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FARO Technologies, Inc. (NASDAQ:FARO)

Q4 2013 Results Earnings Conference Call

February 27, 2014 8:30 AM ET

Executives

Vic Allgeier - TTC Group, Investor Relations

Jay Freeland - President and CEO

Keith Bair – SVP and CFO

Analysts

Mark Jordan - Noble Financial

Jim Ricchiuti - Needham & Company

Hendi Susanto - Gabelli & Company

Robert Richardson - Stifel Nicolaus

Rob Mason - Robert W. Baird

Operator

Please standby, your program is about to begin. Good morning, everyone. And welcome to FARO Technologies Conference Call in conjunction with its Fourth Quarter 2013 Earnings Release. Please note, all participants are now in a listen-only mode. Later, you will have the opportunity to ask questions-and-answers during a question-and-session. (Operator Instructions)

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

Vic Allgeier

Thank you, and good morning, everyone. My name is Vic Allgeier with the TTC Group, FARO’s Investor Relations firm. Yesterday after the market closed, FARO released its 2013 fourth quarter and year end results. By now, you should have received a copy of the press release. If you have not received the release, please call Nancy Setteducati at (407) 333-9911. The press release is also available on FARO’s website at www.faro.com.

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

I would like to remind you that, in order to help you understand the company and its results, management may make some forward-looking statements during the course of this call. These statements can be identified by words such as expect, will, believe, assume, anticipate, plan, should, potential, continue 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

Thank you, Vic, and good morning, everyone. Sales in the fourth quarter of 2013 were $89.9 million, an 11.4% increase from $80.7 million in the fourth quarter of 2012. That brought our 2013 annual sales to $291.8 million, a 6.7% increase from $273.4 million in 2012.

On a regional basis, fourth quarter sales in 2013 in the Americas increased 9.5% to $36.1 million, compared to $33 million in the fourth quarter of 2012. Sales increased 12% in Europe to $36.8 million from $32.9 million in the fourth quarter of 2012. Sales in the Asia/Pacific region increased 14.4%, to $17 million from $14.8 million in the fourth quarter of 2012.

The effect of changes in foreign exchange rates on sales was a net increase of approximately $100,000 in fourth quarter of 2013, compared to the fourth quarter of 2012 and includes a positive effect on sales in Europe of $1.9 million, partially offset by reductions in Asia of $1.6 million and the Americas at $200,000.

Comparing year-over-year growth, 2000 sales -- 2013 sales in the Americas increased 10.9% to $120.4 million from $108.6 million in 2012. Europe sales for 2013 increased 3.3% to $103.4 million from $100.1 million in 2012. Asia sales increased 5% in 2013 to $68 million from $64.7 million in 2012.

The effective changes in foreign exchange rates on sales were a net decrease of $2 million in fiscal year 2013, compared to fiscal year 2012. The effect on sales was a reduction in Asia of $5.2 million and the Americas of $400,000, partially offset by a benefit of $3.6 million in Europe.

New orders increased 20.1% in the fourth quarter of 2013 to approximately $98.6 million, compared to approximately $82.1 million in the fourth quarter of 2012. On an annual basis, new orders increased 6.2% to $293.3 million in 2013 from $276.2 million in 2012.

On a regional basis, fourth quarter orders in 2013 in the Americas increased 16.1% to $38.9 million, compared to $33.5 million in the fourth quarter of 2012. Orders increased 27.5% in Europe to $39 million from $30.6 million in the fourth quarter of 2012. Orders in the Asia/Pacific region increased 15% to $20.7 million compared to $18 million in the year ago quarter.

Again, comparing year-over-year orders growth, new orders in the Americas increased 9.2%, to $119.5 million in 2013 from $109.4 million in 2012. Orders increased 5.6% in Europe to $103.3 million in 2013, compared to $97.8 million in 2012 and orders increased by 2.2% in Asia in 2013 to $70.5 million from $69 million in 2012.

The top five customers by sales volume in 2013 were Boeing, the U.S. military, General Motors, VRSI and Volkswagen, and together represented only 2.2% of sales. The top 10 customers in 2013 together represented only 3.3% of our sales, once again indicating our lack of dependence on any one or a handful of customers.

Our gross margin increased to 54.9% in the fourth quarter of 2013 from 53.4% in the year ago quarter, primarily due to an increase in product gross margins to 58% in the fourth quarter of 2013 from 56.1% in the fourth quarter of 2012, as a result of lower manufacturing costs and slightly higher average selling prices, including a decrease in the sales mix of the laser scanner product sold to distributors to 53.1% from 65.7% in the prior year quarter.

Gross margin from service revenues remained flat at 37.5% in both quarters. Gross margin in fiscal 2013 increased to 55.5% from 54.7% in fiscal 2012. Gross margin from product sales increased to 59.1% in fiscal 2013 from 58.7% in fiscal 2012 as a result of lower manufacturing costs, partially offset by lower average selling prices.

The sales mix of the laser scanner products sold to distributors were approximately 55% in both 2013 and 2012. Gross margin from service revenues increased to 39.1% in fiscal 2013, compared to 34.8% in fiscal 2012, primarily as a result of increased warranty sales.

