and regulatory action brought
against us, (ii) quality issues with our products, (iii) excess or obsolete
inventory, shrinkage or other inventory losses due to product obsolescence,
change in demand for our products, scrap or material price changes, (iv) raw
material price fluctuations and other inflationary pressures, (v) expansion of
our manufacturing capability, (vi) the size and timing of customer orders,
(vii) the amount of time that it takes to fulfill orders and ship our products,
(viii) the length of our sales cycle to new customers and the time and expense
incurred in further penetrating our existing customer base, (ix) manufacturing
inefficiencies associated with new product introductions, (x) costs associated
with new product introductions, such as product development, marketing, assembly
line start-up costs and low introductory period production volumes, (xi) the
timing and market acceptance of new products and product enhancements,
(xii) customer order deferrals in anticipation of new products and product
enhancements, (xiii) the inability of our sales and marketing programs to
achieve their sales targets, (xiv) start-up costs associated with opening new
sales offices outside of the United States, (xv) fluctuations in revenue without
proportionate adjustments in fixed costs, (xvi) inefficiencies in the management
of our inventories and fixed assets, (xvii) compliance with government
regulations including health, safety, and environmental matters, and (xviii)
costs associated with the training and ramp-up time for new sales people;
•changes in gross margins due to a changing mix of products sold and the
different gross margins on different products and sales channels;
•changes in applicable laws, rules or regulations, or their interpretation or
enforcement, or the enactment of new laws, rules or regulations that apply to
our business operations or require us to incur significant expenses for
compliance;
•our inability to successfully comply with the requirements of the Restriction
of Hazardous Substances Directive and the Waste Electrical and Electronic
Equipment Directive in the European Union;
•the inability of our products to displace traditional measurement devices and
attain broad market acceptance;
•the impact of competitive products and pricing on our current offerings;
•our ability to successfully complete our executive officer transitions and the
loss of any of our executive officers or other key personnel;
•difficulties in recruiting research and development engineers and application
engineers;
•the failure to effectively manage the effects of any future growth;
•the impact of reductions or projected reductions in government spending, or
uncertainty regarding future levels of government expenditures, particularly in
the defense sector;
•variations in our effective income tax rate, which makes it difficult to
predict our effective income tax rate on a quarterly and annual basis, and the
impact of the U.S. Tax Cuts and Jobs Act of 2017 on the global intangible
low-taxed income of foreign subsidiaries;
•the loss of key suppliers and the inability to find sufficient alternative
suppliers in a reasonable period of time or on commercially reasonable terms;
•the impact of fluctuations in exchange rates;
•the effect of estimates and assumptions with respect to critical accounting
policies and the impact of the adoption of recently issued accounting
pronouncements;
•the magnitude of increased warranty costs from new product introductions and
enhancements to existing products;
•the sufficiency of our plants to meet manufacturing requirements;
•the continuation of our share repurchase program;
•the sufficiency of our working capital and cash flow from operations to fund
our long-term liquidity requirements;
•the impact of geographic changes in the manufacturing or sales of our products
on our effective income tax rate;
•our ability to comply with the requirements for favorable tax rates in foreign
jurisdictions; and
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•other risks and uncertainties discussed in Part I, Item 1A. Risk Factors in our
Annual Report on Form 10-K for the year ended December 31, 2019 and risks
identified on this Quarterly Report on Form 10-Q.
Moreover, new risks and uncertainties emerge from time to time, and we undertake
no obligation to update publicly or review the risks and uncertainties included
in this Quarterly Report on Form 10-Q, unless otherwise required by law.
Overview
We are a global technology company that designs, develops, manufactures, markets
and supports software driven, three-dimensional ("3D") measurement 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, Sweden, 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 condensed 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 or
the nine months ended September 30, 2020.
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Acquisition of ATS
On August 21, 2020, we acquired all of the outstanding shares of Advanced
Technical Solutions in Scandinavia AB ("ATS"), a Swedish company focused on 3D
digital twin solution technology for a purchase price of €5.1 million
($6.0 million) paid, net of cash acquired, subject to certain additional
post-closing adjustments, and up to €1.0 million ($1.2 million) in contingent
consideration that may be earned by the former owners if certain product
development milestones are met in a three-year period. The U.S. Dollar amounts
have been converted from Euros based on the foreign exchange rate in effect on
the closing date of the acquisition. We believe this acquisition enables the
Company to provide high accuracy 3D digital twin simulations for industries such
as automotive and aerospace. The results of ATS's operations as of and after the
date of acquisition have been included in our condensed consolidated financial
statements as of September 30, 2020, and for the three and nine months ended
