FARO Technologies - Q2 2023

Transcript

Operator (participant)

Good day, everyone, and welcome to the FARO Technologies second quarter 2023 earnings call. For opening remarks and introductions, I will now turn the call over to Michael Funari at Sapphire Investor Relations. Please go ahead, sir.

Michael Funari (Investor Relations)

Thank you. Good afternoon. With me today from FARO are Yuval Wasserman, Executive Chairman; Peter Lau, President, Chief Executive Officer; and Allen Newitt, Chief Financial Officer. Today, after market close, the company released its financial results for the second quarter of 2023. The related press release in 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 Yuval Wasserman.

Thank you, Mike. Welcome, everyone, to our call. Second quarter revenue of $88.2 million was up 10% year-over-year, with hardware revenue of $56.8 million, up 16%, enabled by increased shipment of both our Quantum Max ScanArm and Laser Tracker product lines, as well as the addition of GeoSLAM to our revenue base following the September 2022 acquisition. While the overall demand environment has remained relatively unchanged since our last earnings call, we did see some customers accelerate their purchase decision-making, particularly on Quantum Max, which when combined with better-than-expected Laser Tracker supply availability, resulted in higher-than-expected revenue. Related to profitability, we also began to see the effects of our previously announced cost reduction activities that further contributed to a better-than-expected bottom line.

While we are pleased with our improved second quarter results, we continue to expect longer than usual sales cycles due to several factors, including the ongoing macro softness in commercial construction, the global PMI continuing below 50, and customers signaling a push in purchasing decision into future quarters. As a result, we remain cautious on second half 2023 revenue levels. In response to the uncertain economic outlook on our last call, we discussed our intention to accelerate an additional $10 million to $20 million in annualized operating expense reductions to realize a reduced quarterly spending rate of $40 million to $43 million and improve FARO's underlying profitability. I'm pleased to report that during the second quarter, we have completed these actions, which included, first, driving synergies by right-sizing our software investment to streamline and consolidate multiple cloud environments that resulted from the combination of internal development and recent acquisitions.

Our software roadmap continues to include a robust feature set that enables user to view and collaborate on 3D models created by various capture devices on a single cloud platform with a single user interface. Software remains a key element of our strategy, we believe by eliminating the redundancy inherent in our prior model, we'll be able to provide customers valuable solutions more efficiently, quickly, and cost-effectively. Second, executing opportunities to improve productivity in our global sales organization. We are proactively learning from our high-productivity regions and affecting change in lower productivity areas to optimize our overall investment. We believe we have the formula to execute this change without adversely affecting revenue levels. Third, creating additional synergies across our global organization by consolidating certain functions and eliminate redundancies within our global cost structure, including those that resulted from acquisitions.

Finally, executing on the reduction in our global footprint by consolidating sites, exiting inefficient buildings, and leveraging our distributed organization model to reduce costs. With this work now complete, we have executed a plan, which in combination with the actions announced in February, will result in non-GAAP operating expenses of between $40 million to $43 million on a quarterly basis, which represents an approximate 17% reduction from our current run rate when considering the effects of inflation, a weakened dollar exchange rate, and the addition of GeoSLAM in September 2022. In formalizing this plan, I spent time speaking with many of our stakeholders and would like to share with you some of my observations. First and foremost, as I've met with employees around the globe, I'm struck with the passion, technical expertise, and commitment of our broad and talented employee base.

They believe in FARO and the mission we've set for ourselves in delivering the industry's very best 4D tools for use in applications ranging from, ranging from 3D metrology to construction management progress, and crime and accident scene analysis, which in turn are targeted at our automotive, aerospace, AEC, and public safety end markets. From a customer's point of view, it's apparent that FARO's technology and our brand has demonstrated long-term value. Market trends, customer feedback, and competitive analysis reinforces that our efforts to developing a cloud-based solution, which aligns 3D models from different capture devices onto a single coordinate system, will simplify and eliminate waste in the virtual management of both facility construction and operation.

