FARO Technologies Inc (FARO) 2005 Q1 法說會逐字稿

Good morning, everyone, and welcome to the FARO Technologies conference call in conjunction with its first quarter 2005 earnings release. For opening remarks and introductions, I will now turn the call over to Vic Allgeier. Please go ahead.

Thank you, and good morning, everyone. My name is Vic Allgeier of the TTC Group, FARO's investor relations firm. Yesterday, after the market closed, FARO released its fiscal first quarter results. By now, you should have received a copy of the press release. If you have not received a release, please call Sharon Trowbridge at 407-333-9911.

Representing the Company today are Barbara Smith, Chief Financial Officer; Jay Freeland, President and Chief Operating Officer; Greg Fraser, Executive Vice President; and Simon Raab, Chief Executive Officer. Barbara will present a summary of the financial results, and then Jay will follow with his comments. We will then open the call to questions.

I would like to remind you that in order to help you understand the Company and its results, management may make some forward-looking statements during the course of this call. These statements can be identified by words such as "we expect," "we believe," "we predict," and similar words. It is possible that the Company's actual results may differ materially from those projected in these forward-looking statements. Important factors that may cause actual results to differ materially are the risk factors set forth in yesterday's press release and in the Company's filings with the SEC.

I will now turn the call over to Barbara.

Thank you, Vic. Good morning, everyone.

Sales in the first quarter were 27.6 million, a 31.4% increase from 21 million in the first quarter 2004. Since our April 12 pre-release of sales, we recognized some additional sales from our new Korea office, which explains why our final first quarter sales figure is 300,000 more than the pre-released number. New orders also grew 31.4% in the first quarter to approximately 25.1 million, compared to approximately 19.1 million in the first quarter of 2004.

The top five customers by sales volume in the first quarter were Airbus, Donghee Auto Company Ltd., the Max Planck Institute, Goodyear, and Mitsubishi. Donghee, which is spelled D-o-n-g-h-e-e, is a large automotive parts supplier in Korea. The Max Planck Institut purchased our FARO ScanArms to capture the shape of a nuclear fusion reactor. The top 10 customers in the quarter represented 12.3% of all sales.

Our gross margin was 62.8% in the first quarter, compared to 64% in the year ago quarter, but higher than the 61.8% for the full year 2004.

SG&A expenses were 40.2% of sales in the first quarter, up from 38.6% in the year ago quarter. This increase was primarily due to our continuing ramp-up in the sales force in Asia-Pacific, as well as higher professional and legal fees in the first quarter in conjunction with our Sarbanes-Oxley 404 compliance and other projects, including the shelf registration statement.

Our operating margin was 15.2% in the first quarter compared to 15.9% in the year ago quarter because of the previously mentioned decrease in gross margin and higher SG&A expenses for the quarter.

Our blended tax rate for the first quarter was 19.2% compared to 21.2% in the first quarter of 2004, and just below our forecast of 20% for 2005. The majority of our sales are shipped from our Swiss plant with a favorable tax status, combined with the use of some previously deferred NOLs, gave rise to the lower tax rate.

Net income increased 21.8% to 3.47 million in the first quarter from 2.85 million in the first quarter of 2004, primarily due to higher sales in the quarter.

Cash provided by operations was approximately 1.7 million for the quarter, and following the $4 million cash outlay of the part of the iQvolution acquisition our ending cash and investments were 35 million. Accounts receivable were 23.5 million on April 2, 2005 compared to 22.5 million at December 31, 2004.

DSOs at April 2, 2005 were 75 days compared to 84 days at the end of 2004. Inventories were 19.2 million April 2, 2005 compared to 16.4 million at December 31, 2004. Approximately 40% of this increase is due to higher demonstration equipment resulting from our expanded sales force. The remainder was primarily raw materials and work in process needed to meet our increasing demand.

I will conclude my portion of the presentation with an update on employee headcount. At the end of the first quarter, we had 482 employees, an increase of 29, or 6%, from 453 at the end of 2004. 19 of the new hires in the quarter were in the Americas, and all but three of these were salespeople. I will now hand the call over to Jay.

Thanks, Barbara, and good morning, everyone. We had good growth in sales and new orders in all regions in the first quarter. In particular, Asia-Pacific grew to 17.6% of total sales compared to 11.4% in the year ago quarter and 12.6% for all of 2004. Although we may not see linear growth in Asia-Pacific sales as a percentage of total sales by quarter, this is an encouraging sign as we shoot for one-third of our sales to be in that region in 2006.

