FARO Technologies Inc (FARO) 2007 Q1 法說會逐字稿

Good morning, everyone, and welcome to the FARO Technologies conference call in conjunction with its first-quarter 2007 earnings release. For opening remarks and introductions I will now turn the call over to Mr. Vic Allgeier. Go ahead, please.

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 first-quarter results. By now you should have received a copy of the press release. If you have not received a release, please call Darrin Sahler at 407-333-9911.

Representing the Company today are Jay Freeland, President and Chief Executive Officer, and Keith Bair, Senior Vice President and Chief Financial Officer. Keith and Jay will deliver 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, we target, our growth targets, our goals, our guidance, 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 Keith.

Thank you, Vic, and good morning, everyone. Sales in the first quarter of 2007 were $40.3 million, a 25.5% increase from $32.1 million in the first quarter of 2006. On a regional basis, first-quarter sales in 2007 in the Americas grew 48.8% to $19.2 million compared to $12.9 million in the first quarter of 2006. Sales grew 20% in Europe to $15 million from $12.5 million in the first quarter of 2006. Sales in the Asia-Pacific region declined 9% to $6.1 million from $6.7 million in 2006.

New orders grew 15.4% in the first quarter of 2007 to approximately $38.2 million compared to approximately $33.1 million in the first quarter of 2006. On a regional basis, first-quarter orders in 2007 in the Americas grew 25.5% to $17.2 million compared to $13.7 million in the first quarter of 2006. Orders increased 14.3% in Europe to $15.2 million from $13.3 million in the first quarter of 2006. Orders in the Asia-Pacific region declined 4.9% to $5.8 million compared to $6.1 million in the year-ago quarter.

The top five customers by sales volume in the first quarter of 2007 were Sumisho Computer System Corporation, Boeing, Atomic Energy of Canada Limited, Tiger Technologies, and [Northwest Laser Tracker]. The top 10 customers in the first quarter of 2007 represented only 6.8% of our sales, once again indicating our lack of dependence on any one or handful of customers.

Our growth margin was 59.2% in the first quarter of 2007 compared to 58.8% in the year-ago quarter. This increase was due to changes in the sales mix, resulting in increasing unit sales of product lines with a lower than average cost of sales. The gross margin was within our previously issued guidance of 57% to 59%.

Selling expenses were 30.5% of sales in the first quarter of 2007, down from 32% in the year-ago quarter primarily as a result of improved sales force productivity.

Administrative expenses in the first quarter of 2007 were 12.5% of sales compared to 17.6% in the first quarter of 2006. This decrease was due to a reduction in professional fees related to the FCPA matter and patent litigation to $600,000 in the first quarter of 2007 from $1.6 million in the first quarter of 2006.

Our operating margin was 8.6% or $3.4 million in the first quarter of 2007 compared to 1.2% or $73,000 in the year-ago quarter. This increase is primarily due to the previously-mentioned increase in sales and gross profits, and lower operating expenses as a percentage of sales.

Net income was $3.2 million or $0.22 per share in the first quarter of 2007 compared to $500,000 or $0.03 per share in the first quarter of 2006, marking our 19th consecutive profitable quarter.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $33.1 million at March 31, 2007, compared to $31.5 million at December 31, 2006. Accounts receivable was $40 million at March 31, 2007, compared to $42.7 million at December 31, 2006.

Days sales outstanding at March 31, 2007, decreased to 91 days from 102 days at December 31, 2006. Inventories were $29.7 million at March 31, 2007, compared to $30.7 million at December 31, 2006. The decline in inventories was primarily due to a reduction in raw materials and finished goods, offset by an increase in service inventories.

Finally I will conclude with some statistics regarding our headcount numbers. We had 692 employees at March 31, 2007, compared to 641 at December 31, 2006, an increase of 51 or 8%. Account manager headcount at March 31, 2007, was 130, with 41 account managers in the Americas; 53 account managers in Europe; and 36 account managers in Asia. Geographically we now have 312 employees in the Americas; 247 employees in Europe; and 133 employees in the Asia-Pacific region. I will now hand the call over to Jay.

