FARO Technologies Inc (FARO) 2010 Q3 法說會逐字稿

(Operator Instructions)

Good morning, everyone, and welcome to the FARO Technologies Conference call in conjunction with its Third Quarter 2010 Earnings Release. For opening remarks and introductions, I will now turn the call over to Vic Allgeier. Please go ahead, sir.

Thank you, and good morning, everyone. My name is Vic Allgeier, the TTC Group, FARO's Investor 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 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 SEC.

I'll now turn the call over to Keith.

Thank you, Vic, and good morning, everyone. Sales in the third quarter of 2010 were $45.3 million, a 26.8% increase from $35.7 million in the third quarter of 2009.

On a regional basis, third quarter sales in 2010 in the Americas increased $3.7 million, or 26.9%, to $17.4 million compared to $13.7 million in the third quarter of 2009.

Sales increased 13.8% in Europe to $16.6 million from $14.6 million in the third quarter of 2009. Sales in the Asia-Pacific region were up 52.2% to $11.3 million from $7.4 million in the third quarter of 2009. The effect of changes in foreign exchange rates on sales was a decrease of approximately $1.2 million in the third quarter of 2010.

New orders increased 30.7% in the third quarter of 2010 to approximately $46.8 million compared to approximately $35.8 million in the third quarter of 2009. On a regional basis, third quarter orders in 2010 in the Americas increased 34.3% to $18.8 million compared to $14 million in the third quarter of 2009.

Orders increased 12.2% in Europe to $16.6 million from $14.8 million in the third quarter of 2009. Orders in the Asia-Pacific region increased 62.9% to $11.4 million compared to $7 million in the year-ago quarter.

The top five customers by sales volume in the third quarter of 2010 were the US Military, Airbus, Daimler AG, Premium AEROTEC GmbH and Goodyear Tire & Rubber Company and represented only 6.5% of sales. The top ten customers in the third quarter of 2010 represented only 9.1% of our sales, once again, indicating our lack of dependence on any one or a handful of customers.

Our gross margin was 58.3% in the third quarter of 2010 compared to 54.9% in the year-ago quarter. This increase was primarily due to a change in the sales mix between higher margin product sales and lower margin service revenue resulting from an increase in higher margin product sales.

As a percentage of sales, selling expenses declined to 25.9% of sales in the third quarter of 2010 compared to 32.2% in the year-ago quarter. Selling expenses increased by $200,000 to $11.7 million in the third quarter of 2010 from $11.5 million in the third quarter of 2009.

As a percentage of sales, administrative expenses were 15.9% of sales in the third quarter of 2010 compared to 17.2% in the third quarter of 2009. Administrative expenses in the third quarter of 2010 increased by $1 million to $7.2 million from $6.2 million in the third quarter of 2009, primarily as a result of an increase of $800,000 related to the cost of the monitor in connection with the DOJ and SEC settlement and legal fees related to patent litigation of $400,000 offset by a decrease in compensation of $200,000 due to reduced headcount.

Research and development expenses remained flat at $2.8 million for the third quarter of 2010 and 2009. R&D expenses declined to 6.3% of sales in the third quarter of 2009 compared to 7.8% in the prior-year period.

Operating margin for the third quarter of 2010 was 6.3% compared to a negative margin of 6.3% in the year-ago quarter as a result of the previously mentioned increase in sales and gross margin.

Net foreign currency transaction gains were $500,000 in the third quarter of 2010 compared to a gain of $200,000 in the third quarter of 2009. Foreign exchange gains and losses result from inter-company transactions and changes in the value of the inter-company account balances denominated in different currencies.

Income tax expense increased by $1.9 million to $1.1 million in the third quarter of 2010, from a benefit of $800,000 in the third quarter of 2009. The Company's effective tax rate for the third quarter of 2010 was 32% compared to an effective tax benefit rate of 37.6% for the third quarter of 2009, primarily due to an increase in taxable income.

