FARO Technologies Inc (FARO) 2009 Q4 法說會逐字稿

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

Thank you, and good morning, everyone. My name is Vic Allgeier of the TTC Group, FARO's investor relations firm. Yesterday, after the market closed, FARO released its fourth-quarter results. By now, you should have received a copy of the press release. If you have not received a release, please call Nancy Setteducati at 407-333-9911. The press release is also available on FARO's website 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. 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 Securities and Exchange Commission.

I will now turn the call over to Keith.

Thank you, Vic, and good morning, everyone. Sales in the fourth quarter of 2009 were $46 million, an 18.3% decrease from $56.3 million in the fourth quarter of 2008. That brought our 2009 annual sales to $147.7 million, a 29.4% decrease from $209.2 million in 2008.

On a regional basis, fourth quarter sales in 2009 in the Americas declined 19.4% to $16.6 million, compared to $20.6 million in the fourth quarter of 2008. Sales decreased 20.6% in Europe to $20.8 million, from $26.2 million in the fourth quarter of 2008. Sales in the Asia-Pacific region decreased 9.5% to $8.6 million, from $9.5 million in the fourth quarter of 2008. The effective changes in foreign exchange rates on sales was an increase of $2.5 million in the fourth quarter of 2009.

Comparing year-over-year growth, 2009 sales in the Americas decreased 29.8% to $55 million, from $78.3 million in 2008. Europe sales for 2009 decreased 32.7% to $63 million, from $93.6 million in 2008. And Asia sales decreased 20.4% in 2009 to $29.7 million, from $37.3 million in 2008. The effective changes in foreign exchange rates on sales was a decrease of $1.6 million in fiscal 2009.

New orders declined 5.9% in the fourth quarter of 2009 to approximately $53.1 million, compared to approximately $56.4 million in the fourth quarter of 2008. On an annual basis, new orders decreased 28.2% to $151.7 million in 2009, from $211.3 million in 2008.

On a regional basis, fourth quarter orders in 2009 in the Americas decreased 11% to $18.6 million, compared to $20.9 million in the fourth quarter of 2008. Orders decreased 5.3% in Europe to $24.9 million, from $26.3 million in the fourth quarter of 2008. Orders in the Asia-Pacific region increased 4.3% to $9.6 million, compared to $9.2 million in the year-ago quarter.

Again, comparing year-over-year orders growth, new orders in the Americas decreased 28.4% to $55.2 million in 2009, from $77.1 million in 2008. Orders decreased 30% in Europe to $66.5 million in 2009, compared to $95 million in 2008. And orders declined by 23.5% in Asia in 2009 to $30 million, from $39.2 million in 2008.

The top five customers by sales volume in 2009 were the US military, Northrop Grumman, Volkswagen, BMW and the High Energy Accelerator Research Organization in Japan, and represented only 3.2% of sales. The top 10 customers in 2009 represented only 5.2% of our sales, once again indicating our lack of dependence on any one or a handful of customers.

Our gross margin was 55.4% in the fourth quarter of 2009, compared to 57.3% in the year-ago quarter. Gross margin in fiscal 2009 was 54.6%, compared to 59.8% in fiscal 2008. Gross margin decreased in both the fourth quarter of 2009 and fiscal 2009 primarily as a result of the change in the sales mix between product sales and service revenue resulting from a decrease in product sales.

Gross margin from product sales decreased to 60.7% in fiscal 2009, from 66.1% in fiscal 2008, primarily due to a change in product mix. Gross margin from service revenues increased to 31% in 2009, from 22.5% in fiscal 2008, due to a decrease in customer service costs.

Selling expenses were 26.4% of sales in the fourth quarter of 2009, compared to 28.6% in the year-ago quarter. Selling expenses declined to $12.2 million in the fourth quarter of 2009, from $16.1 million in the fourth quarter of 2008, primarily as a result of decrease in compensation of $1.9 million, marketing and advertising expenses of $800,000 and travel expenses of $700,000. In fiscal 2009, selling expenses increased to 32.9% of sales, compared to 30.1% in fiscal 2008.

