Bob Seidel – Chief Financial Officer Simon Raab – Chairman and Chief Executive Officer.

Greg Palm – Craig-Hallum Capital Group Jim Ricchiuti – Needham & Company Hendi Susanto – Gabelli & Company.

Good morning, everyone, and welcome to FARO Technologies’ Conference Call in conjunction with its Q3 2018 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, everyone. Yesterday after the market closed, we released our financial results for the third quarter and first nine months of 2018. The press release is available on FARO’s website at www.faro.com.

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, intent, 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, 2017 and Form 10-Q for the quarters ended March 31, 2018, June 30, 2018 and September 30, 2018.

During the third quarter of 2018, we made changes to our verticals and reporting segments. We created a new vertical name photonics reflecting the roll up of three acquisitions dedicated to light steering technology and included this emerging business as a part of our emerging vertical segment.

With the recent acquisition of open technologies, we elected to rename our former product design vertical to 3D design in order to better reflect the nature of the applications.

During our prepared remarks today, we will reference certain non-GAAP financial metrics in order to provide you with financial measures more reflective of the underlying performance of the business.

We do not intend for these non-GAAP financial measures to be considered in isolation or as a substitute for financial information provided in accordance with GAAP. These non-GAAP financial metrics are reconciled to GAAP metrics in yesterday’s earnings press release.

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

Thanks, Bob, and good morning, everyone. We continue to pursue our performance goals for the end of 2019 of mid-teens sales growth, gross margin at 60% or greater and mid-teens operating margin.

Sales growth is driven by systematic increase in the number of sales and marketing employees and the introduction of market leading products in our chosen verticals. Sales into new worldwide markets are driven by investing in a clearly stated mission, aggressive sales representation and the values of performance driven product strategy.

Gross margin is driven by attention to manufacturing costs and efficiencies and pricing driven by clear market leading value propositions. Operating margin is driven by minimizing operating costs through the implementation of leading technology platforms and a culture of constant improvement in all processes.

We are actively pursuing all elements of these imperatives in our strategic efforts. FARO’s extraordinary challenge is the worldwide delivery of advanced 3D solutions in multiple chosen markets. Our chosen verticals of 3D Factory, Construction BIM, public safety forensics, 3D design and photonics are all being transformed by 3D technology.

We deliver our products in 10 or more languages and support our users with training and service representation around the world. FARO’s market ambitions present unique challenges to product development, manufacturing, sales and support. Our mission is aggressive for our size.

However, we are fast approaching the size where economies of scale can leverage our sales along with our infrastructure to serve our large addressable and developing markets with growing profitability. The 3D revolution is penetrating all elements of the economy does providing FARO and immense opportunity for future growth and profitability.

The FARO team is making great progress in achieving our goals at every level. Sales are growing year-to-date at 14.3% compared to the prior year. This is the result of a strong year-to-date growth at 10.5% in our most established vertical 3D Factory Metrology representing 66% of sales.

15.6% growth in Construction BIM representing 24% of sales and 41% growth in emerging verticals comprising public safety, 3D design and photonics together representing 10% of sales. Product sales, which comprised 76% of total sales has a gross margin of 60% year-to-date and service revenue, which comprises 24% of our sales has a gross margin of 44%.

The service margin is benefiting from attention to improve processes and product reliability. Combined we are approaching our growth margin goal of 60% overall. We expect to reach our 60% or greater gross margin goal in the coming quarters. FARO has a direct selling and marketing force of 785 employees worldwide.

This quarter, there was a reduction in selling and marketing expenses as a percentage of sales by 0.9 points and the trailing 12 months orders per FTE was once again increasing over the first quarter as all the new hires begin to reach maturity and products and processes improve.

We have increased sales by 14.3% year-over-year, while increasing the salesforce by only 11.3% year-over-year, a 3% increase in sales efficiencies.

The direct salesforce puts us in charge of our destiny and is essential to the missionary work of bringing our disruptive 3D products in important new verticals for which there are no established conventional channels.

