FARO Technologies, Inc. Q3 2009 Earnings Call Transcript

| About: FARO Technologies, (FARO)

FARO Technologies, Inc. (NASDAQ:FARO)

Q3 2009 Earnings Call

November 5, 2009 11:00 am ET


Vic Allgeier - IR, The TTC Group

Jay Freeland - President and CEO

Keith Bair - SVP and CFO


Mark Jordan - Noble Financial

Jim Ricchiuti - Needham & Company

Richard Eastman - Robert W. Baird

Andy Schopick - Nutmeg Securities


Good morning, everyone, and welcome to FARO Technologies conference call in conjunction with its third quarter 2009 earnings release. For opening remarks and introductions, I will now turn the call over to Vic Allgeier. Please go ahead.

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 third quarter results. By now you should have received a copy of the press release. If you have not received the release, please call Nancy Setteducati at 407-333-9911. The press release is also available on FARO's website at www.faro.com.

Representing the company today are Jay Freeland, President and Chief Executive Officer and Keith Bair, Senior Vice President and Chief Financial Officer. Keith and Jay will deliver prepared remarks first and will then be available for questions.

I would like to remind you that, in order to help you understand the company and its results, management may make some forward-looking statements during the course of this call, including statements regarding the future state of the economy, the company’s future financial condition and results of operations, the company’s operational plans and strategies and their impact on the company’s product development and sales model, the company’s ability to reduce costs, streamline operations, improve efficiencies and reduce inventories, and their short and long-term impact on the company, the balance between new and existing customers and the success and continuation of the FARO Test Drive program.

These statements can be identified by words such as expect, believe, predict, intend, will, should, and similar words. These forward-looking statements are subject to a number of risks and uncertainties that may cause actual results to differ materially from those projected in these forward-looking statements.

Important factors that may cause actual results to differ materially are those set forth under the heading Risk Factors in the company’s Annual Report on Form 10-K for the year-ended December 31, 2008 filed with the Securities and Exchange Commission.

I will now turn the call over to Keith.

Keith Bair

Thank you, Vic, and good morning, everyone.

Sales in the third quarter of 2009 were $35.7 million, a 27.3% decrease from $49.1 million in the third quarter of 2008. Sales in the European and Asian regions were $22 million, representing 62% of total sales for the quarter. On a regional basis, third quarter sales in 2009 in the Americas decreased $4.7 million or 25.5% to $13.7 million, compared to $18.4 million in the third quarter of 2008.

Sales declined 32.1% in Europe to $14.6 million from $21.5 million in the third quarter of 2008. Sales in the Asia Pacific region were down 19.6% to $7.4 million from $9.2 million in the third quarter of 2008. The effect of changes in foreign exchange rates on sales was a decrease of approximately $400,000 in the third quarter of 2009.

New orders decreased 27.2% in the third quarter of 2009 to approximately $35.8 million, compared to $49.2 million in the third quarter of 2008. On a regional basis, third quarter orders in 2009 in the Americas declined 20.5% to $14 million, compared to $17.6 million in the third quarter of 2008. Orders decreased 32.1% in Europe to $14.8 million from $21.8 million in the third quarter of 2008.

Orders in the Asia Pacific region decreased 28.6% to $7 million, compared to $9.8 million in the year ago quarter. The top five customers by sales volume in the third quarter of 2009 were the U.S. Military, Comau Pico, Volkswagen, GE, and Ford, and represented only 4.6% of sales. The top ten customers in the third quarter of 2009 represented only 8.5% of our sales, once again indicating our lack of dependence on any one or a handful of customers.

The company initiated the third reduction in force in August 2009 of approximately 8% of its then current workforce. We incurred severance cost of $600,000 and expect to save $4.1 million in compensation cost on an annual basis. In addition, we eliminated several corporate positions in the third quarter, incurring an additional $300,000 in severance cost and expect to save approximately $900,000 in annual compensation cost.

In total, in 2009, we reduced our workforce by 270 employees globally and incurred $2.7 million in severance cost. The combined annual compensation cost savings are expected to be approximately $17.3 million. Our gross margin was 54.9% in the third quarter 2009, compared to 59.1% in the year ago quarter.

