Summary of FARO TECHNOLOGIES INC

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following information should be read in conjunction with the Financial Statements, including the notes thereto, included elsewhere in this Quarterly Report on Form 10-Q, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.

Forward Looking Statements

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," "will," "believe," "plan," "should," "could," "seek," "expect," "anticipate," "intend," "estimate," "goal," "objective," "project," "forecast," "target" and similar words, or discussions of our strategy or other intentions identify forward-looking statements. Other written or oral statements that constitute forward-looking statements also may be made by the Company from time to time. Specifically, this Quarterly Report on Form 10-Q contains, among others, forward-looking statements regarding:

• the Company's ability to achieve and maintain profitability;

• 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 impact of changes in technologies on the competitiveness of the Company's products or their components;

• the magnitude of increased warranty costs from new product introductions and enhancements to existing products;

• the outcome of litigation and its effect on the Company's business, financial condition or results of operations;

• the continuation of the Company's share repurchase program;

• the sufficiency of the Company's working capital, cash flow from operations, and credit facility to fund its long-term liquidity requirements;

• the impact of geographic changes in the manufacturing or sales of the Company's products on its tax rate; and

• the imposition of penalties against the Company for failure to comply with its continuing obligations with respect to the FCPA Matter.

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. The Company does 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:

• the slowdown in the manufacturing industry or the domestic and international economies in the regions of the world where the Company operates;

• the Company's inability to further penetrate its customer base;

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• development by others of new or improved products, processes or technologies that make the Company's products obsolete or less competitive;

• the cyclical nature of the industries of the Company's customers and material adverse changes in its customers access to liquidity and capital;

• the inability to protect the Company's patents and other proprietary rights in the United States and foreign countries;

• fluctuations in the Company's annual and quarterly operating results and the inability to achieve its financial operating targets;

• changes in gross margins due to changing product mix of products sold and the different gross margins on different products;

• the Company's inability to successfully maintain the requirements of Restriction of use of Hazardous Substances ("RoHS") and Waste Electrical and Electronic Equipment ("WEEE") compliance into its products;

• the inability of the Company's products to displace traditional measurement devices and attain broad market acceptance;

• risks associated with expanding international operations, such as fluctuations in currency exchange rates, difficulties in staffing and managing foreign operations, political and economic instability, compliance with 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;

• variations in the effective income tax rate and the difficulty in predicting the tax rate on a quarterly and annual basis;

• the loss of key suppliers and the inability to find sufficient alternative suppliers in a reasonable period or on commercially reasonable terms; and

• other risks and uncertainties discussed in Part I, Item 1A. Risk Factors in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.

Overview

The Company designs, develops, manufactures, markets and supports portable, software driven, 3-D measurement and imaging systems used in a broad range of manufacturing, industrial, building construction and forensic applications. The Company's FaroArm, FARO Laser ScanArm and FARO Gage articulated measuring devices, the FARO Laser Scanner LS, the FARO Laser Tracker, and their companion CAM2 software, provide for Computer Aided Design ("CAD")-based inspection and/or factory-level statistical process control, and high-density surveying. These products integrate the measurement, quality inspection, and reverse engineering functions with CAD software to improve productivity, enhance product quality and decrease rework and scrap in the manufacturing process. The Company uses the acronym "CAM2" for this process, which stands for computer-aided measurement. As of October 3, 2009, the Company's products have been purchased by approximately 9,800 customers worldwide, ranging from small machine shops to such large manufacturing and industrial companies as Audi, Bell Helicopter, Boeing, British Aerospace, Caterpillar, Daimler Chrysler, General Electric, General Motors, Honda, Johnson Controls, Komatsu America International, Lockheed Martin, Nissan, Siemens and Volkswagen, among many others.

The Company derives revenues primarily from the sale of its FaroArm, FARO Laser ScanArm, FARO Gage, FARO Laser Tracker and FARO Laser Scanner LS 3-D measurement equipment, and their related multi-faceted software. Revenue related to these products is generally recognized upon shipment. In addition, the Company sells one and three-year extended warranties and training and technology consulting services relating to its products. The Company recognizes the revenue from extended warranties on a straight-line basis. The Company also receives royalties from licensing agreements for its historical medical technology and recognizes the revenue from these royalties as licensees use the technology.

