FARO Technologies Q3 2023 Earnings Call Transcript

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November 2, 2023

There are 6 speakers on the call.

Operator

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

Speaker 1

Thank you, and good morning. With me today from Ferro are Peter Lal, President and Chief Executive Officer and Alan Newich, Chief Financial Officer. Yesterday after market close, the company released its financial results for the Q3 of 2023. The related press release and Form 10 Q are available on FARO's website at www.ferro.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.

Speaker 1

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.

Speaker 1

Generally Accepted Accounting Principles or non GAAP financial measures. In the press release, you will find additional disclosures regarding these non GAAP measures, including reconciliations to comparable GAAP measures. While not recognized in our GAAP, management believes these non GAAP financial measures provide investors with relevant period to period comparisons of core operations. However, they should not be considered in isolation or as a substitute for a measure of financial performance prepared in accordance with GAAP. Now I'd like to turn the call over to Peter Lau.

Speaker 2

Thank you, Mike. Good morning, and welcome, everyone, to our call. We made notable progress in the Q3, exceeding the high end of our guidance range by delivering $86,800,000 in revenue. In addition, due to our lower cost structure and sequential 90 basis point non GAAP gross margin expansion, adjusted EBITDA improved by 2 point $6,000,000 or 300 basis points over the 2nd quarter despite a small sequential decline in revenue. From a top line perspective, the better than expected performance resulted from focused sales activities to increase our overall pipeline An acceleration in customer decision making in our target markets that combined with an improved material availability and improved sales and operations execution enabled higher than expected unit shipments.

Speaker 2

During the quarter, we continued to make excellent progress on our initiatives to streamline operations by taking a series of actions that reduced our footprint, rightsized our cloud investment, integrated prior acquisitions and increased our overall productivity. We have increasing confidence that these cost actions will optimize our performance and not adversely affect our ability to capture Long term market share. While we are pleased with the progress, we are in the early innings of improving results and driving increased execution. Our team recognizes that we have more work to do and is committed to executing with intensity. The revised cost structure reflected in our In the quarters ahead, we will continue to be vigilant on maintaining current spending levels and capturing additional opportunities with a particular focus on expanding gross margins while continuing our focused investment in new products and technologies.

Speaker 2

On the product front, the Q3, we accelerated our product development process while focusing on key product launches, which we believe will have the greatest impact in the market. An example of this is our recently launched Orbis mobile scanner, a groundbreaking advancement in one device. It's best of both worlds performance, providing the ease of use and speed of a mobile scanner, while also providing the unique ability to seamlessly switch to stationary mode, which significantly enhances accuracy. When combined with automated integration to our recently announced Sphere XG platform, FARO provides The ability to automatically process 3 d data, making completed 3 d images available for viewing and collaboration in a cloud, a desktop or mobile environment up to 90% faster than alternatives. These advancements reflect the fusion of Ferro's legacy technologies with those of our recent GeoSlam and HoloBuilder acquisitions and further demonstrate our commitment to innovation.

Speaker 2

Before turning the call over to Alan, will provide greater detail on our Q3 results. I want to take a moment to share some of my observations. Since joining FARO, my primary focus has been on building a point of view on what is working, where we need to improve, our opportunity for sustained technology differentiation and finally, on a sustainable financial success model. I'm very impressed by what I've learned. Having met with customers around the world, the strength of Ferro's brand in the market is clear And not only speaks to the trust customers have in us, but also our reputation for 3 d application expertise and innovation.

Speaker 2

By leveraging our core stance in the market, we are well positioned to remain at the leading edge of product performance, while exploring near adjacencies that expand our addressable market, solve our customers' toughest problems and ultimately drive growth. Customer feedback has affirmed our overarching product solution strategy. In speaking with our employees, the team's unwavering commitment to our organization is Given the macro challenges and uncertainties over the past several years, their dedication is truly commendable. The team is not only engaged but driven by a shared ambition to be a leader in the market through a commitment to our customers, shareholders and the legacy of Ferro. I'm encouraged by the opportunity to improve upon the solid foundation we have as a company.

