FARO Technologies Inc (FARO) 2011 Q1 法說會逐字稿

Good morning, everyone, and welcome to FARO Technologies' conference call in conjunction with its first-quarter 2011 earnings release. (Operator Instructions). Please note the call is being recorded. It is now my pleasure to turn the conference over to Mr. 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 first-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 will now turn the call over to Keith.

Thank you, Vic, and good morning, everyone.

Sales in the first quarter of 2011 were $52.6 million, a 24.4% increase from $42.3 million in the first quarter of 2010.

On a regional basis, first-quarter sales in 2011 in the Americas increased $3 million, or 18.4%, to $19.3 million, compared to $16.3 million in the first quarter of 2010. Sales increased $3 million, or 18.6%, in Europe to $19.1 million from $16.1 million in the first quarter of 2010. Sales in the Asia-Pacific region increased $4.3 million, or 43.4%, to $14.2 million from $9.9 million in the first quarter of 2010.

The effect of changes in foreign exchange rates on sales was an increase of approximately $1 million in the first quarter of 2011.

New orders increased 40.5% in the first quarter of 2011 to approximately $55.9 million, compared to approximately $39.8 million in the first quarter of 2010.

On a regional basis, first-quarter orders in 2011 in the Americas increased 22.9% to $20.4 million, compared to $16.6 million in the first quarter of 2010. Orders increased 56.2 million -- 56.2% in Europe to $21.4 million from $13.7 million in the first quarter of 2010. Orders in the Asia-Pacific region increased 48.4% to $14.1 million, compared to $9.5 million in the year-ago quarter.

The top five customers by sales volume in the first quarter of 2011 were Airbus, Boeing, Hong Kong [Blue Ready] Machinery Technology, Metro Metrology, and Nakamura Koki Co. Ltd., which represented only 4.5% of sales. The top 10 customers in the first quarter of 2011 represented only 6.6% of our sales, once again indicating our lack of dependence on any one or a handful of customers.

Gross profit increased $4.9 million, or 19.2%, to $30.3 million in the first quarter of 2011 from $25.4 million in the prior-year quarter. Our gross margin was 57.6% in the first quarter of 2011, compared to 60.1% in the year-ago quarter, primarily as a result of the substantial increase in the laser scanner sales, which currently carry a slightly lower gross margin and lower arm sales of some customers waited for the release of the new Edge Arm.

Our service costs have also increased as a result of opening a new direct-service facility in Brazil and adding new application engineers to meet the needs of our increased install base of customers.

As a percentage of sales, selling expenses increased to 26.9% of sales in the first quarter of 2011, compared to 26.6% in the year-ago quarter. Selling expenses increased $3 million to $14.2 million in the first quarter of 2011 from $11.2 million in the first quarter of 2010, primarily due to an increasing compensation cost of $2.1 million and travel-related costs of $700,000.

As a percentage of sales, administrative expenses declined to 12.5% of sales in the first quarter of 2011, compared to 14.8% in the first quarter of 2010. Administrative expenses in the first quarter of 2011 increased by $400,000 to $6.6 million from $6.2 million in the first quarter of 2010, primarily as a result of an increasing compensation cost of $600,000, offset by a decrease in professional and legal fees of $200,000 primarily related to patent litigation.

Research and development expenses increased to $3.6 million for the first quarter of 2011, or 6.9% of sales, compared to $3 million, or 7.1% of sales, in the first quarter of 2010. The increase is primarily related to an increase in compensation expenses.

Total operating expenses were $26 million in the first quarter of 2011, or 49.4% of sales, compared to $22 million, or 52.1% of sales, in the year-ago quarter. Operating profit increased $900,000, or 26.7%, to $4.3 million in the first quarter of 2011 from $3.4 million in the year-ago quarter. Operating margin for the first quarter of 2011 was 8.2%, compared to 8% in the year-ago quarter.

Other income expense net increased by $600,000 to an income of $100,000 in the first quarter of 2011 from an expense of $500,000 in the first quarter of 2010, primarily as a result of changes in foreign exchange rates that created net foreign currency transaction gains in the intercompany account balances at the Company's subsidiaries, denominated in different currencies.

Income tax expense increased to $1.2 million in the first quarter of 2011, compared to $800,000 in the first quarter of 2010, due to an increase in pretax income. The Company's effective tax rate in the first quarter of 2011 was 26.5%, compared to 28% in the first quarter of 2010. Net income increased by $1.1 million, or 57.1%, to $3.2 million, or $0.20 per share in the first quarter of 2011, from $2.1 million, or $0.13 per share, in the first quarter of 2010. The number of fully diluted outstanding shares in the first quarter of 2011 was 16.6 million, compared to 16.3 million in the first quarter of 2010.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $118.3 million at April 2, 2011, compared to $115.7 million at December 31, 2010, and include $65 million of U.S. treasury bills.

