FARO Technologies Inc (FARO) 2007 Q3 法說會逐字稿

Good morning, everyone. And welcome to the FARO Technologies Conference Call -- in conjunction with the 3rd Quarter 2007 Earnings Release.

For opening remarks and introductions, I'll now turn the call over to Vic Allgeier. Please go ahead.

Thank you, and good morning, everyone. My name is Vic Allgeier of the TTC Group -- FARO's investor relations firm.

Yesterday after the market closed, FARO released its 3rd quarter results. By now, you should've received a copy of the press release. If you have not received a release, please call Daryn Sailor 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'll now turn the call over to Keith.

Thank you, Vic. And good morning, everyone.

Sales in the 3rd quarter of 2007 were 44.5 million -- a 16% increase from 38.4 million in the 3rd quarter of 2006.

On a regional basis, 3rd quarter sales in 2007 in the Americas grew 21.4% -- to 19.1 million, compared to 15.7 million in the 3rd quarter of 2006.

Sales grew 13.7% in Europe, to 16.9 million -- from 14.9 million in the 3rd quarter of 2006. Sales in the Asia-Pacific region increased 9.7% -- to 8.5 million -- from 7.8 million in 2006.

New orders grew 13.2% in the 3rd quarter of 2007, to approximately 43.8 million -- compared to approximately 38.7 million in the 3rd quarter of 2006.

On a regional basis, 3rd-quarter orders in 2007 in the Americas grew 30.3% -- to 20.2 million -- compared to 15.5 million in the 3rd quarter of 2006. Orders increased 9.5% in Europe, to 16.1 million -- from 14.7 million in the 3rd quarter of 2006.

Orders in the Asia-Pacific region decreased 11.8% -- to 7.5 million -- compared to 8.5 million in the year-ago quarter.

The top 5 customers by sales volume in the 3rd quarter of 2007 were Boeing, the US Military, Caterpillar, General Motors and SNC Lavaland Nuclear, Inc.

The top 10 customers in the 3rd quarter of 2007 represented 11.9% of our sales, and 5.6% of our sales on a year-to-date basis. Once again, indicating our lack of dependence on any one or a handful of customers.

Our gross margin was 59.4% in the 3rd quarter of 2007, compared to 58% in the year-ago quarter. The increase was due to an increase in unit sales and product lines with lower unit costs than in the prior-year period -- as a result of continuing productivity improvement.

Selling expenses were 30.6% of sales in the 3rd quarter of 2007, compared to 27.6% in the year-ago quarter -- due to increased compensation and marketing and advertising costs.

Administrative expenses in the 3rd quarter of 2007 were 17.9% of sales, compared to 14.4% in the 3rd quarter of 2006. Administrative expenses included a $2.65 million charge for estimated fines and penalties with respect to the FCPA matter -- and 400,000 of professional fees related to the Company's FCPA matter.

The 3rd quarter of 2006 also included $1 million of professional fees related to the FCPA matter and patent litigation costs.

Our operating margin was 2.2% -- or 1 million -- in the 3rd quarter of 2007, compared to 8.9% -- or 3.4 million -- in the year-ago quarter. This decrease is primarily due to the previously mentioned increase in operating expenses as a percentage of sales.

Our effective income tax rate for the quarter was 69.5%, as a result of an increase in non-deductible expenses for US income-tax purposes related to the FCPA matter -- compared to 13.9% in the 3rd quarter of 2006.

The Company's effective income tax rate, excluding the effects of the $2.65 million charge related to the FCPA matter would've been 19.9% for the 3rd quarter of 2007.

Net income was $700,000 -- or $0.04 per share -- in the 3rd quarter of 2007, compared to 3.2 million -- or $0.22 per share -- in the 3rd quarter of 2006. Marking our 21st consecutive profitable quarter.

Excluding the $2.65 million charge related to the FCPA matter, and the $600,000 of related tax effects, net income would've been 4 million -- or $0.25 per diluted share.

Additional information regarding our 3rd-quarter net income and tax rate -- excluding the effects of the $2.65 million charge related to the FCPA matter -- is contained in our 3rd-quarter 2007 earnings release, a copy of which is available on our website.

I will now briefly discuss a few balance sheet and cash flow items.

Cash and short-term investments were 98.2 million at September 29th 2007 -- compared to 31.5 million at December 31st 2006. This increase was primarily the result of net cash proceeds of 53 million, related to the Company's registered direct offering on August 14th 2007.

Accounts receivable were 44.6 million at September 29th 2007 -- compared to 42.7 million at December 31st 2006.

Days Sales Outstanding at September 29th 2007 decreased to 90 days, from 102 days at December 31st 2006.

Inventories increased by 20.1% -- or 6.2 million -- at September 29th 2007, to 36.9 million compared to 30.7 million at December 31st 2006. This increase in inventories was primarily related to an increase in finished goods and demonstration inventory.

Finally, I'll conclude with some statistics regarding our headcount numbers.

