FARO Technologies Inc

NASDAQ:FARO

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good day, everyone, and welcome to the FARO Technologies Second Quarter 2024 Earnings Call. For opening remarks and introductions, I would now like to turn the call over to Michael Funari at Sapphire Investor Relations. Please go ahead.

[Michael Funari]

Thank you, and good afternoon. With me today from FARO are Peter Lau, President and Chief Executive Officer; and Matt Horwath, Chief Financial Officer.

Today, after market close, the company released its financial results for the second quarter of 2024. The related press release and Form 10-Q is available on FARO's website at www.faro.com.

Please note certain statements in this conference call, which are not historical facts, may be considered forward-looking statements that involve risks and uncertainties, some of which are beyond our control and include statements regarding future business results, product and technology development, customer demand, inventory levels, our outlook and financial guidance, economic and industry projections or subsequent events. Various factors could cause actual results to differ materially. For a more detailed description of these and other risks and uncertainties, please refer to today's press release and our annual and quarterly SEC filings. Forward-looking statements reflect our views only as of today, and except as required by law, we undertake no obligation to update or revise them.

During today's conference call, management will discuss certain financial measures that are not presented in accordance with U.S. generally accepted accounting principles, or non-GAAP financial issues. In the press release, you'll find additional disclosures regarding these non-GAAP measures, including reconciliations to comparable GAAP measures. While not recognized under GAAP, management believes these non-GAAP financial measures provide investors with relevant period-to-period comparisons of core operations. However, they should not be considered in isolation or as a substitute for a measure of financial performance prepared in accordance with GAAP.

Now I'd like to turn the call over to Peter Lau.

[Peter Lau, executive]

Thank you, Mike. Good afternoon, and welcome, everyone, to our call.

In the second quarter, we continued to make significant progress towards the strategic plan we outlined in March and are well ahead of where we expected to be at this time. We exceeded our targets on all items within our control. Non-GAAP gross margin was 55%, an increase of 300 basis points sequentially, and non-GAAP operating expenses were $40 million, down 9% over prior year and 2% sequentially. As a result, we generated $0.18 of non-GAAP EPS, which is above the high end of our guidance range, the fifth straight quarter of exceeding expectations.

Adjusted EBITDA was $8.4 million or 10.3% of sales, bringing our first half adjusted EBITDA up to $14 million. That $14 million exceeds our full year 2023 adjusted EBITDA performance and represents an improvement of 1,100 basis points as a percent of revenue. Operating cash flow was positive in the quarter, our third straight quarter of operating cash flow generation, a first for our business since 2019.

As I reflect on the last year, we've made substantial progress in improving our operational efficiency. Our second quarter gross profit and EBITDA margins represent a step-up from our strong first quarter performance, and we believe this validates the targets we set out in March and demonstrates the significant operating leverage now built into our business as our organic growth initiatives take hold in the quarters and years ahead.

For reference, at our investor event in March, we laid out long-term targets of 600 basis points of improvement in gross margin with flat operating expenses, delivering an EBITDA margin of 9% to 11%, assuming no revenue growth. In Q2, we have already achieved these targets, and we expect to see additional long-term upside in the years ahead as we continue to optimize our operations through a number of initiatives.

From a top line perspective, we delivered $82.1 million in revenue in the second quarter. Like many others, we saw a mix of demand levels across both the markets and geographies we serve. Within our various served markets, discretionary CapEx spending remains a focus as our customers evaluate the macroeconomic outlook and the potential implications it has for their business.

As seen in our Q2 results, deals largely continue to move forward as planned. However, in certain subsectors, such as the construction market, there continues to be a degree of caution and budget spending beyond what we would normally see in a healthy macro environment. With that said, while discretionary CapEx spend remains soft, we continue to see strong demand in our software and service offerings, and we continue to believe in our ability to grow faster than the markets we serve over time.

Geographically, in the Americas and EMEA, demand remained stable, while in Asia, we again saw a decline in the overall region. As we discussed in May, while overall results were stable for Asia-Pac in the first quarter, it was a small number of deals that created the strength. Given the ongoing macroeconomic challenges in China, including a slower environment in 3D metrology, market demand proved softer than we had anticipated at the end of the first quarter.

