FARO Technologies Q4 2007 Earnings Call Transcript

Feb.18.08 | About: FARO Technologies, (FARO)

FARO Technologies Inc. (NASDAQ:FARO)

Q4 2007 Earnings Call

February 14, 2008 11:00 am ET

Executives

Vic Allgeier - TTC Group, FARO, IR

Keith Bair - SVP and CFO

Jay Freeland - President and CEO

Analysts

Mark Jordan - Noble Financial

Fred Russell - Fredric E. Russell Company

Richard Eastman - Robert Baird

Jeff Bash

Operator

Good morning, everyone, and welcome to the FARO Technologies Conference Call in conjunction with its Fourth Quarter 2007 Earnings Release. For opening remarks and introductions, I'll now turn the call over to Vic Allgeier. Please go ahead.

Vic Allgeier

Thank you, and good morning, everyone. My name is Vic Allgeier, TTC Group, FARO's Investor Relations firm. Yesterday after the market closed, FARO released its fourth quarter results. By now you should have received the copy of the press release. If you have not received the release, please call Darin Sahler at 407-333-9911. 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, we expect, we believe, we predict, we target, our growth targets, our goals, our guidance, and similar words.

It is possible that the company's actual results may differ materially from those projected in these forward-looking statements. Important factors that may cause actual results to differ materially are the risk factors set forth in yesterday's press release and in the company's filings with the SEC.

I'll now turn the call over to Keith.

Keith Bair

Thank you, Vic, and good morning, everyone. Sales in the fourth quarter of 2007 were $59.2 million, 34.9% increase from $43.9million in the fourth quarter of 2006. That brought our 2007 annual sales to $191.6 million, a 25.7% increase from $152.4 million in 2006. On a regional basis, fourth quarter sales 2007 in the Americas grew 22.6% to $21.9 million, compared to $17.9 million in the fourth quarter of 2006.

Sales grew 48.7% in Europe to $27.2 million from $18.3 million in the fourth quarter of 2006. Sales in the Asia-Pacific region increased 30.1% to $10.1 million from $7.7 million in 2006.

Comparing year-over-year growth, 2007 sales in the Americas increased 27% to $80 million from $62.9 million in 2006, Europe sales for 2007 increased 28.6% to $78.3 million from $60.9 million in 2006, and Asia sales increased 16.7% in 2007 to $33.3 million from $28.6 million in 2006.

New orders grew 31.3% in the fourth quarter of 2007 to approximately $65.4 million compared to approximately $49.8 million in the fourth quarter of 2006. On an annual basis, new orders grew 21.8% to $197.8 million in 2007 from $162.4 million in 2006. On a regional basis, fourth quarter orders in 2007 in the Americas grew 10.8% to $22.6 million compared to $20.4 million in the fourth quarter of 2006.

Orders increased 47.3% in Europe to $32.7 million from $22.2 million in the fourth quarter of 2006. Orders in the Asia-Pacific region increased 40.3% to $10.1 million compared to $7.2 million in the year ago quarter.

Again comparing year-over-year orders growth, new orders in the Americas increased 19.4% to $80.5 million in 2007 from $67.4 million in 2006. Orders increased 27.6% in Europe to $84.7 million in 2007 compared to $66.4 million in 2006, and orders grew by 14% in Asia in 2007 to $32.6 million from $28.6 million in 2006.

The top five customers by sales volume in 2007 were The Boeing Company, Daimler, The U.S. Military, Volkswagen, and Caterpillar, and represented only 3.8% of sales. The top ten customers in 2007 represented only 5.8% of our sales, once again indicating our lack of dependence on any one or handful of customers.

Our gross margin was 60% in the fourth quarter of 2007 compared to 58.8% in the year ago quarter. This increase was due to an increase in unit sales and product lines with lower unit costs than in the prior year period as a result of continuing productivity improvement.

Gross margin of fiscal 2007 was 60% compared to 58.7% in fiscal 2006. Selling expenses were 27.3% of sales in the fourth quarter of 2007 compared to 29.2% in the year ago quarter due to improved productivity of the sales force. In fiscal 2007, selling expenses declined to 29.3% of sales compared to 29.7% in fiscal 2006. Administrative expenses in the fourth quarter of 2007 were 11.8% of sales compared to 14.2% in the fourth quarter of 2006.

General and administrative expenses in the fourth quarter of 2006 included $1.5 million of professional fees related to the company's Foreign Corrupt Practices Act matter and patent litigation.

