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FARO Technologies (NASDAQ:FARO)

Q1 2008 Earnings Call

May 1, 2008 11:00 am ET

Executives

Vic Allgeier - IR

Keith Bair - SVP and CFO

Jay Freeland - President and CEO

Analysts

Mark Jordan - Noble Financial

Rob Mason - R. W. Baird

Richard D’Auteuil - Columbia Management

Fredric Russell

Jeff Basch

Operator

Good morning, everyone, and welcome to FARO Technologies Conference Call in conjunction with its First Quarter 2008 Earnings Release. For opening remarks and introductions, I will now turn the call over to Vic Allgeier. Please go ahead.

Vic Allgeier

Thank you, and good morning, everyone. My name is Vic Allgeier of the TTC Group, FARO’s investor relations firm. Yesterday, after the market closed, FARO released its first quarter results. By now you should have received a copy of the press release. If you have not received the release, please call Darin Sahler 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 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 material are the risk factors set forth in yesterday’s press release and in the company’s filings with the SEC.

I will now turn the call over the Keith.

Keith Bair

Thank you, Vic, and good morning everyone. Sales in the first quarter of 2008 were 46.1 million, a 14.4% increase from 40.3 million in the first quarter of 2007. On a regional basis, first quarter sales in 2008 in the Americas decreased $100,000 or 0.4% to 19.1 million compared to 19.2 million in the first quarter of 2007. Sales grew 25.9% in Europe to 18.9 million from 15 million in the first quarter of 2007. Sales in the Asia-Pacific region increased 32.8% to 8.1 million from 6.1 million in 2007.

The effective changes in foreign-exchange rates on sales, was an increase of approximately 6.9%, or 3.2 million in the first quarter of 2008. New orders grew 23% in the first quarter of 2008 to approximately 47 million compared to 38.2 million in the first quarter of 2007.

On a regional basis, first quarter orders in 2008 in the Americas grew 7% to 18.4 million compared to 17.2 million in the first quarter of 2007. Orders increased 27.6% in Europe to 19.4 million from 15.2 million in the first quarter of 2007. Orders in the Asia-Pacific region increased 58.6 to 9.2 million compared to 5.8 million in the year-ago quarter.

The top five customers by sales volume in the first quarter of 2008 were the Boeing Company, Northrop Grumman, Sumisho Computer Systems, Korea Aerospace Research Institute and the U.S. military, and represented only 5.4% of sales. The top 10 customers in the first quarter of 2008 represented only 8.4% of our sales, once again indicating our lack of dependence of any one or a handful of customers.

Our gross margin was 60.1% in the first quarter of 2008 compared to 59.2% in the year-ago quarter. This increase was due to an increase in unit sales of product lines with lower unit costs than in the prior-year period as a result of continuing productivity improvements. Selling expenses were 31.3% of sales in the first quarter of 2008 compared to 30.5% in the year-ago quarter primarily due to an increase in sales and marketing personnel.

Administrative expenses in the first quarter of 2008 were 12.2% of sales compared to 12.5% in the first quarter of 2007. General and administrative expenses in the first quarter of 2008 increased by $600,000, primarily related to increased compensation costs and costs related for additional leased space, offset by a reduction of professional fees related to the FCPA matter and patent litigation.

Research and development expenses were 2.7 million for the first quarter of 2008, or 5.9% of sales, compared to 2 million, or 4.9% of sales in the first quarter of 2007. The increase is primarily related to compensation expense and reflects the company’s continued investments in new growth platforms.

Operating margin for the first quarter of 2008 was 8.5% compared to 8.6% in the year ago quarter as a result of the previously mentioned increase in gross margin, offset by slightly higher selling and administrative expenses. The first quarter of 2008 also included an accrual for interest expense of approximately $400,000 associated with the company’s FCPA resolution.

Income tax expense was $900,000 for the first quarter of 2008 compared to $800,000 in the first quarter of 2007. The company’s effective tax rate for the first quarter of 2008 increased to 21.8% compared to 20.5% for the first quarter of 2007, primarily as a result of an increase in taxable income in jurisdictions with higher tax rates.

Net income was 3.4 million, or $0.20 per share, in the first quarter of 2008 compared to 3.2 million, or $0.22 per share, in the first quarter of 2007, marking our 23rd consecutive profitable quarter. The number of fully diluted shares outstanding in the first quarter of 2008 was 16.7 million compared to 14.7 million in the first quarter of 2007. The increase of approximately 2 million shares is primarily related to the sale of 1.65 million shares of common stock in the company’s registered direct offering in August 2007, and the exercise of stock options by employees throughout 2007.