Administrative expenses in the fourth quarter of 2009 were 13.8% of sales, compared to 12.2% in the fourth quarter of 2008, declining by $500,000 to $6.4 million, from $6.9 million in 2008, primarily as a result of lower compensation costs of $400,000, travel-related expenses of $300,000 and recruiting and training costs of $400,000 offset by an increase in professional fees of approximately $750,000 related to the patent litigation and the settlement of the IRS matter.

In fiscal 2009, general and administrative expenses were $24.9 million, or 16.9% of sales, compared to fiscal 2008 of $26.1 million, or 12.5% of sales. Fiscal 2009 expenses decreased primarily as a result of a decrease in compensation costs of $1.8 million, decreased travel costs of $900,000 and a reduction in recruiting and training costs of $700,000 offset by an increase in the reserve for doubtful accounts of $500,000 and an increase of $1.3 million in professional fees related to patent litigation and the settlement of the IRS audit.

Research and development expenses decreased to $3 million for the fourth quarter of 2009, or 6.6% of sales, compared to $3.5 million, or 6.2% of sales, in the fourth quarter of 2008. R&D expenses for fiscal 2009 and fiscal 2008 were $12.6 million.

Operating margin for the fourth quarter of 2009 was 5.4%, compared to 8.1% in the year-ago quarter, as a result of the previously mentioned decline in gross margin and increased selling and administrative expenses as a percentage of sales. Operating margin for fiscal 2009 was a negative 7.4%, compared to an operating margin of 9.1% in fiscal 2008.

Other income and expenses, which includes foreign exchange transactions with our subsidiaries, changed to income of $232,000 in the fourth quarter of 2009, compared to a loss of $1.5 million in the fourth quarter of 2008. On a year-to-date basis, foreign exchange transactions included in other income and expense was a gain of $592,000 in fiscal 2009, compared to a loss of $2.3 million in fiscal 2008.

Income tax expense was $3.3 million in the fourth quarter of 2009, compared to $1.4 million in the fourth quarter of 2008. The effective income tax rate was 122.7% in the fourth quarter of 2009. Income tax expense in the fourth quarter of 2009 included $2.6 million related to a settlement with the Internal Revenue Service. Excluding the effect of the $2.6 million tax settlement, the Company's effective tax benefit rate would have been 26.3% for the fourth quarter of 2009.

The Company believes that calculating its effective tax rate without the impact of the IRS settlement is useful to Management and investors to provide greater clarity and to facilitate internal and external comparisons to the Company's historical tax rate.

Income tax expense decreased to $424,000 for fiscal 2009, compared to $4.4 million in fiscal 2008, primarily as a decrease in pre-tax income. The Company's effective income tax rate for fiscal 2009 was 4.2%. Excluding the effects of the $2.6 million tax settlement, the Company's effective tax benefit rate would have been 21.7% for fiscal 2009, compared to an effective tax rate of 24% for the year ended December 31, 2008. The tax settlement will not impact the Company's tax rate going forward.

The net loss was $621,000, or $0.04 per share, in the fourth quarter of 2009 and included the IRS settlement of $2.6 million, or $0.16 per share, compared to net income of $10.6 million, or $0.13 per share, in the fourth quarter of 2008. The net loss for fiscal 2009 was $10.6 million, or $0.66 per diluted share, compared to net income of $14 million, or $0.83 per diluted share, in fiscal 2008.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $100.1 million at December 31, 2009, compared to $105.5 million at December 31, 2008. Accounts receivable was $42.9 million at December 31, 2009, compared to $49.7 million at December 31, 2008. Day sales outstanding at December 31, 2009, increased to 85 days, from 81 days at December 31, 2008.

Inventories decreased to $38.7 million at December 31, 2009, from $46.3 million at December 31, 2008. The decrease in inventories was primarily related to a decrease in finished goods and raw materials.

Finally, I'll conclude with some statistics regarding our headcount numbers. But before I do, I would like to remind everyone that the Company implemented three reductions in force during the year ended December 31, 2009, to lower costs in view of the effects of the deteriorating global economic conditions.

The first reduction in force was announced on February 20, 2009, and affected approximately 7% of the Company's workforce. The second reduction in force, effective April 3, 2009, was announced on April 6, 2009, and affected approximately 14% of the Company's workforce. The third reduction in force was effective August 24, 2009, and affected approximately 8% of the Company's workforce.

