FARO Technologies Inc

NASDAQ:FARO

Earnings Call Transcript 2024-Q3

[Operator]

Good afternoon, everyone, and welcome to the FARO Technologies Third Quarter 2024 Earnings Call.

For opening remarks and introductions, I will now 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 third 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 measures. 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 third quarter, we continued to make progress towards optimizing our operations. We again exceeded our targets on all items within our control. Non-GAAP gross margin was 56.1%, expanding 730 basis points year-over-year and 110 basis points sequentially over the high bar that we set in the second quarter. Non-GAAP operating expenses were $40.1 million, remaining at the lower end of our targeted guidance range of $40 million to $43 million per quarter.

As a result, in the third quarter, we generated $0.21 of non-GAAP EPS, which was above the high end of our guidance range and represented the sixth straight quarter of exceeding our expectations. Adjusted EBITDA was $8.9 million or 10.7% of sales, bringing our adjusted EBITDA year-to-date up to $22.9 million and $36 million in the trailing 12 months. More importantly, we continue to demonstrate the fundamental improvement in our operating structure over the past year.

EBITDA margins were above 10% for the second quarter in a row and for the first time in almost a decade. As a result, operating cash flow was again positive in the quarter, representing our fourth straight quarter of operating cash flow generation. I'm very proud of the significant improvements in our operational efficiency this year, despite the challenging macroeconomic landscape. Year-to-date, our gross margins have expanded by over 600 basis points, and our EBITDA margins have experienced even more rapid growth, increasing by more than 900 basis points. With our strong third quarter results, we have delivered on the margin targets that we set earlier this year well ahead of schedule.

Looking ahead, we believe there is further upside over the long-term as we expect to continue to optimize our operations through a number of ongoing initiatives. From a top line perspective, in the third quarter, we achieved $82.6 million in revenue, reflecting stable demand in certain sectors such as 3D metrology, while facing ongoing challenges in others, including commercial construction in specific regions like China and Germany. Within our served markets, discretionary capital expenditure remains a key area of focus for our customers as they assess the macroeconomic landscape and its potential impacts on their businesses.

Given the ongoing conversations we're having with our customers as well as broader industry sentiment factors, including the global PMI, we remain cautious on the outlook beyond next quarter. Geographically, demand within the Americas was consistent with the prior quarter, while demand within EMEA increased sequentially, driven by strength in France and Eastern Europe. Offsetting this, demand in Asia again declined this quarter as economic challenges in that region persist.

Operationally, our gross margin again came in ahead of expectations in the third quarter as we continue to realize incremental savings, both from our supply chain localization plan as well as our ongoing optimization efforts. Looking ahead, we expect that we will continue to benefit from these ongoing initiatives. However, we expect that volume and mix will play a larger role in sustainably growing gross margins above the current levels. Related to operating expenses, we remain focused on developing initiatives to help drive cost containment while delivering on our near and mid-term objectives.

As an example, we continue to implement a series of actions that dynamically reallocates resources, both geographically and within operational functions to better align with the opportunities we currently see ahead of us. By carefully evaluating and making incremental changes to our ongoing operational spend, we believe we'll be in a better position to continue to maximize investments in key growth and operational areas, while at the same time, maintaining our overall spend at current levels. Our focus on improving profitability and working capital has also led to our fourth consecutive quarter of positive operating cash flow. With the strengthening financial foundation of our business, we are increasingly confident in our ability to generate consistent earnings and cash flow. We believe this commitment is reflected in our ongoing efforts to optimize capital allocation. In the third quarter, we repurchased $10 million of our outstanding shares.

Looking ahead, we'll continue to assess opportunities to redeploy our improving cash flow, whether through the remaining $8 million in our share repurchase program or by repurchasing debt like we did in the second quarter to maximize returns for our shareholders. Looking beyond our operational initiatives, we continue to focus on the strategic investments and actions we're taking around customer experience, regional diversification and new products and technologies, which we believe will enable us to improve our growth profile beyond the growth of the underlying market itself.

During the quarter, I had the opportunity to meet with dozens of customers and participate in several global events such as INTERGEO in Stuttgart and IMTS in Chicago. I'm extremely pleased with the reception of our solutions and the reaction of customers to FARO's service. I was also struck by the appetite from our customers for further advances in technology solutions and satisfied that our strategic priorities are very well aligned with not only the trends in the technology, but the wants and the needs of our current and future customers.

With that in mind and as a part of our commitment to our strategic plan that we outlined in March, we continue to advance our product roadmap. I'm very excited to announce that we've recently refreshed 2 of our major product lines, the Arm with Quantum X and our next-generation of laser scanners, both of which we announced in October. We believe these updates reflect our ongoing efforts to innovate and meet the evolving needs of our customers, as well as advance our strategic growth initiatives we outlined in March, refreshing our key solutions, adding solutions that increase addressable market and strategically adding partnerships to enhance our scale. We look forward to providing further updates on all of these growth vectors in the coming quarters.