We had 745 employees at September 29th 2007, compared to 641 at December 31st 2006 -- an increase of 104, or 16.2%. Account manager headcount at September 29th 2007 was 145, with 50 account managers in the Americas, 50 account managers in Europe, and 45 account managers in Asia.

Geographically, we now have 343 employees in the Americas, 246 employees in Europe, and 156 employees in the Asia-Pacific region.

I will now hand the call over to Jay.

Thanks, Keith.

I continue to be pleased by the performance of our team. Year-to-date, we're exactly where we want to be. We've grown the top-line over 22% -- well within the full-year guidance we've been providing since the start of the year.

Gross margin through 3 quarters is at 60% -- a full point above our previously-issued guidance range of 57 to 59%. And solid enough that we're raising our gross margin guidance to 58 to 60% for the year.

In total, the fundamentals of this business are firmly intact and have not changed. This is a growth company, with world class technology, selling into a highly under-penetrated and developing market space.

Orders and sales growth were solid in the 3rd quarter, with the Americas running particularly strong. Europe and Asia suffered some of the typical August slowdowns, but the 4th-quarter pipeline looks good for both of those regions, as it does for the Americas, as well.

We're also going into the 4th quarter with a $10.5 million backlog -- a bit higher than we typically enter a quarter with. Historically, the 4th quarter of each year has always been our strongest, by far. And we see no indication otherwise for the 4th quarter of this year. The combination of these facts keeps me confident that our 20 to 25% sales growth guidance for the year remains achievable.

Sales to new customers were 49% in the 3rd quarter, and 50% year-to-date -- inline with our ongoing goal of maintaining a 50/50 balance between new and existing customers. As we've previously discussed, this is an important measure of our ongoing penetration around the world -- balancing widespread adoption of the technology, with deep penetration of our existing users.

Finally, market demand remains very strong. We're always going to see some minor fluctuations from one quarter to the next, when it comes to our sales volume. The most important sales measure for us is consistent year-over-year growth, which comes from addressing the continued untapped potential in this market.

Our 60.1% gross margin performance year-to-date is a continued reflection of the ongoing benefits of our productivity programs. Particularly material cost productivity. It is also driven by slight variations in the sales mix, quarter-to-quarter.

As stated previously, we are increasing our gross margin guidance for the year, and remain confident that the steps we've taken in 2007 provide the foundation for ongoing gross margin improvements.

Obviously, there was a substantial non-recurring item in our administrative expenses, this quarter. For the last 18 months, I've been cautioning that a fine by the DOJ and/or the SEC as a result of the FCPA investigation was a distinct possibility. I've always been very open about the fact that the total dollar amount was unpredictable.

No one looks forward to the prospect of incurring a significant expense, and feeling the associated cash impact to the Company. That certainly is the case with respect to the expense hit caused by our $2.65 million accrual for the estimated fines and penalties from the FCPA matter.

However, on the positive side, our discussions with the DOJ and SEC have indicated that no criminal action will be taken against the Company. And these fines -- once finalized -- also put a box around the investigative portion of this matter.

As indicated in the earnings release -- we're anticipating that we'll be required to engage a monitor for the next 2 years, to ensure our ongoing compliance in this matter. Our preliminary estimate is that we expect to incur approximately $1 to 2 million of expenses associated with the monitor during that time period. Depending on the scope of work, which has not yet been determined.

The reality for our Company, though, in complying with these requirements is also part of our standard operating procedure -- and the processes the monitor will be tracking are processes we would have been following regardless of his or her presence.

On the R&D front, I'm extremely excited by our recent launch of the Quantum FARO Arm and the Fusion FARO Arm. The technology advancements we achieved with the Quantum are significant, and represent a one-of-a-kind product in the marketplace. It is geared toward the highest-end applications, with the ultimate needs in accuracy and performance.

The Fusion FARO Arm targets a completely different application need. While using several of the technology advancements we achieved in the Quantum Arm, the Fusion Arm targets applications with less-stringent accuracy demands.

Initial orders for both products indicate a sign of good things to come. I've never been more excited about the R&D pipeline within the Company, and the 2 products we just released are only the beginning. The next 24 months will bring a significant level of continued innovation from our Company.

Finally, as we look at our cash position, I want to highlight the strength of that nearly $100 million vehicle, in terms of how it positions us for the future.

The secondary offering contributed a significant source of new capital -- as has our year-to-date operating cash flow. New acquisitions and R&D programs, which provide an ongoing competitive edge -- as well as continued sales force expansion -- are all possible uses for this cash.

The markets we serve remain highly fertile ground, with significant opportunity. And as I've stated before, I still believe we've only scratched the surface.

As always, I'd like to thank our FARO team around the world, and our investors who support us and believe in and understand the long-term growth prospects of this Company.

I appreciate your attention. And I'll now open the call to questions.

