FARO Technologies Inc (FARO) 2017 Q3 法說會逐字稿

Good morning, and welcome to the FARO Technologies' conference call in conjunction with its third 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 to everyone.

Yesterday, after the market closed, we released our financial results for the third quarter and first 9 months of 2017. The press release is available on FARO's website at www.faro.com. As a note, certain prior year stock compensation expenses were reclassified between cost of sales, selling and marketing, general 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 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, 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, and Form 10-Q for the quarter ended September 30, 2017.

I will turn the call over to Simon to provide his insights on our company's progress, and afterwards, we'll 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.

The end of the second quarter of this year marked the official end of our Going Vertical in Harmony or GVH initiative. Virtually every element of the company was reorganized over a period of 18 months. The premise of Going Vertical was to focus the company on a specific set of markets and their needs by tailoring the sales force, the product and marketing to better meet their needs. In addition, we undertook a harmonization effort to realign all business processes in our 3 regions to achieve synergies and efficiencies and slow the growth in G&A.

The effort to increase our sales growth to the mid-teens increased the gross margin through technical leadership and slow the growth in G&A is essential to achieve our objective to increase the operating margin to the mid-teens by 2019. The third quarter of this year is the first post-GVH quarter and the first where we should see the realization of some of these goals. In fact, our third quarter results demonstrated important progress in the pursuit of our long-term financial objectives and execution of our strategic initiatives.

We reported a 13.4% year-over-year growth in new order bookings and sales in the third quarter with a continued strong performance of construction BIM/CIM and a 52% increase in our other segment, which includes, among others, the public safety forensics and product design verticals. Our third quarter top line growth was generally in line with our long-term mid-teens sales growth objective.

This year, we made deliberate investments in growing our sales force, expanding the use of online demo studios and delivering new products that are starting to drive top line growth and margin increases.

We reported a gross margin of 57.7%, an increase of 4.1 percentage points compared to last year and 1.1 percentage points above last quarter. We are increasing our product gross margin by realizing higher average selling prices on new products across verticals and technology platforms, in conjunction with our new product drumbeat. Also, last year, we took active steps to sell aged sales demonstration equipment to reduce the average age of our demo inventory. This contributed to the improved margin with higher ASPs of later model demo sales.

We continue to target a 60% gross margin objective by 2019. We have several key initiatives underway including better pricing practices, design changes and supply chain optimization. We are confident that we can hit the target in time despite continuing to disrupt the market with new value-priced offerings and aggressive competitive pressures. With our sales growth, increase in gross margin and cost controls, we return to a quarterly operating income in the third quarter after 2 quarters of operating losses. We made a strategic decision to focus on long-term growth rather than a short-term quarterly mindset by investing in the addition of sales headcount this year, and then provide time and training to mature those product sales hires into full-time experienced or FTE sellers.

At the end of the first quarter of this year, we communicated that we would increase our sales FTE headcount at greater than 20% rate in 2017. We are substantially on plan. Our trailing 12-month average sales FTE headcount was 501 for the third quarter 2017, an increase of 18.2% compared with 424 for the third quarter 2016. We are expecting to end the year at approximately 535 compared to 432 at the end of last year, an increase of 24%.

Our new order bookings for the trailing 12 months were $362.2 million. The ratio of our trailing 12 months' new order bookings per average sales FTE headcount for the third quarter 2017 was approximately $723,000, down $20,000 from the prior quarter. This 3% decline in trailing 12-month new order bookings per sales -- average sales FTE headcount is directly related to our strategic decision to add sales headcount in emerging verticals and geographies in the pursuit of long-term growth in unaddressed market areas. It may take longer for some of these hires and emerging verticals to achieve our corporate average orders per FTE. In addition, it may take us longer to introduce disruptive products into these new verticals. As such, we may see additional modest declines in our trailing 12-month new order bookings per average sales FTE metric over the next few quarters until we gain more experience and introduce more products into these emerging verticals.

Our period-ending gross sales headcount was 635, an increase of 26% compared to 502 at the end of third quarter 2016. Our sales FTE at the end of the third quarter of 2017 was 548. The difference between our period-ending gross sales headcount and FTE headcount represents start-up sales headcount of 87 and an incremental cost of approximately $2 million in selling expenses for the third quarter of 2017. We increased our sales force by almost 100 people since the end of 2016, which required great HR execution across the organization. Through the end of the third quarter this year, our incremental start-up sales headcount cost is estimated at approximately $7.4 million in selling expenses.

As previously noted the results of Q3 and Q4 this year provide an indication of the success of our strategy and drive our tactical priorities for 2018. Our current plan is to increase our sales headcount modestly in the fourth quarter by 10 to 15 persons, specifically within our construction BIM/CIM and emerging verticals to help penetrate unaddressed market opportunities.

