FARO Technologies Inc (FARO) 2006 Q2 法說會逐字稿

Good morning, everyone and welcome to the FARO Technologies conference call in conjunction with the second quarter 2006 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, FARO released its fiscal second quarter results. By now you should have received a copy of the press release. If you have not received the release, please call Sharon Trowbridge at 407-333-9911.

Representing the Company today are Jay Freeland, Co-Chief Executive Officer; Barbara Smith, Chief Financial Officer and Keith Bair, Interim Chief Financial Officer. Jay and Barbara will deliver prepared remarks first and then all three will be available for 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'll now turn the call over to Barbara for her review of the financial results.

Thank you, Vic. Sales in the second quarter were 38 million, a 23% increase from 30.9 million in the second quarter of 2005. That brings our first half 2006 sales to 70.1 million, a 19.8% increase over the first half of 2005. New orders grew 18.3% in the second quarter to approximately 40.8 million compared to approximately 34.5 million in the second quarter of 2005.

New orders for the first half of 2006 grew 24% to 73.9 million compared to 59.6 million in the same period of 2005. On a regional basis, second quarter sales in the Americas grew 10% to 16.5 million compared to 15 million in 2005. Sales were up 24.8% in Europe to 15.1 million from 12.1 million in the second quarter of 2005.

Sales in the Asia Pacific region grew 68.4% to 6.4 million, compared to 3.8 million in the year ago quarter. The overall sales increase was driven primarily by the continued leveraging of the new salespeople we added around the world in the second half of 2005. The top five customers by sales volume in the second quarter of 2006 were Boeing, which represented 3.3% of sales, followed by the US Military, Global Tooling Systems, DaimlerChrysler and Advanced Integration Technologies.

The top 10 customers in the second quarter of 2006 represented only 11.9% of our sales, a key metrics reinforcing our lack of dependence on any one customer. Year-to-date, our top 10 customers represent 9.7% of total sales. Our gross margin improved on a sequential basis for the second straight quarter to 59.3% compared to 58.8% in the first quarter of 2006 and 56.6% in the fourth quarter of 2005. The ongoing gross margin improvement is the result of continued cost control programs implemented by the company.

You may recall that last year we experienced shifts in product mix as the FARO Gage adoption rate accelerated. Though our product mix continues to shift each quarter, our productivity programs are helping to minimize the impact on gross margins. Selling costs as a percentage of sales decreased to 30.5% in the second quarter from 32% in the first quarter of 2006 and 33.7% in the fourth quarter of 2005. This half point improvement was driven by continued leverage of the new sales personnel hired in the second half of 2005.

Administrative expenses in the second quarter were 18.7% of sales, compared to 14.2% in the year ago quarter. The increase was driven by 2.2 million of incremental costs related to the company's Foreign Corrupt Practices Act internal investigation and 0.4 million of incremental costs associated with our ongoing patent litigation. Excluding these items, administrative expenses in the second quarter of 2006 would have been 11.8% of sales.

Net income was 853,000 or $0.06 per diluted share in the second quarter, compared to 1.9 million or $0.13 per diluted share in the second quarter of 2005, marking our 16th consecutive profitable quarter. Cash and short-term investments were 22.7 million at July 1, 2006, improving slightly over the balance at April 1, 2006 of 22.3 million. Accounts receivable were 34.5 million at July 1, 2006, compared to 28 million at April 1, 2006 due to the increase in sales.

We continue to make progress on inventory, reducing our overall balance by 400,000 in the second quarter to 31.4 million at July 1, 2006 from 31.8 million at April 1, 2006. We generated 1.9 million of cash from operations in the second quarter. Overall, the quarter was strong, with topline growth of 23%, improving gross margins, sustained profitability and good working capital management.

I will conclude with some statistics regarding our headcount. We had 631 employees at the end of the second quarter, a decrease of 33 compared to the end of the first quarter of 2006. This decrease was the result of productivity programs to eliminate certain open positions, timing delays in filling required open positions and continued restructuring of personnel in Asia. Account manager headcount at the end of the second quarter was 148, with 45 account managers in the Americas, 65 account managers in Europe and 35 account managers in Asia. Geographically, we now have a total of 292 employees in the Americas, 223 in Europe and 116 in the Asia-Pacific region.

