FARO Technologies Inc (FARO) 2011 Q3 法說會逐字稿

Good morning everyone and welcome to FARO Technologies' conference call in conjunction with its third quarter fiscal 2011 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 of 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 the 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 third quarter of 2011 were $64.8 million, a 43.1% increase from $45.3 million in the third quarter of 2010.

On a regional basis, third quarter sales in 2011 in the Americas increased $7.6 million or 43.6% to $25 million compared to $17.4 million in the third quarter of 2010. Sales increased $8.8 million or 53% in Europe to $25.4 million from $16.6 million in the third quarter of 2010. Sales in the Asia Pacific region increased $3.1 million or 27.7% to $14.4 million from $11.3 million in the third quarter of 2010.

The effect of changes in foreign exchange rates on sales was an increase of approximately $2.6 million in the third quarter of 2011.

New orders increased 28.6% in the third quarter of 2011 to approximately $60.2 million compared to approximately $46.8 million in the third quarter of 2010.

On a regional basis, third quarter orders in 2011 in the Americas increased 22.9% to $23.1 million compared to $18.8 million in the third quarter of 2010. Orders increased 40.4% in Europe to $23.3 million from $16.6 million in the third quarter of 2010. Orders in the Asia Pacific region increased 21.1% to $13.8 million compared to $11.4 million in the year ago quarter.

The top five customers by sales volume in the third quarter of 2011 were Airbus, the U.S. Military, Johnson Controls, Boeing, and Tata Lockheed Martin Aerostructures which represented only 4.3% of sales. The top ten customers in the third quarter of 2011 represented only 6.3% of our sales once again indicating our lack of dependence on any one or a handful of customers.

Gross profit increased $10 million or 37.9% to $36.4 million in the third quarter of 2011 from $26.4 million in the prior year quarter. Our gross margin was 56.1% in the third quarter of 2011 compared to 58.3% in the year ago quarter primarily due to a decrease in gross margin from product sales to 60% in the three months ended October 1, 2011 from 64.9% in the three months ended October 2, 2010 as a result of a change in the historical product sales mix caused by the increase in sales of the new Laser Scanner product which currently has a lower gross margin.

As a percentage of sales, selling expenses decreased to 22.7% of sales in the third quarter of 2011 compared to 25.9% in the year ago quarter. Selling expenses increased $3 million to $14.7 million in the third quarter of 2011 from $11.7 million in the third quarter of 2010 primarily due to an increase in compensation and commission expenses of $2.4 million, marketing and advertising costs of $400,000, and travel related costs of $400,000.

As a percentage of sales, administrative expenses declined to 9.9% of sales in the third quarter of 2011 compared to 15.9% in the third quarter of 2010. Administrative expenses in the third quarter of 2011 decreased by $800,000 to $6.4 million from $7.2 million in the third quarter of 2010 primarily as a result of a decrease in legal and professional fees of $700,000 related to the cost of the FCPA Monitor in connection with the DOJ and SEC settlement and a decrease in patent litigation costs of $200,000.

Research and development expenses increased to $3.6 million for the third quarter of 2011 or 5.5% of sales compared to $2.8 million or 6.3% of sales in the third quarter of 2010. The increase is primarily related to an increase in compensation expense of $500,000 and subcontractors' expense of $200,000.

Total operating expenses were $26.4 million for the third quarter of 2011 or 40.8% of sales compared to $23.6 million or 52% of sales in the year ago quarter. Operating profit increased $7.2 million or 250.2% to $10 million in the third quarter of 2011 from $2.8 million in the year ago quarter. Operating margin for the third quarter of 2011 was 15.4% compared to 6.3% in the year ago quarter.

Other income expense net increased by $1.3 million to expense of $800,000 in the third quarter of 2011 from income of $500,000 in the third quarter of 2010 primarily as a result of an increase in foreign currency transaction losses due to the effects of changes in foreign exchange rates on the Company's intracompany account balance of the Company's subsidiaries denominated in different currencies.

Income tax expense increased to $2.8 million in the third quarter of 2011 compared to $1.1 million in the third quarter of 2010 due to an increase in pre-tax income. The Company's effective tax rate for the third quarter of 2011 was 30.1% compared to 32% for the third quarter of 2010.

Net income increased by $4.1 million or 176.2% to $6.4 million or $0.38 per share in the third quarter of 2011 from $2.3 million or $0.14 per share in the third quarter of 2010. The number of fully diluted shares outstanding in the third quarter of 2011 was 16.8 million compared to 16.3 million in the third quarter of 2010.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short term investments were $119.3 million at October 1, 2011 compared to $115.7 million at December 31, 2010 and included $65 million of U.S. Treasury bills.

Accounts receivable was $50.7 million at October 1, 2011 compared to $51.9 million at December 31, 2010. Days Sales Outstanding at October 1, 2011 decreased to 71 Days from 81 Days at December 31, 2010 primarily as a result of improvements in the collection cycle in Europe and Asia.

