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spk01: Your program is about to begin. If you need audio assistance during today's program, please press star zero. Good afternoon, everyone, and welcome to the Ferro Technologies third quarter 2021 earnings call for opening remarks and introductions. I will now turn the call over to Michael Frenari at Sapphire Investor Relations. Please go ahead.
spk06: Thank you. Good afternoon.
spk07: With me today from Farrow are Michael Berger, Chief Executive Officer, and Alan Muhich, Chief Financial Officer. Today after the close, the company released its financial results for the third quarter of 2021. The related press release and form 10Q for the third quarter are available on Farrow's website at www.farrow.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, It includes 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. 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.
spk03: Thank you, Mike. Good afternoon. Welcome to our call. While third-quarter demand for our products remains strong, with reported orders of $80.4 million, ongoing pandemic-related logistical challenges impacted our customers' ability to coordinate deliveries. resulting in roughly $5 million of primarily Asia-Pacific orders and shipments slipping into the fourth quarter. Typical summer softness within the European markets, in addition to the well-documented rolling automotive shutdowns, further contributed to the expected sequential order decline. As we look ahead to our product roadmap, this quarter we will begin beta testing our unified software environment, which we call Ferrosphere. Ferrosphere is our new cloud-based platform that is the foundation to our software and solution strategy, whose objective is to provide differentiated value by offering workflow enhancements. These improvements include automated laser scan data uploads from any location, access to our existing suite of 3D software applications, cloud-based data analysis, and global user access, as well as ultimately the ability for our customers to purchase, renew, or manage all of their Ferro software and hardware assets. This is an important milestone for Ferro and it represents the first large step into expanding our cloud-based software offerings that we believe will deliver greater value to our customers and to our shareholders. We believe the Ferro sphere environment targeted globally across a wide range of markets including construction management, facilities, operations and maintenance, robotic simulation, and incident pre-planning will lead to exponentially increased number of users, enabling accelerated revenue growth, and a shift toward increased levels of high margin recurring revenue over time. In addition to the rollout of Ferrosphere, last quarter we discussed the launch of our new Quantum Max, which is a scan arm solution developed to solve our customers' need for both speed and accuracy in metrology-grade scanning applications. Unlike prior physical arm solutions, the Quantum Max allows customers to swap laser measurement heads on the fly, creating a versatile tool which meets a wide spectrum of speed, accuracy, and resolution needs in a single solution. When combined with the latest generation of our CAM2 metrology software, our customers can realize a productivity increase of over 30% compared to prior generation devices. Now, three and a half months into the rollout of the product, I am pleased to report customer feedback has been overwhelmingly positive and resulted in sequential quarterly increase in arms shipments despite the slow European summer and the turbulence in the automotive market. Given the overall flexibility and the value creation of this product, we are starting to see early signs of accelerated legacy tool replacement. We view this as a positive indicator and validates our strategy of early customer engagement to better understand their needs and in turn develop differentiated solutions that will generate greater value and drive additional product demand. Another update on our product roadmap has been the strong demand for our photogrammetry-based digital twin solution, which we acquired with HoloBuilder last quarter. HoloBuilder's leading SaaS platform delivers hardware-agnostic image capture, registration, and viewing while utilizing artificial intelligence, which automates many tasks, such as identification of scanned objects. The HoloBuilder application adds fast and easy photo documentation and remote access capabilities to Ferro's highly accurate 3D laser scans to create the industry's first end-to-end digital twin solution. Initially targeted at the construction management segment of the market, our team is working towards broadening the offer into facility management and public safety markets. Given the momentum in the hollow builders solution, when combined with our increased investment, we believe demand is on track for hollow builders recurring revenue to double over the next 12 months, which confirms our view of the strategic importance of the digital twin opportunity. Shifting to operations, last quarter we announced the signing of an agreement to outsource our manufacturing to Sanmina. Thus far, the transition has been going smoothly, and while the cost benefits associated with outsourcing will not impact our financial results until next year, we have already started to see indirect benefits of leveraging Sandmina's supply chain. We discussed last quarter component shortages and freight logistics continue to impact many industries, including our own. Through the diligent effort of our supply chain team and the additional resources now available from Sandmina, we have thus far been successful in navigating this situation. That said, we remain cautious as market uncertainties may continue for an extended period of time, which could have an adverse effect on our ability to deliver and to service demand. We believe that our strategic transition of developing differentiated solutions through a deeper understanding of our customers' workflows while at the same time adjusting our operating structure to generate leverage is paying off. While our third quarter results were softer due to historic seasonality and the timing of customer shipments, the reported Q3 year-on-year growth is consistent with what is required to return to 2019 revenue levels in the fourth quarter. We are encouraged by the underlying market demand that has resulted in the fourth quarter funnel growth, and together with the benefit of new product offerings, we expect to see continued strengthening of our fourth quarter activity. With that, I'll turn the call over to Alan for an overview of our third quarter financial results.
