Victor Allgeier - TTC Group, Investor Relations Jay Freeland - President and Chief Executive Officer Peter Abram - Senior Vice President and Chief Financial Officer.

Patrick Newton - Stifel Jim Ricchiuti - Needham & Company Hendi Susanto - Gabelli & Company Ben Rose - Battle Road Research Mark Jordan - Noble Financial Richard Eastman - Robert W. Baird.

Good morning, everyone. And welcome to FARO Technologies conference call in conjunction with its first quarter 2014 earnings release. (Operator Instructions) For opening remarks and introductions, I will now turn the call over to Vic Allgeier. Please go ahead, sir..

Thank you, and good morning, everyone. My name is Vic Allgeier, 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 Nancy Setteducati at 407-333-9911.

The press release is also available on FARO's website at www.faro.com. Representing the company today are Jay Freeland, President and Chief Executive Officer; and Peter Abram, Senior Vice President and Chief Financial Officer. Peter and Jay will deliver prepared remarks first and will then be available for questions.

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

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

I'll now turn the call over to Peter to review the financial results for the quarter..

Thank you, Vic, and good morning, everyone. Sales in the first quarter of 2014 were $73.4 million, an increase of $8 million or 12% growth compared to $65.4 million in the first quarter of 2013.

Product sales increased by $7.3 million or 14% to $59.8 million for the first quarter of 2014 from $52.5 million in the first quarter of 2013, primarily as a result of higher sales volumes in our arm and laser tracker product lines as well as higher average selling prices in our laser scanning product line due to the introduction of the X330 unit late last year.

Service revenue increased by $0.7 million or 5.2% to $13.6 million for the first quarter of 2014 from $12.9 million in the same period during the prior year, primarily due to an increase in warranty revenue.

On a regional basis, first quarter sales in 2014 in the Americas increased $3.5 million or 13.3% to $29.6 million compared to $26.1 million in the first quarter of 2013, primarily driven by increased volume in laser trackers, increased average sale prices in laser scanners and increased arm sales volumes.

In Europe, sales increased 8.8% to $23.8 million in the first quarter of 2014 from $21.9 million in the first quarter of 2013, primarily driven by increased arm sale volumes, average selling and average selling prices and service revenue related to warranty and training, partially offset by slightly lower laser tracker volume.

In Asia-Pacific, sales increased 14.9% to $19.9 million for the first quarter of 2014 from $17.4 million for the first quarter of 2013, primarily driven by higher volumes and average selling prices in both our laser tracker and laser scanner product lines.

The effect of changes in foreign exchange rates on sales was a decrease of $0.5 million in first quarter of 2014 compared to the first quarter of 2013. Turning to orders. New orders increased 9.8% in the first quarter of 2014 to $70.9 million compared to $64.6 million in the first quarter of 2013.

On a regional basis, first quarter orders in 2014, the Americas increased 7% to $29.2 million compared to $27.3 million in the first quarter of 2013. In Europe, orders increased a healthy 16.7% to $24.5 million in the first quarter of 2014 from $21 million in the first quarter of 2013.

In Asia-Pacific, orders increased 5.5% to $17.2 million in the first quarter of 2014 compared to $16.3 million in the first quarter of 2013. The top five customers by sales volume in the first quarter of 2014 were Boeing, Siemens, the U.S. military, VRSI and SNC-Lavalin Nuclear. Together those five customers represent only 3.4% of sales.

The top 10 customers in Q1 2014 collectively represented only 5.2% of our sales, once again indicating our lack of dependence on any one or a handful of customers. Our gross margin was 54.6% in the first quarter of 2014 compared to 56.3% in the first quarter of 2013.

As identified in our press release, this decrease is primarily driven by a write-down of laser scanner demonstration and service loaner inventory that became obsolete to the highly successful release of the Focus 3D and the X330 and X130 laser scanners.

Partially offsetting this charge was favorable pricing and related gross margin, arising from the laser tracker and the new laser scanner product line.

On a quarter-over-quarter basis, gross margin from product sales decreased to 58% in the first quarter of 2014 from 59.3% in the first quarter of 2013, primarily driven by the one-time inventory charge just discussed.

Gross margin from service revenues decreased to 39.9% in the first quarter of 2014 from 44.1% in the prior period, primarily due to increased warranty and customer service cost. Gross margin declined sequentially from 54.9% in Q4 2013, again primarily related to the one-time inventory charge previously referenced.

Selling expenses were 23.8% of sales in the first quarter of 2014 compared to 25.5% in the first quarter of 2013, primarily driven by better productivity, defined as sales generated per account manager and lower marketing cost in the current quarter.

Selling expenses increased to $17.4 million in the first quarter of 2014 from $16.7 million in the first quarter of 2013, primarily as a result of higher compensation expense due to increased headcount. Administrative expenses in the first quarter of 2014 were flat at 11.5% of sales compared to the first quarter of 2013.

Administrative expenses increased by $0.9 million to $8.4 million in the first quarter of 2014 from $7.5 million in the prior-year quarter.