September 30, 2020.
COVID-19 and Impact On Our Business
Our business is significantly vulnerable to the economic effects of pandemics
and other public health crises, including the ongoing novel coronavirus
("COVID-19") outbreak that has surfaced in virtually every country of our global
operating footprint. During the second and third quarter of 2020, we experienced
a significant decline in the demand for our products and services across all of
our served markets as a result of the impact of the spread of COVID-19. Although
COVID-19 has negatively impacted demand for our products and services overall,
the global pandemic also has provided us with the opportunity to adapt to a
virtual environment and to capitalize on our existing virtual sales
demonstration infrastructure which we have had in place for several years. There
has been an increase in the attendance of our virtual training and product
information seminars as our customers take advantage of the opportunity to
remotely participate and to better understand the capabilities of our products
and software offerings.
We continue to assess the ongoing impact of COVID-19 on our business results and
remain committed to taking actions to address the health and safety of our
employees and customers, as well as the negative effects from demand disruption
and production impacts, including, but not limited to, the following:
•Operating our business with a focus on our employee health and safety, which
includes minimizing travel, remote work policies, maintaining employee
distancing and enhanced sanitation of all of our facilities;
•Monitoring of our liquidity, reduction of supply flows into our manufacturing
facilities, disciplined inventory management, and scrutinization of our capital
expenditures; and
•Continuously reviewing our financial strategy to strengthen financial
flexibility in these volatile financial markets.
We continue to maintain a strong capital structure with a cash balance of $163.5
million and no debt as of September 30, 2020. We believe that our liquidity
position is adequate to meet our projected needs in the reasonably foreseeable
future.
Future developments, such as the potential resurgence of COVID-19 in countries
that have begun to recover from the early impact of the pandemic and actions
taken by governments in response to future resurgence, that are highly uncertain
and not able to be predicted will determine the extent to which the COVID-19
outbreak continues to impact the Company's results of operations and financial
conditions. See Item 1A, Risk Factors, included in Part II of this Quarterly
Report on Form 10-Q for an additional discussion of risks related to COVID-19.
Change in Organizational Structure and Segment Reporting
From the fourth quarter of 2016 through the fourth quarter of 2019, we operated
in five market 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 also began 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 operating structure and reorganized the
Company into a functional structure. Our executive leadership team is now
comprised of global 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 now report as one
reporting segment that develops, manufactures,
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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 disposed of certain recent acquisitions.
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 increased and sustainable value to our
shareholders and customers. Key activities under the Restructuring Plan include
a continued focus on efficiency and cost-saving efforts, which includes
decreasing total headcount by approximately 500 employees upon the completion of
the Restructuring Plan.
These activities are expected to be substantially completed by the end of 2021.
Pre-tax charges of approximately $49 million were recorded in the fourth quarter
of 2019 in connection with the implementation of our new strategic plan and
included the following:
•$21.2 million impairment of goodwill;
•$12.8 million charge, increasing our reserve for excess and obsolete inventory;
•$10.5 million impairment of intangible assets associated with recent
acquisitions;
•$1.4 million impairment of intangible assets related to capitalized patents;
•$3.4 million impairment of other assets and other charges.
In connection with the Restructuring Plan, we recorded a pre-tax charge of
approximately $13.7 million during the first quarter 2020 and $0.6 million
during the second quarter primarily consisting of severance and related
benefits. We estimate total additional pre-tax charges of $7 million to
$17 million for the remainder of fiscal year 2020.
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.
Reclassification and Related Changes to Presentation
Certain prior year amounts have been reclassified in the accompanying condensed
consolidated financial statements to conform to the current period presentation:
•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 three and nine months ended
September 30, 2019 have been reclassified throughout this Quarterly Report on
Form 10-Q to reflect this reclassification of selling, general and
administrative expenses and to conform to the current period presentation, as
set forth in the following table;
•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 three and nine months ended September 30, 2019 have been
reclassified throughout this Quarterly Report on Form 10-Q to reflect this
reclassification of software maintenance revenue and to conform to the current
period presentation, as set forth in the following table; and
•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 three and nine months ended September
30, 2019 have been reclassified throughout this Quarterly Report on Form 10-Q to
reflect this reclassification of software maintenance cost of sales and to
conform to the current period presentation, as set forth in the following table.

