FARO Technologies Inc (FARO) 2014 Q1 法說會逐字稿

Good morning everyone and welcome to FARO Technologies' conference call in conjunction with its first quarter 2014 earnings release.

At this time all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question and answer session. (Operator Instructions)

Please note that this call is being recorded.

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

Thank you and good morning everyone. My name is Vic Allgeir of the TTC Group, FARO's investor relations firm.

Yesterday after the market closed, FARO released its first quarter results. By now you should have received a copy of the press release. If you have not received 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 Peter Abram, Senior Vice President and Chief Financial Officer. Peter 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 set forth in yesterday's press release and in the Company's filings with the SEC.

I will now turn the call over to Peter to review the financial results for the quarter.

Thank you, Vic and good morning everyone.

Sales in the first quarter of 2014 were $73.4 million, an increase of $8 million or 12% growth compared to $65.4 million in the first quarter of 2013.

Product sales increased by $7.3 million or 14% to $59.8 million for the first quarter of 2014 from $52.5 million in the first quarter of 2013 primarily as a result of higher sales volumes in our Arm and laser tracker product lines as well as higher average selling prices in our laser scanning product line due to the introduction of the X330 unit late last year.

Service revenues increased by $0.7 million or 5.2% to $13.6 million for the first quarter of 2014 from $12.9 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 2014 in the Americas increased $3.5 million or 13.3% to $29.6 million compared to $26.1 million in the first quarter of 2013 primarily driven by increased volume in laser trackers, increased average sale prices in laser scanners, and increased Arm sales volumes.

In Europe, sales increased 8.8% to $23.8 million in the first quarter of 2014 from $21.9 million in the first quarter of 2013 primarily driven by increased Arm sales volumes and average selling prices and service revenue related to warranty and training, partially offset by slightly lower laser tracker volume.

In Asia Pacific, sales increased 14.9% to $19.9 million for the first quarter of 2014 from $17.4 million for the first quarter of 2013 primarily driven by higher volumes and average selling prices in both our laser tracker and laser scanner product lines.

The effect of changes in foreign exchange rates on sales was a decrease of $0.5 million in the first quarter of 2014 compared to the first quarter of 2013.

Turning to orders, new orders increased 9.8% in the first quarter of 2014 to $70.9 million compared to $64.6 million in the first quarter of 2013.

On a regional basis, first quarter orders in 2014 in the Americas increased 7% to $29.2 million compared to $27.3 million in the first quarter of 2013.

In Europe, orders increased a healthy 16.7% to $24.5 million in the first quarter of 2014 from $21 million in the first quarter of 2013.

In Asia Pacific, orders increased 5.5% to $17.2 million in the first quarter of 2014 compared to $16.3 million in the first quarter of 2013.

The top five customers by sales volume in the first quarter of 2014 were Boeing, Siemens, the U.S. Military, VRSI, and FMC (inaudible) nuclear. Together, those five customers represent only 3.4% of sales. The top ten customers in Q1 2014 collectively 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 54.6% in the first quarter of 2014 compared to 56.3% in the first quarter of 2013. As identified in our press release, this decrease was primarily driven by a write-down of laser scanner demonstration and service loaner inventory that became obsolete due to the highly successful release of the Focus 3D and the X330 and X130 laser scanners. Partially offsetting this charge was favorable pricing and related gross margin arising from the laser tracker and the new laser scanner product lines.

On a quarter over quarter basis, gross margin from product sales decreased to 58% in the first quarter of 2014 from 59.3% in the first quarter of 2013 primarily driven by the onetime inventory charge just discussed.

Gross margin from service revenues decreased to 39.9% in the first quarter of 2014 from 44.1% in the prior period primarily due to increased warranty and customer service costs.

Gross margin declined sequentially from 54.9% in Q4 2013, again primarily related to the onetime inventory charge previously referenced.

Selling expenses were 23.8% of sales in the first quarter of 2014 compared to 25.5% in the first quarter of 2013 primarily driven by better productivity defined as sales generated per account manager and lower marketing costs in the current quarter. Selling expenses increased to $17.4 million in the first quarter of 2014 from $16.7 million in the first quarter of 2013 primarily as a result of higher compensation expense due to increased headcount.

Administrative expenses in the first quarter of 2014 were flat at 11.5% of sales compared to the first quarter of 2013. Administrative expenses increased by $0.9 million to $8.4 million in the first quarter of 2014 from $7.5 million in the prior year quarter. The increase in administrative expenses primarily stems from higher compensation expenses of $1.2 million partially offset by $0.3 million in decrease in bad debt expense due to specific accounts previously reserved for being collected in the quarter.

Research and development expenses increased to $5.4 million for the first quarter of 2014 or 7.4% of sales compared to $5.1 million or 7.8% of sales in the first quarter of 2013. R&D expenses increased primarily due to an increase in compensation as we accelerate spending in this area in 2014.