We are optimizing our marketing and sales activities and expect to hold the 2018 marketing expenses constant in absolute terms in 2019. We also intend to further increase our sales personnel by 15% with emphasis on the fastest growing verticals.

G&A expense dropped as a percentage of sales on a year-to-date basis by 0.9 points, showing the process benefits of our complete reconstruction of the IT platform and business processes to support our current growth. It is our intention to maintain our 2018 G&A expense constant in absolute terms through 2019.

The R&D organization has performed magnificently this year with a total of 14 market leading product introductions, while decreasing as a percentage of sales on a year-to-date basis by 0.3 points.

It is also our intention to keep our 2018 R&D expense constant in absolute terms through 2019, while continuing to efficiently support the verticals with market leading product improvements.

In 2019, the increase salesforce improved sales efficiency, expanding gross margins and reductions in G&A and R&D as a percentage of sales will support the profitability improvements designed to achieve our corporate objective of mid-teens operating margin by the end of 2019.

Thank you all for your attendance today and particular thanks to all our employees worldwide for the tremendous effort on behalf of our shareholders. I’ll now turn the call over to Bob..

Thank you, Simon. Sales for the third quarter of 2018 were $99.7 million, an increase of 10.5%, compared with $90.3 million for the third quarter of 2017.

This increase was primarily driven by higher unit sold in average selling prices across all segments, highlighted by 17.4% year-over-year sales growth for Asia-Pacific region, which represents a significant increase compared to the trailing two quarters.

We entered the third quarter last year with additional order backlog of approximately $5 million between Construction BIM and public safety forensics, as the demand for our new focus laser scanner models exceeded our production capacity at that time.

We shipped this additional backlog in the third quarter last year, which shifted the timing of our quarterly sales with the third quarter in 2017 driven higher than our typical seasonality.

Normalizing for these unique higher backlog shipments in the prior year period, our sales growth would have been mid-teens for the third quarter of this year consistent with year-to-date sales growth of 14.3% and our long-term objective.

New order bookings increased by $10.0 million, or 11.0%, to $100.5 million for the third quarter of 2018 from $90.5 million for the third quarter of 2017.

With new order bookings of $100.5 million and sales of $99.7 million, our book-to-bill ratio was 1.01 for the third quarter of 2018, which is consistent with our book-to-bill ratio for the same prior year period.

With our trailing 12 months, new order bookings of $413.7 million and sales FTE headcount of 586, our trailing 12 months orders per sales FTE metric was approximately $706,000, up $8,000 from first quarter of this year and same as prior quarter.

It is our priority to continue an upward trend in this metric in order to drive operating leverage of our sales force investment. In our 3D Factory segment, sales for the third quarter of 2018 were $64.2 million, an increase of 9.7% compared with $58.5 million for the third quarter of 2017.

This increase was mostly driven by higher unit sold and average selling prices, as well as continued growth in service revenue. This segment reported strong quarterly sales growth from our Asia Pacific region after more modest growth in the trailing two quarters.

In our Construction BIM segment, sales for the third quarter of 2018 were $23.7 million, an increase of 4.2% compared with $22.8 million for the third quarter of 2017.

As I mentioned earlier, Construction BIM sales in the third quarter last year represented an exceptionally strong comparison period with uniquely high order backlog entering the quarter and being shipped in the quarter. For 2018 year-to-date, Construction BIM sales increased 15.6% year-over-year.

In our Emerging Verticals segment, sales for the third quarter of 2018 were $11.8 million, an increase of 31.7% compared with $9.0 million for the third quarter last year, primarily due to higher unit sold as our dedicated sales headcount investments are delivering new opportunities in previously unaddressed markets.

During the third quarter of 2018, we performed an analysis of our inventory reserves in connection with our recent new product introductions and acquisitions and recorded a charge of $4.7 million, or approximately 5% of total inventory, increasing our reserve for excess and obsolete inventory based on the determination that quantities on-hand for certain legacy products exceeded our revised sales projections.