Starting with our new Arm offering, the Quantum X is an exciting addition to our 3D metrology portfolio and represents another step forward in the technology that we help to pioneer. With probing and scanning designed to improve manufacturing efficiency in a configurable and scalable solution, Quantum X offers up to a 15% increase in accuracy compared to the previous Quantum Max, unlocking a range of 3D metrology opportunities for the manufacturing sector. As we've done for over 40 years, FARO is setting the performance bar high to help our customers stay at the forefront of their industries.

Moving on to our next-generation of scanners. With improved technology, we've extended scanning ranges across our existing Focus portfolio, while at the same time introducing the Focus Premium Max, which adds long-range features up to 400 meters, enabling users to gather data from large outdoor environments. In addition to added range, we also simplified the full Focus portfolio, enabling all users to reduce scanning time by up to 50% through Hybrid Reality Capture powered by our Flash Technology solution that's included in each model. Flash Technology is the first-of-its-kind workflow that combines the accuracy of a terrestrial laser scanner with the speed of a panoramic camera. Through listening to valuable customer feedback, we've made some significant changes to the entire capture to insights workflow.

Now, customers who need more extensive range capabilities and faster data collection times can feel confident in their data capture. We believe this refreshed lineup gives existing and new customers more flexibility in choosing a solution that equips them with accurate data and actionable insights, keeping the Focus lineup at the forefront of laser scanning. In addition to our new offerings in the third quarter, we also saw continued success with the expansion opportunities within existing customers. For example, the Royal BAM Group, the largest construction company in the Netherlands, recently awarded us a 6-figure annual license deal for our Sphere XG software.

After using our solution on a project-by-project basis for the last several years, they chose to migrate to a company-wide subscription to standardize our solutions across all their teams in EMEA. With the ability to capture data on site 6x faster than traditional 2D photos and reduce data retrieval time by 5x, the associated productivity gains created significant ROI for the customer. In addition, the increased productivity from FARO solution created opportunities for new use cases such as virtual site walks with clients and construction progress documentation. With a corporate culture of innovation and adopting new technology to provide better outcomes for our customers, FARO is helping to support Royal BAM's move toward adopting more digital tools for construction.

In summary, we are very pleased with the progress we've made to date against our initial plans from mid last year and the margin targets we established earlier this year. Not only are we executing according to our strategy, but we're also exceeding our own expectations ahead of schedule. By capitalizing on our strong brand and our reputation for innovation and high-performance solutions, we believe FARO is well positioned to outpace growth in both our current markets and those we plan to enter. Coupled with our ongoing operational excellence initiatives designed to enhance profitability, we anticipate significant operating leverage as our revenue returns to growth. We are enthusiastic about our strategic direction in the coming years, and are confident in our ability to drive substantial value for our shareholders.

Before turning the call over to Matt, I wanted to take a quick moment to say how excited we are to have Phil Delnick join the team as FARO's SVP of Global Sales. Phil brings a wealth of experience and sales leadership to FARO, with a proven track record of driving revenue growth, profit growth and customer satisfaction across multiple product sectors over nearly 2 decades at Ingersoll Rand. I look forward to working closely with Phil, as we continue to execute on our growth strategy in the quarters and years ahead.

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

[Matthew Horwath, executive]

Thank you, Peter, and good afternoon, everyone.

Third quarter revenue of $82.6 million was down 5% versus prior year. Geographically, the Americas and European regions were down 2% and 1%, respectively, while in the Asia Pacific region, we experienced a $3.4 million decline, or 17% versus the third quarter of 2023 due primarily to continued weakness in China. Third quarter hardware revenue of $50.3 million was down 10% year-over-year, while software revenue of $11.2 million was approximately flat, and service revenue of $21.1 million increased by 6%. Recurring revenue was $17.4 million and represented 21% of sales and grew 2% year-over-year.

GAAP gross margin was 55.7%, and non-GAAP gross margin was 56.1% for the third quarter of 2024 compared to 48.9% in the third quarter of 2023. As Peter mentioned, in the third quarter of 2024, we continued to execute on our variable cost productivity initiatives, including incremental benefits from supply chain localization. Non-GAAP gross margin increased over 100 basis points sequentially versus Q2 and 56.1%, marks the highest quarterly level since 2019.

GAAP operating expenses were $43.8 million and included approximately $3.8 million in acquisition-related intangible amortization and stock compensation expenses. Non-GAAP operating expense of $40.1 million was down $1.4 million from Q3 last year as we continue to realize profitability and productivity improvements. GAAP operating income was $2.2 million in the third quarter of 2024 compared with an operating loss of $6.9 million in the third quarter of 2023. Non-GAAP operating income was $6.3 million in the third quarter of 2024 compared to operating income of approximately $900,000 in the third quarter of 2023. Adjusted EBITDA was $8.9 million, or approximately 11% of sales compared to $3.5 million in the third quarter of 2023.

