FARO Technologies Inc (FARO) 2009 Q3 法說會逐字稿

Good morning, everyone, and welcome to FARO Technologies conference call in conjunction with its third quarter 2009 earnings release. For opening remarks and introductions, I will now turn the call over to Vic Allgeier. Please go ahead.

Thank you and good morning, everyone. My name is Vic Allgeier of the TTC Group, FARO's investment relations firm. Yesterday, after the market closed, FARO released its third quarter results. By now you should have received a copy of the press release. If you have not received the release please call [Nancy Setteducati] at 407-333-9911. The press release is also available on FARO's Web site at www.faro.com.

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, including statements regarding the future state of the economy, the Company's future financial condition and results of operations, the Company's operational plans and strategies and their impact on the Company's product development and sales model, the Company's ability to reduce costs, streamline operations, improve efficiencies and reduce inventories, and their short and long-term impact on the Company, the balance between new and existing customers and the success and continuation of the FARO test drive program.

These statements can be identified by words such as "expect", "believe", "predict", "intend", "will", "should", and similar words. These forward-looking statements are subject to a number of risks and uncertainties that may cause actual results to differ materially from those projected in these forward-looking statements.

Important factors that may cause actual results to differ materially, are those set forth under the heading Risk Factors in the company's annual report on form 10-K for the year ended December 31, 2008 files with the Securities and Exchange Commission.

I'll now turn the call over to Keith.

Thank you, Vic, and good morning, everyone. Sales in the third quarter of 2009 were $35.7 million, a 27.3% decrease from $49.1 million in the third quarter of 2008. Sales in the European and Asian regions were $22 million, representing 62% of total sales for the quarter.

On a regional basis, third quarter sales in 2009 in the Americas decreased $4.7 million or 25.5%, to $13.7 million compared to $18.4 million in the third quarter of 2008. Sales declined 32.1% in Europe to $14.6 million from $21.5 million in the third quarter of 2008. Sales in the Asia Pacific region were down 19.6% to $7.4 million from $9.2 million in the third quarter of 2008.

The effective changes in foreign exchange rates on sales was a decrease of approximately $400,000 in the third quarter of 2009. New orders decreased 27.2% in the third quarter of 2009 to approximately $35.8 million, compared to $49.2 million in the third quarter of 2008.

On a regional basis, third quarter orders in 2009 in the Americas declined 20.5% to $14 million, compared to $17.6 million in the third quarter of 2008. Orders decreased 32.1% in Europe to $14.8 million from $21.8 million in the third quarter of 2008. Orders in the Asia Pacific region decreased 28.6% to $7 million compared to $9.8 million in the year ago quarter.

The top five customers by sales volume in the third quarter of 2009 were the US Military, [Com El Pico], Volkswagen, GE, and Ford, and represented only 4.6% of sales. The top 10 customers in the third quarter 2009 represented only 8.5% of our sales, once again indicating our lack of dependence on any one or handful of customers.

The company initiated a third reduction in force in August 2009 of approximately 8% of its then current workforce. We incurred severance costs of $600,000 and expect to save $4.1 million in compensation costs on an annual basis. In addition, we eliminated several corporate positions in the third quarter, incurring an additional $300,000 in severance costs and expect to save approximately $900,000 in annual compensation costs.

In total, in 2009 we reduced our workforce by 270 employees globally, and incurred $2.7 million in severance costs. The combined annual compensation cost savings are expected to be approximately $17.3 million.

Our gross margin was 54.9% in the third quarter of 2009, compared to 59.1% in the year ago quarter. This decrease was primarily due to a change in the sales mix between higher margin product sales and lower margin service revenue resulting from a decrease in product sales.

As a percentage of sales, selling expenses were 32.2% of sales in the third quarter of 2009 compared to 31.3% in the year ago quarter. Selling expenses declined $3.9 million to $11.5 million in the third quarter of 2009 from $15.4 million in the third quarter of 2008.

As a percentage of sales, administrative expenses were 17.2% of sales in the third quarter of 2009, compared to 13.5% in the third quarter of 2008. Administrative expenses in the third quarter of 2009 decreased by $400,000 to $6.2 million from $6.6 million in the third quarter of 2008, primarily as a result of decreased compensation in travel related costs.