The performance of the sales force in Q4 will largely determine the rate of hiring for 2018. For the moment, we plan moderate sales FTE growth of 5% to 8% in 2018. However, if we sustain the expected sales for FTE in Q4, we intend to expand the sales force at a much more aggressive rate in our effort to meet or exceed our 2019 goals.

Our online demonstration studios are gaining an adoption and continue to provide a fast, cheaper way for our customers to be introduced to our new products. For the moment, we can say that the web demo studios have significantly increased the number of qualified leads for our rapidly expanding sales force. However, it is still too early to state whether they have increased our closing ratios. We intend to continue to add demonstration studios around the world each quarter. We see an increase in the number of online demonstrations across verticals and geographies as both our customers and fellows further embrace the live web interaction. We are starting to realize a more substantial increase in the number of online demonstrations in our Asia Pacific region as we overcome long-standing selling traditions and effectively train our customers to see the advantages of our custom web-based demonstration method.

With our transition to vertical markets, we completely redesigned our FARO website to focus prospective customers first on applications within our verticals and only then on product. The new website was released in mid-August and operates in 16 languages, and it's installed on a more reliable, faster-acting web infrastructure. The new website enhances the user experience and better guides prospective customers to become active opportunities. We are realizing higher click-through rates since the upgrade and have included access points to our extensive knowledge base as well as unifying our software upgrade interface. We encourage all of you to visit our website and learn more about the next-generation applications available in the various verticals.

Over the past year, we executed on our commitment for a new product drumbeat, realizing -- leading new product -- releasing leading new products across our portfolio. Last October, we introduced our next-generation laser scanner, the Focus S 150 and S 350. And in January and August, we released the new high-value M70 and S70 laser scanner model. In January, we released our completely new Laser Tracker line including the Vantage S and E in third quarter this year.

We released our new technology-leading Quantum M and S FaroArms. The Quantum FaroArm is the most accurate, portable and rugged FaroArm that we have ever produced. This new generation of products is being well received with increasing unit sales and ASPs. FARO is the most trusted name in a broad range of 3D measurement capabilities. To maintain this leadership, it's essential that we achieve and sustain technical superiority and continue to lead with disruptive new products in our verticals of interest.

In this effort, we have completely restructured our R&D organization and methodologies to be more responsive and productive. In addition, we generated a drumbeat of M&A activity to add technology and channel opportunities. We have made major new additions to our portfolio of products. BuildIT construction is the first fully featured quality control software for the construction industry, which works seamlessly with our market-leading Focus scanner. We are bringing the same democratized measurement capability that created FARO in the factory metrology market to the new fast-growing 3D BIM/CIM construction market. The construction BIM/CIM vertical has grown at a greater than 27% rate this year.

FARO is the first company to introduce virtual and enhanced reality to the world of inspection and analysis in all its verticals, but most importantly in factory metrology, construction BIM/CIM and public safety forensics. The potential is enormous for increased efficiencies and exciting new VR and ER 3D applications and FARO is committed to leading that evolution.

FARO was proud to recently sign a reseller agreement with KUKA robotics and received the first order for its new Robo-Imager Mobile, the first mobile, fully collaborative robotic inspection system and the first with a renowned TÜV SÜD safety certification. This is consistent with FARO's guiding principle to build highly adaptive measurement systems and to bring advanced 3D measurement capabilities to every corner of the factory and to lead in the factory 4.0 initiatives of the future. FARO will continue to introduce important disruptive technologies later this year and next year into its various verticals.

We are investing for mid-teen sales growth, historically higher gross margins, mid-teen operating margin and technical leadership in all our product categories. We believe that the short-term risk and costs inherent in these initiatives will be rewarded with increased sustainable shareholder value. We continue to actively investigate acquisition opportunities and to add new technologies to our existing verticals and/or create all-new verticals. We deeply appreciate the patience of our shareholders and the hard work of our employees around the world, and we look forward to reporting on our progress each quarter.

Thank you, Simon. New order bookings for third quarter 2017 increased by 13.4% to $90.5 million, from $79.8 million for third quarter 2016. Sales for third quarter 2017 were $90.3 million, an increase of 13.4% compared with $79.6 million for third quarter 2016. Our sales increase was primarily driven by a strong increase in product unit sales within our construction BIM/CIM and other segment, which includes, among other verticals, public safety forensics and product design, higher average selling prices and continued growth in service revenue.

With new order bookings of $90.5 million and sales of $90.3 million, our book-to-bill ratio was 1.0 for third quarter 2017. Product sales were $68.6 million for third quarter 2017, an increase of 11.9% compared with $61.3 million for the prior year period, primarily reflecting an increase in product unit sales within our construction BIM/CIM, public safety forensics and product design verticals as well as higher average selling prices.

