zSpace Stock

Hello, and thank you for participating in today's conference call to discuss zSpace's financial results for the first quarter ended March 31, 2026. Joining us today are zSpace' Chief Executive Officer, Paul Kellenberger; Chief Financial Officer, Erick DeOliveira; and Greg Robles from Investor Relations.

Before we go further, I would like to turn the call over to Mr. Robles as he reads the company's safe harbor statement. Greg, please go ahead.

Thank you, Carmen. Before we begin, I'd like to remind everyone that certain statements made on this call may be considered forward-looking statements. These statements are based on our current expectations and beliefs and are subject to risks and uncertainties that could cause actual results. Additionally, we may discuss certain key business metrics, which are non-GAAP financial measures. A description of these non-GAAP measures and any comparison to the directly -- to the most directly comparable GAAP measures can be found in our earnings release on the Investor Relations section of our website.

Now I would like to turn the call over to the CEO of zSpace, Paul Kellenberger. Paul?

Thank you, Greg, and good afternoon, everyone. Thank you for joining us for our first quarter 2026 earnings call. I am Paul Kellenberger, CEO of zSpace. And with me here is Erick DeOliveira, our Chief Financial Officer. Q1 2026 showed early signs of stabilization for zSpace following a very challenging 2025. As we've discussed on prior calls, last year was largely shaped by uncertainty in the federal education policy and its downstream impact on school district purchasing. While that environment has not fully resolved, we are beginning to see green shoots in the education sector, evidenced by our pipeline rebuild and stronger customer engagement.

New customer additions and software renewal rates in the quarter suggest that despite budget pressures, our customers continue to view zSpace as an important part of their instructional technology strategy. We believe many of the most significant external headwinds have moderated, though the broader funding environment for K-12 and workforce education remains uneven and visibility into the district purchasing cycles is still limited. On the product side, with the launch of zStylus One and our continued investment in our AI road map and a sales team that is executing with discipline, we believe we are positioned to return to growth as market conditions continue to improve. So the pace and timing of that recovery will depend on factors largely outside our control.

Before turning to operational highlights, I want to address one additional item. The Board of Directors believes that the company's current market valuation does not fully reflect the value of our business or the progress we have made. Accordingly, the Board has initiated a formal review of strategic alternatives, which may include strategic partnerships, business combinations or other transactions to ensure our shareholders realize the full value of what we have built. There can be no assurance that this review will result in any specific transaction. The company does not intend to comment further on this process until the Board approved a definitive course of action or determines that further disclosure is warranted.

With that, let me turn to the operational progress in the quarter. Again, on the product side, we began shipping zStylus One, our next-generation stylus featuring embedded sensors and machine learning algorithms that replace the external tracking modules and display markers required by prior generations. ZStylus One ships as the required stylist for Inspire V2 and Inspire V2 Pro and is also supported on Inspire and Inspire Pro platforms. The product has been granted a U.S. patent with additional patents pending, and we have customer deployments well underway through zSpace and our authorized partners. We also released a new version of zSpace Studio, our 3D modeling and creation application available exclusively for Inspire devices. The update includes introduces expanded curriculum aligned model libraries, supporting science and career and technical education pathways, enhanced modeling capabilities for student-driven design and iteration and streamlined workflows for educators and students. The release was made available to all Inspire customers immediately upon launch.

Turning to our customer activity, a few deployments from earlier this year illustrate how districts and workforce partners are continuing to scale with zSpace, even in a constrained spending environment. Firstly, Danbury Public Schools announced an expansion of its immersive learning deployment scaling from a pilot to a full classroom set of 30 devices per school and extending access into alternative programs with a focus on equitable STEM and career-connected learning and the integration of AI-driven career insights.

In Kansas, our partnership with Kansas WorkforceONE is expanding immersive career exploration and workforce development across nearly all 96 counties in the state, deploying mobile zSpace Inspire laptops for K-12 students and adult learners to support hands-on career awareness, reskilling and job transition. And lastly, in Colorado, we launched a mobile learning lab in partnership with Colorado River BOCES and Briggs & Stratton, a branded CTE trailer powered by immersive AR/VR technology that brings industry-aligned career exploration in mechanics, power equipment, agriculture and industrial technologies to students all across Western Colorado.

In closing, 2025 tested the resilience of our business. And while Q1 results are encouraging, we are mindful that 1 quarter does not establish a trend. The early indicators we are seeing modest improvement in customer additions, steady software renewals, expanded deployments with partners like Danbury and Kansas WorkforceONE and the successful launch of zStylus One and the latest zSpace Studio release give us reasonable confidence that the underlying business is on firmer footing.

That said, the funding environment for K-12 and workforce education continues to evolve, and we are managing the business accordingly, disciplined on expense, focused on the product road map and selective on where we invest for growth. The Board is focused on ensuring the long-term value we are building is appropriately reflected for our shareholders, and we will share updates when and as appropriate. We are grateful to our customers, partners, employees and shareholders for their continued support, and we look forward to updating you on our progress in the quarters ahead.

With that, I'll turn the call over to Erick to walk you through the financial results in more detail.

Thank you, Paul. As you consider our results, a reminder that our revenues are substantially recognized upon shipment of laptop units or fulfillment of software license keys. This includes recognizing the full value of multiyear software licenses in the period in which they are fulfilled. Only a small portion of our revenue is ratably recognized. As a result of this revenue recognition treatment, our financial results can exhibit quarter-to-quarter and year-over-year variability that exaggerates the underlying seasonality of the business. In the first quarter of 2026, we executed against familiar global volatility with a much leaner team following our restructuring this past December. While the year is still young, our early results validate the difficult decisions we've made with clear sequential improvements in demand, gross margin and spend management.

And now diving into our first quarter performance. First quarter revenues were $5.3 million, down 22%. In a theme common throughout last year, software and services revenues outperformed hardware, down only 15% in comparison. As a result, software and services made up 47% of total revenue, up from 43% in Q1 2025. Revenues grew 8% sequentially, coming off Q4's prolonged federal government shutdown, which weighed on bookings and shipments of previously placed orders. The pacing of orders throughout Q1 informs a tempered confidence in the stabilization of our market. ZSpace enjoyed meaningful growth through January and February before experiencing significant deceleration in March as orders from Qatar and Dubai were delayed under the Iranian war and one order was returned to us from the Bahrain Airport because of the impracticalities of the customer taking delivery.

However, what we've seen thus far through Q2 tentatively suggests that the balance of the year may more closely track performance from the opening 2 months of the year. As previously discussed, our P&L reflects multiyear software license revenue in period. To help better characterize the run rate health of the business, we offer 2 non-GAAP software operating metrics. As of March 31, 2026, the annualized contract value of renewable software was $10.1 million, down 13% compared with 12 months ago. Also as of December -- as of March 31, 2026, the net dollar revenue retention of customers with at least $50,000 of ACV was 65% for those customers present as of March 31, 2025. Unfavorable performance on these 2 metrics is attributable to the same 2 large customers who collectively expanded their zSpace footprint in 2024, but for whom macro factors prevented full renewal of their expanded commitment, which is a feature in this metric that we will lap in Q3 of this year.