In fiscal 2007, general and administrative expenses were 13.3% of sales and included 2.65% million charge for estimated fines and penalties with respect to the FCPA matter and $1.1 million of professional fees related to the company's FCPA matter and resolution of the patent litigation. Fiscal 2006 G&A expenses were 16.1% of sales and included $6.8 million of professional fees related to the FCPA matter and patent litigation cost.

Research and development expenses were $3.1 million in the fourth quarter of 2007 or 5.4% of sales compared to $1.8 million or 4.2% of sales in the fourth quarter of 2006. R&D expenses for fiscal 2007 were $10.3 million or 5.4% of sales, an increase of $3.1 million from $7.2 million or 4.7% of sales in fiscal 2006. This increase was driven primarily by cost associated with the recent launches of Quantum FAROArm and Fusion FAROArm product lines.

Operating margin for the fourth quarter of 2007 was 13.8% compared to 8.8% in the year ago quarter as a result of the previously mentioned increase in gross margin and lower selling and administrative expenses. Operating margins for fiscal 2007 increased to 10% from 5.4% in fiscal 2006.

Income tax expense was $1.1 million for the fourth quarter of 2007 compared to $800,000 in the fourth quarter of 2006. Company's effective tax rate for 2007 increased to 21.5% compared to 16.2% for fiscal 2006, primarily as a result of the increase in non-deductible expenses for U.S. income tax purposes associated with the FCPA matter. The company's effective tax rate excluding the effects of the $2.65 million penalty would have been 17%.

Net income was $8.4 million or $0.50 per share in the fourth quarter of 2007 compared to $3.7 million or $0.25 per share in the fourth quarter of 2006, marking our 22nd consecutive profitable quarter. Net income for fiscal 2007 increased to $18.1 million or $1.15 per diluted share from $8.2 million or $0.56 per diluted share in fiscal 2006.

I will now briefly discuss a few balance sheet and cash flow items. Cash and short-term investments were $103.2 million at December 31st 2007 compared to $31.5 million at December 31st 2006. This increase was primarily the result of net cash proceeds of $53 million related to the company's registered direct offering on August 14th 2007and cash flow from operations.

Accounts receivable were $54.8 million at December 31st 2007 compared to $42.7 million at December 31st 2006.

Day sales outstanding at December 31st 2007 decreased to 84 days from 102 days at December 31st 2006.

Inventories increased to $40 million at December 31st 2007and $30.7 million at December 31st 2007 and $30.7 million at December 31st 2006. This increase in inventories was primarily related to an increase in raw materials and finished goods inventory.

Finally, I will conclude with some statistics regarding our head count numbers. We had 780 employees at December 31st 2007 compared to 641 at December 31st 2006, an increase of 139 or 21.7%.

Account manager head count at December 31st 2007 was 149 with 53 account managers in the Americas, 51 account managers in Europe, and 45 account managers in Asia. Geographically, we now have 366 employees in the Americas, 255 employees in Europe, and 159 employees in Asia-Pacific region.

I will now hand the call over to Jay.

Jay Freeland

Thanks, Keith. I would like to start this morning by congratulating the entire FARO team. 2007 was a spectacular year in so many ways and it’s the hard work of all our employees around the world who enables our success. The fourth quarter was, as it always is, extremely active on all fronts. We saw significant orders in sales growth in all three regions. Gross margin remains strong and the global sales team continued to improve their productivity. Sales per account manager averaged $1.3 million in 2007, up from $850,000 per account manager only two years ago.

During our last earnings call, I stated that we remained firmly on track for a strong fourth quarter. I also stated that we expected our full year results would remain well within the guidance range we have been providing all year. Obviously our results for 2007 were in fact in line with that guidance. I bring this up because we have always stated that FARO performance cannot be gauged quarter to quarter, but rather needs to be viewed for the full year. We expect to have fluctuations from one quarter to the next. As such our annual growth in sales gross margin and income is the best way to measure the company's financial success. For the last three years we've had a status strategy of achieving and maintaining a 50-50 balance between sales from new customers and sales from existing. In 2007, we remained on track generating 52% of our sales from new customers and 48% from our existing accounts.

Our team spends plenty of time with our existing customers, but this is still very much an early stage penetration story. So getting our products into the hands of new users is extremely important to long-term adoption rates around the world.

2007 was an exciting year for us from an R&D perspective. We introduced two new Arms, a new Scan Arm, a new color Laser Scanner and several new accessories. We continued to invest in the technology, which drives this business and will keep doing so in 2008 and beyond.

