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 endedDecember 31, 2020 .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; •loss of future government sales; and potential impacts on customer and supplier relationships and on the Company's reputation that may result from the GSA matter; •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 ofU.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; •the cyclical nature of the industries of our customers and material adverse changes in our customers' access to liquidity and capital; •changes in the potential for the computer-aided measurement market and the potential adoption rate for our products, which are difficult to quantify and predict; •our inability to protect our patents and other proprietary rights inthe United States and foreign countries; 20 -------------------------------------------------------------------------------- Table of Contents •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 ofthe 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 theEuropean 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 theU.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 •other risks and uncertainties discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year endedDecember 31, 2020 and in otherSEC filings. 21 -------------------------------------------------------------------------------- Table of Contents Moreover, new risks and uncertainties emerge from time to time, and we undertake no obligation to update publicly or review the risks and uncertainties included in this Quarterly Report on Form 10-Q, unless otherwise required by law. Overview We are a global technology company that designs, develops, manufactures, markets and supports software driven, three-dimensional ("3D") measurement, imaging, and realization solutions for the 3D metrology, architecture, engineering and construction ("AEC") and public safety analytics markets. We enable our customers to capture, measure, manipulate, interact with and share data from the physical world in a virtual environment and then translate this information back into the physical domain. Our technology enables highly accurate 3D measurement, imaging, comparison and projection of parts and complex structures within production, assembly and quality assurance processes. Our FARO suite of 3D products and software solutions are used for inspection of components and assemblies, rapid prototyping, reverse engineering, documenting large volume or structures in 3D, surveying and construction, assembly layout, machine guidance as well as in investigation and reconstructions of crash and crime scenes. We sell the majority of our solutions through a direct sales force across a range of industries including automotive, aerospace, metal and machine fabrication, surveying, architecture, engineering and construction, public safety forensics and other industries. We derive our revenues primarily from the sale of our measurement equipment and related multi-faceted software programs. Revenue related to these products is generally recognized upon shipment. In addition, we sell extended warranties and training and technology consulting services relating to our products. We recognize the revenue from hardware service contracts and software maintenance contracts on a straight-line basis over the contractual term, and revenue from training and technology consulting services when the services are provided. We operate in international markets throughout the world and maintain sales offices inAustralia ,Brazil ,Canada ,China ,France ,Germany ,India ,Italy ,Japan ,Malaysia ,Mexico ,the Netherlands ,Poland ,Portugal ,Singapore ,South Korea ,Spain ,Switzerland ,Thailand ,Turkey , theUnited Kingdom , andthe United States . We manufacture our FARO Quantum Arm products in our manufacturing facility located inSwitzerland for customer orders fromEurope , theMiddle East andAfrica ("EMEA"), in our manufacturing facility located inSingapore for customer orders from theAsia-Pacific region , and in our manufacturing facility located inFlorida for customer orders from theAmericas . We manufacture our FARO Focus laser scanner in our manufacturing facilities located inGermany andSwitzerland for customer orders from EMEA and theAsia-Pacific region , and in our manufacturing facility located inPennsylvania for customer orders from theAmericas . We manufacture our FARO Laser Tracker and our FARO Laser Projector products in our facility located inPennsylvania . We expect all of our existing manufacturing facilities to have the production capacity necessary to support our volume requirements during 2021. We account for wholly-owned foreign subsidiaries in the currency of the respective foreign jurisdiction; therefore, fluctuations in exchange rates may have an impact on the value of the intercompany account balances denominated in different currencies and reflected in our consolidated financial statements. We are aware of the availability of off-balance sheet financial instruments to hedge exposure to foreign currency exchange rates, including cross-currency swaps, forward contracts and foreign currency options. However, we have not used such instruments in the past, and none were utilized in 2020 or the three months endedMarch 31, 2021 . New Strategic Plan and Restructuring Plan In the first quarter of 2020, our Board of Directors approved a global restructuring plan (the "Restructuring Plan"), which is intended to support our strategic plan in an effort to improve operating performance and ensure that we are appropriately structured and resourced to deliver increased and sustainable value to our shareholders and customers. Key activities under the Restructuring Plan include a continued focus on efficiency and cost-saving efforts, which 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 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. 