FARO (FARO)

3D measurement and imaging company FARO (NASDAQ:FARO) beat Wall Street’s revenue expectations in Q1 CY2025, but sales fell by 1.6% year on year to $82.86 million. The company expects next quarter’s revenue to be around $83 million, close to analysts’ estimates. Its non-GAAP profit of $0.33 per share was significantly above analysts’ consensus estimates.

Company Overview

Launched by two PhD students in a garage, FARO (NASDAQ:FARO) provides 3D measurement and imaging systems for the manufacturing, construction, engineering, and public safety industries.

Measurement and inspection instrument companies may enjoy more steady demand because products such as water meters are non-discretionary and mandated for replacement at predictable intervals. In the last decade, digitization and data collection have driven innovation in the space, leading to incremental sales. But like the broader industrials sector, measurement and inspection instrument companies are at the whim of economic cycles. Interest rates, for example, can greatly impact civil, commercial, and residential construction projects that drive demand.

Competitors offering similar products include Trimble (NASDAQ:TRMB), Nikon (OTCMKTS:NINOF), and Faro (NASDAQ:PRCP).

A company’s long-term performance is an indicator of its overall quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. FARO’s demand was weak over the last five years as its sales fell at a 1.5% annual rate. This wasn’t a great result and suggests it’s a lower quality business.

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. FARO’s annualized revenue declines of 1.9% over the last two years align with its five-year trend, suggesting its demand has consistently shrunk.

This quarter, FARO’s revenue fell by 1.6% year on year to $82.86 million but beat Wall Street’s estimates by 3.3%. Company management is currently guiding for a 1.1% year-on-year increase in sales next quarter.

Looking further ahead, sell-side analysts expect revenue to grow 2.3% over the next 12 months. Although this projection indicates its newer products and services will spur better top-line performance, it is still below the sector average.

FARO has best-in-class unit economics for an industrials company, enabling it to invest in areas such as research and development. Its margin also signals it sells differentiated products, not commodities. As you can see below, it averaged an elite 52.3% gross margin over the last five years. That means FARO only paid its suppliers $47.73 for every $100 in revenue.

FARO’s gross profit margin came in at 57% this quarter, marking a 5.6 percentage point increase from 51.4% in the same quarter last year. FARO’s full-year margin has also been trending up over the past 12 months, increasing by 6.3 percentage points. If this move continues, it could suggest an environment where the company has better pricing power and stable or shrinking input costs (such as raw materials).

Although FARO was profitable this quarter from an operational perspective, it’s generally struggled over a longer time period. Its expensive cost structure has contributed to an average operating margin of negative 2.8% over the last five years. Unprofitable industrials companies require extra attention because they could get caught swimming naked when the tide goes out. It’s hard to trust that the business can endure a full cycle.

On the plus side, FARO’s operating margin rose by 10.2 percentage points over the last five years. Still, it will take much more for the company to show consistent profitability.

In Q1, FARO generated an operating profit margin of 4.6%, up 10.9 percentage points year on year. The increase was solid, and because its operating margin rose more than its gross margin, we can infer it was more efficient with expenses such as marketing, R&D, and administrative overhead.

Revenue trends explain a company’s historical growth, but the long-term change in earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.

FARO’s EPS grew at an astounding 33.3% compounded annual growth rate over the last five years, higher than its 1.5% annualized revenue declines. This tells us management adapted its cost structure in response to a challenging demand environment.

Diving into the nuances of FARO’s earnings can give us a better understanding of its performance. As we mentioned earlier, FARO’s operating margin expanded by 10.2 percentage points over the last five years. This was the most relevant factor (aside from the revenue impact) behind its higher earnings; taxes and interest expenses can also affect EPS but don’t tell us as much about a company’s fundamentals.

Like with revenue, we analyze EPS over a more recent period because it can provide insight into an emerging theme or development for the business.

For FARO, its one-year annual EPS growth of 270% was higher than its five-year trend. We love it when earnings growth accelerates, especially when it accelerates off an already high base.

In Q1, FARO reported EPS at $0.33, up from $0.09 in the same quarter last year. This print easily cleared analysts’ estimates, and shareholders should be content with the results. Over the next 12 months, Wall Street expects FARO’s full-year EPS of $1.22 to shrink by 9%.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

While FARO posted positive free cash flow this quarter, the broader story hasn’t been so clean. FARO’s demanding reinvestments have drained its resources over the last five years, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 1.9%, meaning it lit $1.89 of cash on fire for every $100 in revenue.

Taking a step back, an encouraging sign is that FARO’s margin expanded by 9.2 percentage points during that time. Despite its improvement and recent free cash flow generation, we’d like to see more quarters of positive cash flow before recommending the stock.

FARO’s free cash flow clocked in at $2.24 million in Q1, equivalent to a 2.7% margin. The company’s cash profitability regressed as it was 3.5 percentage points lower than in the same quarter last year, but it’s still above its five-year average. We wouldn’t read too much into this quarter’s decline because investment needs can be seasonal, leading to short-term swings. Long-term trends are more important.

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

FARO’s five-year average ROIC was negative 5.1%, meaning management lost money while trying to expand the business. Its returns were among the worst in the industrials sector.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, FARO’s ROIC averaged 2.5 percentage point increases each year. This is a good sign, and we hope the company can continue improving.

One of the best ways to mitigate bankruptcy risk is to hold more cash than debt.

FARO is a profitable, well-capitalized company with $102.6 million of cash and $92.06 million of debt on its balance sheet. This $10.57 million net cash position is 2.1% of its market cap and gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

We were impressed by FARO’s optimistic EPS guidance for next quarter, which blew past analysts’ expectations. We were also excited its revenue, EPS, and EBITDA outperformed Wall Street’s estimates. Zooming out, we think this quarter featured some important positives. The stock traded up 13.6% to $30 immediately following the results.

Updated: July 9, 2025 at 11:29 PM EDT

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in FARO.

FARO isn’t a terrible business, but it isn’t one of our picks. First off, its revenue has declined over the last five years. And while its admirable gross margins indicate the mission-critical nature of its offerings, the downside is its relatively low ROIC suggests management has struggled to find compelling investment opportunities. On top of that, its projected EPS for the next year is lacking.

FARO’s P/E ratio based on the next 12 months is 39.6x. This valuation tells us a lot of optimism is priced in - we think there are better opportunities elsewhere.

Wall Street analysts have a consensus one-year price target of $44 on the company (compared to the current share price of $44.03).