Our GAAP net loss was $300,000, or $0.02 per share. Our non-GAAP net income was $4 million, or $0.21 per share for the third quarter of 2024 compared to a non-GAAP net income of approximately $500,000, or $0.02 per share in Q3 2023. Our cash and short-term investment balance at the end of the quarter was $88.9 million, down $9 million sequentially. As Peter mentioned, we repurchased $10 million of our outstanding shares in the third quarter at an average price of $16.99.

Excluding share repurchases, cash and short-term investments increased $1 million sequentially. Given our current working capital levels, expectations for revenue and our current expense base, we expect to be free cash flow positive in the fourth quarter of 2024. We are very pleased with our third quarter results, especially with double-digit adjusted EBITDA margin in back-to-back quarters, positive cash flow from operations in 4 consecutive quarters and our highest reported non-GAAP gross margin over the last 5 years.

As part of our ongoing cost and dynamic resource allocation initiatives, we have announced a restructuring plan, which is intended to support our strategic plan and improve operating performance, especially around underperforming countries. We expect these actions to offset expected increases in operating expenses over the near-term, including inflation and headcount investments in higher-growth countries as Peter discussed earlier on the call. Taken together, we expect to incur $6 million to $9 million in cash charges starting in Q4 2024 through the first half of 2025.

Once complete, we anticipate an approximate $6 million reduction in annualized operating expenses that when taking into account planned inflation and additional investments in high-growth countries, we believe will allow us to maintain our operating expenses at current levels over the near term, assuming current FX rates. The macro environment remains choppy, and we expect continued demand challenges, especially in China. Together with manufacturing PMI remaining below 50 and global uncertainty surrounding the recently announced results of the U.S. election, we want to remain thoughtful and measured in setting expectations for the remainder of the year.

As a result, at present FX rates, we expect fourth quarter revenue of between $88 million and $96 million. At those revenue levels and given corresponding non-GAAP gross margin between 56% and 57.5% and non-GAAP operating expenses of between $40.5 million and $42.5 million, we would expect non-GAAP earnings per share ranging from $0.32 per share to $0.52 per share for fourth quarter profitability.

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

[Operator]

[Operator Instructions] And we'll take our first question from Greg Palm with Craig-Hallum.

[Greg Palm, analyst]

Congrats on the really good results and overall execution. It's been pretty impressive year-to-date.

[Peter Lau, executive]

Thank you, Greg.

[Greg Palm, analyst]

So, I want to start off maybe with the guide for Q4, knowing that we're still in a period of soft macro and not a whole lot of visibility. But kind of curious what kind of went into that guidance assumptions. Sequentially, it assumes a lot less of a sequential increase than what you normally see in Q4. So, I don't know if it's -- if the guide is based on what you're seeing in October or maybe it's out of conservatism. So maybe we can start there.

[Peter Lau, executive]

Sure, Greg. Yes, I think -- I mean, look, there's -- as we said in the script, the macro remains uncertain and choppy. And we feel like we've developed a good cadence and reputation for delivering on our commitments and making sure that we meet our commitments. I would say not based, I think, on anything that we've seen in October, but out of abundance of respect for what we see as an uncertain and choppy macro.

[Greg Palm, analyst]

Okay. Yes, that's fair. And then I want to dive into some of those long-term financial goals that you put out earlier in the year. I mean, you are trending well, well ahead of what you put out at sort of various revenue levels. So, I guess the first question is, do we need to kind of rethink your -- both your earnings power and your free cash flow based on various revenue levels? Has there been anything maybe one-time structural benefit that's kind of hit either these quarters? It doesn't sound like it is, but I just want to sort of dig into that and get your sense on kind of go forward. And when we see that kind of revenue growth, what sort of earnings power is that going to translate into?

[Matthew Horwath, executive]

Yes. I think, Greg, when we looked at the March kind of longer-term aspirational model, certainly, the gross margin levels that we're currently operating, we're a bit ahead of plan. You know the drivers of that, right? We've been executing and kind of pulled in some of the localization initiative on the gross margin line as we've localized the supply chain with Sanmina. So, I'd say that line item is definitely ahead of schedule. And if you remember, we kind of said, hey, operating expenses until we start to see certain kind of revenue growth levels, we're going to operate in a cost-controlled environment, and we're going to ensure that we're delivering incremental levels of profitability. And I would say we're executing on those as well. Obviously, with the ability to grow revenue and some of the operating leverage that comes along with that, we'll look to maybe reset targets, Greg, kind of next year. We're really focused on the near term, and then maybe we'll kind of go out and have reset targets as far as profit targets going into Q1 of next year.