This decreased was primarily due to a change in the sales mix between higher margin product sales and lower margin service revenue, resulting from a decrease in product sales. As a percentage of sales, selling expenses were 32.2% of sales in the third quarter of 2009, compared to 31.3% in the year ago quarter.

Selling expenses declined $3.9 million to $11.5 million in the third quarter of 2009 from $15.4 million in the third quarter of 2008. As a percentage of sales, administrative expenses were 17.2% of sales in the third quarter of 2009, compared to 13.5% in the third quarter of 2008.

Administrative expenses in the third quarter of 2009 decreased by $400,000 to $6.2 million from $6.6 million in the third quarter of 2008 primarily as a result of decreased compensation and travel-related costs.

Research and development expenses were $2.8 million for the third quarter of 2009, or 7.8% of sales, compared to $3.2 million or 6.6% of sales in the third quarter of 2008. This decrease is primarily related to a decrease in compensation cost.

Operating margin for the third quarter of 2009 was a negative 6.3%, compared to a positive margin of 2.6% in the year ago quarter, primarily as a result of previously mentioned decrease in sales and gross margin.

Other income includes foreign currency transaction gains of approximately $100,000 in the third quarter of 2009, compared to a loss of approximately $700,000 in the year ago quarter. Interest income decreased by approximately $500,000 in the third quarter of 2009 to approximately $31,000 from $550,000 in the third quarter of 2008 due to a decline in interest rates.

Income tax expense decreased to a benefit of $800,000 in the third quarter of 2009, compared to an expense of $500,000 in the third quarter of 2008. The company’s effective tax benefit rate for the third quarter of 2009 was 37.6%, compared to an effective tax rate of 19.9% for the third quarter of 2008, primarily due to a taxable loss in jurisdictions with higher tax rate.

Net income decreased to a net loss of $1.3 million or $0.08 per share in the third quarter of 2009, compared to a net income of $2 million or $0.12 per share in the third quarter of 2008.

The number of fully diluted outstanding shares in the third quarter of 2009 was $16.1 million, compared to $16.7 million in the third quarter of 2008. This decrease of approximately 600,000 shares is primarily related to the repurchase of approximately 600,000 shares during the first quarter of 2009 of the company’s common stock as part of its share repurchase program.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $92.4 million at October 3, 2009 compared to $105.5 million at December 31, 2008.

In the first quarter of 2009, the company sold its investment of $82 million is variable rate demand bonds and now hold $65 million of US Treasury Bills. As mentioned earlier during the first quarter of 2009, the company repurchased approximately 624,000 shares of common stock, totaling approximately $8.8 million as part of its previously announced share repurchase program.

Accounts receivable was $35.7 million on October 3, 2009 compared to $49.7 million at December 31, 2008. Day sales outstanding on October 3, 2009 increased to 91 days from 81 days at December 31, 2008, primarily as a result of an extension of the collection cycle in Europe. Inventories decreased by $5.3 million to $41 million at October 3, 2009 from $46.3 million at December 31, 2008.

Finally, I'll conclude with some statistics regarding our headcount numbers. We had 742 employees at October 3, 2009 compared to 959 at December 31, 2008, a decrease of 217, or 22.6%, primarily related to the three reductions in force that occurred in the first and third quarters of 2009.

Account manager headcount decreased from 187 at December 31, 2008 to 156 on October 3, 2009. We now have 43 account managers in the Americas, 52 account managers in Europe and 61 account managers in Asia. Geographically we now have 295 employees in the Americas, 255 employees in Europe and 192 employees in the Asia Pacific region.

I’ll now hand the call over to Jay.

Jay Freeland

Thanks, Keith, and good morning, everyone.

Generally speaking, the business climate in the third quarter continued to be difficult. However, we are starting to see some signs of life in the markets we serve. In particular, September activity was noticeably better than any month in recent memory.

In total, sales in the third quarter were up sequentially over the second quarter of this year, a period during which we historically see about a 10% decline. Sales also grew sequentially between the first quarter and second quarter of this year, so there is some momentum there.

Leads and demos are continuing to grow to our normalized run rates, but in the third quarter our convergence started to improve, albeit slightly. We’ve also maintained our 50:50 balance between new and existing customers indicating the compelling ROI for our products, as new customers continue adopting our technologies despite the downturn.

Suddenly, it's too soon to signal whether we are coming out of woods completely or not. There is still some uncertainty out there. However, we are definitely seeing more positive sentiment from our customers in most countries around the world.