As you may recall from our recent announcement, I will be leaving FARO today to assume a position with another company. Before turning the call over to Jay, I'd like to thank Jay, Simon, Gregg and our board of directors for the opportunity provided to me at FARO. I would like to thank the investors for their support, and finally, I want to thank the FARO employees for their dedication and performance over the last 18 months. I wish everyone at FARO the very best as they continue to profitably grow the business in theCAM2 market.

Thank you very much and I will now turn the call over Jay.

Thanks Barbara. Well, the second quarter was another record breaker for the company. Orders for the quarter exceeded $40 million for the first time in the company's history. Year-to-date, orders were 73.9 million, more than $5 million better than our full-year performance in 2003, a brief 2.5 years ago.

European and American markets continued to show strength in the second quarter and our sales team responded by delivering 22.7% and 24.5% new order growth respectively, compared to the second quarter of 2005. New orders declined slightly by 2.9% in Asia, but we continue to see significant opportunity in all three regions.

Despite a number of proactive changes implemented as a result of the FCPA investigation during the second quarter, China continues to be a significant contributor to the overall business, and we expect Asia in total to return to their originally budgeted run rates sometime in the second half. At the beginning of this year, I stated that 2006 would be year of growth through leverage. One of the initiatives we launched in January to help enable that vision is called the power of one. The measurable goal is simple.

Every FARO employee around the world must identify and implement one cost savings idea worth at least $2,000 by the end of the year. But the broader message of the program is far more valuable, challenge everything you do and eliminate waste in every area of the company, challenge the status crow. Year-to-date, more than one-third of our employees have completed projects and the impact of the program has been felt around the company with many of the financial improves noted by Barbara during her remarks, being directly attributable to the power of one campaign.

Gross margin continues to improve, at 59.3%, we're at our highest gross margin level since the second quarter of 2005, which was 59.5%. We're also on the high side of our historical average. Year-to-date our gross margin is 59.1% compared to 58.1% for all of 2005. Our R&D and production teams continue to make FARO's products simpler to use and easier to build, and our sales team continues to sell on the value of the product, all of which contributing to gross margin performance.

I'd also like to speak about production for a moment. We now have operational manufacturing facilities in the US, Germany and Singapore to serve the corresponding regional markets for each location. The personnel we've hired at those facilities are topnotch, and we've successfully aligned the rigor and structure of our manufacturing processes across all locations.

As output has climbed, production inventory, or the raw materials that we use to produce our products, has continued to decline, dropping from 11.8 million at the end of the fourth quarter of 2005 to 9.1 million at the end of the second quarter of 2006. This represents a 23% decline in production inventory to support our ongoing volume growth. We're working to optimize our inventory even further, and we believe that our current facilities will support FARO's growth requirements for the foreseeable future.

We continue to make good progress on selling expenses. The 3.2 point improvement in selling expenses as a percentage of sales since the fourth quarter of 2005 is a result of the productivity we're starting to see out of our new sales personnel. Account manager headcount at the end of the second quarter was flat with the fourth quarter of 2005, and we expect minimal, if any, additions in the second half of this year.

Based on our performance year-to-date, we are maintaining our original 2006 guidance for the topline and gross margin. For the full year, we expect sales to be $150 to $157 million, a 20 to 25% improvement over 2005. We also expect gross margin to be 57 to 59%, in line with historical averages and in line with our year-to-date performance of 59.1%. Excluding the potential cost of resolution, if any, of the FCPA and patent cases and associated legal expenses, we also expect continued net income improvement in the second half of 2006. I'll also update the annual guidance again at the end of the third quarter.

As always, I'd like to thank our employees and our investors for their continued support of the company. We continue to see significant untapped global market potential for the products we sell, and we intend to continue capturing that market, driving the technology adoption rate around the world and helping our customers improve their own operations everyday. The mission, vision and strategy for this company remain the same, and we will continue executing to that strategy one quarter at a time.

I'm going to wrap-up my prepared remarks today with a special note of thanks to Barbara for the value she has provided this company during her 18 months here. Barbara has completely revamped and strengthened the finance organization, improved our financial controls and business processes and been a valuable partner for me, in particular, and the leadership team as a whole. Her impact will be felt here for quite some time, and I, along with the entire FARO family, wish her the very best in her new endeavor.

