Bob Seidel - CFO Simon Raab - CEO, Chairman.

Jim Ricchiuti - Needham & Company Greg Palm - Craig-Hallum Capital Ben Rose - Battle Road Research Patrick Newton - Stifel Nicolaus Ben Klieve - Noble Capital Hendi Susanto - Gabelli & Company.

Good morning everyone, and welcome to FARO Technologies’ Conference Call in conjunction with its Second Quarter 2017 Earnings Release. For opening remarks and introductions, I will now turn the call over to Chief Financial Officer, Bob Seidel. Please go ahead, sir..

Thank you and good morning everyone. Yesterday after the market closed, we released our financial results for the first six months and second quarter of 2017. The press release is available on FARO's Web site at www.faro.com.

As you know, certain prior year stock compensation expenses were reclassified between cost to sales, selling and marketing, general and administrative, and research and development expenses in the condensed consolidated financial statements to reflect the appropriate departmental costs.

I would like to remind you that in order to help you understand the Company's 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, goals, objective, intend, may, 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 Form 10-K for the year ended December 31, 2016, Form 10-Q for the quarter ended March 31, 2017, and Form 10-Q for the quarter ended June 30, 2017.

I will turn the call over to Simon to provide an update on our company's strategic initiatives, and afterwards will return with a summary of our financial results. After our prepared remarks we will open the call for questions..

Thanks, Bob, and good morning everyone. At the beginning of 2016 we undertook a systematic global reorganization initiative, which we termed Going Vertical in Harmony, aimed at reinventing FARO's organizational structure and business processes worldwide, and returning FARO to our long-standing status as an innovative high-growth technology company.

The end of our second quarter marks the successful completion of this extraordinary process. Today, we are laser-focused, and the pun is intended, on growing our market verticals. We have harmonized literally hundreds of global processes, and have a far more agile and efficient platform.

We have used our balance sheet, cash, know-how, and global marketing reach to aggressively create important new products, pursue strategic acquisitions, and grow the top line.

Over the last six quarters, we've been investing in the platform necessary to support FARO's long-term growth, increase sales and marketing personnel, new web-based demonstration studios, activation of new verticals, increased R&D, aggressive new product development, and the acquisition of next-generation technology.

However, there is a natural maturation period between the hiring of sales people, investing in system improvements, executing acquisitions, and seeing the top and bottom line results from these investments.

Consequently, while our short-term profitability necessarily has been negatively affected, we can already see the benefits of these investments, and are confident in the value being created. Following are some important observations on our recent investments and growth initiatives.

The front-end loading of our sales organization is necessary to achieve accelerated growth. It takes approximately one year to mature a sales person from startup status.

Consequently, as we grow the sales force there will be gap of time between the incurrence of the related training and onboarding costs, and the realization of the results in top line contribution.

Since the start of Going Vertical in Harmony, in January 2016, we expect to increase the sales headcount by 42% till the end of 2017, which includes an additional 20 sales hires in the second half of 2017, resulting in 21% growth in 2017.

Following this front-end investment, we only anticipate increasing sales headcount by 5% to 10% annually until 2019. At the end of the first quarter, we reported that we would increase FTE sales headcount by at least 20% in 2017, and are substantially on plan.

As a reminder, sales FTE headcount is a time-weighted average headcount measure which we ratably discount the first year of a new employee by an experience factor. We ended the second 2017 with an FTE sales headcount of 516, an increase of 21.7% compared to the ending second quarter 2016.

Our trailing 12-month average FTE was 473, an increase of 13% compared to the same prior year period. The trailing 12-months orders per FTE was 746,000 at Q2, 2017. In the past, we reported orders for FTE at 670,000 based on a period-ending calculation.

We are now using a trailing 12-month orders per FTE to better account for our seasonality, resulting in orders per FTE for Q4 of 2016 of 769,000 and 432 sales FTE. We entered our second quarter with an incremental startup sales headcount of 111, for a total sales headcount of 627.

We refer to startup headcount as the difference between the ending headcount and the FTE headcount. The startup sales headcount increase resulted in an incremental cost of approximately $5.5 million in selling expenses for the first half of 2017.

We expect to end Q3 and Q4 with FTE headcounts at 570 and 610 respectively for a net increase in sales FTE headcount of 26% and 34% respectively compared to year-end 2016, thereby demonstrating the benefits of front-end loading. Our new web-based demo studios have gained significant traction as part of our modernized sales process.