Inventories increased to $65 million at October 1, 2011 from $42 million at December 31, 2010 primarily due to an increase in raw material 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 863 employees at October 1, 2011 compared to 781 at December 31, 2010, an increase of 82 or 10.5%. Account Manager headcount increased from 147 at December 31, 2010 to 158 at October 1, 2011 with 50 Account Managers in the Americas, 48 Account Managers in Europe and 60 Account Managers in Asia. Geographically, we now have 339 employees in the Americas, 296 employees in Europe, and 228 employees in the Asia Pacific region.

I will now hand the call over to Jay.

Thanks Keith. The third quarter was particularly good demonstrated by our 29% orders growth, 43% sales growth, and 171% EPS growth.

Volume was good. Production efficiency and output improved and we gained significant leverage from our operating model by controlling costs even as sales grew substantially.

With Op margin at 15.4% in the third quarter we've made a big step towards our long term goal of 18% to 23% operating margin. Going forward, we still expect to get even more leverage from the model.

Demand for our products around the world remains strong. We had double digit orders growth in the Americas and Asia while new orders in Europe grew more than 40% in the quarter. Sales to new customers in the third quarter were 43% compared with 40% last quarter and 38% in the first quarter.

We expect the growth in sales to new customers to continue particularly as the Focus Laser Scanner becomes an even bigger percentage of our sales. Eventually, I still expect we'll see at least a 50/50 split between new and existing customers, similar to what we have historically achieved as a Company.

The Focus Laser Scanner was our second highest volume product for the second quarter in a row. I continue to believe that the Focus will become our number one product both in dollars and units within the next year or two. However, our growth is not just coming from the Laser Scanner. The Faro Edge Arm is doing very well and the release of our new Laser Line Probe, or LLP, at the beginning of the third quarter has also gone well. Our other core products such as the Laser Tracker are selling well too so we're seeing good progress on all fronts.

Operationally, we met our objective of bringing our Laser Scanner production facility up to full speed allowing us to reduce the backlog of Laser Scanners. This will also allow us to quote our standard delivery cycles going forward. Manufacturing capacity for all our products is currently sufficient to meet expected volume for the rest of 2011 and all of 2012.

Our focus on technology leadership and innovate R&D has delivered several new products to the market over the last few months. First, the new Faro Edge Arm along with our latest generation Laser Line Probe attachment appears to be as disruptive to the marketplace as we had hoped.

We are now quoting every Arm with an LLP as a packaged offering rather than viewing the LLP as an accessory. The ease of use, ergonomic and technical advantages provided by both the Edge Arm and the new Laser Line Probe combined with the price advantage of the LLP enable extremely quick ROI for our customers. There is not an offering like it in the market and customer response measured by words and more importantly, dollars, has been extremely favorable.

During the third quarter we also released the latest generation of our CAM-2 software, CAM-2 Measure 10. Our CAM-2 software has been an important element in our success for many years but this release brings my excitement to a new level. For the first time our standard software for a scan arm can also accept and manage point cloud data. A point cloud is made up of millions of three dimensional data points captured by non-contact devices such as the Laser Line Probe.

Historically, customers have been required to purchase a third party package to have point cloud capability with our scan arm which can add substantial incremental cost to the solution. Now with CAM-2 Measure 10 customers get a seamless point cloud solution from FARO at a very competitive price.

Finally, we also introduced the next generation of the Focus Laser Scanner as well as our Faro Scene Webshare software in the third quarter. The next gen Focus Laser Scanner incorporates height sensors and a compass for ease of scan registration. We also added wireless LAN capability.

Faro Scene Webshare is our web based scan viewing application. Not only does the new version allow customers to view scans over the web but it also allows them to perform measurement analysis of the actual scan data. Both the product release and the software release continue to make life easier for FARO's customers while simultaneously making the solution more powerful.

Over the last 12 months we have introduced a series of disruptive products to the market. During the next 12 months and beyond we expect to continue to release highly disruptive technologies and the next one should be in the market by early 2012.

Overall, we executed extremely well in the third quarter and continue to feel very good about the rest of 2011 as well as 2012. As always, I'd like to thank the FARO team for their passionate dedication to the Company as well as our customers, suppliers, and investors.

Thank you for your attention and I will now open the call for questions.

(Operator Instructions) And we'll take our first question from Jim Ricchiuti with Needham & Company. Your line is open.

Two questions -- one on the strength you're seeing in Europe both from shipments and an order standpoint and then just a follow up on service margins.

Jay, from what you're seeing in Europe, there is so much in the way of concern about the macroeconomic outlook in Europe. Is it just a function of the strength you're seeing in the automotive and aerospace markets and how would you characterize the sustainability of the business over there?

Yes, I think you're right. We're seeing very good strength over there right now. I think there is probably, the macro view from our customers appears to be look, that situation in many respects is out of our control right now.

Our Companies are going well and you're right, automotive is a good sector for us. Aerospace remains a very good sector for us in Europe. Germany obviously is a big piece of the industrial hub there and it's a very good country for us in general from a manufacturing standpoint and most of our customers seem to have taken the approach of look, this is technology that we need to enhance the operations almost regardless of what's happening and at the moment, the macro situation is out of our control.

