FARO Technologies Inc

NASDAQ:FARO

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Operator]

Good day, everyone, and welcome to the FARO Technologies Third Quarter 2023 Earnings Call. For opening remarks and introductions, I'll now turn the call over to Michael Funari at Sapphire Investor Relations. Please go ahead, sir.

[Michael Funari]

Thank you, and good morning. With me today from FARO are Peter Lau, President and Chief Executive Officer; and Allen Muhich, Chief Financial Officer. Yesterday, after market close, the company released its financial results for the third quarter of 2023. The related press release and Form 10-Q are 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 measures. In the press release, you will find additional disclosures regarding these non-GAAP measures, including reconciliations to comparable GAAP measures. While not recognized in our 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 morning, and welcome, everyone, to our call. We made notable progress in the third quarter, exceeding the high end of our guidance range by delivering $86.8 million in revenue.

In addition, due to our lower cost structure and sequential 90 basis point non-GAAP gross margin expansion, adjusted EBITDA improved by $2.6 million or 300 basis points over the second quarter despite a small sequential decline in revenue. From a top line perspective, the better-than-expected performance resulted from focused sales activities to increase our overall pipeline and acceleration in customer decision-making in our target markets that, combined with an improved material availability and improved sales and operations execution enabled higher-than-expected unit shipments. During the quarter, we continued to make excellent progress on our initiatives to streamline operations by taking a series of actions that reduced our footprint, rightsized our cloud investment, integrated prior acquisitions and increased our overall productivity. We have increasing confidence that these cost actions will optimize our performance and not adversely affect our ability to capture long-term market share. While we are pleased with the progress, we are in the early innings of improving results and driving increased execution. Our team recognizes that we have more work to do and is committed to executing with intensity.

The revised cost structure reflected in our third quarter expense base and gross margin expansion demonstrates the progress we've made towards improving our operating model. In the quarters ahead, we will continue to be vigilant on maintaining current spending levels and capturing additional opportunities with a particular focus on expanding gross margins while continuing our [ fist ] investment in new products and technologies. On the product front, the third quarter, we accelerated our product development process while focusing on key product launches, which we believe will have the greatest impact in the market. An example of this is our recently launched Orbis Mobile Scanner, a groundbreaking advancement set to redefine 3D reality capture. Orbis is the first-to-market scanner that can be used for both mobile and stationary data capture in 1 device. It's best of both world's performance, providing the ease of use and speed of a mobile scanner while also providing the unique ability to seamlessly switch to stationary mode which significantly enhances accuracy. When combined with automated integration to our recently announced Sphere XG platform, FARO provides customers the ability to automatically process 3D data, making completed 3D images available for viewing and collaboration in a cloud, a desktop or mobile environment up to 90% faster than alternatives.

These advancements reflect the fusion of FARO's legacy technologies with those of our recent GeoSLAM and HoloBuilder acquisitions and further demonstrate our commitment to innovation. Before turning the call over to Allen, who will provide greater detail on our third quarter results, I want to take a moment to share some of my observations. Since joining FARO, my primary focus has been on building a point of view on what is working, where we need to improve our opportunity for sustained technology differentiation and finally, on a sustainable financial success model. I'm very impressed by what I've learned. Having met with customers around the world, the strength of FARO's brand in the market is clear and not only speaks to the trust customers have in us, but also our reputation for 3D application expertise and innovation. By leveraging our core stance in the market, we are well positioned to remain at the leading edge of product performance while exploring near adjacencies that expand our addressable market, solve our customers' toughest problems and ultimately drive growth. Customer feedback has affirmed our overarching product solutions strategy. In speaking with our employees, the team's unwavering commitment to our organization is palpable.

Given the macro challenges and uncertainties over the past several years, their dedication is truly commendable. The team is not only engaged but driven by a shared ambition to be a leader in the market through a commitment to our customers, shareholders and the legacy of FARO. I'm encouraged by the opportunity to improve upon the solid foundation we have as a company. I believe in establishing an operating system centered around an 80/20 philosophy, that relentlessly prioritizes key activities that will drive the greatest impact on shareholder value and a financial model that will yield improved profitability in all market conditions. We are well down the path of implementing organizational initiatives such that all 1,300 FARO employees know how what they do every day contributes to the achievement of the priorities we've aligned on and agreed to as a team. I have confidence the resulting focus and rigor will yield performance improvements. Having had the chance to assess the market opportunity, there is incredible value to be created by the reduction of waste and inefficiencies in the management of the world's physical assets through the use of 3D capture and virtual management tools. Our potential for growth is broad and substantial but will require a focused and disciplined product road map as well as a go-to-market strategy targeted toward customers, markets and applications where we have the highest probability of success.