Service revenue was $21.7 million for third quarter 2017, a strong increase of 18.4% compared with $18.3 million for the prior year period. This increase was mostly due to the continued increase in warranty and customer service revenue, driven by our sales initiatives and growth of our installed serviceable base.

In our factory metrology segment, sales for third quarter 2017 were $59.3 million, an increase of 1.8% compared with $58.3 million for third quarter 2016. This increase was mostly driven by growth in service revenue and higher average selling prices in conjunction with our new product drumbeat.

In our construction BIM/CIM segment, sales for third quarter 2017 were $22.8 million, an increase of 42.9% compared with $15.9 million for third quarter 2016. This increase primarily reflected a strong increase in product unit sales, partly due to shipping second quarter backlog as well as continued growth in service revenue.

In our other segment, sales for third quarter 2017 were $8.2 million, an increase of 52.1% compared with $5.4 million for third quarter 2016, primarily due to higher product unit sales in our public safety forensics and product design verticals, leveraging our recent sales headcount additions in these emerging verticals.

Gross margin for third quarter 2017 increased to 57.7% compared with 53.6% for the third quarter last year. The increase is mostly related to higher average product selling prices in conjunction with our new product introductions, as well as the marked improvement in our service margin as a result of higher service revenue.

Selling and marketing expenses were $26.0 million for third quarter 2017, an increase of 31.4% compared with $19.8 million for third quarter 2016. This increase was primarily driven by higher compensation expense, reflecting 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 28.8% for third quarter 2017 compared with 24.9% of sales for the prior year period.

General administrative expenses for third quarter 2017 were $10.3 million, a decrease of 4.1% compared with $10.7 million for the prior year period. This decrease reflected our continued departmental budget controls on headcount and non-payroll costs. As a percentage of sales, general administrative expenses decreased to 11.4% for third quarter 2017 compared with 13.5% for the prior year period.

Research and development expenses were $9.0 million for third quarter 2017, an increase of 13.8% compared with $7.9 million for third quarter 2016. This increase was mostly related to engineering headcount additions from our 2016 acquisitions. Research and development expenses was unchanged at 10.0% % of sales for third quarter 2017 and third quarter 2016.

Our effective income tax rate for third quarter 2017 was 36.8%, reflecting a higher quarterly rate than our historical trend. With over 60% of our sales outside the United States, we operate across many tax jurisdictions with distinctly different tax rates. In the third quarter of 2017, the increase in our effective income tax rate reflected an increase in our profit expectations within certain higher tax jurisdictions, resulting in higher estimated quarterly income tax expense.

We do not provide specific guidance on our income tax rate as our geographical profit mix may vary quarter-to-quarter. However, at this time, we do not expect our annual effective income tax rate to differ significantly from our historical range.

Our net income was $1.6 million or $0.10 per share for third quarter 2017 compared with net income of $1.1 million or $0.07 per share for the prior year period. As we drive the business towards our long-term financial objectives, we look at our year-to-date performance as an important helpful measure of our progress. I would like to highlight our performance in several key financial metrics for the first 9 months of 2017 compared with the first 9 months of 2016.

New order bookings of $266.4 million were up 13.4%, driven by strong growth in our construction BIM/CIM and public safety forensics verticals.

Reported sales of $254.5 million were up 8.8%, reflecting a 27.4% increase in construction BIM/CIM and 3.0% increase in factory metrology. Gross margin of 56.0% was up 0.7 percentage points, mostly driven by higher average selling prices and continued service revenue growth, improving our service gross margin.

Net loss of $3.5 million, compared with net income of $7.6 million in the prior year, reflected mostly the start-up cost related to growing sales headcount and additional R&D expenses associated with our technology acquisitions.

Turning now to working capital. Accounts receivable was $60.4 million at the end of third quarter 2017 compared with $57.4 million at the end of third quarter 2016. Days sales outstanding was 61 days at the end of third quarter 2017, down 5 days from the end of third quarter 2016.

Total inventories were $94.3 million at the end of third quarter 2017 compared with $88.9 million at the end of third quarter 2016, mostly driven by an increase in raw materials to support our new product drumbeat and sales increase, as well as higher demonstration inventory to equip our new sales hires. At the end of third quarter 2017, cash and short-term investments totaled $140.8 million, of which $99.8 million was held by foreign subsidiaries.

I will conclude with total headcount. At the end of third quarter 2017, our total headcount was 1,669 employees, an increase of 11.6% compared to 1,495 employees at the end of third quarter 2016. Our total headcount now reflects both permanent and contingent employees at the end of the period.

I will now open the call for your questions.

