FARO Technologies - Q4 2022

Transcript

Operator (participant)

Good day, everyone, and welcome to the FARO Technologies Q4 and year-end 2022 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 (Investor Relations)

Thank you, and good afternoon. With me today from FARO are Michael Burger, Chief Executive Officer, and Allen Muhich, Chief Financial Officer. Today, after market close, the company released its financial results for the Q4 and full year of 2022. The related press release in Form 10-K 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'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 the relevant period-to-period comparisons of core operations. They should not be considered in isolation or as a substitute for a measure of financial performance prepared in accordance with GAAP. I'd like to turn the call over to Michael Burger.

Michael Burger (President and CEO)

Thank you, Mike. Welcome to our call. Improving Q4 demand, driven by strength in our laser scanner in European markets, along with the addition of a full quarter of GeoSLAM, resulted in revenue for the quarter of $103.9 million, up nearly 4% year-on-year, despite strong currency headwinds. On a constant currency basis, Q4 revenue was $110.5 million, up approximately 10% year-over-year. Following September's launch of our new Vantage Max tracker, I am pleased to report that all three of our major hardware product lines have now been refreshed with new products. With our new laser scanner gaining global adoption, we believe the hardware success we have seen thus far validates our customer-driven approach to product definition. We look forward to discussing future product releases in the quarters to come.

Beyond our internally developed products, the integration efforts of our recent acquisitions are executing to plan. Following September's acquisition of GeoSLAM, we are pleased with the partnership that has developed quickly. Their mobile scanning roadmap is robust, and we expect a significant new product launch later this year. As a reminder, GeoSLAM's flexible, low-cost handheld mobile scanning portfolio closes a gap in our scanning lineup. We anticipate these products will address several applications within FARO's traditional AECO and public safety customer base. GeoSLAM's products have historically targeted the geospatial and mining markets primarily through an indirect channel. We believe we now have meaningful cross-selling opportunities in front of us. In the Q4, we further expanded our capture technology portfolio through the acquisition of SiteScape, a leader in iOS-based LiDAR scanning.

By enabling LiDAR scanning capabilities inherent in recent generations of iOS devices, we bring the power of potentially millions of devices into FARO's cloud environment, Sphere. Given the limitations on range and speed of capture, we don't expect iOS scanning to replace or cannibalize existing scanning technologies within our portfolio. It does, however, provide a simple and readily available option for customers to address scanning gaps in larger projects within the AECO and public safety applications. By augmenting FARO's existing high-precision leading-edge capabilities with offerings such as mobile scanning, 360-degree photo and video capture, as well as iOS-based LiDAR, we now offer the broadest set of 3D capture devices in the market. This unique capability enables FARO's construction and facilities customers to optimize their capture methods to their scanning application and need.

As we integrate these various capture capabilities into FARO Sphere, we will enable cloud-based access to 4D models from all of our available capture devices onto a single coordinate system. This unique and differentiated offering will provide FARO customers with unprecedented flexibility along the ease-of-use and accuracy continuums. Early feedback on the integration and integrated viewing and usage of 3D data capture using FARO's broad set of capture devices has been strong. We believe the market potential for digitizing the physical world is enormous, and we are uniquely positioned to offer the best 3D solutions that will enable increasing levels of long-term adoption. This is a key differentiator for FARO, and we look forward to sharing our progress through 2023 and beyond. I'll now turn the call over to Allen to provide an overview of our Q4 financial results and Q1 guidance.

Allen Muhich (CFO)

Thank you, Michael. Good afternoon, everyone. Q4 revenue of $103.9 million was up nearly 4% compared with the Q4 of 2021. With roughly 60% of our revenue impacted by US dollar FX rates, our Q4 revenue on a constant currency basis was $110.5 million, up 10% year-over-year. Driving this result was primarily the solid increase in demand for our Focus Premium scanners, a meaningful improvement in our performance in European markets, and the addition of GeoSLAM revenue following our September acquisition. On an actual currency basis, when compared to last year, Q4 hardware revenue of $70.3 million was up 9%. Software revenue of $12.9 million was down 5%. Service revenue of $20.6 million was down 6%.