Through this and other reviews with our management team, I believe this unique combination of hardware capture, cloud processing and hosting, along with software applications specifically designed for individual use case and workflow, will further differentiate FARO in the marketplace, and over the long term, generate increased shareholder value. To enable the realization of our strategic initiatives and deliver best-in-class execution, I'm pleased to welcome Peter Lau as our new President and CEO. Peter brings a wealth of experience and expertise with a distinguished career and a proven track record of driving business success. Peter has held key leadership positions at several industry-leading companies, including GE, Honeywell, and Hubbell, where he has delivered exceptional results and demonstrated a strong commitment to operational excellence in driving sustainable growth.

With demonstrated success in leading organization through the transition to software and solutions, Peter has recognized firsthand how software-enabled solutions can be a key driver of growth and competitive advantage. Under Peter's leadership, we are confident that FARO will continue to expand its global presence and enhance its position as a leader in 4D digital reality technology. With that, let me turn it over to Peter to share a few comments.

Peter Lau (President and CEO)

Thank you, Yuval, and good afternoon, everyone. Let me start by saying I am really excited to join FARO, a company with a rich legacy of innovation and a track record of delivering high-quality solutions to customers across various industries. In my new leadership role, I'm fortunate to have the opportunity to work alongside a talented team dedicated to driving FARO's success. As we look ahead, value creation for customers and shareholders will remain at the heart of our strategy. Our goal is to deepen our understanding of customer needs, enhance our product offerings, and continue to provide exceptional service and support. By forging strong partnerships with our customers, we will ensure that FARO remains their trusted partner in their pursuit of operational excellence and digital transformation. I feel very privileged to lead FARO into our next chapter.

With our strong foundation, unmatched technological capabilities, and commitment to our customers, employees, and shareholders, I believe we are well poised for a future of growth and success. I look forward to speaking with many of you in the months ahead. With that, I'll now turn the call over to Allen to provide an overview of our second quarter financial results.

Allen Newitt (CFO)

Thank you, Peter, and good afternoon, everyone. Second quarter revenue of $88.2 million was up 10%, or 6% organically, when compared with the second quarter of 2022, primarily due to higher shipments of our Quantum Max ScanArm and Laser Trackers. Second quarter hardware revenue of $56.8 million was up 16% year-over-year. Over the last 12 months, hardware revenue, which is a strong leading indicator for service and ultimately software revenue, is up 14%, as reported, or 8% organically over the prior 12-month period, and is a continuing longer-term reflection of the increased differentiation and success of the hardware products we launched 18-24 months ago. Software revenue of $10.8 million was roughly flat year-on-year and continues to reflect the conversion of customer purchases from perpetual licenses to subscriptions.

We continue to expect this conversion to subscription to be predominantly complete by the end of 2023. Finally, while service revenue of $20.6 million represented a modest 2% increase year-over-year, it is the first such year-on-year service revenue growth we've recorded in five consecutive quarters. GAAP gross margin was 37.8%, and non-GAAP gross margin was 48% for the second quarter of 2023. During the quarter, we incurred an $8.1 million inventory reserve and cost of goods sold associated predominantly with discontinued non-core products, as well as demo accessories, which adversely impacted our GAAP results. 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 second quarter's year-over-year non-GAAP gross margin decline.

As a reminder, the higher cost of raw material primarily stems from sourcing semiconductor components in an extremely tight broker market, which we expect to adversely affect reported gross margins through the balance of 2023. Given their unique nature, these transactions are not expected to adversely affect the timing of the previously committed $12 million in annualized savings that we expect to result from the shift in our supply chain to Southeast Asia. We continue to believe the savings from the shift to lower-cost suppliers will begin to be realized as we exit 2023. I want to emphasize that our underlying average selling prices in local currency and the expectations of long-term product mix has remained relatively unchanged, and therefore, as our material costs normalize and we capitalize on a Southeast Asia supply chain, we expect gross margin to significantly improve in 2024.

