FARO Technologies Inc (FARO) 2013 Q1 法說會逐字稿

Good morning, everyone and welcome to FARO Technologies conference call in conjunction with its first-quarter earnings release. At this time all participants are in listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions). Please note today's call is being recorded.

For opening remarks and introductions, I will now turn the call over to Vic Allgeier. Please go ahead.

Thank you and good morning, everyone. My name is Vic Allgeier, 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 copy of 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 expect, will, believe, potential, continue, predict, target, growth targets, goals, 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 2013 were $65.4 million, an increase of $0.2 million compared to $65.2 million in the first quarter of 2012. Product sales decreased by $1.9 million or 3.6% to $52.5 million for the three months ended March 30, 2013 from $54.4 million for the first quarter of 2012, primarily as a result of lower average selling prices across all regions in response to competitive pricing pressure for the Company's products.

Service revenue increased by $2.1 million or 19.3% to $12.9 million for the three months ended March 30, 2013 from $10.8 million in the same period during the prior year, primarily due to an increase in warranty revenue.

On a regional basis, first-quarter sales in 2013 in the Americas increased 4% to $26.1 million compared to $25.1 million in the first quarter of 2012. Sales decreased 4.8% in Europe to $21.9 million in the first quarter of 2013 from $23 million in the first quarter of 2012. Sales in the Asia-Pacific region increased 1.8% to $17.4 million for the first quarter of 2013 from $17.1 million in the first quarter of 2012. The effect of changes in foreign exchange rates on sales was a decrease of $1 million in the first quarter of 2013 compared to the first quarter of 2012.

New orders increased 4% in the first quarter of 2013 to approximately $64.6 million compared to approximately $62.1 million in the first quarter of 2012.

On a regional basis, first-quarter orders in 2013 in the Americas increased 25.2% to $27.3 million compared to $21.8 million in the first quarter of 2012. Orders decreased 7.9% in Europe to $21 million in the first quarter of 2013 from $22.8 million in the first quarter of 2012. Orders in the Asia-Pacific region decreased 6.9% to $16.3 million in the first quarter of 2013 compared to $17.5 million in the year ago quarter.

The top five customers by sales volume in the first quarter of 2013 were VRSI, the US military, [URUSU], Science and Technology Facility Council and Toyota and together represented only 3.3% of sales. The top 10 customers in Q1 2013 together represented only 5.2% of our sales, once again indicating our lack of dependence on any one or a handful of customers.

Our gross margin was 56.3% in the first quarter of 2013 compared to 57% in the year ago quarter. On a quarter-over-quarter basis, gross margin from product sales decreased to 59.3% in the first quarter of 2013 from 62.3% in the first quarter of 2012 as a result of lower average selling prices and an increase in the sales mix of the LaserScan products sold to distributors. Gross margin from service revenues increased to 44.1% in the first quarter of 2013 from 30.2% in the prior period due to increased warranty revenues. Gross margin improved sequentially from 53.4% in Q4 of 2012, primarily due to lower manufacturing costs, improved product pricing, and an increase in warranty revenues in the first quarter of 2013.

Selling expenses were 25.5% of sales in the first quarter of 2013 compared to 24.6% in the year ago quarter. Selling expenses increased to $16.7 million in the first quarter of 2013 from $16 million in the first quarter of 2012, primarily as a result of increase in travel costs of $600,000 and an increase in compensation of $400,000, partially related to additional headcount offset by a decrease in tradeshow expenses of $300,000.

Administrative expenses in the first quarter of 2013 were 11.5% of sales compared to 10.2% of sales in the first quarter of 2012, increasing by $900,000 to $7.5 million in the first quarter of 2013 from $6.6 million in the prior year quarter. Increase in administrative expenses is a result of an increase in compensation costs of $700,000 and bad debt expense of $200,000, offset by lower professional and legal fees of $200,000. Legal and professional fees related to patent litigation decreased by $100,000 to $200,000 in the first quarter of 2013.

Research and development expenses increased to $5.1 million in the first quarter of 2013 or 7.8% of sales compared to $4.4 million or 6.8% of sales in the first quarter of 2012. R&D expenses increased primarily due to an increase in compensation and subcontractors' expenses of $700,000.

Operating margin for the first quarter of 2013 increased 8.7% from -- decreased to 8.7% from 12.9% in the year ago quarter, primarily as a result of an increase in operating expenses of $2.4 million or 8.2% to $31.1 million in the first quarter of 2013 from $28.7 million in the first quarter of 2012.

Other income and expenses net increased on expense of $100,000 for the three months ended March 30, 2013, compared to income of $200,000 in the three months ended March 31, 2012, and consisted primarily of net foreign currency transaction gains and losses resulting from changes in foreign exchange rates on the value of current intercompany account balances of the Company's subsidiaries denominated in different currencies and other expenses.