One of the benefits we have as this company is that approximately two-thirds of our sales are generated outside the Americas that allows us to quickly shift focus as require to different parts of the world. We expected Asia will recover more quickly from the current economic downturn, particular in China, and, as a result, we will be leveraging the strong presence we have in that region to drive our own return to sales growth.

Historically, our fourth quarter generates the significant increase in sales sequentially from the third quarter. This is due to customers acting on a "use it or lose it" mentality with respect to their capital equipment budgets at year-end.

We don’t all foresee the same mentality this year, but there are some favorable signs out there. We used the third quarter to create additional breathing room around our break-even point as a company. In August, we conducted our third reduction in force with a goal of getting our break-even point to roughly $35 million to $36 million in revenue. It appears we have accomplished this.

In the third quarter, we generated over $35 million in sales and we had a loss of approximately $2 million of operating income. However, this quarter included severance cost associated with the reduction in force and unabsorbed manufacturing overhead, which had a one-time negative impact. Without these items, we’re essentially break-even for the quarter.

We expect that this sales level of $35 million to $36 million, assuming approximately 57% gross margin, will keep us break-even going forward. With that complete, we are now focused on increasing our sales volume and improving gross margins as we return to growth. The third quarter is exciting from an R&D perspective.

We introduced the FARO ION Laser Tracker, our newest generation and now the world’s most accurate large volume laser tracker. With the 27% improvement in accuracy, a 36% improvement in range, and a 12% improvement in weight, the new ION is the first of several new generations of product you will see from us over the next 15 months.

Despite the reductions in force that we made this year and the significant cost cuts we executed, R&D spending is one area I purposely left intact. We’re spending almost $5 million per year more today than we were just three years ago.

Obviously in a downturn like we’ve seen in 2009, it would have been very easy to scale back our output on the R&D side. Instead, we allowed R&D to continue running full speed and instead reduced cost anywhere else in the business to make up for it. As we move into 2010, our strategic decision will allow FARO to continue transforming the market.

Needless to say, we spent a lot of time this year restructuring and repositioning the company. We made a lot of tough choices, took a lot cost out of the business and redesigned our operating processes.

As we go forward, we’ll have an operation that is significantly leaner and far more decentralized. This will keep us closer to our customers and quicker to respond. In addition to the reductions in force executed in the third quarter, I eliminated multiple corporate roles, our CTO and SVP of Engineering, the SVP of Human Resources, VP of Information Technology, the VP of Quality, the VP of Product Management, as well as changing our Managing Director in Asia.

I have assumed direct responsibility for the CTO’s role. The rest of the functional responsibilities have been assumed by existing employees within the regions, reducing the senior leadership team to the three managing directors for our regional operations, our CFO and me.

We expect this structure to provide significant leverage, as there should be very few heads that are required to support or return to sales growth. Through standard work and 5S productivity programs executed in the first half of this year, we have already generated significant manufacturing capacity at this reduced headcount levels.

We are experimenting with new sales channels that could be less dependent on the direct sales approach we have used in the past. We have established the new baseline for administrative staffing, and we expect that the team we currently have in place will sustain our growth for an extended period of time.

One benefit from the global downturn is that we are starting to see some interesting opportunities on the acquisition front. Strategically, I am focused on three areas. The first two have been on my radar since I got here, software and non-contact hardware. The third is something I have been interested in but not as focused as I am now.

Technology companies which fit out vision for 3-D measurement and imaging but may deliver as much value through their channel to market as I do through their technology.

As always, I am signaling that they are eminent deals in hand, but I can say that my focus on acquisition opportunities is back to be in approximately 20% to 25% of my typical week. This has been the difficult 18 months for everyone. However, the FARO team has stayed focused through all of it, and we have kept the company extremely healthy. In fact, we made the company even healthier.

We have a strong cask position, zero debt, great technology with new technology on the way and an experienced managed team to management in a global environment. I would like to offer a special thanks to their team for never losing faith and continuing to keep the dream alive.

Our customers and our investors have stayed extremely supportive as well, and I would like to thank them too. I believe we are starting to see some light at the end of the tunnel, and the FARO team remains committed to reach in that light as quickly as possible.

I appreciate you attention and we'll now open the call to questions.