What we see as Companies is that we're doing very well. There is good demand for our products out of Asia. There is good demand for our products in the U.S. Mercedes has had an extremely good year in the U.S. so far from an auto standpoint. Most of our customers, that seems to be the mindset right now and we have not seen any real change to that behavior pattern.

Is the Scanner particularly strong in Europe or is that more balanced between the Americas and Europe?

It's actually, it's pretty balanced. The Scanner you've got maybe a little more in Europe but not noticeably. I think when you look at the LS volume in general it's fairly representative of what the sales split in total looks like for Americas, Europe, and Asia from a proportion standpoint.

Okay and just next on service, the service margins. Is there any seasonality with respect to this service business? It was a pretty significant sequential increase and how should we think about your service margins going forward?

I think in Europe there is a lot of shutdown during the summer so a lot of equipment comes back for servicing so I think you could see some of that. In the third quarter there was some increased sales of warranty contracts so that may have contributed a little bit to the bump in the service margin.

Historically though, I think we have always been about 30%, maybe 32%. I really wouldn't expect that to deviate much from that range.

Okay, thanks Keith. That's helpful. I'll jump back in the queue.

And we'll take our next question from Chuck Murphy with Sidoti & Company. Your line is open.

First, normally you see kind of a meaningful jump in sales for the fourth quarter versus the third quarter. I was wondering if you thought that trend would hold this time around given that the book-to-bill was a little bit lower sequentially.

You're right. The book-to-bill was a little lower. Obviously, a chunk of that was being able to shift the Laser Scanners that were in backlog and we sort of indicated that at the end of Q1 also that we would see some of that in Q3 and when you look at the sales numbers, typically Q3 when you look sequentially quarter two to quarter three we typically decline maybe 15% sequentially even though the quarter over quarter growth is usually up. In this quarter we actually increased sequentially by about 9%. A lot of that was the Laser Scanner.

So when you look at Q4, yes we still expect Q4 to be, should be the strongest quarter. Whether it's the same kind of sequential movement from Q3 to Q4, it may be a little harder to tell only because we had an abnormally high Q3 but we still expect it to be a very -- shipment volume up in Q4. You've got CapEx budgets around the manufacturing world. There is still plenty of cash inside companies. They're making investments so without calling the quarter specifically, we obviously still think that's going to be the best quarter of the year.

Can you talk a bit about why OpEx fell sequentially in the third quarter while sales rose?

Yes. Hey Chuck, this is Keith. Sequentially, we had a couple of different things going on in Q2. Q2 if you remember, in the sales and marketing side we had our Focus users group conference over in Germany. That was roughly maybe $300,000 or so. We also relocated our Andover office which is down in the R&D line so we moved that from Andover down into Kennett Square. We've had some other decreases in professional fees in the admin side so I think that pretty much accounts for most of that decline.

Should we continue to think of OpEx kind of where it is today as a percentage of revenue, I guess around 38% as opposed to kind of the mid-40s that you had been doing the last several quarters?

I think we have a target model out there. We used to refer to it as our five year target. Now I think we're just calling it our long term target and I think that is probably in the 40% to 42% range on the long term basis.

The key is that we think we can still get leverage out of the operation. The types of heads you need to add as sales grow are not necessarily tied to that operating expenditure though we expect we'll continue to improve, increase R&D spending and so forth as we go forward but certainly not at the clip and the rate that we expect sales to continue growing so you should expect to see continued leverage there.

One of the takeaways would be that, don't necessarily think of 3Q OpEx being that low so much as 2Q was probably higher than it should have been.

Yes, Q2 was probably a little higher for sure because you had a couple of real one-timers in there, shutdown of a facility, things like that but again, like I said we do expect good leverage going forward also. It's not like we've got an open floodgate here of heads and other costs we're expecting in Q4 or into 2012.

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

Just trying to understand sort of the longer term gross margin and operating margin implications. Sequentially on flattish gross margins you had one of the best operating margins that you've had in maybe about ten quarters, I think, comparable with June of 2008 just before the downturn but on substantially lower gross margins so just understanding the puts and takes over there from a longer term perspective. I know you are using the indirect channel. I know you also have costing that will start coming down, the costs on the new Laser Scanner. Are you -- forecasting a couple years out, would you say that the delta between the gross and operating margins should stay about the same as what it was in the September quarter so that your peak margins in the future could be 600-basis points higher than what it is today or what it was in June of 2008?

I guess there are a couple of things going on here. Number one is in the second quarter we have had some startup costs related to the LS production and that sort of thing. I think most of that is behind us right now. I think that you'll see that the margin was relatively flat from Q2 to Q3 because of the much higher sales mix of the Laser Scanner product. As Jay said, clearing out some of that backlog.