Research and development expenses were $2.8 million for the third quarter of 2009, or 7.8% of sales compared to $3.2 million or 6.6% of sales in the third quarter of 2008. This decrease is primarily related to a decrease in compensation costs. Operating margin for the third quarter of 2009 was a -6.3% compared to a positive margin of 2.6% in the year ago quarter, primarily as a result of previously mentioned decrease in sales and gross margin.

Other income includes foreign currency transaction gains of approximately $100,000 in the third quarter 2009 compared to a loss of approximately $700,000 in the year ago quarter. Interest income decreased by approximately $500,000 in the third quarter of 2009 to approximately $31,000, from $550,000 in the third quarter of 2008 due to a decline in interest rates.

Income tax expense decreased to a benefit of $800,000 in the third quarter of 2009 compared to an expense of $500,000 in the third quarter of 2008. The company's effective tax benefit rate for the third quarter of 2009 was 37.6% compared to an effective tax rate of 19.9% for the third quarter of 2008, primarily due to a taxable loss in jurisdictions with higher tax rates.

Net income decreased to a net loss of $1.3 million or $0.08 per share in the third quarter of 2009, compared to net income of $2 million or $0.12 per share in the third quarter of 2008. The number of fully diluted outstanding shares in the third quarter of 2009 was $16.1 million, compared to $16.7 million in the third quarter of 2008. This decrease of approximately 600,000 shares is primarily related to the repurchase of approximately 600,000 shares during the first quarter of 2009 of the company's common stock as part of its share repurchase program.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $92.4 million on October 3, 2009, compared to $105.5 million at December 31, 2008. In the first quarter of 2009, the company sold its investment of $82 million in variable rate demand bonds, and now hold $65 million of US Treasury bills.

As mentioned earlier, during the first quarter of 2009 the company repurchased approximately 624,000 shares of common stock, totaling approximately $8.8 million, as part of its previously announced share repurchase program. Accounts receivable was $35.7 million on October 3, 2009 compared to $49.7 million at December 31, 2008.

Day sales outstanding on October 3, 2009 increased to 91 days from 81 days at December 31, 2008, primarily as a result of the extension of the collection cycle in Europe. Inventories decreased by $5.3 million to $41 million at October 3, 2009 from $46.3 million at December 31, 2008.

Finally, I'll conclude with some statistics regarding our head count numbers. We had 742 employees at October 3, 2009, compared to 959 at December 31, 2008, a decrease of 217 or 22.6%, primarily related to the three reductions in force that occurred in the first and third quarters of 2009.

Account manager head count decreased from 187 at December 31, 2008 to 156 at October 3, 2009. We now have 43 account managers in the Americas, 52 account managers in Europe, and 61 account managers in Asia. Geographically, we now have 295 employees in the Americas, 255 employees in Europe and 192 employees in the Asia Pacific region.

I will now hand the call over to Jay.

Thanks, Keith, and good morning, everyone. Generally speaking, the business climate in the third quarter continued to be difficult. However, we are starting to see some signs of life in the markets we serve. In particular, September activity was noticeably better than any month in recent memory.

In total, sales in the third quarter were up sequentially over the second quarter of this year, a period during which we historically see about a 10% decline. Sales also grew sequentially between the first quarter and second quarter of this year, so there is some momentum there.

Leads and demos are continuing to grow at our normalized run rates, but in the third quarter our convergence started to improve, albeit slightly. We've also maintained our 50/50 balance between new and existing customers, indicating a compelling ROI for our products as new customers continue adopting our technology despite the downturn.

Certainly it's too soon to signal whether we're coming out of the woods completely or not. There is still some uncertainty out there. However, we're definitely seeing more positive sentiment from our customers in most countries around the world. One of the benefits we have at this company is that approximately two-thirds of our sales are generated outside the Americas. That allows us to quickly shift focus as required to different parts of the world.

We expect that Asia will recover more quickly from the current economic downturn, particularly in China, and as a result we'll be leveraging the strong presence we have in that region to drive our own return to sales growth.