That being said, I'll note that I also have complete confidence in Keith Bair's ability to perform as Interim CFO. He has worked for companies through their IPO phase, at their peak, in times of trouble and in times of high growth. I believe he has the right mix of large and small company experience, and I look forward to working closely with him during this transition period.

Thank you your attention, and I will now open the call to questions.

[OPERATOR INSTRUCTIONS] We will now take our first question from Mark Jordan from AG Edwards.

Good morning, everyone. Jay, in the statistics that were given relative to the account managers, you were down 10 Q2 versus Q1 of this year with all of the decline primarily occurring in Asia. Is that a structural change you are making in your - the sales force structure there, or is that a result of potential churn you may have seen, say, in China as a result of the FCPA issue?

Yes, good morning, Mark. It's both. There is clearly a little bit of restructuring in terms of how we align the sales force in Asia. And obviously, there is some churn just the timing of backfilling some of the account managers in the roles that we have.

Okay. So would -- exiting the year then, you would assume that you'd be somewhere between the 158 and the 148 that you had this quarter?

Yes, I think that's a fair assessment. I mean, again, we don't anticipate adding too many additional heads, if any. I think that we will probably add a few more. We've got a couple of backfills that we definitely want to do. But I think that's a fair statement. We do still feel like, in total, we're pretty close to the amount we need for all of this year and even into 2007, at least, the first part of the year.

Okay. Looking at the gross margin, obviously, a very positive quarter for you, and it's at the upper end of your guidance range that you mentioned in the press release. Could you comment on the mix that you have here and any thoughts of how that should evolve through the second half of the year?

Yes. Well, as you know, we don't disclose sales by product line. So I won't talk specifics to the mix. What I think you see is there's two things. Number one, though the growth rate on the Gage continues to be strong, obviously, you're growing off of a higher base going into this year than we were last year. So the impact of that growth on the overall mix is lower than it would have been in 2005. So that's a piece of it.

The bulk of the change though on the gross margin is the combination of the sales team truly focusing on selling value or having great success there in both the Americas and Europe. And the cost productivity programs, the research and development teams, in particular, have done a nice job continuing to take cost out of the product to support the ongoing performance. The range, the 57 to 59, obviously, we are at the high end of the range already. I'm trying to leave a little bit of contingency open.

The one thing that could affect the mix still going forward is the laser scanner. And I've been pretty open, I think, before that I'm not 100% pleased with our performance there. But it is a much earlier stage product than the other three and we have to keep remembering that. So as the laser scanner ramps up and in the early stages, that may have a little bit of an impact on the gross margin through the back half of the year. And that's the reason for having a range that has a little bit of downside to it.

Okay. Also where are you with regards to your normal rolling over of your field demonstration units, which is obviously -- when you sell those at a discount and that can -- if you have a -- need to do a larger turnover there that can have negative impact. Are you relatively balanced where you need to be on that normalized rollover or is there a heavier mix next half in rolling over demo units?

Yes. I think the team has done a nice job rolling over this year, certainly more consistently than we did in 2005. I think the second half you always will see a little bit more -- just you get to the backend part of the year, you do have some specials that customers will pick up the demo gear as it runs through the end of the year.

You'll note that our demo inventory balance is up a little bit in the second quarter, and some of that is arming the field sales team with newer versions of the equipment as we put it out there. And so, as a result, you may see a downtick in demo in the back half of the year as some of that demo inventory flushes out. But generally speaking, I think the team has done a pretty even job this year compared to last year.

Yes. Could you refresh us as to what you see in terms of the balance of the year in FCPA-related expenses in terms of either investigation or coming to final conclusion. And secondly, what should be the timeframe of bringing this to conclusion, and what kind of fine or what other event might occur to close the book on this issue?

Yes. We have spent 3.2 million so far this year. We anticipate another approximately $0.5 million to be spent in the back half of the year. The timing unfortunately, Mark, is little bit difficult to predict whether that's in the third quarter or fourth quarter. It really depends on what it takes to wrap up with both the SEC and the Department of Justice, both of them we continue to cooperate with as they look at the case.