Normalizing for these 2 customers, ACV would have been $11.2 million or down 4% and NDRR would have been 82%. Once again, sequentially, ACV of $10.1 million is up 2% from last quarter, suggesting recovery of our recurring high-margin AR/VR software ecosystem. Bookings for the 3-month period ending March 31 were $6.1 million, down 8% year-on-year. Importantly, this performance was up 81% on a sequential basis. Gross profit was $2.8 million, down 13% against the same period last year. First quarter gross margins were 53%, up 5.6 percentage points versus Q1 2025. Revenue mix delivered 1 percentage point of improvement and the remaining 4.6 percentage points of rate base improvement came from both software and hardware. The latter included both rollout of the new zStylus One interaction device, which eliminates the need for an additional tracking peripheral as well as reduced tariff factors that were in play in the comparable quarter last year.

Profitability improved sequentially as well with gross profit up 17% compared with Q4 '25 and 53% margins improving 3.9 percentage points over last quarter's 49%. First quarter operating expenses of $4.9 million, excluding stock-based compensation, were down 35%. People-related costs, which make up 54% of Q1 OpEx were down 43% year-on-year, again, excluding stock-based compensation. This level of spend is consistent with our previous discussion of operating expense following Q4's cost reduction and indicative of an annual run rate of approximately $19 million, still excluding stock-based comp. As of March 31, 2026, zSpace had approximately $2.9 million in cash, cash equivalents and restricted cash compared to $1.1 million in cash, cash equivalents and restricted cash as of March 31, 2025.

Guidance for the rest of the year. Events year-to-date continue to be unpredictable, and our customers' supply chains and order fulfillment processes can be vulnerable in unexpected ways as we saw in multiple ways last year. The cost reduction measures we implemented at the end of last year were designed to position us for success should we face similar demand shocks in 2026 to those we experienced in 2025. While we will not be providing formal guidance, we would like to share our thinking around the 2026 scenario in which we imagine we could deliver a performance close to EBITDA breakeven. In the years immediately prior to our IPO in Q4 2024, demand for the company's augmented reality experiences in schools, other academic settings and CTE training environments grew from $35 million to $44 million. If we were to experience a repeat of last year's approximately $30 million top line, then typical quarterly seasonality would deliver 20% of our demand in Q1, 30% in each of Q2 and Q3 and 20% in Q4, another shoulder period in our customers' business cycles.

As we've often discussed, our business can experience significant quarter-to-quarter volatility. So these quarterly splits are illustrative, but far from ironclad. Coupled with additional modest sequential expansion of gross margins in upcoming quarters, building on what we've delivered over the past quarters and through Q1, we believe our path is consistent with breakeven through year-end on current levels of operating expenses. Our business is not linear, but our success in bringing effective new learning solutions to K-12 and CTE markets, expanding margins and ability to increase software as a percent of revenue and deliver greater than $10 million in recurring ACV gives us tentative optimism.

While we cannot predict what the macro landscape will offer next by way of events, we hope that this provides some measure of insight to management's approach to navigating our waters for the rest of 2026. Q1 demand of $6.1 million in bookings, gross margin expansion to greater than 53% and the effectiveness of our recent cost reductions this quarter are consistent with this outlook.

Now I will turn the call back over to Paul for closing remarks.

Thank you, Erick. We'd like to thank everyone for listening to today's call, and we look forward to speaking with you when we report our second quarter 2026 results. Thanks again for joining us.

And ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Hello, and thank you for participating in today's conference call to discuss zSpace's Financial Results for the Fourth Quarter and Full Year Ended December 31, 2025. Joining us today are zSpace Chief Executive Officer, Paul Kellenberger; Chief Financial Officer, Erick DeOliveira; and Greg Robles from Investor Relations. Following their remarks, we'll open the call for analyst questions.

Before we go further, I would like to turn the call over to Mr. Robles as he reads the company's safe harbor statement. Greg, please go ahead.

Thanks, operator. Good afternoon, and thank you for joining our conference call to discuss our Fourth Quarter and Full Year 2025 Financial Results. Before we begin, I'd like to remind everyone that certain statements made on this call may be considered forward-looking statements. These statements are based on our current expectations and beliefs and are subject to risks and uncertainties that could cause actual results to differ materially.

Additionally, we may discuss certain key business metrics, which are non-GAAP financial measures. A description of these non-GAAP measures and any comparisons to the most directly comparable GAAP measures can be found in our earnings release on the Investor Relations section of our website.

Now I would like to turn the call over to the CEO of zSpace, Paul Kellenberger. Paul?

Thank you, Greg, and good afternoon, everyone. Thank you for joining us for our Fourth Quarter and Full Year 2025 Earnings Call. I'm Paul Kellenberger, CEO of zSpace and with me is Erick DeOliveira, our Chief Financial Officer. We're excited to share zSpace's performance and the progress we've made advancing our strategic priorities. Our fourth quarter results reflect our continued focus on advancing our strategy and controlling what we can control.

During the quarter, our software and services revenue continued to comprise over 50% of total revenue, contributing to gross margin expansion of nearly 850 basis points. This performance was driven by strong customer renewals and the continued adoption of our software offerings, which is a key part of our strategy and a testament to our execution and disciplined focus on delivering value to our customers despite ongoing macroeconomic and funding uncertainty.

As we formally announced in late Q4 2025, we made structural changes in the business to align to the macro headwinds in the business we saw throughout 2025. We continue to look for ways to improve our business, both top line and bottom line as we get close to finalizing Q1. In addition, in January and more recently, we have announced additional capital via Planet One and [ 3i ] as well as announcing last week the additional restructuring of our [ Itria and PISA ] debt.

During the quarter, we continued to advance our strategy by expanding both the capabilities of our platform and the breadth of our customer engagements across K-12, CTE and workforce pathways. We also strengthened our product portfolio with the launch of zStylus One, our next-generation AI-enabled stylist designed to simplify AR deployment and enhance precision across our Inspire and Imagine system. The new zStylus One showcases breakthrough embedded sensors powered by machine learning algorithms that eliminates the need for an external sensor module or embedded tracking in the laptop. Early feedback from customers and partners has been very positive, and we expect this product to support broader adoption of our next-generation platforms as our customers upgrade their hardware.

We also achieved meaningful customer wins across several regions and program areas. In Pennsylvania, the Greater Altoona Career & Technology Center strengthened its Dental Assistant Program through the use of zSpace AR/VR technology, leveraging zSpace Inspire 2 and the zSpace Dental Anatomy Application to improve students' understanding of dental structures, support diverse learners and enhance preparation for hands-on clinical skills.

