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Edited Transcript of FARO earnings conference call or presentation 31-Oct-19 12:00pm GMT

Q3 2019 FARO Technologies Inc Earnings Call

LAKE MARY Nov 4, 2019 (Thomson StreetEvents) -- Edited Transcript of FARO Technologies Inc earnings conference call or presentation Thursday, October 31, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Allen L. Muhich

FARO Technologies, Inc. - CFO

* Michael D. Burger

FARO Technologies, Inc. - President, CEO & Director

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Conference Call Participants

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* Andrew Lodovico DeGasperi

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Danny James Eggerichs

Craig-Hallum Capital Group LLC, Research Division - Research Analyst

* Hendi Susanto

G. Research, LLC - Research Analyst

* Michael Funari

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and thank you for joining today's FARO Technologies Third Quarter 2019 Earnings Release Conference Call hosted by Michael Burger. I'll now turn the call over to Mike Funari at Sapphire Investor Relations. Please go ahead, sir.

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Michael Funari, [2]

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Thank you, and good morning.

With me today from FARO are Michael Burger, Chief Executive Officer; and Allen Muhich, Chief Financial Officer. Yesterday, after the close, the company released its financial results for the third quarter of 2019. The related press release and Form 10-Q for the third quarter are available on FARO's website at www.FARO.com.

In order to help you better understand the company and its results, management may make forward-looking statements during the course of this call. These statements can be identified by words such as expect, will, believe, anticipate, plan, potential, continue, goal, objective, intend, may and similar words. It is possible that the company's actual results may differ materially from those projected in these forward-looking statements. Important factors that may cause actual results to differ materially are set forth in yesterday's press release and the company's Form 10-K for the year ended December 31, 2018, and Form 10-Q for the quarters ended March 31, 2019, June 30, 2019, and September 30, 2019.

During today's conference call, management will discuss some 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 of these measures to comparable GAAP measures.

Management believes that these non-GAAP financial measures provide investors with relevant period-to-period comparisons of core operations. These financial measures are not recognized under GAAP and 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.

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [3]

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

Our third quarter results were disappointing. We closed the quarter with revenue of $90.5 million, down 9% when compared to the third quarter of 2018. As a result, we reported a non-GAAP net loss of $0.01 per share. The continued market uncertainty resulting from trade tensions adversely affected our demand leading to the quarter financial results. This is a similar situation recently reported by many of our industry peers. Allen will provide you with more additional insights into the core financial performance. However, I want to share with you some of the progress we've made on our strategic planning process.

As discussed last quarter, one of my first priorities after joining FARO was to conduct a series of discussions with our employees and customers in an effort to understand the company's technologies, markets, opportunities as we chart a path forward for FARO. I've now completed more than 120 one-on-one interviews with employees, customers, vendors as well as some of our marketplace peers to help build a point of view on the current state of FARO as where -- as well as what I believe we can become.

While our full plan remains incomplete, I did want to share with you a couple of key elements that will help you understand where we're headed. Our customers acknowledge that FARO has been a key provider of hardware that enables some of the industry's fastest and most accurate 3-dimensional data capture. That said, I don't believe it's enough to simply provide world-class hardware products. We need to focus on and gain a better understanding of what our problems that customers are trying to solve. And in terms -- and in turn, provide them the needed solutions, not only for capturing the 3D data but to also provide the tools and services that allow them to easily turn the captured data into workflow-based information. In other words, we need to move up the food chain by providing complete solutions that enable our customers to realize the full potential of a virtualized world. I believe we have a unique opportunity at FARO to transform these products into an environment in which any FARO customer, regardless of industry, application or choice of hardware used to capture the data can enter, share, store, analyze and interact with this data.

