REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of 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, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007.
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, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 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.
As discussed in Note 1 to the consolidated financial statements, the Company adopted Statement No. 123 (revised 2004),Share-Based Payment, as of January 1, 2006 and Interpretation No. 48,Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109, as of January 1, 2007.
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, 2007, based on criteria established inInternal Control–Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 10, 2008 expressed an unqualified opinion.
Orlando, Florida /s/ GRANT THORNTON LLP
March 10, 2008
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders of FARO Technologies, Inc. and Subsidiaries:
We have audited FARO Technologies, Inc. (a Florida Corporation) and subsidiaries’ internal control over financial reporting as of December 31, 2007, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). FARO Technologies, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on FARO Technologies, Inc. and subsidiaries’ internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, FARO Technologies, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established inInternal Control—
Integrated Frameworkissued by COSO.
We have also audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of FARO Technologies, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007 and our report dated March 10, 2008 expressed an unqualified opinion.
Orlando, Florida /s/ GRANT THORNTON LLP
March 10, 2008
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, 2007
December 31, 2006
ASSETS Current Assets:
Cash and cash equivalents . . . $ 25,798 $ 15,689 Short-term investments . . . 77,375 15,790 Accounts receivable, net . . . 54,767 42,706 Inventories . . . 29,100 23,429 Deferred income taxes, net . . . 2,841 1,845 Prepaid expenses and other current assets . . . 6,719 3,222 Total current assets . . . 196,600 102,681 Property and Equipment:
Machinery and equipment . . . 12,895 9,131 Furniture and fixtures . . . 5,008 3,988 Leasehold improvements . . . 3,296 2,615 Property and equipment at cost . . . 21,199 15,734 Less: accumulated depreciation and amortization . . . (13,672) (8,889)
Property and equipment, net . . . 7,527 6,845 Goodwill . . . 19,117 17,266 Intangible assets, net . . . 5,970 6,221 Service inventory . . . 10,865 7,278 Deferred income taxes, net . . . 3,460 3,985 Total Assets . . . $243,539 $144,276 LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable . . . $ 12,450 $ 11,182 Accrued liabilities . . . 17,989 10,379 Income taxes payable . . . 2,266 2,151 Current portion of unearned service revenues . . . 8,594 4,569 Customer deposits . . . 337 618 Current portion of obligations under capital leases . . . 18 90 Total current liabilities . . . 41,654 28,989 Unearned service revenues—less current portion . . . 6,091 2,917 Deferred tax liability, net . . . 1,073 1,200 Obligations under capital leases—less current portion . . . 222 115 Total Liabilities . . . 49,040 33,221 Commitments and contingencies—See Note 15
Shareholders’ Equity:
Common stock—par value $.001, 50,000,000 shares authorized; 16,700,966 and
14,586,402 issued; 16,604,052 and 14,464,715 outstanding, respectively . . . . 17 14 Additional paid-in-capital . . . 146,489 85,160 Retained earnings . . . 43,545 25,452 Accumulated other comprehensive income . . . 4,599 580 Common stock in treasury, at cost—40,000 shares . . . (151) (151) Total Shareholders’ Equity . . . 194,499 111,055 Total Liabilities and Shareholders’ Equity . . . $243,539 $144,276
The accompanying notes are an integral part of these consolidated financial statements.
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31,
(in thousands, except share and per share data) 2007 2006 2005
SALES . . . $ 191,617 $ 152,405 $ 125,590 COST OF SALES (exclusive of depreciation and amortization,
shown separately below) . . . 76,574 62,947 52,658 GROSS PROFIT . . . 115,043 89,458 72,932 OPERATING EXPENSES:
Selling . . . 56,134 45,282 37,274 General and administrative . . . 25,508 24,554 15,539 Depreciation and amortization . . . 4,034 4,135 3,453 Research and development . . . 10,256 7,228 6,440 Total operating expenses . . . 95,932 81,199 62,706 INCOME FROM OPERATIONS . . . 19,111 8,259 10,226 OTHER (INCOME) EXPENSE
Interest income . . . (2,036) (743) (567) Other (income) expense, net . . . (1,898) (790) 806 Interest expense . . . 9 16 89 INCOME BEFORE INCOME TAX EXPENSE . . . 23,036 9,776 9,898 INCOME TAX EXPENSE . . . 4,943 1,580 1,719 NET INCOME . . . $ 18,093 $ 8,196 $ 8,179 NET INCOME PER SHARE—BASIC . . . $ 1.17 $ 0.57 $ 0.58 NET INCOME PER SHARE—DILUTED . . . $ 1.15 $ 0.56 $ 0.57 Weighted average shares—Basic . . . 15,443,259 14,397,050 14,169,140 Weighted average shares—Diluted . . . 15,722,215 14,560,331 14,442,248
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, 2007, 2006, AND 2005
(in thousands except share data)
Additonal Paid-in Capital
Unearned Compensation
Retained Earnings
Accumulated Other Comprehensive
(Loss) Income
Common Stock in
Treasury Total Common Stock
Shares Amounts
BALANCE DECEMBER 31, 2004 . . . . 14,004,092 $14 $ 78,282 $ 505 $ 9,077 $ 1,431 $(151) $ 89,158
Net income . . . . 8,179 8,179
Currency translation adjustment . . . . (3,630) (3,630)
Comprehensive income . . . . 4,549
Options subject to variable accounting . . . . 207 (207) —
Amortization of unearned compensation . . . . (150) (150)
Amortization of restricted stock units . . . . 93 93
Accrual for iQvolution milestone earn-outs . . . . 675 675
Stock issued for iQvolution milestone earn-outs . . . . 12,183 252 252
Stock options exercised . . . . 137,499 340 340
Tax benefit from employee stock option exercises . . . . 382 382
Stock issued for iQvolution purchase . . . . 152,292 3,499 3,499
Board compensation . . . . 24,851 62 62
BALANCE DECEMBER 31, 2005 . . . . 14,330,917 $14 $ 83,792 $ 148 $17,256 $(2,199) $(151) $ 98,860
Net income . . . . 8,196 8,196
Currency translation adjustment . . . . 2,779 2,779
Comprehensive income . . . . 10,975
Reclassification related to SFAS 123R . . . . 148 (148) —
Stock option expense . . . . 236 236
Issuance of restricted stock . . . . 43,826 215 215
Stock issued for iQvolution milestone earn-outs . . . . 68,574 408 408