Selling expenses were 24.4% of sales in the fourth quarter of 2013, compared to 22.8% in the year ago quarter. Selling expenses increased to $22 million in the fourth quarter of 2013 from $18.4 million in the fourth quarter of 2012, primarily as a result of an increase in compensation, travel and recruiting expenses. In fiscal 2013, selling expenses increased to 24.6% of sales, compared to 23.6% of sales in fiscal 2012.

Administrative expenses in the fourth quarter of 2013 were 8.9% of sales, compared to 8.7% in the fourth quarter of 2012, increasing by approximately $900,000 to $7.9 million from $7 million in 2012, primarily as a result of an increase in compensation of $600,000 and reserves for bad debt expense of $500,000, partially offset by lower legal and professional fees of $200,000 related to patent litigation that was settled earlier in fiscal 2013.

In fiscal 2013, general and administrative expenses increased to $30.6 million, representing 10.5% of sales from $29.1 million or 10.6% of sales in fiscal 2012, primarily due to an increase in compensation of $1.8 million, reserves for bad debt expense of $1.2 million, recruiting costs of $1 million and travel of $200,000, partially offset by a decrease of $2.9 million in legal and professional fees, primarily related to the FCPA monitor and patent costs.

Research and development expenses increased to $6.2 million in the fourth quarter of 2013 or 6.9% of sales, compared to $4.6 million or 5.7% of sales in the fourth quarter 2012.

R&D expenses for fiscal 2013 increased $4.8 million or 27.5% to $22.4 million for the year ended December 31, 2013 from $17.6 million for the year ended December 31, 2012, primarily due to an increase in compensation of $2.5 million, subcontractor expenses of $1.6 million and materials of $600,000.

Research and development expenses as a percentage of sales increased to 7.7% for the year ended December 31, 2013 from 6.4% for the year ended December 31, 2012.

Operating margin for the fourth quarter of 2013 decreased to 12.6% from 13.9% in the year ago quarter, primarily due to the effects of increase selling and R&D expenses. Operating margin for fiscal 2013 decreased to 10.3% from 11.5% in fiscal 2012.

Other income and expenses net increased income of $100,000 in the fourth quarter of 2013 compared to an expense of $500,000 in the fourth quarter of 2012 and primarily represents the effects of changes in foreign exchange rate on the intercompany account balances denominated in different currencies.

On a year-to-date basis, other income and expense increased to an expense of $1.3 million in fiscal 2013, compared to an expense of $600,000 in fiscal 2012, primarily as a result of an increase in foreign exchange transaction losses due to the effects of changes in foreign exchange rates on the intercompany account balances denominated in different currencies.

Income tax expense was $3.2 million in the fourth quarter of 2013, compared to $2.9 million in the fourth quarter of 2012. The effective income tax rate was 27.9% in the fourth quarter of 2013, compared to 26.8% in the fourth quarter of 2012.

Income tax expense decreased to $7.4 million for fiscal 2013 from $7.9 million in fiscal 2012, primarily as a result of a decrease in pre-tax income. The company’s effective tax rate for fiscal 2013 was 25.5% compared to 25.7% in fiscal 2012.

Net income increased to $8.3 million or $0.48 per share in the fourth quarter of 2013, compared to $7.8 million or $0.46 per share in fourth quarter of 2012. Net income for fiscal 2013 was $21.5 million or $1.25 per share, compared to net income of $23 million or $1.34 per share in fiscal 2012.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $189.6 million at December 31, 2013, compared to $158.2 million at December 31, 2012.

Accounts receivable was $66.3 million at December 31, 2013, compared to $62.6 million at December 31, 2012.

Day sales outstanding at December 31, 2013 decreased to 67 days, from 71 days at December 31, 2012, primarily as a result of improved collections in all regions. Inventories were flat at $68 million at December 31, 2013 and December 31, 2012. Reductions in raw materials were offset by increases in finished goods and demo inventory.

Finally, I will conclude with some statistics regarding our headcount numbers. We had 1,078 employees at December 31, 2013, compared to 961 at December 31, 2012, an increase of 117 employees or 12.2%.

Account manager headcount increased 22.8% from 180 at December 31, 2012 to 221 at December 31, 2013 with 75 account managers in the Americas, 63 account managers in Europe and 83 account managers in Asia. Geographically, we now have 436 employees in the Americas, 367 employees in Europe and 275 employees in Asia/Pacific.

I will now hand the all over to Jay.

Jay Freeland

Thanks, Keith. The positive momentum we experienced in the third quarter of 2013 continued in the fourth quarter, with orders growing 20% and sales more than 11%. There is solid customer demand across most of our primary market verticals, including aerospace, heavy industrial, many of the surveying related markets and law enforcement.

Likewise, all three geographic regions experienced similar strength in demand delivering double-digit growth in orders. Europe had the strongest quarter with more than 27% orders growth. While economic conditions in Europe remain difficult, customer purchase patterns are improving as the need for productive solutions such as those offered by FARO appears to be outweighing general economic concerns.

Market conditions in the Americas also remain strong as they were for most of 2013. However, credit markets in China and India continue to be tight putting pressure on FARO’s overall performance in Asia despite the positive double-digit growth demonstrated in the fourth quarter.

Sales through our relationships with Trimble and Topcon were good in the fourth quarter, as well as all of 2013 but not at the levels we expected. As a result, we are starting to serve these markets more aggressively through alternative channels as well, most notably our own FARO personnel.

