SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1999 [ ] 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 of (I.R.S. Employer incorporation or organization) Identification No.) 125 TECHNOLOGY PARK DRIVE, LAKE MARY, FLORIDA 32746 - --------------------------------------------- ------------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, including area code: 407-333-9911 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 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 the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: Class: Voting Common Stock, $.001 Par Value Outstanding at November 12, 1999: 11,351,670 1
FARO Technologies Inc. Index to Form 10-Q PART I. FINANCIAL INFORMATION Page Number Item 1. Financial Statements Condensed Consolidated Balance Sheets as of December 31, 1998 and September 30, 1999 3 Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 1998 and 1999 4 Condensed Consolidated Statement of Shareholders' Equity 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1999 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 13 PART II. OTHER INFORMATION Item 5. Other Information 13 Item 6. Exhibits and Reports on Form 8-K 13 Signatures 14 2
PART I. FINANCIAL INFORMATION Item 1. Financial Statements FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1999 1998 (UNAUDITED) ------------- -------------- <S> <C> <C> CURRENT ASSETS: Cash and cash equivalents $ 1,183,656 $ 1,747,152 Short term investments 8,314,337 10,600,492 Accounts receivable - net of allowance 8,963,343 7,879,215 Income taxes refundable 716,048 1,336,785 Inventories 6,443,618 8,290,160 Prepaid expenses and other assets 155,037 311,713 Deferred income taxes 121,543 26,543 ------------ ------------ Total current assets 25,897,582 30,192,060 ------------ ------------ PROPERTY AND EQUIPMENT - at cost: Machinery and equipment 1,873,146 2,438,047 Furniture and fixtures 899,616 936,838 Leasehold improvements 28,889 34,120 ------------ ------------ Total 2,801,651 3,409,005 Less accumulated depreciation (1,276,459) (1,932,909) ------------ ------------ Property and equipment, net 1,525,192 1,476,096 ------------ ------------ INTANGIBLE ASSETS - net 12,821,191 11,351,302 NOTES RECEIVABLE 178,688 132,196 Long-term investments 8,697,494 4,337,620 DEFERRED INCOME TAXES -- 52,617 ------------ ------------ TOTAL ASSETS $ 49,120,147 $ 47,541,891 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Short term notes payable to banks $ 296,230 Accounts payable and accrued liabilities 2,852,452 $ 4,490,462 Current portion of unearned service revenues 329,731 463,268 Current portion of long-term debt 4,156 -- Customer deposits 114,738 108,310 ------------ ------------ Total current liabilities 3,597,307 5,062,040 DEFERRED INCOME TAXES 78,220 -- UNEARNED SERVICE REVENUES - less current portion 31,905 66,895 LONG TERM DEBT - less current portion 37,324 6,275 ------------ ------------ TOTAL LIABILITIES 3,744,756 5,135,210 ------------ ------------ SHAREHOLDERS' EQUITY: Class A preferred stock - par value $.001, 10,000,000 shares authorized, no shares issued and outstanding Common stock - par value $.001, 50,000,000 shares authorized, 11,048,137 and 11,058,336 issued and 11,008,137 and 11,018,336 outstanding, respectively 11,048 11,059 Additional paid-in-capital 47,520,732 47,542,190 Unearned compensation (292,316) (165,632) Retained earnings (deficit) (1,912,829) (4,881,925) Accumulated other comprehensive income: Cumulative translation adjustments, net of tax 199,381 51,614 Treasury stock (150,625) (150,625) ------------ ------------ Total shareholders' equity 45,375,391 42,406,681 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 49,120,147 $ 47,541,891 ============ ============ </TABLE> See accompanying notes to condensed consolidated financial statements. 3
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- ---------------------------- 1998 1999 1998 1999 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Sales $ 4,972,182 $ 7,025,005 $ 19,376,191 $ 22,540,937 Cost of sales 2,460,143 3,391,029 7,921,748 9,577,211 ------------ ------------ ------------ ------------ Gross profit 2,512,039 3,633,976 11,454,443 12,963,726 Operating expenses: Selling 2,870,373 2,824,957 6,665,432 8,120,043 General and administrative 851,532 1,511,350 1,967,250 4,017,697 Depreciation and amortization 1,038,391 879,535 1,718,729 2,607,631 Research and development 737,732 895,227 1,559,710 2,582,794 Employee stock options 43,041 42,243 129,123 126,717 Purchased in-process research and development costs -- -- 3,210,000 -- ------------ ------------ ------------ ------------ Total operating