spk13: Thank you, Michael, and good afternoon, everyone. Third quarter revenue of $79.2 million grew 12% when compared to the third quarter of 2020. as a result of continuing improvement in market demand compared to last year's market softness caused by the pandemic. Product revenue of $57.8 million was up 20%, while service revenue of $21.3 million was down 6%. Bookings of $80.4 million grew 12% year-over-year. Gap gross margin was 53.5%, and non-gap gross margin was 53.7% for the third quarter of 2021. Gross margin increased year over year largely due to volume increases from prior periods that was somewhat offset by an expected increase in material costs resulting from today's inflationary pressures. As a result, we expect gross margin levels will be adversely impacted towards the lower end of our stated success model range of between 55 and 60% until conditions normalize. In addition, as Michael mentioned, the cost benefits from our outsourcing initiative will not begin to impact margins until next year. GAAP operating expenses were $47.5 million and included approximately $3.8 million in acquisition-related intangible amortization and stock compensation expenses and $1.4 million in restructuring costs. Non-GAAP operating expense of $42.4 million was $3.9 million higher than Q3 of 2020 as we continue to increase our software investments. both in Hollow Builder as well as our organic initiatives, and as a result of the travel-related expense savings realized during the pandemic returning. Gap operating loss was $5.2 million for the third quarter of 2021, compared with an operating loss of $4.9 million for the third quarter of 2020, primarily due to lower volumes in the prior year period. Non-GAAP operating income was near break even in the third quarter of 2021 compared to a $2 million loss in the third quarter of 2020. Adjusted EBITDA was 2.7 million or approximately 3.4% of revenue. Our GAAP net loss was 3.9 million or 21 cents per share. Our non-GAAP net loss was 1 cent per share for the third quarter of 2021 compared to a net loss of 8 cents per share in Q3 2020. We continue to maintain a strong capital structure with a cash balance of $126 million and no debt. The third quarter decrease in cash was primarily a result of strategic purchases of inventory to increase safety stock levels as we work to mitigate risk associated with the current supply chain challenges. As Michael mentioned, we're pleased in the continued end market demand improvements and the organic and inorganic progress we're making towards realizing our strategic vision of hardware software solutions that solve our customers' real-world problems in a cloud-based environment. We're excited that the product roadmap for both hardware and software are beginning to build customer momentum, and as the associated recurring revenue contribution increases, our intention is to be transparent in our reporting of both our business objectives as well as the metrics to track our performance. Finally, we remain committed to the achievement of our financial success model, which as a reminder is to achieve 55 to 60 percent gross margin with 40 to 43 percent operating expenses resulting in 20 percent adjusted EBITDA that we expect will be realized with approximately 110 million in quarterly revenue. We look forward to reporting our continued progress in the coming quarters. This concludes our prepared remarks, and at this time, we'd be pleased to take any of your questions.
spk01: At this time, if you'd 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 1 to ask a question. We'll pause for a moment to allow questions to queue. And it looks like our first question comes from Greg Palm. Your line is open. Please go ahead.
spk11: Great. Good afternoon, everybody. I guess just kind of starting with the commentary specific to Q3 around the customer logistical challenges. Can you just go into a little bit more detail around what exactly happened? It sounded more COVID-related versus supply chain related, but maybe there is a relationship there. I just wasn't. I wasn't sure if I picked that up right.
spk03: Actually, the issues that occurred to us were primarily in Asia, as we mentioned, and primarily between AEC and public safety applications specifically. And in more than one situation, orders were committed, but we actually didn't receive the actual paperwork, if you will. in certain instances so we weren't able to book and we've since actually gotten these orders in-house in the quarter. And there were a couple situations where customers wanted the product but weren't able to actually get freight forwarding to service the order. So in a couple situations we were on the cusp of basically claiming revenue but we had to push it into Q4.
spk13: And maybe just a little bit more color. They were actually rather large deals, and therefore the logistics were more on the customer being able to coordinate deployment of the assets versus anything else in a couple of the situations. So hopefully that gives you a little bit more color as well.
spk03: It was not caused by our ability to deliver. In fact, we had the inventory on site.
spk11: Well, it's interesting. My next question was going to be if I add back basically that amount. you know, it would have made that region look really, really good relative to sort of previous quarters. So it sounds like maybe it was a few big deals versus something that was more across the region. Is that the right way to think about it?
spk03: That's exactly right. In fact, I think in general, Greg, we're really excited about what we're seeing out of Asia today. And I And frankly, they're back to 2019 levels already. So Asia's recovery has actually been pretty consistent over the last couple quarters. And we're beginning to see some real deal flow there. So we're very excited, particularly in China specifically.
spk11: Okay, that's good to hear. I guess just maybe we'll segue into that as my last one. The commentary is talking about good demand indicators in Q4 as you sort of approach pre-COVID levels across all regions. Do you still think that's the case in Q4 where you get back to those Q4-19 levels? Has anything changed in the last couple months, whether it's supply chain logistical issues that makes you maybe less confident in getting to that number?
