FARO Technologies Inc (FARO) 2006 Q3 法說會逐字稿

Good morning everyone and welcome to the FARO Technologies conference call in conjunction with its Q3 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 with The TTC Group, FARO's Investor Relations firm. Yesterday, FARO released its fiscal Q3 results. By now you should have received a copy of the press release. If you have not received a release, please call [Darren Saylor] at 407-333-9911. Representing the Company today are Jay Freeland, Co-CEO and Keith Blair, CFO. Jay and Keith will deliver their prepared remarks first and will then 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 Keith for his review of the financial results.

Thank you, Vic.

Sales in the third quarter were $38.4 million, a 17.8% increase from $32.6 million in the third quarter of 2005. That brings our year-to-date 2006 sales to $108.5 million, a 19.1% increase over the comparable period in 2005.

New orders grew 31.2% in the third quarter to approximately $38.7 million, compared to approximately $29.5 million in the third quarter of 2005. Year to date, new orders grew 23.3% to $112.6 million, compared to $91.3 million in the same period of 2005.

On a regional basis, third quarter sales in the Americas grew 16.3% to $15.7 million, compared to $13.5 million in 2005. Sales were up 41.9% in Europe to $14.9 million from $10.5 million in the third quarter of 2005. Sales in the Asia-Pacific region declined 9.3% to $7.8 million, compared to $8.6 million in the year-ago quarter. The overall sales increase was driven primarily by the continued leveraging of the new sales people we added around the world in the second half of 2005.

The top five customers by sales volume in the third quarter of 2006 were the U.S. Air Force, which represented 1.7% of sales, followed by West Wind Technologies, Siemens, Lockheed Martin, and Boeing. The top ten customers in the third quarter of 2006 represented only 10.5% of our sales, a key metric, reinforcing our lack of dependence on any one customer. Year to date, our top ten customers represent 7.9% of total sales.

Our gross margin in the third quarter was 58%, compared to 54.3% in the third quarter of 2005 and a 59.3% gross margin in the second quarter of 2006. The decline in the gross margin in sequential quarters was driven by sales of products with higher than average cost of sales during the quarter. Year to date, our gross margin was unchanged from last year at 58.6% and remains within our estimated full-year 2006 range of 57 to 59%.

Selling cost, as a percentage of sales, decreased to 27.6% in the third quarter from 30.5% in the second quarter of 2006, and 32% in the first quarter of 2006. This improvement was driven by continued leverage with the new sales personnel we hired in the second half of 2005.

Administrative expenses in the third quarter were 14.6% of sales, compared to 18.7% in the second quarter of 2006, and 9.8% in the year-ago quarter. The $2.4 million increase in administrative expenses in the third quarter over the third quarter of 2005 was driven primarily by an increase of $1 million in professional fees, of which $400,000 was related to the Company's Foreign Corrupt Practices Act internal investigation, a $400,000 increase in compensation costs, and a $300,000 increase in incremental expenses related to the Singapore facility, which opened in September 2005.

Year to date, administrative expenses were 16.9% of sales, including $4.9 million of professional fees, of which $3.6 million was associated with the Company's Foreign Corrupt Practices Act internal investigation and $800,000 for incremental costs associated with our ongoing patent litigation. In addition, compensation costs increased by $1 million and we incurred incremental costs related to the opening of the Singapore facility of $600,000.

Excluding the $4.4 million of incremental costs related to the FTPA expenses and the patent litigation, year-to-date administrative expenses would have been $13.9 million, representing 12.8% of year-to-date sales, compared to 12.1% of sales in the nine-month period of 2005. Management believes that the comparison of year-to-date administrative expenses, with the exclusion of incremental FTPA and patent litigation expenses, provides shareholders with the ability to better compare the Company's performance in 2006.

Net income was $3.2 million, or $0.22 per diluted share, in the third quarter, compared to $2.6 million, or $0.18 per diluted share, in the third quarter of 2005, marking our 17th consecutive profitable quarter.

