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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM ______________ TO ____________.
COMMISSION FILE NUMBER 0-23081
FARO TECHNOLOGIES, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
FLORIDA 59-3157093
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(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
125 TECHNOLOGY PARK
LAKE MARY, FLORIDA 32746
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE): (407) 333-9911
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS: ON WHICH REGISTERED:
NONE NONE
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 26, 1999, there were outstanding 11,343,461 shares of Common
Stock. The aggregate market value of the voting stock held by nonaffiliates of
the Registrant based on the last sale price reported on the Nasdaq National
Market as of March 26, 1999 was $39,845,541.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENTS FORM 10-K REFERENCE
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Portions of the Proxy Statement, dated April 2, 1999 Part III, Items 10-13
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PART I
CAUTIONARY STATEMENTS FOR FORWARD-LOOKING INFORMATION
FARO Technologies, Inc. (the "Company") has made forward-looking
statements in this document that are subject to risks and uncertainties. The
statements contained in this report on Form 10-K that are not purely historical
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
including statements regarding the Company's expectations, hopes, beliefs,
intentions, or strategies regarding the future. Forward looking statements
include statements regarding, among other things: (i) the potential loss of
material customers; (ii) the failure to properly manage growth and successfully
integrate acquired businesses; (iii) the Company's financing plans; (iv) trends
affecting the Company's financial condition or results of operations; (v) the
Company's growth and operating strategies; (vi) the ability to attract and
retain qualified sales, information services and management personnel; (vii)
the impact of competition from new and existing competitors; (viii) the
financial condition of the Company's clients; (ix) potential increases in the
Company's costs; (x) the declaration and payment of dividends; (xi) the
potential for unfavorable interpretation of existing government regulations or
new government legislation; (xii) the ability of the Company and its
significant suppliers and large customers to address the year 2000 Issue; and
(xiii) the outcome of certain litigation involving the Company. Prospective
investors are cautioned that any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, and that
actual results may differ materially from those projected in the
forward-looking statements as a result of various factors. All forward-looking
statements included in this document are based on information available to the
Company on the date hereof, and the Company assumes no obligation to update any
such forward-looking statement. Among the factors that could cause actual
results to differ materially are the factors detailed in Items 1 through 3 and
7 of this report and the risks discussed under the caption "Risk Factors"
included in the Company's filings under the Securities Act of 1933. Prospective
investors should also consult the risks described from time to time in the
Company's Reports on Form 10-Q, 8-K, 10-K and Annual Reports to Shareholders.
ITEM 1. BUSINESS.
INDUSTRY BACKGROUND
The creation of physical products involves the processes of design,
engineering, production and measurement and quality inspection. These basic
processes have been profoundly affected by the computer hardware and software
revolution that began in the 1980s. Computer-aided design ("CAD") software was
developed to automate the design process, providing manufacturers with
computerized 3-D design capability. Today, most manufacturers use some form of
CAD software to create designs and engineering specifications for new products
and to quantify and modify designs and specifications for
1
existing products. The benefits of CAD are significant. The CAD process offers
a three-dimensional, highly-efficient and inherently flexible alternative to
traditional design methods. Many manufacturers have also recently adopted
computer-aided manufacturing ("CAM") technology, in which CAD data directs
machines in the manufacturing process. CAM has further improved the efficiency
and quality of the production of manufactured goods.
A significant aspect of the manufacturing process which traditionally has
not benefitted from computer-aided technology is measurement and quality
inspection. Historically, manufacturers have measured and inspected products
using hand-measurement tools such as scales, calipers, micrometers and plumb
lines for simple measuring tasks, test fixtures for certain large manufactured
products and traditional coordinate measurement machines ("CMMs") for objects
that require higher precision measurement. However, the broader utility of each
of these measurement methods is limited. Although hand-measurement tools are
often appropriate for simple measurements, their use for complex measurements
is time-consuming and limited in adaptability. Test fixtures (customized fixed
tools used to make comparative measurements of production parts to "master
parts") are relatively expensive and must be reworked or discarded each time a
dimensional change is made in the part being measured. In addition, these
manual measuring devices do not permit the manufacturer to compare the
dimensions of an object with its CAD model.
Conventional CMMs are generally large, fixed-base machines that provide
very high levels of precision but have only recently begun to provide a link to
the CAD model of the object being measured. Fixed-base CMM's require that the
object being measured be brought to the CMM and that the object fit within the
CMM's measurement grid. In addition, conventional CMMs generally operate in
metrology laboratories or environmentally-stable quality inspection departments
of manufacturing facilities rather than on the factory floor.
Isolation from the factory floor and the relatively small measurement
grids of CMMs limit their utility to small, readily portable workpieces that
require high levels of measurement precision. As manufactured subassemblies
increase in size and become integrated into even larger assemblies, they become
less transportable, thus diminishing the utility of a conventional CMM.
Consequently, manufacturers must continue to use hand-measuring tools or
expensive customized test fixtures to measure large or unconventionally shaped
objects.
An increasingly competitive global marketplace has created a demand for
higher quality products with shorter life cycles. While manufacturers
previously designed their products to be in production for longer periods of
time, current manufacturing practices must accommodate more frequent product
introductions and modifications, while satisfying more stringent quality and
safety standards. In most cases, only a relatively small percentage of the
components of a manufactured product requires highly precise measurements (less
than one-thousandth of an inch). Conventional CMMs provide manufacturers with
very precise measurement capabilities and cost up to $2 million per unit.
However, they are not responsive to manufacturers' increasing need for
cost-effective intermediate precision measurement capabilities. The Company
believes that a greater percentage of components
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requires intermediate precision measurements (between one- and
twenty-thousandths of an inch). In the absence of intermediate precision
measuring systems, manufacturers often are unable to make appropriate
measurements or part-to-CAD comparisons during the manufacturing process,
resulting in decreased productivity, poor product quality and unacceptable
levels of product rework and scrap. Manufacturers increasingly require more
rapid design, greater control of the manufacturing process, tools to compare
components to their CAD specifications and the ability to measure precisely
components that cannot be measured or inspected by conventional CMMs. Moreover,
they increasingly require measurement capabilities to be integrated into the
manufacturing process and to be available on the factory floor.
FARO'S BUSINESS
The Company designs, develops, markets and supports portable,
software-driven, 3-D measurement systems that are used in a broad range of
manufacturing and industrial applications. In May 1998 the Company acquired
CATS Computer Aided Technologies, GmbH ("CATS"), a German company which
develops and markets CAD-based inspection and statistical process control
("SPC") software. The acquisition of CATS provides the Company with a stronger
marketing presence in Europe, as well as an expanded software product line
under the Company's AnthroCam/registered trademark/ product name. The Company's
principal products are the FAROArm/registered trademark/ articulated measuring
device and its multi-faceted AnthroCam/registered trademark/ software which
provides for CAD-based inspection on portable and fixed-base CMMs, and
factory-level statistical process control. Together, these products integrate
the measurement and quality inspection function with CAD, CAM and
computer-aided engineering ("CAE") technology to improve productivity, enhance
product quality and decrease rework and scrap in the manufacturing process. The
Company's products bring precision measurement, quality inspection and
specification conformance capabilities, integrated with leading CAD software,
to the factory floor. The Company is a pioneer in the development and marketing
of 3-D measurement technology in manufacturing and industrial applications and
currently holds or has pending 23 patents in the United States, 13 of which
also are held or pending in other jurisdictions. The Company's products have
been purchased by more than 1100 customers worldwide, ranging from small
machine shops to such large manufacturing and industrial companies as General
Motors, DaimlerChrysler, Ford, Boeing, Lockheed Martin, General Electric,
Westinghouse Electric, Caterpillar and Komatsu Dresser.
FARO PRODUCTS
THE FAROARM/registered trademark/. The FAROArm/registered trademark/ is a
portable, six-axis, instrumented, articulated device that approximates the
range of motion and dexterity of the human arm. Each articulated arm is
comprised of three major joints, each of which may consist of one, two or three
axes of motion. The FAROArm/registered trademark/ is available in a variety of
sizes, configurations and precision levels that are suitable for a broad range
of applications. To take a measurement, the operator simply touches the object
to be measured with a probe at the end of the arm and presses a button. Data
can be captured as either individual points or a series of points.
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Digital rotational transducers located at each of the joints of the arm measure
the angles at those joints. This rotational measurement data is transmitted to
an on-board controller that converts the arm angles to precise locations in 3-D
space using "xyz" position coordinates and "ijk" orientation coordinates.
The FAROArm/registered trademark/ has been designed as an open
architecture system. The communications parameters of the on-board processors
have the ability to combine advanced sensing probes, integrate with
conventional CMM software and communicate with different CAD software packages
and a variety of computer operating systems. This open architecture is designed
to provide for easy integration of the FAROArm/registered trademark/ into the
manufacturing environment. The customer's ability to use an installed base of
computing hardware and software further reduces the cost of installation and
training while initiating the transition to the Company's preferred group of
CAD-based products. To encourage integration of the FAROArm/registered
trademark/ into the manufacturing environment, the Company provides a group of
seamless interface drivers for leading CAD/CAM packages, including
AutoCAD/registered trademark/, CADKey/registered trademark/ and
SURFCAM/registered trademark/. The Company also provides a full serial
communication command protocol to the FAROArm/registered trademark/ for
customers who write their own interfaces.
The Company offers several models of the FAROArm/registered trademark/
under three product lines: the Gold Series, Silver Series and the Sterling
Series.
GOLD SERIES. The Gold Series models are the Company's highest precision
(P.001 to P.005 inches) measuring devices and are available in four, six,
eight, ten and twelve foot measurement diameters. These models are used for
factory floor inspection and fit checking applications requiring higher
precision than the Silver Series. Depending on the component of the
AnthroCam software, the Gold Series models are priced between $50,000 and
$60,000 when sold as a turnkey system including hardware, computer and
software and $45,000 without computer and software.
SILVER SERIES. The Silver Series models are the Company's intermediate
precision (P.003 to P.007 inches) measuring devices and are available in
eight and twelve foot measurement diameters. These models are most
frequently used for factory floor inspection and fit-checking applications.
Depending on the component of the AnthroCam software, the Silver Series
models are priced at $40,000 and $50,000 when sold as a turnkey system
including hardware, computer and AnthroCam/registered trademark/ software
and $35,000 without computer and software.
STERLING SERIES. The Sterling Series models are the Company's
lighter-weight, medium precision (P.002 to P.007 inches) measuring devices
and are available in four, six, eight and ten foot measurement diameters.
These models are most frequently used for applications that do not require
high-level precision, such as 3-D modeling, mold production and
reverse-engineering applications. Depending on the component of AnthroCam
software, the Sterling Series models are priced between $30,000 and $40,000
when sold as a turnkey system including hardware, computer and
AnthroCam/registered trademark/ software and $25,000 without computer and
software.
4
ANTHROCAM/registered trademark/. AnthroCam is the Company's proprietary
CAD-based measurement and statistical process control software. The AnthroCam
product line includes six (6) software programs:
ANTHROCAM CAD ANALYZER/registered trademark/ allows users to convert very
large, complex CAD files from engineering workstations into simpler
graphical images which make them available on a personal computer level for
numerous applications throughout the factory from assembly and inspection
planning, to the creation of user or service manuals. AnthroCam CAD
Analyzer/registered trademark/ sells for $6,500
ANTHROCAM DESIGN/registered trademark/ allows users to measure older
parts without data files, or models of potential products and convert them
into CAD files for manufacturing. It is built on the AutoCAD/registered
trademark/ software development platform, which allows users to benefit
from extensive hardware, software, interfacing and software support
libraries and teaching products. AnthroCam Design/registered trademark/ is
offered with the FAROArm/registered trademark/ and is also offered as an
unbundled product. When unbundled from the FAROArm/registered trademark/,
AnthroCam Design/registered trademark/ sells for $26,000.
ANTHROCAM MEASURE/registered trademark/ allows users to compare
measurements of manufactured components or assemblies with the
corresponding CAD data for the components or assemblies. AnthroCam
Measure/registered trademark/ is offered with the FAROArm/registered
trademark/ and is also offered as an unbundled product. When unbundled from
the FAROArm/registered trademark/, AnthroCam Measure/registered trademark/
sells for $16,000.
ANTHROCAM AUTOMOTIVE/registered trademark/ also allows users to compare
measurements of manufactured components with the corresponding CAD file.
Unlike AnthroCam Measure/registered trademark/, AnthroCam
Automotive/registered trademark/ is especially suited to the measurement of
very large components with large CAD files, typical of those in the
automotive industry. AnthroCam Automotive/registered trademark/ is offered
with the FAROArm/registered trademark/ and is also offered as an unbundled
product. When unbundled from the FAROArm/registered trademark/, AnthroCam
Automotive/registered trademark/ sells for $20,000.
ANTHROCAM SPC GRAPH/registered trademark/ allows the user to organize and
compare measurement results from the FAROArm in the form of pictures,
tables, and charts, for the purpose of statistical process control.
