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| FARO > SEC Filings for FARO > Form 10-Q on 1-May-2012 | All Recent SEC Filings |
1-May-2012
Quarterly Report
The following information should be read in conjunction with the Consolidated Financial Statements, including the notes thereto, included elsewhere in this Form 10-Q, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.
FARO Technologies, Inc. ("FARO", the "Company", "us", "we", or "our") has made "forward-looking statements" in this report (within the meaning of the Private Securities Litigation Reform Act of 1995). Statements that are not historical facts or that describe our plans, beliefs, goals, intentions, objectives, projections, expectations, assumptions, strategies, or future events are forward-looking statements. In addition, words such as "may," "will," "believe," "plan," "should," "could," "seek," "expect," "anticipate," "intend," "estimate," "project" and similar words, or discussions of our strategy or other intentions identify forward-looking statements. Specifically, this Quarterly Report on Form 10-Q contains, among others, forward-looking statements regarding:
the Company's ability to achieve and maintain profitability;
the impact of fluctuations in exchange rates;
the effect of estimates and assumptions with respect to critical accounting policies and the impact of the adoption of recently issued accounting pronouncements;
the impact of changes in technologies on the competitiveness of the Company's products or their components;
the magnitude of increased warranty costs from new product introductions and enhancements to existing products;
the sufficiency of the Company's plants to meet its manufacturing requirements;
the outcome of litigation and its effect on the Company's business, financial condition or results of operations;
the continuation of the Company's share repurchase program;
the sufficiency of the Company's working capital, cash flow from operations, and credit facility to fund its long-term liquidity requirements;
the impact of geographic changes in the manufacturing or sales of the Company's products on its tax rate; and
the imposition of penalties against the Company for failure to comply with its continuing obligations with respect to the Foreign Corrupt Practices Act ("FCPA") Matter.
Forward-looking statements are not guarantees of future performance and are subject to a number of known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Consequently, undue reliance should not be placed on these forward-looking statements. The Company does not intend to update any forward-looking statements, whether as a result of new information, future events, or otherwise, unless otherwise required by law. Important factors that could cause actual results to differ materially from those contemplated in such forward-looking statements include, among others, the following:
economic downturn in the manufacturing industry or the domestic and international economies in the regions of the world where the Company operates;
the Company's inability to further penetrate its customer base and target markets;
development by others of new or improved products, processes or technologies that make the Company's products obsolete or less competitive;
the Company's inability to successfully identify and acquire target companies or achieve expected benefits from acquisitions that are consummated;
the cyclical nature of the industries of the Company's customers and material adverse changes in its customers' access to liquidity and capital;
the market potential for the computer-aided measurement ("CAM2") market and the potential adoption rate for the Company's products are difficult to quantify and predict;
the inability to protect the Company's patents and other proprietary rights in the United States and foreign countries;
fluctuations in the Company's annual and quarterly operating results and the
inability to achieve its financial operating targets as a result of a number
of factors, including, without limitation (i) litigation and regulatory
action brought against the Company, (ii) quality issues with its products,
(iii) excess or obsolete inventory, (iv) raw material price fluctuations,
(v) expansion of the Company's manufacturing capability and other
inflationary pressures, (vi) the size and timing of customer orders,
(vii) the amount of time that it takes to fulfill orders and ship the
Company's products, (viii) the length of the Company's sales cycle to new
customers and the time and expense incurred in further penetrating its
existing customer base, (ix) increases in operating expenses required for
product development and new product marketing, (x) costs associated with new
product introductions, such as product development, marketing, assembly line
start-up costs and low introductory period production volumes, (xi) the
timing and market acceptance of new products and product enhancements,
(xii) customer order deferrals in anticipation of new products and product
enhancements, (xiii) the Company's success in expanding its sales and
marketing programs, (xiv) start-up costs associated with opening new sales