Income tax decreased to $1 million in the first quarter of 2013 from $1.9 million in the first-quarter 2012, primarily as a result of a decrease in pretax income. The effective tax rate decreased to 18.4% in the first quarter of 2013 compared to 22.1% in the first quarter of 2012 and included a reduction in the income tax rate of 1.4% and 5%, respectively, related to the tax benefit of the exercise of employee stock options, the effective tax rate for the first quarter of 2013, also includes the discrete tax benefit of 7.5% related to the retroactive legislation reinstatement on January 2, 2013, of the research and development tax credit for the year ended December 31st, 2012, which is required to be included in the period the reinstatement was enacted into law.

Net income decreased to $4.6 million or $0.27 per share in the first quarter of 2013 compared to $6.7 million or $0.39 per share in the first quarter of 2012.

I will now just briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $169.6 million at March 30, 2013, compared to $158.2 million at December 31, 2012. Accounts receivable was $53.7 million at March 30, 2013, compared to $62.6 million at December 31, 2012. Days sales outstanding at March 30, 2013, increased to 75 days from 71 days at December 31, 2012, primarily related to an increase in DSOs in Europe.

Inventories increased to $68.3 million at March 30, 2012, from $68 million at December 31, 2012. The increase in inventories was primarily related to an increase in finished goods of $2.4 million, offset by reductions in raw materials and service inventory.

I will finally conclude with some statistics regarding our headcount numbers. Globally, worldwide sales and marketing headcount increased by 60 or 17.8% to 398 at March 30, 2013, from 338 at March 31, 2012.

Globally, account manager headcount at March 30, 2013, increased by 36 or 22% to 200 from 164 at March 31, 2012. Regionally, account manager headcount increased by 14 or 26.9% to 66 at March 30, 2013 from 52 at March 30, 2012, in the Americas. Europe account manager headcount increased by nine or 17.3% to 61 from 52 and Asia increased account managers by 13 or 21.7% to 73 from 60. We had 1,004 employees at March 30, 2013, compared to 911 at March 31, 2012, an increase of 93 employees or 10.2%. Geographically, we now have 403 employees in the Americas, 339 employees in Europe and 262 employees in the Asia-Pacific region.

I will now hand the call over to Jay.

Thanks, Keith. I am going to keep my comments relatively brief today so we can get straight to the Q&A.

But for starters, as a highlight in last night's earnings release, we are seeing continued pressure in Europe and Asia from sluggish economies and intensified competition as a direct result of the business climate. While we are seeing some signs of strength in the Americas, as evidenced by our 25% orders growth in that region, it was not enough growth to offset our performance in Europe and Asia. As a result, overall growth suffered in the first quarter.

During our last earnings call, I stated that we believed the first half of this year would be difficult with the potential for improvement in the second half and, based on the current environment, we believe that still to be the case. The business climate across Europe and parts of Asia remains weak. CAPEX budgets of many customers continue to be frozen or slow-moving and financing is difficult to arrange, particularly in China and India.

Sales to new customers in the first quarter were 37%, also a reflection of the current economic environment. Strategically, our goal has been to stay as close to a 50-50 split as possible. However, similar to previous periods of economic weakness, the first-quarter ratio lean more heavily towards existing customers, particularly in the metrology space where they already understand the ROI of FARO's products and thus are more prepared to make the required capital expenditures.

The Focus Laser Scanner continues to be the only device of its kind on the market. Sellthrough rates are encouraging and consistent with our pattern over the last 12 months. Sales through distribution were 63% in Q1, down slightly from 66% in Q4, but up significantly compared with Q1 of last year. And this comes from both the [terminal] relationship as well as expanded access to [top cons] global distribution network. We expect growth in the number of deserters to be slower over the next two quarters, but output from distributors we already have in place should expand as they improve their own efficiency in selling the Scanner.

We invested aggressively in new sales and research and development personnel in the first quarter. 60% of our headcount increase came from account managers that we added around the world to expand territory coverage or add depth to the high potential existing territories. As always, we expect the new personnel to generate meaningful sales volume within six to nine months of their higher day. This positions the new account managers to start delivering on expectations in the second half of this year.

R&D headcount expanded 11% in the first quarter. The additional talent is helping us aggressively pursue multiple development programs. I also made two R&D leadership changes in the first quarter replacing the engineering leader for the arm, ScanArm and Gage product line, and opening a search to find a new engineering leader for our metrology software platform.

The arm leadership role was filled from within FARO, but the software role will come from the outside and creates an opportunity to bring fresh ideas into the organization. The engineering teams from both groups remain firmly intact, but I felt a leadership change needed to happen now as I continue transforming FARO.

