FARO Technologies (FARO) Q2 2022 Earnings Call Transcript

FARO Technologies (FARO -2.00%)
Q2 2022 Earnings Call
Aug 03, 2022, 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 second quarter 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 second quarter of 2022. The related press release and Form 10-Q 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 and include statements regarding future business results, product and technology development, customer demand, inventory levels, economic and industry projections or subsequent events. Various factors could cause actual results to differ materially. Some of these factors have been set forth in today's press release and are described at length in 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 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 Burger.

Michael Burger -- Chief Executive Officer

Thank you, Mike. Welcome to our call. In the second quarter, demand across our served markets remained healthy with noticeable increases in backlog driven largely by demand for both our Quantum Max scan arm and our newly released Focus Premium laser scanner. However, second quarter results were impacted by continued strengthening of the U.S.

dollar, which is up approximately 10% against major currencies from the start of the year. Roughly 60% of our revenue in the quarter was transacted outside the United States and impacted by the changes in the U.S. dollar exchange rate. For comparison purposes on a constant-currency basis, our second quarter revenue would have been $83.9 million, representing a 3% year-on-year increase and up over 7% sequentially.

Nevertheless, customer feedback on our Quantum Max and Focus Premium products remained strong, with Quantum Max now qualified by a large portion of our historical customer base. Focus Premium's recent launch in April is following a similar trajectory of the Quantum Max. We believe the improved speed and ease of use of the Focus Premium scanner coupled with Stream, our new mobile scanning application, are key differentiating features that compare favorably against our competitors' products. These two refreshed product lines represent 75% of our historical hardware revenue.

In the second quarter, shipments of our scan arm and our laser tracker product lines were sourced from Sanmina's Thailand facility. We continue to be pleased with Sanmina's quality levels as well as their ability to meet required volumes. At the end of the second quarter and consistent with our plans, we completed the move of our laser scanner product line to Sanmina. As a result, our manufacturing outsource initiative is now largely complete.

We continue to believe in the long-term financial and operational benefits of this transition. And while the timing of the previously mentioned $12 million in annualized savings is delayed due to the ongoing disruptions in supply chain, we're beginning to have line of sight to a phased shifting of supply chain partners to Southeast Asia that will allow us to begin seeing savings in 2023. In the second quarter, we also launched our new 3-dimensional digital reality capture and collaboration platform, which we call FARO Sphere. Sphere is a cloud-based environment, which enables full 3D model creation, storage and collaboration.

Sphere will be FARO's platform for all future cloud-based software applications, workflows as well as our service and training resources. Adoption rates of Sphere by current generation scanner customers has progressed as expected through our premium offering. While it is still early days, the conversion to paid subscription is on track as we continue to develop new value-added software applications that address the specific needs of customer workflows in the AEC and O&M markets. Turning to HoloBuilder.

We remain pleased with the progress of the business and are very excited about the scale of the opportunity in front of us. In the year since acquiring HoloBuilder, the teams have made progress toward empowering construction professionals the solutions they need to effectively and efficiently monitor and track construction progress. We have continued to enhance our offering, releasing significant new features, including Premium Analytics, a HoloBuilder API and SnapShots. These powerful new tools continue to build upon HoloBuilder's strong foundation, providing new ways to realize productivity and enables strong industry demand for our SaaS-based solution.

HoloBuilder's construction progress management application will be integrated into the Sphere platform by the end of this year. In June, we announced that GOLDBECK, a leading European commercial construction firm, signed an enterprise agreement to deploy HoloBuilder's Construction Progress Management workflow across its entire organization. GOLDBECK site managers will use our platform to track and document the progress of their construction projects over time, linking cloud-based 360 photos of their site to the digitized building plans and storing them securely in the cloud. GOLDBECK is a textbook example of a global firm realizing the full potential and competitive advantage of using FARO's high-accuracy 3D laser scanning technologies in concert with our real-time photo capture technology.

