The following information should be read in conjunction with our Consolidated Financial Statements, including the notes thereto, included in Part II, Item 8 of this Annual Report on Form 10-K. Overview We are a global technology company that designs, develops, manufactures, markets and supports software driven, three-dimensional ("3D") measurement, 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, 2019 or 2018. 30 -------------------------------------------------------------------------------- Table of Contents Executive Summary 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 COVID-19 pandemic 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. We launched an updated web-based learning system withFaro Academy that has resulted in 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$185.6 million and no debt as ofDecember 31, 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 I of this Annual Report on Form 10-K for an additional discussion of risks related to COVID-19. Our total sales decreased$78.0 million , or 20.4%, to$303.8 million for the year endedDecember 31, 2020 from$381.8 million for the year endedDecember 31, 2019 . Our product sales decreased$71.1 million , or 24.5%, primarily due to the unfavorable impact of end market demand softness related to the COVID-19 pandemic and other fluctuations in market conditions. Our service revenue decreased$6.9 million , or 7.5%, primarily due to the unfavorable impact of end market demand softness related to the COVID-19 pandemic. Also, foreign exchange rates had a positive impact on total sales of$0.7 million , decreasing the percent that our overall sales declined by approximately 0.2 percentage points, primarily due to the strengthening of the Euro relative to theU.S. dollar. Change in Organizational Structure and Segment Reporting Historically, we operated in five verticals-3D Manufacturing, ConstructionBuilding Information Modeling ("Construction BIM"), Public Safety Forensics, 3D Design and Photonics-and had three reporting segments-3D Manufacturing, Construction BIM and Emerging Verticals. During the second half of 2019, our Chief Executive Officer ("CEO") and FARO's management team formulated and began to implement a new comprehensive strategic plan for our business. Our strategic planning process included extensive conversations with employees, customers, investors and suppliers to identify both where the Company can provide sustained and differentiated customer value and where opportunities existed to improve operating efficiencies. We identified areas of our business that needed enhanced focus or change in order to improve our efficiency and cost structure. As part of our strategic plan, we reassessed and redefined our go-to-market strategy, refocused our marketing engagement with our customers, re-evaluated our hardware and software product portfolio and examined how key decisions are made throughout our global organization. Additionally, we focused on other organizational optimization efforts, including the simplification of our overly complex management structure. 31 -------------------------------------------------------------------------------- Table of Contents As part of our new strategic plan, and based on the recommendation of our CEO, who is also our Chief Operating Decision Maker ("CODM"), in the fourth quarter of 2019, we eliminated our vertical structure in favor of a functional structure. Our new executive leadership team is comprised of functional leaders in areas such as sales, marketing, operations, research and development and general and administrative, and resources are allocated to each function at a consolidated unit level. We no longer have separate business units, 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 report as one reporting segment that develops, manufactures, markets, supports and sells a suite of 3D imaging and software solutions. In addition to the reorganization of the Company's structure, we evaluated our hardware and software product portfolio and the operations of certain of our recent acquisitions. As a result of this evaluation, we simplified our hardware and software product portfolio and divested our Photonics business and 3D Design related assets obtained from our acquisition of Opto-Tech SRL and its subsidiary Open Technologies SRL (collectively, "Open Technologies") in the second quarter of 2020. OnFebruary 14, 2020 , our Board of Directors approved a global restructuring plan (the "Restructuring Plan"), which supports our strategic plan in an effort to improve operating performance and ensure that we are appropriately structured and resourced to deliver sustainable value to our shareholders and customers. Key activities under the Restructuring Plan, which targeted$40 million in annualized savings to be realized by the fourth quarter of 2020, include decreasing total headcount by approximately 500 employees upon the completion of the Restructuring Plan. The elimination of our vertical structure allowed us to successfully complete our redefined go-to-market strategy which placed increased focus on our customers and enabled our sales employees, supported by our talented pool of field application engineers, to sell all product lines globally. Our new marketing leadership team has focused its efforts on gaining an increased understanding of customer applications and workflows which enables value-based product positioning while optimizing our customer's total cost of ownership. By strengthening our understanding of customer applications and workflows, we will continue to develop high-value solutions across our product and software platforms. Also, our marketing leadership team has transformed our lead generation process and implemented technology to provide our sales organization with higher quality leads which optimizes the time and effort spent by our newly organized sales team. We continue to focus on organizational optimization and improved decision making throughout the Company. Prior to the execution of the Restructuring Plan, the Company had strong geographic organizations with decentralized decision making. Additionally, the previous vertical structure layered on top of the geographic organization led to an overly complex and costly management structure. The newly formed global functional organization has enabled centralized management and clear process ownership, eliminating redundant resources and increasing the Company's agility and ability to execute the new strategic plan during the COVID-19 global pandemic. We made significant progress executing the Restructuring Plan during 2020. 