Were you wanting to take questions at this time? If you'd like to ask a question, please press the * and 1 on your touchtone phone. You may withdraw your question at any time by pressing the # key.

Once again, if you'd like to ask a question, please press the * and 1 on your touchtone phone. And we'll pause a moment to allow any questions to enter the queue.

We'll take our first question from the site of Mark Jordan from AG Edwards. Please go ahead.

Thank you.

Jay, I'd like to talk a little bit more. I know you touched on it relative to the seasonality. Clearly, the sales -- if you're looking at it sequentially by region -- there was a significant decline in Europe from 19.1 to 16.9.

Is that truly -- in your mind -- just the normal seasonal patterns and influenced by the vacation schedules in Europe? Or is there a re-emergence of some productivity issue that you saw last year in the European market?

Yes. Mark, I've not seen any change in the demand over in Europe. When I talked through it with the sales leader and the managing director for Europe, the pipeline there remains full.

Obviously, the August effect definitely hit us during the 3rd quarter, here. But they are firmly confident. And when we look at the pipeline of the opportunities they're working on right now, we're very confident in their ability to return to the growth rate that you would've expected perhaps normally.

And year-to-date, where they stand -- relative to where they need to be for total year 2007 is similar to the Company, in total. It's in a very good position. It's where I'd expect to see it. So I don't see anything that would change them from having a successful finish to the year.

Could you also address the fundamentals of your Asia-Pacific sales force? Again, that went down pretty meaningfully sequentially. Is there a specific technical issue that caused that? Or is that just following to some extent a similar seasonal pattern as Europe?

Yes. You've got a little bit of seasonal pattern, for sure. They have a similar August effect. It's more prevalent now than I saw probably 10 years ago. It's not still as strong as the effect you get in Europe, in my opinion.

You still have a little bit of the fact that the sales force is relatively new in Asia. They are still coming up-to-speed on the products in the marketplace, over there. That's something we've talked before, about.

If a typical account manager in Europe or the Americas takes 12 months to really become effective, it's 18 months over in Asia. So you have a little bit of that there, too.

The Asia position is similar to what we see in Europe right now, though. The pipeline of the opportunities that they're tracking right now is extremely strong. I don't anticipate and don't have any concerns for that region, either, relative to the year-end finish.

Looking at R&D -- obviously a significant spike up to a record level here in the 3rd quarter. You clearly had payback with the announcement and release of new product.

Where should R&D go in the 4th quarter, and into 2008, in terms of absolute dollars?

I'm not going to forecast based on absolute dollars. As you know, we don't do that.

We can always ask.

Of course.

You're absolutely correct that the Quantum and Fusion launches definitely increased the spend, there.

I talked before about how we've been in that 5% range. We've targeted 5 to 7% longer-term -- and if we saw significant opportunity in any one of our product, we'd hit the gas pedal a little bit. And we did hit it a little bit to get the Quantum and the FARO out at the time that we got them out there.

I think that that 5 to 7% range is still appropriate through 2009. That is part of that 2009 model that we've discussed openly before. Could it end up being a little bit on the higher end of that number? It could be.

Obviously, we've got the benefit of a lot of cash on the balance sheet. You've got some interest income being thrown off right now that you could utilize for some of those growth purposes. But again, I don't spend unless I feel like we've got good reason to spend.

As I've indicated, we do have a very exciting R&D pipeline here over the next 24 months. To say it would sit right back at 5 or even sub-5 is probably not 100% accurate, either.

Could you talk about the Arm business, with the introduction of the Quantum and the Fusion? What does this do, in terms of the ASPs for those 2 products? You've always characterized that group as about 45,000 ASPs.

Then secondly, characterize how you stack up with those new products vis--vis your primary competitor.

What you really end up with after the release of the products here are 3 core fundamental Arm products. I'm excluding the Gage for the moment, because that is obviously a little bit of a different product.

Average selling price of the Fusion will be a little bit lower than our average selling price for the Arms in general. That 45,000, Mark, that you mentioned. The average selling price for a Quantum is substantially higher.

The biggest differential -- without getting overly technical -- is that Fusion has accuracy in the 43-micron range. The existing platinum one that we have out there has accuracy in the 25-micron range. And the Quantum -- which is standalone in the marketplace now for a portable product -- the stated accuracy there is in the 17-micron range. That is a significant differentiator that is unique to the marketplace today.

So you've got one product which is about 50% lower accuracy. Almost 100% lower accuracy than the mid-range product. Then you've got the to-end Arm product which is another 30% better accuracy, there.

So we have a real nice spread, which ensures you're not cannibalizing application to application. So Fusion Arms are not going to eat into Platinum.

And the 30% difference between Platinum and the Quantum Arm is not going to cannibalize what would've normally been -- say -- a Platinum Arm. If it's higher-priced and it does cannibalize it a little bit, then that's not necessarily a bad thing.

So that's what you end up with when you look at the Arm portfolio, now. It's a very clear, distinct 3 positions there.

