Bob Seidel - CFO Simon Raab - CEO, Chairman.
Patrick Newton - Stifel Nicolaus Greg Palm - Craig-Hallum Capital Jim Ricchiuti - Needham & Company Mark Jordan - Noble Capital Markets Richard Eastman - Robert W. Baird & Co..
Good morning, and welcome to 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..
Thank you and good morning to everyone. Yesterday after the market closed, we released our financial results for the third quarter and first nine months 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 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 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. We ended the second quarter of this year mark 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 products and marketing to better meet their needs. In addition, we undertook a harmonization effort to realign all business processes in our three regions to achieve synergy and efficiency and slow the growth in G&A.
The effort to increase our sales growth to the mid-teens increased gross margin through technical leadership and slowed the growth in G&A is essential to achieve our objective to increase the operating margin to the mid-teens by 2019.
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 the 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 may deliver the 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 returned to a quarterly operating income in the third quarter after two 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 providing time and training to mature those startup sales hires into full-time experience or FTE sellers.
At the end of the first quarter of this year, we communicated that we will 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 sale -- 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 in emerging verticals to achieve a 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 and sales FTE metrics 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 2017 was 548.
The difference between our period ending gross sales headcount and FTE headcount represents startup sales headcount of 87, 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 startup sales headcount costs is estimated at approximately $7.4 million in selling expenses. As previously noted, the results of Q3 and Q4 of this year provide an indication of the success for 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%, 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 per 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 it 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 sellers 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 tradition and effectively train our customers to see the advantages of our custom web-based demonstration methods.
With our transition to vertical markets, we completely redesigned our FARO Web site to focus prospective customers first on applications in all verticals and only then on product. The new Web site was released in mid-August and operates in 16 languages and its installed in a more reliable faster acting web infrastructure.
The new Web site enhances the user experience and better guides prospective customers to become active opportunities. We're not realizing higher click through rates, since we upgraded and its included access points to our sense of knowledge base, as well as unifying our software upgrade interface.
We encourage all of you to visit our Web site and learn more about the next generation application available in the various verticals. Over the past year, we’ve exceeded 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 S150 and S350, and in January and august we released the new high-value M70 and S70 laser scanner models. In January, we released our completely new laser tracker line, including the Vantage S, and E in third quarter of this year.
We released our new technology leading Quantum M and S FaroArms. The quantum FaroArms is the most accurate portable and rugged FaroArms that we've ever produced. This new generation of product 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’ve 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 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 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. Thus most importantly in Factory Metrology, Construction BIM-CIM, and Public Safety Forensics.
The potential is enormous for increased efficiencies and exciting new R and ER 3D application and FARO was committed to leading that evolution.
FARO is 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 its renowned [indiscernible] safety certification.
This is particularly the 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 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 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 a marked improvement in our service margin as a result of higher service revenue.
Selling and marketing expenses were $26.0 million for third quarter 2617, 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 and 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-payable costs. As a percentage of sales, general and 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 early -- higher quarter rate than 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 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 a 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 healthy measure of our progress. I’d like to highlight our performance in several key financial metrics for the first nine months of 2017 compared with the first nine 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 startup 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 were 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'll now open the call for your questions..
[Operator Instructions] And we will take our first question from Patrick Newton with Stifel. Please go ahead..
Hey, good morning, Simon and Bob. Thank you very much for taking my questions. Jumping right in, I think on the FTE headcount, if I heard you correctly, you said 548 exiting the quarter 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 that do I my math correctly.
And then, secondly, if -- is the metric trailing your target due to increased churn of your sales, slower hiring rates or some other variable?.
Well, the -- good morning, Patrick, and 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-month now, and it seems to be a better indicator.
And so maybe this is the difference between the original calculation of what we were doing there, but your calculation is correct..