Thanks, Keith. Overall our first-quarter results demonstrate the continued improvements in our operating model that we have been executing towards over the last five quarters. Not surprisingly, growth in new orders in the first quarter at 15% was impacted by the strength of our 44% new orders growth in the fourth quarter of 2006 and by the timing of purchase decisions by some of our customers, particularly in Europe. However, we continue to see good demand in all of our market segments and regions.

The moderate growth in new orders in the first quarter does not represent a change in long-term potential, but rather reflects normal quarter-to-quarter fluctuations. Overall visibility from both active quotes and brand-new leads remains in line with our internal requirements for meeting full-year top-line targets.

First-quarter 2007 sales growth of nearly 26% was above our forecast range of 20% to 25%; again driven by the strong fourth-quarter orders I just referenced, as well as by continued demand around the world. Sales growth in the first quarter was particularly strong in the Americas, and Europe remained solid as well.

The sales decline in Asia was driven primarily by our decision to close the Korean sales office at the beginning of the second quarter of 2006. As such the first-quarter comparisons are not quite apples-to-apples. Despite the modest decline Asia experienced in this past quarter, their run rate met our internal targets and remains on track for solid growth for the full year.

Sales to new customers in the first quarter were 50% of revenue, in line with my ongoing goal of maintaining a 50-50 split between new and existing. This remains an important factor in gauging adoption of our products. It demonstrates continued acceptance of our technology as a global standard and, ultimately, will open the door for even deeper penetration within our existing accounts.

On previous calls I have talked a lot about the Laser Scanner LS and shared my disappointment in the speed with which we were penetrating this new and evolving market. I'm pleased to say that in the first quarter of this year the LS started generating the volume momentum I have been looking for over the last 18 months.

Don't get me wrong; we are still in the early-adopter market with this product and will be for some time. However, unit-by-unit sales volume from the Laser Scanner each quarter has actually mirrored quite closely the unit-by-unit ramp-up we experienced with the Laser Tracker when it was at the same stage of the early-adopter market back in 2002. Lots of work remains, but there were clear steps in the right direction in the first quarter of 2007.

Obviously one of the big events from the first quarter was the settlement of our patent suit. Resolving this issue was a favorable step for both parties, and it allows FARO to do what we do best -- that is, competing in the marketplace.

As previously disclosed in our press release and its associated 8-K filing, the settlement dismisses all outstanding disputes with no money changing hands. Neither party has admitted any wrongdoing or liability to the other. By resolving the suit we eliminate the incremental cash drain tied to the trial, its motions, and its associated follow-ups. As a Company we will always incur ongoing legal expenses for normal patent and IP protection. But those expenses should be more in line with our pre-patent suit run rates.

With respect to the Company's ongoing investigation and potential violations of the US Foreign Corrupt Practices Act, we continue to cooperate with the Department of Justice and the Securities and Exchange Commission. However, there is still no way to predict or anticipate the final outcome at this time. As such, I will remind everyone that we do not have a reserve established for any financial impact that a final resolution may create.

The Power of One initiative we launched in 2006 continues to drive cultural change across the Company. First-quarter participation rates were approximately 15% and were in line with our internal target. Approximately $1.5 million in cost savings and cost redeployments were achieved, and the pipeline of active projects remains full. Projects completed during the first quarter ranged in size from $2,000 up to $175,000. We continue to see creative ideas coming from all departments and all regions.

In total our $0.22 earnings per share is a good reflection of the performance we can deliver as we reduce the cost impacts of unusual items like the patent suits and the FCPA investigation. There is still room for additional operating leverage, particularly in sales and marketing, as well as administration.

We will continue executing our productivity programs to maximize that leverage. But as always, we won't make short-term decisions to the detriment of long-term needs.

Based on our performance in the first quarter and an assessment of the market in total, we are maintaining our top-line guidance for 2007 of 20% to 25% sales growth, and gross margin guidance of 57% to 59% of sales. We intend to continue updating our progress toward those goals at the end of each quarter.