Let me share with you an example that illustrates what we believe is a solutions-based market opportunity. Within the operation of a high-precision manufacturing facility, our products are used to capture with a high degree of accuracy a factory image that includes the building layout, fixture and tooling placement, which results in a manufacturing workflow, effectively creating a digital twin of the factory in a virtual environment. This data can be time-based and used to measure tool tolerances, workflow efficiencies or inefficiencies and relay out simulations to name a few, giving the factory operator the ability to simulate and anticipate the impact of future changes, all within a virtual digital model of the existing facility, thereby reducing the risk profile of any factory change or facility change.

This example provides FARO an opportunity not only for a hardware sale but also reoccurring software and services revenue by virtue of ongoing utilization of solutions. This approach by its very nature is also exceptionally sticky. To enable success, our marketing teams truly need to understand our customer's business and workflow so they can guide our development teams on the products and solutions that solve real-world problems. In doing so, our objective is to become much more market and customer-focused while continuing to leverage our technology leadership. To lead this process, we have recently added a new VP of Product Marketing to the team whose charter is to navigate this transition.

As part of our strategic planning process, we've also identified a need to change our go-to-market strategy. Today, we are fortunate to have a large portion of our revenue come from repeat customers. However, several years often pass between major purchases, requiring us to stay in front of and attached to a customer through a relatively long buying cycle. In today's model, we often have multiple salespeople representing different products from our portfolio calling on a single customer. From a customer's perspective, this can be confusing and suboptimal, not to mention expensive and unscalable, for FARO. In an effort to streamline and provide a more integrated experience to our customers, we plan to enable our -- members of our sales team with the full breadth of the FARO product line within their assigned territory or account base while technically supporting them with a group of product specialists.

We believe that pivoting to this well-established sales model, which is used by many of our peers in the technology space, will focus our sales team on better understanding our customer base and provide the foundation of a scalable sales model that will enable us to grow much faster than sales head count. We've already begun to make strides in this new direction and plan to be fully transitioned to the new sales model in the first half of 2020. To aid in this initiative, we will be hiring a Senior Vice President of Sales to lead our global sales team.

We have recently hired a new VP of Corporate Marketing who is chartered with launching a marketing-driven customer engagement process that will leverage current IT technology to help manage our customer relationships, a task that has previously fallen entirely to our sales team. Further, we'll be transitioning our marketing-qualified lead-generation process to emphasize quality over quantity as an additional step towards improving sales efficiency. Finally, while our go-to-market approach will continue to primarily be B2B relationship, we think that there is an opportunity to leverage B2C efficiencies into our sales process. As an example, we have soft launched an e-commerce site, which will initially enable customers to more effectively purchase post-sale items such as service contracts and training. However, our intention is to expand our e-commerce offering aggressively over time. We will also be increasing our use of indirect sales channels where it makes sense.

As I mentioned previously, our full strategic plan remains in process. That said, I look forward to sharing with you the full extent of our plan, including an updated financial success model in early 2020.

We have an enviable set of technologies that have earned us a meaningful market share in each of our large growing target markets. While near-term macro industry trends and economic uncertainty will likely be a headwind to our near-term top line growth, I strongly believe the revised strategies that I've outlined today, along with others, will enable FARO to grow the top line and the bottom line at above-market rates over the long term.

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

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Allen L. Muhich, FARO Technologies, Inc. - CFO [4]

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Thank you, Michael, and good morning, everyone.

I joined FARO about 3 months ago because I believe combining the strength of FARO's product offerings in the 3D-sensing market, with the strategies Michael just described, positions the company well for increased shareholder value in the years ahead.

Moving on to our financial results. Total sales were $90.5 million for the third quarter of 2019 as compared to $99.7 million for the third quarter of 2018. Similar to what others in our space have indicated, this year-over-year decline is primarily the result of continuing softness in many of the company's served markets due to the uncertainty surrounding ongoing trade disputes and the effect it's having on many countries in Asia Pacific as well as the broader automotive industry.