I think going forward, our long term model still talks about and still shows it 60% to 65% gross margin and I think when you talk about, talking about a few years going out, I think that's still a valid gross margin target for all of our product portfolio in total and again, I think if we can leverage our existing infrastructure we should still be able to hit that 18% to 23% operating margin target but this is a longer term model.

Why wouldn't it be materially higher? So if you look at the September quarter, 56%, if you get into the 60s, why wouldn't you be north of that 23% operating margins?

If you add a couple of points to the margin and have that drop down to the Op margin so you're taking the 15% and you're adding maybe three or four points to that so you're probably in that 18% to 23% range if we were to hit a 59% or 60% margin this quarter.

If your question, Ajit, is if you got all the way to 65%, might that improve the top end of the Op margin? For sure we would expect it to do that, no doubt. And from the 56% where we are now, getting to the 60% may take a little bit of time but the moving parts inside of there, you're right. You've got some cost that continues to come out of Laser Scanner. You've got the new Edge Arm. The more Edge Arms that we sell, they've got pretty good pricing, and the more of those we sell with the Laser Line Probe which is a very high margin accessory that goes with it, that improves the Op margin on products like that and obviously, we have been pretty open that we have new products coming down the pipe which have the opportunity for some incremental margin to them as well.

So, we are still continuing. It's not like we are sitting flat at the 56% necessarily. There are efforts underway. There are other opportunities to bring that up. Knowing that having that much more Laser Scanner in the mix obviously puts a little bit of pressure on the gross margin just from the indirect channel and so forth.

And then just looking at the channels, so you're using the indirect channel and I think I have asked you this question over the last couple of quarters as well, about how much, since it's on a sell-in basis and not a sell-through basis, do you think that the big sell into the channel is already done which means that you're going to see rapid moderation in growth rates, of your orders now that the channel is stocked or do you think that the additional folks that you are signing on to the channel can actually prolong the growth rates you are seeing in that business?

I'm cautious when I say prolong. However, I think that what we've seen, the early results are the distributors who have received their units, many of them have had good sell-through rates, without saying exactly what they are. We've seen them come back for, you've got the first five. Now we're ready for the next five. We've got the first ten. We've already sold them. Now we're ready for the next ten.

We do look at it say, when you look at third quarter and we moved a lot of that backlog out to the field, many of those units are going to distributors so it's now our chance to really start measuring their success. The bulk of the distributors now have product in hand which even as late as a quarter ago I wouldn't have said the bulk of distributors had product in hand yet. And we're still continuing to sign some up as we go forward.

I don't necessarily think it's a spike and then a slow-off because of the initial orders through all the distributors. I just don't think that is what we're going to see and like I said, the early results at least from those who had the units earliest in their possession would probably support that.

And then the last question is looking at your direct channel which, during the downturn of 2008, 2009, I think you cut back quite a bit on your sales headcount and at that point in time you believed that the continuing sales force, the best of the talent, and that productivity could be increased materially for those folks over the next two to three years. How do you feel about that decision now? Do you still feel that productivity can improve further? Do you think that you need to be hiring more? Is it going to be within the same geographies or new geographies?

I hate to say it this way but it's sort of yes to all of that. I think for sure it was the right decision. We've gotten very good productivity. Even in the Americas and Europe where we had established Account Managers and markets they've achieved very decent productivity. If you look at Asia their productivity is I think at this point more than doubled essentially or essentially doubled on a sales per Account Manager basis. So we really are starting to get very good productivity out of it.

That being said, as we look at 2012, again generally speaking -- that's not our guidance for 2012 -- but we still believe this is a Company that should be growing that 25% per year type of clip. I think we've reached a point where we've achieved enough productivity that we need to be adding more Account Managers to this mix. You've got that physical capacity in terms of how many demos they can do in a month. How many door-to-doors can you actually get into every single month? At some point you get topped out.

So, we've got openings out there today. It is around the world. It is selected based on the regions that have the deepest potential penetration and the least clustering of Account Managers. Where they already have good volume is typically where you split territories and bring in a new Account Manager and the previous Account Manager has a smaller territory but has the same types of sales expectations because they now can go deeper into the territory, hit the accounts you might not have hit before, things like that. And that is fairly -- I won't say it's equally split around the world but it's not like we're doing it all in one region and not the others and you'll see that continue through 2012.

Our anticipation is still that we should not need to grow the sales force at the same rate that sales grow. We do expect continued productivity. Some of that is just to, there is room to grow for some of the Account Managers who are already on board and some of it is knowing that you've got an indirect channel that will be generating sales particularly for the Laser Scanner and obviously that improves, if you look at the overall productivity on a sales per head basis, it officially makes it a little bit better but it certainly gives that view that you don't need to increase the sales headcount at the same rate, but we will be adding. They're actively searching right now and will be actively searching. As you go forward it will probably be an ongoing thing every quarter going forward. It just won't be at the same rate as sales are.

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

Another question on the Account Manager headcount. If you look over the last four quarters or so you see good growth in the Americas, sales reps from the low 40s to 50 but in Europe you're actually down from the low 50s to 48 in the most recent quarter. Why have you had those two different trends in what are I assume relatively developed markets?

