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Faro Technologies Inc (NASDAQ:FARO)
Q4 2020 Earnings Call
Feb 18, 2021, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, everyone, and welcome to the FARO Technologies Fourth Quarter and Full Year 2020 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. Good morning. With me today from FARO are Michael Burger, Chief Executive Officer, and Allen Muhich, Chief Financial Officer.

Yesterday, after the market close, the Company released its financial results for the fourth quarter and full year of 2020. The related press release and Form 10-K for the fourth quarter and full year have been filed with the SEC and are available on FARO's website at www.faro.com.

In order to help you better understand the Company and its results, during the course of this call, management may make statements that may be considered forward-looking and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements can be identified by words such as expect, will, believe, anticipate, plan, potential, continue, goal, objective, intend, seek, estimate, may, and similar words.

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. It is possible the Company's actual results may differ materially from those projected in these forward-looking statements. Important factors in a discussion of the risks and uncertainties that may cause actual results to differ materially are set forth in yesterday's press release and in the Company's Form 10-K for the year ended December 31st.

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 will 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 Michael.

Michael D. Burger -- President and Chief Executive Officer

Thank you, Mike. Good morning, and welcome to our call.

I am pleased to report our fourth quarter demand continued to improve as global economies adjust to the ongoing impacts of the pandemic and our customers gained confidence. Demand across each of our geographies grew sequentially, with particular strength in Europe where year end budget utilization helped enable 60% sequential growth.

We experienced sequential demand increase in each of our served markets with notable strength in both AEC and Public Safety, which enabled year-on-year growth of our scanner product line. While near-term demand levels remain below those seen in 2019, the increased activity in the fourth quarter further heightens our confidence that the demand trough is behind us and a market recovery continues. That said, in addition to typical first quarter seasonal softness, we remain cautious on the near-term outlook and continue to expect a more gradual demand improvement throughout 2021 versus a continuation of the strong sequential growth we experienced in the fourth quarter.

In February of last year, we outlined a new FARO strategy with the objective of realizing profitable revenue growth that would ultimately drive increased long-term shareholder value. Broadly speaking, the strategy relied on two key tenants. The first was to create a cost structure that would enable us to realize our success model of 20% EBITDA on flat to 2019 revenue levels by targeting $40 million in annualized savings. The targeted savings would primarily result from a transformation of our go-to-market approach, as well as the globalization of many of our back office processes. The second strategic tenant was to enable long-term product differentiation by better understanding our customers and delivering hardware and software solutions that solve their problems better than our competitors. In the last 12 months, we've made significant progress in both of these strategies.

In our go-to-market transformation, we have -- brought the leadership of our sales team under one executive, eliminated our vertical business unit structure, reduced sales headcount by approximately 40% and enabled our sales team to sell FARO's entire product portfolio. These changes enabled fourth quarter sales productivity per person to improve by 50% when compared to the first half of 2019.

Driven by our new product marketing organization, our customer-focused and market-focused product managers are now enabling our engineering team with the product roadmap targeted at delivering long-term differentiation. Our focus is on developing a deep understanding of our customers' workflow, which can be translated into product features that will enable our hardware to capture data faster, provide our customers with increased software intelligence that enables more data automated, and finally, enable them to access their information everywhere through a cloud-based architecture. These three simple concepts, better data faster, more data automated and information everywhere, encapsulate our strategic intent and they influence everything we do. We anticipate the rollout of these additional capabilities to occur over time.

In corporate marketing, we previously outlined a strategy to improve the quality of our sales leads to further increase sales force productivity. Our historical focus on lead quantity versus lead quality resulted in literally hundreds of thousands of leads going to our sales team, which resulted in a very inefficient lead management process. I'm pleased to report, last week, our new website faro.com went live and provides the foundation for a new technology-based approach of targeting customers, identifying qualifying and tracking leads provided to our sales team. We expect this initiative will further improve the efficiencies we've already realized in our new sales process.

I'm pleased with the progress we've made over the last year, but we have much more to do. In 2020, despite the pandemic, we launched 10 new products, setting a pace we expect to accelerate in this coming year. I look forward to sharing these with you as they launch.

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

Allen Muhich -- Chief Financial Officer

Thank you, Michael, and good morning, everyone.

