Q1 2023 FARO Technologies Inc Earnings Call
Participants
Allen L. Muhich; CFO; FARO Technologies, Inc.
Michael Funari; Partner; Sapphire Investor Relations, LLC
Michael D. Burger; President, CEO & Director; FARO Technologies, Inc.
Yuval Wasserman; Independent Chairman of the Board; FARO Technologies, Inc.
Danny James Eggerichs; Research Analyst; Craig-Hallum Capital Group LLC, Research Division
Robert W. Mason; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
Stephanie Angela Vallace; Associate; Joh. Berenberg, Gossler & Co. KG, Research Division
Presentation
Operator
Good day, everyone, and welcome to the FARO Technologies First Quarter 2023 Earnings Call. For opening remarks and introduction, I will now turn the call over to Michael Funari at Sapphire Investor Relations. Please go ahead, sir.
Michael Funari
Thank you, and good afternoon. With me today from FARO are Michael Burger, Chief Executive Officer; Allen Muhich, Chief Financial Officer; and Yuval Wasserman, Chairman of the Board.
Today after market close, the company released its financial results for the first quarter of 2023. The related press release is 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, some of which are beyond our control and include statements regarding future business results, product and technology development, customer demand, inventory levels, our outlook and financial guidance, economic and industry projections or subsequent events. Various factors could cause actual results to differ materially.
For a more detailed description of these and other risks and uncertainties, please refer to today's press release and 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 D. Burger
Thank you, Mike. Welcome to our call. First quarter revenue of $85 million was up 11% year-on-year with hardware revenue of $55 million, up 18% and 9% organically that was enabled by increased shipments of our new Focus Premium Laser Scanner as well as the addition of GeoSLAM to our revenue base, following our September 2022 acquisition.
Sequentially, revenue benefited from the weakening of the U.S. dollar exchange rates. While we remain pleased with the overall market adoption of our latest products, late in the first quarter, we saw sales cycles begin to lengthen. Further, while we saw meaningful growth in our overall opportunity funnel, the expected close date of those opportunities shifted from second quarter later into 2023. We believe these are 2 relatively strong indicators that the long anticipated softening of the macro environment is beginning to impact our customers' purchasing behavior.
While this phenomenon was evidenced across all geographies and markets, it was especially a true in Europe and Asia Pacific. We have recently heard from several large global customers that they are reducing or delaying capital expenditures, which were planned for 2023, given their higher cost of money and the pessimistic outlook for their business in the second half of this calendar year.
To help offset this dynamic, we continue to improve our product offering and create further differentiation by streamlining our customers' workflows such that they can realize increasing levels of productivity and value from their 3-dimensional models. As an example, we recently released a new product capability, which we call Flash, which is a hybrid reality capture technology, a first-of-its-kind solution that delivers faster stationary scanning for large volume projects.
Access through our cloud platform, Sphere, Flash is the newest scan mode for Focus Premium Laser Scanner users, combining the accuracy of static 3D laser scanners with the speed and ease and use of panoramic cameras. The unique combination of fast scans with colorized 360-degree images enable users to reduce their on-time on-site scan time by half. Flash will be available as an annual subscription to current generation standard customers, whether added as an upgrade to existing hardware or at the time of initial hardware purchase.
Beyond our internally developed products, the integration efforts of our acquisitions are executing to plan. Following September's acquisition of GeoSLAM, which brings to FARO expertise in mobile scanning, December's acquisition of SiteScape, which basically adds iOS-based LiDAR capture capabilities and now with the addition of Flash to our stationary standards, we now offer the broadest and most complete set of 3-dimensional capture devices in the market.
As we integrate these various capture capabilities into FARO Sphere, we will enable cloud-based access to 4-dimensional models, overlaid onto a single coordinate system and viewed through a single user interface. This unique and differentiated offering will provide FARO customers with unprecedented flexibility along the ease of use and accuracy continuums. To date, feedback on our offerings and our road map have been very positive.
When we spoke back in February, we outlined $10 million of annualized savings to be realized in the first half of 2023. At that time, we also indicated a continued strong demand environment. The delayed customer decision-making and extended opportunity pipeline I mentioned earlier is causing us to reconsider our growth expectations for the remainder of 2023. As a result, we are accelerating a further $10 million to $20 million in annualized operating expense reductions that will improve our profitability as we exit the second and third quarters. Taken together, these actions, which we discussed in February, are now totaling a total of $20 million to $30 million of annualized savings.
