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, 2009 and 2008, and the related statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule 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, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
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, 2009, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 26, 2010 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP Orlando, Florida
February 26, 2010
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, 2009
December 31, 2008 ASSETS
Current Assets:
Cash and cash equivalents . . . . $ 35,078 $ 23,494 Short-term investments . . . . 64,986 81,965 Accounts receivable, net . . . . 42,944 49,713 Inventories . . . . 26,582 33,444 Deferred income taxes, net . . . . 4,473 5,581 Prepaid expenses and other current assets . . . . 6,016 7,879 Total current assets . . . . 180,079 202,076 Property and Equipment:
Machinery and equipment . . . . 19,867 16,748 Furniture and fixtures . . . . 5,225 4,099 Leasehold improvements . . . . 9,434 9,893 Property and equipment at cost . . . . 34,526 30,740 Less: accumulated depreciation and amortization . . . . (20,788) (16,604)
Property and equipment, net . . . . 13,738 14,136 Goodwill . . . . 19,934 18,951 Intangible assets, net . . . . 7,985 8,580 Service inventory . . . . 12,079 12,843 Deferred income taxes, net . . . . 1,895 2,728 Total Assets . . . . $235,710 $259,314 LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable . . . . $ 8,985 $ 10,813 Accrued liabilities . . . . 8,173 14,032 Income taxes payable . . . . 229 1,988 Current portion of unearned service revenues . . . . 12,226 11,501 Customer deposits . . . . 2,173 425 Current portion of obligations under capital leases . . . . 80 87 Total current liabilities . . . . 31,866 38,846 Unearned service revenues - less current portion . . . . 5,910 6,772 Deferred tax liability, net . . . . 1,143 1,107 Obligations under capital leases - less current portion . . . . 193 281 Total Liabilities . . . . 39,112 47,006 Commitments and contingencies - See Note 13
Shareholders’ Equity:
Common stock - par value $.001, 50,000,000 shares authorized; 16,795,289 and
16,741,488 issued; 16,115,054 and 16,658,552 outstanding, respectively . . . . 17 17 Additional paid-in-capital . . . . 152,380 149,298 Retained earnings . . . . 46,915 57,497 Accumulated other comprehensive income . . . . 6,361 5,742 Common stock in treasury, at cost - 680,235 and 55,808 shares, respectively . . . . (9,075) (246) Total Shareholders’ Equity . . . . 196,598 212,308 Total Liabilities and Shareholders’ Equity . . . . $235,710 $259,314
The accompanying notes are an integral part of these consolidated financial statements.
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
Years ended December 31,
2009 2008 2007
SALES
Product . . . $ 117,714 $ 179,209 $ 170,236 Service . . . 29,989 30,040 21,381 Total Sales . . . 147,703 209,249 191,617 COST OF SALES
Product . . . 46,293 60,736 59,930 Service . . . 20,702 23,287 16,644 Total Cost of Sales (exclusive of depreciation and amortization,
shown separately below) . . . 66,995 84,023 76,574 GROSS PROFIT . . . 80,708 125,226 115,043 OPERATING EXPENSES:
Selling . . . 48,598 63,015 56,134 General and administrative . . . 24,956 26,144 25,508 Depreciation and amortization . . . 5,530 4,505 4,034 Research and development . . . 12,613 12,625 10,256 Total operating expenses . . . 91,697 106,289 95,932 (LOSS) INCOME FROM OPERATIONS . . . (10,989) 18,937 19,111 OTHER (INCOME) EXPENSE
Interest income . . . (253) (2,170) (2,036) Other (income) expense, net . . . (592) 2,295 (1,898) Interest expense . . . 14 452 9 (LOSS) INCOME BEFORE INCOME TAX EXPENSE . . . (10,158) 18,360 23,036 INCOME TAX EXPENSE . . . 424 4,408 4,943 NET (LOSS) INCOME . . . $ (10,582) $ 13,952 $ 18,093 NET (LOSS) INCOME PER SHARE—BASIC . . . $ (0.66) $ 0.84 $ 1.17 NET (LOSS) INCOME PER SHARE—DILUTED . . . $ (0.66) $ 0.83 $ 1.15 Weighted average shares—Basic . . . 16,125,449 16,632,608 15,443,259 Weighted average shares—Diluted . . . 16,125,449 16,734,403 15,722,215
The accompanying notes are an integral part of these consolidated financial statements.
