FARO Technologies, Inc.

Good morning, everyone, and welcome to Ferro Technologies' first quarter 2021 earnings call. For opening remarks and introductions, I will now turn the call over to Michael Fennari at Sapphire Investor Relations. Please go ahead.

Thank you, and good morning. With me today from Ferro are Michael Berger, Chief Executive Officer, and Alan Mewich, Chief Financial Officer. Yesterday, after the market closed, the company released its financial results for the first quarter of 2021. The related press release and Form 10-Q for the first quarter are available on FARO's website at www.faro.com. To help you better understand the company and its results, during the course of this call, management may make statements that may be considered forward-looking and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements can be identified by words such as expect, will, believe, anticipate, plan, potential, continue, goal, objective, intend, seek, estimate, may, and similar words. 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. It is possible a company's actual results may differ materially from those projected in these forward-looking statements. Important factors in a discussion of the risks and uncertainties 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 31st and Form 10-Q for the quarter ended March 31st, 2021. 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.

Thank you, Mike. Good morning and welcome to our call. First quarter demand for our products reflected a combination of expected seasonality as well as ongoing improvement as our markets continue to recover from the adverse effects of our pandemic. On a geographic basis, each of our served regions exhibited similar levels of seasonal softness. Within our end markets, we saw broad-based seasonality in line with historical trends. Service revenue, which typically does not have a seasonal component, through incrementally off of fourth quarter levels. While near-term demand remains below 2019 run rate levels, we continue to believe order activity will improve throughout 2021 as our customers' activities normalize. When combined with our new cost structure, we continue to have line of sight to achieving our stated success model once revenue levels return to 2019 levels. That said, we remain cautious as market uncertainties such as global health conditions and semiconductor supply chain shortages may adversely affect near-term demand for our products. In February, Farrell celebrated its 40th anniversary, providing an opportunity to acknowledge the contributions of several generations of Farrell employees whose commitment and hard work have created the business we have today. As an historically engineering-led organization, Ferro has been a pioneer in developing many of the core measurement technologies used in the industry, and as such, earned a reputation for being an industry leader in three-dimensional measurement in terms of quality and accuracy. As we look to the future of Ferro, our strategy is to leverage both our core technology and reputation Ferro has created. and transition to a marketing-led organization focused on understanding the problems our customers are trying to solve and delivering hardware and software solutions to meet those needs. We believe this will create long-term differentiation. Transitions like this take time and begin with developing a better understanding, a deeper understanding of our customers and what they are ultimately looking to accomplish with our products. For Ferro, this meant forming a new product marketing organization with the primary focus of capturing the voice of the customer in order to ensure our product roadmap is in alignment with our customer's workflow to generate the greatest value possible. To provide a simple, real-world example of how this works, we can look to the AEC or construction market and specifically the task of pouring concrete. For large warehouses requiring precise level of floor flatness, a typical process is to pour the concrete, let it cure, then measure to verify the floor is within tolerance. If the floor is out of tolerance, a manual and expensive process is employed to rework the floor to create the desired result. By understanding both the process and the problem, we have developed a solution whereby the floor can be measured with high precision while the concrete is still curing. The data is then analyzed quickly on site, and if the floor is out of tolerance, action can be taken to resolve the situation before curing is complete, thereby saving time and expense associated with rework. This solution, when combined with the right sales training, A targeted lead generation process will ultimately lead to new opportunities that were previously not realized given our historically generic market messaging. It is this alignment of customer needs and product roadmaps supported by an evolving go-to-market strategy that we believe will enable us to differentiate our solutions and capture share in our targeted markets. We are presently targeting 26 different workflows over three markets, which will ultimately create an ever-growing library of solutions that will enable our sales team to move beyond selling scanners, arms, and trackers to selling comprehensive solutions which align with our customers' applications. Our increased focus on voice of the customer is influencing our solutions roadmap, and we continue to expect a steady flow of product announcements throughout the balance of the year. We believe taken together, this approach will add more value to our customers and ultimately drive enhanced financial performance at Ferrell. In addition to product development alignment, we also understand that as software drives a larger portion of value into our solutions, it is important to aggregate both our legacy and future software applications into a single cloud-based platform, enabling customers to seamlessly leverage a suite of applications for the problems they are looking to solve. In addition to delivering a unified user experience, a cloud platform can also enable customers to capture and upload data in the field. leverage cloud resources to process and analyze this data in real time, and to access the resulting information, enabling collaboration both within and across organizational boundaries over time. Taken together, this forms the basis for our strategic transition, namely developing a deep understanding of our customers' workflows, which can be translated into product features that will enable our hardware to capture better data faster. provide customers with increased software intelligence that enables more data automated, and finally, enable them to access their information everywhere through a cloud-based architecture. With that, I'll turn the call over to Alan for an overview of our first quarter financial results.