Then investment in our core products helps fuel the on growing growth we've come to expect. Though we don't disclose revenue by product line, I can tell that early orders volume from the products introduced in 2007 is very promising. Innovation remains at the core of our company and you will continue to see exciting new products from us over the next 24 months. We also continue to look outside the company for potential technologies which will complement our portfolio.

There's a lot of interesting technology available and we are looking at all of it. The key is determining which is the best fit for FARO not just in terms of potential products, but also in terms of talent and culture of the company we are reviewing. We are very patient buyers and will only take action when we see an opportunity which comfortably matches our criteria. In previous calls, I have talked about the Power One initiative, an internal program we launched in 2006. The program's financial metric is quite simple; every employee finds one idea that can generate $2000 in savings for the company regardless of where that idea comes from. However, it's not just the financial program, it's bigger than that. It is also meant to drive cultural change. We've had great success with the program since launching it.

In 2007, we spent a significant amount of time driving participation and finished the year with over 90% of the global employee base being involved. That compares with 45% in 2006. We also generated approximately $6 million from completed projects, which was redeployed to more productive uses and in some cases, dropped through to the bottom line. This is double the $3 million in projects we completed in 2006.

On the legal front, we remained very close to resolving the ongoing FCPA matter, which first surfaced almost two years ago. We continue to cooperate with both the Department of Justice and the Securities and Exchange Commission in order to conclude the matter.

As stated during our last call, we booked a $2.65 million reserve in the third quarter of 2007 for the estimated fines and penalties that we anticipate could be necessary to resolve the matter with DOJ and the SEC.

As also stated last quarter, we expect that the resolution of the FCPA matter will include a monitor for the next two years following such resolutions to review our ongoing compliance.

Our preliminary estimate of the aggregate cost of this monitoring obligation will be in the range of approximately $1.5 million to $2.5 million during that time period. Of course, the actual cost incurred with respect to the monitor may vary. Separately, the class action matter remains outstanding and we continue to believe that our directors’ and officers’ insurance policy is adequate to defend this action.

Looking ahead to 2008, we are maintaining our forecast guidance range of 20% to 25% growth in full year sales. We’re also maintaining our forecast guidance range of full year gross margin of 58% to 60%. We will continue our practice of guiding to those numbers only, and will as always provide updates on our progress towards those targets at the end of each quarter.

With respect to our sales growth guidance range of 20% to 25%, there is no doubt that recent macroeconomic challenges around the world are of some concern. Like most companies, we monitor the situation and we review it relative to the industries we serve, our target customers and our global sales model.

However, despite the current global economic conditions, we still see plenty of positive signals below the waves on the surface. We believe that those signals indicate that our top line growth estimate of 20% to 25% is both appropriate and achievable in 2008. This remains a highly under-penetrated market with significant needs for the products we offer. There is a tremendous amount of opportunity out there and we intend to continue growing with that.

With respect to our gross margin guidance range of 58% to 60%, we are leaving some room for flexibility. Clearly, our actual 2007 gross margin is at the top end of the target range for 2008. We are as always allowing room for price flexibility or other potential circumstances which may not be foreseeable at this time. However, I can also assure you that the FARO team continues to execute on existing and new productivity programs, always looking for ways to improve our gross margin.

In summary, I’d like to thank the global FARO team one more time. You continue to deliver on your commitments and your ongoing passion for FARO keeps us on top. Our recent honor of being named the 18th Fastest Growing Tech Company in America by Forbes Magazine is just one example of what your commitment and dedication brings us. For those in the investment community, I also offer my thanks for your ongoing support of this fantastic enterprise. And I look forward to another successful year in 2008. I appreciate your attention and I will now open the call to questions.

Question-and-Answer Session

Operator

(Operators instructions). We can pause a moment to allow questions to queue. Our first question comes from Mark Jordan with Noble Financial.

Mark Jordan - Noble Financial

Good morning gentlemen. Congratulations on a good end to the year.

Vic Allgeier

Thanks Mark.

Keith Bair

Thanks Mark.

Mark Jordan - Noble Financial

First question relative to selling expense, you obviously saw a significant improvement in that metric vis-à-vis sales in the fourth quarter versus the third dropping down to the 27.3%. Could you give us what your goals might be for next year, for a full year in terms of improving efficiency there? And also talk about what you think might be the appropriate long-term metric for you to drive the company towards?