offices outside of the United States, (xv) fluctuations in revenue without
proportionate adjustments in fixed costs, (xvi) the efficiencies achieved in
managing inventories and fixed assets, (xvii) investments in potential
acquisitions or strategic sales, product or other initiatives,
(xviii) shrinkage or other inventory losses due to product obsolescence,
scrap or material price changes, (xix) adverse changes in the manufacturing
industry and general economic conditions, (xx) compliance with government
regulations including health, safety, and environmental matters, (xxi) the
ultimate costs of the Company's monitoring obligations in respect of the FCPA
matter; and (xxii) other factors noted herein;
changes in gross margins due to changing product mix of products sold and the different gross margins on different products, or as a result of extraordinary production costs associated with the roll-out of new products:
the Company's inability to successfully maintain the requirements of Restriction of use of Hazardous Substances ("RoHS") and Waste Electrical and Electronic Equipment ("WEEE") compliance in its products;
the inability of the Company's products to displace traditional measurement devices and attain broad market acceptance;
the impact of competitive products and pricing in the CAM2 market and the broader market for measurement and inspection devices;
the effects of increased competition as a result of recent consolidation in the CAM2 market;
risks associated with expanding international operations, such as fluctuations in currency exchange rates, difficulties in staffing and managing foreign operations, political and economic instability, compliance with import and export regulations, and the burdens and potential exposure of complying with a wide variety of U.S. and foreign laws and labor practices;
the loss of the Company's Chief Executive Officer or other key personnel;
difficulties in recruiting research and development engineers and application engineers;
the failure to effectively manage the effects of the Company's growth;
variations in the effective income tax rate and the difficulty in predicting the tax rate on a quarterly and annual basis;
the loss of key suppliers and the inability to find sufficient alternative suppliers in a reasonable period or on commercially reasonable terms; and
other risks and uncertainties discussed in Part I, Item 1A. Risk Factors in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.
Overview
The Company designs, develops, manufactures, markets and supports portable, software driven, 3-D measurement and imaging systems that are used in a broad range of manufacturing, industrial, building construction and forensic applications. The Company's FaroArmฎ, FARO Laser ScanArmฎ and FARO Gage articulated measuring devices, the FARO Laser Tracker ION, the FARO Focus3D, the FARO 3D Imager AMP and their companion CAM2ฎ software, provide for Computer-Aided Design, or CAD,-based inspection and/or factory-level statistical process control, and high-density surveying. Together, these products integrate the measurement, quality inspection, and reverse engineering functions 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 measurement.
As of March 31, 2012, the Company's products have been purchased by approximately 13,000 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 America International, Lockheed Martin, Nissan, Siemens and Volkswagen, among many others.
The Company derives revenues primarily from the sale of its FaroArm, FARO Laser ScanArm, FARO Gage, FARO Laser Tracker ION and FARO Focus3D measurement equipment, and their related multi-faceted software. Revenue related to these products is generally recognized upon shipment. In addition, the Company sells one and three-year extended warranties and training and technology consulting services relating to its products. The Company recognizes the revenue from extended warranties on a straight-line basis. The Company also receives royalties from licensing agreements for its historical medical technology and recognizes the revenue from these royalties as licensees use the technology.
The Company manufactures its FaroArm, FARO Gage, FARO 3D Imager AMP, and FARO Laser Tracker ION products in the Company's manufacturing facilities located in Florida and Pennsylvania for customer orders from the Americas, in its manufacturing facility located in Switzerland for customer orders from the Europe/Africa region and in its manufacturing facility located in Singapore for customer orders from the Asia/Pacific region. The Company manufactures its FARO Focus3D product in its facility located in Stuttgart, Germany. The Company expects all its existing plants to have the production capacity necessary to support its volume requirements through 2012.
The Company operates in international markets throughout the world. It maintains sales offices in the United States, Brazil, Mexico, France, Germany, Great Britain, Italy, Netherlands, Poland, Spain, China, India, Japan, Malaysia, Singapore, Thailand, and Vietnam. The Company manages and reports its global sales in three regions: the Americas, Europe/Africa and Asia/Pacific.