In California, Mayfair High School has established a 36-station zSpace Inspire AR/VR laptop lab, where students interact with immersive simulations, applications and guided lessons aligned to CPE and core academic subjects. The lab serves as a central hub where teachers across the campus can bring classes to explore career pathways through interactive 3D experiences, demonstrating how dedicated immersive learning can drive cross-departmental adoption and provide students with early exposure to high-demand career pathways.

And more recently, zSpace highlighted the long-standing success of its immersive augmented and virtual reality learning platform across Atlanta Public Schools, or APS, where students have used AR/VR technology since 2020 -- sorry, since 2015 to deepen STEM learning and explore career pathways. Over nearly a decade, Atlanta Public Schools has integrated zSpace immersive learning experiences across elementary, middle and high school classrooms, giving students hands-on opportunities to explore complex science, scientific concepts and practice real-world career skills in safe, simulated environments. Their long-term success underscores the durability of our platform and the impact we can achieve as districts expand diversive learning from early grade through workforce preparation.

Finally, our Career Explorer powered by Career Coach AI was formally recognized with Tech & Learning's Best of 2025 Award of Excellence. This recognition reinforces the value our customers are seeing as they adopt immersive career exploration tools that engage students through real-world simulations and align directly to emerging skill trades and technical careers. Collectively, these wins highlight continued demand we see in immersive AI-enabled tools that simplify adoption for educators, deepen engagement for students and help districts strengthen both academic and workforce outcomes.

In addition to support our global expansion and ensure accessibility across various educational geographies, we're strategically leveraging artificial intelligence to eliminate language barriers. AI is enabling quick and efficient translation across our platform, including website content and application interfaces and providing tools that can understand and interact in over 50 languages. This initiative not only expands our global reach, but ensures students and educators regardless of their native language, can fully utilize zSpace's award-winning educational experiences, significantly broadening our global reach.

In closing, we remain confident in the long-term growth potential of zSpace and our ability to deliver on our vision. That said, we approach 2026 with continued cautious optimism given the ongoing uncertainty and the macro environment in the education market in the U.S. In addition, due to the war in Iran, we are seeing opportunities in the Middle East being delayed. We continue to believe that as the Federal Education Policy continues to take shape and funding mechanisms become more predictable, the longer-term outlook for our business will strengthen.

With that, I will turn the call over to Erick to walk you through our financial results in more detail. Erick?

Thank you, Paul. As you consider our results, a reminder that our revenues are substantially recognized upon shipment of laptop units or fulfillment of software license fees. This includes recognizing the full value of multiyear software licenses in the period in which they are fulfilled. Only a small portion of our revenue is rapidly recognized. As a result of this revenue recognition treatment, our financial results can exhibit quarter-to-quarter and year-over-year variability that exaggerates the underlying seasonality of the business.

Throughout 2025, we saw dual themes of internal execution success, driving product innovation, quality of revenues and spend management, opposed by external headwinds from tariff policy, freezes and education funding and the longest federal government shutdown in U.S. history to close out the year. Both internal and external themes played familiar roles in our financial performance through the period ending December 31. And now diving into our full year performance.

Revenues were $27.9 million, down 27%. As noted throughout the year, software and services revenues outperformed, down only 15% in comparison to total revenues and making up 49% of the revenue portfolio, up from 42% in 2024, a 7 percentage point improvement. This was an important driver of gross margin expansion. As previously discussed, our P&L reflects multiyear software license revenue in period. To help better characterize the run rate health of the business, we offer 2 non-GAAP software operating metrics. As of December 31, 2025, the annualized contract value of renewable software was $9.9 million, down 12% compared with 12 months ago. Also as of December 31, 2025, the net dollar revenue retention of customers with at least $50,000 of ACV was 71% for those customers present as of December 31, 2024.

Unfavorable performance on these 2 metrics is attributable to 2 large customers who collectively expanded their zSpace footprint in 2024, but for whom macro factors prevented full renewal of their expanded commitments. Normalizing for these 2 customers, ACV would have been $11.1 million or down 2% and NDRR would have been 88%, pointing to wider stability across the customer base.

Bookings for the 12-month period ending December 31 were $26.1 million, down 34% year-over-year. Gross profit was $13.3 million, down 15% against the same period last year. This includes a onetime charge for discontinued software license inventory, which is at once related to our exit of China and also our continued efforts to bring previously resold third-party titles in-house for both acquisition of applications and internal development. Gross profit was also affected by applicable tariffs and duties.

2025 gross margins were 47.6%, up 6.7 percentage points versus 2024. Factors driving improved quality of revenue were sustained throughout the year and highlighted in our quarterly results. Firstly, favorable growth in the mix of software content of our revenues drove 2.5 percentage points of margin. Secondly, product line refreshes in our hardware ecosystem led by the Inspire 2 platform reduced our bill of materials costs. Thirdly, increased first-party zSpace software content, combined with those hardware improvements for a total of 4.2 percentage points of margin, delivering the total 6.7 percentage points of gross margin expansion across the 12-month period.

2025 operating expenses of $28.3 million, excluding stock-based compensation, were up 11%. People-related costs, which make up 66% of 2025 OpEx were up 6% year-over-year, again, excluding stock-based compensation. As a result of corporate restructuring efforts in December 2025, management believes that our current OpEx run rate is closer to $19 million, still excluding stock-based comp, assuming stability of the current external environment.

And now for the fourth quarter. Q4 revenues of $4.8 million were down 43% year-over-year, reflecting what amounted to a freeze in both orders and shipments during the U.S. federal government shutdown. For business secured during the effectively truncated quarter, revenue mix trends continue to be in evidence. Software and services represented 57% of total revenues, a 10 percentage point mix shift with significant gross margin implications, with hardware revenues falling below 50% for the second quarter in a row. Bookings for the 3-month period ending December 31 were $3.4 million, down 21% year-over-year. CTE customers drove 56% of bookings value, down from 58% in Q4 '24. Gross profit was $2.4 million and gross margins were 49.1%, up 8.4 percentage points versus Q4 '24. This laps the 6 percentage point margin expansion in that quarter and continues the improvements in profitability we have been delivering. Within the quarter, the 10 percentage point mix shift in revenues was responsible for 2.8 percentage points of margin gain and rate-based factors drove 5.6 percentage points of improvement.

Operating expenses of $6.5 million for the quarter, excluding stock-based compensation, were up 9% year-over-year. Our Q4 reported results include $2 million in stock-based compensation expense attributable to grants made as part of our employee equity incentive program. Relative to the 22.8 million shares issued and outstanding at the start of the year, we managed issuance of RSUs to a target burn rate of 6.2% or 1.4 million RSUs, well below our 7% target. As of December 31, 2025, zSpace had approximately $1 million in cash, cash equivalents and restricted cash compared to $4.9 million in cash, cash equivalents and restricted cash as of December 31, 2024.