And we will take our first question from Patrick Newton with Stifel.

Jumping right in. I think on the FTE headcount, if I heard you correctly, you said 548 exiting the quarter, I'd back into 590 for fourth quarter based on your trailing 12-month commentary. And that means that your FTE headcount for both 3Q and 4Q is trailing your prior targets you provided us of 570 and 610. So I guess, one, is, did I do my math correctly? And then secondly, is the metric trailing your target due to increased churn of your sales, lower hiring rates or some other variable?

Thank you for the question. Your calculation is correct and we have been working on making sure that we get an accurate view of how this FTE is working. And we are doing the average trailing 12 months now as it seems to be a better indicator. And certainly, this is the difference between the original calculation and what we're doing now, but your calculation is correct.

To note you, I'm sorry, I believe last quarter you explicitly had said your target was 570 heads exiting 3Q, 610 for in count. So your -- looks like you're about 20 off of both. So no change to hiring plans, no change to churn or...

Yes.

Okay. And then just shifting to revenue trends. I wanted to understand the impact of the $5 million in FLS shippable bookings that you had last quarter. So my question is, did all this revenue ship in the quarter? And would it be overly simplistic to take $5 million out of your 3Q overall revenue and BIM/CIM segment revenue and put it into 2Q when we look at trends? Meaning, should we think about 3Q revenue being something like an $85 million quarter for purposes of seasonality when we're looking forward at revenue potential for 4Q?

So our operations team did a fantastic job to ship the backlog on our laser scanner products that we had at the end of the second quarter. So as I've mentioned, the 42.7% increase in sales and in construction BIM/CIM was partly driven by that fact. However, the Focus Laser Scanner serves -- could serve any of our verticals but primarily it serves the construction BIM/CIM vertical and it serves public safety forensics. So if you -- as I look at it, if you would say that about 80% of that volume is related to public -- construction BIM/CIM, you saw that's about an 18% to 19% growth rate in construction BIM/CIM. So that's how I look at it. In terms of seasonality, the best way to look at seasonality, and one of the things Simon has refocused us on is the new order bookings. So when I look at the seasonality, I see $86.9 million in first quarter for new order bookings, $89 million for Q2 and $90.5 million. So there's no reason from that to suggest we have any difference in our seasonality.

Okay, that's helpful. And then just last one for me is, looking at the Arm, can you comment on customer interest and demand trends, especially pertaining to the Quantum? And I'm curious if there was any pent-up demand given that this is a very long product refresh cycle relative to the norm. And then, by geography, if you could discuss the demand environment for Arm in general, especially focus on North America and EMEA. And I ask because I would have thought, given the new product, that your factory metrology business would have been a little bit stronger sequentially.

What's interesting about all the verticals is that it has less to do with product and more to do with headcount because our throughput in sales is limited by our ability to demonstrate. We had a very -- our FaroArm before the latest Quantum introduction was an excellent product. They're highly competitive in the marketplace to begin with. We have improved it in some substantive ways. We had a late quarter introduction of the -- of that Arm and that caused us some disruption in terms of having to requote a lot of clients who had prior received quotations on the Edge and other Arms. And so we did go in with a higher backlog of Arm shipments into Q4, but it's a little bit too early to see if the demand will increase substantively. What we have seen already though is an increase in the ASPs relating to the improved performance of the product. So I would say that we'd be -- it would be better to comment on that in the fourth quarter with regards to demand.

And our next question will come from Greg Palm with Craig-Hallum Capital.

Simon, was hoping you could maybe talk about the GVH initiative a little bit. Are you winning brand new customers? Are you penetrating markets that maybe you weren't penetrating before? Just curious kind of what sort of benchmarks you're looking at to track the success there?

Well, clearly, the increase of 50% -- over 50% in our other category, which includes public safety forensics and product design as well as the 3D machine vision, represents an important result definitely tied to the focus on those verticals and the increased FTE headcount in those verticals. The increased FTE headcount was not as expensive in the metrology vertical because of the, first of all, the size of it. It's approximately 60% of our sales. It's harder to have a significant incremental change, plus we wanted to play catch-up with our existing verticals. So a lot of the increase this year comes from the increase in headcount in the construction BIM/CIM and the other segment, as you -- as was noted, somewhere between 18% to 27%, depending on how you want to do the numbers for the BIM/CIM growth rate and then over 50% in the other. So I would say that -- I mean, we're trying to keep it very simple. It's going to be sales in each of those verticals, which are the best indicator of the top line efforts from GVH. The other element of the GVH, of course, was control of cost, and I think we're all quite proud of the newest system implementations and harmonizations that we made around the world, which caused the significant decrease as a percentage of sales of the G&A expenses, and we expect that to continue. So we regard it both from the top line as well as from our cost components of how successful we've been.

