FARO Technologies Inc (FARO) 2005 Q3 法說會逐字稿

Good morning everyone and welcome to the FARO Technologies Conference Call in conjunction with its Third Quarter, 2005 Earnings Release. Please note that this call may be recorded. 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 Third 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 and Simon Raab, Chief Executive Officer. 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 Simon.

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

I want to explain our rational for the past guidance in attempt to show how we arrived at our decisions. However, while explaining this miss, I will also highlight that which is very positive about our results. First, I would like to remind you that in the Q2 Report we stated that the most substantial half of the year was yet to occur and based on order growth and margins, as well as a variety of cost containment efforts that we still felt that achieving the low-end of the guidance range was reasonable.

We modeled the remainder of the year based on our observations of prior years, and the relative order rate between the first and second halves of the year. We modeled it also based on the margin experience, implemented cost cuts and tax rates in our various jurisdictions. We had planned elimination of more than $1 million in expenses in the U.S. and Europe. We felt that sales would grow by 11% quarter-by-quarter based on past experience. And we modeled the gross margin based on historical patterns, and we felt that a number of product cost reduction initiatives would put us in the higher end of our margin historical range.

I want to discuss unpredictability. In the past we have always been conservative with our earnings guidance, but since there are always opposing views on Wall Street we were accused of sandbagging our growth rates. We have been conservative in the past with our guidance because our admitted inability to forecast orders and production for the variety of products on the variety of markets.

Our size also was an issue because $1 million in shipments in one direction or another, a week earlier or later, could dramatically change the results. That is the primary reason we started reporting new order growth rates. Clearly from this experience guiding too optimistically can be perilous.

I want to reiterate that this degree of unpredictability in the business still continues 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 to be able to ship within days to orders placed in the last days of the quarter. This resulted in substantially more complex inventory management situations, and resulted in the substantial inventory increases.

This was further in support of the corporate initiative to reduce the backlog to less than one week, even though 70% or more of the sales in a month could arrive in the last week of the month. And we have tried many approaches to change this customer ordering pattern.

We'll turn now to sales growth. We have been pushed by many investors to try to define the so called "elbow" in the growth curve and we have been reluctant to do so. We have typically said that we would say so when we saw it, we have however been progressively increasing our predicted growth rates. It may be a testament to how we are perceived that our stock is under a great deal of pressure, while we report a 33% growth rate year-over-year, in a year with 92 million in sales.

We've been guiding in the 25 to 30% new order growth rates and internally projected sales in Q3 of 11% greater than Q2, in line with the experience of the last two years. Unfortunately we expressed -- we experienced new order growth rates of 15% less in Q3 than Q2 a 27% shift from historical patterns. We were surprised by this and isolated the problem primarily to the European economy and the European sales organization, which showed a new order growth rate of only 15%.

As soon as we discovered the problem we analyzed it, implemented changes in Europe which includes expansion, sales department reorganization and management changes. In respect to the fourth quarter sales predictions, we remained concerned about our ability to boost European sales in the short-term to achieve the high-end of our revenue range. In addition, sales of the new iQvolution scanner were lower than as we expected, as we continued to deploy the new sales force. From the optimistic point of view however, we are very happy with the enviable overall growth rate of 33% for the year-to-date.

Now turning to gross margin, this quarter we were surprised by the need to take a 1.6 million cost adjustment to inventory and hence cost of goods, due to processing problems relating to the implementation of our new accounting and inventory management systems. While we have maintained substantial reserves established for inventory based on experience for obsolescence and excess of slow moving inventory, this issue could not be predicted. It was discovered and promptly analyzed and corrected through process changes, additional controls and staff changes.

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

Together, these conspire to make margins difficult to predict, and result in the range of now 54% to 63%. In this quarter we had a different mix, and would have shown an approximate 58% were if not for the inventory adjustment. Once again, lest we overstate the negative, we are maintaining near to historic margins for the year-to-date at just below 59%, which is respectable in any market.