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For the three months ended, September
30, 2019
                                                               Selling, General and             Software
                                                                  Administrative             Maintenance and
                                          As Reported               Adjustment              Other Adjustments          As Adjusted
Sales
Product                                 $     63,641          $                 -          $          3,147          $     66,788
Service                                       26,875                            -                    (3,147)               23,728
Total sales                             $     90,516          $                 -          $              -          $     90,516

Cost of Sales
Product                                 $     26,495          $                 -          $            591          $     27,086
Service                                       13,249                            -                      (591)               12,658
Total cost of sales                     $     39,744          $                 -          $              -          $     39,744

Operating Expenses
Selling, general and administrative     $          -          $            45,880          $              -          $     45,880
Selling and marketing                         30,218                      (30,218)                        -                     -
General and administrative                    15,662                      (15,662)                        -                     -
Research and development                      10,783                            -                         -                10,783
Total operating expenses                $     56,663          $                 -          $              -          $     56,663




For the nine months ended, September
30, 2019
                                                               Selling, General and             Software
                                                                  Administrative             Maintenance and
                                          As Reported               Adjustment              Other Adjustments          As Adjusted
Sales
Product                                 $    200,434          $                 -          $          8,977          $    209,411
Service                                       77,190                            -                    (8,977)               68,213
Total sales                             $    277,624          $                 -          $              -          $    277,624

Cost of Sales
Product                                 $     83,632          $                 -          $          1,910          $     85,542
Service                                       39,461                            -                    (1,910)               37,551
Total cost of sales                     $    123,093          $                 -          $              -          $    123,093

Operating Expenses
Selling, general and administrative     $          -          $           131,909          $              -          $    131,909
Selling and marketing                         87,438                      (87,438)                        -                     -
General and administrative                    44,471                      (44,471)                        -                     -
Research and development                      33,048                            -                         -                33,048
Total operating expenses                $    164,957          $                 -          $              -          $    164,957




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The following table summarizes total stock-based compensation expense for each
of the line items on our condensed consolidated statement of operations:
                                                      Three Months Ended                            Nine Months Ended
                                                                      

September 30, September 30, September 30,


                                            September 30, 2020             2019                 2020                  2019
Cost of Sales
Product                                    $           39             $       170          $        234          $       482
Service                                                88                     100                   257                  288
Total cost of sales                        $          127             $       270          $        491          $       770

Operating Expenses
Selling, general and administrative        $        1,527             $     2,745          $      4,666          $     7,052
Research and development                              430                     372                 1,271                  881
Total operating expenses                   $        1,957             $     3,117          $      5,937          $     7,933

Amounts reported in millions within this Quarterly Report on Form 10-Q are computed based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. Certain columns and rows within the tables that follow may not add due to the use of rounded numbers. Percentages presented are calculated based on the respective amounts in thousands.