We believe that we have substantial opportunity to grow that market by significantly increasing our direct involvement and that is the path we are pursuing in 2014. Although price pressure in the arm marketing stabilized in the third quarter, prices were still substantially lower than normal. Those price levels did not improve in Q4.

We assume these conditions will also not improve in 2014 and have planned the business accordingly. While there’s been a moderate impact on sales growth and gross margin, we have seen almost no impact on our win/loss ratio.

In addition to being as competitive as necessary on the pricing side, we are working aggressively to reduce costs in the arm. Tracker pricing remains strong. And the higher pricing we introduced for the X 330 Laser Scanner last fall has held up well. As a result, both of those products are offsetting the margin pressure from the arm.

Moving forward, we believe we will see improvement in gross margin despite the ongoing price pressure in the arm market. The team controlled SG&A costs well in the fourth quarter. One exception, however, was a large increase from incremental selling costs connected to our expansion of the sales organization.

This expansion is in anticipation of support requirements to meet our 2014 revenue expectations. As a result, our expenses of percentage of sales in the fourth quarter increased almost two full points. The additional sales headcount was spread almost evenly across all three regions and as always, was targeted at expanding coverage in highly underpenetrated territories. Performance of the sales team, while still not at full productivity, is improving every month.

Our sales model is critical to the ongoing success of FARO and we anticipate a mid-teens percentage increase in the size of the sales organization for several years to come. We increased our research and development spending again in the fourth quarter as well, coming in at almost 7% of sales.

In the third quarter of last year, we started a more aggressive and strategic push in R&D to go along with our M&A strategy. We continue to look for targeted acquisitions to expand the business meaningfully, but every company we’ve looked at to date has failed to meet our expectations at the technology, people or financial level. I still believe that finding good acquisitions for FARO is not a matter of if but only a matter of when.

The incremental R&D spending is spread across multiple projects, all of which are focused on either solving customer problems that are not being solved today or solving customer problems more efficiently than they are being solved today. These projects will create several new products with release dates starting in 2014.

While 2013 was a very productive R&D year, with the release of our next-generation Laser Line Probe, the new X 330 Laser Scanner, our WebShare cloud-based point cloud server and latest generation Metrology Software, 2014 should be even more productive.

We are planning several product releases in 2014, which include new generations of our existing products, new products not currently in the portfolio and new generations of software. We anticipate that R&D spending in 2014 will increase again modestly as a percentage of sales.

We have a lot of cash available and we continue to believe that the best place to deploy the cash is in acquisitions or short bursts of R&D acceleration. The incremental R&D spending will give us greater control over our future and strategically positions us for continued growth, while we still search aggressively for good fit acquisition candidates.

As we look at 2014, we feel good about the position of the company. We have an aggressive product release year coming and we are reshaping the strategy we use to focus the business.

We have historically focused on products first, but for the last several months, we have started diving deeper into the best -- into our best vertical markets to understand all the technologies used by those customers and translating that information to develop new products for R&D or through M&A. Our sales organization is best-in-class and has the broadest reach in the industry.

The strong longstanding relationships we have with our existing customers provides tremendous fuel for growth. At the same time, new customers continue to become more aware of the advantages of using FARO’s products and technologies.

While we don’t provide specific financial guidance, we believe that achieving meaningful double-digit top line growth is still possible in this environment. While it may not be the 20% to 25% per year we experienced in earlier years when the company was smaller, we believe there are significant opportunity to outperform in double-digit fashion.

In summary, we continue to be the world’s most trusted source for 3D measurement, imaging and realization technology. And we expect 2014 to be a great year.

Thank you for your attention. And I’ll now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Mark Jordan from Noble Financial. Your line is open.

Mark Jordan - Noble Financial

Good morning, Jay. Question relative to the unfulfilled orders that you carried over in the backlog into the start of the New Year, a relatively sizable number, around $9 million. Are those all for early 2014 deliveries, first quarter deliveries, or do some of those orders stretch out over longer time frame?

Jay Freeland

No, they are all for first quarter. You are right. It’s a little bit higher than we’ve had in the past. A lot of it was just timing when customers could accept delivery. They are all delivered well before Q1 ends.

Mark Jordan - Noble Financial

Okay. Second question was, sort of, relates to your last statements about, you know, not giving guidance, you really refrain from that as we went into the recession a few years ago. Clearly we’ve moved beyond that. I guess, you do allude to the fact that you expect to be able to move back towards double-digit revenue growth versus the 6 plus percent this year.

I guess my question is looking at your sales growth of headcount of reps of over 22% this year and the fact that they have been on board for a while. You should be getting a sense of improved productivity. Is there any way that -- or do you have a sense that you could give a little bit better guidance with regards to, sort of, the top line outlook again with the fact that you have those reps in hand for a number of months now?

Jay Freeland

Yeah, so a couple of thoughts, I guess. The first is relative to productivity, the reps, you are correct. So we -- the reps we have had on board for call it a couple of years or more, most of them are performing at the types of productivity levels we would expect. $1.5 million, give or take, depending on which product they are selling.

Tracker folks are always a little higher. Arm folks are typically teeny bit lower than that. The newer ones for sure are not at full productivity but we see the improvement every month. So we see that creeping up, creeping up.