The driving force remains our underlying strategy of hardware augmented by software to deliver solutions that solve customer problems. Yet there is likely some refinement to key elements and focus areas that will accelerate and optimize our success. In the coming months, I expect to continue building upon our operating cadence and further refine my strategic point of view with our employees, executive team and Board of Directors to develop a cohesive strategy. When finalized, I plan to publicly communicate to our stakeholders, our key priorities, target markets, targeted financial model and long-term goals as well as a road map for achievement. With that, I'll now turn the call over to Allen to provide an overview of our third quarter financial results.

[Allen Muhich, executive]

Thank you, Peter, and good morning, everyone. Third quarter revenue of $86.8 million was up 2% compared with the third quarter of 2022. 3D metrology demand remained relatively healthy, particularly in the automotive and aerospace industries. Geographically, demand within the Americas and Europe continue to perform well, but the softness we saw in China causes a bit of caution near term and into the fourth quarter. In.

The third quarter, we continued to see our sales activities yield an expanded pipeline. While too early to call a trend in remaining longer than historical averages, our sales cycles modestly shortened after 2 consecutive quarters of lengthening. This positive timing change created an uplift in demand and with improved execution in sales and operations planning positively impacting our [ finish availability ], we were able to accelerate product availability and satisfy the increased customer demand. Third quarter hardware revenue of $55.7 million was up 1% year-over-year, while software revenue of $11.2 million was up 6% and service revenue of $19.9 million increased slightly. Recurring revenue was $17.1 million and represented 20% of sales. As discussed in prior quarters, over the past year, we have seen a modest flattening of overall software revenue as we convert customer purchases of perpetual licenses to subscriptions. In the third quarter, we began to see a resumption in both sequential and year-over-year growth as we exit this transitionary stage. Service revenue showed a modest 1% year-over-year increase, marking the second straight quarter of year-on-year growth, as our service revenue continues to show signs of recovery from the contraction in our serviceable installed base that resulted from softness in 2020 and 2021 hardware shipments.

GAAP gross margin was 48% and non-GAAP gross margin was 48.9% for the third quarter of 2023. On a non-GAAP basis, continued high raw material costs and relative strength of the U.S. dollar compared to historical exchange rates resulted in the third quarter's year-over-year gross margin decline. Sequentially, we are pleased that reported non-GAAP gross margin improved 90 basis points due in part to improved product mix, a modest decrease in unfavorable purchase price variance that resulted from our 2022 broker buys. And importantly, we saw initial benefits from supply chain localization. The sequential gross margin improvement from our shift to a Southeast Asia supply chain is important as it marks up a point on our way to realizing $12 million in annualized savings. Additionally, in Q3, while lower than Q2, we continue to recognize approximately 300 basis points of the unfavorable 2022 broker buy PPV amortization that will no longer affect us in early 2024. Taken together, we continue to expect a meaningful improvement in 2024 gross margin. GAAP operating expenses were $48.6 million and included approximately $4.6 million in acquisition-related intangible amortization and stock completion expenses and $2.5 million in restructuring and other transaction costs.

Non-GAAP operating expense of $41.5 million was down $2.8 million from Q3 last year, as we realized the first full quarter benefit of our restructuring efforts. As we stated last quarter, with our expense reductions largely completed, we remain committed to realizing quarterly spending at present FX rates of approximately $40 million to $43 million. GAAP operating loss was $6.9 million in the third quarter of 2023 compared with an operating loss of $7.1 million in the third quarter of 2022. Non-GAAP operating income was $900,000 in the third quarter of 2023 compared to a loss of approximately $750,000 in the third quarter of 2022. Adjusted EBITDA was $3.5 million or approximately 4.1% of sales. Our GAAP net loss was $8.8 million or 46% per share. Our non-GAAP net income was approximately $450,000 or $0.02 per share for the third quarter of 2023 compared to a net income of approximately $550,000 or $0.03 per share in Q3 2022. In May, we discussed a total charge of between $22 million and $28 million to realize our new quarterly expense base. On a year-to-date basis, we have incurred approximately $25 million in charges resulting from cash severance for affected employees, inventory write-offs as we increase our focus on core strategic product lines and facility and other asset-related write-downs as we seek to reduce utilized work [ footage ].

We continue to expect that approximately 40% of the combined charges to be cash payments. Our cash balance at the end of the quarter was $79.9 million, down $8.6 million from Q2, largely due to restructuring charges. Excluding the restructuring and other nonrecurring cash payments, our free cash flow would have been approximately neutral in the third quarter. We remain very focused on improving our days sales outstanding with accelerated collections expected in the fourth quarter of 2023 and into 2024. Given our current accounts receivable balance, expectations for revenue and our new expense base as well as further enhancements to our inventory management, we continue to expect cash flow to be positive in the second half of 2023. While we are pleased with our third quarter results and view them as evidence, the business is moving in the right direction, we remain cautious on extrapolating this trend into the fourth quarter. From a geographic perspective, in the third quarter, we experienced an unexpected softening in the Chinese market. At this stage, we do not expect China demand to rebound in the fourth quarter, which will create an incremental headwind to the seasonal year-end strength. Together with PMI remaining below 50 and sales cycles remaining above historical levels, we want to remain thoughtful and measured in setting expectations for the remainder of this year.