spk03: Actually, no, I would argue it's the opposite. I'm actually more confident based on the fact, as we mentioned in the script, Greg, we're seeing the beginning of quarter funnel, pretty significant growth quarter on quarter, so that gives us confidence. As you know, the way we run our business is really looking at opportunity flow into the quarter that's expected to book. And of course, not everything does book in the quarter, and so there's some discounting associated with that in terms of, or handicapping, if you will, of that number. But growth quarter on quarter in terms of the funnel size, and you're right, across all three regions, it's been very encouraging. And so we feel pretty comfortable and actually put it in the script that we believe we should see Q4 levels in Q4.
spk13: Yeah, the other thing we commented on in the script as well is the Quantum Max performance. And again, we launched it three and a half months ago and the response back from the customers has been quite positive. and the approach around having swappable laser line probes has been well received. And so we are beginning to gain some confidence that that may lead to a faster replacement cycle, which also, again, is one of the contributors to the incremental pipeline that Michael referenced that we see heading into the fourth quarter.
spk03: I think our confidence is growing in that context.
spk11: Okay. Yeah, good to hear. I'll leave it there. Best of luck going forward. Thanks.
spk03: Thanks, Greg. Thanks, Greg.
spk01: Our next question comes from Andrew Desposari. Your line is open. Please go ahead.
spk12: Thank you. I guess one question I had is in terms of the legacy tool replacement cycle. I thought that was a very interesting comment you made. And it sounds like you mentioned the quantum max is driving that. But is there anything else that's happening? I mean, is it just, you know, I guess people that might have paused that cycle, so to speak, during the pandemic? are now confident to ramp it up, or is there something incremental that we're not aware of?
spk03: I think it's twofold. I think first is the new product. I've talked to customers directly that have had an arm in their shop for over 10 years and just didn't want to give it up, but I think the value that this particular new product is offering is very compelling. That said, I would believe that the second-order effect is that there is confidence that the market is coming back, particularly with some of the smaller shops, and therefore they're doing some of the much-needed upgrade that, frankly, I think has been on hold through the pandemic. So I think it's a combination of both.
spk12: Got it. And then on HoloBuilder, one of their competitors, I guess, went public recently, Matterport. Just Curious in terms of that landscape, I mean, how does it differ from those other digital twin products and how would you say it stacks up? That's a great question.
spk03: First of all, the market in which Halo Builder is pointed is pretty much the retail space largely. And, of course, they've made a lot of noise about where they want to go, which is great. Our solution is really two-fold. Our solution is really aimed at the high-end, ultra-high definition scanning, which is used by many guys for very highly accurate, highly sensitive things like robot simulation is an example, where they use our traditional focus scanner. What's great about that is that that is the basis or a backbone, if you will, for a highly accurate, you know, down to sub-millimeter levels in terms of distance over 100 square meters. So very, very, very accurate scanning. And what HallowBuilder does is then lays on top of that this photogrammetry capability that is much less accurate. And so the combination of the two We think we have a differentiation. If you were to take the Matterport solution and point it in the applications where we're pointed, I don't think they could compete. That's helpful.
spk12: Thanks. You're welcome.
spk01: Our next question comes from Rob Mason. Your line is open. Please go ahead.
spk02: Yes, good afternoon. Thanks for the question. First, I just wanted to... Touch on, you did mention some material cost constraints, inflation, you know, the obligatory supply chain challenges everybody's dealing with. But you just talk about the trends in those, how you're seeing that, and then your ability, you think, to offset any of that via price, what the pricing environment's like. you know, where that might lead to just in terms of addressing pressures on gross margin, because you seem to suggest either the supply chain challenges themselves probably don't alleviate themselves, you know, right away, which I think is, you know, kind of conventional wisdom maybe perhaps, but just your thoughts there.
spk03: Yeah. Let me start by saying from a philosophical perspective, Alan mentioned that we have, taken an aggressive stance on inventory to ensure that we don't sacrifice revenue. So that goes without saying. The second thing is that where we have long term plans for product mix, we're basically putting in longer term contracts that basically sequester supply. The third thing is that we are seeing opportunistically price increases anywhere from 5% to 12% depending upon who you talk to and where regionally you are in that. Samina has been fantastic at helping us find, finding supply. been able to help us a great deal on the pricing. Pricing, I think, is all of us are suffering with. But frankly, we've not been in a situation where we couldn't ship a product because we didn't have the raw materials. And so the net effect of that is our COGS is continuing to grow. But that's basically risk mitigation on our part.
spk02: What about your ability to capture price in the market and, to that degree, what the competitive situation or environment presents on that front as well?
spk03: It's a great question. We haven't really seen our competitors at large go out and actually put a surcharge, if you will, on the end selling price of their equipment. That said, the new Quantum Max, as an example, is at a higher ASP than the previous version, and we believe that we're able to garner that price by virtue of the value that we bring. Certainly that helps us with the gross margin set, but that said, the assumptions that we made on what COGS would be is probably low compared to where we are today based just on what's happening with supply. I don't know if that answered your question.