Finally I would like to thank and congratulate our employees on their outstanding performance in the first quarter. And I'd like to thank our investors for their continued support. As always, the FARO team maintains a passion for success that shows through every day. Thank you for your attention, and I will now open the call to questions.

(OPERATOR INSTRUCTIONS) Mark Jordan with A.G. Edwards.

Good morning, gentlemen. Jay, could you talk about the relative productivity of your sales force by region? Try to contrast them and quantify where they are today and what type of increase in productivity could you shoot for over a 12- to 18-month time frame?

In total, what I will say about the productivity is that the Americas and Europe are still relatively similar. Productivity in Asia is a little bit lower.

The main driver for that is we historically have seen a fairly finite split between performance of somebody who has been on board for less than 12 months and somebody who has been on board for more than 12 months. Not surprisingly, the team in Asia has a larger proportion of folks still who have been on board less than 12 months. So as a result their productivity in total is going to be behind both the Americas and Europe for some period of time to come.

We do anticipate productivity from all the regions, though we have not ever stated what the productivity goal is for account managers. But I can tell you that every year, when the budgets get set for each account manager, there is a productivity assumption and there is a growth assumption that is tacked on to each of their budgets.

Obviously that gets reflected if you know that somebody had a larger order or a large amount of transaction volume from a single account that may not repeat the following year, we do adjust for that. But generally speaking each person is going to pick up a piece of, if not all of, that 20% to 25% growth expectation on their individual budget going into the next year.

Certainly the folks who have been around longer than a year have that expectation. The ones who have been around less than a year would have a slightly lower increase to their target budget. But generally speaking that is what we expect as each year goes by.

You added 8% to the headcount in the quarter. Could you talk about what your headcount addition plans are for the year; and how that mix or how that some 51 individuals were spread, in terms of what segments of the Company?

I will talk in general for a moment, and I will let Keith talk about any of the specifics that we can disclose. Generally speaking we had said at the start of the year that we anticipated anywhere from probably an 8% to 10% headcount increase in total for the year. Obviously we wanted to get some of that accelerated, and we've done so in the first quarter here, having risen 8% right out of the gate.

I do anticipate that we are still in that 8% to 10% range, because you get normalized turnover. It may lean towards the 10% side, because we have done a couple of additional -- made a couple of additional hiring targets, particularly in Asia, for some areas where we think they strategically make sense for us to do so.

But in total we still feel that the headcount growth for the year will be in that 8% to 10% range, albeit probably at the high end of the 8% to 10% range. Keith, maybe you want to give a couple of generalizations about the splits in the layouts?

Well, within each region I can tell you that the US, just specific headcounts, within the US we've added 17 since December 31, the last time we disclosed our total employees by region. In Europe we've added 28; and Asia-Pacific we've added six. Primarily these have come in in the production, or sales, and our R&D departments.

A final series of questions relative to the Foreign Corrupt Practices Act. Obviously the significant investigation work is over with. I assume there is some ongoing response to the government that is occurring. What is the current run rate in terms of cost of the FCPA action?

From a historical standpoint are there any benchmarks as to what might be a range of settlement costs, from zero to what number, to clean this up?

I will let Keith talk to the cost piece.

I can tell you in the first quarter of '06 we spent $1 million on the FCPA investigation. In the first quarter of '07 we spent $100,000. I think we are subject to the speed with which the DoJ and the SEC consider this a priority or has the appropriate resources to continue to move forward with it. But we are really dependent upon those folks in order to determine our run rate for legal costs.

In total we believe it could be anywhere from $300,000 to $500,000 for the year. Again that is normal, just the back and forth dialog that occurs, without knowing how long it will take during the course of the year.

Unfortunately there is no great set of reference cases we can turn to, to say that this is a predictable or typical settlement coming out of one of these cases. They've all been fairly unique. Quite frankly that is one of the primary reasons that we have not been able to figure out a reserve amount to put up, because there has just been no standard math or standard precedent for how you would calculate that coming through one of these investigations.

Okay, but you expect -- you would think it's reasonable to assume that resolution will occur this year?