AnthroCam SPC Graph/registered trademark/ is tailored to an individual
user. AnthroCam SPC Graph/registered trademark/ sells for $1,000.
ANTHROCAM SPC PROCESS/registered trademark/ allows for the collection,
organization, and presentation of measurement data factory-wide. Not
limited to measurements from the FAROArm/registered trademark/, AnthroCAM
SPC Process/registered trademark/ accepts data from CMMs and other
computer-based measurement devices from many different measurement
applications along the production line. AnthroCam SPC Process/registered
trademark/ sells for $90,000 per assembly line.
DEVELOPMENT OF A NEW TRADEMARK
In February 1999 the Company filed an application in the United States
Patent and Trademark Office (the "Trademark Office") for the trademark CAM2.
Upon initial acceptance
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of the CAM2 trademark by the Trademark Office, the Company intends to rename
its software family preface from AnthroCam/registered trademark/ to CAM2.
SPECIALTY PRODUCTS. The Company licenses and supports certain specialty
products based on its articulated arm technology that are used in medical and
multimedia applications. License and support fees from these products do not
represent a significant portion of the Company's revenues and the Company does
not intend to actively market these products.
The Company's products overcome many limitations of hand-measurement
tools, test fixtures and conventional CMMs by incorporating the following
features:
INTEGRATION WITH CAD TECHNOLOGY. The Company's products provide a bridge
between the virtual 3-D world of the CAD process and the physical 3-D world
of the factory floor. The interface to CAD allows manufacturers to
integrate design, production and measurement and quality inspection
processes on a common software platform. The Company believes that this
integration creates significant savings by reducing the need for test
fixtures and improves productivity by reducing production set-up times.
Finally, the Company's integration with CAD technology significantly
enhances product quality by maximizing the opportunities to make precise
measurements based on engineering specifications within the manufacturing
process.
SIX-AXIS ARTICULATING ARM. The FAROArm/registered trademark/ incorporates
a six-axis instrumented, articulating device that approximates the range of
motion and dexterity of the human arm. The flexibility of the
FAROArm/registered trademark/ enables the user to measure complex shapes
and ergonomic structures and to reach behind, underneath and into
previously inaccessible spaces, such as interior surfaces of aircraft or
automobiles. The flexibility of the FAROArm/registered trademark/ allows
customers to measure more accurately and efficiently than previously
possible.
PORTABILITY AND ADAPTABILITY. The FAROArm/registered trademark/ is
lightweight, portable and designed for operation in the often harsh
environments typical of manufacturing facilities. The FAROArm/registered
trademark/ can be moved to multiple locations on the factory floor to
measure large parts and assemblies that cannot be easily moved to a
conventional CMM. This portability extends 3-D measurement to previously
inaccessible areas of the factory floor and eliminates the travel time to
and from quality inspection departments.
LEVELS OF PRECISION RESPONSIVE TO INDUSTRY NEEDS. The Company's products
respond to manufacturers' need for intermediate levels of measurement
precision. Although high levels of precision (less than one-thousandth of
an inch) are required for certain manufacturing applications, the
FAROArm/registered trademark/ satisfies the greater demand for measurements
that require intermediate precision (one- to twenty-thousandths of an
inch). The Company's products meet the precision measurement requirements
of a substantial portion of products in the manufacturing process and
address the underserved market for intermediate precision measurement
systems.
6
BROAD AFFORDABILITY. The Company offers various models of the
FAROArm/registered trademark/ ranging in price from $25,000 to $60,000,
while conventional CMMs range in price from $20,000 to $2 million. The
relatively low cost of the Company's products compared to conventional CMMs
has afforded manufacturers the opportunity to introduce cost-effective
measurement and quality inspection functions throughout the manufacturing
process. Manufacturers are able to purchase multiple units to be used at
different locations within a single manufacturing facility and to introduce
measurement and quality inspection at additional points in the
manufacturing process.
EASE OF USE. The Company's software products have been specifically
designed to be used by production line personnel with minimal prior
computer or CAD experience. The bundled hardware and software system is
designed to require minimal training for production line personnel to reach
proficiency with the product. To take a measurement, the operator simply
touches the object to be measured with a probe at the end of the arm and
presses a button. The FAROArm/registered trademark/ is also ergonomically
designed to facilitate use in typical factory floor applications.
PAPERLESS DATA COLLECTION. The FAROArm/registered trademark/ allows for
paperless data collection by a connected computer hosting related CAD
application software. This function responds to current trends toward
automated statistical process controls for facilitating data analysis.
Paperless data collection improves productivity and eliminates the risk of
error in transcribing the collected information.
OPEN ARCHITECTURE. The FAROArm/registered trademark/ and
AnthroCam/registered trademark/ have been designed as an open architecture
system, allowing the user to unbundle the hardware and software to
interface the FAROArm/registered trademark/ with other CAD-based software
packages and to interface AnthroCam/registered trademark/ with other 3-D
measurement devices. In addition, the Company's software and hardware are
built in accordance with computer and communications industry standards so
that these products may be integrated with a broad range of application
software packages.
7
CUSTOMERS
The Company's products have been purchased by more than 1100 customers
ranging from small machine shops to large manufacturing and industrial
companies. The Company's ten largest customers by revenue represented an
aggregate of 19% of the Company's total revenues in 1998. No customer
represented 10.0% or more of the Company's sales in 1998. The following table
illustrates, by vertical market, the Company's diverse customer base:
AEROSPACE APPAREL AND FOOTWEAR AUTOMOTIVE
Boeing Nike AO Smith
GE Aircraft Engines Reebok DaimlerChrysler
Lockheed Martin General Motors
Nordam Repair Division Samsung Motors
Northrop Grumman HyundaiToyota
Orbital Sciences Vehma International
Dee Howard Johnson Controls
Lear Corporation
Porsche
Ford
Honda
BUSINESS AND CONSUMER ELECTRIC UTILITIES AND FARM/LAWN EQUIPMENT
MACHINES MANUFACTURERS New Holland North America
Corning Asahi General Electric Toro
Xerox Southern California Edison
Tennessee Valley Authority
Westinghouse Electric
HEAVY EQUIPMENT PERSONAL ROAD/ WATER/ PLASTICS
MANUFACTURERS SNOW CRAFT Able Design Plastics
Caterpillar Harley Davidson Paramount Plastics
Komatsu Dresser Polaris Industries Thermoform Plastics
Champion Road Machinery
Texas Steel
SALES AND MARKETING
The Company directs its sales and marketing efforts from its headquarters
in Lake Mary, Florida. At December 31, 1998, the Company employed 68 sales
professionals who operate from the Company's headquarters, seven domestic
regional sales offices located in Charlotte, Chicago, Columbus (Ohio), Dallas,
Detroit, Los Angeles and Seattle, four German regional sales offices in
Stuttgart, Munich, Gladbeck and Hanover, and sales offices located in Coventry,
United Kingdom, and suburban Paris, France. The Company also utilizes six
domestic and 24 international distributors in territories where the Company
does not have regional sales offices. See Footnote 13 to the Notes to
Consolidated Financial Statements incorporated by reference herein from Item 8
hereof for financial information about the Company's foreign and domestic
operations and export sales required by this Item.
8
The Company uses a process of integrated lead qualification and sales
demonstration. Once a customer opportunity is identified, the Company employs a
team-based sales approach involving inside and outside sales personnel who are
supported by application engineers.
The Company employs a variety of marketing techniques, including direct
mail, trade shows, and advertising in trade journals, and proactively seeks
publicity opportunities for customer testimonials. Management believes that
word-of-mouth advertising from the Company's existing customers provides an
important marketing advantage. The Company also has a computerized sales and
marketing software system with telemarketing, lead tracking and analysis, as
well as customer support capabilities. Each of the Company's sales offices is
linked electronically to the Company's headquarters.
In June 1996, the Company entered into an OEM agreement with Mitutoyo
Corporation ("Mitutoyo"), a Japanese company that is the world's largest
manufacturer of metrology tools. Mitutoyo markets the FAROArm/registered
trademark/ in Japan under the name SPINARM/registered trademark/. The
agreement, which grants Mitutoyo a non-exclusive right to sales in Japan,
expires in June 1999 and is renewable for successive one-year terms.
In March 1999, the Company entered into an OEM agreement with Brown &
Sharpe Manufacturing Company ("Brown & Sharpe"), a North Kingstown, Rhode
Island company that is a world leader in the manufacture of traditional CMMs
and other metrology products. Brown & Sharpe will market the FAROArm/registered
trademark/ worldwide under the name GAGE 2000 A. The agreement, which grants
Brown & Sharpe a non-exclusive right to sales worldwide, expires in March 2000,
and is renewable for successive one-year terms.
RESEARCH AND DEVELOPMENT
The Company believes that its future success depends on its ability to
achieve technological leadership, which will require ongoing enhancements of
its products and the development of new applications and products that provide
3-D measurement solutions. Accordingly, the Company intends to continue to make
substantial investments in the development of new technologies, the
commercialization of new products that build on the Company's existing
technological base and the enhancement and development of additional
applications for its products.
The Company's research and development efforts are directed primarily at
enhancing the technology of its current products and developing new and
innovative products that respond to specific requirements of the emerging
market for 3-D measurement systems. The Company's research and development
efforts have been devoted primarily to mechanical hardware, electronics and
software. The Company's acquisition of CATS resulted in the addition of 11
software developers to the research and development efforts. The Company's
engineering development efforts will continue to focus on the
FAROArm/registered trademark/ and the family of AnthroCam/registered trademark/
products. Significant efforts are also being directed toward the development of
new measurement technologies and additional features for existing products. See
"Technology."
9
At December 31, 1998, the Company employed 43 scientists and technicians
in its research and development efforts. Research and development expenses were
$2,587,000 in 1998 as compared to $1,076,000 in 1997 and $730,000 in 1996.
Research and development activities, especially with respect to new products
and technologies, are subject to significant risks, and there can be no
assurance that any of the Company's research and development activities will be
completed successfully or on schedule, or, if so completed, will be
commercially accepted.
TECHNOLOGY
The primary measurement function of the FAROArm/registered trademark/ is
to provide orientation and position information with respect to the probe at
the end of the FAROArm/registered trademark/. This information is processed by
software and can be compared to the desired dimensions of the CAD data of a
production part or assembly to determine whether the measured data conforms to
meet dimensional specifications.
To accomplish this measurement function, the FAROArm/registered trademark/
is designed as an articulated arm with six or seven joints. The arm consists of
aluminum links and rotating joints that are combined in different lengths and
configurations, resulting in human arm-like characteristics. Each joint is
instrumented with a rotational transducer, a device used to measure rotation,
which is based on optical digital technology. The position and orientation of
the probe in three dimensions is determined by applying trigonometric
calculations at each joint. The position of the end of a link of the arm can be
determined by using the angle measured and the known length of the link.
Through a complex summation of these calculations at each joint, the position
and orientation of the probe is determined.
The Company's products are the result of a successful integration of
state-of-the-art developments in mechanical and electronic hardware and
applications software. The unique nature of the Company's technical
developments is evidenced by the Company's numerous U.S. and international
patents. The Company maintains low cost product design processes by retaining
development responsibilities for all electronics, hardware and software.
MECHANICAL HARDWARE. The FAROArm/registered trademark/ is designed to
function in diverse environments and under rigorous physical conditions. The
arm monitors its temperature to adjust for environments ranging from -10
degrees to +50 degrees Celsius. The arm is constructed of pre-stressed
precision bearings to resist shock loads. Low production costs are attained by
the proprietary combination of reasonably priced electromechanical components
accompanied by the optimization and on-board storage of calibration data. Many
of the Company's innovations relate to the environmental adaptability of its
products. Significant features include integrated counter-balancing,
configuration convertibility and temperature compensation.
ELECTRONICS. The rotational information for each joint is processed by an
on-board computer that is designed to handle complex analyses of joint data as
well as communications with a variety of host computers. The Company's
electronics are based on
10
digital signal processing and surface mount technologies. The Company's
products meet all mandatory electronic safety requirements. Advanced circuit
board development, surface mount production and automated testing methods are
used to ensure low cost and high reliability.
SOFTWARE. AnthroCam/registered trademark/ is a Windows-based, 32-bit
application family written for the most recent PC-based technology.
AnthroCam/registered trademark/ has been entirely designed and programmed by
the Company utilizing field input and industry wide beta site installations.
AnthroCam CADanalyser/registered trademark/ is a family member for viewing,
analyzing and browsing CAD files. AnthroCam Design/registered trademark/ is a
family member primarily used for reverse engineering and is written as an
AutoCAD runtime extension (ARX) that is the AutoCAD Application Programming
Interface (API). Family member AnthroCam Measure/registered trademark/ is
simplified version of Design for pure measurement applications written entirely
on the ACIS CAD development platform. Family member AnthroCam
Automotive/registered trademark/ is a measurement software designed for large
CAD files and specific Automotive applications and is written using a
proprietary graphics display engine. Family member AnthroCam SPC
Process/registered trademark/ is designed for plant wide dimensional data
acquisition and presentation in classical SPC (Statistical Process Control)
formats for plant-wide quality control.