With respect to the search for a new Managing Director in the Americas, I can say that it is proceeding well. There are several excellent candidates in the mix and I am hoping to make my selection before the end of this quarter.

No doubt this is a difficult business environment. As a Company, our goal is to succeed in any market. We are investing aggressively, particularly in sales and R&D to ensure that we are positioned to break through the economic difficulties and remained the market leader in our space. At the same time we are working every angle we can to keep the rest of our expenses tight.

As always I would like to thank the FARO team for their hard work and dedication, thank you for your attention and I will now open the call for questions.

(Operator Instructions). Chris Godby, Stephens.

Good morning. Can you talk a little bit about promotional activity and the effect it had on the quarter? And then as the year goes on, how do you expect to utilize promo activity?

Yes, so we certainly continued promotional activity in Q1 more so in Europe and Asia than in the Americas. The Americas market is definitely stronger right now and we expect that to continue to be relatively strong over the rest of the year.

Commercial activity was, we tried to be as surgical about it as we could. If you actually look at gross margin, obviously we had some sequential improvement in gross margin from Q4 to Q1. Some of that was a little bit of improved pricing as we were more surgical about how we made the -- we did the discounting.

We have certainly had plenty of dialogue with the team to understand what accelerated this count and make a significant difference in the overall sales volume in the marketplace. The general feedback is that, no, it would not make a substantial difference; if we continue to be surgical about it, the team feels that that is the right approach to the market place. Obviously in any opportunity if we felt like we needed to move further on price to maintain our share to maintain our customers, particularly at our strategic accounts, we certainly are going to do that.

So, yes, there's definitely more pricing pressure in the environment right now, but it tends to be more selective on where we are seeing it.

Okay, thanks for the color. Hopping over to the Laser Scanner product, can you give us some additional color on how the Trimble agreement performed in the quarter?

I think it performed -- it's still what I would say is relatively in line with our expectations. As we had expected, they are strongest in the Americas and so we saw a nice benefit in the Americas there. It is certainly not the only driver of the 25% growth in orders in the Americas, but it is the relationship in the Americas is probably the best there and that is because they have their most coverage there as well.

Europe and Asia, they have a decent significant amount, lower coverage, from terms of distributors in the marketplace. And so not surprisingly, I would say that one is off to a little bit of a slower start, and that's not necessarily unexpected from how we knew Trimble's position in the marketplace and, quite frankly, it is another reason as to why we have continued to increase our activity with Topcon, who tends to be strongest in Asia, not quite as strong in Europe, and very weak in the Americas.

So it is almost a direct, it is almost the polar opposite of the coverage and strength we see on the Trimble side.

Thank you very much.

Mark Jordan, Noble Financial.

Good morning, Jay. A question relative to R&D. You mentioned, I believe, that you had subcontracted out about $700,000 of the $5.1 million. Do you see that subcontract need continuing and so should we assume $5 million plus in R&D through the -- quarterly through the balance of the year?

Well, I think -- a couple of thoughts. One is, we have always subcontracted portions of our work where not surprisingly we are still a relatively small company. So where you have specific one-off activities where it doesn't make sense to maintain a dedicated headcount because we don't have enough activity for them, those are the types of things that we subcontract out.

The $700,000 was not all subcontractors. There's also increased compensation. You have got severance in there from the changeover in the leadership. So you have a few other things that are in the mix there as well.

On an ongoing basis I would say that we still -- our target for R&D is to be somewhere between 5% to 7% of sales. Obviously we are at the high end, in fact slightly above that in Q1 at 7.8%. A little bit of that is a reflection of the sales were obviously lower than we anticipated as a company and so we had -- we added the resources where we needed them, specifically R&D projects that are underway. To ensure delivery, we have got some coming this year, some coming next year, and so the timing of that was almost independent of the current revenue profile.

Would we be at the high end of 7%, slightly above, slightly below for the rest of the year? I think that is a reasonable prospect. Obviously as you get deeper into the year, we would still expect to see our normal sales pattern, so you get to the end of the year even though we may be spending similar amounts on R&D from a dollar standpoint. But percentage would probably come down a bit just because of the normal sales profile.

Second question, looking at the Q, you have got to break out of operating profit by segment in the Americas this year swung to $1 million operating loss versus about $0.5 million gain in the first quarter of last year. With that swing the cause of a mix shift that impacted gross margin? Or was it more an increase in operating expenses that caused the lower profitability in the Americas this quarter?

It is more in the operating expenses. Primarily R&D, when you look at the other reasons Europe has R&D, Asia doesn't have any R&D, so you are going to see primarily the increases in R&D occurred or affect the Americas profitability from the operating side. You are also going to see all of the severance pay running through the Americas regions since that's where those changes took place. As well as that is where all the corporate overhead is as well.

