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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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, 2003 or
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________ to _________
Commission File Number 0-23081
FARO TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
Florida 59-3157093
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
125 Technology Park, Lake Mary, FL 32746
(Address of Principal Executive Offices) (Zip Code)
(Registrant's Telephone Number, Including Area Code): (407) 333-9911
Securities to be 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 definite proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |_| No |X|
As of March 15, 2004, there were outstanding 13,572,426 shares of Common
Stock. The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of June 27, 2003 was $53.6 million based on the last sale on
such date on the Nasdaq National Market.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated by reference into Part III of this Form
10-K portions of its proxy statement for its Annual Meeting of Shareholders
currently scheduled to be held May 11, 2004.
FARO Technologies, Inc.
Annual Report on Form 10-K
INDEX
Part I.
Cautionary Statements for Forward-Looking Information
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Part II.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Item 9A. Controls and Procedures
Part III.
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
Part IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8- K
Signatures
Exhibit Index
PART I
CAUTIONARY STATEMENTS FOR FORWARD-LOOKING INFORMATION
FARO Technologies, Inc. (the Company) has made "forward-looking
statements" in this report within the meaning of the Private Securities
Litigation Reform Act of 1995. All statements, other than statements of
historical fact, about our plans, beliefs, goals, intentions, objectives,
projections, expectations, assumptions, strategies, and future events are
forward-looking statements. Words such as "may," "will," "believe," "plan,"
"should," "could," "seek," "expect," "anticipate," "intend," "estimate," "goal,"
"objective" and similar words, or discussions of our strategy or other
intentions identify forward-looking statements. Forward-looking statements are
subject to a number of known and unknown risks, uncertainties, and other factors
that could cause actual results to differ materially from those contemplated by
such forward-looking statements. Consequently, you should not place undue
reliance on these forward-looking statements. We disclaim any obligation to
update any forward-looking statements, whether as a result of new information,
changes in expectations, future events, or otherwise, unless otherwise required
by law. Important factors that could cause a material difference in the actual
results from those contemplated in such forward-looking statements include among
others those under "Cautionary Statements" and elsewhere in this report and the
following:
o our inability to further penetrate our customer base;
o development by others of new or improved products, processes or
technologies that make our products obsolete or less competitive;
o our inability to maintain our technological advantage by developing
new products and enhancing our existing products;
o the cyclical nature of the industries of our customers and the
financial condition of our customers;
o the inability to protect our patents and other proprietary rights in
the United States and foreign countries and the assertion of
infringement claims against us;
o fluctuations in our annual and quarterly operating results as a
result of a number of factors;
o the inability of our products to displace traditional measurement
devices and attain broad market acceptance;
o the impact of competitive products and pricing in the CAM2 market
and the broad market for measurement and inspection devices;
o risks associated with expanding international operations, such as
fluctuations in currency exchange rates, difficulties in staffing
and managing foreign operations, political and economic instability,
and the burdens of complying with a wide variety of foreign laws and
labor practices;
o the loss of our Chief Executive Officer or our Executive Vice
President and Chief Financial Officer or other key personnel;
o our inability to identify, consummate, or achieve expected benefits
from acquisitions;
o the failure to effectively manage our growth; and
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o the loss of a key supplier and the inability to find a sufficient
alternative supplier in a reasonable period or on commercially
reasonable terms.
ITEM 1. 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. The Company's principal products are
the Faro Arm and Faro Gage articulated measuring devices, the Faro Laser
Tracker, and their companion CAM2 software, which provide for CAD-based
inspection and/or factory-level statistical process control. Together, these
products integrate the measurement and quality inspection function with CAD
software to improve productivity, enhance product quality and decrease rework
and scrap in the manufacturing process. The Company uses the acronym "CAM2" for
this process, which stands for Computer-aided manufacturing measurement. 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, marketing and
manufacturing of 3-D measurement technology in manufacturing and industrial
applications and currently holds 33 issued or pending patents. The Company's
products have been purchased by approximately 3,500 customers worldwide, ranging
from small machine shops to such large manufacturing and industrial companies as
Audi, Bell Helicopter, Boeing, British Aerospace, Caterpillar, Daimler Chrysler,
General Electric, General Motors, Honda, Johnson Controls, Komatsu Dresser,
Lockheed Martin, Nissan, Siemens, Volkswagen among many others.
We were founded in 1982, and we re-incorporated in Florida in 1992. Our
worldwide headquarters are located at 125 Technology Park, Lake Mary, Florida
32746, and our telephone number is (407) 333-9911.
Industry Background
The Company believes that there are three principal forces driving the
need for its products and services: 1) the widespread use by manufacturers of
Computer-Aided Design (CAD) in product development which shortens product
cycles; 2) the adoption by manufacturers of quality standards such as Six Sigma
and ISO-9000 (and its offshoot QS-9000), which stress the measurement of every
step in a manufacturing process to reduce or eliminate defects, and 3) the
inability of traditional measurement devices to address many manufacturing
problems, especially those related to large components for products such as
automobiles, aircraft, and heavy duty construction equipment.
CAD changes the manufacturing process. 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. 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 existing products. Use
of CAD can shorten the time between design changes. 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. Assembly fixtures and measurement tools must be figuratively
linked to the CAD design to enable production to keep up with the rate of design
change.
Quality standards dictate measurement to reduce defects. QS-9000 is the
name given to the Quality System Requirements of the automotive industry that
were developed by Chrysler, Ford, General Motors and major truck manufacturers
and issued in late 1994. Companies that become registered under QS-9000 are
considered to have higher standards and better quality products. Six Sigma
embodies the principles of total quality management that focus on measuring
results and reducing product or service failure rates to 3.4 per million. All
aspects of a Six Sigma company's infrastructure must be analyzed, and if
necessary, restructured to increase revenues and raise customer satisfaction
levels. The all-encompassing nature of these and other quality standards has
resulted in manufacturers measuring every aspect of their process, including
stages of product assembly that may have never been measured before, in part
because of the lack of suitable measurement equipment.
Traditional products don't measure up. A significant aspect of the
manufacturing process, which traditionally has not benefited 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
(or check) 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 geometric
measurements, including hole diameters or length and width of a rectangular
component, their use for complex part measurements, such as the fender of a car,
is limited. Also these devices do not allow for the measurements to be directly
compared to the CAD model of the part. Test fixtures (customized fixed
tools used to make comparative measurements of complex 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 and provide a link to the CAD model of the object
being measured. However, fixed-base CMM's require the object being measured be
brought to the CMM and the object fit within the CMM's measurement grid. 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, in order to measure
large or unconventionally shaped objects. Some parts or assemblies are not
easily accessible and cannot be measured at all using traditional devices.
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Escalating global competition has created a demand for higher quality
products with shorter life cycles. Manufacturers require more rapid design,
greater control of the manufacturing process, tools to compare components to
their CAD specifications and the ability to precisely measure components that
cannot be measured or inspected by conventional devices. Moreover, they
increasingly require measurement capabilities to be integrated into the
manufacturing process and to be available on the factory floor.
FARO Products
The Faro Arm Control Station. The Faro Arm Control Station is a combination of a
portable, six or seven-axis, instrumented articulated measurement arm, a touch
screen computer, and software programs under the acronym CAM2.
|_| Articulated Arm - We introduced our third-generation measurement arms in
September and October 2002. Each articulated arm is comprised of three
major joints, each of which may consist of one, two or three axes of
motion. The articulated arm is available in a variety of sizes,
configurations and precision levels that are suitable for a broad range of
applications, and measures objects up to 12 feet. To take a measurement,
the operator simply touches the object to be
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measured with a probe at the end of the arm and presses a button. Data can
be captured at either individual points or a series of points. 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.
|_| Touch Screen Computer - One of the main goals of the Control Station
system is to provide computer-based inspection without requiring the
operator to program the inspection software or even have to touch a
keyboard. As such the company developed software (see the following
section) which runs entirely by the operator touching simple icons on the
touch screen, not unlike how a restaurant waiter enters an order. The
computers are not manufactured by the Company, but are purchased from
various suppliers.
CAM2 Software - See separate section on CAM2 Software below
The Faro Laser Tracker Control Station. A combination of a portable,
large-volume laser measurement tool, a touch screen computer, and CAM2 software
programs.
|_| Laser Tracker - The Faro Laser Tracker(R) utilizes an ultra-precise laser
beam to measure objects of up to 230 feet. It enables manufacturing,
engineering, and quality control professionals to measure and inspect
large parts, machine tools and other large objects on-site and/or
in-process. With its greater angular resolution, repeatability, and
accuracy, the Faro Laser Tracker advances already-proven tracker
technology. Among its many enhanced features is SuperADM, which improves
upon existing Absolute Distance Measurement technology by providing the
new time-saving ability to reacquire the laser beam without the need to
return to a known reference point or the need to hold the target
stationary.
|_| Touch Screen Computer - See description under Faro Arm Control Station
above.
|_| CAM2 Software -- See description below.
The Faro Gage. Sold as a combination of an articulated arm device with a
computer and software, the Faro Gage is a smaller, higher accuracy version of
the FaroArm product. What distinguishes the Faro Gage from just another size of
the FaroArm are the special mounting features and the basic software which are
unique to the Faro Gage. The Faro Gage is targeted at the machine tools and
bench tops around machine tools where basic measurements of smaller machined
parts must be measured. As such the CAM2 software developed for this device
features basic 2D and 3D measurements common to these applications. We
introduced the FARO Gage in May 2003. (See also "Faro Gage Software" below.)
CAM2 Software CAM2 is the Company's family of proprietary CAD-based measurement
and statistical process control software. The CAM2 product line includes six
software programs, many of which are translated into seven languages:
|_| CAM2 CAD Analyzer(R) 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.
|_| CAM2 Measure(R) allows users to compare measurements of manufactured
components or assemblies with the corresponding CAD data for the
components or assemblies. CAM2 Measure(R) is offered with the Faro Arm(R)
and the Faro Laser Tracker and is also offered as an unbundled product.
5
|_| CAM2 Automotive(R) also allows users to compare measurements of
manufactured components with the corresponding CAD file. Unlike CAM2
Measure(R), CAM2 Automotive(R) is especially suited to the measurement of
very large components with large CAD files, typical of those in the
automotive industry. CAM2 Automotive(R) is offered with the Faro Arm(R)
and Faro Laser Tracker and is also offered as an unbundled product.
|_| CAM2 SPC Process allows for the collection, organization, and presentation
of measurement data factory-wide. Not limited to measurements from the
Faro Arm(R) or Faro Laser Tracker, CAM2 SPC Process(R) accepts data from
CMMs and other computer-based measurement devices from many different
measurement applications along the production line.
|_| Soft Check Tool(R) is a custom software program designed to lead an
operator through a measurement process on the Faro Arm or Faro Laser
Tracker with minimal training. These programs are created by the Company
from specifications provided by the customer.
|_| Faro Gage Software includes a dedicated graphical interface designed for
the ease of use of the operator. Capable of producing graphical and
tabular reports, the software runs a library of gaging and Soft Check
tools.
Specialty Products. The Company licenses and supports certain specialty products
based on its articulated arm technologies that are used in medical applications.
License and support fees from these products do not represent a significant
portion of the Company's revenues. However, the Company is maintaining an active
campaign to license its formerly developed medical intellectual property to
manufacturers of computer assisted surgical products.
Customers
The Company's products have been purchased by approximately 3,500
customers worldwide, ranging from small machine shops to large manufacturing and
industrial companies. The Company's ten largest customers by revenue represented
an aggregate of 9.9% of the Company's total revenues in 2003. No customer
represented more than 2.5% of the Company's sales in 2003.
Sales and Marketing
The Company directs its sales and marketing efforts from its headquarters
in Lake Mary, Florida. At December 31, 2003, the Company employed 120 sales and
marketing professionals who provide global representation, operating from both
the Company's headquarters in the United States, and regional sales offices
located in Canada, Germany, United Kingdom, France, Spain, Italy, China, and
Japan. The Company is rapidly expanding its sales force throughout the Asia
Pacific region. In addition to its direct sales force, the Company sells through
19 distributors in countries where it does not have a direct presence. See
Footnote 15 to the Notes to Consolidated Financial Statements, incorporated
herein by reference to Item 8 hereof, for financial information about the
Company's foreign and domestic operations and export sales required by this
Item.
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 to promote brand awareness and customer identification.
6
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 functional adaptability 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 engineering development efforts will continue to focus
on enhancing our existing products and developing new products for the CAM2
market.
At December 31, 2003, the Company employed 41 scientists and technicians
in its research and development efforts. Research and development expenses were
approximately $4.5 million in 2003 as compared to $4.0 million in 2002 and $3.4
million in 2001. 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.
Intellectual Property
The Company holds or has pending 33 patents in the United States. The
Company also has 16 registered trademarks in the United States, 31 foreign
registered trademarks, one trademark application pending in the United States,
and 9 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.
Manufacturing and Assembly
The Company manufactures its products at its headquarters in Lake Mary,
Florida, and at its plants in Kennett Square, Pennsylvania and Schaffhausen,
Switzerland. Manufacturing consists primarily of assembling finished products
with 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 and are readily available and can be purchased from multiple
sources. All products are assembled, calibrated and 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. The Company's manufacturing,
engineering and design headquarters have been registered to the ISO 9001
standard since July 1998. Semi-annual surveillance audits have documented
continuous improvement to this multinational standard. The Company continues to
examine its scope of registration as the business evolves and has chosen English
as the standard business language for its operations. This decision is expected
to significantly influence the Company's operations and documentation globally.
This has been done in concert with the ISO Standard Registrar, and is expected
to increase customer confidence in the Company's products and services
worldwide.
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The Company continues to achieve new levels of certification, achieving
Accreditation to Guide 25 in May 2000, and Registration to ISO/IEC 17025 in
October 2001. These global standards apply to the "Calibration and Certification
of Measuring and Test Equipment", and certify the organization's level of
training, procedures, and efficiency.