Jay Freeland

I'll go in reverse order, Mark. The long-term target is to still get that metric down to 25% of sales. We have stated for a while now that the target to get there is the end of 2009 on a run rate basis. I have also stated before that that probably has a little bit of risk to it given that the model is, obviously, highly dependant still on that direct sales and marketing team that's in the field given that it's still very much a missionary sales process.

In the fourth quarter, no doubt you got some leverage, you had obviously significant increase in sales volume relative to the headcount that we have in the team, and because it's such a variable cost element for us, you obviously get some leverage as the sales go up that way.

The run rate in 2008, as you know, we don't forecast costs other than sales line and the gross margin for the year. So I am not going to give you a direct number.

Do I believe that we’ll make some continuous improvement in ’08 and in ‘09 to get towards that 25%? Yes. I think that's probably going to happen. We are definitely still going to keep adding account managers and in side sales reps and marketing people to drive the volume of the company. And, we stated before that if overall headcount is going to increase 5%, 10%, give-or-take in a year, and we don't obviously ever project what that will be one year to the next. You can certainly expect that the sales and marketing team would increase a fair amount larger than that. Probably not at the full 25% growth target that we have laid out there, the top end of the range, but you might see it increase 17% or 18% to go along with it.

So I am not going to give you an exact percentage for 2008, but the number, the target for run rate at the end of '09. And like I just said, obviously, the goal is to make moderate, continuing improvement along the way.

Mark Jordan - Noble Financial

Thank you. You mentioned on the call that R&D was still being influenced by spending related to the third quarter new product introductions. Moving into '08, you expect R&D on an absolute dollar basis to plateau given the fact that you completed those two major projects? Or should we see it continue to attract fairly steady as a percent of revenues?

Jay Freeland

Yeah. I think continued growth is the right way to look at it. We've historically run in the 5% to 7% range and we still feel that will be appropriate range for the company. Obviously, the last year and a half or so it's been much closer to the 5% mark and has even been a little bit below that. But so as sales continue to increase with a goal of staying within the 5% to 7% range, obviously the absolute dollar would go up with it.

Mark Jordan - Noble Financial

Okay. Could you also talk about the tax rate that we might look at, again with a normalized tax rate of 18%. Should we assume that that should have an upward bias as the company becomes more profitable worldwide?

Keith Bair

Right. Our effective tax rate depends on the particular regions, sales and profitability on any particular quarter. But going forward, I would anticipate a range in the 18% to 22% area.

Mark Jordan - Noble Financial

Okay. And a final question, if I may, on the cash flow statement there is a line that you said the effective exchange rates on cash and equivalents and it was a minus $5 million number. Could you discuss the dynamics of how that is created and the significance of it say to the P&L?

Jay Freeland

What was basically instead of just taking the difference between balance sheets at any end point dates, we really have to consider the effect of the foreign exchange rates on those balance sheets as well. So you could have situations where just looking at year-over-year changes and the balance sheet will result on one number when in effect. There is foreign exchange effects built into the changes in the balance sheet. And when you do that that’s basically where that FX effect on cash number falls through.

Mark Jordan - Noble Financial

Okay. Thank you very much.

Jay Freeland

Thanks Mark.

Keith Bair

Thanks Mark

Operator

Our next question comes from the Private Investor, Jeff Bash. Your line is open.

Jeff Bash

Hi. Good morning.

Jay Freeland

Good morning, Jeff Bash.

Jeff Bash

With a 15% order growth rate in Q2 and 13% in Q3, the performance for Q4 far exceeded my expectations, was there earlier a holding back on orders waiting for the new products? Or other factors such as currency devaluation issues that caused this huge shift in the order pattern? Or anything else you might to able to identify?

Jay Freeland

Yeah. Well, I think there is a couple of things. Number one, I don’t believe there is anything tied to hold back on new orders because we were pretty tight lipped about what. I mean people knew we are working on new Arm, particularly, they knew we were working on one new Arm. The marketplace had no idea we were working on the lower cost Arms as well. But we had given no indication as to when that might come out other than we obsoleted ourselves roughly every five years. And we are roughly at the five-year mark. So I don’t think there is any holdback there.

On the FX side, hard to tell. I would guess, no, only because we’re pricing in local currency anyways around the world, so I wouldn't imagine that has too much impact. No question we saw a lot of buying in the fourth quarter in the typical pattern of the use-it or lose-it mentality from a CapEx purchasing standpoint, and I think that probably drove the bulk of it.

