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September
11, 2006
Via
EDGAR and U.S. Mail
Mr.
Jay
Webb
Reviewing
Accountant
United
States Securities and Exchange Commission
Mail
Stop
6010
100
F
Street, NE
Washington,
DC 20549
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Re:
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FARO
Technologies, Inc.
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Form
10-K
for the fiscal year ended December 31, 2005
Filed
June 29, 2006
File
No.
0-23081
Dear
Mr.
Webb:
We
are
providing responses to your comment letter dated September 8, 2006 in sequential
order corresponding to your comment.
Form
10-K for the period ended December 31, 2005
Managements
Discussion and Analysis, page 23
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1.
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In
future filing, please expand your MD&A disclosures to discuss
managements assessment as to the impact significant litigation such
as the
Cimcore-Romer litigation and the class action suits have or may have
on
operations and liquidity.
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A:
In
future filings, we will expand our discussion in MD&A disclosures of the
Cimcore-Romer litigation and the class action suit to include the impact they
have had or may have on operations and liquidity.
Results
of Operations, page 28
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2.
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We
note in your analysis and discussion of the results of operations
that
changes in certain costs and expenses were the result of numerous
factors,
some offsetting others. For example, we see that gross margins were
affected by product mix, higher service costs and price discounts.
In
future annual and interim filings, to more clearly comply with Item
303 of
Regulation S-K, each individually significant factor contributing
to the
change should be quantified to the extent practicable and an explanation
should be given as to why that factor changed. Management’s assessment as
to how these changes are expected to affect future operations should
also
be presented where possible.
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A:
In
future filings, we will more fully describe and quantify, where practicable,
those factors that had a significant effect on current and expectations on
future operations.
Critical
Accounting Policies, page 32
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3.
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We
note that your discussion of critical accounting policies is merely
a
reiteration of the accounting policy as disclosed in the footnotes
to the
financial statements. We would expect you to describe the factors
unique
to each accounting policy, such as assumptions and estimates, which
makes
that policy critical to your financial and operating status With
regards
to critical accounting estimates, we would expect you to describe
the
estimate, the methodology that you use to obtain it, any significant
assumptions used by management to derive the estimate, and the nature
and
possible impact of reasonably likely changes in those assumptions.
Explain
the significance of the estimate to your financial statements and
discuss
any changes in the estimate made during the periods presented, as
well as
the reasons for the changes and the impact of the changes on your
financial statements and overall financial performance. Please review
these disclosure requirements and expand your disclosures accordingly
in
future filings.
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A:
In
future filings, we will include in our discussion those factors that management
considers in its judgment that affect our critical accounting policies. We
will
describe the assumptions and estimates used in the formulation of our estimates
and the sensitivity of those judgments under changing
circumstances.
Notes
to Consolidated Financial Statements, page 43
Summary
of Significant Accounting Policies, page 43
Inventories,
page 43
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4.
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It
is noted that you distinguish between inventory held for sale, sales
demonstration inventory and service inventory. Please tell us in
detail
how you account for sales demonstration inventory and service inventory,
from finished goods to its eventual disposition. Tell us why you
believe
they are properly classified as current assets on your balance sheet.
Also, tell us whether or not you depreciate the equipment when it
is used
for demonstration and service purposes, the reasons therefore and
the GAAP
you rely upon to support your accounting and presentation of this
type of
inventory.
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A:
Inventory that is used for demonstration purposes is transferred from our
finished goods warehouse to a separate demonstration warehouse and bin location
within our software program by processing an inventory transaction. Each Account
Manager (salesperson) has a bin location so that we can identify the
demonstration inventory in their possession. We classify the demonstration
inventory as a current asset since these items are normally sold within six
to
twelve months at a slight discount. We do not depreciate our demonstration
inventory as it is only held for six to twelve months before being sold. This
inventory is always available for sale.
Service
inventory represents finished goods that have been transferred from our finished
goods warehouse location to the Service Inventory warehouse in our software
program. This inventory is initially used to provide a temporary
replacement product to a customer covered by a premium warranty who needs to
send their unit to us for service or repair, before it is ultimately sold.
After
we return the customer’s unit, the customer then returns the temporary loaner
unit to us. We then process a transaction to put the loaner unit back into
service inventory.
Our
service inventory is reflected on the Balance Sheet as a non-current asset.
This
inventory is also not depreciated, but is subject to our policy of being stated
at the lower of cost or net realizable value, in accordance with ARB 43, Chapter
4, Statement 5. This inventory is also always available for sale. Gross margin
from the sales of service inventory has averaged in the range of approximately
48% to 52%.
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5.
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We
see during 2005 you changed your method of computing the pricing
of
inventory from average cost to FIFO. While we also see you indicate
this
change did not materially impact your 2005 results of operations,
it is
not clear why you do not appear to have included a preferability
letter
from your accountants as an exhibit 18 in your first applicable Form
10-Q
filing following the change. Please either file this exhibit, tell
us
where it was previously filed or why you do not believe it is required
to
be filed. We may have further comments after reviewing your
response.
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A:
We
changed our method of pricing inventory from average cost to FIFO during the
second quarter of 2005. We changed to FIFO to better reflect our current
inventory costs. We did not file a preferability letter because the difference
in the value of the inventories using average costs compared to FIFO costs
was
approximately $594.73 and deemed not to be material. We also determined that
the
change to FIFO would not have a material effect on future operations.
Note
14 Income Taxes, page 55
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6.