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The Company operates in international markets throughout the world. It maintains sales offices in China, France, Germany, Great Britain, Italy, India, Japan, Malaysia, Netherlands, Poland, Spain, Singapore and Vietnam. The Company manages and reports its global sales in three regions: the Americas, Europe/Africa and Asia/Pacific. In the nine months ended October 3, 2009, 37.9% of the Company's sales were in the Americas compared to 37.7% in the first nine months of 2008, 41.3% were in the Europe/Africa region compared to 44.1% in the first nine months of 2008, and 20.8% were in the Asia/Pacific region compared to 18.2% in the same prior year period. In the third quarter of 2009, new order bookings decreased $13.4 million, or 27.2%, to $35.8 million from $49.2 million in the prior year period. New orders decreased $3.6 million, or 20.5%, in the Americas to $14.0 million from $17.6 million in the prior year period. New orders decreased $7.0 million, or 32.1%, to $14.8 million in Europe/Africa from $21.8 in the third quarter of 2008. In Asia/Pacific, new orders decreased $2.8 million, or 28.6%, to $7.0 million from $9.8 million in the third quarter of 2008.

The Company manufactures its FaroArm, FARO Gage, and FARO Laser Tracker products in the Company's manufacturing facilities located in Florida and Pennsylvania for customer orders from the Americas, in its manufacturing facility located in Switzerland for customer orders from the Europe/Africa region, and in its manufacturing facility located in Singapore for customer orders from the Asia/Pacific region. The Company manufactures its FARO Laser Scanner LS product in its facility located in Stuttgart, Germany. The Company expects all its existing plants to have the production capacity necessary to support its volume requirements through 2009.

The Company's effective tax benefit rate was 22.7% for the nine months ended October 3, 2009 compared with an effective tax rate of 20.1% in the prior year period. The Company's tax rate continues to be lower than the statutory tax rate in the United States primarily as a result of favorable tax rates in foreign jurisdictions. However, the Company's tax rate could be impacted positively or negatively by geographic changes in the manufacturing or sales of its products. The Company has received a favorable income tax rate commitment from the Swiss government as an incentive to establish a manufacturing plant in Switzerland. In addition, in 2006, the Company received approval from the Singapore Economic Development Board for a favorable multi-year income tax holiday for its Singapore headquarters and manufacturing operations, subject to certain terms and conditions including employment, spending and capital investment.

The Company accounts for wholly owned foreign subsidiaries in the currency of the respective foreign jurisdiction, and therefore, fluctuations in exchange rates may have an impact on inter-company accounts reflected in the Company's consolidated financial statements. The Company is 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 (see Item 3. Foreign Exchange Exposure below). However, it does not regularly use such instruments, and none were utilized in 2008 or the nine months ended October 3, 2009.

The Company implemented three reductions-in-force during the nine month period ended October 3, 2009 to lower costs in view of the effects of deteriorating global economic conditions. The first reduction-in-force was announced on February 20, 2009, and affected approximately 7% of the Company's workforce. As a result of this first reduction-in-force, the Company expects to save approximately $4.5 million in compensation costs on an annualized basis. Severance costs related to the first reduction-in-force equaled $0.7 million. The second reduction-in-force, effective April 3, 2009, was announced on April 6, 2009, and affected approximately 14% of the Company's workforce. As a result of this second reduction-in-force, the Company expects to save $7.4 million in compensation costs on an annualized basis. Severance costs for the second reduction-in-force were $1.0 million. The third reduction-in-force was effective August 24, 2009, and affected approximately 8% of the Company's workforce. As a result of this third reduction-in-force, the Company expects to save approximately $4.1 million in compensation costs on an annualized basis. Severance costs for the third reduction-in-force were $0.6 million.

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The Company incurred a net loss in the quarter and nine months ended October 3, 2009, primarily as a result of a decrease in product sales. The Company attributes the decrease in product sales principally to the deterioration of the global economy. Prior to 2009, the Company had a history of sales and earnings growth and 26 consecutive profitable quarters through December 31, 2008. Its sales and earnings growth were the result of a number of factors, including:
continuing market demand for and acceptance of the Company's products; increased sales activity in part through additional sales staff worldwide, new products and product enhancements such as the FARO Gage and FARO Laser Scanner LS; and the effect of acquisitions. However, the Company's historical financial performance is not indicative of its future financial performance and the Company can offer no assurance as to when or if it will be profitable again in the future.