Fourth quarter revenue of $93 million was down 11% when compared to the fourth quarter of 2019, as a result of continuing market softness caused by the pandemic. As Michael indicated earlier, in the fourth quarter, we saw continuing demand improvement. As a result, on a sequential basis, bookings were -- bookings of $95.1 million were up 30%, while total revenue was up 31%. Service revenue decreased 6% sequentially off a strong third quarter. Our product revenue of $71.7 million was up 49% sequentially. While pleased to see a healthy sequential increase in demand, we continue to believe the recovery in the markets we serve, barring any unforeseen pandemic impacts, will continue to reflect the historical seasonality patterns and gradually improve over the coming quarters.

Fourth quarter GAAP gross margin was 54.6% and non-GAAP gross margin was 54.9%. While gross margin remained lower than last year, it improved sequentially due primarily to the increased revenue and its positive effect on fixed cost absorption, partially offset by unfavorable product mix as demand in the fourth quarter returned more strongly for our lower priced lower margin configurations.

GAAP operating expenses were $48.1 million and included approximately $2.3 million in acquisition-related intangible amortization and stock compensation expenses, $1.6 million in one-time product related charges, and $1.2 million in restructuring costs. With respect to the product charges, during the quarter, we elected to replace certain of our customers' prior generation Edge arm products that were exhibiting lower-than-desired reliability as part of our ongoing focus on customer satisfaction. The specific issues were fixed in subsequent product generations and we do not anticipate the need for further charges.

Non-GAAP operating expenses of $42.9 million were $10.3 million lower than Q4 of 2019, as the Company benefited from cost savings related to restructuring actions taken earlier in the year and our continued focus on making prudent investments. This $10 million Q4 year-over-year reduction is aligned with our committed $40 million in annualized savings, while it also resulted in a $41 million reduction on a full year 2020 basis when compared to 2019. That said, this sequential increase in Q4 non-GAAP operating expense was primarily a result of performance-based compensation on higher-than-expected revenue, as well as continuing R&D investments we're making into our software and hardware roadmaps.

GAAP operating income was $2.7 million for the fourth quarter of 2020, while non-GAAP operating income was $8.1 million compared to $4.7 million for the fourth quarter of 2019, as our lower expense base more than offset lower revenue.

Adjusted EBITDA was $11.1 million or 11.9% of revenue.

Our Q4 GAAP net income was $27.4 million, or $1.52 per share, and included an approximate $24 million benefit that resulted primarily from the completion of changes made to our international tax structure. In the quarter, we recognized deferred tax assets that will be amortized over a multi-year period, effectively reducing future international taxable income. Barring any unforeseen global tax rate changes, we continue to believe our normalized tax rate will approximate 20% on both a GAAP and non-GAAP basis.

Our non-GAAP net income was $6.3 million or $0.35 per share for the fourth quarter 2020 compared to non-GAAP net income of $0.18 per share in Q4 2019.

We continue to maintain a strong capital structure with a cash balance of $185.6 million and no debt. In the fourth quarter of 2020, cash increased by $22 million, primarily as a result of working capital reductions and a benefit from the exercise of previously issued stock options.

I would also like to note that despite the soft demand environment, our current short-term inventory balance has decreased steadily by a total of nearly $11 million, or 19%, throughout 2020 as our operations team has done a fantastic job of tightening our inventory management processes. Further, overall combined levels of accounts receivable, short- and long-term inventory and accounts payable have decreased by nearly $44 million from the first half of 2019 on similar revenue levels, representing a meaningful reduction in the working capital necessary to operate our business.

In summary, despite the impact of global pandemic has had on our business, we're pleased with our progress over the last 12 months. We've executed on the necessary changes to our cost structure and have now delivered on the promise of increased sales efficiency and scalability. Our focus on understanding and translating the voice of customer into product roadmap requirement has improved significantly and our marketing team is also on the verge of providing focused and qualified leads to our sales team that will further our go-to-market efficiencies.

Finally, we significantly -- we're significantly more efficient with the assets required to support our operations as evidenced by our lower working capital levels. This reduction provides a glimpse into the broader operational improvements we've made throughout our business. While we remain cautious about the near-term demand levels, we're excited about 2021. We expect the foundation we have built in 2020 to deliver long-term profitable revenue growth and strong shareholder returns.

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

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Greg Palm from Craig-Hallum Capital. Your line is open. Please go ahead.

Greg Palm -- Craig-Hallum Capital -- Analyst

Yeah, thanks. Morning, Michael. Hey, Allen. Congrats on the good quarter here.

Allen Muhich -- Chief Financial Officer

Thanks, Greg.

Michael D. Burger -- President and Chief Executive Officer

Thanks, Greg.