GAAP operating expenses were $58.7 million and included approximately $5.8 million in acquisition-related intangible amortization and stock compensation expenses, and $8.8 million in restructuring and other transaction costs. Non-GAAP operating expense was $44.1 million, roughly flat with Q2 last year, despite the inclusion of GeoSLAM operating expenses as we began to realize the benefits of our restructuring efforts. With the sooner-than-expected completion of our expense reductions, we are committed to realizing quarterly spending at present FX rates of approximately $40 million to $43 million, now beginning in the third quarter instead of the fourth quarter of 2023. GAAP operating loss was $25.4 million in the second quarter of 2023, compared with an operating loss of $9 million in the second quarter of 2022.

Non-GAAP operating loss was $1.8 million in the second quarter of 2023, compared to a loss of $2.5 million in the second quarter of 2022. Adjusted EBITDA was $900,000. Our GAAP net loss was $28.2 million, or $1.49 per share. Our non-GAAP net loss was $2.6 million, or $0.14 per share for the second quarter of 2023, compared to a net loss of approximately $600,000 or $0.03 per share in Q2 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 $22 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 square footage by over 25%, given our hybrid work environment. 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 $88.5 million and remained approximately flat with Q2. We generated $700,000 in free cash flow during the quarter, or $3.9 million when excluding $3.2 million of cash restructuring payments incurred during the quarter. We remain very focused on improving our day sales outstanding with a 6-day sequential improvement in Q2 and further accelerated collections expected in the second half of 2023.

Given our current accounts receivable balance, expectations for revenue, and our new expense base, as well as further enhancements to our inventory management, we expect to remain free cash flow positive in the second half of 2023. Moving on to guidance. 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 of between 46% and 48% and non-GAAP operating expenses of between $41 million and $42.5 million, we would expect a non-GAAP loss per share of between $0.35 and $0.10. As a reminder, Q3 tends to be a seasonally softer quarter for us, due primarily to the summer months in Europe. There are exceptions, such as last year, Q3 and Q2 this year, where we experienced a strong benefit from backlog reductions.

The Q3 2023 projected sequential decline of approximately 10% at the midpoint when considering the effects of these backlog changes, is representative of our historical third quarter seasonality. This concludes our prepared remarks, and at this time, we'd be pleased to take any of your questions.

Operator (participant)

At this time, if you would like to ask a question, please press the star and one on your touchtone phone. You may withdraw your question at any time by pressing star two. Once again, to join the question queue, that is star and one. We'll move first to Greg Palm with Craig-Hallum. Your line is open.

Greg Palm (Senior Research Analyst)

Thanks. Good afternoon, everyone, and Peter, welcome aboard. Look forward to working with you and congrats on the improved results here in the quarter.

Peter Lau (President and CEO)

Thanks, Greg.

Yuval Wasserman (Executive Chairman)

Thank you.

Greg Palm (Senior Research Analyst)

I, I guess maybe just starting off, you know, revenue, you know, even ahead of the, the top of the range that you provided last quarter. You know, it doesn't sound like the demand environment has changed, but maybe you can just give us a little bit more color on, on what you saw, whether it was by end market, by geography, whether it was a kind of an end of quarter flush, because, you know, clearly the, the, the quarter came together, you know, quite a bit better than I think what any of us were, were thinking a few months ago.

Yuval Wasserman (Executive Chairman)

Allen, would you like to answer that?

Allen Newitt (CFO)

Sure. Greg, I, I think relative to our expectations entering the quarter, we were, we were, we were pleasantly surprised to see a couple of folks accelerate some of the decision making related to opportunities that they had provided us at the beginning of the quarter, that they had expected to close out in time a little bit further. As we navigated the quarter, we did, we did see some incremental demand as we, as we closed out the quarter. Additionally, we had some upside that we were able to realize based upon material availability becoming available to us, predominantly on the arm and the Laser Tracker, as we indicated. As we head into the third quarter, you're, you're right, we, we the underlying demand position remains relatively steady with what we saw at the end of the second quarter.

