FARO Technologies' CEO Discusses Q4 2012 Results - Earnings Call Transcript

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 |  About: FARO Technologies, Inc. (FARO)
by: SA Transcripts

Operator

Good morning, everyone, and welcome to the FARO Technologies Conference Call in conjunction with its Q4 2012 Earnings Release. For opening remarks and introductions I will now turn the call over to Vic Allgeier. Mr. Allgeier, you may begin.

Vic Allgeier

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

Yesterday after the market closed FARO released its Q4 results. By now you should have received a copy of the press release. If you have not received a copy of the press 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’ll now turn the call over to Keith.

Keith Bair

Thanks, Vic. Sales in Q4 2012 were $80.7 million, a 4.7% increase from $77.1 million in Q4 2011. That brought our 2012 annual sales to $273.4 million, a 7.6% increase from $254.2 million in 2011.

On a regional basis, Q4 sales in 2012 in the Americas increased 5.4% to $33.0 million compared to $31.3 million in Q4 2011. Sales increased 5.4% in Europe to $32.9 million from $31.2 million in Q4 2011, and sales in the Asia-Pacific region increased 1.4% to $14.8 million from $14.6 million in Q4 2011. The effective changes in foreign exchange rates on sales was a decrease of approximately $1.4 million in Q4 2012 compared to Q4 2011.

Comparing year-over-year growth, 2012 sales in the Americas increased 11.4% to $108.6 million from $97.5 million in 2011. Europe sales for 2012 increased 0.5% to $100.1 million from $99.6 million in 2011. Asia sales increased 13.3% in 2012 to $64.7 million from $57.1 million in 2011. The effective changes in foreign exchange rates on sales was a decrease of $8.7 million in F2012 compared to F2011.

New orders increased 6.5% in Q4 2012 to approximately $82.1 million compared to approximately $77.1 million in Q4 2011. On an annual basis, new orders increased 8% to $276.2 million in 2012 from $255.7 million in 2011. On a regional basis, Q4 orders in 2012 in the Americas decreased 0.3% to $33.5 million compared to $33.6 million in Q4 2011. Orders increased 11.3% in Europe to $30.6 million from $27.5 million in Q4 2011. Orders in the Asia-Pacific region increased 12.5% to $18 million compared to $16 million in the year-ago quarter.

Again, comparing year-over-year orders growth, new orders in the Americas increased 8.9% to $109.4 million in 2012 from $100.5 million in 2011. Orders increased 0.9% in Europe to $97.8 million in 2012 compared to $96.9 million in 2011, and orders increased by 18.4% in Asia in 2012 to $69.0 million from $58.3 million in 2011.

The top five customers by sales volume in 2012 were the US military, Boeing, Volkswagen, PT Smart Mitra Solutions, and BMW. Together, these five customers represented only 2.5% of our sales. The top ten customers in 2012 together represented only 3.7% of our sales, once again indicating our lack of dependence on any one or a handful of customers.

Our gross margin was 53.4% in Q4 2012 compared to 56.5% in the year-ago quarter, primarily due to a decrease in product risk margin to 56.1% in Q4 2012 from 60.8% in Q4 2011 as a result of lower average selling prices related to sales promotions and an increase in sales of the laser scanner product to distributors. Gross margin from service revenues increased to 37.5% in Q4 2012 compared to 30.9% in Q4 2011.

Gross margin for F2012 was 54.7% compared to 56.5% in F2011. Gross margin from product sales decreased to 58.7% in F2012 from 61.2% in F2011 as a result of lower average selling prices, a change in the historical sales mix caused by an increase in the sales of the laser scanner product which currently has a lower gross margin, and an increase in the sales mix of the laser scanner product sold to distributors. Gross margin from service revenues increased to 34.8% in F2012 compared to 32.4% in F2011.

Selling expenses were 22.8% of sales in Q4 2012 compared to 23.3% in the year-ago quarter. Selling expenses increased to $18.4 million in Q4 2012 from $18.0 million in Q4 2011, primarily as a result of the increase in compensation and travel expenses. In 2012, selling expenses decreased to 23.6% of sales compared to 24.4% of sales in 2011.

Administrative expenses in Q4 2012 were 8.7% of sales compared to 8.9% in Q4 2011, increasing by approximately $100,000 to $7.0 million from $6.9 million in 2011 primarily as a result of an increase in legal and professional fees of $200,000 related to patent litigation.