I will now briefly discuss the few balance sheet and cash flow items. Cash and short-term investments were 106 --102.6 million at March 29th, 2008, compared to 103.2 million at December 31st, 2007. Accounts receivable is 48.1 million at March 29th, 2008, compared to 54.8 million at December 31st, 2007. Day sales outstanding at March 29th, 2008 increased to 95 days from 84 days at December 31st, 2007, primarily as a result of an increase in international sales. Inventories increased 49 million at March 29th, 2008 from 40 million at December 31st, 2007. This increase in inventories was primarily related to an increase in raw materials and finished goods inventories.

Finally I will conclude with some statistics regarding our head count numbers. We had 825 employees at March 29th, 2008 compared to 780 at December 31st, 2007, an increase of 45 or 5.8%. Account manager head count increased from 149 at December 31st, 2007, to 160 at March 29th, 2008, with 54 of account managers in the Americas, 58 account managers in Europe and 48 account managers in Asia. Geographically we now have 389 employees in the Americas, 264 employees in Europe and 172 employees in the Asia-Pacific region.

I will now hand the call over to Jay.

Jay Freeland

Thanks, Keith. Growth in the first quarter maintained the same strength we have been seeing over the last two years, with orders increasing 23%. Asian growth at 58%, led the way with solid performance from Europe as well. No doubt, growth in the Americas was slower than usual at 7%, but we continue to see all the right signals from customers in all three regions. One of the on-going benefits, as we get bigger and more geographically dispersed, is our ability to maintain our overall growth objectives even when the performance in individual regions varies. Certainly, that was the case in the first quarter. In total, this remains an extremely under-penetrated market opportunity, and we continue to lead the charge in growing the space.

Sales grew less than we had planned in the first quarter, driven by a large influx of orders near the end of the quarter, which had customer defined delivery requirements in April. Had those delivery dates been designated March instead of April, our sales growth would have been more closely aligned to our full-year projection. Regardless of the quarterly fluctuation, our sales guidance of 20 to 25% growth remains realistic and continues to be our guidance for the year.

Make no mistake, current economic conditions around the world remain a concern, particularly in the U.S. However, when we consider our orders growth in the first quarter, what we have in our pipeline and what we hear from our customers, we believe that our full-year target remains achievable. One of the concerns people raise with me at the start of the year was whether or not we could maintain our historical growth rate in this economic environment without sacrificing price. However, our first quarter gross margin of 60.1% is a pretty good indicator that this should not be a major concern. Our solutions offer significant increases in productivity and are valuable to our customers regardless of economic conditions. Customer ROI relative to the price they pay for our products continues to be extremely strong for those who adopt our technology. As a result we see no reason to change our previously issued 2008 gross margin guidance of 58 to 60%.

I continue to be encouraged by our internal research and development activities. And our product releases from the last four quarters have proven to be well received in the field. However and as you know, I also believe there are opportunities from external R&D in the form of acquisitions particularly in the areas of non-contact measurement and software.

Last night we made a very exciting move in this regard. As announced in our press release, FARO has acquired Global Technology Rights from Dimensional Photonics International for industrial manufacturing applications. DPI is a leader in high-speed, high-accuracy digital shape scanners. Their technology is unique and well protected. In a nutshell DPI utilizes a combination of lasers and cameras to create extremely accurate 3D renderings of objects being measured.

We have looked at a lot of similar non-contact technology over the last 12 months, and this is by far the best one out there. Speed and accuracy for the DPI product is 25 microns; however, it has performed far better than that. The accuracy range is at least equal to our current world-class Arm technology. However, unlike an Arm it achieves that level of accuracy without making any contact with the object it is measuring.

Though it uses lasers and the natural surface reflections of the object being measured, DPI’s technology is very different from our existing non-contact technology. Our existing laser scanner LS is used for capturing huge volumes of data at high speed. DPI’s technology is far more accurate, but for example is not meant to digitize and measure the volume of an entire room or facility, which we are capable of doing with the LS. The current FARO ScanArm or LLP is also not as accurate as the DPI product but is currently far more portable for the end user.

With over 20 current and pending patents and a strong relationship with the Massachusetts Institute of Technology, acquiring these rights presents a great opportunity for FARO. It is also very similar to outright acquisitions we have done in the past. A small company with great technology, but in need of market presence, manufacturing capacity and ongoing research and development resources.

We will be using a third party for production in the near-term, but also, anticipate bringing that function in-house at the appropriate time. DPI’s current product is similar to FARO’s current products from the stand point that it is a final assembly process and requires minimal plant and equipment expense. At this time we anticipate that assembly can be managed at one of our existing facilities once we make the move to bring production in-house.