Our model supporting our previous guidance for 2005 used higher margins, but still margins well within historical ranges. The problem is that a 3% shift in the margin due to mix can result in a $1 million shift in earnings in any given quarter. Evidently we did not predict the product mix or the margin effectively. On the optimistic side we are very pleased by the high rate of growth in the ground-breaking FARO Gage market and the state-of-the-art trackers, both currently lower margin products.

Now a short discussion on selling expenses. Selling expenses have come down in the quarter to 26.5% of sales as Asia ramps up, but was somewhat offset by higher selling expenses in Germany. This also was a surprise and is directly related to the European sales growth issues which are being worked on. We will continue to tolerate higher selling expenses in order to invest as needed in the revenue growth objective. It is our intention to moderate this sales hiring rate in the short-term to allow the sales to catch up to the head count and provide a more profitable balance.

Now a few comments on administrative expenses and R&D. Administrative expenses have crossed a threshold in very trying circumstances. Our model in the next five years was aiming for admin under 10%. To have achieved this in Q3 with the additional Sarbanes and higher litigation costs was a very positive indication of our improvement in leveraging our worldwide organization. However, in addition we have modeled higher litigation expenses in the fourth quarter projections.

R&D expenses were within our model at 5.7% and tends to be quite predictable. They have resulted in significant product additions like the recently announced Target CAM. The Target CAM significantly enhances the tracker's ability to measure many targets in unspecified locations in large volumes, by identifying them by video and directing the tracker to measure the locations. This is highly useful in large-scale, automated environments such as aerospace, and because of it we have already had a number of substantial wins at major aerospace suppliers.

New product revisions and improvements will be announced in the first half of 2006, and continued investment in the scanner and other products will further expand the addressable market for FARO products. I will close with comments on taxes. Tax rates remain fairly predictable however, changing regional profitability affects the overall effective tax rate. Current negotiations in Singapore are almost complete, and the low rates expected will help stabilize and minimize the tax rate in Asia.

I hope this has helped a little in understanding how we might have honestly missed our guidance by being optimistic in a number of business areas which remain difficult to predict. I can say with some certainty that after this year, that we would be far more conservative going forward.

Now I'd like to turn to the litigation with Hexagon. As we've said in our latest press release on this subject, a "Markman" hearing was held on October 3rd. In this hearing the Judge redefined the patent claims in a manner which we believe is advantageous to FAROL. This time the claims are improved in specificity, where before they were too broad. We now await a new infringement hearing on November 14th, which has been moved from November 7th to allow more time for input by expert witnesses. We continue to be confident in our position, even if the case ends up in an appeal to a higher court.

And finally a couple of words on 2006, we had stated in our press release that we believe the 25 to 30% growth rate can be sustained in 2006, and we will refine this view as we complete the fourth quarter. The various organizational efforts around the world should allow us to stabilize and improve earnings going forward.

Thank you very much for you patience, and I'll now open the call to questions.

[Operator Instructions].

We'll take our first question from the site of Mark Jordan with AG Edwards. Go ahead please.

I'd like to talk first, about what you see in terms of the macro-economic view of your most significant target markets being auto, aerospace and heavy equipment. How do the current economic trends impact near-term buying indications out of those industries and what impacts might the macro-economic environment have on your assumptions for '06?

Mark, this is Simon. We have a certain empirical experience from the past about how we respond to these various market changes. Clearly in 2001 we had the extreme act of terrorism which essentially halted sales in better part of a quarter. And those are conditions in which we had little control over. However our experience in other times, when we had downturns in industrial -- the machine market as well as manufacturing we have generally continued to experience the growth rates, albeit at smaller scales in the past.

But we experienced the growth rates that were positive because of our ability to sell ROI to companies that continued to have quality issues, but could not invest in the same amount of monies. And in general because of our distribution of clientele of nobody greater than -- I think our top-10 clients are below 9% of our total sales. That nobody being greater than 1 or 2%, means that we have a broadly distributed clientele which mitigates some of the risk. Now, that's not to say that a lot of those clientele aren't tied to aerospace and/or automotive, so there is an impact, but in general we have not seen a great impact.

Okay, specifically let's talk about the auto industry, have you seen any change in buying patterns relative to the GMs and Fords and or the parts industry?

No we have not. We continue to get strong orders from the automotive industry, GM to be specific and around the world we have not seen any indications.

