FARO TECHNOLOGIES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS.

(Edgar Glimpses Via Acquire Media NewsEdge) The following information should be read in conjunction with the Consolidated Financial Statements of the Company, including the notes thereto, included in Part II, Item 8 of this Annual Report on Form 10-K.

Overview The Company designs, develops, manufactures, markets and supports portable, software driven, 3-D measurement and imaging systems used in a broad range of manufacturing, industrial, building construction and forensic applications. The Company's FaroArm, FARO Laser ScanArm and FARO Gage articulated measuring devices, the FARO Laser Tracker Vantage, the FARO Focus3D, the FARO 3D Imager AMP and their companion CAM2 software systems provide for CAD-based inspection, high-density surveying and other applications. 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.

22-------------------------------------------------------------------------------- Table of Contents The Company derives revenues primarily from the sale of its measurement equipment and their related multi-faceted CAM2 software programs. 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 and revenue from training and technology consulting services when the services are provided. 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 operates in international markets throughout the world and maintains sales offices in France, Germany, Great Britain, Japan, Spain, Italy, Turkey, China, India, Poland, the Netherlands, Malaysia, Thailand, Singapore and Vietnam. The Company manages and reports its global sales in three regions: the Americas, Europe/Africa and Asia/Pacific.

The Company manufactures its FaroArm, FARO Gage, FARO 3D Imager AMP, and FARO Laser Tracker Vantage products in its manufacturing facility located in Switzerland for customer orders from the Europe/Africa region, in its manufacturing facility located in Singapore for customer orders from the Asia/Pacific region, and in its manufacturing facilities located in Florida and Pennsylvania for customer orders from the Americas. 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 2013.

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 the value of the intercompany account balances denominated in different currencies. 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. However, it does not regularly use such instruments, and none were utilized in 2012, 2011 or 2010.

The Company was profitable in each quarter in the years ended December 31, 2012, 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.

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: 23 -------------------------------------------------------------------------------- Table of Contents Years ended December 31, 2012 2011 2010 Statement of Operations Data: Sales 100.0% 100.0% 100.0% Cost of sales 45.3% 43.5% 40.9% Gross margin 54.7% 56.5% 59.1% Operating expenses: Selling 23.6% 24.4% 26.4% General and administrative 10.6% 10.5% 14.0% Depreciation and amortization 2.6% 2.6% 3.3% Research and development 6.4% 6.0% 6.6% Total operating expenses 43.2% 43.5% 50.3% Income from operations 11.5% 13.0% 8.8% Interest income (0.1%) 0.0% (0.1%) Other expense 0.3% 0.5% 1.5% Interest expense 0.0% 0.0% 0.0% Income before income tax expense 11.3% 12.5% 7.4% Income tax expense 2.9% 3.3% 1.6% Net Income 8.4% 9.2% 5.8% 2012 Compared to 2011 Sales. Total sales increased $19.2 million, or 7.6%, to $273.4 million in the year ended December 31, 2012 from $254.2 million for the year ended December 31, 2011. This increase resulted primarily from an increase in worldwide demand for products. A weaker Euro relative to the U.S. Dollar, on average, resulted in lower sales of approximately $7.4 million in the year ended December 31, 2012, as sales denominated in Euros were translated into U.S. Dollars. Product sales increased by $15.3 million, or 7.2%, to $227.9 million for the year ended December 31, 2012 from $212.6 million in the year ended December 31, 2011.

Service revenue increased by $3.9 million, or 9.5%, to $45.5 million for the year ended December 31, 2012 from $41.6 million in the year ended December 31, 2011.

Sales in the Americas region increased $11.1 million, or 11.4%, to $108.6 million for the year ended December 31, 2012 from $97.5 million in the prior year period. Product sales in the Americas region increased by $9.0 million, or 11.3%, to $89.0 million for the year ended December 31, 2012 from $80.0 million in the prior year. Service revenue in the Americas region increased by $2.1 million, or 12.1%, to $19.6 million for the year ended December 31, 2012 from $17.5 million for the prior year, primarily due to an increase in warranty revenue.