In July 2002 the Company's European operations were registered to ISO
9001:2000. In addition the calibration and certification facilities in Europe
were accredited to ISO 17025. In October 2002, the Company's headquarters
completed the transition to the ISO9001:2000 standard, and continued
registration to ISO 17025 for Calibration and Certification Laboratories. In
October 2003, the Company's Laser Tracker production and research and
development plant was added to the Company's ISO 9000:2000 registration. This
common registration now encompasses all manufacturing operations of the Company.
Competition
The broad market for measurement devices, which includes hand-measurement
tools, test fixtures and conventional, fixed-base CMMs, and portable measurement
systems such as the Company's products, 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 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.
With respect to the articulated measurement arm market, the Company
believes that it has the largest worldwide market share. The Company's
significant direct competitors for its Faro Arm Control Station and related
software are Romer SRL (France), Romer, Inc., a Cimcore Company (California),
and Kosaka Laboratory Ltd. (Japan). In addition the Company is aware of a direct
competitor for its Faro Arm Control Station in Germany, two direct competitors
in Italy, and a direct competitor in the United Kingdom, each of which the
Company believes currently has significantly less sales volume than the Company.
However, there can be no assurance that these companies or other companies will
not devote additional resources to the development and marketing of products
that compete with those of the Company. With respect to the laser tracker
market, Leica Geosystems (Switzerland) is the company's primary direct
competitor. Leica Geosystems has the largest market share in the laser tracker
market, is well established and is substantially larger and possesses
substantially greater financial, technical, and marketing resources than the
Company. Automated Precision Inc. (Maryland), a former supplier of Leica
Geosystems, markets a laser tracker under its own name, and is expected to
compete with the Company on a global basis. There are no direct competitors
known to the Company for our new Faro Gage product. Rather, the primary
resistance to Faro Gage sales is expected to be the resistance to change from
traditional hand measurement tools such as calipers, height gages, micrometers
and smaller conventional CMMs. As the market for laser trackers and our portable
coordinate measurement machines expands, additional competition may emerge and
the Company's existing and future competitors may commit more resources to the
markets in which the Company participates.
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,
8
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, 2003, the Company had orders representing approximately
$7.5 million in product sales outstanding. The majority of these specific orders
were shipped by March 5, 2004, and, as of March 12, 2004, the Company had orders
representing approximately $6.5 million in product sales outstanding. At
December 31, 2002 and 2001, the Company had orders representing approximately
$8.8 million and $706,000 in product sales outstanding respectively.
The Company's decreased backlog is the result of the increased production
of its new laser tracker and articulated arm product lines in 2003. The Company
believes that substantially all of the outstanding sales orders as of March 12,
2004 will be shipped during 2004.
Employees
At December 31, 2003, the Company had 341 full-time employees, consisting
of 120 sales and marketing professionals, 77 production staff, 41 research and
development staff, 49 administrative staff, and 54 customer service/application
engineering specialists. 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 its
staffing requirements over the foreseeable future.
Available Information
We maintain a web site with the address www.faro.com. Information
contained on our web site is not a part of, or incorporated by reference into,
this Annual Report on Form 10-K. We make available free of charge through our
web site our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, and proxy statements, and amendments to these
reports, as soon as reasonably practicable after we electronically file these
reports with, or furnish these reports to, the Securities and Exchange
Commission.
Management of the Registrant
The officers and key management personnel of the Company are as follows:
Name Age Principal Position
- ---- --- ------------------
Simon Raab, Ph.D ........... 51 Chairman of the Board, Chief Executive Officer, and
President
Gregory A. Fraser, Ph.D .... 49 Executive Vice President, Chief Financial Officer,
Secretary, and Treasurer
Robert P. Large ............ 54 Vice President of Sales
Joanne M. Karimi ........... 45 Vice President of Human Resources
Allen Sajedi ............... 44 Vice President and Chief Technical Officer
Wendelin K.J. Scharbach .... 48 Co-Managing Director of FARO Europe
Siegield K. Buss ........... 38 Co-Managing Director of FARO Europe
9
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
Executive Vice President, Secretary, and Treasurer since August 1999. Prior to
that Mr. Fraser 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.
Robert P. Large has served as Vice President of Sales since June, 2001.
Prior to that, Mr. Large was Vice President of Sales of the Hill - Rom Company,
a division of Hillenbrand Industries, Batesville, Indiana (HB-NYSE). Mr. Large
has held upper management positions in sales and marketing with Hillenbrand, as
well as Biomet Corp. (BMET - NASDAQ), OEC Co., and AHS Corp. Mr. Large holds a
Bachelor of Business Management degree from Baldwin - Wallace College, Berea,
Ohio and attended New England School of Law, Boston, MA and Western New England
School of Law, Springfield, MA.
Joanne M. Karimi., has served as Vice President of Human Resources of the
Company since July 2001 and as Director of Human Resource Systems since October
1998. Prior to that, Ms. Karimi served as Director of Human resources of the
Disney Vacation Club, a unit of The World Disney Company (DIS-NYSE). Ms. Karimi
holds a MBA and a Bachelor's Degree in Business Management from the University
of West Florida.
Allen Sajedi has served as Vice President and Chief Technical Officer
since 2002 and as Chief Engineer of the Company since 1990. Mr. Sajedi holds a
Bachelor's Degree in Mechanical Engineering from McGill University, Montreal,
Canada.
Wendelin K.J. Scharbach, a co-founder of CATS GmbH, a predecessor of FARO
Europe, the Company's principal subsidiary in Europe, has served as Co-managing
Director of FARO Europe since May 1998. Prior to that Mr. Scharbach was Managing
Director of CATS GmbH.
Siegfried K. Buss, a co-founder of CATS GmbH, a predecessor of FARO
Europe, the Company's principal subsidiary in Europe, has served as Co-managing
Director of FARO Europe since May 1998. Prior to that Mr. Buss was Managing
Director of CATS GmbH.
ITEM 2. PROPERTIES.
The Americas
The Company's worldwide headquarters are located in a leased building in
Lake Mary, Florida containing approximately 35,000 square feet. This facility
houses the Company's U.S. sales and marketing, manufacturing, research and
development, administrative staff, and customer service/application operations.
Additionally, the Company has a leased facility consisting of 20,800 square feet
located in Kennett Square, Pennsylvania. Such facility houses research and
development and manufacturing operations of the laser tracker product lines.
Europe
The Company's European headquarters are located in a leased building in
Stuttgart, Germany containing approximately 19,500 square feet. The Company has
a research and development facility that is
10
located in a leased building in Aveiro, Portugal containing approximately 2,800
square feet. Additionally the Company has a leased facility consisting of 15,930
square feet located in Schaffhausen, Switzerland. Such facility houses
manufacturing operations for the Company's products that are shipped to
customers in Europe, Africa and Asia.
Asia/Pacific
The Company's Japan headquarters are located in a leased building in
Nagoya, Japan containing 5,209 square feet. This facility houses the Company's
Japan sales, marketing and service operations. The Company's China headquarters
are located in a leased building in Shanghai, China containing 1,700 square
feet. Such facility houses sales and marketing operations.
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 or enhanced production needs as those needs develop.
The information required by the remainder of this Item is incorporated
herein by reference to Exhibit 99.1 attached hereto.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any material pending legal proceedings other
than ordinary routine litigation incidental to the Company's business. The
Company is subject to various claims and contingencies related to lawsuits
arising out of the normal course of business. The Company believes that the
ultimate outcome of any pending legal proceeding, even if the outcome were
unfavorable to the Company, is not likely to have a materially adverse effect on
the Company's business, financial condition or results of operations.
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 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's Common Stock, par value $.001 per share, trades on the
NASDAQ Stock Market under the symbol FARO. The following table sets forth the
high and low sale price of the Company's Common Stock for its two most recent
fiscal years:
2003 2002
---- ----
High Low High Low
----- ----- ---- ----
First Quarter 3.31 1.91 3.50 1.53
Second Quarter 7.72 3.12 3.56 1.45
Third Quarter 13.53 6.67 2.17 1.06
Fourth Quarter 30.20 12.10 2.10 1.35
11
The Company has not paid any cash dividends on its Common Stock to date.
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. 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. As of
March 15, 2004, the last sale price of the Company's Common Stock was $24.34,
and there were approximately 78 holders of record of Common Stock. The Company
believes that there are approximately 11,300 beneficial owners of its Common
Stock.
In 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. In 1998, the
Company purchased 40,000 shares of its Common Stock in the open market under
such stock repurchase plan. During the three years in the period ended December
31, 2003 the Company did not purchase any shares of its Common Stock in the open
market.
On November 12, 2003, the Company sold 1,158,000 shares of its common
stock, and two of the Company's founders sold 772,000 shares of the common stock
to certain institutional investors in a private placement that was not
registered under the Securities Act of 1933. The shares were sold for $21.50 per
share, resulting in total proceeds before placement agent fees and other
offering expenses of $24.9 million and $16.6 million to the Company and the
co-founders, respectively. The purchasers of the shares sold in the transaction
were 31 institutional investors. Robert W. Baird & Co. served as the placement
agent for the transaction, and received a fee equal to $2,489,700, or 6% of the
aggregate sales proceeds. The Company also reimbursed Robert W. Baird & Co. for
$50,000 in expenses incurred in connection with the transaction.
The private placement transaction was exempt from registration under the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereof and Rule
506 under Regulation D promulgated by the Securities and Exchange Commission
thereunder. These exemptions were available for the private placement
transaction on the basis that the transaction did not involve a public offering
and satisfied each of the criteria under Rule 506 of Regulation D.
12
ITEM 6. SELECTED FINANCIAL DATA
Historical - Year Ended December 31
-----------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------ ------------ ------------ ------------
Statement of Operations Data:
Sales $71,785,980 $ 46,246,372 $ 36,121,696 $ 40,912,663 $ 33,614,490
Gross profit 42,265,731 25,136,763 21,817,613 26,164,035 19,453,522
Income (loss) from operations 7,440,135 (2,939,243) (3,361,610) (237,350) (9,705,477)(1)
Income (loss) before income taxes 9,435,270(2) (1,804,831) (2,506,226) 464,198 (8,516,286)
Net income (loss) 8,277,740 (2,015,571) (2,847,964) 39,517 (7,394,822)
Net income (loss) per common share:
Basic $ 0.68 $ (0.17) $ (0.26) $ -- $ (0.67)
Diluted $ 0.64 $ (0.17) $ (0.26) $ -- $ (0.67)
Weighted average common shares outstanding:
Basic 12,181,221 11,853,732 11,032,449 11,021,606 11,015,140
Diluted 12,845,992 11,853,732 11,032,449 11,094,144 11,015,140
Historical - Year Ended December 31
-----------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------ ------------ ------------ ------------
Consolidated Balance Sheet Dam:
Working capital $53,869,567 $ 18,338,541 $ 22,303,204 $ 23,672,736 $ 24,869,844
Total assets 81,913,888 45,194,780 39,654,124 44,699,274 42,103,912
Total debt 107,234 1,556,125 80,626 66,657 26,236
Total shareholders' equity 68,921,099 33,383,649 32,336,461 35,955,453 36,599,346
(1) Includes a charge to write down development and core technology in the
amount of $3.1 million.
(2) Includes a favorable legal settlement of $1.1 million in other income.
13
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. The Company's principal products are
the Faro Arm and Faro Gage articulated arm measuring devices, the Faro Laser
Tracker, a laser-based measuring device and their companion CAM2 software, which
provide for CAD-based inspection and factory-level statistical process control.
Together, these products integrate the measurement and quality inspection
function with CAD software 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 33
patents. The Company's products have been purchased by approximately 3,500
customers worldwide, ranging from small machine shops to such large
manufacturing and industrial companies as Audi, Bell Helicopter, Boeing, British
Aerospace, Caterpillar, DaimlerChrysler, General Electric, General Motors,
Honda, Johnson Controls, Komatsu Dresser, Lockheed Martin, Siemens and
Volkswagen among many others.
In 1995, the Company made a strategic decision to target international
markets. The Company established sales offices in France and Germany in 1996,
Great Britain in 1997, Japan and Spain in 2000, Italy in 2001, and China in
2003. International sales represented 47.3%, 57.0%, and 59.1% of sales in 2003,
2002, and 2001, respectively. The Company expects higher percentage sales growth
in the Asia Pacific region than other regions in 2004 and 2005 as a result of
opening its China sales office, and the addition of sales personnel and the
opening of a service center in its Japan organization.
The Company derives revenues primarily from the sale of its Faro Arm and
Faro Laser Tracker 3-D measurement equipment, and its related multi-faceted CAM2
software. Going forward, the Company also expects to generate revenue from the
sale of its new Faro Gage product. Revenue related to these products is
recognized upon shipment. In addition, the Company sells one, two and three-year
maintenance contracts and training and technology consulting services relating
to its products. The Company recognizes the revenue from extended maintenance
contracts proportionately, in the same manner as costs are incurred for such
revenues. The Company also receives royalties from licensing agreements for its
historical medical technology and recognizes the revenue from these royalties as
licensees report use of the technology. In 2003 royalties from licensing
agreements were $601,000, or 0.8% of total sales.
In 2003 the Company began to manufacture its Faro Arm products in
Switzerland for customer orders from Europe and Asia. It will begin to
manufacture its Faro Laser Tracker and Faro Gage products in its Swiss plant by
mid 2004. The production of these products for customer orders from the Americas
will be done in the Company's headquarters in Florida, and its manufacturing
plant in Pennsylvania. The Company expects all its existing plants to provide
the necessary capacity for its growth, at least through 2005.
Cost of sales consists primarily of material, production overhead and
labor. Since the Company's IPO in 1997 it has had gross margin in the range
54-64%. The Company expects to maintain gross margin at or near 60% going
forward. Selling expenses consist primarily of salaries and commissions to sales
and
14
marketing personnel, and promotion, advertising, travel and telecommunications.
Selling expenses as a percentage of sales dropped significantly in 2003 as
compared to 2002, to 25.6% from 30.0% and holding selling expenses as a
percentage of sales to 25% or less will be a long-term goal of the Company,
although the addition of new sales personnel in Asia may temporarily cause a
rise in selling expenses as a percentage of sales in 2004 until these new sales
people are fully trained and productive.