(Operator Instructions). We will go first to the line of Mark Jordan with Noble Financial.

Mark Jordan - Noble Financial

Jay nice to hear off, a little bit of an improved tone in your comments. First question relative to gross margin sequentially declined about 270 basis points is that just severance and overhead or what was any change in the underlying margin opportunity on product?

Keith Bair

Mark, it’s Keith. Primarily overhead there is some severance in their in the cost of sales number for this quarter, but primarily some of that unobserved overhead that comes from lower unit volume, that was expense during the quarter.

Mark Jordan - Noble Financial

Okay. So, at higher volume you would see no reason, why you shouldn’t move back to the 65% plus tight gross margin on product?

Jay Freeland

What our comments specifically to our gross margin on product, but I think yes, in fact even without higher sales volumes I look at this and say the item that hit us in the third quarter are not necessary repeatable in the coming quarters regardless of sales volume.

Mark Jordan - Noble Financial

Okay, but there is nothing that happen in the marketplace with regard to pricing that would fundamentally change a longer term gross margin module that you would aspire to?

Jay Freeland

Yes, certainly not fundamentally obviously look there is plenty of pricing pressure in the marketplace, as there always has been, as you know our one competitor is predominantly price focused. So, we’ve certainly seen a little bit more of that, but not to the point where we look at it and felt concern either near-term and certainly long-term relative to that competitive price pressure.

Mark Jordan - Noble Financial

One or two just confirm, when you’re taking about account managers, I believe you said there were 43 in the US and my number said that you had 57 in the second quarter. It seem that, they have a little bit of drop in the other two geographies, but was that a significant drop in terms of your restructuring of the accounts reps domestically here?

Jay Freeland

Yes, certainly sales was a part of the reduction in force particularly in the one that we did in August here. We are not getting the same productivity as we had in the past. It was time to make some moves there and again as we start experimenting with some of these other potential sales channels we may have a little bit less reliance on that direct model, and I’m not saying that going to go away obviously any time soon, but reducing opportunities for strengthening the bench so to speak by playing down to a number of account managers that was more appropriate and quite frankly still should get leverage out at their current productivity levels, we should get leverage out of that as we go forward here for pretty good period of time.

Mark Jordan - Noble Financial

As hopefully sales start to rise here beginning the fourth quarter. Right now in the third quarter you had selling expenses 32.2% of revenue with each incremental dollar. What kind of incremental selling expense would you experience, is it more to $0.10 from the dollar to the incremental revenue?

Jay Freeland

Yes, obviously I’m not going to try to predict it perfectly, Mark because there are lot of things that can go into that, but generally speaking you are right. You’ve got an established account manager base and baseline of account managers, not base, sorry, but baseline of account managers and they all on a commission on the sales, called it roughly, you are right, $0.10 in the dollar give or take. Obviously that is travel it goes with that, you got a team that’s out in the field and I do move a decent amount account to account see that some of that factor in there as well, but the route you are on is exactly the type of leverage that we are looking for.

The model where we were trying to get that to from a sales and marketing irrespective of getting those two categories combined down to 25% of our sales that is still the right long-term goal to be thinking about for the company and obviously, some of the moves that we just made and the way we are going to try to leverage is going forward, is intended to accelerate that and get it back on the right track.

Mark Jordan - Noble Financial

In the third quarter you had $2.8 million in R&D expense you said it was down because of lower compensation taken that was part of the restructuring and that’s more consistent run rate moving forward?

Jay Freeland

There’s a little bit that was tied back to the first production in force. The first go around we had a few head that we are moved in the engineering side, not a ton, and then obviously, the removal of the CTO as we went through that as well. So, there’s slightly lower spending just purely based on those, but the actual number of activity the team engaged in is, is higher from a development standpoint.

Mark Jordan - Noble Financial

Okay. A final question, I missed some of the headcount numbers. Could you give me the geographic headcount breakdown again please?

Keith Bair

Sure. We had account manager headcount decreased from 187 at December 31st to 156 on October 3rd, 2009. We have 43 account managers in the Americas, 52 in Europe and 61 in Asia. Geographically, we are 295 in the Americas, 255 in Europe and 192 in Asia.


(Operator Instructions). We’ll go now to the line of Jim Ricchiuti with Needham & Company.