Net income increased to $2.3 million, or $0.14 a share, in the third quarter of 2010 compared to a net loss of $1.3 million, or $0.08 per share, in the third quarter of 2009. The number of fully diluted shares outstanding in the third quarter of 2010 was 16.3 million compared to 16.1 million in the third quarter of 2009.

I will now discuss a few balance sheet and cash flow items. Cash and short-term investments were $409.6 million at October 2nd, 2010, compared to $100.1 million at December 31st, 2009, and include $65 million of US Treasury bills.

Accounts receivable was $43.2 million at October 2nd, 2010, compared to $42.9 million at December 31st, 2009.

Days sales outstanding at October 2nd, 2010, increased to 87 days from 85 days at December 31st, 2009, primarily as a result of an extension of the collection cycle in Europe.

Inventories increased by $3.2 million to $41.8 million at October 2nd, 2010, from $38.6 million at December 31st, 2009, primarily as a result of an increase in raw materials and finished goods.

Finally, I'll conclude with some statistics regarding our headcount numbers. We had 774 employees at October 2nd, 2010, compared to 734 at December 31st, 2009, an increase of 40 or 5.4%.

Account manager headcount increased from 146 at December 31st, 2009, to 152 at October 2nd, 2010. We now have 44 account managers in the Americas, 52 account managers in Europe and 56 account managers in Asia.

Geographically, we now have 310 employees in the Americas, 260 employees in Europe and 204 employees in the Asia-Pacific region.

I will now hand the call over to Jay.

Thanks, Keith. Market conditions for our customers continue to improve. They're seeing increased demand from their own customers and, as a result, they're investing in their businesses again.

FARO's technology is viewed as the market leader and, as a result, customers are choosing FARO to help them generate productivity in their operations. We've grown more than 30% year to date, and we continue to see favorable signs across all the verticals we sell into.

Historically, sales have declined approximately 10% sequentially from the second quarter to the third quarter of each year due to August holidays and plant shutdowns. This year, however, buying patterns shifted. Sales stayed relatively flat instead of declining, and orders actually grew sequentially from Q2 to Q3.

This may be an anomaly that we see only in 2010, but I think it's indicative of the overall improvement we're seeing in the manufacturing world. Customers are running their plants at significantly higher capacity than they did in 2009, and they're doing so without increasing their headcount, which again drives the need for productivity solutions like ours.

Pricing remains strong due to the compelling ROI our devices produce. Our prices -- although our prices remain higher than our primary competitor, we continue to win most of the deals where we compete with them. Likewise, product cost has been flat or lower, and the supply chain has responded well to our rapid increase in sales this year.

Gross margin declined slightly between the second and third quarter, primarily driven by sales of older laser scanners and demo units to make room for the new Focus 3D, which we released four weeks ago. Year to date, gross margin is just below 60%, and I believe that we'll see continued strength in gross margin going forward.

As you may have read, we announced a new partnership with Carl Zeiss in the third quarter, the Innovative Solutions Network. This partnership is focused in North America at the moment, but we expect to expand it globally over the coming months.

Zeiss is the world leader in fixed-space metrology equipment, just as FARO is the world leader in portable metrology equipment. There is almost no overlap in our offerings, which of course makes the relationship very complementary for both parties.

To be clear, this is not a joint venture, and neither party has made an investment in the other. It is purely a marketing relationship, which will allow us to leverage the two top brands in this space. It will create a strong network for both the existing customers we already share as well as the new customers we'll continue to add.

Zeiss and FARO account managers will work together, as will the marketing teams, on a broad range of initiatives. We expect the network to provide real value to all of our customers, and I'll provide periodic updates as we move forward.

We recently introduced two new products, the FARO AMP and the FARO laser scanner, Focus 3D. Both of these products are revolutionary in their own right.

The AMP is a highly accurate, non-contact device to be used in the same manufacturing segments where we already sell. This initial launch is meant to be a device, which gets our feet wet. We believe subsequent generations will be the real game-changers.