Relative to 2014, without giving a specific number, I think when you look at the double-digit we did in Q3 and Q4, orders line in and revenue line, I think, that gives us, (a) it’s a lot of momentum going into 2014, (b) the mood of the sales organization is significantly better than it was at this time last year. When we did our internal budgeting in December, the mood was strong. When I hit the sales meetings in early January and I went to all three regions and spent time with all the account managers, the mood had improved even more.

So I think when you look at that momentum in the second half thinking about double-digit growth in 2014, (a) without calling out a number, I think, it’s reasonable and (b) I think the second half paints a pretty good picture of -- with some improvement where that can go.

Mark Jordan - Noble Financial

Okay. Sort of a final question related to sales. You’ve replaced sales management both in the Americas and in Europe. Now that those replacements have been on the job for a period of time, what has been the most significant change in terms of management of the sales efforts in those two geographies with the new management in place?

Jay Freeland

Yes. I think there is -- I’ll take two different angles on it. The managing directors, as they got changed out, so the managing director for Europe has been on board for a little over a year now. The managing director in the Americas has been on board for about six and half, seven months now. Those roles are full P&L roles. So they own all of the engineering and all of the manufacturing that occurs within those two regions, which is very substantial in the Americas and somewhat substantial in Europe.

So in Europe, there was a leadership change at the sales leader level as well. So below the managing director, he did change out the sales leader. The existing person is still at FARO playing a critical role. He brought in a different person to sort of attack the market or focus the team differently without losing the core of what the FARO sales model is all about because that part we know still runs well and is a significant driver to our overall growth.

In the Americas, the imaging director there is a little different. The sales leader in place underneath Kathleen has been the same sales leader for multiple years now. So there was less of a transition there and a lot more of her time is spent on the engineering and manufacturing side, getting comfortable with the sales side but it was a little bit different when you look at the performance of the Americas team. They were already performing a little bit better than Europe was.

So Europe needed a little bit more of a shake up until there was that sales leader and in fact some of the regional leaders below that have swapped seats as well. You didn’t have nearly the same turnover in the Americas during first eight months with Kathleen on board in that role.

Mark Jordan - Noble Financial

Thank you very much.

Operator

Our next question is from Jim Ricchiuti from Needham & Company. Your line is open.

Jim Ricchiuti - Needham & Company

Hi. Thank you. Good morning. Just wanted to go a little more deeply into gross margins, the sequential decline there. Maybe it was a case of the Q3 margin being unusually strong relating to mix. But just given these kind of revenue levels in Q4, you think the product gross margin might be a little stronger. So I’m trying to understand what might have led to that, particularly since you had more of the scanners. I think, going direct versus indirect?

Keith Bair

Jim, it’s Keith. I think as Jay mentioned, we continue to face pricing pressure and we continue to face that in Q4. I think primarily that’s the major contributor to the sequential decline, not only in the arm. But we are facing a little bit -- probably a little bit more pricing pressure in Europe than any of the other regions that could be because it’s in our primary competitor’s backyard but primarily that’s the main driver behind that gross margin decline.

Jim Ricchiuti - Needham & Company

Got it. That’s helpful, Keith. But just given that, Jay, it sounds like you still feel there’s an opportunity to move margins up from here. So maybe elaborate on that.

Jay Freeland

Yeah, so without giving specifics we certainly think there’s room for improvement. So a couple of thoughts, one is, as I mentioned, I don’t expect the arm market pricing to improve a whole lot. We, sort of, planned around that. If it does, that would be nice, not necessarily mission critical.

The opportunities are number one, tracker pricing continues to be very strong in the list price for the new tracker that we have in the marketplace that’s been out there for a year now is about $10,000 higher than the previous version. We are retaining a decent portion of that. So as tracker volume continues to grow and that product has been good, there’s opportunity there.

On the scanner side, the price point of the X 330 is almost $10,000 higher. It’s a little bit less than that of the previous version. And if you look at Q4, there is a mix of X 330s and the previous Focus 120 in the portfolio. So as the X 330 becomes a bigger piece as we phase out the 120 over time here that gives some opportunity for increment because [the validity of] [ph] the cost structure of the X 330 is not substantially different.

It’s a little bit higher but not substantially different from the previous Gen. So a lot of that margin, we should be able to retain that as it goes through. So for me, even though those two product lines are both -- the arm is still number one, tracker and scanners are numbers two and three, kind of they swap back and forth from one to the other, quarter-to-quarter right now. So they are a little bit smaller than the arm revenue, but they do provide the opportunity to improve the gross margin because of those two items.

Jim Ricchiuti - Needham & Company

Okay. And maybe just a question on the scanner business, and I’ll jump back in the queue. Do you have any sense or maybe you could give us some color as to the sales of that product? Are you seeing more of a mix shift in terms of repeat sales to existing customers, who are using the product more, or is it still a function of just getting more of these scanners into the hands of new customers?

Jay Freeland

Yeah. Right now, a lot of it is new customer oriented. If you look at the spaces and we’ve started skinning this a little bit differently, we kept saying the surveying space - the surveying space. You’re going to hear me refer to it a lot more frequently now, as there is the architectural, engineering and construction space, of which a lot of it is surveying applications, of course. And there is law enforcement. That’s a fairly big one. And then the third one for the scanner is that manufacturing, sort of asset management side of your scanning facilities to get out built and things like that.

Right now, particularly, on the architectural, engineering and construction side and the law enforcement side, it’s a lot of customers buying their first unit. A lot of them are smaller firms that are first out of the gate who are sort of the pioneers for a lack of a better word to adopt the technology and start showing the value and start demonstrating its capability.