In F2012, general and administrative expenses increased to $29.1 million, representing 10.6% of sales compared to 10.5% of sales in F2011 primarily due to an increase of $1.0 million related to the FCPA monitor and an increase in legal and professional fees of $1.4 million related to patent litigation. In total in F2012, legal and professional fees related to the FCPA monitor were $1.4 million and patent costs were $2.3 million.

Research and development expenses increased to $4.6 million in Q4 2012 or 5.7% of sales compared to $4.2 million or 5.4% of sales in Q4 2011. R&D expenses for F2012 increased $2.4 million or 15.7% to $17.6 million for the year ended December 31, 2012, from $15.2 million for the year ended December 31, 2011, primarily due to an increase in compensation of $1.7 million and subcontractor expenses of $900,000 offset by expenses of $400,000 incurred in the prior year related to the closing and relocation of the R&D facility in Andover, Mass., to our existing facility in Kenneth Square, PA. Research and development expenses as a percentage of sales increased to 6.4% for the year ended December 31, 2012, from 6.0% for the year ended December 31, 2011.

Operating margin for Q4 2012 decreased to 13.9% from 16.7% in the year-ago quarter, primarily due to the effects of lower gross margins. Operating margin for F2012 decreased to 11.5% from 12.9% in F2011. Other income and expenses net increased to an expense of $500,000 in Q4 2012 compared to an expense of $400,000 in Q4 2011 primarily as a result of an increase in foreign currency losses due to the effects of changes in foreign exchange rates on the intercompany account balances denominated in different currencies.

On a year-to-date basis, other income and expense decreased to an expense of $600,000 in F2012 compared to an expense of $1.2 million in F2011, primarily as a result of a decrease in foreign exchange transaction losses due to the effects of changes in foreign exchange rates on the inter-company account balances denominated in different currencies.

Income tax expense was $2.9 million in Q4 2012 and 2011. The effective income tax rate was 26.8% in Q4 2012 compared to 23.8% in Q4 2011. Income tax expense decreased to $7.9 million for F2012 compared to $8.3 million in F2011 primarily as a result of a decrease in pre-tax income. The company’s effective rate for F2012 was 25.7% compared to 26.3% in F2011.

Net income decreased to $7.8 million of $0.46 per share in Q4 2012 compared to $9.5 million or $0.56 per share in Q4 2011. Net income for F2012 was $23.0 million or $1.34 per share compared to net income of $23.4 million or $1.39 per share in F2011.

I’ll now discuss a few balance sheet and cash flow items. Cash and short-term investments were $158.2 million at December 31, 2012, compared to $129.5 million at December 31, 2011. Accounts receivable was $62.6 million at December 31, 2012, compared to $57.5 million on December 31, 2011. Days sales outstanding at December 31, 2012, increased to 71 days from 68 days at December 31, 2011, primarily as a result of an increase in DSOs in Europe.

Inventories increased to $68 million at December 31, 2012, from $67.3 million at December 31, 2011. The increase in inventories was primarily related to an increase in demo and service inventories of $3.7 million offset by a reduction in raw materials and finished goods of $3.0 million.

Finally, I’ll conclude with some statistics regarding our headcount numbers. We had 961 employees at December 31, 2012, compared to 885 at December 31, 2011, an increase of 76 employees or 8.6%. Account manager headcount increased 12.5% from 160 at December 31, 2011, to 180 at December 31, 2012, with 61 account managers in the Americas, 56 account managers in Europe, and 63 account managers in Asia. Geographically, we now have 384 employees in the Americas, 324 employees in Europe, and 253 employees in the Asia-Pacific region. I’ll now hand the call over to Jay.

Jay Freeland

Thanks, Keith. Economic uncertainty continued in Q4, putting continued strain on the speed at which customers make their purchase decisions. Globally, sales increased almost 5% in Q4 leaving full year sales growth at almost 8%. Yes, the market environment was difficult, however this is not the type of sales growth FARO strives to achieve.

The Americas and Europe both grew approximately 5% in Q4 while Asia grew just 1%, demonstrating the amount of pressure all three regions faced. For the full year, Asia and the Americas both had double-digit sales growth at 13% and 11% respectively but Europe was flat year-over-year. European customers continue to be concerned over the slow pace of progress in addressing the Eurozone’s fiscal issues. We believe the region has stabilized but economic conditions are still less than desirable.

Asia was also impacted by European concerns in Q4, a continuation of the impact we experienced in Q3. The Americas improved in December once the US elections cycle passed, however US customers are still cautious in their business planning and CAPEX purchasing due to the ongoing fiscal concerns here. In total, it’s not an ideal market environment; however, we see a path to growth and continued improvement in the business model in 2013, and I’ll discuss that more in a bit.