All the AnthroCam/registered trademark/ family members are written in the
C++ development language using Microsoft Foundation Class (MFC) standards. The
software fully implements UNICODE standards for worldwide translation allowing
the Company to create foreign language versions to enter international markets
more effectively. The software is developed with the cooperation of diverse
user beta sites and a well developed system for tracking and implementing
market demands.
INTELLECTUAL PROPERTY
The Company holds or has pending 23 patents in the United States, 13 of
which are also held or pending in other jurisdictions. The Company also has 13
registered trademarks in the United States, 10 foreign registered trademarks,
10 trademark applications pending in the United States and 15 foreign trademark
applications pending.
The Company relies on a combination of contractual provisions and trade
secret laws to protect its proprietary information. There can be no assurance
that the steps taken by the Company to protect its trade secrets and
proprietary information will be sufficient to prevent misappropriation of its
proprietary information or to preclude third-party development of similar
intellectual property.
Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
to obtain and use information that the Company regards as proprietary. The
Company intends to vigorously defend its proprietary rights against
infringement by third parties. However, policing unauthorized use of the
Company's products is difficult, particularly overseas, and the Company is
unable to determine the extent to which piracy of its software products exists.
In addition, the laws of
11
some foreign countries do not protect the Company's proprietary rights to the
same extent as the laws of the United States.
The Company does not believe that any of its products infringe on the
proprietary rights of third parties. There can be no assurance, however, that
third parties will not claim infringement by the Company with respect to
current or future products. Any such claims, with or without merit, could be
time-consuming, result in costly litigation, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such royalty
or licensing agreements, if required, may not be available on terms acceptable
to the Company or at all, which could have a material adverse effect upon the
Company's business, operating results and financial condition.
MANUFACTURING AND ASSEMBLY
The Company manufactures its products primarily at its headquarters in
Lake Mary, Florida. Manufacturing consists primarily of assembling components
and subassemblies purchased from suppliers into finished products. The primary
components, which include machined parts and electronic circuit boards, are
produced by subcontractors according to the Company's specifications. All
products are assembled, calibrated and finally tested for accuracy and
functionality before shipment. In limited circumstances, the Company performs
in-house circuit board assembly and part machining.
"Quality" has rapidly emerged as a new emphasis in commerce and industry,
and is a significant factor in international trade. Various national and
multinational standards have been developed in the quality systems arena for
commercial and industrial use. On September 3, 1998 the Company announced that
the Company's quality management system received ISO 9001 certification from
Bureau Veritas Quality International, an international ISO auditor based in
Jamestown, New York. The ISO 9000 series of quality assurance standards ("ISO
9000"), which is administered by the American National Standards Institute, was
developed to bring together existing multinational standards and to provide
consistence in quality and terminology. ISO 9000 Certification demonstrates
that a company has implemented an adequate quality system for products and
services it offers. By this, better internal commitment, as well as enhanced
purchaser confidence, may be achieved.
COMPETITION
The broad market for measurement devices, which includes hand-measurement
tools, test fixtures and conventional, fixed-base CMMs, is highly competitive.
Manufacturers of hand-measurement tools and traditional CMMs include a
significant number of well-established companies that are substantially larger
and possess substantially greater financial, technical and marketing resources
than the Company. There can be no assurance that these entities or others will
not succeed in developing products or technologies that will directly compete
with those of the Company. The market for measurement software to retrofit
traditional CMMs, and for statistical process control is also highly
competitive. The
12
Company will be required to make continued investments in technology and
product development to maintain its technological advantage over its
competition. There can be no assurance that the Company will have sufficient
resources to make such investments or that the Company's product development
efforts will be sufficient to allow the Company to compete successfully as the
industry evolves. The Company's products compete on the basis of portability,
accuracy, application features, ease-of-use, quality, price and technical
support.
The Company's only significant direct competitor for its
FAROArm/registered trademark/ and related software is a joint venture of Romer
SRL (France) and Romer, Inc. (California). The Company is aware of a direct
competitor in Germany, two direct competitors in Italy, and a new direct
competitor in the United Kingdom, each of which the Company believes currently
has negligible sales. The Company also has an established, indirect competitor
in Japan that markets a measuring device that is mobile but not portable. There
can be no assurance that such companies will not devote additional resources to
the development and marketing of products that compete with those of the
Company.
The worldwide trend toward CAD-based factory floor metrology has resulted
in the introduction of CAD-based inspection software and statistical process
control for conventional CMMs by most of the large CMM manufacturers. Certain
CMM manufacturers are miniaturizing, and in some cases increasing the mobility
of, their conventional CMMs. Nonetheless, these CMMs still have small
measurement volumes, lack the adaptability typical of portable, articulated arm
measurement devices and lose accuracy outside the controlled environment of the
metrology lab.
BACKLOG
At December 31, 1998, the Company had orders representing $844,000 in
sales. All outstanding orders at December 31, 1998 were shipped by March 3,
1999.
EMPLOYEES
At December 31, 1998, the Company had 190 full-time employees, consisting
of 68 sales/application engineering staff, 36 production staff, 43 research and
development staff, 33 administrative staff, and 10 customer service
specialists. None of the Company's employees is represented by a labor
organization, and the Company is not a party to any collective bargaining
agreements. The Company believes its employee relations are good. Management
believes that its future growth and success will depend in part on its ability
to retain and continue to attract highly skilled personnel. The Company
anticipates that it will obtain the additional personnel required to satisfy
the staffing requirements caused by its planned expansion over the next 12
months.
13
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, as well as certain key employees,
and their ages, are as follows:
NAME AGE PRINCIPAL POSITION
- --------------------------- ----- ------------------------------------------------
EXECUTIVE OFFICERS:
Simon Raab ................ 45 Chairman of the Board, Chief Executive Officer,
and President
Gregory A. Fraser ......... 44 Chief Financial Officer, Executive Vice
President, Secretary, and Treasurer
KEY EMPLOYEES:
Ali S. Sajedi ............. 38 Chief Engineer
SIMON RAAB, PH.D., a co-founder of the Company, has served as the Chairman
of the Board, Chief Executive Officer and a director of the Company since its
inception in 1982 and as President since 1986. Mr. Raab holds a Ph.D. in
Mechanical Engineering from McGill University, Montreal, Canada, a Masters of
Engineering Physics from Cornell University and a Bachelor of Science in
Physics with a minor in Biophysics from the University of Waterloo, Canada.
GREGORY A. FRASER, PH.D., a co-founder of the Company, has served as Chief
Financial Officer and Executive Vice President since May 1997 and as Secretary,
Treasurer and a director of the Company since its inception in 1982. Mr. Fraser
holds a Ph.D. in Mechanical Engineering from McGill University, Montreal,
Canada, a Masters of Theoretical and Applied Mechanics from Northwestern
University and a Bachelor of Science and Bachelor of Mechanical Engineering
from Northwestern University.
ALI S. SAJEDI has been Chief Engineer for the Company since its inception
in 1982. Mr. Sajedi has been responsible for implementation of research and
development plans and for production oversight of the Company's self-managed
production team. Mr. Sajedi holds a Bachelor of Mechanical Engineering from
McGill University.
ITEM 2. PROPERTIES.
The Company's headquarters and principal operations are located in a
leased building in Lake Mary, Florida containing approximately 35,000 square
feet. The Company's European headquarters are located in a leased building in
Karlsruhe, Germany containing approximately 4,400 square feet. The Company has
a combined sales and research and development facility which is located in a
leased building in Aveiro, Portugal containing approximately 2,800 square feet.
The Company believes that its current facilities will be adequate for its
foreseeable needs and that it will be able to locate suitable space for
additional regional offices as those needs develop.
In addition, the Company has seven sales offices in the United States and
six sales offices in Europe. All of the offices comprising the sales offices
are leased by the Company.
14
The information required by the remainder of this Item is incorporated herein by
reference to Exhibit 99.1 attached hereto.
ITEM 3. LEGAL PROCEEDINGS.
On April 2, 1998 the Company filed an action for declaratory judgement
action against Kosaka Laboratory Ltd. of Tokyo, Japan (Civil Action No.
98-381-CIV-ORL-19A in the Federal Court for the Middle District of Florida).
The Company seeks to have the Court declare its rights with regard to Kosaka's
U.S. Patent number 4,430,796 regarding a method of measuring an object using,
for example, a coordinate measuring machine (CMM), when an object is larger
than the coordinate system physically measurable by the CMM. Over the past one
to two years, the Company and Kosaka have sought to resolve this matter in an
amicable manner. However, Kosaka has persisted in its erroneous claims that its
patent is infringed by the Company, and has threatened to file suit if the
Company did not pay a relatively large licensing fee. In order to make it clear
to the market that the Company does not infringe the patent, the Company
decided to file the above mentioned action. The Company strongly believes that
the outcome to this declaratory judgement action will be favorable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the last
quarter of calendar 1998.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock, par value $.001 per share, began trading on
the NASDAQ Stock Market on September 18, 1997, under the symbol FARO. Before
that date, there was no established public trading market for the Common Stock.
The following table sets forth the high and low sale price of the Company's
Common Stock since its initial public offering:
1997
------------------
HIGH LOW
------- --------
September 18-30 ........... 18-1/8 15-3/8
Fourth Quarter ............ 18 11-5/8
1998
------------------
HIGH LOW
------- --------
First Quarter ............ 14-1/2 10
Second Quarter ........... 12-1/2 9-1/4
Third Quarter ............ 11-3/8 2-3/8
Fourth Quarter ........... 4-1/16 2-3/8
The Company has not paid any cash dividends on its Common Stock to date.
The payment of dividends, if any in the future is within the discretion of the
Board of Directors and will depend on the Company's earnings, its capital
requirements and financial condition, and may be restricted by future credit
arrangements entered into by the Company. The Company expects to retain future
earnings for use in operating and expanding its business and does not
anticipate paying any cash dividends in the reasonably foreseeable future. As
of March 26, 1999, there were approximately 59 holders of record of Common
Stock.
On August 10, 1998 the prospectus comprising part of the Company's
Registration Statement on Form S-1, File No. 333-57395, was declared effective
by the Securities and Exchange Commission. Common Stock was the only class of
securities registered. Of the 343,750 shares registered, none had been sold as
at March 26, 1999.
On August 26, 1998 the Board of Directors authorized the officers of the
Company, without further approval of the Board, to purchase in the open market,
up to a maximum of one million shares of the Company's Common Stock. During the
period August 26, 1998 to December 31, 1998 the Company purchased 40,000 shares
of Common Stock in the open market.
16
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED CONSOLIDATED FINANCIAL DATA
The following is a summary of selected financial data of the Company and
its subsidiaries as of and for each of the five years ended December 31, 1998.
The historical consolidated financial data has been derived from the historical
financial statements of the Company. These data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Company's Consolidated Financial Statements appearing
elsewhere in this document.
Year ended December 31, 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Sales ................................. $ 27,514,699 $23,516,385 $14,656,337 $9,862,242 $4,508,837
Cost of sales ......................... 11,291,313 9,610,838 6,486,268 4,987,779 2,222,085
- ----------------------------------------------------------------------------------------------------------------
Gross Profit .......................... 16,223,386 13,905,547 8,170,069 4,874,463 2,286,752
Operating expenses:
Selling ............................... 9,960,914 5,676,113 3,731,762 2,008,301 1,569,014
General and administrative ............ 3,161,599 1,519,657 744,206 503,184 521,040
Depreciation and amortization ......... 2,816,135 293,996 230,799 341,494 270,615
Research and development .............. 2,587,181 1,075,505 730,124 363,871 173,400
Employee stock options ................ 172,164 408,000 23,100 106,700 --
Purchased in-process research and
development costs ................... 3,210,000 -- -- -- --
- ----------------------------------------------------------------------------------------------------------------
Total operating expenses .............. 21,907,993 8,973,271 5,459,991 3,323,550 2,534,069
- ----------------------------------------------------------------------------------------------------------------
(Loss) income from operations ......... (5,684,607) 4,932,276 2,710,078 1,550,913 (247,317)
Interest income ....................... 1,077,713 442,444 -- -- --
Other income .......................... 139,355 57,308 25,145 62,212 11,706
Interest expense ...................... (13,023) (110,768) (212,669) (355,468) (192,543)
- ----------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes ..... (4,480,562) 5,321,260 2,522,554 1,257,657 (428,154)
Income tax expense (benefit) .......... 450,532 2,114,630 1,115,892 (342,000) --
- ----------------------------------------------------------------------------------------------------------------
Net income (loss) ..................... $ (4,931,094) $ 3,206,630 $ 1,406,662 $1,599,657 $ (428,154)
- ----------------------------------------------------------------------------------------------------------------
Net income (loss) per common share:
Basic ................................. $ (0.46) $ 0.41 $ 0.20 $ 0.23 $ (0.06)
Assuming dilution ..................... $ (0.46) $ 0.39 $ 0.19 $ 0.22 $ (0.06)
Weighted-average common
Share outstanding:
Basic ................................. 10,632,708 7,831,715 7,000,000 7,000,000 7,000,000
Assuming dilution ..................... 10,728,783 8,189,048 7,349,041 7,166,739 7,149,690
At December 31, 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA:
Working capital .................... $30,997,769 $37,277,545 $3,832,424 $1,321,517 $ (718,564)
Total assets ....................... 49,120,147 41,192,333 7,815,668 5,479,698 4,229,551
Total debt ......................... 333,554 -- 1,501,267 2,200,000 2,925,000
Total shareholders' equity ......... 45,375,391 38,939,411 3,773,699 2,343,937 637,580
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING INFORMATION SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY, INCLUDING THE NOTES THERETO,
INCLUDED ELSEWHERE IN THIS DOCUMENT.