Operationally, our gross margin came in ahead of expectations as our focus on variable cost productivity, mitigation of broker fees and supply chain localization efforts continue to progress. In addition, we continue to identify new opportunities to further identify -- optimize our operations.

Using logistics as an example, over the last 6 months, we have enhanced the efficiency of the shipments from our manufacturing facilities, improved shipping methods and brought on new partners to leverage our global spend that we expect will save us a substantial amount of money in our run rate. Beyond that spend optimization in the second quarter, we also saw incremental contribution from the pricing actions we took at the start of the year. Taken together, our operating and pricing initiatives contributed meaningfully to our sequential gross margin improvement despite the nominal decrease in revenue.

Related to operating expenses, we are focused on initiatives which help drive cost containment, while delivering our near and midterm objectives. As an example, we continue to evaluate ways in which we backfill resources and shift our spend to lowest cost regions to optimize productivity. Within R&D, we remain focused on dynamic resource allocation to ensure the investments we make are directly aligned with our focused product road map, including addressable market expansion opportunities and refreshing our key products, while protecting and enhancing our core competencies in developing our talent.

As I mentioned earlier, the improved profit and our emphasis on working capital improvements resulted in our third straight quarter of positive operating cash flow. As the underlying financial foundation of our business continues to improve, we have a growing confidence in the ability for our business model to consistently generate earnings and cash flow.

Based on this confidence, we took an action in the second quarter to repurchase $3 million of convertible debt at attractive terms. Going forward, we will continue to closely evaluate opportunities to redeploy our improving cash flow, either through our existing $18 million share repurchase program or debt repurchase to generate the highest return for our shareholders.

Looking ahead, we remain focused on improving productivity through both existing and new initiatives to fully realize the strategic targets we already have in place. With these actions well underway, we're placing a greater focus on the strategic investments and actions we can take around customers' experience, regional diversification and new products and technologies to improve our growth profile beyond the growth of the market itself.

Related to our product road map, as we discussed in March, in addition to refreshing our existing product portfolio, we firmly believe there are opportunities to leverage FARO's technology and innovation beyond the markets we currently serve. As we look out over the next few quarters, our intention is to begin introducing these products to the market. As we do so, we look forward to discussing these impactful new solutions with you in greater detail, including the markets they target and opportunities they represent.

Within our existing portfolio, our Orbis Mobile Scanner continues to see great receptivity in the market, with revenue for our mobile scanning solutions, again, increasing double digits year-over-year. In Q2, we delivered a new Sphere XG workflow for mobile scanning, which has allowed us to capture more share of wallet with key customers through our full, differentiated workflow that merges 2 fully processed 3D scans in the cloud automatically without require manipulation in the desktop software. This workflow is providing productivity and insights to some of our most strategic customers.

In one case, an existing customer focused on commercial real estate measurement recently refreshed their fleet of FARO hardware. By upgrading to the Orbis platform and integrating Sphere XG into their workflows, they were able to significantly improved productivity through the ability to quickly scale and expedite project deliveries.

In addition to Orbis' success, we continue to see further traction with our solution strategy, combining the power of our hardware offerings with Sphere XG software platform, to create greater value for our customers. This quarter, Ferguson, a leading distributor of HVAC products to a variety of markets, upgraded their FARO terrestrial and mobile scanners, emphasizing the growth and enhancement of the reality capture solutions.

By using 360-degree photo documentation, model import and FARO scanners of Sphere XG, Ferguson now uses the FARO platform to remotely scope mechanical, electrical and plumbing project bids nationwide, monitor progress of projects and be more competitive against local contractors.

Specific to Sphere XG, we continue to make promising progress on delivering biweekly value feature releases, while upgrading legacy customers to our SaaS platform. Customers increasingly recognize the productivity and quality and utilizing our leading collaboration and reviewing platform.

