raab, gregory a. fraser, and ) defendants. ) class...

Case 6:05-cv-01810-ACC-DAB Document 1 Filed 12/06/05 of 50 PageID 1

UNITED STATES DISTRICT COURTMIDDLE DISTRICT OF FLORIDA

ORLANDO DIVISION

DIANE GOLDBERGER, Individually and On )Behalf of All Others Similarly Situated, )

Plaintiff, )

VS. )

FARO TECHNOLOGIES, INC., SIMON )RAAB, GREGORY A. FRASER, AND )BARBARA R. SMITH, )

Defendants. )

CLASS ACTION COMPLAINT

Plaintiff, individually and on behalf of all other persons similarly situated, by plaintiff's

undersigned attorneys, for plaintiff's complaint against defendants, alleges the following based upon

personal knowledge as to plaintiff and plaintiff's own acts, and upon information and belief as to all

other matters, based on, inter alia, the investigation conducted by and through plaintiff's attorneys,

which included, amongst other things, a review of the defendants' press releases, Securities and

Exchange Commission ("SEC") filings by FARO Technologies Inc. ("FARO Technologies" or the

"Company") and media reports about the Company. Plaintiff believes that substantial evidentiary

support will exist for the allegations set forth herein after a reasonable opportunity for discovery.

SUMMARY AND OVERVIEW

1. This is a securities class action on behalf of all persons who purchased or acquired the

securities of FARO Technologies between May 6, 2004, and November 3, 2005 (the "Class

Period").

2. FARO Technologies and its international subsidiaries develop and market software

and devices for portable, computerized measurement for the broad-based, global manufacturing

industries. The Company's products allow manufacturers to perform three-dimensional inspections


The "FARO Technologies" brand soon became synonymous with "state of the art" manufacturing

processes and practices.

5. During the Class Period, the Company, however, failed to disclose that its internal

controls and corporate compliance, governing its own manufacturing process and practices, were

deficient and defective. The Company, in particular, failed to implement adequate inventory

accounting practices and internal controls, that, as a result, adversely impacted the Company's

finances and ability to fill orders for its products. Despite these inadequate controls, defendants

repeatedly issued positive quarterly and annualized financial guidance during the Class Period that

they knew, or recklessly disregarded, was erroneous, false and misleading.

6. At all times during the Class Period, defendants were motivated to conceal the truth

about their deficient and defective systems and controls and to issue false and misleading quarterly

and annualized guidance in order to artificially inflate the value of the Company's stock. This

allowed defendants to use the inflated value of that stock as currency in its March 2005 acquisition

of iQvolution AG. 3 Moreover, defendants took advantage of the artificial inflation in the price of

FARO Technologies shares by selling or causing to be sold over 1.48 million of their own shares for

net proceeds of $40.9 million. These proceeds included profits from highly complicated forward-

sales transactions with Bank of America that allowed defendants to arguably "sell short against the

box," assuring immediate profits, as well as an opportunity for continued appreciation, absent any

present tax liabilities.

7. Defendants explained to the investment community that these forward sales

transactions left them with considerable control of valuable option and voting rights. In addition,

defendants assured investors that pursuant to the terms of the forward sales contracts, they were

detected significant and material discrepancies, demonstrating "a significant deficiency with regardto the Company's internal controls."

3 Defendants purchased iQvolution AG for $12 million, of which 67% was in shares of FAROcommon stock and 33% in cash. See ¶ 53. See also FARO Technologies's Form S-3 of April 12,2005, in support of the sale of 314,736 shares of common stock of FARO Technologies, Inc. byshareholders who acquired stock in connection with the iQvolution AG acquisition.

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`forced" to relinquish their shares at certain fixed "mileposts " of "12 and 18 and 24 months." In

truth, defendants were able to accelerate the maturity of the contracts and, during the Class Period,

contracts on 500,000 shares were suspiciously accelerated to maturity, causing undesirable and

immediate significant tax liabilities, as well as loss of valuable option and voting rights, at "final

prices" well below the "floor price" initially paid by Bank of America.4

8. On November 18, 2004, the Company announced the dismissal of Ernst & Young

LLP as its auditors because of the Company's purported "desire, in the spirit of the Sarbanes-Oxley

Act of 2002, to ensure a more clear separation between tax consulting and audit assistance for the

Registrant."

9. On July 18, 2005, the truth began to emerge. On that day, the Company issued a

press release lowering its guidance for the second quarter of 2005. The Company revealed that its

backlog of unfilled customer orders had grown significantly.

10. On November 3, 2005, the last day of the Class Period, investors finally learned the

truth about the adverse impact of the Company's defective and deficient inventory-related controls

and systems on the Company's financial performance. 5 On that day, the Company announced its

third quarter of 2005 results. In addition, the Company revealed that it had incurred $1.6 million in

"inventory costing and consumption variances ... due to processing problems relating to the

implementation of our new accounting and inventory management systems." Defendant Raab

admitted in a conference call discussing the third quarter results that the Company had not been able

to keep up with customer orders, in particular, "late arriving Asian orders in Q2," resulting in

"substantially more complex inventory management situations, and ... substantial inventory

increases." As a result of defendants' shocking news and disclosures, the price of FARO

Technologies stock plummeted $5.88, from its closing price of $22.38 on November 3, 2005, to

4 For a complete understanding of these transactions, see the Forms 4 of Simon Raab filed on July 6,2004, April 1, 2005 and May 16, 2005.5 See ¶ 69 and the Company's Form 10-Q filed with the SEC on November 9, 2005.

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finally close on November 7, 2005, at $16.50, for a two-day loss of 26.3%, on combined volume of

over 5.9 million shares.

11. During the Class Period, defendants concealed the following:

(a) one or more of the Company's internal controls and systems for corporate

compliance were deficient and defective;

(b) the Company's inventory accounting and practices were deficient and

defective, resulting in false and misleading financial statements and guidance;

(c) the change of accountants in November of 2004 served to facilitate the

continued concealment of the Company's deficient and defective inventory accounting and practices;

(d) the Company's inefficient management of its inventory requirements was the

cause or result of difficulties the Company had experienced in meeting quarterly goals for order

fulfillment, necessary to meet the Company's forward guidance;

(e) the maturity date of defendants' forward sales contracts on their shares could

be accelerated, to occur at times other than the fixed dates communicated to the investment

community; and

(f) the acceleration of the maturity dates of forward sales contracts for 500,000

shares served to limit investor concerns about insider trading in the stock, that would potentially

arise on the original maturity dates.

JURISDICTION AND VENUE

12. The claims asserted arise under § § 10(b) and 20(a) of the Securities Exchange Act of

1934 ("Exchange Act") (15 U.S.C. §§ 78j(b) and t(a)) and Rule lOb-5 (17 C.F.R. § 240.10b-5)

thereunder. Jurisdiction is conferred by § 27 of the Exchange Act (15 U.S.C. § 78aa), § 22(a) of the

Securities Act (15 U.S.C. § 77v(a)) and 28 U.S.C. § 1331. Venue is proper in this district pursuant

to § 27 of the Exchange Act, and 28 U.S.C. § 1391(b) because the defendants maintain an office in

this District and the wrongful conduct giving rise to the violations of law complained of herein,

including the preparation and dissemination to the investing public of false and misleading

information, took place in this district.

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13. In connection with the acts and conduct alleged herein, defendants, directly and

indirectly, used the means and instrumentalities of interstate commerce, including the United States

mails and the facilities of the national securities exchanges.

PARTIES

14. Plaintiff, as set forth in the accompanying certification, incorporated by reference

herein, purchased shares of FARO Technologies stock at artificially inflated prices during the Class

Period, as described in the attached certification, and was damaged thereby.

15. Defendant FARO Technologies is a Florida corporation and maintains its corporate

and administrative offices at 125 Technology Park Drive, Lake Mary, Florida.

16. Defendant Simon Raab ("Raab") was, at all relevant times hereto, Chief Executive

Officer ("CEO"), Chairman of the Board, co-founder and member of the compensation committee of

FARO Technologies. During the Class Period, defendant Raab sold shares of his FARO

Technologies stock, for proceeds of approximately $33.7 million.

17. Defendant Gregory A. Fraser ("Fraser") was, at all relevant times hereto, Executive

Vice President, Secretary, Treasurer, Director, co-founder and member of the compensation

committee of FARO Technologies. During the Class Period, defendant Fraser sold shares of his

FARO Technologies stock, for proceeds in excess of $7.1 million.

18. Defendant Barbara R. Smith ("Smith") was, at all relevant times hereto, Chief

Financial Officer of FARO Technologies.

19. The defendants referenced above in IT 16-18 are referred to herein as the "Individual

Defendants."

DEFENDANTS' CONTROL OVER FARO TECHNOLOGIES AND ITSCOMMUNICATIONS TO THE PUBLIC CONCERNING FINANCIAL RESULTS

20. The Individual Defendants, by virtue of their high-level positions with the Company

and committee memberships, directly participated in the management of the Company, were directly

involved in the day-to-day operations of the Company at the highest levels and were privy to

confidential proprietary information concerning the Company and its business, operations, growth,

financial statements and financial condition, as alleged herein. Said defendants were involved in

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drafting, producing, reviewing and/or disseminating the materially false and misleading press

releases, statements and information alleged herein, knew or recklessly disregarded that materially

false and misleading statements were being issued regarding the Company, and approved or ratified

these statements, in violation of the federal securities laws.

21. In addition to the above-described involvement, each Individual Defendant had

knowledge of FARO Technologies's problems. Each defendant was motivated to conceal such

problems. Defendants Fraser and Smith, serving as Treasurer and CFO, respectively, provided for

financial reporting and communications with the market. Defendant Fraser directed communications

with the market, including conference calls, as well as internal reports showing FARO

Technologies's forecasted and actual growth. Defendant Raab, serving as Chairman and CEO, also

provided for communications with the market, including conference calls, as well as reports on

Company operations, financing and press releases issued by the Company.

22. Each Individual Defendant sought to demonstrate that he or she could lead the

Company successfully and generate the growth expected by the market. Each Individual Defendant

also owed a duty to the Company and its shareholders not to trade on inside information.

FRAUDULENT SCHEME AND COURSE OF BUSINESS

23. Each defendant is liable for (a) making false statements, or (b) failing to disclose

adverse facts known to him/her about FARO Technologies. Defendants' fraudulent scheme and

course of business that operated as a fraud or deceit on purchasers of FARO Technologies's publicly

traded securities was a success, as it (a) deceived the investing public regarding FARO Technologies

prospects and business; (b) artificially inflated the prices of FARO Technologies's publicly traded

securities; (c) allowed defendants to use the inflated value of the Company's stock as currency for

their March 2005 acquisition of iQvolution AG; (d) allowed defendants to sell over $1.48 million

shares of FARO Technologies stock at inflated prices, for proceeds of approximately $40.9 million;

and (e) caused plaintiff and other members of the Class to purchase FARO Technologies's publicly

traded securities at artificially inflated prices.

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BACKGROUND AND DEFENDANTS' PRE-CLASS STATEMENTS

24. Defendant FARO Technologies develops, markets, and supports portable, software-

driven, 3D measurement systems for a range of manufacturing and industrial applications, including

articulated electromechanical and laser-based measuring devices that enable manufacturing,

engineering, and quality control professionals to measure and inspect parts, machine tools, and other

objects onsite and/or in-process. The Company also markets its own proprietary Computer-Aided

Design (CAD)-based measurement and statistical process control software, as well as a variety of

software designed to assist operators through measurement processes, for comparative measurements

and for the production of graphical and tabular reports. The company sells its products through its

direct sales force primarily to manufacturers in the automobile, aerospace, and heavy equipment

industries in the Americas, Europe/Africa, and Asia/Pacific regions.

25. The Company associates its business with its premier global manufacturing

"customers," as stated on its website:

FARO has provided quality equipment, software and support to a variety of smalland large companies. Below are just of few of FARO's valued customers.