Thank you, Michael, and good morning, everyone. First quarter revenue of $76.3 million was down 4% when compared to the first quarter of 2020, as a result of continued market softness caused by the pandemic. Product revenue of $54.6 million was down 3% and service revenue of $21.7 million was down 6%. Bookings of $80.6 million grew 3% year over year. Both GAAP and non-GAAP gross margin approximated 53% for the first quarter of 2021. Gross margin remained lower than last year, primarily due to lower fixed cost absorption on lower overall demand, as well as the ongoing higher demand for lower priced product configurations. We remain confident in our ability to achieve our 55% to 60% gross margins when revenue returns to pre-pandemic levels. GAAP operating expenses were $46.8 million, and included approximately $2.6 million in acquisition-related intangible amortization and stock compensation expenses and $1.5 million in restructuring costs. Non-GAAP operating expense of $42.8 million was $1.5 million lower than Q1 of 2020 as the prior period only included a partial benefit from the cost savings related to restructuring actions announced last February. GAAP operating loss was $6.4 million for the first quarter of 2021, compared with an operating loss of $16.6 million for the first quarter of 2020, due to the restructuring-related expenses incurred last year. Non-GAAP operating loss was $2.3 million in the first quarter of 2021, compared to a $200,000 loss in the first quarter of 2020. Adjusted EBITDA was approximately $400,000. our gap net loss was $3.2 million, or 18 cents per share. Our non-gap net loss was $600,000, or 3 cents per share, for the first quarter 2021, compared to non-gap net loss of 2 cents per share in Q1 2020. Included in the first quarter other income and expense was a $1 million gain associated with the remeasurement of global cash balances as a result of changes in foreign currency exchange rates, as well as the receipt of $300,000 of COVID-related foreign incentives. We continue to maintain a strong capital structure with a cash balance of $170 million and no debt. The Q1 decrease in cash was primarily a result of a $12.3 million payment made to the US government as a result of the satisfactory resolution to our previously reported and reserved GSA matter that was finalized and closed in the first quarter. While we expected the combined impact of both the pandemic and our typical first quarter seasonality and are fortunate to have taken the cost reduction actions last February, we're not satisfied with our near break-even non-GAAP profitability. We are looking forward to demonstrating our ability to capitalize on continued market improvements that, when combined with our new cost structure, will ultimately yield our 20% adjusted EBITDA success model. This concludes our prepared remarks, and at this time, we'd be pleased to take any of your questions.

At this time, if you would like to ask a question, please press the star and 1 on your touchtone phone. You may remove yourself from the queue at any time by pressing the pound key. Once again, that is star and one to ask a question. We will pause for a moment to allow questions to queue. We'll take our first question from Jim Ricutti from Needham. And your line is open. Please go ahead.

Thank you. Good morning. Yeah, I know Q1 is not a good indicator, just given the seasonality of the business. But I wanted to maybe focus a little bit on what you're seeing in the business geographically, because just looking at it on a year-over-year basis, the U.S. was maybe off a little bit more than we would have thought, as was APEC, just given some of the signs of recovery that we're seeing.

Right. Yeah, we continued to, again, I think Asia was the first to really show some signs of improvement. And we've seen that, as you know, Q3, Q4, we've seen Asia coming back pretty nicely. And I think from a seasonality perspective, certainly Chinese New Year is a big effect in Q1. North America continues to struggle. I think we're seeing the Northeast opening up a little bit more, which is encouraging. The West Coast has been relatively strong, the West Coast and Southwest for us, but the Northeast has continued to struggle and we're seeing signs of recovery now, which is really good. I think the automotive space, we're also seeing signs of life in the Detroit area, which is helpful. We're encouraged by what we're seeing in terms of funnel build and quoting activity. But Q1, we expect it to be down. Europe continues to impress us with its recovery. And even though we're seeing lockdowns in places like Italy and the Netherlands, we're pretty encouraged by what we're seeing in Europe.

Hey, Michael, I was intrigued a little bit by that use case and this identifying these 26 different workflows. And I'm wondering, you know, can you talk a little bit about maybe what the top three or four of these workflows might be? Or, you know, is it still pretty early?