Historically, our fourth quarter generates a significant increase in sales sequentially from the third quarter. This is due to customers acting on a use-it-or-lose-it mentality with respect to their capital equipment budgets at year end. We don't know if we'll see the same mentality this year but there are some favorable signs out there.

We used the third quarter to create additional breathing room around our break even point as a company. In August, we conducted our third reduction in force with a goal of getting our break even point to roughly $35 to $36 million in revenue. It appears we have accomplished this. In the third quarter, we generated over $35 million in sales, and we had a loss of approximately $2 million of operating income. However, this quarter included severance costs associated with the reduction in force, and unabsorbed manufacturing overhead which had a one-time negative impact. Without these items, we were essentially break-even for the quarter.

We expect at this sales level of $35 to $36 million, assuming approximately 57% gross margin, will keep us break even going forward. With that complete we're now focused on increase in our sales volume and improving gross margins as we return to growth.

The third quarter was exciting from an R&D perspective. We introduced the Faro Ion Laser Tracker, our newest generation, and now the world's most accurate large volume laser tracker. With a 27% improvement in accuracy, a 36% improvement in range and 12% improvement in weight, the new ion is the first of several new generations of product you'll see from us over the next 15 months.

Despite the reductions in force that we made this year and the significant cost cuts we executed, R&D spending is one area I purposefully left intact. We're spending almost $5 million per year more today than we were just three years ago. Obviously in a downturn like we've seen in 2009, it would have been very easy to scale back our output on the R&D side.

Instead, we allowed R&D to continue running full speed, and instead reduced costs everywhere else in the business to make up for it. As we move into 2010, that strategic decision will allow FARO to continue transforming the market. Needless to say, we spent a lot of time this year restructuring and repositioning in the company. We made a lot of tough choices, took a lot of cost out of the business, and redesigned our operating processes.

As we go forward, we'll have an operation that is significantly leaner and far more decentralized. This will keep us closer to our customers and quicker to respond. In addition to the reductions in force executed in the third quarter, I eliminated multiple corporate roles. Our CPO and SVP of engineering, the SVP of human resources, VP of information technology, the VP of quality, VP of product management, as well as changing our managing director in Asia.

I have assumed direct responsibility for the CTO's role. The rest of the functional responsibilities have been assumed by existing employees within the regions, reducing the senior leadership team to the three managing directors for our regional operations, our CFO, and me.

We expect this structure to provide significant leverage, as there should be very few heads that are required to support a return to sales growth. Through standard work and (inaudible) productivity programs executed in the first half of this year, we've already generated significant manufacturing capacity at these reduced head count levels. We're experimenting with new sales channels that could be less dependent on the direct sales approach we've used in the past. We've established a new baseline for administrative staffing, and we expect that the team we currently have in place will sustain our growth for an extended period of time.

One benefit from the global downturn is that we're starting to see some interesting opportunities on the acquisition front. Strategically I'm focused on three areas. The first two have been on my radar since I got here, software and non-contact hardware. The third is something I've been interested in, but not as focused as I am now. Technology companies, which fit our vision for 3D measurement and imaging, but may deliver as much value through their channel to market as they do through their technology. As always, I'm not signaling that there are eminent deals at hand, but I can say that my focus on acquisition opportunities is back to being approximately 20% to 25% of my typical week.

This has been a difficult 18 months for everyone. However, the FARO team has stayed focused through all of it and we have kept the company extremely healthy. In fact, we made the company even healthier. We have a strong cash position, zero debt, great technology with new technology on the way, and an experienced team to manage in a global environment.

I'd like to offer a special thanks to that team for never losing faith and continuing to keep the dream alive. Our customers and our investors have stayed extremely supportive as well, and I'd like to thank them too. I believe we are starting to see some light at the end of the tunnel, and the FARO team remains committed to reaching that light as quickly as possible.

I appreciate your attention and will now open the call to questions.

(Operator Instructions). And we'll go first to the line of Mark Jordan with Noble Financial. Please go ahead.

Good morning, everyone. Jay, nice to hear a little bit of an improved tone in your comments. The first question is relative to gross margin. Sequentially it declined about I think 270 basis points. Is that just severance and overhead, or was there any kind of change in the overlying margin opportunity on product?