I'll now turn the call over to Allen to provide an overview of our first quarter financial results.
Allen L. Muhich
Thank you, Michael, and good afternoon, everyone. First quarter revenue of $85 million was up 11% compared with the first quarter of 2022 that primarily resulted from higher shipments of our focused premium scanners and the addition of GeoSLAM revenue following our September acquisition. First quarter hardware revenue of $55 million was up 18%, while software revenue of $10.3 million and service revenue of $19.7 million were roughly flat, respectively. Recurring revenue was $16.7 million and continues to represent 20% of sales.
As discussed in prior quarters, we have seen a modest flattening of overall software revenue as we convert customer purchases of previously perpetual licenses to subscription. Our perpetual software revenue is down approximately 60% when compared to its high in 2019, indicating that by the end of 2023, our conversion from perpetual licenses to subscription revenues should be predominantly complete.
On service revenue, the lower 2020 and 2021 hardware unit shipments compared to earlier years, has reduced the installed base of products eligible for our service offerings and when combined with the meaningful product quality enhancements we've made over the last 18 months has resulted in continued lower service revenue.
GAAP gross margin was 46.7%, and non-GAAP gross margin was 47.6% for the first quarter of 2023. Continued increases in the cost of raw materials adversely impacted gross margin by approximately 250 basis points that when combined with the roughly 300 basis points of adverse effect that resulted from the relative strength of the U.S. dollar compared to historic exchange rates we discussed in November, resulted in the first quarter's low gross margin rate.
The higher cost of raw material primarily stems from sourcing semiconductor components in an extremely tight broker market, where we have had to make large payments to secure delivery in advance of receiving certain components. In the quarter, we incurred approximately $2 million in incremental costs associated with these broker component receipts.
Going forward, we expect to receive and consume additional associated inventory and as a result, adversely affect reported gross margins through the balance of 2023. Given their unique nature, these transactions are not expected to adversely affect the timing of the previously committed $12 million in annualized savings that is expected to result from the shift in our supply chain to Southeast Asia. We continue to believe the savings from the shift to lower cost suppliers will begin to be realized as we exit 2023.
I want to emphasize that our underlying average selling prices in local currency and the expectations of long-term product mix has remained relatively unchanged, and therefore, as material costs normalize, and we capitalized on the Southeast Asia supply chain, we would expect gross margin to significantly improve in 2024.
GAAP operating expenses were $58.3 million and included approximately $4.8 million in acquisition-related intangible amortization and stock compensation expenses and $5 million in restructuring and other transaction costs. Non-GAAP operating expense of $48.8 million was $4.6 million higher than Q1 of 2022 due to the inclusion of GeoSLAM operating expenses and sequentially, the increase was primarily due to the impact of a weakening U.S. dollar.
As Michael mentioned previously, we're committed to realizing now $20 million to $30 million in annualized savings, which is expected to reduce our quarterly spending at present FX rates to approximately $40 million to $43 million beginning in the fourth quarter of 2023. GAAP operating loss was $18.6 million in the first quarter of 2023 compared with an operating loss of $7.2 million in the first quarter of 2022.
Non-GAAP operating loss was $8.3 million in the first quarter of 2023 compared to a loss of $3 million in the first quarter of 2022. Adjusted EBITDA was a loss of $5.5 million. Our GAAP net loss was $21.2 million or $1.12 per share. Our non-GAAP net loss was $7.1 million or $0.38 per share for the first quarter of 2023 compared to a net loss of $2.5 million or $0.14 per share in Q1 of 2022.
We are disappointed by our greater than expected first quarter loss, a combination of a softer end market, higher material costs and higher than normal mix towards lower margin scanners adversely affected gross margin and along with an increase in operating expenses due to a weaker U.S. dollar resulted in an unacceptable operating loss.
In February, we discussed a $10 million to $16 million charge to realize our $10 million in targeted savings. Given the incremental $10 million to $20 million in savings, that charge is now expected to total between USD22 million and USD28 million, of which we incurred $5 million in the first quarter with the remaining $17 million to $23 million to be incurred over the balance of 2023. Of the total, we expect approximately 40% of the combined charges to be cash payments.