We continue to believe there is a large and growing untapped market opportunity for FARO's technology that leverages our high-accuracy laser scanning expertise, along with easy-to-use photo-based solutions, coupled ultimately to our mobile scanning solution. With the launch of FARO Sphere, we are bringing these capabilities together to provide a one-stop experience across FARO's application software, workflow insights and customer support tools. The market potential for digitizing the physical world is enormous, and we are excited that our technology and expertise positions us well both now and over the long term. We continue to execute on the areas we can control and are closely monitoring both the demand environment and our own operation given the loud and consistent rhetoric related to recessionary and supply chain risks.

While we have not seen direct effects on our opportunities or booking pace, we remain cautious and are managing our business accordingly. With that, I'll turn the call over to Allen to provide an overview of our second quarter financial results.

Allen Muhich -- Chief Financial Officer

Thank you, Michael, and good afternoon, everyone. Second quarter revenue of $79.9 million was down approximately 3% compared with the second quarter of 2021. As Michael mentioned, with roughly 60% of our revenue impacted by the stronger U.S. dollar in the second quarter, on a constant-currency basis, our second quarter revenue was $83.9 million, up 3% year over year.

Driving this result was primarily the increase in demand for both our Focus Premium scanner and Quantum MAX scan arm, particularly in the Americas, where overall orders grew 14% year over year. We expect to continue to leverage the strength in the Americas into our other geographies in the coming quarters. On an actual-currency basis, hardware revenue of $49.2 million was down 2% year over year. Software revenue of $10.5 million was up 4% year over year.

And service revenue of $20.2 million was down 7% year over year. Recurring revenue of $17.1 million was up 8% when compared to Q2 of 2021, primarily due to the growth in our HoloBuilder Construction Progress Management application. As we discussed last quarter, we've begun to see a modest flattening of overall software revenue as we convert customer purchases of previously perpetual licenses to subscriptions. Additionally, we've made meaningful product quality enhancements over the last 12 to 18 months that is improving our customer experience but adversely impacting revenue realized from time and material billings.

GAAP gross margin was 50.6%, and non-GAAP gross margin was 51% for the second quarter of 2022. This gross margin was lower than our recent history for two primary reasons. The first is related to the strengthening of the U.S. dollar exchange rates as our products are often priced in local currency, however, manufactured on a U.S.

dollar basis. The second relates to some geographic specific opportunities for lower-margin configurations that closed in the quarter that we believe may continue in upcoming quarters. We remain committed to our success model, which for gross margin targets 55% to 60%. That said, near-term pressures from the previously discussed 200 basis points of unfavorable material cost increases to now the effect of USD FX rates and mix shift including lower configuration products implies we will operate below our targeted range until external conditions improved or we begin realizing the savings associated with shifting our supply chain to Southeast Asia.

GAAP operating expenses were $49.4 million and included approximately $3.9 million in acquisition-related intangible amortization and stock compensation expenses and $2.3 million in restructuring costs. Non-GAAP operating expense of $43.2 million was $1.4 million higher than Q2 of 2021 due primarily to the inclusion of HoloBuilder operating expenses in our financial results given our acquisition one year ago that more than offsets the benefit we're seeing as a result of strengthening U.S. dollar exchange rates. GAAP operating loss was $9 million in the second quarter of 2022 compared with an operating loss of $650,000 in the second quarter of 2021.

Non-GAAP operating loss was $2.5 million in the second quarter of 2022 compared to a profit of $3.9 million in the second quarter of 2021. Adjusted EBITDA was approximately $500,000. Our overall operating income levels were relatively unaffected by the strengthening dollar. And while both reported revenue and costs were lower, they virtually offset, creating a natural hedge against FX movements today and in the future.

Our GAAP net loss was $8.6 million or $0.47 per share. Our non-GAAP net loss was approximately $600,000 or $0.03 per share for the second quarter of 2022 compared to a profit of $2.2 million or $0.12 per share in Q2 2021. I should note that included in our non-GAAP financial results was a $1.5 million gain recognized in other income and expense that was primarily due to the remeasurement of U.S. dollar bank balances held by our foreign legal entity.