Mark, it's Keith. It's primarily overhead. There is some severance in there in the cost of sales number for this quarter. But it's primarily some of that unabsorbed overhead that comes from lower unit volume that was expensed during the quarter.

Okay, so at higher volumes you would see no reason why you shouldn't move back to the 65% plus type gross margin on product?

Without commenting specifically to our gross margin on product, but I think, yes, in fact, even without higher sales volume I would look at this and say the items that hit us in the third quarter are not necessarily repeatable in the coming quarters, regardless of sale volume.

Okay, but there's nothing that's happened in the marketplace with regard to pricing that would fundamentally change a longer-term kind of gross margin model that you would aspire to?

Yes, certainly not fundamentally. Obviously, look, there's plenty of pricing pressure in the marketplace, as there always has been. As you know, our one competitor is predominantly price focused. So we've certainly seen a little bit more of that, but not to the point where we've looked at it and felt concerned either near term and certainly long-term relative to that competitive price pressure.

I wanted to just confirm, when you're talking about account managers, I believe you said there were 43 in the US, and my number said that you had 57 in the second quarter -- seemed to have a little bit of a drop in the other two geographies. But did you do -- was that a significant drop in terms of your structuring of the account reps domestically here?

Yes, certainly sales was a part of the reductions in force, particularly in the one that we did in August here. The view being, look, we're not getting the same productivity as we had in the past. It was time to make some moves there. And, again, as we start experimenting with some of these other potential sales channels, we may have a little bit less reliance on that direct model. And I'm not saying that's going to go away any time soon.

But we did see an opportunity for strengthening the bench, so to speak, by pulling down to a number of account managers that was more appropriate and quite frankly still should get leverage out of at their current productivity levels. We should get leverage out of that as we go forward here for a pretty good period of time.

Okay, as hopefully sales start to rise here again in the fourth quarter, right now in the third quarter you had selling expenses 32.2% of revenue. With each kind of incremental dollar, what kind of incremental selling expense would you experience? Is it more to the tune of $0.10 on the dollar for the incremental revenue?

Yes, obviously I'm not going to try to predict it perfectly, Mark, because there are a lot of things that could go into that. But generally speaking, you're right. You've got an established account manager base and -- a baseline of account managers, not base salary but baseline of account managers, and they all earn a commission on the sales, call it roughly, you're right, $0.10 on the dollar give or take. Obviously there is travel that goes with that.

You've got a team that's out there in the field and they do move a decent amount account to account. So you've got some of that factored in there as well. But the route you're on is exactly the type of leverage that we're looking for. The model of where we were trying to get that to, from a sales and marketing perspective of getting those two categories combined down to 25% of our sales, that is still the right long-term goal to be thinking about for the company. And obviously, some of the moves that we just made and the way that we're going to try to leverage this going forward is intended to kind of accelerate that and get it back on the right track.

In the third quarter you had $2.8 million in R&D expense. You said it was down because of lower compensation. I take it that was part of the restructuring and that's a more consistent run rate moving forward?

Yes, there's a little bit that was tied back to the first reduction of force. The first go around we had, a few heads that we removed in the engineering side, not a ton, and then obviously the removal of the CTO as we went through that as well. So, it's slightly lower spending just purely based on those. But the actual number of activities the team is engaged in is higher from a development standpoint.

Okay. A final question. I missed some of the head count numbers. Could you give me the geographic head count breakdown again please?

Sure, we had account manager head count decrease from 187 at December 31 to 156 on October 3, 2009. We have 43 account managers in the Americas, 52 in Europe and 61 in Asia. Geographically we're at 295 in the Americas, 255 in Europe, and 192 in Asia.

Thank you very much.

Thanks, Mark.

(Operator Instructions). We'll go now to the line of Jim Ricchiuti with Needham & Company. Please go ahead.

Thank you. Good morning.

Good morning, Jim.

Jay, I wonder if you can comment a little bit more about what you're doing in terms of developing the sales channel, and possible relying on some new channels of distribution. It appears that it's right now taking place more in the Americas. How far along are you on it? Is there anything you can say at least as it relates to business in this area over the next quarter or so?