As you know, we had some things in second and third quarter that either from the second quarter had been pulled into the first quarter or from the third had been pushed the fourth and we sort of anticipated that ramp up, which is why at the end of third quarter, we are still very comfortable with what the full year range was going to look like. But most of that, I really believe is that traditional use-it or lose-it. The budgets are there and they get into the fourth quarter and say, yep, I’ve still got it. I don't need it for a machine tool. I don’t need it for something else. I am going to go ahead and add the equipment we have been talking about for the last six months, four months depending on the product.

Jeff Bash

You expressed some concern about the future relative to U.S. economic situation and there had been comments from companies like Cisco expressing similar concern, yet you didn't lower the guidance. I mean you really feel comfortable with the 20 to 25, or you were just reluctant to lower it from the historical pattern? Or can you add any additional color on that?

Jay Freeland

Yes. There was not reluctance. I can tell you that. I am not reluctant to do anything when I know it's the right way to go. So we really believe that that is still the right growth rate. Some of that is the softer side of just dialogue with our existing customers and understanding what they're budgeting for this year. We obviously get a chance to look at that from day one and seeing what they are putting together.

No question there is -- in the U.S. in particular, there's a little bit concern, we just look at generally speaking sub prime, the write-offs, the lower availability of cash, and knowing the commercial industrial loan dollars over the last five years have increased almost threefold, and some of those T&I loans clearly we have the benefit of from smaller customers in particular.

On the flip side though, number one; we are still unbelievably under-penetrated. We've used this 5% number a lot over the last several years and it's still at best 5% penetrated when we look at again the SIC codes and we look at the comparable codes over in Europe and when we look at potential customers in Asia.

And these signals that they’re sending are not that they're going to slowdown necessarily on their spending relative to the productivity programs or anything of the like. And the other thing, of course, is that given that our sales are roughly 40% from the Americas and not all that is U.S. based obviously, but the bulk of it is. and then 60% from Europe and Asia right now, which though clearly the Asian economies are still booming particularly China and India which were in both of; European economies, Germany in particular, the growth rate not that different from what they’re predicting for industrial operations here in the U.S., but that balancing effect certainly helps.

And I guess the final thing I would look at is that the industrial output in the U.S., I think they are forecasting about 1.9% this year and it’s similar in Europe for the EU, it’s about 2% there I think.

If you look at that growth and index it over the last say four years, it's been relatively the same number over the last four years in both territories. And our growth, when you index it against that has been I mean sizably factors of 10 above that during that time period. So that combination of all those things gives me comfort, Jeff, just that the 22% to 25% is still the right way to go.

Jeff Bash

Good. Now in terms of multiple orders, are you seeing any progress from let's say sort of lack of material progress in the past on that issue, because that's really what would drive a lower percentage of selling expense through sales.

Jay Freeland

Sure. We're seeing them as a ratio to our overall sales. It's still not meaningful. That still will come with time. And, quite frankly, as we continue to add more account managers, obviously, you are diluting the pool of people out there, who are getting new accounts mostly relative to guys who have been around a while who are getting some of the repeat orders. We have some that are, I will never say predictable because they are not, we have some who have been consistent over the last few years of continuing to add and they are picking up multiple units at time. Certainly, we still feel that’s going to expand, but in terms of being meaningful to the company today as ratio wise, it is still not meaningful.

Jeff Bash

And a final question, on the FCPA matter, it’s public knowledge that Lucent had an FCPA problem, which if you read the public information seems to have been vastly larger than the company’s, yet their penalty is no larger than FARO’s provisions for its matter, such that I would conclude that if FARO really had to pay what you reserved, it would be patently unfair relative to Lucent. Can you comment on that?

Jay Freeland

Yeah. I can comment shortly obviously or briefly. The first thing I would say is that the cases are very different. And even though the dollars involved are sizably different, the biggest differential and I can’t comment a whole lot further on this given that we are still finalizing this, but what we see in reviewing this our lawyers and, of course, we have looked to that case, is that the biggest difference in the Lucent case is that though there was a direct benefit being conveyed to the third party, it was not direct cash payments. And, unfortunately, there is a significant distinction between those from what we have seen and understand, and that’s about as far as I can go with it.

But based on our review, that is unfortunately the delta between the two and why the fines may look disproportionate relative to the size.

Jeff Bash

Okay. Thanks. Thanks again for a great quarter.

Jay Freeland

Thanks, Jeff.

Operator

Our next question comes from the Fred Russell with Fredric E. Russell Company. Your line is open.