As a result of these three reductions in force, the Company incurred $2.7 million in severance costs, with $900,000 in cost of sales, $1 million in selling, $700,000 in administration, and $100,000 in R&D. The Company expects to save approximately $17.3 million in compensation costs on an annualized basis, with $5.9 million from cost of sales, $6.2 million in selling, $3.4 million in administration, and $1.8 million in R&D.

We had 734 employees at December 31, 2009, compared to 959 at December 31, 2008, a decrease of 225 employees. Account manager headcount at December 31, 2009, was 146, with 42 account managers in the Americas, 51 account managers in Europe and 53 account managers in Asia. Geographically, we now have 297 employees in the Americas, 249 employees in Europe and 188 employees in the Asia-Pacific region.

I will now hand the call over to Jay.

Thanks, Keith. (Technical difficulty.)

So as expected, 2009 was an extremely difficult year. The first three quarters of the year were particularly tough. However, the fourth quarter started showing clear signs of improvement, so I'm going to start there with my comments today, for the second time.

Although sales in the fourth quarter declined when compared with 2008, sequential growth between Q3 and Q4 was actually quite strong at 29%. Now, I'm sure many of you are saying to yourself, "Well, sure, but Q4 is always the strongest quarter for FARO." And that's correct; however, the size of the increase we experienced in 2009 was fairly unusual. With the exception of a 33% increase in 2007, our historical sequential increase from Q3 to Q4 over the last five years has been anywhere from 5% to 15%. That makes this year's 29% increase fairly unique. And from what I'm seeing in the markets, it appears to be a positive sign for coming quarters.

Our targeted ratio of achieving a 50-50 sales split between new and existing customers also held firm in 2009 at 51% new and 49% existing. In the fourth quarter, we actually generated 53% of our sales from new customers. This continues to be a favorable sign. In a difficult environment, it could have been a lot easier to cherry pick sales from existing customers. However, the strong ratio of sales from new customers indicates that the ROI for our technology is compelling even in a tough environment.

As the economy continues to recover, we believe that customers will spend even more time searching for technologies which will make them more productive. Our solutions are an excellent fit for any customer looking to improve their own efficiency.

Just as all of our end markets contributed to the decline in 2009, no one vertical contributing more substantially, the recovery we experienced in Q4 followed the same path. One of the strengths of our company continues to be that we have minimal reliance on any one customer or vertical market. This gave us a lot of flexibility in 2009 and should continue to do so for us in 2010.

We have started experimenting with additional channels to market as we look for ways to accelerate our growth and the continued adoption of our technology. At the same time, we're driving our direct sales team to higher levels of productivity while ensuring we maintain the personalized touch with our customers, which has been so successful for us in the past.

We're also far better positioned as a company as we head into 2010. We took a lot of cost actions in 2009, amounting to approximately a 29% reduction in our employee base. These actions were difficult at the time, but they'll generate approximately $17 million in savings on a go-forward basis. We expect these savings to continue at least for the foreseeable future, because the team generated tremendous efficiency in their operations and created additional capacity despite having a sizably lower headcount.

Going forward, we will operate this lean, streamlined and decentralized structure. It allows us to move more quickly in the marketplace, and it will allow us to improve our business model substantially.

One area we didn't cut in 2009 was R&D spending. As Keith mentioned, we spent the exact same amount on R&D in 2009 that we did in 2008. Technology is a key component to the longevity of FARO, and I refuse to sacrifice our potential in this regard for some modest short-term financial benefits.

We would not have had the successful product releases of the photon laser scanner, the ion tracker and our Cam2 Q software in 2009 if we had reduced our R&D spending. We also wouldn't be in the position to be releasing new generations of virtually every product in 2010.

Because we maintained our R&D spending, we remain on track for an extremely active year of product releases. I believe we're on the verge of democratizing 3D measurement and imaging globally, and we intend to remain the world leader by constantly obsoleting existing offerings and driving the market aggressively towards new technology.