OVERVIEW
The Company designs, develops, markets and supports portable,
software-driven, 3-D measurement systems that are used in a broad range of
manufacturing and industrial applications. In May 1998 the Company acquired
CATS Computer Aided Technologies, GmbH ("CATS"), a German company which
develops and markets CAD-based inspection and statistical process control
("SPC") software. The Company's principal products are the FAROArm/registered
trademark/ articulated measuring device and its multi-faceted
AnthroCam/registered trademark/ software which provides for CAD-based
inspection on portable and fixed-base CMMs, and factory-level statistical
process control. Together, these products integrate the measurement and quality
inspection function with CAD, CAM and computer-aided engineering ("CAE")
technology to improve productivity, enhance product quality and decrease rework
and scrap in the manufacturing process. The Company's products bring precision
measurement, quality inspection and specification conformance capabilities,
integrated with leading CAD software, to the factory floor. The Company is a
pioneer in the development and marketing of 3-D measurement technology in
manufacturing and industrial applications and currently holds or has pending 23
patents in the United States, 13 of which also are held or pending in other
jurisdictions. The Company's products have been purchased by more than 1,100
customers worldwide, ranging from small machine shops to such large
manufacturing and industrial companies as General Motors, DaimlerChrysler,
Ford, Boeing, Lockheed Martin, General Electric, Westinghouse Electric,
Caterpillar and Komatsu Dresser.
From its inception in 1982 through 1992, the Company focused on providing
computerized, 3-D measurement devices to the orthopedic and neurosurgical
markets. During this period, the company introduced a knee laxity measurement
device, a diagnostic tool for measuring posture, scoliosis and back
flexibility, and a surgical guidance device utilizing a six-axis articulated
arm.
In 1992, in an effort to capitalize on a demand for 3-D portable
measurement tools for the factory floor, the Company made a strategic decision
to target its core measurement technology to the manufacturing and industrial
markets. In order to focus on manufacturing and industrial applications of its
technology, the Company phased out the direct sale of its medical products and
entered into licensing agreements with two major neurosurgical companies for
its medical technology. In 1995, the Company made a strategic decision to
target international markets. The Company established sales offices in France
and Germany in 1996 and Great Britain in 1997. International sales represented
26.1% of sales in 1996 and 35.0% of sales in 1997, and 57% of sales in 1998.
18
The Company derives revenues primarily from the sale of the
FAROArm/registered trademark/, its six-axis articulated measuring device, and
its multi-faceted AnthroCam/registered trademark/ software. Revenue related to
these products is recognized upon shipment.
Revenue growth has resulted from increased unit sales due to an expanded
sales effort that included the addition of sales personnel at existing offices,
the opening of new sales offices, expanded promotional efforts and the
acquisition of CATS. In September 1998 the Company announced the introduction
of a new product line consisting of two additional FAROArm models, and the
addition of 3 new software components to the AnthroCam family, from the CATS
acquisition.
In addition to providing a one-year basic warranty without additional
charge, the Company offers its customers one, two and three-year extended
maintenance contracts, which include on-line help services, software upgrades
and hardware warranties. In addition, the Company sells training and technology
consulting services relating to its products. The Company recognizes the
revenue from extended maintenance contracts proportionately as costs are
projected to be incurred.
Cost of sales consists primarily of material, production overhead and
labor. Selling expenses consist primarily of salaries and commissions to sales
and marketing personnel, and promotion, advertising, travel and
telecommunications. General and administrative expenses consist primarily of
salaries for administrative personnel, rent, utilities and professional and
legal expenses. Research and development expenses represent salaries, equipment
and third-party services.
Accounting for wholly-owned foreign subsidiaries is maintained in the
currency of the respective foreign jurisdiction and, therefore, fluctuations in
exchange rates may have an impact on intercompany accounts reflected in the
Company's consolidated financial statements. Although the Company has not
historically engaged in any hedging transactions to limit risks of currency
fluctuations, it intends to do so in the future.
19
RESULTS OF OPERATIONS
The following table sets forth for the periods presented, the percentage
of sales represented by certain items in the Company's consolidated statements
of operations:
Year Ended December 31,
---------------------------------------
1998 1997 1996
---- ---- ----
STATEMENT OF OPERATIONS DATA:
Sales ..................................... 100.0% 100.0% 100.0%
Cost of sales ............................. 41.0 40.9 44.3
----- ----- -----
Gross profit .............................. 59.0 59.1 55.7
Operating expenses:
Selling .................................. 36.2 24.1 25.5
General and administrative ............... 11.5 6.5 5.1
Depreciation and amortization ............ 10.2 1.3 1.6
Research and development ................. 9.4 4.6 5.0
Employee stock options ................... 0.6 1.7 0.2
----- ----- -----
Total operating expenses ................ 79.6 38.2 37.4
----- ----- -----
(Loss) income from operations ............. (20.7) 20.9 18.3
Interest Income ........................... 3.9 1.9 -
Other income .............................. 0.5 0.2 0.2
Interest expense .......................... -- ( 0.5) ( 1.5)
----- ----- -----
(Loss) income before income taxes ......... (16.3) 22.5 17.0
Income tax expense ........................ 1.6 9.0 7.6
----- ----- -----
Net (loss) income ......................... (17.9)% 13.5% 9.4%
1998 COMPARED TO 1997
SALES. Sales increased $4.0 million, or 17.0%, from $23.5 million in 1997
to $27.5 million in 1998. The increase was a result of increases in sales in
Europe ($5.4 million) and Canada ($634,000), offset by decreases in sales in
Asia ($992,000) and the United States ($841,000).
GROSS PROFIT. Gross profit increased $2.3 million, or 16.7%, from $13.9
million in 1997 to $16.2 million in 1998. This increase was a result of a
proportional increase in sales in 1998, at a gross margin of 59.0%, virtually
unchanged from 59.1% in 1997.
SELLING EXPENSES. Selling expenses increased $4.3 million, or 75.5%, from
$5.7 million in 1997 to $10.0 million in 1998. This increase was primarily the
result of a 100% increase in the number of sales and marketing staff, and their
resulting sales activities. The number of sales and marketing employees grew
from 34 at December 31, 1997 to 68 at December 31, 1998. The cost per sales
employee was higher in 1998 in part as a result of the greater proportion
(primarily as a result of the CATS acquisition) of European employees and the
higher cost of payroll benefits and travel costs in Europe.
20
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $1.6 million, or 108.0% from $1.5 million in 1997, to $3.2 million in
1998. This increase resulted primarily from the increased number of
administrative personnel both at the Company's headquarters and from the
acquisition of CATS.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expenses increased $2.5 million or 857.9%, from $294,000 in 1997 to $2.8
million in 1998. This increase was primarily due to $2.2 million in
amortization expenses related to the intangible assets associated with the
Company's acquisition of CATS.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased $1.5 million, or 140.6%, from $1.1 million in 1997 to $2.6 million in
1998. This increase was a result of an increase in the number of research and
development employees from 14 at December 31, 1997 to 43 at December 31, 1998.
EMPLOYEE STOCK OPTIONS. Employee stock option expenses decreased $236,000,
or 57.8%, from $408,000 in 1997 to $172,000 in 1998. This decrease was a result
of a reduction in the amortized deferred compensation expense relating to stock
options issued in 1995 and 1997. For all options issued in 1998, no
compensation expense was recorded, as the exercise price of the options was
equal to the market price at the day of the grant.
IN-PROCESS RESEARCH AND DEVELOPMENT RESULTING FROM ACQUISITION. On May 15,
1998 the Company acquired CATS for $5 million and 916,668 of the Company's
common stock and the assumption of certain liabilities. The $3.2 million
portion of the purchase price that was attributed to in process research and
development and was expensed immediately.
INTEREST INCOME. Interest income increased $635,000 or 143.6%, from
$442,000 in 1997 to $1.1 million in 1998. This increase was a result of a full
year of interest in 1998 on the remaining portion of the proceeds from the
Company's initial public offering in September 1997, compared to approximately
three months of interest on the portion of these proceeds which were invested
in 1997.
INCOME TAX EXPENSE. Income tax expense decreased $1.7 million or 78.7%
from $2.1 million in 1997 to $451,000 in 1998. The income tax provision in 1998
results primarily from the Company's U.S operations being in a taxable
position, and the deferred tax benefit of the Company's foreign loss being
offset by a $3 million valuation allowance.
NET INCOME (LOSS). The Company's net income (loss) for 1998 decreased $8.1
million, from net income of $3.2 million in 1997 to a net loss of $4.9 million
in 1998. This decrease was a result of a one-time in-process research and
development charge ($3.2 million), amortization costs related to the CATS
acquisition ($2.2 million), and higher sales, general and administrative, and
research and development expenses as a percentage of sales.
1997 COMPARED TO 1996
SALES. Sales increased $8.9 million, or 60.5%, from $14.6 million in 1996
to $23.5 million in 1997. The increase was primarily the result of increased
unit sales due to an
21
expanded sales effort that included the addition of sales personnel at existing
offices, and the opening of sales offices. International sales increased to
35.0% of total sales in 1997, from 26.1% in 1996, in part because of increased
sales in the European countries in which the Company has sales offices, and
increased sales to several international distributors.
GROSS PROFIT. Gross profit increased $5.7 million, or 70.2%, from $8.2
million in 1996 to $13.9 million in 1997. Gross margin increased from 55.7% in
1996 to 59.1% in 1997. This margin increase was attributable to a reduction in
product costs as a result of technological improvements, purchasing economies
and production efficiencies.
SELLING EXPENSES. Selling expenses increased $1.9 million, or 52.1%, from
$3.7 million in 1996 to $5.7 million in 1997. This increase was a result of the
Company's expansion of sales and marketing staff in the United States and
Europe, and expanded promotional efforts. Specifically, hiring, training, and
salary expenses increased $965,000, sales commissions and bonuses increased
$378,000, and promotional expenses increased $333,000. Selling expenses as a
percentage of sales decreased from 25.5% in 1996 to 24.1% in 1997.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $775,000, or 104.2%, from $774,000 in 1996 to $1.5 million in 1997.
This increase resulted primarily from the hiring of additional administrative
personnel, and increases in professional and legal expenses, in part as a
result of the Company's periodic reporting requirements with the Securities and
Exchange Commission resulting from the Company's initial public offering in
September 1997. General and administrative expenses as a percentage of sales
increased from 5.1% in 1996 to 6.5% in 1997.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased $345,000, or 47.3%, from $730,000 in 1996 to $1.1 million in 1997.
This increase was primarily a result of a $246,000 increase in hiring,
training, and salary cost related to new personnel. Research and development
expenses as a percentage of sales decreased from 5.0% in 1996 to 4.6% in 1997,
as the growth in these expenses did not match the percentage growth in sales.
EMPLOYEE STOCK OPTIONS EXPENSES. Employee stock options expenses increased
$385,000 from $23,000 in 1996 to $408,000 in 1997. This increase was primarily
attributable to the grant of 52,733 options in May 1997, which was made at an
exercise price below the fair market value of the Common Stock on the date of
the grant.
OTHER INCOME. Other income increased $475,000 from $25,000 in 1996 to
$500,000 in 1997. This increase was attributable to interest income on the $30
million proceeds from the Company's initial public offering in 1997.
INTEREST EXPENSE. Interest expense decreased $102,000, or 47.9%, from
$213,000 in 1996 to $111,000 in 1997. This reduction was attributable to the
refinancing of the Company's indebtedness at a lower interest rate, and also
the utilization of the proceeds from the Company's initial public offering to
repay all indebtedness.
22
INCOME TAX EXPENSE. Income tax expense increased $999,000, or 89.5%, from
$1.1 million in 1996 to $2.1 million in 1997. The provision for income taxes as
a percentage of income before income taxes was 44.2% in the twelve months of
1996 and 39.7% in the twelve months of 1997. The lower effective tax rate in
1997 was because of a higher Research and Development tax credit and the
creation of a Foreign Sales Corporation.