Automotive Aerospace Auto/Hero SuppliersDaimlerChrysler Boeing Johnson Controls

General Motors Lockheed Martin Magna

Ford Northrop Grumman Faurecia

Honda EADS Airbus Securit St. Gobaln

Toyota Snecma Plastic Omnium

Nissan Rolls Royce Lear Corporation

Porsche GE Aerospace Delphi Automotive

Volkswagen Nordam Thyssen

BMW SAE Webasto

Opel Dassault Aviation Ebersplicher

Jaguar Hughes Brothers VDO

Lotus Fiat Avlo Karman

Audi Heggemann EDAG

Aston Martin Sommer Alibert

Renault Contitech

Flat

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Consumer Goods Electric Power Heavy EquipmentGeneration

Harley Davidson General Electric John Deere

Polaris Westinghouse Case Corporation

Bombardier Southern California Edison Caterpillar

Xerox ABB Power Generation Komatsu Dresser

Hewlett Packard Hydro Quebec Clark Industries

Mercury Marine Siemens Ingersoll Rand

Amanda Voith Hydro AGCO

Braun Corporation Turbo Care HAY and Forage

Eastman Kodak Potomac Electric Power Renault Agriculture

Miele Turbine Technology Volvo Construction EquipmentInternational

Steinway&Sons Alstom

Bulthaupt GmbH & Co Thermo King

Siemens Haushaltsgeriite Dennis Eagle

EvobusLinde

26. On March 5, 2001, defendants issued a press release entitled, "RWD Announces

Partnership with FARO Technologies, Combines Products and Services for Total Process

Management Solution." The press release, which associated the Company's products, software and

services as key components of manufacturing "management solutions" to increase product quality

for the Company's customers while reducing their costs of production, stated in part:

Lake Mary, Fla. -- RWD issued the following news on March 5,2001:COLUMBIA, MD - March 5, 2001 - RWD Technologies, Inc. (Nasdaq:RWDT), announced today that it has signed a partnership agreement with FAROTechnologies Inc. (Nasdaq: FARO), the leader in Computer-Aided ManufacturingMeasurement (CAM20). RWD and FARO are delivering Total Process Management(TPM) solutions that integrate RWD's eManufacturing consulting, qualityengineering and systems integration services with FARO's suite of 3D measurementequipment and software products. The combined product and service solutionenables a company's plant-floor quality processes to be fully integrated withcomputer-aided design (CAD), computer-aided manufacturing (CAM) and computer-aided engineering (CAE) technology. FARO software, which enables real-timemanagement of manufacturing and process data from the designer's desk to the shopfloor, fuels this capability and leads to improved productivity and increased quality.Coupled with the application of RWD's manufacturing and systems expertise, apowerful integrated solution emerges.

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"RWD's and FARO's approach brings people, processes, and technologytogether in a unique way that simplifies and streamlines pre-production, improvesproduct quality and drives process improvement on the plant floor," explained DanSlater, president of RWD's Manufacturing Performance Group.

Simon Raab, FARO's CEO and president said, "FARO's CAM2 SPCProcess Software and family of measurement hardware coupled with RWD's LeanManufacturing and Project Management expertise offer an unparalleled ability toprovide total manufacturing solutions."

Through the elimination of non-value added steps from the engineeringprocess, reducing incoming out-of-specification parts and using real-time,enterprise-wide statistical process control (SPC) systems and processes, RWD andFARO's combined services offer the following benefits to the discrete andrepetitive manufacturing industries:

• Shortened new product development time and a 30% reduction inengineering costs

• Improved process capability, increased product quality and reducedmanufacturing costs

•Reduced rework, scrap and lost production time

FARO and RWD recently co presented a paper on TPM Solutions thatresulted in international attention and collaboration between the aerospace andautomotive industries. As partners, RWD and FARO anticipate playing a key rolein the worldwide trend toward CAD-based total process and quality management.[Emphasis added.]

27. Defendants reiterated their expertise and the ability of FARO Technologies to offer

its customers "Total Management Solutions" for improving product quality and productivity. On

July 12, 2001, defendants issued a press release entitled, "FARO Signs Preferred Supplier

Agreement with Vought Aircraft Industries." The press release stated in part:

Lake Mary, Fla. - July 12, 2001 - Leading manufacturer of 3D measuringequipment and software, FARO Technologies Inc. (Nasdaq: FARO) announced it hasrecently signed a worldwide preferred supplier agreement with Vought AircraftIndustries Inc., the world's largest independent supplier of aerostructures. Thepreferred supplier agreement follows the projected expansion of Vought's use ofFARO CAM2 (Computer-Aided Manufacturing Measurement) products includingthe 3D articulating FaroArma and CAM2 softwarea. The agreement will apply toVought's corporate headquarters in Dallas, Texas, and other product-focusedassembly sites in Hawthorne, Calif., Stuart, Fla., Milledgeville, Ga., and Perry, Ga.

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Stephen Starner, FARO's Director ofAerospace Enterprise Solutions, said,"Today's manufacturing environment is highly competitive. The leaders in theirindustries will be leveraging the Total Manufacturing Solutions of FAROTechnologies to improve both the productivity and the quality of their products.Vought and FARO are already going down that road together."

Cliff Collier, Purchasing Manager at Vought, said, "We are committed toapplying leading-edge technology to help our customers gain a competitiveadvantage. The use of FARO Technologies' solutions moves us in the rightdirection." [Emphasis added.]

28. Pointing once again to the importance of obtaining improvements in product

quality and productivity, on July 23, 2001, defendants disclosed the astonishing success of their

own efforts to streamline production and achieve efficiency through "lean manufacturing"

operations, issuing a press release entitled, "FARO Technologies and Florida MEP report an 89

percent increase in plant productivity due to lean manufacturing." The press release stated in

part:

ORLANDO, Fla. - The Florida Manufacturing Extension Partnership (FloridaMEP) and FARO Technologies Inc. (Nasdaq: FARO) announced today that FAROexperienced significant productivity improvements as a result of adopting leanmanufacturing principles. "Lean manufacturing has significantly improved ourmanufacturing operations while simultaneously improving quality," said EdPelshaw, Vice President of Manufacturing at FARO. Over a three-month periodduring the second quarter of 2000, FARO experienced the following impacts:

• 89% increase in monthly production capacity

• 84% reduction in subassembly work in process inventory

• 47% decrease in shop floor space

• 45% decrease in unit labor costs

• 25% reduction in final assembly of work-in-process

Lean manufacturing, which originated from the Toyota Production System,focuses on eliminating nonvalue-added activities and streamlining its value-addedactivities. Traditional manufacturing processes typically include seven "deadly"wastes: (1) overproduction; (2) wait time; (3) transportation; (4) inefficientprocess; (5) inventory; (6) motion; and (7) defects. Lean manufacturing, on theother hand, is based on the elimination of waste and the creation of a smooth flow

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in a manufacturing process. Lean manufacturing is one of the most promisingproductivity methods available to manufacturers today.

"Florida MEP consultants did an excellent job at a very reasonable cost,and the return on investment was realized within a matter of months, " Pelshawstated. [Emphasis added.]

29. "Lean manufacturing," according to the "Toyota approach," calls for the

implementation of changes in operations and methods to address inventory waste, including the

adoption of "first in, first out" (FIFO), to replace "last in first out" (LIFO) inventory practices.

According to an article on the Toyota Production System, entitled "Toyota Production System and

Lean Manufacturing," types of inventory waste include the following 6:

Inventory Waste

Characteristics:

• Extra Space on Receiving Docks

• Material Between Processes

• Stagnated Material Flow

• LIFO instead of FIFO

• Extensive Rework When Problems Surface

• Long Lead Time for Engineering Changes

• Additional Material Handling Resources (Men, Equipment,

Racks, Storage Space)

30. Defendants' expertise and actions regarding the Company's "Total Management

Solutions" and its "significant productivity improvements as a result of adopting lean manufacturing

principles" would necessarily strengthen corporate compliance practices, through the

improvement of internal controls and practices. Defendants failed to disclose, however, in the

6 D. Jorge Leon, Toyota Production System and Lean Manufacturing, " Texas A&M University,http://etidweb.tamu. edu/ftp/entc4l 2/Lean%20Part%20I.pdf#search='toyota%20fifo%201ean%20manufacturing'

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Company's annual report, filed with the SEC on a Form 10-K for the year ending December 31,

2001, (i) that internal controls necessary for defendants to develop reliable consolidated financial

statements did not exist or were inadequate; (ii) that information had come to the attention of the

Company's accountants that rendered the Company's financial statements unreliable; or (iii) that

there was a significant need to expand the scope of the accountant's auditing activities. These

activities, if further investigated, may materially have impacted the fairness or reliability of

defendants' financial statements.

31. The Company's Form 10-K for the year ending December 31, 2002, filed on March

27, 2003 stated, in part, that not only had there been no significant changes in the Company's

internal controls or in other factors that could significantly affect those controls during the period,

but also describes the corporate compliance standards that the Company had adopted as early as

1998:

"Quality" has rapidly emerged as a new emphasis in commerce and industry,and is a significant factor in international trade. The Company's manufacturing,engineering and design headquarters have been registered to the ISO 9001 standardsince July 1998. Semi-annual surveillance audits have documented continuousimprovement to this multinational standard The Company continues to examine itsscope of registration as the business evolves and has chosen English as the standardbusiness language for its operations. This decision is expected to significantlyinfluence the Company's operations and documentation globally. This has been donein concert with the ISO Standard Registrar, and is expected to increase customerconfidence in the Company's products and services worldwide.

ITEM 14. CONTROLS AND PROCEDURES.

The Company currently has in place systems relating to internal controls andprocedures with respect to its financial information. Management periodicallyreviews and evaluates these internal control systems with its internal auditors and itsindependent accountants. The Company has completed such a review and evaluationin connection with the preparation of this Annual Report. The Company hasdetermined that there have been no significant changes in its internal controls orin other factors that could significantly affect these controls subsequent to its mostrecent evaluation. While the Company believes its internal controls are effective, theCompany cannot provide assurance that the current internal controls will not changein the future to reflect potentially new rules of the SEC. [Emphasis added.]

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32. The Company's SEC Form 10-K for the year ending December 31, 2003, filed on

March 24, 2004, again stated, in part, that there had been no significant changes in the Company's

internal controls or in other factors that could significantly affect those controls during the period

and describes the corporate compliance standards that the Company had adopted as early as 1998:

"Quality" has rapidly emerged as a new emphasis in commerce and industry,and is a significant factor in international trade. The Company's manufacturingengineering and design headquarters have been registered to the ISO 900 standardsince July 1998. Semi-annual surveillance audits have documented continuousimprovement to this multinational standard. The Company continues to examine itsscope of registration as the business evolves and has chosen English as the standardbusiness language for its operations. This decision is expected to significantlyinfluence the Company's operations and documentation globally. This has been donein concert with the ISO Standard Registrar, and is expected to increase customerconfidence in the Company's products and services worldwide.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE.

None

ITEM 9A. Controls and Procedures.

Our management evaluated, with the participation of our Chief ExecutiveOfficer and our Chief Financial Officer, the effectiveness of our disclosure controlsand procedures, as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act,as of December 31, 2003. Based on this evaluation, our Chief Executive Officer andour Chief Financial Officer have concluded that our disclosure controls andprocedures are effective to ensure that information we are required to disclose inreports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in SEC rules and forms.

There were no changes in our internal controls over financial reportingduring the quarter ended December 31, 2003, that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting. [Emphasis added.]

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DEFENDANTS' FALSE AND MISLEADING STATEMENTSMADE DURING THE CLASS PERIOD

33. On May 6, 2004, the Company issued a press release entitled, "FARO's Earnings

Per Share Jump to 20 Cents From 4 Cents on 57% Sales Increase." The press release stated in

part:

LAKE MARY, Fla., May 6 /PRNewswire-FirstCall/ -- FARO Technologies,Inc. (Nasdaq: FARO) today reported a 473% increase in net income in the firstquarter of 2004 to $2.8 million, or 20 cents per diluted share, from $489,000, or fourcents per diluted share in the first quarter of 2003. Fully diluted shares grewapproximately two million shares or 16.5% to 14.1 million shares at April 3, 2004,from 12.1 million shares at March 29, 2003. Sales for the quarter increased 56.7% to$21.0 million, from $13.4 million in the first quarter of 2003. Gross margin increasedeight percentage points to 64.0% in the quarter, from 56.0% in the first quarter of2003, as a result of lower service expenses, less price discounting, and increasedproduction efficiencies.