Finally, FARO remains an extremely healthy Company. We have $100 million of cash, no debt, a great product portfolio, and a full slate of product releases scheduled for 2010. Though I hate the financial results from 2009, I couldn't be happier with the way the FARO team adjusted and executed in this difficult environment, and I'm encouraged by the results we achieved in Q4, most notably the strong sequential sales growth and our return to profitability.

One thing I won't be doing in 2010 is issuing guidance. We did not issue guidance in 2009, and I believe that continues to be the responsible route to take. Despite my improving confidence in the overall business climate, there is still a very low level of visibility out there.

Now, as long as economic conditions do not deteriorate again, we should see growth in profitability for FARO in 2010. However, it is still way too early to comfortably predict that in any way that would be helpful to our investors, and that's why I will not be issuing guidance.

In closing, I'd like to thank the FARO team, our customers and our investors. Let's put 2009 behind us and move forward. I continue to see great opportunities for FARO in 2010 and beyond, and I intend to capture those opportunities as we execute our strategy.

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

Certainly (Operator instructions). And we will take our first question from Chuck Murphy with Sidoti & Company. Your line is open.

Morning, guys.

Morning, Chuck.

I'm just wondering, given how strong the fourth quarter was sequentially -- and that it was stronger than normal sequentially -- do you worry at all that maybe the first quarter would be down more than normal sequentially?

Yes, I can't necessarily -- I'm worrying about it more or less than typically. As you know, Q4 is -- or Q1 is almost always a decline. In fact, historically, I think it is always a decline from Q4 sequentially. A lot of that is just the historical atmosphere has been use it or lose it on CapEx budgets by our customers in Q4. That drives them to pop, and then they slow down a little bit in Q1 as they get their hands around the next year's business plan. So whether I think it will be more or less of a decline than typical, that's way too hard to predict.

Got you. Okay. And can we talk a little bit about the gross margin situation? I mean, would have thought it would be up a fair amount given how much sales improved. And I'm just wondering, was there any price discounting or what all was included there?

I think, again, our service margin has increased a little bit, but what you see happening is the change in the margin from the product sales primarily as a result of there's fewer arms that are being sold and more laser trackers and scanners. So, with the Arm product -- and we've talked about this in the past -- being ranked number one in terms of gross margin. When you have that Arm product sales declining, it's going to affect the overall product margin as well. But there was nothing abnormally unusual other than that.

Yes, and it would be too hard to predict at this point if that mix continues in 2010 or not. As you know, Arm is historically a very strong product line for us, so whether that was just a near-term phenomenon based on the customers who were buying versus what it looks like in 2010, it's obviously a little bit too early to tell that.

Got you. Okay. I'll hop back in the queue. Thanks.

Thanks, Chuck.

Thanks, Chuck.

We'll take our next question from Mark Jordan with Noble Financial. Your line is open.

Good morning, gentlemen. Couple of questions, one relative to the composition of where the sales came from in the fourth quarter. Was that an improvement in the closure rates of demos done in the quarter? Or how much of that incremental pop in sales would have been generated from demos that had been done previously in the year, where the customer base was kind of sitting on their hands?

Yes, I think you're seeing a little bit of both. I mean, we've got -- for sure, we had deals closing in Q4 that had been demo'd in Q's 1, 2 and 3, and the customers just had no idea whether they could spend or not. No doubt, we had some that were new activities that closed within the same quarter, where the customer hadn't even wanted a demo before and took the demo and made the sale happen at the same time. So I think it was a little bit of both.

As you know, the pipeline of opportunities throughout 2009 continued to grow at our normalized rates, so we had this huge build up of opportunities in the pipeline. So it's possible as we go into 2010 that we'll continue to see some of that. We've got deals that had already been demo'd, where the customer finally has some budgetary dollars available. They don't need to put it into any of their other capital expenditures. They're not repairing machine tools at the same clip, the facility is stable again, and so we may see some of that benefit in 2010.

Now, that being said, I still think we obviously have to do a lot of demos at our normalized rates anyways, just to ensure that we continue driving that growth.