And the warranty revenue that you had that favorably impacted the services piece from a profit standpoint, was that tied to renewals or new sales?

It is a little of both, but I would say there's been an aggressive push on new sales. When you look at the reliability of the products, we have always had reliable products. But as that reliability has improved even further, the sales teams have aggressively been pushing multi-year warranties in the marketplace, extended warranties or extended coverage, depending -- we call them slightly different things in each region and they have a slightly different flavor to them. But generally speaking, they are all extended warranties in terms of how we would think of it.

And I think that the customers, though, you will always have a significant portion of customers who are not interested in that. There are customers who see the value there and if they see us, if you see a decent deal on the warranty of the FARO equipment, we have customers who have said yes, you know what, I like that, it keeps the equipment up to date, it keeps it certified. Things that are important to them. In some cases it is about traceability within their own facilities and the team has been fairly successful in pushing that a little bit in Q4, definitely showed up more in Q1 obviously.

Should we assume that that profitability of that gross margin should be in the low 40% range versus I guess, historically, you would have viewed it -- we would have viewed it in the low 30s moving forward?

Yes, I think we have moved up from Q4 roughly 34%, now we are at 44%. A lot of it depends on the mix of what you are actually servicing in that quarter. Some customers are actually -- that don't have warranties -- they are kind of paying by the drink versus those that do. So you get a little bit of a mix difference there. But I think we are targeting probably close to that 40%, give or take, for the gross margin going forward.

Thank you very much.

Jim Ricchiuti, Needham & Co.

Good morning. Listening to some of the commentary, the need to raise R&D spending, increase headcount, the sales and marketing and just some of the price competition. It sounds as if there may be some share shift going on. Do you feel you are losing some share in the market at this point?

I don't think we're losing what I would call any type of significant share in the marketplace, for sure. I think you've got the products themselves. There's some differentiation between the products, for some productlines and obviously for others it gets a little bit closer in terms of the differentation of the product.

For us, there's a couple of things. One is, on the sales side which is recognition that we still have significant portions of territory that are, in fact, either uncovered, that's a little bit less of the case. New country and things like that. More so, you've got what appear to be an historical event, fairly fruitful territories where we looked at it and said, Look, there's a constraint still of how many demos a month an account manager can do and there's way more lead activity coming in for that territory than that account manager can possibly handle. And that's obviously a good indication to split the territory.

And though we haven't seen the full sale benefit from that yet, for sure, given the environment, when the environment improves even a little bit and when you have that team fully up to speed kind of that six to nine month curve, we would expect to see improvement in the output at that point.

The R&D side is -- quite frankly is a little more strategic in terms of what we are doing there. We have obviously a core set of products we are working on. We have next generation in the works for all of them. And they are at various stages and we have also seen the opportunity to both improve sort of the time cycle on those as well as there are a couple of newer things the team is working on that have come out of the camera end process that though I wouldn't say those are near-term expectations for the team, those are products that are coming down the pike as well. So there is this recognition that we have reached a point that we need to start adding some additional resource to help support that, as well.

Jay, earlier in the year you had alluded to the possibility of maybe looking at an acquisition or acquisitions just to maybe move into some other areas of the market. Where does that stand? Is the environment changing to the point where you are a little bit more cautious on moving forward?

No. I would say we are still very interested in moving forward. There are several companies out there that are of extreme interest, and without saying where we would be in dialogue with any company for sure, the pursuit of acquisitions is something that is still of high interest and the current market environment does not change that. Because the types of acquisitions that we look at give the opportunity to expand the portfolio, expand a complete offering to the customer base allow us to more aggressively penetrate the verticals that we tend to be best in, and give us the opportunity to have a complete suite of products for those customers. So that side of it doesn't change at all from a strategic standpoint.

And just a final question. If we look at the way you are entering the quarter it seemed like you had a little bit more momentum coming out of Q4 so how quickly did the environment change? And seasonally this is a weaker quarter so what are you seeing late in the quarter in terms of activity?

Yes and that is probably the right way to look at it. So the seasonal shift that we normally see when you look at, say, January and February was not all that different from what we have seen in the past. We are feeling a little bit more pressure but not to the point where we said, oh my goodness, this is looking like a flat quarter. We still looked at -- we were looking at a decent growth quarter even as late as February.

Shifts in March, I think we started seeing there was demand shifts, for sure, on the world. You got just to use one customer, Daimler, who has now sort of talked about this openly has seen a fairly decent falloff in demand particularly when it comes to markets like China. And so they have shifted their expectations for the year, they've gone into -- any time customers do that, one of the things they frequently do is they will look at all of their capital expenditures, all their operating expenditures and hold back on some of the programs so we are seeing that. I don't want to cherrypick just Daimler because they are -- it is just a small customer amongst all the different customers we sell to. But it was that type of environmental shift that we started seeing in March.