Selling, general and administrative ("SG&A") expenses decreased as apercentage of sales from 41.4% in the first quarter of 2003 to 38.6% in the firstquarter of 2004. On a sequential quarter basis SG&A expenses as a percentage ofsales increased 0.9 percentage points compared to 37.7% in the fourth quarter of2003, resulting from higher selling expenses as a percentage of sales, partially offsetby lower general and administrative expenses as a percentage of sales. The Companyhad forecast this increase in selling expenses as a percentage of sales in the first halfof 2004, primarily as a result of costs related to the expansion of its worldwide salesforce.

Income from operations increased $2.8 million from $459,000 in the firstquarter of 2003 to $3.3 million in the first quarter of 2004. This increase wasprimarily a result of an increase in gross profit of $6.0 million, offset by a $2.5million increase in SG&A expenses. On a sequential quarter basis, operating marginimproved to 15.9% in the first quarter of 2004, compared to 11.8% in the fourthquarter of 2003.

Income tax expense in the first quarter of 2004 was $765,000 or 21.2% oftaxable income, in line with the 20%-25% guidance given by the Company for 2004,and compared to $72,000, or 12.9% of taxable income in the year-ago quarter.

"We showed continued strong year-over-year growth in the first quarter,continuing a trend shown throughout 2003," said Simon Raab, President and CEO."We took a number of initiatives in the quarter to help continue our penetration intothe large, underserved CAM2 market. These included expansion of our sales forcearound the world, with an emphasis in the Asia/Pacific, and the establishment ofservice centers in key newer markets including Brazil, Japan, and China. Besidesexpanding into new geographic regions, we are also focused on further penetratingour larger existing customers. Sales to existing customers represented 68% of totalsales in the quarter, compared to 62% in all of 2003."

Regionally, sales in the Americas increased 57.4% in the first quarter of 2004to $8.5 million, from $5.4 million in the first quarter of 2003. Sales in theEurope/Africa region increased 65.6% to $10.1 million, from $6.1 million in 2003.

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Sales in the Asia/Pacific region grew 26.3% to $2.4 million, from $1.9 million in2003.

Market Evolution and Size Assessment

"We believe that the growth in the CAM2 market (Computer AidedManufacturing Measurement) should parallel the growth already seen in the first twostages of the CAD (Computer Aided Design) revolution which started in earnest overthree decades ago," continued Raab. "CAD is now virtually 100% adopted in theindustrial design environment, and has grown to a multi-billion dollar market. TheCAM (Computer Aided Machining) stage of the CAD revolution followed next.CAM allowed single parts to be machined on computer-controlled machine toolsusing CAD data. Eventually the majority of machine shops around the worldrequired such CAM hardware and software, and this market has also grown into thebillions. The penetration of CAD/CAM into the manufacturing environment washowever incomplete. Once the single parts manufactured through CAM are broughtto assembly, where very little CAD exists and problems with dimensional fit, toolingand scrap occur, that is where the CAM2 market emerges. Today this market is at anearly stage of its evolution, at an estimated amount of approximately $200 million.We expect that this market will continue to grow as the manufacturing evolution thatstarted with CAD and CAM continues. The penetration of CAD-based measurementtools adaptable to the manufacturing environment is the final stage of the CADevolution. In fact, we believe that our continued strong year-over-year growth inorders is in part at the expense of a diminishing market for conventional, non-portable coordinate measuring machines and check fixtures but more importantly dueto the inevitable expansion of the CAM2 market."

Outlook for the Remainder of 2004.

As stated in an earlier news release, on the basis of new order growth in thefirst quarter, we are now expecting sales for 2004 to be $90-$93 million, a 25%-30%increase compared to $71.8 million in 2003. We expect gross margins to be in arange of 59%-63% in the remaining quarters of 2004, and we expect that the highergross margins will be somewhat offset by taxes at the higher end of our 20-25%guidance, so we are maintaining our earlier forecast for net income at $0.71-$0.86per diluted share.

34. Defendants' press release of May 6, 2004 was false and misleading. On or before

this date, the Company's internal controls and corporate compliance (governing its own

manufacturing process and practices) were deficient and defective. Although the Company claimed

expertise in achieving "total management solutions," it had implemented corporate compliance

standards appropriate to its business as early as 1998 and had already implemented "lean

manufacturing" practices. But, the Company's operations were inefficient — particularly in its

inventory management and accounting practices. While maintaining that the Company's 2004

financial guidance was not impossible, defendants knew or recklessly disregarded that the Company

16


was rapidly approaching the limit of its capacity to accommodate aggressive growth, both in terms

of its preparedness to manufacture in accordance with forecasts and to coordinate its production

capabilities with aggressive sales activities across international markets.

35. Defendants concealed these limitations, as they did a key indication of them, in the

form of deficient and defective inventory accounting and practices. Although defendants had

represented to the investment community that they had already adopted "lean manufacturing"

practices, in truth, the Company had not yet adopted this approach for their inventory accounting and

practices, including FIFO inventory practices. 7 Thus, with respect to inventory accounting and

practices, defendants' manufacturing operations were still in "the stone age, "having not actually

embraced Toyota's "lean manufacturing" approach. Although defendants' failure to adopt "lean

manufacturing" for their inventory accounting and practices were arguably immaterial to the

Company's performance until earnings growth became unsustainable, they were material against

any opportunity defendants sought to sell a significant portion of their shares of the Company, well

before the investing public would learn of the problems facing the Company.

36. On May 11, 2004, defendants issued a press release entitled, "Faro Technologies

Reports Resumption of Executives Stock Option Exercise and Sale Plan." Defendants stated in part:

LAKE MARY, Fla., May 11 /PRNewswire-FirstCall/ -- FARO Technologies, Inc.(Nasdaq: FARO) today announced that two executive officers intend to resume theprocess of exercising compensation-related stock options, which they began inSeptember 2003. Simon Raab, President and CEO, is expected to exercise and sellthe underlying shares for up to 148,500 stock options, and Gregory Fraser, ExecutiveVice President and CFO, is expected to exercise and sell the underlying shares for upto 78,500 stock options.

"We have very strict guidelines for when we, as executive officers, can buy or sellcompany stock," said Simon Raab. "All of these stock options are part of ourcompensation package and this stock option exercise and sale will allow us to

7 See FARO Technologies's SEC Form 10-Q of August 10, 2005, informing of a change in the"method of computing the pricing of inventory from average cost to FIFO," reflective of theCompany's efforts to accomplish "an inventory system conversion, to allow for improved systemefficiencies." See also FARO Technologies's Form 10-Q of November 11, 2005, informing ofdiscrepancies in its "physical inventory of approximately $1.6 million related to inventory costingand consumption variances," which required "changes to its internal control over financialreporting."

17


somewhat diversify our holdings without changing our core (non option-related)share holdings."

37. Defendants' press release of May 11, 2004 was false and misleading because

defendants were highly motivated to exercise and sell their stock options, in light of the

challenges facing the Company. Defendants knew or were in conscious and reckless disregard

of the fact that the Company's growth was rapidly approaching the limit of its capacity to

accommodate explosive expansion, both in terms of its preparedness to manufacture in

accordance with forecasts and to coordinate its production capabilities with aggressive sales

activities across international markets. In the face of these worrisome issues, defendants renewed

their commitment to sell their holdings in the Company.

38. Defendant Raab asserted in the Company's press release of May 11, 2004 that

defendants only wished to access their compensation-based stock options, without targeting

their "core holdings" of Company stock However, as members of the Company's

compensation committee, defendants Raab and Fraser knew that neither of them had received

any compensation-related options since 2002. 8 Thus, defendants' compensation-based stock

options were, in fact, long-term compensation, that they clearly intended to liquidate at the

earliest possible opportunity.

39. On May 12-14, 2004, defendant Simon Raab, Chief Executive Officer and

Chairman of the Board of FARO Technologies, sold 148,500 shares of Company stock, for

proceeds of $3.4 million.

40. On May 12-13, 2004, defendant Gregory A. Fraser, Chief Financial Officer of

FARO Technologies, sold 78,500 shares of Company stock, for proceeds of $1.8 million.

41. On June 24, 2004, defendant Fraser was interviewed by Tom Gardner of The

Motley Fool (Fool.com) on the topic of defendants' startling decision to aggressively liquidate

one million shares of Company stock, representing "core holdings" of their shares. The

astonishing interview stated in part:

18


Tom Gardner: Greg Fraser, co-founder and CFO of FARO Technologies(Nasdaq: FARO), thanks for taking time out. I've got some different questionsmostly to do with the STARS insider transaction and how it works.

Greg Fraser: All right.

Tom Gardner: So why don't we start with having you tell us why you chosethe STARS and lOb5-1 vehicle for the stock sale?

Greg Fraser: Sure. We've come to know this variable prepaid forwardconcept as a very popular one for executives in our position. That position is thatfor both Simon (CEO Simon Raab) and I, as founders of this corporation, we havean enormous amount of our net worth in FARO stock. But we don't want to sell itnecessarily, and we don't want to pay the tax on it. But we do want to generatesome liquidity to obviously do some divesting, reinvest in other equities, and at thesame time, protect ourselves from downward price movement.

So the variable prepaid-forward contract allows an executive like me to dothat -- where I can monetize some of that stock and still retain the upside potentialin it over a period of, in this case, two years. I still retain my voting rights over thestock so we can still direct or set the direction of the company, with Simon, untilthose shares are actually surrendered in two years.

So it's a great combination of allowing us to divest somewhat today, but notsell the stock, not pay the tax, and retain upside potential.

Tom Gardner: And this is unusual in that you've carved out that upsideincentive. Can you explain how that will work and I guess overall how thetransaction works? You're working with Bank of America. Does Bank of Americaalready have the shares? Have you all already been paid cash from the sale?

Greg Fraser: Oh no, let me try to lay it out. I'm not the expert on this. I wouldhave to defer to investment bankers to give you the expert explanation, but I'll give itto you from my perspective. We certainly do not hand over shares because thatwould be a taxable event. But we've pledged these shares as collateral, if you will,for an upfront payment that we'll get from Bank ofAmerica at a discount to, let'scall it, today's stockprice as opposed to the one 12 months from now or 24 monthsfrom now.

When the transaction is signed, from that stock price, we'll get somesignificant percentage upfront. Then what happens is that locks in the maximumnumber of shares that we'll have to hand over at the anniversary date of 10 and 17and 24 months; a third of the shares, a third of the shares, a third of the shares.That's the maximum amount we'll ever have to give to Bank of America inpayment for that upfront discounted payment amount. Let's call it 90% to pick anumber. We will get 90% of the value. That's just to pick a number; that's not theactual number.

Tom Gardner: Just for context.

s See the Company's Form DEF 14A filed, with the SEC on April 26, 2005, which shows nocompensation related options received by defendants for calendar years 2003 and 2004.

19'


Greg Fraser: Just for this example. So that's the maximum number of shareswe will ever have to give. So what happens then is we set, in exchange for gettingthat discounted amount, only 90%, we have the ability then to benefit from the stockappreciating over the next 10, 17 and 24 months up to values that we think thecompany might reach.

In our case, that is $27 in 10 months, $34 in 17 months and $42 or $43 in 24months. OK? Now, and a lot of this is based on when taxes are triggered and so onand so forth, but if the stock goes above those levels, we lose the benefit of thatstock appreciation. It's the uncertainty of how many shares that we will actuallygive, because if we are above, -- let's say today's price is $25 and the price goes to$27 -- we will not have to give as many shares. We can pay back with shares thatare now worth $27, so we don't have to give as many as initially thought at $25,OK?

Similarly, for the second third, if we are at $34, we get the full appreciation ofthat, and we can pay back the amount that was advanced to us with $34 shares, so wedon't have to give the full third amount.

If we go above those levels, at the $27 level, if we happen to be at $30 at 10months and have to hand the shares back, then we must give $27 value back.