Okay. Second question, and then I'll hop off. It relates to the G&A expenses relative to the IRS and litigation. Could you flesh out a little bit more -- and I'm sorry if I missed it. I was off the call for a while -- relative to what specifically was the IRS issue and why is it non-recurring? And of the $750,000, what was that was IRS-related versus litigation, and what should we expect on the litigation front through 2010?

I'll let Keith talk about the IRS piece, and then I'll wrap up that with a quick discussion about the litigation and where we're at.

Well, let me give you the breakdown of the incremental expense of $750,000. $300,000 was related to professional fees for the IRS settlement, and the $450,000 was related to professional fees regarding the patent litigation.

Now, what the actual IRS settlement was all about -- first of all, the years were 2005 through 2007, and it related to the valuation of some intangible assets that we contributed to a foreign subsidiary quite a few years ago. They went back; they did a revaluation of those assets, and that's why it's a one-time effect, and it really doesn't affect our tax rate or our tax structure going forward.

And relative to the litigation, obviously it's tied to the patent case that we have currently pending with what was Metris and now is Nikon after the acquisition of Metris by Nikon earlier last year. We continue to feel very good about our position in the case. As a reminder, there's two patents in question here, both of which we are very certain that we don't infringe. It's our belief that they just don't understand how our technology works.

And we are confident enough that we actually, within the last month, have filed motion for summary judgment to push this forward, which essentially means going forward without -- going straight to the judge without a jury trial. And we will not hear anything back on that probably for, my guess is, a couple of months at least, just given the way the court system works. That's hard to predict. It's just a matter of, obviously, caseload for the judge currently handling this particular case.

But that's where the dollars are coming from. Obviously, we are expecting some dollars to continue in 2010 given that it's still open at the moment, but as always, we are working to get this resolved as quickly as we can, too.

Just any gauge as a range of potential expenses that might be incurred -- high side, low side -- in 2010?

I don't think we have a range that we could predict. Could it be at the same run rate if it took the entire year? I guess that's always possible, but it's just way too hard to predict, Mark.

Thank you.

Thanks, Mark.

We'll take our next question from Rob Mason with R.W. Baird. Your line is open.

Yes. Good morning, Jay and Keith.

Hi, Rob.

With respect to the $17 million in structural savings that we're going to -- that we captured from the actions we took in 2009, how much of the $17 million do you think you captured in 2009?

Well, that's a hard number to actually get your hands around because these RIF occurred over different quarters. It affected a different mix of people, some up in cost of sales, up in direct labor, some down in the operating expenses. You could maybe do a quick math and say if most of the RIF occurred maybe in the first three quarters, quite possibly you may have achieved one-quarter of that number.

Yes. At a full run rate, I would suspect Q4 -- I think we achieved all of that number on a quarterly basis. But yes, Keith is right, you figure two-thirds of the affected people really occurred during the first quarter. You had some severance there. Some -- and then you had the other third affected in the third quarter with severance there. The severance amounts were different between the two quarters based on the types of people and the level of the people that we rolled out. Q4 I think probably is a fair representation of -- we probably got the full quarter's worth of savings out of Q4.

Okay. So maybe just rough estimation, roughly half or better of the savings will carry into 2010, will annualize in 2010?

Well, actually we -- obviously, we think that the bulk of the $17 million is in -- you get the whole amount in 2010. The one area where -- that -- depending on R&D spending, where you could see some shifts there, but in the other areas, we feel like there's minimal to zero reason to add back given the amount of productivity the team has achieved and the capacity they've created on the manufacturing side, on the service side, where there obviously were heads affected, and then on the admin side, where we've pulled people out and restructured our processes and changed how we do things.

I see minimal reason to add back to that number, except in, like I said, a couple of small cases, maybe in R&D and, if you really got pressed, if production volumes swung so much you got pressed and you had to add a couple back at some point on the production side. Otherwise, it should maintain itself.

Okay. Okay. So with that thought in mind and the idea that we'll run perhaps a leaner organization given some of those changes going forward, can you give us a sense of what you think your organization -- as it's configured today, from a revenue standpoint, what it can support?

Generally speaking -- and obviously, Rob, this is really -- it's hard to predict because it depends on product mix and where -- which manufacturing plant needs to increase their loads, at what rates and things like that.

Sure.