The increase in administrative expenses primarily stems from higher compensation expenses of $1.2 million, partially offset by $0.3 million decrease in bad debt expense due to specific accounts previously reserved for being collected in the quarter.

Research and development expenses increased to $5.4 million for the first quarter of 2014 or 7.4% of sales compared to $5.1 million or 7.8% of sales in the first quarter of 2013. R&D expenses increased primarily due to an increase in compensation, as we accelerate spending in this area in 2014.

Operating margins for the first quarter of 2014 increased to 9.5% from 8.7% in the first quarter of 2013. Operating margins favorably impacted in the quarter by topline sales growth, solid cost management and timing of planned R&D expenditures.

Our income and expense now remains flat at $0.1 million for the first quarter of 2014 compared to the first quarter of 2013.

This continued expense is attributed primarily to net foreign currency transaction losses resulting from changes in foreign exchange rates on the value of company account balances of the company subsidiaries denominated in different currencies.

Income tax expense increased to $1.8 million in the first quarter of 2014 from $1 million in the first quarter of 2013, primarily as a result of an increase in pre-tax income and a discrete tax benefit of $0.4 million recognized in the first quarter of 2013 related to retroactive legislated reinstatement of the research and development tax credit for the year ended December 31, 2012.

The effective tax rate increased to 27% in the first quarter of 2014 compared to 18.4% in the first quarter of 2013.

The effective tax rate for the first quarter of last year included discrete tax benefit equivalent to 7.5% and a 1.4% benefit related to the exercise of employee stock options as compared to the current quarter stock option benefit of 0.2%.

Net income increased to $5 million or $0.29 per share in the first quarter of 2014 compared to $4.6 million or $0.27 per share in the first quarter of 2013. I will now briefly describe a few balance sheet and cash flow items. Cash and short-term investments were $187.7 million as of March 29, 2014, compared to $189.6 million as of December 31, 2013.

Accounts receivable was $64.7 million as of March 29, 2014, compared to $66.3 million as of December 31, 2013. Day sales outstanding as of March 24, 2014, decreased to 65 days from 67 days as of December 31, 2013. Inventories increased $70.6 million as of March 29, 2014, from $68 million as of December 31, 2013.

The increase in inventories is primarily related to an increase in service inventory of $1.3 million, finished goods of $0.8 million and demonstration inventory of $0.4 million. Accounts payable on accrued liability decreased from $75.5 million as of December 31, 2013, to $68.5 million as of March 29, 2014.

The decrease is attributed primarily to a decrease of $4.5 million in accounts payable, a $1.6 million decrease in accrued liabilities and a $1.7 million decrease in income taxes payable, partially offset by $1.1 million increase in current unearned service revenues.

The accounts payable decrease is attributed primarily to higher yearend expense accruals. The decrease in accrued liabilities and income taxes payable is attributed primarily to higher commission, bonus and federal tax liabilities as of December 31, 2013, that were paid during the quarter ending March 29, 2014.

Finally, I'll conclude with some statistics regarding our headcount numbers. Globally, worldwide sales and marketing headcount increased by 60 or 16.9% to 416 as of March 29, 2014, from 356 as of March 30, 2013. Globally, account manager headcount as of March 29, 2014, increased by 18 or 9% to 218 from 200 as of March 30, 2013.

Regionally, in the Americas, account manager headcount increased by 10 or 15.2% to 76 as of March 29, 2014, from 66 as of March 30, 2013. In Europe, account manager headcount increased by 7 or 11.5% to 68 from 61 as of March 30, 2013. And in Asia-Pacific, account manager headcount increased by 1 or 1.4% to 74 from 73 as of March 30, 2013.

We had 1,112 employees as of March 29, 2014, compared to 1,004 as of March 30, 2013, an increase of 108 employees or 10.8%. Geographically, we now have 442 employees in the Americas, 384 employees in Europe and 286 employees in Asia-Pacific region. I will now hand the call over to Jay, for his comments..

Thanks Peter. I am pleased with our first quarter results, which were in line with internal expectations. Overall, market conditions are good, as demonstrated by our double-digit sales growth in the Americas and Asia and double-digit orders growth in Europe.

The Americas continues to be our most favorable market environment, but the overall environments in Europe and Asia are clearly better than they were one year ago. In Asia, the credit markets in China and India continue to have some negative impact on the region, but is manageable and we've seen good improvement from Japan.

In Europe, we still haven't seen meaningful economic improvement, but overall sentiment continues to improve and is favorably impacting customer purchase patterns. Overall, we feel very good about current market conditions as well as going forward.

Looking at the first quarter sales more closely, product demand for arms, scanner arms and laser trackers was very good. The Vantage Laser Tracker released 18 months ago, continues to be particularly well received by both existing and new customers.

While the pricing environment for arms continues to be difficult globally, Europe and Asia were able to achieve moderate price increases in the first quarter of this year. However, it's too early to note, if the slight increases will hold, and as a result we continue to plan the business accordingly.