The Focus Laser Scanner was highly successful in the marketplace again last quarter. Sales through distribution reached 66% of all laser scanner sales in Q4, up from 52% in Q3, demonstrating both the positive impact of the Trimble agreement as well as the ongoing success of our other distributors in selling this product. Market acceptance has been very strong and the Focus Laser Scanner remains the only product of its kind in terms of its features, ease of use, and its price.

Average selling price through distribution is approximately 25% lower than list price. This has a negative impact on gross margin, however, overall operating margin improves with incremental laser scanner sales since there are little to no sales or marketing expense associated with it. In 2013, we expect the Focus to perform well again as the Trimble relationship builds momentum and as other verticals adopt more broadly.

The Vantage Laser Tracker launched in Q3 performed well again in Q4. Running at full capacity we sold everything we built during the quarter and went into 2013 with good backlog. Early reliability data is good and overall customer feedback is very positive.

In Q4 we ran sales promotions for the Arm and [LOP] product lines similar to the promotions we ran in Q3. These promotions were primarily targeted at getting customers to purchase in the current quarter. The promotions were successful in generating sales volume for the business though not enough to drive our overall sales growth rates to the targets we set for ourselves internally.

Though the promotions had some impact on gross margins they generated sales volumes that otherwise would not have been here this quarter, thus helping the business in total. We are scaling back the promotions in Q1 of this year and anticipate a return to normal pricing by the second half.

Sales to new customers were 42% in Q4, a 7 point improvement from Q3. Some of this growth was driven by the increase of sales through distribution referenced in my earlier comments. We continue to target a 50/50 split in this metric to help drive adoption of our technology in the marketplace. As the laser scanner becomes a bigger piece of the portfolio, the metric may even skew higher in favor of new customers since most customers in the laser scanner space are new to FARO.

The R&D pipeline at FARO continues to improve. As mentioned last quarter, we have several new programs in development as part of our CAMbrian Explosion Initiative. We’re also actively driving the next-generation developments for our existing products. We target a complete disruption to our product portfolio every three to four years. The Vantage Laser Tracker and the latest version of our CAM2 Measure 10 software are great examples of our engineering team’s ability to execute in this regard.

Equally important in 2012 we had 45 initial patent filings, an increase of 50% over 2011. We now have 251 patents in force and 333 pending worldwide. Looking forward to 2013, and although we don’t discuss specific product programs or release dates, we do anticipate having product releases during the course of this coming year.

Operationally, the FARO team kept things tight in the quarter, helping offset slower sales growth and lower gross margin. Operating costs as a percentage of sales declined in admin and sales, with marketing costs as a percentage of sales remaining constant and R&D increasing slightly. We anticipate generating additional leverage from the model in 2013 and have planned the business accordingly.

As many of you know, I’ve been making fairly significant leadership changes at FARO over the last twelve months. These changes were not necessarily driven by financial performance. They were, however, tightly connected to where I want to take this company, how I want it to grow, and making sure we have the right people in place to ensure our success. Our new Managing Director in Europe, Ralf Drews, is off to a great start and has already brought a fresh perspective to the team over there as well as to the strategic vision the Board and I have for FARO.

The first set of candidates for the Americas Managing Director role looks extremely good. It took six months for me to find the right person for Europe and three more months to have him start with the company. Though I don’t want the Americas’ process to take that long, I will not force the speed either. Finding the best fit for this role is priority number one over anything else. I believe we are in the early stages of a significant and exciting transformation of our company, all focused on fulfilling the vision we have for FARO.

With 2012 behind us and 2013 underway, I feel great about the company’s prospects. Economic conditions are difficult for sure; however, FARO has faced challenging environments in the past and successfully pushed through them. In keeping with our past practice we are not providing specific financial guidance for 2013. We certainly believe we will grow this year and also believe that we will improve the overall operating performance of the company.

We have a world-class technology portfolio, the best people in the industry, and the vision to expand this company significantly over the coming years. In short, we are the world’s most trusted source for 3D measurement and imaging technology. Will it be a challenge to achieved our historical and long-term growth rates in 2013? Yes. Do we have a team that is absolutely focused on executing and positioning us to meet that challenge? Absolutely.

As always I’d like to thank the FARO team for their hard work and dedication to making FARO successful. Thank you for your attention this morning and I’ll now open the call to questions.