But I mean, I believe the capacity the team created probably at least gets us back to the levels we were at -- kind of our peak as a Company was the $209 million in revenue we achieved in 2008. I believe that the team can get itself there certainly with the new structure that we have in place from a headcount standpoint. And then at that point, there may be some challenges where we need to start adding back a few people. Again, predominantly it would be on -- maybe some on the sales side, maybe some on the production side at that point. I still believe that on the admin side we've actually got ourselves in a position where this structure can maintain itself much further than that.

Okay. Okay. And maybe just one last question. As I look at the regional figures that you gave, Keith, perhaps what stepped out is Europe increased the most sequentially. And just given the general or conventional wisdom that Europe is tending to lag both the US and Asia-Pacific in a recovery, could you explain why Europe was as strong as it was for you?

Well, this is Jay. I guess I don't want to say it's a fluke, because that's not the right word at all, but I think that they just -- generally speaking, number one, Q3 obviously is a little bit lower in Europe than typically the other regions. So you get a little bit of benefit there. But if you look at it compared to 2008, you say, well, Q3 in 2008 was slow like it always is too because of the August effect.

We had some good deals that came through, and they may have just closed at a slightly higher rate than in the other two regions, but I can't say that there's something that fundamentally was so different in Europe that you would point to it and say, yes, that was the biggest driver for it.

Right. Yes, there was no particular customer and no particular industry in Europe that stood out in Q4 relative to their historical mix. I think it's probably fairly similar to the US, where maybe things just started to turn around a little bit.

Okay.

We'll take our next question from Ajit Pai with Thomas Weisel. Your line is open.

Yes, good morning and congratulations on a solid quarter.

Thanks, Ajit.

Thanks.

A couple of quick questions. I think the first one is just looking at your gross margins. I think you have addressed why the gross margins were relatively low or expanded very modestly sequentially. I think you talked about mix issues, both within products as well as you talked about the mix of services relative to products. But going forward, at what level do you think that you can get back to the 60% gross margin? What would the quarterly revenue level have to be? And do you think that the mix shift -- most of your demand I take it is coming from products rather than services right now, in the order book at least, so how quickly do you expect to get back to 60% gross margins?

Well, certainly the intent is to get back to 60%, and we still believe, without giving any time cycle on it, that we could probably go higher than that at some point also. The easy answer would be, well, if we get ourselves back to that kind of 209 mark that we were at in 2008, that would make some logical sense because the bulk of our decline this past year was in product sales. You would expect that all the increases now will come from product sales, which should start ratcheting the gross margins back up.

It's the easy answer. I can't say that that's absolutely the right number, though, Ajit, obviously. Could it happen quicker than that? Sure. We've had some cost productivity on some things that could help. Could it be a little slower than that if we feel any price pressure? Maybe.

No doubt, the new products, as they start rolling out -- it's not just changing the technology and giving something that's dramatically different to the marketplace. We get cost benefit for sure in each of the new products as they roll out also, and that helps create some of that breathing room too.

Got it. And then the second question would be just looking at your OpEx on a sequential basis between December and March. Outside of the specifics that you've called out already, is there any reason why on a sequential basis there were any costs that were taken out during December -- I know your last restructuring announcement was in August -- that would be captured in the full quarter in March and wasn't captured in the full quarter in December?

No, I don't think so. I think primarily in the fourth quarter of 2009, we had additional professional fees, as I talked about earlier, related to the IRS settlement and the patent litigation. And the patent litigation is a wildcard. We'll incur expenses as quickly as the case proceeds. But other than that, those are the --

Yes, but from a cost structure perspective, the December quarter had the full impact of all the restructuring, streamlining, everything that's been done so far. So sequentially, from December to March, we don't expect any sort of full-quarter impact. We only got a partial impact from December from a broader basis, not one of these one-times. Is that fair?

That's right. We did receive the benefit of those RIFs in the fourth quarter, and that would be expected to continue into the first quarter.