We don't have any way to predict what a possible fine could be at this point. And so as result, number one, that means we've not reserved for any. So that is always a possibility in the second half of the year. But we've gotten no indication as to what the actual magnitude would be, if any at all. That part we'll - we're going to have to continue to play by year.

Okay. But it would be -- at this point in time, you would assume that this issue should be resolved at some point in time during the balance of this year?

I would assume by the end of the year, again, I don't have obviously control over that, but I certainly think that's the track we're on.

Okay. And could you give us an update as to what are your current views in terms of the outlook of your, I guess, two major patent issues or litigation issues, one with on the ARM, two, your countersuit that you have, and three, any ideas of when you might hear something from the Patent Office relative to their examination?

Yes, I'll go in reverse it on. On the patent office, yes, we still obviously, we don't have a great way of predicting how much time it will take them to finish their review of the second motion. So I don't have a good feel there. On the case itself, as you know, the court date to move to the end of October. That was due purely to a scheduling conflict for the judge that required it to be pushed off until that time period.

We still feel very comfortable that we're in the right position on that case. I will say and just to correct you mildly, it's not necessarily a countersuit, necessarily. We do have two other open technical patent suits as we've talked about before that are not unrelated -- I mean I guess they are unrelated to the existing patent suit, but maybe a piece of the total solution here. And we do still feel like there is significant opportunity to resolve this prior to going to the trial. But that again is dependent obviously upon the two parties before we get to that trial date.

Okay. Thank you very much.

Thanks, Mark.

We will take our next question is from Liam Burke from Paris, Baker Watts.

Yes. That's Ferris, Baker Watts. Thank you. Jay, Barbara, how are you this morning?

Good morning, Liam.

Good Liam.

On the Asia-Pacific, you had strong revenues and then orders were down year-over-year. Was that a function of just a faster sales cycle, or is it just a timing issue on the orders?

It's a timing issue in my opinion. One thing I'll state is the sales number obviously they were working off of a fairly low base line here --

Sure.

-- so you have a huge growth of that base. On the order side, I think, it's a timing issue. Like I said the Asia sales team, as we went though our detailed rolloffs over the last three two weeks preparing for this. They're very confident in what the back half of the year looks like, and that's why why I felt comfortable making a statement that they believe they can get to their originally budget run rates on a monthly basis at some point before the year is over here. And that is based on a demand in the marketplace hasn't changed over there.

Okay. And Barbara, you generated positive cash free flow for the quarter as you had said in the first quarter call that you'd anticipated doing. Are there any second half capital needs that would be extraordinary wouldn't allow you to continue on this trend?

No, nothing other than just the normal sustaining type items. As we said in the past a number of times, last year we made a number of investments in the business to expand the production capacity, and we see most of those behind us.

Great. Thank you.

Thanks, Liam.

We will take our next question from John Emerich from Iron Works Capital. Go ahead please.

My question was actually answered. Thank you.

Thank you. We will take our next question from Jeff Bass, who is a private investor.

Good morning, Jay.

Good morning, Jeff.

With respect to your comments about hitting originally budgeted run rates in the second half on Asia Pacific, the company in the past has said that they thought at the end of 2006, Asia Pacific might be one-third of total sales. Well, I think that's now unlikely. I'd be interested in hearing your view as to whether from an longer-term point of view, you still have that confidence in that area of eventually delivering that amount.

Yes. You are right -- for sure, we will not get that this year. We're running at about 18% year-to-date, so mathematically, we just can't do it, not would I want to obviously because we're having tremendous growth in the Americas and Europe. The fact that the Asia sales team feels they're going to back to their originally budgeted run rates tells me that possibly, we get into that track again at the end of 2007.

But the other factor at play here really is that when we first calculated what that would mean for the company, the America's growth rate was, in fact, a little bit slower than it is right now. So it may take us a little bit longer just because of the catch-up they needed to achieve to get to the Americas level. However, certainly, whether it's in end of '07 or in 2008, we are going to reach a point where we're a third, third, third, and that's based on the number of opportunities out there, the different customers we can serve out there. It's a fairly well balanced spread around the world, and I think our sales will reflect that.