Selling expenses as a percentage of sales were above our long-term goal of 25% because of sales force growth related to geographic expansion and new product introductions. This ramp-up will continue to affect selling expenses until the new people complete their learning curve, in part as a result of the iQvolution acquisition.

R&D spending as a percentage of sales fell slightly below 5% in the quarter, as spending was based on the lower end of our sales guidance. We will work to maintain R&D spending at 5% to 7% of actual sales as the year plays out, as we continue to see R&D spending as a major pillar supporting our long-term growth.

Only 40% of our sales in the first quarter were to existing customers, which is a big shift from the past two years, in which sales to existing customers was trending upward to more than half our sales. The shift in the first quarter was seen in the Americas and Asia-Pacific, where 68% and 79% of sales were to new customers, respectively.

As previously reported, we acquired iQvolution three days before the end of our first quarter. As such, our balance sheet reflects the tangible assets and goodwill associated with the purchase, and our income statement does not include any sales or income for the quarter. We will talk more about the impact of iQvolution on the remainder of 2005 in our outlook discussion which follows.

Turning to some future-looking subjects, the SEC has allowed delayed implementation of stock option expensing until 2006. Besides taking advantage of this delay, we are also studying the various implementation alternatives, as well as alternative strategies for competitive long-term compensation. This may result in a less dilutive effect, but also achieve the key employee retention and motivation goals that traditional stock options achieve. As a result, we are adding back approximately $0.14 per share to our earnings estimate for 2005, since the $2 million we previously forecast for stock option expense will not be expensed this year.

We expect the iQvolution acquisition to dilute our 2005 EPS by $0.04 to $0.07 per share. This primarily results from our plan to accelerate the hiring of new salespeople who will be on a learning curve this year.

As previously announced, we have established a new company in Singapore to become our Asia-Pacific headquarters. We expect our G&A expenses as a percentage of sales to remain higher than our long-term goal of 10% of sales in 2005 as we grow our infrastructure there to support our existing sales. The AP headquarters will be modeled on our existing European headquarters in Germany. We have also chosen Singapore as the location for our Asia manufacturing plant, and we now expect to start production there this year rather than in 2006 as previously forecast.

As we had indicated in yesterday's press release, we are increasing our 2005 revenue guidance to $125 to $132 million from 121 to 126 million in our previous forecast. We are also increasing our EPS guidance to $1.15 to $1.45 from our earlier guidance of $1.03 to $1.36. Factors which could sway our results towards either end of our forecasted earnings range include how quickly our new salespeople ramp up, our tax rate, and the overall execution of our revenue plan.

I will now open up the call to questions and answers.

(OPERATOR INSTRUCTIONS) Rob Mason, Robert W. Baird.

Just a couple of questions. Nice job on the quarter, by the way. I was curious if you could characterize the tone of business across your three main geographies as you progress through the quarter there have been a lot of mixed signals, especially out of Europe; some out of the Japan region within Asia. But I guess briefly, did you see the environment get better? Did it get worse? Any discernible change as you moved through the quarter?

This is Simon speaking. We have not really picked up anything. Certainly Japan is not, for example, driving as well as China is. China is dominating Asia. Europe, as you know, showed strong growth last year, and continues to show that strong growth.

We have an upsurge in the Americas, but it is not clear whether that is due to our strategy or the local economy. I want to remind you that at previous times when the general economy has been in a downtrend, our kind of equipment has still resulted in large increases in sales, because we are an effective and cost-effective -- or efficient way of providing quality control in those difficult environments. So overall, all the territories seem to be performing well for us.

Okay. I was curious if you can update us on the progress of the Gage product, as well as -- maybe it is too early to really give an update. But (technical difficulty) product was rolled out?

Sure. I think on the gauge Gage side, we continue to see traction there. And we continue to see growth. I think from a business perspective, we see this as a significant long-term opportunity in terms of where the tool can be used and how we target the specific users out there on the machine benches around the world.

On the Digital Template side, I think it is a little too early to tell. We really have just formally released that, as you know. We obviously had some good success in the trial markets when that first came out. And we expect to seek acceleration there as we add salespeople to support the product.

Could you tell us where we are in that process of adding the salespeople?

Sure. We have added salespeople in each of the regions in the United States, and we continue to add in Europe and Asia to support it as well. Primarily, right now, the market would be geared towards the United States and to Europe. And we do see not only the focus from the standpoint of the Digital Template for the countertop market; we obviously look at the other alternatives of where else we can use the product in the construction market as well.