Sales in the Europe/Africa region increased $0.5 million, or 0.5%, to $100.1 million for the year ended December 31, 2012 from $99.6 million in the year ended December 31, 2011. Product sales in the Europe/Africa region decreased by $0.2 million, or 0.2%, to $83.1 million for the year ended December 31, 2012 from $83.3 million in the prior year. Service revenue in the Europe/Africa region increased by $0.7 million, or 4.5%, to $17.0 million for the year ended December 31, 2012 from $16.3 million in the prior year, primarily due to an increase in warranty revenue.

24 -------------------------------------------------------------------------------- Table of Contents Sales in the Asia/Pacific region increased $7.6 million, or 13.3%, to $64.7 million for the year ended December 31, 2012 from $57.1 million in the year ended December 31, 2011. Product sales in the Asia/Pacific region increased by $6.5 million, or 13.0%, to $55.8 million for the year ended December 31, 2012 from $49.3 million in the prior year. Service revenue in the Asia/Pacific region increased by $1.1 million, or 14.4%, to $8.9 million for the year ended December 31, 2012 from $7.8 million in the same period during the prior year, primarily due to an increase in warranty revenue.

Gross profit. Gross profit increased by $5.9 million, or 4.1%, to $149.6 million for the year ended December 31, 2012 from $143.7 million for the year ended December 31, 2011. Gross margin decreased to 54.7% for the year ended December 31, 2011 from 56.5% for the year ended December 31, 2011. The decrease in gross margin is primarily due to a decrease in gross margin from product sales to 58.7% in the year ended December 31, 2012 from 61.2% for the prior year, primarily as a result of lower average selling prices, a change in the sales mix caused by an increase in the sales of the Laser Scanner product which has a lower gross margin, and an increase in the sales mix of the Laser Scanner product sold to distributors. Gross margin from service revenues increased to 34.8% in the year ended December 31, 2012 compared to 32.4% for the prior year.

Selling Expenses. Selling expenses increased by $2.3 million, or 3.7%, to $64.4 million for the year ended December 31, 2012 from $62.1 million for the year ended December 31, 2011. This increase was primarily due to an increase in commissions and compensation expense of $0.8 million, an increase in marketing and advertising expenses of $0.6 million, and an increase in travel expenses of $0.7 million.

Worldwide sales and marketing headcount increased by 38, or 11.6%, to 365 at December 31, 2012 from 327 at December 31, 2011. Regionally, the Company's sales and marketing headcount increased by 18, or 20.0%, to 108 at December 31, 2012 from 90 at December 31, 2011 for the Americas; increased by 10, or 8.8%, to 123 at December 31, 2012 from 113 at December 31, 2011 in Europe/Africa; and increased by 10, or 8.1%, in Asia/Pacific to 134 at December 31, 2012 from 124 at December 31, 2011.

As a percentage of sales, selling expenses decreased to 23.6% of sales in the year ended December 31, 2012 from 24.4% of sales in the year ended December 31, 2011. Regionally, selling expenses were 20.0% of sales in the Americas for the year ended December 31, 2012 compared to 20.5% of sales in the year ended December 31, 2011; 26.4% of sales for Europe/Africa for the year ended December 31, 2012 compared to 28.1% of sales in the prior year; and 25.1% of sales for Asia/Pacific for the year ended December 31, 2012 compared to 24.9% of sales in the prior year.

General and administrative expenses. General and administrative expenses increased by $2.3 million to $29.1 million, or 8.4%, for the year ended December 31, 2012 from $26.8 million in the year ended December 31, 2011, primarily due to an increase of $1.0 million related to the FCPA monitor, and an increase in legal and professional fees related to patent litigation of $1.4 million. General and administrative expenses as a percentage of sales increased to 10.6% for the year ended December 31, 2012 from 10.5% for the year ended December 31, 2011.