The Focus 3D, our new laser scanner, is one of the most disruptive technology offerings I've been associated with. The laser scanner is a non-contact device, which creates highly accurate, 3-dimensional models of large spaces in a very short amount of time. In operation, the laser scanner only needs a couple of minutes to collect millions of 3D data points and create an initial working model.

The disruption created by our newest release comes from the technical achievements as well as how we've priced it in the market. The Focus 3D is five times smaller and four times lighter than its predecessor.

It has full color capability built in rather than having a large camera attached to the top. It has a built-in five-hour rechargeable battery. It has a very intuitive, on-board, touch-screen display, which allows full operation of the unit as well as scan viewing.

Scans are stored on a standard SD card, which is easily removed. No laptop is needed, period. IT has the same accuracy as its predecessor, and it has a 10% improvement in noise, an essential element in the quality of the scan data. Finally, we priced it 60% lower than the previous unit without sacrificing any gross margin.

There's not a unit in the market that can come close to the Focus 3D. We launched it at the Intergeo Show in Germany 1 month ago. At the show, the Focus 3D was the only product we had on display. Attendees were lined up five and six people deep at each of the viewing stands to get their first look at the device.

We generated more leads in the first day than we had during the entire week at the same show the previous year. Best of all, the Intergeo Show is primarily geared toward -- geared towards surveying, a vertical we haven't really focused on previously.

For the last five years, I've said that the laser scanner had not yet crossed the chasm from early adopters into the early majority of the marketplace. With the Focus 3D, it appears we have made that jump.

We've always been an aggressive R&D company. Over the last two years, we've gotten even more aggressive. I've been very open about the fact that we would be disruptive to the marketplace and we would disrupt on a regular basis.

The release of the Focus 3D and the AMP, are just the beginning. All of our products are receiving substantial generational makeovers right now. The next six to nine months should be equally exciting for us on the R&D front, and we expect to continue our aggressive R&D push in the subsequent years as well.

During the third quarter, we had the first review by the monitor that was assigned to us in connection with our settlement with the SEC and DOJ over the FCPA matter from 2006.

The cost to FARO in the third quarter was approximately $1 million, which obviously had a substantial impact on the bottom line. The monitor and her team visited several of our remote offices as well as our regional and global headquarters, conducting interviews and reviewing, policies, procedures and adherence to them.

Overall, we believe the review went well and look forward to reviewing the monitor's report. The monitor will return one more time next year, probably in the third quarter again. We don't expect that review to be as costly as the one we just finished. And, assuming things go well, that will complete the process.

Our patency with Nikon continues. We're in -- we're currently in the hearing phase of our motion we put forward charging inequitable conduct. We feel good about all our positions. We remain ready to settle if we can negotiate favorable terms. However, at the moment, we believe it is better for us to follow the path we've been on.

2010 remains on track, and we're starting to feel good about 2011 as well. The FARO team has executed well. Sales are strong, and the operation is tight. I'd like to thank our team around the world for demonstrating every day their ability to innovate and execute.

As always, I'll also thank our customers for placing their trust in FARO and our investors for believing in us. I appreciate your attention, and I will now open the call to questions.

(Operator Instructions)

We will take our first question from Mark Jordan with Noble Financial. Please go ahead.

Good morning, Jay. I was wondering, just to clarify on the monitor costs, you assume that there will be no expenses until a year from now when they come in for the follow-ups. So the next three quarters should -- there should be nominal expense. Is that correct?

That's correct, Mark.

And then, secondly, I'm sorry I missed the headcount by region and total again. Could I get those numbers, please?

Yes, sure. We had 774 employees at October 2nd. And on a regional basis, we had 310 employees in the Americas, 260 employees in Europe and 204 employees in the Asia-Pacific region.