General and administrative expenses consist primarily of salaries for
administrative personnel, rent, utilities and professional and legal expenses.
The Company expects general and administrative expenses to drop as a percentage
of sales as higher sales should not require a proportionate increase in these
expenses. Research and development expenses represent salaries, equipment and
third-party services. The Company has a commitment to ongoing research and
development and intends to continue to fund these efforts at the level of 5-7%
of sales going forward.
The Company has received a favorable income tax rate commitment from the
Swiss government as an incentive for the Company to establish a manufacturing
plant there. As a result the Company expects its blended (consolidated) tax rate
to be in a range between 25% and 30% of consolidated taxable income for at least
2004 and 2005.
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 inter-company accounts reflected in the
Company's consolidated financial statements. The Company is aware of off-balance
sheet financial instruments to hedge its exposure to foreign currency exchange
rates, including cross-currency swaps, forward contracts, and foreign currency
options (see Foreign Exchange Exposure below). However the Company does not
regularly use such instruments.
During fiscal years 2002 and 2001, the Company's sales growth was
adversely affected by the economic slowdown, which began in 2001 in the United
States and Europe. This effect, however, was offset by sales growth resulting
from the acquisition in January 2002 of SpatialMetrix Corporation (SMX), which
manufactured the predecessor to the Faro Laser Tracker, and the introduction in
September and October 2002 of the latest generation of the Company's traditional
Faro Arm product. In 2003 sales growth resulted primarily from strong customer
response to the new Faro Arm and Laser Tracker products, and an increase in
worldwide sales and marketing activities, including an increase in headcount
from 106 in 2002 to 120 at the end of 2003.
In 2003 the Company recorded approximately $1.1 million in "other income"
as a result of recovering approximately 100,000 shares of Company stock related
to a positive arbitration settlement between the Company and the former SMX
shareholders.
15
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,
--------------------------------
2003 2002 2001
------ ------ ------
Statement of Operations Data:
Sales 100.0% 100.0% 100.0%
Cost of Sales 41.1% 45.6% 39.6%
------ ------ ------
Gross profit 58.9% 54.4% 60.4%
Operating expenses:
Selling 25.5% 30.0% 37.2%
General and administrative 12.7% 17.0% 16.1%
Depreciation and amortization 3.0% 5.0% 7.1%
Research and development 6.3% 8.7% 9.3%
Employee stock options 1.0% -- --
------ ------ ------
Total operating expenses 48.5% 60.7% 69.7%
------ ------ ------
Income (loss) from operations 10.4% (6.3)% (9.3)%
Interest income 0.1% 1.2% 2.5%
Other income, net 2.7% 1.3% (0.1)%
Interest expense (0.1)% (0.1)% --
------ ------ ------
Net income (loss) before income taxes 13.1% (3.9)% (6.9)%
Income tax expense 1.6% 0.5% 0.9%
------ ------ ------
Net income (loss) 11.5% (4.4)% (7.8)%
====== ====== ======
2003 Compared to 2002
Sales. Sales increased $25.6 million or 55.4%, from $46.2 million for the
year ended December 31, 2002 to $71.8 million for year ended December 31, 2003.
The increase resulted from higher unit sales of the Faro Arm and Laser Tracker
products, an increase in headcount in sales and marketing from 106 in 2002 to
120 in 2003, and from a 15% average price increase on existing products on
January 1, 2003. Geographically, sales increased $15.4 million or 68.5% in the
Americas, $9.2 million or 49.8% in Europe/Africa, and $0.9 million, or 17.8% in
the Asia/Pacific region.
Gross profit. Gross profit increased by $17.1 million or 68.1%, from $25.1
million for the year ended December 31, 2002 to $42.2 million for the year ended
December 31, 2003. Gross margin percentage increased from 54.4% for the year
ended December 31, 2002 to 58.9% for the year ended December 31, 2003 due to
higher selling prices and efficiencies in Laser Tracker manufacturing plant
output.
Selling expenses. Selling expenses increased by $4.5 million or 32.6%,
from $13.8 million for the year ended December 31, 2002 to $18.3 million for the
year ended December 31, 2003. This increase was a result of increased sales head
count and higher commissions due to higher sales. As a percentage of sales,
selling expenses dropped to 25.6% of sales in 2003 from 30.0% in 2002.
General and administrative expenses. General and administrative expenses
increased by $1.2 million or 15.2% from $7.9 million for the year ended December
31, 2002 to $9.1 million for the year
16
ended December 31, 2003. The increase was primarily due to the increase in
professional and legal fees, service charges and network costs. General and
administrative expenses as percentage of sales fell to 12.7% of the sales in
2003 from 17.0% of the sales in 2002.
Depreciation and amortization expenses. Depreciation and amortization
expenses decreased by $148,000 or 6.6%, from $2.3 million for the year ended
December 31, 2002 to $2.1 million in 2003, due to a reduction in amortization of
existing product technology of $374,000, offset by an increase of $226,000 in
depreciation of new equipment.
Research and development expenses. Research and development expenses
increased by $497,000 or 12.3%, from $4.0 million for the year ended December
31, 2002 to $4.5 million for the year ended December 31, 2003 due primarily to
the increased subcontractor costs and materials. The Company plans to spend at
least 5% of sales on research and development.
Employee Stock Option expenses. Employee Stock Option expenses increased
by $709,000 from $9,000 for the year ended December 31, 2002 to $718,000 for the
year ended December 31, 2003 due primarily to an increase in the price of the
Company's stock and the recording of expense in connection with certain stock
options that are accounted for as variable options. (See also "Note 12 - Stock
Compensation" to the Consolidated Financial Statements contained herein).
Interest income / expense. Interest income decreased by $479,000 or 85.4%,
from $561,000 for the year ended December 31, 2002 to $82,000 for the year ended
December 31, 2003 primarily from lower average investments and lower interest
rates in 2003. Interest expense increased by $18,000 from $28,000 for the year
ended December 31, 2002 to $46,000 for the year ended December 31, 2003 due to
increased use of a credit line (See Liquidity and Capital Resources below).
Other income. Other income increased by $1.3 million from $601,000 for the
year ended December 31, 2002 to $1.9 million for the year ended December 31,
2003 due primarily to the settlement of litigation with the former shareholders
of SMX for $1.1 million. (See also "Note 2--Acquisition).
Income tax expense. Income tax expense increased by $946,000 from $211,000
for the year ended December 31, 2002 to $1.2 million for the year ended December
31, 2003. The effective tax rate in 2003 was 12.8% of net income before income
tax. The primary reason for the relatively low tax rate was a reduction in
valuation allowance of approximately $4.0 million. Of that reduction, $2.8
million relates to usage of "net operating losses" in foreign jurisdictions and
$1.2 million of the reduction in valuation allowance relates to domestic assets
for which the Company now believes are more likely than not to be realized. The
Company has $1.7 million in deferred tax assets remaining, which may be
recognized in 2004 if the Company remains consistently profitable. (See also
"Note 10- Income Taxes" to the Financial Statements contained herein). Separate
from income tax expenses, the Company recorded an addition to Shareholders'
Equity of $1.4 million for the income tax benefit received from the exercise of
unqualified stock options by employees.
Net Income (loss). The results from operations increased by $10.3 million
from a loss of $2.0 million for the year ended December 31, 2002 to $8.3 million
for the year ended December 31, 2003 as a result of the factors described above.
2002 Compared to 2001
Sales. Sales increased by $10.1 million or 28.0%, from $36.1 million for
the year ended December 31, 2001 to $46.2 million for year ended December 31,
2002. The increase resulted primarily from sales of the new laser product line
in 2002. Geographically sales increased in all regions primarily due to sales of
the new laser product line (United States increased $5.1 million or 34.5%,
Europe increased $2.2
17
million or 15.4%, Japan increased $1.9 million or 111.8%, other foreign sales
increased $900,000 or 16.4%). (See also Note 15 to the Consolidated Financial
Statements). Royalty income included in sales decreased by $20,000 from
$1,010,000 for the year ended December 31, 2001 to $990,000 for the year ended
December 31, 2002.
Gross profit. Gross profit increased by $3.3 million or 15.1%, from $21.8
million for the year ended December 31, 2001 to $ 25.1 million for the year
ended December 31, 2002. Gross margin decreased from 60.4% for the year ended
December 31, 2001 to 54.4% for the year ended December 31, 2002. The decrease in
gross margin was primarily a result of a one-time inventory write-down
($729,000) recorded in the second quarter of 2002 related to the new laser
product line, the impact of the new laser product line acquired in January 2002
and, to a lesser extent, the new generation arm products introduced in the third
quarter of 2002 (see New Products above). Gross margins on sales are expected to
ultimately meet or exceed the Company's historic levels once both production
facilities are at full production levels. Plant capacity utilization is expected
to increase with additional manufacturing efficiencies expected in 2003.
Selling expenses. Selling expenses increased by $456,000 or 3.4%, from
$13.4 million for the year ended December 31, 2001 to $13.9 million for the year
ended December 31, 2002. This increase was a result of higher sales commissions
on higher sales in the U.S. ($1.0 million) and higher expenses in Japan
($382,000) offset largely by cost reduction measures implemented in the United
States ($742,000) and Europe ($184,000). While an increase in total expenses was
experienced in 2002 compared to 2001, this amount represents a decrease in the
percentage of sales from 37.2% in 2001 to 30.0% in 2002.
General and administrative expenses. General and administrative expenses
increased by $2.1 million or 36.2% from $5.8 million for the year ended December
31, 2001 to $7.9 million for the year ended December 31, 2002. The increase was
due to administrative expenses resulting from the integration of the former SMX
in 2002 ($915,000), professional fees unrelated to SMX ($352,000), a provision
for doubtful accounts receivable ($245,000) recorded in the second quarter of
2002 related to the recently acquired laser product line, and a shifting of
personnel from Research and Development to Administrative positions ($549,000).
Depreciation and amortization expenses. Depreciation and amortization
expenses decreased by $292,000, or 11.2%, from $2.6 million for the year ended
December 31, 2001 to $2.3 million in 2002. Depreciation and amortization
expenses in 2002 reflect the effect (approximately $740,000) of the adoption,
effective January 1, 2002, of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" (SFAS No. 142) partly offset by an increase in
depreciation resulting from newly acquired assets in late 2002. (See Note 6 to
the Consolidated Financial Statements).
Research and development expenses. Research and development expenses
increased by $663,000, or 19.5%, from $3.4 million for the year ended December
31, 2001 to $4.0 million for the year ended December 31, 2002 principally as a
result of research and development expenses of the new laser tracker product
line ($1.6 million) offset in part by lower expenses for the new generation arm
development in the US ($388,000) and shifting of personnel to administrative
positions costs in Europe ($549,000--see General and Administrative expenses
above).
Interest income. Interest income decreased by $339,000, or 37.7%, from
$900,000 for the year ended December 31, 2001 to $561,000 for the year ended
December 31, 2002. The decrease was primarily attributable to lower interest
bearing cash balances (see Liquidity and Capital Resources below) and lower
interest rates prevailing in 2002.
Other income(loss). Other income increased by $644,000, from $43,000 loss
for the year ended December 31, 2001 to $601,000 in income for the year ended
December 31, 2002 primarily due to foreign currency gains during the current
year.
18
Income tax expense. Income tax expense decreased by $131,000 from $342,000
for the year ended December 31, 2001 to $211,000 for the year ended December 31,
2002.
Net loss. Net loss decreased by $800,000 from $2.8 million for the year
ended December 31, 2001 to $2.0 million for the year ended December 31, 2002
primarily due to higher gross profit from increased sales and cost savings
measures implemented in the US and Europe, partially offset by integration
expenses of the Laser Division and reduced income tax expense.
Liquidity and Capital Resources
Since 1997, the Company had financed its operations primarily from cash
provided by operating activities and from the proceeds of its 1997 initial
public offering of Common Stock (approximately $31.7 million). On November 12,
2003 the Company along with Company's two co-founders completed a $41.5 million
private placement of its common stock with various institutional investors. In
the private placement, the Company sold 1,158,000 shares, or approximately 8% of
total shares outstanding, and the two co-founders of the Company, Simon Raab and
Gregory Fraser, sold 772,000 shares, or approximately 20% of their holdings, in
the aggregate. The shares were sold for $21.50 per share, resulting in total
proceeds before placement agent fees and other offering expenses of $24.9
million and $16.6 million to the Company and the co-founders, respectively.
On September 17, 2003, the Company entered into a loan agreement with
SunTrust Bank for a line of credit of $5 million. The Company has not drawn on
this line of credit.
Total marketable securities (cash and cash equivalents and investments) at
December 31, 2003 were $33.5 million, compared to $5.9 million at December 31,
2002. This $27.6 million increase was primarily due to the $24.9 million private
placement on November 12, 2003 described above. (See Note 1 to the Consolidated
Financial Statements)
For the year ended December 31, 2003, net cash provided by operating
activities was $4.7 million compared to net cash used by operating activities of
$5.0 million in 2002. The $9.7 million increase reflects strong growth in sales
and operating income, partially offset by increases in accounts receivable,
taxes, and unearned revenue and the other income realized in Company stock in
the settlement of the SMX litigation.
Net cash used by investing activities for the year ended December 31, 2003
was $15.2 million, compared to $118,000 in 2002 primarily due to increased net
investment purchases of $14.1 million.
Net cash provided by the financing activities for the year ended December
31, 2003 was $23.0 million compared to a provision of $1.4 million in 2002. The
increase was primarily the proceeds of the $24.9 million private placement of
the Company common stock in November 2003.
We believe that our working capital, together with anticipated cash flow
from our operations, will be sufficient to fund our long-term liquidity
requirements. Our liquidity is not dependant upon the use of off-balance sheet
financing arrangements, such as securitization of receivables or obtaining
access to capital through special purpose entities.
On January 16, 2002, in connection with its acquisition of SMX, the
Company issued 500,000 shares of FARO common stock to the former shareholders.
On September 16, 2003 the Company settled a dispute with the former SMX
shareholders, which resulted in approximately 100,000 shares being returned from
the 500,000 initially issued in the acquisition.