I think when you look at the two of them, number one you have had this push to get additional productivity so the Americas, yes they're up a bit. I think many of those adds came in the third quarter here as we started pushing and prepping for 2012 so it's not like it's been up that much the whole year. I think they were actually relatively flat when we got out of the second quarter.

In Europe, they've added a few heads. We've had sort of your natural transition of, your lower performers have transitioned themselves out or we have transitioned them out and it has sort of been kind of a one-for-one. I would expect to see Europe, you look at the openings they have right now and they've got a few more they're posting, you'll expect to see that number look maybe a little more similar to the Americas when you get through Q4 and into Q1.

There is no reason not to because both markets are really strong right now and both have, when you think about how many people we're covering the Americas and Europe with relative to the overall potential, it's still obviously very light compared to how many feet we could have on the street but we want it to be a balanced and managed load when you bring it in because it takes a little while to get them ramped up. It takes a certain amount of Management control to make sure they're doing it the right way and so we don't want that -- what I don't want is that part to get ahead of the horse again which I do think we were a little ahead of it in 2008 going into the downturn.

An update on the FCPA, at least in my model I assume that the third quarter was the anniversary of the visitation of the Monitor, that the Monitor was due back in. Obviously, that wasn't the case so question one, when do you expect the Monitor in for the final visit and does that still look like a $700,000 type of fee?

Yes, I think we're expecting, it looks like probably Q1 based on dialog that we've had with the Monitor and we'll be having some more here very shortly and that's just when the appropriate timing was for her and for her team to be able to do their follow up. It's just getting it in and scheduled.

Cost-wise, Keith, do you want to talk to --?

Yes, I think that $700,000, $800,000 range is probably a good number.

And could you give us just an update of how you see the last of the patent suits? I think you mentioned in the Q that you had some favorable rulings from September?

Yes, we did. I'll try to be relatively short on it. In the second quarter we had a favorable ruling. We had filed a suit claiming inequitable conduct on their part at the patent office when they were prosecuting the patents a long time ago and the Court ruled in our favor on the first of those two patents.

The standard changed on what it takes to prove inequitable conduct and the Judge actually decided to reverse herself in the third quarter but at the same time, when she reversed herself, essentially saying we needed to prove -- we still have the opportunity to prove inequitable conduct and we think under the new standard we would still prove it -- but she said you have to come back and prove it under the new standard but at the same time she also ruled that we don't infringe the patent in question. So it was a reversal of the ruling and then actually a favorable ruling in the fact that she ruled we don't infringe.

There is still one patent out there which is a derivative of that first one which is still a question. At this point there is still a possibility we would end up at trial. We have met and attempted to mediate. I can't say there has been a ton of progress made there but obviously, our goal would still be if we can settle, obviously that is the best if it is the right settlement for FARO and when I think about the right settlement I still think about something similar to what we had when we settled with Hexagon where we put it to bed. There is a release across the board and there are no penalties going backwards, no royalties going forward and we're at a point as a Company where this one, we should be prepared to go ahead and continue to fight if we had to through a court trial to make sure that we have proven everything that we know about the fact that number one, we don't infringe and that there are some other issues at hand here like the inequitable conduct that we would like to prove out if we can't reach a meaningful settlement with them.

A final question if I may, your cash position continues to be very sizeable. Is there any level of cash that you would deem surplus?

I don't know if I would use the word surplus. We recognize that we have plenty and we certainly don't need it operationally. I would never call out a level where I say it's surplus. Are there things that we still would like to do with it which could include acquisitions? Absolutely. So might we continue seeing it grow for awhile? Short of doing an acquisition then I think the answer is yes in that regard but I wouldn't put a specific balance on it, so to speak.

And we'll take our next question from Richard Eastman with Robert W. Baird. Your line is open.

I know you don't disclose sales dollars on the various products but understanding that you took some backlog down on the 3D Scanner, if I make some adjustment and assumption on sales for the 3D Scanner in the quarter, I'm trying to get a sense of what the growth rate was year over year on your non-3D Focus sales -- in other words, the core products. Can you just characterize that year over year growth rate? Is it low double digits, low teens, or is it high teens?

I guess maybe I'll try to give two data points that are roughly useful, the first one probably being the most useful but I would say the characterization would be strong double digit. I'm not going to say low teens or high teens. It is strong double digit for the core products or what I would call the original products for sure. It's not like we're sitting single digit or anything that would be concerning in my view of the world which is that side of the business should be able to grow 20% to 25% on its own even if you didn't tap the Laser Scanner.

And just from an order of magnitude standpoint on the Laser Scanner, maybe the only characterization I can say is that historically, prior to the release of the Focus, the Laser Scanner was the lowest revenue generator by a landslide. In Q2 it became the second highest volume generator and what I would say is it sort of creeped into that position ahead of the Laser Tracker. It is now firmly the number two product line. I know that doesn't give you a lot to go with but I know you're been tracking the Company for awhile too. It is firmly number two. It isn't squeaking through as number two anymore.