Service sales were up 13% year-over-year to $26.9 million, reflecting our continued focus on the sale of the aftermarket products, such as training and tool calibrations. Product sales were $63.6 million, down 16% as compared with $75.8 million in the third quarter of 2018.

In the third quarter, charges related to the previously disclosed GSA matter were $145,000 consisting of an accrual for interest expense. I should note that we have no further update on the status of our self-reported GSA pricing issue as we wait for a response to our proposed resolution. New order bookings were $94.8 million for the third quarter of 2019, down 6% as compared with $100.5 million for the third quarter of 2018.

In our 3D manufacturing segment, third quarter 2019 sales were $56 million as compared with $64.2 million for the same quarter last year. This decrease was mostly driven by lower unit sales as a result of the previously mentioned Asia Pacific and automotive market softness. In our Construction BIM segment, third quarter 2019 sales were $23.9 million as compared to $23.7 million for the third quarter of 2018. In our Emerging Verticals segment, sales were $10.6 million for the third quarter of 2019 as compared with $11.8 million for the same prior year period. This decrease was mainly a result of lower unit sales coming from prior acquisitions recorded in this vertical.

GAAP gross margin was 56.1%, and non-GAAP gross margin was 56.4% for the third quarter of 2019 as compared with 55.8% for the same prior year period. Overall, our non-GAAP gross margins increased as a result of a nearly 10 percentage point increase in our service business gross margins. As I mentioned previously, the sales efforts to ensure our customers maintain well calibrated tools has been a focus area that has also resulted in higher service profitability.

GAAP operating expenses were $56.7 million and included approximately $4 million in acquisition-related intangible amortization and stock compensation expenses. Non-GAAP operating expenses of 50.1 million -- $51.1 million or $800,000 higher than Q3 of 2018 as a result of increased sales head count.

GAAP operating loss was $5.9 million for the third quarter of 2019 as compared with an operating loss of $2.7 million for the third quarter of 2018 driven by the lower demand environment. Adjusted EBITDA was $3.8 million or 4% of sales. Our GAAP net loss was $6.2 million. Our non-GAAP net loss was $153,000 or $0.01 per share for the third quarter 2019 compared to non-GAAP earnings of $0.26 per share in Q3 2018.

We continue to maintain a strong capital structure with high liquidity and no debt. In the third quarter of 2019, we consumed $1.5 million in cash as a result of our near breakeven non-GAAP financial performance and payments of $2.9 million in contingent consideration for previously disclosed acquisitions.

Our accounts receivable balance of $64.7 million decreased in the quarter by approximately $10 million, while days sales outstanding remained relatively steady at 65 days. Combined short- and long-term inventory decreased slightly to $109.3 million from $111.4 million in the second quarter of 2019. And accounts payable of $11.7 million decreased $4.5 million in the quarter. Overall, our combined accounts receivable, short- and long-term inventory and accounts payable balance netted to $162.3 million or over $9 per share with a cash conversion cycle of 291 days. Improving overall working capital levels will be an important area of focus for us.

Finally, I want to comment on a couple of reporting changes we made this quarter. First, you'll have noted an increased use of non-GAAP financial measures in our communications. Our definition of non-GAAP is typical in the industry where we exclude stock compensation and acquisition-related intangible amortization expenses, along with material nonrecurring items. We believe this supplemental information increases the transparency of the underlying performance of our operations.

Additionally, our reporting no longer calls out depreciation and amortization expense as its own line reported within operating expenses. Instead, we are including those expenses and the function they support on the income statement. Taken together, we believe these changes provide our reporting in a way more consistent with industry practice and, therefore, enables improved comparability to our peers.