We saw at the end of the second quarter, and it continued into the third quarter, where our pipeline of, of building opportunities tends to be a bit more out in the outer quarters, as opposed to expectations of closing in the third quarter, which is somewhat consistent with traditional seasonality, as we highlighted in our prepared remarks. Also, also indicating that, that the continued softness in the PMI and continued push out of customer decisions appears to be, to be there. The good news continues to be that we, we don't believe we're losing share. We, we see customers actively pushing, demand sideways as opposed to, again, making different decisions, in terms of who they're gonna buy or what they're going to buy.

I think that, you know, given the, the longer term revenue growth, and especially on the hardware side, that we've now demonstrated and we highlighted in the prepared remarks, we, we're cautiously optimistic that as, as the market stabilizes and continues to improve, that we'll be able to enjoy the benefits of that.

Greg Palm (Senior Research Analyst)

Understood. Just on the Q3 guide, specifically, you know, I understand the comments, but I think that, you know, at least at the midpoint, it suggests, you know, I think, a lot more of a sequential decline than what you've seen historically. I guess the question is: did, did some of those Q3 sales get pulled into Q2, or maybe it's just a little bit of conservatism? Just, just curious what the thought process is on Q3 as well.

Yuval Wasserman (Executive Chairman)

I think. This is Yuval. I think that you, what you see right now is seasonality, also, getting signals from our customers in some areas that are delaying, you know, buying decisions. Seasonality, of course, you know, last year, Q2 was I mean, Q3 was unique. You know, we basically expect to see a decline. I'm sorry, Q2 was unique. We expect to see a decline mainly because of seasonality, and also, we're being cautious. You know, we see some headwinds coming from the AEC market. The 3DM, the product manufacturing market, is spotty and tend to be changing based on industries and regions. What you see is a result of our analysis of the market and expectations going forward.

Allen Newitt (CFO)

Greg, just another comment around the sequential, because, you know, recent history is a little bit hard to interpolate, given COVID and the effect in 2020, the recovery from COVID in 2021. We certainly saw some odd sequential changes by quarter that is not typical of our history. If you look back in 2018 and 2019, the 10% sequential decline is right in the wheelhouse of where we have historically been. I know that's ancient history, but unfortunately, we do have to go back a while before we see things where it's not affected by the, the broader demand environment, where it's not impacted by material availability challenges that cause revenue to be recognized in one quarter and demand in another.

That combined with, as Yuval indicated, just the pipeline of opportunities that we see, the two line up, and a desire, excuse me, to be somewhat conservative, the three line up to how we guide it.

Greg Palm (Senior Research Analyst)

Yeah. Okay, makes sense. I guess last one, you know, for Peter, if I can. You know, this question, maybe it's not, not fair because you, you've only been in the role for a little over a week. Just kind of curious, as you've looked around, what excites you most? I mean, anything that you think from a strategic standpoint that can be changed, that can be improved upon, and a little bit more color on why you joined, that'd be helpful as well. Thanks.

Peter Lau (President and CEO)

Yeah, sure, Greg. Thanks, thanks for the question. You know, strategically, I think our, our strategy is sound, and, you know, it's all about execution for us in, in the short and midterm. You know, I think, you know, exciting technology at FARO, right at the convergence of, of hardware and software, in a really fast-moving and growing market is a pretty exciting place to be. The opportunity to strategically drive revenue growth in FARO, combined with you know, our operating execution opportunity that's right there in front of us, you know, will give us the ability to expand margins and generate cash. That's very exciting, and, and I think it's a great opportunity for us to create value for all of our shareholders.

Greg Palm (Senior Research Analyst)

Okay, great. I'll hop back in the queue. Thanks.

Peter Lau (President and CEO)

Thanks, Craig.

Yuval Wasserman (Executive Chairman)

Thank you.