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. The reduction of our global workforce and new cost structure allowed the Company to maintain a strong capital structure despite depressed sales levels primarily as a result of the COVID-19 pandemic. At this time, we are continuing to evaluate the future key activities by which these additional charges will originate. We estimate additional pre-tax charges of$5 million to$15 million for fiscal year 2021. These activities are expected to be substantially completed by the end of 2021. Acquisition of ATS OnAugust 21, 2020 , we acquired all of the outstanding shares of Advanced Technical Solutions inScandinavia 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. TheU.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 consolidated financial statements as ofDecember 31, 2020 . 32 -------------------------------------------------------------------------------- Table of Contents Presentation of Information and Reclassifications Amounts reported in millions within this Annual Report on Form 10-K are computed based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. Certain columns and rows within the tables that follow may not add due to the use of rounded numbers. Percentages presented are calculated based on the respective amounts in thousands. Depreciation and amortization expenses are being reported in our statements of operations to reflect departmental costs. Previously, those expenses were reported as a separate line item under operating expenses. Amounts related to depreciation and amortization expenses for the year endedDecember 31, 2018 have been restated throughout this Annual Report on Form 10-K to reflect this reclassification of depreciation and amortization expenses and to conform to the current period presentation. 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 year endedDecember 31, 2018 have been restated throughout this Annual Report on Form 10-K to reflect this reclassification of selling, general and administrative expenses and to conform to the current period presentation. Software maintenance revenue is now being reported in the accompanying statements of operations as a component of product sales. Previously, these revenues were reported in service sales. Amounts related to software maintenance revenue for the year endedDecember 31, 2018 have been restated throughout this Annual Report on Form 10-K to reflect this reclassification of software maintenance revenue and to conform to the current period presentation. Software maintenance cost of sales is now being reported in the accompanying statements of operations as a component of product cost of sales. Previously, these cost of sales was reported in service cost of sales. Amounts related to software maintenance cost of sales for the year endedDecember 31, 2018 have been restated throughout this Annual Report on Form 10-K to reflect this reclassification of software maintenance cost of sales and to conform to the current period presentation. 33 --------------------------------------------------------------------------------
Table of Contents Results of Operations 2020 Compared to 2019 Years ended December 31, 2020 2019 Change ($) (dollars in millions) % of Sales % of Sales 2020 vs 2019 Product$ 218.6 72.0 %$ 289.7 75.9 %$ (71.1) Service 85.2 28.0 % 92.1 24.1 % (6.9) Total sales 303.8 100.0 % 381.8 100.0 % (78.0) Product 98.9 32.5 % 133.2 34.9 % (34.4) Service 45.1 14.8 % 50.4 13.2 % (5.3) Total cost of sales 143.9 47.4 % 183.6 48.1 % (39.7) Gross profit 159.8 52.6 % 198.1 51.9 % (38.3) Operating expenses Selling, general and administrative 131.8 43.4 % 177.4 46.5 % (45.6) Research and development 42.9 14.1 % 44.2 11.6 % (1.3) Restructuring costs 15.8 5.2 % - - % 15.8 Impairment loss - - % 35.2 9.2 % (35.2) Total operating expenses 190.5 62.7 % 256.8 67.3 % (66.3) Other expense 0.1 - % 2.4 0.6 % (2.3) Income tax (benefit) expense (31.4) (10.3) % 1.1 0.3 % (32.5) Net income (loss)$ 0.6 0.2 %$ (62.1) (16.3) %$ 62.7 Consolidated Results Sales. Total sales decreased by$78.0 million , or 20.4%, to$303.8 million for the year endedDecember 31, 2020 from$381.8 million for the year endedDecember 31, 2019 . Total product sales decreased by$71.1 million , or 24.5%, to$218.6 million for the year endedDecember 31, 2020 from$289.7 million for the year endedDecember 31, 2019 . Our product sales decreased due to the unfavorable impact of end market demand softness related to the COVID-19 pandemic and other fluctuations in market conditions. Service sales decreased by$6.9 million , or 7.5%, to$85.2 million for the year endedDecember 31, 2020 from$92.1 million for the year endedDecember 31, 2019 , primarily due to the unfavorable impact of end market demand softness related to the COVID-19 pandemic and other fluctuations in market conditions. Foreign exchange rates had a positive impact on sales of$0.7 million , reducing our overall sales decline by approximately 0.2 percentage points, primarily due to the strengthening of the Euro relative to theU.S. dollar. Gross profit. Gross profit decreased by$38.3 million , or 19.3%, to$159.8 million for