Accounts receivable was $47.5 million at April 2, 2011, compared to $51.9 million at December 31, 2010. Days sales outstanding at April 2, 2011, increased to 83 days from 81 days at December 31, 2010, primarily as a result of an extension of the collection cycle in Europe. Inventories increased to $50.7 million at April 3, 2011, from $42 million at December 31, 2010, primarily due to an increase in raw materials related to the production of the new Focus laser scanner and the new Edge FaroArm.

Finally, I'll conclude with some statistics regarding our headcount numbers. We had 828 employees at April 2, 2011, compared to 781 at December 31, 2010, an increase of 47, or 6%. Account manager headcount increased from 147 at December 31, 2010, to 154 at April 2, 2011, with 45 account managers in the Americas, 51 account managers in Europe, and 58 account managers in Asia. Geographically, we now have 327 employees in the Americas, 282 employees in Europe, and 219 employees in the Asia-Pacific region.

I will now hand the call over to Jay.

Thanks, Keith.

Starting the year with 40% orders growth, 24% sales growth, and 57% income growth was a great way to get things going. Market conditions are extremely favorable, and we continue to see strong demand across all verticals in all our territories. Recognizing that we haven't issued specific sales guidance for 2011, we still believe that, generally speaking, FARO should be growing at least 20% to 25% per year. The demand and behavior we're currently seeing from our customers certainly supports this view.

Our sales channels are executing well to meet the demand we're seeing in the market, growing orders more than 40%. As pointed out by Keith, Europe and Asia were particularly strong, both growing approximately 50%. However, the Americas also had a very good quarter, growing more than 22%. The rate of growth contributed by each region may shift each quarter, but we are seeing enough demand in the marketplace to feel good about the rest of 2011 for all three regions.

Similar to the pattern we saw in each of the last five quarters, there was substantial demand from our existing customers in the first quarter, representing 62% of our total sales. We still believe that this will eventually shift back to a 50-50 mix, but the current strength we're seeing from the existing customer base may cause that to take some time.

We're actively pursuing new customers and we're certainly getting good business from them. However, the immediate and first-hand knowledge of the ROI our products provide is definitely resonating well with the existing customer base right now.

Gross margin declined slightly during the quarter. However, we should see improvement as we increase our production capacity to meet demand for the Focus laser scanner and as Edge Arm sales ramp up. I expect that we'll see a return to our more historical gross margins of approximately 60% during 2011.

I continue to be extremely excited by the progress we're making in our R&D programs. The Focus laser scanner continues to generate substantial interest, and orders have been coming in at an extremely high rate. We are making final adjustments to our production processes to match the new demand rate and we expect similar success with the product for the rest of 2011.

We also just released our latest-generation FaroArm, called the Edge. We believe the Edge is extremely disruptive, just as the Focus laser scanner was when we released it seven months ago. The Edge introduces an elegant combination of simplicity and power. It was completely redesigned by the engineering team, improving performance, ease of use, ergonomics, and manufacturability. It adds a first-of-its-kind touchscreen for simple measurement tasks with an onboard operating system which eliminates the need for a laptop or more sophisticated software. We improved the exterior materials for more ruggedness and we expanded the wireless capabilities of the device.

Perhaps the most disruptive element of the Edge Arm is our new Laser Line Probe accessory. The new LLP is substantially smaller and lighter. It has a wider stripe for greater coverage. It's faster than ever, and it attaches to the Arm with a simple, integrated, quick-change handle, the only scanner in the market to provide that kind of simplicity and ease of use. The total package for the Edge with an LLP is highly disruptive and one of a kind in terms of form, fit, and function.

We received our first Edge order within three days of its release. However, that's not the last of our disruptive releases in 2011. The next product on deck is coming soon.

Finally, I'll spend a couple of minutes discussing last night's press release relating to our patent case with Nikon. As most of you know, a company named Metris, now owned by Nikon, brought a patent infringement suit against us about three years ago. We were confident we didn't infringe and, at the same time, felt there was substantial evidence of inequitable conduct on the inventor's part when prosecuting the patent application with the U.S. Patent Office.

As a result, we filed for inequitable conduct, and due to the evidence presented, the court chose to hear our case first. Yesterday, the same court confirmed our belief by ruling in our favor that there was inequitable conduct on the part of the inventor and ruling that the patent in question is unenforceable.

There are still some remaining steps to be taken with Nikon now, most notably addressing our counterclaims and working to pursue our attorneys' fees from this matter. We'll continue to keep you posted, but will reinforce that yesterday's ruling in favor of FARO was a substantial step forward.