Okay. Thank you. And I guess a final question relative to your closure metrics, has there been any substantive change in terms of sales force productivity? Or are you still running at sort of the same kind of average rates you had in the last couple of quarters in terms of closure rates?

Yes, we're definitely seeing improvement in the productivity. The account manager headcount is only up six people since the end of 2009. And so when you look at the sales growth that's been generated here, 30% plus, that, clearly, we're seeing improved productivity from the team.

We will still add a few folks here and there at best as we go forward here, at least the next couple of quarters. At some point, you will see us start adding more account managers again at slightly higher levels. And that should be expected because there is still a bit of a max capacity for each particular account manager. But we're only going to do that as we really get close to the time where it's required.

Okay. A final question relative to R&D; you mentioned you've got a lot of very robust new product introduction pipeline. You've been spending at a pretty decent clip, a very consistent clip over the last year and a half.

Is this something that will peak? Or, as you get -- roll out this mixed generation of products, should we expect that just R&D will continue to be kind of flattish moving forward from 2011?

No, I think you'll see us continue to increase R&D spending. But the caveat they'll put on it is it's somewhat related to our sales growth. We still target roughly 5% to 7% of sales to be spent in R&D. So in the fact that we expect sales to continue growing, as long as we stay in that 5% to 7% range, obviously, the raw dollar would increase in some appropriate fashion.

And, obviously, we look at it. It's a program-to-program basis. So we have good projects we're putting the money into. So we're not increasing it just to increase it. We actually have known activities and hard projects identified when we put the people in place and the additional expenses in place.

Okay, thank you very much.

Thanks, Mark.

And we will take our next question from Jim Ricchiuti with Needham & Company. Please go ahead.

Hi, thank you. Just with respect to clearing out some of the older product in terms of the impact that had on gross margins, product gross margins, in the quarter, do you feel you're pretty much through that?

Yes, I mean it's -- you always have a little bit of that. The laser scanner; because the product was such a game changer, we knew that the previous [gem] was clearly obsolete. So we wanted to make sure we removed as many of those as possible from the pool.

Given that we have other product releases coming, you'd expect us to do similar sort of wind downs and ramp ups because they're a substantial change as well. I don't think it will impact us to the point where you see gross margin move two or three points, let's say. I mean, I think we feel pretty good and consistent.

We're right around that 60% range, and we have been hovering around there for a while. I still think that's a pretty good number.

Okay, and just with respect to OpEx in the quarter, should we assume -- I don't know if you could help us at all with legal expense. You're not going to have the big chunk of legal expense this quarter. But is there any other additional expense that we might be aware of this quarter and factoring in?

Yes, I mean, obviously, the -- as Mark had pointed out, the monitor expense comes down to a crawl for the next few quarters. So that's a good thing. That's a positive that doesn't repeat in Q4, Q1 and Q2, again, assuming few returns in Q3. I assume it'll be Q3 and not Q2. But it's -- at this point, it's kind of irrelevant.

While, obviously, the patent case continues, we had a lot of activity in Q2 because we were in the hearing phase for a portion of the patent case. That probably slows down a bit here in Q4 and Q1.

But, unfortunately, as you know, once you're into sort of hearing and trial phases, it's a little bit harder to predict. And you get some ramp ups and ramp downs. But I think it will be a little bit lower here for a while at least.

And, Jay, one last question; just with respect to the new products, it's going to be -- it sounds like a pretty active year for new product launches. Can you talk a little bit about -- you touched on some of the response so far to the new product. But is there any sense as to how you could see the ramp up of some of the new product this year?

Yes, well I think, number one, I will say that the initial results are very favorable. Not unexpectedly, when you've got a product that you think has finally crossed the chasm, you'd expect to see a fairly decent ramp up as well.

And I'll remind everybody I say that knowing that laser scanner has been our -- it was always the lowest sales volume for us as a company. So it's coming off of a pretty low base to begin with.

We -- and I've also said for quite a while that there is a distinct possibility that at some point in time the laser scanner could outsell all of the other products. And we're certainly not going to see that in the next year over the next 12 months or even 24 months probably.