FCPA Update

As previously reported by the Company, the Company conducted an internal investigation in 2006 into certain payments made by its China subsidiary that may have violated the Foreign Corrupt Practices Act ("FCPA") and other applicable laws (the "FCPA Matter") and entered into settlement agreements and documents with the U.S. Securities and Exchange Commission (the "SEC") and the U.S. Department of Justice (the "DOJ") in 2008 related to the FCPA Matter. The Company incurred expenses of $3.8 million in 2006, $3.1 million in 2007, and $0.3 million in 2008 relating to the FCPA Matter and paid $2.95 million in fines, penalties, and interest to the DOJ and SEC in 2008 related to the FCPA Matter. The Company has a two-year monitoring obligation and other continuing obligations with the SEC and the DOJ with respect to compliance with the FCPA and other laws, including full cooperation with the government and the adoption of a compliance code containing specific provisions intended to prevent violations of the FCPA. The selection process of the monitor is not yet complete. Failure to comply with any such continuing obligations could result in the SEC and the DOJ seeking to impose penalties against the Company in the future.

Results of Operations

Three Months Ended October 3, 2009 Compared to the Three Months Ended September 27, 2008

Total sales decreased by $13.4 million, or 27.3%, to $35.7 million in the three months ended October 3, 2009 from $49.1 million for the three months ended September 27, 2008. This decrease resulted primarily from a decrease in unit sales in all regions related to the weakness in the global economy. Product sales decreased by $13.2 million, or 32.1%, to $27.9 million for the three months ended October 3, 2009 from $41.1 million in the third quarter of the prior year. Service revenue decreased by $0.2 million, or 2.5%, to $7.8 million for the three months ended October 3, 2009 from $8.0 million in the same period during the prior year, primarily due to a decrease in training revenue in Europe and the Americas regions.

Sales in the Americas region decreased $4.7 million, or 25. 5%, to $13.7 million for the three months ended October 3, 2009 from $18.4 million in the three months ended September 27, 2008. Product sales in the Americas region decreased by $4.8 million, or 31.4%, to $10.5 million for the three months ended October 3, 2009 from $15.3 million in the third quarter of the prior year. Service revenue in the Americas region increased by $0.1 million, or 3.2%, to $3.2 million for the three months ended October 3, 2009 from $3.1 million in the same period during the prior year.

Sales in the Europe/Africa region decreased $6.9 million, or 32.1%, to $14.6 million for the three months ended October 3, 2009 from $21.5 million in the three months ended September 27, 2008. Product sales in the Europe/Africa region decreased by $6.2 million, or 34.8%, to $11.6 million for the three months ended October 3, 2009 from $17.8 million in the third quarter of the prior year. Service revenue in the Europe/Africa region decreased by $0.7 million, or 18.9%, to $3.0 million for the three months ended October 3, 2009 from $3.7 million in the same period during the prior year, primarily due to a decrease in customer service and training revenue.

Sales in the Asia/Pacific region decreased $1.8 million, or 19.6%, to $7.4 million for the three months ended October 3, 2009 from $9.2 million in the three months ended September 27, 2008. Product sales in the Asia/Pacific region decreased by $2.2 million, or 27.5%, to $5.8 million for the three months ended October 3, 2009 from $8.0 million in the third quarter of the prior year.

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Service revenue in the Asia/Pacific region increased by $0.4 million, or 33.3%, to $1.6 million for the three months ended October 3, 2009 from $1.2 million in the same period during the prior year, primarily due to an increase in warranty revenue.

Gross profit decreased by $9.4 million, or 32.4%, to $19.6 million for the three months ended October 3, 2009 from $29.0 million for the three months ended September 27, 2008. Gross margin decreased to 54.9% for the three months ended October 3, 2009 from 59.1% for the three months ended September 27, 2008, primarily due to a change in the sales mix between product sales and service revenue resulting from a decrease in product sales. Gross margin from product sales decreased to 59.6% in the three months ended October 3, 2009 from 65.4% for the three months ended September 27, 2008, primarily due to a change in the product sales mix resulting in a decrease in average unit selling prices. Gross margin from service revenues increased to 38.1% in the three months ended October 3, 2009 from 26.7% for the three months ended September 27, 2008, primarily due to a decrease in customer service costs.