Fred Russell - Fredric E. Russell Company

I don’t want to congratulate you on a great quarter because I know that’s not the way you run your business, but you are doing a great job. Do you see any difference in the nature of your customers and their orders, what they are looking for, what their problems are, how FARO approaches these problems in their marketing pitch or presentation this year versus last year, do you see any trends? Specifically, do you see that smaller businesses are getting interested in what FARO has to offer versus last year or previous years?

Jay Freeland

Yeah. The types of problems that we see and the types of issues that we are solving for the customers haven't changed a whole lot. Obviously, the specific of how say, somebody at Boeing is using a Tracker versus how a small machine shop is using GAGE. Obviously, that is very different, but the general concept of the time savings or the scrap and rework production between those two, and then the ease of use because it's portable piece of equipment.

Those fundamentals really don't change regardless of how they're going to use the product, what the application is, which is great because from a training of the sales force standpoint and helping them understand the concept of how to go in and start the problem solving process. It gives you an easy baseline to work off of. So that part hasn't changed the whole lot. It's just different dynamic of how they're going to use the tools relative to the specific application.

No question because of the GAGE product, in particular, smaller customers definitely are starting to understand the product better and some of that is our marketing also, as we continue in the U.S. to look at the SIC codes and where we've sold and how many are still available that we have never touched, and same thing in Europe with comparable codes and what we do in Asia. No question that smaller companies -- we’re starting to get some more traction from them and it is absolutely common for us now to sell equipments to a one-man shop. It happens all the time. Again, particularly in machine shops to find a GAGE, it happens all the time and it's just as likely to happen, as say the CADs in the VW’s of the world, who are our largest customers, they just have the benefit of having more plants to spread it over which is why they show up as a larger customer than smaller guys.

Fred Russell - Fredric E. Russell Company

How much does a GAGE cost? And when you say smaller customer, what kind of revenue, annual revenue are you talking about?

Jay Freeland

Well, we do look at them -- obviously, I am not going to split how we've sold in and what the ratio has been, but we've got folks who are certainly well under the $1 million of revenue’s mark for purchasing our equipment. And we've got plenty in that smaller size range that go $1 million to $5 million, and we do look at SIC codes and break downs that are less than $1 million, $1 million to $5 million, $5 million to about $50 million, and then $50 million after that point is a totally different ballgame, even though still obviously a Boeing is going to be much larger than a company with $51 million of revenue.

The average price of a GAGE today typically runs about $23,000. It's a little higher when you add accessories. And the biggest driver still for that adoption, there’s kind of two things there. One is, obviously, hand tools, which is the more traditional way to do the job of a GAGE. These guys have to have lots of them. They do, they can break, you drop them, you've got this renewed maintenance and things like that. And, it can run you several thousand dollars a year just in the replacement or the maintenance cost alone.

And the beauty of the GAGE is you’re getting all of the abilities of those tools and then some in a single package. And we do still see a lot of the smaller machine shops if they are serving upstream to a larger customer. If that customer starts putting demands on them, such as you need to inspect everything or hey, we want to see that this has passed inspection prior to shipping the parts to us, the GAGE can do all that electronically and capture it and immediately send it up there. And you just can’t put enough people; enough hand tools in the facility to go from say a 5% inspection rate to 100% inspection rate and provide all the data ahead of the shipment.

Fred Russell - Fredric E. Russell Company

What do you think is a reasonable pay off on investment rate of return investment in a typical FARO product? Is it two to three years? Is it shorter?

Jay Freeland

Yeah. It’s definitely shorter. What would be typical, if you look at an Arm, five to six months is not uncommon depending on the size of customer. Obviously, smaller customer may take a little longer. Could be twelve months. Flip side is the payback in some respects for smaller customer is that they get to stay in business because they are able to meet that increased inspection demand or the new pressure that’s been put on them.

Tracker payoff tends to be a little bit longer; nine to twelve months is not uncommon there. But we have seen as quick as a couple of ships sometimes depending on, we have got some auto manufacturers use the product to measure the stamping die, say, for doors or something else. And look, it doesn’t take many doors that are out of alignment to go down the line and have them figured out at the end of the line. And they have already got 300 door stamped and pressed. And you’ve more or less paid for the product in one or two ships at that point. So that’s an extreme, but that’s kind of the range we look at.

Fred Russell - Fredric E. Russell Company

What do you think would might be a catalyst that could accelerate FARO’s growth? Is it, one, could FARO get to the point where the company is selling to companies and the company realizes that they must buy a FARO just to stay competitive?

