Victor Allgeier - President, TTC Group, Inc. Laura A. Murphy - Chief Financial Officer & Senior Vice President Jay W. Freeland - President, Chief Executive Officer & Director.

Ben Hearnsberger - Stephens, Inc. Richard C. Eastman - Robert W. Baird & Co., Inc. (Broker) Ben Z. Rose - Battle Road Research Ltd. Mark C. Jordan - Noble Financial Capital Markets Holden Lewis - Oppenheimer & Co., Inc. (Broker) Christian Jacobi McDonald - Kennedy Capital Management, Inc. Hendi Susanto - G.research LLC.

Good day, everyone. Welcome to FARO Technologies' conference call in conjunction with its Third Quarter 2015 Earnings Release. All lines are currently in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session, and instructions will be given at that time.

Please note, today's call is being recorded. It is now my pleasure to turn the call over to opening remarks and introductions from Mr. Vic Allgeier. Please go ahead, sir..

Thank you, and good evening, everyone. My name is Vic Allgeier of the TTC Group, FARO's investor relations firm. Today, after the market closed, FARO released its third quarter results. By now you should have received a copy of the press release. If you have not received a copy, 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 Laura Murphy, Chief Financial Officer. Jay and Laura will deliver prepared remarks first and then will 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, anticipate, plan, potential, continue, growth model, goals, objective, 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 today's press release and in the company's Form 10-K for the year ending December 31, 2014.

For comparability, where indicated, results exclude the impact of foreign currency transactions, which is a non-GAAP measure. I will now turn the call over to Laura..

Thank you, Vic, and good evening, everyone. Reported sales for the third quarter of 2015 at $72.5 million were lower by $9.7 million or 12% compared with $82.2 million for the third quarter of 2014. Adjusted for an unfavorable foreign exchange impact of $6.4 million, third quarter 2015 sales were 4% lower than the prior-year period.

Third quarter sales primarily reflect the continued unfavorable impact of foreign currency translation and the delay and cancellation of customer capital spending budgets. I will provide additional detail by region in a movement. In the third quarter, Focus laser scale unit sales declined 40% compared with period year.

Focus laser scanner unit sales were impacted by the delay and cancellation of customer capital budgets – spending budgets, a shift in our in our channel strategy, as well as weakness in the architecture, engineering and construction vertical are primarily vertical markets for laser scanners.

Jay will discuss our Focus laser scanner sales more fully in his remarks. Turning to product and service sales. In the third quarter of 2015, product sales at $57.8 million were lower by $9.8 million or 14%, compared with $67.6 million in the third quarter of 2014.

Adjusted for an unfavorable foreign exchange impact of $4.9 million, third quarter 2015 product sales were 7% lower than prior year. In the third quarter, total company sales through distribution were 7%. Focus laser scanner sales through distribution were 46%.

In the third quarter of 2015, service revenue at $14.7 million was up $0.1 million compared with the prior period. Adjusted for an unfavorable foreign exchange impact of $1.5 million, third quarter 2015 service revenue was up 10% compared with prior year, reflecting higher premium warranty revenue through Focus sales initiatives.

Turning to sales by region. In the Americas, sales in the third quarter, at $33.7 million, were lower by $1.4 million or 4% compared with $35.1 million in the third quarter of 2014. Adjusted for an unfavorable foreign exchange impact of $1 million, third quarter 2015 sales in the Americas were down 1%.

These results primarily reflect lower Focus Laser Scanner sales in the macro economic situation in Brazil, partially offset by a higher average Arm selling price due to the continued momentum of the Laser Line Probe HD.

In Europe, sales in the third quarter at $22.4 million were lower by $3.6 million or 14% compared with $26 million in the third quarter of 2014. Adjusted for an unfavorable foreign exchange impact of $4 million, third quarter 2015 sales in Europe were up 2%.

Third quarter sales in Europe primarily reflect lower Focus Laser Scanner sales as well as delayed customer capital budgets. In Asia, sales in the third quarter at $16.4 million were lower by $4.7 million or 22% compared with $21.1 million in the third quarter of 2014.

Adjusted for an unfavorable foreign exchange impact of $1.4 million, third quarter sales in Asia were 16% lower than prior year. The year-over-year sales decrease in Asia reflects lower Focus Laser Scanner sales, the delay and cancellation of customer capital spending budgets, particularly in China and Japan, and aggressive price competition.

Turning to orders. New order bookings in the third quarter at $72.3 million were lower by $4.7 million or 6% compared with $77 million in the third quarter of 2014. Third quarter 2015 reported results represent a book-to-bill ratio of 1.0, which is consistent with our long-term growth model. Turning to gross margin.

Gross margin for the quarter at 48.1%, compared with 56% in the prior year period, was unfavorably impacted by a $7.9 million increase in inventory reserve based upon the planned timing of new product introductions and in light of lower-than-anticipated 2015 sales.

Excluding the increase in inventory reserve, adjusted gross margin was 59%, primarily reflecting the continued strong sales momentum of the Laser Line Probe HD and a more favorable product mix, with beyond product line accounting for a higher percentage of sales. Turning to operating expenses.

Selling and marketing expenses in the third quarter of 2015 were $19 million or 26.1% of sales, compared with $19.1 million or 23.2% of sales in the third quarter of 2014.

This decrease of $0.1 million primarily reflects lower sales commissions and favorable exchange rates, partially offset by higher account manager and marketing head count in support of our vertical market strategy.

General and administrative expenses in the third quarter of 2015 were $8.2 million or 11.4% of sales, compared with $8.8 million or 10.7% of sales in the same period last year. This decrease of $0.6 million reflects primarily lower compensation expense and favorable exchange.