Question-and-Answer Session

Operator

(Operator instructions.) We’ll first go to the site of Chris Godby with Stephens. Your line is now open.

Chris Godby – Stephens Inc.

Morning everyone, thanks for taking my call. I guess first of all thinking about order trends, obviously very solid in Q4 considering the macro environment. Have you seen that positive momentum from Q4 carry into Q1 2013?

Jay Freeland

Yeah, without talking specifically about Q1 what I will say is as you know, historically Q1 sequentially, just Q4 to Q1 declines just because Q4 tends to be a bigger quarter for us. So from a market environment standpoint is it possible we’d see that typical sequential decline Q4 to Q1? Yeah. I think history has shown that and I’m not sure there’s anything different in the history that will imply something other than that.

What I will say is that the market environment in Q1 feels fairly similar to Q4. Obviously we’re partway into the quarter now. Our typical trends of still seeing as much as half of our sales during the final couple weeks of the quarter is in play so we’ve only seen a portion of what we actually will see for the full quarter at this point. But generally speaking I think the market environment is fairly similar to Q4.

Chris Godby – Stephens Inc.

Great thanks, that’s good color. And then as a follow-up, can you talk about your progress breaking into the insurance industry with the laser scanner?

Jay Freeland

Yeah, I’d say it’s still a very early stage at this point. The person I hired in the business development role to drive that for us as a specific initiative has found number one that there is definite interest, both on the underwriting side of the house as well as the claims adjustment side of the house. Not surprisingly there tends to be more interest at the firms who are covering or insuring the larger types of assets, so I’m not sure this is a consumer portfolio product yet at this point and quite frankly I’m not sure we really expected it to be there in the early stages anyways.

Most of the insurers that we have talked with have specific technology adoption groups and we have had what I’d call good sort of initial dialog with those folks as well, all of which is geared at what is the right model for utilization inside the insurance carrier and what is the best way to approach them. So in total I feel pretty good about the progress that’s been made there and but it is still definitely early stage.

Chris Godby – Stephens Inc.

Thanks for taking my call.

Operator

And we’ll next go to the site of Patrick Newton with Stifel. Your line is open.

Patrick Newton – Stifel Nicolaus & Co.

Hey, good morning, thanks for taking my questions. I have several so I’ll try to get through as many as possible, but I guess number one I would assume that the Trimble relationship, and you alluded to as much, was a big point of success in the quarter. Can you help us understand sell-in versus sell-through? I believe that you do recognize revenue on sell-in, and if you could let us know or help us understand what the stocking effect was in the quarter and how that should play out. And is there any potential that we see any kind of hiccup as we reach a normalized sell-in/sell-through type of metric?

Jay Freeland

Sure. So you’re correct that we do recognize revenue on sell-in and you’re right that the Trimble relationship definitely had benefit in Q4, though I’d say it’s still at what I’d call the early stages. When you look at the benefit for the quarter, the Trimble distributors that are out there I sort of break into two categories. You have the ones that we had already established individually who were selling, they were already selling the FARO Laser Scanner into the marketplace directly.

So the transition to the FARO agreement with Trimble and the private labeled product was simply a transition of as those distributors finish selling the FARO units that they already had then they transitioned to the new Trimble unit and started selling those. And in all cases the bulk of the distributors, it’s not like they’re carrying 20 units on their shelves. They tend to carry four, five, two, six – I mean that’s sort of the size of portfolio that we’re seeing which is not a bad thing because that ensures, I shouldn’t say “ensure” but it gives us the best possible flow that they’re not putting 20 or 30 units on the shelf and then there’s no activity for three or four months.

Then if you take the other group, which is the distributors which had not previously been working with FARO, I would call that group in sort of the ramp-up and learning phase. And we saw this with not just Trimble distributors, with all the distributors we have set up over the past year and a half to two years that we’ve been doing this now. There is a sort of sequence of get them to understand the product, they order their first set of products – it might be one or two, it might be three or four, that’s fairly typical; not a whole lot more than that depending on the size of the distributor. The products come in; our application engineer will spend some time training.

In the case of the Trimble agreement now we spent a decent amount of time in the quarter also doing train-the-trainer with the Trimble folks to try to allow them to have more of that relationship on an ongoing basis with their distributors because that’s similar to how they already operate with their other products that they sell through. So those newer distributors, there’s more sell-in than there’s sell-through for the quarter for sure because they’re just getting ramped up though, like I said, it’s not like they’re all taking 20 units a pop and there is a significant one-time influx from that.