But there has been a substantial amount of demand coming out of the show and coming out of the first demos that have been taken around the world. We have revisited our capacity planning again to make sure that we, in fact, will be able to respond to the next 12 to 24 months within the current FARO system.

The nice thing is, similar to all of our other products we have extreme flexibility and can produce at sizably higher output levels without adding a whole lot more to the facility to the plant. There's not a lot of CapEx involved. It's more -- we have more of the capacity planning from a people standpoint and for the supply chain.

And even on the people side, it's, again, one of those products where we can get substantial leverage on output without bringing in a whole lot more people.

And normally Q4 would be seasonably strong. You had, I guess a -- you didn't experience as much seasonality in Q3. How should we think about Q4 seasonality?

Given our history, and even last year when things were so ugly through the year, Q4 was still pretty good. You still had a lot of that budget flush. So we do expect Q4 to be very robust.

Okay, thanks very much.

Thanks, Jim.

And we will take our next question from Andy Schopick with Nutmeg Securities. Please go ahead.

Thank you very much. A follow-up question here on the Focus 3D. Have you looked at how many potential new market opportunities, a device such as this might open up for the Company?

We have. The device, previously, when it was an early adopter, we really -- it was niched into a couple of key areas. You saw a lot of use in just sort of plant documentation, a little bit in process power and pipe, a little bit in heritage. And we do expect all of those to accelerate now with the new product.

But what it really starts getting into is, for sure, that surveying space, the response we receive from the show is a pretty clear indicator of the power of the device for that field.

We have long said that forensics is a very substantial opportunity for us. And the price and the product itself was kind of the hold back for getting the forensics. So I think we'll see a lot more activity there.

The insurance world; I think we'll see a lot of activity in the insurance world at some point in time here. And I think on the construction side, which is not quite the same as the survey side, this is truly -- I look at the construction side as being tied more to architecture. I think we'll see a lot of increase from that group as well.

The thing that's interesting with the device as we've released it and we start moving forward is that there are other potential markets out there that, as people start playing with the device and using the device, that we could see more verticals kind of show up at that point in time. And certainly as they do we'll discuss them.

But I do believe you're going to see a lot of non-manufacturing-related use, far more non-manufacturing-related use than manufacturing related now that we have the product in the market.

And we think the overall market size -- we've said before the total adjustable market for all our technology is somewhere between $3 billion to $5 billion a year. And so the release of the Focus starts giving us access to the higher ends of that range in terms of what the addressable market should be. Now, obviously, we've got to drive the adoption side because it's not a technology that's really being used at all today.

Will you be addressing additional members of -- will this become a product family that can be scaled up or down to address different types of applications?

Yes, what I see happening is, right now, the Focus has to be released. It has two different ranges. There's a 20-meter range and a 120-meter range.

What I think you'll see is the device itself, because it's really just the collection of the data points and the simplicity of the processing of those points, is one aspect.

And then to address the different verticals, I think you will see different layers of application software that will be thrown on top. And those will be where you've got the scalability and you've got differentiation from one vertical to the next. It will be less in the device, I think, than it will be in the software.

That's great. Keith, a couple of quick ones for you, please; R&D tax credit, if it's renewed and retroactive to the beginning of this year, about how would that impact your results in terms of either the effective tax rate or the dollar amount of the credit that you might receive based on your understanding today?

Yes, we typically wouldn't disclose that number until you see that ending up in a footnote. So, right now, it clearly is going to have a favorable impact. The actual percentage number was a dollar amount I'm not exactly sure at this point.

Could you repeat the number of account managers in Asia-Pac for me?

Sure. We have 56 account managers in Asia.

And, finally, the FX losses, translation losses, what were they in the quarter?

Transactions gained in the quarter?

Transaction -- yes, the gain loss from foreign exchange.

That was $500,000.