Depreciation and amortization expenses were $2.8 million or 3.8% of sales in the quarter, up $1 million from third quarter of 2014, primarily reflecting the new Exton facility, implementation of a new ERP system, and amortization expense related to first quarter acquisitions.

Research and development expenses in the third quarter of 2015 were $5.8 million or 8% of sales, compared with $7.4 million or 8.9% of sales in the prior-year period.

This decrease of $1.6 million was mainly related to a reduction in higher cost contractor expense, fluctuation of expense consistent with the product development cycle, and favorable foreign exchange rates. Turning to profitability.

Operating income in the third quarter of 2015 was a reported loss of $0.9 million, compared with an income of $9 million in the prior-year period. Income tax expense in the third quarter of 2015 was a benefit of $0.2 million, compared with a benefit of $2.1 million in the prior year.

In the third quarter of 2014, we had a discrete tax benefit of $4.5 million that did not repeat in the third quarter of 2015. Net income was a loss of $0.9 million, or a loss of $0.05 per share in the third quarter of 2015, compared with income of $11.2 million or $0.64 per share in the third quarter of 2014.

In the third quarter of 2014, excluding a discrete tax benefit of $4.5 million, net income was $6.7 million, or $0.38 per share. Now for the balance sheet. Cash and short-term investments were $161 million at the end of third quarter 2015, compared with $174.3 million as of December 31, 2014.

This decrease of $13.3 million primarily reflects the closing of the two acquisitions for a total cash payment of $12.1 million. Accounts receivable was $63.8 million at the end of third quarter 2015.

DSO was 80 days at the end of third quarter 2015, reflecting seasonally slower collections in Europe with the summer holidays, and lower prepayments in China sales. Inventories totaled $87.8 million at the end of third quarter 2015. Finally, I'll conclude with head count numbers.

We had 1,386 employees at the end of the third quarter 2015, representing a year-over-year increase of 214 employees or 18%. Geographically, we have 529 employees in the Americas, 548 in Europe and 309 in Asia. Account manager head count increased by 29 or 13% to 250 at the end of third quarter 2015.

In the Americas, account managers increased by 7 or 9% to 88. In Europe, account managers increased by 14 or 21% to 81. And in Asia, account managers increased by 8 or 11% to 81. I will now hand the call over to Jay for his comments..

Thanks, Laura. Clearly, our third quarter results are below our internal expectations and historical performance. While the sales pipeline remained strong, customers did not close opportunities at the rate we anticipated as market conditions deteriorated rapidly during the final weeks of the quarter.

In that regard, there are a few keys points to consider from the third quarter. First, customer interest and the number of opportunities in the pipeline remain strong. However, our customers' capital expenditure decision-making slowed considerably in the quarter.

Customers recognize the ROI of our products but have concerns of spending cash, and their inability to get budgets approved or purchase orders released in a challenging economic environment. Second, each region realized increased competitive price pressure as a result of softening market demand, especially in Asia.

And third, despite heightened competitive pressure, we experienced very few competitive losses as accuracy and reliability remain the top purchase criteria of our customers. On the product side, our Laser Line Probe HD, released last fall, remains the clear market leader in performance, size, weight, ease of use and price.

Our new CAM2 Measure 10.5 metrology software, released during the third quarter, received strong customer approval and provides FARO with a distinct competitive advantage in the critical areas of balancing functionality and ease of use.

Finally, the release of Freestyle X in September provides increased accuracy in a hand-held laser scanner for short range applications.

Similar to the first few quarters of this year, the primary headwinds against our third quarter year-over-year sales growth were unfavorable foreign currency translation and weaker capital spending in Brazil and parts of Asia.

However, a notable difference in the third quarter was a 40% year-over-year unit sales decline in our Focus Laser Scanner product line. We do not see fundamental or significant shifts in the market opportunity for the 3D Laser Scanner. We remain the price and technology leader.

As I have said before, I still believe this technology is in the early adopter stage, with strong sales runway. We remain focused on driving the Laser Scanner across the chasm and into the early majority.

However, this requires a meaningful reduction in product cost to enable a more appropriate price level, and improved ease of use for the processing of the point cloud data. Obviously this is a key focus point for our R&D team.

That being said, there is plenty of market opportunity at our current technology and price point, and our long-term vision and potential also remain the same. Our R&D team continues to work aggressively to deliver the next generation product. Several key factors impacted third quarter Focus Laser Scanner sales.

First, there was a material decline in third quarter closure rates due to delayed and cancelled customer capital spending budgets, especially in the architecture, engineering and construction vertical. The wind-down of our distribution agreement with one of our major distributors was completed at the end of the second quarter of this year.

We have been and will continue to expand our direct sales force and distribution network to replace this sales volume. We realized lower distributor re-stocking orders after increased sales to distributors in the second quarter, especially in the Americas region.

And finally, the recent release by a Japanese competitor of its next generation laser scanners contributed to decreased sales in Japan, one of our bigger markets. Their initial sales primarily reflect the deep relationships with customers in Japan.

The FARO sales and marketing team is taking proactive steps to drive Laser Scanner adoption and sales in the fourth quarter. We are shifting sales focus and resources to our direct sales channel as a way of improving our reach to new customers.

For example, we made a strategic decision in Germany, our largest market in Europe, to terminate some of our existing distribution agreements and shift to a more direct sales channel. We are increasing our efforts to educate our remaining distributors on products, target vertical markets, and ROI.

Our marketing teams are maximizing the use of trade shows, print and online media to educate new customers. For example, our Americas team is hosting a series of hands-on group demonstrations in over 50 cities across the United States, Canada and Mexico. As of today, we have seen solid traction with this initiative, with over 2,000 registrants.

These demonstrations cover our entire product portfolio. Despite the volume decline in the third quarter, we maintain our positive outlook on 3D laser scanning technology, and continue to believe it represents a significant addressable market growth opportunity for FARO.