Operating margin for the first quarter of 2014 increased to 9.5% from 8.7% in the first quarter of 2013. Operating margin was favorably impacted in the quarter by top line sales growth, solid cost management, and timing of planned R&D expenditures.

Our income and expense net remains flat at $0.1 million for the first quarter of 2014 compared to the first quarter of 2013 which continued expenses is attributed primarily to net foreign currency transaction losses resulting from changes in foreign exchange rates on the value of the current intercompany account balances of the Company's subsidiaries denominated in different currencies.

Income tax expense increased to $1.8 million in the first quarter of 2014 from $1 million in the first quarter of 2013 primarily as a result of an increasing pretax income and a discrete tax benefit of $0.4 million recognized in the first quarter of 2013 related to retroactive legislated reinstatement of the research and development tax credit for the year ended December 31, 2012. The effective tax rate increased to 27% in the first quarter of 2014 compared to 18.4% in the first quarter of 2013.

The effective tax rate for the first quarter of last year included the discrete tax benefit equivalent to 7.5% and a 1.4% benefit related to the exercise of employees' stock options as compared to the current quarter stock option benefit of 0.2%.

Net income increased to $5 million or $0.29 per share in the first quarter of 2014 compared to $4.6 million or $0.27 per share in the first quarter of 2013.

I will now briefly describe a few balance sheet and cash flow items. Cash and short term investments were $187.7 million as of March 29, 2014 compared to $189.6 million as of December 31, 2013.

Accounts receivable was $64.7 million as of March 29, 2014 compared to $66.3 million as of December 31, 2013.

Days Sales Outstanding as of March 29, 2014 decreased to 65 Days from 67 Days as of December 31, 2013.

Inventories increased to $70.6 million as of March 29, 2014 from $68 million as of December 31, 2013. The increase in inventories was primarily related to an increase in service inventory of $1.3 million, finished goods up $0.8 million and demonstration inventory of $0.4 million.

Accounts payable and accrued liabilities decreased from $75.5 million as of December 31, 2013 to $68.5 million as of March 29, 2014. The decrease is attributed primarily to a decrease of $4.5 million in accounts payable, a $1.6 million decrease in accrued liabilities, and a $1.7 million decrease in income taxes payable, partially offset by $1.1 million increase in current unearned service revenues. The accounts payable decrease is attributed primarily to higher yearend expense accruals. The decrease in accrued liabilities and income taxes payable is attributed primarily to higher commission bonus and federal tax liabilities as of December 31, 2013 that were paid during the quarter ending March 29, 2014.

Finally, I will conclude with some statistics regarding our headcount numbers. Globally, worldwide sales and marketing headcount increased by 60 or 16.9% to 416 as of March 29, 2014 from 356 as of March 30, 2013. Globally, account manager headcount as of March 29, 2014 increased by 18 or 9% to 218 from 200 as of March 30, 2013.

Recently in the Americas, account manager headcount increased by ten or 15.2% to 76 as of March 29, 2014 from 66 as of March 30, 2013. In Europe, account manager headcount increased by seven or 11.5% to 68 from 61 as of March 30, 2013 and in Asia Pacific, account manager headcount increased by one or 1.4% to 74 from 73 as of March 30, 2013.

We had 1,112 employees as of March 29, 2014 compared to 1,004 as of March 30, 2013, an increase of 108 employees or 10.8%. Geographically, we now have 442 employees in the Americas, 384 employees in Europe, and 286 employees in the Asia Pacific region.

I will now hand the call over to Jay for his comments.

Thanks, Peter. I am pleased with our first quarter results which were in line with internal expectations.

Overall, market conditions are good as demonstrated by our double digit sales growth in the Americas and Asia and double digit orders growth in Europe.

The Americas continues to be our most favorable market environment but the overall environments in Europe and Asia are clearly better than they were one year ago.

In Asia, the credit markets in China and India continue to have some negative impact on the region but it is manageable and we have seen good improvement from Japan.

In Europe, we still haven't seen meaningful economic improvement but overall sentiment continues to improve and is favorably impacting customer purchase patterns.

Overall, we feel very good about current market conditions as well as going forward.

Looking at first quarter sales more closely, product demand for Arms, scan Arms, and laser trackers was very good. The Vantage laser tracker released 18 months ago continues to be particularly well received by both existing and new customers.

While the pricing environment for Arms continues to be difficult globally, Europe and Asia were able to achieve moderate price increases in the first quarter of this year. However, it is too early to know if these slight increases will hold and as result, we continue to plan the business accordingly.

Demand for laser scanners was strong as well with the new X130 released this quarter generating great interest on top of the successful launch of the X330 in the fourth quarter of last year. The market appears to have embraced the new technology platform, the extended range, and the new GPS functionality.