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Results of Operations
The following table sets forth, for the periods indicated, our unaudited results
of operations expressed as dollar amounts and as a percentage of total sales.
                                                    Three months ended September 30,                                                       Nine Months Ended September 30,
(dollars in thousands)            2020              % of Sales             2019              % of Sales                 2020                 % of Sales              2019              % of Sales
Sales
Product                       $  48,082                   68.0  %       $ 66,788                   73.8  %       $       146,866                   69.7  %       $ 209,411                   75.4  %
Service                          22,654                   32.0  %         23,728                   26.2  %                63,949                   30.3  %          68,213                   24.6  %
Total sales                      70,736                  100.0  %         90,516                  100.0  %               210,815                  100.0  %         277,624                  100.0  %
Cost of Sales
Product                          22,413                   31.7  %         27,086                   29.9  %                66,812                   31.7  %          85,542                   30.8  %
Service                          12,025                   17.0  %         12,658                   14.0  %                34,936                   16.6  %          37,551                   13.5  %
Total cost of sales              34,438                   48.7  %         39,744                   43.9  %               101,748                   48.3  %         123,093                   44.3  %
Gross Profit                     36,298                   51.3  %         50,772                   56.1  %               109,067                   51.7  %         154,531                   55.7  %
Operating Expenses
Selling, general and
administrative                   30,163                   42.6  %         45,880                   50.7  %                96,523                   45.8  %         131,909                   47.5  %
Research and development         10,754                   15.2  %         10,783                   11.9  %                31,355                   14.9  %          33,048                   11.9  %
Restructuring costs                 239                    0.3  %              -                      -  %                14,563                    6.9  %               -                      -  %
Total operating expenses         41,156                   58.2  %         56,663                   62.6  %               142,441                   67.6  %         164,957                   59.4  %
Loss from operations             (4,858)                  (6.9) %         (5,891)                  (6.5) %               (33,374)                 (15.8) %         (10,426)                  (3.8) %
Other (income) expense
Interest expense, net               161                    0.2  %            (24)                     -  %                   407                    0.2  %              72                      -  %
Other expense, net                 (256)                  (0.4) %            514                    0.6  %                   334                    0.2  %           2,398                    0.9  %
Loss before income tax
benefit                          (4,763)                  (6.7) %         (6,381)                  (7.0) %               (34,115)                 (16.2) %         (12,896)                  (4.6) %
Income tax benefit               (1,739)                  (2.5) %           (182)                  (0.2) %                (7,336)                  (3.5) %            (444)                  (0.2) %
Net loss                      $  (3,024)                  (4.3) %       $ (6,199)                  (6.8) %       $       (26,779)                 (12.7) %       $ (12,452)                  (4.5) %