Laura discussed our end-of-quarter inventory levels and inventory reserve adjustment. I wanted to share my longer-term perspective.

I explain many times how being a capital expenditure for customers translates to a high percentage of our sales in the final stages of the quarter Visibility and predictability are reduced right now, given the current customer capital spending environment.

We set in course a manufacturing plan based on higher anticipated closure rates, especially in laser scanner and did not realize the anticipated end-of-quarter sales that we are used to seeing.

Based upon the planned timing of new product introductions, and in light of the lower anticipated 2015 sales, we had excess inventory and purchase commitments for inventory that we no longer expect to use for service or warranty commitments. As a result, it is appropriate to increase the reserve for that inventory.

We are in a midst of a product refresh cycle, in which the next generation of every one of our primary products will be released to the market, and I wanted us to be well positioned.

In the quarter, we continued to focus on controlling discretionary spending, limiting the hiring of non-customer-facing roles, and adjusted the annual incentive compensation accrual to align with year-to-date performance.

In response to the continued economic softness, we are implementing the following deliberate actions to realign our cost structure. First, we will reduce the size of our workforce immediately without sacrificing the long-term strategic position of the company. The total reduction will be approximately 8% globally.

We will be reducing production in the fourth quarter through furloughs and short work weeks. We will be monitoring our sales and inventory levels carefully, so we have the right products in the right place to ensure the capture of opportunistic sales at the end of the quarter.

In addition to the head count reductions, we will be taking further cost out of our business without inhibiting product development, customer service, quality or long-term growth. With over $160 million in cash and noted in our balance sheet, we will continue to reinvest in R&D as we refresh our entire portfolio.

Product innovation, technology, leadership and market disruption are our core tenets. The senior leadership team and I will also continue to pursue meaningful acquisitions. The board of directors has authorized the increase of our existing share repurchase program from $30 million to $50 million of our common stock.

Effective immediately, we intend to opportunistically buy back our shares. Finally, I'd like to take a few moments to discuss the other press release from this evening, highlighting my decision to step down as President and CEO. For those of you know me well, you know this was not an easy decision.

Leading this company for the last 11 years has been a privilege, and I have enjoyed every minute of it. However, 11 years is a long time and I am ready for a new challenge. As indicated in the press release, I will remain President and CEO until a successor is named. The board has established a subcommittee to commence an external search.

While it is hard to predict how long this search will take, I can assure all of you that I will continue to drive the company with the same level of focus that I always have, to ensure we remain the market leader, execute in all of our strategic and operational imperatives, and prepare a smooth transition for the next leader of this amazing company.

As I look ahead the near term may be challenging, but I am excited by our aggressive product introduction plan to take our products to the next level and further disrupt our markets. As always, I thank each FARO team member, all of our customers and our shareholders. I will now open the call to questions..

Thank you. We will take our first question from Ben Hearnsberger with Stephens. Please go ahead..

Hey, thanks for taking my question.

First on the restructuring charges, can you give us a sense of what we can expect – what kind of number we can expect? And then when we can expect them to impact the model?.

So we anticipate approximately 8% of the workforce globally will be impacted, with the exception of any customer facing or R&D, and the restructuring charges themselves we are still calculating, and you will see those in our 10-K..

Okay. And Jay, I had a question on the scanner decline. You listed out demand, competition in Japan, and then some channel issues.

If you had to kind of weight the three, can you kind of talk through which impacted the most?.

Yeah. Certainly in the near term I think the slowdowns in the verticals, particularly in AEC, would be the primary driver.

If you look at our product, even with the competitive release, in Japan in particular, of the other scanner from Topcon, we still have what we believe is the market-leading technology – the smallest size, lowest weight, best performance overall, still the best price point overall. There was clearly a real slowdown though in the markets.

And then I think as we transition the distribution model, that's a piece of it as well, but I would put that one sort of third behind the other two. But the biggest one is just the vertical markets themselves..

Okay.

And then when you dig into each market and kind of listen to what your customers are saying, is the expectation that this sales decline continues for a while? Are we in a prolonged down period, or do you see this as more of a one, two, three quarter thing?.

Yeah. I mean, without obviously giving specific guidance, I think number one, the decline we saw is near-term.

It's certainly not a market demand issue, right? So there is definitely, even if we didn't get to the next generation scanner – which as you know has been part of our development plan for a while now, we're deep into it and it's part of this product refresh cycle – even without that, there is still plenty of market opportunity, and that hasn't changed at all.

The customers, when they see what the scanner is capable of, when they see the data it can – that it presents, when they see the clarity of the data, the usability of the data, all of those are still key factors. So I think, could we have a little bit more time, another quarter or two of bumpiness? Sure.

But I would say it's, again, more tied to the macro conditions. And as we see those improve a bit, and as we continue to transition into the direct sales model, which obviously is something we know really well – and it's not that we're going entirely for the direct sales model in LS, either.

We're going to have – we will still have plenty of distributors out there. Those would be the things that help drive it back..

Okay. And then my last question, Jay, kind of a higher level question.

As you reflect on your 11 years at FARO and you look at where the business is today, I guess, what do you see as some of the biggest challenges and opportunities for the next CEO to be hired?.

Well, I think number one is just continuing to disrupt the marketplace. So staying ahead of the competitive curve, the technology edge that we have and maintaining and driving that, is vital.

I think that we are in a great position right now as we disrupt everything, or obviously everything that's currently in the portfolio, over the coming multiple quarters here, that put us in a great position and gives me great comfort for the subsequent years after that. So I think that's number one.

Equally important as it relates to that, particularly on the scanner side, is to continue to drive and evolve this sales model to get the reach that we know is required to truly be in the early majority of that space. So from a technology standpoint we have a clear path to get where we need to go, to bring it over the chasm and get it in there.