Jim Ricchiuti - Needham & Company

Jay, I wonder if you could comment a little bit more about what you’re doing in terms of developing the sales channel and possibly relying on some new channels of distribution. It appears that is right now taking place more in the Americas. How far long are you on it? Is there anything you can say at least it relates to business in this area over the next quarter or so?

Jay Freeland

Certainly we are just in the phases of launching this right now and there is some easy examples. Obviously we are test driving some distributors, which would be a natural test for us and they are not meant to replace necessarily, but to compliment and enhance the potential sales channel.

We are looking at it, as it relates to products like the Gage, which are a little bit lower price and much more closely tied to smaller machine shops around not just the US, but around the world that have obviously there is tremendous amount of geographic reach that’s required to hit all of the machine shops. It’s a simpler tool to use. It’s a little bit more logical to tied it to or give the opportunity to some of the distributors to move that.

The other opportunity it goes with that is a lot of these distributors are selling machine tools as well and so there is some benefit of being able to bid a machine tool and a Gage as the standard accessory simultaneously to the customers and to push that technology.

So, certainly that’s one of the opportunities and it’s not just in the US, it is in Europe and Asia as well, even in places like China there are potential distributors that we are looking at right now. The key is making sure that you feel like they are still essence part of the team, you can manage them in that regard and keep them close to the company, but at the same time that they are truly a variable cost, that the only cost you are picking up is when they sell and they pick up their commission on the account.

Obviously we tried the test drive in the second quarter and third quarter. We’ve talked about that before. Predominantly in the US, that we're in the process of both remarketing and again in the US, as well as having just started launching that in Europe and Asia.

Test drive was fairly successful lot of the Gate. We had at least a couple of dozen customers, who signed up for the United States. The bulk of them were customers that would not have purchased FARO equipment if didn't have that plan or that program in place, and we're at the point now what we are starting to see some of the rollovers into actually acquiring the asset instead of just having it as on the four-month rental trial.

So, we are going to continue with that program going forward. We believe that it maybe a way to get some additional inroad with new customers, who. Still today there is a bit of fear of technology even if you get their heads around the potential ROI that the equipment will generate for them, and so we're looking to resolve some of that as well.

The final piece is there are some potential partners that we work with that have very good, let's call it deep roots into certain types of accounts that by partnering with us whether it's a software supplier or some other potential hardware suppliers. We get some access to their channel of the market and that those accounts that we're not necessarily in yet and have an opportunity to market ourselves through them to that group. So, those are three of the key things that we are trying right now.

Jim Ricchiuti - Needham & Company

Is there is anything you can share with us in terms of your targets or the third-party distribution in 2010 in terms of percent of revenues. I'm sure you have something in mind, but I wonder if you would give us a range of how you are thinking about this developing?

Jay Freeland

Yes, not that I want to put out there. We certainly have the internal targets of what we think it will do to help generate growth and what kind of leverage we'll get from a cost standpoint by utilizing those groups because the cost deferential it is, it's certainly is better than our current percentage of sales, no question there. So, not, but I would not want to put something out there right now.

Jim Ricchiuti - Needham & Company

Okay. Fair enough. The pickup you saw in September, I wonder if you could elaborate on that, also it looks like the order strength was more pronounced in the Americas, Europe was down I guess sequentially for a seasonal reasons, and then Asia-Pacific it look like a turn down a little bit. I wonder if you could just talk to us a little bit about what’s happening on the bookings front?

Jay Freeland

Well, I think there are a couple of things. One is just generally speaking in the current climate, yet a lot of companies, who drained inventories pretty low, finish products inventories and so now there’s some catch up that’s occurring and people are starting to ramp up the plans again, and we are seeing that in aerospace. We are seeing it in auto.

We’re seeing that in heavy machine and in heavy manufacturing. We have seen it in most of the sectors and to be honest the aerospace has actually still been relatively stable for us throughout the year even with, some of the issues the Boeing’s had on the Dreamliner they have still and running pretty close to foretell at the type of levels that where used to same.

So, in that regard, it’s across the industries. The other pop in the Americas, I do think some of it is planning for Q4, that use at a loser mentality, customer started playing important place in the orders in Q3. The risks in why I still say that there’s someone uncertainty out there obviously is how much of the inventory recovery is sustainable versus it becomes a one-time pop that rises and then settles back down to slightly more normalized level again.