The studios, which have been setup around the globe, are increasing utilization rates, and have helped us reach and qualify more customers in shorter time than ever before possible. WE are currently performing over 1,000 web demos per quarter, and expect this rate to increase substantially.

Our vertical focus is leading to significant growth and product portfolio expansion in the construction BIM-CIM. The tremendous value proposition of building and construction information management solutions is still in the early adoption phase. We believe that we have the most advanced cost-effective solution in the market.

In second of this year, we proudly produced our 10,000th laser scanner. In the second half of 2017, we intend to introduce the first ever fully-featured CAD-based surveying and construction 3D quality control software called BuildIT Construction, for use with the FARO laser scanner, and Tracer Laser Projector.

FARO's construction BIM-CIM segment boasted an order growth rate of 30% for the first half of 2017 on the strength of this commitment to a vertically-focused agile organization. Our segment, which includes Product Design, Public Safety Forensics, and 3D Machine Vision increased by 12% in the first half of 2017.

The expansion of our 3D capabilities outside of our traditional factory metrology market into the new verticals with much larger addressable markets is an essential component to our growth strategy. In-hand and virtual reality factory control tools are increasingly used in factory metrology and automation.

Light BIM-CIM, enhanced, and virtual reality tools are in the early adoption phase. In the second half of 2017, we intend to introduce FARO Visual Inspect, the first ever ER/VR tool for factory quality control, enabling factor assemblers to literally see the CAD model of what they are building projected on the physical part.

We expect that this product line will grow quickly, and establish a new standard in fully-informed and individualized quality control. High accuracy and resolution 3D sensors that see and measure on the move are the next evolution in factory automation. In the second half of 2017 we intend to introduce the two new products into this space.

The Dynamic Machine Vision Sensor, DMVS, will be introduced as an early-adopter product that can see in high resolution and accuracy 3D while on the move. Dynamic 3D vision sensors that allow robots to see and measure in high accuracy while moving will change the way factories program and use robots.

In addition, we will reintroduce Vector RI 3D laser radar which will be capable of performing multiple high-speed 3D scanning measurement operations over large distances, and at multiple locations at the same time. We are renaming our 3D solutions vertical to 3D Machine Vision to better align with its purpose and our new products.

Product line excellence will drive sustained growth. Over the last 18 months, we executed on our commitment for our new product, [indiscernible] releasing leading new products across our portfolio. In October, we introduced our next generation laser scanner, the Focus S150 and Focus S350.

Then in January, we introduced the Focus M70, which sets a completely new standard in value-price performance. We also released our completely new laser tracker line, the Vantage S, and Vantage E. And in August, we plan to introduce our new Focus S70 laser scanner and technology. As well, we intend to introduce the Quantum S and Quantum M FaroArms.

The Quantum S and Quantum M FaroArms represent the most accurate, portable, rugged FaroArms that we have ever produced. We have listened to our customers' demands for application-specific software by releasing vertically focused software applications for Factory Metrology, Construction BIM-CIM, Product Design, and Public Safety Forensics.

With upcoming releases in the second half of 2017, we expect our entire product line to reach the technical excellence required to hold the premium position in the various vertical markets, and deliver a strong return on investment to our customers.

Gross margin increased in the second quarter by three percentage points from the first quarter, to 56.6%. We continue to target 60% gross margins effective by 2019. We have several key initiatives underway including better pricing practices, design changes and supply chain optimization.

We expect to hit the target in time despite continuing to disrupt the market with new value price offerings. However, we do expect quarterly fluctuations in margin as we introduce value priced elements to our product line continue to reduce our age pre-owned inventory and deal with competitive pressures.

I’ll make further closing remarks after Bob reviews our financial results..

Thank you, Simon. We believe that year-to-date financial information is more in line with how we actually view our progress and manage our operations throughout the year, with that in mind I wanted to start with an overview of our financial and operational performance. For the first six months of 2017 compared with the first six months of 2016.

New order bookings at $175.8 million were up 13.3% with similar percent increases in both product and service orders, reported sales at $164.2 million were up 6.5%. Service revenue continued its strong growth trend by increasing 18.0%. Gross margin of 55.1% was down one percentage point on a lower first quarter.

Net loss of $5.1 million compared to net income of $6.5 million in the prior year primarily reflecting our investments in start up sales headcount. Let us turn to second quarter 2017 results, new order bookings for second quarter 2017 increased by 9.1% to $89.0 million from $81.6 million for second quarter 2016.