Operator (participant)

We'll move next to Andrew DeGasperi with Berenberg. Your line is open.

Andrew DeGasperi (Senior Analyst and Associate Director)

Thanks. Good afternoon. Peter, I know it's only been recently you joined and just wondered, in terms of the, the strategy that was implemented before your arrival, you know, I, I guess maybe if you could broadly discuss, you know, do you think there's any changes that you would make going forward, number one? Number two, in terms of the previous experience you've had at other firms, can you maybe elaborate in terms of how did you, how did you essentially commercialize the software, hardware solutions? Do you see a similar path for FARO to do so?

Peter Lau (President and CEO)

Yeah, thank you. Thank you very much for the question. In terms of strategy changes, as I, as I mentioned, I think the strategy is very sound. There may be degrees of changes as I get in and look under the hood, but I don't think material strategy changes are on the horizon. Again, I think the, the opportunity for, you know, execution ahead of us is, is there, and it's there for the taking. I think that execution is gonna enable us to create a lot of shareholder value. You know, over the last 2 decades, I've spent with industrial multinational corporations, you know, in, in, in pretty high technology businesses where both hardware and software offerings, you know, intersected really to create customer value.

I see the same opportunity here, here, here at FARO. The similarities between those businesses that I've run and, and what's here is, is pretty striking. Most of the businesses were public, had hardware and software sales, were all global in nature. We all required some form of transformation to new business models, and a keen understanding of agile product development. We're all in really fast-paced environments that placed a premium, you know, on urgency and execution. All the same stuff that I see here, and, and what the opportunity is ahead of us for FARO.

If we do those, I think we execute on those key priorities, we've got an opportunity to, you know, continue on this growth trajectory, expand the margins, which is, grow the bottom line faster than the top line, and increase our cash flow generation.

Andrew DeGasperi (Senior Analyst and Associate Director)

That's helpful. Then maybe, if I may, on, on the, on the, what you just said in terms of, grow the bottom line and, I mean, is, is, is, is by any chance, and I-- it doesn't sound like it, but are you taking a precaution and, and sort of cutting more on the, on the, on the expense side to reflect the, the current weakness in the macro? Is this, you know, in other words, we should expect some weaker revenue, for, for a while, and, and in other words, are you essentially making that, creating that balance between, like, margin and growth?

If not, you know, what kind of revenue level would you say after this change in, in the cost structure, would you say your EBITDA margins potentially would land at? Is it still around that 20% that was discussed previously?

Peter Lau (President and CEO)

Yeah. Maybe a little early to, you know, to get into real detail about, you know, what we expect on, on the expenses, and certainly on the revenue, given the uncertainty in the macroeconomic environment. What I can say is I, I think, we have a tremendous opportunity, you know, in the gross margin. I think we have opportunity as we grow to lever the improved fixed cost base, that we've set out the actions for here in Q2, that we'll begin to see the benefit of in Q3 and Q4, and then obviously, into 2024 as well.

Yuval Wasserman (Executive Chairman)

Yeah, if, if I may chime in, this is Yuval. You know, the Q2 actions we've taken, the majority of the actions will be realized in Q3 and Q4. In fact, we have accelerated our program in the restructuring to realize the benefit as soon as possible, and also with a look into the future. The way we approached it was very surgical. We restructured for efficiency, simplicity, speed, focus, and synergies. A lot of the benefit of this restructuring and cost savings will be realized during the second half of this year, as early as Q3. Obviously, as Pete is going to, you know, spend more time under the hood, more than the week and a half, he's gonna have the opportunity to really look deep into the company and address some of the questions you've raised.

Both myself and Peter Lau has deep, deep experience in operational excellence, operational leverage, running companies in an efficient way, driving execution fast and realizing shareholder value. A lot of what we expect to see, and a lot of the excitement that we see right now, is the cross-section between the vast opportunities we have and the experience management has to deliver on those opportunities.

Andrew DeGasperi (Senior Analyst and Associate Director)

Thank you.