$500,000; are you doing anything to mitigate foreign exchange fluctuations going forward?

As far as entering into hedging contracts --?

Yes.

No, we are not.

Okay. So you're basically going to be -- continue to be exposed to the euro yen primarily?

That's right.

Okay, thank you.

And we will take our next question from Robert Mason with Robert W. Baird. Please go ahead.

Yes, good morning, Jay and Keith.

Hey, Rob.

Keith, or I guess, Jay, I'll pose this question to you. You had mentioned you would add additional account managers when you deem appropriate. In the past, you've referenced a $200 million revenue run rate as perhaps a trigger to be more aggressive on the headcount addition side. Is that still kind of what your thought process revolves around?

Yes, generally speaking, I think that's correct. It might be a little more than $200 million.

But -- and one of the things that we're seeing almost immediately out of the gates here is that the laser scanner, the new one, has really opened the doors to a distribution network that wasn't necessarily interested or potentially available to us before.

So the raw number side of this, the normal math, for lack of a better word, probably changes a bit, particularly as it relates to the laser scanner. So that's where I say maybe the number's a little bit higher because you're going to see some increase coming from LS. And that may be driven more by distribution than it would be by -- from adding additional account managers. We're going to have to see on that one.

But, otherwise, yes, a little more than $200 million; I think you start seeing us add some heads at that point because we still have productivity to go with the current guys. We're definitely seeing improvement there that still has some runway.

Okay, maybe I'll come back to the scanner comment. But you added roughly 20 people overall, but very few account managers. Where were most of those adds slotted? One, I think you added 20 people sequentially --

Yes.

-- and I guess, 40 or so year to date.

Many of those were in customer service --

Right.

Primarily --

Yes, account --

Spread throughout all the regions.

Exactly. Application engineers, phone support; we continue to expand service presence within individual countries; China, Japan, India; making sure we have the right -- because, in a lot of cases, it's easy -- in Europe, it's easy to get everything back to Switzerland and Germany to do service work and return it. In Asia, it's a lot harder to get stuff back to Singapore. So setting up that local capacity is pretty important for the customer.

Okay. And then just back to the laser scanner, do you have a dedicated sales force to sell that product today? Or do they sell your other products?

We do have a dedicated sales force in each of the regions. But like -- and they certainly are going to generate sales for us of the product. What we're going to see is some of these other verticals as they start popping up. I think we're going to see opportunity to sell through distribution in a lot of those cases.

And that will supplement what we do with the direct folks.

Okay.

And to the extent surveying has risen, I guess, its profile has risen in terms of addressable market opportunity for you, and you mentioned the ASP differential versus the prior generation. How does the ASP for the product that would address surveying compare to comparable products in that field today?

Yes, it's -- most surveyors, the folks who have been looking and placing orders now are looking at the 120-meter unit. So it's the longer range unit, which has a slightly higher price.

The price tag of that unit is just under $40,000. It is sizably better than any other laser scanning equipment, by a lot, by 50% or more in many cases.

And it actually is competitive with many of the surveying equipment, total stations and things like that, that surveyors would have been using historically, which is why it has generated so much interest. Because it's far more useful than a single point total station, for sure.

Okay. Okay.

And maybe just last question. Could you expand a little bit on this Zeiss relationship? What might your thoughts be around first year objectives there, what you would hope to have that contribute to the top line or bottom line? And are their sales -- would the Zeiss sales force actually be selling some of your products or just pulling you into accounts or any color you can add there would be helpful.

Yes. I won't give you a number. We do expect that we will get benefit out of it and increased sales from it. That's one of the ways that we get some additional leverage to the selling expense side of the equation, excuse me.

Will they be selling our product directly? In some cases, I think we'll be seeing that. Initially, I think you'll see a lot more of lead sharing and pull the FARO account manager in and vice versa, FARO pulling in the Zeiss account manager when it's a clear CMM opportunity. And the good news is, is that they're very distinct applications that make it easy for us to make that call for each other.

