FARO Technologies Inc

NASDAQ:FARO

Earnings Call Analysis

Consolidating Core Operations and Remaining Cautious Amidst Market Challenges

The company entered the first quarter of 2024 on the back of a strong end to the prior year. Executives expressed satisfaction with the fourth quarter results, considering it a testament to the business's positive trajectory. However, they remain wary about near-term prospects, especially because they anticipate a lack of recovery in China's demand. Furthermore, since the global manufacturing PMI is persisting at or below the 50 mark, the company is taking a conservative stance in its expectations for the initial quarter of 2024. .

Leveraging Significant Orders and Stabilizing Sales Cycles to Drive Growth

Highlighting a significant $3 million public safety order from Romania, which was won through a competitive tendering process, the company sees this as a pivotal win and plans to fulfill the remainder of this order in the course of 2024. Despite broader economic challenges, the company witnessed sales cycles that had shortened in the third quarter of the previous year; a trend they managed to maintain in the fourth quarter and anticipate will continue into the new year.

Diversifying Revenue Streams Despite Software Sales Downturn

A downturn in software sales, attributed mainly to the decrease in perpetual license sales attached to hardware at the point of sale, was noted. However, executives did not express undue concern regarding this, emphasizing their continued diversification of revenue streams.

Pursuing Ambitious Growth Targets and Responding to Macroeconomic Factors

The company sets its sights on exceeding market growth through a mix of pricing strategies, productivity enhancements, and new products. Their foundational business principle is not only to expand revenue more rapidly than market norms but also to see that cash flow accelerates faster than earnings growth. With regards to China, even though government initiatives have not yet shown results, the firm remains proactive in capturing any opportunities that present themselves, prepared to act swiftly on potential deals.

Optimizing for Improved Gross Margins and Focusing on Cost Efficiencies

An optimistic outlook is present for gross margins in the current year, with anticipated improvements believed to be driven mostly by revenue and volume increases. Because the company has successfully dealt with negative purchase price variances as of the end of 2023, they are now positioned to advance without this burden into the next quarter and beyond.

Financial Guidance Reflects Prudence and Future Expectations

For the first quarter, the company forecasts a revenue range of $77 million to $85 million with a non-GAAP gross margin between 49.5% and 51%. With this forecast, the company is preparing for a non-GAAP loss per share spanning from $0.20 to a break-even point of $0.00, serving as a clear indication of the management's cautious yet forward-looking approach in a challenging economic environment.

Earnings Call Transcript 2023-Q4

[Operator]

Good day, everyone, and welcome to the FARO Technologies Fourth Quarter and Year-End 2023 Earnings Call. For opening remarks and introductions, I will now turn the call over to Mike Funari at Sapphire Investor Relations. Please go ahead.

[Michael Funari]

Thank you, and good morning. With me today from FARO are Peter Lau, President and Chief Executive Officer; and Matt Horwath, Chief Financial Officer. Yesterday after market close, the company released its financial results for the fourth quarter and full year 2023. The related press release and Form 10-K 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 yesterday'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 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. In the fourth quarter, our focus on execution across all aspects of our operations continue to drive meaningful results. Whether it be refining our product development process and road map, enhancing customer experiences or streamlining our internal processes, we remain committed to delivering on our 3 core tenets: first, to grow revenue faster than the markets we serve; second, to grow earnings at a faster rate than revenue; and third, to grow cash at a faster rate than earnings.

We not only met but exceeded our targets in the fourth quarter delivering $98.8 million in revenue, which was towards the high end of our guidance range. We delivered $0.36 of non-GAAP EPS, which was above the high end of our guidance range. $13.2 million of adjusted EBITDA, a 12% year-over-year increase and $14.7 million of free cash flow. From a top line perspective, the better-than-expected performance resulted from strong execution by our sales teams in the Americas and Europe include a $3 million order with a channel partner in Romania to outfit the Romanian police force with FARO's public safety solutions. This deal is the largest public safety order in FARO's history and demonstrates the value of our unique solutions. As expected, the industrial and construction markets in China remained especially weak, creating a headwind to year-over-year revenue growth.

Operationally, we saw a notable sequential improvement in gross margin in the fourth quarter, which we attribute to several factors. First, due to seasonality and the strong year-end demand environment, we benefited from fixed cost absorption. Second, as we have discussed on prior calls, the purchase price variance headwind we have incurred since the beginning of 2023 continued to abate in the fourth quarter, and we have taken a number of steps to ensure PPV remains at nominal levels going forward. Lastly, our supply chain efforts within Southeast Asia continued to progress as planned. Taken together, our non-GAAP gross margin improved 360 basis points sequentially to 52.5%. This is very encouraging progress towards our stated objective of expanding gross margins.