Allen Newitt (CFO)

The only other thing. Sorry. Hey, Andrew.

Andrew DeGasperi (Senior Analyst and Associate Director)

Go ahead.

Allen Newitt (CFO)

The only other thing I might add is you asked the question around revenue effect, I think as Yuval indicated, and again in our prepared remarks, how we've outlined and how we've surgically made those changes, we do not expect those changes to adversely affect our ability to be able to generate revenue over the longer term, and even in the near term. It's not going to have an effect on us, at least that's the current expectation. We were able to eliminate redundancies resulting from acquisitions, some redundancy in terms of cloud environments, et cetera. We feel pretty good about our ability to be able to continue on with revenue levels.

Andrew DeGasperi (Senior Analyst and Associate Director)

That's helpful. Thank you.

Operator (participant)

Once more for your questions today, that is star and 1. We'll move next to Joseph Donahue with Baird. Your line is open.

Joseph Donahue (Research Analyst)

Hey, everyone. It looks like geographically, the trends were maybe the strongest year-over-year in the Americas, weakest in Asia. Could you just give a general overview of how sales are trending by geography to give us some more perspective into that?

Yuval Wasserman (Executive Chairman)

Allen, do you have this information?

Allen Newitt (CFO)

Sure, I, I sure do. In the Americas, I think we've benefited from a very strong organization and strong leadership of the organization, and the relative growth in the Americas has been quite strong. It also has not had the unfortunate effect of, of a weakening dollar, or a weakening dollar over the last-- excuse me, a strengthening dollar over the prior 12 months. Therefore, you know, we've seen some relatively steady, steady performance that has continued in the first half of 2023. In EMEA, it's been a little bit more sporadic. The, the second quarter in EMEA, we had a very strong particular period. I think we saw some very nice performance within the 3D metrology space, specifically within automotive and aerospace, that, that helped us as we closed out the quarter.

Asia Pacific tends to be a bit of an area where we need to spend a bit of time and focus on, because in the quarter, EMEA, APAC was a bit of a decliner for us, leading us overall to have a 10% revenue growth basis. As I commented earlier, the hardware growth for us overall has been quite strong over the last year, where we've grown roughly about 8% on an actual currency basis, when you exclude the effects of acquisitions, and on a constant currency basis, it's closer to 12%.

We think we've got the right products, we think we've got the right sales organization to go capitalize on these products, and we look forward to, to continuing the progress that we've made here over the last 12 months into the next several quarters.

Joseph Donahue (Research Analyst)

That's great. Thank you. kind of continuing on that line, the release today mentioned taking some products out of the portfolio. Can you give any, any perspective on how this could contribute to growth margin in the second half and maybe 2024, or how it could potentially impact the top line?

Allen Newitt (CFO)

The products that we're referring to are products that are a bit around the periphery. They are, of course, not our laser scanner, not our arm, and not our Laser Tracker. I won't go into the details of specifically which ones, there's a couple of them that have launched over, I want to say probably three or four years ago, that have not benefited our revenue materially, and therefore has not really affected our gross margin materially either. We don't expect to see any significant change in top line or bottom line as a result of the changes. What you will see, though, internally at least, is an ability to be able to focus more heavily on the products that really matter to us.

That streamlining and that focus has been a mantra of ours that we expect to continue on in the future and help us become more and more successful over time.

Joseph Donahue (Research Analyst)

Great, thanks. I'll pass it on.

Operator (participant)

It does appear that there are no further questions at this time. I would now like to turn the call back to Yuval Wasserman for any closing remarks.

Yuval Wasserman (Executive Chairman)

Thanks, everyone, for joining us today. Q2 was a good quarter for us, realizing some of the changes we're implementing and realizing earlier results than we planned. We're excited about the future, we're excited about the opportunities ahead of us, and we're excited with the new leadership in the company, and we're looking forward to speaking to many of you in the near future. Thank you so much.

Operator (participant)

This does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful evening.