Our path to profitability continues to run through revenue growth via operating leverage, our ongoing expansion of gross margins and tight stewardship of operating expenses. While overall revenues are challenged by headwinds in the U.S. K-12 market, our success in driving more of the revenue portfolio from software is bearing fruit. The gross margin expansions from revenue mix shift into software from additional first-party software and from new hardware product releases are now part of our track record in delivering results. As part of our ongoing attention to operating expenses, we undertook a significant restructuring in December 2025 that resulted in eliminating approximately half the FTE positions of zSpace across all levels and 1/3 of the people costs. We further reduced the size of our Board of Directors from 7 seats to 5 and abolished the executive bonus plan for 2026. Our consideration of these factors was made with the intention of aligning revenues and costs and putting a breakeven EBITDA performance in reach for 2026.

Now moving on to our outlook for 2026. Familiar obstacles such as trade and tariff policies remain steadfastly unresolved, although promising developments have materialized. And the macroeconomic picture remains persistently volatile. These external factors present the same challenges to forecasting that we identified last year. Management's approach to 2026 was to consider the scenario in which we see a repeat of 2025's revenue performance and what it would take to weather such an environment. If 2026 presents a second year of top line volume similar to 2025, we believe the cost reductions made in December will allow us to deliver an adjusted EBITDA performance at or close to breakeven. We further believe that the company retains sufficient resources to scale back up to historical revenue highs. And in the event that opportunities for outperformance beyond that should appear, we will consider responsible reinvestment in the business at that time.

We do not yet feel strongly enough about our ability to restore guidance on a sustained basis and want to avoid offering guidance in one quarter only to rescind the practice in the subsequent quarter. We will continue to manage the quality and mix of revenues for continued gross margin expansion as we've demonstrated over the past year as well as tight control of operating expenses as these are our 2 best levers for positioning the company to capture upside until our K-12 markets in the U.S. stabilize.

Now I will turn the time back to the operator for Q&A.

[Operator Instructions] And our first question comes from the line of Alex Paris with Barrington Research.

To start off with the macro, maybe 2025 was obviously a tough year for K-12, the industry in general due to perceived funding disruptions, including Department of Education layoffs and inter-agency transfers of responsibilities, not to mention tariffs and the government shutdown. And as I recall, about 10% of your K through 12 STEM revenue comes from federal sources, if I'm not mistaken. So despite what was going on in 2025, most federal dollars came through. I know there was uncertainty, which probably made school districts hesitant to order or renew and things like that, but most of those dollars came through. And the government shutdown is essentially over with the exception of DHS currently.

What does the funding outlook look like for 2026? I know you expressed some cautious optimism. And then how has Q1 gone so far? I know a lot of the revenue comes in the last 10 days of the quarter, but maybe talk about January, February.

Sure. Alex, this is Paul here. By the way, about 10% of the funding in K-12 in our market does come from the federal side of things. So you're correct. That being said, particularly in the middle part of last year, Q2, Q3, we saw some very peculiar things. And I can't recall whether we had this conversation previously, but there was one specific state in the middle part of the country that actually sent money back to the federal government because of the uncertainty, and I'll just say their discomfort given all the headwinds and all the stopping and starting of funding. So you're correct with the 10% number.

However, was, I would say, the ramifications and implications to our specific buyers, both in the K-12 STEM as well as in Career and Technical Education made them really hesitant and hesitate -- to hesitate to move things forward. So I think that was a big part of the middle of last year, Q2, Q3. Then I think in the fourth quarter, and we had business that in -- towards the end of the year that was impacted by the government shutdown. And maybe it was an excuse, but those facts were pretty -- it was pretty straightforward. That's what we were being told by a number of different school districts.

So I know it's sounding like I'm making excuses here, but it was not the year that we wanted by any means, no surprise there. Although I do believe things -- and again, cautious optimism, things are starting to settle. And that's the best answer I can give you kind of looking -- I'll say, looking back at last year and the funding. And then this year, I'll maybe let Erick talk a little bit about the outlook. And here we are, it's March 30. We're not quite done the quarter, but we're pretty close to it and you asked about January, February.

Yes, happy to pick up from there, Paul. What I'd say about the outlook for Q1 firstly requires an understanding that our Q1 is ridiculously back-end loaded, both in terms of bookings and shipments. And some of those on this call will recall Q1 of last year when with only a few days left in the quarter, we ultimately wound up outperforming our guidance by something like 30%. Now that said, we -- earlier in this quarter, the year started out, and we were observing some encouraging year-on-year strength through January and February.

In March, the picture has become more mixed in large part because a number of our significant customer opportunities were customers that had previously started their zSpace relationship and are based in the Middle East and are therefore, in the midst of the current conflict there. So it remains an open question even with 48 hours left in the quarter, how much of that volume will actually ship and be accepted to capture revenue in the quarter.

What I think I would say is the experience earlier in the year has given us some sense that the market has resumed its willingness to open their wallet, so to speak, and actually take possession and book new zSpace content. But our progress clearly has not been linear for much of the last 12 or 15 months.

Okay. Understood. And then just a point of clarification, Erick, one of your last comments in the prepared comments, if revenues were roughly equal to what they were in 2025, so say, around $28 million, you're saying that the hope or target is to get close to adjusted EBITDA profitability or breakeven, at least [indiscernible] versus the current consensus of negative $12.5 million for 2026 adjusted EBITDA?

Correct. And the 2 big levers there. So we -- in the absence of being able to forecast in the current environment, we engaged in some scenario planning and said, you know what, there are a lot of factors driving revenue that have proven themselves to be out of management's control. But if we saw a repeat of a $27 million, $28 million year what are the factors in our hands. And to that end, our ability to expand gross margins by approximately 7 percentage points year-on-year and to sustain the underlying business drivers that delivered that margin expansion, coupled with the cost reductions we took in December, we believe, put something close to a breakeven EBITDA performance within reach for 2026.

Now obviously, as we move through the year, the revenue performance and the operating leverage we see on that will be the biggest driver. But we feel pretty good around our improvements around quality of revenue that delivered that margin expansion. Again, it all comes back to our ability to retain and renew existing software agreements, our ability to continue delivering hardware improvements that reduce that cost of initial deployment and also to roll out more zSpace-owned software where we just control more of the margin.

Okay. In the absence of formal guidance, that's pretty helpful and reasonable sort of conversation regarding what 2026 might look like. My last question for now, and I'll get back in the queue is I just wanted to talk a little bit about that strategic investment from Planet One in late January, $3 million convertible preferred. But the really exciting thing there was the potential to expand international sales perhaps through cooperation or a joint venture based on what your press release said. What are you thinking there? And is that a potential opportunity in 2026?

Let me take that, Alex. The answer is we hope so. And the war in Iran just really put everything kind of on the back burner for obvious reasons. Erick alluded -- so the answer is we think so. It's something that we're still pursuing. There are some other opportunities, Erick alluded to in his commentary in the Middle East, even some bigger ones. And we're hoping those come back.

[Operator Instructions]. Our next question is from Rohit Kulkarni with ROTH Capital Partners.