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In
future filings, please expand your note to disclose the aggregate
dollar
and per share effects of the favorable tax treatment. Refer to the
guidance in SAB Topic 11-C.
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A:
In
future filings we will include the aggregate dollar and per share effects of
the
favorable tax treatment in accordance with SAB Topic 11-C based upon the
difference in the statutory rates in Switzerland and Singapore compared to
the
favorable rates received by the Company. We will also describe the factual
circumstances including the expected dates of expiration of these favorable
rates.
Note
20 Geographic Data, page 63
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7.
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We
see that in 2003 you began to manage and report global sales in three
regions: the America, Europe/Africa and Asia/Pacific. We also see
you have
begun manufacturing in those regions for those particular regions.
As
discussed in paragraph 69 of the SFAS 131, a management approach
to
defining segments allows enterprises to present the information that
they
use internally. In future filings please provide the related disclosures
required by paragraphs 25 and 26 of the statement. Also, since specific
geographic areas can constitute operating segments, please provide
supplemental support for your apparent conclusion that disclosures
are
only required under paragraph 37, 38 and 39 there under and expand
your
segment reporting disclosures to more fully comply with the
enterprise-wide disclosure requirements of paragraphs 37 through
39. For
example, if revenue derived from any particular foreign country is
material, disclose the name of the country and the amount of revenue
from
that country
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A:
In
2003, we began to manage and report global sales in three regions: the Americas,
Europe/Africa and Asia/Pacific. At that time, the Europe/Africa and Asia/Pacific
organizations were much smaller, the management teams for those regions were
not
in place, and the scope of operations for those regions was limited. We are
continuing to expand these areas as well implementing the final phases of a
global ERP software system. Through the end of 2005, we were managed centrally
and the chief operating decision maker, the CEO, reviewed financial results
for
the company as a whole. As a result, the company operated in one geographic
segment and provided disclosures in accordance with SFAS 131, paragraphs 37,
38
and 39.
We
believe that by the end of 2006, as a result of the continuing growth in the
Europe/Africa and Asia/Pacific operations and the integration of company-wide
financial reporting systems, we will have established three regional operating
segments. Accordingly, the company will include the disclosures required by
SFAS
131, paragraphs 25 and 26, in its Form 10-K for 2006.
Item
9A Controls and Procedures, page 65
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8.
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We
refer to the Audit Report of Grant Thornton where they issued an
adverse
opinion on the company’s internal control over financial reporting.
Consistent with the Auditor Report, you describe certain material
weaknesses in internal control over financial reporting which existed
as
of December 31, 2005. However, it is not clear how management concludes
herein that the disclosure controls and procedures were effective,
as
indicated under Evaluation of Disclosure Controls and Procedures.
Please
tell us how management arrived at this conclusion. We may have further
comments after reviewing your response. Revise the filing as necessary
based on our comment.
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A:
We
believe that our disclosure controls and procedures were effective to provide
reasonable assurance that information required to be disclosed by the company
in
the reports it submits under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Commission’s rules and
forms. We also believe that our disclosure controls and procedures are designed
to ensure that information required to be disclosed is accumulated and
communicated to management to allow timely decisions regarding required
disclosure.
Our
internal investigation of certain payments made in China that may have violated
the FCPA and other applicable laws has resulted in the conclusion by management
that certain material weaknesses in the design and operation of internal
controls related to financial reporting existed. However, these material
weaknesses in internal controls do not mean that our disclosure controls were
not effective.
We
conducted the investigation independently based on concern regarding these
certain payments, and believe that the investigation as conducted is evidence
of
the effectiveness of our disclosure controls and procedures. As a result of
the
investigation, it was found that these payments had been recorded properly
in
the financial statements as selling expenses; and, based upon our internal
investigation, no changes to the financial statements were required. Therefore,
although certain elements of our internal controls may have been circumvented
the disclosure controls were effective.
Certifications
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9.
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The
Section 302 and 906 certifications were included with Form 10-K filed
6/29/06, Form 10-Q filed 6/29/06 and Form 10-Q filed 8/9/06. However,
they
do not contain conforming signatures. Please revise to include properly
signed reports- Refer to Item 302 of Regulation S-T, which addresses
signatures in electronic filings.
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A:
The
company will revise the filings to include the conforming signatures next to
the
“/s/” for the Section 302 and 906 certifications for the Form 10-Q filed 6/29/06
and Form 10-Q filed 8/9/06 simultaneously with the filing of this letter. The
company will revise its Form 10-K filed on 6/29/06 to include the conforming
signatures after the Commission has cleared all comments.
Report
of Independent Registered Public Accounting Firm, page 67
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10.
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Please
tell us how this report complies with PCAOB Auditing Standard 2.
We note
this report does not appear to opine on management’s assessment of the
company’s internal control over financial reporting or the effectiveness
of the company’s internal control over financial reporting We may have
further comments after reviewing your response- Revise the filing
as
necessary based on our comment.
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A:
During
the Edgarization process with our service provider, the page containing the
last
two paragraphs of this report was erroneously omitted from the filing. We will
revise the filing to include the complete report.
As
requested in your letter dated, September 8, 2006, the company acknowledges
that:
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·
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The
company is responsible for the adequacy and accuracy of the disclosure
in
the filings;
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·
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Staff
comments or changes to disclosure in response to staff comments do
not
foreclose the Commission from taking any action with respect to the
filing; and
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·
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The
company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
laws of the United States.
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Thank
you
for your comments.
Sincerely,
Keith
S.
Bair
Interim
Chief Financial Officer