Faro Technologies Inc (FARO) Q3 2021 Earnings Call Transcript

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Faro Technologies Inc (FARO -1.48%)
Q3 2021 Earnings Call
Oct 27, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon, everyone, and welcome to the FARO Technologies' Third Quarter 2021 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 -- Partner

Thank you, and good afternoon. With me today from FARO are Michael Burger, Chief Executive Officer; and Allen Muhich, Chief Financial Officer. Today, after the close, the company released its financial results for the third quarter of 2021. [Operators Instructions]. Now I'd like to turn the call over to Michael.

Michael Burger -- President, Chief Executive Officer & Director

Thank you, Mike. Good afternoon. Welcome to our call. While third quarter demand for our products remained strong, with reported orders of $80.4 million, ongoing pandemic-related logistical challenges impacted our customers' ability to coordinate delivery, resulting in roughly $5 million of primarily, Asia-Pacific orders and shipments slipping into the fourth quarter. Typical summer softness within the European markets in addition to the well-documented rolling automotive shutdowns, further contributed to the expected sequential order decline. As we look ahead, to our product roadmap, this quarter, we will begin beta testing our unified software environment, which we call FARO Sphere.

FARO Sphere is our new cloud-based platform that is the foundation to our software and solution strategy, whose objective is to provide differentiated value by offering workflow enhancements. These improvements include automated laser scan, data uploads from any location, access to our existing suite of 3D software applications, cloud-based data analysis and global user access as well as ultimately, the ability for our customers to purchase, renew or manage all of their FARO software and hardware assets. This is an important milestone for FARO, and it represents the first large step into expanding our cloud-based software offerings that we believe will deliver greater value to our customers and to our shareholders. We believe that FARO Sphere environment targeted globally across a wide range of markets, including construction management, facilities, operations and maintenance, robotic simulation and incident preplanning will lead to exponentially increase number of users, enabling accelerated revenue growth and a shift toward increased levels of high-margin recurring revenue over time.

In addition to the rollout of FARO Sphere, last quarter, we discussed the launch of our new Quantum Max, which is a ScanArm solution developed to solve our customers' need for both speed and accuracy in metrology-grade scanning applications. Unlike prior physical arm solutions, the Quantum Max allows customers to swap laser measurement heads on the fly, creating a versatile tool, which meets a wide spectrum of speed, accuracy and resolution needs in a single solution. When combined with the latest generation of our CAM2 metrology software, our customers can realize a productivity and increase of over 30% compared to prior generation devices.

Now 3.5 months into the rollout of the product, I am pleased to report customer feedback has been overwhelmingly positive and resulted in sequential quarterly increase in Arm shipments despite the slow European summer and the turbulence in the automotive market. Given the overall flexibility and the value creation of this product, we are starting to see early signs of accelerated legacy tool replacement. We view this as a positive indicator and validates our strategy of early customer engagement to better understand their needs and in turn, develop differentiated solutions that will generate greater value and drive additional product demand. Another update on our product road map has been the strong demand for our photogrammetry-based digital twin solution, which we acquired with HoloBuilder last quarter.

Holobuilder's leading SaaS platform delivers hardware-agnostic image capture, registration and viewing while utilizing artificial intelligence, which automates many tasks such as identification of scanned objects. The Holobuilder application adds fast and easy photo documentation and remote access capabilities to FARO's highly accurate 3D laser scans to create the industry's first end-to-end digital twin solution. Initially targeted at the construction management segment of the market, our team is working toward broadening the offering into facility management and public safety markets. Given the momentum in the Holobuilder solution, we are -- we had combined with our increased investment, we believe demand is on track for Holobuilder's recurring revenue to double over the next 12 months, which confirms our view of the strategic importance of the digital twin opportunity.

Shifting to operations. Last quarter, we announced the signing of an agreement to outsource our manufacturing to Sanmina. Thus far, the transition has been going smoothly and while the cost benefits associated with outsourcing will not impact our financial results until next year, we have already started to see indirect benefits of leveraging Sanmina's supply chain. We discussed last quarter component shortages and freight logistics continue to impact many industries, including our own. Through the diligent effort of our supply chain team and the additional resources now available from Sanmina, we have thus far been successful in navigating this situation. That said, we remain cautious as market uncertainties may continue for an extended period of time, which could have an adverse effect on our ability to deliver and to service demand.