spk02: Yeah, that's helpful. And then just to follow up, I think you probably touched on this when you addressed maybe the health of your smaller customers and maybe their attitudes. But I'm just curious, as you think about into year-end and capital budgets and perhaps if there's any year-end budget flush, how do you feel about being able to get your entitlement there, your fair share from a QA, you know, QC function that you provide there? versus some other categories that are competing for those budgets?
spk03: Better every day. I think that the confidence that we're seeing in our customer base really across all regions and really all three segments is growing. I think the smaller guys particularly have been really reticent to place capital buys in lieu of all the things that have been between supply shortages and kind of work stoppages, et cetera, that seems to be waning a bit. And so confidence is growing. We've seen that reflected in our opportunity funnel that we track religiously. So I think the answer to your question is overall I think we are really well positioned if in fact there are capital flushes to be had. We have, as you know, we repositioned the way we go to market with our sales channels. And so now we have clear customer ownership. We're talking to our customers probably more than we ever have. Face-to-face visits are as high as they've been since the pandemic started. Yet we're still leveraging these virtual demos that we started to do way back in February of 2020. So I think the combination of being able to get in front of customers more often, the excitement that we're seeing in our customers around things coming back to normal, the fact that we've got new products in the marketplace, and the fact that our new go-to-market strategy is all about being front and center, I think that really bodes well for us if, in fact, there is a heyday to be had with capital flush.
spk02: Just a last question, just around Ferrospheres, as you work to bring that to market and go to beta tests, I'm just curious how you think about the profile of that beta test customer who you're planting that seed with perhaps initially?
spk03: Initial offerings are around our AEC product offering, and so we're talking to some relatively large and some very small customers in the AEC space because our first offering in Sphere will be an AEC product line and workflow associated with that. So we're trying to actually do kind of a four corners test, big guys and small guys. We've got about 20 customers that we're talking about through the beta process, and the feedback will start rolling in here as we speak. I'm super excited by this. I mean, this is repositioning our company, and this is where the rubber hits the road. we will officially be announcing to our entire customer base Ferrosphere in the Q4 as originally planned. That's great.
spk02: Very helpful. Thank you.
spk04: You're welcome.
spk02: Thank you.
spk01: Once again, that is star and one to ask a question. We'll take our question from Ben Rose. Your line is open. Please go ahead.
spk10: Yes, good afternoon, Alan and Michael. Hi. Michael, I think you indicated last quarter that, you know, Asia, China in particular, was recovering at a faster pace than Europe and the U.S. Can I take it from your comments that you're now seeing a pickup in those regions, you know, specifically for the manufacturing part of the product line?
spk03: So Q3, not so much, right? Europe was on vacation actually all the way through August. And frankly, that's a seasonal thing that if you look back in our history, it's happened every year. So we expected Europe to be slow in Q3. That said, the opportunity funnel for all three regions is up significantly in Q4. And so the answer is yeah, we're seeing yet to be actually realized, but the opportunity funnels are very, very robust and the growth quarter on quarter has been very encouraging. So we believe Q4, and I think we've said this now for probably 18 months, we believe, we've said all along that we'd be disappointed if Q4 wasn't back at the 2019 level for Q4 in 2019. And our confidence is growing that that's going to occur. save some catastrophe in supply chain, et cetera, which of course, you know, would affect not just us, it would affect others. So I'm very encouraged.
spk10: Okay. And you made some comments about the automotive sector in your initial remarks. You sort of alluded to the sector at large. Is there anything that you can provide in terms of color, in terms of what you're seeing in that sector, in terms of demand?
spk03: No, I think all of us have read, you know, ad nauseum all the horror stories of what's happened in the automotive space over the last quarter, you know, with rolling shutdowns and that type of thing. And certainly that, I think, contributed to some of the delay in some of the orders that, you know, were hopeful. That said, it looks like that's pretty much behind us. And again, this is anecdotally in talking to our customers. They don't believe... That will occur in Q4 as it did in Q3. So that being said, assuming that happens, I think we're in a good place, a very good place.
spk10: Okay. And if I may, just one more on the public safety side. Is there any update there specifically on what you're seeing in the U.S. in terms of customer demand?
spk03: No, I actually believe it's stabilizing. It's been very spotty regionally, and we're encouraged by the pipeline. I think North America should return to normalcy, if not in Q4, ideally in Q1. As you know, it's a relatively small portion of our business. That said, as Al I think alluded to in his answer around Q3 and the delay in shipments, a lot of those delays in Asia were public safety, and they are big deals. And I continue to be excited about our penetration in Europe and in Asia in the public safety sector. I don't think it'll rival the North American numbers short term, but the traction that we're getting is really, it's exciting. So I'm encouraged.
spk10: Okay. Thanks very much.
spk03: You're welcome. Thank you. Thanks, Ben.
spk01: It appears we have no further questions at this time. I will now turn the program back over to Michael for any closing remarks.
spk03: Well, as I said, we're very excited about the quarter coming and very excited about Sphere, very excited about our new products, and I know you're tired of hearing me say very excited. That said, we look forward to talking to you next quarter about Q4. Thank you for your interest. Bye.