To note, I’m sorry, I believe last quarter you explicitly had said your target was 570 heads exiting 3Q, 610 for end count, so your -- it looks like you’re about 20 off of both, so no change to hiring plans, no change to turn -- okay.
And then just shifting to revenue trends, I wanted to understand the impact of the $5 million in FLS shippable bookings that you have 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 in 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 that 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 mentioned, the 42.7% increase in sales and 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 about 18% to 19% growth rate in construction with 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 thing Simon has refocused us on is the new order bookings.
So when I look at the seasonality I see 86.9 in first quarter for new order bookings, 89 for Q2 and 90.5. So there's no reason from that to suggest we’ve 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've thought given the new product that your Factory Metrology business would've been a little bit stronger sequentially..
So 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 is -- in sales is limited by our ability to demonstrate. We had a very -- our FaroArms before the latest Quantum introduction was an excellent product, 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 it calls 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 where we have seen already there was an increase in the ASPs relating to the improved performance of the product. So I would say that it would be better to comment on that in the fourth quarter with regards to demand..
Great. Thank you for the details, Simon. Good luck in the quarter..
Thank you..
Thanks, Patrick..
And our next question will come from Greg Palm with Craig-Hallum Capital. Please go ahead..
Good morning. Thanks for taking my questions. Simon, I was hoping you could maybe talk about the GVH initiative a little bit. Are you winning brand-new customers or you penetrate in markets that may be 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 extensive in the metrology vertical, because of the -- first of all, the size of that is -- its 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 and a lot of the increase this year comes from the increase in headcount in the Construction BIM-CIM and the other in the other segment, as you -- as was noted somewhere between 18% and 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 are 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 costs.
And I think we are all quite proud of the newest system implementations and harmonization that we made around the world, which cost a significant decrease as a percentage of sale of the G&A expenses, and we expect that that to continue. So, we regarded 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 may be how large that install base is? I mean, presumably there's got to be a pretty big replacement opportunity.
And then, just curious if you have the sales mix or the mix of sales for the Quantum versus the previous arm, specifically as it related to Q3?.
I don't have it at my finger tips. Unfortunately the average life of the products, I can't say that there's a bit of both -- these are very durable products. We provide great service and there are many of that 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 will make an effort to have the product life -- 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 will have that for you in the 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's -- it's a percent from leads or amount of web demos that you’re doing or whatnot, but just curious if you can give us or quantify any sort of result there from the refresh?.
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 could speak to that a little more in the fourth quarter. It was just too late in the quarter to allow a 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. We requote them for the new arm, a lot of new demos had begun and that's why we are speaking about 100 arm backlog just because of the late quarter interest. It's hard to get the timing right for a 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 useful as a metric, because maybe you thought when you begin tracking it. I know you’ve changed the way you report and tracked at 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 a 12-month, or if you think that could potentially be higher than that or any other reason why maybe that metric is not of a useful as indicators you maybe initially thought?.
Okay. So let me quickly change any perception you have, it is the most important indicator. What we're trying to do is figure out what's the most accurate representation of it and we are 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 points, there was -- we are seeing -- 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 are 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 verticals. So as you know we only started this approximately midyear last year.
So we have a very early date, but we’re already starting to see significant trends in each of the verticals. I can say 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 will start to report some of that, so that you'll have a better indicator of how the verticals are growing.
But let me be absolutely clear, the most important factor that we have relating to our future growth rate and are planning is around FTE and the dollars per FTE in the different verticals..
Got it. Appreciate the color. Good quarter overall. Thanks..
Thanks, Greg..
And our next question is from Jim Ricchiuti with Needham & Company. Please go ahead..
Good morning. Just wanted to go through the market verticals and the impact of 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 expect that seasonality that we've seen?.
Well, the -- let me take a first shot at this and I will give Bob a chance to talk about it. When you have a high growth rate, you have two combined effects. You have these seasonality that relates to the market and the manner in which budgets are used, and then over top of that you have a sharp slope for sales growth.