We believe that our strategic transition of developing differentiated solutions through a deeper understanding of our customers' workflows, while at the same time, adjusting our operating structure to generate leverage is paying off. While our third quarter results were softer due to historic seasonality and the timing of customer shipments, the reported Q3 year-on-year growth is consistent with what is required to return to 2019 revenue levels in the fourth quarter. We are encouraged by the underlying market demand that has resulted in the fourth quarter funnel growth. And together with the benefit of new product offerings, we expect to see continued strengthening of our fourth quarter activity. With that, I'll turn the call over to Allen for an overview of our third quarter financial results. Thank you, Michael, and good afternoon, everyone. Third quarter revenue of $79.2 million, grew 12% when compared to the third quarter of 2020 as a result of continuing improvement in market demand compared to last year's market softness caused by the pandemic. Product revenue of $57.8 million, was up 20%, while service revenue of $21.3 million was down 6%. Bookings of $80.4 million, grew 12% year-over-year. GAAP gross margin was 53.5% and non-GAAP gross margin was 53.7% for the third quarter of 2021. Gross margin increased year-over-year, largely due to volume increases from prior periods that was somewhat offset by an expected increase in material costs resulting from today's inflationary pressures. As a result, we expect gross margin levels will be adversely impacted toward the lower end of our stated success model range of between 55% and 60% until conditions normalize. In addition, as Michael mentioned, the cost benefits from our outsourcing initiative will not begin to impact margins until next year. GAAP operating expenses were $47.5 million and included approximately $3.8 million in acquisition-related intangible amortization and stock compensation expenses and $1.4 million in restructuring costs. Non-GAAP operating expense of $42.4 million, was $3.9 million higher than Q3 of 2020 as we continue to increase our software investments, both in Holobuilder as well as our organic initiatives and as a result of the travel-related expense savings realized during the pandemic returning. GAAP operating loss was $5.2 million for the third quarter of 2021 compared with an operating loss of $4.9 million for the third quarter of 2020, primarily due to lower volumes in the prior year period. Non-GAAP operating income was near breakeven in the third quarter of 2021 compared to a $2 million loss in the third quarter of 2020. Adjusted EBITDA was $2.7 million or approximately 3.4% of revenue. Our GAAP net loss was $3.9 million or $0.21 per share. Our non-GAAP net loss was $0.01 per share for the third quarter of 2021 compared to a net loss of $0.08 per share in Q3 2020. We continue to maintain a strong capital structure with a cash balance of $126 million and no debt. The third quarter decrease in cash was primarily a result of strategic purchases of inventory to increase safety stock levels as we work to mitigate risk associated with the current supply chain challenges. As Michael mentioned, we're pleased in the continued end market demand improvements and the organic and inorganic progress we're making toward realizing our strategic vision of hardware, software solutions that solve our customers' real-world problems in a cloud-based environment. We're excited that the product road map for both hardware and software are beginning to build customer momentum and as the associated recurring revenue contribution increases, our intention is to be transparent in our reporting of both our business objectives as well as the metrics to track our performance. Finally, we remain committed to the achievement of our financial success model, which, as a reminder, is to achieve 55% to 60% gross margin with 40% to 43% operating expenses, resulting in 20% adjusted EBITDA that we expect will be realized with approximately $110 million in quarterly revenue. We look forward to reporting our continued progress in the coming quarters. 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] And it looks like our first question comes from Greg Palm.

Greg Palm -- Craig-Hallum Capital Group LLC -- Analyst

Good afternoon everybody. I guess, just, kind of starting with the commentary specific to Q3 around the customer logistical challenges, can you just go in a little bit more detail around what exactly happened? It sounded more COVID-related versus supply chain related, but maybe there is a relationship there. I just wasn't sure if I picked that up right.

Michael Burger -- President, Chief Executive Officer & Director

Actually, the issues that occurred to us were primarily in Asia, as we mentioned, and primarily between AEC and public safety applications, specifically. And in more than one situation, orders were committed, but we actually didn't receive the actual paper work, if you will, in certain instances. So we weren't able to book, and we've since, actually gotten these orders in-house in the quarter. And there were a couple of situations where customers wanted the product but weren't able to actually get freight forwarding to service the order. So in a couple of situations, we were on the cusp of basically claiming revenue, but we had to push it into Q4.

Allen L. Muhich -- Chief Financial Officer

And maybe just a little bit more color. They were actually rather large deals, and therefore, the logistics were more on the customer being able to coordinate deployment of the assets versus anything else in a couple of the situations. So hopefully, that gives you a little bit more color as well.