NET INCOME. Net income increased $1.8 million, or 128.0%, from $1.4
million in 1996 to $3.2 million in 1997. This increase was a result of
increased sales, higher gross margin, $442,000 in interest income in 1997 which
was zero in 1996, and a lower tax rate.
LIQUIDITY AND CAPITAL RESOURCES
In September 1997, the Company completed an initial public offering of
common stock which provided net proceeds of $31.7 million. For the year ended
December 31, 1998, net cash used by operating activities was $3.1 million
compared to net cash used by operating activities of $705,000 for 1997. Net
cash decreased due to increases in accounts receivable, inventories, and
accounts payable. Net cash used in investing activities was $25.2 million for
the year ended December 31, 1998 compared to $792,000 for 1997. Net cash used
in investing activities increased in 1998 primarily due to a $17.0 million
increase in short term investments, a $5.7 million acquisition of business, net
of cash acquired, and $1.0 million in purchases of property and equipment
related to the expansion of the Company's headquarters. Net cash provided by
financing activities for the year ended December 31,1998 was $288,000 compared
to net cash provided by financing activities of $30.2 million for 1997. The
Company invests excess cash balances in short-term investment grade securities,
such as money market investments, obligations of the U.S. government and its
agencies, and obligations of state and local government agencies.
In April 1997, the Company obtained a one-year secured $1.0 million line
of credit which bears interest at the 30-day commercial paper rate plus 2.65%
per annum. There were no outstanding borrowings under this loan agreement at
December 31, 1997.
The Company has available with two financial institutions short-term,
revolving lines of credit aggregating $445,000. Under these lines, a subsidiary
may borrow funds for operations. These lines of credit are personally
guaranteed by certain shareholders. The amount outstanding on these lines at
December 31, 1998 was approximately $296,000. The average interest rates on
such borrowings at December 31, 1998 was 9%.
The Company's principal commitments at December 31, 1998 were leases on
its headquarters and regional offices, and there were no material commitments
for capital expenditures at that date. The Company believes that its cash,
investments, cash flows from operations and funds available from its credit
facilities will be sufficient to satisfy its working capital and capital
expenditure needs at least through 1999.
FOREIGN EXCHANGE EXPOSURE
Sales outside the United States represent a significant portion of the
Company's total revenues. Currently, the majority of the Company's revenues and
expenses are invoiced
23
and paid in U.S. dollars. In the future, the Company expects a greater portion
of its revenues to be denominated in foreign currencies. Fluctuations in
exchange rates between the U.S. dollar and such foreign currencies may have a
material adverse effect on the Company's business, results of operations and
financial condition, particularly its operating margins, and could also result
in exchange losses. The impact of future exchange rate fluctuations on the
results of the Company's operations cannot be accurately predicted.
Historically, the Company has not managed the risks associated with
fluctuations in exchange rates but intends to undertake transactions to manage
such risks in the future. To the extent that the percentage of the Company's
non-U.S. dollar revenues derived from international sales increases in the
future, the risks associated with fluctuations in foreign exchange rates will
increase. The Company may use forward foreign exchange contracts with foreign
currency options to hedge these risks.
INFLATION
The Company believes that inflation has not had a material impact on its
results of operations in recent years and does not expect inflation to have a
material impact on its operations in 1999.
YEAR 2000
The Company has invested significant resources in the latest information
technologies over the past five years and therefore has minimized the effect of
Year 2000 issues. Management initiated a program to evaluate all internal
computer systems and applications, and products with computer systems and
determined the adjustments necessary to become Year 2000 compliant. Management
is confident that existing internal resources are sufficient to correct any
internal systems deficiencies that have or may be determined. The Company has
set a target date of September 30, 1999 for complete compliance of internal
computer systems, applications, and products. The Company has also made
inquiries of its major suppliers, customers and other third-party entities with
which it has business relations to obtain assurances of their Year 2000
compliance. However, there can be no assurance that the systems of other
companies on which the Company relies will be timely corrected, or that any
failure by another company to correct such systems would not have a material
adverse effect on the Company. Contingency plans are currently being developed
to be implemented in the event any information technology system,
non-information technology system, third party or supplier is not Year 2000
compliant in a timely manner.
The total cost to the Company of these Year 2000 Compliance activities has
not been and is not anticipated to be material to its financial position or
results of operations in a given year. The Company has a provision of $12,500
per quarter in 1999 to cover the cost of any unexpected corrections to any
internal sysytems or product deficiencies. These costs are based on
Management's best estimates, which were derived utilizing numerous assumptions
of future events including the continued availability of certain resources,
third party modification plans, and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
from those plans.
24
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this item is incorporated by reference herein
from the section of this Report in Part II, Item 7, under the caption "Foreign
Exchange Exposure."
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS
PAGE
-----
Independent Auditors' Report .......................................... 27
Consolidated Balance Sheets as of December 31, 1997 and 1998 .......... 28
Consolidated Statements of Income for the Years Ended
December 31, 1996, 1997 and 1998 .................................... 29
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1996, 1997 and 1998 .................................... 30
Consolidated Statements of Cash Flows for the years Ended
December 31, 1996, 1997 and 1998 .................................... 31
Notes to Consolidated Financial Statements ............................ 32
26
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
of FARO Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of FARO
Technologies, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing
standards. 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, such consolidated financial statements present fairly, in
all material respects, the financial position of FARO Technologies, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Jacksonville, Florida
February 19, 1999
27
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------------------
1998 1997
--------------- --------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 1,183,656 $28,815,069
Short-term investments ............................................. 17,011,831
Accounts receivable, less allowance
for doubtful accounts of $139,690 and $9,534...................... 8,963,343 6,159,173
Income taxes refundable ............................................ 716,048
Inventories ........................................................ 6,443,618 4,275,376
Prepaid expenses and other assets .................................. 155,037 109,649
Deferred income taxes .............................................. 121,543 126,572
------------ -----------
Total current assets ............................................. 34,595,076 39,485,839
------------ -----------
PROPERTY AND EQUIPMENT -- at cost:
Machinery and equipment ............................................ 1,873,146 1,014,309
Furniture and fixtures ............................................. 899,616 605,913
Leasehold improvements ............................................. 28,889
------------
Total ............................................................ 2,801,651 1,620,222
Less accumulated depreciation and amortization ..................... (1,276,459) (792,442)
------------ -----------
Property and equipment -- net .................................... 1,525,192 827,780
------------ -----------
INTANGIBLE ASSETS -- net ............................................ 12,821,191 747,979
NOTES RECEIVABLE .................................................... 178,688
DEFERRED INCOME TAXES ............................................... 130,735
-----------
TOTAL ASSETS ........................................................ $ 49,120,147 $41,192,333
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short term notes payable to banks .................................. $ 296,230
Accounts payable and accrued liabilities ........................... 2,852,452 $ 1,196,967
Income taxes payable ............................................... 413,167
Current portion unearned service revenues .......................... 329,731 476,802
Current portion of long-term debt .................................. 4,156
Customer deposits .................................................. 114,738 121,358
------------ -----------
Total current liabilities ........................................ 3,597,307 2,208,294
DEFERRED INCOME TAXES ............................................... 78,220
UNEARNED SERVICE REVENUES -- less current portion ................... 31,905 44,628
LONG-TERM DEBT -- less current portion .............................. 37,324
------------ -----------
Total liabilities ................................................ 3,744,756 2,252,922
------------ -----------
COMMITMENTS AND CONTINGENCIES (Note 9)
SHAREHOLDERS' EQUITY:
Class A preferred stock -- par value $.001, 10,000,000 shares
authorized, no shares issued and outstanding .....................
Common stock -- par value $.001, 20,000,000 shares authorized,
11,048,137 and 9,919,000 issued; 11,008,137 and 9,919,000
outstanding ...................................................... 11,048 9,919
Additional paid-in capital ......................................... 47,520,732 36,502,004
Unearned compensation .............................................. (292,316) (464,480)
Retained earnings (accumulated deficit) ............................ (1,912,829) 3,018,265
Accumulated other comprehensive income ............................. 199,381 (126,297)
Common stock in treasury, at cost -- 40,000 shares in 1998 ......... (150,625)
------------ -----------
Total shareholders' equity ....................................... 45,375,391 38,939,411
------------ -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .......................... $ 49,120,147 $41,192,333
============ ===========
See notes to consolidated financial statements.
28
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
---------------- -------------- --------------
SALES ..................................... $ 27,514,699 $23,516,385 $14,656,337
COST OF SALES ............................. 11,291,313 9,610,838 6,486,268
------------ ----------- -----------
Gross profit ........................... 16,223,386 13,905,547 8,170,069
------------ ----------- -----------
OPERATING EXPENSES:
Selling .................................. 9,960,914 5,676,113 3,731,762
General and administrative ............... 3,161,599 1,519,657 744,206
Depreciation and amortization ............ 2,816,135 293,996 230,799
Research and development ................. 2,587,181 1,075,505 730,124
Employee stock options ................... 172,164 408,000 23,100
Purchased in-process research
and development costs .................. 3,210,000
------------ ----------- -----------
Total operating expenses ............... 21,907,993 8,973,271 5,459,991
------------ ----------- -----------
(LOSS) INCOME FROM OPERATIONS ............. (5,684,607) 4,932,276 2,710,078
OTHER INCOME (EXPENSE):
Interest income .......................... 1,077,713 442,444
Other income ............................. 139,355 57,308 25,145
Interest expense ......................... (13,023) (110,768) (212,669)
------------ ----------- -----------
(LOSS) INCOME BEFORE INCOME TAXES ......... (4,480,562) 5,321,260 2,522,554
INCOME TAX EXPENSE ........................ 450,532 2,114,630 1,115,892
------------ ----------- -----------
NET (LOSS) INCOME ......................... $ (4,931,094) $3,206,630 $1,406,662
============ =========== ===========
NET (LOSS) INCOME PER COMMON
SHARE -- BASIC .......................... $ (0.46) $ 0.41 $ 0.20
NET (LOSS) INCOME PER COMMON
SHARE -- DILUTED ........................ $ (0.46) $ 0.39 $ 0.19
See notes to consolidated financial statements.
29
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL
---------------------- PAID-IN UNEARNED
SHARE AMOUNTS CAPITAL COMPENSATION
------------ --------- -------------- --------------
BALANCE, JANUARY 1, 1996 ............ 7,000,000 $ 7,000 $ 3,971,764 $ (39,800)
Net income .........................
Comprehensive income ...............
Employee stock options,
forfeitures and amortization of
unearned compensation ............. (10,200) 33,300
--------- ------- ----------- ----------
BALANCE, DECEMBER 31, 1996........... 7,000,000 7,000 3,961,564 (6,500)
Net income .........................
Currency translation adjustment,
net of tax ........................
Comprehensive income ...............
Granting of employee and
director stock options ............ 866,793 (501,834)
Amortization of unearned
compensation ...................... 43,854
Issuance of common stock ........... 2,919,000 2,919 31,673,647
--------- ------- ----------- ----------
BALANCE, DECEMBER 31, 1997........... 9,919,000 9,919 36,502,004 (464,480)
Net loss ...........................
Currency translation adjustment,
net of tax ........................
Comprehensive loss .................
Issuance of common stock ........... 1,129,137 1,129 10,323,564
Income tax benefit resulting from
the exercise of stock options ..... 695,164
Amortization of unearned
compensation ...................... 172,164
Acquisition of treasury stock ......
BALANCE, DECEMBER 31, 1998........... 11,048,137 $11,048 $47,520,732 $ (292,316)
========== ======= =========== ==========
RETAINED ACCUMULATED
EARNINGS OTHER
(ACCUMULATED COMPREHENSIVE TREASURY
DEFICIT) INCOME STOCK TOTAL
---------------- --------------- -------------- -------------
BALANCE, JANUARY 1, 1996 ............ $(1,595,027) $ 2,343,937
Net income ......................... 1,406,662 1,406,662
-----------
Comprehensive income ............... 1,406,662
Employee stock options,
forfeitures and amortization of
unearned compensation ............. 23,100
---------- -----------
BALANCE, DECEMBER 31, 1996........... (188,365) 3,773,699
Net income ......................... 3,206,630 3,206,630
Currency translation adjustment,
net of tax ........................ $ (126,297) (126,297)
-----------
Comprehensive income ............... 3,080,333
Granting of employee and
director stock options ............ 364,959
Amortization of unearned
compensation ...................... 43,854
Issuance of common stock ........... 31,676,566
----------- ---------- -----------
BALANCE, DECEMBER 31, 1997........... 3,018,265 (126,297) 38,939,411
Net loss ........................... (4,931,094) (4,931,094)
Currency translation adjustment,
net of tax ........................ 325,678 325,678
-----------
Comprehensive loss ................. (4,605,416)
Issuance of common stock ........... 10,324,693
Income tax benefit resulting from
the exercise of stock options ..... 695,164
Amortization of unearned
compensation ...................... 172,164
Acquisition of treasury stock ...... $ (150,625) (150,625)
----------- ---------- ---------- -----------
BALANCE, DECEMBER 31, 1998........... $(1,912,829) $ 199,381 $ (150,625) $45,375,391
=========== ========== ========== ===========
See notes to consolidated financial statements.
