Why, oh why must companies spit on us and tell us it's raining?
This time around it's FARO Technologies (NASDAQ:FARO), which announced a fairly substantial earnings miss last night, but still felt the need to spin the headline, leading with "FARO's New Orders Grow 57% in Second Quarter," only then following with "Earnings Expected to Be Lower".
Great. At least we found the Shinola.
FARO is a recommendation of our Hidden Gems newsletter, and it's been a spectacular performer. We're pretty sanguine about the ebbs and flows of business -- we don't expect smoothness and we don't expect perfect visibility. And our faith in FARO Technologies based on this latest quarter is no more shaken than our faith in gravity. But it's disappointing that FARO felt the need to try to spin. And being cautious sorts, we naturally assume that if they're shucking and jiving, there's something else they're hiding.
So, like Ben Folds warbled about Rockford Files, there'd be some things we'd change if it were up to us.
OK, perhaps I should describe what's happened. Last night, FARO warned that its earnings number for the quarter that ended July 2 would be substantially lower than earnings from the same quarter the year previous because of lower gross margins, higher administration (SG&A) costs, and problems related to order flow.
Let's work backward. As for the problems in shipping late orders, assuming the company isn't lying (and I believe firmly that it is not), this will simply be pushed back a quarter. Given the rapid rise in orders, including a new Boeing (NYSE:BA) order for 10 FARO lasers, it is perhaps unsurprising that facilities are taxed.
FARO has often said that it is willing to sacrifice some short-term performance in order to manage the company best for the longer term. With larger orders rolling in, it seems likely that the company is sacrificing margins and staffing up for the time when it will be a much larger company. We'll know more when we see the actual numbers. But the thing that troubles me is this: Instead of pulling out a dog-and-pony show about "ORDERS UP!," why didn't management waste two or three lines stating why it is missing numbers?
It looks to me like FARO is taking some risks, but in this case, it underestimated costs and overestimated the short-term returns. That makes for a bad miss, and that means some lost credibility. That's too bad.
What this means, of course, is even though the company didn't address it, we can safely assume that there's no way FARO is going to be hitting its full-year 2005 guidance. If it has earnings of $0.24 in the first quarter and "significantly less than $0.29" for the second quarter, FARO's previous full-year guidance of $1.15-$1.45 seems a bit absurd. Let's assume that the company comes in at $0.25 per share, or $0.49 for the first half. That means that to hit minimum earnings guidance, it'll have to do between $0.66 and $0.96 a share. That seems unlikely.
The thing that troubles me most of all is the feeling that this was a surprise for FARO. Last quarter, management noted that it expected that gross margins would remain strong, and apparently believed that the growth in sales would counteract any additional spending. Smooth growth is something that comes in fairy tales; companies and commerce don't work that way. But if a company is going to spend money for more growth as FARO has done, it simply must manage the process better. Each marginal dollar spent has to have a positive expected return, or else that growth isn't worth a thing.
We're disappointed, then, in how the message was delivered, and in the apparent misstep. But these things happen. What we want to see from FARO's management is some improvement in both regards. I doubt the stock would have dropped 12% if the press release had simply said "Here's what happened. Here's why." Instead we get nonsense, and shareholders have departed in heavy numbers.
We anxiously await signs that the lesson has been learned.
Bill Mann writes for the Motley Fool Hidden Gems newsletter. No lyrics were harmed in the making of this article. The Motley Fool is investors writing for other investors.