The existing distributors, which were a decent portion of Trimble’s base going into the relationship, they were clearly in sell-through mode throughout the entire quarter. So I think it was well balanced in that regard.

Patrick Newton – Stifel Nicolaus & Co.

Thanks for the details. Jay, just to confirm, I believe in prior conference calls you had said that you were roughly 20% to 25% penetrated into Trimble prior to the OEM relationship – is that fair? Just to kind of give us a sense of the existing Trimble distributors versus new?

Jay Freeland

I don’t know if I said exactly 20% to 25% but for sure we were at what I’d call less than their majority, let me say it that way. And what I will say is there are still some Trimble distributors that have not fully adopted the technology yet, so there is still some initial sell-in that’s occurring today and some of that’s really just timing more than anything else. We wanted to manage this appropriately with the Trimble folks and they have been, the Trimble team has been fantastic in getting this launched.

They’ve done all the right things; they’ve been marketing it aggressively. We’ve seen Trimble independent ads for the product line in different trade publications and with different organizations that work with the product. So and from a support standpoint we wanted to make sure this was laid out in a fairly cohesive and structured manner.

Patrick Newton – Stifel Nicolaus & Co.

Okay. And then I guess shifting gears to Europe from the top line perspective, I think my math shows a little over 56% sequentially. Can you help us understand the growth from an FOS perspective relative to the rest of the business? And as we think about the changes that you’ve made there, you talked about the new GM in place, in 2011 I think you churned about 30% of the account managers – should we anticipate, or is this the leading edge of productivity gains from the churn-over that you had or should we anticipate continued productivity gains in that geography?

Jay Freeland

Let me go in reverse order, so I’ll talk about sort of the people part and I’ll let Keith talk about the number parts. So I’d say you’re right, number one, that there was about a 30% churn within say a quarter of the initial changes that occurred during Q1 and the beginning of Q2 last year. Clearly that team has stabilized, so when you got to Q4 you had minimal turnover and you have account managers; you’ve got the existing team of course who have already been there and you have the new ones who are anywhere from still maybe a month or two to upwards of four months or five months onboard. So yes, you’re starting to see productivity.

Are they fully productive yet? Definitely not. We still see that learning curve as being 9 months to 12 months for the typical account manager, so I would anticipate that that new group starts getting additional productivity even here in Q1; and as we get to Q2 that’s when they ought to be hitting what we consider full stride. Looking at the current year, no doubt we’re going to continue adding account managers to help drive the growth we’re anticipating for the year, and that’s part of the standard model for us.

We definitely still see substantial opportunity to split territories and do it in a way that you are not stealing necessarily from the existing account managers – you’re not jeopardizing and cannibalizing the work that they’ve done so it is truly in fact an incremental add to the company as you split that territory and bring in the new folks. And Keith can talk about the numbers side.

Keith Bair

Yeah, as far as sequentially you’re right, it’s a 56% increase. But historically Q4 primarily in Europe has been roughly in the 40%’s, mid-40%’s growth sequentially. I think what you see though is Q2 and Q3 sequentially, Q2 was flat, Q3 was down. So I think given the historical growth in Q4 there was probably a lot of delayed orders that just didn’t ship in Q2 and Q3, and now you see some of that budget flush that historically they’ve experienced in Q4.

Patrick Newton – Stifel Nicolaus & Co.

Okay, so we should read that as laser scanner relative to the rest of the business, it was good across the board and laser scanner was not an outsized contributor to that 56% sequential increase.

Keith Bair

Well, I’m not breaking it out by product line; I’m just saying in total.

Patrick Newton – Stifel Nicolaus & Co.

Okay.

Jay Freeland

What I would say Patrick is there is good growth coming across the board. It does vary obviously by product line for sure but you know, it’s not like we’ve got a whole bunch of product lines sitting flat and the LS is the only thing that’s moving.

Patrick Newton – Stifel Nicolaus & Co.

Okay. And then I guess last one from me is Jay, you talked about new products. You talked about investments and you talked about refreshes coming roughly on average every three years. I believe your Focus Laser Scanner was launched in Q4 2010 meaning that it’s kind of right on that cusp of a three-year refresh but you lack a material competitor in this business. Is this a product line that, I guess is that the focus around kind of the leading edge of perhaps where you’re investing?

