Earnings Transcript for FARO - Q4 Fiscal Year 2023

Operator: Good day, everyone, and welcome to the FARO Technologies Fourth Quarter and Year End 2023 Earnings Call. For opening remarks and introductions, I will now turn the call over to Mike Funari at Sapphire, Investor Relations. Please go ahead.

Mike Funari: Thank you, and good morning. With me today from FARO are Peter Lau, President and Chief Executive Officer; and Matt Horwath, Chief Financial Officer. Yesterday after market close, the company released its financial results for the fourth quarter and full year 2023. The related press release and Form 10-K 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 yesterday'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'll find additional disclosures regarding these non-GAAP measures, including reconciliations to comparable GAAP measures. While not recognized in our 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 a substitute for a measure of financial performance prepared in accordance with GAAP. Now, I'd like to turn the call over to Peter Lau.

Peter Lau: Thank you, Mike. Good morning, and welcome, everyone, to our call. In the fourth quarter, our focus on execution across all aspects of our operations continue to drive meaningful results. Whether it be refining our product development process and road map, enhancing customer experiences or streamlining our internal processes, we remain committed to delivering on our three core tenets

Matt Horwath: Thank you, Peter, and good morning, everyone. Fourth quarter revenue of $98.8 million was down 5% compared with the fourth quarter of 2022. Geographically, while demand remained healthy within Europe and the Americas, particularly Latin America, continuing softness in China was responsible for the year-over-year decline. Fourth quarter hardware revenue of $66.6 million was down 5% year-over-year, while software revenue of $12.2 million was down 6% and service revenue of $20 million decreased by 3% in concert with hardware. Recurring revenue was $17.4 million and represented 18% of sales. GAAP gross margin was 50.9% and non-GAAP gross margin was 52.5% for the fourth quarter of 2023 compared to 52.8% in 2022. On a non-GAAP basis, lower revenue levels resulted in the fourth quarter's year-over-year gross margin decline. Sequentially, as Peter mentioned, we are pleased that reported non-GAAP gross margin improved 360 basis points due in part to higher revenue, a decrease in unfavorable purchase price variance and increasing benefits from supply chain localization. Related to the purchase price variances, we believe these charges are largely complete, exiting 2023, and together with the opportunity ahead in shifting our supply chain to Southeast Asia, we continue to expect a meaningful improvement in 2024 gross margin. GAAP operating expenses were $48.9 million and included approximately $6.3 million in acquisition-related intangible amortization and stock compensation expenses and $1.3 million in restructuring and other transaction costs. Non-GAAP operating expense of $41.3 million was down $4.5 million from Q4 last year as we realized the benefit of our restructuring efforts. GAAP operating income was $1.4 million in the fourth quarter of 2023 compared with an operating loss of $1.6 million in the fourth quarter of 2022. Non-GAAP operating income was $10.6 million in the fourth quarter of 2023 and compared to income of $9.1 million in the fourth quarter of 2022. Adjusted EBITDA was $13.2 million or approximately 13.3% of sales compared to $11.7 million and 11.3% of sales in the fourth quarter of 2022. I want to highlight that adjusted EBITDA grew 12% year-over-year and expanded 200 basis points despite the lower fourth quarter revenue. Our GAAP net income was approximately $1.6 million or $0.08 per share. Our non-GAAP net income was $6.8 million or $0.36 per share for the fourth quarter of 2023 compared to net income of $7.1 million or $0.38 per share in Q4 2022. Our cash and short-term investment balance at the end of the quarter was $96.3 million, up $16.4 million from Q3, largely due to improved profitability and improvements in our cash conversion cycle. Free cash flow of $14.7 million in the fourth quarter 2023 was up $24.2 million versus the fourth quarter of 2022. Free cash flow of -- we remain very focused on our working capital efficiency and currently expect to be cash flow positive in 2024. We are pleased with our fourth quarter results and view them as evidence the business is moving in the right direction. As Peter mentioned, the team continues to execute well on the operations priorities we have established, namely refining our product development process and road map, enhancing customer experiences gross margin expansion, streamlining and improving internal processes, including our IT systems and free cash flow generation. That said, we remain cautious in the near term. From a geographic perspective, we do not expect China demand to rebound in the first quarter and together with global manufacturing PMI remaining at or below 50 and sales cycles remaining above historical levels, we want to remain thoughtful and measured in setting expectations for the first quarter of 2024, while looking forward to a macro recovery. As a result, at present foreign exchange rates, we expect first quarter revenue of between $77 million and $85 million. At those revenue levels and given corresponding non-GAAP gross margin between 49.5% and 51% and non-GAAP operating expenses of between $41 million and $43 million, we would expect non-GAAP loss per share of between $0.20 and $0.00 per share. This concludes our prepared remarks. And at this time, we'd be pleased to take questions.