spk01: this does conclude today's program thank you for your participation you may disconnect at any time Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. you you Thank you. Thank you. Good afternoon, everyone, and welcome to the Ferro Technologies third quarter 2021 earnings call for opening remarks and introductions. I will now turn the call over to Michael Frenari at Sapphire Investor Relations. Please go ahead.
spk06: Thank you. Good afternoon. With me today from Ferro are Michael Berger, Chief Executive Officer, and Alan Muhic, Chief Financial Officer.
spk07: Today, after the close, the company released its financial results for the third quarter of 2021. The related press release and Form 10-Q for the third quarter 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 history 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.
spk03: Thank you, Mike. Good afternoon. Welcome to our call. While third quarter demand for our products remained strong, with reported orders of $80.4 million, ongoing pandemic-related logistical challenges impacted our customers' ability to coordinate delivery, resulting in roughly $5 million of primarily Asia-Pacific orders and shipments slipping into the fourth quarter. Typical summer softness within the European markets, in addition to the well-documented rolling automotive shutdowns, further contributed to the expected sequential order decline. As we look ahead to our product roadmap, this quarter we will begin beta testing our unified software environment, which we call Ferrosphere. is our new cloud-based platform that is the foundation to our software and solution strategy, whose objective is to provide differentiated value by offering workflow enhancements. These improvements include automated laser scan data uploads from any location, access to our existing suite of 3D software applications, cloud-based data analysis, and global user access, as well as ultimately the ability for our customers to purchase, renew, or manage all of their Ferro software and hardware assets. This is an important milestone for Ferro and it represents the first large step into expanding our cloud-based software offerings that we believe will deliver greater value to our customers and to our shareholders. We believe that Ferro sphere environment targeted globally across a wide range of markets including construction management, facilities, operations and maintenance, robotic simulation, and incident pre-planning will lead to exponentially increased number of users, enabling accelerated revenue growth, and a shift toward increased levels of high margin recurring revenue over time. In addition to the rollout of Ferrosphere, last quarter we discussed the launch of our new Quantum Max, which is a scan arm solution developed to solve our customers' need for both speed and accuracy in metrology-grade scanning applications. Unlike prior physical arm solutions, the Quantum Max allows customers to swap laser measurement heads on the fly, creating a versatile tool which meets a wide spectrum of speed, accuracy, and resolution needs in a single solution. When combined with the latest generation of our CAM2 metrology software, our customers can realize a productivity increase of over 30% compared to prior generation devices. Now, three and a half months into the rollout of the product, I am pleased to report customer feedback has been overwhelmingly positive and resulted in sequential quarterly increase in arms shipments despite the slow European summer and the turbulence in the automotive market. Given the overall flexibility and the value creation of this product, we are starting to see early signs of accelerated legacy tool replacement. We view this as a positive indicator and validates our strategy of early customer engagement to better understand their needs and in turn develop differentiated solutions that will generate greater value and drive additional product demand. Another update on our product roadmap has been the strong demand for our photogrammetry-based digital twin solution, which we acquired with HoloBuilder last quarter. HoloBuilder's leading SaaS platform delivers hardware-agnostic image capture, registration, and viewing while utilizing artificial intelligence, which automates many tasks, such as identification of scanned objects. The HoloBuilder application adds fast and easy photo documentation and remote access capabilities to Ferro's highly accurate 3D laser scans to create the industry's first end-to-end digital twin solution. Initially targeted at the construction management segment of the market, our team is working towards broadening the offer into facility management and public safety markets. Given the momentum in the hollow builders solution, when combined with our increased investment, we believe demand is on track for hollow builders recurring revenue to double over the next 12 months, which confirms our view of the strategic importance of the digital twin opportunity. Shifting to operations, last quarter we announced the signing of an agreement to outsource our manufacturing to Sanmina. Thus far, the transition has been going smoothly, and while the cost benefits associated with outsourcing will not impact our financial results until next year, we have already started to see indirect benefits of leveraging Sandmina's supply chain. We discussed last quarter component shortages and freight logistics continue to impact many industries, including our own. Through the diligent effort of our supply chain team and the additional resources now available from Sanmina, we have thus far been successful in navigating the situation. That said, we remain cautious as market uncertainties may continue for an extended period of time, which could have an adverse effect on our ability to deliver and to service demand. We believe that our strategic transition of developing differentiated solutions through a deeper understanding of our customers' workflows while at the same time adjusting our operating structure to generate leverage is paying off. While our third quarter results were softer due to historic seasonality and the timing of customer shipments, the reported Q3 year-on-year growth is consistent with what is required to return to 2019 revenue levels in the fourth quarter. We are encouraged by the underlying market demand that has resulted in the fourth quarter funnel growth, and together with the benefit of new product offerings, we expect to see continued strengthening of our fourth quarter activity. With that, I'll turn the call over to Alan for an overview of our third quarter financial results.