Specific terms of the deal were not announced. But I will tell you that it involves an up front cash payment and an ongoing royalty stream with a well defined end date. As stated in our press release we will establish a new technology center of excellence outside of Boston to add the resources required of for our planned development efforts. We already have several specific development projects identified which we will start work on as soon as the technology transfer process is complete.

Job postings for our initial R&D team will be available by the end of the week and recruiting will kick off simultaneously. This transaction represents an extremely exciting growth opportunity for FARO. DPI’s technology fits with our core mission and vision for the company while maintaining good barriers to entry in the marketplace. It also ties extremely well to the measurement and optical expertise we already possess.

There are significant opportunities we have identified from an R&D standpoint to change the game and how the technology is applied and I look forward to providing additional updates as we go forward.

Finally we are still putting a few legal matters behind us. We entered into a memorandum of understanding in the first quarter to settle the class action matter. This settlement was fully covered by our Directors and Officers insurance policy and is currently in the procedural steps of court approval. With regard to the Foreign Corrupt Practices Act matter, it is important to know that we have executed settlement agreements with both the U.S. Department of Justice and the U.S. Securities and Exchange Commission and are waiting for their formal approval. We expect this to occur shortly which will then conclude the investigative portion of the matter.

As previously disclosed resolution of the matter includes a monitoring obligation in connection with FCPA compliance for two years starting with the final resolution. Our preliminary estimate of the total cost of the monitor is between approximately 1 million and $2 million. However because of the scope of the monitoring obligation has not yet been determined and the outside monitoring firm has not yet been selected the actual cost incurred may vary from that preliminary estimate.

In summary and to wrap up Q1 we are maintaining our 2008 forecast guidance range of 20 to 25% growth in sales and 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 as towards those targets at the end of each quarter.

My thanks go out to the global FARO team, our customers and our investors. This continues to be an exciting growth company with tremendous prospects and I look forward to our ongoing success. I appreciate your attention and I will now open that call to questions.

Question-and-Answer Session

Operator

Very good. (Operator Instructions). We’ll take a question from the site of Mark Jordan of Noble Financial).

Mark Jordan - Noble Financial

Good morning Jay.

Jay Freeland

Morning.

Mark Jordan - Noble Financial

Question relative initially to selling expense. Obviously over 31% is fairly high here. You’re continuing also to add to your sales force. Where will that selling expense as a ratio of sales, potentially go this year, and do you still think that your longer-term target should be 25% of sales?

Jay Freeland

Yes. I still believe the long-term target of being about 25% of sales is correct. As we have talked about before, we simply won’t short-change growth if it needs to be a little higher than that, but I still think that’s the right target. No doubt we spent a little more in raw dollars in the first quarter than we did in the year-ago quarter, and obviously that’s related to increased heads. If you look at the percentage relative to the first quarter, and quite frankly for many of our expenses in the first quarter on a pure percentage basis, if that incremental shipment volume had actually gone through, if we hadn’t had all those delivery dates set for April. The percentages actually would have been -- obviously much more inline with where we anticipate the continued declines being. So over the year, we don’t forecast obviously expenses below the gross margin line, but certainly 31.5%, you would expect to see that coming down because we still feel that the long-term goal of 25% is appropriate.

Mark Jordan - Noble Financial

Okay. Looking at Dimensional’s website is it correct then, you are getting the products that they have that do not include the dental arena?

Jay Freeland

Correct. The most important current product is the AFI 5000. There is a digital shape scanner as well that is part of the package. What we get rights to is all of the technology, regardless of the applications. So we are not going to be selling into the dental market that is not part of the rights, but we do have rights to all the technology associated with that equipment as well as what they currently have today. So when you think about ongoing R&D, all of those are available to us as we start working the platform.

Mark Jordan - Noble Financial

Okay. Just looking at Dimensional’s strategy, did they just make a decision that they couldn’t affectively address this segment of the marketplace and decide to focus on dental and are using the funds that you will be paying them as to fund the development of their business in the dental market?

Jay Freeland

Yes. I certainly don’t want to speak directly for their CEO, but they have definitely made the decision that the focus on industrial is better served by somebody who has that presence like FARO.

Mark Jordan - Noble Financial

Okay, and could you give us some sense, you mentioned that this will have a negative drag on performance, clearly you will be more in a startup remote R&D-type mode. Could you tell us what incremental R&D this might require over the next, through ‘08 and ‘09?