Okay. Could you -- you said that you were also setting aside reserves, inventory reserves for the fourth quarter. Could you quantify what you think would be that number relative to the 1.6 million you had in Q3, and as that you become fully implemented and your ERP capabilities should not -- is it expected that these reserves or adjustments, however you want to term them, should go away?

Yes absolutely. The numbers that we have in our predictions for the fourth quarter are on the order of 0.5 million, and they would only be one-time. They are not related to the normal obsolescence and/or excess inventory reserves that we would normally take. And yes, once we get some confidence in this final quarter on our ability to control that, we don't expect those to be repeated.

Okay. Final question if I may, and I'll get back in the line. The -- as you point out the sequential growth or the absolute level of sales is below, for the fourth quarter, is below what you would normally assume in terms of the seasonality of your company. And that you've, I guess in the past, stated roughly 30% of sales occurs in the fourth quarter. The range is clearly below that indication, given the relatively softer sales that are occurring in the -- basically third and fourth quarter, what are the specific reasons or things that you point to assume the -- that you will see a resumption of, or seemingly more, resumption of growth as we move into '06, versus sort of a plateauing which seems to have occurred in the third and fourth quarters?

I think that's a great question, it was somewhat referred to in my comments on the European causes for some of that. We feel that there is a, clearly an economic issue, in Europe, but we feel that it hasn't been responded to properly by management in Europe. And so, the restructuring and intensifications of sales and marketing efforts we hope will mitigate some of that. Clearly our penetration is so light in so many of the industries that there is opportunity to -- they're constantly is opportunity.

So, we did not feel however, that we could be confident that we could get them running back at full speed in the fourth quarter ,and that's why we downgraded a little bit of their performance in the fourth quarter, and why the top revenue line has been moved a little bit.

So -- but we still don't have any other reason to suspect that we could not continue to achieve the kind of growth that we're talking about in 2006. And even if Europe was flat or marginally increasing we felt that the turn up in the performance in Asia would more than make up for that. So our model right now indicates that that's achievable. Clearly, we have stated also in my text that we would refine that view as we saw the fourth quarter roll out.

And if I may cheat and get one more. Could you talk about what your initial response has been, in Asia clearly you've added a lot of people there. The incoming orders in Asia seem to be relatively flat over the last two quarters. How you view the outlook for the productivity of those people you have added and when and why do you expect them to -- the productivity of that sales force to increase?

Well first of all I want to define the "flat" I mean we've had 100% increases in the sales quarter-to-quarter and -- I'm sorry, year-over-year. And that's being reflected in that. Are you meaning the accelerating rate of increases is flat?

Well sequentially it's been I think it was about 5.5 million, something like that. So clearly it's up meaningfully year-over-year, but one would think with the significant number of bodies that have been added in the first half of the year that sequentially you might have seen some growth?

Yes, well I think that this purely applies to ramp up time. I think that the introduction -- we had a little bit of trouble dealing with the training and communication and implementation because of the Singapore headquarters is not fully phased in. The full management team is almost in place now, in Singapore, facilities are in place and this will help us manage that a little bit better. So this is a ramp up time which I think will be mitigated substantially by the headquarters there. And so, we expect to catch up very quickly.

Thank you, I'll go back in the queue.

Thank you.

Thank you. We'll take our next question from the site of Jed Dorsheimer with Adams Harkness. Go ahead please.

Thank you. Couple of questions, first, the ERP system that was implemented in some of the, I guess deficiencies, for lack of a better word, in the inventory. I was wondering if you could maybe elaborate on what the issues were there that caused the 1.6 and then the 500 in reserves this quarter, and what gives you 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 of production is the need to have accurate builds of materials to have all the codes set for 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 manufacturing floor for WIP, work in processing, shop orders processing, the training of individuals, and a whole variety of reasons which resulted in variations either in costing 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 to the reporting we were concerned that there might be other issues. So we put some reserve in as we continue to implement.