Okay. And then just lastly, you mentioned demo inventory factored into the inventory increase this quarter. And we obviously saw some impact from that on your gross margins in the fourth quarter. As we look at this current quarter, the second quarter, could you characterize how maybe gross margin would be affected by -- or maybe not affected by -- demo inventory, also factoring in iQvolution into the second quarter as well?

I think that -- this is Simon -- I think that with respect to the iQvolution, working back to your question, the cost of that product is not dissimilar to the cost on average between the Arms and the Tracker. So as a per salesman increase in demo equipment, I would not expect that to be too different than what we had seen in the past.

With respect to demo equipment, we have found ourselves unfortunately with a little bit of surplus in demo equipment last year, some of it which was inappropriately aging beyond our internal standard, which is two rotations a year of the demo equipment. That is why we still classify it as inventory. So we made an extra effort to move some of that and extra inventory late last year.

I think better management of that demo inventory process will result in less of a quarter -- or even ending quarter blip on the gross margin. I think the largest contributor to gross margin shifts will be contribution of service expenses and territorial discounting of any product line.

Brandi Shaw, Beekman Capital.

Great quarter. I seem to be having some difficulties with my model. I seem to be hitting at the low-end range of the margins on the gross and the operating. And I think one of the things -- a couple of the things I wanted to look at is what percentage of revenues are you guys targeting for the sales and G&A?

Well, I think -- to answer your question, Brandi, a couple of ways. Number one, on the gross margin side, we still anticipate gross margin to sit inside the range of our model between 60% and 65% during the course of the year. And as we have talked about before, during any one quarter there may be certain fluctuations, as Simon mentioned, based on some regional discounting or things that we do there between the different quarters.

On the G&A side, as discussed earlier, we do expect it to be slightly higher on a percent of sales basis during the course of the year. But on a dollar run rate, we anticipate it maintaining the rate that it is at right now for G&A. Selling expense -- we will always be shooting for that 25% mark, as we have talked about before.

And again, obviously, on a percent of sales basis, the raw dollar obviously will change the percent of sales if we go into the higher end of the forecast versus the midrange or the low-end of the forecast.

Okay. That's it. Thank you.

Jay Cooper, Loeb Partners.

Good morning, gentlemen. I wanted to ask how you see your business going with the automotive and machine-tool industries, particularly in Europe. We are hearing some pretty negative signals about that, but maybe your base is small enough, your penetration low enough so that you are working right through it. Could you comment?

Sure. I think your point is exactly right. The base is low enough now that we are able to work through that. We have a sizable representation of other industries now from a product mix standpoint, and obviously we get the benefit of that. When you see an individual downturn for one market, you get the balancing effect of the other markets.

Steven Pinsk, Noble Financial Group.

A few questions for you. First of all, I seem to have only captured four of the five of the top customers you mentioned. I have Airbus, Donghee, Max Planck, Goodyear -- and who was the fifth?

Mitsubishi.

Mitsubishi?

Yes.

Okay, great.

Steven, that would be Mitsubishi in Japan as opposed to any other district. Mitsubishi Heavy Industries does a lot of work for Boeing and many other markets, for that matter.

Okay, fair enough. Switching over to iQvolution for a minute, when I look at the revenue contribution you expect that to make, the 4 to 6 million, is there any seasonality to that? Or will the quarterly breakout be fairly consistent with what the overall Company's quarterly revenue contribution is as a percentage of the total?

This is Simon. I think that is probably going to be more a direct function of how quickly we get salespeople in place. The representation right now that we want the Company -- and there's maybe a couple of direct and some distributors. We are rolling out tens of people over the next few quarters, and the rate at which we can find those people in the two markets that we are focusing on in the different regions will probably be the biggest determinants. This really is turning into a recruiting and training issue, as it relates to generating those revenues.

Okay. And I assume that four 4 to 6 million that you have in your press release reflects your hiring expectations and ramp up of those new sales personnel?

Yes, and admittedly, a usually (ph) conservative view of the rate at which the sales will occur.

Okay. And then how much of a price differential is there between the iQvolution Laser Scanner and the competing products? Everything else aside, is the price differential sufficiently compelling?

Yes. I at think the moment, there is good price differential. This is Jay. It is roughly 25% to 30% right now. And obviously, we view our ability as a team to execute on the opportunity to continue to driving that price point in the marketplace as being one of the long-term benefits and values that FARO brings to the equation.

Fair enough. That is all I had. Thank you very much.

(OPERATOR INSTRUCTIONS). Jeff Basch (ph), Investor.

I had a couple of questions on the iQ acquisition, but I joined the call late, so if you have answered them already, just let me now. The forecast seems to be lower than when you originally announced the acquisition, both in terms of sales and results. Have you commented on that?