We continued our shift away from our go to market arrangements with Trimble and Topcon in the first quarter in favor of a more direct model using a mix of our own Account Managers and selected independent distributors. There is a substantial opportunity for FARO in the $1 billion addressable portion of the architecture, engineering and construction space as well as the $300 million estimated annual opportunity in law enforcement. We are moving aggressively to attack those markets and believe we are in a position to do so more effectively with our shift in approach. That shift includes not only our sales strategy but also our research and development efforts too.

In that regard, research and development spending increased moderately in the first quarter. However, I expect the rate of increase to accelerate in the remaining three quarters of this year as we push aggressively into new markets and into new industries which require new technologies.

As I have stated in previous calls, we have a very robust product release schedule planned for 2014. The schedule calls for new generations in existing products as well as at least one new product that does not currently exist in our portfolio.

However, the 2014 product release schedule is just a piece of a much bigger, more expansive development push. The opportunities for FARO to disrupt its existing markets as well as new ones are substantial. We are expanding the engineering organization and giving them aggressive goals and deadlines to create newer and more disruptive solutions. Some of the solutions will solve problems that are not being solved today. Others will solve existing problems more efficiently and more effectively. The timing is right for us to be creative and aggressive. The market need is there and we have the core expertise to be successful.

To complement our research and development push we remain diligent in identifying and reviewing acquisition opportunities. Optical technologies and software capability remain our highest priority. However, if we look deeper into the markets we serve currently as well as our newer expansion verticals, we may also find different priorities while still remaining true to the Company mission of 3D measurement, imaging and realization.

There are plenty of opportunities in the pipeline and I continue to believe that it is not a matter of if but more a matter of when.

The FARO team did a nice job controlling costs this quarter across the operation. Selling costs as a percentage of sales declined from the first quarter of last year and administrative costs remained flat.

Our hiring is primarily targeted in the R&D, service and sales organizations and we continue to look for ways to drive efficiency everywhere else. The two newest members of my senior team, CFO Peter Abram, and General Counsel Jody Gale, have settled in and have already had a positive impact on the Company. They, along with the three Managing Directors and my Chief Technology Strategist create a formidable leadership team and represent a group of people that will work diligently with me to drive FARO to the next level.

In summary, our first quarter results establish a good foundation for the rest of 2014. Markets are solid. We are pushing aggressively in sales and R&D and we have a great team in place globally to realize the vision for the Company.

As always, I would like to thank the FARO team for their dedication to the FARO mission and I would like to thank all of you for your continued support and I will now open up the call to questions.

(Operator Instructions) And we will take our first question from Patrick Newton with Stifel. Please go ahead. Your line is open.

First question is I guess the one I always ask is new customer sales versus existing, if we could get that percentage from you?

Sure, Patrick. New customer sales this quarter were 38%.

Alright and then I guess distribution, you talked about kind of moving away from Foxconn and Trimble but can you help us understand what distribution was in the quarter and how you expect that to phase out over the next several quarters?

Yes, the distributor percentage this quarter was 53%, 47% direct and I think as Jay alluded, we will continue to see that start to decline.

Yes, I think the real shift you will see, Patrick, is while we will still have selected distributors we work with, some of them may even be a Trimble distributor or a Topcon distributor, the global arrangements are disappearing rapidly and it is our intent to serve that market directly and aggressively.

In order to do that, that seems to be a little bit more of a hands-on and different types of markets than FARO normally targets. Do you need to add more account managers or do you think that the account manager level is pretty sustainable given the headcount you have added over the last, call it, four to six quarters?

Certainly we need to add more account managers. I think the typical run rates that you see run in mid-teens in terms of percentage increases which is comparable to what we did here in the first quarter and what we have been doing historically will do the trick. The account managers that we hire will be focused and dedicated on either AEC or law enforcement or both to tackle those markets and some of those hires have already occurred. Obviously, some of them still are to come and this is one where you are right, while some of the missionary work in concept is not different from what we see in the industrial market every day, so we're very used to what it takes to that. The expertise is a little bit different. We need people who come from that space and understand those spaces and speak that language so not surprisingly, the types of people we are targeting are a little bit different than what we had targeted for the industrial side in the past.

And while on the account manager subject, your Asia account managers were down sequentially quite substantially -- nine -- which I guess in your history has never really happened. Anything you can walk us through that drove that reduction?

Yes, I think number one, it's just timing so we had a few departures that we forced performance-wise. We are up one net quarter over quarter. You're right, we're down a bit sequentially and as always, hiring of account managers for us can be a little bit lumpy and it is only because finding the right people is really critical so we will have quarters where we will be slightly ahead of our normal rate and we will have quarters where we are slightly behind it. If you look at Asia specifically, we are definitely a little bit behind the typical rate. It did not have an impact on the region for the quarter certainly and don't anticipate it having any negative impact going forward. I think you'll see that number strip in the other direction here in Q2.