And then continuing to drive the same sort of reach and coverage and market demand that we get on the metrology side will, I think, be equally important. Third is the continued push into optical technology. So taking people on the measurement process is one of our key strategic thrusts as a company.

And so doing that with products like the next generation of our imager, and looking for other opportunities for perhaps technology that can be acquired in, is a big piece of that. And then I think the fourth thing is, when you look at the acquisition pipeline, we have several very interesting opportunities that we are looking at right now.

That has been the case obviously for a while.

And getting a couple of those into the fold with successful integration and leveraging the market presence that FARO has, combined with what the other companies bring to the table that we are looking at, I think that's – we have already picked four, those are the four that would lay out there, and those are the easy ones over the next three to five years..

Okay. Thank you very much..

Thank you. We'll take our next question from Richard Eastman with Robert W. Baird. Please go ahead..

Yeah. Thank you. And Jay, just every geography fell below kind of seasonal trends, when you look quarter-to-quarter. And again, it's not currency because again quarter-to-quarter currency is not as big of a hit.

But I'm just – maybe I am a little bit surprised, and maybe you could tell men which of those geographies underperformed from a surprise standpoint. Is this – there's nothing here sequentially that suggests the trends are going to stabilize or reverse themselves here in the fourth quarter.

So just maybe your feel here as we move forward through quarters?.

Yeah. Well I think the one that probably was the biggest surprise was Asia, it was furthest off of the mark, in terms of what we would expect performance-wise internally. And that's obviously a mix of Japan and China. There are some known issues for both countries currently, today.

If I pull it more broadly, if you took the regional aspect out of it, the laser scanner impact was far-reaching, it was across all three regions. And so I look at that and say, from a impact to the company standpoint, and thinking about seasonal patterns, that did have a meaningful impact to what is normally sort of sequentially flat, Q2 to Q3.

So I think that's a big piece of it. Obviously, the Trimble relationship was part of a 12-month, roughly, wind-down that we had, and that came down to the end of second quarter, we had obviously have plenty of time to plan for it. And that had some impact.

Some of the offsets that we were planning for and counting on did not materialize as quickly as would have liked, so I think that's another key piece..

And when Topcon introduced its short and long range scanners recently, I guess the suggestion is that they took some sales.

I mean, I'm thinking kind of out loud here, but the distribution channel that you have established, obviously it's not exclusive to your Focus Laser, so that Topcon introduced a product and it's an immediate subtraction from your sales, is that through distribution?.

Topcon does the majority of their revenue through distribution. I think when we look at the impact of the Topcon unit, it was fundamentally a Japan issue, first and foremost. It was sort of minimal impact elsewhere.

While the unit was good, it still has many shortcomings relative to our view of the capabilities of our laser scanner, certainly on size and weight and price in particular.

So I think what you do see, though, is that their presence in Japan – they've been in business for more than 100 years there – the relationships that they have with, particularly customers in the AEC space and their surveying markets through their traditional surveying technology is very beneficial and useful to them from a go-to-market standpoint, and obviously that's something that we cannot build up overnight, and we will continue to build it up using the FARO brand, but it takes some time, and they do have the ability to leverage that..

Okay.

And then just – just a last question, when you look at this inventory situation and you have these excess purchase agreements, and basically I understand that concept, but what's – what's the thought process in adding back the cost of the excess inventory and purchase agreements to the cost of goods sold line, and then suggesting that your gross margin was up around 59%? I mean, I'm not sure that I understand that logic..

Well, I think if you look at it just of, what it could have been, right? That's what the number was if you were to pull those out. As it relates to the inventory itself, what you have there is, you've got the mix of, clearly sales are lower than expected, particularly in the Laser Scanner, and it takes a while to unwind.

We've got lead times that are short and we have some lead times that are long. And it takes a while to unwind, obviously, the longer-lead-time items. And when you combine that with the fact that we're in the middle of this product refresh cycle, without saying when we have new products coming out – obviously we're not going to say that.

But it did have an impact on what the actual burn down looked like. So you've got to combine the sales shortfall, way below what our expectation was, and the plan for that inventory is not usable.

The new – the next generation of all of our products, from a materials and components standpoint, is dramatically different, and that ranges from product-to-product, but it's dramatically different from what we are using today, and that sort of forced the issue..

Okay. All right. Thank you..

Thanks, Rick..

Thank you. We'll take our next question from Ben Rose with Battle Road Research. Please go ahead..

Good afternoon. Firstly, Jay, I wanted to say thank you for your insights into FARO and the industry over the last number of years, and really wish you a lot of success in the future..

Thanks, Ben..

And also, I just wanted to ask regarding industry verticals within discrete manufacturing, could you give us just a sense of kind of the current state of the state with regard to your aerospace and automotive business, and what you saw there during the quarter? That would be great..

Yeah, so, probably not a surprise. Aerospace continues to be very strong. So that is a very good vertical for us, still. Automotive is very good. It's obviously manufacturer-dependent, without making commentary towards any one individual OEM; that industry is still doing pretty well. Depends on which OEM you are talking about.

The M&A vertical, so metalworking, machining, that vertical, that one is, I'd say, good. It certainly wouldn't be in the great bucket, and so you've got a combination of some of those who are partially tied to automotive or partially tied to, say, other capital equipment, the Deeres and CATs and those folks, are struggling a little bit.

Some of them are doing just fine. So I'd say, if you're looking at the industry side – and those are always the big three for us. They make up a meaningful portion of our industrial revenue and metrology revenue; that would be my take on where they sit today..

Okay, thanks.

And then on the handheld tracker, was it a material contributor to revenue for the quarter?.