Demand for laser scanners was strong as well with the new X130 released this quarter, generating great interest on top of the successful launch of the X330 in the fourth quarter of last year. The market appears to have embraced the new technology platform, the extended range and the new GPS functionality.

We continued our shift away from our go-to-market arrangements with Trimble and Topcon in the first quarter, in favor of a more direct model using the mix of our own account managers and selected independent distributors.

There is a substantial opportunity for FARO in $1 billion addressable portion of the architecture, engineering and construction space, as well as the $300 million estimated annual opportunity in law enforcement. We are moving aggressively to attack those markets and believe we are in a position to do so more effectively with our shift and approach.

That shift includes not only our sales strategy, but also our research and development efforts too. In that regard, research and development spending increased moderately in the first quarter.

However, I expect the rate of increase to accelerate in the remaining three quarters of this year, as we push aggressively into new markets and into new industries, which require new technologies. As I stated in the previous calls, we have a very robust product release schedule planned for 2014.

The schedule calls for new generations and existing products as well as at least one new product that does not currently exist in our portfolio. However, the 2014 product release schedule is just a piece of a much bigger, more expensive development push. The opportunities for FARO to disrupt its existing markets as well as new ones are substantial.

We're expanding the engineering organization and giving them aggressive goals and deadlines to create newer and more disruptive solutions. Some of the solutions will solve problems that are not being solved today. Others will solve existing problems more efficiently and more effectively.

The timing is right for us to be creative and aggressive, the market need is there and we have the core expertise to be successful. To complement our research and development push, we remain diligent in identifying and reviewing acquisition opportunities. Optical technologies and software capability remain our highest priority.

However, if we look deeper into the markets we serve currently as well as our newer expansion verticals, we may also find different priorities, while still remaining true to the company mission of 3D measurement, imaging and realization.

There are plenty of opportunities in the pipeline and I continue to believe it is not a matter of if, but more a matter of when. The FARO team did a nice job controlling cost this quarter across the operation. Selling cost as a percentage of sales declined from the first quarter of last year and administrative cost remained flat.

Our hiring is primarily targeted in the R&D service and sales organizations, and we continue to look for ways to drive efficiency everywhere else. The two newest members on my senior teams, CFO, Peter Abram; and General Counselor, Jody Gale, have settled in, and have already had a positive impact on the company.

They along with the three Managing Directors and my Chief Technology Strategist, create a formidable leadership team and represent a group of people that will work diligently with me to drive FARO to the next level. In summary, our first quarter results stand us a good foundation for the rest of 2014.

Markets are solid, we're pushing aggressively in sales and R&D and we have a great team in place globally to realize the vision for the company. As always, I'd like to thank the FARO team for their dedication to the FARO mission. And I'd like to thank all of you for your continued support. And I now open up the call to questions..

(Operator Instructions) And we'll take our first question from Patrick Newton with Stifel..

First question is, I guess, the one I always ask is new customer sales versus existing, if we could get that percentage from you?.

Sure, Patrick. New customer sales for this quarter were 38%..

And then, I guess distribution, you talked about kind of moving away from Foxconn and Trimble.

But can you help us understand what distribution was in the quarter and how you expect that to kind of phase out over the next several quarters?.

Yes. So the distributor percentage this quarter was 53%, 47% direct. And I think as Jay alluded, we'll continue to see that start to decline..

Yes. And I think real shift you'll see Patrick is while we'll still have selected distributors we work with, some of whom may even be a Trimble distributor or a Topcon distributor. The global arrangements are disappearing rapidly. And it's our intent to serve that market directly and aggressively..

In order to do that I guess that seems to be a little bit more of a hands on in different types of markets than FARO normally targets.

Do you need to add more account managers or do you think that the account manager level is pretty sustainable, given the headcount you've added over the last, call it, four to six quarters?.

Certainly, we need more account managers. I think the typical run rates that you see, run in mid-teens in terms of percentage increases, it's comparable. We did here in the first quarter and what we've been doing historically, will do the trick.

The account mangers that we hire will be focused and dedicated on either AEC or law enforcement or both to tackle those markets and some those hires have already occurred. Obviously, some of them still are to come and this is one where, you're right.

While some of the missionary working concept is not different from what we see in the industrial market everyday, so we're used to what it takes to do that. The expertise is a little bit different. We need people who come from that space and understand those spaces and speak that language.

And so not surprisingly the types of people we're targeting are a little bit different than what we have targeted for the industrial side in the past..

And while on that account manager subject, your Asia account managers were down sequentially, quite substantially nine, which I guess in your history has never really happened.

Anything you can walk us through that drove that reduction?.

Yes. I think, number one, is just timing. So we had a few departures that we force, performance wise. We're up one, quarter-over-quarter. You're right, we're down about sequentially. And as always, hiring the account managers for us is, it can be a little bit lumpy and it's only because finding the right people is really critical.