the year endedDecember 31, 2020 from$198.1 million for the year endedDecember 31, 2019 . Gross margin increased to 52.6% for the year endedDecember 31, 2019 from 51.9% in the prior year period. Gross margin from product revenue increased by 0.8 percentage points to 54.8% for the year endedDecember 31, 2020 from 54.0% in the prior year period. This increase in gross margin from product revenue was primarily due to 2019 being burdened by a$12.8 million increase in our reserve for excess and obsolete inventory recorded in connection with our strategic decisions to simplify our hardware and software product portfolio and cease selling certain products. Gross margin from service revenue increased by 1.8 percentage points to 47.1% for the year endedDecember 31, 2020 from 45.3% for the prior year period, primarily due to a reduction in departmental costs as a result of the Restructuring Plan. 34 -------------------------------------------------------------------------------- Table of Contents Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses decreased by$45.6 million , or 25.7%, to$131.8 million , for the year endedDecember 31, 2020 from$177.4 million for the year endedDecember 31, 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. SG&A expenses as a percentage of sales decreased to 43.4% for the year endedDecember 31, 2020 from 46.5% for the year endedDecember 31, 2019 . Research and development expenses. Research and development expenses decreased$1.3 million , or 2.9%, to$42.9 million for the year endedDecember 31, 2020 from$44.2 million for the year endedDecember 31, 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 14.1% for the year endedDecember 31, 2020 from 11.6% for the year endedDecember 31, 2019 . 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 year endedDecember 31, 2020 were$15.8 million primarily consisting of severance and related benefits charges. Impairment loss. As a result of our annual goodwill and intangible asset impairment test performed in the prior year, we recorded an impairment loss of$35.2 million in the fourth quarter of 2019, which included$21.2 million in goodwill,$10.5 million in intangible assets associated with recent acquisitions,$1.4 million in intangible assets related to capitalized patents, and$2.1 million in other asset write-downs. There were no similar impairments in 2020. Other expense. Other expense was$0.1 million for the year endedDecember 31, 2020 compared to$2.4 million for the year endedDecember 31, 2019 . This decrease was primarily driven by the impairment charge related to our equity investment in present4DGmbH ("present4D") recorded in the second quarter of 2019 and the impairment charge related to our note receivable due from present4D recorded in the fourth quarter of 2019. Income tax (benefit) expense. Income tax benefit for the year endedDecember 31, 2020 was$31.4 million compared with an income tax expense of$1.1 million for the year endedDecember 31, 2019 . Our effective tax rate was 102.0% for the year endedDecember 31, 2020 compared to 1.9% for the year endedDecember 31, 2019 . The change in income tax (benefit) expense was primarily due to the Company completing an intra-entity transfer of certain intellectual property rights ("IP Rights") which resulted in the Company establishing a deferred tax asset benefit of$19.2 million , based on the fair value of the IP rights transferred inDecember 2020 . Net income (loss). Net income was$0.6 million for the year endedDecember 31, 2020 compared with net loss of$62.1 million for the year endedDecember 31, 2019 , reflecting the impact of the factors described above. 35 --------------------------------------------------------------------------------
Table of Contents 2019 Compared to 2018 Years ended December 31, 2019 2018 Change ($) (dollars in millions) % of Sales % of Sales 2019 vs 2018 Product$ 289.7 75.9 %$ 320.6 79.4 %$ (30.9) Service 92.1 24.1 % 83.0 20.6 % 9.0 Total sales 381.8 100.0 % 403.6 100.0 % (21.9) Product 133.2 34.9 % 130.9 32.4 % 2.4 Service 50.4 13.2 % 51.2 12.7 % (0.8) Total cost of sales 183.6 48.1 % 182.1 45.1 % 1.6 Gross profit 198.1 51.9 % 221.6 54.9 % (23.4) Operating expenses Selling, general and administrative 177.4 46.5 % 169.7 42.0 % 7.7 Research and development 44.2 11.6 % 46.1 11.4 % (1.9) Impairment loss 35.2 9.2 % - - % 35.2 Total operating expenses 256.8 67.3 % 215.8 53.5 % 41.0 Other expense 2.4 0.6 % 1.2 0.3 % 1.2 Income tax expense (benefit) 1.1 0.3 % (0.4) (0.1) % 1.5 Net (loss) income$ (62.1) (16.3) %$ 4.9 1.2 %$ (67.0) Consolidated Results Sales. Total sales decreased by$21.9 million , or 5.4%, to$381.8 million for the year endedDecember 31, 2019 from$403.6 million for the year endedDecember 31, 2018 . Total product sales decreased by$30.9 million , or 9.6%, to$289.7 million for the year endedDecember 31, 2019 from$320.6 million for the year endedDecember 31, 2018 . Our product sales decrease reflected lower unit sales primarily driven by continuing softness in many of our served markets, with particular softness in the automotive and broader Asian markets. Service sales increased by$9.0 million , or 10.9%, to$92.1 million for the year endedDecember 31, 2019 from$83.0 million for the year endedDecember 31, 2018 , primarily due to an increase in warranty and customer service revenue driven by the growth of our global installed, serviceable base and focused sales initiatives to maintain customer relationships after the purchase of our measurement devices. Foreign exchange rates had a negative impact on sales of$13.0 million , decreasing our overall sales by approximately 3.2%, primarily due to the weakening of the Euro and Chinese Yuan relative to theU.S. dollar. Gross profit. Gross profit decreased by$23.4 million , or 10.6%, to$198.1 million for the year endedDecember 31, 2019 from$221.6 million for the year endedDecember 31, 2018 . Gross margin decreased to 51.9% for the year endedDecember 31, 2019 from 54.9% in the prior year period. Gross margin from product revenue decreased by 5.2 percentage points to 54.0% for the year endedDecember 31, 2019 from 59.2% in the prior year period. This decrease in gross margin from product revenue was primarily due to the$12.8 million increase in our reserve for excess and obsolete inventory recorded in the fourth quarter of 2019 in connection with our strategic decisions to simplify our hardware and software product portfolio and cease selling certain products, compared to a$4.7 million increase in our reserve for excess and obsolete inventory recorded in 2018. Gross margin from service revenue increased by 7.0 percentage points to 45.3% for the year endedDecember 31, 2019 from 38.3% for the prior year period, primarily due to the leveraging effect of higher warranty and customer service revenue as well as improved efficiencies in our customer service repair process. 36 -------------------------------------------------------------------------------- Table of Contents Selling, general and administrative expenses. Selling, general and administrative ("SG&A") expenses increased by$7.7 million , or 4.5%, to$177.4 million , for the year endedDecember 31, 2019 from$169.7 million for the year endedDecember 31, 2018 . This increase was driven primarily by executive team transition costs, including the acceleration of stock-based compensation expense related to the accelerated vesting of stock options and restricted stock units granted to our prior executive officers and severance costs, professional fees incurred related to the GSA Matter, and an increase in compensation expenses related to our increased selling headcount, partially offset by lower commission expense due to the decrease in product sales. SG&A expenses as a percentage of sales increased to 46.5% for the year endedDecember 31, 2019 from 42.0% for the year endedDecember 31, 2018 . Research and development expenses. Research and development expenses decreased$1.9 million , or 4.1%, to$44.2 million for the year endedDecember 31, 2019 from$46.1 million for the year endedDecember 31, 2018 . This decrease in research and development expenses was mainly due to a decrease in materials and consulting costs, as well as favorable changes in foreign currencies as theU.S. dollar strengthened against the Euro, which decreased the compensation cost of foreign research and development employees. Research and development expenses as a percentage of sales increased to 11.6% for the year endedDecember 31, 2019 from 11.4% for the year endedDecember 31, 2018 . Impairment loss. As a result of our annual goodwill and intangible asset impairment test performed inDecember 2019 , we recorded an impairment loss of$35.2 million in the fourth quarter of 2019, which included$21.2 million in goodwill,$10.5 million in intangible assets associated with recent acquisitions,$1.4 million in intangible assets related to capitalized patents, and$2.1 million in other asset write-downs. There were no similar impairments in 2018. Other expense. Other expense was$2.4 million for the year endedDecember 31, 2019 compared to$1.2 million for the year endedDecember 31, 2018 . This increase was primarily driven by the impairment charge related to our equity investment in present4DGmbH ("present4D") recorded in the second quarter of 2019 and the impairment charge related to our note receivable due from present4D recorded in the fourth quarter of 2019, partially offset by a favorable adjustment to the contingent consideration liability from a prior year acquisition. Income tax expense (benefit). Income tax expense for the year endedDecember 31, 2019 was$1.1 million compared with an income tax benefit of$0.4 million for the year endedDecember 31, 2018 . Our effective tax rate was 1.9% for the year endedDecember 31, 2019 compared to (8.2%) for the year endedDecember 31, 2018 . The change in income tax expense (benefit) was primarily due to$8.5 million of income tax expense recorded in the year endedDecember 31, 2019 resulting from our determination that it is more likely than not that certain foreign deferred tax assets will not be fully realized and the establishment of a valuation due to a history of cumulative losses in related jurisdictions. Additionally, the year-over-year change in our income tax expense (benefit) and our effective tax rate was partially due to a pretax book loss during the year endedDecember 31, 2019 as compared with pretax book income in the year endedDecember 31, 2018 , as well as provision-to-return adjustments recorded in 2019 and 2018. Net (loss) income. Net loss was$62.1 million for the year endedDecember 31, 2019 compared with net income of$4.9 million for the year endedDecember 31, 2018 , reflecting the impact of the factors described above. Liquidity and Capital Resources Cash and cash equivalents increased by$52.0 million to$185.6 million atDecember 31, 2020 from$133.6 million atDecember 31, 2019 . Cash flows from operating activities provide our primary source of liquidity. We generated positive cash flows from operations of$21.4 million during the year endedDecember 31, 2020 compared to$32.5 million during the year endedDecember 31, 2019 . The change was mainly due to a decrease in non-cash adjustments to reconcile net income more than offsetting an increase due to certain working capital reductions. Cash flows provided by investing activities during the year endedDecember 31, 2020 were$13.9 million compared with cash flows used in investing activities of$9.3 million during the year endedDecember 31, 2019 . The change was primarily due to proceeds from sales of investments of$25.0 million during the year endedDecember 31, 2020 , compared to no such activity in the year endedDecember 31, 2019 . Cash flows provided by financing activities during the years endedDecember 31, 2020 andDecember 31, 2019 were$11.1 million and$2.2 million , respectively. The increase was primarily driven by higher proceeds from the issuance of stock relating to the exercise of stock options during the year endedDecember 31, 2020 compared to the prior year and decreased contingent consideration paid in connection with our recent acquisitions in the year endedDecember 31, 2020 . 