Sales for second quarter 2017 were $82.7 million an increase of 5.3% compared with $78.5 million for second quarter 2016 excluding an unfavorable foreign exchange impact of approximately $1.4 million, second quarter sales, second quarter 2017 sales would have increased by 7.0% compared with the same prior year period.

Our sales increase was primarily driven by continued service revenue growth and higher average selling prices with new order bookings at $89.0 million and sales at $82.7 million, our book-to-bill ratio was 1.08 at second quarter 2017, the increase in our book-to-bill ratio was mostly due to the demand for the new Focus M70; laser scanner in both the construction BIM-CIM and public safety forensics verticals, which temporarily exceeded our production capacity late in the second quarter.

Product sales were $62.5 million for second quarter 2017 an increase of 1.4% compared with $61.6 million for the prior year period primarily reflecting higher average selling prices and generally modest unit sales increases.

Service revenue was $20.1 million for second quarter 2017, a strong increase of 19.2% compared with $16.9 million for the prior year period, this increase was primarily due to the continued increase in warranty and customer service revenue driven by the growth of our installed serviceable base and focused sales initiatives.

In our factory metrology segment, sales for second quarter 2017 were $57.2 million an increase of 1.9% compared with $56.2 million for second quarter 2016, this increase was mostly driven by an increase in service revenue and slightly higher average selling prices.

In our construction BIM-CIM segment, sales for second quarter 2017 were $18.9 million an increase of 13.2% compared with $16.7 million for second quarter 2016 primarily reflecting an increase in service revenue and higher average selling prices, we ended the second quarter with approximately $5 million in product sales backlog between construction BIM-CIM and public safety forensics as our demand for a new Focus laser scanner models exceeded our production capacity late in the second quarter.

In our other segment, sales for second quarter 2017 were $6.6 million an increase of 15.5% compared with $5.7 million for second quarter 2016 mostly driven by higher sales in our public safety forensics vertical.

Gross margin for second quarter 2017 increased to 56.6% compared with 55.9% for the second quarter last year and increased 3.0 percentage points compared with first quarter 2017. The increase is related primarily the higher average selling prices and improve production efficiency and our factory metrology vertical.

Selling and marketing expenses were $26.0 million in second quarter 2017 and increase of 39.0% compared with $18.7 million for second quarter of 2016. This increase was driven primarily by an increase in selling headcount as part of our strategic initiatives to drive sales growth.

Selling and marketing expenses as a percentage of sales were 31.5% for second quarter 2017 compared with 23.8% of sales for the prior year period. General administrative expenses for second quarter 2017 were $11.9 million and increase of 16.0% compared with $10.2 million for the prior year period.

G&A headcount remained unchanged compared to second quarter last year. The increase was mostly driven by higher compensation expense and global system implementation cost to facilitate our modernization initiatives.

As a percentage of sales general administrative expenses increase to 14.4% for second quarter 2017 compared with 13.0% for the prior year period. Research and development expenses were $9.0 million for second quarter 2017 and increase of 25.4% compared with $7.2 million for second quarter 2016.

This increase was mostly related to engineering headcount additions for 2016 acquisitions. Research and development expenses increased to 10.9% of sales for second quarter 2017 compared with 9.2% of sales for second quarter 2016.

Our net loss was $3.6 or $0.22 per share for second quarter 2017 compared with net income of $3.4 million or $0.20 per share for the prior year period.

Turning now the working capital accounts receivable was $58.8 million at the end of second quarter 2017 compared with $56.8 million at the end of the second quarter 2016 Days sales outstanding were 65 days at the end of second quarter 2017 down one day from the end of second quarter 2016.

Total inventories were $9.3.1 million at the end of the second quarter 2017 compared with $84.9 million at the end of the second quarter 2016 mostly driven by an increase in raw materials to support a new product of drumbeat and higher demonstration inventory to outfit our new sales hires.

At the end of the second quarter 2017 cash in short term investments totaled $139.6 million of which $99.9 million was helped by foreign subsidiaries. I will conclude with total headcount. At the end of second quarter 2017 our total headcount was 1,580 employees and increase of 16.8% compared to 1,353 employees at the end of second quarter 2016.

Simon will now make his closing comments..

Thanks, Bob. In summary, FARO has the necessary element in place to leverage a new cycle of sustainable growth into new verticals with very substantial addressable market. FARO is in control of it definitely for the most part and the rest of the company's businesses are substantially mitigated by various attributes.

FARO is globally distributed with sales, evenly distributed between the Americas and EMEA and APAC minimizing Geographic risk. FARO has a direct sales force of over 600 people, and minimal dependence on distribution, thereby guaranteeing product and market focus.