Our cash balance at the end of the quarter was $88.6 million, included in our operating cash consumption during the quarter, was the timing of large non-customer receipt totaling over $10 million, which moved from the first quarter to the second quarter. These payments have now been received and will benefit second quarter cash flow. Additionally, worsening shipment linearity as well as the Lunar New Year, which historically has reduced Q1 shipments into China, where most invoices are on pay in advance terms has resulted in extended days sales outstanding.
We remain confident in the collectability of our trade receivables, where our greater than 90-day past due balance remains relatively unchanged. Despite the unfavorable cash timing in the quarter, our team has targeted improved collections and reduced overall working capital levels. In addition, for 2023, our internal incentive program was modified such that all executives and the senior leadership team are now incented on achieving certain levels of both total company revenue and annual recurring revenue as well as free cash flow generation. As such, the combined team is now focused on driving broad working capital efficiencies, and we remain confident in our ability to realize our free cash flow objectives.
Moving on to guidance, we have incorporated the recent slowing of customer decision-making in our projections. And as a result, at present FX rates would expect second quarter revenue of between USD79 million and USD87 million. At those revenue levels and given corresponding non-GAAP gross margin of between 45% and 48% and operating expenses of between USD45 million and USD46.5 million, we would expect a non-GAAP loss per share of between USD0.47 and USD0.22.
With that, I'll turn the back -- call back over to Michael for some closing times.
Michael D. Burger
Thank you, Allen. Over the last several years, we have made tremendous strategic progress. Beyond the manufacturing and go-to-market restructuring efforts we've implemented, we have executed on a strategy that has created the industry's broadest set of 3D capture devices. This portfolio ranges from iOS-based LiDAR to 360-degree cameras to mobile scanners and finally, to ultra-high accuracy stationary scanners.
We have created a cloud environment that will host the data generated by this portfolio onto a single coordinated system for viewing, collaboration and storage. We have also begun the process of developing real applications that target streamlining workflows between various parties within the construction ecosphere such that they're able to realize increasing levels of value from the 3D models hosted in FARO's cloud environment, all of which will be enabled by a SaaS business model. Our products are targeted at markets that are expected to have healthy long-term growth profiles.
Finally, as stated in today's press release, I am announcing my retirement coincident with my 65th birthday, which is today. I remain extremely excited and bullish about FARO and its short- and long-term future. I want to thank the Board of Directors for the courage to pursue our strategy, my management team and the entire FARO family for their tireless dedication to making the strategy reality.
Yuval Wasserman, our Executive Chairman, will be stepping in as Interim CEO. And with that, I'd like to turn the call over to Yuval.
Yuval Wasserman
Thank you, Michael, and hello, everyone. First, I'd like to thank Michael for his contribution to FARO and wish him all the best in his retirement. As we move forward, my key message to you is that FARO is a key player in exciting and growing markets. We have a very solid foundation of unique technology, a valued brand, incredible talent and a sound strategy. However, our performance has been challenged, and I believe while pursuing our strategy, we need a sharper focus to optimize our business and deliver on our great potential. My priority and that of our next CEO will be to ensure that we focus on delivering more value to our customers, stability and career paths for our employees and a better return for our shareholders.
Over the next few weeks, I will be meeting with many of our stakeholders with the objective of identifying and accelerating our business optimization plan, which we will update you on in our next earnings call. Thank you.
Michael D. Burger
This concludes our prepared remarks. And at this time, we'd be pleased to take any of your questions.
Question and Answer Session
Operator
(Operator Instructions) First question comes from Greg Palm, Craig-Hallum Capital Group.
Danny James Eggerichs
This is Danny Eggerichs on for Greg today. I guess I will start by offering my congratulations to you, Michael.
Michael D. Burger
Thank you. Thank you very much.
Danny James Eggerichs
Yes, I guess, just starting there, anything noteworthy on your retirement, the why, maybe the timing, anything you want to point out there?
Michael D. Burger
No. The details will be announced, obviously, in our Q. But I'm 65 years old. I think that's the why? I've been at this game for a long time. And I think we're in a place now from a transition perspective, where I think it's probably appropriate. And I feel very excited and very proud of the team that we're leaving behind there, as you've all said, extremely talented. And I feel like the strategy is well underway and in place. And I feel like it's around execution. And I think this is -- this would be probably an optimum time for me to move on. And so that's how we made the decision.