Tom Gardner: So that is Bank of America's opportunity is $27 to $30.

Greg Fraser: Correct. Or if it is $40 or $50, exactly.

Tom Gardner: Right.

Greg Fraser: OK. So that is how the mechanism works and so that is how weretain a lot of upside potential in the transaction.

Tom Gardner: At the same time, you protect the downside to whatever thepercentage is of the present price that you lock in.

Greg Fraser: Correct. Yes. Let's say that the contract is predicated on $26,and the stock is $19 on the anniversary date. Then we only have to give the pre-determined number, the maximum number of shares that was contemplated at thebeginning. Not any more than that.

Tom Gardner: So, Greg, what is in it for Bank of America is the super-upside potential, and obviously the fees for running the transaction?

Greg Fraser: Yes. They essentially get that upfront fee, whatever discountwe take at the beginning, yes.

Tom Gardner: Can you explain the voting versus non-voting? It seemsunusual to me. I don't understand how non-voting shares would be sold until thesurrender in two years and then they would regain their voting privileges.

Greg Fraser: No, no. If I said that that way, it's not what I intended to say.Let's look at it this way. The tax event, the handing over of the shares, is whattriggers this. We vote those shares until we actually hand them over to the bank.

Tom Gardner: Gotcha, all right.

20


Greg Fraser: So we will lose a third, nominally, depending on what thecalculation is, whether we give back fewer or more or the whole amount, but we losethe voting rights when we actually physically hand over the shares.

Tom Gardner: Got it. Now if I understand this correctly, under this version,you all are getting paid upfront. But my understanding was that under l Ob5-1 trades,those trades are played out over a period of time. Am I right that that's not reallywhat's happening here for you all? Whatever percentage minus the discount that youguys are locking in today, you are locking that capital in today.

Greg Fraser: Let's separate, Tom, if we can, let's separate a planned sale ofstock under a 10b5-1 program from a variable prepaid forward contract, whichincludes a 10b5-1 program.

Tom Gardner: OK.

Greg Fraser: Under, let's go to the first one. With a 1Ob5 program, if I justentered into a 10b5 program, generally that's used as what is called a programmedsale of stock into the market, which can continue through blackout periods or quietperiods that we executives bump into at the end of quarters and so on and so forth.Essentially a 10b5 allows you to say, "I want to sell 100,000 shares over the nextyear in a programmed way, between such and such a price and such and such a price,and I want it to continue." Under a lOb5 program I can do that as long as I give upcontrol. I say to my broker that I want to sell 100,000 shares between this price andthis price. Go and do it. I lose control. I must lose control under the 10b5 program;otherwise I run into the problems that I would run into if we sold inside of a quietperiod, a blackout period. So that's the conventional use, as I understand it, of a 1Ob5program.

Now, let's put that aside for a second and now let's enter into this variableprepaid forward contract, in which the stock is not being sold until the mileposts ofsay 12 and 18 and 24 months to round it off.

Tom Gardner: Right.

Greg Fraser: The way this transaction occurs is that the bank goes out andborrows not our stock, but it borrows FARO stock and starts to sell it into themarket, as a hedging process.

Tom Gardner: So it is effectively shorting FARO to hedge itself.

Greg Fraser: Correct. And they started that, in our case, they started thatprocess in early June. And our control over whatever price they sell that at endswhen our trading window closed, and our window did close on or about the 10th or11th or 12th of June.

Tom Gardner: OK.

Greg Fraser: Our window closed. So for that process to complete itself, for itto continue and complete itself, they are hedging, essentially setting theprocess upthrough this hedging process. We had to let them continue that under a IOb5program.

Tom Gardner: Aaah.

21


Greg Fraser: That's where the 1Ob5 comes in.

Tom Gardner: So they did not complete all of the, say, million shares ofshorting before the window closed.

Greg Fraser: Before the window closed, yes, yes. That's why the 10b5plan ispart of this.

Tom Gardner: And so why not just structure this as a 10b5 plan period?

Greg Fraser: Oh, because I would have to sell my stock and I wouldn't getany upside potential. I wouldn'tget any upside participation. If I think my stock isgoing to $42 in two years, I don't get that if I just sell the stock. Plus I pay capitalgains tax immediately.

Tom Gardner: And so then, OK, I'm professing ignorance here...

Greg Fraser: No, no. You're only one step behind what I was before Istarted learning all about this to do it. So go ahead.

Tom Gardner: So my question then is if you're confident about where thestock is going, why enter into the variable plan at all?

Greg Fraser: That's a very good question. Think about this. The vast majorityof my net worth is in FARO stock. If there is a -- God forbid -- a terrorist act onthis country a year from now, and capital spending by my customers gets shut offlike it did after 9111, thank God for only a couple of months, the capital spendinggoes down and my stock gets cut in half, then so does my net worth.

This way, I'm able to get what I consider, as many executives have, some ofthe best of both worlds. Iget to take some of it out, monetize it as the bank calls it. Iget to take some of it out but to keep a significant amount back for upsidepotential.

Tom Gardner: OK.

Greg Fraser: That is why.

Tom Gardner: Greg, I sent the FARO press release announcement of theSTARS transaction to aprofessor, NejatSeyhun, at Michigan Business School. Hewrote a wonderful book entitled Investment lntelligence from Insider Trading. Heread the press release, and here's what he wrote back to me. Then I'll give you achance to respond.

Greg Fraser: Sure.

Tom Gardner: Dr. Seyhun wrote, "Tom, I would view this transaction as abearish signal right away if I held a large position in FARO as an outsideshareholder. Given the magnitude of the shares to be sold and the titles of thesellers, I would view this as negative news. It's the same as if the founders simplysold one million shares right away."

Greg Fraser: So I guess he saw two different view points. It depends onwhich viewpoint you take. What he also has to realize, or what one has to realizehere, is that we might only have to give up about 700,000 shares, not the million

22


shares, if the price targets are met. But let's assume it is the most, a million sharessold. Then Simon will still retain more than 10% of the ownership of this companyand I will retain about 1%, which is about a third of what I had a year ago. Simonwill have about a half of what he had a year ago.

Tom Gardner: OK.

Greg Fraser: Yes.

Tom Gardner: I had calculated that you've sold more than that, but you are athird of where you were?

Greg Fraser: About a year ago. I have those numbers. About a year ago, thatwas before the PIPE transaction that we did in November. I had about 440,000shares.

Tom Gardner: And after this full transaction is settled, you will have?

Greg Fraser: About 100,000.

Tom Gardner: And that is if the incentive does not kick in?

Greg Fraser: Correct.

Tom Gardner: OK. And if the incentive does kick in, to the maximum level,then you'll get a portion of the 300,000 shares?

Greg Fraser: Well, Simon will get most of those, to a 75%/25% ratio. Simonwill get 75% of it and I will get 25%.

Tom Gardner: So would you say that this transaction has nothing to do withyour perception of any weakness in your business?

Greg Fraser: On the contrary.

Tom Gardner: The downside illustration you gave was of a massive terroristattack. You did not give the illustration of, well, if your product just becomes lessrelevant than it is today, for example.

Greg Fraser: Yes. A year ago at today's prices I had about $12 million inFARO stock, $12 million. The vast, vast, vast majority of my net worth. After this,same price, assuming it is the same price, I will have $2 million or more. If I exerciseoptions, that's another issue, but about $2 million. So think about that as an investor,or as an individual who owns stock. That's a very undiversified portfolio, and sothat's the scenario I am talking about.

Now for Simon, of course, that's even more dramatic an example of howmuch he will have left. If I do that math on what he will have left, he will still have$40 million in FARO stock left.

Tom Gardner: So this has nothing to do with any weakness in the business.The only thing in looking through the financials, and having studied the companyas intensively as I have, the only thing I have seen is a creep-up in finished goodinventory. Is that a question mark for you as CFO at all? I know you carry salesdemo inventory in there.

23


Greg Fraser: Yes, a great deal of the growth is demo inventory. We havedramatically increased our sales force headcount in Asia in particular, but alsocontinuing in Europe and to a lesser extent in North America. We added a newproduct, the Gage, to ourproduct line and not long before that, the Laser Tracker.So absolutely the most significant increase in our inventory is related to demoinventory.

Tom Gardner: Now I want to look at this overall, since you are one of the twopeople that has presided over an incredible turnaround in the stock value. You'vebeen emphasizing wealth diversification and protection as the motivation behind thesale. So this is not about your future involvement in the business. This doesn't signalthat you might be taking a lesser role in the company, does it?

Greg Fraser: Certainly not, but I'm not sure exactly where you are coming atwith that. Simon and I are not old men. This isn't our swansong, so to speak.

Tom Gardner: OK.

Greg Fraser: But having said that, all of our investment community knowsthat we have published ads for a COO. We have added to the management in thiscompany, especially since going public. Over the last six years, we have been able toattract high quality leaders. Let me say that another way, Tom. When we went publicin 1997, you had Simon and I, and then you went down quite a long way to the nexthighest level of management in the company. That is not the case anymore becausewe've recruited and added to our management team. We've added people from big,medium and small companies who have a great deal of knowledge in each of the keyareas: from human resources to sales to quality and so on and so forth. We're goingto continue to do that.

We are not a couple of guys that started a company and are refusing to let go,if you will. So we are going to, as we grow, if we're going to grow from a $70 to$100 to a $250 million company, we are not pretending that the two of us can do itall. We need to add to our management team and we intend to do that. But that's aseparate issue from this diversification step we are taking.

Tom Gardner: Right. I totally embrace the build out of running a greatcompany, the build out of a management team. I think the fear is, expressed in adirect and concerning way, "Are these guys just eliminating their equity exposurein the company in a rather quick fashion here? And in so doing, are theydowngrading their involvement in the business because of some perceivedoncoming weakness, or something that we outside shareholders don't see?"

Greg Fraser: No. An unequivocal no. Think about how much we will haveleft, and of course it is all relative. Simon has so much more than I do, but considereither my situation individually or his individually and you will see that this is, for anindividual, a fiscally responsible thing to do, guarding against the sky falling, theterrorist act. It is begin done at a time when we're very late in the quarter. I can'tgive you any comments on this quarter, but if you just look back at the last seven oreight quarters, we have grown the business to the point where the investors value thiscompany at four times sales. And we don't see that as an unreasonable valuation totake this diversification step with the wonderful opportunity of keeping some upsidepotential in those shares, yes.

Tom Gardner: So how did this come about today rather than last year or sixmonths ago? Was it that the transaction was made possible to you by Bank of

24


America at this time for a given reason? What is it about now that caused you to usethe STARS transaction rather than six months ago?

Greg Fraser: Or a year ago. A year ago we were at $6 per share. Then a fewmonths ago we were $30-some. We didn't want to do something, obviously, a yearago, at $6. We didn't see that as the true valuation of the company. In the middle$30s, was probably, you know, we were happy with that valuation; we just probablyoverextended it a little bit. So to do something at that point would be, perhaps,rubbing something in some shareholder's face who is now back at $25. But at thispoint, we think the stock is fairly valued and it was more our decision than the Bankof America willing to do it at this point.

Tom Gardner: Got it. OK. Here is the most deeply cynical interpretation ofthis transaction that an outside investor could take. Play along and tell us whatyouthink: "The founders have seen their stakes rise 10 times in value in the last twoyears. So this new vehicle allows them to get a large portion of their holdings outnow. By doing so, they off-load the risk on Bank of America who, in turn, simplyprotects itself by hedging. And the net result is that the Bank ofAmerica gets theirfees. The founders get their large position out now as downside protection.Together, they place a very high incentive to keep shareholders excited. But inreality if the growth rate begins to slow and the stock falls, the shareholders lose,while the bank gets its fees, and the founders get their stock out.

Greg Fraser: (Sighs.) I don't disagree, if that happens.

Tom Gardner: But that is not why you made the transaction?

Greg Fraser: Certainly not. We don't expect the growth to slow. We'veprojected what our growth goals are very clearly for this year and it is ourintention to do everything possible to reach that. This transaction is not a statementabout our thinking that things are cooling off or anything to that effect, that wereceived or that we intend to give, whatsoever.