Gross margin was 52.5% for the third quarter of 2018, compared with 57.7% for the third quarter of 2017, mainly driven by the increase in our inventory reserve, the product mix of used demo sales, and lower service margin.

Excluding the $4.7 million increase in our inventory reserve, gross margin would have been 57.2%, down 0.5 percentage points compared with the same prior year period. Product mix unfavorably impacted our underlying gross margin compared with trailing quarters.

Starting in the fourth quarter, our products entering China will be subject to an import tariff. The impact of this tariff cannot be determined fully at this time. Selling and marketing expenses were $27.8 million for the third quarter of 2018, an increase of 7.0% compared with $26.0 million for the third quarter of 2017.

This increase was driven mostly by expansion of our sales force and higher sales commissions due to our sales growth. Selling and marketing expenses as a percentage of sales decreased to 27.9% for the third quarter of 2018 compared with 28.8% for the same prior year period.

For the second consecutive quarter, we delivered a reduction in selling and marketing expenses as a percentage of sales compared with the same prior year period. At the end of the third quarter of 2018, our ending sales headcount was 707, an increase of 72 or 11.3% compared with 635 at the end of third quarter of 2017.

As communicated in our fourth quarter earnings call, we plan to increase our ending sales headcount by approximately 100 or between 15% to 20% during 2018 in equal increments by quarter.

At the end of the third quarter of 2018, we were in line with this projection by increasing our ending sales headcount by 76 compared with the end of the fourth quarter of 2017. General and administrative expenses for the third quarter of 2018 were $12.5 million, an increase of 21.2% compared with $10.3 million for the third quarter last year.

This increase was driven mainly by an increase in headcount and professional advisory services related to our recent acquisitions and associated business integration activities. As a percentage of sales, general and administrative expenses increased to 12.5% for the third quarter of 2018 compared with 11.4% for the same prior year period.

For 2018 year-to-date, general and administrative expenses as a percentage of sales decreased by 0.9 percentage points to 12.0% compared to prior year. Research and development expenses were $10.0 million for the third quarter of 2018, an increase of 10.6% compared with $9.0 million for the third quarter of 2017.

This increase was mainly driven by higher engineering headcount related to our acquisitions and activities to accelerate our new product development. Research and development expenses as a percentage of sales were 10.0% for both the third quarter of 2018 and 2017.

For 2018 year-to-date, research and development expenses as a percentage of sales decreased by 0.3 percentage points to 10.1% compared to prior year. Net loss was $2.5 million or loss of $0.15 per share for the third quarter of 2018, compared with net income of $1.6 million or $0.10 per share for the third quarter of 2017.

Excluding the $4.7 million increase in our inventory reserve, earnings per share would have been $0.09 per share. Our third quarter of 2018 year-to-date financial performance demonstrated marked improvements over prior year. Our new product drumbeat and expanded sales force delivered 14.3% year-to-date sales growth versus prior year.

Excluding the $4.7 million increase in our inventory reserve during the third quarter, our gross margin would have increased by 2 percentage points to 58.0% and our earnings per share would have increased by $0.40 per share to $0.19 per share compared with the same prior year period.

At the end of the third quarter of 2018, cash and short-term investments totaled $135.0 million, of which $71.4 million was held by foreign subsidiaries. Cash flow from operations for 2018 year-to-date was $4.9 million, an increase of $5.7 million, compared to cash used in operations of $0.8 million for the first nine months of 2017.

A more complete presentation and discussion of our third quarter of 2018 results is available in our Form 10-Q for the quarter ended September 30, 2018. We deeply appreciate the support of our shareholders and the hard work of our employees around the world.

Thank you for your attendance on today’s call and we will now open the call for your questions through the start of market trading..

[Operator Instructions] And we’ll go ahead and take our first question from Greg Palm with Craig-Hallum Capital Group. Your line is now open..