Jay Freeland

Yeah. God knows, I wish I could absolutely predict that. What I visualize happening that will drive the catalyst is, number one, the product will become the standard for not just measurement, but it will become a de facto standard that in certain types of manufacturing processes you just need or want to have a FAROArm or GAGE or Tracker involved. And the more customers that we get that we have today who take the product and make it a standard part of the manufacturing process not just an inspection device. And it’s still inspecting, but you are making it a common piece of the manufacturing process. The more that that happens, the more that word of mouth will spread, the more we have that take out to the other customers who don't use the product yet. And then for the existing ones that that point they are hooked on it, and then they do start ordering in multiple batches.

And I've used an examples before of a fairly large customer who just picks up the phone now and calls and says, send me three more GAGEs, send me two more GAGEs, send me five more GAGEs because they’ve done exactly that. They have put it. They have ingrained it so deeply into the manufacturing process that they’re now at the point where they can’t live without it as a piece of the normalized process. It's not just inspecting for certain defects or certain quality elements.

Fred Russell - Fredric E. Russell Company

Are there certain industries that would be highly prone, and therefore advantageous to FARO for that automatic de facto standard for that automatic incorporation into the manufacturing process?

Jay Freeland

I am not going to pick any one because I think in my view they are all applicable. And that's just the marketing of me coming out of that. Any product that has the tight tolerance in its design, it absolutely make sense to have the product. And since the bulk of the world has adopted to CAD in their design and newer and younger engineers the last 15 years at least who are coming out of school now design at very, very tight tolerances. And all of those have the applicability of an Arm or GAGE or a Tracker.

Fred Russell - Fredric E. Russell Company

Well, I want to come down and visit you. I say that because there doesn't seem to me too many people on this phone call, so I want to make a personal appeal. And you're doing a great job. And we about 100,000 shares. So keep up the good work. And we'll be talking offline, I hope.

Jay Freeland

Sounds good. We are happy to host people here and show off what we've got. So, call the office and we'll get you set up.

Fred Russell - Fredric E. Russell Company

Thank you. Thank you.

Jay Freeland

Thank you.

Operator

Our next question comes from Richard Eastman with Robert Baird. Your line is open.

Richard Eastman - Robert Baird

Hi, Jay and Keith.

Jay Freeland

Hi Rick.

Richard Eastman - Robert Baird

A couple of questions for you. Is there any dynamic at play here given the fourth quarter level of orders from some of the new products that you've introduced, particularly later in the year? And I am thinking along the lines of higher ASPs or any particular marketing push on the new products. Would you attribute any of the fourth quarter strength to that new order, new product flow?

Jay Freeland

Yeah. I can't say that, like I said, the orders that we've gotten are promising because the pick up, the adoptions was pretty quick. I can't say that it’s a meaningful piece of the fourth quarter numbers though either. So do I think that that bodes well as we go forward? Absolutely, no question about it, but I can't say that it was a significant contributor to the fourth quarter volume.

Richard Eastman - Robert Baird

Is the ASP, I'm thinking, particularly on the two Arm products, is the ASP just generally fall in line with kind of an average ASP and products from last year? That they are displacing?

Jay Freeland

Actually, the Quantum doesn't displace anything because it’s so much higher accuracy. So that one relative to kind of the bread and butter on the Arms side call which is the Platinum, the Quantum is a higher price because of the higher accuracy. And it's a step fold price increase relative to the step fold accuracy increase. The Fusion Arm actually is a lower accuracy Arm and so as a result relative to the Platinum.

As a result, the price is lower. You are targeting a slightly different manufacturing element there in particular where they still have tight tolerances, but they don’t need the tolerance of a Platinum or Quantum. So for a slightly lower price you are getting step fold lower accuracy. So in that introduction, we actually had one that was higher price, one was lower price relative to the average price.

Richard Eastman - Robert Baird

Okay. So we are kind of netting out, alright. And then you ran in ’07, I know you don’t disclose sales contribution by product line. But can you just give us a general sense of how much the scanner is contributing to sales? Has that gained some traction through the year? And can that have a material influence on the growth rate going forward?

Jay Freeland

Yeah. Going forward, I still certainly believe it’s going to have a material influence at some point. It is not necessarily material at this point, though we have had plenty of sales. And I would state that I am extremely pleased. Earlier this year, I think it was the second quarter maybe, I mentioned that we are finally starting to see some take up of the product that I have been hoping for probably two years prior and just my own fault for not realizing how far back in the early adopter stage we were with that product.