With respect to the exceptional strength in North America, and the very strong recovery in Europe, I know Simon in the past talked about hockey stick and how you would only recognize it after the fact. Would you characterize this extra strong growth as more likely just a result of the maturing of the new sales sides last year or do you think maybe we are moving up the hockey stick a bit?

Well, I mean this will sound terribly wishy-washy, Jeff. I think it's a little bit of both. I think there is definite -- the adoption rate continues to grow out there. This is not just us forcing this down the throat of customers. We continue to see a good spread of new customers versus existing customers. So that tells you that the technology continues to become more and more standardized around -- our customers around the world.

But I will say that to the Americas and in particular Europe's teams' credit, a lot of it is the leadership of that team and getting the sales force in Europe's case realigned with the right priorities and getting themselves focused day to day on the right activities. And On the America's side, it's sustaining what they started last year. So it's a combination of both.

And finally, you said you spent 2.2 million, I think, in the second quarter on the CPA investigation and relatively modest amounts of expense for the latter part of the year. Isn't the fair conclusion of that is that in effect earning pretax have a $2 million head start for the third quarter?

Certainly, Jeff, I do view all of those as being extraordinary expenses. So I think, generally speaking, that's a fair statement.

Okay. Thanks a lot. And I really appreciate the great sales and new order effort recently.

Thanks Jeff.

We will take our next question from Richard Eastman from Robert Baird. You may go ahead sir.

Yes. Good morning Jay.

Good morning Rick.

A quick question. When we look at the order strength in North America and in Europe, can you give us a sense of what industries are driving that, if not what product lines?

Certainly the industries remain the same. We are having great success with aerospace, we continue to have a good success in the auto and we have good success in heavy manufacturing. So the mix of those kind of the major three has not shifted at all. What it does prove is, and we've talked about this before, is that a global company, number one, the size of FARO's, we are still under penetrated in all of the markets that we serve. That's a general statement, but I think it's a very fair one.

So even when we see difficulty say with some of the US automotive manufacturers that we've seen in the course of 2006, that either means, number one, they have need for additional productivity, which we're there to help them with, or number two, means that there is alternative activity being offset elsewhere in the world which we also see and we pick up from the team in Asia or the team in Europe. But those big three continue to be the -- they're still the largest three for us by far.

Were there any big orders in either the North America or Europe in the quarter -- I mean that step out at you?

Yes I mean we had a couple of large ones. Certainly Boeing being the top customer for the quarter would be one that we point to. It was a couple of orders put together that made them -- put them at 3.3% of sales. But that would certainly be one. There were several large orders that we have not necessarily disclosed in press releases yet. But one or two that are worthy that we'll put into the website and show as customer application examples, new applications and using the tracker and/or the arm that we weren't utilizing before.

Okay. And what percentage of second quarter sales came from existing customers? Do have that number?

Yes. I do have that number. It was --

48.3% from new customers, 52% roughly from existing.

Okay. Excellent.

And the other thing I'll point out Rick -- I do want to retrace my steps for a second on the large orders question. I think the one thing that we should point to is that there is still a positive of not having too many large orders in any one given quarter as well. We're always focused on selling to not just the large customers, which account for maybe 25% of our sales, but selling to all the smaller customers, the second and third-tier suppliers that feed that network. They still make up probably 75% of the sales of the Company.

Okay. And then also, I noticed your top five customers, US military shows I think for the first time.

Yes.

What branch or application would that be?

It is a combination of the Air Force and the Marines. I can't state what the specific application was that they used before but it was a combination of those two branches.

And that's a direct sale to the military, not to a OEM supplier?

Correct.

Okay. And then just last question I have. Jay, historically, we've talked about gross margin in the 60 to 65% range was a targeted number. Now we're kind of speaking to more of a historic range of 57 to 59%. And I'm trying to get a sense of in the past, when we've approached the 20% operating margin, we've always done that -- it's been driven by a gross margin number that has been in the 60s somewhere. And I'm trying to understand is -- if we're going to settle into this 57 to 59% gross margin range and talk to that being the high end, do we need to think of that as applying to the operating margin line. In other words, do we now target an operating margin in the 15 to 17% range, or how should we think about the business model here?