And just the AEC space, in general, does have a fairly sizable number of relatively small companies in there. So for a period of time, I think, you’re going to see a lot more of it rest on new customers, as the word gets out. And then some of the bigger ones, as they come into play, will have some meaningful incremental unit pickup, but I think we’re seeing a lot more of the latter first.

Jim Ricchiuti - Needham & Company

Okay. Thanks. I will jump back into queue.

Operator

Our next question is from Hendi Susanto from Gabelli & Company. Your line is open.

Hendi Susanto - Gabelli & Company

Good morning, Jay and Keith. First question is for Keith. Earlier this month at the Investor Conference, you shared that R&D is estimated to run at 7% to 9% of total sales for the next two years. Would you be able to share, like, similar estimates for G&A and selling expenses?

Keith Bair

I think we may have talked about R&D running a little bit higher. I’m not really sure that we put a specific timeframe any length of time, but I think going forward, you may see it run in the 7% to 9% range. Typically as we talked about earlier, we don’t provide guidance. So I wouldn’t be able to provide you with specific admin and selling expenses going forward. We do have a longer-term model out there that talks about an 18% to 23% operating margin target. And in that model, we talked about sales and marketing at 25%. We talked about admin at about 10% and R&D at 5% to 7%, which like I said, may actually get bumped up to maybe 7% to 9%.

Hendi Susanto - Gabelli & Company

Okay. Got it. And then, Jay, you mentioned that there are significant opportunities for double-digit growth in 2014. And then in the earlier question, you mentioned that AEC looks promising for 2014. Do you have, like, more anecdotal insights into, let’s say, your major markets and then your major Asian markets as well? Should we think that seasonally in 2014 will be similar to 2013?

Jay Freeland

Yes, so let me cut it in two different ways. If you look at it by vertical, you are right, AEC has substantial opportunity. There’s a real need out there, as we define the market and we keep looking at it deeper and deeper. We think it’s at least $1 billion type of opportunity when you look at the ability to penetrate the space, and you’re displacing some of the traditional technology that’s in there today for the right applications, but it’s at least a $1 billion opportunity.

The more we get out there through distribution, the more we put our own people on the street focused on selling into that space. We have discovered that we can address that space pretty well with our own people. That creates opportunity there. Auto, in 2013 in Q4, a little bit lighter than usual, but not terribly so. And so, you know, it’s pockets. We do see momentum there though. So I think auto is good in 2014, aerospace continues to be strong. And that market has been strong for us even through the downturn in ‘09. That was the only vertical in ‘09 that was solid. Even now you know four years later now heading into five years later, that momentum continues. So aerospace will be good and heavy industrial is still pretty good too again, but in pockets.

So then you go to the pockets and say, let’s look at the regions. From everything we see the Americas seems very strong. There’s a lot of momentum in the U.S. right now. You know, I think there’s this short-term, people got a little concerned at the tail end of the year and the first part of this year with the weather and did that have any type of meaningful impact longer term, and we’ve not seen anything from that behavior wise from our customers necessarily.

Europe, the economic situation is definitely not any better, but it’s been stable for a couple of quarters now. Most of the customers we sell to seem to be taking that mindset of, look stability is a good thing as long as we’re not in a continued spiral. We’ve got a business to run. We’ve been holding off on capital expenditures. We’ve definitely seen them start opening the check books again. You saw that in Q4 with the performance out of Europe in Q4.

And then, Asia, that’s the one where there is still a little bit of hit or miss. The demand is there. The credit markets in China and India are still mediocre at best. They are slow. It’s hard to get financing. We still make a decent portion of our customers in those two countries pay upfront, which many of them because they are smaller tier 2 and tier 3 size suppliers, they are forced to go to the financing markets. And until we see some improvements there, which probably can only come from sort of government intervention of trying to force the financial markets to either loosen the process or whatever they need to do to get that moving, our customers will eventually get financing, but it really takes a long time.

So that’s the one where could Asia continue to be a double-digit growth region, for sure, it’s a question of how high can the double-digit growth be, and that’s the part that hinges on those credit markets. And it really is a China and India issue. Japan is not necessarily the issue. Korea is not the issue. Southeast Asia is not the issue. It’s really centered on those two.

Hendi Susanto - Gabelli & Company

Thank you, Jay and Keith. I’m looking forward to the Analyst Day.

Jay Freeland

Thank you. We’ll see you then.

Operator

(Operator Instructions) Our next question is from Patrick Newton from Stifel. Your line is open.

Robert Richardson - Stifel Nicolaus

Good morning, gentlemen. Thanks for taking my call. This is Robert Richardson on for Patrick this morning. I’m just wondering if we could discuss operating margin in Asia. It looks like it’s down sequentially and year-over-year fairly significantly. Just wondering what drove that impact. I mean, is that revenue impact from some kind of tight credit standards you mentioned or is that something you see continuing?

Keith Bair

Well, typically, we don’t get that granular in our discussion of the OpEx lines by region. What I can tell you though is, as you mentioned, and Jay mentioned, there are credit issues in the Asia region. Also, Asia has continued to encounter some of the selling pricing pressures as the other regions have and they have also continued to increase their account managers. I think their account manager growth is roughly about 33% year-over-year. And I think there maybe a little bit of a longer learning curve for the Asia account managers than maybe the other two regions. So what’s happening in Asia is fairly much along the lines of what we’re doing on a global basis as far as adding account managers and continuing to feel some pricing pressure.