37 -------------------------------------------------------------------------------- Table of Contents Of our cash and cash equivalents,$119.2 million was held by foreign subsidiaries as ofDecember 31, 2020 . OnDecember 22, 2017 ,the United States enacted theU.S. Tax Cuts and Jobs Act, resulting in significant modifications to existing law, which included a transition tax on the mandatory deemed repatriation of foreign earnings. 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 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. Subsequently, inOctober 2015 , our Board of Directors authorized an increase to the existing share repurchase program from$30.0 million to$50.0 million . InDecember 2018 , our Board of Directors authorized management to utilize the share repurchase program, beginningJanuary 1, 2019 , to maintain the number of our issued and outstanding shares to address the dilutive impact of stock options exercises and the settlement of restricted stock units. Acquisitions for the share repurchase program may be made from time to time at prevailing prices as permitted by securities laws and other legal requirements and subject to market conditions and other factors under this program. The share repurchase program may be discontinued at any time. There is no expiration date or other restriction governing the period over which we can repurchase shares under the program. We made no stock repurchases during the years endedDecember 31, 2020 , 2019 and 2018 under this program. As ofDecember 31, 2020 , we had authorization to repurchase$18.3 million of the$50.0 million authorized by our Board of Directors under the existing share repurchase program. We believe that our working capital and anticipated cash flow from operations will be sufficient to fund our long-term liquidity operating requirements for at least the next 12 months. We have no off-balance sheet arrangements. Contractual Obligations and Commercial Commitments We are party to capital leases on equipment with an initial term of 36 to 60 months and other non-cancellable operating leases. These obligations are presented below as ofDecember 31, 2020 (dollars in thousands): Payments Due by Period Contractual Obligations Total < 1 Year 1-3 Years 3-5 Years > 5 Years Operating lease obligations$ 33,322 $ 6,914 $ 10,193 $ 7,611 $ 8,604 Capital lease obligations 445 292 134 19 $ - Purchase obligations 45,138 44,196 942 - - Transition tax liability 11,080 1,166 3,353 6,561 - Other obligations 1,056 - 1,056 - - Total$ 91,041 $ 52,568 $ 15,678 $ 14,191 $ 8,604 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 ofDecember 31, 2020 , we had approximately$44.2 million in purchase commitments that are expected to be delivered within the next 12 months. To ensure adequate component availability in preparation for new product introductions, we also had$0.9 million in long-term commitments for purchases to be delivered after 12 months. During the fourth quarter of 2017, we recorded a provisional amount of$17.4 million related to the increase to our taxes payable pursuant to theU.S. Tax Cuts and Jobs Act associated with the mandatory deemed repatriation of the earnings of our foreign subsidiaries, or transition tax. During the fourth quarter of 2018, we decreased the provisional estimate of the one-time transition tax by$2.8 million upon completing our analysis of earnings and profits of our foreign subsidiaries and utilization of foreign tax credits.$1.8 million of the decrease related to a change in our deferred tax assets, and$1.0 million was an income tax benefit recorded in the fourth quarter of 2018. We made our first three transition tax payments in 2018, 2019, and 2020 and will pay the remaining liability over the next five years. Other obligations included in the table primarily represent estimated payments due for acquisition related earn-outs of$1.1 million . 38 -------------------------------------------------------------------------------- Table of Contents Inflation Inflation did not have a material impact on our results of operations in recent years, and we do not expect inflation to have a material impact on our operations in 2021. Critical Accounting Policies The preparation of our consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as disclosure of contingent assets and liabilities. We base our estimates on historical experience, along with various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Some of these judgments can be subjective and complex and, consequently, actual results may differ from these estimates under different assumptions or conditions. While for any given estimate or assumption made by our management there may be other estimates or assumptions that are reasonable, we believe that, given the current facts and circumstances, it is unlikely that applying any such other reasonable estimate or assumption would materially impact the financial statements. In response to theSEC's financial reporting release, FR-60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies," we have selected our critical accounting policies for purposes of explaining the methodology used in our calculation, in addition to any inherent uncertainties pertaining to the possible effects on our financial condition. The critical policies discussed below are our processes of recognizing revenue, the reserve for excess and obsolete inventory, income taxes, the reserve for warranties, goodwill impairment, business