As a result, at present FX rates, we expect fourth quarter revenue of between $92 million and $100 million. At those revenue levels and given corresponding non-GAAP gross margin improvement to between 50.5% and 52% and non-GAAP operating expenses of between $41 million and $43 million, we would expect non-GAAP earnings per share of between $0.18 and $0.34. This concludes our prepared remarks. And at this time, we'd be pleased to take questions.

[Operator]

[Operator Instructions]

We will go first to Greg Palm with Craig-Hallum Capital Group.

[Greg Palm, analyst]

Yes. Congrats on the results and Pete and especially a good start for you. So congrats as well.

[Peter Lau, executive]

Thanks, Greg. Nice to speak to you.

[Greg Palm, analyst]

Maybe just kind of starting on the revenue and the sort of demand outlook side of things, as you kind of look back on the quarter and just general activity, I'm curious, are you characterizing the better than expected activity due to -- how much is due to market conditions versus just better execution and sort of company specific? I'm guessing it's a mix of both, but maybe leans towards the latter, but I just wanted to get some kind of further input on what your thoughts are.

[Peter Lau, executive]

Yes, Greg, thanks for the question. I mean geographically, I would say we continue to see broad strength in the Americas region with EMEA staying study. APAC contraction driven by China. I would say that the execution was driven by a number of factors, probably most notably normalization of material availability, which obviously allows us to react to our sales forecast a little bit better -- be in a better position with finished goods, a better position to move our products around the world to satisfy set customer demand. So a little bit of market, a little bit of execution, which obviously drove a better-than-expected results, Greg.

[Greg Palm, analyst]

And other than calling out China as a maybe a region of weakness. Is there anything out there geographic-wise or end market-wise that cautions you going forward relative to maybe what you would have thought a few months ago?

[Peter Lau, executive]

Yes. I mean, look, Greg, I think we're all kind of looking at the developing situation in the Middle East and trying to understand what that means for the broader macroeconomic environment. The AEC market continues to remain a little soft with the decline in resi and commercial projects. But that said, I would say industrial applications on the 3DM side still pretty strong, I would say, a good macroeconomic environment there. So look, we're watching it closely, the continued normalization of our supply chain should allow us to continue to react and drive execution of that demand, and we'll be particularly focused on that execution in the fourth quarter.

[Greg Palm, analyst]

Understood. And then if I could just shift gears a little bit on gross margin. In terms of the outlook for Q4, Allen, does that take into account a lower maybe headwind from the broker fees? Or is that still taking into account kind of a full 300 basis points?

[Allen Muhich, executive]

If you think about the purchase price variance that we experienced in Q3, I think we expect that the combination between the 2022 broker buys as well as the localization of our supply chains to Southeast Asia. The effect that we're seeing in Q3, we expect to modestly improve in Q4, but generally, by and large, remain the same. The margin improvement that we see in Q3 -- from Q3 to Q4 is mainly going to be driven by the increase in revenue and our above corporate average contribution margins and better fixed cost absorption.

[Greg Palm, analyst]

Okay. And so do you realize then most of that benefit in Q1? Or is it sort of exiting Q1 where you see most of that headwind dissipate?

[Allen Muhich, executive]

There's certainly going to be a sizable improvement in Q1, but not to the full extent that we've outlined, that would be more of a -- into the second half -- mid-Q2 into the second half, not to get too precise.

[Operator]

[Operator Instructions]

We will go next to Jim Ricchiuti with Needham & Co.

[Chris Grenga, analyst]

This is actually Chris Grenga on for Jim. And congrats on the quarter, by the way. With the release of Sphere XG, I was just wondering if you could talk about the trend that you're seeing in terms of bookings in terms of the revenues per user. Any color even at a high level that you could provide there, that would be great.

[Peter Lau, executive]

Chris, thanks for the question and I appreciate the commentary. Probably too early to talk about Sphere XG and that trend as it just released in the middle of August.

What I will say is the added functionality on Sphere XG along with the workflow component and the integration with our new Orbis product will allow many of our customers to seamlessly automate the capture and the readiness of that 3D data. And so we expect really big things from Sphere XG and look forward to talking more about that in quarters to come.

[Chris Grenga, analyst]

Got it. And on automotive, could you just maybe talk a little bit more about what you're seeing there? And -- was there any exposure to sort of what we're hearing about with respect to the UAW situation?

[Peter Lau, executive]

Thanks, Chris. Yes. No, look, it's something that we're watching closely. As I commented, we are still seeing broad strength in our Americas business. And at this point, would expect that to continue into the fourth quarter. So no specific effects, but we'll continue to watch that situation pretty closely.

[Operator]

Thank you, ladies and gentlemen. This does conclude today's program. You may now disconnect.