So we'll have quarters, where we'd be slightly ahead of our normal rate, over the last quarters where we were slightly behind it. If you look at Asia specifically we are definitely behind the typical rate. It did not have an impact on the region for the quarter certainly and don't anticipate having any negative impact going forward.

I don't think you'll see that numbers strip the other direction again here in Q2..

And then just last one for me.

I guess, Peter, can you help us quantify the overall impact to gross margin from your inventory write-down? And then, as we think about this shift to more and more direct sales adding account managers and moving away from distribution, can you help us understand, if we I guess under the thought process of seasonal revenue growth through 2014, how gross margin should trend?.

On the inventory write-down question, the overall impact to that was $1 million. That was a total impact on that. As we think about the shift from the distribution model to the more direct model, I think that that's going to be a slow shift. I don't think that's going to happen overnight.

But I think that will in a longer-term improve the margins from a gross margin perspective. Jay, I don't know, if you want to comment on that..

I agree with that, the latter part sure. But that's some color to the inventory too, Patrick. The write-downs that we are doing are units that were in many cases five, six, seven years old, so not just one generation, but two generations away from where we are now.

Historically, as you know, we're pretty aggressive about taking demo units, refurbing them and selling them into the marketplace. And we've been doing that even with their generation of unit as late as tail-end of last year. It was never a meaningful piece of revenue. It's always been a little piece of revenue.

We got to a point during the course of Q1 that the relatively small number of units that were left, getting them to what we consider customer quality grade and the sustainability of those units over the long-term from a service standpoint otherwise, the damage to the FARO brand of trying to keep pushing that unit relative to what is available now in the Focus product line as well as the X product line, we got them released for the last two generations, it just wasn't worth trying here, it just wasn't worth the effort anymore at that point..

So if we take that inventory $1 million, back it out, you're looking at about 56% gross margin, Peter, is what I'm talking..

That's correct..

So if we think about that 56% is kind of the true base of what you're operating at and then we think about the distribution shift on a go-forward basis, would 56% be a fair kind of gross margin base for the year?.

Correct..

Yes, I think you're right. It's absolutely right. I'm going to think about it as our starting point coming out of Q1, yes, absolutely..

And we'll take the next question from Jim Ricchiuti with Needham & Company..

So in your Investor Day, you talked about realignment of some of the key verticals under your respective geographic heads, talking about the AEC and aerospace and auto.

It's early, but I'm just wondering, is there anything, any indication as to how that's going or do you see that really playing out over the course of the year?.

So two comments with that I guess. The first is I wouldn't think of it necessarily as realignment because just the phrase, I'll be really specific for a moment, always makes me think of true organizational and structural change and that's not what we've done at all certainly as it relates to those verticals.

We had account managers that sell into different verticals or across multiple verticals and that's kind of the one spot where you see a little bit of that.

So the initiatives as we lay them out, as we have for example, our Managing Director in Europe, Ralf Drew, is responsible for the global deep dive on better understand the automotive market and some of that is given the strength of automotive in Europe, particularly in Germany and the understanding we have of it.

And he then needs cross-functional teams from the Americas and Asia to also make sure we've captured the folks in Detroit and the Southeast and the folks over in Japan and Indonesia and Korea and places like that.

To better understand that market, so then we and the senior team can work efficiently and effectively, design the rest of the strategies to go around the automotive.

And then the same thing for aerospace with Kathleen, here in the Americas; same thing for the AEC market, for Joe in Asia, given that actually was his background, a long time ago before he even joined FARO. In terms of the legwork that's been done, we've seen great progress.

The senior team is back together in face-to-face for one of our quarterly retreats in a few weeks here. And at that point in time, I will see the first full report in detail, with all the data to go with it.

And I do still remain convinced that while our strategy has several different pieces to it, one of which is looking at technologies across multiple verticals, I do believe that the deep dives we're doing on the five or six different markets we have at FARO, are going to offer -- they will identify other opportunities for us to better serve those markets where we know we generated a significant portion of our current revenue..

Jay, you gave some color as to the market environment certainly versus a year ago. I wonder if you'd characterize the market environment versus the last time, your last call, in terms of some of the end markets, what are you seeing.

Are you seeing condition is stable or improving and maybe you could touch on each of these key verticals?.

So the easy one, I guess I'd start with is aerospace. And I'll say the word stable, I hate the word stable, but it's only because aerospace has been so strong for the last five years, it would be hard to say that it can improve a whole lot more. It continues to be a very strong market.

So that one is stable, and I mean that on the positive sense of the word stable. I think automotive has improved a little bit from what we have seen from our customers. We're getting better purchasing out of that group. AEC has definitely improved.

Now, I try to balance that with knowing it's a very new market for us, so any incremental sales that we have there, some of it's just because we're coming off of still a relatively low base line compared to a penetration, say in automotive or aerospace, but the AEC market, the construction market appears to be improving as well.

The customer interest appears to be improving as well. And I think I'll get a better feel for that next week through representing at the World Geospatial Forum, which is a fairly large gathering of geospatial professionals from around the world.