In the first quarter of 2012, 38.4% of the Company's sales were in the Americas compared to 36.8% in the first three months of 2011, 35.3% were in the Europe/Africa region compared to 36.2% in the first quarter of 2011, and 26.3% were in the Asia/Pacific region compared to 27.0% in the same prior year period. In the first quarter of 2012, new order bookings increased $6.2 million, or 11.1%, to $62.1 million from $55.9 million in the prior year period. New orders in the first quarter of 2012 increased $1.4 million, or 6.9%, in the Americas to $21.8 million from $20.4 million in the prior year period. New orders in the first quarter of 2012 increased $1.4 million, or 6.5%, to $22.8 million in Europe/Africa from $21.4 million in the first quarter of 2011. In Asia/Pacific, new orders in the first three months of 2012 increased $3.4 million, or 24.1% to $17.5 million from $14.1 million in the first quarter of 2011.
The Company accounts for wholly owned foreign subsidiaries in the currency of the respective foreign jurisdiction; 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 the availability of off-balance sheet financial instruments to hedge exposure to foreign currency exchange rates, including cross-currency swaps, forward contracts and foreign currency options (see Foreign Exchange Exposure below). However, it does not regularly use such instruments, and none were utilized in 2011 or the three months ended March 31, 2012.
The Company was profitable in each quarter in the years ended December 31, 2011 and December 31, 2010. The Company incurred a net loss in the year ended December 31, 2009, primarily as a result of a decrease in product sales. The Company attributes the decrease in product sales principally to the decline of the global economy. Prior to 2009, the Company had a history of sales and earnings growth and 26 consecutive profitable quarters through December 31, 2008. Its historical sales and earnings growth were the result of a number of factors, including: continuing market demand for and acceptance of the Company's products; increased sales activity in part through additional sales staff worldwide, new products and product enhancements such as the FARO Edge Arm and FARO Focus3D, and the effect of acquisitions. However, the Company's historical financial performance is not indicative of its future financial performance.
FCPA Update
As previously reported by the Company, the Company conducted an internal investigation in 2006 into certain payments made by its China subsidiary that may have violated the Foreign Corrupt Practices Act, or the FCPA, and other applicable laws, which we refer to as the FCPA Matter, and entered into settlement agreements and related documents with the SEC and the U.S. Department of Justice, or the DOJ, in 2008 related to the FCPA Matter. Under the terms of the agreements with the SEC and the DOJ, the Company assumed a two-year monitoring obligation and other continuing obligations with respect to compliance with the FCPA and other laws, including full cooperation with the U.S. government and the adoption of a compliance code containing specific provisions intended to prevent violations of the FCPA. During the second quarter of 2010, the Company, in conjunction with the SEC and the DOJ, completed the selection of the FCPA monitor. As a result of delays in the SEC/DOJ approval of the monitor, the Company is currently still in the monitoring period, which otherwise would have already expired. The Company is cooperating with the monitor as the monitor completes a work plan to assess the Company's compliance with the requirements of the settlement agreements. Failure to comply with any continuing obligations with respect to the FCPA Matter could result in the SEC and the DOJ seeking to impose penalties against the Company in the future.
Results of Operations
Three Months Ended March 31, 2012 Compared to the Three Months Ended April 2, 2011
Sales increased by $12.6 million, or 24.1%, to $65.2 million in the three months ended March 31, 2012 from $52.6 million for the three months ended April 2, 2011. This increase resulted primarily from an increase in worldwide demand for our products. Product sales increased by $11.4 million, or 26.7%, to $54.4 million for the three months ended March 31, 2012 from $43.0 million for the first quarter of 2011. Service revenue increased by $1.2 million, or 12.5%, to $10.8 million for the three months ended March 31, 2012 from $9.6 million in the same period during the prior year, primarily due to an increase in warranty revenue.
Sales in the Americas region increased $5.8 million, or 29.7%, to $25.1 million for the three months ended March 31, 2012 from $19.3 million in the three months ended April 2, 2011. Product sales in the Americas region increased by $5.4 million, or 35.0%, to $20.6 million for the three months ended March 31, 2012 from $15.2 million in the first quarter of the prior year. Service revenue in the Americas region increased by $0.4 million, or 9.8%, to $4.5 million for the three months ended March 31, 2012 from $4.1 million in the same period during the prior year, primarily due to an increase in Customer Service revenue.