Depreciation and amortization expenses. Depreciation and amortization expenses increased by $0.3 million to $7.0 million for the year ended December 31, 2012 from $6.7 million for the year ended December 31, 2011 as a result of an increase in property, equipment and intangible assets.

Research and development expenses. Research and development expenses increased $2.4 million, or 15.7%, to $17.6 million for year ended December 31, 2012 from $15.2 million for the year ended December 31, 2011, primarily due to an increase in compensation of $1.7 million and subcontractor expenses of $0.9 million, offset by expenses of $0.3 million incurred in the prior year period related to the closing and relocation of the R&D facility in Andover, MA to our existing facility in Kennett Square, PA. Research and development expenses as a percentage of sales increased to 6.4% for the year ended December 31, 2012 from 6.0% for the year ended December 31, 2011.

25-------------------------------------------------------------------------------- Table of Contents Other (income) expense, net. Other (income) expense, net decreased by $0.6 million to $0.6 million of expense for the year ended December 31, 2012, from expense of $1.2 million for the year ended December 31, 2011, primarily as a result of a decrease in foreign exchange transaction losses due to the effects of changes in foreign exchange rates on the value of intercompany account balances of the Company's subsidiaries denominated in different currencies.

Income tax expense. Income tax expense decreased by $0.4 million to $7.9 million for the year ended December 31, 2012 from $8.3 million for the year ended December 31, 2011, primarily due to a decrease in pretax income. The Company's effective tax rate decreased to 25.7% for the year ended December 31, 2012 compared to 26.3% for the year ended December 31, 2011 and included a reduction in the income tax rates of 1.5% and 1.6% related to the tax benefit of the exercise of employee stock options in the years ended December 31, 2012 and 2011, respectively. 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. Net income decreased by $0.4 million to $23.0 million for the year ended December 31, 2012 from $23.4 million for the year ended December 31, 2011 as a result of the factors described above.

2011 Compared to 2010 Sales. Total sales increased $62.4 million, or 32.6%, to $254.2 million in the year ended December 31, 2011 from $191.8 million for the year ended December 31, 2010. This increase resulted primarily from an increase in worldwide demand for products and some recovery in the global economy. Product sales increased by $55.3 million, or 35.2%, to $212.6 million for the year ended December 31, 2011 from $157.3 million in the year ended December 31, 2010. Service revenue increased by $7.1 million, or 20.6%, to $41.6 million for the year ended December 31, 2011 from $34.5 million in the year ended December 31, 2010.

Sales in the Americas region increased $25.1 million, or 34.7%, to $97.5 million for the year ended December 31, 2011 from $72.4 million in the prior year period. Product sales in the Americas region increased by $23.1 million, or 40.7%, to $80.0 million for the year ended December 31, 2011 from $56.9 million in the prior year. Service revenue in the Americas region increased by $2.0 million, or 12.6%, to $17.5 million for the year ended December 31, 2011 from $15.5 million for the prior year, primarily due to an increase in customer service revenue.

Sales in the Europe/Africa region increased $24.9 million, or 33.2%, to $99.6 million for the year ended December 31, 2011 from $74.7 million in the year ended December 31, 2010. Product sales in the Europe/Africa region increased by $21.4 million, or 34.5%, to $83.3 million for the year ended December 31, 2011 from $61.9 million in the prior year. Service revenue in the Europe/Africa region increased by $3.5 million, or 27.2%, to $16.3 million for the year ended December 31, 2011 from $12.8 million in the prior year, primarily due to an increase in customer service revenue.

Sales in the Asia/Pacific region increased $12.4 million, or 27.9%, to $57.1 million for the year ended December 31, 2011 from $44.7 million in the year ended December 31, 2010. Product sales in the Asia/Pacific region increased by $10.8 million, or 28.0%, to $49.3 million for the year ended December 31, 2011 from $38.5 million in the prior year. Service revenue in the Asia/Pacific region increased by $1.6 million, or 26.8%, to $7.8 million for the year ended December 31, 2011 from $6.2 million in the same period during the prior year, primarily due to an increase in warranty revenue.