Greg Palm -- Craig-Hallum Capital -- Analyst

Maybe to start, it would be good to get some color on maybe the cadence of activity. It sounds like you outperformed a bit, but anything more to add, I'm guessing, when it was all said and done, the revenue number surprised you guys a bit?

Michael D. Burger -- President and Chief Executive Officer

A little bit. I think we were taken back by the strength in Europe. We kind of discounted the traditional trends that we would see at the end of the year based on what we've been through this year. We didn't expect that there was a lot of pent-up capital budgets to be placed. And certainly that was not the case, and it happened in Europe, and so it was a positive surprise, for sure.

Greg Palm -- Craig-Hallum Capital -- Analyst

Michael, has your view on the pace of the recovery changed at all? You've been pretty clear that this is gradual. But based on what we saw in Q4 and just sort of end market demand, I mean, do you think the pace is running ahead of prior expectations, or is it just too early to make that conclusion?

Michael D. Burger -- President and Chief Executive Officer

No, I don't think it is. I think we still feel, and I think we've said publicly, that I would be disappointed if we're not back to 2019 levels by exiting Q4 of this calendar year 2021. But I think the recovery to that level will be gradual throughout the balance of the year. And we still expect to see kind of the seasonal swings that we've gone through traditionally. We don't see any reason that that won't be repeated.

Greg Palm -- Craig-Hallum Capital -- Analyst

Yeah. Okay. Makes sense. And then just as far as new product introductions go, I'm curious, for this year, should we view that more as upgrades to existing product lines, or is it something more substantial I'm thinking sort of adjacent incremental -- something new to the market that can be incremental to what you're going to market with today?

Michael D. Burger -- President and Chief Executive Officer

Yeah. It's always a mix, right. You're always delivering on upgrades for products, but we are also planning on doing some things that are differentiated and should put us in a different position than we've historically been. And when I say historic, I'm talking about over the last three or four years. So, it's a mix, Greg. And I'm very pleased with what we were able to achieve despite working from home, primarily through the bulk of 2020. But I think we've got our rhythm and I believe we'll actually eclipse the number of products that we introduced in 2020 in 2021.

Greg Palm -- Craig-Hallum Capital -- Analyst

Yeah. Okay, great. I look forward to hearing those. Best of luck going forward. Thanks.

Michael D. Burger -- President and Chief Executive Officer

Thanks for your interest, Greg. I appreciate it.

Operator

Our next question comes from Jim Ricchiuti at Needham. Your line is open. Please go ahead.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Hi. Good morning. I want to go back to what the business that you saw in Europe in the quarter. Any color you can give, Michael or Allen, just in terms of the metrology business versus 3D scanning and the strength you saw there?

Michael D. Burger -- President and Chief Executive Officer

Yeah. We saw strength in 3D metrology, particularly at the end of the quarter type of favor. We were very pleased with our scanning business overall, not just in Europe, but around the world, and Europe certainly led the charge there in the AEC business. So, I think, we were also very surprised at kind of just the level of recovery in 3D metrology.

And we've been working hard on Public Safety outside of the United States and that's begun to bear fruit. And we saw a couple of relatively big deals happened in Europe in Public Safety. So, I would say, Europe, in general, is kind of hitting on all cylinders. And it looks even -- Germany is back in lockdown and there are other countries talking about it. I don't think that should have a negative effect on the levels that we've traditionally seen in Europe. So, I think, Europe feels pretty strong as of right now, and I think it was driven really across the board. 3D metrology was a lead, followed by AEC, and some big deals in Public Safety.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Got it. And then if we look at the other markets, North America or APAC, which of these areas of the business maybe potentially given you a little bit more confidence about recovery and which was maybe lagging?

Michael D. Burger -- President and Chief Executive Officer

That's a great question. We feel really good about where we are in Asia, and they were the first to recover for us. And we're seeing by virtue of the way we've restructured, we're seeing a lot of benefit, particularly, in China proper. So, China, we believe is back and strong and we have a lot of confidence. Clearly, right now, they're on Chinese New Year holiday, so Q1 will be down from Q4 in Asia just because of that. Probably the most concerning is North America and it's spotty at best. And it's really hard to predict versus Europe and where we are with Asia right now. So, I think from a strength perspective, Europe was very strong last quarter, Asia continues to grow in strength, and North America is lagging.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Got it. Maybe one more and I'll jump back in the queue. Allen, if I may, just how should we be thinking about you executing against the financial model in terms of the margin profile targets that you've laid out? I mean, you're getting pretty close. Certainly, in Q4, you hit some of those targets. I'm just wondering as we think about the business in '21, anything we should be mindful in terms of those targets either investments or additional -- potentially even the additional cost that you're incurring as it relates to COVID?