Sales in the Europe/Africa region increased $3.9 million, or 21.2%, to $23.0 million for the three months ended March 31, 2012 from $19.1 million in the three months ended April 2, 2011. Product sales in the Europe/Africa region increased by $3.5 million, or 23.7%, to $18.8 million for the three months ended March 31, 2012 from $15.3 million in the first quarter of the prior year. Service revenue in the Europe/Africa region increased $0.4 million, or 10.9%, to $4.2 million for the three months ended March 31, 2012 from $3.8 million in the same period during the prior year.
Sales in the Asia/Pacific region increased $2.9 million, or 20.4%, to $17.1 million for the three months ended March 31, 2012 from $14.2 million in the three months ended April 2, 2011. Product sales in the Asia/Pacific region increased by $2.5 million, or 20.2%, to $15.0 million for the three months ended March 31, 2012 from $12.5 million in the first quarter of the prior year. Service revenue in the Asia/Pacific region increased by $0.4 million, or 22.1%, to $2.1 million for the three months ended March 31, 2012 from $1.7 million in the same period during the prior year.
Gross profit increased by $6.9 million, or 22.8%, to $37.2 million for the three months ended March 31, 2012 from $30.3 million for the three months ended April 2, 2011. Gross margin decreased to 57.0% for the three months ended March 31, 2012 from 57.6% for the three months ended April 2, 2011. The decrease in gross margin is primarily due to a decrease in gross margin from product sales to 62.3% in the three months ended March 31, 2012 from 63.7% for the three months ended April 2, 2011. Gross margin from product sales decreased primarily as a result of a change in the historical product sales mix caused by the increase in sales of the new Laser Scanner product which currently has a lower gross margin. Gross margin from service revenues was 30.0% both periods.
Selling expenses increased by $1.8 million, or 13.3%, to $16.0 million for the three months ended March 31, 2012 from $14.2 million for three months ended April 2, 2011. This increase was primarily due to an increase in compensation expense of $0.8 million, an increase in marketing and advertising costs of $0.4 million and an increase in travel related costs of $0.4 million.
Worldwide sales and marketing headcount increased by 15, or 4.6%, to 338 at March 31, 2012 from 323 at April 2, 2011. Regionally, the Company's sales and marketing headcount increased by 7, or 8.0%, to 94 from 87 for the Americas; decreased by 4, or 3.4%, in Europe/Africa to 113 from 117; and increased by 12, or 10.1%, in Asia/Pacific to 131 from 119.
As a percentage of sales, selling expenses decreased to 24.6% of sales in the three months ended March 31, 2012 from 26.9% of sales in the three months ended April 2, 2011. Regionally, selling expenses were 22.4% of sales in the Americas for the quarter compared to 22.9% of sales in the first quarter of 2011; 27.8% of sales for Europe/Africa compared to 32.4% of sales from the same period in the prior year; and 23.4% of sales for Asia/Pacific compared to 25.1% of sales from the same period in the prior year.
General and administrative expenses were flat at $6.6 million for the three months ended March 31, 2012 and for the three months ended April 2, 2011.
Depreciation and amortization expenses increased slightly to $1.7 million for the three months ended March 31, 2012 from $1.6 million for the three months ended April 2, 2011.
Research and development expenses increased to $4.4 million for the three months ended March 31, 2012 from $3.6 million for the three months ended April 2, 2011 primarily as a result of an increase in compensation expense of $0.5 million. Research and development expenses as a percentage of sales decreased to 6.8% for the three months ended March 31, 2012 from 6.9% for the three months ended April 2, 2011.
Other (income) expense, net remained flat at $0.1 million of income for the three months ended March 31, 2012, and for the three months ended April 2, 2011, and consisted primarily of net foreign currency transaction gains resulting from changes in foreign exchange rates on the value of the current intercompany account balances of the Company's subsidiaries denominated in different currencies.