Yes, great question. Number one, we're by no means settling into a 57 to59 range on the long term here. Our 2009 target as you referenced was still to be somewhere between 60 and 65%, and I do still believe that's achievable between the cost reduction programs that the R&D team is working on. Every day, they find another area where we can design something out of the product, reduce costs through a supplier base, use a different material. Every single day, they find a new area there. And I also think that as we continue selling, there's going to continue to be an opportunity to sell the value of the product in the marketplace to help offset some of that, too. So though 57 to 59 is the range for '06, that is not the target range through the end of '09. That remains 60 to 65.

I see. Okay. Good point. Thank you.

We will take our next question from Brian Bears from Bears Capital Management. Go ahead sir.

Jay how do you think about capital allocation especially given the new Suntrust amendment?

Well, number one, obviously, in some respects we think of the new Suntrust amendment as having the available line for a rainy day and rainy day can be defined in a lot of different ways. It could be defined as should we need it in the event -- an unfortunate event of significant fines related to the FCPA matter which we don't expect but you could use it for that, you could use it for acquisitions. We always are looking for new technology that could complement or enhance the product portfolio. And we constantly are looking for that.

So from a capital allocation standpoint, the Company does have a CapEx planning process that we go through, and we're in the process of developing the plans for 2007 right now and looking at are there any additional changes that need to be made for 2006, though, to Barbara's point we do not anticipate any significant CapEx expenditures in the back half of the year that would affect cash. So in many respects though I know the SunTrust guys would love to have me draw on the line, my goal obviously is the exact opposite, which is to never draw on the line and generate all the cash that we need for whatever purpose from the operation itself.

You don't envision using it to expand internally?

Not in the near term. If we have the need to expand internally, which again right now, I certainly feel like we have the infrastructure in place, certainly on the sales and marketing side to last us through '06 and into '07 and on the facilities side, significantly longer than that. So it really depends on if something dramatically different happened in the marketplace because to go back to Jeff's question, if you suddenly had a sizable ramp, again, in the adoption rate or in the growth cycle, you might look at it for that purpose. But generally speaking, we've been fairly successful being able to fund any expansion through the cash that's generated from the operation itself and would certainly continue to try and do so.

Great. And then could you talk a little bit about what you're seeing competitively from a pricing standpoint?

Yes, we continue to see -- price is always a factor in the decision making process. Obviously I can't say that it's not. And pricing is competitive in the marketplace, not unlike I think most capital goods industries. But at the same time and it goes back to things we've talked about before where the -- when the return on investment for your customer is sometimes measured in weeks, not months or years, the pricing equation changes dramatically.

And one of the things that we do do is we have a very specific program that the sales will sit down and go through when they're with their customers to help them understand what's the return on investment. How we're going to be utilizing that equipment and trying to show them what that brings to the table. And that can often offset some of the pricing pressure that you feel in the market.

Okay. Great. And then finally could you give a little update -- just talk generally about the digital template and laser scanner and just in particular how your efforts to further your market penetration are paying off?

Yes. The digital template as a product is really -- clearly is a secondary product. It was launched a couple of years ago as an experiment to test the waters. And we've seen though we still sell it, there are limited applications, there are very specific used applications for it. I don't expect the digital template to ever be a significant contributor to the revenue of the company.

The laser scanner, on the other hand, we do still anticipate that being a significant contributor to revenue over the long term. And the exciting things there is twofold. Number one, is it in fact is a completely different measurement device in terms of what value it's provides than any of the other products that we have, and number two, it can address markets that we do not address with the laser tracker or the arm, or the scan arm or the Gage today. It is a dramatically different marketplace for the laser scanner.

And so -- and as we've talked before openly in these calls here, certainly I would like to add more laser scanner sales today. And what we're seeing, though, is that we're just a little further back on the adoption curve. I liken it to where the tractor was probably five years ago right after the company acquired the SMX business. They were moving into the marketplace. The sales process, though, was a little bit slower, a little bit different. Again to tell you the laser scanner folks are doing many demos as the arm and tractors guys are.

And so from that standpoint, there's good activity in the marketplace. It's really a matter of you're building up the adoption of that product from a lower starting point than we see it with the arm and the tracker engaged today, because they've been in the market longer.

Okay. Great. Thanks a lot. And Barbara, good look in your future endeavors.

