REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders
FARO Technologies, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of FARO Technologies, Inc. (a Florida corporation) and subsidiaries as of December 31, 2010 and 2009, and the related statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FARO Technologies, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), FARO Technologies, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 25, 2011 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP Orlando, Florida
February 25, 2011
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, 2010
December 31, 2009
ASSETS Current Assets:
Cash and cash equivalents . . . $ 50,722 $ 35,078 Short-term investments . . . 64,986 64,986 Accounts receivable, net . . . 51,862 42,944 Inventories, net . . . 28,242 26,582 Deferred income taxes, net . . . 4,455 4,473 Prepaid expenses and other current assets . . . 8,045 6,016 Total current assets . . . 208,312 180,079 Property and Equipment:
Machinery and equipment . . . 24,840 19,867 Furniture and fixtures . . . 5,700 5,225 Leasehold improvements . . . 9,682 9,434 Property and equipment at cost . . . 40,222 34,526 Less: accumulated depreciation and amortization . . . (24,982) (20,788)
Property and equipment, net . . . 15,240 13,738 Goodwill . . . 19,015 19,934 Intangible assets, net . . . 7,204 7,985 Service inventory . . . 13,726 12,079 Deferred income taxes, net . . . 2,522 1,895 Total Assets . . . $266,019 $235,710 LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable . . . $ 12,025 $ 8,985 Accrued liabilities . . . 15,208 8,173 Income taxes payable . . . 1,138 229 Current portion of unearned service revenues . . . 13,357 12,226 Customer deposits . . . 3,679 2,173 Current portion of obligations under capital leases . . . 91 80 Total current liabilities . . . 45,498 31,866 Unearned service revenues—less current portion . . . 6,758 5,910 Deferred income taxes, net . . . 1,161 1,143 Obligations under capital leases—less current portion . . . 125 193 Total Liabilities . . . 53,542 39,112 Commitments and contingencies—See Note 13
Shareholders’ Equity:
Common stock - par value $.001, 50,000,000 shares authorized; 16,894,374 and
16,795,289 issued; 16,214,139 and 16,115,054 outstanding, respectively . . . . 17 17 Additional paid-in capital . . . 156,310 152,380 Retained earnings . . . 57,983 46,915 Accumulated other comprehensive income . . . 7,242 6,361 Common stock in treasury, at cost—680,235 shares . . . (9,075) (9,075) Total Shareholders’ Equity . . . 212,477 196,598 Total Liabilities and Shareholders’ Equity . . . $266,019 $235,710
The accompanying notes are an integral part of these consolidated financial statements.
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
(in thousands, except share and per share data) 2010 2009 2008
SALES
Product . . . $ 157,331 $ 117,714 $ 179,209 Service . . . 34,444 29,989 30,040 Total Sales . . . 191,775 147,703 209,249 COST OF SALES
Product . . . 54,571 46,293 60,736 Service . . . 23,806 20,702 23,287 Total Cost of Sales (exclusive of depreciation and amortization,
shown separately below) . . . 78,377 66,995 84,023 GROSS PROFIT . . . 113,398 80,708 125,226 OPERATING EXPENSES:
Selling . . . 50,679 48,598 63,015 General and administrative . . . 26,776 24,956 26,144 Depreciation and amortization . . . 6,326 5,530 4,505 Research and development . . . 12,690 12,613 12,625 Total operating expenses . . . 96,471 91,697 106,289 INCOME (LOSS) FROM OPERATIONS . . . 16,927 (10,989) 18,937 OTHER (INCOME) EXPENSE
Interest income . . . (105) (253) (2,170) Other expense (income), net . . . 2,783 (592) 2,295 Interest expense . . . 34 14 452 INCOME (LOSS) BEFORE INCOME TAX EXPENSE . . . 14,215 (10,158) 18,360 INCOME TAX EXPENSE . . . 3,147 424 4,408 NET INCOME (LOSS) . . . $ 11,068 $ (10,582) $ 13,952 NET INCOME (LOSS) PER SHARE—BASIC . . . $ 0.69 $ (0.66) $ 0.84 NET INCOME (LOSS) PER SHARE—DILUTED . . . $ 0.68 $ (0.66) $ 0.83 Weighted average shares—Basic . . . 16,153,831 16,125,449 16,632,608 Weighted average shares—Diluted . . . 16,365,826 16,125,449 16,734,403
The accompanying notes are an integral part of these consolidated financial statements.