We are now starting to see that traction. And in some respects, the curve is following very similar to the curve we saw with Tracker in the early stages there. I mean it’s interesting that they are almost not quite unit to unit, but it’s very similar. And that’s been a fantastic curve for us in the later year.

So I do believe it’s going to add significantly in the coming years. At the moment, it stopped. It’s still not meaningful from a materiality standpoint. Though the growth rate itself is meaningful in terms of the adoption and the pick up even though it’s still obviously much smaller.

Richard Eastman - Robert Baird

In that product line all in with the selling effort and the headcount, would likely not be profitable at the OP line?

Jay Freeland

We have never actually stated whether it’s profitable or not at the OP line. What I will say is, historically, the acquisitions we've made have been breakeven within a couple of years. And I have stated before, I think, that this one is in that same ballpark.

Richard Eastman - Robert Baird

Yeah. Okay. And then from a backlog perspective, I guess the good news is we didn't work down backlog but I guess that's a little bit of bad news as well. Because I know you were trying to bring that down. We built some more backlog here in the fourth quarter. Should we think of your order growth rate in ‘08 also being in the 20% to 25% range or does that backlog give you some question in case your orders show some economic sensitivity?

Jay Freeland

Yeah. Great question. Number one, yes, in my view the orders rate should be roughly the same as what the sales rate is. So you can use the same target range there because it's just obviously a direct feed. The 19 in backlog, roughly 19 I think now, in some respects when you look at the ongoing growth, we've always said a couple of weeks worth of backlog is probably about right for the business. And reality is, we are still pretty close to that. Actually even at the 19 when you look at the forward move next year 20%, 25% growth on top where we are now, could it be a little bit of cushion if the orders growth rate was below the sales growth rate? Sure. Could be, but certainly it is not the intent either.

Richard Eastman - Robert Baird

Yeah. Okay. And then just the last question. Can you just give us a number as to what currency benefited you at the sales and orders line?

Jay Freeland

Yeah. I would let Keith walk through that one with you.

Keith Bair

For fiscal ‘07 it’s about 3.5% of sales.

Richard Eastman - Robert Baird

That’s okay. Was the fourth quarter presumably higher than that?

Keith Bair

Yeah. The fourth quarter was a little over 5%.

Richard Eastman - Robert Baird

Okay. Alright. Very good. Well thanks, guys.

Jay Freeland

Thanks Rick.

Operator

Our next question comes from Jeff Bash. Your line is open.

Jeff Bash

Okay. I have a follow-up question. On your comments to Mr. Russell about selling GAGEs to one-man shops.

Jay Freeland

Yeah.

Jeff Bash

I recall you said earlier in the year as well that that was your most rapidly growing aspect of your business. But if we were to go into an economic downturn, these one-man shops arguably might be financially more vulnerable in large companies. Do you think that increases the cyclical risk of the company slightly compared to the period before you had the GAGE?

Jay Freeland

No question a significant downturn could obviously impact that growth, because they are more likely to go out and get financing for their product. I can't say that it's a meaningful enough piece that it would be a hit to the company or change the nature of the company in any one quarter. So, yes, I think it's a risk, but again it's not necessary a risk to 20% to 25% overall.

Jeff Bash

Okay. Thanks.

Operator

(Operator Instructions). Our next question comes from Fred Russell with Fredric E. Russell. Your line is open.

Fred Russell - Fredric E. Russell Company

Yes. I was interested in Mr. Bash's comment. And I would appreciate if management could facilitate Mr. Bash's phone number for me because I would like to exchange ideas with another friendly shareholder, friendly to FARO that is, and hope to me. I do hope that too. Is that possible? Thank you.

Jay Freeland

Yeah. I'd just say, if Jeff wants to chime in and give it to you or if he is okay with that. I know Jeff posts on some of the message boards, you guys can figure that one out. We are happy to have you guys talking to each other though.

Fred Russell - Fredric E. Russell Company

Thank you.

Operator

It appears that we have no further questions at this time. I would like to turn the call back over to Jay Freeland.

Jay Freeland

Okay. Well, thanks again for the call today. I appreciate everybody’s interest and the ongoing support. Thanks again for the whole FARO team that’s on the phone there. It was great a ’07. And now I’ve got our work cut out for us to make another great year in 2008. So, thanks again everybody. We will talk to you at the end of the first quarter.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!