Could you characterize what would be a couple of applications that would be where someone would clearly be willing to pay for the increased accuracy of the Quantum?

Yes. What you have with the Quantum is, you truly have a product that is competitive with many of the stationary CMMs now. So applications which -- we certainly have -- I've always said that we believe there's always going to be a long-term market for the CMMs. Or stationary CMMs. We just don't believe it's a long-term growth market. Because there's so much better utilization of the product when you can do it on the floor.

The Quantum changes that quite a bit. So applications. And we've heard auto industry customers talk about it. We've hard some air customers talk about it already. Certainly the first orders were from folks that are needing that type of CMM accuracy, and wanted the ability to do it out on the floor, and had just been waiting it out.

I don't want to necessarily highlight any one specific application, because there are many. But I can tell you that there was a distinct differential between that 25-micron barrier that we were sitting at before and the flush up to the 17 that we're at now -- in terms of the number of opportunities it opens up.

A final question, if I may. Looking at the settlement cost -- does that reflect a surrendering or a disgorgement of the gross profit dollars of the tainted revenues? Or how was that calculated?

Yes. This will sound awful, Mark. It's very difficult to determine that. You've got 2 different components, there. You have a Department of Justice component to the fine, and you have an SEC component to the fine. I believe both have math that is logical for what they were trying to do. It is a little different between the 2 of them, also.

I suspect that probably some of it may be based on the disgorgement of some of the profits -- from a calculation perspective.

Based on the [inaudible] that we've had, and really it's been over the last couple of weeks that we've gotten into a serious discussion. That got us to the point now where we could actually book a reserve that was predictable, with a fair degree of accuracy. Over those last 2 weeks, that's how that has developed.

So I can't say definitively that it's just disgorgement or that it's just the revenue that was generated off of certain portion of the sales or anything of the like.

Thank you very much.

Thanks, Mark.

We'll take our next question from the site of Fred Russell from Fredric E Russell Investment Management. Please go ahead.

Good morning. I just want to tell you that we are not unhappy shareholders. We view today as an opportunity to significantly increase our position.

I'm pleased to hear that, Fred.

And we support the Company and the efforts. We understand the emotional but sometimes not the logical effects of a DOJ quote in a press release.

You say that the continued innovation is part of a very exciting pipeline. Does this suggest that the kinds of companies in the next 3 to 5 years that are buying FARO products will be smaller? That the markets will broaden significantly?

Or that in the well-penetrated areas that you're in -- automotive, Boeing, et cetera, et cetera -- there will be different types of applications?

Perhaps you can give us some details. It would be very interesting.

Yes. I think it is a combination of both of those. Generally speaking, let me say first that that 50/50 split we have between new customers and existing customers today I expect will continue for the next several years. It certainly will be a strategic focus for the next several years.

Because there is that much new, untapped market out there that we need to touch. And at the same time, of course, we want to continue helping our existing customers to improve their processes and give them technology they can really use.

The initial orders that we're seeing in the marketplace for -- say -- Quantum and Fusion came from existing customer. So you've got customers who are out there buying for applications they were waiting for the product for -- for lack of a better word. So I suspect you will see plenty of that.

And at the same time, we know there are customers out there who've held off in the past -- either because they didn't have the accuracy demand, which would open up the Fusion product line -- or they had a significant accuracy demand and just didn't believe that portable could get them to where they needed to be. Which obviously is a huge opportunity for Quantum.

The other thing I'll say is that when you look at the overall technology portfolio, obviously the next 24 months is not just going to be releases of incremental Arm products, by any stretch of the imagination. We've got Tracker and Laser Scanner and Gage out there, as well.

I do believe that the addressable market will continue to grow as we introduce new technology. Particularly in areas that are touched by the Laser Scanner product line. As we've talked before, that one's still way back in the early-adopter phase of the marketplace. All of our other products have crossed the chasm, and they're into that early majority and starting to generate that flow.

Laser Scanner is way back in the early-adopter phase. And one of the many characteristics of that phase is actually defining the markets that you're selling into.

I am confident and I am certain that the applications we sell the LS to today are only a fraction of the applications we could and should be selling the LS into in 5- or 10-years' time -- if you take the very, very broad view. And we do spend a lot of time looking at how we can redeploy that.

So you're going to get a combination of both of those effects.

That's good. Do you see any improvement or weakening in marketshare?

Tracking the marketshare has always been very difficult. Because neither we nor our competitor disclose the data. We do believe that we are at least maintaining our share on the Arms side of the business. And I'll be watching as closely as I can over the next couple of years with the release of Quantum, in particular. But Fusion, also -- to see if we feel like there's an increase coming.

We do believe we are still increasing our market share on the tracker side. And on the LS, I definitely believe we're increasing market share. Mostly because we're coming off of such a low position, and it's such a new market at that point. It's hard to believe we're not increasing market share at the same time that the market is growing, here.