spk13: Thank you, Michael, and good afternoon, everyone. Third quarter revenue of $79.2 million grew 12% when compared to the third quarter of 2020. as a result of continuing improvement in market demand compared to last year's market softness caused by the pandemic. Product revenue of 57.8 million was up 20% while service revenue of 21.3 million was down 6%. Bookings of 80.4 million grew 12% year over year. Gap gross margin was 53.5% and non-gap gross margin was 53.7% for the third quarter of 2021. Gross margin increased year over year, largely due to volume increases from prior periods that was somewhat offset by an expected increase in material costs resulting from today's inflationary pressures. As a result, we expect gross margin levels will be adversely impacted towards the lower end of our stated success model range of between 55 and 60% until conditions normalize. In addition, as Michael mentioned, the cost benefits from our outsourcing initiative will not begin to impact margins until next year. GAAP operating expenses were $47.5 million and included approximately $3.8 million in acquisition-related intangible amortization and stock compensation expenses and $1.4 million in restructuring costs. Non-GAAP operating expense of $42.4 million was $3.9 million higher than Q3 of 2020 as we continue to increase our software investments. both in Hollow Builder as well as our organic initiatives and as a result of the travel-related expense savings realized during the pandemic returning. Gap operating loss was $5.2 million for the third quarter of 2021 compared with an operating loss of $4.9 million for the third quarter of 2020, primarily due to lower volumes in the prior year period. Non-GAAP operating income was near break even in the third quarter of 2021 compared to a $2 million loss in the third quarter of 2020. Adjusted EBITDA was 2.7 million or approximately 3.4% of revenue. Our GAAP net loss was 3.9 million or 21 cents per share. Our non-GAAP net loss was one cent per share for the third quarter of 2021 compared to a net loss of eight cents per share in Q3 2020. We continue to maintain a strong capital structure with a cash balance of $126 million and no debt. The third quarter decrease in cash was primarily a result of strategic purchases of inventory to increase safety stock levels as we work to mitigate risk associated with the current supply chain challenges. As Michael mentioned, we're pleased in the continued end market demand improvements and the organic and inorganic progress we're making towards realizing our strategic vision of hardware software solutions that solve our customers' real-world problems in a cloud-based environment. We're excited that the product roadmap for both hardware and software are beginning to build customer momentum, and as the associated recurring revenue contribution increases, our intention is to be transparent in our reporting of both our business objectives as well as the metrics to track our performance. Finally, we remain committed to the achievement of our financial success model, which as a reminder is to achieve 55 to 60% gross margin with 40 to 43% operating expenses resulting in 20% adjusted EBITDA that we expect will be realized with approximately 110 million in quarterly revenue. We look forward to reporting our continued progress in the coming quarters. This concludes our prepared remarks, and at this time, we'd be pleased to take any of your questions.
spk01: At this time, if you'd 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 1 to ask a question. We'll pause for a moment to allow questions to queue. And it looks like our first question comes from Greg Palm. Your line is open. Please go ahead.
spk11: Great. Good afternoon, everybody. I guess just kind of starting with the commentary specific to Q3 around the customer logistical challenges. Can you just go into a little bit more detail around what exactly happened? It sounded more COVID-related versus supply chain related, but maybe there is a relationship there. I just wasn't. I wasn't sure if I picked that up right.
spk03: Actually, the issues that occurred to us were primarily in Asia, as we mentioned, and primarily between AEC and public safety applications specifically. And in more than one situation, orders were committed, but we actually didn't receive the actual paperwork, if you will. in certain instances, so we weren't able to book, and we've since actually gotten these orders in-house in the quarter. And there were a couple situations where customers wanted the product but weren't able to actually get freight forwarding to service the order. So in a couple situations, we were on the cusp of basically claiming revenue, but we had to push it into Q4.
spk13: And maybe just a little bit more color. They were actually rather large deals, and therefore the logistics were more on the customer being able to coordinate deployment of the assets versus anything else in a couple of the situations. So hopefully that gives you a little bit more color as well.
spk03: It was not caused by our ability to deliver. In fact, we had inventory on site.
spk11: Well, it's interesting. My next question was going to be if I add back basically that amount. you know, it would have made that region look really, really good relative to sort of previous quarters. So it sounds like maybe it was a few big deals versus something that was more across the region. Is that the right way to think about it?
spk03: That's exactly right. In fact, I think in general, Greg, we're really excited about what we're seeing out of Asia today. And I And frankly, they're back to 2019 levels already. So Asia's recovery has actually been pretty consistent over the last couple quarters, and we're beginning to see some real deal flow there. So we're very excited, particularly in China specifically.
spk11: Okay, that's good to hear. I guess just maybe we'll segue into that as my last one. The commentary is talking about good demand indicators in Q4 as you sort of approach pre-COVID levels across all regions. Do you still think that's the case in Q4 where you get back to those Q4-19 levels? Has anything changed in the last couple months, whether it's supply chain logistical issues that makes you maybe less confident in getting to that number?