expenses 5,541,069 6,153,312 15,250,244 17,454,882 ------------ ------------ ------------ ------------ Loss from operations (3,029,030) (2,519,336) (3,795,801) (4,491,156) Interest income 215,766 165,393 838,545 522,116 Other (expense) income 19,391 230,522 22,145 380,923 Interest expense (3,234) (1,945) (11,099) (1,945) ------------ ------------ ------------ ------------ Loss before income taxes (2,797,107) (2,125,366) (2,946,210) (3,590,062) Income tax (expense) benefit 56,298 461,616 (480,939) 620,966 ------------ ------------ ------------ ------------ Net loss $ (2,740,809) $ (1,663,750) $ (3,427,149) $ (2,969,096) ============ ============ ============ ============ NET LOSS PER SHARE - BASIC $ (0.25) $ (0.15) $ (0.33) $ (0.27) ============ ============ ============ ============ NET LOSS PER SHARE - DILUTED $ (0.25) $ (0.15) $ (0.33) $ (0.27) ============ ============ ============ ============ </TABLE> See accompanying notes to condensed consolidated financial statements. 4
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Unaudited) <TABLE> <CAPTION> ADDITONAL RETAINED COMMON STOCK PAID-IN UNEARNED EARNINGS SHARES AMOUNTS CAPITAL COMPENSATION (DEFICIT) ------ ------- ------- ------------ --------- <S> <C> <C> <C> <C> <C> BALANCE DECEMBER 31, 1996 7,000,000 $ 7,000 $ 3,961,564 $ (6,500) $ (188,365) Net income 3,206,630 Currency translation adjustment, net of tax Comprehensive income Granting of employee and director stock options 866,793 (501,834) Amortization of unearned compensation 43,854 Issuance of common stock 2,919,000 2,919 31,673,647 --------- ------------ ------------ ------------ ------------ BALANCE DECEMBER 31, 1997 9,919,000 9,919 36,502,004 (464,480) 3,018,265 Net loss (4,931,094) Currency translation adjustment, net of tax Comprehensive loss Issuance of common stock 1,129,137 1,129 10,323,564 Income tax benefit resulting from the exercise of stock options 695,164 Amortization of unearned compensation 172,164 Acquisition of treasury stock (40,000) --------- ------------ ------------ ------------ ------------ BALANCE, DECEMBER 31, 1998 11,008,137 11,048 47,520,732 (292,316) (1,912,829) Net loss (2,969,096) Currency translation adjustment, net of tax Comprehensive loss Issuance of common stock 10,199 11 21,458 Amortization of unearned compensation 126,684 ---------- ------------ ------------ ------------ ------------ BALANCE, SEPTEMBER 30, 1999 11,018,336 $ 11,059 $ 47,542,190 $ (165,632) $ (4,881,925) ========== ============ ============ ============ ============ </TABLE> <TABLE> <CAPTION> ACCUMULATED OTHER COMPREHENSIVE TREASURY INCOME STOCK TOTAL ------------- -------- ----------- <S> <C> <C> <C> BALANCE DECEMBER 31, 1996 $ 3,773,699 Net income 3,206,630 Currency translation adjustment, net of tax $(126,297) (126,297) ----------- Comprehensive income 3,080,333 Granting of employee and director stock options 364,959 Amortization of unearned compensation 43,854 Issuance of common stock 31,676,566 BALANCE DECEMBER 31, 1997 (126,297) 0 38,939,411 Net loss (4,931,094) Currency translation adjustment, net of tax 325,678 325,678 ----------- Comprehensive loss (4,605,416) Issuance of common stock 10,324,693 Income tax benefit resulting from the exercise of stock options 695,164 Amortization of unearned compensation 172,164 Acquisition of treasury stock (150,625) (150,625) --------- -------- ----------- BALANCE, DECEMBER 31, 1998 199,381 (150,625) 45,375,391 Net loss (2,969,096) Currency translation adjustment, net of tax (147,767) (147,767) ----------- Comprehensive loss (3,116,863) Issuance of common stock 21,469 Amortization of unearned compensation 126,684 --------- -------- ----------- BALANCE, SEPTEMBER 30, 1999 51,614 (150,625) 42,406,681 </TABLE> See accompanying notes to condensed financial statements. 5
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ------------------------------ 1998 1999 ------------- ------------- <S> <C> <C> OPERATING ACTIVITIES: Net loss $ (3,427,149) $ (2,969,096) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation, amortization and other 1,829,314 2,800,828 In-process research and development 3,210,000 -- Deferred income taxes (1,391,422) 42,383 Change in operating assets and liabilities: Decrease (increase) in: Accounts receivable (575,203) 1,084,128 Income taxes refundable -- (698,957) Inventories (1,537,663) (1,846,542) Notes receivable -- 46,491 Prepaid expenses and other assets (42,878) (177,522) Increase (decrease) in: Accounts payable and accrued liabilities (992,933) 1,638,008 Income taxes payable 1,403,017 -- Unearned service revenues (169,056) 168,527 Customer deposits 39,643 (6,429) ------------ ------------ Net cash (used in) provided by operating activities (1,654,330) 81,819 ------------ ------------ INVESTING ACTIVITIES: Sales of investments 9,239,075 2,073,718 Purchases of property and equipment (852,906) (607,354) Payments of patent costs (65,587) (121,665) Payments of product design costs (485,120) (358,592) Payments for other intangibles -- (173,384) Acquisition of business, net of cash acquired (5,306,057) -- ------------ ------------ Net cash provided by investing activities 2,529,405 812,723 ------------ ------------ FINANCING ACTIVITIES: Payments on debt -- (331,435) Proceeds from issuance of common stock, net 225,228 148,156 Acquisition of treasury stock (150,625) -- ------------ ------------ Net cash provided by (used in) financing activities 74,603 (183,279) ------------ ------------ EFFECT OF EXCHANGE RATE CHANGES ON CASH (32,868) (147,767) ------------ ------------ INCREASE IN CASH AND CASH EQUIVALENTS 916,810 563,496 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 717,498 1,183,656 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,634,308 $ 1,747,152 ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 11,099 $ 1,945 ============ ============ Cash paid for income taxes $ 492,749 $ -- ============ ============ Noncash financing activities: Acquisition of business: Fair value of assets acquired $ 17,667,382 Common stock issued 10,395,000 Liabilities assumed (1,614,000) </TABLE> See accompanying notes to condensed consolidated financial statements. 6
FARO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999 NOTE A - DESCRIPTION OF ORGANIZATION AND BUSINESS FARO Technologies Inc. and Subsidiaries (the "Company") develops, manufactures, markets and supports Computer Aided Design (CAD)-based quality assurance products and CAD-based inspection and statistical process control software. On May 15, 1998 the Company acquired all the stock of privately held CATS Computer Aided Technologies, Computeranwendungen in der Fertigungssteurung, GmbH ("CATS") of Karlsruhe, Germany for $5 million in cash, 916,668 shares of common stock of the Company, plus the right to receive up to an additional 333,332 shares of Company common stock if CATS meets certain performance goals. In addition, the Company assumed certain of CATS outstanding liabilities. CATS develops, markets and supports 3-D measurement retrofit and statistical process control software used in both mainframe and PC based CAD environments. The acquisition was treated as a purchase for accounting purposes. The Company has three wholly owned operating subsidiaries, FARO Worldwide, Inc., Faro Europe GmbH and Co. KG, a German company, and Antares LDA, a Portuguese company. In connection with a restructuring of legal entities in Europe, effective January 1, 1999, CATS was consolidated under the name of Faro Europe GmbH and Co. KG. NOTE B - BASIS OF PRESENTATION The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and footnote disclosure required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the consolidated financial position and operating results for the interim periods have been included. The consolidated results of operations for the three and nine months ended September 30, 1999 are not necessarily indicative of results that may be expected for the year ending December 31, 1999. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company as of December 31, 1997 and 1998, and for each of the three years in the period ended December 31, 1998 included in the Company's Annual Report to Stockholders included by reference within the Company's Annual Report on Form 10-K and in conjunction with the Form S-1, as amended, dated August 7, 1998. Effective January 1, 1998 the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130). SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Prior year financial statements have been restated for comparative purposes to conform with this new standard. Certain prior year amounts have been reclassified to conform to current year presentation. NOTE C - ACQUISITION OF CATS The operating results of CATS have been included in the consolidated statements since May 15, 1998, the date of the acquisition. The following unaudited pro forma results of operations are presented for 7