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2010, 2009, AND 2008
Common Stock Additonal Paid-in Capital
Retained Earnings
Accumulated Other Comprehensive
Income
Common Stock in Treasury Total
(in thousands except share data) Shares Amounts
BALANCE DECEMBER 31, 2007 . . . 16,644,052 $17 $146,489 $ 43,545 $4,599 $ (151) $194,499 Net income . . . . 13,952 13,952
Currency translation adjustment . . . . 1,143 1,143
Comprehensive income . . . . 15,095
Stock Option Expense . . . . 1,793 1,793
Issuance of restricted stock . . . . 29,724 343 343
Stock issued for iQvolution milestone earn-outs . . . . 17,219 433 433
Stock options exercised . . . . 14,362 195 195
Tax benefit from employee stock option exercises . . . . 45 45
Stock Buy Back . . . . (6,805) (95) (95) BALANCE DECEMBER 31, 2008 . . . 16,698,552 17 149,298 57,497 5,742 (246) 212,308
Net loss . . . . (10,582) (10,582)
Currency translation adjustment . . . . 619 619
Comprehensive loss . . . . (9,963)
Stock Option Expense . . . . 2,449 2,449
Issuance of restricted stock . . . . 42,487 — —
Stock issued for iQvolution milestone earn-outs . . . . 30,692 546 546
Stock options exercised . . . . 7,750 83 83
Tax benefit from employee stock option exercises . . . . 4 4
Stock Buy Back . . . . (624,427) (8,829) (8,829) BALANCE DECEMBER 31, 2009 . . . 16,155,054 17 152,380 46,915 6,361 (9,075) 196,598
Net income . . . . 11,068 11,068
Currency translation adjustment . . . . 881 881
Comprehensive income . . . . 11,949
Stock Option Expense . . . . 2,392 2,392
Issuance of restricted stock . . . . 23,330 —
Stock options exercised . . . . 75,755 1,405 1,405
Tax benefit from employee stock option exercises . . . . 133 133
BALANCE DECEMBER 31, 2010 . . . 16,254,139 $17 $156,310 $ 57,983 $7,242 $(9,075) $212,477
35
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(in thousands) 2010 2009 2008
CASH FLOWS FROM:
OPERATING ACTIVITIES:
Net income (loss) . . . $ 11,068 $(10,582) $ 13,952 Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization . . . 6,326 5,530 4,505 Compensation for stock options and restricted stock units . . . 2,392 2,449 2,237 Provision for bad debts . . . 2,408 1,852 1,092 Deferred income tax (benefit) expense . . . (693) 1,986 (1,972) Change in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable . . . (13,018) 5,769 2,993 Inventories, net . . . (6,273) 8,301 (6,429) Prepaid expenses and other current assets . . . (2,172) 1,964 (1,187) Income tax benefit from exercise of stock options . . . (133) (4) (45) Increase (decrease) in:
Accounts payable and accrued liabilities . . . 10,435 (7,891) (5,317) Income taxes payable . . . 829 (1,749) (355) Customer deposits . . . 1,474 1,736 82 Unearned service revenues . . . 2,338 (396) 3,710 Net cash provided by operating activities . . . 14,981 8,965 13,266 INVESTING ACTIVITIES:
Purchases of property and equipment . . . (4,047) (3,387) (9,705) Payments for intangible assets . . . (979) (670) (3,766) Purchases of short-term investments . . . — (64,986) (81,965) Proceeds from sales of short-term investments . . . — 81,965 77,375
Net cash (used in) provided by investing activities . . . (5,026) 12,922 (18,061) FINANCING ACTIVITIES:
Proceeds from notes payable . . . 2,490 — — Payments on notes payable . . . (2,490) — — Payments on capital leases . . . (84) (88) (11) Income tax benefit from exercise of stock options . . . 133 4 45 Purchases of treasury stock . . . — (8,829) (95) Proceeds from issuance of stock, net . . . 1,405 83 92
Net cash provided by (used in) financing activities . . . 1,454 (8,830) 31 EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS . . . 4,235 (1,473) 2,460 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . 15,644 11,584 (2,304) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD . . . 35,078 23,494 25,798 CASH AND CASH EQUIVALENTS, END OF PERIOD . . . $ 50,722 $ 35,078 $ 23,494
The accompanying notes are an integral part of these consolidated financial statements
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2010, 2009 and 2008 (in thousands, except share and per share data or as otherwise noted) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business—FARO Technologies, Inc. and its subsidiaries (collectively the “Company” or
“FARO”) design, develop, manufacture, market and support software-based three-dimensional measurement and imaging systems for manufacturing, industrial, building construction and forensic applications. The Company’s principal products include the FaroArm, FARO Laser ScanArm and FARO Gage, all articulated
electromechanical measuring devices, and the FARO Laser Tracker ION, FARO Focus3Dand FARO 3D Imager AMP all laser-based measuring devices. Markets for the Company’s products include automobile, aerospace, heavy equipment, and law enforcement agencies. The Company sells the vast majority of its products through a direct sales force located in many of the world’s largest industrialized countries.
