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, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. 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, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 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, 2012, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2013 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP Orlando, Florida
February 27, 2013
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
December 31, 2012
December 31, 2011 ASSETS
Current Assets:
Cash and cash equivalents . . . $ 93,233 $ 64,540 Short-term investments . . . 64,990 64,997 Accounts receivable, net . . . 62,559 57,512 Inventories, net . . . 48,894 49,934 Deferred income taxes, net . . . 7,216 5,297 Prepaid expenses and other current assets . . . 11,186 9,207 Total current assets . . . 288,078 251,487 Property and Equipment:
Machinery and equipment . . . 32,236 29,171 Furniture and fixtures . . . 6,516 5,963 Leasehold improvements . . . 10,897 10,233 Property and equipment at cost . . . 49,649 45,367 Less: accumulated depreciation and amortization . . . (34,305) (29,134)
Property and equipment, net . . . 15,344 16,233 Goodwill . . . 18,816 18,610 Intangible assets, net . . . 7,048 6,849 Service inventory . . . 19,125 17,316 Deferred income taxes, net . . . 2,396 2,296 Total Assets . . . $350,807 $312,791 LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable . . . $ 10,413 $ 13,396 Accrued liabilities . . . 18,216 18,076 Income taxes payable . . . 4,886 2,682 Current portion of unearned service revenues . . . 19,460 15,638 Customer deposits . . . 2,662 4,072 Current portion of obligations under capital leases . . . 45 84 Total current liabilities . . . 55,682 53,948 Unearned service revenues - less current portion . . . 11,221 9,540 Deferred tax liability, net . . . 1,149 1,148 Obligations under capital leases - less current portion . . . 19 257 Total Liabilities . . . 68,071 64,893 Commitments and contingencies - See Note 13
Shareholders’ Equity:
Common stock - par value $.001, 50,000,000 shares authorized; 17,653,879 and 17,381,110 issued; 16,973,644 and 16,700,875 outstanding,
respectively . . . 18 17 Additional paid-in capital . . . 181,094 169,780 Retained earnings . . . 104,358 81,360 Accumulated other comprehensive income . . . 6,341 5,816 Common stock in treasury, at cost - 680,235 shares . . . (9,075) (9,075) Total Shareholders’ Equity . . . 282,736 247,898 Total Liabilities and Shareholders’ Equity . . . $350,807 $312,791
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) 2012 2011 2010
SALES
Product . . . $ 227,905 $ 212,635 $ 157,331 Service . . . 45,490 41,529 34,444 Total Sales . . . 273,395 254,164 191,775 COST OF SALES
Product . . . 94,103 82,408 54,571 Service . . . 29,673 28,067 23,806 Total Cost of Sales (exclusive of depreciation and
amortization, shown separately below) . . . 123,776 110,475 78,377 GROSS PROFIT . . . 149,619 143,689 113,398 OPERATING EXPENSES:
Selling . . . 64,446 62,117 50,679 General and administrative . . . 29,065 26,806 26,776 Depreciation and amortization . . . 6,976 6,712 6,326 Research and development . . . 17,578 15,196 12,690 Total operating expenses . . . 118,065 110,831 96,471 INCOME FROM OPERATIONS . . . 31,554 32,858 16,927 OTHER (INCOME) EXPENSE
Interest income . . . (160) (101) (105) Other expense, net . . . 744 1,217 2,783 Interest expense . . . 28 37 34 INCOME BEFORE INCOME TAX EXPENSE . . . 30,942 31,705 14,215 INCOME TAX EXPENSE . . . 7,944 8,328 3,147 NET INCOME . . . $ 22,998 $ 23,377 $ 11,068 NET INCOME PER SHARE - BASIC . . . $ 1.36 $ 1.42 $ 0.69 NET INCOME PER SHARE - DILUTED . . . $ 1.34 $ 1.39 $ 0.68 Weighted average shares - Basic . . . 16,910,830 16,503,773 16,153,831 Weighted average shares - Diluted . . . 17,129,128 16,868,471 16,365,826
The accompanying notes are an integral part of these consolidated financial statements.
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31,
(in thousands) 2012 2011 2010
Net income . . . $22,998 $23,377 $11,068 Currency translation adjustment, net of tax . . . 525 (1,426) 881 Comprehensive income . . . $23,523 $21,951 $11,949
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, 2012, 2011, AND 2010
Accumulated Other Comprehensive
Income Additional
Paid-in Capital
Retained Earnings
Common Stock in Treasury Common Stock
(in thousands except share data) Shares Amounts Total
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, net of
tax . . . . 881 881
Stock option expense . . . . 149 2,416 2,416
Issuance of restricted stock . . . . 23,181 (24) (24)
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
Net income . . . . 23,377 23,377
Currency translation adjustment, net of
tax . . . . (1,426) (1,426)
Stock option expense . . . . 2,767 2,767
Issuance of restricted stock . . . . 15,039 (40) (40)
Stock options exercised . . . . 471,697 9,150 9,150
Tax benefit from employee stock option
exercises . . . . 1,593 1,593
BALANCE DECEMBER 31, 2011 . . . . 16,740,875 17 169,780 81,360 5,816 (9,075) 247,898
Net income . . . . 22,998 22,998
Currency translation adjustment, net of
tax . . . . 525 525
Stock option expense . . . . 4,097 4,097
Issuance of restricted stock . . . . 14,339 (79) (79)
Stock options exercised . . . . 258,430 1 6,161 6,162
Tax benefit from employee stock option
exercises . . . . 1,135 1,135
BALANCE DECEMBER 31, 2012 . . . . 17,013,644 $18 $ 181,094 $ 104,358 $ 6,341 (9,075) $ 282,736
The accompanying notes are an integral part of these consolidated financial statements.