A couple of questions to kick this off. Can you frame kind of size, scale, scope of these kind of recent announcements in the PR, Greater Altoona, Bellflower Mayfair High School and Atlanta Public School. Just talk about how they came about and how significant do you feel they could be for 2026 just from direct contribution as well as incremental on top of the base of '25.

Yes. Let me take that, Rohit. This is Paul. Every one of those deals was -- I'll put it in the significant category. They're in the 6 figures. They have the potential, Atlanta being a very large school district APS [ length of ] schools, which, as I mentioned, we've been -- they've been our customer for 10 years. And we see some other -- I don't want to jinx us, but we see some other opportunities within that specific district late this year. So all of them, I'll put them in the category of substantial. Greater Altoona was in the CTE segment in a very specific in the dental component of it. I would again say strategic, Mayfair out here, again, a school system here in California that is newer customer. And so we have a combination of both newer customers and existing customers purchasing more.

And I'm going to go back to something else. Erick kind of touched on it. I touched on it on my opening remarks. Over 50% of our revenue in the fourth quarter was software and services. And the way we look at the business and the way I look at the business is any time we're over 50% in that category, it's a really good thing. Now by the way, we also had a bunch of other changes we made in the fourth quarter. So that's the best summary I can give you.

The other thing that, Rohit, I'm going to reemphasize is the zStylus One, which I mentioned, which is the new -- doesn't require the little device on the side. There's clearly a lower [ bond ] because we have one less device and the implications for it, including how we're using AI in the process. We're super bullish on. We're early in the shipments of it still, but we feel really, really positive about it.

Okay. Great. I guess you mentioned CTE, Paul. How is the mix today versus previous periods? And is CTE growing as compared to the shrinking on the other side of the business? Maybe comment on that.

Yes. So CTE is more than 50%. I think the exact number is 56% versus 48%, Erick, in the previous year. Sorry? Yes. So it continues to grow. And some of that, Rohit, had to do with the funding. And again, Alex was asking the questions about the funding. Perkins is a big part of money in the CTE world that is a federal funding that has continued to expand and it's an annuity. But the CTE side of the business -- and by the way, along with the applications that we own and control has continued to grow for us.

Okay. Great. And in terms of -- I think just drawing out what the previous question was around kind of run rate OpEx and kind of run rate revenues that may lead us to a point not too far out in the future that you could have breakeven operating cash flows or even kind of positive EBITDA. Is that something that you feel reasonable to expect in '26, assuming modest shrinkage in revenues, but pretty significant drop in your expenses?

Rohit, this is Erick. I'll take that one. That's our current outlook through the combination of continued margin expansion and the expense cuts we took in December. We think that our run rate OpEx is closer to $19 million, again, excluding stock-based compensation and with continued margin gains and a top line that looks relatively like last year, that could put a breakeven adjusted EBITDA performance in front of us.

And at this time, this concludes our question-and-answer session. I would like to turn the call back to Mr. Kellenberger for closing remarks.

Thank you, Carmen. We'd like to thank everyone for listening into today's call, and we look forward to speaking with you when we report our first quarter 2026 results. Thanks again for joining us.

And ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Hello, and thank you for participating in today's conference call to discuss zSpace's financial results for the third quarter ended September 30, 2025. Joining us today are zSpace's CEO, Paul Kellenberger; and CFO, Erick DeOliveira; and Greg Robles from Investor Relations. Following their remarks, we'll open the call for analyst questions.

Before we go further, I would like to turn the call over to Mr. Robles as he reads the company's safe harbor statement. Greg, please go ahead.

Thanks, Operator. Good afternoon, and thank you for joining our conference call to discuss our third quarter 2025 financial results.

Before we begin, I'd like to remind everyone that certain statements made on this call may be considered forward-looking statements. These statements are based on our current expectations and beliefs and are subject to risks and uncertainties that could cause actual results to differ materially.

Additionally, we may discuss certain key business metrics, which are non-GAAP financial measures. A description of these non-GAAP measures and any comparison to the most directly comparable GAAP measures can be found in our earnings release on the Investor Relations section of our website.

Now I would like to turn the call over to the CEO of zSpace, Paul Kellenberger. Paul?

Thank you, and good afternoon, everyone. Thank you for joining us for our third quarter earnings call. I am Paul Kellenberger, CEO of zSpace, and with me is Erick DeOliveira, our Chief Financial Officer. We're excited to share zSpace's Q3 performance and the progress we've made advancing our strategic priorities.

Our third quarter results reflect our focus on advancing our strategy and controlling what we can control. During the quarter, our software and services revenue comprised over 50% of total revenue, contributing to gross margin expansion of over 640 basis points. This performance was driven by strong customer renewals and the continued adoption of our software offerings, which is a key part of our strategy.

In addition, we grew revenue 18% sequentially, which is a testament to our execution and disciplined focus on delivering value to our customers despite ongoing macroeconomic and funding uncertainties.

We've made meaningful internal progress across our products and innovation. As announced last quarter, we completed the integration of Second Avenue Learning, leading to the launch and delivery of our career exploration application. We're pleased with our team's dedication to excellence and their ability to deliver innovative AI-powered education products with speed and impact.

In addition, to support our global expansion and ensure accessibility across various educational geographies, we're strategically leveraging artificial intelligence to eliminate language barriers.

AI is enabling quick and efficient translation across our platform, including website content and application interfaces and providing tools that can understand and interact in over 50 languages. This initiative not only expands our global reach, but ensures students and educators regardless of their native language, can fully utilize zSpace's award-winning educational experiences, significantly broadening our global reach.

Building on this, we began deploying our solutions with GEMS Education at their flagship School of Research and Innovation in Dubai. This partnership represents a regional first in AR/VR learning integration across K-12 education in the UAE and allows students to explore complex STEM concepts through interactive 3-dimensional simulations. Beyond Dubai, we've secured deployments in Italy, Bulgaria, Poland and additional locations across the Middle East, continuing to build momentum in international markets.

While funding uncertainty persists in the U.S., we've also achieved meaningful customer wins. Union Interactive, a key partner in Bulgaria, expanded its use of zSpace as part of the National STEM project for K-12, which was funded by the European Union.

In Florida, Dixie County Schools made a significant investment in robotics and health applications for high school students, which was funded by the workforce development incentive grant. Lastly, in Alabama, the Challenger Learning Center deployed zSpace to enhance elementary STEM education to foster STEAM and STEM interest and learning.

In closing, we remain confident in the long-term growth potential of zSpace and our ability to deliver on our vision. That said, we approach the fourth quarter with cautious optimism given the ongoing uncertainty related to tariff impacts and the education funding environment in the U.S.

Importantly, this caution is not a reflection of customer demand. Recent wins and ongoing engagement demonstrate that both existing customers and prospects continue to express interest in our solutions and a desire to expand usage. We believe that as federal education policy continues to take shape and funding mechanisms become more predictable, the longer-term outlook for our business will strengthen.