I think the only piece that I would look at -- for everybody as you're thinking about 2010 -- is 2009 does not include any bonuses for anybody in the Company. And so, assuming 2010, if things are moving in the right direction, we might expect to pay some bonuses again in 2010, so you might see some modest increases to the cost lines there, but it would not be because of incremental heads or anything of the like. It's only as we -- if we felt comfortable putting back some of the bonus money, we would do so at that point. And that's probably the one big differentiator between what we did in 2009 and what you might see in 2010.

Got it. And then the last question would be, just looking at the M&A environment and looking at the net cash on your balance sheet, is there a pipeline right now, given the stress in the markets, smaller players probably going through more stress? Are you seeing a fairly rich pipeline of acquisitions than what you had thought right now in terms of where your company is and your comfort level of making additional acquisitions?

I would say that there is always an interesting pipeline. I can't say that the markets being distressed in any way, shape or form would increase that necessarily. The pipeline we've been looking at has always been pretty strong, and we move potential acquisitions in and out of there on a fairly regular basis.

We have no discomfort making an acquisition if it is the right fit for the Company. It either brings some technology, it brings some channel, it focuses on areas that we want to focus on, such as software applications or noncontact technology that can get us into broader, different types of markets. Those are all the same types of technologies we continue to look at. But I can't say the environment itself necessarily guarantees a better chance of doing some of these deals, and I think these companies we would be looking at regardless of the environment.

Got it. Thank you so much.

Thanks, Ajit.

Thanks.

And we will take our next question from Andy Schopick with Nutmeg Securities. Your line is open.

Thank you, and good morning. I can't blame you for hesitating to offer any guidance, but I do want to ask one question on the tax rate given what I've heard. Would it be fair to assume, for those of us trying to model the Company's performance, that we could use a effective tax rate of, say, 26%, 28% for this calendar year?

Yes, that sounds about right. As we talked about, this did not impact our rate going forward, and I believe the 25%, maybe to 27%, rate going forward is probably a good rate to model. It all depends on the mix of the taxable income in our various regions.

I understand that, but that, for working purposes, is a ballpark kind of an estimate?

Right.

Okay. Let's go back to Europe, Jay. How does the current turmoil in the euro zone -- and I'm referring to Greece, but of course it could extend beyond Greece. How is this affecting business right now, or what concerns do you have that it could be an impediment to your activities in Europe based on what actually transpires?

Yes, I mean, obviously we watch it, because anything that could drive the economy would be a concern if it -- in that regard. And we do a lot in Germany and we know that Germany is heavily involved in helping drive and spearhead some of this. We don't do a significant amount of business in Greece itself, so obviously a little bit less concern about just overall macroeconomic impacts there.

When we look at the industries and the verticals in Europe, hey, look, we had pretty good cash-for-clunkers programs running across Europe in 2009. As those start to wind down, would that have some impact potentially negatively or positively on FARO? Possibly. We sell to that market, obviously. Aerospace has continued to be pretty strong there, just like it was around the world, in 2009, so a little less concern there.

I think, again, it's still -- if you go back to just, in a general macroeconomic sense, if something really dramatic happened in the euro zone that was impacting multiple countries, then obviously that would have some impact on us. I think individual events tied to -- unless Greece dragged everybody down because of the amount that needs to be -- the amount of help that they require, I think the impact to us is a little bit lower.

One last one, on the foreign exchange component of this. How much of your foreign exchange activities are related to the euro versus the yen?

We typically don't break out FX by type of currency, but you can imagine the euro is fairly significant, and in Asia the yen is a fairly large component of that FX component for Asia as well.

But generally speaking, if you look at it and said, well, 40% of our sales occur in Europe, and almost all of it is in Euros, and 20% of our sales happen in Asia, and it's nowhere close to the bulk of the 20%, even though Japan is a big piece of Asia, obviously, but it's not the full 20%. That can give you some rough order of magnitude perhaps to model.

Yes, that helps a lot. Thank you.

And it appears we have a follow up from Chuck Murphy with Sidoti & Company. Your line is open.

Hi, guys. I think one of you mentioned before that you were looking at new channels to market. Have you used any of these new channels yet, and what are they?

Yes. We've started testing them. One obvious one is distributors. There are some opportunities with products like the Gage. And not just the Gage, quite frankly, but starting with the Gage and moving to potentially LS, potentially even the Arm. That gives us some opportunity there, so we are testing that in all three regions.