FARO's top five customers generally comprise less than 5% of sales, hence there's no existential reliance on any one customer. FARO serves multiple unrelated markets, which is intended to maximize addressable markets for its technology, and to minimize cyclical risks.

FARO now has a globally integrated, efficient operational and manufacturing structure, and has achieved the growth year-to-date with no increase in G&A headcount.

FARO's hardware technology platforms are very broad with the deep resources and a proven ability to innovate, and now more agile then ever with a newly organized platform structure, and progressively more globally integrated use of resources.

FARO's software platforms in all verticals are best or approaching best in class, and are now also working towards full global integration and resource utilization. FARO has over 17,000 customers, and a worldwide direct service and training organization generating a recurring revenue stream of almost 24% of total revenue in the first half of 2017.

FARO's financial stability is characterized best by no debt, and approximately $8 per share in cash, and improved globally-integrated financial controls. After our investments in 2016 and the first half of 2017, we are now focused on delivering mid-teen sales growth, historically higher gross margins, and mid-teen operating margins by 2019.

As well as technical leadership in all product categories, we believe that the short-term risk and costs inherent in these initiatives will be rewarded with increased sustainable shareholder value.

I'm also proud to announce that we will be releasing our new global Web site later this month in up to 15 languages, which fully represents our newly focused vertical markets, and our geographic reach. I invite you all to explore the new Web site, which we expect will improve in content every day.

We deeply appreciate the patience of our shareholders and the hard work of our employees around the world, and look forward to reporting on our progress each quarter. I'll now open the call for questions..

[Operator Instructions] We will take our first question from Jim Ricchiuti of Needham & Company. Please go ahead..

Hi, good morning. A couple of questions, first on operating expense, and I understand and recognize the selling expense is a bit of a moving target just given the headcount additions that are planned, but if we look at G&A, and if we look at R&D, fairly significant increases from the March quarter.

Are these levels we should think about on a go-forward basis in absolutely dollars?.

Jim, thanks for joining the call. If I look at R&D specifically, much of R&D the increase you see year-over-year, the overwhelming majority of that as driven by the acquisitions that we made in 2016.

So it's a [farewell] [ph] presentation in the absence of other acquisitions coming onboard in the future, and what you see now is kind of a baseline going forward, because if I look at the increase of $1.8 million year-over-year, $1.4 million of that is related to the acquisitions.

In terms of G&A, G&A is up $1.7 million, but again I would say that the baseline that you see or the average between Q1 and Q2 is more representative of where we're going forward.

The big piece here that Simon and I, and the leadership team are focused on in these two areas is managing the overall headcount for these, controlling the absolute dollars, and really holding those dollars as best as possible going forward so we get leverage as we grow the top line..

Okay. And with respect to the goal of getting to mid teens operating margins in 2019, how should we think about the path to that goal? I mean, obviously initially you've got some significant front-end expense. But in terms of measuring where you are relative to that goal as we think about the back half of this year with some of the newer products.

I mean, how should we think about this path? Is it going to be fairly gradual or do you -- what is your sense in terms of seeing some of this productivity from some of the hires you've made over the past six to nine months?.

Jim, it's Simon. Thanks for that question. I think it's a very important one.

The sales per FTE, which is still holding at around the $760,000 mark annualized, is the primary tool that we're using to predict our top line growth, along with the maturation of the sales force where, as we noted, we would end up with almost 40% increase in FTE headcount over at the beginning of 2016 at the end of '17.

We only expect to increase the sales force between 5% and 10% at the max in '18, and '19. Increased efficiencies of the sales process through the web studios, and well as improvements of our product line are expected to sustain the high-$700,000s of sales per FTE.

If you look at the expenses that we just talked about being respectively flat, except for potential acquisitions that we may make, which are unpredictable at this point, we would expect them to see that increase in operating margin..

Okay, thank you. I'll jump back in the queue..

Thanks, Jim..

We will take our next question from Greg Palm of Craig-Hallum Capital. Please go ahead..

Morning, thanks for taking my questions..

Yes, thank you for initiating coverage, we appreciate it..

Simon, maybe to start with some of the newer products that you talked about launching, I guess the first one's in the Machine Vision vertical.

Just curious what types of applications, end-markets are you targeting? What do you sort of envision is the market opportunity there?.

I think it would be commensurate with the expectations of growth in automation. As you know, robotics have been very much in the news lately, and there is a new wave of collaborative robots which are also being introduced by all the robot makers. Well, that means that more robots involved in more collaborative manufacturing sizes with people.