I would say it's still not material, in the pure financial sense of the word. But it has been very successful in the space, and we are seeing great adoption, not just in AEC, but we are seeing good adoption in law enforcement there too, which is exactly what we wanted.

That price point and capability is a great testing ground for getting people to use three-dimensional scan data and three-dimensional scan technology. And as you get used to that and get used to the simplicity of it, then it opens up more opportunity on the scan – the large-volume scanner side as well..

Okay. Thanks very much..

Thank you. We will take our next question from Mark Jordan with Noble Financial. Please go ahead..

Good afternoon, Jay. Could you share with us a little bit of your plans with regards to – you were talking about an 8% overall head count reduction.

Are you doing anything specifically with the sales force, and how would you expect that head count to move, say, through the next 12 months?.

Yeah. So if you start with the sales side, obviously we're up 13% overall in terms of account managers, which is the one that everybody tends to focus on first. In many respects, a lot of the heads that have been added over the last, say, two quarters are in preparation for 2016.

It's still a 9- to 12-month cycle to get them up to speed and fully sort of running at the pace we require.

There may be a few moves within sales and marketing, as we look for, if you got areas that are just really not performing, the particular territory has been more impacted, say, with the macro conditions than others, you may see a little bit of that.

But as always, sales and marketing is one that we try not to impact too heavily, even when you've got, obviously, we're down some on revenue from where we would like to be currently, because you do impact what it looks like two and three and four quarters out.

R&D is also equally low on impact, in terms of number of people that we may remove from that organization without saying what a number is there.

We are in the middle of that product refresh cycle, and every single one of the engineering teams is sort of at peak pace right now in preparation for the various dates that we have for their planned launches, all of which remain on track, so it would be very difficult and it would be strategically damaging for the company to make meaningful moves there.

Obviously a lot will come, we've got a mix of then production, the back office, service; you will see some activity there, that contributes to a meaningful chunk of the reduction as well. In total, if you look at the number of heads we've added over the last 12 months, roughly half of that comes back with the reduction that we're doing.

And again, it's, I think – we have not done meaningful head count reductions in the past, so I think it's appropriate in sizing the business for at least the near-term..

Okay.

Could you give orders by region?.

Yes. Hold on one second, we'll get that for you..

Okay. So in the Americas is $34.5 million, Europe $22.3 million, Asia $15.5 million, for a total of $72.3 million..

Okay. Thank you. A final question, relative to the buyback, is the full $50 million available? I saw that on the balance sheet you have repurchased $9 million in the past.

Is this in essence a full new $50 million?.

So, you are correct. We have already purchased $9 million in the past, so it would be the $50 million minus the $9 million to get you to the $41 million..

Thank you very much..

Thanks, Mark..

Thank you. We'll take our next question from Holden Lewis with Oppenheimer. Please go ahead..

Thank you, and good afternoon. As it relates to the inventory reserves, I mean, it sounds like you're kind of calling it out as being kind of one-time item when you talked about the gross margin, for instance.

Is this more of a one-time item, and if so is it mostly cash, non-cash? And then, do you know what the impact was at the EPS line of that item?.

So, let me give you some of the high-level perspective on that for a moment, and I'll let Laura give some of the financial specifics. So in general, I would say, yes, we ought to think of it as a one-time item. Look, as you know, in any tech company part of your M.O.

is that you're constantly obsoleting what you did one year ago, two years ago, three years ago. So there's always some risk of inventory obsolescence that comes with that. And we always have some amount that were taken in any given quarter.

This one happens to be sizably larger because you have that combination of the aggressive product refresh cycle, and unfortunately doubled up with the lower sales volume relative to expectation. So that's – at the high level, that's why I think it is a kind of a one-time event. And Laura, maybe you can talk to the other specifics financially..

Right. So as Jay said, reflecting the 2015 lower than anticipated sales as well as the upcoming product launches, we do have recurring E&O process that we do on inventory, but the $7.9 million that we took in the quarter is unusually high for us, which is why we called it out..

Okay.

And do you have a sense, Laura, of what that meant down at the bottom line, EPS impact of that item?.

Well, you can take a look at the financials and take the $7.9 million and pretty much tote that out, coming pretty close..

So, just apply – what kind of tax rate do you apply to it to get to the bottom line?.

Well, the tax rate reflects our geographical footprint, and clearly is going to be different depending upon where the impact is..

I think if you look at our history over the last, call it year, year and a half, there is relative consistency there, obviously, at 16 and change. That's pretty low because of the third quarter footprint..

Okay.

So you are not able to or willing to tell us what was the sort of bottom-line cents impact was of that?.

No..

Yeah, we won't do it specifically Holden, but you probably – I'm sure you can get it pretty close..

Okay. And then you talked about kind of the restructuring and all that sort of thing, head count.

Do you have a sense of what the annualized savings will be from that program? And do you anticipate that program being done exiting 2015 and going into 2016?.

So, we are still working through that. And we don't have that available for you right now, and the intention is to end it at the 2015..

Okay. Is there any way that you can bracket sort of what the impact is? And obviously we have to build models going into 2016, and it would be helpful knowing kind of what you planning on taking out.

I know you may not have the specific number, but are we talking about $20,000, $300 million? What's kind of the order of magnitude impact on the savings?.

Yeah, I can appreciate what you're asking, but as we said it's about 8% of the workforce, so you can take a look at that and calculate kind of what the average is. I am sure that will get you close enough to what the number is..

Yeah, if you look at – like many companies, I expect our average cost per employee is relatively similar to other companies, so you could probably get yourself within a stone's throw of it, or closer at that point..

Okay. All right, great. Thank you..

Thanks, Holden..

Thank you. We'll take our next question from Chris McDonald with Kennedy Capital. Please go ahead..

Hi, good afternoon.