Michael Burger -- President, Chief Executive Officer & Director

It was not caused by our ability to deliver. In fact, we had inventory on site.

Greg Palm -- Craig-Hallum Capital Group LLC -- Analyst

It's interesting. My next question was going to be, if I add back, basically, that amount, it would have made that region look really, really good relative to sort of previous quarters. So it sounds like, maybe, it was a few big deals versus something that was more across the region. Is that the right way to think about it?

Michael Burger -- President, Chief Executive Officer & Director

That's exactly right. In fact, I think in general, Greg, we're really excited about what we're seeing out of Asia today. And frankly, they're back to 2019 levels already. So Asia's recovery has actually been pretty consistent over the last couple of quarters, and we're beginning to see some real deal flow there. So we're very excited, particularly, in China, specifically.

Greg Palm -- Craig-Hallum Capital Group LLC -- Analyst

Okay. That's good to hear. I guess, just maybe we'll segue into to that as my last one. The commentary is talking about good demand indicators in Q4 as you sort of approach pre-COVID levels across all regions. Is -- do you still think that's the case in Q4, where you get back to those Q4 '19 levels? Has anything changed in the last couple of months, whether it's supply chain logistical issues that makes you maybe less confident in getting to that number?

Michael Burger -- President, Chief Executive Officer & Director

Actually, no, I would argue it's the opposite. I'm actually more confident based on the fact, as we mentioned in the script, Greg, we're seeing the beginning of quarter funnel, pretty significant growth quarter-on-quarter. So that gives us confidence. As you know, the way we run our business is really looking at opportunity flow into the quarter that's expected to book. And of course, not everything does book in the quarter, and so there's some discounting associated with that in terms of -- or handicapping, if you will, of that number. But growth, quarter-on-quarter in terms of the funnel size. And you're right, across all three regions, it's been very encouraging. And so we feel pretty comfortable and actually put it in the script that we believe we should see Q4 levels in Q4.

Allen L. Muhich -- Chief Financial Officer

Yes. The other thing we commented on in the script as well is the Quantum Max performance. And again, we've launched it 3.5 months ago, and the response back from the customers has been quite positive. And the approach around having cost swappable laser line probes has been well received. And so we are beginning to gain some confidence that, that may lead to a faster replacement cycle, which also, again, is one of the contributors to the incremental pipeline that Michael referenced that we see heading into the fourth quarter.

Michael Burger -- President, Chief Executive Officer & Director

I think our confidence is growing in that context.

Greg Palm -- Craig-Hallum Capital Group LLC -- Analyst

Okay, good to hear. Best of luck going forward.

Operator

Our next question comes from Andrew DeGasperi.

Andrew DeGasperi -- Joh. Berenberg, Gossler & Co. KG -- Analyst

I guess, one question I had is, in terms of the legacy tool replacement cycle, I thought that was a very interesting comment you made. And it sounds like you mentioned the Quantum Max is driving that. But is there anything else that's happening? I mean, is it just, I guess, people that might have paused that cycle, so to speak, during the pandemic are now confident to ramp it up? Or is there something incremental that is -- that we're not aware of?

Michael Burger -- President, Chief Executive Officer & Director

I think it's two -- I think twofold. I think first is the new product. I think we -- I've talked to customers directly that have had an Arm in their shop for over 10 years and just didn't want to give it up. But I think the value that this particular new product is offering is very compelling. That said, I would believe that second order effect is that, there is confidence that the market is coming back, particularly with some of the smaller shops. And therefore, they're doing some of the much-needed upgrade that, frankly, I think, have been -- has been on hold through the pandemic. So I think it's a combination of both.

Andrew DeGasperi -- Joh. Berenberg, Gossler & Co. KG -- Analyst

Got it. And then on, Holobuilder, one of their competitors, I guess, went public recently at Matterport. Just curious in terms of that landscape, I mean, how does it differ from those other digital twin products? And how would you say it stacks up?

Michael Burger -- President, Chief Executive Officer & Director

A great question. First of all, the market in which HoloBuilder is pointed is pretty much the retail space largely. And of course, noise has been -- they've made a lot of noise about where they want to go, which is great. Our solution is really twofold. Our solution is really aimed at the high-end, ultra-high definition scanning, which is used by many guys for very highly accurate, highly sensitive things like robot simulation as an example, where they use our traditional Focus scanner.