Cash and short-term investments were $24.7 million at September 30, 2006, improving $2 million over the balance of July 1, 2006 of $22.7 million. AR was $36.7 million at September 30, 2006, compared to $34.5 million at July 1, 2006, due to an increase in DSOs to 89 days from 83 days, primarily related to the increase in international sales, which typically have longer collection cycles. We generated $3.1 million of cash from operations in the third quarter of 2006. Overall, the quarter was strong, with nice profitability, as we realized the benefits of leveraging the global team in controlling our expenses.

I will conclude with some statistics regarding our headcount. We had 613 employees at the end of the third quarter, a decrease of 18 compared to the second quarter of 2006 and a decrease of 19 compared to the third quarter of 2005. This decrease was the result of productivity programs designed to eliminate certain open positions and timing delays in filling required open positions. Account manager headcount at the end of the third quarter was 143, with 38 account managers in the Americas, 67 account managers in Europe, and 38 account managers in Asia. Geographically, we now have a total of 279 employees in the Americas, 212 in Europe, and 122 in the Asia-Pacific region.

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

Thanks, Keith.

Our results for the third quarter are a direct reflection of the growth through leveraged strategy we've had in place since the beginning of this year, and that strategy calls for maximizing the potential of every aspect of this organization and I think our results this quarter demonstrate the power of that focus. We're applying the leverage strategy to every element of the business from sales effectiveness to material productivity to R&D program delivery to administrative efficiency. Only in an environment of continuous improvement can a Company drive itself in this matter and FARO's culture, just like our products, is all about continuous improvement.

Looking at the front end of the business let me say that the markets we serve have never looked better. Europe and Asia experienced tremendous growth in the third quarter and American markets maintain their strength. I remain particularly pleased with the consistency in Europe this year, which aligns quite well with the consistent performance our team in the Americas has been delivering since the beginning of 2005.

I'm also pleased by our recovery in Asia, as evidenced by their new orders growth of 46.6% in the third quarter. Europe and the Americas grew 37.4% and 19.2%, respectively, in the third quarter and we continue to see strong demand around the world. Our largest competitor posted 9% organic growth in the third quarter, compared to our 31.2%, so I remain confident in our team's ability to continue penetrating this large underserved market everyday. Given the strength that we're seeing, we continue to believe that our 20 to 25% top-line growth estimates through 2009 remain achievable.

Gross margin in the third quarter was 58% and year to date is 58.6%, in line with our target full-year range of 57 to 59%. Now, as product mix shifts we'll continue to see modest variations in gross margin, but we remain on track to achieve our stated range for 2006. The sales team continues to sell the value of FARO's products with our customers and the R&D team continues to effectively balance their work on future product developments with their work on productivity programs. This will enable us to drive towards our 2009 gross margin target of 60 to 65% gross margin.

Selling expenses, as a percentage of sales, improved again in the third quarter, dropping to 27.6%, six full points lower than in the fourth quarter of 2005. The sales personnel we hired in the second half of last year are really starting to perform and you see that both in the new orders growth I talked about earlier, as well as in the selling cost line. We expect continued leverage of the sales team through the end of this year and throughout 2007, as I don't feel it will be necessary to do any significant hiring of additional sales personnel for the foreseeable future. We will add selectively to support new markets or unique penetration opportunities, but broad sweeping increases like the kind we did in the second half of 2005 should not be required over the next 15 months.

Based on our performance year to date, we are maintaining our 2006 top-line guidance of $150 to $157 million and gross margin range of 57 to 59%. Excluding the potential cost of resolution, if any, of the FCPA and patent cases and associated legal expenses, we expect continued net income improvement in the fourth quarter as well.

I'd like to thank our employees around the world for their continued dedication and the outstanding execution they continue to display. I'd also like to thank our investors for their support of the Company. FARO Technologies is a fantastic enterprise with significant untapped market potential. We have the best team in the industry and that team will continue to deliver going forward.

I'd like to close my remarks today by congratulating Keith Blair on his promotion to CFO. Keith, as you may know, was previously our Director of Accounting and served as interim CFO for the last three months. After conducting an extensive search, it was my determination that Keith is the right guy for this job. He has the right mix of financial skills and previous company experiences. He and I have developed an extremely strong working relationship and we share the same vision and goals for this Company going forward. I expect great things from Keith, just like I expect great things from FARO as a whole. Thank you for your attention and I'll now open the call to questions.