I do think it’s going upward for sure it’s just a matter of at what rate and that’s the part that we will see, as we go through Q4 here and then see what adjust to, if it adjusts in Q1.

Asia, I think it's just the timing thing. Like I said, we do expect the Asia to recover more rapidly than the other parts of the world, setting aside Japan from a moment, which is obviously in a real economic mess at this point. The other countries, they are back in the growth mode already. China certainly is moving. Obviously, India from an economic standpoint is moving. So we are seeing good activity there. You are right Europe is more just a seasonal pattern. August is always brutal in Europe, and that was clearly reflected in the numbers.

Jim Ricchiuti - Needham & Company

Did that business in Europe's order activity start to come back in September?

Jay Freeland

The September phenomenon was across all three regions. The Americas started hinting at it first, because there were actually starting to see, as we tailed out of August where the sales leadership was saying, hey, customers are starting to ask the right types of questions again. It's different from what they’ve been asking over the last six to nine months, as we’ve gotten into the demos, and they were the first to start signaling that, but Europe and Asia weren't too far behind, as we got into September where they were seeing the same types of. Again, there's certain types of questions that are much obvious by signals or real by signals than what we’ve been seeing.

Jim Ricchiuti - Needham & Company

Last question for me and I will jump back in the queue. Keith, was there any monitor-related expense in quarter and how do you see that going forward?

Keith Bair

We had no monitor-related expense in the quarter, but I will let Jay talk to the current status of the monitor.

Jay Freeland

Current status is as follows. The clock is still running. Everything that we’ve been told by the DOJ, the clock’s running. So the clock and is based on the signature we have with the DOJ, it ends in July of next year. So we're down to basically eight months call it.

Our choice has gone to the approval committee at the Department of Justice. They have not had our monitor on the agenda yet, but it is supposed to be eminent. My understanding is that, once they say, yes, which we expect they will, we would expect the monitor to start almost, almost immediately thereafter.

So as I said in the previous quarters, I absolutely will not say definitively that they are starting in the current quarter. However, I will say, it certainly seems likely that they will start their work this quarter, and we would anticipate again at least probably a $1 million worth a cost during the time period that they are here.

It's still a wildcard because we just don’t how much labor work will be required. Other than we still get the opportunity from a planning perspective. At the very beginning, we, the monitor, and the DOJ jointly agreed to the scope of work and the estimated approach and that would at least give us some feel for how much is coming, but, as always, it comes to billable hours, number of people involved and so forth. So that's the apart, it makes a little bit hard to predict even once we have the scope identified with them.


We will go next to the line of Richard Eastman with Robert W. Baird. Please go ahead.

Richard Eastman - Robert W. Baird

Just a quick question. As we talk about maybe order momentum and you talked that it was picked up in September relative to the Q3. As we continue that into the fourth quarter here, you are suggesting that there could at least be some budget for us here in the fourth quarter that impacts the fourth quarter. Is there any, should we be thinking about the typical sequential improvement or something better in terms of orders for the fourth quarter?

Jay Freeland

Great question. I will never say we should be expecting that. I do believe we are going to see again because of the types of questions that are being asked. I think we are going to see some fourth quarter budget flush. Predicting whether it's normal, higher or lower that's the hard part. Our baseline Q3 was actually up sequentially over Q2, which is unusual. So the question is are we coming off of a unusually higher base line, or is it just because Q2 and Q1 were just so ugly that there was some catch-up? I just don’t have a good feel for that.

We do think that there is some budget flush that's going to occur. It's across the board. I do expect they will be more focused on tractors and arms predominantly, and that's just based on kind of the level of activity. Gages, though it is still a great product for us, we do sell far more Gages to the small machine shops and no doubt, they have been most impacted I think by the economic downturn that we are going through. So that’s what I can say in terms of what we are expecting. How much of an upswing that will be really, really hard to predict.

Richard Eastman - Robert W. Baird

I am just curious, in some of the business that you talked a little bit about the closure rate improving in September and I don’t know how you want to answer this question, but I am curious, as we move forward with orders, are those orders, let's say, discounted, so that maybe the pressure on gross margin continues into next year until we have a real sustainable improvement?