But I think you will, at some point, you'll see Zeiss account managers actually moving the FARO product on their own, once they've gotten used to it and comfortable with it, they've been trained up.

The good news is, they certainly understand the metrology and high precision measurement. So that side of the equation is already solved for them.

And really, what it does for both parties is it gives us the ability to offer kind of the full suite, the full portfolio, the piece that we didn't have, which is fixed-based CMM, and we really didn't want to get into, necessarily on our own. And the same for Zeiss, likewise, it gives them a portable side. And so it makes it a fairly formidable partnership. And so for the customers, to be able to see the two parties working together in that regard and being able to place orders, in some cases, even for multiple pieces of equipment, let's say, in a single PO, the simplicity that creates for the customer to do it through one party versus having to go to two different parties is a big plus.

Okay.

So we'll see how it develops. You know, right now it's in the very early sort of infant stage and then as we get into next year, we start seeing a little bit more traction, then I'll be able to provide a little bit more feel for how much do we think it's contributing, at least in a general sense.

You may never pin me down on the exact number, but I'll give you a general feel.

Sure.

Maybe a last question is if things have stabilized and somewhat more normal, any thoughts to returning to providing guidance?

Not yet. We haven't -- right now, I'm just focused on 2010. We'll see, as we go into 2011.

If we -- if, if we ever return to it, it would probably be very similar to what we used to do, which would be very basic kind of revenue growth guidance ranges and maybe a gross margin range guide. And that would be about it.

But I'm still torn on the value side of the guidance. I'm sure you can provide the input on that.

Very well. All right. Thank you.

Thanks, Rob.

(Operator Instructions)

We will take our next question from Sam Pfeifle with Spar Point Group. Please go ahead, sir.

How's it going, guys?

Hi, Sam.

On the price reduction of about 60% on the scanner, can you talk a little bit about how important the price is to growing demand in the market? And also, where you see price going, how much room there is to get price lower while still keeping gross margin where you want it to be?

Yes.

Great questions.

And in some respects, I don't have the perfect answer yet, but I'll tell you what our thought process is.

There were several things, in my opinion, that were keeping the laser scanner from moving -- crossing the chasm and into the early majority.

The -- just the overall kind of the complexity of the device, the cumbersomeness of having to carry this giant device with a specialized tripod and the camera and everything else, I mean, it really wasn't a great field unit, versus now you can throw the thing in a backpack and grab a regular old camera tripod and off you go. Its 12-pounds total gear, pretty easy to move around.

So the size was one piece. Having to bring around a laptop and do all that was a pain, I think, as well, so, the ability to have the SD card and the very simple on-board display.

The great thing about the touch screen display is that as you take the scan, you can immediately look at it, make sure you got everything you needed before going back to the office or back to wherever you're headed and find out then, oh my gosh, I don't have enough data, I've got to go back to the site. That's a huge advantage, and a productivity advantage, for customers.

So the -- that was the one piece. The second piece is on the software, just ease of processing. And I think there's still -- there's some ways to go there, for sure. Particularly as we start developing and working with other parties to develop applications that are specific to each vertical. That, I think, is a huge enabler.

And then the third was price, not because I had a definitive knowledge of what the price needed to be, but there was clear -- price was clearly a drag, in my opinion.

So we went down to -- we're roughly at $30,000 and $40,000 for the 20-meter and 120-meter units respectively.

I have said previously that at some point, if you really wanted to get it into, say, the trunk of every insurance adjusters' car or every squad car, you might even have to get as low as $10,000. I still think that is, number one, a reasonable expectation over some period of time. That is not an overnight thing, for sure. It will take some time to get there.

And whether that's the right number, is it 10? Is it 15? I don't know.

We believe that we have the opportunity to drop enough costs out to get it into that range at some point in the future. Like I said, not in the next couple of years, for sure, but that would be sort of the next step. And it may depend on what kind of use we're seeing in the marketplace today. Our goal is to continue to be disruptive like that.