Yes, certainly we are just in the phases of launching this right now. And there's some easy examples. Obviously, we are test driving some distributors, which would be a natural test for us. And they are not meant to replace necessarily, but to complement and enhance the potential sales channel.

We are looking at it, as you -- relates to products like the Gage, which are a little bit lower price, and much more closely tied to smaller machine shops around not just the US but around the world that have -- obviously there is tremendous amount of geographic reach that's required to hit all of the machine shops. It's a simpler tool to use. It's a little bit more logical to tie it to, or give it the opportunity to, some of the distributors to move that.

The other opportunity that goes with that is a lot of these distributors are selling machine tools as well, and so there's some benefit of being able to bid a machine tool and the Gage as a standard accessory simultaneously to the customers, and to push that technology. So certainly that's one of the opportunities, and it's not just in the US. It is in Europe and Asia as well. Even in places like China there are potential distributors that we are looking at right now.

And the key is making sure that you feel like they are still in essence part of the team that you can manage them in that regard, and keep them close to the company, but at the same time that they are truly a variable cost that the only cost you're picking up is when they sell and they pick up their commission on the account.

Obviously, we tried the test drive in the second quarter and third quarter. We talked about that before. Predominantly in the US though, we are in the process of both remarketing it again in the US as well as having just started launching it in Europe and Asia.

The test drive was fairly successful out of the gate. We had at least a couple of dozen customers who signed up for it in the United States. The bulk of them were customers that would not have purchased FARO equipment if we didn't have that plan, or that program in place. And we're at the point now where we're starting to see some of the rollovers into actually acquiring the asset, instead of just having it on the four-month rental trial.

So we are going to continue with that program going forward. We believe it may be a way to get some additional inroad with new customers, who still today there is a bit of fear of technology, even if you can get their heads around the potential ROI that the equipment will generate for them. So we're looking to resolve some of that as well.

And then the final piece is there are some potential partners that we work with that have very good let's call it deep roots into certain types of accounts that by partnering with us, whether it's a software supplier or some other potential hardware suppliers, we get some access to their channel to market. And those accounts that we are not necessarily in yet, and have an opportunity to market ourselves through them to that group. So those are kind of three of the key things that we're trying right now.

Is there anything you can share with us in terms of your targets for the third party distribution in 2010 in terms of percent of revenues? Do you have something -- I'm sure you have something in mind, but I wonder if you could give us a range of how you're thinking about this developing.

Yes, not that I'd want to put out there. We certainly have the internal targets of what we think it will do to help generate growth, and what kind of leverage we will get from a cost standpoint by utilizing those groups. Because the cost differential, it certainly is better than our current percentage of sales, no question there. So -- but I would not want to put something out there right now, I think.

Okay, fair enough. The pickup you saw in September, I wonder if you could elaborate on that. Also, it looks like the order strength was more pronounced in the Americas. Europe was down, I guess sequentially for seasonal reasons. And then Asia Pacific looked like it turned down a little bit. I wonder if you could just talk to us a little bit about what's happening on the bookings front.

Yes, well, from a -- I think there's a couple things. One is just generally speaking in the current climate you had a lot of companies who drained inventories pretty low -- finished product inventories. And so now there's some catch up occurring and people are starting to ramp up the plants again. And we are seeing that in aerospace, we're seeing it in auto, we're seeing it in heavy machining and heavy manufacturing. We're seeing it in most of the sectors.

And to be honest with you, aerospace has actually still been relatively stable for us throughout the year, even with some of the issues that Boeing's had on the Dreamliner. They've still been running pretty close to full tilt at the types of levels that we're used to seeing. So in that regard it's across the industries.

The pop in the Americas, I do think some of it is planning for Q4, that use-it-or-lose-it mentality. Customers started planning for it and placing their orders in Q3. The risk, and why I still say there's some uncertainty out there, obviously, is how much of the inventory recovery is sustainable versus it becomes a one-time pop that rises and then settles back down to a slightly more normalized level again. I do think it's going upward for sure. It's just a matter of at what rate, and that's the part that we will see as we go through Q4 here, and then kind of see where it adjusts to, and if it adjusts in Q1.