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008, AND 2007
(in thousands, except share data)
Common Stock Additional Paid-in Capital
Retained Earnings (Deficit)
Accumulated Other Comprehensive
Income
Common Stock in
Treasury Total Shares Amounts
BALANCE DECEMBER 31, 2006 . . . . 14,504,715 $14 $ 85,160 $ 25,452 $ 580 $ (151) $111,055
Net income . . . . 18,093 18,093
Currency translation adjustment . . . . 4,019 4,019
Comprehensive income . . . . 22,112
Stock Option Expense . . . . 1,041 1,041
Issuance of restricted stock . . . . 23,553 176 176
Stock issued for iQvolution milestone earn-outs . . . . 24,773 730 730
Stock options exercised . . . . 441,011 1 5,381 5,382
Tax benefit from employee stock option exercises . . . . 963 963
Issuance of stock . . . . 1,650,000 2 53,038 53,040 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 . . . . 1,679 1,679
Issuance of restricted stock . . . . 42,487 770 770
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
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FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31,
2009 2008 2007
CASH FLOWS FROM:
OPERATING ACTIVITIES:
Net (loss) income . . . $(10,582) $ 13,952 $ 18,093 Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation and amortization . . . 5,530 4,505 4,034 Compensation for stock options and restricted stock units . . . 2,449 2,237 1,216 Provision for bad debts . . . 1,852 1,092 373 Deferred income tax expense (benefit) . . . 1,986 (1,972) (464) Change in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable . . . 5,769 2,993 (9,121) Inventories, net . . . 8,301 (6,429) (7,265) Prepaid expenses and other current assets . . . 1,964 (1,187) (3,208) Income tax benefit from exercise of stock options . . . (4) (45) (963) Increase (decrease) in:
Accounts payable and accrued liabilities . . . (7,891) (5,317) 9,884 Income taxes payable . . . (1,749) (355) 1,278 Customer deposits . . . 1,736 82 (269) Unearned service revenues . . . (396) 3,710 8,007
Net cash provided by operating activities . . . 8,965 13,266 21,595 INVESTING ACTIVITIES:
Purchases of property and equipment . . . (3,387) (9,705) (2,930) Payments for intangible assets . . . (670) (3,766) (359) Purchases of short-term investments . . . (64,986) (81,965) (77,375) Proceeds from sales of short-term investments . . . 81,965 77,375 15,790
Net cash provided by (used in) investing activities . . . 12,922 (18,061) (64,874) FINANCING ACTIVITIES:
Payments on capital leases . . . (88) (11) (92) Income tax benefit from exercise of stock options . . . 4 45 963 Purchases of treasury stock . . . (8,829) (95) — Proceeds from issuance of stock, net . . . 83 92 58,421
Net cash (used in) provided by financing activities . . . (8,830) 31 59,292 EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS . . . (1,473) 2,460 (5,904) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . 11,584 (2,304) 10,109 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD . . . 23,494 25,798 15,689 CASH AND CASH EQUIVALENTS, END OF PERIOD . . . $ 35,078 $ 23,494 $ 25,798
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, 2009, 2008 and 2007 (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 and the FARO Laser Scanner Photon, both 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 though 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 $23,181 and $17,907 as of December 31, 2009 and 2008, 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 the 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 $4,143, $3,485 and $3,319 in 2009, 2008 and 2007, 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 the reporting units using discounted cash flows (“DCF”) of 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, 2009, 2008 and 2007.
Other acquired intangibles principally include patents, existing product technology and customer relationships that arose in connection with the 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 concluded that there was no impairment of these assets for the years ended December 31, 2009, 2008 and 2007.
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 our 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 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
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statements of Financial Accounting Standards (“SFAS”) No. 141 (R),Business Combinations, codified as Accounting Standards Codification (“ASC”) 805,Business Combinations.ASC 805 requires an acquirer to measure the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquired entity at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. This impacted acquisitions closed on or after January 1, 2009. The adoption did not have a material effect on the Company’s financial position or results of operations.
In March 2008, the FASB issued guidance now codified within ASC 815 which expands the disclosure requirements for derivative instruments and hedging activities requiring enhanced disclosure of how derivative instruments impact a company’s financial statements, why companies engage in such transactions and a tabular disclosure of the effects of such instruments and related hedged items on a company’s financial position, results of operations and cash flows. The Company adopted these amendments on January 1, 2009 on a prospective basis. The adoption did not have a material effect on the Company’s financial position or results of operations.
In April 2008, the FASB issued guidance now codified within ASC 350 which outlines the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of recognized intangible assets. The intent of this guidance is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset in accordance with ASC 350 and other U.S. GAAP authoritative literature. These amendments must be applied prospectively to all intangible assets acquired after its effective date. The Company adopted these amendments effective January 1, 2009. The adoption did not have a material effect on the Company’s financial position or results of operations.
In June 2009, the FASB issued guidance now codified within ASC Topic 105,Generally Accepted Accounting Principles(“ASC 105”). ASC 105 establishes the FASB Accounting Standards Codification (the
“Codification”) as the single source of authoritative non-governmental U.S. GAAP. ASC 105 does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all authoritative literature related to a particular topic in one place. Rules and interpretative releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of
authority. The Codification superseded all existing non-SEC accounting and reporting standards, and all other non-grandfathered, non-SEC accounting literature not included in the Codification became non-authoritative. The provisions of ASC 105 are effective for interim and annual reporting periods ending after September 15, 2009.
The Company adopted ASC 105 in its interim reporting for the period ended September 30, 2009. The adoption of ASC 105 is for disclosure purposes only and did not have a material effect on the Company’s financial position or results of operations.
In June 2009, the FASB issued guidance now codified within ASC Topic 810,Consolidation(“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 Company does not expect the adoption of ASC 810 to have a material effect on its financial position or results of operations.