[Operator Instructions.] Mark Jordan, A.G. Edwards

Congratulations on the [technical difficulty] and allow that came in on the upside. Jay, I would like to talk a little more about selling expenses. They declined slightly over $1 million sequentially. Should we look at Q3 as the base run rate and then moving forward our additions would be for sort of general inflation and also higher commissions as the sales rate [reverses]?

Yes, I think, generally speaking, that's correct, Mark. The model, as you know, is highly variable. The sales team is virtually 100% variable comp in the field. Admittedly, the sales and marketing line includes some fixed costs in the marketing side for driving the programs that we have in place, the trade shows, etc. And, obviously, there is some one-for-one comparison. As sales go up, there is a proportional increase in the compensation that goes with the sales team from that. But, generally speaking, I think that run rate is appropriate. As you know, our target model is 25% selling cost as a percentage of sales, and we continue to drive ourselves towards that. I can't say that we're going to get there in the fourth quarter or not. It, quite frankly, depends on the volume and the productivity of the team that's there, but obviously we're moving it in the right direction in that regard.

Okay. Could you give us an update specifically on the FTPA issues, when you might expect to see some resolution of that? And could you give us a range of what those resolutions might be in terms of zero to some number?

And then secondly, could you update us on where you are with regards to the timeline on the patent litigation?

Sure. Let me start with the FCPA first. We have continued to cooperate with both the SEC and the DOJ, as we have from the beginning when we self reported immediately after learning of the issue. The timeline is very difficult to predict at this point. Obviously, we work closely with them. There is no great way to estimate what the timeline is. My preference certainly would be to have the issue resolved before the end of the year, but I'm not going to press that issue either. We want to make sure this gets resolved the right way.

And so it's difficult to say whether that would occur this year or next. There is just no predictability to it. In terms of the range of possibilities, we don't know if we will receive a fine or not and there is no standard map or precedent that I can point to that would say here's a way to predict what the outcome might be. There are plenty of previous cases out there from FCPA perspective of companies, when they did receive a fine and if they were to receive one, what their fine was. But the map associated with that is fairly different and unique to each case. And so I can't put a number on it nor have we tried to historically.

On the patent suit side, the trial did start yesterday. It is in the Southern District Court of California and we are in the midst of that right now. We are told that their trial should run roughly two to three weeks, but obviously that's really dependent upon how much time it takes to present the case and the facts. But -- and then at the end of that time period, this is a jury trial, so it really will depend on the outcome. And depending on what happens at that point, that will determine the next steps of whether this continues into 2007 or not. And the same thing on the patent case, there is no good way at all to try and predict what the possible outcome is or range of dollars on that one. But we will, like I said, the trial started yesterday, and certainly we believe by the end of November, assuming a normal case timeline, we'd have a feeling for what the result was of this -- of the jury trial.

Okay. And so has there been anything [technical difficulty] line that was in question?

I'm sorry, Mark, you broke up a little bit there.

Has there been any activity at the Patent Office relative to its review of the base patent?

We have not heard anything back at this point. As you know, there were two different filings we made with the Patent Office regarding the construction of the patent claim itself and we are waiting to hear back still on the second one. Have not gotten anything from them. And, again, that one is a timeline that's hard to determine because they are working -- in this type of case, the Patent Office works directly with the company that receives the patent, so in this case, Hexagon, and through their former subsidiary. So they would be having more of the interaction that we are at this point.

Okay. A final question, if I may, and then I'll turn it over to anyone else. Looking at Asia, obviously a decline year-over-year, order patterns, is that just an issue of the dislocations that you went through in that market with that CPA and you are getting back on track or what would you characterize sort of the mid-term outlook for that geography?

What we see in Asia, there are two things. On the shipment side, you are correct. Shipments were down about 9% versus the third quarter of 2005, though I'll say the third quarter of 2005 was a sizeable increase in shipments for that operation last year. So you were you running off of a higher number from 2005 than what I would say would be normal.