As I mentioned earlier, from a cash flow perspective, we generated $14.7 million in free cash flow in the fourth quarter, delivering on our commitment to achieve positive cash flow in the second half of 2023. This was achieved by significantly improving our operating performance and driving efficiency in working capital. Although I am pleased with the progress we've made in the last 2 quarters, it is still clear to me that we are in the early stages of improving execution and results. Our team understands there's still much to accomplish and is dedicated to executing on the plan ahead.

The adjustments made to our cost structure as evidenced by our fourth quarter expense base and increased gross margin as well as working capital performance indicate the strides we've taken in refining our operational framework. Moving forward, we will remain committed to operational excellence, being diligent in controlling expenses with an emphasis on expanding gross margins while making targeted investments in new products and technologies.

On the product front, following October's launch of our new FARO Orbis mobile scanner. I am very pleased to report that customer feedback thus far has been extremely positive. While still early in the launch cycle, initial interest has been robust, and we are extremely excited about the future prospects of this product. With our new mobile scanner gaining global adoption, we believe the hardware success we have seen thus far from our new products validates our customer-driven approach to product definition. Expanding our footprint of data acquisition devices expands our future opportunity to monetize that installed base through software that allows customers to store, analyze and collaborate in the cloud.

In addition, in December, we launched FARO Zone 2024, expanding upon our strong position in the public safety market. Zone 2024 empowers investigators, forensic analysts and law enforcement agencies to enhance their capabilities in documenting, analyzing and presenting evidence. Key highlights of the new FARO Zone product include the conversion of photos and videos to 3D visuals, ortho image creation and collision prediction and systems. These advancements reflect the fusion of FARO's legacy technologies with those of our recent acquisitions, GeoSLAM and Holobuilder and further demonstrates our commitment to innovation. We look forward to discussing more new product launches in the quarters to come.

Reflecting on the progress we've achieved thus far, none of it would have been possible without the skill and devotion of all of our teammates that work together every day at FARO. The team's steadfast commitment to our organization was clearly evident in this past year. Despite macro challenges and uncertainties, their dedication to driving results and outcomes is truly commendable. To further support this momentum, we've recently added 3 new members to our leadership team, including our new Chief Financial Officer, Matt Horwath; Chief Digital Officer, Roger Isern; and Software Solutions leader, Shelley Gretlein. Overall, I'm proud to say our global organization remains highly motivated by a common goal, namely to continue market leadership by prioritizing both customers and shareholders alike.

As we look ahead, FARO's brand holds a strong position in the market, reflecting the trust of customers and our reputation for 3D application expertise and innovation. We intend to capitalize on this market position by focusing on where we add value. We will maintain our leading edge product performance and will leverage our channels to market to solve more of our existing customers' existing challenges. Customer feedback thus far supports our product solutions strategy, laying a solid foundation for further improvement.

Operationally, to help profitably capture these opportunities, we're utilizing an 80/20 philosophy, prioritizing activities that maximize shareholder value and profitability, irrespective of market conditions. Our ongoing organizational initiatives ensure alignment among our 1,200 employees fostering a focus and rigor to drive performance enhancements. As we assess the market opportunity ahead, we believe there is significant value in leveraging 3D capture and virtual management tools to reduce waste and inefficiencies and managing physical assets across the globe. While our growth potential is vast, converting it to demand requires a focused product road map and go-to-market strategy, targeting high probability success areas where we feel we have a right to play and a right to win.

To further expand on our strategy, which I've highlighted over the last 2 quarters, the company will be hosting an investor event in New York City on March 11, 2024. myself as well as several members of the senior executive team will discuss our key priorities, target markets, targeted financial model and long-term goals as well as conduct product demonstrations. We look forward to seeing many of you in person.

With that, I'll now turn the call over to Matt to provide an overview of our fourth quarter financial results.

[Matthew Horwath, executive]

Thank you, Peter, and good morning, everyone. Fourth quarter revenue of $98.8 million was down 5% compared with the fourth quarter of 2022. Geographically, while demand remained healthy within Europe and the Americas, particularly Latin America, continuing softness in China was responsible for the year-over-year decline.