Jay Freeland

So let me hit a couple of points there without trying to be coy about it, I guess. Every three to four years, so the four is still in there, too, but are we putting significant investments into the laser scanner? For sure. We love what we’ve done with the Focus Laser Scanner and it has proven itself to be a fantastic product in the marketplace. We are a company that firmly believes that you disrupt yourself as fast as you can; you don’t wait for the others to do it. And you don’t wait if you’re done and you’re ready to go, you let it go.

So is it possible that the LS could be on a three-year stint instead of a four-year stint? For sure it’s possible just like any of the other products and I’m not going to commit, certainly not going to commit to any one of them. And to be fair we think of it the same way across the other product lines as well, not just the LS even though it’s the newer and the one that people like to talk about a lot because it’s a brand new market for us. But we’re investing I think fairly significantly across the board in all of them would be a way to describe it.

Patrick Newton – Stifel Nicolaus & Co.

Okay thank you, good luck.

Operator

We’ll next go to the site of Jim Ricchiuti with Needham & Company.

Jim Ricchiuti – Needham & Company

Hi, good morning. Jay, looking at the Q4 to Q1 seasonality, I guess it’s average low double-digit declines over the last couple of years. Is there any reason to think that you wouldn’t see a similar pattern? Or does the fact that you’re still in somewhat of channel fill with Trimble, does that change things at all?

Jay Freeland

In that order I think number one, I think you’re correct that typically the sequential decline is low double digits, is that right, Keith?

Keith Bair

Yeah.

Jay Freeland

You know, 11%, 12%, 13%. It’s probably too early to say definitely, but what I will say is as the Laser Scanner has become a bigger piece of the portfolio. We all know it’s number two now and two years ago it was kind of insignificant, not meaningless but it was financially insignificant to the company so that’s a shift for sure. And as we sell more and more through Trimble, do I believe that the seasonal patterns will shift over time? For sure.

So what I can’t tell you, Jim, is it a slow roll or does it slowly eat away at say the sequential decline from Q4 to Q1 or the giant increase that we sometimes see from Q3 to Q4? Is it a sequential change or is there some step function we’re going to experience? It’s too early to tell that. I do believe it does affect it over time because there definitely appears to be at least a different purchasing pattern over in that marketplace than what we see in the industrial world.

Jim Ricchiuti – Needham & Company

Okay, that’s helpful. And then just turning to margins, your service margins in the last two quarters have been meaningfully above levels that I think we’ve seen in the last couple of years, including I guess what looks like a record level for Q4. What’s driving this? Is it sustainable?

Keith Bair

Well, it’s primarily an increase in our warranty sales and the warranty sales has a much higher gross margin compared to the rest of our service business. And I think in all regions they’ve been focused over the past few years on increasing the sales of those warranties because as you noted, they are very profitable compared to training or the customer service work that they pay by the drink.

Jay Freeland

Yeah, and some things we’ve done there, to add some more color, there are sort of two that stand out to me. One is changing the process by which we actually attack the warranty sale, and how we address the customer. And the way with which we go about that from a sale and down to the actual salesperson level has shifted fairly significantly in all three regions over the last two years.

And then the broader sort of side of it is depending on the region, whether you call it the extended warranty or you call it... We found in places like Asia that warranty as a term doesn’t resonate the same way as service agreement seems to feel more proactive and more value-added, so depending on how you shift the actual offering itself as a solution to the customer has had some impact on customer acceptance as well.

Jim Ricchiuti – Needham & Company

Okay, thanks. One final question and I’ll jump back in the queue. Jay, you’ve alluded recently in some of your public commentary about the possibility of making an acquisition that potentially would be more meaningful to revenues than some of the previous acquisitions you’ve done which I guess have been more technology related. Any update on where you are with that?

Jay Freeland

I certainly still believe that’s the case. We are, as we look to aggressively grow the company, and again, I’ve talked about sort of this transformation of FARO – the next wave of transformation. One of the things that that includes is the possibility of larger acquisitions. So yes, it is absolutely still possible in 2013. Yes, there are candidates out there that we are looking at without saying anything obviously specific about who they are.

And what I would say though is that the one thing that does remain a constant for us is that the profile we look for must have what we consider to be market changing or market influencing or cutting edge, leading edge technologies that can be leveraged and accelerated is critical factor number one. And if you clear that you are looking at the team – what kind of people are we getting? Are they a right fit for FARO? Do they think the way we do? Do they think way outside of the box and do they share that same aggressive sort of view of the world, of how we can help solve customer problems?

And then third becomes the financial profile. The big difference obviously is if you’re looking at a smaller startup type, the financial profile and what you look at is sizably lighter in terms of its impact versus a larger company that has a fully-established operation and in many cases a global operation.