22 -------------------------------------------------------------------------------- Table of Contents In connection with the Restructuring Plan, we recorded a pre-tax charge of approximately$15.8 million during the year endedDecember 31, 2020 primarily consisting of severance and related benefits, professional fees and other related charges and costs including a non-cash expense of$0.4 million related to the disposal of our Photonics business and 3D Design related assets. We received$0.7 million in cash payments for the disposal of our Photonics business and 3D Design related assets in the second quarter of 2020. Currently, we have several significant cost reduction initiatives underway to achieve our 20% target EBITDA margins that could result in pre-tax charges in the range of$5 million to$15 million for fiscal year 2021. At this time, we are continuing to evaluate the future key activities by which these additional charges will originate. 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. In connection with the Restructuring Plan, we paid$13.1 million during the year endedDecember 31, 2020 and$1.4 million during the three months endedMarch 31, 2021 , primarily consisting of severance and related benefits. We expect an additional$6 million to$8 million of cash payments to be made for fiscal year 2021 related to the Restructuring Plan. Amounts reported in millions within this Quarterly Report on Form 10-Q are computed based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. Certain columns and rows within the tables that follow may not add due to the use of rounded numbers. Percentages presented are calculated based on the respective amounts in thousands. 23
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Results of Operations The following table sets forth, for the periods indicated, our unaudited results of operations expressed as dollar amounts and as a percentage of total sales. Three months ended March 31, (dollars in thousands) 2021 % of Sales 2020 % of Sales Sales Product$ 54,635 71.6 %$ 56,525 71.1 % Service 21,696 28.4 % 22,990 28.9 % Total sales 76,331 100.0 % 79,515 100.0 % Cost of Sales Product 24,804 32.5 % 23,066 29.0 % Service 11,120 14.6 % 12,576 15.8 % Total cost of sales 35,924 47.1 % 35,642 44.8 % Gross Profit 40,407 52.9 % 43,873 55.2 % Operating Expenses Selling, general and administrative 33,348 43.7 % 36,324 45.7 % Research and development 11,973 15.7 % 10,415 13.1 % Restructuring costs 1,524 2.0 % 13,688 17.2 % Total operating expenses 46,845 61.4 % 60,427 76.0 % Loss from operations (6,438) (8.4) % (16,554) (20.8) % Other (income) expense Interest expense, net 10 - % 34 - % Other (income) expense, net (1,615) (2.1) % 473 0.6 % Loss before income tax benefit (4,833) (6.3) % (17,061) (21.5) % Income tax benefit (1,612) (2.1) % (2,238) (2.8) % Net loss$ (3,221) (4.2) %$ (14,823) (18.6) % Consolidated Results Three Months EndedMarch 31, 2021 Compared to the Three Months EndedMarch 31, 2020 Sales. Total sales decreased by$3.2 million , or 4.0%, to$76.3 million for the three months endedMarch 31, 2021 from$79.5 million for the three months endedMarch 31, 2020 . The decline in sales is the result of the economic effect of COVID-19 pandemic, which is still in the recovery stage. Total product sales decreased by$1.9 million , or 3.3%, to$54.6 million for the three months endedMarch 31, 2021 from$56.5 million for the three months endedMarch 31, 2020 primarily due to the continuing COVID-19 related market softness and other fluctuations in market conditions. Similarly, service revenue decreased by$1.3 million , or 5.6%, to$21.7 million for the three months endedMarch 31, 2021 from$23.0 million for the three months endedMarch 31, 2020 . Foreign exchange rates had a positive impact on total sales of$2.3 million , decreasing the percent that our overall sales declined by approximately 2.9 percentage points, primarily due to the strengthening of the Euro relative to theU.S. dollar. Gross profit. Gross profit decreased by$3.5 million , or 7.9%, to$40.4 million for the three months endedMarch 31, 2021 from$43.9 million for the three months endedMarch 31, 2020 , and gross margin decreased to 52.9% for the three months endedMarch 31, 2021 from 55.2% for the three months endedMarch 31, 2020 . Gross margin from product revenue decreased by 4.6 percentage points to 54.6% for the three months endedMarch 31, 2021 from 59.2% for the prior year period primarily due to changes in product mix, an increased charge to our reserve for excess and obsolete inventory, and 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 3.4 percentage points to 48.7% for the three months endedMarch 31, 2021 from 45.3% for the prior year period, primarily due to a reduction in departmental costs as a result of the Restructuring Plan. 24 -------------------------------------------------------------------------------- Table of Contents Selling, general and administrative expenses. Selling, general and administrative expenses decreased by$3.0 million , or 8.2%, to$33.3 million for the three months endedMarch 31, 2021 from$36.3 million for the three months endedMarch 31, 2020 . 