Jay Freeland

I certainly believe there will be continued price pressure for the next year as long as the economy continues to be mediocre or even if it's slightly growing again. There still is going to be some price pressure, but, like I said, a lot of that is still historical. We had that no matter what. We feel it. Does it have a little bit impact in kind of quarter-to-quarter? Yes, a little bit, but, on average, we still have deals that are coming through at the types of prices we are used to.

The one impact on pricing that you could see happen and this has happened to us in the past too. As you know, if we sell more demo gear, it appears to be lower prices. It's actually just because it's used equipment that's been depreciated a year or two when we offer a lower price to the customer as it comes up. So from that regard, maybe that would create the appearance of some price pressure, but generally speaking, yes, there is a little bit, but our team continues to kind of fighting that's through and have minimal [hitch to us].

Richard Eastman - Robert W. Baird

Then just one last question, Jay. As you start to plan for calendar '10 and toss you financial plan together at least draft it out, how are you thinking about the expenses, just the operating expenses and maybe headcount as you head into next year? How do you plan for that at this point given what you see on the sales line?

Jay Freeland

Generally speaking, because we are obviously actually wrapping that process up right now. Generally speaking, headcount should be virtually flat, and I'd say virtually, because we may add a couple more R&D heads in various strategic spots based on projects and delivery that’s coming in 2010. So you may see us add a couple of there, maybe a couple in customer service depending on call volume and so forth, even as service expenses have declined and we have gone through all of these.

The fleet is still growing. So, there is just a natural ratio of the number of calls that come in surely because there is a fleet that that's much larger than it was a year ago or two years ago. So possibly end up with a couple of phone reps in there and maybe a few account managers adds in Asia to support this focus of returning to growth through Asia first more than any other region. So, but outside of that, I’m hard pressed to see any reason to add hedge in 2010 and possibly even as we go into 2011, except in those couple of categories. So I would call it a handful, as what we’re thinking at this point.

Richard Eastman - Robert W. Baird

Then just one kind of strategic question. Any movement in terms of the laser scanner product, we’ve been trying to get the price down there and where are we in terms of the generations of product there?

Jay Freeland

The LS, I think I guess it’s probably our fourth generation now since acquiring them because they have been very consistent [and obsolete in] the previously gen, basically every 12 months, 14 months at the worst.

So the generation that's out there right now is in fact best-in-class for our type of laser scanning technology and has a pretty good price point. It is not the price point that I want to be at. So when you look at the next generation, and we certainly would expect another generation to come in kind of the 14, 16-month time frame give or take, you would look for substantial improvements again and substantial price improvements again.

Price and overall software usability are still the two things that keep that from getting as we call it over the chasm and into the early majority. So I don’t believe we’re in the early majority, yet. I still think it’s in the early adopter phase. Certainly, the number of units sold for year continues to grow even in this environment and so we expect that as we go through Q4 here, this year.

So, all of those are good signals. It’s still the lowest revenue generator out of all of our products, not surprisingly given that it still has the newest history with us, but I think we talked before about when you start getting into markets like insurance and heavily into forensics and much more into the architecture more deeply, true not quite consumer, but closer to consumer type of product line. Yes, we still maybe 24 months off from that, but we are certainly driving that from an R&D perspective, we continue to invest heavily in that group since we acquired them.


We’ll go next to the line of Andy Schopick with Nutmeg Securities. Please go ahead.

Andy Schopick - Nutmeg Securities

Keith a couple of quick questions for you, nine months year-to-date you’ve repurchased $8.83 million of shares. How many shares were involved in that repurchase?

Keith Bair

It’s a little over 600,000 shares and that was basically done back in Q1.

Jay Freeland

Last purchase was in February.

Andy Schopick - Nutmeg Securities

Is there any current authorization that remains unused?

Keith Bair

Yes, the total program was for $30 million.

Andy Schopick - Nutmeg Securities

Okay. I want to ask question about the service inventory, Keith could you just explain that’s basically remain unchanged on the balance sheet from year end the $12.8 million. What is that? How does that get revalued and measured, and if you could just comment a little bit in terms of giving us some clarity to that item.

Keith Bair

The service inventory is comprised of primarily raw material and [loner] demos that loner stock that we use for our customers. It contains inventory that we use for our warranty work and for the annual calibration and certification work. Typically we don’t revalue that, but we measure that based upon roughly of five years raw material component availability based on the current sales module but typically our installed based continues to grow. So, we have quite few arms engaged that we need to continue to service.