combinations and stock-based compensation. These policies affect current assets, current liabilities and operating results and are therefore critical in assessing our financial and operating status. These policies involve certain assumptions that, if incorrect, could have an adverse impact on our operating results and financial position. Revenue Recognition For arrangements with multiple performance obligations, which represent promises within an arrangement that are capable of being distinct, we allocate revenue to all distinct performance obligations based on their relative standalone selling prices ("SSP"). When available, we use observable prices to determine the SSP. When observable prices are not available, SSPs are established that reflect our best estimates of what the selling prices of the performance obligations would be if they were sold regularly on a standalone basis. Revenue related to our measurement and imaging equipment and related software is generally recognized upon shipment from our facilities or when delivered to the customer's location, as determined by the agreed upon shipping terms, at which time we are entitled to payment and title and control has passed to the customer. Fees billed to customers associated with the distribution of products are classified as revenue. We generally warrant our products against defects in design, materials and workmanship for one year. A provision for estimated future costs relating to warranty expense is recorded when products are shipped. To support our product lines, we also sell hardware service contracts that typically range from one year to three years. Hardware service contract revenues are recognized on a straight-line basis over the term of the contract. Costs relating to hardware service contracts are recognized as incurred. Revenue from sales of software only is recognized when no further significant production, modification or customization of the software is required and when the risks and rewards of ownership have passed to the customer. These software arrangements generally include short-term maintenance that is considered post-contract support ("PCS"), which is considered to be a separate performance obligation. We generally establish a standalone sales price for this PCS component based on our software maintenance contract renewals. Software maintenance contracts, when sold, are recognized on a straight-line basis over the term of the contract. Revenues resulting from sales of comprehensive support, training and technology consulting services are recognized as such services are performed and are deferred when billed in advance of the performance of services. Payment for products and services is collected within a short period of time following transfer of control or commencement of delivery of services, as applicable. Revenues are presented net of sales-related taxes. 39 -------------------------------------------------------------------------------- Table of Contents Reserve for Excess and Obsolete Inventory Because the value of inventory that will ultimately be realized cannot be known with exact certainty, we rely upon both past sales history and future sales forecasts to provide a basis for the determination of the reserve. Inventory is considered potentially obsolete if we have withdrawn those products from the market or had no sales of the product for the past 12 months and have no sales forecasted for the next 12 months. Inventory is considered potentially excess if the quantity on hand exceeds 12 months of expected remaining usage. The resulting obsolete and excess parts are then reviewed to determine if a substitute usage or a future need exists. Items without an identified current or future usage are reserved in an amount equal to 100% of the first-in first-out cost of such inventory. Our products are subject to changes in technologies that may make certain of our products or their components obsolete or less competitive, which may increase our historical provisions to the reserve. Income Taxes We review our deferred tax assets on a regular basis to evaluate their recoverability based upon expected future reversals of deferred tax liabilities, projections of future taxable income, and tax planning strategies that we might employ to utilize such assets, including net operating loss carryforwards. Based on the positive and negative evidence of recoverability, we establish a valuation allowance against the net deferred assets of a taxing jurisdiction in which we operate, unless it is "more likely than not" that we will recover such assets through the above means. Our evaluation of the need for the valuation allowance is significantly influenced by our ability to achieve profitability and our ability to predict and achieve future projections of taxable income. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of operating a global business, there are many transactions for which the ultimate tax outcome is uncertain. We establish provisions for income taxes when, despite the belief that tax positions are fully supportable, there remain certain positions that do not meet the minimum probability threshold as described by FASB ASC Topic 740, which is a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority. In the ordinary course of business, we are examined by various federal, state, and foreign tax authorities. We regularly assess the potential outcome of these examinations and any future examinations for the current or prior years in determining the adequacy of our provision for income taxes. We assess the likelihood and amount of potential adjustments and adjust the income tax provision, the current tax liability and deferred taxes in the period in which the facts that gave rise to a revision become known. Reserve for Warranties We establish at the time of sale a liability for the one-year warranty