I did some research. DEM can be best described as a box placed over a section of the earth. A grid is placed in the box and the height at each point is output as a value in a stream of heights.
Because the LIDAR is scanning from one location. With a little math, it will spin around and send a stream of points(X,Y,Z) relative to the scanners location, for all the objects(points) the laser hits. The points are not a perfect grid. Imagine scanning a room from the floor. If you scan a wall with an open door. The wall points are all in a line. But the points measured through the doorway are all further away and show as higher than the points before and after it. This shows even more, as the angle of the scanner increases.
From all the advice so far. I need to find a modeling tool that can take (X,Y,Z) points and create a landscape.