I certainly hope that resolution will occur this year. It certainly feels like there is momentum moving in that direction. But I certainly could not state that it is reasonable to assume that. It is certainly what we are hoping for.

Thanks a lot, Jay.

Thanks, Mark.

Rob Mason, R.W. Baird.

Jay, I was wanting to know if you could provide a little more color on your comment regarding the order growth in Europe. Just Europe, just the timing in orders. What might have influenced that? I assume it to mean customers maybe pushed orders forward or pushed orders out.

Yes, we certainly felt a little bit of that. The piece you always spot-check on that is -- are they delaying them indefinitely? Are they killing them? Or is it simply part of the normalized cap goods spending process, where they used the money on something different because they have a different need in the first quarter, and it delays it for a month or a month and a half or two months.

Certainly we believe it is the latter, that the customers --. The feedback we have from the sales team and as they've gone through it with their customers is that these are not delayed indefinitely. These are not deals dying. That it is simply the push for another couple of months because of changes in demands during the first quarter on the business of the customer itself.

Does your industry mix, in-customer industry mix, vary dramatically between the Americas and Europe?

No, it is actually fairly similar. It is fairly similar around the world. Most similarly matched between the Americans and Europe, when you think about the auto industry and the aerospace industry, and how much activity there is in both of those regions in general.

Then obviously we have historically had a significant amount of our sales come from those two industries, and still do today, both to the large players as well the whole supply chain feeding them. So generally speaking they are pretty similar.

Okay. Could you provide us some color as well on gross margin? You mentioned mix was favorable for you in the quarter. How sustainable do you think that is given the trends that you are seeing, mainly I guess in the Americas and Europe right now?

Yes, I think from a sustainability standpoint, certainly I think it is accurate to believe that you will see some quarterly fluctuations on the gross margin throughout 2007. But we certainly believe that we are still in that 57% to 59% range at the end of the year. I do recognize that still is a fairly broad range. 2 points on that sales volume for this year is a sizable range.

So will it always sit above 59% for the rest of the year? Probably not. I think you will see it will tick down a little, tick back up a little bit.

Generally speaking, we also though are still moving toward that 60% to 65% target by '09 that we've talked about before. And still believe that is achievable based on the cost productivity programs that both the engineering team as well as the manufacturing teams are working on. As well as where we see price in the market price at the moment.

Then finally I will just state that in total the rank order of gross margin contribution -- we don't disclose dollars, obviously, by product line -- but it still remains Arm, Laser Tracker, Gage, Laser Scanner, in that order. Obviously we will continue to modify and update that as time goes by if any of that shifts.

Okay. Then just lastly on the Laser Scanner, where you are seeing some better traction. Is this along the industrial customers that you are targeting? Or is it outside the industrial area? Then if you have just broadly an ASP for that product currently.

Yes, it's a little of both. The ASP is still running about $85,000. The A part obviously I still struggle with a little, given the current volume; to say it is an average is probably not 100% accurate. But we had enough volume in the first quarter that it certainly starts feeling like it is more predictable than what you had in the past.

Split-wise it is actually probably 50-50 between industrial and nonindustrial. We've had some nice success in the heritage markets. Italy last year we had nice success there, and we are seeing some continued success in those types of markets here in the first quarter as well. I anticipate that that probably will be the same for a while, given that the tool is applicable to both industrial and nonindustrial applications.

Thanks.

(OPERATOR INSTRUCTIONS) [Jeff Bass], a private investor.

Good morning, Jay. A lot of companies in their reports are talking about strong overseas results due to the low dollar. To what extent does having substantial overseas operations physically dilute this effect for FARO?

Actually we certainly get some benefit of the weaker dollar right now; and I will let Keith talk to the specifics on that. But given the manufacturing structure both in Switzerland and in Asia right now, and as the dollar continues to weaken, we do get some benefit from that. I will let Keith talk about the actual numbers.

Right. We received roughly a $1.3 million benefit in top-line growth as a result of the weaker dollar Q1 '06 versus Q1 '07.