Asia I think is just a timing thing. Like I said, we do expect Asia to recover more rapidly than the other parts of the world. Setting aside Japan for a moment, which is obviously in a real economic mess at this point. The other countries there -- they're back in the growth mode already. China certainly is moving. Obviously India from an economic standpoint is moving. And so we're seeing good activity there. And you're right, Europe, it's more just a seasonal pattern. August is always brutal in Europe, and that was clearly reflected in the numbers.

Did that business in Europe -- so order activities start to come back in September?

Yes, the September phenomenon was across all three regions. The Americas started hinting at it first because they were actually starting to see it as we tailed out of August where the sales leadership was saying, hey, customers are starting to ask the right types of questions again. It's different from what they've been asking over the last six to nine months as we've gotten into the demos. And they were the first to start signaling that. But Europe and Asia weren't too far behind as we got into September where they were seeing the same types of -- again, there's certain types of questions that are much more obvious buy signals, or real buy signals than what we've been seeing.

And last question for me and I'll jump back in the queue. Keith, was there any monitor related expense in the quarter and do you see -- how do you see that going forward?

Well, we had no monitor related expense in the quarter, but I'll let Jay talk to the current status of the monitor.

Yes, current status is as follows. The clock is still running. Everything that we've been told by the DOJ, the clock's running. So the clock ends based on the signature we have with the DOJ. It ends in July of next year. So we're down to basically eight months, call it.

Our choice has gone to the approval committee at the Department of Justice. They have not had our monitor on the agenda yet, but it is supposed to be eminent. And my understanding is that once they say yes, which we expect they will, we would expect the monitors to start almost immediately thereafter. So, as I said in the previous quarters, I absolutely will not say definitively that they're starting in the current quarter.

However, I will say it certainly seems likely that they will start to work this quarter, and we would anticipate, again, at least probably $1 million worth of costs during the time period that they are here. And that's still a wild card, because we just don't know how much leg work will be required, other than we still get the opportunity from a planning perspective. At the very beginning, we, the monitor and the DOJ jointly agreed to the scope of work and the estimated approach, and that would at least give us some feel for how much is coming.

But as always, it comes to billable hours, number of people involved, and so forth. So that's the part that makes it a little bit harder to predict even once we have the scope identified with them.

Okay, thank you.

Thanks, Jim.

Thanks, Jim.

And we'll go next to the line of Richard Eastman with Robert W. Baird. Please go ahead.

Yes, hi, Jay, and Keith.

Hi, Rick. How are you?

Hi, just a quick question, as we talk about maybe order momentum, and you talked that it was picked up in September relative to the Q3. As we continue that into the fourth quarter here, you're kind of suggesting that there could at least be some budget flush here in the fourth quarter that impacts the fourth quarter. Is there any -- should we be thinking about the typical sequential improvement or something better in terms of orders for the fourth quarter?

Great question. I'll never say we should be expecting that. I do believe we are going to see, again, because of the types of questions that are being asked, I think we're going to see some fourth quarter budget flush. Predicting whether it's normal, higher or lower, that's the hard part.

Our baseline Q3 was actually up sequentially over Q2 which is unusual. So the question is, are we coming off of an unusually higher baseline, or is it because Q2 and Q1 were just so ugly that there was some catch up? I just don't have a good feel for that. We do think that there's some budget flush that's going to occur. It's across the board. I do expect it will be more focused on trackers and arms predominantly, and that's just based on kind of the level of activity. Gage is, though it's still a great product for us, we do sell far more Gages to the smaller machine shops, and no doubt they have been most impacted, I think, by the economic downturn that we're going through.

So that's what I can say in terms of what we're expecting. How much of an upswing it will be -- really, really hard to predict.

And do you -- I'm just curious. In some of the business that you talked a little bit about the closure rate improving in September, and I don't know how you want to answer this question, but I'm curious, as we move forward with orders, are those orders let's say discounted so that maybe the pressure on gross margin continues into next year until we have a real sustainable improvement?

I certainly believe there'll be continued price pressure for the next year, as long as the economy continues to be mediocre, or even if it's slightly growing again. There's still going to be some price pressure, but like I said, a lot of that is still historical. We've had that no matter what.