Got it, thank you. And last on the ERP system, the--going forward, what do you expect the savings to be particularly as I was thinking this might be an ability to see some cost benefits with respect to Sarbanes-Oxley? I'm not sure if that's where your cost benefits are going to be, I'm sure it's throughout the company that you see those. But was just wondering what sort of leverage you would be able to get from implementing this system in place? Thanks.

I think that the primary reason that we're implementing is for just dealing with the order processing around the world. We have three -- we will have three manufacturing facilities each of them -- actually four manufacturing facilities if you include our Pennsylvania operation which each makes certain sub-components and bring the components together for a final manufacturing and calibration certification. So it's just the processing of all of that while also increasing the number of turns of the inventory, which is one of our goals, will obviously contribute to the bottom line.

But, our product line is quite extensive for the size of company that we are, and the processing of all that and all the hundreds of accessories that relate to those, and the training and the implementation of the delivery on a timely basis with the kind of very tight goals of one-week delivery that we've tried to sustain. That's where we get the advantage. And remember as well, that we've always tried to design our systems to be prepared for the future growth. And so we are putting systems in place now to be able to take us to the half billion without a significant amount of stress, and while reducing head count and maintaining flat expenses to get leveraging in admin and other areas.

Right. Was wondering if you could give us -- elaborate on the competitive environment, particularly Europe where there's some -- and the reason that I ask about Europe is coincidental to some of the weakness that you're seeing is also there's been an acceleration, I guess, of some of your competitors to get a product portfolio that's competitive, particularly Hexagon.

And I was just curious, is it more economic-related or are you starting to see some competitive pressures in the product line that's causing some of those issues over in Europe? And then also if you could comment on ASPs as far as what those are declining to? Thanks.

Well first, my comment, I would answer you the way I answer our sales managers. Is please don't bring to me the competition as an excuse for not making your sales, I won't accept that. And I usually don't accept the economy as a good excuse either. The reality is that our penetration is so light in so many of these markets I mean we've qualified it as a multi-billion dollar market, we have 100 million in sales, of which 40 million odd in Europe. We don't believe that that's -- any of those reasons are justified reasons for not continuing the sales growth.

Clearly, sometimes you have to adapt to a new competitor, but that's not a reason for not having tactics to get you the growth. I think that with respect to Hexagon, albeit that we had a number of competitors which some people believe is now one competitor, actually what we have is one owner for a number of competitors. There is no, at this point, clear, consolidated representation by the competition. And in fact, if there were there would be significant conflicts because they sell contradictory equipment such as fixed-base CMMs and portable equipment. So that has not been an issue.

With respect to the ASPs clearly what we -- where we've put our own pressure on the ASPs, usually before anybody else forces us to. We've always been pushing prices down and trying to maintain our high gross margins. Clearly on product introductions like the trackers where we want to take market share, and/or the gauges where the market can only tolerate certain prices, we will tolerate lower margins and hence lower average selling prices. I can't say though that we have been -- in general there -- have not been a general lowering in prices, in fact if anything there seems to be a slight increasing in prices. So, I hope that answers your question.

Yes it does. One last question, I guess is you bring up what's tolerated by the sales force. You've seen an increase in the number of hires, and I'm curious, as you look out to 2006 what -- how many of your, or what percentage of the sales force do you think that they'll hit their quotas? And then also, when you mention the 25 to 30% year-over-year growth to be able to continue in 2006, what year is that combined annual growth rate starting or, did you mean to imply that 25 to 30% would be over what this year's -- let's call it the 125 million level, to get to some number for next year.

That is, with respect to the sales growth, that would be the number it would be the -- over this year's final year's sales, for 2006. With respect to the expectations of the sales people, depending on the product line you're in it can vary anywhere from three to six months to get a salesman fully up and running. And that's usually a number that is -- happens only when it's well supported by training and/or additional infrastructure.

I think you understand then perhaps why we were extremely -- it was extremely urgent that we accelerate the introduction -- or the implementation of the Singapore office because here we had all these people in China that we were adding yet they weren't being properly supported by a local service and/or training organization. So it was -- we were a little bit out of sync there and it was very important to get that up and running. So once they're up an running, we would expect that to accelerate a little. But that's generally how long we would tolerate waiting for a salesman to get up to speed would be anywhere from three to six months.