To help provide context for the pace of our progress, in the last month alone, we have migrated roughly 18 terabytes of customer data to the platform, with the expectation of reaching over 360 terabytes by the end of Q3. Finally, we've made a number of investments in our customer experience over the last year. Our NPS scores are up 10 points year-over-year. We also recently completed our latest brand loyalty survey, which reflected an 80% overall loyalty score, with 82% likely to continue buying from us. These metrics speak to our commitment of operating a customer-focused business, and customers are responding with their loyalty and satisfaction. This further reinforces our view that the FARO brand is a significant asset and is renowned through the markets we serve.

In summary, we are very excited about our progress to the plan that we set out over the last 12 months. We are not only executing to that plan, but are exceeding our own expectations ahead of schedule. We believe that FARO has great potential to outgrow both the markets we currently serve as well as those we look to target. By leveraging our strong brand name with our reputation for innovation and high-performance solution, we position ourselves well to deliver innovation that effectively addresses our customers' most pressing challenges.

Combined with both existing and new operational excellence initiatives to expand gross margins and profitability, we expect to be in a position to realize meaningful operating leverage as revenue grows. We are enthusiastic about our strategy in the years ahead and are confident in its capacity to drive substantial shareholder value.

With that, I'll now turn the call over to Matt to provide an in-depth overview of our second quarter financial results and third quarter outlook.

[Matthew Horwath, executive]

Thank you, Peter, and good afternoon, everyone. Second quarter revenue of $82.1 million was down 7% versus prior year. Geographically, Americas region demand improved sequentially in the second quarter versus a soft Q1, while in the Asia Pacific region, we experienced a $4.7 million decline or over 20% versus the second quarter of 2023. The Europe region remained stable with a 1% decline year-over-year in Q2 and up 2% year-to-date versus the first half of 2023.

Second quarter hardware revenue of $50.1 million was down 12% year-over-year, while software revenue of $11.3 million was up 4%, and service revenue of $20.8 million increased by 1%. Recurring revenue was $17.1 million and represented 21% of sales. GAAP gross margin was 54.6% and non-GAAP gross margin was 55% for the second quarter of 2024 compared to 37.8% in 2023.

As Peter mentioned, in the second quarter, we executed on our variable cost productivity initiatives, including mitigating broker fees and incremental benefits from supply chain localization. Non-GAAP gross margin increased over 300 basis points sequentially versus Q1 and marks the highest quarterly level since 2021, as Peter mentioned.

GAAP operating expenses were $43 million and included approximately $1.6 million in acquisition-related intangible amortization and stock compensation expenses and $1.4 million in restructuring and other executive transition costs. Non-GAAP operating expense of $40 million was down $4.1 million from Q2 last year, as we realized the benefit of our restructuring efforts and continued productivity improvements.

GAAP operating income was $1.8 million in the second quarter of 2024 compared with an operating loss of $25.4 million in the second quarter of 2023. Non-GAAP operating income was $5.1 million in the second quarter of 2024 compared to a loss of $9.9 million in the second quarter of 2023. Adjusted EBITDA was $8.4 million or approximately 10% of sales compared to an EBITDA loss of $7.2 million in the second quarter of 2023.

Our GAAP net loss was $500,000 or $0.03 per share. Our non-GAAP net income was $3.4 million or $0.18 per share for the second quarter of 2024 compared to a net loss of $10.8 million or $0.57 per share in Q2 2023. Our cash and short-term investment balance at the end of the quarter was $97.9 million, up $1.6 million from Q4 and down $1.4 million sequentially. As Peter mentioned, we repurchased $3 million of our convertible debt principal in the second quarter. Excluding debt repurchases and the impact of foreign exchange, cash and short-term investments increased $2.3 million sequentially. Given our current working capital levels, expectations for revenue and our new expense base, we expect to be free cash flow positive throughout the second half of 2024.

We are very pleased with our second quarter results, especially with adjusted EBITDA margin reaching over 10% and continued generation of positive cash flow from operations. The macro environment remains choppy, and we expect continued demand challenges in China and normal seasonality trends in the Europe region, driven by the summer holiday schedule in the third quarter.