Yes, good morning. Thanks. Maybe start with the some commentary on the overall demand environment that would be helpful from a geographic standpoint and maybe from an end market standpoint as well. Anything that you’re seeing or feeling that that’s different than maybe last quarter..

Well, what are the changes we saw in the third quarter versus the prior two quarters I commented one was a strong increase in our sales growth in Asia-Pacific. We sold that across the segments, but most particularly our 3D Factory.

We saw nice demand coming out of China across all products and one of the things to note in our third quarter is our unit sold were higher than prior year across every one of our segments. Then from America’s perspective, it was fairly stable from the last three quarters. So we’ve had a nice trailing three quarters in our America segment.

Europe was slightly weaker at the end of the quarter. If you adjust that for FX, its still high-single digits, but certainly we saw little bit of weakening in Europe.

And as we churn forward go from a vertical perspective, we’ve seen a very nice year kind of within the range we’re expecting from our 3D Factory segment, a good quarter in Q2 and a solid quarter in Q3. The 4% that you saw in third quarter in Construction BIM, that was related as we talked about last year the order and new product development.

And then in terms of the emerging verticals, we’re above that 30% consistently in a very nice year-to-date.

I mean we’re looking forward to the fourth quarter from the perspective of we have new products that we put out there, eight new products in the last – in this last quarter, and certainly, the sales people that we’ve hired and the growing FTE number..

Okay, that’s helpful. Maybe it’s a good segue to my next question. Any sizable contribution from new products specifically in Q3 and I’m talking more along the lines of the newer platforms and really would be interested in knowing how the feedback has been so far from the customer base..

So the feedback that I’ve gotten from the sales teams that I’ve talked to most specifically is there is a lot of excitement from our customer base and from our sales team on our eight-axis. This really provides some time advantages to those customers that use our product. It will be mainly sold as a necessary.

So it’s not necessarily significant revenue driver, but we saw some sales of it in Q3 and I would expect as we do demos in Q4, you would see that addition. In terms of the 6DoF Tracker that we released at the start of October, that’s something we’ve been looking forward to that’s something our sales teams in 3D Factory are very excited about.

But certainly did not have an impact in the quarter, it may take several quarters till that gets out in the field and starts to demo. The last new product I’ll kind of talk to is the Scan Plan developed through our FARO labs group. This has applications in public safety forensics, Construction BIM, could be for interior design.

Again that was released in the quarter. It takes a demo process to get out there, but certainly as we released that new product, we have quite a bit of interest and it has a great opportunity in the market for us as we go into Q4 and also go into 2019..

Right. I’ll hop back in queue. Thanks..

And we will take our next question from Jim Ricchiuti with Needham & Company. Your line is now open..

Hi, thank you. Good morning. I just wanted to go back to gross margins. So even if we adjust for the inventory reserve looks like your gross margins, at least going back over the last several quarters are at a lower level and I’m just wondering you alluded to mix, but I’m also thinking you had a number of new product introduction.

So how do we think about the various puts and takes with respect to gross margins?.

Well, one of the – this is Simon, thanks for the question. One of the side effects or collateral damage, if you will of introducing such a large number of new products is that we are presented with a large number of demo products that are legacy at that point. So we had to move a lot of that material.

In fact, the reserve we took is in I mean large part demo equipment. So that drops the pricing and drops the margin during these changeover periods.

So we’re not going to see that effect at that – to that degree going forward, because all the products now are at the market leading position that they needed to be and they’re very happy about finally getting there. So we expect that to bounce back.

I think that there was a little disappointment around the service margins are dropping, but a very focused effort on that it is being taken and we expect that to come back up as well.

So we believe it’s a blip really just relating to our introduction of so many new platforms, which then constituted significant certified pre-owned product challenge for the company, which we are getting through..

And Jim just to kind of quantify that for you to help you understand or underlying margin as we see it. If you look at the third quarter, the mix of our demos sales decrease our gross margin versus a trailing quarters and prior quarter by about 1%.