On the order side, though, the 46-plus percent growth that they experienced this quarter, I think is obviously a very positive sign. You may recall when we first talked about the Foreign Corrupt Practices Act issue, my message to the sales team in China, as they were resetting themselves and trying to get this fixed was that I didn't care if sales went to zero, they were to go find the customers who were going to do business the FARO way and the right way and that we would reset ourselves based on that as the priority.

And both in the second quarter and in the third quarter, sales in China did not go to zero, and now I'm referring specifically to orders at this point, they did not go to zero. In fact, China continues to be a sizeable contributor to the overall volume there. So the 46% that we saw in Asia in orders growth this quarter over the third quarter of 2005 I think is a function of that team picking up steam again in China and the teams in Japan and India and the other countries that we serve performing particularly well also. And that's both the strength of the markets as well as the execution of the team.

[Brian Barrs], [Barrs Capital Management]

Jay, in the press release, I saw that gross margin declined sequentially due to changes in the sales mix. Can you talk about what products caused that shift?

Well, generally speaking, we don't -- Brian, we don't disclose gross margin by product line nor do we disclose sales by product line.

Okay.

We've stated generally in the past that the Gage, just by the nature of the lower price, does carry a slightly lower gross margin with it. And Gage continues to grow quite rapidly in the marketplace. Faster growth rate than the other products, albeit off of a much lower baseline. So you would expect to see a higher growth rate at this early stage. So it really is -- it's dependent on any given quarter, other than if you have a slight increase in Gage shipments versus some of the other products. And there are some slight regional bases as well. But there is not any one thing that I can point to and say that it was a great concern to call it out and look at it with the team either.

Okay, great. And then my last question is what were the results of the "Power of One" campaign? I believe -- was that where you were trying to take $2,000 per employee of costs out of the system?

Yes. We've not disclosed the numbers out of it, but I'll tell you this, that the targets that I set for the team have been achieved, the first go around, and we have a new stretch target that's out there. The dollars that we're getting, as we talked about before, don't necessarily all drop through to the bottom line. In some cases, we use the dollars to redeploy it for a different program. Save money on something we're doing today that doesn't make any sense and use it to do something that's more effective that we can put towards the growth of the Company or towards the productivity of the Company in a different fashion.

The big thing for this year was all about participation rates and participation rate Company-wide. The goal was to at least clear 80%, and that is what's on the metrics screen of everybody who's on the leadership team. That they need to get their organizations to at least an 80% participation rate. And we are, though we still have some room to go there, we've cleared at least the 50% mark at this point, which I think is -- I'm very pleased with that progress, being that we're really only seven months into the program at this point. And we may share the numbers once the year clears and be able to talk specifically about what dropped through to the bottom line and what we put back into the growth or to other elements of the Company. I'm going to save that one until we clear the fourth quarter and then we'll talk about it again.

Okay, great. Congrats on a great quarter.

Richard Eastman, Robert W. Baird

What was the percentage of sales to existing customers in the quarter?

Yes. In the quarter, sales to existing customers was 56%. Sorry, existing was 43% and sales to new customers was 56%. So right in line. We've consistently said that we at least want 50/50 and, quite frankly, my preference is always to be a little bit on the higher side for new customers, given that we're still in what I feel as market penetration and ramp up mode. I'd rather see more new customers than existing at this point.

Okay. And then can I just circle back for a second to the selling expense number? The concept of leverage here, I understand that, that's what we're targeting for the year, but I'm not all that clear as to how that number drops in absolute dollars by $1 million sequentially. I mean, if I look at our sales number, clearly it's a bit higher sequentially. What -- how does that -- how does the selling expense number drop by $1 million quarter to quarter? What causes that?

Well, you have a couple of things that drive the decrease obviously. One is that we do have fewer account managers right now than we did in the second quarter and obviously than we did last year. And that's not going to drive a $1 million drop in total. Some of it depends on the mix of the products we sell. We do have slightly different compensation rates and percentages from a Gaged sales person versus a Tracker sales person versus an Arm sales person. So that can drive a portion of it as well. So it's a combination of those things.

And is -- have you moved some sales people off of a draw or is there a draw decrease?