Speaker 2

I believe in establishing an operating system centered around an eightytwenty philosophy that relentlessly prioritizes key activities will drive the greatest impact on shareholder value and a financial model that will yield improved profitability in all market conditions. We are well down the path of implementing organizational initiatives such that all 1300 FARO employees know how what they do every day contributes to the achievement of the priorities we've aligned on and agreed to as a team. I have confidence the resulting focus and rigor will yield performance improvements. Having had the chance to assess the market There is incredible value to be created by the reduction of waste and inefficiencies in the management of the world's physical assets through the use of 3 d capture and virtual management tools. Our potential for growth is broad and substantial, but will require a focused and disciplined product roadmap as well as a go to market strategy targeted toward customers, markets in applications where we have the highest probability of success.

Speaker 2

The driving force remains our underlying strategy of hardware augmented by software to deliver solutions that solve customer problems. Yet there is likely some refinement to key elements and focus areas that will accelerate and optimize our success. In the coming months, I expect to develop a cohesive strategy. When finalized, I plan to publicly communicate to our stakeholders our key priorities, target markets, targeted financial model and long term goals as well as a road map for achievement. With that, I'll now turn the call over to Alan to provide an overview of our 3rd quarter financial results.

Speaker 3

Thank you, Peter, and good morning, everyone. 3rd quarter revenue of 86 $800,000 was up 2% compared with the Q3 of 2022. 3 d metrology demand remained relatively healthy, particularly in the automotive and aerospace industries. Geographically, demand within the Americas and Europe Continued to perform well, but the softness we saw in China causes a bit of caution near term and into the 4th quarter. In the Q3, we continued to see our sales activities yield an expanded pipeline.

Speaker 3

While too early To call a trend and remaining longer than historical averages, our sales cycles modestly shortened after 2 consecutive quarters of lengthening. This positive timing change created an uplift in demand and with improved execution in sales and operations planning positively impacting our 3rd quarter hardware revenue of $55,700,000 was up 1% year over year, while software revenue of 11,200,000 was up 6% and service revenue of $19,900,000 increased slightly. Recurring revenue was 17,100,000 and represented 20% of sales. As discussed in prior quarters, over the past year, we have seen a modest flattening of overall software As we convert customer purchases of perpetual licenses to subscriptions, in the Q3, we began to see a resumption in both sequential and year over year growth as we exit this transitionary stage. Service revenue showed a modest 1% year over year increase marking the 2nd straight quarter of year on year growth as our service revenue continues to show signs of recovery from the contraction in our serviceable installed base that resulted from softness in 2020 GAAP gross margin was 48% and non GAAP gross margin was 48.9% for the Q3 of 2023.

Speaker 3

On a non GAAP basis, continued high raw material costs and relative strength of the U. S. Dollar compared to historical Change rates resulted in the 3rd quarter's year over year gross margin decline. Sequentially, we are pleased that reported non GAAP gross margin improved 90 basis points due in part to improved product mix, a modest decrease in unfavorable purchase price variance that resulted from our 2022 broker And importantly, we saw initial benefits from supply chain localization. The sequential gross margin improvement From our shift to a Southeast Asia supply chain is important as it marks a proof point on our way to realizing $12,000,000 in annualized savings.

Speaker 3

Additionally, in Q3, while lower than Q2, we continued to recognize approximately 300 basis to the unfavorable 2022 brokered by PPB amortization that will no longer affect us in early 2024. Taken together, we continue to expect a meaningful improvement in 20 24 gross margin. GAAP operating expenses $48,600,000 and included approximately $4,600,000 in acquisition related intangible amortization and stock compensation And $2,500,000 in restructuring and other transaction costs. Non GAAP operating expense of $41,500,000 was down $2,800,000 from Q3 last year as we realized the 1st full quarter benefit of our restructuring efforts. As we stated last quarter, with our expense reductions largely completed, we remain committed to realizing quarterly spending at present FX rates of approximately $40,000,000 to $43,000,000 GAAP operating loss was $6,900,000 in the Q3 of 2023 compared with an operating loss of $7,100,000 in the Q3 of 2022.