Now, that means that we need very active 3D Machine Vision while the robots are moving to provide them the degree of awareness that's required for that kind of work.

In addition, the new technology has allowed us to introduce new methodologies for part pick and place, as well as various operations such as welding because you'll have real-time 3D monitoring of the robot positioning. So we expect it to grow commensurate with the robot market.

We have good relationships with companies such as [Kooka] [ph], and have integrated products with them. We also have the Cobalt Imager, which is a structured light sensor for doing 3D measurement in combination with the DMVS and our Vector RI which is a -- rather than putting a sensor on a robot, this is a robotic sensor.

We expect to have growth in that sector which is related very much to the growth in automation around the world. It's our newest vertical, and we recently hired a head for that. And you should understand that one of the initial issues around that market is the fact that it's a lot of custom work.

And so it represents a slightly new business model for us. And we are developing the internal structure to make sure that we deliver solutions based on custom requirements by our users..

Any sense on how big the opportunity is, and what's the competitive landscape there look like?.

There are a number of companies with sensors for vision, however they're not a vision on the move, so we are unique in that respect, and have IP that covers that. We do not have a good fix on the addressable market for ourselves. I would make it commensurate with robot.

Well, the robotic market analysis shows that the greatest growth in robotics will be in the area of inspection. And of course that's our area of expertise. So it's a little early for us to be able to determine what our addressable market will be..

Got it. Bob, you mentioned a backlog.

Can you tell us how that compares, that $5 million, to year-over-year levels, and then Q1? And then can you maybe talk a little bit about your production capacity, when some of that might get freed up here?.

Sure. So what I was referring to in my prepared remarks is that we have $82.7 million in revenue this quarter. And you saw the book-to-bill of 1.08. Much of that book-to-bill related to that we brought forward the new M70 laser scanner, as well as our Focus S 150, 350.

We ended the quarter with about $5 million of shippable backlog just related to that product in those two verticals BIM-CIM factoring the trial, in BIM-CIM and Public Safety. So if you look at it that would've -- if we would've shipped that $5 million we would have been in more 12% sales growth than where we came in at. So that's a piece.

Really as we go forward though we'll be working through the process to really work through our launches for the new Quantum to make sure that we have supply both for our demo units and supply for our customers, as well as working through really our supply chain and production on our laser scanner unit to clear the backlog out as soon as possible.

Generally speaking, we come in to any quarter with $12 million to $14 million of backlog. We came into this quarter with the same. We tend to clear that out by the -- two months of a quarter, and we see that going forward the same. Our goal is to get back to closer to the 1.0 book-to-bill going forward..

In addition to that, we are ramping up production capabilities in all the areas. What caught us a little bit flat-footed was the mix change when we introduced a new model, like the M70 which is a lower-priced unit with less performance for specific markets than our usual BIM-CIM market. We can't predict what the product mix will be.

And our predictions were wrong, there was a much bigger uptake of the M70 than we had expected. And we've not caught up. But when we introduce these products we're going to have these little mispredictions of product mix going forward. But we accommodate those quickly within the next quarter..

And just to be clear, the Quantum, is that an entirely new arm product or is that just the refreshed version of your base product now?.

No, that's a completely new product. We're very proud of it. It's got a new level of portability with onboard batteries. It's one that is the first product in the market that is fully ISO certified. And we also have put it through very rugged ISO-based -- ISO certified readiness testing.

So it's a completely new product with about 25% increases in our -- for the top model in accuracy. So we're kind of unprecedented readiness, portability, and accuracy. And it is a completely new product..

Great. I'll hop back in queue. Thanks..

Thanks, Greg..

[Operator Instructions] We will take our next question from Ben Rose of Battle Road Research. Please go ahead..

Yes, good morning. A quick question for Bob here, in looking at the trajectory of services revenue in 2016, it looks like you saw a pretty good acceleration in year-over-year growth.

Would you expect that to be the case in this current year?.

Well, with the implementation of our dedicated service sales agents and an increase in our service days, we really, as you said, really sorry to see that uptick in our service revenue growth, I would say, starting Q1 of '16. We saw that uptick from Q4 '15 to Q1 of '16.

We maintain an aftermarket sales team dedicated to selling warranties and repair activities. Much of the increase has been from the warrantee side to really drive that service revenue growth. So our near-term growth outlook remains positive. And really, for the remainder of the year we would see similar increases.