26-------------------------------------------------------------------------------- Table of Contents Gross profit. Gross profit increased by $30.3 million, or 26.7%, to $143.7 million for the year ended December 31, 2011 from $113.4 million for the year ended December 31, 2010. Gross margin decreased to 56.5% for the year ended December 31, 2011 from 59.1% for the year ended December 31, 2010. The decrease in gross margin is primarily due to a decrease in gross margin from product sales to 61.2% in the year ended December 31, 2011 from 65.3% for the prior year, 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 increased to 32.4% in the year ended December 31, 2011 compared to 30.9% for the prior year.

Selling Expenses. Selling expenses increased by $11.4 million, or 22.6%, to $62.1 million for the year ended December 31, 2011 from $50.7 million for the year ended December 31, 2010. This increase was primarily due to an increase in commissions and compensation expense of $8.8 million, an increase in marketing and advertising expenses of $1.7 million, and an increase in travel expenses of $1.5 million.

Worldwide sales and marketing headcount increased by 27, or 9.0%, to 327 at December 31, 2011 from 300 at December 31, 2010. Regionally, the Company's sales and marketing headcount increased by 9, or 11.1%, to 90 at December 31, 2011 from 81 at December 31, 2010 for the Americas; increased by 2, or 1.8%, to 113 at December 31, 2011 from 111 at December 31, 2010 in Europe/Africa; and increased by 16, or 14.8%, in Asia/Pacific to 124 at December 31, 2011 from 108 at December 31, 2010.

As a percentage of sales, selling expenses decreased to 24.4% of sales in the year ended December 31, 2011 from 26.4% of sales in the year ended December 31, 2010. Regionally, selling expenses were 20.5% of sales in the Americas for the year ended December 31, 2011 compared to 21.9% of sales in the year ended December 31, 2010; 28.1% of sales for Europe/Africa for the year ended December 31, 2011 compared to 30.1% of sales in the prior year; and 24.9% of sales for Asia/Pacific for the year ended December 31, 2011 compared to 27.5% of sales in the prior year.

General and administrative expenses. General and administrative expenses remained flat at $26.8 million for the years ended December 31, 2011 and December 31, 2010. Increases in compensation costs of $1.7 million and increases in recruiting and relocation costs of $0.3 million were offset by decreases of $1.0 million in bad debt expenses, decreases of $0.4 million related to the FCPA monitor, and a decrease in legal and professional fees related to patent litigation of $0.6 million. General and administrative expenses as a percentage of sales decreased to 10.5% for the year ended December 31, 2011 from 14.0% for the year ended December 31, 2010.

Depreciation and amortization expenses. Depreciation and amortization expenses increased by $0.4 million to $6.7 million for the year ended December 31, 2011 from $6.3 million for the year ended December 31, 2010 as a result of an increase in property, equipment and intangible assets.

Research and development expenses. Research and development expenses increased $2.5 million, or 19.7%, to $15.2 million for year ended December 31, 2011 from $12.7 million for the year ended December 31, 2010, primarily due to an increase in compensation of $1.9 million, subcontractor expenses of $0.6 million and expenses of $0.4 million related to the closing and relocation of the R&D facility in Andover, MA to our existing facility in Kennett Square, PA. Research and development expenses as a percentage of sales decreased to 6.0% for the year ended December 31, 2011 from 6.6% for the year ended December 31, 2010.

Other (income) expense, net. Other (income) expense, net decreased by $1.6 million to $1.2 million of expense for the year ended December 31, 2011, from expense of $2.8 million for the year ended December 31, 2010, primarily as a result of a decrease in foreign exchange transaction losses due to the effects of changes in foreign exchange rates on the value of intercompany account balances of the Company's subsidiaries denominated in different currencies.