Tom Gardner: That's very helpful. Thank you. Greg, why don't we just closewith you briefly sharing what you're most excited about at FARO right now?

Greg Fraser: We're most excited, I think, about the fact that we have got threedifferent products. And our first product, the FAROArm, has achieved a level ofacceptance now that, well, if it hasn't happened yet, it's going to very soon become astandard in the industry. We often cite a book called Crossing the Chasm and thereare many, including many of us, who think that we may have crossed the chasm inthe market for the FAROArm. We are very excited about that.

Tom Gardner: That's a wonderful book and a wonderful reference to work offof at FARO. Greg, the important thing for me here, as somebody looking at yourcompany and recommending it, is to match up all the quantitative work and productreview work I can do with attempts to grasp the mindset of management. Thisdiscussion was helpful. It was very useful to hear about the transaction from youdirectly. And to hear why and what your plans are for the company as well. So, thankyou.

Greg Fraser: Well look, we appreciate it. I've talked to Simon after he'stalked to you in the past and we appreciate the level of effort that you've put intounderstanding our company. Anybody that does that, we are happy to talk to.

25


Tom Gardner: Thanks, Greg, and best of luck. [Emphasis added.]

42. Defendant Fraser's remarks during the interview of June 24, 2005, were false and

misleading because defendants knew or were in conscious and reckless disregard of the fact that the

Company's internal controls and corporate compliance, governing its own manufacturing process

and practices were deficient and defective. Although the Company claimed expertise in achieving

"total management solutions," had implemented corporate compliance standards appropriate to its

business as early as 1998, and had already implemented "lean manufacturing"practices in 2001,

the Company's operations were, in fact, inefficient, particularly in its inventory management and

accounting practices. While maintaining the Company's 2004 financial guidance was not impossible,

defendants knew or recklessly that the Company was rapidly approaching the limit of its capacity to

accommodate explosive growth, both in terms of its preparedness to manufacture in accordance with

forecasts and to coordinate its production capabilities with aggressive sales activities across

international markets.

43. Defendants concealed these limitations, as they did a key indication of them, in the

form of deficient and defective inventory accounting and practices. Although defendant Fraser was

asked about inventory issues, at no time did he point to any problems with them, including the fact

that the Company's inventory accounting and practices would be unable to meet the demands of

future growth. Although defendants had already represented to the investment community that they

had already adopted "lean manufacturing" practices, in truth, the Company had not yet adopted

FIFO inventory practices. Faced with defendants' expectations for accelerated growth, these

concealed facts were material, in view of the opportunity defendants sought to sell their "core

holdings" of the Company's shares, well before the investing public would learn of the problems

facing the Company.

44. Defendant Fraser explained to investors that, even though the highly complicated

forward-sales method and transaction with Bank of America selected by defendants assured

defendants of immediate profits, as well as an opportunity for continued appreciation, absent of any

present tax liabilities, the method appropriately "staggered" defendants' sales. However, while it

26


was true these forward sales transactions left defendants with considerable control of valuable option

and voting rights that were attached to their shares, defendant Fraser's statements regarding the

fixing of the actual "sales dates" was false and misleading.

45. There was, in fact, no truth to the assurances Fraser gave to investors of fixed

"mileposts" of "12 and 18 and 24 months." At least as long as those shares traded at or below the

price the bank received when it shorted the stock, it appeared possible to accelerate the maturity

dates of the contracts. 9 Of course, if defendant Fraser's explanations for the contracts were to be

believed, defendants lacked any motivation for acceleration of the contract maturity dates, other than

their concerns about factors indicating that (i) the opportunity for continued stock appreciation did

not in fact exist, and (ii) the original maturity dates complicated the management of any adverse

news or "corrective disclosures," that would necessarily draw attention to defendants' trading

activity.

46. On July 6, 2004, the Company filed Form 4's with the SEC on behalf of defendants

Raab and Fraser. In what amounted to a "sell short against the box"101 the Form 4's documented

the disposition of 1 million shares of the Company's stock by defendants Raab and Fraser pursuant

to the "forward sales agreements" they had entered into with Bank Of America. Based on these

filings, on or about June 10, 2005, Bank of America "shorted" one million shares of the

Company's stock into the market, receiving an average price of $25.90 and defendants received the

following monetary compensation in consideration for their agreement for the various represented

maturity dates for their contracted sales:

9 See ¶60.

10 This trading method allows an investor to lock in profits on a stock already owned, byborrowing an equivalent number of shares of the same stock through a broker and selling themshort. Later on, the investor buys back the shares and repays the broker. However, unlikedefendants' complex strategy to do essentially the same thing, an ordinary investor incurs ataxable event on the date he shorts the stock. For more on the pitfalls of selling short against thebox, see Hedging Technique Opens a Pandora's Box of Tax Concerns,http://www.thestrect.com/pf/funds/taxforum/769361.html, last accessed on November 12, 2005.

27


Defendant Shares Contracted Compensation Maturity Date

Simon Raab 250,000 $ 5,612,053 March 30, 2005

250,000 $ 5,273,434 November 30, 2005

250,000 $ 5,121,937 March 30, 2006

Gregory Fraser 83,333 $ 1,870,676 March 30, 2005

83,333 $ 1,757,806 November 30, 2005

83,333 $ 1,707,326 March 30, 2006

47. According to Form 4's filed with the SEC by defendants Raab and Fraser on July 6,

2004, Raab received, on or about June 10, 2004, proceeds of $16.0 million from the above

transactions, and Fraser received, on or about June 10, 2004, proceeds of $5.3 million from same.

48. On November 18, 2004, the Company filed a Form 8K with the SEC announcing the

dismissal of Ernst & Young LLP as its principal accountants. The Company stated that the reason

for Ernst & Young's dismissal was its purported "desire, in the spirit of the Sarbanes-Oxley Act of

2002, to ensure a more clear separation between tax consulting and audit assistance for the

Registrant. " Ernst & Young, however, indicated that there was no basis to agree with these reasons

given by defendants. The Form 8K stated, in part, as follows:

Item 4.01. Changes in Registrant's Certifying Accountant.

The Audit Committee of the Board of Directors of Faro Technologies, Inc.(the "Registrant") recently participated in, recommended and approved theengagement of Grant Thornton LLP as the Registrant's principal accountant to auditthe financial statements of the Registrant. Grant Thornton LLP was engaged by theRegistrant on November 15, 2004. The Registrant dismissed Ernst & Young LLP onNovember 16, 2004 as its principal accountant to audit the Registrant's financialstatements. The reason for the change in Registrant's principal accountant to auditfinancial statements was a desire, in the spirit of the Sarbanes-Oxley Act of 2002,to ensure a more clear separation between tax consulting and audit assistance forthe Registrant. Ernst & Young LLP is still being retained by the Registrant as itsprincipal accountant for tax purposes.

Prior to the engagement of Grant Thornton LLP, Ernst & Young LLP hadserved as the principal accountant to audit the Registrant's financial statements for aperiod including the Registrant's two most recent fiscal years. The decision tochange accountants was recommended and approved by the Audit Committee of theRegistrant's Board of Directors.

28


Ernst & Young LLP audited the Registrant's financial statements for theyears ended December 31, 2002, and 2003, and issued its audit report datedFebruary 20, 2004. During the two most recent fiscal years and the subsequentinterim period preceding November 16, 2004 (date of dismissal), no report of Ernst& Young LLP on the Registrant's financial statements contained an adverse opinionor a disclaimer of opinion, nor was one qualified as to uncertainty, audit scope, oraccounting principles.

During the two most recent fiscal years and the subsequent interim periodpreceding November 16, 2004 (date of dismissal), there were no disagreements withErnst & Young LLP on any matter of accounting principles or practices, financialstatement disclosure, or auditing scope or procedure, which disagreements, if notresolved to the satisfaction of Ernst & Young LLP would have caused Ernst &Young LLP to make a reference to the subject matter of the disagreements inconnection with its report on the Registrant's financial statements for any suchperiods. The Registrant requested that Ernst & Young LLP furnish it with a letteraddressed to the Securities and Exchange Commission stating whether or not itagrees with the above statements. The letter is attached hereto as Exhibit 16.

Item 9.01. Financial Statements and Exhibits.

(c) Exhibits: Letter from Ernst & Young LLP regarding Change inCertifying Accountant

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by the undersignedhereunto duly authorized.

FARO TECHNOLOGIES, INC.

Date: November 18, 2004 By: /s/ Gregory A. Fraser

Gregory A. Fraser

Executive Vice President,

Secretary and Treasurer

November 18, 2004

Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, DC 20549

Gentlemen:

We have read Item 4 of Form 8-K dated November 18, 2004, of FAROTechnologies, Inc. and are in agreement with the statements contained therein except

29


for the first, second, and fourth sentence of the firstparagraph with which we haveno basis to agree or disagree.

Very truly yours,

/s/ Ernst & Young LLP [Emphasis added.]

49. Defendants' SEC Form 8K was false and misleading. Well aware of the demands of

aggressive growth upon their organization, defendants were in the process of selection and/or

implementation of an enterprise resource planning ("ERP") system. In knowing or conscious

disregard of the "auditing dilemma" that the implementation of this Company-wide computerized

platform would create for the Company and its accountants, the selection of a new accountant served

to facilitate defendants' continued concealment its already deficient and defective inventory

accounting and practices.

50. Although the Company claimed that it had expertise in achieving "total management

solutions," it had implemented corporate compliance standards appropriate to its business as early as

1998, and it had already implemented "lean manufacturing" practices in 2001, includingpractices

essential to assure a smooth manufacturing process and prevent "inventory waste," the

Company's operations were in fact inefficient, particularly in its inventory management and

accounting practices. Defendants created expectations for accelerated growth, but concealed facts

concerning the Company's inadequate internal controls in order to sell their "core holdings" of

Company's shares, well before the investing public would learn of the problems facing the

Company.

51. On March 16, 2005, defendants filed a Form 10-K for the year ending December 31,

2004 ("2004 Form 10-K"). The filing stated in part:

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As of December 31, 2004, management carried out an evaluation, under thesupervision and with the participation of its Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of its disclosurecontrols and procedures as such term is defined under Securities Exchange Act of1934, as amended (the "Exchange Act") Rule 13a-15(e). Based on this evaluation,management has concluded that as of December 31, 2004, such disclosure controls

30


and procedures were effective to provide reasonable assurance that the Companyrecords, processes, summarizes and reports the information the Company mustdisclose in reports that the Company files or submits under the Exchange Act withinthe time periods specified in the SEC's rules and forms.

Management's Report on Internal Control Over Financial Reporting

Our Chief Executive Officer and Chief Financial Officer, together with othermembers of management of FARO Technologies Inc., are responsible forestablishing and maintaining adequate internal control over financial reporting.

Internal control over financial reporting is the process designed under oursupervision, and effected by our Board of Directors, management and otherpersonnel, to provide reasonable assurance regarding the reliability of financialreporting and the preparation of our financial statements for external purposes inaccordance with accounting principles generally accepted in the United States ofAmerica.

There are inherent limitations in the effectiveness of internal control overfinancial reporting, including the possibility that misstatements may not beprevented or detected. Accordingly, even effective internal controls over financialreporting can provide only reasonable assurance with respect to financialstatement preparation. Furthermore, the effectiveness of internal controls canchange with circumstances.

Management has evaluated the effectiveness of internal control over financialreporting as of December 31, 2004, in relation to criteria described in InternalControl-Integrated Framework issued by the Committee of Sponsoring OrganizationsCommission of the Treadway Commission (COSO). Based on that assessment,management concluded that, as of December 31, 2004, our internal control overfinancial reporting is effective based on the criteria established in Internal Control-Integrated Framework.

Grant Thornton LLP, our independent registered public accounting firm, hasissued their report on management's assessment of internal control over financialreporting, which appears below.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company's internal control over financialreporting during the quarter ended December 31, 2004 that have materiallyaffected, or are reasonably likely to materially affect, the Company's internalcontrol over financial reporting. [Emphasis added.]