As you transition to more of a direct sales model with the FLS, do you anticipate needing to add more account managers, or would you expect to be able to cross-train the existing sales force?.

Yeah. We certainly would anticipate adding more, so it would be sort of one-to-one versus the distributors. So the impact to our margin relative to the revenue generated by them should be sort of net neutral, it just ends up being a FARO head versus external through distribution. The cross-training is not really an option.

When you look at those who sell in the metrology market and how they sell and what they're selling, is really different from the laser scanner.

And in many respects actually, selling within AEC, it's not 100% different than selling in law enforcement, but there are real differences in what the customer is looking for, how to apply it, the even little things like the been-there-done-that factor that come through. So it will require a little bit of specialization.

For us, the good news is we are very familiar with the direct model, so the rate at which we add and the way that we manage that team, we do have good success with that. But it for sure requires incremental heads to do it..

Okay, thanks.

And then I think we all recognize the tremendous value in FARO's products, and I'm just wondering in light of all the organizational change that the company's undergone over the course of last year and what's in front of it, it would seem logical that now might be a time that the board would even pursue a sale of the company, and I just wanted to get your thoughts on that? Thanks..

Yeah. So I would start with, from a strategic standpoint, you know, we believe that the strategic plan that we've put in place, the growth targets that we have for the next three and five years, are achievable as an independent organization.

So we focus on how to drive the business that way, and that's – we want to keep the clean focus for the rest of the organization. As it relates to the turnover, obviously you're right, there has been turnover at the senior team level for sure, that was very both purposeful and thoughtful as we went through it and did it.

I think the one important thing for FARO when you think about stability is that, at the operations level, so the sales team, the feet on the street that are out there, we have great longevity and tenure with many of our account managers; same thing for the sales leadership that represents that group.

You've got a lot of people who've been here for 10, 12, and 15 years, who really know the market and really have those relationships. And likewise, while we've continue to add people on the R&D side as well, you have core engineering teams in the Arm business and in the tracker business and even in the scanner business that go back 10 years and more.

And so, while there is some – there has clearly been some turnover at the top, one of the great things that FARO has done, we do have great stability in the – within the pool of talent at the lowest levels. And so I think that those are key things.

And then when you think about the transition that's going to occur with me as well, look, number one, I am here all the way until we get the new person into the seat and up and running. And you've got a Board of Directors that I work very well with and have for a long time.

Three of them have been with me as long as I've been here and longer, and three of them have been with me for anywhere from six to seven years. So I think that helps at the senior leadership team level, also ensures stability there..

Okay. Thanks, Jay..

Thanks, Chris..

Thank you. We'll take our next question from Hendi Susanto with Gabelli & Company. Please go ahead..

Good evening, Jay and Laura..

Thanks Hi, Hendi..

Good evening..

Jay, what is your expectation in terms of whether or not we may see some year-end budget flush?.

So, I would expect we'll see it. Even in our worst performing year, which was 2009 when everybody sort of fell off the cliff, we saw that sort of sequential, I think it was 25%, 30%-ish pop even Q3 to Q4 of that year. This is not the same type of down year that we saw in 2009 by any stretch, so I would expect to see some meaningful.

Now how big is meaningful? I don't know. Will it match our historical pattern, which tended to be in that 25% to 30% range? It's still too early to tell. That flush is always in the final two to three weeks of the quarter, like any one of the other quarters.

We've not heard anything to tell us that we wouldn't see the budget flush, regardless of the economic conditions; that just obviously coming off a lower baseline now in Q3 than we would have anticipated..

And then can you share whether or not you see some, like, push-out orders, like around the end of Q3 that may go into Q4?.

For sure. We did see, just like we saw in Q1, there were a lot of opportunities that went into the budget delay, not budget cancellation. Look, we definitely saw budget cancellations in Q3. They were a bit more meaningful then what we saw in Q1.

That wouldn't be a surprise, because you're deeper into the year and companies have a better picture of what their own business looks like for the rest of that year. But there are also plenty that went into the budget delay bucket, again. So do those become high priorities in Q4 to push? Absolutely.

And will some of them close? I'm a realist, probably not all of them, but will some of them close when they are into Q4? I'm sure that will occur..

Okay.

And then with regard to the further transition toward more direct sales, would you refresh our mind what your sales coverage footprint looks like, between direct sales force and distributors? In addition to that, let's say if I see it from a different angle, how should we feel of your ability to maintain and expand sales coverage using your direct sales versus, let's say, having a strategic partner who can strengthen your distribution?.

Yeah. So maybe I'll go in reverse order. I think the ability to manage the hiring and the transition is something that we do really well, because that's been our bread and butter for the metrology business.

Still today, virtually all of our revenue in metrology goes through the direct sales force, and so understanding when's the right time to add, how long it takes them to come up to speed, how to split the territory, how to have the right leadership in place to manage the size of the team, and how does one expand the regional leader level versus the individual account manager level? Those are all things we do really well.

On scanning today, so the 3D documentation business today, in the third quarter, I think Laura, it was 46% went through distribution?.

Yes..

So that's a little bit lower than we've seen as high as 57% and 58% during the course of this year. So, already there's a bit of a transition there.

Hendi, think it's too early to say what's the right balance, because while strategically we are adding more direct people to help drive the 3D documentation business, the final decision criteria is what is the best way to cover the market.

So we clearly have regions where the distribution model works, the distributors there are very effective, they have great coverage and they have great customer relationships. And in those cases we certainly would continue to leverage distribution.

And if there are territories where that doesn't appear to be the opportunity, then for sure those become the targets for going direct..

And then one last questions. Jay, in the past you highlighted growth opportunity in the law enforcement field.

Would you share some insight for the state of that market, and whether we should feel that as a near-term or a long-term opportunity for FARO?.