What's great about that is that, that is the basis or a backbone, if you will, for a highly accurate down to seven-millimeter levels in terms of distance over 100 square meters. So very, very, accurate scanning. And what HoloBuilder does is then lays on top of that, this photogrammetry capability that is much less accurate. And so the combination of the two, we think we have a differentiation, if you were to take the Matterport solution and point it in the applications where we're pointed, I don't think they could compete.

Andrew DeGasperi -- Joh. Berenberg, Gossler & Co. KG -- Analyst

Got it, that's helpful. Thanks.

Operator

Our next question comes from Rob Mason.

Rob Mason -- Robert W. Baird & Co. Incorporated -- Analyst

First, I just wanted to touch on, you did mention some material cost constraints inflation. The obligatory supply chain challenges, everybody's dealing with. But you just talk about the trends in those, how you're seeing that. And then your ability, you think to offset any of that via price -- what the pricing environment is like, where that might lead you just in terms of addressing pressures on gross margin because you seem to suggest these supply chain challenges themselves probably don't alleviate themselves right away, which I think is kind of the conventional wisdom, maybe perhaps, but just your thoughts there.

Michael Burger -- President, Chief Executive Officer & Director

Yes. Let me start by saying from a philosophical perspective, and Allen mentioned that we have taken an aggressive stance on inventory to ensure that we're -- that we don't sacrifice revenue. So that goes without saying. The second thing is that, where we have long-term plans for product mix, we're basically putting in longer-term contracts that basically sequester supply. The third thing is that we are seeing opportunistically price increases anywhere from 5% to 12%, depending upon who you talk to and where regionally you are in that.

Sanmina has been fantastic at helping us find -- finding supply. They've not been able to help us a great deal on the pricing. Pricing, I think is all of us are suffering with. But frankly, we've not been in a situation where we couldn't ship a product because we didn't have the raw materials. And so the net effect of that is where our COGS is continuing to grow and -- but that's basically risk mitigation on our part.

Rob Mason -- Robert W. Baird & Co. Incorporated -- Analyst

What about your ability to capture price in the market? And to that degree, what the competitive situation or environment presents on that front as well?

Michael Burger -- President, Chief Executive Officer & Director

It's a great question. We haven't really seen our competitors at large go out and actually put a surcharge, if you will, on the end selling price of their equipment. That said, the new Quantum Max, as an example, is at a higher ASP than the previous version. And we believe that we're able to garner that price by virtue of the value that we bring. Certainly, that helps us with the gross margin set. But that said, the assumptions that we made on what COGS would be is probably low compared to where we are today based on -- just on what's happening with supply. I don't know if that answered your question.

Rob Mason -- Robert W. Baird & Co. Incorporated -- Analyst

Yes. That's helpful. And then just a follow-up. I think you probably touched on this when you addressed maybe the health of your smaller customers and maybe their attitudes. But I'm just curious, as you think about into year-end and capital budgets and perhaps, if there's any year-end budget flush, how do you feel about being able to get your entitlement there, your fair share from a QA, QC function that you provide versus some other categories that are competing for those budgets?

Michael Burger -- President, Chief Executive Officer & Director

Better every day. I think that the confidence that we're seeing in our customer base really across all regions and really all three segments is growing. I think the smaller guys particularly, have been really reticent to place capital buys in lieu of all the things that have been between supply shortages and kind of work stoppages, etc., that seems to be waning a bit. And so confidence is growing. We've seen that reflected in our opportunity funnel that we track religiously. So I think the answer to your question is, overall, I think we are really well positioned if, in fact, there are capital flushes to be had. We have -- as you know, we've repositioned the way we go to market with our sales channel. And so now we have clear customer ownership.

We're talking to our customers probably more than we ever have. Face-to-face visits are as high as they've been since the pandemic started, yet we're still leveraging these virtual demos that we've been -- that we started to do way back in February of 2020. So I think the combination of being able to get in front of customers more often, the excitement that we're seeing in our customers around things coming back to normal. The fact that we've got new products in the marketplace, and the fact that our new go-to-market strategy is all about being front and center, I think that really bodes well for us if, in fact, there is a hay day we had with capital flush.

Rob Mason -- Robert W. Baird & Co. Incorporated -- Analyst

Just last question, just around FARO Sphere as you bring that -- work to bring that to market and go to beta test, I'm just curious what the -- how you think about the profile of that beta test customer? Who you're planning that seed with, perhaps initially?