And that would give me a couple of days to not just present to the group, but also to interface and understand what they're seeing, what they're feeling, where is the sort of the current pulse of the market for those folks.

Law enforcement, little to early to tell, just because that is really new for us, so I can't give you a feel, if I think that market is improving or not. We know it represents significant opportunity for us. And then the other one I'd hit is heavy industrial. I think we've seen moderate improvement there. It really depends on sort of sector to sector.

The energy sector I think is driving a little bit, right now, which we kind of include in that when we say heavy industrial, we include selling to the power guys, and say turbine manufacturers and folks like that. But the CATS and Deere's and those folk seem to be doing pretty well, which I think is a reflection of what we're seeing in the AEC side..

I'll jump back in the queue, but last question for me is, I think you referenced some price increases in the ARM business. Don't recall hearing that from you in a while.

Can you talk a little bit about that?.

Yes, so you're correct. We have only talked about price decreases or stable at a really low level for the last year. And 2013 remind everybody, there were significant price pressures in the ARM market. The first two quarters were a rapid descent and then Q3 and Q4 were relatively stable, but at that much lower level.

Europe and Asia, not the Americas yet, but Europe and Asia we saw a little bit of price increase, and if you look at the average selling prices across the board, it was enough that I can say, it was meaningful enough for me to put in the script, not enough for me to say that we think it may or may not stick at this point.

So I'm still planning for the worst. But it was a sign of improvement. It was real, when we look at the average selling prices. I have not heard of the same chatter about price from the field.

Just generally speaking, the chatter that we were getting last year, some of that maybe that are just, may rolled on a custom's level or price level, that's not necessarily a good thing. I prefer they not have chattered, because they feel like it's actually been a little bit better. I think the next two quarters will be a better feel for that.

One quarter certainly doesn't make the trend. But we feel little bit better in at least from what we've seen..

And we'll take our next question from Hendi Susanto with Gabelli & Company..

First question, at the Analyst Day, you shared your target of at least six software packages, are those software packages complementary to your products or separate products that would generate new sales growth?.

So most are currently complementary, or let me say it this way, all products end up complementary to the technology that we have. So they really work hand in gloves together. You will see new generations of several and then you'll see one or two new ones, I think come through the door this year. And the timing of that is perfect.

You asked the question, two minutes after we announced the release of our latest version of CAM2 Measure 10, so I didn't put in the script, because I didn't want to takeaway the thunder from our marketing team. So we released this morning, the latest version of CAM2 Measure 10. Now, this is clearly an existing product.

It's a next generation of the product. But there is a real meaningful shift here that's important for everybody to understand, which is for FARO this is the first time that we feel we have a metrology software package that is absolutely complete as it relates to both probing and scanning.

So historically, we've had minimal point cloud capability in our own software and rely very heavily on third-party providers that are in the market space.

The new version that comes out that's been released today and given the feedback we've heard throughout the alpha and beta testing, it's a substantial step-forward as it relates to point cloud management in metrology. So not laser scanner, just in metrology.

And if you think about sort of an 80/20 Rule on applications, the bulk of our applications that we sell into now can be served by that software, and certainly it will be, what we are presenting to the customers, first foremost and most aggressively.

And the point cloud capability that is down to a very select number of very high-end, very expert level applications becomes the place for we will sell third-party software.

So on a go-forward basis, number one, it gives us a deeper connection to the customer, which of course long-term is very important to us, when we already have great connections to our customers. This just takes us one step further.

But secondarily, it means more software -- it should mean more software content sold that belongs to FARO directly that should have some positive impact on gross margin and a better long-term strategy for us as it relates to the connection to metrology devices.

So Hendi thanks for giving me the opportunity to clear that one up, since your timing of the question perfectly as it relates to the press release..

And then my second question is about gross margin. In Q1 2013, gross margin benefited from increase warranty revenue, while in Q1 2004 we saw increases in warranty expenses.

How should we think of the dynamic of the warranty, its impact on the gross margin? And I think it will be great if you can remind us whether or not it just still have room for like higher interest rate on warranty?.

I think that the way I'd answer that question on kind of a quarterly basis, our 1Q revenue fluctuates quarter-to-quarter and when you look at our warranty expenses and our cost base, it's more of a fixed costs base. We have very little variability there.

And so you will see some variability on the margin aspects on warranty quarter-over-quarter, but we continue to see our warranty grow and expect that to continue into the future..

And strategically we do have still, which we started last year, which is help the process. We had people who are dedicated to selling those warranties and servicing the customer the right way with them, which historically we had not done prior to 2013. So that is another reason that we believe that you will continue to see that growth there..

And then, Peter, CapEx is higher than my estimate and relative to last year, do you have the insight into CapEx for the year and where investment is made?.

So our CapEx spend for the quarter was $1.9 million.

Jay, I don't know whether you want to comment?.

Yes, that's right. I apologize, I don't know where you had it targeted for the quarter, for the year. I think the one thing you would see with slightly higher CapEx spending this year than our typical run rate.