Jay Freeland

Yes, it’s -- obviously it’s hard to predict perfectly, but let me just give you a couple of thoughts there. On the areas that we do forecast, that being sales and gross margin, we don’t anticipate this having a significant impact on those two lines over the course of ‘08 and possibly even in ‘09. Though we obviously are going to -- we have a product that’s immediately sellable and we will be working quickly on a couple of these R&D opportunities we have identified, which I think have some leverage from a speed standpoint, which is a good thing. Obviously the bulk of your expense on a venture like this is going to be R&D. I do still believe that all of the expenditures that we make will fit within the 5 to 7% R&D range that we have consistently targeted as our goal over the long haul. So, that gives you a flavor for where we think that will go. And, the other thing I will open with, because you are going to see the postings on Friday anyways, is that we anticipate immediately posting five to six positions for that team and then you would expect to see some incremental ads after that as we get the ball moving, but again, all within that 5 to 7% of sales range.

Mark Jordan - Noble Financial

Okay, could you talk about the technology itself? How far is the range that this technology is effective in terms of, is it a diam -- as an arm has a 12-foot diameter, what is the range that this device -- this technology would have?

Jay Freeland

Yes, this is one of the things that’s very exciting about the uniqueness of how DPI has created the product. By utilizing lasers to create, essentially they are creating fringes, its accordion fringe technology, and these fringes; you are measuring the distances across the fringe as they move. The beauty of laser versus traditional white light applications and things like that is that the laser is in focus to infinity. So, from an accuracy standpoint you can go, I mean, literally to infinity and as long as you have the camera to capture the image at that distance you have the ability to still take that same measurement and create relatively high accuracy measurements in the same way you can go obviously much, much smaller with that in terms of the field of view. So, the key there is, yes, it’s scaleable in either direction and that does open up a significant number of new opportunities for us in terms of how we measure and how our customers measure in the marketplace, both very close to the object as well as further away from the object that is being analyzed.

Mark Jordan - Noble Financial

Does this cannibalize your -- any of your existing products or is this truly complimentary?

Jay Freeland

It is certainly complimentary today. Over time could it continue to be used in some of the work that we do today with, say an LLP or even with an Arm, may be, that’s really hard to predict. As we use the technology right now and certainly as we are planning to utilize it, it is a different application from how you would traditionally use an arm or a gauge. Certainly how you would -- different from you had use a laser scanner or laser tracker. But in the toolbox of what it brings to us and all of that optical expertise meshed with some of the existing products we have today that creates a significant opportunity going forward as well.

Mark Jordan - Noble Financial

Is this a similar technology to what Metris does, I guess it’s a UK company?

Jay Freeland

Metris has multiple divisions it’s actually a Belgian company. They have multiple divisions and this is similar to other types of -- again I use the word white-light technologies that are out there, that and there are other technologies out there that use cameras associated with another object that creates a pattern to pick up the image. But is unique in, again that’s why they have such good patent protection, it’s very unique in terms of how it’s applied. So I will say it’s only similar in general concept to some of the others that are out there.

Mark Jordan - Noble Financial

Okay, so you think you have a real technological leadership or barrier here?

Jay Freeland

I really do, and in particular again, it’s the accuracy associated with it that makes a significant difference from many of the others that are our there that are no where close.

Mark Jordan - Noble Financial

Okay, one last question. You obviously added a number of heads on the market inside here in the first quarter. I guess that -- is that from your standpoint an endorsement of the fact that you truly see 20% plus type growth opportunity in this business here this year?

Jay Freeland

No question.

Mark Jordan - Noble Financial

Okay. Thank you.

Jay Freeland

Thanks Mark.

Operator

We’ll move next to the site of Rob Mason of R. W. Baird.

Rob Mason - R. W. Baird

Yes, Jay, would you be able to walk through the order trends as you went through the first quarter? Again the North America growth is minimal, I was just curious how your various geographies kind of progressed through the quarter?

Jay Freeland

Yes. Generally speaking, the pattern is not dissimilar to what we have typically seen first off, where you get roughly 40, 50% of your activity occurs in the first month and then the other 50 to 60% occurs at the final month, and its really a question of how late in the month it occurs. Europe and Asia followed the pattern pretty closely, generally speaking. The Americas, no question, though the market is still there, when you look at the pipeline in the Americas it’s fantastic and when you listen to what the customers are talking about it still feels like it always has. No doubt though that the current situation, and I think even some of the general depress activity, creates that near-term panic. And what it does is it causes people to sit on their hands, and they wait as late as they possibly can, and we certainly saw that from those who placed orders in the Americas. In the first quarter they were waiting as long as they possibly could, and no doubt it caused many of them to just sit on their hands going into the second quarter, waiting to see the additional turns or the additional signs.