Speaker 3

Non GAAP operating income was $900,000 in the Q3 of 2020 3 compared to a loss of approximately $750,000 in the Q3 of 2022. Adjusted EBITDA was $3,500,000 or approximately 4.1 percent of sales. Our GAAP net loss was $8,800,000 or 46 percent share per share. Our non GAAP net income was approximately $450,000 or 0 point compared to a net income of approximately $550,000 or $0.03 per share in Q3 2022. In May, we discussed a total charge of between $22,000,000 $28,000,000 to realize our new quarterly expense base.

Speaker 3

On a year to date basis, we have incurred approximately $25,000,000 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. We continue to expect that approximately 40% of the combined charges to be cash payments. Our cash balance at the end of the quarter was $79,900,000 down $8,600,000 from Q2, largely due to restructuring charges. Excluding the restructuring and other non recurring cash payments, our free cash flow would have been approximately neutral in the Q3. We remain very focused on improving our days sales outstanding with accelerated collections expected in the Q4 of 2023 and into 2024.

Speaker 3

Given our current accounts receivable balance, expectations for revenue and our new expense base as well as further enhancements to our inventory management, We continue to expect cash flow to be positive in the second half of twenty twenty three. While we are pleased with our Q3 results and view them as evidence the business is moving in the right direction, we remain cautious on extrapolating this trend into the 4th quarter. From a geographic perspective, in the Q3, we experienced an unexpected softening in the Chinese market. At this stage, we do not expect China demand to rebound in the Q4, which will create an incremental headwind to the seasonal year end strength. Together with PMI remaining below 50 And sales cycles remaining above historical levels, we want to remain thoughtful and measured in setting expectations for the remainder of this year.

Speaker 3

As a result, in at present FX rates, we expect 4th quarter revenue of between $92,000,000 $100,000,000 At those revenue levels And given corresponding non GAAP gross margin improvement to between 50.5% 52% and non GAAP operating expenses of between $41,000,000 $43,000,000 we would expect non GAAP earnings per share between $0.18 $0.34 This concludes our prepared remarks. And at this time, we'd be pleased to take questions.

Operator

At this time, we will open the floor for questions. We will go first to Greg Palm with Craig Hallum Capital Group. Your line is open.

Speaker 4

Yes, thanks. Good morning, everybody, and congrats on the results. And Pete, an especially good start for you. So congrats as well.

Speaker 2

Thanks, Greg. Nice to speak to you.

Speaker 4

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

Speaker 2

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

Speaker 4

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

Speaker 2

Yes. I mean, look, Greg, I think we're all Looking at the developing situation in the Middle East and trying to understand what that means for the broader macroeconomic environment. The AEC market continues to remain a little soft with the decline in resi and commercial projects. But That said, I would say industrial applications on the 3dm side, still pretty strong, I would say a good macroeconomic environment there. So look, we're watching it closely.

Speaker 2

The continued normalization of our supply chain should allow us to continue to react and drive execution of that demand, and we'll be particularly focused on that execution in the 4th quarter.

Speaker 4

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

Speaker 3

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

Speaker 4

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

Speaker 3

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

Speaker 4

Okay, understood. All right. I will leave it there. Best of luck.

Speaker 2

Thanks, Greg. Thanks, Greg.

Operator

We will go next to Jim Ricchiuti with Needham and Company. Your line is open.

Speaker 5

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

Speaker 2

Hey, Chris. Thanks for the And appreciate the commentary. Probably too early to talk about SPHERE XG and that trend as it just released in the middle of August. What I will say is the added functionality on Sphere XG, along with the work Flow component and the integration with our new Orbis product will allow many of our customers to seamlessly Automate the capture and the readiness of that 3 d data. And so we expect really big things from SPHER And look forward to talking more about that in quarters to come.

Speaker 5

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

Speaker 2

Thanks, Chris. Yes, no, look, it's something that we are watching closely. As I commented, we are still seeing broad Strength in our Americas business and at this point, would expect that to continue into the 4th quarter. No specific effects, but we'll continue to watch that situation pretty closely.

Speaker 5

Great. Thank you very much.

Operator

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

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