So the manner in which we try to do that is we have used the quarterly proportions for orders in the past. And as we’ve 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 is off for month and a half, 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 -- Okay, Bob..
The only thing, Jim the only piece I would say that has any kind of complexity versus our prior seasonality is just that we have had a new product drumbeat. We were -- 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 and 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 trends really to measure our progress, one quarter doesn’t make a trend.
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 audit or whether it’s any kind of activities that we're doing here to improve efficiencies, but we are really focused on controlling the spend, but the same time executing those activities.
I look at it going forward as our year-to-date quarterly average is about $11 million. That’s what we’re focused on 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’ve rolled out over the past year, or is there potentially another wave coming?.
The drumbeat is just the drumbeat. So you will hear about new things 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’ve to sustain that both through organic development as well as through acquisition..
And, Simon, the new products its 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 in sales and is market-leading. Everyone of the introductions that we're doing have a very similar potential. We introduced the VR and ER elements to the various verticals.
We believe that our introductions in public safety and in construction BIM-CIM could be equally disruptive. These markets are all accelerating now, so I think they’re actually going to have a higher rate of return than just the scanner example.
We are -- we mentioned before the vector of products which will be reintroduced in this quarter, we mentioned it before. I believe it will be extremely disruptive that the new Robo-Imager, the first collaborative inspection, automated inspection device using clever robotics.
Everyone 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 increase has to be -- the rate of return to be even more profound, because of that very specific focus.
So we are excited about all the products we are introducing. It's fair to say that some of them will be less impactful than others. But we're looking for a very significant product introduction as part of our effort to transform these different industry..
Okay. Thank you..
And our next question goes to Mark Jordan with Noble Capital Markets. Please go ahead..
Good morning, gentlemen. I'd like to talk a little bit about the service business. It's really been a stellar performer here for the last four quarters -- four or five quarters. My question is really to try to dig in a little bit deeper than just saying that the margin expansion is based upon higher sales levels and focused in marketing.
I guess, my question here is given those kind of dynamic, 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 number is, 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 are 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, we -- 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 products increases, the cost of our service decreases, and we expect the margins continue to improve unless we get some get reliability bump. But every effort is being made to make sure that those margins are increasing. The serviceability through design of our products is improving.
And so I think you should regard this -- I mean, if we have mid-teens growth, usually that's related to unit count. So the unit count is going up in the teens rate. There is no reason why the service shouldn’t fall. 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 recurring revenue and an 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 had a large international cash position for quite a while, and I guess, it's a related question, if you were to repatriate that cash which you would be paying roughly a 25% to 30% tax penalty?.
So currently our premise are not policies that we will reinvest that cash into those regions where the cash resides. If you look at that, call half of our cash is in Europe, half of the cash is in Asia. Most of it is accessible to do M&A transaction, to invest in our business to grow our business.
So we will look at it -- external acquisitions, that we can do in region. For instance, if you look at kind of the 70 deals that we’ve done, [indiscernible] was the deal that we did in the 2014, 2015 timeframe that came out of Germany. We purchased MWF-Technology last year, which came out of the European region.
So we will 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 -- we look at that. But at this point, time is not clear what and when that will be. So that's our focus that has been and we will continue to -- will be until, so really the legislative environment will change..
Thank you very much..
Sure..
And our next question will come from Richard Eastman with Robert W. Baird. Please go ahead. Your line is open..
Yes, good morning..
Good morning, Rick..
Simon and Bob, could you just kind of maybe speak a little bit through the factory automation business, what were still order growth there relative to that 1.8% sales growth?.
So, we’ve not disclosed 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 financial. 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 will not disclose at this time the orders until we start in -- the start of 2018..
Well let me just kind of speak to maybe the heart of the question would be, in fact to automation we’ve 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 Factory Metrology business, I -- go ahead..
Rick is asking about factory automation.
Are we confusing in factory automation and factory metrology?.