And if you just look at those percentage of sales, we have a couple of key projects underway, one of which is SAP, which is a project that is long overdue that we presented to Board last year and received approval to move forward with. It is, what I call, a slow and steady implementation.

We have a fully-functioning and operating ERP system today inside of FARO. So we have the luxury of being able to do this on a time schedule, a spending schedule and most importantly an implementation schedule that has the least amount of disruptions in the business.

But I think you would see that's part of the primary drive over the course of the year, where it will be up a little bit. It's not like it takes off. We're not going to have a massive increase in CapEx as it relates to, you'll see a little bit separation there..

And then one last question for me.

Jay, would you be able to share what product mix look like? I would like to understand like whether it's still similar or like different compared to a year ago?.

We're just looking at kind of one other thing on the CapEx that you should be aware of as well as the new Exton facility that's being built. And so that's going to drive some additional capital expenditures both in Q1 and for the remainder of this year, as that facility is waiting to come on line in Q4 of this year..

And to remind everybody that that facility is directly associated with the wind-down of our laser tracker and imager facility in Kennett Square, Pennsylvania. So Exton is the next town over. So we are in the middle of putting together a new facility there. A huge chunk of that -- number one is, we are completely out of space.

We had pushed the limits probably for two or three years on that existing facility. So a lot of it is geared towards significant improvements in the manufacturing quality, ease of manufacturing, the efficiency of manufacturing laser trackers and imagers and in preparation for the growth as well.

Imager, as everybody knows, we had a kind of moderate release at the tail-end of last year, probably no one would be surprised to know that we have new releases planned in that product line and they are substantial releases. So it's also in preparation for the volume we would anticipate from that product line.

And I felt that, Hendi, I missed the last question you just had..

What the latest product mix look like and especially compared to a year-ago or 2013, whether you are seeing some shift of product mix?.

I would say no to that. Certainly not, as you think about the general rakings, arm being number one, scanner/tracker neck and neck at number two and three, and then everything else below that. That mix has not shifted meaningfully at this point..

And we'll take our next question from Ben Rose with Battle Road Research..

A question I have is specifically on the aerospace market.

Could you comment on the health of both the commercial and defense portion of the market, hearing kind of back and forth on whether the defense portion of aerospace is improving, but we'd be curious to get your take on that?.

Most what we do in aerospace is on the commercial side. The defense side tends to be very, very small. Even though you occasionally see any number of the defense agency show up in our top five customer list, that doesn't necessarily mean they're in the aerospace side.

So from what we hear is probably no different than what you hear is that there is sort of hints that it's getting a little bit better. I can't say that we've seen anything significant in that regard, yet. The commercial side, where we do virtually all of our aerospace business has been very strong, it continues to be..

And we'll take our next question from Mark Jordan with Noble Financial..

A question back on the development of specialized reps for the scanner markets that you're assuming from distribution.

By the end of this year, what percentage of reps in the Americas, Europe and Asia-Pac you believe would be of your specialized group and will there be a much higher focus on that growth of reps in the Americas?.

I think it's too early to be able to say exactly what the percentage would be. And actually I am not sure we will split that out even as we get to the end of the year, it's comparable too. We don't currently split out the difference between arm reps and tracker reps and the other product lines.

Would there be more in the Americas? Potentially just because the law enforcement market in the Americas is a little more prepared for the next step and moving into laser scanning than the other two markets. Not by a substantial margin, but they are definitely a little bit more prepared for that.

And so you might see a little bit more on the law enforcement side if you really got to look that to be heads name-by-name. The AEC side, that market is ready and it is global. So the increases that we make to address the AEC market would be very similar across all three regions.

And like I said before, there would be people who come from that space and already understand the workflow, the utilization, and they understand the sweet spots for where scanner should be used in a process and where a scanner is complete over to offer the typical projects the do..

Related question, to move away from distribution, on your master agreements, was that just a function of a lack of focus on your partners there or was it an economic reason that you decided to shift?.

It's less economics from a cost standpoint. That's certainly not the driver. I think there is less focus for sure.

I think what we also learned over the last year, as we got the opportunity to start interfacing with some of the customers directly, even with the relationships in place is that serving that marketplace, the early impression was that you really had to be a attached to distribution.

And like I said, there are some regions -- there are some territories we will really definitely still use distribution, because we know they are focused, we know they're doing it well, and it is definitely more efficient than adding three or four or five whatever the number of extra people to cover a particular territory.

But we have found that the reliance on the distribution network is not as critical as having the expertise, having the ability to describe, why you're using scanners, why they are able to disrupt a meaningful portion of the current AEC space and disrupt the current technology that's been used there today.

It many respects, I feel like we possibly have still underestimated just how far the scanner could go to displace traditional technology. So I think when we talk about accelerating R&D and the types of things that we're working on.

Many of those are now geared at kind of the question of, why do people even keep using point-to-point total stations and theodolites and things like that, well beyond the original estimate we have for the market..

And we'll go next to Richard Eastman with Robert W. Baird..