And let me finish up with the Gage. The Gage is still a standalone product in the market space with no equivalent or competing technology. So obviously I feel like we're gaining share, there.

What would you say the size of the average business is that is a customer of FARO?

Well, generally speaking -- this is a huge generalization. But generally speaking, 25% of our customers are large Fortune 500 type of companies. 75% are smaller mid-tier second-level or even third-level tier companies that either sell into their own market space directly, or they're part of the supply chain feeding up to the larger end manufacturers.

And we've got customers as large as -- obviously -- Boeing, which we had a huge order from in the 3rd quarter. Down to we have individual one-man machine shops that buy Gages. Not just in the US. But we see it in Europe, we see it in Asia -- so we really have a pretty broad spectrum of who's picking the product up and using it.

Some of these have revenues less than $1 million.

Yes.

Okay. Any thoughts about a share repurchase activity after today's surprise?

We have always thought about share repurchase. I can't necessarily say it would be accelerated necessarily by what the market is doing today.

I never say "never," in either direction. I once said, "never," on a share repurchase about 3 years ago and got beat up incessantly for months after that.

I still feel that the cash that we've just brought in, in particular, from the secondary -- that there are better applications for the cash for the long-term growth potential of the Company, relative to new technologies that we're looking at on the acquisition screen, right now. The possibility of helping some of the R&D processes move even faster.

I think that we're still better served by that than repurchasing shares. Particularly so close to a secondary offering. Like I said -- never say, "never." But it hasn't necessarily changed my opinion one way or the other, either -- just based on today's movement.

All right. Fair enough. Thank you.

Thanks, Fred.

We'll take our next question from the site of Richard Eastman from Robert Baird. Please go ahead. Mr. Eastman, your line is open.

Could you give us the FX impact in the quarter on the sales line?

The FX impact on the sales line was a little over 3%.

Okay. And then Jay, do you think that there was any anticipation for introduction of the Fusion and Quantum product --whether it be in your sales force or by customer -- that potentially disrupted the order and shipment schedule in Q3?

I don't. Obviously, that's a concern that you always have when you're working something in the pipeline.

The Quantum Arm obviously was the first one to come. We kept that extraordinarily quiet internally. There were only a handful of people who knew about it. None of whom were field account managers.

And then I'll be the first to admit that they probably suspected we were working on something. Because it had been a while before we'd done a product release. But they had no idea what the order of magnitude could have been on the increase in accuracy and the change to the styling and the smart probe -- the intelligent probe -- the Bluetooth capability. All the things that we ended up putting in there. And certainly we had not given any heads up to our customer base about that.

So I don't suspect that would've had an impact to sales volume in the 3rd quarter. I really do believe we had a little bit of that August slowdown. We had a few things that may have moved from 3rd quarter to 4th quarter. Not enough that it would be substantial. It's the typical things that we do see occasionally.

Second quarter was very, very large. Because we had some stuff from first quarter push out into it. And we had some things from third quarter that got pulled into the second quarter. Which is why we did have a sizable 2Q growth, this year.

And when you look at it on the balance, that's why I'm still very, very comfortable at the 22% that we've achieved year-to-date.

Just out of curiosity, because our math is similar in terms of your backlog and carry-forward into Q4. But you ahead a pretty substantial backlog heading into Q3. Why did we not ship more of that? I'm just curious. Would it not have been your plan for sales growth in the 3rd quarter to be 20%?

Actually, what I'd say is that all of the backlog going into Q3 would've shipped. What you had going into Q4 is the combination of -- you've got a Boeing order in there, which had a combination of Q3 and Q4 shipment dates that were predefined by the customer. And you had in the 3rd month of the quarter, several orders. In some cases, a little more so than usual. Which is why the backlog's a little higher than usual. Where the customers defined delivery date was October or even November in some cases. But they wanted to place the order in the 3rd quarter, to go ahead and get the process moving.

So I can't say that there's Q2 backlog that we're still sitting on now going into Q4. All of that moved out. This would be new backlog that was generated during the orders process in Q3.

So the fact that the book-to-bill was below 1 in the quarter, and we need a $50 to 51 million minimum 4th quarter to get to your 20%-plus target -- that shouldn't concern us? We have backlog and we have an order number that was low. But you're feeling good about the very short-term pipeline of business?

I do. Obviously, and we've talked before. I know everybody looks at the book-to-bill. We look at it, but I don't use it as a significant gauge of what's coming. That's why I cautiously state that -- "Hey. The backlog is a little bit higher going into this quarter."

As you know, the most firm opportunities or view of our performance that we have is 90 days out. Because those are the hard customer opportunities. You've got the name of the customer identified. You have the application identified. You've either done the demo already or you have the demo set up, or you're close to having the demo set up.

That 90-day pipeline is always the best view we have of the company. And then you get another 90 days beyond that purely based on lead counts.

And so when I look at what's in the pipeline right now, we do feel very good about what that 4th quarter needs to be, and whether it can come from what's in the pipeline at the moment.