Yes, Jeff, this is Jay. Sorry. The original number that we talked about was a full year forecast. When we look at the 4 to 6, that is a reflection of 3 quarters worth of sales and the effect on our income statement this year.

With respect to the Company, based on something which I (indiscernible) Simon (ph), it looks like the market is a fairly decent sized market that is highly fragmented with some larger players. Do you have any particular strategy aside from price to capture the sizable market that you have in your other product lines?

This is Simon, Jeff. Thanks for your call. The real issue for us will be how we differentiated ourselves in the past with our other products. And I think it has got to do with the sales model, the way we promote various applications and their use, the way we focus on specific markets.

You will find a lot of those scanning devices right now are sold by a basically surveying companies. And they are focused on the surveying areas. We would have chosen to, first of all, focus on indoor applications where our technology is appropriate right now, and underserved markets that don't tie our hands in any particular sector. So we chose Vensic (ph) as the natural place. I know some of you may have seen CSI (ph) recently had actually a scanner being used in a crime site. I think there is a tremendous opportunity there.

With respect to our plant facility management, clearly that is a separate market which is somewhat inside of the surveying market and relates very much to our addition of quality controls inside the plant environment, but consistent with our markets.

So I think we are going to differentiate ourselves both on our selection of markets, which is certainly our pricing and performance. We have always been the aggressive member of the marketplace. And then we think our sales model and our sales process and marketing process will differentiate us as well.

Good. Now yesterday, Cognex bought a manufacturing factory floor (ph) or a machine vision systems company. To what extent is this a material part of the CAM2 market? And is this an area where FARO needs to have a presence in?

Right, this is Simon. I think if you wanted to differentiate it, certainly everybody -- both companies, FARO and Cognex, are into quality. However, Cognex identifies -- or describes itself as a vision company and vision systems. So its primary technology is two-dimensional cameras that can be installed either by value-added resellers or directly by the factory into an environment and programmed for the identification measurement, and observation of certain quality issues related to a product.

I am not entirely familiar with the company that it bought, but I believe that it is a company in a related area. So they remain in the automated vision systems area. There is certainly an overlap their. I mean, FARO is always attentive to quality control in factories. And we are in the factories, so perhaps automated measurement to something that we should be focused on, even though in the past we have generally described ourselves as being manual oriented.

And we continue to believe that the vast majority of the marketplace is operated by people in manufacturing environments doing manual activities. So that is going to continue to be our focus. But that should not exclude us examining automated measurement as a potential market.

And finally, a company named Keltec (ph), which you highlight on your web site, says that they make extensive use of FaroArms. But they still use the conventional CMM. I would be curious as to whether this is because these companies have a substantial investment in the CMM, and as long as it is workable, they will use it in limited areas. Or are there areas where CMM will always find application that a FaroArm just won't quite enter?

I think your last point may be appropriate. There is always -- even today, after the PC revolution, there is room for mainframes. And they occupy a certain piece of the computer marketplace. I guess the mainframe equivalent for the CMM is, for example, our highest factory (ph) is 0.2 of a thousand (ph) per gauge, which measures in a 4 foot volume. There are CMMs in very important installations that measure in the 8 foot volume, and measure down to a couple of microns, or 1 micron, and no microns in some cases.

So there is an unusually high accuracy in large volume applications -- is I think an area were you are always going to see CMMs, at least for the foreseeable future, just as you announced the mainframes in the computer market for things like weather prediction, military simulations, things of that sort.

So there is a place for it. You'll also see a certain amount of inertia in a lot of these companies, because they have implemented a standard CMMs in an automated environment where parts are brought in by automated palette and measured like engine blocks, and things of that sort. As I just finished saying a minute ago, we are not in the automated environment. And so you will find CMMs in some of those applications as well.

And then obviously, there is inertia. There is everybody who has -- who was using conventional technology, feels comfortable with their conventional technology, is not ready to move into a new area of measurement.

One final question. With respect to the dollar value, when you opened the Swiss plant, the dollar had quite a different exchange rate, and the tax benefit sort of made that plan a no-brainer. Does there come a point in your thinking that the value of the dollar can influence the decision as to whether to go overseas or not? There might even be some larger than the value being considered a local presence and reduced shipping costs and things like that?

Jeff, this is Jay. I think that is always an equation that you look at, both for the current period and forward-looking. I would argue that the dollar is just one piece of the equation, including the tax rates that you get from the specific country, the location you are in, and the ability to distribute to the regional markets that you are serving from that location, availability of qualified, talented workforce. I think all of those need to be factored in together.