Certainly it's a long-term opportunity, because there is real – from all the data that we gathered in our market study last summer, it's at least a $300 million opportunity for us to pursue, for the type of technology that we sell currently today. Near term, it is not going to be as big AEC.

The adoption curve is a little different there, it's tied to municipal budget planning processes which can take sometimes 12 months to get those budgets in place.

But I will say is that I think the success we are seeing with Freestyle right now, because it's at a price point a municipality can afford within a current budget cycle without having to get approval from anybody higher up the food chain. I think that's a good indicator of the desire to leverage and use three-dimensional technology.

And again, we know because of some of the range limitations of the Freestyle that eventually that will – some of those will translate into larger scale, the large volume laser scanners. The one thing I've always said about law enforcement that I do like is that the word-of-mouth in this vertical is greater than any vertical I have witnessed.

They talk to each other constantly, ways that I wouldn't – that nobody else would within their industry. So I think that's a plus when it comes to adoption..

Thank you, Jay. Thank you, Laura. And good luck finishing the year..

Thanks, Hendi..

Thank you..

Thank you. We'll take our next question from Bobby Burleson from Canaccord. Please go ahead..

This is Prab (49:55), calling in for Bobby. Hey, Jay. Couple of quick question just on the Focus Laser Scanner, you'd talked about there was a broader weakening demand in AEC, right? And you talked about lowering ASPs could help spur demand.

Is that part of your new product refresh? What is the timeline for it, and what are your expectations there?.

Yeah. Hey, Prab (50:20). So clearly one of the big factors that still keeps the product in the early adopter phase is the price point. So while we are the lowest priced laser scanner in the marketplace, it's not where the ideal set of early majority and late majority customers need it to be.

So yes, in the development cycle we've been working aggressively to reduce the cost of the unit. We believe the sweet spot for that product is probably in the 20-ish range, give or take, over time. We certainly will not go all the way to 20 overnight, or at least we probably won't go to 20 all the way overnight.

What I will say is that the engineering team has a great path on how to take that cost out, and large chunks of that have been solved for the next generation.

What I won't give you any detail on is the date, only because as you know I don't – I made that mistake one time about four years ago, I let people know that the tracker was relatively soon, and everybody – a lot of customers stopped buying trackers for about six months.

So I won't give the date on it, but there's clear momentum on solving the problem, and from an internal standpoint, we have a clear date now that we are working towards on delivery..

And as a follow-up, Topcon, the second-gen product, is it closer to this price point or is still more expensive than your laser scanner?.

Closer for sure, but not – it's closer to what we currently have, and still not there, and not anywhere close to what the market price is going to need over time..

Okay.

And the last question I had was, in terms of the mix of the inventory reserve, is it across all products that you took the reserve on, or is there a specific bucket that was a bigger portion of the $7.9 million?.

We took a comprehensive view of all the inventory on hand, and so it does hit all the regions and the various product lines..

Okay, great. Thanks for taking my questions..

Thanks, Prab (52:19)..

Thank you..

Thank you. We'll take a follow-up from Ben Hearnsberger with Stephens. Please go ahead..

Hey, thanks for taking my follow-up.

On the product refresh cycle, I guess you're not going to give us a timeline, but without giving us maybe a product name and a specific date, can you give us a sense for whether we will at least see one in 2016, or we'll see multiple in 2016?.

Okay, yeah, so that's fair. So this should be consistent with what I said last quarter, too. Generally speaking, the entire portfolio should turn over over the next, call it five, maybe six quarters. Obviously we have – the closer you get to it, you have firm fixed dates that you work with; not everything is within the next two quarters for sure.

So on those, what I'll – the caveat I always add is that while have a date we're marching towards, if we get closer to that date and we feel like alpha testing or beta testing is not going the way we would like, then we would obviously move the date, because we're not going to release something into the market that does not solve the problem and have meaningful impact from a customer standpoint and an ROI standpoint.

But I will say that within the window that we're looking at, everything right now is on track in that sort of five, call it six-quarter roll..

Okay..

And they are not all back-end loaded, if that's maybe the next question, they are not all back-end loaded..

Okay. Okay. Thanks for that. And I wanted to talk about leads and quoting activity, and I think the commentary is that they're still strong.

Can you give us a sense for, what does strong mean? Are they up year-over-year, are they up sequentially; just kind of frame that up for us a little bit?.

They are.

So the way we look at it is, the constant measure is are they growing at the rate that we would require to achieve the internal sales targets? So, without giving away what the internal sales target is, there's a very clear ratio of leads to demos to closures, and unless something meaningfully changes in one part of the equation, that has been consistent for the 11 years, and I think even longer than that probably, as a company.

So if you look at the quarter, leads grew at the right rate; demos grew at the right rate; it was the close rate that delayed and pushed. If we ever saw leads dropping meaningfully or demos dropping meaningfully, that gives me a different level of concern and a different pause..

Okay.

Are they up sequentially?.

Yes..

Got it.

And is it safe to assume that your internal sales model is in line with the long-term operating model that we know of?.

It is..

Okay. Thank you..

Thank you. We'll take our next question, follow-up from Richard Eastman with Robert. W. Baird. Please go ahead..

Yeah.

Jay, could you just elaborate a little bit on your comment about pricing pressure, aggressive pricing pressure? I think you tossed that into your Asia-Pac commentary, but what product lines is that, and also what's pricing like in the Americas and Europe?.

So, let me start, so generally – let's start with Arm pricing. Arm by itself without the HD LLP continues to be very aggressive across all three regions, and that's been similar, as you know, for the last, call it two and a half years now, it's been – while it hasn't necessarily deteriorated meaningfully, it is still aggressive.

And we've seen increased aggressiveness on, say, strategic accounts, or accounts where our competitor clearly would like to get in. When you add in the HD LLP, pricing is a whole different factor.