And then just last one for me, Peter -- two part -- can you help us quantify the overall impact to gross margin from your inventory write-down and then as we think about this shift to more and more direct sales, adding account managers and moving away from distribution, can you help us understand if we, I guess under the thought process of seasonal revenue growth through 2014, how gross margin should trend?

On the inventory write-down question, the overall impact to that was $1 million. That was the total impact on that. As we think about the shift from the distribution model to the more direct model, I think that is going to be a slow shift. I don't think that is going to happen overnight but I think that will, in the longer term, improve the margins from a gross margin perspective. Jay, I don't know whether you want to comment on that.

I agree with that, the latter part for sure but to add some color to the inventory too, Patrick, the write-downs that we are doing are units that were in many cases, five, six, seven years old so not just one generation but two generations away from where we are now.

Historically, as you know we have been, we are pretty aggressive about taking demo units, refurbing them and selling them into the marketplace and we have been doing that even with that generation of unit as late as the tail end of the last year and while it is never a meaningful piece of the revenue, it has always been a little piece of revenue.

We got to a point during the course of Q1 that the relatively small number of units that were left, getting them to what we consider customer quality grade and the sustainability of those units over the long term from a service standpoint otherwise, the damage to the FARO brand of trying to keep pushing that unit relative to what is available now in the Focus product line as well as the X product line that have been released in the last two generations, it just wasn't worth the effort anymore at that point.

So if we take that inventory, $1 million, back it out, you are looking at about a 56% gross margin, Peter, is what I am calc-ing.

That is correct.

So if we think about that 56% as kind of the true base of what you are offering at and then we think about the distribution shift on a go forward basis, would 56% be a fair gross margin base for the year?

Correct.

Yes, I think you are right. That is the right number to think about as our starting point coming out of Q1, yes, absolutely.

And we'll take the next question from Jim Ricchiuti with Needham & Company. Please go ahead.

In your Investor Day, you talked about realignment of some of the key verticals under your respective geographic heads, talking about the AEC and aerospace and auto. It's early but I am just wondering is there anything, any indication as to how that is going or do you see that really playing out over the course of the year?

Two comments with that, I guess -- the first is I wouldn't think of it necessarily as realignment because just the phrase -- I'll be really specific for a moment -- always makes me think of true organizational and structural change and that is not what we have done at all certainly as it relates to those verticals. We have account managers that sell into different verticals or across multiple verticals and that is kind of the one spot where you see a little bit of that.

The initiatives as we have laid them out is we have, for example, our Managing Director in Europe, Ralf Drews, is responsible for the global deep dive on better understanding the automotive market and some of that is given the strength of automotive in Europe, particularly in Germany and the understanding we have of it and he then needs cross functional teams from the Americas and Asia to also make sure we have captured the folks in Detroit and the Southeast and the folks over in Japan and in Asia and Korea and places like that to better understand that market so then me and the Senior Team can more efficiently and effectively design the rest of the strategies to go around automotive, and then the same thing for aerospace with Kathleen here in the Americas, same thing for the AEC market for Joe out in Asia given that actually was his background a long time ago before he even joined FARO.

In terms of the legwork that has been done, we have seen great progress. The Senior Team is back together and face to face for one of our quarterly retreats in a few weeks here and at that point in time, I will see the first full report outs in detail with all the data to go with it and I do still remain convinced that while our strategy has several different pieces to it, one of which is looking at technologies across multiple verticals, I do believe that the deep dives we are doing on the five or six markets we have with FARO are going to, they will identify other opportunities to better serve those markets where we know we generate a significant portion of our current revenue.

Thanks for clarifying that. Jay, you gave some color as to the market environment (inaudible) versus a year ago. I wonder if you would characterize the market environment versus the last time you, your last call. In terms of some of the end markets, what are you seeing? Are you seeing conditions as stable or improving and maybe you could touch on each of these key verticals?

The easy one I guess I would start with is aerospace and I will say the word stable which I hate the word stable but it is only because aerospace has been so strong for the last five years. It would be hard to say that it could improve a whole lot more. It continues to be a very strong market so that one is stable and I mean that in the positive sense of the word stable.

I think automotive has improved a little bit from what we have seen from our customers and we are getting better purchasing out of that group.

AEC has definitely improved. Now, I try to balance that with knowing that is a very new market for us so any incremental sales that we have there, some of it is just because we are coming off of still a relatively low baseline compared to our penetration in, say, automotive or aerospace but the AEC market, the construction market, appears to be improving as well. The customer interest appears to be improving as well and I think I will get a better feel for that next week too. I will be presenting at the World Geospatial Forum which is a fairly large gathering of geospatial professionals from around the world and that will give me a couple of days to not just present to the group but also to interface and understand what they are seeing, what they are feeling, where is the current pulse of the market for those folks.