Got it. Moving on to factory metrology, piggybacking off a previous question. I'm curious, do you have any idea what the average age of the Arm is from your installed base and maybe how large that installed base is? I mean, presumably, there's got to be a very pretty replacement opportunity and then was just curious if you have the sales mix or the mix of sales for the Quantum versus the previous Arm specifically as related to Q3.

I don't have it at my fingertips, unfortunately, the average life of the products. I can say that there's a -- these are very durable products. We provide great service. And there are many out there that have been out there for decades or more. And so we -- the replacement expectation is unclear at this point. We have no -- we have insufficient evidence to speak about the Quantum Arm. What's interesting is it still represents one of our core products. It speaks to the degree of penetration of the product. It's still very linear with the amount of headcount that we have and we're working on increasing that headcount in factory metrology. I think it's important not to overplay this issue or this storyline about the product refresh or new versions of the product. We have -- our products have remained competitive throughout. And while it's important to continue to add new technological capabilities, we still believe that the primary growth consequence of our efforts is around FTE headcount, getting more demos, making more sales, exposing more people to that business, and we believe that there's still a lot of room to go. I think that we should have -- next quarter, I think we'll make an effort to have the product lifetime averages, lifetimes for the different products. I think it would be interesting for people to see just how long they are in the marketplace and we'll have that for you next time.

Can you give us any sense of maybe what the interest level for the new Arm is or feedback? I don't know whether that is a percent from leads or amount of web demos that you're doing or whatnot? But just curious if you can give us -- sort of quantify any sort of result there from the refresh.

Well, the demand has been, I would say, good. As I mentioned, it was late quarter. I think it's too early to give you a number on that. I think we can speak to that a little more in the fourth quarter. It was just too late in the quarter to allow substantive indication of what the interest level was. It was very clear that we had to requote a lot of the Arms that we had quoted for the quarter and requote them for the new Arm. A lot of new demos had to be done. And that's why I was speaking of about a 100 Arm backlog just because of the late quarter interest. It's hard to get the timing right for our new core product introduction. I'm quite delighted that we actually executed without any effect on revenue because we had to put out about 250 of them into the field just for demonstration purposes and meet the demand for production. It's interesting to note that there was a late quarter increase in the demand for our previous product, which speaks to the fact that the quality of that product, even in the prior generation, was sufficient for many people and the pricing was advantageous. So I think we can report more on the demand for the Arm next quarter.

Got it, fair enough. Last one, I wanted to just spend a few minutes on this FTE metric. I'm just -- I'm wondering if you still think that's as useful as a metric as maybe you thought when you began tracking it? I know you've changed the way you report and track that a couple of different times. But I mean, you just put up a pretty solid quarter, double-digit growth, revenue bookings, yet FTE trended down from Q2. So I'm just curious if you believe that, whether it's the ramp of new sales headcount, if that still remains kind of 12 months, or if you think that could potentially be higher than that or any other reason why maybe that metric is not of a useful indicator as you maybe initially thought?

Okay. So let me quickly change any perception you have. It is the most important indicator. What we are trying to do is figure out what's the most accurate representation of it. And we're working right now with the 12 months -- 12-month -- trailing 12-month average FTE count as a primary indicator. The information that is changing is there is a different rate of maturity in each of the verticals and there's a different dollars per FTE in each of the verticals. And as I mentioned in my talking point, there was a -- we are seeing a -- we only saw a 3% drop, which is not, in my mind, that significant, a 3% drop in the sales per FTE as the company overall, and we are seeing different changes in each of the respective verticals. We're not going to speak about those for competitive reasons, but it's very clear that the correlation is directed to FTE but the dollars per FTE is going to vary by vertical. And the maturity -- maturation rate for the FTE will vary by vertical. So as you know, we only started this approximately midyear last year, so we have very early data. But we're already starting to see significant trends in each of the verticals. I can say as just from a general point of view, the dollars per FTE, for example, in BIM/CIM is significantly higher than the dollars per FTE in factory metrology. And we're going to start to see that change. And hopefully, when we feel confident with the numbers, we'll start to report some of that so that you'll have a better indicator of how the verticals are growing. But let me be actually clear, the most important factor that we have relating to our future growth rate and our planning is around FTE and the dollars per FTE in the different verticals.

And our next question is from Jim Ricchiuti with Needham & Company.

Just wanted to go through the market verticals and the impact, this verticalization strategy, the impact that it may be having on the historical seasonality that we have been accustomed to with FARO from Q3 to Q4. I mean, if you go back a decade or so, apart from recessions, you guys have shown any -- probably mid-teens type sequential revenue growth or even better going from Q3 to Q4. And I'm not looking for specific guidance, but I'm just trying to get a sense as to this new strategy. How does that affect that seasonality that we've seen?