We certainly recognize though that we must increase our unit sales growth in product sales, deliver those units to the field, get them into our installed base to provide really a long-term sustained double-digit mid-teen sales growth from the service revenue..

Okay. And a question on sales and marketing with regard to the compensation of the sales force, could you speak maybe just in broad terms as to kind of the fixed versus variable component of that.

Trying to get a flavor for if given the increase that you're seeing in orders, if that translates into revenue in the back half of the year, what kind of incremental compensation expense we could see?.

As we talked about in our Q1 2017 call, we indicated the average sales person costs about $100,000 a year between salaries, benefits, travel. And then generally speaking, we incur about 6% to 7% average commission rate.

So, as Simon indicated in his prepared remarks, we ended the second quarter at 627 in our sales headcount ending period which then translated into selling and marketing expense of $26.0 million. We will be adding about 20 additional new sales hires probably ratably over the next two quarters. So we would expect to end the year at 647.

So I think you can look at our trailing two quarters, and you can look at the fact we'll be adding 20 more sales people ratably over the next two quarters, combined with the statement on our compensation to get a pretty good understanding of how, at least, the headcount hat.

Then think about what we've indicated in terms of the orders per FTE, our top line will grow, and you'll get a very good idea I believe how our selling and marketing should trend, how we would expect it to trend..

Okay. And then just kind of a final question for Simon in terms of the go-to-market strategy for the 3D sensor; as we understand the market, there are a variety of companies that are selling using direct sales forces versus distribution.

Can you speak to the kind of advantage that you think might be provided with this direct sales force that you're setting up versus others who are going to the market through third-party distribution?.

I think the advantage that we see most often is when you're brining new concepts of product in. For example, the DMVS is a completely new concept. And we require missionary work in order to convince the people how to use it. FARO's had a tradition of working direct versus through distribution.

We saw the reliance on distribution affect our laser scanner sales when we went through our experiences in the early BIM-CIM market. So keeping control over our direct sales force is relevant. With respect to the margins that that affects, typical discounts to many distributors are in the 25% to 35% range in any case.

So the question is, for that discount to the retail pricing what kind of sales force and what kind of control over your markets do you want to have. So we view direct sales as a far more communicative and responsible way to grow the product lines. There are products which are more commodity-based as they progress through their lifecycle.

And those could be amenable to some kind of distribution. But in the case that you represent, which is in the 3D Vision, there's this custom issue around it. Now, there are some companies that use value-added resellers. We're going to have to also speak to them.

I believe that they will become part -- integrators will become part of this 3D Machine Vision group in terms of its sales process. It's the one vertical that we have not added substantive sales staffing in. We've only just recently added leadership in there.

And of the 20 that we intend for the rest of the year, only about half of them will be going into that new vertical. So I expect your point is correct in the sense that ultimately value-added resellers or integrators are going to be required for that vertical. It'll be part of building up that sales force of that representation in the marketplace.

So probably much less direct in 3D Machine Vision, and much more through integrators..

Okay, thank you..

Sure..

[Operator Instructions] We will take our next question from Patrick Newton of Stifel. Please go ahead..

Yes, good morning, Simon and Bob, thank you for taking my questions. I guess first, Bob, a clarification. You'd talked about $5 million in product sales, backlog in BIM-CIM in Public Safety Forensic.

I wanted to make sure that would all have shipped in the June quarter had you not had some of these capacity constraints?.

Yes..

Okay, so it's reasonable to think then you would have been, I think you said 12% growth would've put you around $87 million - $88 million normal seasonality, which I have you flat.

And then you could layer on that extra, roughly, $5 million revenue, as a ballpark way to think about how September to play out?.

Yes, that is correct..

I think that's -- I mean, your point is one around why we're trying to emphasis on order growth rates at this point. We don’t have large fluctuations in canceled orders or anything like that. So our order growth rate is highly representative of our efforts.

With all the new product introductions, and the product mixes, and our ability to respond one quarter to the next with respect to getting the shipping is the point I made before about the M70 mix surprise for us. Going forward, there's going to be that kind of quarterly variation. And that's why we're looking at order growth as the primary indicator.

But your point is correct. If you'd added that back in it would be up around the percentage of growth that we would've expected..

Great. Appreciate the detail, Simon. And then I guess on the aged service and sales demo inventory.

Is there any impact you can quantify in the June quarter, and just remind us how close you are to getting that demo inventory to the age that you want long-term?.