Law enforcement, a little too early to tell just because that one is really new for us so I can't give you a feel if I think that market is improving or not. We know it represents significant opportunity for us.

And then the other one I did is heavy industrial. I think we have seen moderate improvement there. It really depends on sort of sector to sector. The energy sector I think is driving a little bit right now which we kind of include in that. When we say heavy industrial we include selling to the power guys and to the turbine manufacturers and folks like that but the CATs and the Deeres and those folks seem to be doing pretty well which I think is a reflection of what we are seeing in the AEC side.

Okay, I will jump back in the queue but last question from me is I think you referenced some price increases in the Arm business. I don't recall hearing that from you in a while. Can you talk a little bit about that?

Yes, you are correct. When we talked about price increases or stable at a really low level for the last year and 2013, to remind everybody, there was significant price pressure in the Arm market. The first two quarters were a rapid descent and then Q3 and Q4 were relatively stable but at that much lower level.

Europe and Asia, not the Americas yet, but Europe and Asia we saw a little bit of price increase when you look at the average selling prices across the board. It was enough that I can say it was meaningful enough for me to put it in the script, not enough for me to say that we think it may or may not stick at this point so I am still planning for the worst but it was a sign of improvement. It was real when we look at the average selling prices. I have not heard the same chatter about price from the field, just generally speaking, the chatter that we were getting last year. Some of that may be that they are just, they have all gotten accustomed to that lower price level. That is not necessarily a good thing. I prefer they not have chatter because they feel like it is actually getting a little bit better.

I think the next two quarters will be a better feel for that. One quarter certainly doesn't make the trend but we feel a little bit better at least from what we have seen.

And we will take our next question from Hendi Susanto with Gabelli & Company. Please go ahead.

First question, at the Analyst Day you shared your target of at least six software packages. Are those software packages complementary to your products or separate products that will generate new sales growth?

Most are currently complementary. Let me say this -- all products end up complementary to the technology that we have. They really work hand in glove together. You will see new generations of several and then you will see one or two new ones, I think, come through the door this year and the timing of that is perfect. You asked the question two minutes after we announced the release of our latest version of CAM2 Measure10 so I didn't put it in the script because I didn't want to take away the thunder from my marketing team.

We released this morning the latest version of CAM2 Measure10. Now, this is clearly an existing product. It is a next generation of the product but there is a real meaningful shift here that is important for everybody to understand which is for FARO, this is the first time that we feel we have a metrology software package that is absolutely complete as it relates to both probing and scanning. Historically, we have had minimal point cloud capability in our own software and relied very heavily on third party providers that are in the market space.

The new version that comes out that is being released today and given the feedback we have heard through all the alpha and beta testing, is a substantial step forward as it relates to point cloud management in metrology, so not laser scanner, just in metrology and if you think about an 80/20 rule on application, the bulk of our applications that we sell into now can be served by that software and certainly will be what we are presenting to the customers first, foremost and most aggressively and the point cloud capability that is down to a very select number of very high end, very expert level applications becomes the place where we will sell third party software so on a go forward basis, number one, it gives us a deeper connection to the customer which of course, long term is very important to us. We already have great connections with our customers. This just takes us one step further.

But secondarily, it means more software, it should mean more software content sold that belongs to FARO directly. That should have some positive impact on gross margin and a better long term strategy for us as it relates to the connection to metrology devices.

Hendi, thanks for giving me the opportunity to tee that one up since you timed the question perfectly as it relates to the press release.

And then my second question is about gross margin. In Q1 2013, gross margin benefited from increased warranty revenue while in Q1 2014 we saw increases in warranty expenses. How should we think of the dynamic of the warranty, its impact on gross margin? I think it will be great if you can remind us whether or not just to have room for higher tax rate on warranty.

I think the way I would answer that question on kind of a quarterly basis, our warranty revenue fluctuates quarter to quarter. When you look at our warranty expenses and our cost base it is more of a fixed cost base. We have very little variability there and so you will see some variability on the margin aspects of warranty quarter over quarter. I believe we will continue to see our warranty grow and expect that to continue into the future.

Strategically, we do have still, which we started last year which helped the process, we had people who are dedicated to selling those warranties and servicing the customer the right way with them which historically, we had not done prior to 2013 so that is another reason that we believe that we will continue that growth there.

Peter, CapEx is higher than my estimate and relative to last year. Do you have insight into CapEx for the year and where investment is made?

Our CapEx spend for the quarter was $1.9 million. Jay, I don't know whether you want to comment.