Well, the -- let me take a first shot at this and I've give Bob a chance to talk about it. The -- when you have a high growth rate, you have 2 combined effects. You have the seasonality that relates to the market and the manner in which budgets are used. And then over top of that, you'll have a sharp slope for sales growth. So the manner in which we try to do that is we have used quarterly proportions for orders in the past. And as we previously indicated, for example, the third quarter is around 24% of our orders in an annualized year and then 29% in the fourth quarter. What we do is we take our sales in the quarter and we annualize them based on that in order to deduce our dollars per FTE. So that's the reason why we give you our period-ending trailing 12-month FTEs, which we, as I've noted, is expected to be 535. We use the 723 sales per FTE and then we use our 29.2% seasonal to try to estimate how we will perform in the fourth quarter. And so the seasonality is still very much in play because it's around factors which are out of our control, more to do with the way companies operate in the field. European holidays, for example, in the third quarter, where most of Europe's off 1.5 months impact the third quarter and year-end budgets, of course, play a large role in the fourth quarter. So we believe that, that seasonality still should be strongly considered.

Okay. And -- go ahead, Bob.

The only thing, Jim, the only piece that I would say that adds any kind of complexity versus our prior seasonality is just that we have had a new product drumbeat, where a significant part of our revenue is the new Quantum Arm that has come out. So that will be flowing through our business. But generally, you see our typical seasonality from Q3 to Q4.

Okay. And Bob, maybe this one's for you. Fairly significant step down in the G&A expense. And I think, Simon, you even alluded to it in your opening commentary. How should we think about G&A going forward?

Internally, we're very focused, as I said, on controlling the G&A department headcount and non-payroll cost to really improve our G&A expense as a percentage of sales. If I -- we manage the business, as I mentioned, on a year-to-date trend really to measure our progress. So one quarter doesn't make a trend. But if I look at our year-to-date quarterly average G&A expense, it's about $11 million. We have quarter-to-quarter variations with certain activities, whether it's internal -- whether it's audits or whether it's any kind of activities that we're doing here to improve efficiencies, but really focused on controlling the spend, but at the same time executing those activities. I look at it going forward is our year-to-date quarterly average is about $11 million. That's what we're focused on and trying to decrease over time.

Okay. And final question, you've been very active on the -- from the standpoint of new product introductions. Should we assume that there might be some pause here, just in light of the number of products you rolled out over the past year? Or is there potentially another wave coming?

The drumbeat is just that, a drumbeat. So you will hear about new things this quarter and all of through next year. The new verticals have created a tremendous opportunity to introduce new products and to bring them in a specific fashion for each of those verticals. So it's going to accelerate, in my opinion, and we have to sustain that both through organic development as well as through acquisition.

And Simon, the new products, it's sometimes tough to gauge, how meaningful they could be? Some are more modest in scope. Can you talk a little bit about how we might think about the impact of some of these new products?

Sure. I think it's important to maybe use an example for FARO. Approximately 10 years ago, we did an acquisition of a company called iQvolution. It was a $10 million or $15 million acquisition. It was for the Laser Scanner. 10 years later, that product generated approximately a 20% internal rate of return against its acquisition and represents close to $100 million in sales and is market leading. Every one of the introductions that we're doing has a very similar potential. We introduced the VR and ER elements to the various verticals. We believe that our introductions in the -- in public safety and in construction BIM/CIM could be equally disruptive. These markets are all accelerating now. So I think they actually could have a higher rate of return than just the scanner example. We are -- we mentioned before the Vector product, which will be reintroduced in this quarter. We mentioned this before. I believe it will be extremely disruptive, the new Robo-Imager, the first collaborative inspection -- automated inspection device using collaborative robotics. Every one of these is playing into an extremely dynamic market and can have dramatic impact. One of the benefits of now having gone vertical is that each one of these are receiving the necessary market-specific focus that they need. So we expect the increases to be -- or the rate of return to be even more profound because of that very specific focus. So we're excited about all the products we're introducing. It's fair to say that some of them will be less impactful than others, but we are looking for very significant product introductions as part of our effort to transform these different industries.

And our next question goes to Mark Jordan with NOBLE Capital Market.

Like to talk a little bit about the service business. It's really been a stellar performer here for the last 4 quarters -- 4 or 5 quarters. My question is really to try to dig in a little bit deeper than just saying that margin expansion is based upon higher sales levels and focus in marketing. I guess, my question here is, given those kind of dynamics, should we assume that this business should continue to show modest top line growth on average and that the new normal here is kind of in the mid-40% range because of the sustainability of that revenue moving forward?