We feel it. Does it have a little bit of impact in kind of quarter to quarter? Yes, a little bit. But on average we still have deals that are coming through at the types of prices we're used to. The one impact on pricing that you could see happen, and this has happened to us in the past too, is if we sell more demo gear it appears to be lower prices, it's actually just because it's used equipment that's been depreciated a year or two and we offer a lower price to the customer as it comes out.

So from that regard, maybe that would create the appearance of some price pressure, but generally speaking, yes, there's a little bit but our team continues to kind of fight and manage through it and have minimal hits to us.

Okay, and then just one last question, Jay. As you start to plan for calendar '10 and toss your financial plan together, at least draft it out, how are you thinking about the expenses? Just the operating expenses, and maybe head count as you head into next year? How do you plan for that at this point, given what you see on the sales line?

Yes, generally speaking, because we're obviously actually wrapping that process up right now, generally speaking, head count should be virtually flat. And I say virtually, because we may add a couple more R&D heads in very strategic spots based on projects and delivery that's coming in 2010. So you may see us add a couple there. Maybe a couple in customer service, depending on call volume and so forth.

Even as service expenses have declined, and we've gone through all of this, the fleet is still growing. So there's just a natural ratio of the number of calls that come in purely because there's a fleet that's that much larger than it was a year ago or two years ago. So possibly you end up with a couple of phone reps in there, and maybe a few account manager adds in Asia to support this focus of returning to growth through Asia first more than any other region.

So but outside of that I'm hard pressed to see any reason to add heads in 2010 and possibly even as we go into 2011 except in those couple of categories. And so I would call it a handful is what we're thinking at this point.

Okay. And then just one kind of strategic question, any movement in terms of the laser scanner product? We've been trying to get the price down there. Where are we in terms of the generations of product there?

Yes, the LS, we're on, I think, I guess, it's probably our fourth generation now since acquiring them, because they have been very consistent in obsoleting the previous gen basically every 12 months, 14 months at the worst. So the generation that's out there right now is in fact best in class for our type of laser scanning technology, and has a pretty good price point. It is not the price point that I want to be at, and so when you look at the next generation and we certainly would expect another generation to come in kind of the 14, 16 month timeframe, give or take, you would look for substantial improvements again and substantial price improvements again too.

Price and overall software usability are still the two things that keep that from getting, as we call it, over the chasm and into the early majority. So I don't believe we're in the early majority yet. I still think it's in the early adopter phase. Certainly the number of units sold per year continues to grow, even in this environment. And we expect that as we go through Q4 here this year.

So all of those are good signals. It's still the lowest revenue generator out of all of our products, not surprisingly, given that it still has the newest history with us. But I think we are -- we've talked before about when do you start getting into markets like insurance and heavily into forensics, and much more into the architecture more deeply. True not quite consumer but closer to consumer type of product line. Yes, I think we're still maybe 24 months off from that, but we are certainly driving that from an R&D perspective. We continue to invest heavily in that group since we acquired them.

Okay, great. Thank you.

Thanks, Rick.

And we'll go next to the line of Andy Schopick with Nutmeg Securities. Please go ahead.

Yes, Keith, a couple of quick questions for you. Nine months year-to-date you've repurchased $8.83 million of shares. How many shares were involved in that repurchase?

Yes, so a little over 600,000 shares. And that was basically done back in Q1.

Yes, the last purchase was in February.

And is there any current authorization that remains unused?

Yes, out of -- the total program was for $30 million.

Okay. I want to ask a question about the service inventory. Keith, if you could just explain -- that's basically remained unchanged on the balance sheet from year end, the $12.8 million. What is that? How does that get revalued and measured? And if you could just comment a little bit in terms of just giving some clarity to that item.

Yes, the service inventory is comprised of primarily raw material and loner demos or loaner stock that we use for our customers. It contains inventory that we used for warranty work and for the annual calibration and certification work. Typically we revalue -- well, we don't revalue that. But we measure that based upon roughly a five-year sort of a raw material component availability based on the current sales model. But typically our install base continues to grow, so we have quite a few Arms and Gages out there that we need to continue to service.