Danny James Eggerichs
Yes. Fair enough. I totally get it. Well, congrats on that again. Maybe just digging into the quarter a little bit more. It sounds like it was kind of late in the quarter, where you saw the big slowdown. Just wondering if you can give any more detail there? Obviously, you said, outsized weakness in Europe and APAC. So maybe a little more detail there and what you saw in this first month here, whether or not Americas has kind of stayed steady? Or you start to see that lag behind or just kind of overall?
Michael D. Burger
What we saw at the end of the quarter at the end of Q1 is -- and as you know, we've talked about this in the past that we are very back in quarter loaded as it relates to closing orders to be shipped. And frankly, this was probably the worst we've seen. We've had a lot of orders that were actually booked that continued to be pushed through the quarter towards the end, and it actually made it extremely, extremely difficult for us to ensure that we have the right mix of products in the right regions to optimize revenue. Our operations team did a fantastic job. But that said, it's troubling what we've seen as it relates to the orders and how they actually folded into the quarter.
Q1 is pretty -- or Q2 is pretty much on track with historical backlog and backlog bookings. So I feel good about our guidance, and I feel good about the strength of the portfolio, but time will tell. And I think it's concerning that we've seen kind of that push through the end of the quarter. The other concerning thing, and it was mentioned in our prepared remarks is that our opportunity funnel, which we talked about a lot actually grew very, very significantly within Q1, which is good news. That said, the number of opportunities that are slated for Q2 is a bit lower than we've seen traditionally. And so a large portion of that funnel growth is really for Q3 and Q4. And that's a change. That is something that we had not seen traditionally. And so I think a couple with the funnel being pushed towards the end of the year and the way the orders have tracked throughout the quarter. Those are kind of the 2 things that really kind of keep us awake at night and has been the impetus for us to really rethink what we think the revenue growth opportunity is for the balance of the year. We think they're leading indicators of a slowing in the second half.
Danny James Eggerichs
Yes. Got it. Maybe if I can just sneak one more in on kind of the additional cost savings. I think just to get the details right, I think you said full run rate starting Q4, is that right?
Allen L. Muhich
Yes, that's correct, Danny.
Danny James Eggerichs
Okay. And then I guess, just any additional detail you can give on what exactly you're doing there and how you get to the top or bottom end of that range?
Michael D. Burger
Go ahead. No, please.
Allen L. Muhich
No. Well, what I was just going to comment on is, again, I think a little bit of that is work that will begin to continue to flesh out with you all. But the focus is really on how do we make the engine more efficient, how do we refine and continue to drive and enable the things that will enable us to realize the long-term growth objectives that we have between both hardware and software, but it's really about getting more efficient in how we manage the business and how we manage some of the back office functions as well.
Operator
Our next question comes from Andrew DeGasperi, Berenberg Capital Markets.
Stephanie Angela Vallace
This is Stephanie actually on for Andrew who's traveling, I'm filling into (inaudible). We're wondering with the change in leadership, if going forward, there's going to be any change to the software strategy and whether the Board supports the strategy and efforts that Michael implemented, particularly with the transition to more software recurring revenue?
Yuval Wasserman
Michael, would you like to answer the question?
Michael D. Burger
Yes. I think -- Yuval, go ahead.
Yuval Wasserman
So the Board and myself stand behind the strategy. We believe that the strategy is sound. We believe that the future of the application space we're pursuing is fantastic and expected to grow in multiple markets and multiple application sets. It's all about the pace, the efficiency and execution, right? So we're very cognizant of the dynamic in the market around us and hence, the comment about optimizing what we do. And it's not about what we do, it's how we do it to, the point that Allen made about efficiency and optimization. We continue to pursue the strategy of software. We continue to pursue the strategy of SaaS and looking at recurring revenue, as we broaden our applications from hardware only into hardware and software and with the systems associated with allowing our customers to use the software effectively to generate actionable information.
Operator
Our next question comes from Robert Mason, Baird.
Robert W. Mason
Best wishes to you, Michael. I wanted to see if -- just first, maybe this is a question for Allen. Just -- could you speak to the trajectory that we may be on to get to those cost savings in the interim as well as the gross margin trajectory until that improves here over the next few quarters? Is it linear just on the savings? And what does the gross margin curve look like until we get past some of the inflation impacts?