With that, I will turn the call over to Erick to walk through our financial results in more detail. Erick?

Thank you, Paul. As you consider our results, a reminder that our revenues are substantially recognized upon shipment of laptop units or fulfillment of software license keys. This includes recognizing the full value of multiyear software licenses in the period in which they are fulfilled.

Only a small portion of our revenue is ratably recognized. As a result of this revenue recognition treatment, our financial results can exhibit quarter-to-quarter and year-over-year variability that exaggerates the underlying seasonality of the business.

Throughout this year, we have seen the dual themes of internal execution success, driving product innovation, quality of revenues and spend management, opposed by external headwinds from tariff policy and uncertainty around education funding. Both themes continue to be in evidence as we review financial performance through the period ending September 30.

And now diving into our year-to-date performance. Year-to-date revenues were $23 million, down 22% year-over-year. As noted in our Q1 and Q2 results, we have been enjoying outperformance in software and services revenues, which make up 48% of the revenue portfolio versus 42% for the first 9 months last year or up 6 percentage points. This dynamic continues to be an important driver of gross margin expansion.

As previously discussed, our P&L reflects multiyear software license revenue in period. To help better characterize the run rate health of the business, we offer 2 non-GAAP software operating metrics. As of September 30, 2025, the annualized contract value of renewable software was $10.2 million, down 10% compared with 12 months ago. Also as of September 30, 2025, the net dollar revenue retention of customers with at least $50,000 of ACV was 77% for those customers present as of September 30, 2024.

Unfavorable performance on these 2 metrics is attributable to 2 large customers who collectively expanded their zSpace footprint a year ago, but who were not able to fully renew their expanded commitment at this time due to macro factors. Normalizing for these 2 customers, ACV would have been flat year-over-year and NDRR would have been 94%, pointing to stability across the broader customer base.

Bookings for the 9-month period ending September 30 were $22.7 million, down 35% year-over-year versus the comparable prior year period.

Gross profit was $10.9 million, down 10% against the same period last year. This includes a onetime charge in the second quarter for discontinued software license inventory, which is at once related to our exit of China and also our continued efforts to bring previously resold third-party titles in-house through both acquisition of applications and internal development. Gross profit was also affected by applicable tariffs and duties. Although we have largely treated these as pass-through on a dollar basis, we incurred some margin compression from doing so.

Gross margins for the 9-month period were 47.3%, up 6.4 percentage points versus the prior year period. Improvements in profitability continue to be driven by the same 3 factors identified earlier in the year, a favorable mix of hardware versus software and services revenues, which contributed 2.4 percentage points to the margin expansion over the year-to-date period and rate-based factors, including new hardware products with better price performance profiles and an increased amount of zSpace-owned software content. These rate-based factors delivered an additional 4 percentage points of margin expansion over the year-to-date period.

Operating expenses, excluding stock-based compensation, were up 9% for the first 9 months of the year. People-related costs, which make up most of our operating expenses were up 3% year-on-year for the same comparable period, again, excluding stock-based compensation.

And now for the third quarter. Q3 revenues of $8.8 million were down 38% year-on-year against the prior year quarter, which included an unusually large customer order that did not fully repeat this year. Notably, this represents an 18% sequential improvement over Q2.

As previously mentioned, strength in high-margin revenues continued into the third quarter with software and services representing 57% of total revenues, an 11 percentage point mix shift with significant gross margin implications.

Previously discussed turbulence in the U.S. K-12 market has persisted, resulting in unpredictable purchasing patterns and delays in school districts across the country. Bookings for the 3-month period ending September 30 were $7.4 million, down 37% year-over-year. CTE customers drove 49% of bookings value, up from 41% in the prior year comparable period.

Gross profit was $4.5 million and gross margins were 51.2%, up 6.4 percentage points versus Q3 last year. This laps the 6 percentage point margin expansion in that quarter and continues the improvements in profitability we have been delivering for 5 consecutive quarters now.

Within the quarter, the 11 percentage point mix shift in revenues was responsible for 4.3 percentage points of margin gain and the rate base factors drove 2.1 percentage points of improvement. Normalizing for a $0.1 million adverse impact of tariffs, Q3 margins would have been 52.3%.

Operating expenses of $6.6 million for the quarter, excluding stock-based compensation, were up 4% year-over-year. People-related costs, excluding stock-based compensation, which make up the bulk of costs, were up 5% year-over-year against the comparable prior year quarter.

Our reported results include $2.7 million in stock-based compensation expense attributable to grants made as part of our employee equity incentive program. Relative to the 22.8 million shares issued and outstanding at the start of the year, we continue to manage the issuance of RSUs as part of the employee equity incentive program to a target burn rate of less than 7% for the full year.

Turning to the balance sheet. As of September 30, 2025, zSpace had approximately $4.3 million in cash, cash equivalents and restricted cash compared to approximately $3.0 million in cash, cash equivalents and restricted cash as of September 30, 2024. Our path to profitability continues to run through revenue growth via operating leverage through our ongoing expansion of gross margins and tight stewardship of operating expenses.

While overall revenues are challenged by the headwinds in the U.S. K-12 market, our success in driving more of the revenue portfolio from software is bearing fruit. The gross margin expansions from revenue mix shift into software from additional first-party software and from new hardware product releases are now part of our track record in delivering results. Additional and yet unannounced hardware innovations will further improve on this performance.

Cautious and measured OpEx investments have also been a tool for driving performance and innovation while staying on the path to profitability. As a result, our adjusted EBITDA losses have narrowed to below $2 million for the third quarter, in sharp sequential contrast to earlier quarters this year.

Now moving on to our outlook for the final quarter of the year. 2025 is concluding with familiar obstacles still before us and the challenges of the government shutdown over the first 6 weeks of the quarter. Clearly, many of our customers continue to value the contributions which zSpace makes in their classrooms and training environments as demonstrated by the proportion software and services revenues make up in our Q3 results. However, the overall outlook remains difficult to project at this time.

As demonstrated throughout the year, we remain confident in our ability to improve the quality of both hardware and software revenues and move the company forward to profitability but cannot credibly project business volume under current circumstances in the U.S. education sector. Given this, we will continue to refrain from issuing formal financial guidance.

Now I will turn the time back to the operator for Q&A.

[Operator Instructions] Our first question coming from the line of Alex Paris with Barrington Research.

Nice job on revenue in the quarter, better than our expectations, better than the consensus in this still uncertain environment. Diving into the uncertainty of the environment, and you mentioned that I want to talk a little bit about the funding environment. But before I talk about that, you referenced the government shutdown first 6 weeks of the quarter. How does that impact zSpace directly? Or is it just another point of uncertainty influencing decision-making?

Erick, do you want to take that?

Yes, I can take that. And Paul, you can add in. Thanks for the question, Alex. I think the way to think about the shutdown is, in many ways, it feels like the kind of headwind we felt throughout the year where our end users have obstacles to overcome in making purchasing and funding decisions and additional challenges in accessing those funds.