Michael Burger -- President, Chief Executive Officer & Director

Initial offerings are around our AEC product offering. And so we're talking to some relatively large and some very small customers in the AEC space because our first offering in Sphere will be an AEC product line and workflow associated with that. So we're trying to actually do kind of a four corners test, big guys and small guys. We've got about 20 customers that we're talking about through the beta process and feedback will start rolling in here as we speak. I'm super excited by this. I mean this is repositioning our company and this is where the rubber hits the road. We will officially be announcing to our entire customer base, FARO Sphere in the Q4 as originally planned.

Rob Mason -- Robert W. Baird & Co. Incorporated -- Analyst

That's great. Pretty helpful, thank you.

Operator

[Operator Instructions] We'll take our question from Ben Rose.

Ben Rose -- Battle Road Research Ltd. -- Analyst

Michael, I think you indicated in your last quarter that Asia, China, in particular, was recovering at a faster pace than Europe and the U.S. Can I take it from your comments that you're now seeing a pickup in those regions, specifically for the manufacturing part of the product line?

Michael Burger -- President, Chief Executive Officer & Director

We're -- so Q3, not so much, right? Europe was on vacation actually all the way through August. So -- and frankly, that's a seasonal thing that, if you look back in our history, it's happened every year. So we expected Europe to be slow in Q3. That said, the opportunity funnel for all three regions is up significantly in Q4. And so the answer is yes, we're seeing -- yet to be actually realized, but the opportunity funnels are very, very robust, and the growth quarter-on-quarter has been very encouraging. So we're -- we believe Q4, and I think we've said this now for probably 18 months, we believe we've said all along that we'd be disappointed if Q4 wasn't back at the 2019 level for Q4 in 2019. And our confidence is growing that, that's going to occur. Save some catastrophe and supply chain, etc., which, of course, would affect not just us, it would affect others. So I'm very encouraged.

Ben Rose -- Battle Road Research Ltd. -- Analyst

Okay. And you made some comments about the automotive sector. In your initial remarks, you sort of alluded to the sector at large. Is there anything that you can provide in terms of color, in terms of what you're seeing in that sector, in terms of demand?

Michael Burger -- President, Chief Executive Officer & Director

No. I think all of us have read ad nauseam, all the core stories of what's happened in the automotive space over the last quarter with rolling shutdowns and that type of thing. And certainly, that, I think, contributed to some of the delay in some of the orders that we're hopeful. That said, it looks like that's pretty much behind us. And again, this is anecdotally, in talking to our customers. They don't believe that will occur in Q4 as it did in Q3. So that being said, assuming that happens, I think we're in good place, a very good place.

Ben Rose -- Battle Road Research Ltd. -- Analyst

Okay. And if I may, just one more. On the public safety side. Is there any update there, specifically, on what you're seeing in the U.S. in terms of customer demand?

Michael Burger -- President, Chief Executive Officer & Director

No. I actually believe it's stabilizing. It's been very spotty regionally, and we're encouraged by the pipeline. I think North America should return to normalcy, if not in Q4, ideally in Q1. As you know, it's a relatively small portion of our business. That said, as Allen, I think, alluded to in his answer around Q3 in the delay in shipments, a lot of those delays in Asia were public safety, and they were -- they're big deals. And I continue to be excited about our penetration in Europe and in Asia in the public safety sector. I don't think it will rival the North America numbers short-term. But the traction that we're getting is really -- it's exciting. So I'm encouraged.

Ben Rose -- Battle Road Research Ltd. -- Analyst

Okay, thanks very much.

Operator

It appears we have no further questions at this time. I will now turn the program back over to Michael, for any closing remarks.

Michael Burger -- President, Chief Executive Officer & Director

Well, as I said, we're very excited about the quarter comments and very excited about Sphere, very excited about our new products. And I know you're tired of hearing me say, very excited. That said, we look forward to talking to you next quarter about Q4. Thank you for your interest. Bye.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Michael Funari -- Partner

Michael Burger -- President, Chief Executive Officer & Director

Allen L. Muhich -- Chief Financial Officer

Greg Palm -- Craig-Hallum Capital Group LLC -- Analyst

Andrew DeGasperi -- Joh. Berenberg, Gossler & Co. KG -- Analyst

Rob Mason -- Robert W. Baird & Co. Incorporated -- Analyst

Ben Rose -- Battle Road Research Ltd. -- Analyst

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