Yes. You're right. There is also a draw decrease. As time goes by, sales people come on and they are on a draw for the first six to eight, sometimes as long as 12 months, depending on the product and also depending on the region. And some of those folks do start coming up draw in the third quarter because that's when they came onboard, was the third or fourth quarter of last year.

So when you said earlier about this being potentially the base to work off of, what's the base, the $10.5 million or the 26 -- 27.6%? I mean what -- how are you viewing that as a base?

Yes, sorry, Rick. I view it more as the percentage, but I believe the 26.7%, in that range, is probably appropriate. And, again, given that we've got people off draw and just knowing product mix and where we are, obviously when we go into the fourth quarter we are looking to increase sales. Again, when you look at what our total sales are year to date versus what our estimate is, that means we would have higher sales in the fourth quarter. So you would expect to see higher expenses, but I should be in that same 26% range, give or take.

Okay. So that's how you're viewing that. And then also, as you move into the fourth quarter, when you look at your gross profit margin expectation, are we going to see any of this demo inventory discounting in the quarter that may pull that down sequentially on better sales?

Never say never obviously. We have historically had some demo inventory move in the fourth quarter, and not that we don't move it in the first three quarters of the year, and we've tried to push harder this year to balance some of that, because we are trying to churn demo inventory, generally speaking, we're trying to churn it once a year anyway. But there does tend to be a slight uptick in the fourth quarter, which can drive pricing down a little bit and gross margin down a little bit. And in some respects, that's why we've left our gross margin open at this point from 57 to 59, albeit, at 58.6% year to date, you'd have to have a fairly sizeable chunk in the fourth quarter to drive it as low as the 57. But I want to have a little bit of flexibility there, given that we do want -- the beauty of the demos is that most of the demo orders that we get are going to brand new customers that may not have been able to afford an Arm or afford a Tracker earlier but have tremendous utilization for the product. And so it gets us in the door there and that brings us some of the future business later at the higher gross margin.

Okay. All right. And just -- you have a number -- the deferred service revenue continues to kind of move higher. Is that -- is there anything from an incentive standpoint going on there or is that strictly unit volume growth?

Yes, that's purely unit volume growth. It's directly associated with new equipment that goes into the field and delayed revenue on training or on any of the warranty expense that goes with it.

Okay. And then the same with the DSL kind of stretching out. I know you said earlier -- Keith said earlier that it was mainly international sales. But, again, any incentives going on there? Stretching out payment terms or anything?

The [DSO] primarily related to the increase in the international sales.

Okay.

But there is no change in terms being offered or special promotions or anything like that.

Okay.

And, Rick, I will say, obviously, we do occasionally do it in certain instances, significant -- certain types of strategic orders or large orders may occasionally come with it a longer terms, but, generally speaking, the sales team is pretty effective at not taking those steps.

Okay. And then was there any FX impact on sales or orders in the quarter?

It was a little bit less than 1%.

Okay. Positive?

Yes.

Yes, okay. And then just lastly, Jay, any thoughts on your domestic exposure, industry exposure? I'm thinking kind of auto. Have you seen any softness there that's discernible in the number?

We haven't. I continue to believe that we, as a Company, are significantly under-penetrated enough in all of the industries, even though we obviously still have -- look, we still do a lot of business from aero and auto on a total basis. At each individual company level, we are still so far under-penetrated that we tend to be below the waves as they're going through. If you look at Ford and some of the things they're going through right now, we tend to be below the waves.

And the other thing is that even when customers are going through a productivity issue, from a company perspective, we tend to see in some cases even upticks in the number of demos that we're doing. Admittedly, the selling process takes perhaps a little bit longer or the decision-making process a little bit harder when a company is not in full proactive mode like that. But we do see -- they are looking for productivity tools and we certainly have significant productivity tools that we're offering.

John Emerich, Iron Works Capital

Two quick ones. The tax rate I have in my model is around 25%, but it keeps coming in lower than that. Was there anything unusual that had to do with interest income investments or do I just have the wrong rate?

Well, what happened in the third quarter of 2006 is we received formal notification from the Singapore Economic Development Board that we received a four-year tax holiday. So we had previously been using the statutory rate in Singapore of 20% and now we have a 0% effective tax rate in Singapore for the next four years, subject to certain economic requirements.