And so again, to do the math, it was strong double digits but it doesn't start with a two, I wouldn't think. I don't think it can.

I don't think I'll go any further --

And one more thought, if you look at the book-to-bill in the third quarter for again, the core products meaning everything but 3D Focus, was the book-to-bill in the core products greater than one?

I think it would be similar to one if you looked at the core products. The 20% orders growth, when you look at it, is actually fairly consistent with what we had in Q1 and Q2 I think too so it's a fairly decent view of look, it's a good strong market. Yes, we had a little upside this quarter because we were unloading some backlog out of Laser Scanner but otherwise I think it's still kind of our normal steady state and you would expect to continue seeing that going forward.

Was there a positive influence in the order growth rate on the Arms from the availability of the LLP for the Edge Arm?

For sure. Not just the order rate but also in some cases even the ability to ship. We had customers who had placed orders, wanted the Arm but said look, I really want the LLP so don't ship it until the LLP is available. You have a little bit of that but I can't say that there is a massive backlog, let's say, of those types of deals in Q2 going into Q3. It was no more than what you would normally see from the Company but availability has certainly helped the orders rate and the interest in the Arm again from a marketing standpoint and a customer standpoint.

The Edge Arm with the LLP now available, when you just look at order of magnitude, when you look at your Arm sales, is that product with the LLP kind of packaged out at pricing, is that half of what you're now kind of quoting and demo-ing in terms of Arms?

What I'll say is that virtually -- go in reverse order -- virtually every Arm deal is being quoted with the LLP now so that's the first, the first thing we go into the customer with is here is the new Arm, or if you're a new customer and you don't know anything about it, here is an Arm. It includes a Touch Probe. It includes a Laser Line Probe. The Laser Line Probe has this one-of-a-kind design that only adds two ounces to the handle and allows you to snap it in and out just through a serial port without having to use any other types of tools or anything like that and this is how it comes. And then if the customer says, well geez, the price tag seems a little heavy. What can you do? Then the first thing our guys will talk about is well, you don't necessarily have to have the LLP. That will take $12,500 off your price tag. Does that feel better for you?

And at that point, the Arm price is still very, very strong, essentially close to list and still very competitive. The LLP at $12,500 when you embed it with the Arm is maybe one-third the price of other types of LLPs that could be attached to competitors' Arms and so forth so there is huge value there.

What I will say is that we've seen a massive uptake in the number of customers who are buying their Arms with the LLP. If it was, call it a quarter of them historically, it is more than half of them now and that is kind of the initial run rate out of the gate so the interest level is there and the ease of use and the value proposition is certainly there based on this new release.

Just the last question, this might be kind of a messy answer but when I looked in the Q, I thought it was interesting that your selling expense by region varies quite a bit and is that a function, Keith, of currency or is that a go-to-market kind of pricing strategy?

I think there is just maybe a little bit more of leverage that we get here in the U.S. compared to some of the other regions and that could be as far as just infrastructure costs and the ability to do a certain number of demos per month in certain countries. There is also some selling expenses related to travel and that sort of thing as well as in Asia, typically our Account Managers from an annual quota standpoint are not as high as either in Europe or the Americas so there is additional selling expense there. You get a little bit of that travel and infrastructure cost related in Asia as well.

But when you get down to the EBIT line, is it -- translation will affect that as well but when you get to the EBIT line, is the EBIT on the product sales by region reasonably comparable? In other words, can you make up for some of the selling expense in the gross margin in those regions where it's higher?

Typically in some countries within Asia the margins on the products are a little bit higher than you would see in other parts of the world so without actually disclosing that type of EBIT margin by region, I would think that there is not anything materially different basically when you look at, I don't know if I would call it an EBIT margin but certainly a gross margin less your selling expenses.

And we'll take a follow up from the line of Jim Ricchiuti with Needham & Company. Your line is open.

Jay, I don't know if you'd be willing to share with us what the unit growth was for the Scanner quarter over quarter, just to give us some sense as to the impact the new production capacity is having.

Not in unit terms. I'll give you some general comments. In each of the last few quarters we, from an order standpoint we have received more unit orders in the quarter than we had in the entire year, well more than we had in the entire year of the previous generations.

From a shipment standpoint -- you know, a lot of those were going into backlog -- so from a shipment standpoint now in the third quarter it is, the output in the third quarter alone was sizably higher, more than double and you can imagine it's even higher than that, what we used to produce in an entire year before that and that capacity actually has room to grow still which gives us flexibility next year and it is certainly maintainable going through next year.

As we think about those factors that are driving the Scanner right now, you alluded to the fact that there were distributors out there that didn't have the product that you're now getting the product to. There is clearly expansion of the channel and presumably there are some reorders. Can you rank this for us or somehow weight them just to give us a sense as to what is happening with the product?