spk03: Actually, no, I would argue it's the opposite. I'm actually more confident based on the fact, as we mentioned in the script, Greg, we're seeing the beginning of quarter funnel, pretty significant growth quarter on quarter, so that gives us confidence. As you know, the way we run our business is really looking at opportunity flow into the quarter that's expected to book. And, of course, not everything does book in the quarter, and so there's some discounting associated with that in terms of, or handicapping, if you will, of that number. But growth quarter on quarter in terms of the funnel size, and you're right, across all three regions, it's been very encouraging. And so we feel pretty comfortable, and actually I put it in the script, that we believe we should see Q4 levels in Q4.
spk13: Yeah, the other thing we commented on in the script as well is the Quantum Max performance. And again, we launched it three and a half months ago, and the response back from the customers has been quite positive. and the approach around having swappable laser line probes has been well received. And so we are beginning to gain some confidence that that may lead to a faster replacement cycle, which also, again, is one of the contributors to the incremental pipeline that Michael referenced that we see heading into the fourth quarter.
spk03: I think our confidence is growing in that context. Okay.
spk11: Yeah, good to hear. I'll leave it there. Best of luck going forward. Thanks.
spk03: Thanks, Greg. Thanks, Greg.
spk01: Our next question comes from Andrew Desbazari. Your line is open. Please go ahead.
spk12: Thank you. I guess one question I had is in terms of the legacy tool replacement cycle. I thought that was a very interesting comment you made. And it sounds like you mentioned the quantum max is driving that. But is there anything else that's happening? I mean, is it just, you know, I guess people that might have paused that cycle, so to speak, during the pandemic? are now confident to ramp it up, or is there something incremental that we're not aware of?
spk03: I think it's twofold. I think first is the new product. I've talked to customers directly that have had an arm in their shop for over 10 years and just didn't want to give it up, but I think the value that this particular new product is offering is very compelling. That said, I would believe that the second-order effect is that there is confidence that the market is coming back, particularly with some of the smaller shops, and therefore they're doing some of the much-needed upgrade that, frankly, I think has been on hold through the pandemic. So I think it's a combination of both.
spk12: Got it. And then on HoloBuilder, one of their competitors, I guess, went public recently, Matterport. Curious in terms of that landscape, I mean, how does it differ from those other digital twin products and how would you say it stacks up? That's a great question.
spk03: First of all, the market in which Halo Builder is pointed is pretty much the retail space largely. And, of course, they've made a lot of noise about where they want to go, which is great. Our solution is really two-fold. Our solution is really aimed at the high-end, ultra-high definition scanning, which is used by many guys for very highly accurate, highly sensitive things like robot simulation is an example, where they use our traditional focus scanner. What's great about that is that that is the basis or a backbone, if you will, for a highly accurate, you know, down to sub-millimeter levels in terms of distance over 100 square meters. So very, very, very accurate scanning. And what HallowBuilder does is then lays on top of that this photogrammetry capability that is much less accurate. And so the combination of the two We think we have a differentiation. If you were to take the Matterport solution and point it in the applications where we're pointed, I don't think they could compete.
spk12: That's helpful. Thanks. You're welcome.
spk01: Our next question comes from Rob Mason. Your line is open. Please go ahead.
spk02: Yes, good afternoon. Thanks for the question. First, I just wanted to touch on, you did mention some material cost constraints, inflation, the obligatory supply chain challenges everybody's dealing with. But you just talk about the trends in those, how you're seeing that, and then your ability, you think, to offset any of that via price, what the pricing environment's like. you know, where that might lead to just in terms of addressing pressures on gross margin, because you seem to suggest either the supply chain challenges themselves probably don't alleviate themselves, you know, right away, which I think is, you know, kind of conventional wisdom maybe perhaps, but just your thoughts there.
spk03: Yeah. Let me start by saying from a philosophical perspective, Alan mentioned that we have, taken an aggressive stance on inventory to ensure that we don't sacrifice revenue. So that goes without saying. The second thing is that where we have long term plans for product mix, we're basically putting in longer term contracts that basically sequester supply. The third thing is that we are seeing opportunistically price increases anywhere from 5% to 12% depending upon who you talk to and where regionally you are in that. Samina has been fantastic at helping us find, finding supply. been able to help us a great deal on the pricing. Pricing, I think, is all of us are suffering with. But frankly, we've not been in a situation where we couldn't ship a product because we didn't have the raw materials. And so the net effect of that is our COGS is continuing to grow. But that's basically risk mitigation on our part.
spk02: What about your ability to capture price in the market and to that degree, what the competitive situation or environment presents on that front as well?
spk03: It's a great question. We haven't really seen our competitors at large go out and actually put a surcharge, if you will, on the end selling price of their equipment. That said, the new Quantum Max, as an example, is at a higher ASP than the previous version, and we believe that we're able to garner that price by virtue of the value that we bring. Certainly that helps us with a gross margin set, but that said, the assumptions that we made on what COGS would be is probably low compared to where we are today based just on what's happening with supply. I don't know if that answered your question.