So if I look at that, we were at 57.9% in the first quarter, 58.7% and that would’ve put us excluding the reserve in that low 58% as well for the third quarter. So that’s just quantifies it for you..

Okay, that’s helpful. I’m just shifting to I guess the hot button for everyone is tariffs and China, you showed good growth in Asia-Pacific. We don’t know how big a market China is for you, but I guess it’s fair to say it is one of your bigger markets.

So two questions relating to that, was there any, do you think – has there been any pre-buying ahead of this? And secondly, your competitor is not facing the same types of pressures with respect to tariff.

So how do we think about the outlook for China going forward for you?.

So in that regard obviously it’s hard to know if there was pre-buying that could be part of the increase over the – 17% increase that we mentioned with regards to APAC. But I would point out that most of our competitors also produced product outside of China. I mean there may be some smaller elements that are produced in China.

So I think we’ll all be facing a similar pressure. And I think the bigger impact will be the fact that we have the leading generation product with the highest value propositions. So all of our products are generational leading in the technology, which means that we – our ASPs in fact are going up.

And in that context, I think we will remain still competitive in APAC and in China..

Okay, thank you..

Thank you, Jim..

[Operator Instructions] We will take our next question from Hendi Susanto with Gabelli & Company..

Good morning, Simon and Bob..

Good morning..

Good morning, Hendi..

Along with similar line with discussion on China that Jim brought up, some companies talk about higher labor and material costs.

Can you share some colors on those areas?.

The comments that I would share is from a material cost perspective, excluding the tariffs, that’s not really a factor in China for us, just because of our manufacturing footprint.

I would expect that we will have manufacturing cost pressures from the raw materials perspective with the tariffs on a limited basis with several of our products overall globally. More specifically to the labor in China, what we are seeing across the board, whether it is administrative, finance, accounting, IT, labor, it is going up.

And so we are having escalates certainly, our labor costs higher than in maybe other regions you see. So for us, we have a significant presence in Shanghai, that is pressuring for us that G&A costs, as well as the other administrative functions, selling and marketing,.

And then any estimate, how much of an impact that could be?.

I mean, for us, China is our number two market in Asia. And so, we would hope to kind of absorb those costs, but certainly that does have pressure on our G&A. Simon did comment that our G&A costs, we’re planning to hold those constant in 2019.

So we will have to look through ways to offset merit increases and other cost increases through our FARO best lean initiatives..

Got It. And Bob, can you share revenue contribution from recent acquisitions and will you be able to share revenue run rates of your tool last acquisitions landmark at Open Technologies..

So the financial contribution of our recent acquisitions were not significant for us in the overall financial results for the quarter. So we did not disclose this separately in the course of the queue for the call.

We did realize some incremental expenses in the quarter, Hendi, relating to the acquisition and integration process, mostly in G&A, as well as some ongoing expenses such as headcount and infrastructure. But as we talked about in last quarter’s call, Simon had mentioned most of these, you would start to see the growth more in 2019.

And if they become – an one-way become more significant we would point those out. But in terms of the quarter, they would not significant to our overall financial results..

Hendi, I would also add that, almost all the acquisitions are really technology bolt-ons, as I believe the term. Often used, where their technology becomes integrated into our product lines and the acquisitions are made to mitigate technical risk and they’re not really won’t be standalone or have a product line that standalone going forward.

So it’s going to be difficult to measure that..

Got it. Okay, thank you..

And we will next take a follow-up question from Greg Palm. Your line is now open..

Yes, thanks for the follow-ups. First, higher ASPs, that’s been a big driver of growth and somewhat to margins also over the past three to four quarters. So I’m just curious how you feel about that going forward, as you start anniversary and some of those first initial bumps..

My look of it would be that one of the primary drivers for us of the higher margins, certainly comes from two places. It is ASPs, as you mentioned, the other is our operations team has done extensive work to really improve our manufacturing efficiencies, which I expect will continue as we go into 2019.