I don't think the weighting would be meaningful at this point. I would say that you've got more going to distributors and being sold through our direct people still at the moment as those distributors now have product to sell. I do think that that ranking would change fairly dramatically over the next few quarters. It won't change overnight but it will be pretty relatively quick, only because it's not that our Account Managers aren't going to be able to sell as many. It's that you're going to be selling that many more out of distributors with their reach.

There is nothing we have seen in the marketplace to indicate anything but the interest level is high and it's not just because distributors want these and then they just park them on their shelf because they're making fairly substantial investments to buy the product and the ones who have bought and got their first ones have certainly seen good sell-throughs.

What is the mix rate now between direct, indirect for the product?

It still at the moment leans more towards direct than indirect and again that's a function of a lot of the indirects were just starting to get their units in Q3 because they had been in backlog.

And just finally, are you now making a bigger push to broaden the distribution channel now that you have the ability to produce more of these?

We are pushing to broaden it for sure but it's more, it's to make sure we've got coverage in all areas. Where we've got distributors signed up and we have many who have good coverage territories already, the push will be more focused on how do we ensure that they are actually moving units in their marketplace, making sure we're doing the right marketing efforts to help them out as they get ramped up here.

And one final question, you made a comment about extremely quick ROIs on the Edge with the LLP. How much has that changed? What kind of an ROI are we talking about now?

When you look at it in the scheme of things you're still looking at it's four to six months at the worst in most cases. The LLP used to be $35,000-ish and all the competitive ones are that price or higher so at $12,500 if you buy it with the Arm, it improves it fairly dramatically. Now, is it going from six months down to one? Probably not just in the purchase. You have to have the right volume and the throughput and utilization and so forth but it is a very, very quick ROI still.

And we'll take another follow up from the line of Chuck Murphy with Sidoti & Company. Your line is open.

Just a couple quick ones for you, is there any update on the 3D Imager product? Have you seen any sales from that yet?

We've seen interest from customers and we do have some with customers right now. Sales of the Imager are still immaterial relative to the overall results which we have expected because it is a very new product.

The exciting thing is what we did do is the move from Andover to our facility in Kennett Square sort of revamped and relaunched the activity surrounding that product. We actually have a couple of different derivative R&D activities underway now that are associated with it that will improve the next generations of the product. Most notably, what we still need to improve is capture speed in particular and then there are some other, some weight and some other things that will go with it but those are the things we're working on now that will make it a much more meaningful product. It won't be a meaningful product in 2012 though we'll be selling some in 2012. It may be in 2013 you start seeing a little bit of movement. It's probably not dissimilar to what we had with the Laser Scanner where it took us a few years to get -- it had good volume but to make it material relative to the size of all of our other product lines at this point, it will take a little bit more time.

I know you've said before that the Scanner, you expect it to have similar margins to the other products long term. Is that on both a gross and operating basis? I was wondering given perhaps a difference in distribution whether we should expect the Scanner's gross margins to be a little bit lower long term.

I think purely from pricing and from a bond standpoint I think the target is still within our historical range of the 60% to 65%. You're going to definitely see a little bit more of a distribution of that product so to the extent distributors in the 20% to 30% discount, that's going to have an impact on that gross margin but at the same time we're not going to be paying commissions to an Account Manager for those sales so on an operating basis it should level out.

We'll take another follow up from Ajit Pai with Stifel Nicolaus. Your line is open.

Your Laser Scanner product has been in the market now for about four quarters and been ramping quite nicely so what has the competitive response been because by now you should have started impacted sales of your bigger competitors and the incumbents over there. Have you seen any change in the way they're pricing their products, new products out of them, or any other sort of response to your obtaining critical mass now that it is the second largest product category for your folks?

I'll go in reverse order, Ajit. Generally speaking, there has been minimal competitive response. We assume that one or more of the competitors are probably working on a next generation laser Scanner. We have not seen anything from them or any hints as to when it may or may not come out.

We did see Hexagon, I guess it was about a quarter ago, maybe a little more even, their current Scanner, they made what appeared at first blush to be a fairly substantial price move. They dropped it to about EUR40,000 which is still higher than ours and then when we looked at it we realized that that was without the distance module which you have to have so you needed to add EUR10,000 to that and it was without a couple of other elements that went with it so by the time you added everything back it really was still the same or close to $100,000 price tag that they always have been.

We have really seen no competitive response at this point. Like I said, we always assume it will come at some point which is why we continue to work aggressively on our next generations as well.

In terms of sales, I can't say we've seen a whole lot of other laser scanner sales at this point and certainly anywhere we had what appeared to be a competitive situation, I'm not aware of any that we lost, where it was a true Laser Scanner/Laser Scanner head-to-head competition.

The real question and this is the one where it is hard to see the data is given how many of our Laser Scanners appear to be going into that surveying space, the professional surveyor, the civil engineers and folks like that which historically is dominated by people who provide pillow stations. Hexagon has them, Topcon, Trimble, guys like that. I don't know if there has been any meaningful impact there yet. Probably not enough that it would show up necessarily in their financials but we do know we're getting business there so it has to be having at least some impact. How much? It's too hard to tell.