We continue to maintain a strong capital structure with a cash balance of $102 million and no debt. We made significant progress on our aged receivables with an approximate 10-day sequential quarter reduction in days sales outstanding that results in a reduced AR balance despite the sequential increase in revenue. Further, we saw an approximate $10 million reduction in short-term inventory as a result of our Sanmina partnership that didn't affect Q2 cash flow given the timing of payments. We remain focused on reducing overall working capital levels with improvements expected through the remainder of the year.

Moving on to guidance. In the third quarter, we expect revenue of between $79 million and $87 million, which assumes a constant exchange rate from today's levels. If the U.S. dollar were to further strengthen during the remainder of the quarter, we would again experience a headwind to reported revenue levels.

We expect non-GAAP earnings per share of between negative $0.08 and positive $0.08. In closing, while all the talk of recession may ultimately prove a challenge, we continue to see several signs of improvement in our business. With our recently launched FARO Sphere ecosystem, we now have the platform from which customers can view, collaborate and ultimately gain greater insights from their 3D models. We are excited by our software road map targeted at new workflows and applications that will enable our customers with new and unique value from the 3D models they create with FARO hardware.

In the second quarter, we had the highest non-Q4 quarter of laser scanner units booked in our history and the highest level since Q4 2019. Following approximately 18 months of work by our team, our manufacturing transition is complete. Recurring revenue continues to steadily grow. Quarterly levels have increased from below $14 million in Q2 2019 to about $17 million this quarter, representing an 8% CAGR over this time.

Increased recurring revenue levels is a key result of the execution of our strategy, and we're pleased to show progress. We've entered the last two quarters with material availability concerns. And while the situation remains fluid and can change quickly, material availability challenges appear to be easing heading into the second half of 2022. Finally, entering the third quarter, we've seen a modest increase in both the absolute size of our pipeline despite the typically slow summer months as well as a modest increase in our conversion rates in each of our geographic regions.

Our recently launched scanner and laser scanner products, which comprise 75% of our hardware portfolio, are gaining good customer retention, and we're winning. We're excited about the building momentum in our business for our near-term opportunities while also executing on the long-term vision that we have for generating shareholder value from the customers digitalizing the world's physical objects. This concludes our prepared remarks at this time. We'd be pleased to take any of your questions.

Questions & Answers:

Operator

[Operator instructions] We'll move first to Greg Palm with Craig-Hallum Capital Group. Please go ahead.

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

Yeah. Good afternoon. Thanks for taking the questions. I was hoping you could maybe start with just giving us a high-level view of kind of how the quarter shook out from a cadence standpoint and really more interested in what you saw sort of in those last most important couple of weeks of the quarter.

Michael Burger -- Chief Executive Officer

Yeah, we typically have a rush to the end of the quarter, as we've talked in the past, and this quarter was no different. I think -- I will say that it probably -- our quarter built a little bit more linear than we've seen traditionally. And I think that's because some of our products -- because of material shortage issues, we've been very vocal about what we think the lead times are, and I think that's had some effect to that build. But we saw a lot of momentum going into the last month of the quarter.

And as history shows, we've done a lot of turns in that last month. So we didn't see anything materially different other than perhaps a little bit more linearity in the beginning of the quarter.

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

OK. And from a geographic basis, I understand the FX headwinds. I was surprised in the Americas region, where FX really isn't an impact, and you had revenue that was down a couple of million quarter over quarter, which is inconsistent with normal seasonal trends. Can you maybe just detail exactly what the reason was for that?

Michael Burger -- Chief Executive Officer

Well, it was down in revenue but up in bookings. And so I think Allen referenced this in his script. We saw really strong demand. Much of it wasn't able to be shipped within the quarter, came in toward the latter part.

We're actually feeling pretty good about America today, driven largely by 3DM. So I think this is more of a timing issue than an actual market change. 3DM was strong. We also saw public safety actually did really well in the quarter for us as well.