I apologize. Hendi, I don't know where you had it targeted for the quarter or for the year. I think the one thing you will see, there will be slightly higher CapEx spending this year than our typical run rate, and still get a percentage of sales. We have a couple of key projects underway one of which is SAP which is a project that is long overdue that we presented to the Board last year and received approval to move forward with. It is a, what I would call a slow and steady implementation. We have a fully functioning and operating ERP system today inside of FARO so we have luxury of being able to do this on a time schedule, a spending schedule and most importantly, on an implementation schedule that has the least amount of disruption to the business but I think you would see, that is probably the primary driver over the course of the year. It will be up a little bit. It's not like it takes off. We are not going to have a massive increase in CapEx as it relates to it but you will see a little bit of acceleration there.

And then one last question for me, Jay, would you be able to share what product mix looks like? I would like to understand whether it is still similar or different compared to a year ago.

One other thing on the CapEx that you should be aware of as well is the new Exton facility that is being built and so that is going to drive some additional capital expenditures both in Q1 and for the remainder of this year as that facility is slated to come online in Q4 of this year.

And to remind everybody that that facility is directly associated with the wind down of our laser tracker and imager facility in Kennett Square, Pennsylvania. Exton is the next town over. We are in the middle of putting together a new facility there. Number one is we are completely out of space. We had pushed the limits probably for two or three years beyond that existing facility so a lot of it is geared towards submitting improvements in the manufacturing quality, ease of manufacturing, the efficiency in manufacturing laser trackers and imagers and in preparation for the growth as well. Imager, as everybody knows, we had a moderate release at the tail end of last year. Probably no one would be surprised to know that we have new releases planned in that product line and they are substantial releases so it is also in preparation for the volume we would anticipate from that product line.

And I apologize, Hendi, I missed the last question you asked.

What the latest product mix looked like and especially compared to a year ago, or 2013, whether you are seeing some shift of product mix?

I would say no to that, certainly not as you think about the general rankings, Arm being number one. Scanner, tracker, neck and neck at number two and three and then everything else below that. That mix has not shifted meaningfully at this point.

And we will take our next question from Ben Rose with Battle Road Research. Please go ahead.

Question is about specifically on the aerospace market, could you comment on the health of both the commercial and defense portion of the market? Hearing kind of back and forth on whether the defense portion of aerospace is improving but would be curious to get your take on that.

Most of what we do in aerospace is on the commercial side. The defense side tends to be very, very small. Even though you occasionally see any number of the defense agencies show up in our top five customer list, that doesn't necessarily mean they are on the aerospace side.

From what we hear -- it is probably no different than what you hear -- is that there is sort of hints that it is getting a little bit better. I can't say that we have seen anything significant in that regard yet. The commercial side where we do virtually all of our aerospace business has been very strong and continues to be.

And we will take our next question from Mark Jordan with Noble Financial. Go ahead, please.

A question back on the development of specialized reps for the scanner markets that you are assuming from distribution. By the end of this year, what percentage of reps in the Americas, Europe, and Asia-Pac do you believe will be of this specialized group and would there be a much higher focus on that, growth of reps in the Americas?

I would say it is too early to be able to say exactly what the percentage would be and actually, I am not sure we will split that out even as we get to the end of the year. It is comparable to we don't currently split out the difference between Arm reps and tracker reps and any other product lines.

Would there be more in the Americas? Potentially, just because the law enforcement market in the Americas is a little more prepared for the next step in moving into laser scanning than the other two markets, not by a substantial margin but they are definitely a little more prepared for that so you might see a little bit more on the law enforcement side if you really got to look at the heads name by name.

The AEC side, that market is ready and it is global so the increases that we make to address the AEC market would be very similar across all three regions and like I said before, they would be people who come from that space and already understand the workload utilization and they understand the speech thought for where scanners should be used in the process and where a scanner is complete overkill for the typical projects they do.

A related question, to move away from distribution and your master agreements, was that just a function of lack of focus on your partners there or was it an economic reason that you decided to shift?

It is less economics from a cost standpoint. That is certainly not the driver. I think there is less focus for sure. I think what we also learned over the last year as we got the opportunity to start interfacing with some of the customers directly even with the relationships in place is that serving that marketplace, the early impression was that you really had to be attached to distribution and like I said, there are some regions, there are some territories where we will definitely still use distribution because we know they are focused, we know they are doing it well and it is definitely more efficient than adding three or four or five or whatever the number is, extra people to cover a particular territory but we have found that the reliance on the distribution network is not as critical as having the expertise, having the ability to describe why you are using scanners, why they are able to disrupt a meaningful portion of the current AEC space and disrupt the current technology that is being used there today.

In many respects, I feel like we possibly have so underestimated just how far the scanner could go to displace traditional technology so I think when we talk about accelerating R&D and the types of things that we are working on, many of those are now geared at kind of the question, why do people even keep using point to point [fill-up] stations and (inaudible) things like that well beyond the original estimate we had for the market?

And we will go next to Richard Eastman with Robert W. Baird. Please go ahead.