And then the second question is just looking at that whole channel on the surveying side, the agreements that you have right now with your distributor, I'm just trying to understand the operating leverage there. Is the cost of marketing, the sales and marketing, advertising, all of that, is that a shared cost or is borne more by one party than the other?

Yes, it's all up to them. We obviously, we will spend some money in the early stages here from a marketing standpoint because it still benefits also our own direct guys that are out there selling products in their territory or into different types of accounts. Many of the distributors are very focused just on that surveying world and they aren't going to be trying to sell to oil and gas guys and other folks that we know can use the device.

So there are some marketing costs there that maybe benefits them to help get the product moving in their space and it's no different than costs we would have already spent for our own people who are already out there. As we go forward though, the cost to sell and market that product, all of that is borne by the distributors.

Then it would be fairly reasonable to assume, if you're expecting your gross margins to expand by 400 to 700-basis points and your operating expenses not to increase at the same pace at your revenue then it would fairly reasonable to assume that your operating margins should get back to the high end of your target range in the next couple of quarters. Is that fair?

I'll never say in the next couple of quarters particularly when you say the high end of the target range. Is it reasonable to assume that that helps us get into that target range? Yes, I think that is a fair assumption but you're right. It depends on how long it takes those distributors to really get ramped up to meaningful volume. Today, we still have more Laser Scanners sold by our own people only because it took awhile to populate the distributor channel with their own units but you should get -- you're absolutely right. You should get some leverage there and it should help improve that Op margin line.

And from a cost perspective or a gross margin perspective with the Laser Scanner, I know you said that the margins will be lower than the rest of your portfolio on the gross margin side but over time you have also talked about your overall portfolio getting back to the low 60s, that 60% to 65% range. What kind of time do you foresee getting to that range for the overall company, from the 56% to the 62%, 63%?

It's hard to imagine it happening in a single year. Let me say it that way. I think, could it? Maybe but again, the difficulty is it's the moving part of how quickly the sales through distribution ramps up. If it ramps up much faster, then obviously you're got gross margin pressure there because you're taking the haircut on the price at the gross margin line. But over time, as you get again, additional cost out and as you get more of the higher volume on the Arm which has really strong gross margin and then the Laser Line Probe accessory which has even better gross margin and other new products when they get released will help that.

Is it possible within a year? Yes, but boy, it would be a stretch. I would have to imagine you would be more like at least a 2013 sort of view of that, to really get above 60% meaningfully.

And then the last question I think would be, just looking at the M&A environment you've had a slowdown in the broader economy has led to a lot of smaller companies feeling challenges and some of the end markets slowing. I know you're not seeing it in your business but has the M&A environment gotten more attractive and given that is has been now some time since you have sort of acquired, made a material acquisition, is there anything out there that is looking much more interesting now that you are firmly profitable and your cash generation, the growth moderate is likely to accelerate?

Nothing that I could say meaningful. I need to clarify though because the bigger piece for us has always been we wouldn't be compelled to do a deal if we thought the price tag was going to drop lower or it did drop lower, necessarily. The first and foremost for us is do they have meaningful technology that could be a great compliment or a great addition or a great disrupter to the portfolio that we could bring in? Obviously, no change in the economic environment will change our view of people's technology and that has been, as you know it's been awhile and that has been our struggle is to find something that we really felt was the right fit and could bring that value to us on the technology side and then and only then would we look at now the price tag and so forth. A lower priced deal, if it's the wrong technology, it doesn't matter how bad the environment got for them it still wouldn't be interesting to us.

Right, but even a deal where you like the technology, if the price is -- expectations of the (inaudible). It's a moot point if you actually haven't found anything where you like the technology.

That's a fair point. Do we have a couple where we like the technology and we felt like the price tag was way too high? For sure. Whether they would come down off that expectation, that's a different dialog. I can't say it's necessarily affecting them in total but it may. In the meantime, sometimes we see those technologies and when the price tag is way too high we look at it and say, okay, well we have the same capability so if we're willing to wait it out a year or two maybe we can have the same thing.

And we'll take our final follow up from Jim Ricchiuti with Needham & Company. Your line is open.

I was just wondering what the, how the orders tracked as you went through the quarter. What was the order linearity like?

Still relatively similar to what we've seen historically. Again, I think there is a possibility the more distributors we use and the more we sell into some of the verticals we don't know as well or there may not be the same use it or lose it CapEx mentality, it may flatten out a little bit but I can't say we've seen anything meaningful there yet.

And Jay, just a final question, just with respect to the growth in the Americas, you guys have talked about the investments you've been making in Latin America, particularly Brazil. Are you seeing the benefit of that yet?

I think maybe a little bit. It's still a little bit early. It was really only kind of second quarter I guess that we finally went direct and finished that off so next year I think you'd see maybe more meaningful impact to the Americas from that move.

There are no further questions in queue.

Very good. Thanks for your participation, everybody.

This concludes today's teleconference. You may now disconnect and enjoy the rest of your day.