Recurring revenue of $18.1 million was up 10% when compared to Q4 of 2021, primarily due to growth in our cloud-based software offerings. Hardware revenue on a constant currency basis was $75.8 million, up 17% year-on-year, is a strong indicator of our new product customer adoption. As we discussed in prior quarters, we have seen a modest flattening of overall software revenue as we convert customer purchases of previously perpetual licenses to subscriptions. On service revenue, the lower 2020 and 2021 hardware unit shipments compared to earlier years have reduced the installed base of products eligible for our service offerings that when combined with the meaningful product quality enhancements we've made over the last 18 months, has resulted in continued lower service revenue.

Similarly, but with the opposite effect, as 2022's higher unit shipments come off warranty, we would expect to see service revenue pick up later in 2023 and into 2024. GAAP gross margin was 49.1%, and non-GAAP gross margin was 52.8% for the Q4 of 2022. Our global footprint for both customer revenue and internal operating expenses results in a relatively effective natural hedge that has limited the overall year-to-date profitability impact of recent and unprecedented FX changes. The relative strengthening of US dollar exchange rates over the past year have adversely impacted reported gross margins by nearly 350 basis points when compared to the success model we set in early 2020.

While unfavorable material costs have predominantly been offset by price increases, until FX rates normalize, we expect to operate below our targeted gross margin range. As supply chain conditions continue to normalize, we expect to realize approximately $12 million in annualized material cost savings as we reposition our supply chain to lower cost providers in Southeast Asia. As a result, we remain committed to our long-term success model, which for gross margin targets 55%-60% of revenue. GAAP operating expenses were $52.7 million and included approximately $4.3 million in acquisition-related intangible amortization and stock compensation expenses and $2.6 million in restructuring and other transaction costs.

Non-GAAP operating expense of $45.8 million was $1.6 million higher than Q4 of 2021, due primarily to the inclusion of GeoSLAM operating expenses, which more than offset the benefit we experienced as a result of strengthening US dollar exchange rates. GAAP operating loss was $1.6 million in the Q4 of 2022, compared with an operating profit of $3.9 million in the Q4 of 2021. Non-GAAP operating income was $9.1 million in the Q4 of 2022, compared to $11.7 million in the Q4 of 2021. Adjusted EBITDA was $11.7 million or 11.3% of sales. Our GAAP net loss was $2.2 million or $0.12 per share.

Our non-GAAP net income was $7.1 million or $0.38 per share for the Q4 of 2022, compared to net income of $8.7 million or $0.48 per share in Q4 of 2021. Our cash balance at the end of the quarter was $37.8 million with no debt. Included in our cash consumption during the quarter was inorganic investments we made in both SiteScape as well as a minority investment in technology targeting lower cost lasers we have slated for coming years. We remain focused on reducing overall working capital levels with improvements expected in 2023.

On January 20th, after the close of the quarter, we placed $75 million of 5.5% convertible senior notes, including the underwriter's option to purchase additional notes at a strike price of $42.36, which represents a 20% premium to FARO's closing stock price on January 19th. The net proceeds from the offering was approximately $72.2 million, which will be reflected in our March 31st balance sheet reporting. Given relatively high interest rates, we expect to invest a portion of proceeds in short-term treasuries that will offset some of our interest expense. We are aggressively integrating the recent acquisitions of HoloBuilder, GeoSLAM, and SiteScape. In the 1st quarter, we are announcing an integration plan which includes the consolidation of our three cloud-based environments as well as the rationalization of our facilities footprint and incremental expense savings.