Through the first 6 weeks of this quarter, their biggest obstacle has been just an inability to access funds that would have cascaded down from various federal departments, whether it's Department of Labor or Education. And that imposes a delay in many cases in accepting shipments of products as well as upfront determination to conclude purchase orders with us.

So in many ways, it feels like more of the same from the first half of the year. In other ways, it's a slightly different wrinkle that doesn't necessarily influence their decision-making, but the timing of their decisions.

Yes, that's what I was thinking because if -- what buckets of federal money do schools access to purchase your product given that most -- the vast majority of K through 12 funding is state and local derived. But things like Title I and so on come through the federal government, but it's my understanding that, that money continued to flow.

To take that from the perspective of...

Yes. Let me take that one. As you well know, and 2 different pieces to the business, Alex, the CTE business, which a lot of the funding is Perkins, and that has flown. I think the speed at which the funding has flown is different, depending on which color the state is, and I can make that comment. But that funding on the CTE side is flowing.

On the K-12 STEM side of it, 10% of the funding is from the DoE, which is federal. And there are a number of different title programs that we participate in. Some of them are even things like Title I. But as you noted, the vast majority of the funding is state and local.

And I just think it's the overall macro environment. And to give you a little bit of a little more detail, I was at a conference about 3 weeks ago with a group of superintendents. I won't name any of them, but there was about 60 of them, and I probably spoke to about 15 of them.

They were all, I'll say, believing things have kind of gone back to the way they were previously with significant nuance that federal funding is now flowing directly to the states unencumbered. And when I say unencumbered, if you recall, as a part of the administration's revisions in education, the funding is no longer tied to specific title acts.

And again, Title I and some of the other titles have a lot of things like special education learning, English learning programs, supplemental type things, they no longer have those connections. So I think the term we're continuing to use is cautiously optimistic. We actually -- in the big scheme of things, and thank you for your comments on our results. We're -- again, we're just cautiously optimistic, and that's probably the best way to leave it.

Okay. That works. I appreciate that color. The -- in talking about your recent wins, Paul, both in the press release and your prepared comments, I don't know that you mentioned Danbury. The Danbury school press release looked quite interesting. It's the largest school -- largest high school, school district in the state of Connecticut and the seventh largest overall. What is the deployment there? Is it 1 high school and 3 middle schools? Or is it going to be ultimately more than that?

Ultimately, we are -- right now, I'll say it's the beginning. There's still more opportunity. We're hoping it goes entirely across the district. And I think it's got a lot even more opportunity that goes beyond it. We announced it pretty recently. It's been deployed. We know there -- and as evidenced by our continued focus on the software side of the business and the renewals. We know they're quite happy with it, which we hope to keep them there.

It is -- they are using Career Explorer, which, as we've discussed previously, the acquisition of Second Avenue Learning has been instrumental in us helping move that one forward. But it is right now really focused on the middle and high schools. And I think there's 12,000 students, something like that in the district.

The other one that I will mention that you didn't ask about it, but it was in -- I happen to be in the Middle East as we speak and met with GEMS Education this week. GEMS Education is the largest private school network in the world, and they put in a zSpace classroom lab into a brand-new facility. I was meeting with the senior leaders this week.

And we're working hard, nothing is concluded on really making this broader within GEMS. And when I say broader across the entire UAE, Saudi markets within the Middle East. They're also in the U.K., they're also in India with schools. So that one is very much at the beginning.

That sounds exciting. But essentially, you put it in this classroom lab, do a great job, they use it. And in time, there's opportunities to roll out to other schools. That's the idea, right?

Correct. And also the opportunity to roll out additional software applications within the existing -- in Danbury's case, there's other applications that we would like them and quite frankly, more devices as well to make it even broader.

Okay. And then while I'm kind of on the same topic, you talked about -- Erick talked about the net dollar revenue retention 77% and said that, that is due -- it looks like in large part to 2 large customers who collectively expanded their footprint last year, but could not renew at the same rate. Maybe just a little bit more color there.

Yes, I'll take that one, Paul. That's correct, Alex. And in particular, what stands out as encouraging for us is this was one -- the largest of the 2 had a deployment of several hundred, not quite 1,000 units across 6 schools in their district and faced with the same budgetary constraints that many schools, many of our K-12 customers are dealing with, they made a decision to not fully renew.

They've gone from being a 7-figure software renewal account to being a mid-6-figure account. And just taken by itself, if you were to normalize for that one customer, both of those metrics would have been essentially flat year-on-year.

Now by way of color, what's encouraging is how they made the decision to shoehorn themselves into their next year budget. They didn't go dark on all of the devices. So they had, I think, about 700 devices, 800 devices across the school district in 6 schools or so. And they have preserved all of those.

So they thinned out some of the software titles on those devices, but they've kept a presence on all of the 700, 800 student desks that feature zSpace. So to put it in other terms, we're still farming the same acreage. There are fewer crops growing there, but it's the same footprint that they have preserved going into their next year of experience with zSpace.

Encouraging. So the idea there would be hopefully, when the budget constraints are not so prevalent, maybe they'll take additional software titles onto that farm.

No, exactly. As Paul said, cautiously optimistic.

By the way, if I can add a little more color, Alex, and this is allowed in the public domain. So I'm not saying anything confidential here, but there have been massive changes at the superintendent level in St. Louis over the course of the last 1.5 years. And I'll just call it upheaval. They've been through 2 superintendents and a lot of, I'll just say, disruption at the board level between that and the funding challenges and having to make some decisions about closing schools, that's -- it's been a really difficult situation when you look at it from the school district side of things. But as Erick said, we're happy they're with us and they continue to use the product, and we have an upsell opportunity down the road here.

Great. And then let me just ask one last quick one, and I'll pass the -- pass it along. The guidance, I appreciate the fact that you can't credibly project volumes here at this point. But seasonally, there tends to be an increase in revenues from Q3 to Q4. Do you think that, that pattern will persist this year without getting into the numbers or the magnitude? Or is there a risk that it could be lower sequentially?

I'll take that one, Paul. I think that this is really where the government shutdown looms as a huge wildcard. And because our revenue recognition is tied to actual shipment and fulfillment of product and very little of our revenue is ratably recognized, it is, at least as of today, an unanswerable question.

You're correct that typically, we see a sequential increase in revenues into Q4 or at least relatively strong revenues that come from fulfillment of orders that came in late in Q3. The government shutdown just means that the timing of those shipments continues to be up in the air.

And our next question coming from the line of Rohit Kulkarni with ROTH Capital Partners.

This is Jared Osteen on for Rohit. And going a little bit deeper into the several recent developments within the Workforce and CTE segment, could you walk us through some of the ones you're most excited about and generally how CTE traction has been trending?

Let me take that one, Erick, to start. And if you want to add in numbers by all means, do so. Jared, as I was saying earlier, the -- I'll say the vibe in the CTE segment and a lot of the CTE market, again, the way that we go to market, there's really 2 segments. One is the K-12 CTE market and the other one is in the community colleges and other type groups and workforce development.