Allen Muhich -- Chief Financial Officer

No. Just as -- I appreciate the question, Jim, and it's a good one. Again, a year ago, we outlined a success model that had us at 55% to 60% gross margins. We still believe that that is a very good achievable range for us. Again, we were right at the lower end of that here in the fourth quarter. And in operating expenses, we outlined 40% to 43% on relatively flat revenue, which would translate into, again, approximately $40 million to $43 million. We were a bit at the higher end of that range, but I think it's more of a temporary thing caused by some additional compensation given the higher revenue levels that will, again, be -- reset a bit as we head into 2021. Overall, we still anticipate and are focused on the adjusted EBITDA of 20%. That's our success model. We have every intention of delivering on that in 2021.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Got it. Thank you.

Michael D. Burger -- President and Chief Executive Officer

Thank you, Jim.

Operator

Our next question comes from Andrew DeGasperi from Berenberg Capital. Your line is open. Please go ahead.

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

Good morning.

Michael D. Burger -- President and Chief Executive Officer

Hey, Andrew.

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

I just had a -- Hi. I just had a few questions. The first, in terms of -- I mean, this year being a little bit of an odd year given the pandemic...

Michael D. Burger -- President and Chief Executive Officer

Do you think?

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

But just thinking about 2021 and the seasonality that we should expect for next year, because -- I'm just wondering if there's anything that we should be mindful looking at 2020 and as we look at our models next year that don't repeat themselves, particularly given the larger deals that you saw in Public Safety in Q4?

Michael D. Burger -- President and Chief Executive Officer

No. I think, we are planning on seeing evidence of the same seasonal pattern that we experienced in 2019. Forget 2020, right. But, in 2019, if you go back and historically look at Q4 to Q1, Q1 to Q2, etc., we're planning on and expect to see that same revenue profile in 2021 that we experienced at the end of 2018 through 2019. And that's what we're planning on.

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

Got it. And I know you can't tell us how big these deals were, but like if we were to look at Public Safety and how lumpy it is, I mean, is this typical in terms of the deal sizes that you get out of that end market?

Michael D. Burger -- President and Chief Executive Officer

Yeah, they're typical. I think, what's really encouraging is if you look back historically where we've been strong in Public Safety, it's primarily been in North America. And we've been working hard over the last 18 months really trying to grow that outside of North America, and we're beginning to see kind of fruits of that labor in Europe, and by the way also in Asia. So, Asia hasn't materialized in new business, but the opportunity funnel is growing dramatically. And so I'm really encouraged in Public Safety overall. And you're right, they are relatively lumpy. So, there is nothing unusual about the size of the deals or the lumpiness of the deal structure that we're seeing in Europe and Asia.

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

That's helpful. Just one on the sales force productivity. I mean, obviously, that's been a big focus for you since you -- the FARO Tech [Phonetic]. I'm just wondering -- you're obviously pleased where that ended up. I was just wondering if there's anything more that you think you could get out of that, not that I'm thinking you're doing a good job or not, just curious to know what would be the ideal level where you think the sales force can deliver?

Michael D. Burger -- President and Chief Executive Officer

Yes. As we mentioned in the script, we're spending a lot of time and effort on lead generation. And as we said in the script, we -- historically, we just thrown thousands of leads to the individual sales guy, and it's mind numbing to expect that people are going to follow up on all those leads, etc. So, as a result, I think we had a very low efficiency.

We just last week introduced our new website, which is pretty exciting. And if you get a chance you should check it out. It's a completely new look. And that's kind of will act as a front-end, but behind that front-end, we have put a lot of time, effort and money in a technology stack behind that, that will help our corporate marketing people, our product marketing people, direct leads to the right sales guy in the right region, in the right market set, that basically adds more value than what we've been doing historically. We think that will be another productivity hit upside, if you will, for the sales -- for the selling organization.

And then, of course, as we begin to add more and more value by virtue of the products that we're offering to the market, the hit rate of opportunity to conversion to revenue will continue to improve. And so, yeah, I think there is a lot to be done still in terms of improving the productivity of our sales force. But we're pretty excited about having a metric to share with you and to show the first substantiation of that productivity improvement, but there is more to come.

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

That's great. And last one for Allen. Just in terms of the model on the OpEx side going forward, I mean, some companies we're speaking with are starting to assume that the second half of next year is going to see a resumption in travel, marketing -- I guess, conferences and like [Phonetic]. Should we assume a similar kind of trend in terms of sales and marketing costs for that -- for 2021?