Have you ever had to take any provisions against that account?

We typically do a calculation for excess and obsolete. We do an excess calculation based upon prior sales and future forecast sales, and do a calculation there, and that's pretty much been stable over the past few years.

Okay, and kind of a more general question. You know, a lot of companies, including yourselves, have cut costs very severely. And we're starting to see more signs that at least the situation isn't as dire as perhaps the concerns that existed earlier in the year in the overall global economy. What do you feel is a sustainable kind of head count and employment run rate for this company as you begin to get back into a more accelerated revenue growth with profitability? Can these kinds of cuts really be sustained to continue to grow the company in a recovery?

Yes, this is Jay. I mean, I'll say that I certainly believe they can be sustained for at least the near term, and near term could be defined at a minimum through 2010 and possibly even parts of 2011. Again, depending on how fast the recovery occurs. As growth ramps up, if you think about our historical growth rates, which ran 20%, 25%, let's call it 25% compounded for several years there, the places where you might need to start adding again as we hit those levels would be production.

We do have -- obviously there is a labor component to production. It's the adds that are required are no where close to a one-to-one ratio as sales growth picks up. But you would start seeing some handfuls there if we were back at the 25% level. In the meantime, we don't anticipate needing to do that. Again, a little bit on customer service, depending on call volume and what's coming through there.

And then at some point, you would start adding some more on the sales and marketing side, particularly the account managers more than anything else. Once we get back to productivity levels that we believe are appropriate for the team that's in the field, but that being said, we're well below the productivity that that team should be able to generate. So, again, it should run us for a decent period of time here before we need to start thinking about any type of heavy adds there. So, yes, we've cut pretty deeply. I think that as we did it every one of the teams was forced to think about how to do their jobs dramatically different, because in some cases it wasn't purely tied to volume when we made the cuts, and it forced them to rethink how they operate, generate the stop doing lists and refocus the processes and redesign the processes, all the things that you would expect to do during that. And now we've got -- I do think we have a sustainable model as we go forward.

Okay, thank you.

Thanks, Andy.

Thank you.

(Operator Instructions). We'll go now to the line of Jim Ricchiuti with Needham & Company. Please go ahead.

Hey, I just was hoping you'd go back to some of the commentary you made about new products. Is this going -- is 2010 going to be a more active year for you in terms of new product introductions? And is that more toward the back half of the year, or is this similar to what you've done in the past in terms of moving to the next generation product?

Yes, I won't tell you timing for a lot of different reasons. Though I think you could say you'll see it kind of throughout the year. Yes, is the answer, it will be more active than previous years. And the types of things that come, we've got some stuff that is clearly brand new like the 3D imager, and we've got some generational changes in the technology that I would say some of it is significant, and some of it is good generational change. We have no bad or mediocre generational change. I'll say that for sure.

And then R&D expense was down from Q2 levels and how should we think about your R&D over the next few quarters?

Well, certainly the levels we're at right now are kind of bare minimum. You might just see a little bit of an increase next year without us actually forecasting that line item. Yes, you can see that if you're going to have an active release year, you might see a little bit of an uptick there. But certainly still I think within kind of our historical norms of -- if 5% to 7% of sales is the target, and I know we're certainly at the high end, and actually a little above that right now, but you would expect us to still kind of run in that range.

Keith, tax rate for next year, any changes there? Can you give us -- remind us where you're expecting tax rate to be?

Well, typically it's been in the 20% to 25% range and that assumes a certain level of the taxable income mix. This quarter was a little unusual in that we had a much larger taxable loss in some higher tax rate jurisdictions. But if we return to our historical model, I think that 20% to 25% range should hold true, pending any changes in tax laws changes from this administration.

Okay, thank you.

(Operator Instructions). And it does appear at this time that there are no further questions. So I'd like to turn the program back over to our presenters for any closing remarks.

Very good. Well, we'll just close by saying thanks very much, everybody, for your attention today. Enjoy the fourth quarter and the holiday season, and we will look forward to updating everybody as we clear through year end here. Thanks very much.

And this does conclude today's teleconference. Thank you again for your participation. You may now disconnect and please enjoy the rest of your day.