Robert Richardson - Stifel Nicolaus

Great. Thank you for that. And so kind of along this added headcount, so sequentially headcount increased about similar rate that it’s done throughout 2013, just wondering on that selling expense, it seems fairly kind of typical increase in headcount that expense line went up, maybe a little more than we would have expected. I know you mentioned that there was some travel and other kind of costs associated with that. I’m just wondering how we should think about that going forward?

Jay Freeland

Well, I think, [there is couple], one is, so the going forward part. We tried to do everything we can to keep it as, sort of, level loaded through the course of the year as possible. And most of that is driven because when you met somebody say in Q1 right now, you really aren’t expecting significant productivity out of them until Q4. And in some respects, we are already hiring now for people that we don’t expect to deliver productivity, like real productivity. They will sell but not at real productivity levels until the first quarter of next year in some cases.

So we tried to keep that as low as we can. What we have also seen in the past is there’s always a little bit of lumpiness there. And I think for sure you saw that in Q4 and Asia is a good example. In a place like, in all of our regions and it seems to be a little more or so in Asia, perhaps. We had a really specific model of person that we are looking for. They need to be technically astute. They need to be capable of solving problems as they walk the manufacturing floor and thinking about where to deploy the technology. It’s very much a solution sell with the customer. And at the same time, you need somebody who is comfortable living with a highly leveraged variable comp plan where the sky is the limit in terms of what you can earn.

That’s a pretty unique profile and not everybody fits that bill. And by the way, we are going to ask the person to be on the road four to five days a week. So we’ve seen periods of time where you get a bunch of candidates and none of them fit the profile and we are really, really selective about, look, I am not just going to bring you in because I need it today. If this person we know doesn’t fit the model, we are going to pass for a quarter or two.

And likewise, if you, in the case, we get a batch saying, again, all of them are highly capable or a good portion of the ones we saw clearly could do this job. We won’t wait, we will go ahead and bring them in at that point. So you see a little bit of that. I think we saw a little bit of that in Asia in Q4. And the other important thing to remember, though, is that as we add the people, we’re always adding into territories that are highly uncovered for lack of a better word.

So, yes, we may have an account manager covering it. But our world today, not in every country but in a good portion of our countries, we’ve got regions where the account manager covering that territory, it would take them 50 or 100 years to talk to every one of the potential customers even one time. And so we add when we see momentum. We add where we know there is significant opportunity that we’re not stretching the list of customers or thinning out the list of customers too much on the person who is already this.

And so you combine those two, and that does create some of these pockets and spikes occasionally that occur. The goal is to try and do it as level as we can. And I think, generally speaking, a mid-teens percentage is the right expectation looking forward.

Robert Richardson - Stifel Nicolaus

Great. I appreciate that. And then, I guess, so thinking about seasonality, first, for March quarter, I mean, your expectations that you’re going to see kind of a normal seasonal demand environment?

Jay Freeland

I guess, the question is, are we expecting sort of the normal -- you get the sequential decline from Q4 to Q1? Probably, I mean, I’ve been here nine years now -- 9.5 years, I’ve never seen a Q1 that I don’t think was sequentially down from Q4. That’s not necessarily because we think Q1 is weak, because if you look at quarter-over-quarter growth, we’ve got lots of quarter-over-quarters from Q1 that are double-digit.

It’s more just a factor of -- you get that use it or lose it mentality still of the CapEx budgets at the end of the year from a lot of manufacturers that always drives the fourth quarter to be a little bit higher than the other quarters, you sequentially drop a little in Q1, even though Q1-over-Q1 will grow a good percentage rate and you sort of restart the cycle again from there.

Robert Richardson - Stifel Nicolaus

Great. Appreciate that. And then last one for me, and I will drop off. Can you provide what your revenue from new customers was or percentage from new customers was for the quarter.

Jay Freeland

39 for the quarter and 37 for the year.

Rob Richardson - Stifel Nicolaus

Great. Appreciate that. Thank you.

Jay Freeland

Thank you.

Operator

Your next question is from Rob Mason from Robert W. Baird. Your line is open.

Rob Mason - Robert W. Baird

Yes, good morning, Jay and Keith.

Jay Freeland

Hi, Rob.

Rob Mason - Robert W. Baird

I just want to revert back to the fourth quarter and maybe the seasonality question in a different manner. You did see very good strength, probably above seasonal strength, particularly in Europe in the fourth quarter. Just any sense of what maybe pent-up demand there. You talked about the end of year budget mentality. Did that get magnified do you think in any of your regions in the fourth quarter or was it just some of this better seasoning of the sales force?

Jay Freeland

I think it’s more tied to -- I mean, a little bit of a seasoning of the sales force, although the European team is not quite as green as the Asian team, but definitely less mature in terms of time at FARO than the Americas team. So, yeah, you get a little bit as they continue to improve and there is a little bit of that. I think it’s less, the pent-up demand, even though there was a bit of that because we did have customers holding back in the first couple of quarters of last year.