Just a couple quick questions on the orders in the quarter -- again, just kind of looking at the orders and how they came in at about $71 million, it seems like the seasonal orders here were maybe a little bit softer than one would expect and I am curious, as we kind of talk through the pieces, how do you feel about that internally, that seasonally, orders maybe should have been a bit higher?

In a general sense, because we tend to run a pretty close one to one book to bill, I would say we would have liked to have seen a little bit closer to the revenue number. There are real positives in that as well. Europe's growth on the order side was very strong and is a little bit of a leading indicator as to the turnaround we are seeing there.

The rest of the regions, when you talk to the leadership, when you talk to the sales team, there is not a lot of concern about slightly softer orders in the first quarter. The revenue side was good. Because we are close to a book to bill of one, nobody has flagged concerns about their ability to hit the internal targets we have for Q2, three and four and three and four is a little further out. That one is always more of a general or directional feel. Q2 is the near term one and we are not hearing any whistle or concerns about that from the field.

And so maybe just the same question, when I look at Asia and I look at that book to bill and the order growth relative to the sales growth there, it still seems like, is that market stable or is there still some continued softness and with that order number, that is enough to support your internal plans for the second, third, and fourth quarter, meaning in Asia?

Yes, it is. Again, most because -- for starters, we typically, any given quarter we go into the next quarter with three, maybe four weeks of backlog so everything we had in backlog at the end of Q1 is already shifted here in Q2 except maybe a small handful.

Asia, historically, has always had that same pattern too so yes, what we see is Japan definitely got stronger in Q1 and a little bit of it is that Q1 for us is typically Q4 for a lot of Asian companies -- for Japanese companies -- so we always had a little bit of a blip because of that in Q1 out of Japan but beyond that, the Japanese market felt strong regardless of the fact that it was their Q4 so that was a positive sign.

China and India, those credit markets are still, they are slow. They are no different than where they were. I think because we have been dealing with that for a year now, sort of a cycle has adjusted itself accordingly and so we are not hearing from the team quite the same negative impact that they were feeling from it last year. Even though the speed of the cycle is not where we would like it to be, we have been dealing with it for 12 months so everything has sort of cycled through and you get that stable pattern to go with it.

So yes, even in Asia, the team there feels very good about the internal targets for Q2.

When, I think it was Peter -- it might have been you -- just kind of mentioned the sales mix in Asia-Pac, there was a heavy emphasis laser tracker/laser scanner, no comment on Arms. Is the mix there shifted particularly towards the scanner and laser tracker products? Is that a market related issue or is that just a --?

No, I wouldn't say meaningfully. I think the credible thing was to highlight success with tracker and scanner. Arm is still the number one product line. You would not find a region in the world where it is not the number one product line for us still.

Can I just ask, on the Focus laser scanner products, now with the 130 and the X330, can I ask you was the growth rate in the first quarter year over year of those products, did it match the corporate average or was it above or below?

I am not sure we have disclosed that in the past, Rick. What I would say is that the growth rate was essentially in line with our expectations and you know we have very high expectations for that product line and I think what you would see is that not surprisingly, as we transition from relationships that we had to going more direct or dealing with distributors on a one-off basis who are critical, it would be a little slower than we might have planned for internally but you would still see good growth out of the product line.

I think the one other thing you would say there is that with the 330 coming on in fourth quarter of last year, that did push the average selling prices up for the overall.

That is maybe -- part of the question here is kind of the split between volume and price. I mean, given what is going on with the X330, given the transition between distribution and direct, although distribution was still 53% of sales, I guess but I was curious if the volume in the Focus laser scanner product line is being impacted by the shift in distribution and it sounds like it is.

I would say a little bit but not meaningful to the point where you would say hey, hey -- certainly not where you would say this is the wrong decision for us and not to a point where I would say I feel like we have any risk to achieving the types of targets that we have set for ourselves internally specific to the product line and then for FARO in general.

Just to stay on that same theme, when we first came to market with X120, we primarily went direct and we kind of quickly realized we didn't have access to that market. We had a tough time. We didn't know that market. I understand we've got the X120 in the market. We've got the 130 upgrade with the X330 but what gives you the confidence that we can build a direct sales force that can effectively reach that market kind of at the same rate that distribution starts to fade some?

A couple of thoughts there, Rick, because you are right. Number one is we are not fully going away from distribution, obviously. As we highlighted, there will be territories for sure where we continue to work with distributors who are performing very well for us and they really understand the scanner product line and are focused on selling it because they know that it is a far superior solution to what is out there for a large portion and even larger than we might have expected originally, number of applications.

Number two is that in dealing with customers over the last year, year and a half, even with the global arrangements that we had, as we would get to interface with customers directly whether it was service calls or otherwise, it is clear that customers are not necessarily as attached to their distributor as they are attached to bringing the best technology with the best efficiency.