And can I ask -- in terms of the overall sales growth rate in the quarter at 16% -- when you look at your 2 main product lines -- the Arms and the Laser Tracker products -- how did those grow, relative to the 16%?

As you know, we don't disclose any of our revenue by product line. So I will not answer the question based on growth rates relative to the 16%. What I'd say is that we do have strong growth across the board. No question, there's some variation.

The one we have talked about before is that we know the growth rate on the Gage is very, very powerful, right now. Again, though, it's still coming off a lower installed base.

Growth rate on the LS looks great, because that's coming off an even lower installed base.

Arm and Tracker -- I'll answer it this way. I've not seen anything there from a growth rate perspective that would necessarily be a concern longer-term for the company. Maybe I'll put it that way.

And any difference in growth rates between the Arm and the tracker? I guess what I was getting at -- did it influence gross margin either way?

I mean, was there a mix towards Arms and more profitable?

Yes. I mean obviously, there's always a little bit of shift in the sales mix quarter-to-quarter. Gage, in particular. As we've talked before, the rank order of gross margin -- though we don't disclose the actual gross margin by product -- Gage is Number 3 on the list.

When you have a slight uptick in Gage orders and in our sales in an individual quarter, it may shift the mix one way or the other. We definitely had a little bit of that effect in the 3rd quarter. I can't say necessarily between Arm and Tracker, though, that it would've had a substantial effect.

Okay. And then just the last question, Jay.

We do talk about 3rd quarter results kind of hitting plan. But again, I'm stuck a little bit on the fact that your plan wouldn't have shown Americas up 30 and Asia down 12, in terms of orders.

And so, can you just walk me through that distribution a little bit? I mean that clearly would not, I would think, have been planned. But should that -- I guess -- alarm us. Especially the Asian number?

Yes. Certainly, we would not have had an internal plan that would've called for somebody going down in a quarter. No question about that.

The plan for the Company, of course, was 20 to 25. And that's what we look at. So obviously, the Americas contributed quite substantially to that in the 3rd quarter. We've had other regions contribute substantially to that in other quarters.

I've not seen anything out of Asia or Europe. I know people will ask about Europe and already have, obviously. I've not seen anything there that would be a concern.

One quarter in this Company doesn't make a change to the market space. Even a couple of quarters doesn't necessarily change the market space. We saw some of that last year with Asia, in particular.

It comes back up after some period of time. It's always these short-term effects.

I don't see anything there that's a concern long-term for the Company. I do suspect you'll see growth back there again in all 3 regions in the 4th quarter, and it will be right at that 20 to 25% range.

Can't predict who's going to be the highest contributor or the lowest contributor to it, yet, going into the quarter. Because that one is always -- that's part of this fluctuation you get. And that's part of the balancing effect of being a global company.

Okay. Thank you.

Thanks, Rick.

We'll take our next question from the site of [Kim Depauley from Glider]. Please go ahead.

Hi. This is Mike McCormick. Hi, guys.

Hi, Mike.

Just to orders, a little bit. If you just took the orders over a 9-month perspective, the US was up 23% year-over-year. Europe up 17 -- 18. And Asia up 5. So the trend is -- and it's surprising, concerning the economies -- that US is the most robust. Is it because your sales force is the most mature there?

Maybe you can just walk us through why the success is not as in Europe and in Asia. Maybe we could talk a little bit more.

Sure. I do believe that the maturity of the sales organization does have a significant impact on overall growth rates for the Company.

We've historically felt -- and I still believe today -- that significant swings in the overall economy, say for one particular region -- or swings in the economies of a particular vertical, even, have not had a discernable impact on sales growth for the Company in the past. And I still don't think they do, today. Because we're so under-penetrated, we're still -- at best, at this kind of 5% penetration level -- perhaps even less than that, when we really start looking at all the SIC codes around the world.

So yes, for sure, the maturity of the sales organization has a significant impact. The sales team in the Americas really does have a very, very effective process. The sales team in Europe has a very effective process. They also are fairly mature. Very close to the overall tenure that we've had in the Americas.

No doubt, Asia is younger. Not in terms of age. Just in terms of overall time with the Company. Definitely still feeling their way around the market space a little bit.

And so, yes. Do we expect them to be a 5% year-to-date? Definitely not. But the pipeline still looks good for that team, there. It's really a matter of how they capture it.

There are 3 regional leaders, and the sales leaders of those territories do talk on a fairly regular basis. And they'll get into various specifics about, "Why are you doing so well with this product line in this particular country, and I'm not here? What are you doing differently?"

They try to figure out who's doing things differently? Then they try to translate that back to, "Is there a different training that we need to give back to the sales guys? Is it a different way that we're actually just approaching the customer? Is it a totally different set of verticals that they're having the best success in, and maybe we need to target those a little bit differently?"