The financing environment, which is very important in places like India and China for not just FARO, I think for a lot of customers, many of our companies but a lot of our customers, are buying on credit in those markets and that appeared to get really tight. China was already tight the last couple of quarters. Probably the last three to four China has been so-so on the financing side, but India started getting really tight final sort of five, six weeks of the quarter which was a bit of a surprise in that environment. So that was a bit of a driver too. So a lot of this that we saw was in the final five to six weeks of the quarter. It is definitely more pressure than what we expected when we were coming into the quarter though we expected first have to still be sort of sluggish in general I would say that the last four to five, six weeks of the quarter were harder than expected even though we had lower expectations coming in.

Thanks, Jim.

Patrick Newton, Stifel.

Thank you, good morning. Just dovetailing off of that last three to four weeks being a little bit harder than anticipated would it be fair to say that it would be realistic that the June sequential uptick or normal seasonal uptick would be a little bit more muted this year?

Obviously we can't say definitively because there were -- you look at -- in some respects there's some bright spots on America's orders. They did growth rate in the first quarter and I would say that that growth rate was kind of in-line with our stretch expectations but it was a stretch to think 25% orders growth in the first quarter.

No doubt the first half feels -- the total first half feel sluggish. So might in the second quarter not be as -- look at the sequential uptick we normally see, might there be more pressure on that in 2013 than we've seen in the last couple of years? Probably. Could I put a finger on what does it feel like it's flat with Q1 up from Q1? I can't give a flavor for that either at this point.

The thing that's both difficult and frustrating for the team in the field is that leads coming in are really good. The number of demos that the team is doing is also very good. There's plenty of interest out there and that leaves it to them, is the customer going to pull the trigger or not? So similar to when we have seen previous downturns, it is not that there's a drop-off in the demand for the product, it tends to be more focused on can the customer execute in this quarter? Do they need to delay? Those tend to be the harder side of the equation.

So, yes, I would say we definitely feel more pressure still -- or continued pressure I guess, I won't say more but continued pressure in Q2. The second half of the year harder to predict, though it does seem like that at least the sentiment would appear that customers are going to feel more inclined to buy in the second half of the year. Obviously that we all know can shift relatively quickly. But.

And I guess just sticking on the near-term outlook, Keith, could you help us understand? I think you gave the metric of gross margin on a private basis was 59.3% versus 62.3%. So of that 300 basis point delta, can you help us understand what was the FLS impact relative to an ASP impact?

Yes. Typically we don't provide that level of detail, but I think as you will know throughout 2012, we've continued to run promos throughout 2012 started in the first quarter and continued through the fourth quarter. I think what you're seeing on a sequential basis is looking at Q4 of '12 versus Q1 of '13 is that I think prices on some of the products have firmed up a little bit. So -- but not all of the products. And I think you'll -- we have seen some reductions in our manufacturing costs in the first quarter of 2013, but you've also seen when you are looking at the Laser Scanner product the huge increase in the sales through the distribution channel from 37% in the first quarter of '12 to like 65% or so and 63% in the first quarter of 2013. That is quite an impact to the margin. So I think I'll just leave it at that.

So I guess the net is as you get your manufacturing costs down and, now, we are getting distribution steadily at 60% and perhaps higher as you continue to ramp Focus Laser Scanner are the 53% margin days behind us? We are looking -- I'm not saying that March levels are sustainable, but are we looking more at a 55% on a go forward basis?

Yes. I think 55 plus -- roughly 55%, 56% I think that is probably the range. I think the 53% days of the heavy promotional discounting could be behind us.

Perfect. Then, Jay, you mentioned access to Topcon, the global distribution network. I was wondering if you can expand on that? I understand you don't have an OEM relationship like you do with Trimble, but I'm wondering do you have access to their entire network at this point or are you targeting piece by piece the way you did with Trimble before the OEM relationship?

So I won't say we have access to the entire network yet for sure, but I would say we have got a significant increase in access through their distribution network. Some of which has come with higher level discussions within Topcon versus doing it on a distributor by distributor basis. We do not have an OEM relationship. You are correct about that. And our intent is not to try to do the same private label at the current Focus Laser Scanner in any way, shape, or form.

We would like to and they seem to be very open to working with us as a FARO brand and moving that through their channel. And as long as there is a good partnership in that regard, I think that that works for them as well. So you are right, it is not OEM. It is exciting from the standpoint that they do have a good number of distributors around the world. Like I said before they are strongest in Asia and sort of midpoint in Europe and, then, relatively low coverage in the Americas and that is almost the polar opposite of how Trimble's coverage will allow.

And so is it fair to say that the benefit of that relationship is still forthcoming?