informational purposes assuming that the Company had acquired CATS as of January 1, 1998. The $3.2 million charge off for in process research and development has been excluded from the pro forma results as it represents a material non-recurring charge. NINE MONTHS ENDED SEPTEMBER 30, 1998 ------------------ Revenues $ 20,200,000 Net income (loss) (1,798,000) Income (loss) per share: Basic $ (.16) Diluted $ (.16) The pro forma results of operations have been provided for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had the acquisition occurred on the date indicated, or which may result in the future. NOTE D - Earnings Per Share A reconciliation of the number of common shares used in the calculation of basic and diluted earnings per share ("EPS") is presented below: THREE MONTHS ENDED SEPTEMBER 30, 1998 1999 - -------------------------------------------------------------------------------- PER-SHARE PER-SHARE SHARES AMOUNT SHARES AMOUNT - -------------------------------------------------------------------------------- Basic EPS Weighted-Average Shares 11,028,890 $(.25) 11,017,810 $ (.15) Effect of Dilutive Securities Stock Options ---------- ---------- Diluted EPS Weighted-Average Shares and Assumed Conversions 11,028,890 $(.25) 11,017,810 $ (.15) ========== ========== Nine months ended September 30, 1998 1999 - -------------------------------------------------------------------------------- PER-SHARE PER-SHARE SHARES AMOUNT SHARES AMOUNT - -------------------------------------------------------------------------------- Basic EPS Weighted-Average Shares 10,506,189 $(.33) 11,013,885 $ (.27) Effect of Dilutive Securities Stock Options ---------- ---------- Diluted EPS Weighted-Average Shares and Assumed Conversions 10,506,189 $(.33) 11,013,885 $ (.27) ========== ========== 8
NOTE E - SEGMENT GEOGRAPHIC DATA The Company develops, manufactures, markets and supports Computer Aided Design (CAD)-based quality assurance products and CAD-based inspection and statistical process control software. This one line of business represents more than 99% of consolidated sales. The Company operates through sales teams established by geographic area. Each team is equipped to deliver the entire line of Company products to customers within its geographic area. The Company has aggregated the sales teams into a single operating segment as a result of the similarities in the nature of products sold, the type of customers and the methods used to distribute the Company's products. The following table presents information about the Company by geographic area: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------------------------------- SALES: 1998 1999 1998 1999 -------------------------------------------------------------- <S> <C> <C> <C> <C> United States $ 2,496,012 $ 2,297,742 $10,664,459 $10,449,564 Germany 1,303,421 1,849,935 3,296,021 5,100,516 United Kingdom 264,037 450,032 1,368,561 1,791,406 Canada 158,977 1,108,009 Other foreign 749,735 2,427,296 2,939,141 5,199,451 ----------- ----------- ----------- ----------- Total $ 4,972,182 $ 7,025,005 $19,376,191 $22,540,937 =========== =========== =========== =========== </TABLE> <TABLE> <CAPTION> DECEMBER 31, SEPTEMBER 30, LONG-LIVED ASSETS (NET) 1998 1999 ------------------------------ <S> <C> <C> UNITED STATES $ 2,707,920 $ 3,058,709 GERMANY 11,592,360 9,726,073 OTHER FOREIGN 46,103 42,615 ----------- ----------- TOTAL $14,346,383 $12,827,397 =========== =========== </TABLE> 9
PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING INFORMATION SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY, INCLUDING THE NOTES THERETO, INCLUDED ELSEWHERE IN THIS FORM 10-Q, AND THE MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INCLUDED IN THE COMPANY'S QUARTERLY REPORTS ON FORM 10-Q DATED MAY 14, 1999 AND AUGUST 13, 1999. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1998 SALES. Sales increased $2.1 million, or 41.3%, from $5.0 million for the three months ended September 30, 1998 to $7.0 million for three months ended September 30, 1999. The increase was due to increases in product sales in the United States ($1.3 million) and in the three European countries where the Company has sales offices ($757,000). GROSS PROFIT. Gross profit increased $1.1 million, or 44.7%, from $2.5 million for the three months ended September 30, 1998 to $3.6 million for the three months ended September 30, 1999. Gross margin increased to 51.7% for the three months ended September 30, 1999 from 50.5% for the three months ended September 30, 1998. The increase in gross margin was primarily a result of smaller price discounts in the three months ended September 30, 1999, partially offset by fewer sales of higher margin software. SELLING EXPENSES. Selling expenses decreased $45,000, or 1.6%, from $2.9 million for the three months ended September 30, 1998 to $2.8 million for the three months ended September 30, 1999. This decrease was primarily a result of lower selling expenses in the United States ($373,000), partially