We expect these actions to offset a portion of the inflationary expenses we've experienced over the past few quarters, as well as some of the expected increase in reported expense levels associated with continued normalization of FX rates. Taken together, we expect to incur $10 million-$16 million in charges through the end of 2023, split roughly evenly between cash and non-cash. Once complete, we anticipate an approximate $10 million reduction in annualized operating expenses that will maintain expense levels modestly higher than reported in 2022, given the expected and offsetting expense headwinds of inflation, FX, and variable compensation plans. Moving on to guidance. In the Q1, we expect revenue of between $81 million and $89 million, which assumes a constant exchange rate from current levels.

If the US dollar were to further strengthen or weaken during the remainder of the quarter, we would experience a corresponding headwind or tailwind to reported revenue levels. We expect a non-GAAP loss per share of between 2 and $0.22. Before closing, based upon feedback from many investors about March 2023 travel challenges, we have made the difficult decision to postpone our previously announced Analyst Day. We continue to have a strong desire to share our progress and provide a hands-on experience for investors to see our virtualization tools. We will be looking for a date in the future that is more suitable to ensure greater investor participation, giving the meaningful distraction, effort, and investment necessary to successfully pull off such an event. In closing, notwithstanding the recessionary concerns echoing throughout the macro environment, our opportunity funnel remains strong.

We're increasingly excited about the building momentum in our business and remain committed and optimistic about executing on our long-term vision of digitalizing the physical world. That said, we are actively monitoring demand signals to ensure alignment with spend levels and will adjust should future conditions warrant. The pace of our product announcements, both hardware and software, are accelerating, and we expect to continue providing increasing levels of value from 4D virtualized models to our customers throughout 2023. We look forward to sharing our progress with you in the quarters ahead. This concludes our prepared remarks. 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 star and 1 on your touch-tone phone. You may remove yourself from the queue by pressing star and 2. Once again, to ask a question, please press star and 1. We'll take our first question from Greg Palm with Craig-Hallum Capital Group. Your line is open.

Greg Palm (Senior Research Analyst)

Hey, good afternoon. Thanks for taking the questions. Starting off with-

Allen Muhich (CFO)

Hey, Greg.

Greg Palm (Senior Research Analyst)

Hey, wanted to start with some comments on geographic results, 'cause that's kinda what stood out to us, really surprising strength in Europe and maybe likewise, not as strong results in APAC. Maybe you can just dive into those specific regions a little bit more.

Allen Muhich (CFO)

Yeah. I think APAC was not a surprise. We, you know, APAC has actually been on a tear here for the last year for us, so we're not necessarily overly disappointed. The opportunity funnel in Asia continues to grow and I think it was more timing of some of the bigger deals that just kinda got pushed into future quarters. Europe took us all by surprise. We saw a resurgence, a large resurgence in the AEC space, and we had a couple big public safety deals close. In general, a very nice surprise. As you know, you and I have been talking about this now for over a year. Europe has been depressed for us. It's great to see it back where I think it belongs.

We're excited, not just from a revenue and booking perspective, but their opportunity funnel also took a very nice turn. We're feeling pretty good and I think it's a testament both to the AEC market and also now our position in that with our new scanner.

Greg Palm (Senior Research Analyst)

Yeah, makes sense. That's, that's helpful color. If I could just shift gears a little bit, to the cost savings program. Allen, I might have you repeat a little bit of what you said 'cause I couldn't write it down fast enough. Can you just go through what the, what the potential cost savings are? I'm not sure if what you were alluding to was there's gonna be a, you know, a sort of a pickup in expenses, and so these savings are expected to offset, or whether we've already seen some of that pickup and the savings will offset that going forward. Maybe just a little bit more color there.

Allen Muhich (CFO)

Sure, Greg. The areas where we are expecting to see some benefit, and again, we outlined $10 million of annualized expense savings that will be feathered in kinda throughout 2024, is predominantly a focus on finalizing the integrations of the three acquisitions that we've done over the last year and a half. We have three cloud-based environments today that we're supporting. We really only need to have that be one, and therefore there's some expense savings associated with that. Given the remote and hybrid work environments that we've adopted, our facilities are underutilized, and therefore we have an opportunity to consolidate those facilities into smaller square footage, frankly. Those also, again, will feather in over 2023.