Yes, I think so. Look, we have been working -- no doubt we have been working with Topcon for a while so it is not like this is all brand-new to us. But as we have added more here in Q4 and Q1, yes, I would say there's always a learning curve with the distributor on how long it takes for them to get effective with the product as well. So I certainly would anticipate and, quite frankly, we certainly anticipate Trimble in that relationship continuing to improve the output of their distributors to improve as well as they get more comfortable with the product.

Okay. And last one for me is on the Trimble side, I think you had talked about being fairly highly penetrated in their distribution channel exiting 4Q but they were still a chunk and I don't want to put words in your mouth, but I think it was roughly 20% that were still -- had not started the ordering in that relationship. Are you now 100% penetrated? Are we through that stocking phase and are we now on a sellthrough basis for Trimble on a go forward?

Since you don't want to put words in my mouth, I don't know if I will say it was 20% that we were uncovered with before. We certainly didn't --. There was a piece we didn't have penetration with yet. I think we are probably there. When I think about the Trimble relationship, are there some onesies, twosies that either we had not signed up yet or hadn't gotten into the boat yet, possibly. But if there is change out at Trimble distributors they make, obviously, that's not something we control and so that may have some continuous flow in that regard.

But we are at a point where I would say, yes, I am looking more for expanded productivity out of the distributors that are in place now versus growth coming from tooling up the ones that were new to the product or new to the relationship.

Great. Thank you for taking my questions. Good luck.

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

Good morning. Just a question on the Americas, this 25% order rate, could you do a couple of things and maybe just parse that out to core business versus Trimble? Was the core business up in terms of orders double-digit, number one? And number two, where is that strength actually coming from? Exclusive of Trimble, where does -- which customer base is seeing that kind of -- delivering that kind of order growth?

I will go in reverse order. So when you look at the customer base, no doubt auto, aero, heavy manufacturing have all been pretty good actually in the Americas for FARO. And I think you see that in general in the marketplace. So they have been fairly good for us here in the first quarter.

Aerospace, as you know, has been actually pretty good for us around the world and fairly consistently for multiple quarters now. That industry has certainly, even with hiccups that Boeing has had along way here with the Dreamliner, it has not had any type of meaningful impact on the business and they continue to be a good customer. So if you look at the big three, certainly those are the big three in the Americas, probably not a surprise in that regard.

Core versus Trimble, I guess what I would say is that there is growth in the core for sure. There is growth in Trimble also. To parse it out and say is one double-digit, one single-digit are they both double-digit? I would say they are both growing well. I would like to see both grow more aggressively than the 25% even. That may sound, given the current environment that may sound implausible for lack of a better word, but I think there's opportunity.

And it's -- when you look at where the growth comes from, it is not just -- people have asked in the past, hey, is it because Brazil is now direct and you have got huge opportunity there and you are growing there? Yes, Brazil is a good market, but I would say that the United States is our largest market still by far and has been pretty good.

So I can't say that it is just because of emerging markets that we are getting into. The US market has actually been fairly strong here the last three, four months.

And with the Focus Laser Scanner, can you just give a sense of growth there direct versus distribution?

I think the rate is relatively similar if you look at the amount of scanner that went through distribution in the first quarter last year, globally was 37%, I believe. And in the first quarter the amount that went through distribution was at 63%. I don't think we parsed it region by region before, but I would say that those upticks are relatively consistent. The Americas, maybe a teeny bit ahead of the curve only because we had more distributors signed up in the Americas at a more rapid pace.

So the fact that obviously the inverse of the distribution split with direct, we still were up with direct sales?

I don't know if I'll get into the specifics. I will [re up] with our director, up with distribution. The direct-sales force continues to be very effective and part of the exercise has been focusing them on other markets. They do not go call on surveying and civil engineering now, which is Trimble and Topcon. We are very focused on the distributors there, spend their time on that. So our team is getting into the manufacturers, the architects, the forensics side, the historical preservation side. They have been spending a lot more of their time there to help develop those markets and thread the needle a bit for future growth.

And then maybe just -- should we be a little bit surprised that maybe you got off to start -- such an aggressive start to the year with the growth in investments, sales, R&D, relative to the tone of topline sales. It just feels like your operating expense ratios are exposed here because sales were light, but I am a little surprised that you got off to that quick a start with the growth investments rather than matching them up to the tone of business.

Yes. Perhaps a little bit. I just said, it just follows our pattern the first two months of the quarter are usually relatively slow and then the third month picks up substantially. And through the first two months, things felt still pretty good. Like I said not when we look at our internal expectations, we knew it was a little bit short of that, but all the data said this is still potentially a fairly good growth quarter for us.