For your convenience, our press release includes a set of supplemental tables, including a historical trend of our previously reported results, updated to reflect these changes.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions)

We'll take our first question from Andrew DeGasperi with Berenberg.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [2]

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In terms of the 3 -- well, the 3-pronged strategy you have, I wanted to focus a little bit on the software. It sounds like there's going to be a big change in the software, potentially moving to a software-as-a-service model. I just wanted to know -- I know you're going to discuss most of this on your Capital Markets Day, but just trying to understand mostly the timing around this. Do you have the necessary tools to transition to this? So would M&A be a vehicle for that? And then maybe if you were to transition to this model, do you potentially see a drop in sales from your perpetual licensing that you currently provide as part of the hardware?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [3]

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It's a great question. Initially, we believe we've got a lot of the basic capabilities today. And by the way, the company has been working on a software-as-a-service interface for some period of time. So this is not necessarily a brand-new initiative, but I think the real issue -- or the real difference will be emphasis.

We have quite a large number of software engineering organizations today. I think we actually have almost 13 individual software platforms that have been developed over time and our challenge is to sit through those, optimize where we believe the real value is. And then offer it as kind of a, if you will, an environment. And so we're -- we've been working on this for some period of time. We think, initially, we have enough resources. But I think over time, we will grow the software resource. And that would be part of our R&D spend and will be part of the discussion that we talked about when we release our go-to-market model, which -- or success model, which we'll talk about early next year.

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Allen L. Muhich, FARO Technologies, Inc. - CFO [4]

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And then as it relates to the transition to a more of a recurring revenue stream as opposed to a perpetual license model, we don't anticipate seeing a drop in revenue over the time horizon until we make that transition. We think that it might level our software revenue out as a percentage for a period of time and then ultimately grow, as I'm sure you've seen other companies make that transition. But again, we don't expect a material decrease in any software revenue as we go through the transition.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [5]

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Got it. And just -- I don't know if you can disclose it, but in terms of timing around this, do you think this is a 2020, early 2020 event, where you're going to start pushing this or potentially later on?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [6]

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I think it's a transition. We believe that it's something -- as we've talked about, we've been developing the capability for some period of time. I believe that we will be in a position to kind of roll it out second half of 2020.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [7]

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Got it. And just on the indirect sales trend, I think you made some sense about expanding that. I think FARO in the past was changed to direct because they felt the close rates were higher. But it sounds like you're potentially moving back in that direction. Can you maybe elaborate on that?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [8]

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It's not a major shift from direct to indirect, we still believe in the direct sales model. We do believe that we could leverage indirect sales models better. And so as I said in our script, we will continue to look at it and where it makes sense, we'll use it. But it will not replace our direct sales channel going forward, it would be an augment to.

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Allen L. Muhich, FARO Technologies, Inc. - CFO [9]

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It's more of an opportunistic. Where it makes sense, we might deploy it. But we're certainly not adverse to it by its very nature.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [10]

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Got it. And then lastly for me, in terms of optimizing the sales force. Does this potentially deliver incremental margins, if you don't see a recovery in the revenue side?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [11]

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I'm sorry, I don't understand the question. Could you repeat it?

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [12]

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No, I mean in terms of your strategy and optimizing the sales force.

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [13]

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Right.

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Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [14]

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Is there a potential for margin improvement without any increase in revenue or in other words, without any improvement in revenue?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [15]

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We believe so, yes. And I think this will be part of the success model that we'll talk about.

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Operator [16]

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We'll take our next question from Greg Palm with the Craig-Hallum Capital Group.

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Danny James Eggerichs, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [17]

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This is actually Danny Eggerichs on for Greg today. So just wondering on that sales force, is there any way to quantify those disruption challenges to the top line there for the quarter?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [18]

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Actually, we don't believe -- I think that change is scary. And -- but we don't believe -- we believe that we've got a very, very talented sales force today that is primarily direct. And so the transition, in our view, should be relatively straightforward. I think the objective should be to really continue the revenue and revenue growth as we have in the past. But we do not see -- there's always risk, but we don't -- we're not really concerned about the disruption short term.

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Danny James Eggerichs, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [19]

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Got it. I appreciate that. And then, I guess, in light of the more challenging, broader macro environment, just wondering what you're seeing throughout your competitive environment.