Overall, I couldn't be happier with our first-quarter results or our prospects for the rest of the year. We're combining fantastic growth with operational leverage and aggressive research and development. It's a great combination for our customers and, ultimately, should be a great combination for all our shareholders.

As always, my thanks go out to the FARO team, our customers, and our investors. I look forward to updating you again at the end of the second quarter. I appreciate your attention and I'll open the call to questions.

(Operator Instructions). Mark Jordan, Noble Financial.

A question relative to the Edge Arm. What is the pricing and -- and the introduction of the Edge, what has that done to your pricing structure for your legacy Arms?

Good morning, Mark. Good question. So, a couple of things to note out. To note. Number one, the Edge Arm obsoletes the previous generation of Arms, so the Platinum series and the Quantum series go away.

We'll still have the Fusion series, which is our lower-end arm. It's slightly lower accuracy. So you still have the Fusion Arm out there to address those different applications which don't need quite the same accuracy at that price point.

The Edge Arm comes in three lengths, and the lengths -- the pricing on those lengths is comparable to what we already had in the marketplace. A little bit different from the laser scanner where we knew that pricing was a substantial factor in getting that product over the CASM and into the early majority.

The Edge Arm and the Arm market in general has been very -- it's a more mature market. It's been very price in elastic for the last, call it, six years now, and so we did not feel the need to move the price on the Edge Arm when we released it. Certainly did not feel the need to go downwards with it, and we believe that it's a substantial enough technology shift, an improvement to, again, the form factor, the ease of use, et cetera, that maintaining that closer to that list price is certainly the right way to go and certainly achievable.

Where we get a little disruptive on the pricing is how you package the new LLP with it, and so to highlight, I mean, really the ability to take this -- the new Laser Line Probe and interchange it instantaneously with the handle that's on the Arm -- just snap it in and out; it's a serial port interface with a small threaded nut that goes around the outside -- the exterior of the Arm -- is a substantial change to the marketplace. The size of the unit is so small that it's a substantial change in the ergonomics for the user, and so we look at it and say in many respects part of the strategy is there's no reason why a customer shouldn't just buy the Arm and the Laser Line Probe at the same time, and historically, the Laser Line Probe really was a different type of accessory sale.

So the new Laser Line Probe, the pricing on it -- the device by itself will be lower than the current LLP that's in the market with the same type of gross margin that we had before. But we do believe that because of the ease of use, because of the ergonomics and the simplicity that go with it, we will actually increase the number of Arms that go into the market with an LLP on them, and it is a -- from a disruptive standpoint, it is in the area that will make it -- it's very difficult for the other -- the independent laser line probe players to compete, and we believe for our primary competitor to compete as well. It really does bring substantial value to the customer in that regard.

So, Arm by itself, comparable pricing to what you already see in the marketplace. Scan Arm, including the LLP, slightly more disruptive pricing, but probably generates more volume than we've ever had before.

Since the first quarter of last year, you've shown sequential growth in maintenance revenue. Now that we're getting into a more normal market, does the maintenance revenue -- should it continue to grow sequentially or could we see it plateauing or is there a possibility of decline now that people might be more willing to buy new versus a major refurbishment?

I think that the service revenue, a lot of it is strictly related to units in the field and the install base. So, as the units in the field continued to increase, I would expect that service revenue in total should also increase, but certainly not anywhere near the range that the product sales would increase.

Final question, relative to your rough headcounts. Given your -- the fact that you seem to be becoming more positive with regards to the visibility of growth, when are you going to start matching that rep count growth with that 20% to 25% annualized revenue target?

Generally speaking, you would expect to see us continue adding account managers throughout the year because we do see that opportunity. We do see the demand in the marketplace.

I'll say that we are trying to keep it slightly unmatched, for lack of a better word. Growing the sales 20%, 25% as a target, I still think we should be able to get some productivity from our entire sales channel. That includes sales of the laser scanner, which may go through distributors, so that's a slightly different angle, obviously, than what we did before.

So, I'm not sure we actually will need a perfect one-to-one match on sales growth to account manager headcount growth. So, if you grew 20% to 25%, I would expect maybe the account manager growth into the teens, whether that's mid-teens, low teens. That's more of a question of where do we see demand and where do we see it accelerating?

As you know, there is still a bit of a learning curve to go along with an account manager. So you have to time that a little bit with when you expect them to really start full production. But that's how I would look at it. I would not expect a one-to-one match. You should see some productivity out of that.

Finally, in Japan, any disruption relative to the nuclear incident and the tsunami?

Great question. We had zero disruption on the sales side and we had zero disruption on the supply chain, and we anticipate that to be the case for the rest of the year. We don't see any issue there at all.

Jim Ricchiuti, Needham & Company.