Allen Muhich -- Chief Financial Officer

Yeah. We certainly today have less than normal or less than typical travel and related expenses within our run rate. We have, however, increased some of that activity as we exited 2020 compared to what it was in the earlier parts of 2020. So, certainly, Q4 was higher than the second quarter and third quarter, as an example. I think we still remain -- despite that, we still remain very committed to that $40 million to $43 million and staying within that range as we continue to grow revenue. And that will then ultimately enable us to deliver the model that we've talked about earlier. But, so you might see us drift a little bit higher as the year goes by due to that as well to some of the R&D investments that we've talked about previously, but we still expect to stay within the range.

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

That's helpful. Thank you.

Operator

[Operator Instructions] We have a question from Ben Rose from Battle Road. Your line is open. Please go ahead.

Ben Rose -- Battle Road Research -- Analyst

Yes. Good morning, Allen and Michael.

Michael D. Burger -- President and Chief Executive Officer

Hey, Ben.

Ben Rose -- Battle Road Research -- Analyst

Couple of questions. Was curious to ask you a little bit about the performance this quarter, specifically of the FARO Gage in factory metrology, as well as the Focus Swift on the scanning side and whether these products were meaningful contributors?

Michael D. Burger -- President and Chief Executive Officer

They are. They are new in terms of adoption. I'm pleased with both. I guess, I'm pleasantly surprised with the Gage adoption rate. And I think that it kind of goes hand in hand with some of the 3D metrology recovery in Asia and in Europe. Swift is very positive. Mobile scanning, I think, is a trend that we have to capitalize on. And we're spending a lot of time and effort on mobile scanning and Swift is really arguably our first real flagship product in that space, and we expect that to continue to ramp. The ASP differences between the two are significant. So, yeah, I'm pleased with both of them. And we will continue to innovate in both, both in the articulating arm and the mobile scanning space in 2021.

Ben Rose -- Battle Road Research -- Analyst

Okay. And I'm curious, specifically within 3D metrology, you had commented earlier in the call that you were pleased with how the segment is performing. I'm curious to know which of the end markets that you serve appear to be coming back the fastest in terms of their investment in 3D measurement?

Michael D. Burger -- President and Chief Executive Officer

Well, it's a interesting phenomenon. We're seeing automotive coming back pretty strong actually, and particularly, in Europe and in Asia. And we're seeing the smaller machine shops coming back with some force with the exception of North America. We're not seeing broad-based recovery in America in the small to medium machine shop area, which I think that is kind of a hold over for where we are in the pandemic. And for example, the West Coast is stronger than the East Coast, and the automotive space in North America is not where we're seeing the recovery as it relates to Asia and Europe. So -- and aerospace, in general, is still lagging 2018-2019 levels. We are seeing activity in terms of projects quoting that type of thing, but they're not pulling the trigger in terms of purchases. So, was that helpful? Is that what you're...

Ben Rose -- Battle Road Research -- Analyst

Yes, that's a very helpful kind of broad overview. And if I may just one for Allen. It looked like the services gross margin was very strong in Q4. I'm curious to know, does that have to do with the sale of extended warranties for products or whether that kind of level can be sustained into 2021?

Allen Muhich -- Chief Financial Officer

Yeah. I think, we saw a couple of small items within services that enabled us to have a little bit of a one-time pickup in margins. I would expect that the -- what we've demonstrated over the last -- over a longer extended period is more what we would expect moving forward. Nothing of -- out of the -- overall, nothing out of the ordinary though, Ben.

Ben Rose -- Battle Road Research -- Analyst

Okay. All right. Thanks very much.

Michael D. Burger -- President and Chief Executive Officer

Thanks, Ben.

Allen Muhich -- Chief Financial Officer

Yeah.

Operator

It appears that we have no further questions at this time. I will now turn the call back over to our speakers for any additional closing -- additional or closing remarks.

Michael D. Burger -- President and Chief Executive Officer

Well, we thank everyone for listening. We are very excited about where we are. As Allen said in his script, we are very much looking forward to 2021. And we appreciate your attention. Thank you. Talk to you in next quarter.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Michael Funari -- Investor Relations

Michael D. Burger -- President and Chief Executive Officer

Allen Muhich -- Chief Financial Officer

Greg Palm -- Craig-Hallum Capital -- Analyst

James Ricchiuti -- Needham & Company, LLC -- Analyst

Andrew DeGasperi -- Berenberg Capital Markets LLC -- Analyst

Ben Rose -- Battle Road Research -- Analyst

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