Okay. Do you see any favorable trends in the number of sales per demonstrations, to sort of suggest maybe the hockey-stick is approaching, or not?

I know we are always trying to predict the hockey-stick. In total, we continue -- from a close rate standpoint we are still running about 30% to 40% close rate, depending on the region and the person and the product. In some cases how long they've been on board obviously too can drive that. I've not seen necessarily a discernible change there.

The math of the number of leads it takes to generate the right number of demos; and the number of demos the typical account manager can do in a month; and then knowing that 30% to 40% closure rate has been fairly consistent for quite some time now and hasn't necessarily changed any, either. Which is also a good thing because it does help our predictability when we look further out and further downstream.

Knowing that we never have more than, say, 90 days worth of hard deals in the pipe at any given time, the ability to monitor the lead side of the equation, and knowing that gets you additional visibility outside of that first 90-day window, and knowing it has been fairly predictable is helpful.

Next, is infinite rotation back in the product line now or not?

It is.

Finally, Immersion is a tiny competitor with a relatively small sales and an infrastructure, so it is not really a meaningful competitor. But they've recently introduced a new CMM product. I'm curious. Two things.

Number one, is the feature set competitive? Number two, do you have a practice of reviewing the feature set of competitor offerings for possible patent infringement, other than what you obviously did last year for Hexagon?

Sure. We are familiar with the new arm that they just introduced. We had seen a spec for it very recently. Actually Tuesday of this week when they launched it at the tradeshow, we did have a chance to take a look at it there also. So we do have a process for looking at that.

Based on what we've seen so far it is our belief that this is a private-labeled arm from a small manufacturer in Europe. What it does is gives Immersion the right to distribute it probably.

It is also our understanding that they are going to use the existing distribution channel, which is the same one they use for their small desktop MicroScribe arm right now.

Then obviously we are going to examining all aspects of the product now that we've seen the spec sheet, and we've had a chance to look at it at the show, and determine if there is any appropriate action we should take relative to patents. I'm not ready to speak specifically to that yet, of where we stand on that.

Okay, thanks a lot.

Graeme Rein, Bares Capital Management.

Two questions for you. One, can you speak to the competitive environment for the Gage. Are you seeing anyone coming into that markets?

Then secondly, can you talk about any capacity constraints you might have in terms of -- I don't know if you can put a dollar figure on the amount of revenue you currently crank out, or kind of your plans for ramping up that side of the business? Thanks a lot.

Yes. On the Gage the answer is no. Certainly that is one of the beauties of the Gage product. Now obviously we do have a competing product out there, which are all the hand tools around the world. But from a new technology, advanced technology like the Gage represents, we have not seen any out there to date, which is obviously a good thing.

When it comes to capacity, global capacity for the Company, we still have plenty of room to go. I've stated before that we at least have a couple more years worth of capacity. That is kind of a generalized statement and here is why.

Number one is you just take basic things like we still only run single shift in all of our facilities. I don't love second shift, but if you had to you could easily run second shift, no problem, and double your capacity or more.

The other nice thing about the way the product works is we are in fact primarily a final assembly shop. We do very little manufacturing. We certainly don't do any heavy manufacturing. So the ability to expand in many respects as only tied to the number of trained people you have and the amount of space you have available to you to add more assembly stations, which are fairly simple workstations that the people sit at and put the product together. Albeit the assembly process itself is complex, which is why you want the trained assemblers to do that.

But it is very easy to continue to expand as you need to in very short order utilizing existing space that you already have, and even picking up new space. There are very few physical requirements on the space that make it difficult to find new buildings or additional locations that you might need to go to.

Thanks a lot.

Michael McCormick, GGH.

I was wondering if you could speak to the sales force in Europe. If I recall I think you've had some personnel changes there. The productivity of the sales force is significantly less, as I calculate it, than the United States. Maybe kind of goals and targets you might be putting in place for that.

Generally speaking, obviously, again we did some additional staffing of the sales force in Europe last year. So they do have some newer folks onboard; ratio-wise it's not entirely different from the US. But they do have a slightly larger population of newer account managers.