It's not that we haven't used distributors in the past, as you'll recall. Countries where we didn't have a direct presence, we would use distributors to start testing the market, so this is expanding that, putting those distributors in place to actually pick up additional coverage in the countries that we're already located in and managing it in that regard from a more feet on the street standpoint.

Partnerships with other OEM players not necessarily in our space but directly tied to our space, but not obviously directly competing in the space. That is a logical one that we are looking at. That could be both on the software side as well as the hardware side, and we've got a couple of things in the works there right now.

And then continuing programs, like the test drive that we launched last year was pretty successful. We got a nice revenue stream out of that during the second half of the year in the United States, and looking to remarket and expand that even further. So trying programs like that, which that is a different method in the doorway. Obviously, from a customer, it allows them to prove some ROI first before making the full commitment on the product.

We still think even as economic conditions improve, that actually is a model that probably has benefit to customers regardless of the current economic conditions. And we need to keep refining that model and making it a core way of going to market.

Got you. Okay. And my last one was, can you give us an update on the SCPA settlement and whether you're going to have that external monitor come in?

Yes. Obviously, the settlement was a while ago now. The only piece that has remained open is, in fact, would we get a monitor or not. The agreement that we had reached was that -- part of the agreement was that we would have a monitor for a three-year time period and the -- or a two-year time period and that that would run from July -- I don't remember the exact date, but July of 2008 until July of 2010.

So everything that we have heard is that, yes, the clock is running and it is, in fact, stopping in July of 2010. We still have not had the monitor onsite at all. We've actually not even initiated any work with the monitor. It's been a couple of months, several months probably now, since we heard anything from the DOJ relative to the case, and so we're still in kind of a wait-and-see mode.

I assume that at some point the monitor may start and do some quick work before the clock expires here in July. At the same time, the Company has been extremely efficient. We've been extremely effective with everything that we've done in Asia, and obviously we've had zero repeat types of issues over there or anything of the like. So in that regard, the controls that were put in place have been extraordinarily effective also. So even if the monitor does come for some short time period, I do still feel comfortable with the position that we're in if they do have to come in here.

Got you. Okay, thank you.

And we have a follow up from Rob Mason with R.W. Baird. Your line is open.

Yes, guys, I know in the past the fourth quarter sometimes will contain a higher level of revenue from demo inventory. Did that have any impact this quarter? Did that have any bearing on the gross margin performance?

I think there is always an effort to keep that demo inventory moving, and I think there was quite a bit of that activity in the fourth quarter. But I don't think it was such that it had any material effect on the margin or on the sales number either.

Yes. We even proactively -- and last year was a good opportunity to try it, Rob, obviously trying to move more of it in each quarter versus having a slower kind of build up into Q4. Last year was a good time to try it because the economy was a little bit lower. There was some price sensitivity out there, not that we really saw it in our overall pricing scheme. But it was an opportunity to move more demo gear perhaps a little bit more efficiently across the quarters, which I would always prefer to do.

Sure. Keith, do you happen to have the year-end demo inventory number? And then while you're looking for that, I did want to circle back on the tax rate just a moment. Are we essentially widening the tax rate range, or are we raising it? I think in the past we thought 20% to 25% was a reasonable range to use. Are we moving that low end up?

Well, let me answer your demo question first. We had about $16 million in demo inventory at the end of the year.

Okay.

And with regards to the tax rate, if you'll recall, we have a negotiated tax treaty with Singapore, and the first piece of that treaty was at 0%, and that piece ended December 31, 2009. Then we move into another phase through 2013, and that's at a 10% rate. So that changed from a 0% to a 10%. That accounts for primarily most of that increase from the 20% to 22% up to the 25% range.

Okay. But just to be clear, so 25% to 28%? Is that what I heard you say?

That's right. Again, it depends on the mix of the taxable income by region.

Okay. Sure.

That's right.

Okay. Thank you.

And it appears we have no further questions at this time.

Very good. Well, thanks, everybody, for joining the call today, and we look forward to updating everyone at the end of the first quarter here. Thanks very much.

This concludes today's teleconference. You may now disconnect, and have a great day.