Fourth quarter hardware revenue of $66.6 million was down 5% year-over-year, while software revenue of $12.2 million was down 6% and service revenue of $20 million decreased by 3% in concert with hardware. Recurring revenue was $17.4 million and represented 18% of sales. GAAP gross margin was 50.9% and non-GAAP gross margin was 52.5% for the fourth quarter of 2023 compared to 52.8% in 2022.

On a non-GAAP basis, lower revenue levels resulted in the fourth quarter's year-over-year gross margin decline. Sequentially, as Peter mentioned, we are pleased that reported non-GAAP gross margin improved 360 basis points due in part to higher revenue, a decrease in unfavorable purchase price variance and increasing benefits from supply chain localization. Related to the purchase price variances, we believe these charges are largely complete, exiting 2023, and together with the opportunity ahead in shifting our supply chain to Southeast Asia, we continue to expect a meaningful improvement in 2024 gross margin.

GAAP operating expenses were $48.9 million and included approximately $6.3 million in acquisition-related intangible amortization and stock compensation expenses and $1.3 million in restructuring and other transaction costs. Non-GAAP operating expense of $41.3 million was down $4.5 million from Q4 last year as we realized the benefit of our restructuring efforts. GAAP operating income was $1.4 million in the fourth quarter of 2023 compared with an operating loss of $1.6 million in the fourth quarter of 2022. Non-GAAP operating income was $10.6 million in the fourth quarter of 2023 compared to income of $9.1 million in the fourth quarter of 2022.

Adjusted EBITDA was $13.2 million or approximately 13.3% of sales compared to $11.7 million and 11.3% of sales in the fourth quarter of 2022. I want to highlight that adjusted EBITDA grew 12% year-over-year and expanded 200 basis points despite the lower fourth quarter revenue. Our GAAP net income was approximately $1.6 million or $0.08 per share. Our non-GAAP net income was $6.8 million or $0.36 per share for the fourth quarter of 2023 compared to net income of $7.1 million or $0.38 per share in Q4 2022. Our cash and short-term investment balance at the end of the quarter was $96.3 million, up $16.4 million from Q3, largely due to improved profitability and improvements in our cash conversion cycle. Free cash flow of $14.7 million in the fourth quarter 2023 was up $24.2 million versus the fourth quarter of 2022. Free cash flow of 14 -- we remain very focused on our working capital efficiency and currently expect to be cash flow positive in 2024.

We are pleased with our fourth quarter results and view them as evidence the business is moving in the right direction. As Peter mentioned, the team continues to execute well on the operations priorities we have established, namely refining our product development process and road map, enhancing customer experiences, gross margin expansion, streamlining and improving internal processes, including our IT systems and free cash flow generation.

That said, we remain cautious in the near term. From a geographic perspective, we do not expect China demand to rebound in the first quarter and together with global manufacturing PMI remaining at or below 50 and sales cycles remaining above historical levels, we want to remain thoughtful and measured in setting expectations for the first quarter of 2024, while looking forward to a macro recovery. As a result, at present foreign exchange rates, we expect first quarter revenue of between $77 million and $85 million. At those revenue levels and given corresponding non-GAAP gross margin between 49.5% and 51% and non-GAAP operating expenses of between $41 million and $43 million, we would expect non-GAAP loss per share of between $0.20 and $0.00 per share.

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

[Operator]

[Operator Instructions] We'll take our first question from Jim Ricchiuti with Needham & Company.

[James Ricchiuti, analyst]

I wanted to go back to the reference you made about the large public safety order that you got, and I believe you said it was Romania. You said it's from a channel partner. I was just trying to get a little bit more color on that. Is this a channel partner that you've been working with for a while because this channel partner cover other parts of EMEA? If you could, just a little bit more color on that, given the nice win.

[Peter Lau, executive]

Jim, thanks for the question. It is a channel partner we've been working with for a while, and they cover the Romania territory. It was a tender, Jim, a competitive tender with other bidders. And we -- the end user ultimately decided to go with the FARO product. Again, it was a $3 million order. We shipped about half of that in the first quarter and would expect -- or in the fourth quarter, and we expect to shift the rest of it throughout the year of 2024. But very exciting win. Again, as we said, our largest public safety order ever. And between our local teams there, and our channel partner really, really nice win for us.

[James Ricchiuti, analyst]

Got it. Congrats on that. In the last call, I think you alluded to -- you talked about sales cycles shortening a bit, and I was wondering what you saw as you went through Q4 and whether there's been any change thus far in 2024? Yes, the macro is clearly a challenge. But I'm just wondering what you've been seeing in terms of sales cycles?