40
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(in thousands) 2012 2011 2010
CASH FLOWS FROM:
OPERATING ACTIVITIES:
Net income . . . $ 22,998 $ 23,377 $ 11,068 Adjustments to reconcile net income to net cash provided by
operating activities: . . . .
Depreciation and amortization . . . 6,976 6,712 6,326 Compensation for stock options and restricted stock
units . . . 4,018 2,727 2,392 Provision for (net recovery of) bad debts . . . (23) 2,169 2,408 Deferred income tax benefit . . . (2,016) (672) (693) Change in operating assets and liabilities:
Decrease (increase) in: . . . .
Accounts receivable . . . (4,840) (8,979) (13,018) Inventories, net . . . (844) (27,329) (6,273) Prepaid expenses and other current assets . . . (1,870) (1,417) (2,172) Income tax benefit from exercise of stock options . . . (1,135) (1,593) (133) Increase (decrease) in: . . . .
Accounts payable and accrued liabilities . . . (3,079) 4,644 10,435 Income taxes payable . . . 3,497 2,998 829 Customer deposits . . . (1,374) 668 1,474 Unearned service revenues . . . 5,565 5,384 2,338 Net cash provided by operating activities . . . 27,873 8,689 14,981 INVESTING ACTIVITIES:
Purchases of property and equipment . . . (3,843) (4,474) (4,047) Payments for intangible assets . . . (1,361) (890) (979) Net cash used in investing activities . . . (5,204) (5,364) (5,026) FINANCING ACTIVITIES:
Proceeds from notes payable . . . - - 2,490 Payments on notes payable . . . - - (2,490) Payments on capital leases . . . (132) (163) (84) Income tax benefit from exercise of stock options . . . 1,135 1,593 133 Proceeds from issuance of stock, net . . . 6,162 9,150 1,405 Net cash provided by financing activities . . . 7,165 10,580 1,454 EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS . . . (1,141) (87) 4,235
INCREASE IN CASH AND CASH EQUIVALENTS . . . 28,693 13,818 15,644
CASH AND CASH EQUIVALENTS, BEGINNING OF
YEAR . . . 64,540 50,722 35,078 CASH AND CASH EQUIVALENTS, END OF YEAR . . . $ 93,233 $ 64,540 $ 50,722
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, 2012, 2011 and 2010
(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 its subsidiaries, all of which are wholly owned. 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 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 $53.2 and $37.5 as of December 31, 2012 and 2011, respectively. The Company does not intend to repatriate those funds.
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 to 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 6 to 12 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.
Reserve for Excess and Obsolete Inventory—Since the value of inventory that will ultimately be realized cannot be known with exact certainty, the Company relies upon both past sales history and future sales forecasts to provide a basis for the determination of the reserve. Inventory is considered obsolete if the Company has withdrawn those products from the market or had no sales of the product for the past 12 months and has no sales forecasted for the next 12 months. Inventory is considered excess if the quantity on hand exceeds 12 months of 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 FIFO cost of such inventory. The Company’s products are subject to changes in technologies that may make certain of its products or their components obsolete or less competitive, which may increase its historical provisions to the reserve.
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 remaining term of the lease, not to exceed 7 years.
Depreciation expense was $5,769, $5,394 and $4,842 in 2012, 2011 and 2010, 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 or indefinite lived intangible assets 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 Company first performs a qualitative assessment to determine whether it is necessary to perform the two-step goodwill impairment test. If the Company believes, as a result of its qualitative assessment, that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test are unnecessary. The Company elected to early adopt this accounting guidance at the beginning of its fourth quarter of 2011 on a prospective basis for goodwill impairment tests.
If necessary, after performing the qualitative assessment, 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 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 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, 2012, 2011 and 2010.
Other intangible assets principally include patents, existing product technology and customer relationships that arose in connection with the Company’s acquisitions of iQvolution AG and Dimensional Photonics International. Other intangible assets are recorded at fair value at the date of acquisition and are amortized over their estimated useful lives of 3 to 20 years.
Product technology and 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 and indefinite lived intangible assets, 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, 2012, 2011 and 2010.
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 the embedded twelve-month warranties included with its products 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 included 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 and included in Cost of Sales-Service in the accompanying consolidated statements of operations. 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 tax 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, short-term investments, accounts receivable and accounts payable and accrued liabilities. 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.