27-------------------------------------------------------------------------------- Table of Contents Income tax expense. Income tax expense increased by $5.2 million to $8.3 million for the year ended December 31, 2011 from $3.1 million for the year ended December 31, 2010, primarily due to an increase in pretax income. The Company's effective tax rate increased to 26.3% for the year ended December 31, 2011 compared to 22.1% for the year ended December 31, 2010, primarily due to the release of a valuation allowance of approximately $1.2 million in the year ended December 31, 2010 related to net operating losses of a subsidiary in Germany as a result of being included in a group consolidated tax filing with net taxable earnings. 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. Total deferred tax assets for the Company's foreign subsidiaries relating to net operating loss carryforwards were $14.9 million and $14.1 million at December 31, 2011 and 2010, respectively. The related valuation allowance was $11.8 million and $11.1 million at December 31, 2011 and 2010, respectively.

Net income. Net income increased by $12.3 million to $23.4 million for the year ended December 31, 2011 from $11.1 million for the year ended December 31, 2010 as a result of the factors described above.

Liquidity and Capital Resources Cash and cash equivalents increased by $28.7 million to $93.2 million at December 31, 2012 from $64.5 million at December 31, 2011. The increase was primarily attributable to net income and non-cash expenses of $32.0 million and proceeds from stock option exercises of $6.2 million, partially offset by an increase in working capital of $2.9 million, and $5.2 million in purchases of equipment and intangible assets.

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 on 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 each of the Company's fiscal quarters. As of December 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, expires on March 31, 2015. The Company has not drawn on this line of credit.

On December 21, 2012, the Company filed a registration statement on Form S-3 with the SEC registering shares of common stock, preferred stock, and warrants to purchase common and preferred stock, either individually or in units, with a proposed maximum aggregate offering price of $250 million. The registration statement was declared effective on January 7, 2013. The proceeds from any offerings with respect to this registration statement, if any, would be used for either repayment or refinancing of debt, acquisition of additional businesses or technologies or for working capital and general corporate purposes.

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.

28-------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Commercial Commitments The Company is party to capital leases on equipment with an initial term of 36 to 60 months and other non-cancelable operating leases. These obligations are presented below as of December 31, 2012 ($ in thousands): FARO CONSOLIDATED Contractual Obligations For the year ended December 31, 2012 Payments Due by Period Contractual Obligations Total < 1 Year 1-3 Years 3-5 Years > 5 Years Capital lease obligations $ 64 $ 45 $ 19 $ - $ - Operating lease obligations 27,001 6,228 8,365 5,731 6,677 Purchase obligations 28,683 28,683 - - - Total $ 55,748 $ 34,956 $ 8,384 $ 5,731 $ 6,677 The Company enters into purchase commitments for products and services in the ordinary course of business. These purchases generally cover production requirements for 60 to 90 days. The Company has a $0.3 million liability for unrecognized tax benefits that is excluded from the contractual obligations table due to the uncertainty of the period of settlement, if any, with the respective taxing authorities.

Inflation Inflation did not have a material impact on the Company's results of operations in recent years, and the Company does not expect inflation to have a material impact on its operations in 2013.

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 the 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, 29-------------------------------------------------------------------------------- Table of Contents 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 condition. 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 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 used 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 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 reserved in an amount equal to 100% of the FIFO cost of such inventory. The Company's products are subject to changes in technologies that may make certain of its products or their components obsolete or less competitive, which may increase its historical provisions to the reserve.

Income Taxes The Company reviews its deferred tax assets on a regular basis to evaluate their recoverability based upon expected future reversals of deferred tax liabilities, projections of future taxable income over a two-year period, and tax planning strategies that it might employ to utilize such assets, including net operating loss carryforwards. Based on the positive and negative evidence of recoverability, the Company establishes a valuation allowance against the net deferred tax assets of a taxing jurisdiction in which it operates, unless it is "more likely than not" that it will recover such assets through the above means.

In the future, the Company's evaluation of the need for the valuation allowance will be significantly influenced by its ability to achieve profitability and its ability to predict and achieve future projections of taxable income.