So we're feeling really good about the Americas, particularly in the context of bookings going forward.

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

Do you have a book-to-bill by chance or a quarter end backlog? I don't know if you gave either of those. I missed them if so.

Michael Burger -- Chief Executive Officer

Allen, I don't recall if we actually published that in our...

Allen Muhich -- Chief Financial Officer

Those are numbers that we haven't published, Greg. But at the same time, I think that we did indicate at the beginning of Michael's section that we did build some backlog within the quarter. So I think you can assume that book-to-bill was greater than one.

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

Yeah, OK. Perfect. And then on gross margin, maybe, Allen, just go in a little bit more detail exactly the reason behind the decline. I think you said something about the lower-price or lower-margin configurations.

I'm not sure if that was a byproduct of a new geography you entered or new customers or whatnot. I guess I missed the reason behind that as well.

Allen Muhich -- Chief Financial Officer

Yeah. I think that, again, we commented on two reasons for the reduction. One was simply the currency exchange rates adversely affecting revenue, and our purchases are denominated in U.S. dollar.

The second is exactly what you indicated, which is a bit of a shift toward lower-priced, lower-margin configurations. You also recall that we had some backlog that was held up in China heading out of the first quarter into the second quarter. Quite a bit of that, of course, shipped in. In fact, all of it shipped here in the second quarter.

That product tends to be a bit on the lower side of the margin scale for us, which, again, I think, adversely affected some of the margin profile that we see in the quarter. China continues to be a very strong geography for us, which is why we also made the comment that we don't really expect too much change from that mix as we head into the next couple of quarters. Our line of sight is not overly long, but from what we can see at this point in time, we expect those lower-margin regions to remain relatively strong, which is one of those good news, bad news types of comments.

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

Yeah, make sense. OK, I'll leave it there. Thanks and good luck.

Michael Burger -- Chief Executive Officer

Thanks, Greg. Nice seeing you.

Allen Muhich -- Chief Financial Officer

Thanks, Greg.

Operator

And we'll take our next question from Andrew DeGasperi with Berenberg. Please go ahead.

Andrew DeGasperi -- Berenberg -- Analyst

Yeah, thanks, for taking my question. I guess from my perspective, it seems like the tone from year-end seems to have improved quite a bit since last quarter. I guess, one, just painting like a broad picture. I mean is it a function of demand that you've seen come back much stronger, like the question that Greg just asked, and toward the latter part of the quarter? Is it pipeline? Is it a function of the inflation pressures that you were seeing? I guess can you maybe break out a little bit why you feel that the second half is going to improve quite a bit versus the first?

Michael Burger -- Chief Executive Officer

Well, like we said, I think, Andrew, we're cautiously optimistic. We hear the same and read the same snippets that everyone does. And so we're cautiously optimistic. I think what's making us optimistic is the traction we're seeing in our new products.

And that includes the new hardware products, both Quantum Max and the Focus Premium. We kind of gave you some statistics, but this was our second-highest booking quarter in some time in terms of scanners, and that was driven largely by the strength of demand for the new product. Quantum Max continues to do really, really well globally. And so we're very encouraged by the adoption rate of the new hardware products.

We're also very excited by the feedback that we're getting from our customer base and the premium sign-up for subscribers for FARO Sphere. Also very, very positive. And then finally, the HoloBuilder traction continues to grow. And we believe all of this is kind of coming together at a really great time.

We also have seen our total opportunity pipeline grow. Despite all the bad news in the world, our funnel continues to grow. That has an effect on our confidence around our Q3 guide. If you notice, we're guiding up off of Q2, which frankly hasn't happened seasonally since I've been here.

So this is a very positive trend for us, and again, driven largely by the new products. Something could change tomorrow, but everything that we know and everything that we can control is pointing up and to the right. And so we are feeling really, really good about where we are right now.