I believe so. It's a very important -- it's kind of the internal realization within the company that the 17,000 or 18,000, I'm not sure what the actual numbers are but it's around 17,000 installed sites around the world, constitute an enormous continuous opportunity to serve our customers and to relate and communicate with our customers. And we're introducing new apps, we've introduced knowledge bases. We're increasing the amount of interaction that we have with the clients. We are now doing active software monitoring through our online capabilities to detect the performance of our products in the field where possible. And so our engagement with the installed base is very much part of our overall focus. Whether that means selling additional warranties, accessories, additional software, training and/or even performing services on behalf of the clientele, all of these are possibilities. As the reliability of the product increases, the cost of our service decreases and we expect the margins to continue to improve unless we get some reliability bump. But I -- every effort is being made to make sure that those margins are increasing. The serviceability through design our products is improving. And so I think you should regard this -- I mean, we -- kind of mid-teens growth, usually that's related to unit count. So the unit count is going up in the teens rate. There's no reason why the service shouldn't follow. In fact, the service could exceed that because of the lack of full penetration into that 18,000 user base. So we're going to increase the penetration, increase customer engagement, increase the services and products that we provide for the clients. And we are going to continue to view the installed base as a very, very important source of the current revenue and improvement in actually new sales because of that engagement.

Question on your cash position. You mentioned that $99.8 million is overseas. Do you have an active strategy to put that to work? I mean, you've had a large international cash position for quite a while. And I guess, this is a related question. If you were to repatriate that cash, would you paying roughly a 25% to 30% tax penalty?

So currently, our premise is that we will reinvest that cash into those regions where the cash resides. If you look at that, I'd call half of our cash is in Europe, half of the cash is in Asia. Most of it is accessible to do M&A transactions to invest in our business, to grow our business. So we will look at external acquisitions that we can do in region. For instance, if you look at kind of the 7 to 8 deals that we've done, kubit was the deal that we did in the 2014-2015 time frame that came out of Germany. We purchased MWF-Technology last year, which came out of the European region. So I would say we're actively looking at ways to invest that cash within the region. If there is some sort of a tax reform, we would relook at that. But at this point in time, it's not clear what and when that will be. So that's our focus that has been and will continue to -- will be until really the legislative environment will change.

And our next question will come from Richard Eastman with Robert W. Baird.

Simon and Bob, could you just kind of maybe speak a little bit to the factory automation business, what was the order growth there relative to that 1.8% sales growth?

So we do not disclose at this point in time the orders growth versus prior year by vertical. We will do so starting in 2018. It's just we went through our process of transitioning last year our financials. I would say at this point, we did see orders growth in the order of our sales growth within -- in that vertical on a year-to-date basis. But we'll not disclose at this time the orders until we start in the start of 2018.

Let me just kind of speak to maybe the heart of the question, would be in factory automation, we have 1.8% sales growth. There is a comment that units were down there. Clearly, the market in the third quarter, I think, was much better than that. But I'm curious, are you willing to give up market share to get a higher price for the Quantum Series Arm?

As I look at the factory metrology business, I -- sorry, go ahead.

Steve -- Rick is asking about factory automation. Are we confusing factory automation and factory metrology?

No. Rick, I think you're talking about factory metrology vertical, correct?

Yes, yes. I'm sorry, yes, I did say that. But no, it's the metrology business and obviously I was kind of focused in just the timing of the release of the Quantum Arm -- yes, go ahead. I'm sorry.

So year-to-date, we're at 3% of our sales growth in the factory metrology business. And when we look at it is that the benefits of our new product drumbeat for that business has been largely in third quarter. So we released in early August our Quantum Arm, which really had limited benefits within the quarter just from a timing perspective and our general sales cycle being 4 to 6 months. So if I look at the new product drumbeat and the positive impact that it had on that vertical, I would say it's limited other than improved pricing on some of the other products that we have there. The other piece I would say is back to the headcount perspective. We -- when we looked at the headcount that we are going to add throughout this year, we put it into places where there were emerging verticals, first and foremost, which had high growth rates and high potential, and our construction BIM/CIM, which had considerable unaddressed market. So the headcount proportionately was slightly less. So you'll see less of a growth related to headcount there as well. Go ahead, Simon.