52. The above statements were materially false and misleading because defendants failed

to disclose that the Company's internal controls with respect to inventory accounting and practices

were deficient and defective during 2004. Moreover, defendants knew or recklessly disregarded that

these statements were false and misleading because the deficiencies and defects in the Company's

internal controls with respect to inventory accounting and practices were apparent and a reasonable

consideration during defendants' implementation of its ERP system.

31


53. On March 29, 2005, defendants issued a press release entitled, "FARO Enters Large

Scale 3D Imaging Market with Acquisition of iQvolution AG." The press release stated, in part, as

follows:

LAKE MARY, Fla., March 29 /PRNewswire-FirstCall/ -- Consistent withtheir previously stated intent to enter broader three-dimensional measurementmarkets, FARO Technologies, Inc. (Nasdaq: FARO) today announced that it hasacquired privately held iQvolution AG ("iQvolution"). "This acquisition representsFARO'S first step in expanding beyond the computer-aided manufacturingmeasurement market to the broader computer-aided measurement market where theworld of three-dimensional measurement opportunities expands significantly," statedSimon Raab, Chief Executive Officer of FARO.

The purchase price for the transaction is approximately $12.0 million ofwhich 67% is in shares of FARO common stock and 33 % is in cash. All of the cashportion of the acquisition and slightly less than half of the stock portion arepayable immediately. The remaining stock will be held in escrow and will be paidover five years subject to achieving predetermined performance goals. Sales foriQvolution are anticipated to be approximately $7.5 million in 2005.

"Similar to our acquisition of SMX in 2002, we expect that the combinationof iQvolution's technology and FARO'S financial backing and worldwide sales andmarketing organization will create a much bigger player in this market thaniQvolution could on its own," said Jay Freeland, President & COO of FARO. "Weanticipate that this acquisition could dilute our 2005 earnings by up to $0.02 pershare, but with the effectiveness of our sales network and anticipated manufacturingand administrative synergies, we believe that the acquisition could be accretive bythe end of 2005."

iQvolution, headquartered in Ludwigsburg, Germany, manufactures andsupplies three-dimensional laser scanning products and services. Their technology iscurrently used for factory planning, facility life-cycle management, quality control,performing forensic analysis and in general, processing large volumes of three-dimensional data. Laser scanning technology simplifies modeling, reduces timerequirements and maintains or increases the accuracy of the image. The resultingdata is used with major CAD systems or iQvolution's own proprietary software formodeling and designing new factories or redesigning existing layouts. [Emphasisadded.]

54. Defendants' press release of March 29, 2005 was false and misleading because

defendants failed to disclose that they had engaged in a fraudulent scheme to artificially inflated the

price of FARO Technologies stock in order to acquire iQvolution using the stock as currency.

55. On April 1, 2005, defendants Raab and Fraser filed Form 4's with the SEC. The

filings documented the maturity of the first tranche of defendants' forward sales contracts with Bank

32


Of America, resulting in defendants' disposition of 333,333 shares of the Company's stock, for

which they previously received compensation on or about June 10, 2005 in the following amounts:

Defendant Shares Contracted Compensation Maturity Date

Simon Raab 250,000 $ 5,612,053 March 30, 2005

Gregory Fraser 83,333 $ 1,870,676 March 30, 2005

56. Since defendant's stock traded on March 30, 2005, at a price of $23.01, or $2.89

below the $25.90 price Bank of America received when it shorted the stock at inception of the

contract, defendants were required to tender all of the shares, rather than a smaller number of them,

had the stock traded above $25.90.

57. On May 9, 2005, defendants issued a press release entitled, "FARO Reports 21.8%

Net Income Increase In First Quarter 2005; Raises EPS Guidance for 2005." The press release stated

in part:

LAKE MARY, Fla., May 9 /PRNewswire-FirstCall/ -- FARO Technologies,Inc. (Nasdaq: FARO) today reported net income for the first quarter ended April 2,2005 of approximately $3.47 million or $0.24 per diluted share, a 21.8% increasecompared with $2.85 million, or $0.20 per diluted share in the first quarter of 2004.Sales for the first quarter of 2005 were approximately $27.6 million, an increase of$6.6 million, or 31.4% from $21.0 million the first quarter of 2004. New orderbookings for the first quarter were approximately $25.1 million, an increase of $6.0million, or 31.4% compared with approximately $19.1 million in the year-agoquarter. The sales increase in the first quarter of 2005 was higher than the 25%-30%annual growth forecast by the Company for all of 2005.

Revised Outlook for 2005

On March 29, 2005 the Company announced its acquisition of iQvolutionAG, a German manufacturer of a software driven laser-based measurement productwhich the company will sell under the name Laser Scanner LS. We expect thisacquisition to add $4.0 - $6.0 million to sales, and to have a dilutive effect ofapproximately four to seven cents on earnings per share in 2005. We expect thisacquisition to be accretive to earnings in 2006, as integration costs and a new salesforce will be fully deployed and productive.

"We are enthusiastic about our latest acquisition as we see a lot of similaritieswith our two previous very successful acquisitions," said Raab. "We have a long-term commitment from the iQvolution management and key technical people, andtheir leading-edge technology and lower pricing compared to the competition.

33


Combining this with our worldwide sales channel and name recognition should allowus to capture a larger portion of the growing laser scanner market."

The SEC has postponed the implementation date for expensing stock optionsuntil 2006, and this is expected to result in lowering our expenses by approximately$2.0 million, or 14 cents per share compared to our previous 2005 earnings per shareguidance.

Therefore based on our actual first quarter results, the impact of theiQvolution acquisition, the postponement of FAS 123(R), and a 20% income taxrate we are increasing our guidance to sales of $125 - $132 million, and earningsper share of $1.15 - $1.45 for 2005, compared to our prior guidance of $121- $126million and $1.03 - $1.36, respectively. [Emphasis added.]

58. The May 9, 2005 press release was materially false and misleading because

defendants failed to disclose that the Company's internal controls with respect to inventory

accounting and practices were deficient and defective during 2004. Moreover, defendants knew or

recklessly disregarded that these statements were false and misleading because the deficiencies and

defects in the Company's internal controls with respect to inventory accounting and practices were

apparent and a reasonable consideration during defendants' implementation of its ERP system.

59. Moreover, since defendants' remaining two tranches of defendants' forward sales

contracts on 766,666 shares had not reached maturity, defendants were motivated to continue in their

concealment of the deficiencies and defects in the Company's internal controls.

60. On May 16, 2005, Raab filed a Form 4 with the SEC, reporting a highly aggressive

and startling series of dispositions involving one million shares of his Company stock. First, the

Form 4 reported that defendant Raab sold 500,000 shares on May 12, 2005, at a price of $28.57, for

proceeds of $14,285,000. These shares were not related in any way to the shares committed to the

forward sales contracts of June 10, 2004. Moreover, according to the Form 4, on May 16, 2005,

Raab abruptly accelerated the maturity dates of his remaining sales contracts of June 10, 2005 with

Bank of America, at a price of $28.03. Based on the artificially inflated value of the stock, defendant

Raab was able to dispose of only 421,557 of the 500,000 shares committed in the remaining two

tranches. As a result, defendant Raab was able to sell another 500,000 shares and `pocket" 79,443

shares of FARO Technologies stock, as a direct result of the stock price inflation caused by the

34


Company's concealment of its deficient and defective internal controls with respect to the

Company's inventory accounting and practices.

THE TRUTH UNFOLDS

61. On July 18, 2005, defendants issued a press release entitled, "FARO's New Orders

Grow 57% in the Second Quarter; Earnings Expected to be Lower." The press release stated in part:

LAKE MARY, Fla., July 18 /PRNewswire-FirstCall/ -- FARO Technologies,Inc. (Nasdaq: FARO) today reported sales of approximately $30.9 million in thefiscal second quarter ended July 2, 2005, a 28.2% increase from $24.1 million in thesecond quarter of 2004. The Company also reported new order bookings ofapproximately $34.5 million during the second quarter, an increase of $12.6 million,or 57.5% compared with approximately $21.9 million in the year-ago quarter.Backlog grew $3.6 million in the quarter to $6.1 million, and the Company expectsto bring backlog down to approximately $3.0 million or less by the end of the thirdquarter. The Company has previously announced that it is accelerating its plans toestablish a manufacturing plant in Singapore to address the growth in orders in theAsia/Pacific region.

The Company expects earnings per share for the second quarter of 2005 to besignificantly less than the $0.29 it earned in the year-ago quarter because of lowergross margin, higher SG&A expenses as a percentage of sales and a short terminability to ship late arriving orders.

"We continued to invest in growth-related initiatives in the second quarter,which will impact our earnings for the quarter, but these initiatives are alreadypaying off in terms of the growth in new orders," said Simon Raab, FARO'sChairman and CEO. "One of the reasons that we give only annual guidance is thatwe expect to have some quarters where we take initiatives which may lower earningsin the short term, but which result in long term top and bottom line growth."

The Company expects to issue its complete earnings release for the secondquarter of 2005 on August 8, 2005. The Company also announced that it would nolonger regularly pre-release revenues and new orders between the end of a quarterand its earnings release. [Emphasis added.]

62. Commenting on the announcement, on July 19, 2005, the Motley Fool published an

article entitled "FARO Almost Gets It - Why, oh why must companies spit on us and tell us it's

raining?" pointing to reasonable concerns for concealment of serious issues in connection with the

failure of the Company to successfully fulfill orders to meet quarterly goals. The article stated in

part:

This time around it's FARO Technologies (Nasdaq: FARO), whichannounced a fairly substantial earnings miss last night, but still felt the need to spinthe headline, leading with "FARO's New Orders Grow 57% in Second Quarter,"only then following with "Earnings Expected to Be Lower."

35


Great. At least we found the Shinola.

FARO is a recommendation of our Hidden Gems newsletter, and it's been aspectacular performer. We're pretty sanguine about the ebbs and flows ofbusiness --we don't expect smoothness and we don't expect perfect visibility. And our faith inFARO Technologies based on this latest quarter is no more shaken than our faith ingravity. But it's disappointing that FARO felt the need to try to spin. And beingcautious sorts, we naturally assume that if they're shucking and jiving, there'ssomething else they're hiding.

So, like Ben Folds warbled about Rockford Files, there'd be some thingswe'd change if it were up to us.

OK, perhaps I should describe what's happened. Last night, FARO warnedthat its earnings number for the quarter that ended July 2 would be substantiallylower than earnings from the same quarter the year previous because of lower grossmargins, higher administration (SG&A) costs, and problems related to order flow.

Let's work backward. As for the problems in shipping late orders, assumingthe company isn't lying (and I believe firmly that it is not), this will simply bepushed back a quarter. Given the rapid rise in orders, including a new Boeing(NYSE: BA) order for 10 FARO lasers, it is perhaps unsurprising that facilities aretaxed.

FARO has often said that it is willing to sacrifice some short-termperformance in order to manage the company best for the longer term. With largerorders rolling in, it seems likely that the company is sacrificing margins and staffingup for the time when it will be a much larger company. We'll know more when wesee the actual numbers. But the thing that troubles me is this: Instead ofpulling outa dog-and-pony show about "ORDERS UP!,"why didn't management waste twoor three lines stating why it is missing numbers?

It looks to me like FARO is taking some risks, but in this case, itunderestimated costs and overestimated the short-term returns. That makes for abad miss, and that means some lost credibility. That's too bad.

What this means, of course, is even though the company didn't address it, wecan safely assume that there's no way FARO is going to be hitting its full year2005 guidance. If it has earnings of $0.24 in the first quarter and "significantly lessthan $0.29" for the second quarter, FARO'S previous full-year guidance of $1.15-$1.45 seems a bit absurd. Let's assume that the company comes in at $0.25 per share,or $0.49 for the first half. That means that to hit minimum earnings guidance, it'llhave to do between $0.66 and $0.96 a share. That seems unlikely.

The thing that troubles me most of all is the feeling that this was a surprisefor FARO. Last quarter, management noted that it expected that gross margins wouldremain strong, and apparently believed that the growth in sales would counteract anyadditional spending. Smooth growth is something that comes in fairy tales;companies and commerce don't work that way. But if a company is going to spendmoney for more growth as FARO has done, it simply must manage the processbetter. Each marginal dollar spent has to have a positive expected return, or else thatgrowth isn't worth a thing.