So Europe and Asia, I anticipate continuing to be very, very strong through the year. The Americas, I think everybody would agree that we are going to see that it’s a tougher market right now. The opportunity hasn’t changed, and I think you will see it free up again as you get in, certainly if not in the second quarter as you are into the third and the fourth. But again, that’s a little bit hard to predict also, because they aren’t, most of the customers aren’t giving any signals that are other than the fact that they are sitting on their hands in the current environment. Do we anticipate, obviously the growth target we have kept the same for the whole year, is it possible that Europe and Asia would be generating more of that than the Americas? Certainly, it’s possible. Obviously we did in the first quarter, but again I think that’s the benefit at being at this size now, and being fairly well dispersed geographically.

Rob Mason - R. W. Baird

Are your customers in North America, needing more signatures, approvals on their purchases? Or are they just waiting?

Jay Freeland

Yes. I can’t say that it’s that. I think it’s more just waiting, and like I said, the need for productivity, that hasn’t changed. If anything, it’s accelerated with some of our customers. It’s more just the waiting.

Rob Mason - R. W. Baird

Was it in any particular industry sectors that you noticed that being pronounced?

Jay Freeland

Can’t say there are any sectors that were more visible than others.

Rob Mason - R. W. Baird

Okay. Then maybe just to close there, have you sensed that the tax incentives in the U.S. are likely to have any impact on your sales as you go through the year?

Jay Freeland

I think it’s too early to tell. And again, a lot of our product -- because it’s such a relatively low price when you look at other investments that companies make, it’s hard to predict that that would actually have a swing on a 50,000 or $60,000 item.

Rob Mason - R. W. Baird

Okay. And then just to the extent that your shipments -- you had some shipments that got requested for later deliveries, did the Easter holiday have any impact in, mainly thinking Europe there?

Jay Freeland

Yes. It’s funny; it did have a little bit of an impact in Europe. Obviously it was earlier this year, and Europeans traditionally that’s a very important holiday, and you see significant holiday time around that. So we did see a little bit of impact there. I think a lot of it is just though, still the way, you know, again sitting on the hands.

Rob Mason - R. W. Baird

Okay. And then just on the FCPA situation, sounds like we are nearing closure there, are you confident that the reserve that you took last year is adequate to cover the penalty that will be due?

Jay Freeland

Yes. We believe the reserve is still appropriate and the interest that has now obviously been booked given the amount of time it took to go from start to closure and obviously that number was taken quite specifically from them as we signed the document so we do believe that that covers it before we start incurring the monitor cost.

Rob Mason - R. W. Baird

Okay. And then just really quickly on DPI. What is the length of the license agreement that you have signed?

Jay Freeland

Obviously it runs length of patents and you have got a combination of patents that have been there for awhile as well as patents that run, you know, just given the apps on that are pending obviously it’s going to run quite a long time so it’s tied to the length of the patent.

Rob Mason - R. W. Baird

Okay. Is the form factor of the product optimized right now for the markets you intend to sell to?

Jay Freeland

Form factor as it stands today is good. Is it ideal? Certainly not. We see a lot of opportunity there but it is absolutely sellable in the form that it’s in today and there are – the customers they have sold to are a direct overlap, virtually all of them are direct overlap with costumers that we already have. So we have actually seen this technology for a little while and are -- we have obviously multiple costumers who are aware of it. The other thing that I – let me back track for one second, Rob, to -- we look at life of the license agreement and I mentioned obviously that some of the patents are still pending and those would obviously run a long time. The life of the royalty stream does not run the length of the pending patents that are getting ready to come. It is significantly shorter than that. That is tied to a specific end date on patents that are already in existence and in a significantly shorter time period.

Rob Mason - R. W. Baird

Okay, I see. Okay, thank you.

Jay Freeland

Thanks, Rob.

Operator

We’ll move next to the site of Mr. Jeff Basch.

Jeff Basch

Hi, Jay.

Jay Freeland

Jeff.

Jeff Basch

I did a study which sort of suggests that the stronger the fourth quarter is the weaker the first quarter tends to be, over the last five years anyway. And that seems to have some logic to it in that if the costumers really go hog-wild in the fourth quarter they may be integrating the product before they place new orders. As such the conceptionality would suggest that if you build backlog in the fourth quarter and you have built 6 million in the fourth quarter 2007 it would be prudent operational strategy to try and work down that backlog in the first quarter and avoid or let’s say level out the sales a little bit. Why wasn’t that done?