Jim Ricchiuti – Needham & Company

Okay, thanks a lot.

Operator

(Operator instructions.) We’ll now go to the site of Rob Mason with R. W. Baird. You line is open.

Rob Mason – R.W. Baird

Jay, could you give us maybe your assessment of how you view order or deal close rates as you exited Q4? It seems like there were a couple of dynamics at play around the Trimble stocking orders, perhaps customers that have been sitting on potential orders for a couple of quarters and now maybe budgets were released. But just as you exited Q4 what’s your assessment of close rates? Has there been much change there underlying?

Jay Freeland

Without saying the specific sort of increases, I would say that number one, close rates improved in Q4 for sure. I would liken, a part of that certainly is the Trimble agreement – as you’re selling through and selling into that relationship as it’s gotten better and better, that’s a piece of it. And then a portion I would say is your Q4 budget flush that we see historically. I would say the flush was not as robust as we’re used to seeing; that obviously demonstrates itself in the numbers when you look at the growth rate. It’s good but it’s not historically what we like to see.

From a color standpoint I’ll say that the budget flush this year occurred much later, much later in the quarter. You know, usually you really start seeing the activity pick up right after sort of the US Thanksgiving holiday and it was deep into the quarter this year that that process started which was both nerve-wracking on the frontend and then hair-greying or –whitening on the delivery side of it as well.

I think that was as much a function of just the overall environment – customers knowing they have the budget but waiting that much longer to be absolutely certain that there wasn’t going to be an edict from above to hold up on purchases at the last second, so I think we certainly saw that in the Americas and Europe. Asia for us and I think for many industrial companies, Q1 particularly in Japan and China in some respects – Q1 for us tends to be there Q4.

So we actually are looking in Q1 now for what that budget flush looks like in Asia and does it follow a similar pattern where it tends to be really tail end of the quarter, like late March instead of early March and late February like we’ve historically seen.

Rob Mason – R.W. Baird

Could you make a distinction between close rates among the laser scanner, which obviously you did have the Trimble dynamic occurring, and the core metrology products?

Jay Freeland

I could. Though it’s still an earlier market for us I’d say close rates for laser scanner are fairly consistent. And what I would say is are they improving some? Yeah probably, just because you have more, I shouldn’t say probably – they are because you have more potential distributors just by the Trimble agreement alone that we are selling into and then are eventually selling through.

On the metrology side, what I’d say is that they’re coming off of what are certainly not historical lows – 2009 would still be the historical low on close rates for industrial customers on the metrology side. But Q2 and Q3 were slow on the metrology side relative to what we’re used to, Q4 definitely improved but still not at what I would call our normal close rates on the metrology side. Definitely better but not completely normal yet.

Rob Mason – R.W. Baird

When would you expect to have all of the initial stocking orders to the Trimble distributors?

Jay Freeland

I think the larger majority have occurred already. There are still some occurring in Q1 for sure. We know that there are a chunk of Trimble distributors that we’ve just not gotten to yet. By the end of Q1 are you down to probably what I’d call just the stragglers or kind of the tail end? Yeah, I think by the end of Q1 we’re there. That seems to be sort of where we’re at at this point. Certainly by the end of the first half all of the initial sell-in is done and you’re already well into sell-through with most of them.

Rob Mason – R.W. Baird

Okay. Keith real quick, you called out the patent and legal fees for last year. What would you expect that number to look like in 2013?

Keith Bair

Without putting a specific number around it I think first of all, much, much lower. I think it depends upon… Nikon’s decisions is going to determine how much as spend going forward, whether they decide to appeal or what the process is from there. But certainly we would not expect to incur the costs that we did this year. You know, we went through a jury trial this year and that’s a very expensive thing to do, so I think we’re getting to the end of that but again, it’s pretty much in Nikon’s court depending on their decision to appeal and where they want to go from here.

Jay Freeland

And certainly the monitor costs which were significant in 2012 are gone.

Rob Mason – R.W. Baird

Right, right. Okay, thank you very much.

Operator

And we’ll next go to the site of Jim Ricchiuti from Needham & Company with a follow-up question. Your line is now open.

Jim Ricchiuti – Needham & Company

Thanks. I just wanted to pick up on some of the order patterns in the Americas. It sounded like post-election and certainly late in the quarter you saw a burst of activity. And I’m wondering in the March quarter what kind of effect you might be seeing if any from sequestration, which is there any caution on the part of customers in the US regarding that?