The K-12 CTE business, right now, and there are a number of deals that we have that were pending, I'll say, funding confirmations. And I think what's changed in the business -- and by the way, again, the CTE funding, it's the one that's supported -- got bipartisan support, and we feel good about that side of the business.

On the K-12 CTE side of it, that side also, I'd say, has been somewhat slowed down than the normal pace, mostly because CPE directors still report to a superintendent and the superintendent is the one leading the K-12 district. But again, we feel bullish on it. So it might have slowed down a little bit.

The biggest piece that continues to resonate with our customers, and we've been talking to many of them is this Career Explorer application that we announced. I know we discussed it and we've been shipping and it's in the market now. And it is really the launch point for us, for careers. And it could be careers and skilled trades.

And as we previously have released and announced, we've got -- we're using AI. We're working with OpenAI and using AI within Career Explorer. Our plan is -- and again, this is in the public domain, to release all of our applications and embed AI into the applications, and that's something that we're working on now.

So I think the Career Explorer piece within CTE is extremely well, strong reception. There's the largest annual conference coming up in December, ACTE. And I think, come the next quarter, we'll even have some more detailed answers to your questions once we get through that.

Erick, I don't know whether you want to talk about any other numbers. I know we -- you talked about the CTE business quarter-to-quarter.

Yes. Since you brought up Career Explorer, I think the one thing that I'd note there that's encouraging is you'll recall back in Q2, we announced that at the very beginning of Q2, we closed on an acquisition for Second Avenue Learning. And we'd indicated that part of the purpose of that team was to drive road map acceleration and bring new products forward soonest.

Our career exploration product was delivered by that team and put into the market in Q3. So very rapid go-to-market from the conception of that idea to actually fielding it through our sales team. And the bookings, I believe -- or bookings, we've actually delivered low 6 figures in value for that product alone.

I think that part of that is encouraging just internally from us that we got a product to market that quickly. But I think also it highlights how well positioned that is that the CTE market is hungry for the kinds of tools that will not only accelerate students through training to the qualifications they're seeking, but also the kinds of institutions that are looking to help guide students into the right programs that are most suitable for them.

So part of that is us being very pleased that having done a good job at bringing that product to market. The fact that we're finding a very receptive market and that we've actually concluded sales within 6 months of closing on Second Avenue, I think highlights that we're well positioned for growth in that segment going forward.

By the way, Jared, one other detail, really tactical, but you probably noticed within the last 6 weeks or so, we announced, I'll say, a broadening of our suite in the robotics applications area. Next week, we'll drop another press release on another important area within the CTE that is going to broaden our offering as well.

Great. And then you recently announced the global availability of the Inspired laptop. Could you discuss how the international segment is contributing to the business? And separately, whether you're seeing any remaining tariff or supply chain challenges?

So let me take the first one about the international piece of it. And then Erick, I'll let you take the tariff piece. Internationally, I would say we've always had very strong demand. It's not an area where we, quite frankly, have really focused or invested. And obviously, given the disruptive year we've had this year, so far in the U.S., we have given it a little bit more focus. And in one of the recent press releases, we talked about our partners in Italy, Bulgaria and Poland.

Part of the GEMS focus; and again, GEMS is headquartered in Dubai, and it's very much a premium-oriented private school system; is, for us, to expand internationally. And so I think you're going to see more and more of that coming, and we've got more and we're building more and more of a pipeline in that area.

On the tariffs, I'll hand that over to Erick to cover the second part. And if you didn't cover it, Jared, to your satisfaction, you can follow up with some of the questions. Go ahead, Erick.

Yes. I think the tariffs were most disruptive to the sales motion in Q1 and early Q2 when they were moving around so much and remained unsettled. Where we are now in Q3, and you'll see this in our filings, they have an impact of about 1 percentage point of gross margin. We've been treating the tariffs for the most part as a pass-through on a dollar basis, but that still creates a small amount of gross margin compression just because we're not marking up the tariff impact to us.

You'd asked about impacts on supply chain as well. We haven't really noticed so much of a dislocation in terms of supply chain as a result of tariffs. The bigger impact is coming right now from just uncertainty in how education funding ultimately flows from federal level funding vehicles down to individual schools where a superintendent can make those decisions. And at that level, tariffs less of a factor, funding more of a factor.

On the P&L, tariffs do show up as a factor, but relatively modest impact to gross margins given the other tailwinds that we've picked up on a profitability basis. Is that helpful?

Yes. And then I think last quarter, you had spoken about shifting some of the manufacturing of core components from China to Thailand. Can you talk to whether that started to become a benefit or where we're at on that? And then also with the hinting of new hardware coming out, can you talk to anything new about where we should expect margins to trend from here with that?

Erick, how about I take that first, and you can add to it. I'll let you talk about.

Yes, I'll come back to the margins.

You will see a press release coming out next week, Jared. And this is -- when we talk about hardware, it's not the laptop, but it's the interaction component. And it is somewhat in the public domain, but it hasn't formally been press released. And this is the new stylus. So you will read more about it next week. I've been actually showing it to a number of people, and people are calling it game changing.

So we think it's going to be -- it's going to simplify everything with the way people use zSpace. And so I think it's super, super impactful. Erick can talk about the margin piece of it. Erick, do you want to take that part?

Yes, I'd be delighted to. So the key drivers of our margin expansion, we've talked about this before. One is the mix between software and hardware. You saw that very much in evidence this quarter.

Every year going back, that's been responsible for 200 to 300 basis points of margin expansion. Structural factors within our software and our hardware revenues. On the software side, as we bring more first-party content to market, you'll see that be a driver of software and software COGS as we break them out in our Q.

On the hardware side, the way to think about this is not an ongoing upward slope, but a sequence of step changes as new hardware is introduced at the laptop level with improved price performance characteristics. With the new tracking device, the new interaction device, you should expect, again, a small, modest but measurable and structural improvement that will show up as a step change improvement in hardware-related costs going forward.

And the big appeal as we see here is, firstly, in the user experience, Paul alluded to that. It's exciting. It's a much better user experience. Secondly, in terms of logistics, there are fewer -- there will be fewer peripherals to manage, which if you're an IT director in a school district, that's going to be attractive.

And obviously, that creates opportunities for us where less hardware in the ecosystem is less costly. And as there are fewer boxes to ship as part of providing a solution, delivering a solution to a school, we expect to see shipping and handling improve as well. So again, modest changes, but structural, and you'll see a onetime step-up improvement that should be sustained in future reporting periods.

I'm showing there are no further questions at this time. I will now turn the call back over to Mr. Paul Kellenberger, for any closing remarks.

Thank you. So this concludes our earnings call, and I just want to thank everybody for participating. And we're looking forward to the next one and getting through the fourth quarter here and through 2025. Thanks to everyone.

This concludes today's conference call. Thank you for your participation, and you may now disconnect.