30
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------------------------
1998 1997 1996
---------------- --------------- ---------------
OPERATING ACTIVITIES:
Net (loss) income .......................................... $ (4,931,094) $ 3,206,630 $ 1,406,662
Adjustments to reconcile net (loss) income to net cash
(used in) provided by operating activities:
Depreciation and amortization ............................. 3,030,272 701,996 253,899
Purchased in process research and development costs ....... 3,210,000
Provision for bad debts ................................... 28,432
Deferred income taxes ..................................... 361,737 (125,107) 232,800
Loss on the sale of fixed assets .......................... 10,850
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable ...................................... (1,759,788) (3,166,492) (843,349)
Income taxes refundable .................................. (716,048)
Inventories .............................................. (2,137,905) (976,632) (1,230,457)
Notes receivable ......................................... 124,683
Prepaid expenses and other assets .................. ..... 66,972 (68,778) 55,435
Increase (decrease) in:
Accounts payable and accrued liabilities ................. 263,912 (513,847) 990,993
Income taxes payable ..................................... (413,167) 284,951 105,216
Unearned service revenues ................................ (159,794) 50,151 471,278
Customer deposits ........................................ (6,620) (109,035) 53,460
------------- ------------ ------------
Net cash (used in) provided by operating activities ..... (3,066,840) (705,313) 1,524,369
------------- ------------ ------------
INVESTING ACTIVITIES:
Purchases of property and equipment ........................ (1,001,655) (480,127) (416,162)
Acquisition of business net of cash acquired ............... (5,668,382)
Short-term investments ..................................... (17,011,831)
Payment of patent costs .................................... (105,651) (203,549) (134,046)
Payments for product design costs .......................... (635,943) (108,286)
Payments for other intangibles ............................. (754,559)
------------- ------------ ------------
Net cash used in investing activities ................... (25,178,021) (791,962) (550,208)
------------- ------------ ------------
FINANCING ACTIVITIES:
Repayment of related party loans ........................... (2,200,000)
Proceeds from debt ......................................... 1,625,816
Payments on debt ........................................... (186,447) (1,501,267) (140,556)
Proceeds from issuance of common stock, net ................ 624,842 31,676,566
Acquisition of treasury stock .............................. (150,625)
------------- ------------ ------------
Net cash provided by (used in) financing activities ..... 287,770 30,175,299 (714,740)
------------- ------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH ..................... 325,678 (126,297)
------------- ------------ ------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ............ (27,631,413) 28,551,727 259,421
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ................ 28,815,069 263,342 3,921
------------- ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR ...................... $ 1,183,656 $ 28,815,069 $ 263,342
============= ============ ============
See notes to consolidated financial statements.
31
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS -- FARO Technologies, Inc. and subsidiaries (the
"Company") develops, manufactures, markets and supports Computer Aided Design
(CAD)-based quality assurance products and CAD-based inspection and statistical
process control software. The Company has three wholly-owned subsidiaries, FARO
Worldwide, Inc, CATS GmbH, a German company, and Antares LDA, a Portugese
company.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of FARO and all wholly-owned subsidiaries (collectively,
the "Company"). All significant intercompany transactions and balances have
been eliminated. The financial statements of the 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 translation of financial
statements are reflected as a separate component of comprehensive income.
REVENUE RECOGNITION, PRODUCT WARRANTY AND EXTENDED MAINTENANCE CONTRACTS
- -- Revenue related to the Company's 3-D measurement equipment and related
software is recognized upon shipment as the Company considers the earnings
process substantially complete as of the shipping date. Revenue from sales of
software only is recognized when no further significant production,
modification or customization of the software is required and where the
following criteria are met: persuasive evidence of a sales agreement exists,
delivery has occurred, and the sales price is fixed or determinable and
collectible. Revenues resulting from sales of comprehensive support, training
and technology consulting services are recognized as such services are
performed. Extended maintenance plan revenues are recognized proportionately as
maintenance costs are projected to be incurred. Prior to November 1, 1997, such
revenues were recognized ratable over the contract term. The change in estimate
with respect to the recognition of such revenues more accurately matches
revenues with costs incurred. The Company warrants its products against defects
in design, materials and workmanship for one year. A provision for estimated
future costs relating to warranty expenses is recorded when products are
shipped. Costs relating to extended maintenance plans are recognized as
incurred.
CASH AND CASH EQUIVALENTS -- The Company considers cash on hand and
amounts on deposit with financial institutions which have original maturities
of three months or less to be cash and cash equivalents.
SHORT-TERM INVESTMENTS -- Short-term investments ordinarily consist of
short-term debt securities acquired with cash not immediately needed in
operations. Such amounts have maturities of less than one year.
32
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
INVENTORIES -- Inventories are stated at the lower of average cost or net
realizable value. In order to achieve a better matching of production costs
with the revenues generated in production, certain fixed overhead costs and
certain general and administrative costs that are related to production are
capitalized into inventory when they are incurred and are charged to cost of
sales as product costs at the time of sale. Such amounts are not material to
the consolidated financial statements.
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 up to six months and are
subsequently sold at prices that produce slightly reduced gross margins.
PROPERTY AND EQUIPMENT -- Property and equipment are recorded at cost.
Depreciation is computed using the straight-line and declining-balance methods
over the estimated useful lives of the various classes of assets as follows:
Machinery and equipment ................. 2 to 10 years
Furniture and fixtures .................. 5 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.
INTANGIBLES -- Goodwill represents the excess of purchase price over the
fair value of businesses acquired and is amortized on a straight-line basis
over 5 years.
Other acquired intangibles principally include core technology, existing
product technology, workforce in place and customer relationships that arose in
connection with the acquisition of CATS. Other acquired intangibles are
recorded at fair value at the date of acquisition and are amortized over their
estimated useful lives of primarily 3 to 5 years.
Product design costs incurred in the development of products after
technological feasibility is attained are capitalized and amortized using the
straight-line method over the estimated economic lives of the related products,
not to exceed 3 years. The Company considers technological feasibility to be
established when the Company has completed all planning, designing, coding and
testing activities that are necessary to establish design specifications
including function, features and technical performance requirements.
Capitalization of product design costs ceases and amortization of such costs
begins when the product is available for general release to customers.
Patents are recorded at cost. Amortization is computed using the
straight-line method over the lives of the patents, which is 17 years.
33
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Other intangibles are amortized over periods ranging from 2 to 5 years.
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.
INCOME TAXES -- The Company utilizes the asset and liability method to
measure and record deferred income tax assets and liabilities. Deferred tax
assets and liabilities reflect the future income tax effects of temporary
differences between the consolidated financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and are measured
using enacted tax rates that apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS -- The Company's financial instruments
include cash and cash equivalents, short-term investments, accounts receivable,
accounts payable and liabilities to banks and shareholders. The carrying amount
of long-term debt to banks approximates fair value based on interest rates that
are currently available to the Company for issuance of debt with similar terms
and remaining maturities. The carrying amounts of other financial instruments
approximate their fair value because of their short-term maturities.
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 reflects the
potential dilution of securities that could share in the earnings. A
reconciliation of the number of common shares used in calculation of basic and
diluted EPS is presented in Note 11.
CONCENTRATION OF CREDIT RISK -- Financial instruments which potentially
expose the Company to concentrations of credit risk consist principally of
operating demand deposit accounts. The Company's policy is to place its
operating demand deposit accounts with high credit quality financial
institutions.
In June 1996, the Company entered into an Original Equipment Manufacturer
agreement with Mitutoyo Corporation ("Mitutoyo"), a Japanese company which
manufactures and markets metrology tools. Under the agreement, Mitutoyo sells
the Company's products under the name SPINARM. The agreement, which grants
Mitutoyo a nonexclusive right to sales in Japan, expires in June 1999 and is
renewable for successive one year terms.
34
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
No customer represented 10% or more of the Company's total sales for the
years ended December 31, 1998 and 1997. One customer accounted for
approximately 10% of total sales for the year ended December 31, 1996.
STOCK-BASED COMPENSATION -- In accordance with SFAS No. 123, "Accounting
for Stock-Based Compensation," ("SFAS No. 123"), the Company has elected to
continue to account for its employee stock compensation plans under APB Opinion
No. 25 with pro-forma disclosures of net earnings and earnings per share, as if
the fair value based method of accounting defined in SFAS No. 123 has been
applied. Under the intrinsic value based method, compensation cost is the
excess, if any, of the quoted market price of the stock at the grant date or
other measurement date over the amount an employee must pay to acquire the
stock. Under the fair value based method, compensation cost is measured at the
grant date based on the value of the award and is recognized over the service
period, which is usually the vesting period.
LONG-LIVED ASSETS -- Long-lived assets, including property and equipment
and intangible assets, are reviewed for impairment whenever events or changes
in business circumstances indicate the carrying value of the assets may not be
recoverable. Impairment losses are recognized if expected future cash flows of
the related assets are less than their carrying values.
ESTIMATES -- The preparation of financial statements in conformity with
generally accepted accounting principles 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.
RECENTLY ADOPTED ACCOUNTING STANDARDS -- In June 1997, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting
Comprehensive Income" ("SFAS No. 130") effective for fiscal years beginning
after December 15, 1997. SFAS No. 130 requires that all items that are required
to be recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements. SFAS No. 130 does not require a
specific format for that financial statement but requires that an entity
display an amount representing total comprehensive income for the period in
that statement. SFAS No. 130 requires that an entity classify items of other
comprehensive income by their nature in a financial statement. For example,
other comprehensive income may include foreign currency and unrealized gains
and losses on certain investments in debt and equity securities. In addition,
the accumulated balance of other comprehensive income must be displayed
35
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
separately from retained earnings and additional paid in capital in the equity
section of a statement of financial position. The Company adopted this
accounting standard on January 1, 1998, as required. Prior year financial
statements have been restated for comparative purposes.
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of
an Enterprise and Related Information" ("SFAS No. 131"), effective for fiscal
years beginning after December 15, 1997. SFAS No. 131 establishes standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. SFAS No. 131 requires reporting segment profit or loss, certain
specific revenue and expense items and segment assets. It also requires
reconciliations of total segment revenues, total segments profit or loss, total
segment assets, and other amounts disclosed for segments to corresponding
amounts reported in the financial statements.
In October 1997 the American Institute of Certified Public Accountants
issued Statement of Position 97-2, "Software Revenue Recognition" (SOP 97-2).
SOP 97-2 provides guidance on applying generally accepted accounting principles
in recognizing revenue on software transactions and is effective for
transactions entered into in fiscal years beginning after December 15, 1997.
The Company adopted SOP 97-2 on January 1, 1998, as required. Adoption of this
SOP 97-2 did not have a material effect on the financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures
about Pensions and Other Postretirement Benefits" ("SFAS No. 132"), effective
for fiscal years beginning after December 15, 1997. SFAS 132 revises employer
disclosures about pension and other postretirement benefit plans. It does not
change the measurement or recognition of those plans. This statement
standardizes the disclosure requirements for pensions and other postretirement
benefits to the extent practicable, requires additional information on changes
in the benefit obligations and fair values of plan assets that will facilitate
financial analysis and eliminates certain disclosures. Restatement of
disclosures for earlier periods is required. Adoption of SFAS 132 did not have
a material impact on the financial statements.
NEW ACCOUNTING STANDARDS -- In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", effective for
fiscal years
36
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
beginning after June 15, 1999. SFAS 133 requires companies to record
derivatives on the balance sheet as assets and liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. The Company has not completed its
evaluation of the impact of this standard on the financial statements.
RECLASSIFICATIONS -- Certain prior year amounts have been reclassified to
conform to current year presentation.
2. ACQUISITION OF CATS
On May 15, 1998, the Company acquired CATS for total consideration of
$16,069,000 consisting of $5 million in cash, 916,668 shares of common stock
and the assumption of certain outstanding liabilities of CATS. In addition,
333,332 shares of common stock will be issued provided CATS meets certain sales
performance goals. The purchase price includes direct costs of the acquisition
in the amount of $674,000.