No, Rick I think you’re talking about factory metrology vertical, correct?.
Yes. So, yes, I did say that, but it's a metrology business and obviously I was kind of focused in on just the timing of the release of the Quantum arm ….
Okay..
Yes, go ahead. I’m sorry..
So, year-to-date we are at 3% of our sales growth in the factory metrology business. And when we look at it is that the benefits of our lead products from the metrology business has been largely in the 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 impacts that it had on that vertical, I would say its 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 were going to add throughout this year, we put it into places where they were emerging verticals first and foremost, which had high growth rates and high potential and our construction BIM-CIM which had a considerable unaddressed market.
So the headcount proportionately was slightly less, so you will see less of a growth related to headcount there as well. Go ahead, Simon..
Yes, and I don't want to contradict Bob, but I think you got it right on the second part of his answer. It's entirely tied to the FTE. The -- its about 60% of our business, so it's very close to our corporate dollars per FTE, which is around $720,000, let's say, annually for 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, our product we had before is quite competitive.
It was a fantastic product, which remained our core product even without the refresher. We had -- remember, additional accessories too is likely market-leading laser line pro, we have ongoing developments with software. So it was a competitive product.
This expectation that we see above by the introduction of a new generation of one of our core products is, I believe unrealistic, because the throughput of sales is related as I've noted before, almost entirely to the number of feed on their street and their ability to provide demo.
So we will see an increase, but perhaps an improvement in the sales per FTE and factory metrology because of the higher -- slightly higher ASPs. But I would not expect there to be an increase in factory metrology that is not commensurate with the increase in FTE.
We did do some late hiring in the factory metrology, and so we expect the FTE count to increase in factory metrology over the next two or three 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. That's -- [technical difficulty], yes..
Yes, we’ve not stated any change in the unit volumes publicly..
Well, okay. But there's disclosure in the Q, that says in the factory metrology business unit volumes are down, prices up, services up, and I’m just referencing that number and asking you ….
Correct..
… if the introduction of the Quantum arms basically put product into backlog that would have normally shipped in the quarter..
Yes..
Okay. So thank you..
That’s correct. We did state all that. We did not state a percentage, that was my comment..
And Rick apologies for misunderstanding your question, but it was about 100 arms that we had identified in the -- exactly 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 there decline in the profit margins there and particular profit dollars in other? Is that all due to growth investment either FTE or new product?.
We’ve done over the past year is, in our hiring we have that the verticals that consist primarily of the other which is Product Design and Public Safety Forensic. 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 on the verticals. So that was impacted, that was intentional and that is to grow those vertical..
Okay. I understand. Okay. And then just a third question.
Does 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 are varying quarter-by-quarter, so the marketing activity 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 a recruiting etcetera. We added less people certainly in the third quarter, so those as well.
So, really when you look at it, a little bit of this transition are marketing expenses as well as just less costly on boarding process [indiscernible]..
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 the question. So a lot of the hiring was frontend loaded. So when we talk about our increase in FTEs, just a maturation of an existing body of sales force. So for example the ending sales headcount in Q2 '17, raw headcount was 6.7. At the end of Q3 it was 635, so almost no change.
And so the only increase that you 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 the 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 -- maybe that's the question, how sustainable is that 61% on the products are?.
Yes, it's very sustainable. In fact, I think it will increase. We are -- we have an initiative all through 2018 for significant sales or the manufacturing efficiency and supply chain improvement.
We also have noted in the past that it does have technical superiority in all cases that we are going to be able to increase our ASPs, which is 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 was new -- there is new competitors entering the field all the time, so that’s only countervailing pressure. But I believe that is still significantly achievable, desperate through internal improvements as well as increases in the ASP..
Right. Okay. Well, thank you very much..
Thank you, Rick. And just [indiscernible] we’ve now crossed across over the 9:30 AM US Eastern Time, we're going to close questions at this point of 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..