[Peter Lau, executive]

Yes. And you're right, we did mention that they should shortened in Q3 relative to some of the earlier quarters. What I would say is we expect them to stay the same as Q3, really kind of the same in Q4. And again, just a reminder that, that's above our historical levels, right? So we still see the macro continuing to be a little bit challenged, but we're working through it, Jim, and expect our operational initiatives to drive financial performance in the current environment.

[James Ricchiuti, analyst]

And last question, if I could just slip one in. Just on the decline that we saw in the software business in Q4 versus a year ago. Can you talk a little bit about what contributed to that?

[Peter Lau, executive]

Yes. Thanks for the question, Jim. It's largely in concert with our hardware and the perpetual software licenses that we sell. We actually saw our service increase a little bit in the first quarter there. Our subscriptions increase in the fourth quarter. But the overall headline of software being down was related to the perpetual license that get attached at point of sale with the hardware.

[Operator]

[Operator Instructions] We'll take our next question from Greg Palm with Craig-Hallum Capital Group.

[Greg Palm, analyst]

Congrats on the quarterly results. I guess, Pete, I'd be curious to think about how you're sort of viewing the year in terms of drivers of growth, how much of that is required from some sort of macro recovery or stabilization? How do you think about volume versus price? Any just thoughts on kind of how you think fiscal '24 will play out from a revenue standpoint? I know you don't give guidance for the year per se.

[Peter Lau, executive]

No, we don't, Greg, and thanks for the question. And appreciate your congratulations on the quarter. We are pleased with it. What I would say is, in our prepared remarks, we talked about China and the expectation that it doesn't get better in the first quarter. As we say, the macro is, I think kind of one of those things where it's anyone's guess. But what I will say is that we do -- we are very excited about our product road map for this year. Again, we talked about Orbis, we talked about Zone, and we've got some exciting launches coming in the quarters ahead. We look to get a little bit of price, which we've talked about with you previously. And ultimately, Greg, our tenet -- our core tenet is to grow revenue faster than the markets we serve. And we think that between price, sales productivity and new products, we should be able to deliver on that and then again, growing our earnings at a faster rate than revenue and cash flow at a faster rate than our earnings. We feel strongly about those core tenets.

[Greg Palm, analyst]

Yes, makes sense. And just to be clear on kind of the overall demand environment, have you seen any change over the last 3 months and specific to what your visibility is in China? Is it about the same? Or has it gotten better or worse since last quarter?

[Peter Lau, executive]

Yes. I would say, Greg, we expect it to be -- to not recover in the first quarter, as we said. And obviously, there's initiatives in China that we're looking at doing. The Chinese government has done some things over there, and we've not seen it take hold. We don't expect it to get any better in the first quarter, but I think time will tell, and we'll continue to be vigilant about taking opportunities that we do see over there and acting with urgency to close as many deals as we can.

[Greg Palm, analyst]

Okay. And just last one on gross margin. I think you talked about still realizing some significant improvements this year. Any help with kind of the cadence of those improvements as we progress throughout the year? And I'm assuming that the gross margin bridge from Q4 to the guidance in Q1 is solely sort of revenue or volume driven. And as the volumes recover, that's when you see better absorption. Is that right?

[Matthew Horwath, executive]

Yes. I think that's the right way, Greg, to think about it. The seasonality that we baked in from Q4 to the Q1 guide, naturally, you've got the fixed cost absorption kind of headwind as you kind of sequentially go from Q4 to Q1. And as we mentioned in the prepared remarks, that negative purchase price variance kind of pretty much behind us exiting 2023. You'll see a little bit of that, but it's not going to be linear, but most of it is due to volume, and that step down from Q4 to Q1 guide.

[Greg Palm, analyst]

Yes. And remind us that unfavorable impact of a couple of million a quarter. Was that what the broker buy impact was?

[Matthew Horwath, executive]

Yes. I think what we said externally is about 300 basis points. And kind of the way to think about it is more at the lower end of the gross margin range in the 20 -- kind of first half of 2023. And so with that behind us, there's not adding much sequentially as you exit Q4 to Q1.

[Operator]

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 very much for your time today and continued interest in FARO. We look forward to speaking with you again soon as the year progresses, and thanks again.

[Operator]

This does conclude today's program. Thank you for your participation. You may disconnect at any time.