The targets but we set out to people though, from the standpoint of those who have been around more than a year, are very similar to the targets that we set out for account managers in the Americas as well, given those are the two regions to compare to.

So when you look at, again -- and productivity obviously tends to swing quarter to quarter as well, when you look at what the output is. So obviously Europe was slower in the first quarter than what they will do in the second quarter. Certainly slower than what they had originally planned for, and that is just part of that quarterly fluctuation in the cap goods purchasing process.

Okay. So you are comfortable with the productivity in Europe?

I am never comfortable with the productivity across the board. You always want the team to be able to do more. Because in many, respects, obviously the more sales that each individual account manager can generate is another identifying factor of the overall market acceptance of the product and the ease with which you are able to sell it.

Obviously it is still a very missionary sale, and we are continuously looking for -- when is that point in time when it becomes less missionary and more automatic? So you want to see continued productivity, so you are never satisfied there. But I think that where they are at, at the moment, is appropriate given what I see path-wise for the rest of the year.

Okay. And congrats on your working capital efficiency.

Thank you.

John Emrich with Ironworks Capital.

Thanks. Can you talk a little bit about the tax rate beyond this year? I won't hold you to it; but just general guidance. I know you had some positive developments in a couple of, one or two foreign markets. I am just wondering how sustainable this is; or should I assume you will kind of step up 500 basis points a year for the next couple years from this level?

As you know we have a tax holiday in Switzerland with a reduced rate roughly anywhere -- it varies from year-to-year -- anywhere from 5% to 8%. In Singapore we have a 0% tax holiday for the next four years, increasing to 10% for the next three or four years after that. Again that is also subject to renegotiation after four years.

Going forward then, you have to make certain assumptions with regards to your profitability mix by region of the world and by country. Based upon what we see things right now, at least going out as far as 2009, we expect to be in the 20% range.

Oh, gosh. Okay. I was way higher than that. Thank you very much.

John, to follow up on that too, we have historically stated that modeling-wise anywhere from 20% to 25% was probably appropriate. We do believe that the ability to hang near the 20% mark is achievable.

Yes, my 30% in 2009 makes no sense.

I hope so.

Great, thank you.

(OPERATOR INSTRUCTIONS) Jed Dorsheimer, Canaccord Adams.

Thanks and congratulations on another fine quarter, Jay. Most of them have been asked already, just one last question. As we look at -- I mean, you've clearly been able to outgrow the markets in which you serve over the past year or so here. I'm curious how much do you attribute to sort of the internal upgrades that you made with respect to the sales force additions?

What do you think some of the end markets, since they are so fragmented, what type of growth rate do you see from an end-market perspective?

Yes, well, I won't talk about the end markets in particular just because we haven't really disclosed anything like that before. Here is how I look at the market growth, though. The 20% to 25% that we are forecasting -- and obviously when you look at the 26%, 25.5% we did here in the first quarter, I actually view that as we are pacing the market. And here is why.

Because I feel like the market growth in total, if you include traditional CMMs and hand tools and things like that, obviously it is far lower. I'm not necessarily playing directly in that game, even though I am in fact, with the Gage at least you are trying to replace the hand tools around the world.

We still view it as we are creating the market every day. Because a large number of the sales that we get, the customers are buying the product and using it in an application that they never used before. So form my perspective we are creating the market. And from that standpoint, saying that we are just keeping pace with the market is probably more appropriate.

I think it is the right way for our team to look at it, too, because it is a view of -- we are very underpenetrated. Sky is the limit, quote unquote. For lack of a better word, it is how you want the team to continue thinking about the opportunity out there. And our team does think about it in that fashion.

So I tend to look at it from that perspective versus looking at it as, hey, are we really outpacing overall growth if you include all different types of measurement devices and what that market looks like in total?

Great, that is helpful. Thank you.

There are no further questions in the queue, so I will turn it back over to you, Mr. Freeland.

Very good. As always, like to thank everybody for their participation today. I look forward to talking to you again and updating you at the end of the second quarter. Thanks, everybody.

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