19
Contractual Obligations and Commercial Commitments
The Company is a party to a capital lease of $107,234 and a party to
automotive and other equipment with an initial term of 36 to 60 months and other
non-cancelable operating leases, including leases with related parties (see Note
8 of Notes to Consolidated Financial Statements) that expire on or before 2007.
Commitments under the lease agreements are as follows at December 31, 2003:
Payments Due Under:
------------------------
Capital Operating
Year Leases Leases Total
- ---------------- -------- ---------- ----------
2004 $ 42,585 $1,145,251 $1,187,836
2005 31,871 1,403,698 1,435,569
2006 30,163 936,589 966,752
2007 2,615 304,292 306,907
2008 -- 159,596 159,596
Thereafter -- -- --
-------- ---------- ----------
Total future minimum lease payments $107,234 $3,949,426 $4,056,660
======== ========== ==========
Critical Accounting Policies
In response to the SEC'S financial reporting release, FR-60, Cautionary
Advice Regarding Disclosure About Critical Accounting Policies, we have selected
our most subjective accounting estimation processes for purposes of explaining
the methodology used in calculating the estimate in addition to any inherent
uncertainties pertaining to the estimate and the possible effects on the
Company's financial condition. The two accounting estimation processes discussed
below are the Company's process of recognizing research and development
expenditures, and the allowance for obsolete and slow-moving inventory. These
estimation processes affect current assets and operating results and are
therefore critical in assessing the financial and operating status of the
Company. These estimates involve certain assumptions that if incorrect could
create an adverse impact on the Company's operations and financial position.
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. 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. The Company periodically assesses the value of
capitalized product design costs and records a reserve for obsolescence or
impairment when, in the circumstances (including the discontinuance or probable
discontinuance of the related products from the market), it deems the asset to
be obsolete or impaired.
The reserve for obsolete and slow-moving inventory was $155,000, $90,000
and $298,000 at December 31, 2003, 2002 and 2001 respectively. The reserve for
obsolete and slow-moving inventory is used to determine the Company's
inventories at the lower of average cost or net realizable value. Since
20
the amount of inventorial cost that the Company will truly recoup through sales
cannot be known with exact certainty, the Company relies on past sales
experience and future sales forecasts. Inventory is considered as obsolete and
an allowance in an amount equal to 100% of the average cost of such inventory is
recorded if the Company has withdrawn it from the market or if the Company has
had no sales of the product for the past 12 months nor sales forecasted for the
next 12 months. The Company classifies as slow-moving inventory those with
quantities on hand greater than the amounts we have sold in the past 12 months
or have forecasted to sell in the next 12 months, and reserve such amount as is
adequate to reduce the carrying value to its estimated net realizable value. The
Company performs an obsolete and slow-moving inventory review twice a year and
writes off identified obsolete and slow-moving inventory accordingly.
The Company performs ongoing evaluations of its customers and adjusts
their credit ratings accordingly. The Company continuously monitors collections
and payments from its customers and maintains a provision for un-collectable
amounts based on its historical experience and any other issues it has
identified. While such credit losses have historically been within its
expectations, the Company cannot guarantee this will continue in the future. The
allowances recorded for 2003, 2002 and 2001 were approximately, $140,000,
$582,000 and $311,000 respectively. The amount written off, net of recoveries in
2003 was $737,000, which related primarily to very old receivables acquired as
part of the SMX acquisition. The Company reserved for these doubtful receivables
in 2002, therefore there was no income statement effect of this write-off in
2003.
Transactions with Related and Other Parties
The Company leases its headquarters from Xenon Research, Inc. ("Xenon"),
all of the issued and outstanding capital stock of which is owned by Simon Raab,
the Company's President and Chief Executive Officer, and Diana Raab, his spouse.
The term of the lease expires on February 28, 2006, and the Company has two
five-year renewal options. Base rent under the lease was $398,000 for 2003. Base
rent during renewal periods will reflect changes in the U.S. Bureau of Labor
statistics consumer Price Index for all Urban Consumers.
Foreign Exchange Exposure
The Company conducts a significant portion of its business outside the
United States. At present, a slight majority of the Company's revenues are
invoiced, and a significant portion of its operating expenses paid, 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, and could specifically result in
foreign exchange gains and losses. The impact of future exchange rate
fluctuations on the results of the Company's operations cannot be accurately
predicted. To the extent that the percentage of the Company's non-U.S. dollar
revenues derived from international sales increases in the future, the Company's
exposure to risks associated with fluctuations in foreign exchange rates will
increase further.
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 2004.
Impact of Recently Issued Accounting Standards
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue 00-21, Multiple-Deliverable Revenue Arrangements ("EITF
00-21"). EITF 00-21 addresses how to account for arrangements that may involve
the delivery or performance of multiple products, services, and/or
21
rights to use assets. The consensus mandates how to identify whether goods or
services or both that are to be delivered separately in a bundled sales
arrangement should be accounted for separately because they are "separate units
of accounting" The guidance can affect the timing of revenue recognition for
such arrangements, even though it does not change rules governing the timing or
pattern of revenue recognition of individual items accounted for separately. The
final consensus will be applicable to agreements entered into in fiscal years
beginning after June 15, 2003 with early adoption permitted. Additionally,
companies will be permitted to apply the consensus guidance to all existing
arrangements as the cumulative effect of a change in accounting principle in
accordance with APB Opinion No. 20, Accounting Changes. The Company is
assessing, but at this point does not believe the adoption of EITF 00-21 will
have a material impact on our financial position, cash flows or results of
operations.
In January 2003, the Financial Accounting Standard Board ("FASB") issued
FASB Interpretation No. 46 (FIN 46) "Consolidation of Variable Interest
Entities." This interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," addresses consolidation by business
enterprises of variable interest entities. Under current practice, two
enterprises generally have been included in consolidated financial statements
because one enterprise controls the other through voting interests. This
interpretation defines the concept of "variable interests" and requires existing
unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse the risks among the
parties involved. This interpretation applied immediately to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. It applied in the first
fiscal year or interim period beginning after June 15, 2003, to variable
interest entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003. If it is reasonably possible that an
enterprise will consolidate or disclose information about a variable interest
entity when this interpretation becomes effective, the enterprise shall disclose
information about those entities in all financial statements issued after
January 31, 2003. The interpretation may be applied prospectively with a
cumulative-effect adjustment as of the date on which it is first applied or by
restating previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year restated. We
have completed our assessment of this interpretation and determined that we are
not party to any variable interest entities as of December 31, 2003.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation- Transition and Disclosure" (SFAS 148), an amendment of
SFAS 123. SFAS 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS
123 to require more prominent and more frequent disclosures in financial
statements about the effects of stock-based compensation. This statement is
effective for financial statements for fiscal years ending after December 15,
2002. Adoption of SFAS 148 did not have a material impact on the Company's
financial position or results of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 (SFAS 149), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." This Statement amends and clarifies financial accounting
and reporting for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under Statement of Financial Accounting
Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities." The statement was effective for contracts entered into or modified
after June 30, 2003. The adoption of this standard did not have a material
impact on our financial position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 (SFAS 150), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This Statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial
22
instrument that is within its scope as a liability (or an asset in some
circumstances). This standard was effective at the beginning of the first
interim period beginning after June 15, 2003, except for mandatorily redeemable
financial instruments of nonpublic entities that are subject to the provisions
of this Statement for the first fiscal period beginning after December 15, 2003.
The adoption of this standard did not have a material impact on our financial
position or results of operations.
Cautionary Statements
We discuss expectations regarding our future performance and make other
forward-looking statements in our annual and quarterly reports, press releases,
and other written and oral statements. These forward-looking statements are
based on currently available competitive, financial, and economic data and our
operating plans. They are inherently uncertain, and investors must recognize
that events could turn out to be significantly different from our expectations.
The following discussion of risks and uncertainties which is not exclusive,
highlights some important factors to consider when evaluating our trends and
future results.
Our customers' buying process for our products is highly decentralized, and
therefore, it typically requires significant time and expense for us to further
penetrate the potential market of a specific customer, which may delay our
ability to generate additional revenue.
Our success will depend, in part, on our ability to further penetrate our
customer base. Most of our customers have a decentralized buying process for
measurement devices. Thus, we must spend significant time and resources to
increase revenues from a specific customer. For example, we may provide products
to only one of our customers' manufacturing facilities or for a specific product
line within a manufacturing facility. We cannot assure you that we will be able
to maintain or increase the amount of sales to our existing customers.
Others may develop products that make our products obsolete or less competitive.
The computer-aided manufacturing measurement ("CAM2") market is emerging
and could be characterized by rapid technological change. Others may develop new
or improved products, processes or technologies may make our products obsolete
or less competitive. We cannot assure you that we will be able to adapt to
evolving markets and technologies or maintain our technological advantage.
Our success will depend, in part, on our ability to maintain our
technological advantage by developing new products and enhancing our existing
products. Developing new products and enhancing our existing products can be
complex and time-consuming. Significant delays in new product releases, or
difficulties in developing new products, could adversely affect our revenues and
results of operations. Because our customers are concentrated in a few
industries, a reduction in sales to any one of these industries could cause a
significant decline in our revenues.
Approximately 75% of our sales are to manufacturers in the automotive,
aerospace, and heavy equipment industries. We are dependent upon the continued
growth, viability, and financial stability of our customers in these industries,
which are highly cyclical and dependent upon the general health of the economy
and consumer spending. The cyclical nature of these industries may exert
significant influence on our revenues and results of operations. In addition,
the volume of orders from our customers and the prices of our products may be
adversely impacted by decreases in capital spending by a significant portion of
our customers during recessionary periods. In addition, we generate significant
accounts receivable in connection with providing products and services to our
customers. If one or more of our significant customers were to become insolvent
or otherwise were unable to pay for the products provided by us, our operating
results and financial condition would be adversely affected.
23
Our inability to protect our patents and proprietary rights in the United States
and foreign countries could adversely affect our revenues.
Our success depends in large part on our ability to obtain and maintain
patent and other proprietary right protection for our processes and products in
the United States and other countries. We also rely upon trade secrets,
technical know-how, and continuing inventions to maintain our competitive
position. We seek to protect our technology and trade secrets, in part, by
confidentiality agreements with our employees and contractors. Our employees may
breach these agreements or our trade secrets may otherwise become known or be
independently discovered by inventors. If we are unable to obtain or maintain
protection of our patents, trade secrets, and other proprietary rights, we may
not be able to prevent third parties from using our proprietary rights.
Our patent protection involves complex legal and technical questions. Our
patents may be challenged, narrowed, invalidated, or circumvented. We may be
able to protect our proprietary rights from infringement by third parties only
to the extent that our proprietary processes and products are covered by valid
and enforceable patents or are effectively maintained as trade secrets.
Furthermore, others may independently develop similar or alternative
technologies or design around our patented technologies. Litigation or other
proceedings to defend or enforce our intellectual property rights could require
us to spend significant time and money and could otherwise adversely affect our
business.
Claims from others that we infringe their intellectual property rights may
adversely affect our operations.
From time to time we receive notices from others claiming we infringe
their intellectual property rights. The number of these claims may grow.
Responding to these claims may require us to enter into royalty and licensing
agreements on unfavorable terms, require us to stop selling or to redesign
affected products, or require us to pay damages. Any litigation or interference
proceedings, regardless of their outcome, may be costly and may require
significant time and attention of our management and technical personnel.
Our operating results may fluctuate due to a number of factors, many of which
are beyond our control.
Our annual and quarterly operating results have varied significantly in
the past and likely will vary significantly in the future as a result of:
o the size and timing of customer orders;
o the amount of time that it takes to fulfill orders and ship our
products;
o the length of our sales cycle to new customers and the time and
expense incurred in further penetrating our existing customer base;
o increases in operating expenses required for product development and
new product marketing;
o costs associated with new product introductions, such as assembly
line start-up costs and low introductory period production volumes;
o the timing and market acceptance of new products and product
enhancements;
o customer order deferrals in anticipation of new products and product
enhancements;
o our success in expanding our sales and marketing programs;
24
o start-up costs associated with opening new sales offices outside of
the United States;
o fluctuations in revenue without proportionate adjustments in fixed
costs;
o the efficiencies achieved in managing inventories and fixed assets;
and
o adverse changes in the manufacturing industry and general economic
conditions.
Any one or a combination of these factors could adversely affect our
annual and quarterly operating results in the future.
The CAM2 market is an emerging market, and our growth depends on the ability of
our products to attain broad market acceptance.
The CAM2 market is in an early stage of adoption. The market for
traditional fixed-base coordinate measurement machines ("CMMs"), check fixtures,
and other handheld measurement tools is mature. Part of our strategy is to
continue to displace these traditional measurement devices. Displacing
traditional measurement devices and achieving broad market acceptance of our
products requires significant effort to convince manufacturers to reevaluate
their historical measurement procedures and methodologies.
We market three closely interdependent products (FaroArms, Faro Laser
Tracker, and Faro Gage) and related software for use in measurement and
inspection applications. Substantially all our revenues currently are derived
from sales of these products and software, and we plan to continue our business
strategy of focusing on the portable software-driven, 3-D measurement and
inspection market. Consequently, our financial performance will depend in large
part on portable, computer-based measurement and inspection products achieving
broad market acceptance. If our products cannot attain broad market acceptance,
we will not grow as anticipated and may be required to make increased
expenditures on research and development for new applications or new products.
We compete with manufacturers of portable measurement systems and traditional
measurement devices, many of which have more resources than us and may develop
products or technologies that will directly compete with us.
Our portable measurement systems compete in the broad market for
measurement devices for manufacturing and industrial applications, which, in
addition to portable articulated arms and laser tracker products, consists of
fixed-base CMMs, check fixtures, and handheld measurement tools. The broad
market for measurement devices is highly competitive. Manufacturers of handheld
measurement tools and fixed-base CMMs include a significant number of
well-established companies that are substantially larger and possess
substantially greater financial, technical, and marketing resources than we
possess. In the laser tracker product line, we compete primarily with Leica
Geosystems, who is significantly larger than us and, we believe, currently the
leader in this product line. We will be required to make continued investments
in technology and product development to maintain our technological advantage
over our competition. We cannot assure you that we will have sufficient
resources to make additional investments in technology and product development
or that our product development efforts will allow us to successfully compete as
the industry evolves.