Thank you. We will take our next question from the site of Richard Eastman with Robert Baird. Go ahead please.

Yes, could you give the number of account managers at the end of the quarter?

Yes Rick this is Jay. The total sales and marketing organization at the end of the quarter was, worldwide, was 266 which is up 41 people. That includes account managers, ISSs, marketing personnel, the entire gamut. In terms of account managers and ISS put together that's 245 worldwide which is up 40, quarter-over-quarter.

Because I think the account manager number, just pure account manager number was like 138 at the end of the second, what compares to that?

We'll have to get back to you on that one, for some reason I don't have that one here in front of me.

Okay. And then just can you clarify one more time, on the guidance for the fourth quarter the gross profit margin range, I presume that incorporates the 0.5 million inventory reserve which might be 150 basis points. So that gets us maybe from the low end 60 to what, 58.5%? And I'm maybe just a little curious, what again is it mix or what exactly are you planning on to deliver a range of 56 to 59%?

Well it's all the reasons that we mentioned before. With respect to the 500 it's with respect to the actual inventory value in count, as we process around the world. With respect to the actual margin itself it's going to be impacted by the product mix and the different geographies. So, we tried to model some of that, albeit very difficult.

Okay. And then in terms of the cost savings surprised me a little bit. I think coming out of the second quarter we talked about trying to take 700,000 of costs out. We were going to split that between quarters. Did we double or triple-down our efforts there sometime during the quarter to get a full 1.5 million off sequentially?

Yes Rick, this is Jay. The first number that we talked about in the second quarter earnings call were relative only to the U.S., at which point in time that's the only cuts we had completed. Immediately after that, we had already had in process cuts in Europe, and those did not finish until after the last earnings call, so that added the incremental that we're looking at now. We have not given an annualized number for those savings in 2006.

Okay. And then, just one last question. I have a question on the sales process itself. I know you track the number of demos and you track the probability of closing transactions. And as you look out into this fourth quarter and you're planning a little slower sales activity, which of those dynamics are you forecasting to be lower?

This is Simon. The area that we're still forecasting the lower performance will be primarily in Europe, and then it will be identified in our dollars and sales per demo.

Sales per demo which means that you would plan on closing fewer?

That's correct.

So it's not -- in terms of the end market the number of demos that there's a demand for that number remains fairly high?

Correct.

Okay. Thank you.

Rick-- let's go to the next question please.

Thank you. We'll take our next question from the site of Andy Schopick, with Nutmeg Securities. Go ahead please.

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

I don't think it would be unfair, but I would want to characterize it as being no 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 all of the effects on inventory in one period, you bring them all into one period. With no one being able to actually resolve where and when those variances might have occurred.

Yes, yes.

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

But this is something above and beyond the obsolescence factor?

That's right. When we traced the root cause of the differences, it wasn't related to obsolescence excess, but due to processing issues with respect to the new accounting system.

Okay. Let me ask a couple of other ones here. What do you expect to be your top-three verticals this year, in terms of revenue contribution, and do you expect or anticipate any change to that in 2006?

Yes, this is Jay. Clearly, the top-three will remain aerospace, auto and heavy manufacturing. I don't expect that to change from the top-three in 2006. Obviously we continue to see new verticals in other smaller niches that we continue to get into that would grow over time, but that top-three shouldn't change in the near term.

Any reason to believe that there might be a material shift between any one of those verticals?

I don't think we have a reason to believe there would be a material shift at this point. It -- I don't think there is.

All right. Finally on the taxes, Simon you mentioned Singapore will lower the tax rate. I see that there is an adjustment here in the third quarter, a further lowering of the overall year-to-date effective rate. Can you give us a little more guidance on what the full impact of Singapore will be on your anticipated, effective rate for 2006? I think we can see where it's kind of tracking for this year.

Yes, this is Barbara. We haven't done a complete evaluation of 2006, but what we have modeled using some different rates for Singapore which we're pretty confident we're going to finalize here shortly, is that we can maintain in that 23 to 25% effective tax rate.

Well Barbara, I think the overall effective rate so far, year-to-date, is about 16% or --?