So just a couple of quick questions on the orders in the quarter. Again, just kind of looking at the orders and how they came in at just about $71 million, it seems like the seasonal orders here were maybe a little bit softer than one would expect.

And I'm curious as we kind of talk through the pieces, how do you feel about that internally that seasonally orders maybe should have been a bit higher?.

In general sense, because we tend to run a pretty close one-to-one book-to-bill, I would say, we would have slightly seen a little bit closer to the revenue number. There are real positives in that as well. Europe's growth on the order side was very strong and it is a little bit of a leading indicator as to the turn around we're seeing there.

The rest of the regions, when you talk to the leadership, when you talk to the sales team, there is not a lot of concern about slightly softer orders in the first quarter. The revenue side was good, because we're close to a book-to-bill of one. Nobody has slight concerns about their ability to hit the internal targets we have for Q2, Q3 and Q4.

And Q3 and Q4 is a little further out. That one's always more of a general or directional feel. Q2 is the near-term one and we're not hearing any whispers or concerns about that from field..

So maybe just the same question.

When I look at Asia and I look at that book-to-bill in the order growth, relative to the sales growth there, it still seems like is that market stable or is there still some continued softness? And with that order number, that's enough to support your internal plans for the second, third, and fourth quarter, meaning in Asia?.

Yes, it is. Again, mostly because from the starters, we typically in any given quarter we go into the next quarter with three, maybe four weeks of backlog. So everything we had in backlog at the end of Q1 has already shift here in Q2, except maybe a small handful. So Asia historically has always had that same pattern too.

So what we see is Japan definitely got stronger in Q1. And a little bit of it is that Q1 for us is typically Q4 for a lot of Asian companies. So we've opt for Japanese companies. So we realize that a little bit of a blip because of that in Q1 out of Japan. But beyond that, the Japanese market felt strong, regardless of the fact that it was their Q4.

So that was a positive sign. China and India, those credit markets are still, they're slow. They're no different than where they were. I think because we've been dealing with that for a year now, sort of a cycle has adjusted itself accordingly.

And so we're not hearing from the team quite the same negative impact that they are feeling from it last year, even though the speed of this cycle is not where we would like it to be. We've been dealing with it for 12 months. So it's kind of everything sort of cycled through and you get that stable pattern to go with it.

So even in Asia, the team there feels very good about the internal progress for Q2..

And I think it was Peter, might have been you, just kind of mentioned, the sales mix in Asia-Pac is having emphasis, laser tracker, laser scanner, no comment on arms.

Is the mix there shifted particularly towards the scanner and laser tracker products? Is that a market-related issue?.

I think, no, I wouldn't say meaningfully. I think the incredible thing was to highlight success with tracker and scanner. I mean arm is still the number one product line. You would not find a reason in the world, where it is not number one product line for us still..

And can I just ask on the Focus laser scanner products, now with the 130 and the X330.

Can I ask you, was the growth rate in the first quarter year-over-year of those products, did it match the corporate average or was it above or below?.

I'm sure not we've disclosed that in the past, Rick. What I would say is that the growth rate was essentially in line with our expectations. And we have very high expectations for that product line.

And I think what you'd see is that not surprisingly as we transition from the relationships that we had to going more direct or dealing of distributors on a one-off basis were critical, it would be a little slower than we might have planned for internally, but you would still see good growth out of the product line..

And I think the one other thing you'd say there is with the 330 coming on in fourth quarter last year that did push the averages selling prices up for the overall..

Maybe the part of the question here is, is kind of the split between volume and price. I mean, given what's going on with the X330, given the transition between distribution and direct.

Although distribution was still 53% of the sales, I guess, but that's why I was curious if the volume in the Focus laser scanner product line is being impacted by the shift in distribution, and its sounds like it is?.

I would say, a little bit, but not meaningful to the point where you'd say -- certainly not where you'd say this is the wrong decision for us. And not to the point where I would say, I feel like we have any risk to achieving the types of targets that we have set for ourselves internally, specific to the product line and then for FARO in general..

Just to stay on that same theme. When we first came to market with X120, we primarily went direct. And we kind of quickly realized we didn't have access to that market. We had a tough time, we didn't know that market. I understand, we've got the X120 in the market. We've got the X130 upgrade with the X330.

But what gives you the confidence that we could build a direct sales force that can effectively reach that market, kind of at the same rate that distribution starts to fade so?.

So I guess a couple of thoughts there, Rick. So number one is, we're not fully going away from distribution, obviously. So we are, as we highlighted, there will be territories for sure, where we continue to work with distributors who are performing very well for us.

And they really understand the scanner product line and are focused on selling that, because they know that it is a far superior solution to what is out there for a large portion and even larger than we might have expected originally in number of applications.

Number two is that in dealing with customers over the last year and a year-and-a-half, even with the global arrangements that we had, as we would get to interface with customers directly, whether it was service calls or otherwise, it is clear that customers are not necessarily as attached to their distributor as they are attached to bringing the best technology with the best efficiency.