Income tax expense increased by $0.7 million to $1.9 million for the three months ended March 31, 2012 from $1.2 million for the three months ended April 2, 2011. This increase was primarily due to an increase in pretax income. The Company's effective tax rate decreased to 22.1% for the three months ended March 31, 2012 from 26.5% in the prior year period, primarily as a result of a decrease in taxable income in jurisdictions with higher tax rates, and included a reduction in the income tax rates of 5.0% and 3.5%, respectively, related to the tax benefit of the exercise of employee stock options. The Company's tax rate continues to be lower than the statutory tax rate in the United States, primarily as a result of favorable tax rates in foreign jurisdictions. However, the Company's tax rate could be impacted positively or negatively by geographic changes in the manufacturing or sales of its products and the resulting effect on taxable income in each jurisdiction.
Net income increased by $3.5 million to $6.7 million for the three months ended March 31, 2012 from $3.2 million for the three months ended April 2, 2011 as a result of the factors described above.
Liquidity and Capital Resources
Cash and cash equivalents increased by $9.1 million to $73.6 million at March 31, 2012 from $64.5 million at December 31, 2011. The increase was primarily attributable to an increase in net income and non-cash expenses of $9.2 million and proceeds from stock option exercises of $5.2 million, offset by an increase in working capital of $3.8 million, purchases of equipment and intangible assets of $0.9 million, and the effect of exchange rate changes on cash of $0.6 million.
On July 11, 2006, the Company entered into a loan agreement providing for an available line of credit of $30.0 million, which was most recently amended effective March 15, 2012. Loans under the Amended and Restated Loan Agreement, as amended, bear interest at the rate of LIBOR plus a fixed percentage between 1.50% and 2.00% and require the Company to maintain a minimum cash balance and tangible net worth measured at the end of the Company's fiscal quarters. As of March 31, 2012, the Company was in compliance with all of the covenants under the Amended and Restated Loan Agreement, as amended. The term of the Amended and Restated Loan Agreement, as amended, extends to March 31, 2015. The Company has not drawn on this line of credit.
The Company believes that its working capital, anticipated cash flow from operations, and credit facility will be sufficient to fund its long-term liquidity requirements for the foreseeable future.
The Company has no off balance sheet arrangements.
Critical Accounting Policies
The preparation of the Company's consolidated financial statements requires the Company's management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as disclosure of contingent assets and liabilities. The Company bases its estimates on historical experience, along with various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Some of these judgments can be subjective and complex and, consequently, actual results may differ from these estimates under different assumptions or conditions. While for any given estimate or assumption made by the Company's management there may be other estimates or assumptions that are reasonable, the Company believes that, given the current facts and circumstances, it is unlikely that applying any such other reasonable estimate or assumption would materially impact the financial statements.
In response to the SEC's financial reporting release, FR-60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies," the Company has selected its critical accounting policies for purposes of explaining the methodology used in its calculation, in addition to any inherent uncertainties pertaining to the possible effects on its financial condition. The critical policies discussed below are the Company's processes of recognizing revenue, the reserve for excess and obsolete inventory, income taxes, the reserve for warranties and goodwill impairment. These policies affect current assets and operating results and are therefore critical in assessing the Company's financial and operating status. These policies involve certain assumptions that, if incorrect, could have an adverse impact on the Company's operations and financial position.
Revenue Recognition
Revenue related to the Company's measurement equipment and related software is generally 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 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 on a straight-line basis over the life of the plan. The Company warrants its products against defects in design, materials and workmanship for one year. A provision for estimated future costs relating to warranty expense is recorded when products are shipped. Costs relating to extended maintenance plans are recognized as incurred. Revenue from the licensing agreements for the use of the Company's historical technology for medical applications is recognized when the technology is sold by the licensees.
Reserve for Excess and Obsolete Inventory
Since the value of inventory that will ultimately be realized cannot be known with exact certainty, the Company relies upon both past sales history and future sales forecasts to provide a basis for the determination of the reserve. Inventory is considered obsolete if the Company has withdrawn those products from the market or had no sales of the product for the past 12 months and has no sales forecasted for the next 12 months. Inventory is considered excess if the quantity on hand exceeds 12 months of expected remaining usage. The resulting obsolete and excess parts are then reviewed to determine if a substitute usage or a future need exists. Items without an identified current or future usage are . . .
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