They started releasing some in Q3, little more in Q4. That being said, they wouldn’t release if there also wasn’t some of that use-it or lose-it mentality on the CapEx. That one is amazingly universal in every region in the world. There is that same mentality that if I don’t spend it this year, I won’t get that same amount of budget money from my CapEx next year. So, I ‘m going to go ahead and spend it on the things I have been holding back or waiting for. But I wouldn’t put the vast majority of it on the pent-up demand side.

Rob Mason - Robert W. Baird

So a lot of the orders that you received in the fourth quarter weren’t from quotes that had been sitting out there since the first half of the year, necessarily?

Jay Freeland

I cannot comment specifically but my sense from talking to the team, talking to the managing director and the sales leaders that that’s correct. Yeah, it’s possible we’ve had some revisits in there that generated orders but my sense is that it is not stuff that’s been sitting open for six months or nine months.

Rob Mason - Robert W. Baird

Well, do you have a better sense of customers being more willing than not to, because we didn’t certainly see that in the first half of the year? Sales cycles being much more elongated, any better sense that customers are not planning to do that as we enter ‘14?

Jay Freeland

I don’t think we are -- particularly Europe, I don’t think we are back to probably normalized sales cycles yet. I suspect that, until their economy really improves, I think you will still see a little bit of caution. That being said, it’s been stable enough, long enough that the customers who have been thinking about it and are interested in buying product. They are definitely buying the product that they wanted. But the sales cycle, it might have shortened it a little bit, maybe. Again, some of that is also just as the sales force matures in Europe because they are a little more green than the one in the Americas. A little bit of it is driven by that and a little bit of it will be customer behavior. I don’t think it is adding normal sales cycle yet.

Rob Mason - Robert W. Baird

Okay. Fair enough. And then just, you mentioned the plan to take the scanner product direct in a bigger fashion. What do you need to do on your rev, either from a manpower standpoint or otherwise to execute on it?

Jay Freeland

So, some of it certainly is just account managers. We have people with experience in that AEC space already, so refocusing some of their efforts, adding some more to go with it. That’s part of the -- when we talk about sort of the mid-teens sales growth -- sales force growth in 2014, they are already included in that number. So it’s not like it’s incremental to that amount.

So that’s sort of the tax side of it. And then, certainly, on the product side of it, we’ve said for a long time that there is still work we want to continue doing on the scanner, all of which is in the works within the R&D organization, that would allow us to better solve the problem.

The scanner solves lots of problems today. When you look at the ability to address sort of that billion dollars opportunity, but it’s not perfect yet. It’s not where I wanted to be and so that’s the other side of it too. And you’ll see us continue to do things there to help, whether it’s AEC or law enforcement or the manufacturing side of it. And it’s all geared towards sort of the ease-of-use of the solution, which opens it up to a much broader category of potential users.

Rob Mason - Robert W. Baird

Okay. And then last question. Just back to the price pressure that you saw during 2013 on the arm product, is there any way to -- it sounds like it has stabilized to a degree now, maybe it’s not a year-over-year headwind. But just, is there any way to quantify what that impact was in ‘13, either -- did it cost you 2 points of growth or just the level of reduction that you saw in arm pricing?

Jay Freeland

Yeah. Well, the one stat, I guess, that we have used is, that the pricing levels themselves have been as much as 30%, in some cases 35% lower than normal, just to give everybody sort of a flavor of how much headwind or how difficult that pricing market was. So, I think that’s the one stat we have given. We have not given any indication as to what the impact was for the company for a whole variety of reasons, one of which is strategic because we have been able to manage through it. We have been able to offset it. We have offset more than what we are actually kind of taking the hit for. I think that’s the right way to think about, but mostly it’s strategic. But I don’t want to say a whole lot more about that.

Rob Mason - Robert W. Baird

Fair enough. Okay. Thanks for taking my questions.

Jay Freeland

Thanks, Rob.

Keith Bair

Thanks, Rob.

Operator

Our next question is from Jim Ricchiuti from Needham & Company. Your line is open.

Jim Ricchiuti - Needham & Company

I just wanted to go back to how we should think about growth rates. It sounds like you still see a double-digit growth rate possible, maybe not the kind of growth rate we’ve seen several years ago. But if we look at the documentation business, the scanner business, Jay, is that in your sense, just given how under penetrated that market is, that it’s still a 20% type growth business?

Jay Freeland

What I’m saying is, because it sounds definitive, right. The documentation business certainly in my opinion could grow faster than a mid-teens growth. That’s not to say I don’t think that the metrology side could also grow at similar rates. Our meteorology business grew pretty well in the second half. So, I think the question mark on the doc business is checked, it’s a matter of penetration.

It’s a matter of continued customer acceptance, moving from the very -- we are not in early adopter stage by any stretch of the imagination there. It’s definitely in the early majority now. But as you ride up that bell curve and the adoption rate that goes with it, that slope of a change, could change for the better for sure. So that maybe presents the opportunity for the upside to that, but, yeah, it’s – I mean that space is wide open.

We still have the best-in-class product by all measures on pricing, performance, size, scale, all the other things. And if we complete the types of work we are doing on the R&D side, which really allow us to penetrate that market more deeply, then I think there is the opportunity for that to grow at even faster rate.

Jim Ricchiuti - Needham & Company

Okay. You alluded to new products for this year, potentially new products aimed at new markets and now I know you don’t want to show your hand, but is there any feeling, any sense you can give us, are these adjacent markets, are these markets that are sizable, or are they more niche-oriented? Any color along those lines? And are these products -- some of the newer products aimed at new markets? Is this something you are planning for this year, or is that introduced in the second half, potentially that contribute in 2015?