We actually are getting gross margin and revenue lift from the HD LLP because it is such a clear-cut – it has such a clear-cut competitive advantage in the marketplace.

So if we can get the customer focused on, you don't just want or need the Arm, you actually want and need the scanning capability to come with it for these certain types of applications, then we have a clear advantage.

And all of our – a lot of our pricing strategy on what we do with the LLP was to ensure the customers would view it as an add-on and not feel like it was a whole separate purchase order that they had to go back and get additional approval from. So, that's been really successful in helping combat that on the Arm side.

No question, we saw more aggressive pricing on Tracker, particularly in Asia, in fact it was predominantly in Asia, in the third quarter. We saw a teeny bit of it at the end of the second quarter, I think maybe they were testing the waters, and it did get more aggressive in the third quarter.

And I suspect, while I don't know if that's truly the new level, but in the current environment I would have to assume, yes, for some period of time they are going to continue to be aggressive there. Scanner side, for the most part we are still the lowest-priced provider on virtually every single opportunity.

So it's less an issue of price on the scanner side, it was more the market weakness that we saw in AEC..

Okay.

And then I just want to double back for a second, is there any impact on your gross margin line, or – let me phrase it this way, is there any impact from reclassifying some of the demo inventory to service inventory, either in $7.9 million write-off or in the service gross margin?.

It would be immaterial..

It's immaterial? Okay. So then if I just back the gross margin to your point about the $7.9 million of write-off, the gross margin on the product side would equate to about 63.5%. How do we do that with price competitive? How do we do that? I don't think we have ever shown a 63.6% gross margin on product.

How do we do that?.

So I think one big thing to look at is, obviously the HD LLP is a meaningful contributor. If you look at the price point we are able to achieve relative to the cost associated with it, and the continued sort of growth in the attach rate and the size of the attach rate on that product is a huge driver there.

So you are right, on the product side that looks unusual in a pricing environment, and that's all the more reason for us to continue pushing. From a customer standpoint, we pitch the ScanArm first, and only if they are absolutely screaming over price do we then think about, okay, reduce price or drop the LLP off and just go on the straight Arm..

The other piece of this is product mix..

With Arms down just 3%?.

With the strength of the Arms relative to the scanner..

Yeah, and the decline in the scanner. That's right..

And the service gross margin at 40.9%, almost 41%, is that just incident rate was lower or something?.

So the strength of the service margin has to do with the focused effort that we implemented a couple of quarters ago on the premium warranty..

I see. Okay. All right, thank you..

Thanks, Rick..

Thank you. We will go next to Holden Lewis with Oppenheimer. Please go ahead..

Thank you. Yeah, I kind of want to touch on, a little bit on sort of the cyclicality, or when I think about your cyclicality I always think about certainly the FARO Arm and Laser Trackers perhaps being the more cyclical of your business. The FARO Arm is down a little bit more for sure, but it's been so much stabler over the course of the year.

The Laser Tracker was down, but it looked like the declines are narrowing a fair bit, including on the ASP ForEx side. And so I mean it looks like your -- the business I typically think of as being more cyclical showed stability, perhaps a little bit of incremental improvement.

I just kind of wanted to get a little bit of flavor for how you're seeing the markets impact those two businesses relative to the Laser Scanner and what that says about underlying cyclicality?.

Yeah. Well, I'd say number one, I think you're right about the cyclicality. Look, the metrology side of the business still generates the meaningful portion of our product revenue, even with the success we've had with Laser Scanner. It's just a – it's a bigger piece of the pie, and so no question, our cyclicality historically has been attached to that.

I think it's still a little early for us to be able to tell what cyclicality looks like for the Laser Scanner and the verticals that we're in there.

I can't say that I think a decline like we saw on Q3 as a cyclical issue, it's definitely more than that, and I – for all I know, Q3 may end up being the best quarter over time for Laser Scanner, it's just too early tell there. But I would say, look, I think there is strength in the metrology business.

No question that capital budget delays and cancellations like we saw on the scanner side are definitely impacting the metrology side, but that's not a surprise in the industrial world, but it is a – look, it's still a great business for us; it's still the bigger portion of FARO's revenue today..

Okay. And then, if you – so if that side of the business is faring relatively better than the Laser Scanner, and that seems like it's likely to remain in the case, I mean, the dynamics that push the product gross profit up, I mean, those look like they are going to be durable over the near term.

So this kind of high 50s gross margin that you put up for the business as a whole, that looks like it's something that – it will be sustainable over the foreseeable future, given the trends in your business.

Is that a reasonable statement, or is there something I'm missing?.

I don't know if I'd given a specific on that, because it would feel like guidance. So I guess what I would reiterate is just, obviously, the moving parts. Mix is one, so a rapid increase in Laser Scanner as it relates to the total mix.

While Laser Scanner gross margin is good, it is definitely a little bit lower than the other products, so that would have some drag on it, even though you'd get the benefit of the associated revenue lift, clearly coming off of a weaker performance in that product in Q3. And the other one would – certainly is the service side.

If you – depending on – we see – not all service can be planned, right? So you do your best to plan according to how customers want to schedule the service, but depending on, you get down to holiday shutdown in the summer, sometimes we get more units than we might have seen this year, so there's a lot of factors on the service side which can drag that a little bit.

That being said, obviously we're pretty pleased with the gross margin, and certainly being in that mid and upper-mid 50s range should be an appropriate number for us, without giving any specific guidance on it..

Okay. All right. Thank you..

Thank, Holden..

And it appears we have no further questions at this time..

Very good. Thanks, everybody. Appreciate the time today, and I look forward to updating all of you after..

This does conclude today's program. You may now disconnect your lines, and have a wonderful day..