Yes. And I don't want to contradict Bob at all. I think you got it right on the second part of his answer. It's entirely tied to the FTE. It's about 60% of our business, so it's very close to our corporate dollars per FTE, which is around $720,000 annually per FTE in that vertical. And as Bob said, we increased primarily in the new verticals to try to do a catch-up in terms of the numbers of FTE that we have for what we believe is the addressable market in each of those. And as I noted in the previous answer, the Arm product we had before was quite competitive. It was a fantastic product, which remained our core product even without the refresh. We had, remember, additional accessories to it like the market-leading Laser Line Probe. We had ongoing developments with software. So it was a competitive product. This expectation that we see a bump by the introduction of a new generation of one of our core products is, I believe, unrealistic because the throughput on sales is related, as I've noted before, almost entirely to the number of feet on the street and their ability to provide demos. So we will see an increase, perhaps an improvement in the sales per FTE in factory metrology because of the higher -- slightly higher ASPs. But I would not expect there to be an increase in the factory metrology that is not commensurate with the increase in FTE. We did do some late hiring in the factory metrology and so expect the FTE count to increase in factory metrology over the next 2 or 3 quarters more substantively than before. But remember, all of our focus on hiring was in the new verticals and that's where we felt we need to play catch-up in terms of our representation in the marketplace.

I guess I understand that. But I mean, again, I'm looking at unit volumes. You don't have -- if I just look at unit volumes, you don't have fewer FTE in metrology, I wouldn't presume. But that wouldn't explain necessarily a minus 2% reduction in unit volume in metrology. So that's -- all I knew is -- yes?

Yes. We have not really -- we've not stated any change in unit volumes publicly.

Well, okay. But there's disclosure in the queue that says in the factory metrology business, unit volumes are down. Price is up. Service is up. And I'm just referencing that number and asking you if the introduction of the Quantum Arms basically put product into backlog that would have normally shift in the quarter.

Yes. That's correct. We did say all that. We did not state the percentage. That was in my comment.

And Rick, apologies for misunderstanding your question. But there was about 100 Arms that we identified in the, for example, in the fourth quarter or in the third quarter that were pushed because of the late introduction and the need for requoting.

I see. Is -- did the new Vantage products, did they grow in the quarter, unit volume?

Yes, substantively.

Yes, okay. And then just a quick question around the profitability. Perhaps you addressed this. The profitability in the other category and obviously the construction BIM/CIM category, is the decline in the profit margins there and in particular profit dollars in other, is that all due to growth investment, either FTE or new product?

Rick, what we have done over the past year is, in our hiring, we have stacked the verticals that consist primarily of the other, which is product design and public safety forensics. So it's really a dedicated sales force. So the decline in profitability that you see is the addition of those hires. And so they have now their own dedicated selling and marketing. Previously, they were kind of leveraging off other verticals. And so that was expected. That was intentional. And that is to grow those verticals.

Okay. I understand. Okay. And then just a third question. Just the selling and marketing expense quarter-to-quarter, nice work on holding that flat. But with all the new hires and the higher sales quarter-to-quarter, I'm just curious, how did we hold that flat?

So in terms of we had about $26 million quarter-to-quarter, part of that is marketing activities that just vary quarter by quarter. So the marketing activities change quarter-to-quarter. The other piece to that is that in terms of the hiring is when we're adding those types of people, we have additional expenses that come along with on-boarding. We have recruiting, et cetera. We added less people certainly in the third quarter, so those as well. So really, when you look at it, a little bit of it is transition or marketing expenses as well as just less cost in the on-boarding process to go along.

But again, the cadence of additions on the selling and marketing side, think of it as through the second quarter, the cadence continues to elevate. I would just have expected the selling and marketing expenses in Q3 to be higher than that in Q2.

Yes, I think I understand your question. So a lot of the hiring was front-end loaded. So when we talked about our increase in FTE, it's just a maturation of an existing value of sale force. So for example, the ending sales headcount in Q2 of '17, raw headcount was 627. The end of Q3, it was 635. So almost no change. And so the only increase that you'll get is the approximately 5% or 6% of commission on sales increase. So that's why it remains relatively flat.

I see, okay. And then just a last question. When I look at the product gross margin at that 61.1%, I'm trying to -- how sustainable might that be? I mean, we've got the -- maybe that's the question. How sustainable is the 61% on the product side?

Yes, it's very sustainable. In fact, I think it could increase. We are -- we have an initiative all through 2018 for significant sales -- or the manufacturing efficiencies and supply chain improvements. We also have noted in the past that because of technical superiority in all cases, that we are going to be able to increase our ASPs, which has already been evident as well. So it's our hope. And of course, the countervailing trend to that is that to remain competitive, you have to be battling around price and there's new competitors entering the field all the time. So that's the only countervailing pressure. But I believe that, that is still significantly achievable just through internal improvements as well as increases in the ASP.

And just that it's -- we've now crossed over the 9:30 a.m. U.S. Eastern Time. We're going to close questions at this point in time because trading has started in the market. We thank you very much for your coverage of -- and your participation in the call today. Thanks again.

This does conclude today's call. Thank you again for your participation. You may disconnect at any time.