Jay Freeland

Well, there’s a couple things. You are – fundamentally you are correct. The easy answer is to say of course always the first quarter orders suffer a little because you have pulled a lot into the fourth quarter because that’s how costumers buy and certainly there’s some truth to that though, obviously there’s still a little bit you can’t doubt, particularly the U.S., there’s some recessionary issue there too that’s forcing customers to sit on their hands. So, from a new business standpoint though I think generally you are correct. When you look at the backlog though, no doubt we built up in the fourth quarter. We went into the first quarter with roughly, give or take, three weeks worth of backlog and we have typically tried to hold it at two. As the company has gotten bigger we have seen that starting to creep -- three weeks worth of backlog versus two. As the company has gotten bigger we have seen that creep up a little bit and the reality is when you look at the first quarter you more or less are flushing out all of the backlog from year end, which we did.

All of that was shipped in the first quarter. Most of it goes that first month. And what you end up seeing though as you get into the final few weeks of the next quarter, a lot of the customers are still holding those delivery dates for the next, it’s almost a wash effect unfortunately. I still believe that we should be trying to optimize down to a couple of weeks worth of sales in backlog, but, you know, again, it’s because the company is growing so fast it’s hard to say is that exactly the right number or is it going to end up being closer to three as you go, or three and a half, who knows going into the next quarter. It’s a catch 22. You love having backlog because it guarantees some of your shipment load for the next quarter. Same time, I hate having backlog because we have a standard product, you want to be able to ship it all as it comes in. It’s really a matter of how the customer behavior is patterning.

Jeff Basch

But then, you apparently did build backlog by another million in the first quarter, since orders were a million more than sales.

Jay Freeland

Yes, I mean generally speaking it’s, it’s probably close to that. You know, we don’t disclose backlog in the quarters, only at year end. But you’re right, when you look at it and say well you flushed out, if you flushed out all of your fourth quarter backlog issue and went into the first quarter and then you don’t have the comparable shipment rate relative to what the orders look like, you must have built some more backlog in the second quarter. In the first quarter delayed into the second quarter, you are absolutely right.

Jeff Basch

With respect to U.S., it is more about sum on, you know where the slow down in the Americas has occurred. I read in the last call the issue of possibly your greater focus on Gage in recent quarters might make that a likely candidate for larger slow down in orders than elsewhere because it’s a smaller and more vulnerable customer. Did you see any of that in the first quarter?

Jay Freeland

I can’t say that we did actually. Gage is still the best growth product that we have. It has been for multiple quarters as you know. I used to say that was because it was obvious because it was coming off such a small installed base. It’s obviously a pretty good installed base now, there’s just that much opportunity for the product out there.

Jeff Basch

Good. Now in DPI, apparently you are not acquiring the right to use for dental uses, but if by chance you wanted to develop a medical application with the technology, and I can think of one. Would you have the right to do so or are you limited just to the industrial applications?

Jay Freeland

Yes, we have – it’s a broad cut of industrial and manufacturing applications. Medical and dental is not one of them so from an application standpoint we will not go after that market with it but the technology itself in any way, any shape or form if there’s a way to utilize it in our applications even though it might be – you know a dental looking product or a dental field that we do have the rights to. So when you think about again from an R&D standpoint, there are lots of applications on the industrial manufacturing side where you can use varieties of all the products they currently have.

Jeff Basch

Okay thanks.

Jay Freeland

Thanks Jeff.

Operator

(Operator Instructions). We will move next to the site of Mr. Rick D’Auteuil of Columbia Management.

Richard D’Auteuil - Columbia Management

Yes I just have a couple of quick ones. You stated that some of the shipments that you had hoped to get out in March went out in April. Can you confirm they in fact did go out in April or has it been further push outs?

Jay Freeland

I won’t confirm that they did or did not go out in April but our track record has always been whatever backlog we had at the end of the previous quarter is gone the first month of the next quarter.

Richard D’Auteuil - Columbia Management

Okay and then secondly, just on the balance sheet the cash – with a lot of companies announcing that they learn after the fact that cash wasn’t in the safest pockets. Can you tell us what the short term investments are in right now?

Jay Freeland

Yes, I’m going to let Keith talk to that because it’s an important question that we obviously have looked a lot at to make sure we have the safety and security we’re looking for there, so Keith why don’t you talk to that one.

Keith Bair

Yes primarily our cash is invested in what are called variable rate demand bonds. I know and typically they are called weekly floaters. These are bought and sold at par. They are backed by a letter of credit from our bank. They are variable maturities. They are typically municipal tax exempt bonds with varying maturities but we do have a put feature that allows us to sell our bonds back to the bank within five business days notice. So they are classified as short-term and they are carried at par.

Richard D’Auteuil - Columbia Management

Okay the put feature allows you to sell them back at par?

Keith Bair

Yes.

Richard D’Auteuil - Columbia Management

Okay. So there’s really no vulnerability to principal?

Keith Bair

That’s right.