Thank you, Brian.

Okay. We will take our next question is from Jed Dorsheimer from Canaccord Adams. You may go ahead, sir.

Hi, thanks. Most of my question has been answered. Just a couple more. Jay as your concentration has increased across a couple customers, Boeing. I was curious, do you think that's -- that you're starting to see a change with the number of demos that are needed in the orders at some customers that you have a longer experience with? Ordering, starting to see greater leverage from a few customers, or is this just an anomaly?

Yes. I'd love to think so. I don't think having one big customer every quarter is an anomaly necessary because we certainly have had that in the past. But what I do see is even though it's a repeat customer that we've had for a long time, we still are doing the demo every time we go in there. It maybe a different part of the plant maybe a different plant altogether. And so though I would like to think where the point where you don't need to do the demo, they just decide and pick up another one and move on, we're not quite there yet.

With no question, we're going to reach a point in time where you sell multiple units after a given demo or that companies will adopt similar to the Johnson Controls example, we've talked about in the past where they put in one arm, fix an existing issue inside a single manufacturing cell, and then decide to roll that out to all of their other matching cells around the world. Just hand them, boom, this is the way we're going to do it and they change their own tractors. We're going to reach a point in time when many customers are doing that, we're just not there yet.

So would it be fair to that most of the sales even at the same customers are fixing isolated problems, and it -- versus actually implementing it throughout a particular line?

No. It's a little bit of both. Certainly, moreso we're still selling more single unit deals than we are multi-unit deals, no question about that. But it is still- it's very much still a missionary sale, where takes going in and doing the demo for multiple groups multiple times.

Great. And then last question, just with respect to the outstanding lawsuit with Romer CimCore. The - are all the concurrent arms using a work around to the infinite rotation, and has that caused any sort of impediment in the sales process as far as not having infinite rotation in the arm?

Yes. To the first part of the question, yes, every arm today has a 50 rotation limiter on it. It's limited through the software and that was put into place in August of last year. Every arms from that point forward has been shipped with that on it. And we have not seen a slowdown in the sales of arms or in the selling process or what it takes to sell that arm during a demo. That part has not changed.

Great and Barbara, good luck. We'll miss you and thanks a lot.

Thanks, Jed.

We will take our next question from Steven Pinsk of Noble. You may go ahead.

Hello?

Good morning, Steven.

How are you?

Good. How are you?

Good. Thanks. Just some points of clarification, if you would. The first one is, Jay, last conference call, you had said that the internal investigation regarding China was completed. And the press release today talks about it being on going. So I'm a little confused there.

Yes. The difference there is that our work that the company engaged in to uncover it, to gets the bottom of the issue and to resolve the issue is complete. It is still an internal investigation from the standpoint that we have follow up that the SEC or DOJ may want to have with us. So that's the piece that we're trying to predict right now. But our legwork is complete at this point other than anything they request.

Okay. In terms of headcount, I guess you had -- there was a budget or expectation that you were going to add 25 new people and it breaks down 17 account managers, five inside sales specialists et cetera, et cetera. Is that still the target or has that been scaled back?

To be honest with you, Steve, I'm not positive where you got the target from, so I apologize for that. But I will say that as we talked about earlier today, do I think we'll finish in the range of the 148 to 158? I think the answer to that is yes on the account manager side.

Okay. You were talking about production inventory. Can you define that?

Yes. Production is all of the raw and the work in process for the company. It does not include service, does not include finished product, does not include demo.

Okay. And when you were talking about the Gage, you said something about the salespeople and account managers trying to sell value. Could you expound on what that means?

Yes. Certainly, the selling of the value of the product goes back to the return on investment. And so at any given customer - again, it depends upon the volume, and how often they're using the product. But we do see many times that the return on investment is one month, sometimes a couple of weeks.

And so what you're doing is you're selling the value to the customer of reducing their scrap, reducing their rework, reducing their inspection time. In some cases, Gage customers -- we have Gage customers who the larger customer that they serve adopts a quality standard that forces them to deliver all of the data electronically, and it all has to be three-dimensional. And if they've been spot checking one out of 100 and now have to do all of those 100, they can't physically do that just using traditional height gages and calipers and things like that.