Selling expenses decreased by $3.9 million, or 25.4%, to $11.5 million for the three months ended October 3, 2009 from $15.4 million for three months ended September 27, 2008. This decrease was primarily due to a decrease in commission and compensation expense of $2.7 million, marketing and advertising expense of $0.3 million, and travel-related costs of $0.7 million.

Worldwide sales and marketing headcount decreased by 45, or 12.2%, to 324 at October 3, 2009 from 369 at September 27, 2008. Regionally, the Company's sales and marketing headcount decreased by 40, or 30.3%, to 92 at October 3, 2009 from 132 for the Americas; decreased by 14 or 10.7%, to 117 at October 3, 2009 from 131 in Europe/Africa; and increased by 9, or 8.5%, in Asia/Pacific to 115 at October 3, 2009 from 106 at September 27, 2008.

As a percentage of sales, selling expenses increased to 32.2% of sales in the three months ended October 3, 2009 from 31.3% in the three months ended September 27, 2008. Regionally, selling expenses were 29.0% of sales in the Americas for the quarter, compared to 32.2% of sales in the third quarter of 2008; 33.5% of sales for Europe/Africa compared to 31.7% of sales from the same period in the prior year; and 35.3% of sales for Asia/Pacific compared to 28.8% of sales from the same period in the prior year.

General and administrative expenses decreased by $0.4 million, or 6.9%, to $6.2 million for the three months ended October 3, 2009 from $6.6 million for the three months ended September 27, 2008, primarily due to a decrease in compensation expense of $0.7 million and lower travel-related costs of $0.2 million, offset by an increase in legal and professional fees of $0.3 million.

Depreciation and amortization expenses increased by $0.2 million to $1.4 million for the three months ended October 3, 2009 from $1.2 million for the three months ended September 27, 2008, primarily due to an increase in property and equipment.

Research and development expenses decreased to $2.8 million for the three months ended October 3, 2009 from $3.2 million for the three months ended September 27, 2008, primarily due to a decrease in compensation costs of $0.2 million. Research and development expenses as a percentage of sales increased to 7.8% for the three months ended October 3, 2009 from 6.6% for the three months ended September 27, 2008.

Interest income decreased by $0.52 million to $0.03 million for the three months ended October 3, 2009 from $0.55 million for the three months ended September 27, 2008, due to a decrease in interest rates related to cash and short term investments.

Other (income) expense, net decreased by $0.9 million to income of $0.2 million for the three months ended October 3, 2009 from expense of $0.7 million for the three months ended September 27, 2008, primarily as a result of foreign currency transaction gains.

Income tax (benefit) expense decreased by $1.3 million to a benefit of $0.8 million for the three months ended October 3, 2009 from expense of $0.5 million for the three months ended September 27, 2008, primarily due to a decrease in pre-tax income. Total deferred taxes for the Company's foreign subsidiaries relating to net operating loss carryforwards were $11.6 million and $10.2 million at October 3, 2009 and December 31, 2008, respectively. The related valuation allowance was $10.1 million and

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$8.7 million at October 3, 2009 and December 31, 2008, respectively. The Company's effective tax benefit rate was 37.6% for the three months ended October 3, 2009, while the Company's effective tax rate was 19.9% in the prior year period, primarily due to a taxable loss in higher tax jurisdictions. The Company's tax rate continues to be lower than the statutory tax rate in the United States primarily as a result of favorable tax rates in foreign jurisdictions. However, the Company's tax rate could be impacted positively or negatively by geographic changes in the manufacturing or sales of its products and the resulting effect on taxable income in each jurisdiction.

Net income decreased by $3.3 million to a net loss of $1.3 million for the three months ended October 3, 2009 from net income of $2.0 million for the three months ended September 27, 2008 as a result of the factors described above.