included with the initial purchase price of our products, based upon an estimate of the repair expenses likely to be incurred for the warranty period. The warranty period is measured in installation-months for each major product group. The warranty reserve is included in accrued liabilities in the accompanying consolidated balance sheets. The warranty expense is estimated by applying the actual total repair expenses for each product group in the prior period and determining a rate of repair expense per installation-month. This repair rate is multiplied by the number of installation-months of warranty for each product group to determine the provision for warranty expenses for the period. We evaluate our exposure to warranty costs at the end of each period using the estimated expense per installation-month for each major product group, the number of units remaining under warranty, and the remaining number of months each unit will be under warranty. We have a history of new product introductions and enhancements to existing products, which may result in unforeseen issues that increase our warranty costs. While such expenses have historically been within expectations, we cannot guarantee this will continue in the future. Goodwill ImpairmentGoodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired. We do not amortize goodwill; however, we perform an annual review each year, or more frequently if indicators of potential impairment exist (i.e., that it is more likely than not that the fair value of the reporting unit is less than the carrying value), to determine if the carrying value of the recorded goodwill or indefinite lived intangible assets is impaired. 40 -------------------------------------------------------------------------------- Table of Contents Each period, and for any of our reporting units, we can elect to perform a qualitative assessment to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. If we believe, as a result of our qualitative assessment, that it is not more likely than not that the fair value of a reporting unit containing goodwill is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary. If we elect to bypass the qualitative assessment option, or if the qualitative assessment was performed and resulted in the Company being unable to conclude that it is not more likely than not that the fair value of a reporting unit containing goodwill is greater than its carrying amount, we will perform the quantitative goodwill impairment test. We perform the quantitative goodwill impairment test by calculating the fair value of the reporting unit using a discounted cash flow method and market approach method, and then comparing the respective fair value with the carrying amount of the reporting unit. If the carrying amount of the reporting unit exceeds its fair value, we impair goodwill for the excess amount of the reporting unit compared to its fair value, not to be reduced below zero. Management concluded there was no goodwill impairment for the years endedDecember 31, 2020 and 2018. However, during 2019 as a result of this test and under our historical reporting unit structure, the estimated fair value of each of the Photonics reporting unit, which included goodwill recognized with theInstrument Associates, LLC d/b/a Nutfield Technology ("Nutfield"),Laser Control Systems Limited ("Laser Control Systems") andLanmark Controls, Inc. ("Lanmark") acquisitions, and the 3D Design reporting unit, which included goodwill recognized with the acquisition of Opto-Tech SRL and its subsidiary Open Technologies SRL (collectively, "Open Technologies"), were determined to be significantly less than the carrying value of such reporting unit, indicating a full impairment. This impairment was driven primarily by historical and projected financial performance lower than our expectations and changes in our go-forward strategy in connection with our new strategic plan. Business Combinations We allocate the fair value of purchase consideration to the assets acquired and liabilities assumed based on their fair values at the acquisition date. The excess of the fair value of purchase consideration over the fair value of the assets acquired and liabilities assumed is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing intangible assets include, but are not limited to, expected future cash flows, which include consideration of future growth rates and margins, customer attrition rates, future changes in technology and brand awareness, loyalty and position, and discount rates. Critical estimates are also made in valuing earn-outs, which represent arrangements to pay former owners based on the satisfaction of performance criteria. Fair value estimates are based on the assumptions management believes a market participant would use in pricing the asset or liability. Amounts recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisition, as additional information about conditions existing at the acquisition date becomes available. Stock-Based Compensation We measure and record compensation expense using the applicable accounting guidance for share-based payments related to stock options, restricted stock, restricted stock units and performance-based awards granted to our directors and employees. The fair value of stock options, including performance awards, without a market condition is determined by using the Black-Scholes option valuation model. The fair value of restricted stock units and stock options with a market condition is estimated, at the date of grant, using the Monte Carlo Simulation valuation model. The Black-Scholes and Monte Carlo Simulation valuation models incorporate assumptions as to stock price volatility, the expected life of options or awards, a risk-free interest rate and dividend yield. In valuing our stock options, significant judgment is required in determining the expected