Thank you. Just a question on the Focus scanner. Can you talk about the constraints you might be seeing in terms of getting product out the door? You discussed increase in capacity, and maybe you could give us a sense, Jay, on the timeline as to when this new capacity comes online.

Sure. As you know, one of the nice things about our model is that from a capacity standpoint, we have minimal demands for CapEx or anything of the like, so it's not like we're waiting on machine tools to arrive and we have a huge amount of investment to make there, which is a great thing. And that's not just for the Focus; that across all of our products still today.

There's two drivers for the demand -- or three. I guess I'll call it three drivers to get that capacity up. One is the demand. As excited as we were about the product when we launched it, the demand is definitely higher than what we had anticipated. And we anticipated what I thought was a pretty substantial increase in demand from where the previous unit was, and it certainly has exceeded our expectations.

So, number one, our expectation has completely changed now relative to what we see in the rest of the year, so that eliminates sort of the did you think you would get less than this? Yes, we did at the time. We thought it would be good; we just didn't think it would be this good.

The second is just people, adding a couple more people to the production process and just getting them trained up. And that certainly has been accomplished for the team in Germany, and Germany is still where we make all of the laser scanners.

And then, the third piece is supply chain. The supply chain itself, just reacting to the substantial increase in demand, even for what we had forecast before, it took a little while for them to get themselves fully up to speed. So what we're looking at is, certainly by the time we get through the end of the third quarter, we would be at a run rate that is our -- what would be our normal kind of quoted cycle times, and probably sooner than that. But I don't want to put a specific date on that at that point.

So you'll see some laser scanner backlogs certainly still through Q2, and then you probably see that drop down a bit in Q3, assuming we don't see another substantial increase in demand, at which point we would flex the system again.

What we don't anticipate is any decreases in demand. Right now, one of the things that we were looking at was, and we've talked before about, is how much of this is going to distributors, who are just stocking their shelf, and how much is actually being sold through. The ratio going to distributors is a little bit lower than I would've anticipated, not that they are not interested, but we are actually selling a lot of laser scanners direct, which is a nice thing, too. And then, at the same time, the flowthrough we're getting from the distributors who have picked up the units has been good.

And we don't -- obviously, we don't disclose any of our numbers by product line, so I know that that doesn't give you a perfect picture, but I think thinking about it in that regard that there's not as much going to the distribution channel right now as we thought originally, and it's mostly because our account managers are selling more than we probably would've anticipated kind of drives that.

The product that we thought was getting a lot of traction in the construction and surveying market, is that a direct sale? The demand that you are seeing from your direct channel, where is that coming from?

Yes, most of that is not coming from the construction and survey space. The distributors who are buying are almost all directly connected to that space.

Everywhere -- we're seeing it everywhere else outside of that. We're seeing it in heritage. We're seeing it in the industrial accounts. We're seeing people use it for facility planning, for just pure asset management, and that's why it's a decent match for all of our account managers who are already out there because those are the types of accounts they already call on. So, it's actually been a very nice mix.

That's a change, isn't it, Jay, from the initial launch of the product where you were seeing more demand, I thought, through distribution?

We were. What I'll say is that the demand hasn't necessarily changed on the construction and surveying side at all. We've just seen an increase.

Now that we've -- units are in the account managers' hands. They've had enough time to get out there and start talking to customers. You're just seeing more demand from that side than, perhaps, we might have anticipated. But we're still seeing -- the construction/survey side is still seeing great demand, too. It's part of the challenge, I think, of did we underestimate a little bit relative to what the order flow might look like? Yes, we definitely did.

I'll jump back in the queue, but I have one other question on this, and you talk about the orders that you are seeing in the last few quarters versus what the product has done -- the previous product -- in a full year. Is there any way you can give us -- put this in context in terms of how this product, the demand you're seeing for this product, versus some of your other products in similar launch stages?

It's hard to generalize. What I would say is from a historical perspective, the immediacy of the ramp-up is probably the best we've seen. That I feel pretty confident saying.

And then, the question mark is if you continue that same curve, then it would far outstrip what we've done in any of the other products. But the other products, it didn't take very long for that curve to get pretty steep that they were on also. So I would say the immediacy of it is definitely faster out of the gate than anything else we've done.

How it goes from here, that still obviously leaves -- there's a lot of question marks there, other than we believe there is substantial opportunity. And as I've said before, I still believe -- the LS is now a contributor to revenue, for sure, a substantial contributor to revenue. I still believe there will be a point in time, when that is, I don't know, but there will be a point in time that the laser scanner probably outsells everything else, not because our other products are stagnant at all, because they're still growing very well also. It's more that the laser scanner is just growing at such a high clip and it has such a broad potential market appeal relative to the other products.

(Operator Instructions). Richard Eastman, Robert W. Baird.