If you look at the headcount increases sequentially, they are not nearly as extreme as the headcount increases quarter over quarter, for sure. So in some respects you look at it that way and so it wasn't like we suddenly added 30% to the headcount sequentially though it is up significantly over Q over Q. A chunk of that was all added in the second, third and fourth quarter of last year.

I think the investments were necessary and I would not have wanted to wait. The R&D side for sure and the sell side was more looking at like I said there's clear markets where the amount of lead activity coming in could not possibly be covered by the account managers in place. And for sure there's always the debate of how long do you wait. Do you pause, do you not go ahead and get a little bit ahead of the curve and we tried not to get too far ahead of the curve here.

I think that as we added them, they certainly felt in line with where we saw the quarter coming in. No doubt, the quarter is not coming in at the tail end as strongly as we would have liked. But I do think it helps position the Company then for, you get a little bit of impact from it at best in second quarter. It is more about Q3 and Q4 and [see] that is when they will become much more productive and closer to the normal output that we see from our experienced account managers.

Okay and a question -- maybe this is for Keith, but your, the P&L when you look at the gross profit margin on products, it tends for some reason historically it tends to be high in the first quarter and fade through the year. I don't know why. It has something to do with the accruals or whatever that is, but the suggestion being that if it was 59% here in the first quarter that maybe that trails down to this 55%, 56% range for the year.

Is that -- is there any reason to assume that that pattern will continue this year? Is there anything in the mix?

Yes, I think there's a couple of things. Last year, it trailed down -- I think because we intensified our sales promotion from Q1 through Q4. So the sales promotion activity increased throughout 2012. And as a result of the increase in the distribution mix of Laser Scanner product, that also has an impact on that product gross margin. But I think I mentioned earlier that we are starting to see little firmer prices on a sequential basis from Q4 2012 on some of the product lines. So I would not expect that same sort of quarter over quarter sequential decline throughout 2013 that you saw throughout 2012.

So that would be less muted. And sorry, last question just for Jay. When you talk about changing out some leadership on the R&D side, you specifically mentioned that you changed out the software leader key designer. Is there any secular shift in your business towards thinking about the value proposition of your tools towards the software component from the hardware piece?

The software piece is always an important element for sure. So and that will not go away and you are right, look, software is the piece that people interface with in some respects more so than even the device. You are holding the Arm in your hand and you are taking measurements, but a lot of the interface with the customer comes on the software side.

So does that increase over time? I think for sure. Do I think it is a substantial increase where you say, my goodness, the software is suddenly far more important than the device itself. I think that is less of a concern. The bigger focus is more about just what is the entire ecosystem of products that you have that can solve the problems that the customer is looking for. And no matter how good the software is somewhere, somehow, you have to have efficient and accurate and repeatable and reliable hardware to capture all of that data.

I think they go hand in glove with each other, for sure, but you certainly can't say one by itself stand-alone is more important than the other.

So the change in both cases was more about wanting a different type of leadership. It was not unlike the thought process I went through as I was changing out European managing director last year, the Americas managing director at the start of this year, a different focus for the Company and more aggressive push for the Company. And you know, look, different ideas bring different results and if done the right way certainly bring fresh life and improvement to things and that was -- it was more about that.

A couple of your software partners have been acquired fairly recently and I just -- is there a void in independent software partners to take your products to the next step in terms of processing power and 3D capabilities?

I would say no. The two that were required are both available to us and we continue to work with him today. We have a really good relationship with [3D systems] and continue that very good relationship with both of those partners. There is another independent who is arguably the largest of the group that we still have a very close relationship with and work with. That being said, obviously particularly the more point cloud you are handling something about scan data whether it is from a scan arm or from a Laser Scanner, the ability to handle that data is late, simply with minimal training and so forth is still sort of an open problem that nobody has solved efficiently met.

And that I think regardless of software partners or what you do internally is something that continues to have -- there is a real need for that and quite frankly even some of the CAD companies are working on that regard as well because we all recognize that there's this seamless thread between what is captured, how it is used in CAD or how it's used in analysis on the floor from an SBC standpoint.

So those are all things that are important. But I would say there's not -- we certainly are not at a point where there is a lack of independent partners to also be working with in that regard.

All right. Thank you so much.

Jim Ricchiuti, Needham & Company.

Is there anything you can help us with in terms of G&A? Your G&A expense was up by a fair amount sequentially as well as year over year. What -- how should we be thinking about G&A for the year as a whole?

There's some compensation increases here, but some of that was related to severance as well. And I think we talked about, I know we filed an 8-K with regards to that. Going forward, I think that the biggest variable in our administrative expenses has always -- has been recently the patent litigation and I think to the extent that that continues or is resolved fairly quickly, that should have -- that should be the only large variable for the administrative expenses going forward.