And then I think the third thing is is that as we look at the go forward development plan on laser scanner, both on hardware and on software, there are still significant and meaningful changes that will occur to that product so the X330 opened up a whole new portion of the addressable market for us mostly because of the range and a little bit because of the GPS and when you think about the range of a lot of the big surveying projects, the 330 shouldn't be a shock and word spread much faster than we would have expected so I think some of that is showing market readiness and acceptance that it is time to adopt that technology.

And then when you think about what is coming for the next generation of that product which will open up the door to essentially the entire addressable market now, we are crystal clear on our own beliefs now so taking all of that into account, that FARO people and distributors who really get what we are doing there, that mix is the best way to address it versus trying to resell through one of the traditional players who is still fighting to keep the traditional product line alive and operating in that mode.

And again, it just strikes me that as we move from the 120 to the 130 to the X330, we add range, we add GPS capabilities. Aren't Trimble and Topcon increasingly viewing you as a competitor in this space versus a complementary product line?

I am sure of that, particularly as we shift away from them. Both already tried to introduce their own laser scanners to the marketplace last fall. We have not seen any delivered out of Trimble yet. We have seen I think a couple delivered out of Topcon. The units are still nowhere close to where FARO is from a performance standpoint, from a capability standpoint and obviously, like I said, we are not waiting for somebody else to disrupt us so the next generation which is coming is a substantial and meaningful move forward again in that regard.

But you are right, in some respects there is a piece of me that says if you set aside everything else that we have learned about the marketplace, they definitely are going to see us more as competitors to their existing technology so longer term, staying tied up with them doesn't make a whole lot of sense just on that point alone.

(Operator Instructions) And we will take a follow up from Patrick Newton with Stifel. Please go ahead.

Jay, I think last quarter you had kind of alluded to a mid-teens growth rate for calendar '14 as being reasonable. You come out the gate with a 12% growth rate, some decent backlog. If we just kind of take the March quarter and seasonally grow it throughout the year, that kind of puts us in the same ballpark. Is that a fair way to think about your revenue potential in 2014?

Without declaring guidance for 2014 which you know we don't do, we do still believe that a mid-teens growth rate organically is the right way to think about FARO in general. That could be '14, '15 and beyond but yes.

And then Peter, given the commentary, we have a big NPI portfolio that is driving R&D investments. I am dovetailing off of Rick's question, building out your channel in order to better target the FLS opportunity, I am assuming that your sales headcount has to continue to go up. How should we think about leverage? You just grew OpEx at 6%, revenue at 12% but on a go forward basis, should we see kind of a continued leverage there or should we imagine that OpEx is going to trend more towards revenue growth rates?

On the first question, I think you are right being we are continuing to add on the sales force headcount. That is going to continue to grow throughout the year both from an organic perspective as well as from covering the new markets and the distributorships and I think you should think about that on the OM side similar vein to what you are seeing on the top line revenue growth.

Outside of what we have said, we are going to make some investments both in R&D and sales and marketing so maybe not to the full level but you are seeing revenue go up.

Yes, I think that is right. The R&D side is the one that I would highlight again. The increase quarter over quarter in Q1 is probably not indicative of the types of increases you would see in the next three quarters. Not the same, we are not still getting leverage out of the model. For sure we expect to get some but the exciting thing for FARO is, why you would see us accelerate the R&D growth rate yet again is the opportunities for us to disrupt these markets and what we are starting to see as we dig deeper into them is substantial and while there will be some M&A opportunities to help us in that regard, we have some things we are working on right now that there is no way I would wait a second longer to put people on the project and finish the [war], in some cases add people to finish the project faster. It is that kind of environment. I am that excited about what the potential holds there and so that is why you would see that part accelerate a bit more.

Okay great, and then I guess just last one on the ASPs increasing, for the laser tracker, is that just a function of the newer product coming out and on a year over year basis, it's just the mix of the new generation with a higher ASP that is driving that up or is it that the new product, you are actually able to increase prices from the original sticker from when it was launched?

I think the pricing increases, not tracker scanner -- tracker, while the prices are higher than they were two years ago because of the new Vantage laser tracker, if you look at them year over year, the tracker has been out long enough now that I wouldn't say you are seeing increased price on tracker year over year, that's for sure. If you look at it versus two years ago, no question because the list price is $10,000 higher.

The X330, we are definitely seeing higher price there because it also has about a $10,000 higher list price. To be fair, we certainly don't ever achieve list price on -- not ever -- not too many deals do we achieve list price on but on a go forward, unless we see some improvement in the Arm, that is the one spot where we are going to watch very carefully, I think you've kind of got the pricing market where it is at the moment until we get to a point where we purposefully decide to disrupt it again.

And it appears we have no further questions at this time so I will turn the program back over to our presenters for any closing remarks.

No further remarks. Thanks everybody, look forward to updating again at the end of Q2.

This concludes today's program. We thank you for your participation. You may now disconnect.