So it's a constant work in motion. No question, there's a lot more feedback or education perhaps given towards the Asia direction than being pulled from the Asia direction right now. But that's okay. It's a newer region, and I would expect that.

I don't expect them to be growing at 5% year-to-date over the next several years. Certainly, we anticipate it to be higher. But I'm comfortable with the overall balancing effect that we have right now.

If you exclude Asia, and you look at the 9-month order trend, it's about a 20% growth for US-Europe in aggregate. Is that the type of order growth you need to support it? 25% type of long-term growth? Or do you need to see those order grades step up?

I think anything that's in the 20 to 25% range is workable. I always am looking for them to step up, of course.

But at 20%, does that still get us where we need to be? Yes. I mean that gets us right into that 20 to 25% range. If it goes higher than that, then obviously you get the additional benefit of that.

And then could you speak specifically to gross margins? What happened in the mix of the quarter? Why the gross margins? I mean you ahead a very successful Q2 gross margin. But why we saw the drop-off sequentially, so significantly?

Yes. Well, similar to what I was discussing with Rick a moment ago -- I can't necessarily say it was Arm or Tracker-related that you'd have that type of an impact. No question that Gage -- which we've talked about before -- is 3rd, in terms of rank-order of gross margin contribution to the Company.

We did have more Gage sales in the 3rd quarter than we did in the 2nd. That did have a little bit of an impact to the overall mix of the products. And so it is predominantly a sales mix item.

Obviously, we're reviewing is there a price issue? Is there price pressure? There's always price pressure. We can't say that it translated into a gross margin issue in 3rd quarter. It was mostly mix-related, and mostly related to the Gage.

And then my last question is, could you talk a little bit about your work in management? It looks like the DSOs were up a bit. The inventory was up a bit.

Our DSOs are down slightly from year-end. They're up a little bit over the 2nd quarter. Primarily as a result of the increase in international sales. Or the international sales component of that.

Inventories have increased primarily in the finished goods section, as well as our demo inventory. And clearly, that comes from our just continuing to build inventory as we go into the 4th quarter.

I'm sorry, but didn't your international business decline as a percentage of sales in the 3rd quarter.

Right. But it's still a fairly large component. We're still roughly at 40/40/20 on our sales on an overall average.

But relative to the 2nd quarter?

I think that 2nd quarter, our DSOs were -- I don't have the information right here -- but 89 or 88. And now we're at 90. So yes, there's a 1- or 2-day increase.

All right. Thanks again, guys.

Thanks, Mike.

We'll take our next question from the site of Dennis Wassung from Canaccord Adams. Please go ahead.

Yes. First, can you talk about any potential or any shifts in spending patterns with some of your major customers? Has there been any change in their patterns or willingness to spend over the last 3 to 6 months?

I can't say we've seen any discernable shift, there. The deals that are in the pipeline that the team has ranked as their best-probables to win are still coming through at the typical rates that we would see.

Like I said -- we have a few things that slid from, say, Q3 into Q4. Obviously. But in the 2nd quarter, we had some things from Q3 that got pulled into the 2nd quarter.

So does the timing change a little bit quarter-to-quarter? Yes. Sometimes. But the overall desire to spend -- the approval of the CapEx budget -- the availability of the CapEx budgets -- we've not seen any discernable change there, at any of the certainly primary customers that we're selling to.

How about if you look at it from more of an end-market perspective. Aerospace versus automotive or some of the other areas? Any meaningful strengths or weaknesses across any of the major segments?

Obviously if you take just a single snapshot, we had a huge order from Boeing in the 3rd quarter. So could you say that that was an indication of an uptick in aerospace? Well, mathematically, it is. I can't say it's a significant change in the overall aerospace industry, per se.

Generally speaking, we've not seen any one vertical be more aggressive than it had been in the past -- or less aggressive. Or at least if it's been more aggressive, it's not discernable enough that you'd say, "Boy. That one's really taking off right now."

Okay. That helps.

Also, on the new product side with the Quantum and the Fusion out there -- are you seeing any kind of spark in activity with the new product out there? How is that impacting your sales force or customer activity at this point? Any meaningful change?

I'll say there's been a significant spark when it comes to excitement in the sales force over both of the new products. Particularly the Quantum, and the availability to have that in their portfolio to sell. Because it is such a unique product out there.

Clearly, we've got great feedback from the customers who have seen it so far. We saw a lot of -- and I got to witness some of this firsthand at the launch event. You had customers who had come in, and they would come in for the demonstration. We'd show them the Arm. They would physically start using the Arm to check the measurements. Because they really were in disbelief of the accuracy that we were able to maintain, measurement over measurement over measurement. And that word of mouth definitely spread pretty quickly. And it was coming from experienced users who are not FARO -- who were saying, "Hey. Look. What they've stated here is absolutely achievable. I did it myself and was able to see it myself."

So I see spark on that side of it. Clearly we've had -- as I indicated -- a few initial orders -- both for Quantum and for Fusion. I can't say necessarily that you've got this massive treadmill of activity occurring now, relative to those products. But that wouldn't be unusual, either.