Yes, and I would say not surprisingly when you look at headcount increases number one I think the increases that we've made were definitely more front end loaded so you would expect to see that slow a bit in the next three quarters anyway. Number two, admin is always the lowest on the pecking order. It takes an awful lot of convincing to get a new administrative head added versus an account manager or somebody from R&D. We have had a little bit of increase in the cost of sell side to help support service and slight amount to support production volume. But even that is a much lower priority and is certainly a much lower growth rate than the other two being the sales and marketing on the R&D side.

But generally speaking, the actual headcount adds themselves the rate slows if you look at Q2, 3, and 4.

That's helpful. And getting back to the product discussion, how would you characterize the demand for the Laser Tracker, the new Laser Tracker in the quarter, just in light of some of the weakness you saw across the business line?

Yes. Tracker demand has actually still been good. As you know, this was now the third full quarter. I guess not quite full when we first launched but it is the third quarter we have had the product in the marketplace. It continues to be received very well by customers. It serves a very -- the higher end tracker market is a little bit more of a specific niche than say the arm market or the scanner market and even potentially the scanner market, the laser scanner market is much newer.

But I still feel good about the Tracker. The performance of where it is at and that being said it also is not immune to the push from R&D standpoint for what the next generation needs to look like and being as aggressive as we can and trying to accelerate what that next generation looks like.

And just a final question, has the weakness in the yen impacted you just from a competitive standpoint? Or is the -- I am just thinking of your Japanese competitor now.

I think in Japan it is less about the yen. I will say that in the first quarter for the first time in a while, there was more price pressure than usual in Japan specifically. Now you have to take it with a grain of salt because Japan, historically, is buying product at higher than this price in many cases. So price pressure there, it's not the same as price pressure you might get, say, in China or the price pressure we might see in India or the price pressure we even see sometimes in occasionally the United States. The customers just think differently about it.

But in Japan specifically it's a little bit more about just overall customer demand for lower price which is an unusual thing in that business environment and probably not a long-term issue. I think it tends to be more tied to the current economic climate there. We have seen it a couple times in the past. I saw it a couple of times in the past at GE where they were always buying at higher price. You occasionally hit these pockets where they would put a little more pressure on the price and then the pocket dissipates within a couple of quarters.

Okay. Thank you.

Patrick Newton, Stifel Nicolaus.

Thank you, Jay, a couple more. One is you previously gave some distributor metrics where the percentage of distributors that reordered two times or more in the last 12 months. I was wondering if you had that metric for 1Q.

We do. I think it is certainly still more in the 50% who have reordered at least twice. The difficulty is as we have transitioned through Trimble, you have got two different things there. One is you have some newer distributor in there. The other is that much of the volume is going through Trimble first and out to the distributor second. So it throws off the metric a little bit also in terms of where that distribution of assets is going.

So I'm not sure the comparison we had in the past is even perfect anymore relative to just how the relationship with Trimble changed in the fourth quarter when we went direct OEM with them.

Generally speaking, when we look at the independents I am pretty comfortable with the reorder rates there. They are all in that pocket of at least twice in the last 12 months. What I like more -- the question has always been what is the right ratio. I look at it and say the right ratio for me is every week. We are certainly not at that pace with any of them. Is it once -- should they be back once a quarter. Should they be back once every other month?

In some respects I think it depends on the size of the distributor and their overall financial means and probably depends somewhat on the depth of the market they serve. There's no doubt that some of them are in lighter markets. Some of them are in more densely populated markets.

That's helpful. And the last one is on the ASP pricing pressure. I'm assuming it is not as prevalent with the FOCUS Laser Scanner giving lack of material competition. You just made a comment that the Laser Tracker demand is actually still quite good. Is it fair to say that the most exacerbated pricing pressure is on the Arm?

Absolutely.

And is that --? I mean I guess I asked a similar question about two quarters ago when [Hexagon] had refreshed its product lineup and asked if it was competitive or if it is macro. I think at that time you said without a doubt it's macro. It feels like now you're saying it could be -- it's both. Is that fair?

Yes. I think to be fair it is a little bit of both. Macro is a big issue for sure and I think macro causes you because of the customer to be more diligent, I guess, at looking at all the available options. Now all in this market is still two for the most part. You have got one small arm competitor in Japan which is less the issue in Japan than it is just the price pressure, I guess.

But yes so is there -- does the macro to drive the customer to look at the product a little bit more closely? Yes, I think there's some of that for sure. Will that continue for the next few quarters? Certainly I think it continues in Q2. Does it continue more in Q3 and Q4? Maybe, just maybe not as aggressively if the environment improves a little bit.

And is the arm still number one on the product line?

It is.

Thank you.

There are no additional questions.

Very good. Thanks, everybody. Look forward to seeing many of you at the conference that's here in the couple of weeks and updating you again after Q2.

This does conclude today's conference. You may disconnect at any time.