Nine months Ended October 3, 2009 Compared to the Nine months Ended September 27, 2008

Total sales decreased by $51.2 million, or 33.5%, to $101.7 million in the nine months ended October 3, 2009 from $152.9 million for the nine months ended September 27, 2008. This decrease is attributable primarily to a decrease in unit sales in all regions as a result of the weakness in the global economy. Product sales decreased by $51.7 million, or 39.5%, to $79.3 million for the nine months ended October 3, 2009 from $131.0 million for the nine months ended September 27, 2008. Service revenue increased by $0.5 million, or 2.3%, to $22.4 million for the nine months ended October 3, 2009 from $21.9 million in the same period during the prior year, primarily due to an increase in warranty revenue in the Americas and the Asia/Pacific regions.

Sales in the Americas region decreased $19.1 million, or 33.1%, to $38.6 million for the nine months ended October 3, 2009 from $57.7 million in the nine months ended September 27, 2008. Product sales in the Americas region decreased by $19.8 million, or 40.4%, to $29.2 million for the nine months ended October 3, 2009 from $49.0 million in the third quarter of the prior year. Service revenue in the Americas region increased by $0.7 million, or 8.0%, to $9.4 million for the nine months ended October 3, 2009 from $8.7 million in the same period during the prior year, due primarily to an increase in warranty revenue.

Sales in the Europe/Africa region decreased $25.4 million, or 37.7%, to $42.0 million for the nine months ended October 3, 2009 from $67.4 million in the nine months ended September 27, 2008. Product sales in the Europe/Africa region decreased by $24.4 million, or 42.5%, to $33.0 million for the nine months ended October 3, 2009 from $57.4 million in the third quarter of the prior year. Service revenue in the Europe/Africa region decreased by $1.0 million, or 10.0%, to $9.0 million for the nine months ended October 3, 2009 from $10.0 million in the same period during the prior year primarily due to a decrease in customer service and training revenue.

Sales in the Asia/Pacific region decreased $6.7 million, or 24.1%, to $21.1 million for the nine months ended October 3, 2009 from $27.8 million in the nine months ended September 27, 2008. Product sales in the Asia/Pacific region decreased by $7.5 million, or 30.5%, to $17.1 million for the nine months ended October 3, 2009 from $24.6 million in the same period of the prior year. Service revenue in the Asia/Pacific region increased by $0.8 million, or 25.0%, to $4.0 million for the nine months ended October 3, 2009 from $3.2 million in the same period during the prior year, due primarily to an increase in warranty revenue.

Gross profit decreased by $37.8 million, or 40.6%, to $55.2 million for the nine months ended October 3, 2009 from $93.0 million for the nine months ended September 27, 2008. Gross margin decreased to 54.3% for the nine months ended October 3, 2009 from 60.8% for the nine months ended September 27, 2008. The decrease in gross margin is primarily due to a change in the sales mix between product sales and service revenue resulting from a decrease in product sales. Gross margin from product sales decreased to 61.3% in the nine months ended October 3, 2009 from 66.6% for the nine months ended September 27, 2008 primarily due to a change in the product sales mix resulting in a decrease in average unit selling prices. Gross margin from service revenue increased to 29.4% in the nine months ended October 3, 2009 from 26.2% for the nine months ended September 27, 2008, primarily due to a decrease in customer service costs.

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Selling expenses decreased by $10.5 million, or 22.3%, to $36.4 million for the nine months ended October 3, 2009 from $46.9 million for nine months ended September 27, 2008, primarily due to a decrease in commission and compensation expense of $6.4 million, a decrease in travel related expenses of $1.8 million, and a decrease in marketing and advertising expenses of $0.8 million.

As a percentage of sales, selling expenses increased to 35.8% of sales in the nine months ended October 3, 2009 from 30.7% in the nine months ended September 27, 2008. Regionally, selling expenses were 33.4% of sales in the Americas for the nine months ended October 3, 2009 compared to 30.2% of sales in the prior year period; 38.1% of sales for Europe/Africa compared to 31.5% of sales from the same period in the prior year; and 35.8% of sales compared to 29.6% of sales for Asia/Pacific from the same period in the prior year.

General and administrative expenses decreased by $0.7 million, or 3.5%, to $18.6 million for the nine months ended October 3, 2009 from $19.3 million for the nine months ended September 27, 2008, mostly due to decreases in compensation expenses of $0.9 million and travel costs of $0.7 million, offset by increases in legal and professional fees of $0.8 million.

Depreciation and amortization expenses increased by $0.8 million to $4.1 million for the nine months ended October 3, 2009 from $3.3 million for the nine months . . .