Okay. A couple of balance sheet items. The inventory in current assets, is there any service inventory component to that?

We have separately identified on the balance sheet the service inventory. So there is a separate line item on there for service inventory.

Okay. So the inventory in the current assets has no service-related inventory. Is that correct?

Correct.

Okay. There is a big jump in the unearned service revenue since the beginning of the year. Can you explain where that's coming from?

Well, it's basically the -- when we sell a product, we typically -- well, we have a one-year warranty that comes with the product. But the customer has an option of buying an extended warranty. And we cannot recognize all that revenue in the current period. You have to recognize it over the life of that warranty. So it's a function of the sales volume and the mix of just taking the one year versus extended.

Okay. That still doesn't make sense to me, unless you're telling me that customers' purchasing patterns for warranties has changed significantly.

Yes, Steven, I apologize. There's one other component, which is also training, which is part of the product offering as well. And we can't recognize the training revenue until the customer takes the training. But we do offer promotions on warranty, and we will do extended warranty promotions, and we've done a couple of those this year and they have been successful. So part of it is a function of some of those promotions.

Is that something that's pretty regular from year-to-year? Or is this sort of unusual sort of the first time that you've tried to stimulate demand for the service products and the training?

It's certainly not the first time we've had promotions for extended warranties. But we do evaluate all of those types of programs on an ongoing basis. And I do know that we had some promotions in the second quarter in particular to stimulate that. And they were successful.

Okay. Just a couple of more questions. In terms of the competitive landscape, specifically with Hexagon, are you seeing any pressure from them? Or you haven't really seen much of a change one way or the other?

We still see about the same amount of pressure from each of the individual components within Hexagon. To say it's from Hexagon specifically, that's really only in corporate name, obviously. We see in this same select markets we always have from Romer and CimCore on the arms side and from Leica on the tracker and on the -- occasionally on the scanner side. So -- but I don't think it's been any noticeable change in one direction or the other.

Okay. Last question. Jay, what's Simon's plans after his employment contract is up at year-end?

Well, the -- as we've talked about to he Street before, the plan was always to transition to -- number one, when I came onboard was President and Chief Operating Officer and we said at that time, we would transition to co-CEOs sometime in early '06, which we did. And the -- the plan at that point was to transition from co-CEOs to one standalone CEO by the time the year ended. The Board obviously has the decision on whether they want to continue with that path or if they want to renew Simon's contract or not. But we do -- we are still on that path at this point.

Okay. Great. Thanks very much.

We will take your next question from Mark McRobert from AG Edwards & Sons. You can go ahead, sir.

Yes. I just had one quick question on the CSI market. I was wondering if we're going to aggregate, track and report the municipal crime scene investigation sales similar to the way we are aggregating the Navy and Marines into a category called US Military.

Generally, the answer is no. And I'll say it from the standpoint that we are not planning to split out product sales still at this time point in time. However, if we were to get a sizable order that was relative to a certain police department or anything like that, then we would claim them as single customer. This one we claimed because they happened to be using the product jointly. And so that's why we put it in a single market.

Okay. Thank you very much.

We have a follow-up question from Richard Eastman Robert Baird. You may go ahead.

Yes. Jay, just a quick question just on the tone of business here as we head into August. I'm curious, at times, we've seen a seasonal fall-off in sales, usually complements of Europe in the third quarter. And I'm little bit curious if your sense this that we'll see that seasonal effect in the third quarter or if you would expect to sequentially grow the revenue line here with the orders that you took in in the second quarter?

I think you're right. I mean, certainly there is always a little bit of lull in August in Europe for all of the capital goods industries, and ours is no exception to that. Generally speaking without talking about the third quarter by itself, we do still anticipate our typical sales pattern whereby the second and third quarter are about the same, the fourth quarter is always a bit higher and the first quarter is always a bit lower.

Okay. Thank you.

It appears we have no further questions at this time. I will turn the program back over to Jay Freeland.

Okay, very good. Thank you, again, everybody for your call today, the continued interest and support. And as always, if you have follow-up questions, please feel free to call Keith and myself here at the office going forward. Have a great weekend. Thank you.

This concludes today's teleconference. You may disconnect at any time. Thank you, and have a great day.