spk02: Yeah, that's helpful. And then just to follow up, I think you probably touched on this when you addressed maybe the health of your smaller customers and maybe their attitudes. But I'm just curious, as you think about into year-end and capital budgets and perhaps if there's any year-end budget flush, how do you feel about being able to get your entitlement there, your fair share from a QA, you know, QC function that you provide there? versus some other categories that are competing for those budgets?
spk03: Better every day. I think that the confidence that we're seeing in our customer base really across all regions and really all three segments is growing. I think the smaller guys particularly have been really reticent to place capital buys in lieu of all the things that have been between supply shortages and kind of work stoppages, et cetera, that seems to be waning a bit. And so confidence is growing. We've seen that reflected in our opportunity funnel that we track religiously. So I think the answer to your question is overall I think we are really well positioned if in fact there are capital flushes to be had. We have, as you know, we repositioned the way we go to market with our sales channel. And so now we have clear customer ownership. We're talking to our customers probably more than we ever have. Face-to-face visits are as high as they've been since the pandemic started, yet we're still leveraging these virtual demos that we started to do way back in February of 2020. So I think the combination of being able to get in front of customers more often, the excitement that we're seeing in our customers around things coming back to normal, the fact that we've got new products in the marketplace, and the fact that our new go-to-market strategy is all about being front and center, I think that really bodes well for us if, in fact, there is a heyday to be had with capital flush.
spk02: Just a last question, just around Ferrospheres, as you work to bring that to market and go to beta tests, I'm just curious how you think about the profile of that beta test customer who you're planting that seed with perhaps initially?
spk03: Initial offerings are around our AEC product offering, and so we're talking to some relatively large and some very small customers in the AEC space because our first offering in Sphere will be an AEC product line and workflow associated with that. So we're trying to actually do kind of a four corners test, big guys and small guys. We've got about 20 customers that we're talking about through the beta process, and feedback will start rolling in here as we speak. I'm super excited by this. I mean, this is repositioning our company, and this is where the rubber hits the road. we will officially be announcing to our entire customer base Ferrosphere in the Q4 as originally planned. That's great.
spk02: Very helpful, thank you. You're welcome, thank you.
spk01: Once again, that is star and one to ask a question. We'll take our question from Ben Rose. Your line is open, please go ahead.
spk10: Yes, good afternoon, Alan and Michael. Hi. Michael, I think you indicated last quarter that, you know, Asia, China in particular, was recovering at a faster pace than Europe and the U.S. Can I take it from your comments that you're now seeing a pickup in those regions, you know, specifically for the manufacturing part of the product line?
spk03: So Q3, not so much, right? Europe was on vacation actually all the way through August. And frankly, that's a seasonal thing that if you look back in our history, it's happened every year. So we expected Europe to be slow in Q3. That said, the opportunity funnel for all three regions is up significantly in Q4. And so the answer is yeah, we're seeing yet to be actually realized, but the opportunity funnels are very, very robust and the growth on quarter on quarter has been very encouraging. So we believe Q4, and I think we've said this now for probably 18 months, we believe, we've said all along that we'd be disappointed if Q4 wasn't back at the 2019 level for Q4 in 2019. And our confidence is growing that that's going to occur. save some catastrophe in supply chain, et cetera, which of course, you know, would affect not just us, it would affect others. So I'm very encouraged.
spk10: Okay. And you made some comments about the automotive sector in your initial remarks. You sort of alluded to the sector at large. Is there anything that you can provide in terms of color, in terms of what you're seeing in that sector, in terms of demand?
spk03: No, I think all of us have read, you know, ad nauseum all the horror stories of what's happened in the automotive space over the last quarter, you know, with rolling shutdowns and that type of thing. And certainly that, I think, contributed to some of the delay in some of the orders that, you know, were hopeful. That said, it looks like that's pretty much behind us. And again, this is anecdotally in talking to our customers. They don't believe... That will occur in Q4 as it did in Q3. So that being said, assuming that happens, I think we're in a good place, a very good place.
spk10: Okay. And if I may, just one more on the public safety side. Is there any update there specifically on what you're seeing in the U.S. in terms of customer demand?
spk03: No, I actually believe it's stabilizing. It's been very spotty regionally, and we're encouraged by the pipeline. I think North America should return to normalcy, if not in Q4, ideally in Q1. As you know, it's a relatively small portion of our business. That said, as Al I think alluded to in his answer around Q3 and the delay in shipments, a lot of those delays in Asia were public safety, and they are big deals. And I continue to be excited about our penetration in Europe and in Asia in the public safety sector. I don't think it will rival the North American numbers short term, but the traction that we're getting is really, it's exciting. So I'm encouraged.
spk10: Okay. Thanks very much.
spk03: You're welcome. Thank you. Thanks, Ben.
spk01: It appears we have no further questions at this time. I will now turn the program back over to Michael for any closing remarks.
spk03: Well, as I said, we're very excited about the quarter coming and very excited about Sphere, very excited about our new products, and I know you're tired of hearing me say very excited. That said, we look forward to talking to you next quarter about Q4. Thank you for your interest. Bye.
spk01: this does conclude today's program thank you for your participation you may disconnect at any time
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