Significant judgment is required in determining the Company's worldwide provision for income taxes. In the ordinary course of global business, there are many transactions for which the ultimate tax outcome is uncertain. The Company establishes provisions for income taxes when, despite the belief that tax positions are fully supportable, there remain certain positions that do not meet the minimum probability threshold as described by ASC 740, which is a tax position that is more likely than not to be 30-------------------------------------------------------------------------------- Table of Contents sustained upon examination by the applicable taxing authority. In the ordinary course of business, the Company and its subsidiaries are examined by various federal, state, and foreign tax authorities. The Company regularly assesses the potential outcomes of these examinations and any future examinations for the current or prior years in determining the adequacy of its provision for income taxes. The Company assesses the likelihood and amount of potential adjustments and adjusts the income tax provision, the current tax liability and deferred taxes in the period in which the facts that gave rise to a revision become known.

Reserve for Warranties The Company establishes at the time of sale a liability for the one-year warranty included with the initial purchase price of equipment, based upon an estimate of the repair expenses likely to be incurred for the warranty period.

The warranty period is measured in installation-months for each major product group. The warranty reserve is reflected in accrued liabilities in the accompanying consolidated balance sheets. The warranty expense is estimated by applying the actual total repair expenses for each product group in the prior period and determining a rate of repair expense per installation month. This repair rate is multiplied by the number of installation-months of warranty for each product group to determine the provision for warranty expenses for the period. The Company evaluates its exposure to warranty costs at the end of each period using the estimated expense per installation-month for each major product group, the number of units remaining under warranty and the remaining number of months each unit will be under warranty. The Company has a history of new product introductions and enhancements to existing products, which may result in unforeseen issues that increase its warranty costs. While such expenses have historically been within expectations, the Company cannot guarantee this will continue in the future.

Goodwill Impairment Goodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired. Indefinite-life identifiable intangible assets and goodwill are not amortized but are tested for impairment. The Company performs an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the carrying value of the recorded goodwill is impaired. 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 Company first performs a qualitative assessment to determine whether it is necessary to perform the two-step goodwill impairment test. If the Company believes, as a result of its qualitative assessment, that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test are unnecessary. The Company elected to early adopt this accounting guidance at the beginning of its fourth quarter of 2011 on a prospective basis for goodwill impairment tests.

If necessary, as a result of the qualitative assessment, the goodwill impairment test is applied using a two-step approach. In performing the first step, the Company calculates the fair values of the reporting units using discounted cash flows ("DCF") of each reporting unit. If the carrying amount of the reporting unit exceeds the fair value, the second step is performed to measure the amount of the impairment loss, if any. In the second step, the implied fair value of the goodwill is estimated as the fair value of the reporting unit as calculated in the first step, less the fair values of the net tangible and intangible assets of the reporting unit other than goodwill. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill.

Management has concluded there was no goodwill impairment in the years ended December 31, 2012, 2011 and 2010.

31-------------------------------------------------------------------------------- Table of Contents Impact of Recently Issued Accounting Standards In June 2011, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income ("ASU 2011-05"). ASU 2011-05 requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the changes in shareholders' equity. The standard does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. The Company has elected to present the components of net income and other comprehensive income as two consecutive statements. ASU 2011-05 was effective for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-05 during the quarter ended March 31, 2012 and for subsequent periods only impacted presentation and did not have any effect on the Company's consolidated financial statements or on its financial condition.

In December 2011, the FASB issued ASU No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 ("ASU 2011-12"). ASU 2011-12 defers the specific requirement to present items that are reclassified from accumulated other comprehensive income to net income separately with their respective components of net income and other comprehensive income. As part of this update, the FASB did not defer the requirement to report comprehensive income either in a single continuous statement or in two separate but consecutive financial statements. In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2012-03"), which will be effective for reporting periods beginning after December 15, 2012. The specific requirements of ASU 2013-02 are not expected to have any impact on the Company's consolidated financial statements.

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