We're disappointed, then, in how the message was delivered, and in theapparent misstep. But these things happen. What we want to see from FARO'S

36


management is some improvement in both regards. I doubt the stock would havedropped 12% if the press release had simply said "Here's what happened. Here'swhy." Instead we get nonsense, and shareholders have departed in heavy numbers.

We anxiously await signs that the lesson has been learned. [Emphasis added.]

63. Although the commentary regarding the Company's growing order backlog correctly

pointed out that there was a need to understand why the Company had now surprised and

disappointed investors, it offered no insight as to why the Company had now warned or what to

expect going forward. As a result, investors remained in the dark about the Company's order

fulfillment issues and how the Company's deficient and defective internal controls with respect to

inventory accounting and practices had a direct impact on order fulfillment, including the resolution

of issues facing the Company's implementation of its ERP system.

64. On August 10, 2005, the Company filed a Form 10-Q with the SEC for the quarter

ending July 2, 2005. The filing stated in part:

NOTE I - INVENTORIES

During the second quarter of 2005, the Company changed its method ofcomputing the pricing of inventory from average cost to FIFO. This change wasmade as a result of an inventory system conversion, to allow for improved systemefficiencies. The underlying calculation between average cost and FIFO cost is notmaterially different. This change did not have a material impact on the results ofoperations for the second quarter of 2005, and is not expected to have a materialimpact for the full year or future years. [Emphasis added.]

65. To the extent that defendants (i) had changed their inventory accounting methods and

practices to conform to its installation of its enterprise resource planning system in January of 2005,

(ii) had failed to actually conform their inventory accounting and practices to "lean manufacturing"

practices intended to prevent "inventory waste," including FIFO cost accounting and (iii) had

actually failed to confirm by an audit of their inventory accounting and practices that the Company's

internal controls in relation to inventory accounting and practices were adequate, defendant's SEC

Form 10-Q of August 10, 2005, was false and misleading.

66. Defendants knew or consciously and recklessly disregarded the fact that the

Company's internal controls and corporate compliance, governing its own manufacturing process

and practices were deficient and defective. Although the Company claimed that it had expertise in

37


achieving "total management solutions," it had implemented corporate compliance standards

appropriate to its business as early as 1998, and it had already implemented "lean manufacturing"

practices in 2001, the Company's operations were in fact inefficient, particularly in its inventory

management and accounting practices. Moreover, the Company had now, predictably, reached the

limit of its capacity to accommodate future growth, both in terms of its preparedness to manufacture

in accordance with forecasts and to coordinate its production capabilities with aggressive sales

activities across international markets.

67. Defendants continued to conceal the truth about the Company's deficient and

defective inventory accounting and practices. Although defendants had represented to the investment

community that the Company had already adopted "lean manufacturing" practices, the Company, in

fact, had not adopted FIFO inventory accounting and practices. Defendants' concealment of these

issues during the Class Period served to inflate the value of the Company's stock, allowing

defendants Raab and Fraser to sell and "sell short against the box" over 1.48 million shares,

including "core holdings" of Company stock, for proceeds of over $40.9 million, well before the

investing public would learn of the problems facing the Company.

68. Finally, on November 3, 2005, after the close of the markets, defendants issued a

shocking press release entitled "FARO Reports Record Third Quarter Sales and Reiterates Strategy."

The press release stated in part:

LAKE MARY, Fla., Nov. 3 /PRNewswire-FirstCall/ -- FARO Technologies,Inc. (Nasdaq: FARO) today reported record sales for the third quarter of 2005 ofapproximately $32.6 million and an increase of $9.2 million, or 39.3% from $23.4million the third quarter of 2004. New order bookings for the third quarter wereapproximately $29.5 million, an increase of $6.5 million, or 28.3 % compared withapproximately $23.0 million in the year-ago quarter. The Company reported netincome for the third quarter ended October 1, 2005 of approximately $2.6 million or$0.18 per diluted share, compared to approximately $3.1 million or $0.22 per dilutedshare in the third quarter of 2004. Third quarter 2005 results included a pre-tax costof $1.6 million for inventory costing and consumption variances arising from theCompany's implementation of a new enterprise resource planning ("ERP')system.

(Logo: http://www.newscom.com/cgi-bin/pmh/20000522/FLM035LOGO)

Gross margin for the third quarter, which was negatively impacted by thepreviously mentioned adjustment to cost of goods sold, was 54.3% compared to63.1% in the third quarter of 2004. Gross margin for the first nine months was58.6%, more in line with the Company's historical gross margin. The Company has

38


determined that issues arising from the ERP system migration have been correctedand it has implemented additional controls.

SG&A expenses as a percentage of sales dropped to the lowest level in eightquarters to 36.2%, compared to 38.5% in the third quarter of 2004. G&A expenseswere 9.8% of sales in the third quarter compared to 13.7% in the third quarter of2004, resulting in part from the Company's previously announced reductions inG&A expenses. [Emphasis added.]

69. On November 4, 2005, shortly after the open of the markets, defendants commented

on their missed growth targets and financial guidance during their 3Q 2005 conference call. During

the call, defendants stated in part:

Simon Raab - FARO Technologies - Chief Executive Officer

Thank you Vic, and good morning everyone. First I'd like to speak directlyabout our guidance. Clearly we have lost credibility in the last three or four monthswith respect to our ability to predict the bottom line. I will not attempt to makeexcuses for this except for the excuse of being too optimistic and will frankly admitthat I remain very optimistic because that is what fuels my efforts.

I want to reiterate that this degree of unpredictability in the business stillcontinues as evidenced by our inability to ship the late arriving Asian orders in Q2.In order to mitigate this we began to increase inventory and distributed regionally tobe able to ship within days to orders placed in the last days of the quarter. Thisresulted in substantially more complex inventory management situations, andresulted in the substantial inventory increases.

Now turning to gross margin, this quarter we were surprised by the need totake a 1.6 million cost adjustment to inventory and hence cost of goods, due toprocessing problems relating to the implementation of our new accounting andinventory management systems. While we have maintained substantial reservesestablished for inventory based on experience for obsolescence and excess of slowmoving inventory, this issue could not be predicted. It was discovered and promptlyanalyzed and corrected through process changes, additional controls and staffchanges.

While we proceed with some confidence, we have put some additionalinventory reserves in place for the fourth quarter. Gross margin is affected by thenumber of items on a regular basis including changes in product mix, since productslike the FARO Gage and Laser Tracker have lower margins than FaroArm. Also,discounting on the sale of demonstration units may depress margins. We also havevariability in pricing by geographic region.

39


QUESTION AND ANSWER

Jed Dorsheimer - Adams Harkness - Analyst

Thank you. Couple of questions, first, the ERP system that wasimplemented in some of the, I guess deficiencies, for lack of a better word, in theinventory. I was wondering ifyou could maybe elaborate on what the issues werethere that caused the 1.6 and then the 500 in reserves this quarter, and whatgivesyou the confidence that there's not going to be -- that that 500 is the end of it?Thanks.


Right. Well good question, part of the processing of inventory as part ofproduction is the need to have accurate builds of materials to have all the codes setfor all the elements to make sure that material is drawn properly, at the right rate,that the costing models are correct. That the procedures in the manufacturingfloor for WIP, work in processing, shop orders processing, the training ofindividuals, and a whole variety of reasons which resulted in variations either incosting and/or in quantities that needed to be adjusted through it's implementation.

And while we have done a substantial amount of inventory evaluation prior tothe reporting we were concerned that there might be other issues. So we put somereserve in as we continue to implement.

Andy Schopick - Nutmeg Securities - Analyst

I have a couple of questions, but I do want to clarify the inventory costingside of the equation. Would it be unfair to state that prior period gross marginsperhaps were overstated by the inaccuracies that you have found to exist in yourinventory value --previous inventory valuation? I'm thinking of a fair way to lookat this.


I don't think it would be unfair, but I would want to characterize it as beingno different than would have happened any time a company did a physical inventory,which a lot -- most companies maybe do once or twice a year, where you capture allof the effects on inventory in one period, you bring them all into one period. With noone being able to actually resolve where and when those variances might haveoccurred.


Yes, yes.


It's typical of an inventory physical, which in fact was part of the reason wediscovered the problem.

40



But this is something above and beyond the obsolescence factor?


That's right. When we traced the root cause of the differences, it wasn'trelated to obsolescence excess, but due to processing issues with respect to the newaccounting system. [Emphasis added.]

70. As a result of defendant's November 3, 2005 press release and subsequent earnings

conference call, investors finally learned the truth about defendants' concealment of the adverse

impact of the Company's defective and deficient inventory-related controls and systems on the

Company's financial performance. Defendants' shocking news and disclosures caused the price of

FARO Technologies stock to plummet $5.88, from its closing price of $22.38 on November 3, 2005,

to finally close on November 7, 2005 at $16.50, for a two-day loss of 26.3 %, on combined volume

of over 5.9 million shares.

71. The nearly 26.3% decline in FARO Technologies' stock price at the end of the Class

Period was a direct result of the unraveling of the nature and extent of defendants' fraud finally

being revealed to investors and the market. The timing and magnitude of FARO Technologies' stock

price decline negate any inference that the loss suffered by plaintiff and other Class members was

caused by changed market conditions, macroeconomic or industry factors, or Company-specific facts

unrelated to the defendants' fraudulent conduct. On the days in which FARO Technologies' stock

price fell almost 26.3% as a result of defendants' fraud being revealed, the Standard & Poor's 500

securities index was flat. The economic loss, i.e., damages, suffered by plaintiff and other members

of the Class was a direct result of defendants' fraudulent scheme to artificially inflate FARO

Technologies' stock price and the subsequent significant decline in the value of FARO

Technologies' stock when defendants' prior misrepresentations and other fraudulent conduct was

revealed.

72. During the Class Period, defendants concealed the fact that:

41


(a) one or more of the Company's internal controls and systems for corporate

compliance were deficient and defective;

(b) the Company's inventory accounting and practices were deficient and

defective, resulting in false and misleading financial statements and guidance;

(c) the change of accountants in November of 2004 served to facilitate the

continued concealment of the Company's deficient and defective inventory accounting and practices;

(d) the Company's inefficient management of its inventory requirements was the

cause or result of difficulties the Company had experienced to meet quarterly goals for order

fulfillment, necessary to meet the Company's forward guidance;

(e) the maturity date of defendants' forward sales contracts on their shares could

be accelerated, to occur at times other than the fixed dates communicated to the investment

community; and

(f) the acceleration of the maturity dates of forward sales contracts for 500,000

shares served to limit investor concerns about insider trading in the stock, that would potentially

arise on the original maturity dates.

DEFENDANTS' CLASS PERIOD STOCK SALES

73. During the Class Period, the following defendants sold their shares of FARO

Technologies stock as follows:

Date Defendant Shares Price Proceeds3/30/2005 FRASER, GREGORY 83333 "short cover' 0

A.6/1/2004 250000* "short sale" 5,335,8085/13/2004 45500 $23.39 10643635/12/2004 33000 $23.54 776998

5/16/2005 RAAB, SIMON 421557 "short cover' 0

5/12/2005 500000 $28.57 14285000

3/30/2005 250000 "short cover' 06/1/2004 750000* "short sale" 160074245/14/2004 25000 $23.80 5947255/13/2004 90500 $23.39 2117030

5/12/2004 33000 $23.54 776998

Totals 1481890 40958346

* Note: "sales shorted" by Bank Of America on June 10, 2004 not included in the totals

42


FALSE FINANCIAL STATEMENTS

74. The financial statements issued by FARO Technologies during the Class Period and

the statements about them were false and misleading, as such financial information was not prepared

in conformity with GAAP, nor was the financial information a fair presentation of the Company's

operations due to the Company's improper accounting in violation of GAAP and SEC rules.