Well, you know, we – We're going to end up talking about these very much like we talk about products. For construction in the AAC space, floor flatness is one. In public safety forensics, where we've been strong in the past, but now we're putting together a complete workflow around, for example, ballistics or blood spatter are examples of workflows that we're going to build on. In 3D metrology, digital twin will be a big part of our or will be one of our leading workflows in the 3D metrology slash AEC space.

Got it. And last question, just if there's any color you could provide in terms of, you know, what you might be seeing in the kind of bookend ship. you know, short cycle business for the current quarter?

Yeah, it's encouraging. I think, you know, honestly, Jim, the reality is Q1 and the seasonality actually returning to a seasonal kind of cadence is encouraging for us. Frankly, you know, none of us really knew what kind of cycle to expect. We were planning and forecasting around a seasonality period, March, where Q1 typically is our softest quarter. And then we begin to Q2 is better. Q3, we kind of go sideways based on the European vacations. And then Q4, if that holds, then I think our, I wouldn't say forecast, but our prediction is that we'll end up in Q4 of 2021, right back to similar levels in 2019. That's what we said a year ago, and we're holding to it. It looks like it's coming true, which is great.

Got it.

Thanks a lot. Thanks, Jim. Appreciate your interest.

Our next question comes from Greg Palm from Craig Hallam. Your line is open. Please go ahead.

Hi, guys. This is Danny Egger, John, for Greg today. Just looking from an end market standpoint, just wondering if there was, if we could get a little more color there, if there's any outperformance or underperformance relative to your expectations in the quarter.

Sure. We've seen, we've seen the AEC market, the construction business continue to kind of build some strength, even though, you know, seasonality, we, we saw a bit of softness across the board, but We expect that, and as it relates to looking at past years, AEC seems to be pretty strong. Public safety is a small market for us, but we're showing signs of penetration both in Europe and Asia, which is new for us and exciting. 3D metrology is really kind of the last holdout, if you will, from a recovery perspective. And we saw some nice recovery in Europe in 3D metrology, but as Jim Rusciutti was asking, we've seen the Northeast and kind of the North Central portions of the United States still continue to be soft. And that's a big part of our 3D metrology market in North America.

Got it. That's helpful. And then appreciate all the color on that. maybe new product intros as we go throughout the year? Any update on maybe a timeline for that kind of aggregated software offering launch?

We're still planning on the second half, and we're working our butts off for it. It's a big thing for us. As it relates to the total cadence, in 2020, we introduced about 10 new products. And I think last quarter we mentioned that we'll do better this year, and we're on track for that.

Great. And then as it relates to that and OPEX, how should we look at OPEX with these new product launches coming, maybe remain a little elevated as we move throughout the year?

I think this is Alan. From an operating expense standpoint, again, our success model has us being around that $40 million to $43 million level. We were at the higher end of the range, obviously, in Q1. I think we would expect to remain approximately in that range as we continue throughout the balance of the year.

Okay, great. That's it for me. Thanks for my questions.

Thanks, Dan. Appreciate it.

We'll take our next question from Andrew Disteri from Barenburg Capital. Your line is open. Please go ahead.

Hi, this is Alex Ross on behalf of Andrew De Gasperi. Thank you for taking our question. I had one on the exposure to the auto industry. We have heard that auto manufacturers are cutting production from the semi-shortage, so I was just wondering if you heard anything from your customers about that and how you think that will impact demand for the rest of the year. Thank you.

Yeah, you know, we're fortunate in a sense that the – Automotive capacity is not a direct tie to capital purchases for our products as we are primarily offline. So we're not tied directly to kind of ebb and flow of capacities, which I think bodes well for us. I think that said, however, with the press revenue levels, spending on capital may take longer cycles. And we believe that that's part of the reason that we've seen kind of the northwest or the northeast and the north central kind of slow, because the automotive world has not really fully recovered yet. I think semiconductor shortage is part of it, yes.

Great. That's helpful. And if I could just ask one more on the competitive landscape, have you seen any change in competition compared to the last quarter?

No, nothing dramatic. I think we're fortunate in that we've got some pretty good competitors in the context of how they price their products. We haven't seen anything unusual or any new competitor of merit.

That's a matter. Great. That's it for me. Thank you.

Thank you. Thank you for your questions.

Our next question comes from Richard Eastman from Baird. Your line is open. Please go ahead.