Just a question on the product gross profit margin. I think you've largely touched on this, so this is basically the fact that it kind of stepped down off of, maybe, a 65% run rate, that is primarily cost associated with the buildout of capacity on the 3-D scanner. And also, has the Edge product impacted that yet?

Rick, I think it's primarily a sales mix issue as opposed to a unit cost issue, and that is that the mix has changed -- shifted a little bit toward the laser scanner. So, that's how I would attribute it, that slight decline in the product margin.

(Multiple speakers). And your question, Rick, of whether the Edge is impacting yet or not, I'd say no.

That was part of the issue in Q1 was we did have sort of a soft launch of the Edge to get it introduced to the market. We definitely had customers who were waiting, not surprisingly, and that -- so that drove some of the mix down as well. The Edge Arm has comparable gross margins to our previous Arm products, so as customers now start picking up the Edge and purchasing it versus being in the holding pattern, you would expect to see that shift back just from that by itself.

So, as we get out to, say, the third and even the fourth quarter, Edge starts selling, maybe any scanner inefficiencies are flushed through. Does that -- are you confident that that gross project -- gross product margin -- gross profit margin on the product side returns to, like, 65%? Is there any reason not to expect that?

Yes, I think that's right. If the mix goes back to the more historical -- within the products, more historical mix, as well as we ramp up to a much higher production level on the scanner and get some of those efficiencies achieved, I think the product profit margin should get back up into that 65% range.

Okay. And then, also, is there any reason or is there any change in your warranty accrual, given both the Edge introduction as well as the scanner?

No, there hasn't been at all.

And we see no reason for that.

Ajit Pai, Stifel Nicolaus.

A few questions. I think they've already been asked before, but perhaps in a slightly different way, I think. When you announced the new laser scanner product and you talked about the great traction you expected there, at that point of time when you talked about the disruptive pricing, you did talk about that, over a period of time, the product gross margins for that product, despite the disruptive pricing, rising to at or above your corporate average -- not corporate average, but the product average gross margins.

So, you know, in the first half of 2010, you had sort of 67% and 66% product gross margin. Can we expect over the next three to four or five or six quarters for that product to actually reach those gross margins or exceed it, or has anything changed over the past six months in the way the pricing is or the amount that goes to distribution that has changed that in your thinking?

I guess a couple of thoughts. Without going specific to the products, we don't disclose it that way, I think number one, as Keith just highlighted a second ago, getting back to sort of a 65%-ish, without saying is it 66%, is it 67%, certainly 65%-ish on the product side, we do still believe that's an appropriate gross margin for the products.

The laser scanner itself should be in the comparable range, without saying the exact number. It should be in the comparable range, and no question, there are some production efficiencies as we continue ramping up, catch up to the demand that's actually out there and match the amount that's being produced to the structure that is in place to go with it. You would obviously get some efficiency to go with that.

No question, as we've talked about with everybody before, that -- those laser scanner sales which go through distribution put a little more pressure on the gross margin side because you're taking your discount at the gross margin level and then you're making it up with zero selling cost associated with it. But we still believe that even managing that and the balance within that, that still in that 65% range is an achievable number.

Got it. And then, just looking at the Edge Arm that you talked about and the transition issues that happened. The two questions I had there, one is you priced it at a similar price point to the previous product, despite all these improvements, and you already mentioned that pricing wasn't the biggest determinant for this product as it is for the laser scanner where you needed disruptive pricing. You really sort of make that market take off. So, why didn't you price it slightly higher?

And then, the second is, was there any gross margin impact from the predecessor product selling at that -- at a greater discount just because you have a successor product to clean up the channel?

I'll let Keith answer the second part. I think the answer is I don't believe so, but I'll let Keith answer that in a second.

What I will say, why didn't I price it higher? I didn't want to push my luck. That sounds awful when I say it that way, but we are already the high-priced player in the marketplace and we have been able to maintain good prices. We win at what is sometimes a substantial premium because of the reliability, the usability, the ergonomics, the ease of use, et cetera. My view was let's not push it on the pricing side with the Arm. We're already above the competition by a substantial amount.

But there is an opportunity to get disruptive on that Laser Line Probes side because I believe it puts together a model that is very difficult for the others to match or emulate. They certainly can't emulate it in the technology, and I think that the combined package makes it more difficult and that gives us some edge there. But that was the primary reason, Ajit. I just -- I don't -- though it's been very good, stable pricing, pushing it a little bit higher didn't feel quite right either.

And then, the other question I think I had was when I look at your orders, and historically you've given us the metric of percentage from existing customers relative to new customers. What is that metric for this quarter?

It was 62% existing, and so, it's obviously higher than the 50-50, and it's been, I think, five quarters now where the existing has been higher.