The acquisition was recorded under the purchase method of accounting and
the final allocation among tangible and intangible assets and liabilities is as
follows:
Tangible assets ........................ $ 1,522,000
Intangible assets:
Developed and core technology ......... 8,940,000
Workforce in place .................... 550,000
Customer relations .................... 590,000
Goodwill .............................. 2,871,000
In process technology ................. 3,210,000
Liabilities ............................ (1,614,000)
-----------
$16,069,000
===========
The valuation of CATS was based on management's estimates of after tax net
cash flows and gives explicit consideration to the Security and Exchange
Commission's ("SEC") recent views on in-process research and development in
purchase transactions. In making the allocation of purchase price, the Company
considered the present value of cash flows and income, the status of projects,
completion costs and project risk. Specifically, the Company considered (1) the
value of core technology and ensured that the relative allocations to core
technology and in process technology were consistent with the relative
37
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. ACQUISITION OF CATS--(CONTINUED)
contributions of each of the final products and (2) the stage of completion of
the individual projects and ensured that the value considered only the efforts
completed as of the transaction date.
The amount allocated to in process research and development of $3.2
million was expensed upon acquisition, as it was determined that the underlying
projects had not reached technological feasibility, had no alternative future
use and successful future development was uncertain.
The operating results of CATS have been included in the consolidated
statements since the date of acquisition. The following unaudited pro forma
results of operations are presented for informational purposes assuming that
the Company had acquired CATS as of January 1, 1997. The $3.2 million charge
off for in process research and development has been excluded from the pro
forma results as it represents a material non-recurring charge.
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997
-------------- ----------------
Revenues .................. $28,357,000 $ 26,860,000
Net (loss) income ......... (1,215,000) 1,369,000
(Loss) income per share:
Basic .................... $ (0.11) $ 0.16
Diluted .................. $ (0.11) $ 0.15
The pro forma results of operations have been prepared for comparative
purposes only and do not purport to be indicative of the results of operations
which actually would have resulted had the acquisition occurred on the date
indicated, or which may result in the future.
38
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. SUPPLEMENTAL CASH FLOW INFORMATION
Selected cash payments and noncash activities were as follows:
YEARS ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
--------------- ------------ -----------
Cash paid for interest ................... $ 13,023 $ 110,768 $256,654
Cash paid for income taxes ............... 569,481 1,951,286 777,876
Noncash investing and financing estimates:
Business acquired:
Fair value of assets acquired ........... 17,667,397
Liabilities assumed ..................... (1,614,000)
Common stock issued ..................... 10,395,015
4. INVENTORIES
Inventories consist of the following:
DECEMBER 31,
-----------------------------
1998 1997
------------- -------------
Raw materials, net of reserve for
obsolescence of $46,930 in 1998......... $2,778,081 $2,432,194
Finished goods ........................... 1,486,572 804,827
Sales demonstration ...................... 2,178,965 1,038,355
---------- ----------
$6,443,618 $4,275,376
========== ==========
5. INTANGIBLE ASSETS
Intangible assets consist of the following:
DECEMBER 31,
-------------------------------
1998 1997
--------------- -------------
Goodwill ............................ $ 3,033,767
Existing product technology ......... 9,446,839
Work force in place ................. 581,181
Customer relationships .............. 623,449
Product design costs ................ 744,229 $108,286
Patents ............................. 956,439 850,788
Other ............................... 130,639 110,166
----------- ---------
15,516,543 1,069,240
----------- ---------
Accumulated amortization ............ (2,695,352) (321,261)
----------- ---------
Intangible assets -- net ............ $12,821,191 $747,979
=========== =========
39
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. LINES OF CREDIT AND DEBT
Long-term debt consists of the following at December 31, 1998:
5.8% secured note ...................... $ 10,092
Unsecured note to shareholders ......... 31,388
--------
41,480
Less current portion ................... (4,156)
--------
$ 37,324
========
The secured note is collateralized by a telephone system with a carrying
value of approximately $13,700. The unsecured note to shareholders is
non-interest bearing and is due after December 31, 1999.
In April 1997, the Company obtained a one-year unsecured $1.0 million line
of credit which bears interest at the 30-day commercial paper rate plus 2.65%
per annum. The line of credit was extended in 1998 and expires on March 31,
1999. No borrowings were outstanding under this line of credit as of December
31, 1998 and 1997.
The Company has available with two financial institutions short-term,
revolving lines of credit aggregating $445,000. Under these lines, a subsidiary
may borrow funds for operations. These lines of credit are personally
guaranteed by certain shareholders. The total amount outstanding on these lines
at December 31, 1998 was approximately $296,000. The average interest rates on
such borrowings at December 31, 1998 was 9%.
7. RELATED PARTY TRANSACTIONS
LEASES -- The Company leases its plant and office building from Xenon
Research, Inc. ("Xenon"), a 24% shareholder. The lease, which was amended in
1997 to provide for additional premises and an increase in base rent of
approximately $150,000, expires on February 28, 2001. The Company has two
five-year renewal options. The base rent during renewal periods will reflect
changes in the U.S. Bureau of Labor Statistics, Consumer Price Index for all
Urban Consumers. Rent expense under this lease was approximately $300,000 for
1998 and $150,000 for both 1997 and 1996.
40
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. INCOME TAXES
(Loss) income before taxes consisted of the following:
1998 1997 1996
--------------- ------------- -------------
Domestic ................................... $ 712,795 $5,584,295 $2,567,455
Foreign .................................... (5,193,357) (263,035) (44,901)
------------ ---------- ----------
Loss (income) before income taxes .......... $ (4,480,562) $5,321,260 $2,522,554
============ ========== ==========
The components of the expense (benefit) for income taxes are as follows:
1998 1997 1996
---------- ------------- -------------
Current:
Federal ......... $ 75,174 $1,945,035 $ 721,700
State ........... 13,621 294,702 161,392
-------- ---------- ----------
88,795 2,239,737 883,092
-------- ---------- ----------
Deferred:
Federal ......... 107,597 (108,646) 221,100
State ........... 10,666 (16,461) 11,700
Foreign ......... 243,474
--------
361,737 (125,107) 232,800
-------- ---------- ----------
$450,532 $2,114,630 $1,115,892
======== ========== ==========
Income taxes for the years ended December 31, 1998, 1997 and 1996 differ
from the amount computed by applying the federal statutory corporate rate to
income before income taxes. The differences are reconciled as follows:
1998 1997 1996
---------------- ------------- -------------
Tax expense (benefit) at statutory rate ............. $ (1,523,391) $1,809,228 $ 857,700
State income taxes, net of federal benefit .......... 46,719 181,713 114,200
Nontaxable interest income .......................... (121,442)
Foreign tax rate difference ......................... (943,551)
Research and development credit ..................... (103,309) (64,893)
Nondeductible items ................................. 22,831 159,198 61,000
Change in deferred tax asset
valuation allowance ............................... 3,033,000
Other ............................................... 39,675 29,384 82,992
------------ ---------- ----------
Total income tax expense ............................ $ 450,532 $2,114,630 $1,115,892
============ ========== ==========
41
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. INCOME TAXES--(CONTINUED)
The components of the Company's net deferred tax asset at December 31, 1998
and 1997 are as follows:
1998 1997
--------------- -----------
Deferred tax assets:
Employee stock options .......................... $ 87,347 $200,599
Unearned service revenue ........................ 150,312 178,271
Intangible assets ............................... 2,089,000
Tax credits and carryforwards ................... 1,178,970
Other ........................................... 72,187 14,770
------------ --------
Total deferred tax assets ........................ 3,577,816 393,640
Valuation allowance .............................. (3,033,000)
----------- --------
Net deferred tax assets .......................... 544,816 393,640
------------ --------
Deferred tax liabilities:
Patent amortization ............................. 72,963 72,963
Depreciation .................................... 22,979 22,979
Foreign currency translation adjustment ......... 132,920
Product design costs ............................ 272,631 40,391
------------ --------
Total deferred tax liabilities ................... 501,493 136,333
------------ --------
Net deferred tax asset ........................... $ 43,323 $257,307
============ ========
At December 31, 1998, the Company's foreign subsidiaries had deferred tax
assets relating to net operating loss carryforwards, which do not expire, and
intangible assets of $944,000 and $2,089,000, respectively. For financial
reporting purposes, a valuation allowance of $3,033,000 has been recognized to
offset the deferred tax assets relating to the net operating losses and
intangible assets.
42
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. COMMITMENTS AND CONTINGENCIES
LEASES -- The following is a schedule of future minimum lease payments
required under noncancelable operating leases, including leases with related
parties (see Note 7), in effect at December 31, 1998:
YEAR ENDING DECEMBER 31 AMOUNT
- ------------------------------------------------- -------------
1999 ......................................... $1,027,000
2000 ......................................... 816,000
2001 ......................................... 333,000
2002 ......................................... 189,000
2003 ......................................... 189,000
----------
Total future minimum lease payments .......... $2,554,000
==========
Rent expense for 1998, 1997 and 1996 was approximately $641,000, $236,000,
and $173,000, respectively.
LITIGATION -- In the normal course of business, the Company is subject to
various proceedings, lawsuits and other claims. Such matters are subject to
many uncertainties, and outcomes are not predictable with assurance. While
these uncertainties could affect future operations, the Company believes that
after final disposition, any monetary liability or financial impact would not
be expected to have a materially adverse effect on the Company's consolidated
financial statements.
10. STOCK OPTION PLANS
The Company has three stock option plans that provide for the granting of
stock options to key employees and nonemployee members of the Board of
Directors. The 1993 Stock Option Plan ("1993 Plan") and the 1997 Employee Stock
Option Plan ("1997 Plan") provide for granting incentive stock options and
nonqualified stock options to officers and key employees of the Company. The
Nonemployee Director Plan provides for granting nonqualified stock options and
formula options to nonemployee directors.
The Company is authorized to grant options for up to 1,000,000 shares of
common stock under the 1993 Plan, of which 295,997 and 133,218 options have
been granted at exercise prices of $.36 and $3.60, respectively. These options
vest over primarily 3 and 4 year periods.
The Company is authorized to grant options for up to 750,000 shares of
common stock under the 1997 Plan, of which 328,000 options have been granted at
exercise prices of $12 and $13.20 (for those meant to qualify for treatment as
incentive stock options). These options vest over a three year period.
43
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. STOCK OPTION PLANS--(CONTINUED)
The Company is authorized to grant up to 250,000 shares of common stock
under the Nonemployee Director Plan. Each nonemployee director is granted 3,000
options upon election or reelection to the Board of Directors (formula
options). Formula options granted directors are generally granted upon the same
terms and conditions as options granted to officers and employees. These
options vest over a three year period. Additionally in 1997, certain
nonemployee directors were granted options to purchase 160,000 of common stock
in consideration for their prior service on the Board of Directors. These
options vested upon grant at an exercise price of $12.
Additionally, the Company's 1997 Nonemployee Directors' Fee Plan permits
nonemployee directors to elect to receive directors' fees in the form of common
stock rather than cash. Common stock issued in lieu of cash directors' fees is
issued at the end of the quarter in which the fees are earned, with the number
of shares being based on the fair market value of the common stock for the five
trading days immediately preceding the last business day of the quarter.
Compensation cost charged to operations associated with the Company's
stock option plans was $172,164, $408,000 and $23,100 in 1998, 1997 and 1996,
respectively. Compensation cost was based on the difference between the value
of the stock, at date of grant, and its exercise price multiplied by the number
of shares vested in each year.
A summary of stock option activity and weighted average exercise prices
follows:
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1998 1997 1996
------------------------ ------------------------ -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISED EXERCISED EXERCISED
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------------ ----------- ------------ ----------- ------------ ----------
Outstanding at beginning
of year .......................... 955,723 $ 8.00 190,512 $ 0.36 210,902 $ 0.36
Granted ........................... 535,381 8.64 797,001 9.90
Forfeited ......................... (84,470) 8.22 (31,790) 9.67 (20,390) 0.36
Exercised ......................... (212,469) 1.17
---------
Outstanding at end of year ......... 1,194,165 9.73 955,723 8.00 190,512 0.36
========== ======= =======
Options exercisable at
year-end ......................... 417,780 10.78 498,680 6.67
Weighted-average fair value
of options granted during
the year ......................... $ 5.26 $ 4.82
44
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. STOCK OPTION PLANS--(CONTINUED)
A summary of stock options outstanding and exercisable as of December 31,
1998 follows:
WEIGHTED-AVERAGE
EXCISE OPTIONS REMAINING OPTIONS
PRICE OUTSTANDING CONTRACTUAL LIFE (YEARS) EXERCISABLE
- ------------- ------------- -------------------------- ------------
$ 0.36 31,385 3.50 31,385
3.57 94,686 8.72 31,562
3.31 185,000 9.95
10.34 130,594 9.55
12.00 652,500 8.96 254,833
13.20 100,000 3.71 100,000
------- -------
1,194,165 417,780
========= =======
Remaining non-exercisable options as of December 31, 1998 become
exercisable as follows:
1999 ................ 300,593
2000 ................ 300,593
2001 ................ 175,199
-------
776,385
=======
Had compensation cost for the Company's stock-based compensation plans
been determined consistent with SFAS No. 123, the Company's net earnings and
earnings per share would have been as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996
---------------- --------------- ---------------
Net income ........................ As reported $ (4,931,094) $ 3,206,630 $ 1,406,662
Pro forma (5,720,379) 2,345,551 1,382,140
Income per share -- Basic ......... As reported $ (0.46) $ 0.41 $ 0.20
Pro forma (0.54) 0.30 0.19
Income per share --
Assuming dilution ............... As reported $ (0.46) $ 0.39 $ 0.19
Pro forma (0.54) 0.29 0.19
45
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. STOCK OPTION PLANS--(CONTINUED)
The Company used the Black-Scholes option-pricing model to determine the
fair value of grants made. There were no options granted in 1996. The following
assumptions were applied in determining the pro forma compensation cost:
YEARS ENDED DECEMBER 31,
---------------------------------
1998 1997
----------------- -------------
Risk-free interest rate ................. 4.86 to 5.83% 5.63%
Expected dividend yield ................. 0% 0%
Expected option life .................... 3-10 years 3-10 years
Expected stock price volatility ......... 91.32% 46.33%
The effects of applying SFAS No. 123 for the pro forma disclosures are not
representative of the effects expected on reported net income and income per
share in future years since the disclosures do not reflect compensation expense
for options granted prior to 1996.