Yes, so Patrick, in the second quarter of '17, we sold about $5.8 million in aged service and sales demo equipment. Now that was down 15% compared to prior year. So we would anticipate an increase in the second half of 2017 in selling or aged service and demo, just as we released the new Quantum arm, we will have demo units available for sale.

At the end of the second quarter 2017, we have approximately $6 million of aged service and sales demo equipment. We consider aged anything greater than three years. So that's what we're working on continue to sell. But generally speaking we look at this business as there will be always a continuum.

What we're trying to do continuum of used equipment that we're selling maybe is 10% of our product sales generally speaking. And what we're trying to do is just make sure that the service and demo inventory we have is of newer age..

Okay, that's helpful. And I guess if we take that information paired against the gross margin in the quarter, and then think about your long-term march towards 60%.

Does this kind of rough level around 56% currently somewhat of a floor that we should march up from or could there be some variability that could pressure that over the next few quarters?.

As I would look at, I'm not going to provide specific guidance, but I would say that we are focused very much between pricing actions, production to increase gross margin. Now, when we do have a new product coming out of a magnitude that the Quantum will be it's a significant percentage of our revenue.

We may see some fluctuations in gross margin in Q2, Q4, whether it's on the manufacturing cost side or selling off the demo equipment. So I would say that let's get to kind of more of a Q4 state before we call the floor. But certainly we have enough of historical track record to say 55% to 56% is kind of the floor..

Okay. And then I guess taking a longer term view, and looking at this 60% gross margin target, kind of trying to couple some of the forward investments you've made on the sales side.

Is there any type of operating margin target range that you could share that you would target over the same timeframe? Or is there any type of revenue level of growth rate that's embedded to meet that 60% gross margin target..

So, in the last earnings call in Simon's prepared remarks, what we really indicated was three specific financial goals or objectives that we have full by really the end of 2019, is mid-teens sales growth, get to high 50s, 60% gross margin, control our headcount on G&A, R&D, and hold the dollar spur -- on those operating expense lines to really get to the double-digit operating margin.

I think if you look back to 2012 through the 2014 timeframe we've demonstrated the ability to do that, when our G&A was low double digits, when our R&D was more 79%. And so we demonstrated the ability to do that in the past, and we're focused on doing that same coming in the future. I would say it's probably our objective by the end of 2019..

Great. Thank you for taking my questions. Good luck..

Sure, thanks, Patrick..

And we will take our next question from Ben Klieve of Noble Capital. Please go ahead..

All right, thank you just a couple of quick questions here, you described improvements in the manufacturing cost, cost structure within the metrology segment wondering first maybe just provide any kind of color on that improvement either qualitatively or quantitatively?.

The factories are under review for all kinds of efficiency issues around Lean manufacturing, we're also significant consolidation in our supply chain procurement to make it more global with seeking the best prices worldwide for underlying components and so between the lean manufacturing and the new supply chain procurement for global, globally we believe that the cost will come down..

Okay.

And then so that the margin improvement that you saw this quarter, do you think that was kind of -- do you think that was due in equal parts to both the improvement that you saw in that structure and average selling price, did one of those to outweigh the other?.

It’s average selling price which was the predominant reason for the margin increase..

Okay, thank you and then the average selling price as you described Ben improving both in the metrology and construction same but didn’t elaborate on that on the other segment, can you just kind of discuss selling prices not segment and if you anticipate those pricing -- prices to expand in that segment here in the next couple of quarters? Thank you..

I think I make a general comment regarding all the verticals which I think is relevant to all of them and that is that we cannot have premium pricing on this sort of technological leader in our particular technology categories.

So our effort in all the verticals is to achieve technological superiority and provide a very high price value proposition, value price proposition to our clientele.

So it's going to be spotty here and there, how things go as we change our product mix for example we just introduced the M70 which is a laser scanner which sells in the mid-20K range, it's taking a larger piece of our scanner product mix even though we have S350s which sell up in the $50,000 range.

So it’s going to be affected by product mix and the rate of uptake in each of the verticals but the effort overall is to increase the quality of the product line, so that we can demand premium pricing where possible..

Thanks, Simon. I’ll jump back in queue..

And we will take our next question from Hendi Susanto of Gabelli & Company. Please go ahead..

Simon and Bob, good morning and thank you for taking my questions; my first question is about machine efficient for Simon, in my past conversation with prior management high speed real time performance is one of the key challenges in real time 3D measurement, would you please share how we should think how FARO can address that requirement?.