offset by an increase in selling expenses in Europe ($327,000). GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased $660,000, or 77.5%, from $852,000 for the three months ended September 30, 1998 to $1.5 million for the three months ended September 30, 1999. The increase was due to increases across many categories related to the company's expansion in the United States and Europe. The Company's United States operations accounted for $492,000 of the increase, including increases in professional and legal ($158,000), salaries ($111,000), subcontractor expenses ($60,000), telecommunications ($47,000) and hiring and training costs ($43,000). Expenses in Europe increased primarily as a result of staffing additions ($160,000). DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization expenses decreased $159,000, or 15.3%, from $1.0 million for the three months ended September 30, 1998 to $880,000 for the three months ended September 30, 1999. This decrease was primarily due to the completion of the amortization of existing product technology in 1998. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased $157,000, or 21.3%, from $738,000 for the three months ended September 30, 1998 to $895,000 for the three months ended September 30, 1999. The increase was primarily due to increases in salaries ($106,000) in the United States, and expenses in Europe ($85,000). INTEREST INCOME. Interest income decreased $50,000, or 23.3%, from $216,000 for the three months ended September 30, 1998, to $165,000 for the three months ended September 30, 1999. The decrease was primarily attributable to a decrease in the amount of interest-earning cash, cash equivalents, and investments. INCOME TAX BENEFIT. Income tax benefit increased $406,000 from $56,000 for the three months ended September 30, 1998, to $462,000 for the three months ended September 30, 1999. The tax 10
benefit in the three months ended September 30, 1999 resulted from tax benefits in the United States ($416,000) and Europe ($46,000). NET LOSS. Net loss decreased $1.1 million from $2.7 million for the three months ended September 30, 1998 to $1.7 million for the three months ended September 30, 1999 due to the factors stated above. NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998 SALES. Sales increased $3.2 million, or 16.3%, from $19.4 million for the nine months ended September 30, 1998 to $22.5 million for the nine months ended September 30, 1999. The increase was primarily a result of an increase in product sales in Germany ($2.5 million), primarily as a result of the Company's acquisition of CATS in May 1998. GROSS PROFIT. Gross profit increased $1.5 million, or 13.2%, from $11.5 million for the nine months ended September 30, 1998 to $13.0 million for the nine months ended September 30, 1999. Gross margin decreased to 57.5% for the nine months ended September 30, 1999 from 59.1% for the nine months ended September 30, 1998. The decrease in gross margin was primarily a result of a decrease in the average selling price of the Company's FAROArm products, beginning in September 1998. SELLING EXPENSES. Selling expenses increased $1.5 million, or 21.8%, from $6.7 million for the nine months ended September 30, 1998 to $8.1 million for the nine months ended September 30, 1999. This increase was a result of the Company's expansion of sales and marketing staff and activities, including those resulting from the Company's acquisition of CATS in May 1998. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased $2.1 million, or 104.2%, from $2.0 million for the nine months ended September 30, 1998 to $4.0 million for the nine months ended September 30, 1999. The increase from the Company's United States operations was $1.2 million, including increases in salaries ($530,000), professional and legal expenses ($408,000) and subcontractor expenses ($190,000). The increase in the Company's European operations was $811,000, primarily from the addition of CATS in May 1998. DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization expenses increased $889,000, or 51.7%, from $1.7 million for the nine months ended September 30, 1998 to $2.6 million for the first nine months of 1999. This increase was primarily due to the amortization expenses related to the intangible assets associated with the Company's acquisition of CATS. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased $1.0 million or 65.6%, from $1.6 million for the nine months ended September 30, 1998 to $2.6 million for the nine months ended September 30, 1999. The increase was primarily due to increases in salaries in the United States of $555,000, and an increase in expenses in Europe of $644,000, resulting from the Company's acquisition of CATS, offset in part by a reduction in other research and development expenses in the United States of $176,000. IN-PROCESS RESEARCH AND DEVELOPMENT RESULTING FROM ACQUISITION. In-process research and development expenses of $3.2 million were recorded in the second quarter of 1998 related to the acquisition of CATS. INTEREST INCOME. Interest income decreased $316,000, or 37.7%, from $839,000 for the nine months ended September 30, 1998, to $522,000 for the nine months ended September 30, 1999. The decrease was primarily attributable to a decrease in the amount of interest-earning cash, cash equivalents, and investments. INCOME TAX EXPENSE (BENEFIT). Income tax expense decreased $1.1 million, or 229.1%, from expense of $481,000 for the nine months ended September 30, 1998, to a benefit of $621,000 for the nine months ended September 30, 1999. The Company had income tax expense for the nine months ended September 30, 1998 due to U. S. taxable income and the writeoff of the deferred tax asset relating to 11
German net operating loss carryforwards. The Company had a net tax benefit for the nine months ended September 30, 1999, primarily due to the generation of U. S. taxable losses. NET LOSS. Net loss decreased $458,000 from $3.4 million for the nine months ended September 30, 1998 to $3.0 million for the nine months ended September 30, 1999, due to the factors stated above. LIQUIDITY AND CAPITAL RESOURCES For the nine months ended September 30, 1999, net cash provided by operating activities was $82,000 compared to cash used in operating activities of $1.7 million for the nine months ended September 30, 1998. The increase was due to decreases in accounts receivable and increases in accounts payable and accrued liabilities. Net cash provided by investing activities was $813,000 for the nine months ended September 30, 1999, compared to net cash provided by investing activities of $751,000 for the nine months ended September 30, 1998. Net cash used in financing activities for the nine months ended September 30, 1999 was $183,000 compared to net cash provided of $75,000 for the nine months ended September 30, 1998. This increase was due to payments on debt during the nine months ended September 30, 1999. In April 1997, the Company obtained a one-year unsecured $1.0 million line of credit which bears interest at the 30-day commercial paper rate plus 2.65% per annum. There were no outstanding borrowings under this loan agreement at September 30, 1999. The Company's principal commitments at September 30, 1999 were leases on its headquarters and regional offices and a loan commitment to the two former shareholders of CATS (see Part II, Item 5, Other Information). There were no material commitments for capital expenditures at that date. The Company believes that its cash, investments, cash flows from operations and funds available from its credit facilities will be sufficient to satisfy its working capital, loan commitment and capital expenditure needs at least through 1999. FOREIGN EXCHANGE EXPOSURE Sales outside the United States represent a significant portion of the Company's total revenues. Fluctuations in exchange rates between the U.S. dollar and the currencies where the Company conducts such business may have a material adverse effect on the Company's business, results of operation and financial condition, particularly its operating margins, and could also result in exchange losses. The impact of future exchange rate fluctuations on the results of the Company's operations cannot be accurately predicted. To the extent that the percentage of the Company's non-U.S. dollar revenues derived from international sales increases in the future, the risks associated with fluctuations in foreign exchange rates will increase. Historically, the Company has not managed the risks associated with fluctuations in exchange rates but may undertake transactions to manage such risks in the future using forward foreign exchange contracts, foreign currency options or other instruments to hedge these risks. YEAR 2000 The Company has invested significant resources in the latest information technologies over the past five years and therefore has minimized the effect of Year 2000 issues. Management initiated a program to evaluate all internal computer systems and applications, and products with computer systems and determined the adjustments necessary to become Year 2000 compliant. Management believes that existing internal resources are sufficient to correct any internal systems