You expect to see this gradual ramp-up as the word gets out. As you bring the product out there, you're still going to demo it to them the way we did the previous products. And you've got to go down and take the time and do that with them.

So I think you'll see a nice steady progression. But I will say there's a lot of excitement just in the overall mental excitement related to the product. We've definitely seen that, both from customers and the sales team.

Okay. And last one for me.

You talked about the growth outlook here 20 to 25% for the year. Any thoughts on beyond 2007, at this point? I don't know if you want to get into that at this point. But should we be thinking as 20-25% as the broader target for the Company? Or is that an '07-specific metric at this point?

That's still a good, broad target. We've been using that one as part of our 2009 operating plan for a couple of years, now. I've not seen anything that would change that perspective, either. I think 20 to 25 is still a very achievable sales track for the Company over the next several years.

Great. Thanks.

Thanks, Dennis.

Once again, if you'd like to ask a question, please press the * and 1 on your touchtone phone. We'll take our next question from the site of Mike DeBernardis from Lazard Asset Management. Please go ahead.

Hi, Jay.

Good morning, Mike.

Could you talk about the selling expense line? It was up closer to 30% this quarter, despite the slower sales growth. And then earlier in the year, you'd hoped to get that closer to 25, I think, by the end of the year. Maybe just talk about your ability to leverage the selling expense?

I'll go in reverse order.

First off, the 25 is the long-term target for the Company. But we have consistently talked about the fact that it's a target for the 2009 model, to get down to that level. So it's not an end-of-year target by any means.

I understand.

Obviously, it's up a lot over Q3 of last year, and that's a combination of more people -- more feet on the street -- and some increased marketing expenditures.

It is up sequentially between Q3 and Q4. A lot of that is based on marketing, in particular. Obviously, with the launch of the Quantum Arm in particular -- that launch did occur during the 3rd quarter.

So you had the launch itself, which was a global event -- a series of global events -- and you ahead all the gear-up for that , with all the related marketing materials and the production materials and the things of the like. So you had a little bit of a spike leading up into that.

I suspect it would trail off a teeny bit in the 4th quarter, but not necessarily a lot, either. I think certainly where we're at this year is -- that is the run rate that we're on for the moment.

I do still feel like -- Number 1 -- 25% is the target we should be shooting for, for the Company. I still think there is a decent possibility of getting it there by the end of 2009. We are going to watch it very, very closely though, over the next year -- because from a Company perspective, what I won't do is -- I'm not going to shave that off purposely just to get it to 25, if I feel like it's going to impact that 20 to 25% growth and that continued penetration in the

So would you expect that to grow close to the 20%, going forward?

Well, it's a little bit hard to predict, obviously. What we have talked about in the past, which I still think is at least a decent estimate for the moment, is that if sales are going to grow 20 to 25%, you would except to see that sales and marketing line grow. It could be as low as 15. But anywhere -- 16 to 17%. In that range is probable.

Clearly, we get some leverage out of the sales team themselves, as each year goes by. The marketing side really is a factor of, "What are you doing, relative to product release," and what you're doing there.

Obviously, we are planning multiple R&D activities over the next 2 years. We may have some marketing expense tied to that that would be higher than a normalized plan. But in general, I think -- hey -- 16 to 17% growth on the sales expense line, relative to 20 to 25% growth on the top-line, is -- certainly for the next year, at least -- reasonable to expect.

And have you slowed the headcount additions? Or is that going to continue to grow closer to what sales is likely to grow?

No. I'm including the --

You're including that. Okay.

Yes. I'm including the headcount additions in that 16 to 17%. It doesn't mean the raw number of heads, necessarily, increases 16 to 17%. Because there is some cost differential. Particularly Asia, relative to the US and Europe. But those are included in that 16 to 17 growth.

And just finally, Keith -- what was the share count in the quarter? And what is it, going forward, here?

At the end of the quarter, we had roughly 16.6 million shares outstanding.

Thanks.

Thanks, Mike.

We have no further questions in the queue at this time.

Okay. Well, thanks again, everybody, for listening today. In summary, I do want to reiterate a few key points. Number 1 -- year-to-date sales growth is 22%. And we are well-positioned, as I discussed, for achieving our full 20 to 25% sales growth year-end estimate.

Sir, I was saying there are no further questions, and a guy queued up right as I was saying that.

Hello?

Gross margins continue to be strong at 60% year-to-date, and as such, we have increased our guidance range to 58 to 60% for the year. Cash flow remains strong from the ongoing success of the operation. And finally, the R&D pipeline has never looked better.

As I've stated before, we are still in the early stages of a significant growth opportunity, and we plan to keep FARO the world leader for a long time to come. So thanks again for listening today, and we look forward to updating you again at the end of the 4th quarter.

This does conclude today's teleconference. You may disconnect at any time, and have a great day.