Okay.

So the target rate, Keith, for the year that we've talked about is roughly 20%.

Right.

And we still believe 25 is the right effective tax rate to predict the longer term. Obviously, that will -- longer term being now through '09 in that model. But we'll continue refining that obviously as each year moves on.

Yes, I mean, I don't know if you could put it in perspective what the Singapore tax rate, the relative impact is on what your overall tax rate, but based on what you just told me, it sounds like this -- your run rate, forget about calendar '06, but your run rate is below 25%, if not below 20% for the next -- for the foreseeable future, right?

Yes. Especially going forward into the fourth quarter for 2006.

Yes. Okay. And then the second question is it looks like -- was CapEx about $1.4 million in the quarter? And is that -- do I -- it's about that level the last two quarters in a row. Is that your -- is that -- are you running at $5.5 million a year? Is that the run rate or is it a little lumpier than that?

CapEx was slightly lower than that in the quarter. I think on a year-to-date basis, it's probably about a little over $3 million. And we did have some build-out in Europe related to that. We also expanded our facilities up in Pennsylvania. Those are two one-time CapEx requirements in '06.

Generally speaking, we believe the CapEx run rate would be in this $2.5 to $3 million range for a total year as we go forward.

Jay Cooper, Loeb Partners, Inc.

Enjoying your illuminating comments. One question basically. Can you tell us if your automotive industry business was up year to date and sequentially in the quarter and should we infer that we're in a bottom there? Should we also infer that there's visibility for additional growth in the aerospace category looking forward?

Yes. We have not disclosed yet for the even the year to date at this point on where we are up or down sequentially inside of auto or aero or any of the other segments. I do believe, generally speaking, Jay, that we have growth in both coming not only -- I know year to date we've had growth in both and I believe we'll have growth in both on the foreseeable future as well. And, again, it's a combination of when there is strength we tend to do very well and when there is some weakness in any one industry we still tend to do fairly well, given that we're so under-penetrated and given that they tend to be looking for productivity tools. We will update that probably as we get through the end of the year here, we'll do our annual recut of that, but generally speaking, we're still running roughly 35% of our sales coming from aerospace and 25% coming from auto.

Okay. One additional question. Europe did very well and I wondered if you have basic driving reason why that happened, other than the fact that you kind of whipped things into shape over there?

Yes. No, I think that's exactly it. I don't -- last year, my biggest complaint with the team over there, Jay, was that I didn't think the market really was all that different from what it had been the previous two years when they were growing extraordinarily well. I think it's a function of the leadership over there, the new focus they've put on the model, the model being it takes x number of leads to create x number of demos, and it takes x number of demos to create x number of sales. And the focus they've had on that through 2006 compared to the focus they've had on 2005 is not quite 180 degrees apart from each other, but it's pretty darn close and I'm certain that's what driving the result.

Dennis Scannell, Rutabaga Capital

Just a couple of quick things. Jay, you had talked about your -- I think it was 143 account managers. And I was comparing that to a presentation that I had seen you guys use where you were saying that you had 265 sales and marketing people at the -- at July 1st. I'm wondering, account managers, are those sales folks? Can you help me reconcile that? Who are the folks that are out there on the factory floors doing the demos and trying to close the sales?

Yes. You are exactly right. The account managers are the actual quota carrying people who live on the variable comp plan. They are out there doing the demos and selling and closing the deals. The 265 -- and we believe that we will finish the year somewhere -- we're still at 150 to 155 on the account manager line. We've got several account manager openings around the world right now. If you look at what's out there posted, mostly backfilling from people we had before that either left or weren't performing well.

The 265 is the total sales and marketing headcount. And so if you look at the account manager basis, we have a team of inside sales people that support all of them who get the customer on the hook. They are making the first phone calls, they are getting the demos set up, they are getting them interested in the product. And we also have both field marketing personnel as well as corporate marketing personnel focused on markets and product lines both who are doing the lead generation side of the equation. Those leads are what the inside sales people are working off of to make their first contact with the customers. So that total 265 is actually still accurate and that's what drives and makes up this 26.7% of cost that we had in the third quarter.