Our competitors may develop products or technologies that directly compete
with us. For example, fixed-base CMMs are introducing computer-aided-design
("CAD")-based inspection software in
25
response to the trend toward CAD-based factory floor metrology. In addition,
some fixed-base CMM manufacturers are miniaturizing and increasing the mobility
of their conventional CMMs. These companies may continue to alter their products
and devote resources to the development and marketing of additional products
that compete with ours.
We derive a substantial part of our revenues from our international operations,
which are subject to greater volatility and often require more management time
and expense to achieve profitability than our domestic operations.
Since 2000, we have derived over 50% of our sales from international
operations. We recently opened a manufacturing facility in Schaufhausen,
Switzerland and have regional sales offices in Germany, France, Spain, Italy,
Japan, and the United Kingdom. We are in the process of opening our first direct
sales offices in China. Should trade relations between the United States and
China deteriorate, our ability to transfer products between China and other
regions of the world, including the United States, Asia, and Europe could be
significantly impaired and our results of operations would suffer. In our
experience, entry into new international markets requires considerable
management time as well as start-up expenses for market development, hiring, and
establishing office facilities before any significant revenues are generated. As
a result, initial operations in a new market may operate at low margins or may
be unprofitable. Our international operations may be subject to a number of
risks, including:
o difficulties in staffing and managing foreign operations;
o political and economic instability;
o unexpected changes in regulatory requirements and laws;
o longer customer payment cycles and difficulty collecting accounts
receivable;
o export duties, import controls, and trade barriers;
o governmental restrictions on the transfer of funds to us from our
operations outside the United States;
o burdens of complying with a wide variety of foreign laws and labor
practices;
o fluctuations in currency exchange rates, which could affect local
payroll utility and other expenses; and
o inability to use net operating losses incurred by our foreign
operations to reduce our U.S. income taxes.
Several of the countries where we operate have emerging or developing
economies, which may be subject to greater currency volatility, negative growth,
high inflation, limited availability of foreign exchange, and other risks. These
factors may harm our results of operations and any measures that we may
implement to reduce the effect of volatile currencies and other risks of our
international operations may not be effective. In addition, during 1997 and
1998, several Asian countries, including Japan, experienced severe currency
fluctuation and economic deflation. If such situations reoccur or occur in other
regions where we operate, it may negatively impact out sales and our ability to
collect payments from customers in these regions.
We rely to a large extent on the experience and management ability of our senior
executive officers.
26
Our success will depend, in part, on the services of our founders, Simon
Raab, our Chief Executive Officer, and Gregory Fraser, our Executive Vice
President and Chief Financial Officer. The loss or interruption of the continued
full-time services of these executives could have a material adverse effect on
us. We do not have employment agreements with these executives.
We may not be able to identify, consummate, or achieve expected benefits from
acquisitions.
We have completed two significant acquisitions since our initial public
offering in 1997. We intend to pursue access to additional technologies,
complementary product lines, and sales channels through selective acquisitions
and strategic investments. We may not be able to identify and successfully
negotiate suitable acquisitions, obtain financing for future acquisitions on
satisfactory terms or otherwise complete acquisitions in the future. In the
past, we have used our stock as consideration for acquisitions. Our common stock
may not remain at a price at which it can be used as consideration for
acquisitions without diluting our existing shareholders, and potential
acquisition candidates may not view our stock attractively.
Realization of the benefits of acquisitions often requires integration of
some or all of the acquired companies' sales and marketing, distribution,
manufacturing, engineering, finance, and administrative organizations. The
integration of acquisitions demands substantial attention from senior management
and the management of the acquired companies. Any acquisition may be subject to
a variety of risks and uncertainties, including:
o the inability to assimilate effectively the operations, products,
technologies, and personnel of the acquired companies (some of which
may be located in diverse geographic regions);
o the inability to maintain uniform standards, controls, procedures,
and policies;
o the need or obligation to divest portions of the acquired companies;
and
o the potential impairment of relationships with customers.
We cannot assure you that we will be able to integrate successfully any
acquisitions or that any acquired companies will operate profitably, or that we
will realize the expected benefits from any acquisition.
We may face difficulties managing growth.
Our growth has placed significant demands on our management and operations
and financial resources. If our business continues to grow rapidly in the
future, we expect it to result in:
o increased responsibility for existing and new management personnel,
and
o incremental strain on our operations, and financial and management
systems.
Our success under such conditions will depend to a significant extent on
the ability of our executive officers and other members of senior management to
operate effectively both independently and as a group. If we are not able to
manage future growth, our business, financial condition, and operating results
may be harmed.
Our dependence on suppliers for materials could impair our ability to
manufacture our products.
27
Outside vendors provide key components used by us in the manufacture of
our products. Although we believe that alternative sources for these components
are available, any supply interruption in a limited source component would harm
our ability to manufacture our products until a new source of supply is
identified. In addition, an uncorrected defect or supplier's variation in a
component, either known or unknown to us, or incompatible with our manufacturing
processes, could harm our ability to manufacture our products. We may not be
able to find a sufficient alternative supplier in a reasonable period, or on
commercially reasonable terms, if at all. If we fail to obtain a supplier for
the manufacture of components of our potential products, we may experience
delays or interruptions in our operations, which would adversely affect our
results of operations and financial condition.
We may experience volatility in our stock price.
The price of our common stock has been, and may continue to be, highly
volatile in response to various factors, many of which are beyond our control,
including:
o developments in the industries in which we operate;
o actual or anticipated variations in quarterly or annual operating
results;
o speculation in the press or investment community; and
o announcements of technological innovations or new products by us or
our competitors.
Our common stock's market price may also be affected by our inability to
meet analyst and investor expectations and failure to achieve projected
financial results, including those set forth in this prospectus. Any failure to
meet such expectations or projected financial results, even if minor, could
cause the market price of our common stock to decline. Volatility in our stock
price may result in your inability to sell your shares at or above the price at
which you purchased them.
In addition, stock markets have generally experienced a high level of
price and volume volatility, and the market prices of equity securities of many
companies have experienced wide price fluctuations not necessarily related to
the operating performance of such companies. These broad market fluctuations may
adversely affect our common stock's market price. In the past, securities class
action lawsuits frequently have been instituted against such companies following
periods of volatility in the market price of such companies' securities. If any
such litigation is instigated against us, it could result in substantial costs
and a diversion of management's attention and resources, which could have a
material adverse effect on our business, results of operations, and financial
condition.
Our executive officers and directors control a significant percentage of our
common stock and these shareholders may take actions that are adverse to your
interests.
Our executive officers and directors and entities affiliated with them, in
the aggregate, beneficially own approximately 24.0% of our common stock, 21.0%
of which is beneficially owned by our two co-founders, Simon Raab and Gregory
Fraser. As a result, these shareholders, acting together, can significantly
influence all matters requiring shareholder approval, including the election and
removal of directors and approval of significant corporate transactions such as
mergers, consolidations, and sales of assets. They also could dictate the
management of our business and affairs. This concentration of ownership could
have the effect of delaying, deferring, or preventing a change in control or
impeding a merger or consolidation, takeover, or other business combination,
which could cause the market price of our common stock to fall or prevent you
from receiving a premium in such a transaction.
28
Anti-takeover provisions in our articles of incorporation and bylaws and
provisions of Florida law could delay or prevent a change of control that you
may favor.
Our articles of incorporation, our bylaws, and Florida law could make it
more difficult for a third party to acquire us, even if doing so would be
beneficial to you. These provisions could discourage potential takeover attempts
and could adversely affect the market price of our shares. Because of these
provisions, you might not be able to receive a premium on your investment. These
provisions include:
o a limitation on shareholders' ability to call a special meeting of
our shareholders;
o advance notice requirements to nominate directors for election to
our board of directors or to propose matters that can be acted on by
shareholders at shareholder meetings; and
o the authority of the board of directors to issue, without
shareholder approval, preferred stock with such terms as the board
of directors may determine.
The provisions described above could delay or make more difficult
transactions involving a change in control of us, or our management.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Exposure
The Company conducts a significant portion of its business outside the
United States. At present, a slight majority of the Company's revenues are
invoiced, and a significant portion of its operating expenses paid, 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, and could specifically result in
foreign exchange gains and losses. The impact of future exchange rate
fluctuations on the results of the Company's operations cannot be accurately
predicted. To the extent that the percentage of the Company's non-U.S. dollar
revenues derived from international sales increases in the future, the Company's
exposure to risks associated with fluctuations in foreign exchange rates will
increase further.
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 2004.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page
--------
Independent Certified Public Accountant's Report 31
Consolidated Balance Sheets as of December 31, 2003 and 2002 32
Consolidated Statements of Operations for the Years Ended
December 31, 2003, 2002 and 2001 33
Consolidated Statements of Shareholders' Equity for the years Ended
December 31, 2003, 2002 and 2001 34
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001 35
Notes to the Consolidated Financial Statements 37 to 52
30
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT'S 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, 2003 and 2002, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 2003. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of FARO
Technologies, Inc. and subsidiaries at December 31, 2003 and 2002 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States.
As described in Note 6 to the financial statements, the Company adopted
Statement of Financial Accounting Standards No. 142 "Goodwill and Other
Intangible Assets", effective January 1, 2002.
/s/ ERNST & YOUNG LLP
Orlando, Florida
February 20, 2004
31
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2003 2002
--------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 17,424,901 $ 4,023,614
Short-term investments 16,037,208 1,437,537
Accounts receivable, net of allowance 16,312,978 14,236,160
Inventories, net 14,771,792 9,126,857
Deferred tax asset - current 564,841 --
Prepaid expenses and other current assets 1,465,690 1,142,576
------------ -------------
Total current assets 66,577,410 29,966,744
------------ -------------
Property and Equipment:
Machinery and equipment 5,612,391 5,338,681
Furniture and fixtures 2,552,766 1,342,207
Leasehold improvements 626,858 332,082
------------ -------------
Total Property, plant and equipment 8,792,015 7,012,970
Less accumulated depreciation (6,038,658) (4,995,111)
------------ -------------
Property, plant and equipment, net 2,753,357 2,017,859
------------ -------------
Intangible assets 25,130,684 21,024,009
Less accumulated amortization (13,691,309) (9,481,520)
------------ -------------
Intangible assets, net 11,439,375 11,542,489
Investments -- 427,478
Notes receivable -- 1,240,210
Deferred tax asset-net 1,143,746 --
------------ -------------
Total Assets $ 81,913,888 $ 45,194,780
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current portion of long-term debt $ 42,584 $ 49,450
Amounts due under credit line -- 1,459,647
Accounts payable 4,713,512 4,781,243
Accrued liabilities 4,776,778 3,202,231
Income taxes payable 605,456 106,954
Current portion of unearned service revenues 2,206,167 1,930,736
Customer deposits 363,346 97,942
------------ -------------
Total current liabilities 12,707,843 11,628,203
Unearned service revenues - less current portion 220,296 135,900
Long term debt 64,650 47,028
------------ -------------
Total Liabilities 12,992,789 11,811,131
------------ -------------
Shareholders Equity:
Common stock - par value $.001, 50,000,000 shares authorized; 13,518,998
and 11,931,726 issued; 13,478,998 and 11,891,726 outstanding, respectively 13,519 11,932
Additional paid-in-capital 75,133,219 49,462,548
Unearned compensation (226,954) (14,768)
Accumulated deficit (5,853,929) (14,131,669)
Other comprehensive income (loss) 5,869 (1,793,769)
Common stock in treasury, at cost - 40,000 shares (150,625) (150,625)
------------ -------------
Total shareholders' equity 68,921,099 33,383,649
------------ -------------
Total Liabilities and Shareholders Equity $ 81,913,888 45,194,780
------------ -------------
See accompanying notes to consolidated financial statements.
32
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
--------------------------------------------------
2003 2002 2001
--------------------------------------------------
SALES $ 71,785,980 $ 46,246,372 $ 36,121,696
COST OF SALES 29,520,249 21,109,609 14,304,083
--------------------------------------------------
Gross profit 42,265,731 25,136,763 21,817,613
OPERATING EXPENSES
Selling 18,341,409 13,891,917 13,436,209
General and administrative 9,116,166 7,873,338 5,812,803
Depreciation and amortization 2,119,030 2,267,763 2,559,495
Research and development 4,530,467 4,033,462 3,370,716
Employee stock options 718,524 9,526 --
--------------------------------------------------
Total operating expenses 34,825,596 28,076,006 25,179,223
--------------------------------------------------
INCOME (LOSS) FROM OPERATIONS 7,440,135 (2,939,243) (3,361,610)
--------------------------------------------------
OTHER INCOME (EXPENSES)
Interest income 81,680 561,112 900,281
Other income, net 1,959,806 601,336 (43,150)
Interest expense (46,351) (28,036) (1,747)
--------------------------------------------------
NET INCOME (LOSS) BEFORE INCOME TAX 9,435,270 (1,804,831) (2,506,226)
--------------------------------------------------
INCOME TAX EXPENSE 1,157,530 210,740 341,738
--------------------------------------------------
NET INCOME (LOSS) $ 8,277,740 $ (2,015,571) $ (2,847,964)
==================================================
NET INCOME (LOSS) PER SHARE - BASIC $ 0.68 $ (0.17) $ (0.26)
==================================================
NET INCOME (LOSS) PER SHARE - DILUTED $ 0.64 $ (0.17) $ (0.26)
==================================================
Weighted average shares - Basic 12,181,221 11,853,732 11,032,449
==================================================
Weighted average shares - Diluted 12,845,992 11,853,732 11,032,449
==================================================
See accompanying notes to the consolidated financial statements.