When we came out of the downturn, for sure there was some pent-up demand, and then the back half of the year, we just saw that, I think, existing customers were really understanding that ROI. They get it. That's the easiest part of the sell when you go back to an existing customer, and we're still seeing some of that.

It's interesting. I try not to get frustrated with it because you love serving your existing customers, but as you know, 50-50 has been a strategic push for us. We are getting good business from the new customers, too. It's just that the existing customers have been so excited. You've got existing customers buying some of the laser scanners. You've got existing customers certainly buying the Arm and the Tracker, and because of the Edge Arm and the launch there, you may see it stay closer to 60-40 for a little while because my gut says that there are a lot of existing customers who are going to be excited by the Edge, and we've already seen some of that feedback.

So, it may sit there for a little while. I'm not going to sweat it too much as long as I feel like we're continuing to do all the right things on the inside sales and the marketing side of the equation to push on to the new accounts so that at some point you would expect that to balance out. So you don't want to let up on any of your activity on the new side as well.

Jay, just a question about -- you talked again on this call, I think in response to someone's question, about still expecting to get more productivity out of the sales force. But do you really think it's not an issue of not hiring new salespeople? While you might get more productivity out of the new sales guys, hiring new salespeople also opens up new customers, right? The existing sales guys have a large chunk of their time that's occupied with existing customers. Wouldn't you agree?

There is some of that, though some of that is controlled by the model as well because our account managers are very focused on demo'ing to customers and closing versus being out on the road just cold-calling or visiting the account. That manages the equation a little bit because their schedules tend to be controlled by the inside sales organization here.

No doubt as we continue to add account managers, that will help. It just gives you more coverage. It gives you more opportunity, perhaps, to demo to some of the new accounts versus the existing. And that's why we will continue adding account managers through the year.

And when you added account managers in this quarter, were those account managers primarily for the laser scanner, or were they product related or were they primarily focused on existing products and existing geographies?

It's a little bit of both. I can't say that we lean more heavily towards one or the other. There is good opportunity for direct account managers on both sides of the equation.

If I were to say, we leaned a little bit towards the existing products versus the laser scanner. There's a little bit of -- a little more emphasis there because you are expecting some of the laser scanner sales volume. Not all of it, but some of it is going to come through the distribution network, so you're not quite adding at a similar rate there.

And then, the last question would be just looking at your order momentum right now and some of the supply-chain constraints you have. Is there any reason why, for the next couple of quarters, you wouldn't expect your book to bill to stay above one?

Yes, and historically, it's always been pretty close to one. We never have too much backlog going into a quarter, so sort of the backlog that built up in the laser scanner is, I think, a bit of an anomaly.

Could it be higher than one for a quarter or two? Maybe. Again, we're just -- as you finalize ramping up all the production on the laser scanner, in particular. But generally speaking, though, I still think as a business model and certainly what we see in the marketplace, this should be pretty close to a one-to-one Company.

Jim Ricchiuti, Needham and Company.

With the a level of service revenue that you're seeing now, can you talk a little bit about where we might see the service gross margins? I was a little surprised that the margins came down sequentially -- actually, I mean, year over year, just given the level of service revenues. Do you think maybe you could talk a little bit about how we should think about service margins?

Yes, I think, typically, maybe historically, they've averaged anywhere from -- I know it's a broad range -- from 25% to 35%.

I think going sequentially from Q4 2010, I think it was about 31.5%, and Q1 of 2010 was about 32.7%. Now we're at 30%. Again, we opened a service facility in Brazil and we added quite a few headcount there. We've also added customer service application engineers in all regions to continue to meet the demand of the increased install base.

But I think, historically, that's probably a good range. Maybe 30 should probably be the average going forward.

So really, the decline was primarily just these investments that you've been making and that you -- we may not see that change a whole lot as we go through the year?

That's right. This was an unusual quarter to the extent that we've added all those application engineers to service the installed base.

And on the OpEx side, looking at G&A, Keith, I don't recall, did you give some number for the legal expense in the quarter, and presumably that drops off? And maybe, you could also provide an update on where we stand with any additional costs relative to the monitor. How should we think about G&A expense, the administrative expense going forward? It was down from Q4. Where do you see that going over the balance of the year?

Let me see if I get the order right. We have not disclosed the fees related to the Metris litigation so far. But I think we have in the past, typically, and I think it's down about $200,000 this quarter.

The monitor costs continued slightly. It's less than -- it's probably less than about $150,000 to $200,000 this quarter.

Going forward, as we talked a little bit about the court order yesterday, I would expect those legal fees to kind of level off and come down. I would also expect the monitor cost [though] I believe is coming back in the third quarter, so we should have, maybe, about $500,000 or so related to the monitor costs.