Well, the technology the DMBS technology is quite unique in the sense that it can provide high resolution 3D Imaging while the robot is moving, this means that the programming and planning around the use of the automation can be significantly enhanced by that kind of data processing.

As I noted, we are only beginning to build our 3D machine vision vertical and we expect that vertical to be primarily dependent on integrators and value added resellers as well as a smaller direct sales force. But it’s a new product, it’s a new category and will mean changes in the way people approach automation and programming of robots..

And then Simon and Bob, you shared a number of full time sales headcount employees, would you be able to share roughly what portion of those headcount have reached maturity levels?.

Sure. As we indicated, our current raw headcount was around 627. The 516 of those had achieved what we call FTE maturity at the end of Q2, 2017 and it's the 111 difference between those two which we call the startup which is how we explained our $5.5 million investment into expanded sales force..

And Bob what product specifically drops higher ASP in the first half of 2017?.

That is really across all the product lines and across all our verticals those the right amount of pricing discipline installed in our commercial organization that we saw and also with the 2 million products that we have launched up to this point in time providing the ability to drive higher pricing in the market.

Those are focus on price and margin..

Okay and then Bob I noticed that the tax rate is lower in Q2 any color on that..

Really our tax rate is going to fluctuate quarter-to-quarter just as our geographic mix fluctuates in our sales so, there's no real to driver of that other than geographic..

Got it. Thank you..

Yes..

[Operator Instructions] We will take our next question as a follow-up from Greg Palm. Please go ahead. .

Yes, thanks for taking the follow-up here. Curious if you could comment on the competitive landscape just in light of all your I guess recent product refreshes lash new introductions by my mind math it seems like you are possibly starting to take share back from competition so first wanted to get your thoughts there.

If you could confirm that and then secondly maybe how is the competitive landscape adjusted or change or how you might think it responds going forward..

Thanks for that question. The Competitive landscape is fairly aggressive out there. I would say that there's, there are no other pure plays like FARO in terms of 3D measurement of our size so, we have companies that we're competing against that have alternative, large alternative revenue bases and we see a lot of discounting in the other markets.

We view that as the sign of some desperation in terms of keeping market share. We're trying to keep a discipline around that and approach it differently by taking market share through having good value propositions in our product.

We have competitions that with that lowball in many markets, in many markets we find that we can sell higher priced used equipment against discounted new equipment from that competition because of the FARO brand name.

And that of course makes us happy but on the other hand, we do have to respond to market pressures and I can describe the pricing out there is to be fairly aggressive particularly and what would now be commodity market areas like the arm business and tracker businesses and our expansion into these other verticals are specifically geared to access of course new addressable market but then also to, to deal with different kinds of competition and retain margin by addressing those differently.

And so we don't like to get into price battles. We certainly won't and we'd rather be at healthy margins going forward so, I say it's going to vary and change between each of the verticals there. But I can't point to any one particular competitive company that's across all our verticals that is making a difference in our response in the marketplace..

Okay, I know you're focused on bookings growth going forward given the kind of the puts and takes around, revenue and production capacity and whatnot but I know you don't guide but would you, would you be disappointed if you didn't grow sales revenue by double digits this year compared to last..

Yes, yes, we would. I mean we have put it through a huge investment into our sales force. At the end of the year we'll have a increase the sales force by 20% many of those will have matured FTEs by the end of the year.

If we don't sustain our high 700,000 sales per FTE, we will not achieve those kinds of growth rates and that would be a severe disappointment. The entire plan is premised on the idea that we can sustain the sales per FTE while we mature the FTE count and that’s primary methodology we're going to use for top line growth.

Of course we see that vertical -- or those vertical sales forces with new product, which is part of R&D initiatives, and we are trying to increase efficiencies with the web demo studios. But all combined, if they don’t result in double-digit growth rate, we are going to have to back off and reexamine what our premises were.

There are going to be fluctuations, for example, in the rate of maturation of the sales force and the different verticals, remember that we are also entering new emerging markets for us, new emerging verticals with the new fresh sales forces in territories that we have not covered before in addition to the new products.

So there are some risks around that that we have to work through.

But yes, I mean your question was about disappointment, we would be disappointed, and right now the indications are very positive, and in the trailing 12 months even with all the additions that we have made that our sales force, FTE sales force has been able to sustain the high 700,000 in sales for FTE. And we hope that continues..

Okay. Thanks again..

Thank you..

At this time we have no further questions..

Thank you everybody for joining our call today, and we look forward to reporting on the next quarter..

This does conclude today's program. Thank you all so much for your participation. You may disconnect at any time..