Consolidated Results
Three Months Ended September 30, 2020 Compared to the Three Months Ended
September 30, 2019
Sales. Total sales decreased by $19.8 million, or 21.9%, to $70.7 million for
the three months ended September 30, 2020 from $90.5 million for the three
months ended September 30, 2019. Total product sales decreased by $18.7 million,
or 28.0%, to $48.1 million for the three months ended September 30, 2020 from
$66.8 million for the three months ended September 30, 2019. Our product sales
decreased primarily due to the unfavorable impact of end market demand softness
related to the COVID-19 pandemic and other fluctuations in market conditions.
Service revenue decreased by $1.0 million, or 4.5%, to $22.7 million for the
three months ended September 30, 2020 from $23.7 million for the three months
ended September 30, 2019, primarily due to the unfavorable impact of end market
demand softness related to the COVID-19 pandemic. Foreign exchange rates had a
positive impact on total sales of $0.6 million, decreasing the percent that our
overall sales declined by approximately 0.6 percentage points, primarily due to
the strengthening of the Euro relative to the U.S. dollar.
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Gross profit. Gross profit decreased by $14.5 million, or 28.5%, to $36.3
million for the three months ended September 30, 2020 from $50.8 million for the
three months ended September 30, 2019, and gross margin decreased to 51.3% for
the three months ended September 30, 2020 from 56.1% for the three months ended
September 30, 2019, primarily due to the unfavorable impact of end market demand
softness related to the COVID-19 pandemic which adversely affected our product
fixed cost absorption. Gross margin from product revenue decreased by 6.0
percentage points to 53.4% for the three months ended September 30, 2020 from
59.4% for the prior year period primarily due to the unfavorable impact of end
market demand softness related to the COVID-19 pandemic which adversely affected
our product fixed cost absorption. Gross margin from service revenue increased
by 0.2 percentage points to 46.9% for the three months ended September 30, 2020
from 46.7% for the prior year period, primarily due to an increase in recurring
service contracts revenue and corresponding decrease in service contracts
expenses due to the impact of the COVID-19 pandemic.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by $15.7 million, or 34.3%, to $30.2 million
for the three months ended September 30, 2020 from $45.9 million for the three
months ended September 30, 2019. This decrease was driven primarily by decreased
salaries and wages and other cost savings initiatives to reduce non-personnel
costs that resulted from the Restructuring Plan. Additionally, a decrease in
selling commission expense and travel expense was driven by reduced global sales
and pandemic stay-at-home orders, respectively. Selling, general and
administrative expenses as a percentage of sales decreased to 42.6% for the
three months ended September 30, 2020, compared with 50.7% of sales for the
three months ended September 30, 2019. Our worldwide period-ending selling,
general and administrative headcount decreased by 374, or 35.9%, to 668 at
September 30, 2020, from 1,042 at September 30, 2019.
Research and development expenses. Research and development expenses remained
flat for the three months ended September 30, 2020 compared to the three months
ended September 30, 2019, driven by a decrease in purchased technology
intangible amortization expense as a result of the impairment of certain
intangible assets in connection with the Restructuring Plan offset by an
increase in personnel costs. Research and development expenses as a percentage
of sales increased to 15.2% for the three months ended September 30, 2020 from
11.9% for the three months ended September 30, 2019.
Restructuring costs. In February 2020, we initiated the Restructuring Plan to
improve business effectiveness, streamline operations and achieve a stated
target cost level for the Company as a whole. Restructuring costs included in
operating expenses for the three months ended September 30, 2020 were $0.2
million primarily consisting of legal and consulting expenses and adjustments to
our restructuring accrual for severance and related benefits.
Interest expense (income), net. For the three months ended September 30, 2020,
we recorded interest expense of $0.2 million compared with interest income of
less than $0.1 million for the three months ended September 30, 2019. This
change was mainly due to interest income earned on investments during the three
months ended September 30, 2019 without such activity during the same period in
the current year.
Other (income) expense, net. For the three months ended September 30, 2020, we
recorded other income, net of $0.3 million compared with other expense, net of
$0.5 million for the three months ended September 30, 2019. This change was
mainly due to changes in foreign exchange rates and its effect on the value of
intercompany account balances of our subsidiaries denominated in other
currencies.
Income tax benefit. For the three months ended September 30, 2020, we recorded
an income tax benefit of $1.7 million compared with income tax benefit of $0.2
million for the three months ended September 30, 2019. Our effective tax rate
was (36.5%) for the three months ended September 30, 2020 compared with (2.9%)
in the prior year period. The change in our income tax benefit was primarily due
to the increase in our pretax loss during the third quarter of 2020 compared to
the same period of 2019. The change in our effective tax rate was primarily due
to the impact of return-to-provision adjustments recorded during the third
quarter of 2019 without such activity during the same period in the current
year.
Our quarterly estimate of our annual effective tax rate and our quarterly
provision for income tax (benefit) expense are subject to significant variation
due to numerous factors, including variability in accurately predicting our
pretax and taxable income or loss and the mix of jurisdictions to which they
relate, as well as the amount of pretax income or loss recognized during the
quarter.
Net loss. Our net loss was $3.0 million for the three months ended September 30,
2020 compared with net loss of $6.2 million for the prior year period,
reflecting the impact of the factors described above.