Got you. Now, just to drill down a little bit more, so generally speaking, that -- with 143 people at present, they're doing about $1 million a year. You guys are roughly around $143 million latest 12 months in sales. Is that -- as you look at your sales group, what is -- what kind of productivity do you think you can generate out of them? It sounds like you're not expecting to add many more sales people once you get to that 150 to 155 by the -- by, let's say -- until the end of 2007. So I'm just trying to gauge. Like, generally speaking, can we expect $1.5 million, $2 million out of these guys or what is reasonable?

Yes. Generally speaking, we have come to expect about $1.3 million on average. Sometimes a little lower and sometimes it's a little higher, which is why just simple math and history tells me that if I finish the year between 150 to 155 and they all do roughly $1.3 million, I don't believe I need any account -- any new account managers, additional account managers, for '07's purposes, other than you might hit a couple that go out to some strategic markets. But not that you're using them to drive the sales growth at 20 to 25%, which we've been estimating.

You have a mix as well that you have people who have been around more than a year tend to be a little bit more productive than people who have been around less than a year. And so obviously as that group matures, that $1.3, we might see that shift a little bit higher, though I'm not banking on that at this point either, given that there is always some churn in the sale force and there is always some churn from one market to the other. Generally speaking, I think $1.3 million is a fairly decent estimate.

Great. And then I think you guys went over this, but I was interrupted during -- when we were going through some of the stuff on the tax front. But if we look -- I got the piece on the Singapore tax holiday, but, Keith, if we're looking at 2007 and beyond, have you guys kind of said what you think you're reported tax rate and then cash tax rate would be?

Well, we're projecting in the 2009 target operating model a 25% effective tax rate. I think going forward, in 2006, it will probably be in the 15 to 18% range, depending on the mix of pretax income by country. But certainly the Singapore tax holiday for -- at 0% for four years has certainly been one of the primary factors for reduction in our effective tax rate in 2006.

So for 2007 and 2008, would we still think it would be kind of 20% or below or would be seeing that 25%?

I think it's probably safe to say it's probably closer to the 20% than it would be to the 25%, all other things being equal. There are some certain economic incentives that we have to meet in Singapore in order to qualify for that, which we clearly have in place to meet.

Great. And is that pretty much a cash rate too?

Yes.

[Operator Instructions.] [Jeff Bass], Private Investor

With respect to sales expense, in the past my understanding was that the commissions ranged between 15 to 20% of sales, depending on a whole load of factors, and the rest was -- tended to be fixed costs. Would you think it would be reasonable to take your current sales expense level and split it that way, roughly speaking, and then increase the fixed part by inflation and the balance in the proportion to sales if you were using a model?

Yes, I mean, I think generally, Jeff, that's probably about right. To say that 15%, in that range, is tied to the commission sales force, and they are both between their expenses and the commission rates and the cost of keeping them in the field, yes, I think 15 to 20%, in that range, and the rest would be fixed tied to the marketing team and other expenses that we have there, and certainly inflation is appropriate.

Okay, thanks. With respect to the trial, you said two to three weeks. If the Company were to unfortunately lose and you then had a damages phase, would that also be included in that timeframe, in your opinion?

No. I think if the Company were to lose, obviously there would be some time clock to go with that. There would be a decision on whether we would appeal or not. Certainly my anticipation is that we would appeal at that point. And once you go to the appeal process, I'm assuming we'd have -- we'd see at least another five to six months. Appeal, at that point, we'd go to a three-judge panel that has more specific patent experience and that would be the final -- the final stop in the process.

No. I guess I wasn't clear. I'm familiar with the appeals process, but do you think the two to three weeks would include the damages phase, if you were to lose, as well?

I can't determine that for certain. Again, it's hard to predict that. Two to three, including damages, might be a little bit short. Three to four, maybe a little longer, including the damages phase, is probably more appropriate.

Okay, thanks. With respect to demos, the Company has historically been a "every sale requires a demo" business and the advantages that are accrued to the Company if you could start getting more than one sale per demo, it would be huge. Do you see that coming in one year, two years, five years? What's your thinking in terms of when that might happen? Or it may never -- or might it never happen?