But overall, our business model was projecting admin costs to stay relatively flat, maybe a 3% to 5% increase going forward, but I think we pretty much have the infrastructure in place on the admin side, the HR, the finance, and the IT folks, that we should be able to leverage this existing infrastructure going forward for quite a few years.

And the tax rate for the year? How should we think about that, Keith?

I think we should probably be in the 28% to 30% range. We had anticipated 30%. It's turning out in the first quarter to be a little bit lower. It looks like it may end up being a little bit lower. So I'm thinking in the 28% to 30% range.

And last question. Jay, I wonder if you could talk a little bit, maybe provide a little bit more color on the order strength that you're seeing in the geographies. Europe, in particular, appeared to be very strong, as well as Asia-Pacific, particularly in light of the fact that you didn't see any impact at all in Japan, but maybe can you talk a little bit about the market strength you're seeing and where it might be coming from?

Yes. It's hard to pick any one vertical because they are all very strong right now. What I will say, and I don't want to discount what Europe's orders growth rate looked like in Q1, but they were coming off of a weaker comp than, say, Asia or the Americas. The Americas came off a very strong company in Q1. So, that helps explain a little bit of the orders growth there, for sure.

Europe is having very good success with the laser scanner, for sure, and having nice success with the other products, too. Asia is -- that's just real growth. They're coming off of a tough comp, and they had an unbelievable quarter again. That's a combination of just overall demand. You've got account managers who are comfortable in the saddle. The workforce -- from our standpoint, the account managers and the salespeople that we have over there, they continue to become more and more experienced.

Two years ago, that sales team in particular was -- maybe had an average tenure of a couple of years, max. And now you've got a sales team that has a tenure of three to four years. You get pretty effective as a salesperson when you get to three to four years. And all the markets are ripe, and you're right, including in Japan. I think the biggest reason we had minimal impact in Japan is that, though there were some shutdowns and some delays, including in some of our industries like auto that we serve well, it's not like we're selling directly into the supply chain of those industries as well.

So, the fact that we are a CapEx purchase that they may have, in some cases, did anyway, even though the plant was shut down, it doesn't mean they're not still thinking about their facility and their processes and how to operate more effectively.

So, that, I think, certainly -- I won't say it helped, but it certainly made it so that we had minimal -- we had zero impact. It's not even minimal. We had zero impact in Japan in Q1 from the events there.

Going forward, I still -- not surprisingly, Asia should be strong all year. It's just -- that market, it's that good right now, particularly China, Japan, and kind of India back right behind it.

Europe and the Americas, you're going to see good growth all year. Are you going to see 50% out of Europe again in Q2 or Q3? Maybe not. That's a pretty good growth number coming off of a tough comp, but it's possible. And like I said in my introductory remarks, you will expect to see some flip-flopping too. You may have the Americas particularly strong one quarter, Europe particularly strong the next quarter.

Some of that is just timing. As you know, the timing from one quarter to the next sometimes can make a difference in one region, and the following quarter, orders don't -- a lot of our orders don't die. They just push, and so, yes, I think we'll see some of that through the rest of the year.

And you've been making some other investments in areas like Brazil. Any early indications how that's going?

I'll say it's very good. And I probably won't go any further than that.

As you know, Brazil is a fantastic market opportunity. We've been serving it with a kind of an arm's length group for quite some time, and now having our own team, which essentially absorbed the existing team so we didn't lose any of that market contact. We've added additional people, including adding the service facility which ultimately is a huge productivity savings for us because, you probably know, getting equipment in and out of Brazil and the associated taxes that go -- that come along with that are astronomical, so being able to do that locally is a huge plus, too.

So it's all positive. That market -- there are so many industries that match what we do in Europe and match what we do in Asia and the Americas that it's just -- it was a logical time.

Richard Eastman, Robert W. Baird.

Yes, just one follow-up question. Jay, now with the Edge available and, you know, we've taken some orders for that product, do you think that that product will trigger a replacement cycle in the existing installed base? Is it that disruptive, that easy to use, that maybe our sales to existing continues to be quite high as that triggers a replacement cycle?

Yes, I think that's a possibility. The size of that, I'm not going to try to gauge or to estimate, but I do think that will happen.

It is that interesting, particularly the new Laser Line Probe that goes with it, the touchscreen for the kind of basic measurements, and the flexibility that that gives you.

We tend to call it more of a displacement cycle. They don't really kill off the Arm that was already there. They just move it somewhere else in the plant. That's all good things. We want them using as many as possible because it continues to allow for further displacement later on.

And I do think, and when I talk about you may see the existing customer sales for some period of time here this year may still be kind of a 60-40, it's because of things like that. I do think you'll see some displacement from the customers -- the existing customer base with the Edge.