[Peter Lau, executive]

And Greg, maybe I would just add, we feel really pleased with the work that we've done, I would say, very much in our baseline and not affected by certain one-timers this year. So we -- as I said in the script, it feels -- or in the prepared remarks, it feels like we've made a lot of progress in our baseline.

[Greg Palm, analyst]

Yes. Okay. And the restructuring that you're going to start here in Q4, can you just talk a little bit about exactly what that is, whether there's any revenue offset to that? And then to be clear, I think you mentioned that you expect to hold this kind of level of -- so are we talking like a $40 million non-GAAP operating expense? Because that's even been trending even lower than kind of what you put out back in March, but it sounds like that's kind of still the level to think about with the offsets of the inflation, headcount and the restructuring that you just announced.

[Matthew Horwath, executive]

Yes. I'd say, Greg, the plan is really focused on getting operationally efficient and getting the right level of productivity. China has been down for us pretty significantly over the last 5 or 6 quarters. And we feel like at this point in time, the reallocation of those resources to higher-growth countries where maybe we're seeing higher growth, albeit at a lower level than the China revenue level, we feel like that's the right reallocation of those resources. And so I think from that aspect, that's how we're thinking about it. It's reallocation, dynamic allocation, not necessarily thinking about it from a level where we would expect revenue to grow significantly from here, but really just optimizing the business. And if you think about the timing of that, Greg, like we talked about on the prepared remarks, kind of a portion of that will come in, in Q4 and then a portion of it during the first half of 2025.

[Greg Palm, analyst]

Got it. Okay. And then my last one on capital allocation. I know you bought back some stock in the quarter. Did you mention if or how much you bought during the current quarter? Or I guess, how much is left currently? Or is it just based on what was completed as of quarter end?

[Matthew Horwath, executive]

Yes. We bought back $10 million in Q3 at an average share price of $16.99. And under the current program, we have about $8.3 million left to go in the current program.

[Operator]

[Operator Instructions] We'll take our next question from Chris Grenga from Needham & Company.

[Chris Grenga, analyst]

This is Chris on for Jim Ricchiuti. I was just wondering if you could elaborate on what you're seeing in the construction end market maybe with respect to trends across regions and maybe even the type of commercial real estate. What, if any, differences are you seeing across that market? Are there any indicators that would be improving for you?

[Peter Lau, executive]

Yes. Chris, thanks, and I appreciate the question. I'd say, obviously, it differs by geographic location. And specifically, when we talk about China, for example, I would say construction in China continues to be a drag even to the global construction market, for example. But I'd say more broadly, Chris, what we see is a little less commercial construction, a little less industrial construction, but health care and institutional or infrastructure construction continues to be a little bit better than, say, commercial construction. And so we'll continue to keep our eye on it. I would say, certainly, the interest rate cut in September and maybe any future interest rate cuts depending on what happens with the Fed over the next certainly couple of days and then over the next 12 months to 18 months, we believe that a reduction in interest rates is an overall tailwind for the construction industry. So, we'll continue to monitor and apply the right amount of resources as we get updates.

[Chris Grenga, analyst]

Great. You had mentioned the Sphere win in the quarter. What is the -- what kind of activity and what kind of -- I guess, what are the cadence and conversations that you're having with customers around the software side? And how has that sort of trended for you over the course of the year? And where does it stand currently?

[Peter Lau, executive]

Yes. I would say very much that our Sphere XG offering since we launched it last year in Q4 has been a tailwind for us. It's being adopted fairly regularly from our customers and not just customers that buy software only, but customers that buy software as a part of our hardware solutions and attach that software solution to our hardware. And so we continue to be, I would say, bullish on the cloud infrastructure and our cloud offering. And I think it's a bright spot in our portfolio certainly now and into the future.

[Operator]

And at this time, I'd like to turn the call back over to Mr. Peter Lau for any closing remarks.

[Peter Lau, executive]

Great. Thank you.

On behalf of all of our colleagues, I want to thank you for your interest in FARO. Despite a challenging and uncertain macro, we continue to deliver and exceed our targets. We're excited about our progress. Our third quarter performance demonstrates the operational leverage we've built into our business with gross margin, operating expenses, profitability and cash flow, all tracking ahead of our multi-year plan. While we continue to focus on ways to further improve these results, our success gives us confidence that as we execute on our ongoing organic growth initiatives in the quarters ahead, we believe we'll be in a position to unlock short- and longer-term shareholder value. We look forward to continuing to share our progress and execution in the quarters ahead.

And this concludes our call today. Thank you very much for your time and your interest in FARO.

[Operator]

Thank you. And this does conclude today's conference. You may now disconnect your lines.