There is one other thing. This is Simon, Jeff. And that is that there is a redundance between what we do for service purposes and what we do for production. It turns out that the infrastructure and the talent required to service products regionally, which is an absolute must from our point of view, also is the same exact talent and resources required very much to do production.

So it really -- part of that equation that Jay was talking about also includes the fact that you already have a lot of the CapEx related to production built into the service. And so it makes it even further a no-brainer of moving production overseas.

Okay. Thanks, guys, and congratulations on a good quarter.

Jay Cooper, Loeb Partners.

Can we go back a second to iQvolution? Could you talk a little bit about why companies feel it is so necessary to measure space so precisely in factories? And what technology is being replaced in indoor measurement here? And are the productivity gains as much? And second, could you discuss any gains that you might have had from the dollar/Euro exchange, etc., in the quarter?

I will talk about the factory. This is Simon. And then Barbara will talk about the currency contribution. With respect to the factory, remember that accuracy is a relative thing. You can measure in microns over a couple of feet, or in millimeters over a large -- multiple tens of feet. And they become relevant each for their own reason.

It is important to note that just the same as in production, factory refurbishment or factory preparation has involved the input of multiple professions in the case of factories, HVAC, robotics, electrical, etc. And very often, the refurbishment -- the as-built information about a factory could result in huge delays and cost overruns in the replenishing and the refurnishing of a plant.

And every time a product line is changed and new production lines put in, all of these issues become important. The last thing you want to do when you bring in the equipment is to find out that there is a water pipe or a girder, or that there are unlevel floors or things of that sort that will be relevant to the introduction.

And if you look at production, the scrap and rework probably are of much greater issue in plant renewal and facility management than it is even in production. And this provides an extremely high-speed way of providing common information for all the trades, and the accuracy is appropriate for the volume dimensions that we are talking about in that market.

Related to your question on the currency do effect, if you neutralize the effects of currency in the first quarter of 2005 as compared to 2004 first quarter, 1.4 million of the total 6.6 million increase in sales is directly related to favorable exchange rate. And 200,000 of the 620,000 increase in net income relates to favorable exchange rates.

(OPERATOR INSTRUCTIONS) Steven Pinsk, Noble Financial Group.

I just wanted to get your sense on the acquisition front, both in terms of -- are you still interested in doing acquisitions near-term, or do you feel like you have enough on your plate with iQvolution? And if you are interested in subsequent acquisitions, can you talk at all about what you are seeing in the acquisition environment in terms of pricing? And are there even interesting companies out there right now?

Steven, this is Jay. I think -- I will answer broadly first by saying, yes, we as a Company will always look for value-added acquisitions, whether it is technology that enhances the portfolio or the ability to get additional presence in the marketplace.

From an activity standpoint, I cannot predict whether it is near-term or longer-term. It really depends on finding the right transaction, finding the right value, and being able to transact it in a way like we did with iQ, where there is tremendous value for them and tremendous value for us based on how the deal is structured.

In terms of anticipations on pricing or what else is out there, certainly, that is one that, if you don't mind, I will keep close to the vest for now.

(OPERATOR INSTRUCTIONS) It appears we have no further questions at this time.

Okay. That being the case -- this is Jay -- I will just take a moment to wrap up and summarize. First, let me thank the entire global FARO team for their dedication and performance. I also would like to acknowledge the ongoing support of our investors. And finally, I would like to welcome the employees of the new Laser Scanner LS business joining us through the acquisition of iQvolution.

In summary, let me just restate that orders and sales grew 31%, with Asia-Pacific contributing almost 18% of the Company's total. And for the full year, we have increased our revenue estimate to a range of 125 to 132 million. Second, the integration of iQvolution continues to proceed as planned, and interest in the second quarter for the scanner has been strong.

Net income for the quarter increased 22%, and we are increasing our total year EPS estimate to $1.15 to $1.45, reflecting the delay in expensing of stock options, strong revenue in the first quarter, and the acquisition impact of iQvolution.

We generated 1.7 million in cash from operations, and our total cash and investments stood at 35 million at April 2, including the impact of our $4 million outlay for iQvolution. We also reduced our days sales outstanding to 75.

And finally, let me just say that we are very pleased with the attendance and feedback on our strategic outlook and guidance call, which we held recently. Anyone who has not had a chance to see that presentation can do so by going to the Investor Relations page on our website at www.FARO.com.

And with that, I would like to thank everybody for your attention, and have a great day.

That does conclude today's conference. You may now disconnect your lines. And thank you for participating.