Jay Freeland

That’s right. Unlike a lot of what you see out there particularly – obviously there’s a lot of fewer right now over variable rate bonds. We obviously are not in that situation which is significant. The auction rate securities, we are not in that market at all.

Keith Bair

That’s right.

Richard D’Auteuil - Columbia Management

And maybe, you know obviously rates have come down so where would you expect interest income to drop? Or maybe if you could, another way of looking at it, what kind of yield were you getting on the portfolio versus what you are seeing right now?

Keith Bair

Roughly tax exempts are somewhere between 2.2 and 2.5. What you project for the year depends on how much we utilize the cash for investments and the acquisitions and that sort of thing.

Jay Freeland

Yes, generally speaking, as you can probably tell based on where we have everything parked, our investment philosophy is we are not really trying to make money off the dollars as they sit there, all we want is the safety. We want to use the dollars for things that we can make productive from our own business standpoint.

Richard D’Auteuil - Columbia Management

But that, I guess a quarter ago, was that 2.2 to 2.5, something like 3.5? Or?

Keith Bair

Yes, it was a little higher.

Richard D’Auteuil - Columbia Management

Okay. Okay, that’s all I have. Thanks.

Jay Freeland

Thanks, Rick.

Operator

We’ll move next to the site of Fredric Russell. Go ahead, please.

Fredric Russell

Yes, good morning. I’m a little confused and a little perplexed about your short-term strategy, if you want to be the safest, why not treasury obligations? It would seem to me, in line with my comments to that to say that there’s no risk in putting back a security to a bank is horribly naïve in today’s market. And I’d like to know, third, please, what kind of differential do you take -- does FARO take, for getting -- what kind of return do you get beyond a treasury obligation with all of these complications?

Keith Bair

Well.

Jay Freeland

Go ahead.

Keith Bair

First of all, they are backed by a letter of credit. We do have the ability to put them back within five days. We have been in this, weekly floaters for about five years or so, and currently we have not experienced, nor has our bank experienced, any issues with regards to liquidity or credit. With regards to interest rate differentials, as I said, we are receiving roughly 2.2 to 2.5 tax-exempt on these municipals versus, treasuries have been fluctuating as you know for the past quarter all over the map.

Fredric Russell

I understand that, and I’m not trying to micro-manage your business, but as a shareholder with a substantial position it’s seems to be complacent. Let’s say that this has been a practice for five years without problems, the mortgage backed security market didn’t experience problems until it had been going on for years and years, and all of a sudden there were problems. And to say that a letter of credit to imply is the same thing that a treasury obligation just doesn’t -- it’s just not accurate.

Keith Bair

And certainly you should not read it as complacent either. I mean obviously we actively review this and mange it on a regular basis. We have looked at it recently and we do still feel that, that is still a comfortable position for us to be in.

Fredric Russell

Okay. I have no questions, except that to say that there is no risk, doesn’t suggest a great deal of intel -- respect for the intelligence of our shareholders.

Keith Bair

Now I don’t think we said there’s no risk, there’s risk in everything we do obviously. We are trying to minimize risk and I didn’t say we were trying to get it in the absolute safest spot. The goal is to have it safe and to have the minimal risk we possibly can. We don’t -- obviously everything in life has risk and certainly these are the, they are in the same boat.

Fredric Russell

I have no other questions. Thank you.

Operator

We have a follow-up question from Mark Jordan with Noble Financial).

Mark Jordan - Noble Financial

Good morning again, I guess I, Jay I’m curious as to you know how you are going to market this and what specific marketing resources you are going to put behind the Dimensional product line in 2008?

Jay Freeland

Yes. Surely the existing product line is what we anticipate selling in 2008. Given, that we have exposure to it already in many of our -- in some or our costumer accounts that we are already in, and then we have great coverage out there. The intent is not to set up a separate sales force. It is our intent to utilize the guys that we already have out there to make sure they are trained and up to speed on the capability of the product. From a marketing standpoint it will be focused on where we see the best applications, certainly not every one of applications -- every one of our customers is not a perfect fit for it.

We are going to do some cherry picking and going after the ones that we think have the best opportunity first. Because also some of that is part of the learning process when we discern from a customer standpoint how they are using it, what the needs are, we can start sharing and we have some that we are very close to that under NDA we can start sharing ideas on where it goes. That helps feed the R&D process as well. And that’s why I said earlier that we don’t anticipate having any significant impact at least this year on certainly either on the top line or gross margin line either. Because, yes, I think we will get some sales of the product in 2008. It won’t be material to the results but it will be material to how it helps drive some of the development activity going forward.

Mark Jordan - Noble Financial

And just initially you said you were going to focus on specific applications, where have, where do you think are the hot points for this product today?