Finally, we've always got some tweaking of expense and investment levels around the edges that will also help contribute to that $10 million. As it relates to when we'll see it and where we expect expenses to level in, some of that will depend, of course, upon where currency rates normalize to. At today's FX rates, we would expect that expenses in 2023 remain about where they are or where we reported them, maybe just a touch higher than where we reported them in 2022. Taking into account the savings, taking into account inflationary pressures, variable compensation plans, merit increases for employee base, all of those things somewhat net themselves out.

Greg Palm (Senior Research Analyst)

Okay, that makes sense. Just lastly, any additional purchase accounting impacts that we should be taking into account either here for Q1 or fiscal 23?

Allen Muhich (CFO)

No.

Greg Palm (Senior Research Analyst)

Okay, easy enough. All right, I'll leave it there. Thanks.

Michael Burger (President and CEO)

Thanks. Thanks for the questions, Greg. Appreciate it.

Operator (participant)

Our next question comes from Rob Mason with RW Baird. Your line is open.

Robert Mason (Managing Director and Senior Research Analyst)

Yes, good evening.

Michael Burger (President and CEO)

Evening.

Robert Mason (Managing Director and Senior Research Analyst)

I wanted to ask just about if you could just speak, Michael, to how it sounded like the AEC markets, public safety, you know, performed better than the 3D metrology. That was my impression. If you could just maybe clarify how those individual markets performed in the Q4, maybe what you're seeing into the Q1?

Michael Burger (President and CEO)

Yeah. I think AEC kind of on a global basis was a very nice surprise. We saw a significant bump as we talked about in Europe, but it was strong in North America and in Asia alike. Public safety, we actually had our largest booking quarter in the history of public safety for us, and we feel really excited about that. I think 3D metrology, I wouldn't say it was down, frankly, overall, we felt really good about the quarter in general. It just wasn't up as much as what we saw in public safety and AEC. I would argue that that's a combination of nice market activity, but I also believe the adoption of our new Focus Premium scanner is exceptional.

We have, in Q4, booked our largest number of units for scanner in the history of the company. All based on the strength of the Focus Premium. I think, we're pretty excited about what that, what that says.

Allen Muhich (CFO)

The only other thing I might add related to the 3D metrology space is last year was a bit of a difficult compare for us because we had very strong performance with our next generation Quantum Max FaroArm in Q4 of 2021. That's why for us, it felt like things were continuing on nicely. When you do the year-over-year compare.

Michael Burger (President and CEO)

Yeah, I think.

Allen Muhich (CFO)

It's challenging.

Michael Burger (President and CEO)

That's exactly right.

Robert Mason (Managing Director and Senior Research Analyst)

How would you characterize, just the sales cycle, the order cycle? As we came through, you know, the end of the year, did you notice any changes, shifts in the ability to close orders, deals?

Michael Burger (President and CEO)

No, no, actually not. We have been relatively pleasantly surprised with the funnel growth, and it's now continued now for probably 2 and a half quarters, and that bodes well for us. By the way, it goes against everything we're reading, right, in terms of what's happening in the end marketplace. We're cautiously optimistic, and I think Al said in his prepared remarks, we continue to kind of watch this. It still looks quite positive. The sales cycle in terms of length of closing deals, in terms of, you know, capital approval cycles, we didn't see a significant change from Q3 to Q4.

Robert Mason (Managing Director and Senior Research Analyst)

It sounded like, again, you noted public safety, largest booking quarter that you'd had. Is that product that will ship in 23, or did some of that... It sounded like some shipped anyway in Q4, but I'm just curious what you carry over? Then maybe just, you know, broader comment on how backlog finished the year and, you know, did that come down as supply constraints alleviated or, just maybe how that trended year over year?

Michael Burger (President and CEO)

Let me start with the backlog. We effectively ended Q4 with pretty much the same backlog we started it with. We had relative very strong bookings overall. We haven't talked about that, but strong bookings. That kept the backlog into Q1 quite healthy. We're feeling good about that. Your first question was what? I'm sorry, Rob.