Given these and the potential of a weakening macroeconomic environment, at present FX rates, we expect third quarter revenue of between $76 million and $84 million. At those revenue levels and given corresponding non-GAAP gross margin between 53.5% and 55% and non-GAAP operating expenses of between $40 million and $42 million, we would expect non-GAAP earnings per share ranging from negative $0.01 per share to positive $0.19 per share for third quarter profitability.

This concludes our prepared remarks. And at this time, we'd be pleased to take your questions.

[Operator]

[Operator Instructions] And we will take our first question from Greg Palm with Craig-Hallum Capital Group.

[Greg Palm, analyst]

Congrats on the continued progress and on the gross margin and overall profitability front.

[Peter Lau, executive]

Thanks, Greg.

[Greg Palm, analyst]

I guess maybe just starting with a little bit around kind of the macro and kind of what you're seeing in terms of sales cycles, kind of cadence of activity. Would be really curious to kind of hear what you're seeing so far in July as it relates to kind of the guidance. And sort of what's baked in or what's assumed in the Q3 guidance versus what you just achieved in Q2?

[Peter Lau, executive]

Greg, I think, look, the macro continues to remain very challenged as we've seen across a number of industries, especially those kind of looking at -- or exposed to discretionary CapEx. We feel that our Q3 guide certainly is achievable. And through July, we would have no indication at this point that it's not, although we'll continue to look at the market and make sure that we're adjusting as necessary and making the right decisions for the business to continue to deliver positive earnings, positive cash flow and the best revenue result we can.

[Greg Palm, analyst]

And just -- I know macro end market, it's outside your control. But I think what -- in the release, it talks about kind of delivering on the next sort of growth plans. Part of that is probably new products, but give us some sense on how you're thinking about the next few years and your ability to at least outgrow the market?

[Peter Lau, executive]

Yes, Greg, as we said, we're very confident in our strategy. And as we've been talking over the last 12 months, the first job in delivering that strategy was getting ourselves to a place where we could continually deliver consistent earnings and cash flow generation. And that has always been our focus for the last 12 months as we've come in, Matt and I, and really focused on getting ourselves in that position.

And from there, the second phase was always going to be really looking at our ways to grow the business organically. And we have a very, very robust and very exciting plan that we've always said, our goal was to outgrow the markets that we serve. And we believe that through a combination of new products, a refresh of some of our products that are maybe a little longer in the tooth and partnerships to aid all of that stuff, we believe very firmly in our strategy that we'll be able to outgrow the market in the coming years.

[Greg Palm, analyst]

Can any of that benefit this year, Q4, for instance? Or should we be thinking about that as more of a '25 and beyond impact?

[Peter Lau, executive]

Yes, I think we would look to introduce more new products this year and certainly hope that they would contribute to 2024, but we certainly are very bullish about our prospects in the next several years, over the long term.

[Greg Palm, analyst]

Yes. Okay. And then my last question is more of a capital allocation question. I appreciate the thoughts around buying back some of the debt. I feel like, Pete, since you've come on board, you've done a lot of things right for the P&L. And again, you're -- you can't control the macro, but you've certainly done a great job of controlling what you can control and you're seeing the benefits in gross margin and overall profitability.

And if the stock is not performing well and it looks like it's down quite a bit here in the after hours, again, why not put a buyback in place? If you're buying back the debt, why not buy back the equity as well? Are you willing to at least comment on that?

[Peter Lau, executive]

Yes, let me start with that, Greg, and then I can turn it over to Matt. I did reference in our prepared remarks that we have an existing $18 million share buyback program. Certainly, at the levels that our stock is at, we would look at that as what we believe would be a fairly attractive investment.

In the third -- in the second quarter, we saw the debt, we saw at attractive levels, and we decided to pull the trigger. But now that we've gotten ourselves to a place where we are really comfortable in our ability to generate cash flow and earnings, we'll continue to look to deploy that. We have the repurchase program in place already. We have $18 million left on it and we will continue to evaluate what the best return for our shareholders is going to be.

[Operator]

[Operator Instructions] We'll take our next question from Jim Ricchiuti with Needham Capital.