volatility of our common stock and the expected life that individuals will hold their stock options prior to exercising. Expected volatility for stock options is based on the historical and implied volatility of our own common stock while the volatility for our restricted stock units with a market condition is based on the historical volatility of our own stock and the stock of companies within our defined peer group. The expected life of stock options is derived from the historical actual term of option grants and an estimate of future exercises during the remaining contractual period of the option. While volatility and estimated life are assumptions that do not bear the risk of change subsequent to the grant date of stock options, these assumptions may be difficult to measure, as they represent future expectations based on historical experience. Further, our expected volatility and expected life may change in the future, which could substantially change the grant-date fair value of future awards of stock options and, ultimately, the expense we record. The fair value of restricted stock, including performance awards, without a market condition is estimated using the current market price of our common stock on the date of grant. We elect to account for forfeitures related to the service condition-based awards as they occur. 41 -------------------------------------------------------------------------------- Table of Contents We expense stock-based compensation for stock options, restricted stock awards, restricted stock units and performance awards over the requisite service period. For awards with only a service condition, we expense stock-based compensation using the straight-line method over the requisite service period for the entire award. For awards with both performance and service conditions, we expense the stock-based compensation on a straight-line basis over the requisite service period for each separately vesting portion of the award, taking into account the probability that we will satisfy the performance condition. Furthermore, we expense awards with a market condition over the three-year vesting period regardless of the value that the award recipients ultimately receive. Also, beginning inOctober 2018 , our non-employee directors may elect to have their annual cash retainers and annual equity retainers paid in the form of deferred stock units pursuant to the 2014 Equity Incentive Plan and the 2018 Non-Employee Director Deferred Compensation Plan. Each deferred stock unit represents the right to receive one share of our common stock upon the non-employee director's separation of service from the Company. We record compensation cost associated with our deferred stock units over the period of service. Impact of Recently Adopted Accounting Standards InFebruary 2016 , the FASB issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842) ("ASU 2016-02"), which is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements to enable users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, was issued by the FASB inJuly 2018 and allows for a cumulative-effect adjustment transition method of adoption. We adopted ASU 2016-02 effective as ofJanuary 1, 2019 utilizing the cumulative-effect adjustment transition method of adoption, which resulted in the recognition on our consolidated balance sheet as ofDecember 31, 2019 of$18.4 million of right-of-use assets for operating leases,$19.6 million of lease liability for operating leases,$0.8 million of property and equipment, net for finance leases and$0.8 million of lease liability for finance leases under which we function as a lessee. We elected certain practical expedients available under the transition provisions to (i) allow aggregation of non-lease components with the related lease components when evaluating accounting treatment, (ii) apply the modified retrospective adoption method, utilizing the simplified transition option, which allows us to continue to apply the legacy guidance in FASB ASC Topic 840, including its disclosure requirements, in the comparative periods presented in the year of adoption, and (iii) use hindsight in determining the lease term (that is, when considering our options to extend or terminate the lease and to purchase the underlying asset) and in assessing impairment of our right-of-use assets. The adoption of ASU 2016-02 also required us to include any initial direct costs, which are incremental costs that would not have been incurred had the lease not been obtained, in the right-of-use assets. The recognition of these costs in connection with our adoption of this guidance did not have a material impact on our consolidated financial statements. InJanuary 2017 , the FASB issued ASU No. 2017-04, Intangible -Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"), which is intended to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the new guidance, we perform our goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value up to the amount of the goodwill allocated to the reporting unit. The new guidance also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test if it fails the qualitative assessment. We adopted this guidance in connection with our annual impairment test for the fiscal year endedDecember 31, 2019 . The adoption of this guidance did not have a material impact on our consolidated financial statements. InJune 2016 , the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13, and subsequent related amendments to ASU 2016-13, replace the existing incurred loss impairment model with an expected loss model that requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. We adopted ASU 2016-13 effective as ofJanuary 1, 2020 , and the adoption of the new guidance did not have a material impact on our consolidated financial statements. 42
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source