deficiencies that have or may be determined. The Company has completed compliance of internal computer systems, applications, and products. A final roll-over test of the Company's headquarters' internal computer systems will be held by November 30, 1999. The Company has received positive responses from its major customers and substantially all of its suppliers regarding their Year 2000 readiness. However, there can be no assurance that the systems of other companies on which the Company relies will be timely corrected, or that any failure by another company to correct such systems would not have a material adverse effect on the Company. Contingency plans have been developed to be implemented in the event any information 12
technology system, non-information technology system, third party or supplier is not Year 2000 compliant in a timely manner. The total cost to the Company of these Year 2000 Compliance activities has not been and is not anticipated to be material to its financial position or results of operations in a given year. This is based on Management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans, and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ from those plans. The Company does not separately track the internal costs incurred on Year 2000 Compliance activities, and such costs are principally the payroll costs of employees participating in these activities. EFFECTS OF INFLATION Inflation generally affects the Company by increasing the cost of labor, equipment and raw materials. The Company does not believe that inflation has had any material effect on the Company's business over the last three years. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is incorporated by reference herein from the section of this report in Part I, Item 2, under the caption "Foreign Exchange Exposure." PART II. OTHER INFORMATION ITEM 5. OTHER INFORMATION On May 15, 1998, the Company acquired CATS Computer Aided Technolgies, GmbH ("CATS"), a company based in Karlsruhe, Germany that develops, markets, and supports 3-D measurement retrofit and statistical process control software. The CATS acquisition agreement provided that the Company would provide a loan to the two former shareholders of CATS to fund their tax liability in connection with the shares of FARO common stock that they received in the acquisition. The former CATS shareholders remain key employees of the Company. Pursuant to a Loan Agreement dated August 2, 1999 with each of the former CATS shareholders, the Company has agreed to loan to the former CATS shareholders an amount equal to their tax obligation to the German tax authorities in connection with the acquisition of CATS. The aggregate amount of the loans is estimated to be approximately $2 million. The Company is not obligated to provide the loans until the German tax authorities request payment for the tax from the former CATS shareholders, which has not yet occurred. Moreover, the loan commitment will cease if the Company's share price rises to $11.34 per share (the price establishing the tax liability) for several consecutive days. If the loans are made, they will be for a term of three years, at an interest rate of approximately 4.3%, with an option for the borrower to extend the term for an additional three years. As collateral for the loans, the former CATS shareholders will pledge to the Company the number of shares of Company common stock equal to the amount of the loan divided by $6.375. If the amount of the loans is $ 2 million, the loans will be secured by 313,725 shares. The loans will be a non-recourse obligation of the former CATS shareholders. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a.) Exhibits EXHIBIT NO. DESCRIPTION ----------- ----------- 27.1 Financial Data Schedule (FOR SEC USE ONLY) 13
99.1 Loan Agreement dated August 2, 1999 between FARO Technologies, Inc. and Wendelin Karl Johannes Scharbach 99.2 Loan Agreement dated August 2, 1999 between FARO Technologies, Inc. and Siegfried Kurt Buss b.) Reports on Form 8-K None SIGNATURES Pursuant to the requirements 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. Date: November 12, 1999 FARO TECHNOLOGIES, INC. (Registrant) By: /s/ STUART W. JONES ------------------------------------- Stuart W. Jones Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 14
EXHIBIT INDEX EXHIBIT NO. DESCRIPTION ----------- ----------- 27.1 Financial Data Schedule (FOR SEC USE ONLY) 99.1 Loan Agreement dated August 2, 1999 between FARO Technologies, Inc. and Wendelin Karl Johannes Scharbach 99.2 Loan Agreement dated August 2, 1999 between FARO Technologies, Inc. and Siegfried Kurt Buss