Principles of Consolidation—The consolidated financial statements of the Company include the accounts of FARO Technologies, Inc. and all of its subsidiaries. All intercompany transactions and balances have been eliminated. The financial statements of the Company’s foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at period-end for assets and liabilities and average exchange rates during each reporting period for results of operations. Adjustments resulting from financial statement translations are reflected as a separate component of accumulated other comprehensive income.
Revenue Recognition, Product Warranty and Extended Maintenance Contracts—Revenue related to the Company’s measurement systems (integrated combinations of a measurement device, a computer and software loaded on the computer and the measurement device) is generally recognized upon shipment, as the Company considers the earnings process substantially complete as of the shipping date. The Company warrants its 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. The Company separately sells one and three year extended warranties. Extended warranty revenues are recognized on a straight-line basis over the term of the warranty. Costs relating to extended maintenance plans 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 following criteria are met: persuasive evidence of a sales agreement exists, delivery has occurred, and the sales price is fixed or determinable and deemed collectible. 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. Revenue from the
licensing agreements for the use of the Company’s technology for medical applications is generally recognized as licensees use the technology. Amounts representing royalties for the current year and not received as of year-end are estimated as due based on historical data and recognized in the current year.
Cash and Cash Equivalents—The Company considers cash on hand and amounts on deposit with financial institutions with maturities of three months or less when purchased to be cash and cash equivalents. The
Company had deposits with foreign banks totaling $34,763 and $23,181 as of December 31, 2010 and 2009, respectively.
Accounts Receivable and Related Allowance for Doubtful Accounts—Credit is extended to customers based on an evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are generally due within 30-90 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due.
The Company makes judgments as to the collectability of accounts receivable based on historical trends and future expectations. Management estimates an allowance for doubtful accounts, which adjusts gross trade accounts receivable to its net realizable value. The allowance for doubtful accounts is based on an analysis of all
receivables for possible impairment issues and historical write-off percentages. The Company writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. The Company does not generally charge interest on past due receivables.
Inventories—Inventories are stated at the lower of cost or net realizable value using the first-in first-out method. Shipping and handling costs are classified as a component of cost of sales in the consolidated statements of operations. Sales demonstration inventory is comprised of measuring devices utilized by sales representatives to present the Company’s products to customers. These products remain in sales demonstration inventory for approximately six to twelve months and are subsequently sold at prices that produce slightly reduced gross margins. Service inventory is comprised of inventory that is not expected to be sold within twelve months, such as training and loaned equipment.
Property and Equipment—Property and equipment purchases exceeding a thousand dollars are capitalized and recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the various classes of assets as follows:
Machinery and equipment . . . 2 to 5 years Furniture and fixtures . . . 3 to 10 years Leasehold improvements are amortized on a straight-line basis over the lesser of the life of the asset or the term of the lease, not to exceed 7 years.
Depreciation expense was $4,842, $4,143 and $3,485 in 2010, 2009 and 2008, respectively. Accelerated methods of depreciation are used for income tax purposes in contrast to book purposes, and as a result, appropriate provisions are made for the related deferred income taxes.
Goodwill and Intangibles—Goodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired. Indefinite-life identifiable intangible assets and goodwill are not amortized but are tested for impairment. The Company performs an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the carrying value of the recorded goodwill is impaired. If an asset is impaired, the difference between the value of the asset reflected on the financial statements and its current fair value is recognized as an expense in the period in which the impairment occurs.
The goodwill impairment test is applied using a two-step approach. In performing the first step, the company calculates the fair values of each reporting units using discounted cash flows for each reporting unit. If the carrying amount of the reporting unit exceeds the fair market value, the second step is performed to measure the amount of the impairment loss, if any. In the second step, the implied fair value of the goodwill is estimated as the fair value of the reporting unit as calculated in the first step, less the fair values of the net tangible and intangible assets of the reporting unit other than goodwill. If the carrying amount of goodwill exceeds its implied fair market value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. Management has concluded there was no goodwill impairment in the years ended December 31, 2010, 2009 and 2008.
Other acquired intangibles principally include patents, existing product technology and customer relationships that arose in connection with the Company’s acquisition of iQvolution AG and Dimensional Photonics International. Other acquired intangibles are recorded at fair value at the date of acquisition and are amortized over their estimated useful lives of 3 to 15 years.
Patents are recorded at cost. Amortization is computed using the straight-line method over the lives of the patents.
Long-Lived Assets—Long-lived assets, other than goodwill, are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable.
Management has concluded that there was no impairment of these assets for the years ended December 31, 2010, 2009 and 2008.