Andy Schopick - Nutmeg Securities

Have you ever have to taken any provisions against that account?

Keith Bair

We typically there’re calculation for excess in arm lead. We do an excess calculation based upon prior sales and future forecast sales and do a calculation there, and that’s a pretty much have been stable over the past few years.

Andy Schopick - Nutmeg Securities

Okay and kind of more general question. Lot of companies including yourself have cut cost very severally and we are starting to see more signs that at least the situation isn’t as dire as perhaps the concerns that existed earlier in the year in the overall global economy.

What you feel is a sustainable headcount and employment run rate for this company, as you began to get back into a more accelerated revenue growth with profitability. Can these kinds of cuts really be sustained that continue to grow the company in a recovery?

Jay Freeland

Yes, this is Jay. I’ll say that. I certainly believe there can be sustained for at least the near-term and near-term could be defined at a minimum through 2010 and possibly even parts of 2011, again depending upon how fast the recovery occurs.

As growth ramps up, if you think about our historical growth rates, which ran 20%, 25% lets call it 25 compounded for several years there. The places where you might need to start adding again as we hit those levels would be production. This is labor components of production. It’s the add that are required and were close to 1 to 1 ratio as sales growth picks up, but you would start seeing some handfuls there if we are back at the 25% level, in the meantime we don’t anticipate, we didn’t do that.

Again a little bit on customer service depending on call volume and what's coming through there, and then at some point you would start adding some more on the sales and marketing side (inaudible) to the account managers more than anything else.

Once we get back to productivity levels that we believe are appropriate for the team that's in the field, but that being said we are well below the productivity that team should be able to generate. So, again it should run us for decent period of time here before we need to start thinking about any type of heavy add there.

So, the answer, we cut pretty deeply. I think that as we did it everyone of the team is supposed to think about how to do their jobs dramatically different. In some cases there was a purely tight volume we made the cuts, and force them to rethink how they operate, generate to stop this doing and refocus the processes and we design the processes. All the things that you would expect to do during that, and now we got. I do think we have a sustainable model as we go forward.


(Operator Instructions). We will now go to line of Jim Ricchiuti with Needham & Company.

Jim Ricchiuti - Needham & Company

Hey, who was helping you to back to on the commentary you made that new products, is 2010 going to be a more active year for you in terms of new products introduction and is that more toward the back of the year or is this similar to what you have done in the past in terms of moving into next-generation product.

Jay Freeland

Yes, I won’t you tell you timing for a lot of different reasons. Though I think you could say, you will see it kind of through out the year. Yes, is the answer it will be more active than previous years and the types of thing that come, we’ve got some stuff that is clearly brand new like the 3D Imager and we got some generational change in the technology that I would say, some of it is significant, some of it is good generational change. We have no bad or mediocre generational change I will say that for sure.

Jim Ricchiuti - Needham & Company

Then R&D expense was down from Q2 levels and how should we think about your R&D over the next few quarters?

Jay Freeland

Well, certainly the levels right now they are minimum, might be see a little bit of an increase next without actually forecast in that line item. Yes, you can see that if you are going to have an active release here you might see a little bit of an uptick there, but certainly still I think within, our historical norms of, if 5% to 7% of sales is the target and I know we are at the high end and actually a little bump there right now, but you’d expect this to still run in that range.

Jim Ricchiuti - Needham & Company

Okay. Keith you tax rate for next year any changes there. Can you remind us, where likely your expecting tax rate to be?

Keith Bair

Well, typically it’s been in the 20% to 25% range and that assumes a certain level of the taxable income mix of this quarter. It was a little unusual and now we had a much larger taxable laws in some higher tax rate jurisdiction, but if we return to our historical model, I think that 20% to 25% range should hold true pending at any changes in tax loss, changes from this administration.


(Operator Instructions). This appears at this time, that there are no further questions. I would like to turn the presentation back over to our presenters for any closing remarks.

Jay Freeland

Very good. We will just close by saying thanks very much everybody for your attention today, enjoy the fourth quarter and holiday season and we will look forward to updating everybody as we clear through year-end here. Thanks very much.


This does conclude today’s teleconference. Thank you again for your participation. You may now disconnect and please enjoy the rest of your day.

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