[James Ricchiuti, analyst]

I wanted to ask you about the gross margins. It came in -- the gross margins came in better than expected. And you highlighted there are a few factors. I'm trying to understand a little more what drove the upside relative to your expectations going into the quarter? You talked about pricing and some mix. But maybe you could just give us a better idea.

[Matthew Horwath, executive]

Yes, Jim, this is Matt, and I appreciate the question. I think, versus the guide, let's just say kind of midpoint of guide on the gross margin line, on the non-GAAP side, was 52%. And if you kind of bridge that to the 55 actuals, I think most of the upside came from just acceleration of variable cost productivity.

We've been talking a lot about the localization and the savings there as we move the supply chain to Southeast Asia, and there's a little bit of acceleration on that line. Plus Pete mentioned in his prepared remarks, even some incremental goodness on the logistics as we kind of look to be as productive as we can.

And then I would say, at a smaller level, a little bit of mix at the hardware line. And then if you look at our overall revenue profile, had a little bit of mix shift to software, which had higher gross margins and then price kind of layered in, gives you that 3% kind of incremental versus the midpoint of the guide.

[James Ricchiuti, analyst]

Got it. In terms of what has the bulk of those benefits that you cited early on in your response has been realized? Or is there still some upside potentially could impact the coming quarter?

[Matthew Horwath, executive]

Yes. Yes. No, I think as you think about the variable cost productivity and what we've been signaling for the last kind of 6 quarters is we think there's $12 million of kind of annualized cost savings on the localization of supply chain. And we think we're kind of in middle innings there, right? We think there's some to go.

And that's not going to be linear, Jim. It kind of steps up as old contracts roll off and new contracts come online. So we think there's a little bit of goodness over the longer term on that particular line item. And then mix can shift a little bit quarter-to-quarter. So I wouldn't get too hung up on mix. I think that may bounce around 50 bps, 80 bps from quarter-to-quarter.

And then price, we still think there's some to go. We signaled that we never really expect to realize too much from price because historically, we really didn't show the ability to realize that, but we saw some goodness in price in Q2, and we think there's a little bit of incremental upside there as well.

[James Ricchiuti, analyst]

Got it. And a final question for me. Talking about the end markets, you called out construction as being one of the markets, I think, where you're seeing probably some slowing in terms of the decision-making. Where else are you -- have you seen changes in demand as it relates to folks maybe taking a little longer to give the PO?

[Peter Lau, executive]

Yes. I think just in general, Jim, I would point to probably regionally. The biggest issue right here right now is in China. And that's something that we're focused on, but it's manufacturing in China. It is construction in China, and that's the bulk of what's driving the revenue or lack thereof revenue growth in our business.

[James Ricchiuti, analyst]

And the outlook for China, again, I don't want to put words in your mouth, but in terms of -- as you look beyond this quarter, do you see any signs of that picking up?

[Peter Lau, executive]

We don't, Jim, at this right here right now, but I will point out that I think we're -- probably Q2 was the last of our really tough comps related to China. We really start to see the China business drop off in the second half of 2023. So while we don't see it materially getting better from here, it should start to ease a little bit in terms of kind of the year-over-year comps as we move forward into the second half of this year and then into 2025.

[Operator]

And we have no further questions in the queue at this time. I will turn the program back over to Peter Lau for any additional or closing remarks.

[Peter Lau, executive]

Okay. Thank you, operator. On behalf of all of our colleagues, I want to thank everyone for your interest in FARO. Despite a really challenging market, we continue to exceed our targets in all areas we can control and are excited about our progress.

Our second quarter performance demonstrates the operational leverage we've already built into our business with gross margin, operating expenses, overall profitability and cash flow generation, all tracking ahead of our plan. While we continue to focus on ways to further improve these results, our success thus far gives us confidence that as we execute on our organic growth initiatives in the quarters ahead, we believe we'll be in a position to unlock short- and long-term shareholder value. We look forward to sharing our progress and execution in the quarters ahead. This concludes our call today. Thank you very much for your interest.

[Operator]

Once again, this does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful day.