Robert Mason (Managing Director and Senior Research Analyst)

Just, the large public safety, booking that you referenced. Is that a 2023 shipment, or did we already ship that?

Michael Burger (President and CEO)

We shipped quite a bit of it within quarter. As I mentioned, backlog quarter-on-quarter for the companies was flat in terms of what we started Q4 with and what we're now starting Q1. Some of that is public safety. I don't think a disproportionate number. I think we shipped a large portion of what we booked in Q4.

Robert Mason (Managing Director and Senior Research Analyst)

Very good. Just one quick one, and then I'll hop off. Allen, how should we model the net interest expense in the Q1 as a partial quarter, you know, for the convert offering? Not sure when you're investing the cash, but I'm just curious what's embedded in the guidance around that.

Allen Muhich (CFO)

Yeah. What's embedded in the guidance is, again, we closed the transaction on the convert in the third week of January, we will have $75 million times 5.5% over that time, over the balance of the quarter. There's also some amortization of fees and fees that are need to be buried in there as well. we have assumed that. those fees, I believe, are just a bit shy of $3 million that would be amortized over the five-year term.

Robert Mason (Managing Director and Senior Research Analyst)

Okay.

Allen Muhich (CFO)

We would expect to invest somewhere in the $30 million-$40 million range is kind of the current thought process for the final month of the quarter. Therefore, you should expect to see, you know, whatever T-bills are somewhere in the 4%-4.5% range.

Robert Mason (Managing Director and Senior Research Analyst)

Okay.

Allen Muhich (CFO)

Interest income to offset. Hopefully that gives the other pieces you need.

Robert Mason (Managing Director and Senior Research Analyst)

Excellent. Yes, it does. Thank you.

Michael Burger (President and CEO)

Thanks, Rob.

Robert Mason (Managing Director and Senior Research Analyst)

Thank you.

Operator (participant)

Our next question comes from Andrew Buscaglia with Berenberg. Your line is open.

Speaker 7

Hi, this is Stephanie. I'm on for Andrew. My first question is about recurring revenue and how we should think about the recurring software and services getting towards that 25% of revenue, and whether these integrations of the acquisitions will change that in any way.

Allen Muhich (CFO)

First of all, I don't believe that the integration of the cloud-based environments will affect that trajectory at all. The recurring revenue component will continue to grow and continue to be an increasing level of our overall revenue. It's a focus area of ours. As you know, recurring revenue for us is both the software components as well as there's some repair contract revenue that's in there as well that's being somewhat blunted today. As we continue to grow our hardware revenue, that ultimately positively affects recurring revenue, as we indicated in our prepared remarks towards the end of 2023 into 2024.

Therefore, again, as we also continue to make investments in our SaaS-based cloud applications, that will drive increased levels of software revenue through recurring revenue, and therefore still believe strongly that we will be able to achieve the 25% objective that we've thrown out there. The only reason why we may not is if hardware revenue continues to grow nicely, and then we end up with a good problem that both of those revenue streams are growing. Right now, we see differentiated growth.

Speaker 7

Okay. Thank you. That makes sense. One more question on your recent acquisition of SiteScape.

Michael Burger (President and CEO)

Yes.

Speaker 7

If you could just elaborate a little bit on the market and competitors and whether this will require investment on your part in the near term or longer? Thank you.

Michael Burger (President and CEO)

The answer is yes, it will require investment. We had a plan internally to develop this capability organically, and the opportunity with SiteScape came up and we jumped at it. I think this will be integrated and not necessarily affect the overall software spend at the rate that we're currently talking to. It's inculcated into our plan and our model. You should feel comfortable with that. I think the market itself is massive. SiteScape, however, was very much focused on consumers, and I would argue, for lack of a better term, hobbyists. What we're doing is taking this low-resolution LiDAR capture capability and really inculcating it into Sphere and then really focusing it on our current markets, which are AEC and ultimately public safety.