Allen L. Muhich
Yes, it's a good question, Bob. And so from an operating expense standpoint, and it's partly why we chose to provide a little bit more granularity within our guidance, because we do have some moving parts. And so we want to make sure that we are being as transparent as we can be. From the guidance, you can lean that there's not -- there is a level of savings that we expect to realize. Those are some of the savings that we had talked about back in February that we'll begin to realize. And therefore, we do see a bit of a decrease in expenses in Q2 compared to the first quarter. As we go through the balance of the year, I think I would expect a bit of a further decrease in the third quarter and then in the fourth quarter, get down to the level that we discussed in our prepared remarks, as we phase in some of the changes that, again, we're going to be working here over the next several weeks.
On the gross margin line, what we tried to articulate is that the incremental material costs that we're seeing, we expect those to continue through the balance of 2023. And so margin profiles assuming a consistent revenue level with where we are today, because, again, our contribution margins tend to be a bit higher than our corporate average gross margin and so fluctuations in revenue can also drive fluctuations in gross margin, but we would expect gross margins to remain relatively steady with where we reported in the first quarter. And then we do see line of sight towards those inflated material costs ending as we exit 2023, given some of the recent conversations we've had within the broker market and within some of our other vendors.
And then finally, we would expect that the efforts that we're making to transition our supply base towards Southeast Asia, which we've been talking about for a period of time here, we're beginning to see traction there. We're beginning to see some benefit. And therefore, as we exit 2023, it should become a bit more meaningful. And I think that as we exit 2023 into 2024, the combination of those 2 effects should see a pretty meaningful increase into our gross margins.
Robert W. Mason
Understood. And just a follow-up on the gross margin question, how -- I'm just curious, how the -- you kind of broker impacts escape your guidance here in the first quarter. Just do you have the level of visibility with your manufacturing partner to be able to see how sourcing it maybe is tracking in real time?
Allen L. Muhich
It's a very good question. And we certainly, as we've set guidance, we certainly saw a portion of it. We did not see all of it. And that's a process that we have now modified so that we make sure that we've got that visibility as early as we possibly can. The other dynamic is that adversely affected us within the quarter that caught us a little bit on the downside to margin is just the underlying effect of FX. So we did see benefit in the quarter in terms of our revenue from FX. That's varied in the $85 million. Without FX, we would have had a lower revenue. And so again, we kind of met the revenue number at the midpoint because of FX. But FX also increases our cost of goods sold. And so at a constant -- at a fixed revenue level, if you will, we will have lower gross margins. And so that's a long-winded way of saying that the softening in the overall market, partially offset by FX, but that FX affected our cost of goods sold as well. The combination of that, combined with the -- a portion of the growth of the increased material cost is why we ended up being lower than expectations.
Robert W. Mason
I see. I see. If I could just ask one more, just again, around the broader demand picture, you said the weakness that you've seen to slowdown more elongated sales cycles is broad-based, from your earlier commentary did not sound like the 3D metrology business contributed to growth. Maybe you did, but that wasn't my interpretation. And is there a distinction you're seeing in the marketplace between 3D metrology and your AEC business? And then a follow-on to that is, could you dive a little bit deeper into AEC and just help us understand where your -- the types of projects you're more or less exposed to just given what's going on in non-res construction?
Michael D. Burger
Yes. Let me answer the last question first. Our exposure in the AEC market is primarily commercial real estate. And so large commercial buildings, even smaller commercial buildings, but commercial is, it represents probably 85% of our AEC marketplace. 3DM, we did see some weakness in 3DM.and I referenced in my prepared remarks that we had talked to several large customers about their capital plans for the balance of 2023. And specifically, 2 of those customers that we talked to, anecdotally are basically paring back their initial capital spend for 2023. Both of these guys are automotive guys, large multinational automotive guys. And I think there's a lot of press recently that I've read about both of these guys stating this publicly. And I think that that tends to ripple through the entire automotive supply chain. And so I think that's a level of concern that we have around 3DM. Did that answer both of your questions?
Robert W. Mason
Yes, very helpful, Michael. Thank you.
Operator
We have no further questions in the queue at this time. I would now like to turn the call over to Michael Burger for any closing remarks.
Michael D. Burger
We appreciate very much your attention today and your interest in FARO, and we look forward to talking in the future about our progress. Again, thank you, again. Goodbye.
Operator
This does conclude today's program. Thank you for your participation. You may disconnect at any time.