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Nine Months Ended September 30, 2020 Compared to the Nine Months Ended September
30, 2019
Sales. Total sales decreased by $66.8 million, or 24.1%, to $210.8 million for
the nine months ended September 30, 2020 from $277.6 million for the nine months
ended September 30, 2019. Total product sales decreased by $62.5 million, or
29.9%, to $146.9 million for the nine months ended September 30, 2020 from
$209.4 million for the nine months ended September 30, 2019. Our product sales
decreased primarily due to the unfavorable impact of end market demand softness
related to the COVID-19 pandemic and other fluctuations in market conditions.
Service revenue decreased by $4.3 million, or 6.3%, to $63.9 million for the
nine months ended September 30, 2020 from $68.2 million for the nine months
ended September 30, 2019, primarily due to the unfavorable impact of end market
demand softness related to the COVID-19 pandemic. Foreign exchange rates had a
negative impact on total sales of $1.5 million, increasing the percent that our
overall sales declined by approximately 0.5 percentage points, primarily due to
the weakening of the Chinese Yuan, Brazilian Real and Mexican Peso relative to
the U.S. dollar.
Gross profit. Gross profit decreased by $45.4 million, or 29.4%, to $109.1
million for the nine months ended September 30, 2020 from $154.5 million for the
nine months ended September 30, 2019, and gross margin decreased to 51.7% for
the nine months ended September 30, 2020 from 55.7% for the nine months ended
September 30, 2019, primarily due to the unfavorable impact of end market demand
softness related to the COVID-19 pandemic which adversely affected our product
fixed cost absorption. Gross margin from product revenue decreased by 4.7%
percentage points to 54.5% for the nine months ended September 30, 2020 from
59.2% for the prior year period primarily due to the unfavorable impact of end
market demand softness related to the COVID-19 pandemic which adversely affected
our product fixed cost absorption. Gross margin from service revenue increased
by 0.4% percentage points to 45.4% for the nine months ended September 30, 2020
from 45.0% for the prior year period, primarily due to an increase in recurring
service contracts revenue and corresponding decrease in service contracts
expenses due to the impact of the COVID-19 pandemic.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by $35.4 million, or 26.8%, to $96.5 million
for the nine months ended September 30, 2020 from $131.9 million for the nine
months ended September 30, 2019. This decrease was driven primarily by decreased
salaries and wages and other cost savings initiatives to reduce non-personnel
costs that resulted from the Restructuring Plan. Additionally, a decrease in
selling commission expense and travel expense was driven by reduced global sales
and pandemic stay-at-home orders, respectively. Selling, general and
administrative expenses as a percentage of sales decreased to 45.8% for the nine
months ended September 30, 2020, compared with 47.5% of sales for the nine
months ended September 30, 2019. Our worldwide period-ending selling, general
and administrative headcount decreased by 374, or 35.9%, to 668 at September 30,
2020, from 1,042 at September 30, 2019.
Research and development expenses. Research and development expenses decreased
by $1.6 million, or 5.1%, to 31.4 million for the nine months ended September
30, 2020 from $33.0 million for the nine months ended September 30, 2019. This
decrease was mainly driven by a decrease in purchased technology intangible
amortization expense as a result of the impairment of certain intangible assets
in connection with the Restructuring Plan. Research and development expenses as
a percentage of sales increased to 14.9% for the nine months ended September 30,
2020 from 11.9% for the nine months ended September 30, 2019.
Restructuring costs. In February 2020, we initiated the Restructuring Plan to
improve business effectiveness, streamline operations and achieve a stated
target cost level for the Company as a whole. Restructuring costs included in
operating expenses for the nine months ended September 30, 2020 were $14.6
million primarily consisting of severance and related benefits charges.
Interest expense, net. We recorded interest expense, net of $0.4 million for the
nine months ended September 30, 2020 compared to $0.1 million for the nine
months ended September 30, 2019. This change was mainly due to interest income
earned on investments during the nine months ended September 30, 2019 with a
decrease in interest income activity during the same period in the current year.
Other expense, net. For the nine months ended September 30, 2020, other expense
decreased by $2.1 million to $0.3 million from $2.4 million for the nine months
ended September 30, 2019. The decrease is primarily driven by the $1.5 million
impairment charge related to our equity investment in present4D recorded in the
second quarter of 2019.
Income tax benefit. For the nine months ended September 30, 2020, we recorded an
income tax benefit of $7.3 million compared with income tax benefit of $0.4
million for the nine months ended September 30, 2019. Our effective tax rate was
(22%) for the nine months ended September 30, 2020 compared with (3%) in the
prior year period. The change in our income tax benefit expense was primarily
due to the increase in our pretax loss during the nine months ended September
30, 2020 compared to the same period of 2019. The change in our effective tax