33
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional
------------------------------ Paid-in Unearned
Shares Amounts Capital Compensation
------------ ------------ ------------ ------------
BALANCE
JANUARY 1, 2001 11,065,225 $ 11,066 $ 47,070,059 $ --
Net loss
Currency translation adjustment, net of
Comprehensive loss
Options granted subject to variable 109,000 (109,000)
Issuances of common stock 10,027 9 25,028
---------- ------------ ------------ ------------
BALANCE
DECEMBER 31, 2001 11,075,252 $ 11,075 $ 47,704,087 $ (109,000)
Net loss
Currency translation adjustment, net of
Comprehensive loss
Options granted subject to variable (84,706) 84,706
Amortization of unearned compensation 9,526
Issuance of common stock in connection
with the acquisition of SMX 850,000 850 1,826,650
Issuance of common stock 6,474 7 16,517
---------- ------------ ------------ ------------
BALANCE
DECEMBER 31, 2002 11,931,726 $ 11,932 $ 49,462,548 $ (14,768)
Net income
Currency translation adjustment, net of
Comprehensive income
Options subject to variable accounting 930,710 (930,710)
Amortization of unearned compensation 718,524
Stock option exercised 528,839 529 1,300,509
Settlement of SMX arbitration settled in stock (99,567) (100) (1,155,873)
Tax benefit from employee stock option
exercises 1,419,678
Issuance of common stock, net of expenses 1,158,000 1,158 23,175,647
---------- ------------ ------------ ------------
BALANCE
DECEMBER 31, 2003 13,518,998 $ 13,519 $ 75,133,219 $ (226,954)
========== ============ ============ ============
Accumulated
Other Common
Accumulated Comprehensive Stock in
Deficit Income (Loss) Treasury Total
------------ ------------- ------------ ------------
BALANCE
JANUARY 1, 2001 $ (9,268,134) $ (2,206,913) $ (150,625) $ 35,955,453
Net loss (2,847,964) (2,847,964)
Currency translation adjustment, net of (796,065) (796,065)
Comprehensive loss (3,644,029)
Options granted subject to variable --
Issuances of common stock 25,037
------------ ------------ ------------ ------------
BALANCE
DECEMBER 31, 2001 $(12,116,098) $ (3,002,978) $ (150,625) $ 32,336,461
Net loss (2,015,571) (2,015,571)
Currency translation adjustment, net of 1,209,209 1,209,209
------------
Comprehensive loss (806,362)
Options granted subject to variable --
Amortization of unearned compensation 9,526
Issuance of common stock in connection
with the acquisition of SMX 1,827,500
Issuance of common stock 16,524
------------ ------------ ------------ ------------
BALANCE
DECEMBER 31, 2002 $(14,131,669) $ (1,793,769) $ (150,625) $ 33,383,649
Net income 8,277,740 8,277,740
Currency translation adjustment, net of 1,799,638 1,799,638
------------
Comprehensive income 10,077,378
Options subject to variable accounting --
Amortization of unearned compensation 718,524
Stock option exercised 1,301,038
Settlement of SMX arbitration settled in stock (1,155,973)
Tax benefit from employee stock option
exercises 1,419,678
Issuance of common stock, net of expenses 23,176,805
BALANCE ------------ ------------ ------------ ------------
DECEMBER 31, 2003 $ (5,853,929) $ 5,869 $ (150,625) $ 68,921,099
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
34
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
---------------------------------------------
2003 2002 2001
------------- ----------- -----------
CASH FLOWS FROM:
OPERATING ACTIVITIES:
Net income loss) $ 8,277,740 $(2,015,571) $(2,847,964)
Adjustments to reconcile net income (loss) to net cash
provided (used in) by operating activities
Depreciation and amortization 2,119,030 2,267,763 2,559,495
Settlement of SMX arbitration received in stock (1,155,973) -- --
Provision For bad debts 140,249 582,463 310,981
Foreign currency (gains) losses -- (184,027) --
Inventory write-down -- 729,286 --
Provision for inventory losses 904,513 663,269 856,551
Deferred income taxes (1,708,587) 76,418 802,722
Employee stock options (718,524) 9,526 --
Change in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable (617,962) (2,514,764) 197,437
Income taxes refundable -- 545,118 (545,118)
Inventories (4,091,519) (3,382,190) (178,323)
Prepaid expenses and other assets (228,618) 468,205 (796,145)
Increase (decrease) in:
Accounts payable and accrued liabilities 961,070 (1,805,060) (894,764)
Income taxes payable 440,270 106,953 (684,409)
Customer deposits 244,585 (947,999) 108,249
Deferred revenues 102,359 404,530 268,794
------------- ----------- -----------
Net cash provided by (used in) operating activities 4,668,633 (4,996,080) (842,494)
------------- ----------- -----------
INVESTING ACTIVITIES:
Acquisition of SMX -- (3,028,615) --
Purchases of property and equipment (1,429,809) (1,287,317) (788,168)
Payments for intangible assets (867,892) (810,895) (245,694)
Proceeds from repayment of notes receivable 1,240,210 -- (2,799,086)
Purchases of Investments (15,847,468) -- (2,150,029)
Proceeds from Investments 1,675,275 5,009,223 6,250,000
------------- ----------- -----------
Net cash provided by (used in) investing activities (15,229,684) (117,604) 267,023
------------- ----------- -----------
FINANCING ACTIVITIES:
Issuance of Treasury Stock -- -- --
Borrowings under line of credit -- 1,459,647 --
Payments of long-term debt, capital lease obligations and notes payable (1,459,205) (30,889) (16,497)
Proceeds from issuance of common stock, net 24,477,843 16,524 25,037
------------- ----------- -----------
Net cash provided by (used in) financing activities 23,018,638 1,445,282 8,540
------------- ----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 943,700 453,452 (223,823)
------------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 13,401,287 (3,214,950) (790,754)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,023,614 7,238,564 3,029,318
------------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 17,424,901 $ 4,023,614 $ 7,238,564
============= =========== ===========
See accompanying notes to consolidated financial statements.
35
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, and 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business--FARO Technologies, Inc. and subsidiaries
develops, manufactures, markets and supports Computer Aided Design (CAD)-based
quality assurance products and CAD-based inspection and statistical process
control software.
Principles of Consolidation--The consolidated financial statements include
the accounts of FARO Technologies, Inc. and all majority-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 (loss) income.
Revenue Recognition, Product Warranty and Extended Maintenance
Contracts--Revenue related to the Company's 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 deemed 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 in proportion to maintenance costs
projected to be 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. Revenue from
the licensing agreements for the use of its technology for medical applications
is generally recognized as received. Amounts representing royalties for the
current year and not received as of year end, are estimated as due (based on
historical data) and recognized in the current year.
Cash and Cash Equivalents--The Company considers cash on hand and amounts
on deposit with financial institutions which have original maturities of three
months or less to be cash and cash equivalents.
All short-term investments in debt securities which have maturities of
three months or less are classified as cash and equivalents, which are carried
at market value based upon the quoted market prices of those investments at each
respective balance sheet date.
Investments--Short-term investments ordinarily consist of short-term debt
securities acquired with cash not immediately needed in operations. Such amounts
have maturities not exceeding one year. Investments ordinarily consist of debt
securities acquired with cash not immediately needed in operations. Such amounts
have maturities of at least one year (none had maturities exceeding two years).
Investments consisted of the following:
December 31
----------------------------
2003 2002
----------- --------
Corporate bonds $ 432,153 $427,478
Commercial paper 15,605,055 --
----------- --------
$16,037,208 $427,478
=========== ========
36
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Management determines the appropriate classification of its short term
investments and investments in debt securities at the time of the purchase and
reevaluates such determinations at each balance sheet date. All investments in
debt securities are classified as held to maturity as the company has the
positive intent and ability to hold the securities to maturity. Held to maturity
securities are stated at amortized cost. The amortized cost of debt securities
is adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization and interest are included in other income in the consolidated
statements of operations. The Company's investments in debt securities are
diversified among high credit quality securities in accordance with the
Company's investment policy. The gross unrealized gain on all held to maturity
debt securities was approximately $0 and $13,000 at December 31, 2003 and 2002,
respectively.
Inventories--Inventories are stated at the lower of average cost or net
realizable value. Shipping and handling costs are classified as a component of
Cost of Sales in the Consolidated Statements of Operations. Sales demonstration
inventory is comprised of measuring devices utilized by sales representatives to
present the Company's products to customers. These products remain in sales
demonstration inventory for six to twelve 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 5 years
Furniture and fixtures 3 to 10 years
Leasehold improvements are amortized on the straight-line basis over the
lesser of the life of the asset or the term of the lease.
Intangibles--Goodwill represents the excess of purchase price over the
fair value of businesses acquired and was amortized on a straight-line basis
over 5 years through December 31, 2001. Effective January 1, 2002, the Company
ceased to amortize goodwill in accordance with the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets."
Other acquired intangibles principally include core technology, existing
product technology 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. Other
intangibles are amortized over periods ranging from 3 to 5 years.
Goodwill represents the excess cost of a business acquisition over the
fair value of the net assets acquired. In accordance with Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement
142"), indefinite-life identifiable intangible assets and goodwill are not
amortized. The Company periodically reviews its identifiable intangible assets
and goodwill, considering factors such as projected cash flows and revenue and
earnings multiples, to determine whether the value
37
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
of the assets are impaired and the amortization periods are appropriate. If an
asset is impaired, the difference between the value of the asset reflected on
the financial statements and its current fair value is recognized as an expense
in the period in which the impairment occurs.
The table below sets forth what reported net income and earnings per share
would have been in all periods presented, exclusive of amortization expense
recognized in those periods related to goodwill and other intangible assets that
are no longer being amortized.
For the Year Ended December 31,
------------------------------------------
2003 2002 2001
---------- ----------- -----------
Reported net income (loss) $8,277,740 $(2,015,571) $(2,847,964)
Add back: Goodwill amortization -- -- 740,946
---------- ----------- -----------
Adjusted net income (loss) $8,277,740 $(2,015,571) $(2,107,018)
Basic earnings per share
Reported net income (loss) $ 0.68 $ (0.17) $ (0.26)
Goodwill amortization -- -- 0.07
Adjusted net income (loss) $ 0.68 $ (0.17) $ (0.19)
Diluted earnings per share
Reported net income (loss) $ 0.64 $ (0.17) $ (0.26)
Goodwill amortization -- -- 0.07
Adjusted net income (loss) $ 0.64 $ (0.17) $ (0.19)
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--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,
investments, foreign exchange rate agreements, and accounts payable. The
carrying amounts of such financial instruments approximate their fair value.
Earnings Per Share--Basic earnings per share ("EPS") is computed by
dividing earnings available to common shareholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS 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 13.
Concentration of Credit Risk--Financial instruments which potentially
expose the Company to concentrations of credit risk consist principally of
corporate bonds, commercial paper and operating demand deposit accounts. The
Company's policy is to place its operating demand deposit accounts with high
credit quality financial institutions.
38
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
No customer represented more than 6% of the Company's total sales for the
years ended December 31, 2003, 2002 and 2001.
Stock-Based Compensation--In accordance with Statement of Financial
Accounting Standards ("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 Accounting Principle Board (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.
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,
------------------------------------------
2003 2002 2001
---------- ----------- -----------
Net income (loss), as reported $8,277,740 $(2,015,571) $(2,847,964)
Add Stock-based employee
compensation expense included in
reported net income, net of related
tax effects* 448,143 9,526 --
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (317,000) (386,801) (325,980)
---------- ----------- -----------
Pro forma net income (loss) $8,408,883 $(2,392,846) $(3,173,944)
---------- ----------- -----------
Earnings (loss) per share
Basic - as reported $ 0.68 $ (0.17) $ (0.26)
---------- ----------- -----------
Basic - pro forma $ 0.69 $ (0.21) $ (0.29)
---------- ----------- -----------
Diluted - as reported $ 0.64 $ (0.17) $ (0.26)
---------- ----------- -----------
Diluted - pro forma $ 0.65 $ (0.21) $ (0.29)
---------- ----------- -----------
* The years ended 2003 and 2002 assume a tax effect of 37.6% and 0%,
respectively.
The Company used the Black-Scholes option-pricing model to determine the
fair value of grants made. The following assumptions were applied in determining
the pro forma compensation cost:
Years Ended December 31,
2003 2002 2001
-------------- -------------- --------------
Risk-free interest rate 2.48% to 3.43% 2.51% to 5.13% 3.60% to 6.72%
Expected dividend yield 0% 0% 0%
Expected option life 3 - 10 years 3 - 10 years 1 - 10 years
Stock price volatility 74.20% 62.30% 62.50%
39
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The effects of applying SFAS No. 123 for the pro forma disclosures are not
representative of the effects expected on reported net (loss) income and income
per share in future years since the disclosures do not reflect compensation
expense for options granted prior to 1996.
In April 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving
Stock Compensation, an Interpretation of APB Opinion No. 25. FIN 44 clarifies
and modifies APB Opinion No. 25, Accounting for Stock Issued to Employees.
During 2001, certain options to purchase common stock were effectively re-priced
and are accounted for as variable plan options. (see also Note 12).
Long-Lived Assets--Long-lived assets, including property and equipment and
certain intangible assets to be held and used by the Company are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying value of the assets may not be recoverable. Impairment losses are
recognized if expected future undiscounted cash flows of the related assets are
less than their carrying values.
Estimates--The preparation of financial statements in conformity with
accounting principles generally accepted in the U.S. 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.
Foreign Exchange Rate Swap Agreement--In January 2001, the Company adopted
FASB Statement No. 133 (SFAS No. 133), "Accounting for Derivative Instruments
and Hedging Activities", as amended. SFAS No. 133 requires companies to
recognize all their derivative instruments as either assets or liabilities at
fair value in the statement of position. In September 2002, the Company entered
into a foreign exchange rate swap allowing the Company the right to purchase up
to $1.8 million at a base rate of 1.0444 Euros per $1.00. Under the agreement,
the Company and the bank are to compensate one another based on the exchange
rate agreement differential at specified measurement dates. This foreign
exchange rate agreement does not qualify for special hedge accounting treatment,
as it does not meet the specified criteria under SFAS No. 133. Therefore the
changes in fair value are included in the determination of earnings.