Yes, thank you, and good morning. Good morning, Michael. Good morning, Rick. A very quick question. Michael, you alluded a bit to the supply chain issues that we're seeing everywhere, I guess, at this point. And is it your perspective that maybe that's more of a top-line impact for Ferro, just when you think about your customer base and their inability to produce and spend, for that matter? Or are you seeing some impact around your gross margins on the product line side for that?

No. The semiconductor situation hasn't really impacted us directly in the context of building our own products. So I think we're fortunate at least to this stage. So I think it's more of a second-order effect and affecting our customers' ability or confidence to actually build capacity, which ultimately I think depresses earnings. And when earnings are depressed, then you basically have an effect on capital buys. And typically what we've seen in this situation is not so much The opportunities go away. They just get pushed out because capital signature authorities typically elongate. So I think the effect may be pushing out of revenue for us relatively short term.

Okay. And that's going to be more on the 3D measurement side as well, presumably?

Yeah. Actually, yes. Across the board, probably. You know, automotive and 3D metrology in general I think will probably be affected the most.

Okay, okay. And then maybe just a quick question around, you know, I noticed in the queue there was some inventory obsolescence charges taken. What did that do to the product gross margin in the quarter? Maybe this is an Allen question around basis points.

Let me talk about how that occurred and then I'll talk about the financial implications. As you know, we have been pretty critical and I think very aggressive in terms of looking at our product portfolio. In this situation, there was a product that was being developed, but we did not believe was going to be competitive or cost effective. So we ended up basically canceling that product and redirecting R&D elsewhere. And the resulting of that move was basically some excess inventory. So go ahead, Al.

Yeah, and the impact on the quarter financially from a margin standpoint on the overall revenue profile was just a bit north of one percentage point.

Okay, okay. to gross margins. And then just this product mix dynamic, we've spoken to this before, and I understand, again, this kind of mix issue or shift maybe towards lower price point product, again, presumably in 3D measurement. Is that kind of stabilizing here in terms of product mix impact? Yes.

Yes, it has. I think on a quarter-to-quarter basis, we have seen it stabilize, which we think is positive. Go ahead.

Maybe just to add a little bit there, I think our product marketing team initiated a couple of actions in the quarter, and frankly, they had a little bit of a positive impact. So I think we saw not only stabilization but a bit of improvement in that mix, but it's still, relative to historic levels, a bit worse than we were at previously a year or two ago.

Okay. Okay. Excellent. All right. Well, thank you.

Thank you.

Once again, that is star and one to ask a question. Our next question comes from Ben Rose from Battle Road. Your line is open. Please go ahead.

Yes, hi. Good morning, Michael and Alan. Just a question. You had mentioned the digital twin use case. Right. on the 3D metrology side, and I know that you have had some, I believe, interesting evaluations going on perhaps in some of the European automotive companies for the use of digital twin technology. Could you speak to those evaluations and perhaps where you think they might stand?

We don't really have an announcement to date as it relates to where we are with customers, but I will say that I'm Super excited about where we are with Digital Twin and the evaluations that are ongoing have increased in terms of the number of evaluations. And the feedback continues to be extremely positive, leveraging the acquisition that we made of ATS out of Sweden. So we're really, I think we're actually making great progress.

Great, great. And then on the public safety side, I know you mentioned last quarter, and it sounds like even this quarter, some pretty good opportunities in public safety. Could you speak to that part of the business in North America and perhaps how that's performing, including seasonal impacts?

Yeah. In general, North America continues to be our largest market for public safety, and we're continuing to make, I think, positive inroads. The sales cycle for public safety is quite a bit longer than our other products, even including construction. So, you know, we're selling to municipalities and townships, if you will. And so, in many cases, that sales cycle takes time. In Europe and Asia, in many cases, we're selling at a country level, which actually, as you can imagine, takes even longer. So it's a marathon, not a sprint. And we did expect to see some seasonality as many municipalities are on a fiscal year. And so many of them are in the process of getting new budgets for the year, which impact their ability to buy equipment. And so that, you know, the process has started all over again. There's some uncertainty about obviously funding, particularly police departments. And so there's some concern about, you know, let's make sure that our capital budgets are intact before we move. That said, our funnel for public safety continues to grow and it's quite healthy, both in North America and external.

Okay, great. Thanks very much.

You're welcome. Thank you.

It appears that we have no further questions at this time. I will now turn the program back over to our speakers for any additional or closing remarks.

We really appreciate everybody's attention today. We know you're all busy, and we look forward to giving you an update next quarter. Thank you very much.

This does conclude today's program. Thank you for your participation. You may disconnect at this time.