Jay Freeland

Yeah, I think is there caution? For sure. But actually that caution from our perspective has been baked into the behavior for at least a quarter and a half now and arguably you started seeing it in Q3 with the Americas starting to slow a bit in Q3 as well. And sort of the thought process is you know, the customers we talked to were expecting sequestration by the end of the year anyways, so yeah, it got kicked a little bit further down but they were already expecting it. They’re still expecting it. I don’t think that’s changed the behavior pattern a whole lot relative to the last six months.

Are they more concerned about it currently than they were say twelve months ago? Absolutely, no doubt there but we’ve been seeing it and managing through it, and what I’d call sort of watching it stabilize over that sort of six-month time period. You get over the initial fear, things slow down, the decision process slows down and then you get to sort of a new normal for lack of a better word I guess that then drives decision patterns from there.

Jim Ricchiuti – Needham & Company

Okay. And then Jay, on the change in the Americas leadership, has there been an accompanying churn factor in the Americas as a result of the change similar to what you experienced in Europe?

Jay Freeland

Yeah, definitely not similar to what we saw in Europe. The big occurrence in Europe was obviously the change with the Managing Director and within a month of that changing the sales leadership. And the combination of those two then led to the substantial account manager churn that Patrick referenced earlier.

When you look at the Americas, the sales leadership is fully intact. The sales leader has been in that role for several years now and is still in that role, so when you look at account manager churn it is no different than normal for us in the Americas. That’s the biggest difference for sure between the change in Europe versus the change in the Americas.

Jim Ricchiuti – Needham & Company

Thanks. And lastly, Keith, on the tax rate what should we assume for this year?

Keith Bair

I think we continue to fluctuate between 26% and 28%. We’ve had some benefit in both 2012 and 2011 from the effect of the exercise of incentive stock options. We’re shifting more now towards nonqualified options that have a different tax treatment so we may not continue to see that effect from the employee exercise. But I think the 26% to 28% is probably still a good range.

Jim Ricchiuti – Needham & Company

Okay, thanks a lot.

Operator

And we have a question from Patrick Newton from Stifel. Your line is open.

Patrick Newton – Stifel Nicolaus & Co.

Yeah, Jay, just a question on (inaudible). You made a comment that in Q4 the budget flush was not as robust as in the past, and when I look at your average sequential Q4 growth rate over the last twelve years it’s 22% and the high is 33% which was in December of 2007 – so you just matched that high on a sequential basis. So am I to interpret that the sequential uptick with lack of a normal seasonal budget flush means that the delta between what is a record sequential uptick in revenue and the sub seasonal budget flush is driven by the Focus Laser Scanner?

Jay Freeland

Certainly not entirely by the Focus Laser Scanner but you’re right – you have to put some of that into the mix, because in 2007 laser scanner sales were completely insignificant relative to the company’s financials. So it’s definitely a piece of it and it would tie then to my feeling that on the metrology side there was budget flush but not at the same rate.

Patrick Newton – Stifel Nicolaus & Co.

Okay, and then I guess just on the promotions side, I believe and correct me if I’m wrong, that your prior promotions in kind of the Q3/Q4 timeframe were largely bundled promotions. Was that true or did you move beyond that and I guess expand your promotion packages in Q4?

Jay Freeland

No, it was primarily still the bundled promotions and that’s the part we start unwinding here in Q1 and finish unwinding in Q2.

Patrick Newton – Stifel Nicolaus & Co.

Okay, and can you quantify at all the success of the promotions or how much revenue you think that you might have pulled in and how we should think about that impacting Q1 and Q2 as you kind of unwind these promotions?

Jay Freeland

Certainly not with a specific number. It definitely had some benefit, and again, just to be clear, we tend to target the promotion at the customers that are sitting on the fence. There was not a ton of trying to get people who were way far away from the fence because many of them would not have closed anyway, so we tried to target it at the fence sitters.

Did it help get some of them over the wall in the current quarter? No question about it. Would we have gotten that revenue eventually? I think we probably would have. Would it have occurred in Q1 or Q2? You know, yeah, it’s hard to tell but it probably would have been in that timeframe. Do I think it robbed Peter to pay Paul so to speak within Q1 versus Q4? Not dramatically.

Patrick Newton – Stifel Nicolaus & Co.

Okay, thank you.

Operator

(Operator instructions.) And at this time there seem to be no additional questions.

Jay Freeland

Very good. Thank you very much everybody for your attention this morning and we look forward to updating you at the end of Q1. Thanks!

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