And then I think the third thing is, is that as we look at the go forward development plan on laser scanner, both on hardware and on software, they are still significant and meaningful changes that will occur to that product.

So the X330 opened up a whole new portion of the addressable market for us, mostly because of the range and a little bit because of the GPS. And when you think about the range of a lot of the big surveying projects, the 330 doesn't -- it shouldn't be a shock. And word spread much faster than we would have expected.

So I think some of that is showing market readiness and acceptance that this time we adopt that technology.

And then, when we think about what's coming for the next generation of that product, which will open up the door to essentially the entire addressable market now, we are crystal clear on our own beliefs now, so taking all that into account, that FARO people and distributors who really get what we're doing there, are that mix is the best way to address it versus trying to resell through traditional players who were still fighting to keep the traditional product line alive and kind of operating in that mode..

And again, it just strikes me that as we move from the 120 to the 130 to the X330, we add range, we add GPS capabilities, are Trimble and Topcon increasingly viewing you as a competitor in this space versus a complementary product line?.

I am sure of that, particularly as we shift away from them. I mean look both already tried to introduce their own laser scanners to the marketplace last fall. We have not seen any delivered out of Trimble yet. We've seen, I think a couple delivered out of Topcon.

The units are still nowhere close to where FARO is from a performance standpoint, from a capability standpoint. And obviously, we are not waiting for somebody else to disrupt us for the next generation, which is coming. It is substantial and meaningful move forward again in that regard.

But you're right, in some respect, there is a piece of me that says, if you satisfied everything else, that we've learned about the marketplace, they definitely are going to see us more as competitors to their existing technology. So longer-term staying tied-up with them doesn't make a whole a lot of sense, just on that point alone..

And we'll take a follow-up from Patrick Newton with Stifel..

Jay, I think last quarter you kind of alluded to a mid-teens growth rate for calendar '14 as being reasonable. You come out of the gate with the 12% growth rate from this backlog. And if we just kind of take the March quarter and seasonally grow it throughout the year. That kind of puts us in the same ballpark.

Is that a fair way to think about your revenue potential in 2014?.

Without declaring guidance for 2014, which you know we don't do, we do still believe that a mid-teens growth rate organically is the right way to think about FARO in general. That could be '14, '15 and beyond, but yes..

And then I guess, Peter, given the commentary, we have a big NPI portfolio that's driving R&D investments for you. Dovetailing out for Rick's question, building out your channel in order to better target the FOS opportunity, I am assuming that your sales headcount has continued to go up.

How should we think about leverage? You just grew OpEx at 6%, revenue at 12%, but on a go-forward basis, should we see kind of a continued leverage there or should we imagine that OpEx is going to trend more towards revenue growth rates?.

So on the first question I think you're right, we are continuing to add on the sales force headcount, that's going to continue to grow through the year, both from an organic perspective as well from covering the new markets and the distributorships.

And I think you should think about that on the OM side, similar range to what you're seeing on the topline revenue growth. Outside of what we've said, we're going to make some investments both in R&D and sales and marketing, so maybe not to the full level that you're seeing revenue go up..

Yes, I think that's right. The R&D side is the one that I would highlight again. The increase quarter-over-quarter in Q1 is probably not indicative of the types of increases you would see in the next three quarters. Not to say, we're not still getting leverage out of the model for sure, we expect to get some.

But the exciting thing for FARO is and why you would see us accelerate the R&D growth rate there again is the opportunities for us to disrupt these markets and what we're starting to see as we dig deeper into them is substantial.

And while, there will be some M&A opportunities to help us in that regard, we have some things, we're working on right now that there is no way I would wait a second longer to put people on the project and finish, and in some cases add people to finish the project faster. It's that kind of environment.

And I'm not excited about what the potential holds there. And so that's why you would see that part accelerate a bit more..

Then I guess, just last one on the ASPs increasing.

For the laser tracker, is that just a function of the newer product coming out on a year-over-year basis or is it just the mix of the new generation with the higher ASP that's driving that up or is it that the new product you're actually able to increase prices on from the originals, take a price from when it was launched?.

So I think the pricing increase is not tracker/scanner. The prices are higher than they were two years ago because of the new Vantage Laser Tracker.

If you look that on a year-over-year, the tracker has been long enough now that I wouldn't say you're seeing increase price on tracker year-over-year, that's for sure, and if you looked at it versus two years ago, no question, because the list price is $10,000 higher.

The X330, we are definitely seeing higher price there because it also has about a $10,000 list price to be fair. We certainly don't ever achieve list price on, not ever -- not too many deals that we achieve list price on.

But on the go-forward, I think unless we see some improvement in the ARM, that's the one-spot where we're going to watch very carefully. I think you kind of got the pricing market where it is at that moment, until we get to a point where we purposely decide to disrupt it again..

And it appears we have no further questions at this time, so I'll turn the program back over to our presenters for any closing remarks..

We have no further remarks. Thanks everybody. Look forward to updating you again at the end of Q2..

This concludes today's program. We thank you for your participation. You may now disconnect..