We're taking a technology that's been proven in the consumer world and now applying it very much to our strategy. We don't see it change our direction or our strategy or our focus from a market perspective, but it does accelerate our roadmap, and it does accelerate our technologies.

Allen Muhich (CFO)

Maybe just one comment to confirm as well, the revenue contribution from SiteScape is very, very immaterial.

Michael Burger (President and CEO)

Yes.

Allen Muhich (CFO)

Therefore, think about it more as a technology acquisition as opposed to a market or revenue expansion.

Speaker 7

Got it. Thank you. That's helpful.

Michael Burger (President and CEO)

You're welcome. Thank you, Stephanie.

Operator (participant)

Once again, to ask a question, please press the star and one, and you may remove yourself from the queue by pressing star and two. We'll take a question from Ben Rose with Battle Road Research. Your line is open.

Ben Rose (President)

Yes, good afternoon, Allen and Michael.

Michael Burger (President and CEO)

Hey, Ben.

Ben Rose (President)

Good. Michael, question for you. In addition to you had mentioned that there were separate cloud platforms for some of these recent acquisitions. Are there other integration tasks that need to be done beyond kind of harmonizing around one cloud platform?

Michael Burger (President and CEO)

Yeah, I think there's always... We're integrating the GeoSLAM hardware engineering organization into our current hardware, engineering organization, which is going extremely well. There are always, you know, G&A sides of that. There are IT projects. There are all kinds of kind of behind the scenes that we don't spend a lot of time talking about tasks that need to be done when you integrate companies the size of GeoSLAM. SiteScape is a relatively small company with very, with few employees, and so that integration, I would argue, is already complete. HoloBuilder was roughly the size of GeoSLAM from a population perspective, and that's pretty much behind us as well. GeoSLAM is probably the largest task we've got in place right now.

When we bought SiteScape, when we bought HoloBuilder, and before we bought them, we were developing our own cloud-based environment. That's really what we're alluding to when we say three cloud environments. That's a big task because, frankly, there's customers in each of those environments. They're using, in some cases, different service providers. Their APIs, the way they actually interface with the cloud is different. There is a lot of development that has been going on. We're just announcing it this quarter.

Ben Rose (President)

Okay. Just a follow-up question with regard to the strength in the AEC market in Europe. How much of it would you say is sort of a general bounce back in the economy versus other things that might be going on in terms of product acceptance or perhaps changes in the competitive environment?

Michael Burger (President and CEO)

Yeah, it's a great question. I wish I had a real finite answer for you, but I don't. What we saw in the quarter was a great pull from our customer base on projects that we had been tracking. Frankly, we had seen many of these projects continue to be pushed quarter to quarter. I think actually you and I have talked about this in the past. I believe that it was somewhat market-driven because, frankly, a lot of the projects were not pushed into the following quarter, but actually did close in Q4. That could be very much around capital capital budget flush. If you don't spend it, you lose it.

Ben Rose (President)

Mm-hmm.

Michael Burger (President and CEO)

We see that actually every year. We hadn't seen that in the AEC market through 2020 and 2021, and I think largely because of, you know, COVID-related issues. It's good to see the budget flush. We did see that. I do believe it's hard to really distinguish between budget flush and the adoption and excitement around the new scanner, which is absolute. It's positive. The projects are closing. As I mentioned, we had our highest booking quarter for scanner in the history of the company.

Ben Rose (President)

Great. Okay. That's really helpful color. Appreciate it.

Michael Burger (President and CEO)

You're welcome, Ben. Thanks for your question.

Michael Funari (Investor Relations)

Thanks, Ben.

Ben Rose (President)

Thanks a-

Operator (participant)

It appears we have no further questions at this time. I'll turn the program back to Michael Burger for any closing remarks.

Michael Burger (President and CEO)

Thank you very much for attending. We're very pleased with the quarter. We're actually really excited about what the future holds. Thank you very much. We'll talk to you next quarter.

Operator (participant)

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