Yes, and part of that is due to losses in certain jurisdictions and our ability to use NOLs in those jurisdictions.

And there will be less availability of that in 2006 so that the rate probably will be north of 20%?

Yes.

Okay. Thank you.

Thank you. We'll take our next question from the site of Sarah Beyrich with Artemis. Go ahead please.

Hello, thank you very much for taking the question. I just wondered, in the past I think you've talked about, of your sales, what percent were to new customers versus old customers, repeat, and I just wondered if you would give that again?

Sure, Sarah this is Jay. In the third quarter, in the Americas 67% were to new customers, in Asia 62% were to new customers and in Europe it was 54% that's for the third quarter.

Okay. And is there any way -- when you've talked about the elbow in sales, I'm assuming that's having a customer go from buying one machine to buying a hundred, or something like that. And is there any way to look at your average orders and say right now, our customer's are still just buying kind of one unit at a time, on average? Or what would -- where are you on the spectrum mode (ph)?

Right, Sarah, this is Jay. I think you're correct on both. I think the elbow could be defined as customers buying multiple units at a time on a regular basis, as well as the technology becoming a more de facto standard so to speak, which is that acceleration of the adoption rate worldwide. And I think you're correct that right now we still see customers buying in much smaller lots of one or two. We've only had one or two instances where that we've announced this year where we've had a sizable order of multiple units at the same time.

Okay. Thank you.

Thank you. We'll take our next question from the site of Jay Cooper (ph) with Loeb Partners Corporation.

Hello, good morning. Just wanted to go back to the plans for Europe to cut -- reduce costs. Wondering -- a couple of things there, particularly on the sales force level, how to integrate and manage a sales force that has to sell the scanner and the tracker. Seems to me the scanner is a lot different. And secondly, in the consolidation or the cost reduction, are there any plant facilities that might have to be realigned?

Okay, this is Simon. With respect to the sales, I want to be very clear that we have different sales groups for the different products unless there is a clear compatibility between either the kind of customers or marketing that would exist. For example, there's no compatibility between somebody doing a countertop unit and selling a high-precision gage for a machine shop.

As you point out there's probably very little compatibility between somebody selling a tracker and somebody selling a scanner, because the applications are so different. So in each of those cases, we have the sales force divided up where we have a team of individuals supported through -- also dedicated marketing individuals that are focused on each product line and sometimes even an application.

And that's how we -- and actually one of the problems in Europe is that that team differentiation has not happened. You put your finger on it sort of inadvertently then one of the issues will be that the differentiation between the different sales groups was not sufficient, and that impact hurt the ability to sell effectively. With respect to the costs, I should point out that the costs were done through efficiency improvements, staff reductions that were permitted through efficiencies, and evaluation of redundant staff and redundant processes.

With respect to the manufacturing facilities, those have simply ramped up in terms of their overall production capacity and they're at an all-time high out in Switzerland. The primary reductions were in administrative and other staff relating to the head office.

All right. So your comments about the sales problems or sales challenge, on the scanner etcetera, does this imply maybe that sales costs would have to rise long-term to deal with these diverse products?

No. I think that generally it's the isolation of that particular product with a particular sales group in a market, that's essential. Once you have that isolation so that you have proper focus, then you have - there's a typical ramp rates that you would expect. So the scanner, as I mentioned before, was one of the reasons why we downgraded the -- or why we felt the third quarter didn't perform where it needed to be, and why the fourth might also be impacted.

Because the implementation of that new sales group for the scanner, and in that particular market, needs to go through an educational process. Marketing needs to get spun up and we did not execute as rapidly as we would have liked in that area. But there's no reason to expect that our general model of three to six months to ramp up the sales groups has changed.

Thanks a lot.

Sure.

[Operator Instructions].

We will take our next question from George Thomasee (ph) with Scott-Macon.

Thanks. What else can you say about the performance by product-line. You talked a little bit about the scanner sales, but what about -- whatever comments you can make regarding other product lines, and how they're performing?

Well in general we have avoided, for obvious strategic reasons, or competitive reasons, to give a lot of detail on that. I can say however, that there is a shifting demographic between the different product lines. We're very pleased by the increases in sales in the gage market which is the high-precision tool for machine shops which replaces virtually all hand tools.