This foreign exchange rate agreement set to expire in September 2003 was
terminated in December 2002. During the year ended December 31, 2002, the
Company recognized a loss of $105,000 related to the change in fair value and
the subsequent termination of the foreign exchange rate agreement. This loss is
included in "Other Income."
Impact of Recently Issued Accounting Standards -In November 2002, the EITF
reached a consensus on Issue 00-21, Multiple-Deliverable Revenue Arrangements
("EITF 00-21"). EITF 00-21 addresses how to account for arrangements that may
involve the delivery or performance of multiple products, services, and/or
rights to use assets. The consensus mandates how to identify whether goods or
services or both that are to be delivered separately in a bundled sales
arrangement should be accounted for separately because they are "separate units
of accounting" The guidance can affect the timing of revenue recognition for
such arrangements, even though it does not change rules governing the timing or
pattern of revenue recognition of individual items accounted for separately. The
final consensus will be applicable to agreements entered into in fiscal years
beginning after June 15, 2003 with early adoption permitted. Additionally,
companies will be permitted to apply the consensus guidance to all
40
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
existing arrangements as the cumulative effect of a change in accounting
principle in accordance with APB Opinion No. 20, Accounting Changes. The Company
is assessing, but at this point does not believe the adoption of EITF 00-21 will
have a material impact on our financial position, cash flows or results of
operations.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46)
"Consolidation of Variable Interest Entities." This interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements," addresses
consolidation by business enterprises of variable interest entities. Under
current practice, two enterprises generally have been included in consolidated
financial statements because one enterprise controls the other through voting
interests. This interpretation defines the concept of "variable interests" and
requires existing unconsolidated variable interest entities to be consolidated
by their primary beneficiaries if the entities do not effectively disperse the
risks among the parties involved. This interpretation applied immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applied in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. If it is reasonably possible
that an enterprise will consolidate or disclose information about a variable
interest entity when this interpretation becomes effective, the enterprise shall
disclose information about those entities in all financial statements issued
after January 31, 2003. The interpretation may be applied prospectively with a
cumulative-effect adjustment as of the date on which it is first applied or by
restating previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year restated. We
have completed our assessment of this interpretation and determined that we are
not party to any variable interest entities as of December 31, 2003.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation- Transition and Disclosure (SFAS 148), an amendment of SFAS 123.
SFAS 148 provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
more prominent and more frequent disclosures in financial statements about the
effects of stock-based compensation. This statement is effective for financial
statements for fiscal years ending after December 15, 2002. Adoption of SFAS 148
did not have a material impact on the Company's financial position or results of
operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 (SFAS 149), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." This Statement amends and clarifies financial accounting
and reporting for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under Statement of Financial Accounting
Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities." The statement was effective for contracts entered into or modified
after June 30, 2003. The adoption of this standard did not have a material
impact on our financial position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 (SFAS 150), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This Statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This standard was effective at
the beginning of the first interim period beginning after June 15, 2003, except
for mandatorily redeemable financial instruments of nonpublic entities that are
subject to the provisions of this Statement for the first
41
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
fiscal period beginning after December 15, 2003. The adoption of this standard
did not have a material impact on our financial position or results of
operations.
Reclassification-Certain 2002 and 2001 amounts have been reclassified to
conform with 2003 classifications.
2. ACQUISITION
On January 16, 2002, the Company acquired SpatialMetriX Corporation ("SMX") in
exchange for 500,000 shares of FARO common stock (50,000 shares of which were
being held in escrow) and the satisfaction by the Company of certain obligations
of SMX. In connection therewith, the Company issued an additional 350,000 shares
of FARO common stock and paid $2.0 million in cash to fully satisfy SMX's
obligations to its two lenders. The Company also assumed and/or satisfied other
obligations of SMX. The transaction was recorded utilizing the purchase method
of accounting in accordance with Statement of Financial Accounting Standard No.
141, "Business Combinations".
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 $ 3,723,000
Intangible assets:
Purchased Technology 1,500,000
Patents and licenses 500,000
Goodwill 7,243,000
Liabilities assumed (5,778,000)
-----------
$ 7,188,000
===========
The operating results of SMX have been included in the consolidated
statements of operations since the date of acquisition. The following unaudited
pro forma results of operations for the year ended December 30, 2002 and 2001
are presented for informational purposes assuming that the Company had acquired
SMX as of January 1, 2001. These 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 the results of operations which may result in
the future.
Year ended December 31
------------------------------
2002 2001
(unaudited) (unaudited)
----------- -----------
Revenues $46,374,076 $47,408,591
Net loss $(2,520,984) $(8,757,839)
Loss per share:
Basic $ (0.21) $ (0.74)
Diluted $ (0.21) $ (0.74)
In 2003 the Company recorded approximately $1.1 million in "other income"
as a result of receiving approximately 100,000 shares of Company stock related
to a positive arbitration settlement between the Company and the former SMX
shareholders.
42
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. SUPPLEMENTAL CASH FLOW INFORMATION
Selected cash payments and non-cash activities were as follows:
Years ended December 31
------------------------------------
2003 2002 2001
---------- ---------- --------
Cash paid for interest $ 47,276 $ 22,927 $ 1,747
Cash paid for income taxes 1,525,644 -- 673,787
Non cash investing and financing activities
Fixed assets acquired under capital lease obligations 60,953 42,376 33,041
Issuance of common stock in connection with the
SMX acquisition -- 1,827,500 --
Conversion of SMX notes receivable in connection
with the SMX acquisition -- 2,875,000 --
4. ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is as follows:
Years ended December 31
-------------------------------------
2003 2002 2001
--------- --------- ---------
Balance, beginning of year $ 851,852 $ 339,715 $ 353,514
Provision 140,249 582,463 310,981
Amounts written off, net of recoveries (737,186) (70,326) (324,780)
--------- --------- ---------
Balance, end of year $ 254,915 $ 851,852 $ 339,715
========= ========= =========
5. INVENTORIES
Inventories, net consist of the following:
December 31
---------------------------
2003 2002
----------- ----------
Raw materials $ 5,624,061 $3,214,119
Work-in-process 352,104 1,580,667
Finished goods 1,435,112 793,094
Sales demonstration 7,360,515 3,538,977
----------- ----------
$14,771,792 $9,126,857
=========== ==========
43
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The allowance for obsolete and slow-moving inventory is as follows:
Years ended December 31
-----------------------------------------
2003 2002 2001
--------- --------- ---------
Balance, beginning of year $ 89,969 $ 297,508 $ 417,930
Charges to Cost of Sales 904,513 663,269 856,551
Amounts written off (839,835) (870,808) (976,973)
--------- --------- ---------
Balance, end of year $ 154,647 $ 89,969 $ 297,508
========= ========= =========
6. INTANGIBLE ASSETS
Intangible assets consist of the following:
December 31
-------------------------------
2003 2002
------------ ------------
Goodwill $ 10,239,788 $ 9,559,888
Existing product technology 5,527,108 3,777,842
Customer relationships 1,572,937 1,055,451
Product design costs 4,548,653 3,704,377
Patents 2,206,750 2,041,979
Other 1,035,448 884,472
------------ ------------
Total 25,130,684 21,024,009
Accumulated amortization (13,691,309) (9,481,520)
------------ ------------
Intangible assets - net $ 11,439,375 $ 11,542,489
============ ============
In 2003 approximately $3.2 million of the $4.1 million increase in total
intangible assets was a result of foreign currency translation. Amortization
expense was $986,805, $1,156,668, and $1,557,819 in 2003, 2002, and 2001,
respectively. Effective January 1, 2002, the Company stopped amortizing certain
indefinite-lived intangibles. This resulted in a decrease in amortization
expense of approximately $740,000. The estimated amortization expense for each
of the five succeeding fiscal years is as follows: 2004--$830,553;
2005--$780,174; 2006--$619,274; 2007--$359,949; 2008--$349,409.
7. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
December 31
--------------------------
2003 2002
---------- ----------
Accrued compensation and benefits $2,418,110 $1,173,438
Accrued royalties and warranties 613,829 114,328
Other accrued liabilities 1,744,839 1,914,465
---------- ----------
$4,776,778 $3,202,231
========== ==========
44
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. NOTES PAYABLE AND DEBT
The Company has available lines of credit aggregating $5,000,000. Drawings
under the lines of credit bear interest at a rate equivalent to a LIBOR plus
1.75%. There were no amounts outstanding under the line of credit at December
31, 2003. Borrowings under the lines of credit aggregated $1,459,647 at December
31, 2002.
December 31
----------------------
2003 2002
-------- -------
Loan and Obligations under capital leases 107,234 96,478
Less current portion (42,584) (49,450)
-------- -------
64,650 47,028
======== =======
Debt consists of the following:
Long-term debt at December 31, 2003 is due as follows: 2005--$31,871;
2006--$30,163; 2007--$2,615.
9. RELATED PARTY TRANSACTIONS
Related Party Lease--The Company leases its plant and office building from
Xenon Research, Inc. ("Xenon"), which is owned by a 17.5% shareholder. Pursuant
to the terms of the lease agreement, which expires in 2006, the Company has a
five-year renewal option. 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 $398,000 in
2003, $398,000 in 2002, and $391,000 in 2001.
Related Party Loans--In May 1998 the Company acquired CATS Gmbh, a German
company ("CATS"). On June 20, 2000 the Company and each of the former CATS
shareholders entered into an Amended and Restated Loan Agreement pursuant to
which the Company granted loans to the former CATS shareholders in the aggregate
amount of $1.1 million ("the Loans"). The Loans outstanding were for a term of
three years, at an interest rate of approximately 4.7%, and granted the
borrowers an option to extend the term for an additional three years. The loans
were repaid to the Company in 2003.
Related party consulting services--The Company engaged Cole & Partners, a
mergers and acquisition and corporate finance advisory service firm, to serve as
the Company's financial advisor in connection with the Company's acquisition in
January, 2002 of SpatialMetrix, Inc. Stephen R. Cole, one of the Company's
directors and member of the audit committee, is the founding partner and
president of Cole & Partners. The Company paid to Cole & Partners total fees of
approximately $450,000 for its services, of which $300,000 and $150,000 were
paid in 2002 and 2001 respectively.
10. INCOME TAXES
Income (Loss) before taxes consisted of the following:
Years ended December 31
-----------------------------------------
2003 2002 2001
---------- ----------- -----------
Domestic $6,455,000 $(1,349,335) $(2,229,368)
Foreign 2,980,270 (455,496) (276,868)
---------- ----------- -----------
Income (Loss) before income taxes $9,435,270 $ 1,804,831) $(2,506,226)
========== =========== ===========
45
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The components of the income tax expense (benefit) for income taxes are as
follows:
Years ended December 31
-------------------------------------------
2003 2002 2001
----------- --------- ---------
Current:
Federal $ 1,535,214 $ 119,076 $(460,984)
State 100,886 15,244 --
Foreign 571,561 -- --
----------- --------- ---------
2,207,661 134,320 (460,984)
----------- --------- ---------
Deferred:
Federal (985,378) 71,708 731,704
State (64,753) 4,712 71,018
Foreign -- -- --
----------- --------- ---------
(1,050,131) 76,420 802,722
----------- --------- ---------
$ 1,157,530 $ 210,740 $ 341,738
=========== ========= =========
Income tax expense (benefit) for the years ended December 31, 2003, 2002, and
2001 differ from the amount computed by applying the federal statutory corporate
rate to (loss) income before income taxes. The differences are reconciled as
follows:
Years ended December 31
-----------------------------------------
2003 2002 2001
----------- --------- -----------
Tax (benefit) expense at statutory rate $ 3,302,348 $(510,740) $ (775,605)
State income taxes, net of federal benefit 291,871 (32,078) (73,568)
Foreign tax rate difference 601,931 638,794 194,430
Research and development credit (106,047) (157,177) (159,160)
Nondeductible items 160,612 27,134 33,356
Change in deferred tax asset valuation allowance (3,973,812) 244,807 1,092,132
Change in foreign tax rate 380,627 -- --
Accrual for tax uncertainties 500,000 -- --
Other -- -- 30,153
----------- --------- -----------
Total income tax expense (benefit) $ 1,157,530 $ 210,740 $ 341,738
=========== ========= ===========
46
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The components of the Company's net deferred income tax asset are as follows:
December 31,
2003 2002
----------- -----------
Net deferred income tax asset - Current
Product design costs ($248,126) ($89,897)
Tax credits 675,132 503,850
Other 137,835 468,900
Valuation allowance -- (882,853)
----------- -----------
Net deferred income tax asset - Current 564,841 $ --
=========== ===========
Net deferred income tax asset - Non-current
Depreciation 488,941 426,909
Employee stock options 227,545 183,348
Unearned service revenue 427,260 313,753
Carryforwards 913,517 3,080,466
Valuation allowance (913,517) (4,004,476)
----------- -----------
Net deferred income tax asset - Non current $ 1,143,746 $ --
=========== ===========
At December 31, 2003 and December 31, 2002, the Company's domestic
entities had deferred income tax assets in the amount of $1,708,587 and $0,
respectively.
At December 31, 2003, the Company's foreign subsidiaries had deferred
income tax assets relating to net operating loss carry-forwards, which do not
expire, of $913,517. For financial reporting purposes, a valuation allowance of
$913,517 has been recognized to offset the deferred tax assets relating to the
net operating losses and intangible assets. The Company continues to maintain a
valuation allowance on net operating losses in jurisdictions for which it does
not have a history of income.
The Company reduced the overall valuation allowance on its assets in the
amount of $3,973,812. The reduction in the valuation allowance relates to the
use of deferred tax assets in foreign jurisdictions as well as the Company's
position that certain domestic deferred tax liabilities are more likely than not
to be utilized.
Significant judgment is required in determining our worldwide provision
for income taxes. In the ordinary course of a global business, there are many
transactions for which the ultimate tax outcome is uncertain. Some of the
uncertainties arise as a result of intercompany arrangements to share revenue
and costs. In such arrangements there are uncertainties about the amount and
manner of such sharing, which could ultimately result in changes once the
arrangements are reviewed by taxing authorities. Because the Company utilized
all of its domestic net operating loss carry forward in 2003, the Company
recorded an accrual for tax uncertainties and exposures.