We firmly believe that everything should be done in 3D and so it's our intent to get that available to the masses as best we can.

And so I do think it's important to continue driving it down.

Certainly the price move that we just made was -- and the response that we've gotten from it was an indicator that price is, in fact, a substantial piece of that equation.

Following up on that processing piece, do you feel that the hardware side of the market has gotten a little bit ahead of the software side? And do you feel that that processing piece and the time to the back office is a drag on scanner sales?

I think, number one, the hardware is ahead of the software at this point. I don't think it was before. I think with the focus, with our release, we have jumped substantially in that regard.

I think that the processing, certainly, is better than it was before. But you're right, it still requires some work back in the office. You have to have a little bit of training. It's not 100% intuitive, though it's not terribly -- it's not unintuitive either, for lack of a better word.

But there's still some room to go there, the speed side. And also, just like I said, I really believe that the availability of very cheap and simple application software layers that you tack onto that, that are specific to the different verticals, what a forensics person needs, obviously, is very different, as you know, than somebody who's out in the field, doing survey work.

So the work flow and creating work flow that eliminates all the other unnecessary stuff for that particular vertical.

I think that will go a long way towards the ease of use.

Great. Thank you very much.

Thank you.

And we will take our next question from Ajit Pai with Stifel Nicolaus. Please go ahead.

Good morning. Actually, this is Chris King filling in for Ajit.

I have a few questions.

You mentioned earlier that the price is about 60% lower. Can you talk about, actually, what the list price is and how large you find -- how large you think the market size will be?

Yes. The list price is the 30 and the 40 respectively that I talked about. It's roughly $30,000 and $40,000. It's just below both of those marks.

The other part of the question was how important the price is to the market size. Yes.

For sure, when we've said before that the overall market for our equipment is $3 billion to $5 billion and a big chunk of that was the scanning potential, the scanner potential in the future, like I said, I think price is a huge factor in getting that market to open up. And like I said in the previous question, price is not done. It'll be here for a while, for sure, but it needs to continue going lower if we really want to open up all the avenues for the $3 billion to $5 billion potential over the long term.

And I guess what will your annual revenue rate be, about, for this product about 12 months out?

Yes. I'm not at a point where I want to disclose that, mostly because we don't disclose any of our products' revenue. We do expect it to rapidly increase, for sure. It will rapidly become a much larger percentage of FARO sales in a fairly short time period. That I feel pretty confident in.

All right. Great. Thank you.

And we will take our next question from Chuck Murphy with Sidoti and Company. Please go ahead.

Hi, guys.

Most of my questions have been answered. I just kind of wanted to touch on the gross margin a bit.

If I kind of compared first quarter and second quarter to the third quarter, was most of that fluctuation due to reducing the older scanner inventory? Or was it other stuff?

Yes, there's some of that in moving some of the demo inventory in there. I think that other than that, we're seeing fairly stable average selling prices on all the rest of our product lines.

Yes.

There is some slight fluctuation in the service revenue that could -- or service margin.

Yes.

But that's primarily seasonal.

Yes. Got you.

So is -- do you think the 60% target is reasonable for 2011?

Without saying whether we think it's perfectly reasonable.

Yes.

What I will say is, what I often say, is that the -- we have said that 60% to 65% for the company over the long term is certainly the right gross margin range.

Yes.

So in effect that we think 60 to 65 is the right target over time, I guess you can look at it in that regard, without specifically pinning what number for 2011.

Yes.

Got you.

Okay. That's all I had. Thanks.

Thanks, Chuck.

And it appears we have no further questions at this time. I would like now to turn it back over to our speakers for any closing remarks.

Okay. Well, very good. Thank you very much, everybody, for joining today. And we look forward to updating you again at the end of Q4.

And this concludes your teleconference for today. Thank you for joining. You may now disconnect and have a wonderful day.