We're also very pleased with the significant wins on the tracker market. Those particular products tend to be a little bit lower margin than our conventional Arm market. But in general we see -- and you will expect this demographic to change as these other products begin to mature. So, we expect the scanner to start playing a more important role in the different markets and the sales to start to shift, shifting to them. The idea that any one or the other would dominate is -- it's such an early stage in the market that we have no idea of where that's going. All we know right now is that they all have a great deal of potential.

And then finally what is the competitive threat, if any, from indoor GPS which I believe is being marketed by Arc Second?

Okay. We have evaluated that technology. We think that first of all it's a misnomer, I think which is important for everybody to recognize that there is probably no relationship whatsoever to GPS which is a time-based -- atomic clock time-based methodology to our integrating satellite information for location and it's used predominately in the surveying business.

Arc Second has a sweeping set of lasers that require fixed locations for the senders --senders if they're occluded from the view contribute to errors. We have looked at their specifications, we don't feel that they constitute certainly a competitive threat for us, in either their pricing, implementation, nor and/or accuracy.

That does not eliminate the fact that in the future, given the right combination of factors, that they could play a role. At this time -- the premise behind the GPS was a large environment measuring system. We have a laser tracker which is able to measure an entire airplane in one coordinate system. But apart from applications like that, you're usually constrained to measuring in a small volume which is why we think Arc Second introduced a more smaller volume model.

But then they have line-of-sight issues which all the optical devices do. So it -- I'm sure it plays a role, I'm sure there are applications. It certainly piqued some interest I'm sure in some people, and we think there's merit to the idea of a larger measurement environment, we're not sure that's the best way to do it though.

Okay. Thank you.

And we have a question from the site of Jed Dorsheimer with Adams Harkness. Go ahead please.

Yes, thanks for taking my follow-up. One quick question Barbara, looking at potential for options expensing. Was wondering without any accelerated investing, I think it looks like about $2 million annually, is that the correct number to sort of use, assuming that there's no acceleration?

Yes, we're intending to adopt the provisions of 123-R in January of 2006. And we still are evaluating the transition method and the associated impact including accelerating of the vesting of options and we've looked at it, and if we accelerate the impact in 2006 would be approximately 0.5 million after tax. If we were to choose not to accelerate the number is around 2.8 million.

Great, thank you.

And we have a question from the site of Liam Burke with Ferris, Baker, Watts.

Simon, how are you this morning?

Great, thank you sir.

I wanted to ask you, is the general split of large corporation to small and midsize business is still approximately 25 to 75?

Yes it is.

Okay. And you don't see any change there?

No.

All right.

In fact, with the introduction of some of our other products like countertop we actually move into the smaller groups that the -- the gage also moves us into single machine shops which are smaller groups. So, there's tending to be a flow in that direction which frankly we're happy about, for obvious reasons.

Now is there a sales productivity difference between the larger corporations and the small and midsize businesses like the machine shops?

You mean with respect to our ability to sell to them?

Right. Well -- they're fewer of larger corporations so --?

Right, they're fewer and they're also more difficult to deal with.

True.

They change their budgets at random. You can sell one plant, but then you have to sell the next plant so you never get the advantages of just doing one demo for the whole group. There are very few corporations that have group think, some of the exceptions might be like Johnston Controls that had a one-time decision to implement worldwide and did so. You've got others like Boeing who would sell one corner of the plant, and then the other corner would have to be sold to almost like a separate customer.

So, the dynamics are very difficult and they're also like sirens on the shore they call out to you with huge potential orders, you spend a lot of time on them and only to find out that they don't materialize. And it's been a long-time policy of ours to always focus on the small and medium-sized businesses, while of course serving, as well as we could, the larger businesses.

Thank you.

Sure.

And that is the last question we have for today. At this time I would like to turn the program back over to Mr. Allgeier. Go ahead please.

Well thank you everyone for joining us. I'm not sure if Simon has any closing comments, but we appreciate everyone joining us on the call.

I don't have any other closing comments, except to express my appreciation to everybody, and to hope that we can do a better job guiding in the future. Thank you.