75. GAAP are those principles recognized by the accounting profession as the

conventions, rules and procedures necessary to define accepted accounting practice at a particular

time. Regulation S-X (17 C.F.R. § 210.4-01(a) (1)) states that financial statements filed with the

SEC which are not prepared in compliance with GAAP are presumed to be misleading and

inaccurate. Regulation S-X requires that interim financial statements must also comply with GAAP,

with the exception that interim financial statements need not include disclosure which would be

duplicative of disclosures accompanying annual financial statements. 17 C.F.R. § 210.10-01(a).

76. Due to these accounting improprieties, the Company presented its financial results

and statements in a manner which violated GAAP, including violations of the following fundamental

accounting principles:

(a) The principle that interim financial reporting should be based upon the same

accounting principles and practices used to prepare annual financial statements was violated (APB

No. 28, ¶ 10);

(b) The principle that financial reporting should provide information that is useful

to present and potential investors and creditors and other users in making rational investment, credit

and similar decisions was violated (FASB Statement of Concepts No. 1, ¶ 34);

(c) The principle that financial reporting should provide information about the

economic resources of an enterprise, the claims to those resources, and effects of transactions, events

and circumstances that change resources and claims to those resources was violated (FASB

Statement of Concepts No. 1, ¶ 40);

(d) The principle that financial reporting should provide information about how

management of an enterprise has discharged its stewardship responsibility to owners (stockholders)

for the use of enterprise resources entrusted to it was violated. To the extent that management offers

43


securities of the enterprise to the public, it voluntarily accepts wider responsibilities for

accountability to prospective investors and to the public in general (FASB Statement of Concepts

No. 1, ¶ 50);

(e) The principle that financial reporting should provide information about an

enterprise's financial performance during a period was violated. Investors and creditors often use

information about the past to help assess the prospects of an enterprise. Thus, although investment

and credit decisions reflect investors' expectations about future enterprise performance, those

expectations are commonly based at least partly on evaluations of past enterprise performance

(FASB Statement of Concepts No. 1, 142);

(f) The principle that financial reporting should be reliable in that it represents

what it purports to represent was violated. That information should be reliable as well as relevant is

a notion that is central to accounting (FASB Statement of Concepts No. 2, IT 58-59);

(g) The principle of completeness, which means that nothing is left out of the

information that may be necessary to insure that it validly represents underlying events and

conditions was violated (FASB Statement of Concepts No. 2, ¶ 79); and

(h) The principle that conservatism be used as a prudent reaction to uncertainty to

try to ensure that uncertainties and risks inherent in business situations are adequately considered

was violated. The best way to avoid injury to investors is to try to ensure that what is reported

represents what it purports to represent (FASB Statement of Concepts No. 2, 1195, 97).

77. Further, the undisclosed adverse information concealed by defendants during the

Class Period is the type of information which, because of SEC regulations, regulations of the

national stock exchanges and customary business practice, is expected by investors and securities

analysts to be disclosed and is known by corporate officials and their legal and financial advisors to

be the type of information which is expected to be and must be disclosed.

44


APPLICABILITY OF PRESUMPTION OF RELIANCE

FRAUD-ON-THE-MARKET DOCTRINE

78. At all relevant times, the market for FARO Technologies securities was an efficient

market for the following reasons, among others:

(a) FARO Technologies's stock met the requirements for listing, and was listed

and actively traded on the NASDAQ, a highly efficient and automated market;

(b) As a regulated issuer, FARO Technologies filed periodic public reports with

the SEC; and

(c) FARO Technologies regularly communicated with public investors via

established market communication mechanisms, including through regular disseminations of press

releases on the national circuits of major newswire services and through other wide-ranging public

disclosures, such as communications with the financial press and other similar reporting services.

79. As a result of the foregoing, the market for FARO Technologies' securities promptly

digested current information regarding FARO Technologies from all publicly available sources and

reflected such information in FARO Technologies's stock price. Under these circumstances, all

persons who purchased or acquired FARO Technologies's securities during the Class Period

suffered similar injury through their purchase of the aforementioned securities at artificially inflated

prices and a presumption of reliance applies.

NO SAFE HARBOR

80. The statutory safe harbor provided for forward-looking statements under certain

circumstances does not apply to any of the allegedly false statements pleaded in this complaint.

Many of the specific statements pleaded herein were not identified as "forward-looking statements"

when made. To the extent there were any forward-looking statements, there were no meaningful

cautionary statements identifying important factors that could cause actual results to differ materially

from those in the purportedly forward-looking statements. Alternatively, to the extent that the

statutory safe harbor does apply to any forward-looking statements pleaded herein, defendants are

liable for those false forward-looking statements because at the time each of those forward-looking

statements was made, the particular speaker knew that the particular forward-looking statement was

45


false, and/or the forward-looking statement was authorized and/or approved by an executive officer

of FARO Technologies who knew that those statements were false when made.

CLASS ACTION ALLEGATIONS

81. Plaintiff brings this action as a class action under Federal Rule of Civil Procedure 23,

on behalf of all persons who purchased or acquired the securities of FARO Technologies between

May 6, 2004, and November 3, 2005, (the "Class Period"). Excluded from the Class are defendants,

any entity in which a defendant has or had a controlling interest, and members of defendants'

families.

82. The members of the Class are so numerous that joinder of all members is

impracticable. The disposition of their claims in a class action will provide substantial benefits to

the parties and the Court. During the Class Period, FARO Technologies had more than 14 million

shares of stock outstanding, owned by thousands of persons. Record owners and other class

members may be identified from records maintained by FARO Technologies and/or its transfer

agents and may be notified of the pendency of the action by mail, using a form customarily used in

securities class actions.

83. There is a well-defined community of interest in the questions of law and fact

involved in this case. There are no conflicts between plaintiff and the Class, and plaintiff's claims

are typical of those of other Class members. The questions of law and fact common to the members

of the Class which predominate over questions which may affect individual Class members include

the following:

(a) Whether §§ 10(b) and 20(a) of the Exchange Act were violated by FARO

Technologies and the Individual Defendants.

(b) Whether defendants misrepresented material facts;

(c) Whether defendants' statements omitted material facts necessary to make the

statements made, in light of the circumstances under which they were made, not misleading;

(d) Whether the defendants knew or should have known that their statements were

false and misleading;

46


(e) Whether the prices of FARO Technologies securities were artificially inflated

during the Class Period; and

(f) The extent of damage sustained by Class members and the appropriate

measure of damages.

84. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all class members is impracticable. Furthermore,

the damages suffered by individual Class members may be relatively small, and the expense and

burden of litigation make it impossible for members of the Class to individually redress the wrongs

done to them. There will be no difficulty in the management of this action as a class action.

Plaintiff will fairly and adequately protect the interests of the Class and have retained counsel

competent and experienced in class and securities litigation.

COUNT

For Violation of § 10(b) of the Exchange Act andRule IOb-5 Against FARO Technologies and the Individual Defendants

85. Plaintiff incorporates 111-84 by reference.

86. During the Class Period, defendants disseminated or approved the false statements

specified above, which they knew or recklessly disregarded were materially false and misleading in

that they contained material misrepresentations and failed to disclose material facts necessary in

order to make the statements made, in light of the circumstances under which they were made, not

misleading.

87. Defendants violated § 10(b) of the Exchange Act and Rule 1 Ob-5 in that they:

(a) Employed devices, schemes, and artifices to defraud;

(b) Made untrue statements of material facts or omitted to state material facts

necessary in order to make statements made, in light of the circumstances under which they were

made, not misleading; or

47


(c) Engaged in acts, practices, and a course of business that operated as a fraud or

deceit upon plaintiff and others similarly situated in connection with their purchases or acquisitions

of FARO Technologies securities during the Class Period.

88. Plaintiff and the Class have suffered damages in that, in reliance on the integrity of

the market, they paid artificially inflated prices for FARO Technologies securities during the Class

Period. Plaintiff and the Class would not have purchased, acquired or exchanged FARO

Technologies securities at the prices they paid, or at all, if they had been aware that the market prices

had been artificially and falsely inflated by defendants' misleading statements.

89. As a direct and proximate result of defendants' wrongful conduct, plaintiff and the

other members of the Class suffered damages in connection with their purchases and acquisitions of

FARO Technologies securities during the Class Period.

COUNT II

For Violation of § 20(a) of the Exchange ActAgainst FARO Technologies and the Individual Defendants

90. Plaintiff incorporates ¶¶ 1-89 by reference.

91. The Individual Defendants prepared, or were responsible for preparing, the

Company's press releases and SEC filings. By reason of their positions as directors and/or officers

of FARO Technologies they had the power and authority to cause FARO Technologies to engage in

the wrongful conduct complained of herein. FARO Technologies controlled each of the Individual

Defendants and all of its employees. By reason of such wrongful conduct, the Individual Defendants

and FARO Technologies are liable pursuant to §20(a) of the Exchange Act.

PRAYER FOR RELIEF

92. WHEREFORE, plaintiff on behalf of herself and the Class, prays for judgment as

follows:

A. Declaring this action to be a class action properly maintained pursuant to Rule 23 of

the Federal Rules of Civil Procedure;

B. Awarding plaintiff and other members of the Class compensatory damages;

48


C. Awarding plaintiff and members of the Class pre judgment and post judgment

interest, as well as reasonable attorneys' fees, expert witness fees, and other costs and disbursements;

D. Awarding extraordinary, equitable and/or injunctive relief as permitted by law, equity

and the federal statutory provisions sued hereunder, pursuant to Rules 64 and 65 and any appropriate

state law remedies to assure that the Class has an effective remedy; and

E. Awarding plaintiff and other members of the Class such other relief as this Court may

deem just and proper under the circumstances.

JURY DEMAND

Plaintiff demands a trial by jury.

DATED: December 5, 2005 MILBERG WEISS BERSHAD &SCHUL a PAN LLP

By:Maya ax-naFla. Bar No. 1,1 [email protected] One, Suite 6005200 Town Center CircleBoca Raton, FL 33486Tel: (561) 361-5000Fax: (561) 367-8400

SCOTT + SCOTT LLCArthur L. Shingler [email protected] B. Street, Suite 1500San Diego, CA 92101Tel.: (619) 233-4565Fax.: (619) 233-0508

-and-SCOTT + SCOTT, LLCDavid R. [email protected] Norwich AvenueColchester, CT 06415Tel.: (860) 537-3818Fax.: (860) 537-4432

Counsel for Plaintiff

49


PLAINTUF CFRTIFICATIONpURSUATIT TO FEDERAL-. SECURITIE S LAWS

^^u STCC-^C( I'Plaintiff ), declares, as to the claims asserted under the federal

securities laws, that:

Plaintiff has reviewed the Complaint and retains Scott + Scott, LLC, and suet w-counsel it deems appropriate to associate with, to p-arsue such action on a contingent fee

basis.

2.plaintiff did not purchase the security that is the subject of this action at the direction

of p laintiffs counsel, or in order to participate in any action.

3. Plaintiff is willing to serve as a representativ e party on behalf of the class, including

providing testirnony at deposition and trial, if necessary.

4. Plaintiff s transaction(s) in the Faro Technologies, Inc. ("FARO") security that is thesubject of this action during the Class Period is/are us follows:

No of Shares/Securities 6; Date Price Per Share

Iv o Fiaaro84.'L^/ /- a3 -os ,3oKSd

o v Fr4i?o 6u^

3 -d^-05 3m ss

5. During the three years prior to the date of this Certification, Plaintiff has not served,or sought to serve as a class representative in a federal securities fraud case, except as

follows:

b. Plaintiff will not accept any payment for serving as a representative party on h ehalf ofthe class beyond Plaintiffs pro rata share of any recovery, except such reasonable costs andexpenses (including lost wages) directly relating to the representation ofthe class as orderedor approved by the Court.

I declare under penalty of perjury that the foregoing is true and correct under the laws of theUnited States of America. Executed this O =̀`$ay of Jl ^^uF^r=.^^ • 2005, at

C c- ^^ /^R C 4t (city, state).

Printed Name: ^ ^ A ll-^(- C7U C j^/3G ;%^^ L 2j T^G(S % L=^

Signature:

Mailing Addmss:_ ^ ^ V^ n i CU

_

Telephone 4. _

raab, gregory a. fraser, and ) defendants. ) class...

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