Research and Development—Research and development costs incurred in the discovery of new knowledge and the resulting translation of this new knowledge into plans and designs for new products, prior to the
attainment of the related products’ technological feasibility, are recorded as expenses in the period incurred.
Reserve for Warranties—The Company establishes a liability for included twelve-month warranties by the creation of a warranty reserve, which is an estimate of the repair expenses likely to be incurred for the remaining period of the warranty measured in installation-months in each major product group. Warranty reserve is reflected in accrued liabilities in the accompanying consolidated balance sheets. The warranty expense is estimated by determining the total repair expenses for each product group in the 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 sold during the period to determine the provision for warranty expenses for the period. The Company evaluates its 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. While such expenses have historically been within its expectations, the Company cannot guarantee this will continue in the future.
Income Taxes—The Company reviews its 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 the Company might employ to utilize such assets, including net operating loss carryforwards. Based on the positive and negative evidence for recoverability, the Company establishes a valuation allowance against the net deferred assets of a taxing jurisdiction in which the Company operates unless it is “more likely than not” that the Company will recover such assets through the above means.
In the future, the Company’s evaluation of the need for the valuation allowance will be significantly influenced by the Company’s ability to achieve profitability and the Company’s ability to predict and achieve future projections of taxable income over a two-year period.
The Company recognizes tax benefits related to uncertain tax positions only if it is more likely than not the tax position will be sustained upon examination by taxing authorities. For those positions where there is less than a 50% likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial
statements. In the ordinary course of business, the Company and its subsidiaries are examined by various federal, state, and foreign tax authorities. The Company regularly assesses the potential outcomes of these examinations and any future examinations for the current or prior years in determining the adequacy of its provision for income taxes.
Fair Value of Financial Instruments—The Company’s financial instruments include cash and cash equivalents, term investments, accounts receivable and accounts payable and accruals. Due to their short-term nature, the carrying amounts of such financial instruments approximate their fair value.
Earnings Per Share—Basic earnings per share (“EPS”) is computed by dividing earnings available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS includes the effect of all dilutive stock options and equity instruments. A reconciliation of the number of common shares used in calculation of basic and diluted EPS is presented in Note 15. Earnings Per Share.
Concentration of Credit Risk—Financial instruments that expose the Company to concentrations of credit risk consist principally of short-term investments and operating demand deposit accounts. The Company’s policy is to place its operating demand deposit accounts with high credit quality financial institutions.
Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Impact of Recently Issued Accounting Standards
As of January 1, 2008, the Company adopted the Financial Accounting Standards Board, or the FASB, Accounting Standards Codification, or ASC, 820-10 (formerly Statement of Financial Accounting Standards, or SFAS, No. 157), “Fair Value Measurements and Disclosures”. This statement defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; rather, it applies to other accounting pronouncements that require or permit fair value measurements. The Company previously adopted the provisions of this pronouncement for its financial assets and liabilities as of January 1, 2008. Effective January 1, 2009, the Company adopted ASC 820-10 for all non-financial assets and liabilities measured at fair value on a non-recurring basis. The adoption of ASC 820-10 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
As of January 1, 2009, the Company adopted FASB ASC 805-20 (formerly SFAS 141 and 141 Revised),
“Business Combinations—Identifiable Assets and Liabilities, and Any Noncontrolling Interest,” or ASC 805-20.
ASC 805-20 requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. The statement also requires the acquirer in a business combination consummated in stages to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their fair values. The provisions of ASC 805-20 are effective prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of ASC 805-20 had no material impact on the Company’s financial position or results of operations.
As of January 1, 2009, the Company adopted FASB ASC 810-10 (formerly SFAS No. 160),
“Consolidation,” or ASC 810-10. ASC 810-10 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. ASC 810-10 is effective prospectively, except for certain retrospective disclosure requirements, for fiscal years beginning after
December 15, 2008. The adoption of ASC 810-10 had no material impact on the Company’s financial position or results of operations.
As of January 1, 2009, the Company adopted FASB ASC 815-10 (formerly SFAS No. 161), “Derivatives and Hedging,” or ASC 815-10. This statement requires enhanced disclosures about an entity’s derivative and hedging activities. ASC 815-10 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The adoption of ASC 815-10 had no material impact on the Company’s consolidated financial statements.
In June 2009, the FASB issued guidance now codified within ASC Topic 810,Consolidation, or ASC 810.
ASC 810 requires entities to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and obligation to absorb losses of the entity that could potentially be significant to the variable interest. The guidance is effective as of the beginning of the annual reporting period commencing after November 15, 2009, with early adoption prohibited. The adoption of ASC 810 as of January 1, 2010 did not have a material effect on the Company’s financial position or results of operations.