Jay Freeland

Certainly we have seen it in the aerospace side, and we have seen it in the automotive side, not a surprise. Those are two markets we are already in and obviously have great coverage in, but when you look at how it’s been used so far. Those are good applications today. Where they need very high accuracy, but it covers more than just what an Arm can do, which is obviously high accuracy too, more than what an LLP can do because it’s lower accuracy, for inspection of larger surface areas that decent sized volume at the accuracy levels they can come to. So those, and you think about field of view, 500mm give or take, you are looking at a couple of feet patches at a time. Those are, that opens up a significant door to do a couple of feet on an LLP or an Arm with measurement points across the entire three-dimensional surface, would certainly take some time. So I think, early stage, that’s certainly where we see the opportunity. There may be some in the heavier manufacturing as well, where you are not talking about high-speed manufacturing process, but more one-off like the aerospace side is, that’s where we see the early stage use.

Mark Jordan - Noble Financial

Final question. Just what would be an ASP of one of the 5000?

Jay Freeland

I can’t state that there’s been a good standard out there, just because it’s a relatively low-volume product today. What I will do is, we will update you on that when we get it at the end of the second quarter here, and we have started putting it out to market, then I will give you a feel for where we have priced it and whether it’s taking or not. We have a good feel of what we think the price should be. I just want to get comfortable with that when we put it out and get a little traction first.

Mark Jordan - Noble Financial

Thank you.

Operator

And we have a follow-up question from Mr. Jeff Basch.

Jeff Basch

Say, you have talked in the past about how, may be even on this call, the market’s perhaps 5% penetrated and that’s despite the fact that sales have been growing rapidly. This number doesn’t really change, which is fantastic. But, what do you think it takes to get 30 or 40% penetrative? I guess there’s two questions here, do you think the estimates of the total market opportunity are really realistic, and what kinds of things do you need to do, need to happen in a market for this to be realized, which would suggest much more rapid growth at some point in the future?

Jay Freeland

Right. Number one, I do still believe that it’s 5% penetrated, and I used a couple of these stats in calls before on the annual report too, that we are in 15, 16 countries direct presence today, and there’s 260 some odd, not all of them are a perfect fit for our product, but certainly many of them are. Fi-Cicos in the U.S., 5.9 million customers and we have sold 3,000 of them. Even if only half of those customers were appropriate for us from a manufacturing standpoint, you’re still at 3,000 out of 3 million. And the data is still similar for Europe and similar for Asia too. In fact when you look at Asia and you look at the number of -- if you do a cut based on number of manufacturing locations, just that space alone, you have got a lot of U.S. and European companies that manufacture over there, the ratio swings even higher in terms of the opportunity there.

When it is safe to get to 30, 40%? Well the easy route of course, is over time no doubt we get there. What’s it take to accelerate that? Well some of it is, as you continue to add people, you know if you accelerated the number of feet on the street that would be an easy answer. We all know that’s not the ideal model going forward, you want a balance of people on the street as well as other channels. I do believe technology like what we just picked up here with DPI in terms of how it can be applied going forward has the opportunity to sell through other channels beyond just the direct sales force, and that’s not to say our direct folks can’t sell it either. I think when you look at some of the R&D work that we are going to do on it; it does create, in some respects, the opportunity for a new model.

We are selling through other parties that happen to be the actual end driver that the customer is buying from, and I think there will be some opportunities like that with the products going forward. You know the Gage is a great example too. Gage is, you know, although it is a very accurate product it is certainly the simplest and easiest to use. We actually had a Gage sale very recently that was purely -- a person went online, saw the online demo bought without even us coming in. That was a new customer, we occasionally -- we certainly get business today with customers who are existing customers and they don’t need the demo because they already know it. Getting a guy to come in and buy it straight unseen just from watching an online video of how it works, that’s a great step in the right direction.

Not going to happen overnight, but certainly the more things like that happen, you know the better that acceleration occurs too. So, now the difficult part, of course, is always predicting when that occurs. We are doing a lot of things right now to try and drive other channels and other ways to market. Does it happen in four to five years? Does it happen in two years? Does it take seven years? That’s still the $100,000 question but we are certainly making the efforts to try and drive the market in that direction.

Jeff Basch

Okay. Thanks.

Operator

And it appears that we have no further questions at this time. I will turn the program back over to Mr. Freeland.

Jay Freeland

Very good. Well again, I just want to thank everybody for your ongoing support and we look forward to updating you again at the end of the second quarter. So thank you very much everybody.

Operator

This concludes our conference call for today. You may now disconnect your lines, and everyone have a great day.

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