The ASP impact year-over-year will become less, certainly once we get into 2019 as that Quantum ARM, kind of anniversaries. So as we go forward, if you say we’re at a 58 right now and how do we get the 60 is the real question.

Certainly, Simon commented on the service margins, we’re looking at ways to increase that service margin to fifth year and beyond. And the other piece is certainly as we continue with bringing out new products.

We will look to bring out products with higher margins and also continue to work on our manufacturing efficiencies and the raw material cost content of our products. So, in terms of the work from here, it’s really focused on efficiencies and the additional products that we could bring out to deliver higher margin..

Okay, makes sense. And on sales and marketing, I just wanted to spend a minute on that. I was surprised even with the increase in headcount that from a dollar standpoint, it was little over $2 million lower in Q3 sequentially.

And I think, Simon, I think your commentary to suggest that you’re attempting to hold that from a dollar standpoint, steady in fiscal 2019 versus fiscal 2018, even though you expect to increase headcount again next year. So in terms of efficiencies and productivity, what exactly is going on there that you feel comfortable with that..

Greg, it’s important for me to clarify the point I made there. I was actually referring only the marketing, I believe, I said marketing expenses. So clearly, we have a fixed expense – fixed and variable expense of related to the addition of any new salesperson.

So the selling expenses will go up commensurate with the 15% increase higher than we talked about. Where we did save the money is that we were looking at the processes and expense, efforts around each salesperson’s efforts. And so we are trying to be more efficient about our travel and more efficient about various other expenses relate to demoing.

We also have an improvement in the number of demos that are being done through the web demo studios. In all, that’s what resulted in the reduction of expenses. So I was referring to the marketing expenses, which we expect to keep a flat for 2019. And that generally represents anywhere from 4.5% to 5% of sales historically..

Got It. Thanks for the clarification, appreciate it..

Sure..

[Operator Instructions] And we will take another follow-up from Jim Ricchiuti. Your line is now open..

We’ve been hearing commentary of slowing in the global automotive market. So I’m wondering what you guys maybe seeing in that vertical.

Are you seeing any change in demand or in purchasing decisions?.

Jim, certainly yesterday some of the announcements that you saw from General Motors and previously intimated by Ford on some of the cost cutting measures that they’re taking for the tariffs related, certainly raised concern here.

But in the same token, where we’re looking for as we’re doing our demos, we have recaps that look strong for the fourth quarter. We’re executing those demos. And for us, we’re following the same process. The last three quarters have been strong from automotive group, from Americas, Europe, Asia.

So there’s no reason this time to say based on the leads, based on the opportunities, based on the demos that we’re currently conducting, that we would see any real change. Certainly, this business as well that it comes down to the end of the quarter. So we’ll see at the end of the quarter.

But for right now, they need those products to increase their quality, to increase their efficiency and certainly, that’s what we’re focused on..

That’s helpful. Can I also ask a question about Vector? I wonder if you can give us an update on where we stand with that. I think you had talked about possibly having an announcement in Q4 and potentially some beta testing in the early part of next year.

Where are you with respect to that?.

We’re still very much on track. We’re already working on the next generation as well. So we have the current generation, which is what you’re speaking and with respect to this quarter and early next quarter. And we’re very excited about where the technology has taken.

And so we’re already working on the next generation of that product for introduction later in 2019. We still hold that in extremely high potential disruptive piece of equipment. And there’s no reason to doubt our current schedule at this time..

This time you have been having conversations with customers about potential beta sites.

Would it be a handful of customers? Is that the plan?.

Yes, yes, absolutely. So we have the Vector, we introduced under the – what are – what we call our early adopter program. We have registered early adopter clients, who have taken specific interest to provide us necessary feedback, and we have another of clients who are interested in a Vector absolutely. They’re primarily in automotive I could mention..

Thanks very much..

And at this time, we have no further questions. So I will turn the call back to our speakers for any additional remarks..

Thank you all for your attendance today and we look forward to speaking to you next time..

This does conclude today’s program. Thank you for your participation. You may disconnect at any time and have a wonderful day..