Ajit Pai, Stifel Nicolaus.

Jay, you had mentioned the monitor-related expenses. Can you give us an idea of what it's been -- which quarters are impacted or were impacted by it, and at what point do you expect that to go away?

You had a little bit in Q1. You'll probably have a little bit in Q2. That's just kind of what I'd call maintenance. They're helping us with some of our policies, doing some revisions, and things like that.

The spike most likely occurs in Q3 because it does appear that Q3 is when the monitor will return with her team to do their final review. So, it should not spike as high as Q3 did last year. At least that's the indication that we've been given. So you'd expect it to be much lower than that, but it would be higher than our current spend, for sure, because they're going to be coming to see each of the offices and doing all that.

Assuming that review goes well, you'd have a little bit of follow-up just, again, basic maintenance probably in Q4. And after that, it should be the end of the entire process, and so the expenses at that point would just almost go to zero, and they wouldn't be monitor related but your normal business expenses of doing business in all those regions.

Right. So the sort of $0.5 million sort of spike into September is what I think would be a decent estimate?

It's probably not -- it's probably in the ballpark, yes. Is it $600,000? Is it $400,000? It's kind of hard to say because it's billable hours, but that's probably very close.

Got it. And then, the next question is you talked about a lot of other disruptive products in the pipeline, and also your sustained investment in R&D. So you don't have to give us specific products, et cetera, that you're going to be introducing, but some idea of whether they're going to be expanding the addressable market and some idea of the broad areas or size of the markets they are addressing would be useful.

I'm trying -- without giving too much detail, for sure you see -- you will see continued disruption of our core products.

I don't believe it expands the addressable market because we already view the addressable market to be extremely wide. It certainly, in my opinion, gives us more opportunity to sell into that addressable market, let me say it that way. Expanding the addressable market, what we did with the laser scanner, that was a substantial kind of expansion of the addressable market with what that laser scanner can do.

So, will we do some more of that as we go forward? For sure. Is it the immediate focus? Not yet. I think the core products, when you look at those, are what you'd be expecting over the coming three quarters.

Got it. And any kind of slowdowns like you had for the Edge Arm, related slowdown with the legacy product? Would there be similar kinds of sort of slowdowns associated with those new introductions?

Yes, my gut says no. That's a soft answer. What I will say is that the Edge was a little bit different because we did have this soft launch when we had -- we previewed the product on the American Chopper show, and that did get a ton of coverage.

We have a lot of customers who knew about it, saw it, and certainly had some excitement about it. That was a unique situation because of how we did it. We combined it with the 30th anniversary of FARO and all those things. The timing was right to do it, even though the Arm wasn't quite ready for the market yet.

You would not necessarily see us do the same thing with the coming releases. They would be more like what we did with the laser scanner where you would end production one day and start the new one the next day, or pretty darn close, your typical kill and launch simultaneously.

So then, what happens to that product? What happens to the legacy product, to the Edge Arm? I mean, you stop production one day. You start the others. The customers that are taking delivery of the previous product, do they get a discount? Do you send them a check? Do you -- what happens to all that product in the channel, et cetera?

Yes, certainly don't automatically skim a discount or send them a check, by any stretch of the imagination. Occasionally, you'll have a customer say, hey, I really wish I had seen that product.

Admittedly this time around, everybody had a pretty good opportunity to know the Edge was coming. So it's a little bit less likely.

When you look at the coming products, it's just like anything else. Hey, look, was I mad when I bought my new iPhone and the next one came out 1.5 months later? Yes, sure. But I get it.

We will take it case by case. If you've got a really strategic customer, might you do something? Maybe. But the reality is is that obviously the predecessor unit is still extremely functional and useful, and we would look at it as, well, is there an opportunity to get -- keep using the one you just bought and get another one into the facility, and look at it that way.

But what about the products that are in the channel? Like you switch production; you have the new Edge Arms selling. Now there is some product that's out there in the channel or is the channel completely clean? What do you do with those products? You've got a new product that selling at the same price? Who would buy that?

Yes, what you typically do is, if you time it in the right way with the launch, which we tend to do, you've burned off all of the existing -- any finished goods inventory and you're kind of left with whatever's out there in demo equipment, which, at that point, becomes a relatively small number because it's just what the account managers have in hand.

And you sell off the demo equipment at a little bit of a discount, and there are customers who will still take it, where they'll look at it and say, you know what, I don't know if I need all that stuff right now. Let me have this basic Arm and let me run with that for a while, and then we'll see if I need the new one.

It appears that we have no further questions at this time. I would like to turn the call back to management for a closing comment.

Very good. Thanks, everybody, for participating today, and we'll talk to you again at the end of Q2.

This concludes this teleconference. You may disconnect your lines and have a wonderful day.