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. Selling, general and administrative expenses as a percentage of sales decreased to 43.7% for the three months endedMarch 31, 2021 , compared with 45.7% of sales for the three months endedMarch 31, 2020 . Our worldwide period-ending selling, general and administrative headcount decreased by 134, or 15.6%, to 727 atMarch 31, 2021 , from 861 atMarch 31, 2020 . Research and development expenses. Research and development expenses increased by$1.6 million , or 15.0%, to$12.0 million for the three months endedMarch 31, 2021 from$10.4 million for the three months endedMarch 31, 2020 . This increase was mainly driven by higher compensation expense resulting from increased engineering headcount and costs to accelerate new product development. Research and development expenses as a percentage of sales increased to 15.7% for the three months endedMarch 31, 2021 from 13.1% for the three months endedMarch 31, 2020 . Restructuring costs. InFebruary 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 endedMarch 31, 2021 andMarch 31, 2020 were$1.5 million and$13.7 million , respectively, primarily consisting of severance and related benefits charges. Interest expense, net. We recorded interest expense, net of less than$0.1 million for the three months endedMarch 31, 2021 and three months endedMarch 31, 2020 . Other (income) expense, net. For the three months endedMarch 31, 2021 , other income was$1.6 million compared with other expense of$0.5 million for the three months endedMarch 31, 2020 . This change was primarily driven by the effect of foreign exchange rates as well as COVID-19 related foreign incentives received in the current year quarter. Income tax benefit. For the three months endedMarch 31, 2021 , we recorded an income tax benefit of$1.6 million compared with income tax benefit of$2.2 million for the three months endedMarch 31, 2020 . Our effective tax rate was 33.4% for the three months endedMarch 31, 2021 compared with 13.1% in the prior year period. The change in our income benefit was primarily due to a lower pretax loss during the first quarter of 2021 and changes in our effective tax rate. The change in our effective tax rate was primarily associated with discrete tax items, including excess tax benefits associated with the Company's stock-based compensation arrangements, and a shift in the geographic mix of pretax income expected for the full year 2021. 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$3.2 million for the three months endedMarch 31, 2021 compared with net loss of$14.8 million for the prior year period, reflecting the impact of the factors described above. 25 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Cash and cash equivalents decreased by$15.6 million to$170.0 million atMarch 31, 2021 from$185.6 million atDecember 31, 2020 . The decrease was primarily driven by net cash used in operating and investing activities. Cash used in operating activities was$10.3 million during the three months endedMarch 31, 2021 , compared to$16.3 million of cash provided by operations during the three months endedMarch 31, 2020 . The decrease was mainly due to changes in working capital accounts, primarily a decrease in accrued liabilities driven by the$12.3 million settlement of liability related to the GSA matter. Cash used in investing activities during the three months endedMarch 31, 2021 was$2.4 million compared to cash provided by investing activities of$7.8 million during the three months endedMarch 31, 2020 . The change was primarily due to the maturity ofU.S. Treasury Bills amounting to$9.0 million during the three months endedMarch 31, 2020 without such activity during the three months endedMarch 31, 2021 . Cash provided by financing activities was$1.7 million during the three months endedMarch 31, 2021 compared to cash provided by financing activities of$1.1 million for the three months endedMarch 31, 2020 . The change was primarily due to$5.1 million in cash received from the exercise of employee stock options during the three months endedMarch 31, 2021 compared to$2.8 million during the three months endedMarch 31, 2020 . Of our cash and cash equivalents,$120.5 million was held by foreign subsidiaries as ofMarch 31, 2021 . OnDecember 22, 2017 ,the United States enacted theU.S. Tax Cuts and Jobs Act, resulting in significant modifications to existing tax law, which included a transition tax on the mandatory deemed repatriation of foreign earnings. As a result of theU.S. Tax Cuts and Jobs Act, the Company can repatriate foreign earnings and profits to theU.S. with minimalU.S. income tax consequences, other than the transition tax and global intangible low-taxed income ("GILTI") tax. The Company has reinvested a large portion of its undistributed foreign earnings and profits in acquisitions and other investments and intends to bring back a portion of foreign cash in certain jurisdictions where the Company will not be subject to local withholding taxes and which were subject already to transition tax and GILTI tax. OnNovember 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. InOctober 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 three month period endedMarch 31, 2021 under this program. As ofMarch 31, 2021 , 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 ofMarch 31, 2021 , we had$42.0 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 endedDecember 31, 2020 . 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 endedDecember 31, 2020 , as filed with theSecurities and Exchange Commission onFebruary 19, 2020 . As ofMarch 31, 2021 , our critical accounting policies have not changed from those described in our Annual Report on Form 10-K for the year endedDecember 31, 2020 . 26
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