Allen Muhich -- Chief Financial Officer

And Andrew, maybe just to quantify it a little bit as well, and a bit of this is a repeat, but we provided constant-currency performance just to simply also provide what's really happening under the covers. And so with $83.9 million of constant-currency revenue, that places us more toward the higher end of the range that we had provided 90 days ago. And at the same time, we built a little bit of backlog. The combination of seeing that quantified combined with what Michael indicated around some of the drivers, I think, is also a bit of why we're feeling a bit more bullish than what you indicated last quarter.

Andrew DeGasperi -- Berenberg -- Analyst

Got it. And then -- that's helpful. And then I guess when it comes to the Sphere and HoloBuilder, which I guess you're going to include toward the end of the year, should we expect a rapid -- like should we expect the product expansion to improve dramatically once that happens? Like are you going to -- are we going to see customers essentially use more of that product once it's in that environment?

Michael Burger -- Chief Executive Officer

We believe that growing ARR is a slow and steady race. It takes time to build recurring revenue of any real girth that moves the needle. As Allen mentioned in his remarks, we continue to see recurring revenue grow at a compound annual growth rate of around 8% from last year. That's a very positive -- from '19, I believe.

That's a very positive sign for us. And HoloBuilder is continuing to accelerate it. We do believe that Sphere and HoloBuilder, combined with some of the new application suite we have in our road map, should continue to accelerate that. But again, I think to put it in the proper context, I believe growing ARR is a multiyear approach.

And I think we've said in the past our objective is to have 25% of our total revenue recurring in nature, and we feel really good about the progress we're making toward that.

Andrew DeGasperi -- Berenberg -- Analyst

That's helpful. And then the last one is on the margins. I understand the issues and why you might be trending below range. Just curious to know like what -- in terms of the things that you do know, like when can we see that sort of return to the historical range that you've guided to? Like is it essentially entirely baked on FX? Or do you think -- particularly the product mix situation, is there a time line as to when that would improve?

Michael Burger -- Chief Executive Officer

Well, the product mix is -- I think product mix is harder to control. What we've seen is in the developing countries, particularly China and the Southeast Asia, actually also Eastern Europe, these guys are typically buying lower-technology products, and I don't mean that the way it sounds, but from the way it is -- actually the configurations are put together. For example, China typically uses probing versus laser scanning, and that has a net effect on the Quantum Max margin for that particular country. Those applications seem to be growing at this point.

And so that mix, as Allen said, we continue to -- we don't think it's going to change overnight. We think that as other economies, for example, as Europe comes back from vacations, that type of thing should drive a stronger mix. But I think that's a multi-quarter kind of move. I think FX continues to be a part of this.

But I also believe that supply chain and supply chain pricing that we've seen -- I think we talked about 200 basis points increase in cost, and that has had a negative effect on gross margins as well. So I think gross margins from a mix perspective or a longer-term deal, who knows when the supply chain thing will completely reverse itself. And I think currency, your guess is as good as ours.

Allen Muhich -- Chief Financial Officer

The only thing I guess I would add also is that the material cost savings that we expect to realize from the transition to a supply chain that's located more in Southeast Asia, we're beginning to see -- as we indicated in our prepared remarks, we're beginning to see line of sight as to when that ultimately happens. And I think that throughout 2023, we now expect to see some benefit from that. And that ultimately, of course, will bolster gross margins back to the historic level depending upon what's happening with mix and what's happening with currency and some of the other effects that we've had.

Michael Burger -- Chief Executive Officer

I think the long-term fix here for us is as the mix goes to recurring revenue, that will be very accretive to gross margins.

Andrew DeGasperi -- Berenberg -- Analyst

Right. Thank you.

Michael Burger -- Chief Executive Officer

You're welcome. Thank you, Andrew.

Operator

[Operator instructions] We'll move next to Rob Mason with Baird. Please go ahead.

Rob Mason -- Robert W. Baird -- Analyst

Yes. Good afternoon. Thanks for taking the question. Michael, I was just curious...

Michael Burger -- Chief Executive Officer

Hi, Rob.