Jay Freeland

I certainly think they contribute this year. So, I will start with that. And that some of the excitement, particularly when you think of a new product, without saying kind of, when or what, that’s one that we could have -- who knows we could have underestimated what the opportunity is there. I think the easiest way, while there is potential for adjacent markets over time, from a focus standpoint to ensure we launch these in the right way, obviously if you have -- if it’s an existing product that we are doing next generation of, it is going to better attack the market that we are already in, or the markets we are already in.

If you look at a new product, let’s say, the things we are working on and I’m thinking of one in particular, certainly helps more aggressively penetrate some of the existing marks we’re going after and they are big markets. Could they expand to adjacent markets later? Very possible. We’ve focused our efforts right now on -- look, we know there is opportunity for it in that current market, and we know we have the ability to serve that current market. Let’s focus the activity there first, get it out the door, test it and get the customer acceptance, start generating the revenue that we think we can, and then we’ll worry about if there is an adjacent market. And if so, how do we serve that. That creates a different sort of strategic paradigm for the company.

Jim Ricchiuti - Needham & Company

And just the way you’re characterizing it, it sounds like this would, some of the new product would go through your existing channels, both direct and indirect?

Jay Freeland

Direct. Yes.

Jim Ricchiuti - Needham & Company

Okay. Keith, tax rate, how should we think about tax rate next year -- for this year, I should say?

Keith Bair

Yeah. I think we’re probably in that 26% to 28% range based upon -- historically, that’s typically where we’ve been and we don’t see anything out there that would change that.

Jim Ricchiuti - Needham & Company

Okay. And the final question just with respect to acquisitions, it sounds like nothing really jumping out. You’re still looking at things. How do you balance the acquisition strategy with the cash you have on the balance sheet and potentially even looking at share buybacks? Jay, it sounds like the acquisition activity level -- the level of activity has dropped a little bit versus, say, a year ago. Is that fair to say?

Jay Freeland

I would say, maybe, it’s dipped a little bit. There is always something on the burner or some things, depending on what time of the year you’re at. I will say that there are not a lot of revisits on the burner. It’s always -- we’re pretty clear when we look at one and decide we’re not going that route. We don’t do a lot of revisits out there. So the activity maybe a little bit lighter than it was a year ago. There is still multiple opportunities that we’re looking at. I still believe that’s the best place to put the cash, if we can find the right ones and like I said, it’s hardly a matter of effort, it’s just a matter of when we find right the right ones.

I think our revised focus on the verticals and understanding the big verticals we are in, like aerospace or AEC, or heavy industrial or auto, what else are those customers doing, how else are they trying to solve problems or not solve problems? I actually think that will point us to a new list that will still be appropriate for the overall strategy we have for the company, on 3D measurement imaging realization. So we are not going to stray too far off that playing field. But I think it will open up similar opportunities that we may not have considered before when we had sort of a horizontal view versus a vertical view of that world.

Jim Ricchiuti - Needham & Company

Do you have a group of folks that are focused on acquisitions? Can you talk a little bit about how you are attacking that?

Jay Freeland

Yeah. So the funnel -- a lot of the ideas not surprisingly come from the field. So you have account managers throughout that are talking to customers because they have such deep relationships with the customers, they can have pretty open dialog about what else you are you doing, how else do you do it, does it work, does it not work, are there gaps? We get very good feedback that way and that comes up through the account managers, through product management or through the sales leadership side.

And then the filters -- Bernd, who is our Chief Technology Strategist, tends to accumulate a large portion of those ideas. And then he and I are the managing directors. And now with Jody on board in the General Counsel seat, we will look at those on a regular basis and understand hey, summer, we only got just too niche or, hey, we don’t think that’s really solving the problem the right way.

And some will say, geez, we heard that from three or four different account managers and one of them was Europe and one of them was Asia, and so clearly that company’s got some different type of reach then we tend to, that’s where we drove a little bit further, Berndt has a couple of people that work with him then who will study and understand the technology.

A little bit of our R&D spend in 2014 will expand his team both from a combination of looking at acquisitions but also doing some, sort of, the initial or raw research side of it to translate downstream into other solutions. So that’s how we attack it. We don’t actually have a specific person called, say, business development or something like that, that you might be used to from other companies. Whether we need that type of role in the future remains to be seen. Right now, I think we manage the pipe pretty well with the people and the process we have.

Jim Ricchiuti - Needham & Company

Do we assume if you do any acquisitions that it’s a greater likelihood that they are going to be technology-related, something more similar to what you’ve done in the past and been able to commercialize the technology?

Jay Freeland

We are always looking at those for sure, because we know we do those really well. It is not out of the question that you might see us acquire something that has some technology to it. But the channel or the reach or the presence they had in the marked could be even more important. We have looked at a couple of those that perhaps, the greatest asset is the customer base, the customer connection, particularly if you look at newer markets that is not the realm of possibility in terms of what it brings to the table.

Jim Ricchiuti - Needham & Company

Okay. Thank you.

Jay Freeland

Thanks, Jim.

Operator

And we have no further questions at this time.

Jay Freeland

Okay. Thank you very much, everybody.

Operator

This does conclude today’s program. You may now disconnect at anytime. And please, have a wonderful day.

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