Stock options exercised . . . . 61,398 351 351
Tax benefit from employee stock option exercises . . . . 10 10
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
38
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
(in thousands) 2007 2006 2005
CASH FLOWS FROM:
OPERATING ACTIVITIES:
Net income . . . $ 18,093 $ 8,196 $ 8,179 Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization . . . 4,034 4,135 3,453 Amortization of stock options and restricted stock units . . . 1,216 401 (57) Provision for bad debts . . . 373 230 112 Deferred income tax (benefit) expense . . . (464) 20 (854) Change in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable . . . (9,121) (12,173) (7,830) Inventories . . . (7,265) 2,804 (13,788) Prepaid expenses and other current assets . . . (3,208) (933) 508 Income tax (benefit) expense from exercise of stock options . . . (963) (102) 382 Increase (decrease) in:
Accounts payable and accrued liabilities . . . 9,884 3,062 4,309 Income taxes payable . . . 1,278 526 1,454 Customer deposits . . . (269) 399 (302) Unearned service revenues . . . 8,007 3,189 1,030
Net cash provided by (used in) operating activities . . . 21,595 9,754 (3,404) INVESTING ACTIVITIES:
Acquisition of iQVolution . . . — — (6,385) Purchases of property and equipment . . . (2,930) (3,357) (3,937) Payments for intangible assets . . . (359) (820) (937) (Purchases of) proceeds from short-term investments . . . (61,585) 700 5,995
Net cash used in investing activities . . . (64,874) (3,477) (5,264) FINANCING ACTIVITIES:
Payments of capital leases . . . (92) (204) (34) Income tax benefit (expense) from exercise of stock options . . . 963 102 (382) Proceeds from issuance of stock, net . . . 58,421 361 784
Net cash provided by financing activities . . . 59,292 259 368 EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS . . . (5,904) (125) 1,221 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . 10,109 6,411 (7,079) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR . . . 15,689 9,278 16,357 CASH AND CASH EQUIVALENTS, END OF YEAR . . . $ 25,798 $ 15,689 $ 9,278
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, 2007, 2006 and 2005 (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 subsidiaries (collectively the “Company” or
“FARO”) design, develop, manufacture, market and support software-based three-dimensional measurement devices for manufacturing, industrial, building construction and forensic applications. The Company’s principal products include the Faro Arm, Faro Scan Arm and Faro Gage, all articulated electromechanical measuring devices, and the Faro Laser Tracker and the Faro Laser Scanner LS, 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 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 (loss).
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 its 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 which have maturities of three months or less when purchased to be cash and cash equivalents. The Company had deposits with foreign banks totaling $15,376 and $9,861 as of December 31, 2007 and 2006, 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 collectibility 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 income. 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 $3,319, $2,842 and $2,154 in 2007, 2006 and 2005, 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. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill and Other Intangible Assets,”indefinite-life identifiable intangible assets and goodwill are not amortized. The Company periodically reviews its identifiable intangible assets and goodwill, considering factors such as projected cash flows and revenue and earnings multiples, to determine whether the value of the assets are impaired and the amortization periods are appropriate. 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.
Other acquired intangibles principally include patents, existing product technology and customer relationships that arose in connection with the acquisition of iQvolution AG (See note 2). 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.
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.
The 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 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. The rate is multiplied by the number of machine-months of warranty for each product group sold during the period to determine the provision for warranty expenses for the period. The Company reevaluates 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 machines remaining under warranty and the remaining number of months each machine 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 described in SFAS No. 109,
“Accounting for Income Taxes”(“SFAS 109”), 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 operates in a number of different countries around the world. In 2003, the Company began to manufacture its products in Switzerland, where it has received a permanent income tax rate commitment from the Swiss government as an incentive to establish a manufacturing plant there. In 2005, the Company opened a regional headquarters and began to manufacture its products in Singapore, where it received in 2006 a favorable multi-year income tax rate commitment from the Singapore Economic Development Board as an incentive to establish a manufacturing plant and regional headquarters there.
On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48
“Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN 48) which clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109 and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on January 1, 2007.
Significant judgment is required in determining the Company’s worldwide provision for income taxes. In the ordinary course of global business, there are many transactions for which the ultimate tax outcome is uncertain. The Company has appropriately reserved for its tax uncertainties based on the criteria established by FIN 48.
Fair Value of Financial Instruments—The Company’s financial instruments include cash and cash equivalents, short-term investments, accounts receivable and accounts payable and accruals. The carrying amounts of such financial instruments approximate their fair value due to the short-term nature of these instruments.
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 17. Earnings Per Share.
Concentration of Credit Risk—Financial instruments which potentially expose the Company to concentrations of credit risk consist principally of short-term investments and operating demand deposit