47
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. COMMITMENTS AND CONTINGENCIES
Leases--The following is a schedule of future minimum lease payments
required under non-cancelable operating leases, including leases with related
parties (see Note 9), in effect at December 31, 2003:
Year Ending December 31 Amount
----------
2004 $1,145,251
2005 1,403,698
2006 936,589
2007 304,292
2008 159,596
Thereafter --
----------
Total future minimum lease payments $3,949,426
==========
Rent expense for 2003, 2002, and 2001, was approximately $1,148,000,
$1,004,000 and $1,101,000, respectively.
Litigation--The Company is not involved in any pending legal proceedings
other than routine litigation arising in the normal course of business. The
Company does not believe the results of such litigation, even if the outcome
were unfavorable to the Company, would have a material adverse effect on the
Company's business, financial condition or results of operations.
12. STOCK COMPENSATION PLANS
The Company has three stock option plans that provide for the granting of
stock options to key employees and non-employee 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
1997 Non-employee Director Plan provides for granting nonqualified stock options
and formula options to non-employee directors.
The Company is authorized to grant options for up to 703,100 shares of
Common Stock under the 1993 Plan, of which 7,032 options are currently
outstanding at exercise prices between $.36 and $3.60. These options vest over
primarily 3 and 4-year periods. The Company is also authorized to grant options
for up to 1,400,000 shares of Common Stock under the 1997 Plan, of which 897,920
options are currently outstanding at exercise prices between $1.50 and $10.34.
These options vest over a three-year period. The Company is also authorized to
grant up to 250,000 shares of Common Stock under the 1997 Non-employee Director
Plan of which 74,000 options are currently outstanding at exercise prices
between $2.21 and $4.48. Each non-employee director is granted 3,000 options
upon election to the Board of Directors and then annually upon attending the
annual meeting of shareholders (formula options). Formula options granted to
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.
48
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company's 1997 Non-Employee Directors' Fee Plan, under which the
Company is authorized to issue up to 250,000 shares of Common Stock, permits
non-employee 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.
In the fourth quarter of 2001, the Company cancelled approximately 548,000
"out of the money" options, including approximately 440,000 options issued under
the 1997 Plan and approximately 108,000 options issued under the 1997
Non-employee Director Plan. As a result, 91,000 options granted in 2001, under
the 1997 Plan and to holders of some of the options cancelled, were subjected to
variable accounting treatment. Under FIN No. 44, stock options issued within six
months of a cancellation must be accounted for as variable under certain
circumstances. Variable accounting requires companies to re-measure compensation
costs for the variable options until the options are exercised, cancelled, or
forfeited without replacement. Compensation is dependent on fluctuations in the
quoted stock prices for the Company's common stock. Such compensation costs will
be recognized over a three-year vesting schedule until the options are fully
vested, exercised, cancelled, or forfeited, after which time the compensation
will be recognized immediately at each reporting period.
Compensation costs charged to operations associated with the Company's
stock option plans were $718,000, $9,526, and $0 in 2003, 2002 and 2001,
respectively. Compensation cost was based on the difference between the value of
the stock, at the end of each accounting period, and its exercise price
multiplied by the number of shares vested in each year. The increases in stock
option associated compensation cost were due to the market price increase in the
Company's common stocks.
A summary of stock option activity and weighted average exercise prices follows:
Years Ended December 31,
-----------------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- -----------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
---------- ------- ---------- ------- ---------- -------
Outstanding at beginning
of year 1,554,513 $ 2.41 949,498 $ 4.19 1,291,315 $ 8.61
Granted 22,500 5.39 958,945 2.20 334,000 1.77
Cancelled -- -- -- -- (548,074) 12.45
Forfeited (69,222) 2.13 (352,930) 8.32 (123,197) 7.60
Exercised (528,839) 2.46 (1,000) 0.36 (4,546) 0.36
---------- ---------- ----------
Outstanding at end of year 978,952 2.42 1,554,513 2.41 949,498 4.19
========== ========== ==========
Outstanding exercisable at
year-end 501,631 $ 2.61 701,042 $ 2.77 474,464 $ 6.32
Weighted-average fair value
of options granted during
the year $ 3.35 $ 1.25 $ 1.00
49
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of stock options outstanding and exercisable as of December 31, 2003
follows:
Weighted-Average
Exercise Options Remaining Options
Price Outstanding Contractual Life (Years) Exercisable
----- ----------- ------------------------ -----------
Up to $1.50 131,296 7.84 62,882
$1.51 - $2.20 234,712 8.44 96,742
$2.21 - $2.40 317,502 6.87 104,667
$2.41 - $3.00 168,634 6.91 129,700
Over $3.00 126,808 3.32 107,640
------- -------
978,952 501,631
======= =======
Remaining non-exercisable options as of December 31, 2003 become exercisable as
follows:
Years Ending December 31 Amount
------------------------ -------
2004 282,920
2005 186,895
2006 7,506
-------
477,321
=======
13. EARNING (LOSS) PER SHARE
A reconciliation of the number of common shares used in calculation of
basic and diluted earning per share ("EPS") and loss per share ("LPS") is
presented below:
Years Ended December 31,
------------------------------------------------------------------------------------
2003 2002 2001
----------------------- ------------------------ ------------------------
PER-SHARE PER-SHARE PER-SHARE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------------------- ------------------------ ------------------------
Basic EPS 12,181,221 $0.68 11,853,732 ($0.17) 11,032,449 ($0.26)
Effect of Dilutive Securities:
Stock Options 664,771 ($0.04)
----------------------- ------------------------ ------------------------
Diluted EPS 12,845,992 $0.64 11,853,732 ($0.17) 11,032,449 ($0.26)
======================= ======================== ========================
The effect of 92,532 and 123,454 dilutive securities were not included in
the computations for the years 2002 and 2001 respectively, because to do so
would be antidilutive.
50
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. EMPLOYEE RETIREMENT BENEFITS PLAN
The Company maintains a 401(k) defined contribution retirement plan for
its U.S. 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 6% of compensation. Costs charged to operations in connection with
the Plan during 2003, 2002 and 2001 aggregated $113,316, $102,900, and $83,400
respectively.
15. 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
approximately 98% of consolidated sales and is the Company's only segment. 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 following table presents information about the Company by geographic
area:
December 31,
--------------------------------------------------------------------------------------------------------
2003 2002 2001
-------------------------------- -------------------------------- --------------------------------
Sales Long-lived Assets Sales Long-lived Assets Sales Long-lived Assets
----------- ----------------- ----------- ----------------- ----------- -----------------
Americas Region $37,862,618 $11,773,933 $22,471,470 $11,561,939 $14,764,091 $2,058,163
Europe/Africa Region 27,700,696 2,190,238 18,490,654 1,849,914 19,655,970 2,029,590
Asia Pacific Region 6,222,666 228,561 5,284,248 148,495 1,701,635 91,737
----------- ----------- ----------- ----------- ----------- ----------
$71,785,980 $14,192,732 $46,246,372 $13,560,348 $36,121,696 $4,179,490
----------- ----------- ----------- ----------- ----------- ----------
The geographical sales information presented above represents sales to customers
located in each respective region whereas the long-lived assets information
represents assets held in the respective regions.
51
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
March 29, June 28, September 27, December 31,
Quarter Ended 2003 2003 2003 2003
- ---------------------------------------------------------------------------------------------------------------
Sales $13,404,265 $16,243,469 $19,183,956 $22,954,290
Gross profit 7,504,685 10,060,436 11,030,876 13,669,735
Net income 489,364 1,558,049 3,333,888 2,896,439
Net income per share
Basic $ 0.04 $ 0.13 $ 0.28 $ 0.23
Diluted $ 0.04 $ 0.12 $ 0.26 $ 0.22
March 31, June 30, September 30, December 31,
Quarter Ended 2002 2002 2002 2002
- ---------------------------------------------------------------------------------------------------------------
Sales $ 8,721,611 $10,309,596 $12,104,696 $15,110,469
Gross profit 4,892,979 5,101,870 6,551,956 8,589,959
Net income (loss) (1,652,763) (2,006,136) 71,995 1,571,333
Net income (loss; per share:
Basic ($0.14) ($0.17) $ 0.01 $ 0.13
Diluted ($0.14) ($0.17) $ 0.01 $ 0.13
52
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 9A. Controls and Procedures.
Our management evaluated, with the participation of our Chief Executive Officer
and our Chief Financial Officer, the effectiveness of our disclosure controls
and procedures, as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange
Act, as of December 31, 2003. Based on this evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that our disclosure
controls and procedures are effective to ensure that information we are required
to disclose in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms.
There were no changes in our internal controls over financial reporting during
the quarter ended December 31, 2003, that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item with respect to identification of
directors and executive officers is incorporated by reference from the Company's
definitive Proxy Statement ("Proxy Statement") for the Annual Meeting of
Stockholders currently scheduled to be held on May 11, 2004 under the captions
"Board of Directors" and "Executive Officers and Key Employees," respectively
and, with respect to executive officers, from the section of this Report in Part
I, Item 1, entitled "Management of the Registrant."
The information required by this item with respect to the information required
under Item 405 of Regulation S-K is incorporated by reference from the Proxy
Statement under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance."
The information concerning our Code of Business Conduct and Ethics required by
this item is incorporated by reference from the Proxy Statement under the
caption "Code of Business Conduct and Ethics".
The information concerning our audit committee and audit committee financial
experts required by this item is incorporated by reference from the Proxy
Statement under the caption "Board and Committee Meetings".
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference from the
Proxy Statement under the caption "Executive Compensation" 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" and provided, further, that the Proxy Statement also
included compensation information for the other key employees of the Company
that are not executive officers.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required under this item is incorporated by reference from
the Proxy Statement under the captions "Security Ownership of Management and
Principal Stockholders" and "Equity Compensation Plans."
53
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required under this item is incorporated by reference from
the Proxy Statement under the captions "Certain Relationships and Related
Transactions" and "Compensation Committee Interlocks."
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information required under this item is incorporated by reference from the
Proxy Statement under the caption "Principal Accountant Fees and Services".
54
PART IV
ITEM 15. 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 Ernst & Young LLP, Independent Certified Public Accountants,
filed as part of this Form 10-K. Additionally, incorporated herein by
reference to Exhibit 99.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2001, are the audited financial statements
of SpatialMetrix Corporation ("SMX") for each of the two years in the
period ended December 31, 2001.
(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)
4.2 Registration Rights Agreement, dated November 11, 2003, by and
among FARO Technologies, Inc. and the investors named on the
signature pages thereto. (Filed as Exhibit 4.1 to Registrant's
Current report on Form 8-K, dated November 11, 2003and
incorporated herein by reference)
10.1 1993 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)
55
Exhibit No. Description
- ----------- --------------------------------------------------------------
10.4 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)
10.5 First Amendment to Business Lease, dated as of January 20,
1998, between the Registrant (as successor by merger to FARO
Medical Technologies (US), Inc.) and Xenon Research, Inc.,
(Filed as Exhibit 10.12 to Registrant's Form 10-K for calendar
year 1997, No. 0-23081 and incorporated herein by reference)
10.6 Securities Purchase Agreement, dated November 11, 2003, by and
among the Company, Xenon Research, Snc., a Florida
corporation, and Gregory A. Fraser, and the investors named on
the signature pages thereto. (Filed as Exhibit 10.1 to
Registrant's Current report on Form 8-K dated November 11,
2003 and incorporated herein by reference)
10.7 Loan Agreement, dated as of September 17, 2003, by and between
FARO Technologies, Inc. and SunTrust Bank. (Filed as Exhibit
10.2 to Registrant's Current report on Form 8-K dated November
11, 2003 and incorporated herein by reference)
21.1 List of Subsidiaries (Filed as Exhibit 21.1 to Registrant's
Form 10-K for calendar year 2001. No. 0-23081 and incorporated
herein by reference)
23.1 Consent of Ernst & Young LLP (Filed herewith)
56
Exhibit No. Description
- ----------- --------------------------------------------------------------
24.1 Power of Attorney relating to subsequent amendments (included
on the signature page(s) of this report).
31.1 Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
99.1 Properties for calendar year 2003.
99.2 Audited Financial Statements of SpatialMetrix Corporation for
the two years in the period ended December, 31, 2001 (Filed as
Exhibit 99.2 to Registrant's Form 10-K for calendar year 2001,
No. 0-23081 and incorporated herein by reference)
(b) Reports on Form 8-K
On October 30, 2003 the Company filed a report on Form 8-K in connection
with a press release announcing its results of operations for the quarter ended
September 27, 2003.
On November 12, 2003 the Company filed a report on Form 8-K in connection
with a press release announcing a private placement of Company common stock by
the Company and its two co-founders.
On November 13, 2003 the Company filed a report on Form 8-K in connection
with the sale to certain institutional investors by the Company of 1,158,000
shares of the Company common stock and by two of the Company's founders of
772,000 shares of the Company common stock.
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.
Date: March 23, 2004 By: /s/ Gregory A. Fraser
------------------------------------
Gregory A. Fraser
Executive Vice President, Secretary
and Treasurer
(Duly Authorized Officer and
Principal Financial Officer)
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.
57
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.
Signature Title Date
--------- ----- ----
/s/ Simon Raab Chairman of the Board, President, March 23, 2004
- ---------------------------- Chief Executive Officer (Principal
Simon Raab Executive Officer), and Director
/s/ Gregory A. Fraser Executive Vice President, Secretary, March 23, 2004
- ---------------------------- Treasurer, and Director
Gregory A. Fraser
/s/ Hubert d'Amours Director March 23, 2004
- ----------------------------
Hubert d'Amours
/s/ Stephen R. Cole Director March 23, 2004
- ----------------------------
Stephen R. Cole
/s/ Norman H. Schipper Director March 23, 2004
- ----------------------------
Norman H. Schipper
/s/ Andre Julien Director March 23, 2004
- ----------------------------
Andre Julien
58