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [20]

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Yes, we've seen a softness primarily in Asia. And I think, actually, we've read most of our peers' releases, and it looks like they're seeing exactly the same effect. We don't believe that we're seeing significant share loss anywhere. So we believe this is probably primarily macroeconomic-driven. And so we're -- we've got a lot of new products in the market. We're driving new product adoption. And I think we are still very well positioned when the economy returns to kind of a normal state.

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Danny James Eggerichs, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [21]

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Got it. That's good. And then just one last one for me. Looking at the Emerging Verticals, revenue down low double digits year-over-year. I know you said that this was due to possibly lower unit sales coming from prior acquisitions. But I guess, is there any deemphasizing or something there? Or what's the cause for those lower unit sales from those acquisitions?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [22]

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Yes. So I think this is part of the strategy that we're going through and will be part of our strategy rollout when we release it early next year. We do believe that there's some opportunity for optimization in some of the acquisitions that have been purchased over time. All of these acquisitions, I think, were really technology-focused. Granted there was a business associated with several of them, I think we're a little bit disappointed with the business aspect of some of these technology acquisitions. That being said, we're overall relatively pleased with the contribution from a technical perspective. And so part of the strategy is really to kind of rationalize the business versus the technology that was originally purchased. So that's part of the sifting that we're going through and will be reflected in our strategy go forward.

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Operator [23]

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(Operator Instructions)

We'll take our next question from Hendi Susanto with G. Research.

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Hendi Susanto, G. Research, LLC - Research Analyst [24]

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Can you characterize the current market environment in terms of pricing pressure, market competition and visibility?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [25]

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Yes, I think it really hasn't changed from last quarter much. I think we've not seen any big competitive pricing moves from our competitors that cause any more concern than the normal course of business. We have not seen a general change or shift competitively. I think we're all concerned about many of the projects that we've been working on in Asia, they continue to be pushed. We don't believe that the projects are going away. But I think access to capital has somehow dried up, in particularly, China and Japan. So we're watching that very closely, but we don't think that's driven primarily by competitors. We think that's driven by kind of the macroeconomic situation.

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Hendi Susanto, G. Research, LLC - Research Analyst [26]

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And then with regard to macroeconomic, let's say, if theoretically, U.S.-China trade tension gets resolved, how soon and how fast can market demand recover in your opinion?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [27]

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Relatively quickly, I believe. I think we -- our situation in China, I don't believe, is directly affected by tariffs as much as it is by the sentiment of the Chinese customers to move away from buying U.S. products. And so I think if that was to be resolved, that would have a positive impact, I would think, within a quarter. That said, it doesn't look like that's going to happen in the short term, and we're not planning on it. So we've got to come up with our own resolution to how to resolve this. So right now, I think -- we believe that, certainly, for the next quarter, the environment that we're in today, probably won't change.

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Hendi Susanto, G. Research, LLC - Research Analyst [28]

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Got it. And then anything that might change in Japan?

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [29]

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We've got some major projects going on in Japan. We've seen some push out and primarily in automotive. And so I think when the automotive market recovers, I think we'll be in a really good position. We continue to invest in Japan, we believe the automotive business is absolutely perfect for FARO and we've had a lot of success historically there. So we're going to continue to focus on it. But I think that is a macroeconomic-driven demand situation. And I think once resolved, we should be a benefactor.

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Operator [30]

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And there are no further questions on the line at this time. I will turn the call to your CEO, Michael Burger for any closing comments.

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Michael D. Burger, FARO Technologies, Inc. - President, CEO & Director [31]

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Thank you very much. We really appreciate you attending the call today, and we look forward to our next quarter in which, hopefully, we can go into a little bit more depth around our strategy. Thank you.

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Operator [32]

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This does conclude today's program. Thank you for your participation, and you may now disconnect.