rate was primarily due to the impact of return-to-provision adjustments recorded
during the third quarter of 2019 without such activity during the same period in
the current year.
Our quarterly estimate of our annual effective tax rate and our quarterly
provision for income tax (benefit) expense are subject to significant variation
due to numerous factors, including variability in accurately predicting our
pretax and taxable
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income or loss and the mix of jurisdictions to which they relate, as well as the
amount of pretax income or loss recognized during the quarter.
Net loss. Our net loss was $26.8 million for the nine months ended September 30,
2020 compared with net loss of $12.5 million for the prior year period,
reflecting the impact of the factors described above.
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Liquidity and Capital Resources
Cash and cash equivalents increased by $30.0 million to $163.6 million at
September 30, 2020 from $133.6 million at December 31, 2019. The increase was
primarily driven by net cash provided by operating and investing activities.
Cash provided by operating activities was $10.8 million during the nine months
ended September 30, 2020, compared to $23.5 million of cash provided by
operations during the nine months ended September 30, 2019. The decrease was
mainly due to a larger net loss in the current period and changes in working
capital.
Cash provided by investing activities during the nine months ended September 30,
2020 was $16.1 million compared to cash used in investing activities of $8.5
million during the nine months ended September 30, 2019. The change was
primarily due to the maturity of U.S. Treasury Bills amounting to $25.0 million
offset by the acquisition of ATS during the nine months ended September 30, 2020
without such activity during the nine months ended September 30, 2019.
Cash provided by financing activities was $1.8 million during the nine months
ended September 30, 2020 compared to cash used in financing activities of $2.4
million for the nine months ended September 30, 2019. The change was primarily
due to $5.4 million in cash received from the exercise of employee stock options
during the nine months ended September 30, 2020 compared to $2.3 million during
the nine months ended September 30, 2019.
Of our cash and cash equivalents, $102.9 million was held by foreign
subsidiaries as of September 30, 2020. On December 22, 2017, the United States
enacted the U.S. Tax Cuts and Jobs Act, resulting in significant modifications
to existing tax law, which included a transition tax on the mandatory deemed
repatriation of foreign earnings. Despite the changes in U.S. 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. Acquisitions for the share repurchase program may be made
from time to time at prevailing prices, as permitted by securities laws and
other legal requirements, and subject to market conditions and other factors.
The share repurchase program may be discontinued at any time. There is no
expiration date or other restriction governing the period over which we can
repurchase shares under the program. In October 2015, our Board of Directors
authorized an increase to the existing share repurchase program from $30.0
million to $50.0 million. We made no stock repurchases during the nine month
period ended September 30, 2020 under this program. As of September 30, 2020, we
had authorization to repurchase $18.3 million remaining under the repurchase
program.
We believe that our working capital and anticipated cash flow from operations
will be sufficient to fund our long-term liquidity operating requirements for at
least the next 12 months.
We have no off-balance sheet arrangements.
Contractual Obligations and Commercial Commitments
We enter into purchase commitments for products and services in the ordinary
course of business. These purchases generally cover production requirements for
60 to 120 days as well as materials necessary to service customer units through
the product lifecycle and for warranty commitments. As of September 30, 2020, we
had $49.3 million in purchase commitments that are expected to be delivered
within the next 12 months. Other than as described in the preceding sentences,
there have been no material changes to the contractual obligations and
commercial commitments table included in Part II, Item 7 of our Annual Report on
Form 10-K for the year ended December 31, 2019.
Critical Accounting Policies
The preparation of our condensed consolidated financial statements requires our
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues, and expenses, as well as disclosure of contingent
assets and liabilities. We base our estimates on historical experience, along
with various other factors believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
value of assets and liabilities that are not readily apparent from other
sources. Some of these judgments can be subjective and complex and,
consequently, actual results may differ from these estimates under different
assumptions or conditions. A discussion of our critical accounting policies is
included in Part II, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in our Annual Report on Form 10-K for the
year ended December 31, 2019, as filed with the Securities and Exchange
Commission on February 19, 2020. As of September 30, 2020, our critical
accounting policies have not changed from those described in our Annual Report
on Form 10-K for the year ended December 31, 2019.
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