11. EARNINGS PER SHARE
A reconciliation of the number of common shares used in calculation of
basic and diluted EPS is presented below:
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1998 1997 1996
------------------------ ----------------------- ----------------------
PER-SHARE PER-SHARE PER-SHARE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------------ ----------- ----------- ----------- ----------- ----------
Basic EPS ............ 10,632,708 $ (0.46) 7,831,715 $ 0.41 7,000,000 $ 0.20
Effect of dilutive
securities:
Stock options ....... 355,495 349,041
Warrants ............ 1,838
--------- ---------
Diluted EPS .......... 10,632,708 $ (0.46) 8,189,048 $ 0.39 7,349,041 $ 0.19
========== ========= =========
12. BENEFIT PLAN
During 1996, the Company established a defined contribution retirement
plan (401(k)) for its employees, which provides benefits for all employees
meeting certain age and service requirements. The Company may make a
discretionary contribution each Plan year as determined by its Board of
Directors. Discretionary contributions or employer matches can be made to the
participant's account but cannot exceed 4% of compensation. The Company made no
contributions to the Plan during the three years ending December 31, 1998.
46
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. SEGMENT GEOGRAPHIC DATA
The Company develops, manufactures, markets and supports Computer Aided
Design (CAD)-based quality assurance products and CAD-based inspection and
statistical process control software. This one line of business represents more
than 99% of consolidated sales. The Company operates through sales teams
established by geographic area. Each team is equipped to deliver the entire
line of Company products to customers within its geographic area. The Company
has aggregated the sales teams into a single operating segment as a result of
the similarities in the nature of products sold, the type of customers and the
methods used to distribute the Company's products. The following table presents
information about the Company by geographic area:
1998 1997 1996
----------------------------- --------------------------- ----------------------------
LONG-LIVED LONG-LIVED LONG-LIVED
SALES SALES ASSETS SALES ASSETS SALES ASSETS
- ------------------------ -------------- -------------- -------------- ------------ -------------- -------------
SALES:
United States .......... $14,740,829 $ 2,707,921 $15,439,776 $1,522,627 $10,829,543 $1,087,830
Germany ................ 4,920,197 11,592,359 1,235,066
United Kingdom ......... 1,916,115 1,263,294 791,727
France ................. 1,647,798
Canada ................. 1,252,423
Korea .................. 890,509
Other foreign .......... 4,289,760 46,103 4,325,826 53,132 2,144,558
----------- ----------- ----------- ---------- ----------- ----------
Total ............... $27,514,699 $14,346,383 $23,516,385 $1,575,759 $14,656,337 $1,087,830
=========== =========== =========== ========== =========== ==========
14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
QUARTER ENDED 1998 1998 1998 1998
==============================================================================================
Sales ................ $ 6,682,201 $ 7,721,808 $ 4,972,182 $ 8,138,508
Gross profit ......... 4,000,439 4,941,965 2,512,039 4,768,943
Net income ........... 1,023,391 (1,709,731) (2,740,809) (1,480,263)
Net income per share:
Basic ............... 0.10 (0.16) (0.25) (0.13)
Diluted ............. 0.10 (0.16) (0.25) (0.13)
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
QUARTER ENDED 1997 1997 1997 1997
==============================================================================================
Sales ................ $ 4,889,471 $ 5,429,064 $ 5,909,306 $ 7,288,544
Gross profit ......... 2,940,922 3,189,333 3,530,192 4,245,100
Net income ........... 719,731 535,877 829,115 1,121,907
Net income per share:
Basic ............... 0.09 0.07 0.11 0.11
Diluted ............. 0.09 0.07 0.11 0.11
47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
Certain information required by Part III is omitted from this Report in
that the Registrant will file a definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this Report and certain information included therein
is incorporated herein by reference. Only those sections of the Proxy Statement
that specifically address the Items set forth herein are incorporated by
reference. Such incorporation does not include the Compensation Committee
Report or the Performance Graph included in the Proxy Statement.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information to be set forth under the captions "Election of Directors"
and "Section 16 (a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement are incorporated herein by reference.
The information concerning the company's executive officers required by
this Item is incorporated by reference herein from the section of this Report
in Part I, Item 1, entitled "Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION.
The information to be set forth under the caption "Executive Compensation"
in the Proxy Statement is incorporated herein by reference; provided, however
that the Company specifically excludes from such incorporation by reference any
information set forth under the caption "Compensation Committee Report on
Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Security ownership of certain beneficial owners and management to be set
forth under the caption "Beneficial Owners and Management" in the Proxy
Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information to be set forth under the caption "Certain Relationships
and Related Transactions" in the Proxy Statement is incorporated herein by
reference.
48
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) DOCUMENTS FILED AS PART OF THIS REPORT. The following documents are
filed as part of this Report:
(1) FINANCIAL STATEMENTS. Included in Part II, Item 8 is an index to the
Consolidated Financial Statements of FARO Technologies, Inc. and Report of
Deloitte & Touche LLP, Independent Certified Public Accountants filed as part
of this Form 10-K
(2) FINANCIAL STATEMENT SCHEDULES. Schedules not listed in the index to
the Consolidated Financial Statements included in Part II, Item 8, have been
omitted because they are not applicable or are not required or the information
required to be set forth therein is included in the Consolidated Financial
Statements or Notes thereto.
(3) EXHIBITS.
EXHIBIT
NO. DESCRIPTION
- -------- -------------------------------------------------------------------------------------------
3.1 Articles of Incorporation, as amended (FILED AS EXHIBIT 3.1 TO REGISTRANT'S REGISTRATION
STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
3.2 Bylaws, as amended (FILED AS EXHIBIT 3.2 TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-
1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
4.1 Specimen Stock Certificate (FILED AS EXHIBIT 4.1 TO REGISTRANT'S REGISTRATION STATEMENT ON
FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.1 1997 Stock Option Plan, as amended (FILED AS EXHIBIT 10.1 TO REGISTRANT'S REGISTRATION
STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.2 1997 Employee Stock Option Plan (FILED AS EXHIBIT 10.2 TO REGISTRANT'S REGISTRATION
STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.3 1997 Non-Employee Director Stock Option Plan (FILED AS EXHIBIT 10.3 TO REGISTRANT'S
REGISTRATION STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.4 1997 Non-Employee Directors' Fee Plan (FILED AS EXHIBIT 10.4 TO REGISTRANT'S REGISTRATION
STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.5 Term WCMA Loan and Security Agreement, dated September 24, 1996, between the
Registrant and Merrill Lynch Business Financial Services, Inc. (FILED AS EXHIBIT 10.5 TO
REGISTRANT'S REGISTRATION STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY
REFERENCE)
10.6 WCMA Note, Loan and Security Agreement, dated April 23, 1997, between the Registrant
and Merrill Lynch Business Financial Services, Inc. (FILED AS EXHIBIT 10.6 TO REGISTRANT'S
REGISTRATION STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.7 Business Lease, dated March 1, 1991, between the Registrant (as successor-by-merger) to
FARO Medical Technologies (U.S.), Inc.) and Xenon Research, Inc. (FILED AS EXHIBIT 10.7 TO
REGISTRANT'S REGISTRATION STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY
REFERENCE)
49
EXHIBIT
NO. DESCRIPTION
- -------- --------------------------------------------------------------------------------------------------
10.8 OEM Purchase Agreement, dated June 7, 1996 between the Company and Mitutoyo
Corporation (FILED AS EXHIBIT 10.8 TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-1,
NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.9 Nonexclusive Unique Application Reseller Agreement, dated September 9, 1996, between
the Registrant and Autodesk, Inc. (FILED AS EXHIBIT 10.9 TO REGISTRANT'S REGISTRATION
STATEMENT ON FORM S-1, NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.10 Form of Patent and Confidentiality Agreement between the Registrant and each of its
employees (FILED AS EXHIBIT 10.10 TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-1,
NO. 333-32983, AND INCORPORATED HEREIN BY REFERENCE)
10.11 Nonexclusive Unique Application Reseller Agreement, dated as of March 1, 1998, between
the Registrant and Autodesk, Inc. (FILED AS EXHIBIT 10.11 TO REGISTRANT'S FORM 10-K FOR
CALENDAR YEAR 1997, 0-23081, AND INCORPORATED HEREIN BY REFERENCE)
10.12 First Amendment to Business Lease, dated as of January 20, 1998, between the Registrant
and Xenon Research, Inc., successor by merger to FARO Medical Technologies (US), Inc.
(FILED AS EXHIBIT 10.12 TO REGISTRANT'S FORM 10-K FOR CALENDAR YEAR 1997, NO. 0-23081 AND
INCORPORATED HEREIN BY REFERENCE)
10.13 Faro OEM Purchase Agreement, dated March 12, 1999 between the Company and Brown &
Sharpe Manufacturing Company. (FILED HEREWITH)
11.1 Statement re Computation of Per Share Earnings (INCORPORATED BY REFERENCE FROM PAGE 1 TO
THE REGISTRANT'S 1998 ANNUAL REPORT TO STOCKHOLDERS FILED AS EXHIBIT 13.1)
13.1 Annual Report to Stockholders for the year ended December 31, 1998 (TO BE DEEMED
PREVIOUSLY FILED HEREWITH ONLY TO THE EXTENT REQUIRED BY THE INSTRUCTIONS TO EXHIBITS FOR REPORTS
ON FORM 10-K)
21.1 List of Subsidiaries (FILED HEREWITH)
23.1 Consent of Deloitte & Touche LLP (FILED HEREWITH)
24.1 Power of Attorney (INCLUDED ON PAGE 51 OF THIS REPORT)
27.1 Financial Data Schedule for the year ended December 31, 1998 (FILED HEREWITH FOR SEC
FILING PURPOSES ONLY)
99.1 Properties
(b) REPORTS ON FORM 8-K
None.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
FARO TECHNOLOGIES, INC.
By: /s/ GREG A. FRASER
-----------------------------------------
Gregory A. Fraser, Ph.D.
Executive Vice President, Secretary,
Treasurer and Chief Financial Officer
Dated: April 2, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Each person whose
signature appears below constitutes and appoints SIMON RAAB and GREGORY A.
FRASER, and each of them individually, his true and lawful attorney-in-fact and
agent, with full power of substitution and revocation, for him and in his name,
place and stead, in any and all capacities, to sign any and all amendments to
this Report and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in connection therewith, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or either of them, may lawfully do or
cause to be done by virtue hereof.
NAME AND SIGNATURE TITLE DATE
- -------------------------------- -------------------------------------- ---------------
/s/ SIMON RAAB Chairman of the Board, President, April 2, 1999
--------------------------- Chief Executive Officer
Simon Raab (Principal Executive Officer),
and Director
/s/ GREGORY A. FRASER Executive Vice President, Secretary, April 2, 1999
-------------------------- Treasurer, Chief Financial Officer
Gregory A. Fraser (Principal Financial and Accounting
Officer), and Director
/s/ HUBERT D'AMOURS Director April 2, 1999
-------------------------
Hubert d' Amours
/s/ PHILIP COLLEY Director April 2, 1999
-------------------------
Philip Colley
/s/ ALEXANDRE RAAB Director April 2, 1999
-------------------------
Alexandre Raab
/s/ NORMAN H. SCHIPPER Director April 2, 1999
-------------------------
Norman H. Schipper
/s/ ANDRE JULIEN Director April 2, 1999
-------------------------
Andre Julien
51
EXHIBIT INDEX
EXHIBIT PAGE
- ------- ----
10.13 Faro OEM Purchase Agreement, dated March 12, 1999 between the
Company and Brown & Sharpe Manufacturing Company. (FILED HEREWITH)
21.1 List of Subsidiaries (FILED HEREWITH)
23.1 Consent of Deloitte & Touche LLP (FILED HEREWITH)
27.1 Financial Data Schedule for the year ended December 31, 1998
99.1 Properties