Rob Mason -- Robert W. Baird -- Analyst

Hi. I'm just curious of your thoughts around just given the tone of business and order input that you are seeing. Are you seeing a bookings level that gives you -- and quoting activity that gives you any kind of comfort around the typical fourth quarter seasonal step-up that we typically get from a level standpoint?

Michael Burger -- Chief Executive Officer

Yeah. We're not giving guidance out that far, but we're feeling much more confident about the year in general. And yes, you're right, seasonality tends to crescendo to Q4. So yes, we think this builds confidence.

As the funnel builds, it really -- it cures a lot of ills. And I think also in Allen's remarks, we talked about conversion rate and that continues to increase with -- primarily due to the new products. So I think both of those things bode well for Q4 for us, yes.

Rob Mason -- Robert W. Baird -- Analyst

OK.

Allen Muhich -- Chief Financial Officer

All that said, we hear the same language and the words out there around recession occurring. We haven't necessarily seen any effects of it yet, but we certainly hear it. And so that's a wildcard that may cause things to be a little bit different than what we're seeing today, certainly.

Rob Mason -- Robert W. Baird -- Analyst

Could you comment a little more expansively just across the regions, what you saw from an order standpoint? I think you didn't comment on Americas or even quantify that, but the other two main regions as well.

Michael Burger -- Chief Executive Officer

Yeah. Asia Pacific, in general, from a bookings perspective, not from a revenue perspective, from a bookings perspective, remains relatively strong for us, driven primarily by China. Japan is still lagging where it has been pre-COVID. And we haven't seen that really bounce back yet.

Europe was slower than we'd like to see from a bookings perspective, and that's driven largely by what we've seen in the AEC marketplace from a traditional perspective. The 3D metrology world in Europe has shown signs of life, and it gives us confidence going into Q3 and Q4. North America was driven largely by the 3DM segment. And I mentioned earlier, public safety also had a nice showing from a booking perspective.

The interesting thing about the new scanner, the interesting -- as we mentioned, it was our second highest bookings of scanners since -- I think in history, actually, but certainly from 2019. And I think what was exciting about that is that was almost a third, a third, a third in terms of geographic split. So I think there was a lot of pent-up demand waiting for FARO's new scanner and it materialized in new bookings. And again, on a global scale, no one region really, really dominated, which I think is encouraging long term.

Rob Mason -- Robert W. Baird -- Analyst

Michael, with the new products out and the reception that they're getting, are you making any changes with the sales force? By that, I mean account reps. Are you adding reps or you think you have existing capacity? Or I'm just curious how the dynamics are trending there.

Michael Burger -- Chief Executive Officer

We are not adding. I do believe that we have adequate capacity. I think in the context of just managing our business close to the chest through this market dynamic that we're all talking about but no one's really seeing, we're just cautiously optimistic. We do believe that we've got enough capacity to fulfill our internal goals for 2022.

If, in fact, we continue to see continued demand growth, we can always -- we can change that. But right now, we're sticking to our knitting, and I think we have enough capacity from the selling organization to get to where we need -- where we believe we need to be in 2022.

Rob Mason -- Robert W. Baird -- Analyst

Very good. Thank you.

Michael Burger -- Chief Executive Officer

You're welcome. Thank you.

Operator

It appears there are no further questions at this time. I would now like to turn the call back to Michael Burger for any closing remarks.

Michael Burger -- Chief Executive Officer

Thank you very much. I think as you guys have denoted, we are feeling really good about where we are right now. Our new products and new product traction is happening and the major milestones around manufacturing consolidation and Sphere are happening. So we feel really good about where we are.

We look forward to talking to you about where we end up in Q3. Thank you very much for your time. Goodbye.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Michael Funari -- Investor Relations

Michael Burger -- Chief Executive Officer

Allen Muhich -- Chief Financial Officer

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

Andrew DeGasperi -- Berenberg -- Analyst

Rob Mason -- Robert W. Baird -- Analyst

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