Well, I'll answer the last question first. I'm convinced it's a matter of if, not when, so I don't think it will never happen. I believe that -- is it two to three years? Possibly. Could it be quicker? I think that's possible too. And we've been trying some things this year at more of the corporate level going in at, say, the VP of Manufacturing, who has responsibility over multiple plants, or at the COO level. And we've been targeting that in select instances because we have had a couple of examples where customers bought 15 or 20 and outfit a series of cells all at once. But we are finding that there are still, generally speaking, a lot of the decision-making power resides at the individual plant manager level and they tend to still buy cell-to-cell in many respects.

The more installed base we get out there, and obviously that's why we keep so much focus on the new customers right now, the better the opportunity that as they are realizing productivity they buy one, they buy another one, they buy another one, then there is the better opportunity to have them come back and say okay, I get it, we're having good success, give me ten more or give me five more and I can deploy them in these other five or six cells. But right now, at least for the next, I'm sure at least through '07 and even '08, you're probably going to see the bulk of it is still coming from one demo to one sale. And predicting when we get a little bit of the leverage out of that is hard, but I do think 2 to 3 is probably more appropriate.

And lastly, I missed the very beginning, and I'm interested in how things are going with the laser scanner business. If you discussed it, I'll just listen again, but if you didn't, I'd like to hear.

Yes. I did talk about it specifically, Jeff. So all year I've said that I'm disappointed in just the ramp up of the laser scanners sales and we found a couple of things. Number one, I'll say that in the third quarter -- each quarter that's gone by we have sold more scanners than we did in the previous quarter, which is a good thing. But it's still not at the level that I would see it at. And we've talked about that as a team multiple times now and it is part of our focus for the strategic planning meeting as we come up here in November.

We have seen that, clearly, each of the different verticals are different in the laser scanner market and so you need specific modeling software, and I think we talked last call about the modeling software that we put into place with some of our third-party software providers was specifically to address that issue. And I'm also seeing that we really are at a phase now where the sales team needs to be a little bit more focused on one or two verticals that match, or most appropriately, match the region or territory that we're in. And we're spending more time there and that seems to be yielding and generating slightly better results at this point.

I do believe that by the end of this year we will have -- we will start seeing the traction that I was expecting and so '07 would probably look more like I was hoping '06 would look at this point. And we're also seeing that, look, this market is, of all of the products, the Arm is the farthest across the chasm at this point, followed by the Tracker and the Gage, and then -- but the laser scanner really is still way into the early adopter phase at this point. We are nowhere close to crossing the chasm with it. So we are still doing a significant amount of market education on just how to use the tool, how it's different from the tools that are out there, how it's different from the fact that there are no tools out there in some cases for how to do this. And so I'm trying my best to be -- to balance the patience that's required there with the anxiety of wanting to sell more and more of them, given how much opportunity I can see in the marketplace. It's just a matter of developing that.

So you are still confident in the long-term opportunity?

I'm still very confident in the long-term opportunity for that product. The product itself is extraordinarily stable, works extremely well. The research and development team over in Germany has already introduced one new product this year and is continuing down the path of our -- the next generation for 2007. And when I look at just the number of applications that you can apply it to, that part in particularly, I remain extraordinarily excited by.

Liam Burke, Ferris, Baker Watts

Keith, you generated $2.7 million in cash from operating activities, but the inventories were down from beginning of the year. Is that a timing issue or --?

I think the inventories are down primarily related to the raw materials and the work in process inventories. That's part of a conscious effort for our production and planning group to continue to get those down.

It appears that we have no further questions at this time and I would like to turn the program back over to Mr. Freeland.

Okay. Well, again, number one, I want to thank all of the team around the world for just an outstanding quarter. I think the results certainly speak for themselves and I do expect to continue seeing this type of improvement over the coming quarters. And I thank everybody for your time today. Have, for those in the U.S., an enjoyable Halloween, and we'll talk to everybody after the year-end. Thanks very much.

This concludes today's teleconference. At this time, you may disconnect. Thank you and have a great day.