Operator: [Operator Instructions] We'll take our first question from Jim Ricchiuti with Needam & Company.

Jim Ricchiuti: I wanted to go back to the reference you made about the large public safety order that you got, and I believe you said it was remaining from a channel partner. I was just trying to get a little bit more color on that. Is this a channel partner that you've been working with for a while because this channel partner cover other parts of EMEA? If you could, just a little bit more color on that, given the nice win.

Peter Lau: Jim, thanks for the question. It is a channel partner we've been working with for a while, and they cover the Romania territory. It was a tender, Jim, a competitive tender with other bidders. And we -- the end user ultimately decided to go with the FARO product. Again, it was a $3 million order. We shipped about half of that in the first quarter and would expect -- or in the fourth quarter, and we expect to shift the rest of it throughout the year of 2024. But very exciting win. Again, as we said, our largest public safety order ever. And between our local teams there, and our channel partner really, really nice win for us.

Jim Ricchiuti: Got it. Congrats on that. In the last call, I think you alluded to -- you talked about sales cycles shortening a bit, and I was wondering what you saw as you went through Q4 and whether there's been any change thus far in 2024? Yes, the macro is clearly a challenge. But I'm just wondering what you've been seeing in terms of sales cycles?

Peter Lau: Yes. And you're right, we did mention that they had shortened in Q3 relative to some of the earlier quarters. What I would say is we expect them to stay the same as really kind of the same in Q4. And again, just a reminder that, that's above our historical levels, right? So we still see the macro continuing to be a little bit challenged, but we're working through it, Jim, and expect our operational initiatives to drive financial performance in the current environment.

Jim Ricchiuti: And last question, if I could just slip one in. Just on the decline that we saw in the software business in Q4 versus a year ago. Can you talk a little bit about what contributed to that?

Peter Lau: Yes. Thanks for the question, Jim. It's largely in concert with our hardware and the perpetual software licenses that we sell. We actually saw our service increase a little bit in the first quarter there. Our subscriptions increase in the fourth quarter. But the overall headline of software being down was related to the perpetual license that get attached at point of sale with the hardware.

Operator: [Operator Instructions] We'll take our next question from Greg Palm with Craig-Hallum Capital Group.

Greg Palm: Congrats on the quarterly results. I guess, Pete, curious to think about how you're sort of viewing the year in terms of drivers of growth, how much of that is required from some sort of macro recovery or stabilization? How do you think about volume versus price? Any just thoughts on kind of how you think fiscal '24 will play out from a revenue standpoint? I know you don't give guidance for the year per se.

Peter Lau: No, we don't, Greg, and thanks for the question. And appreciate your congratulations on the quarter. We are pleased with it. What I would say is, in our prepared remarks, we talked about China and the expectation that it doesn't get better in the first quarter. As we say, the macro is, I think kind of one of those things where it's anyone's guess. But what I will say is that we do -- we are very excited about our product road map for this year. Again, we talked about Orbis, we talked about Zone, and we've got some exciting launches coming in the quarters ahead. We look to get a little bit of price, which we've talked about with you previously. And ultimately, Greg, our tenant -- our core tenant is to grow revenue faster than the markets we serve. And we think that between price, sales productivity and new products, we should be able to deliver on that and then again, growing our earnings at a faster rate than revenue and cash flow at a faster rate than our earnings. We feel strongly about those core tenants.

Greg Palm: Yes, makes sense. And just to be clear on kind of the overall demand environment, have you seen any change over the last 3 months and specific to what your visibility is? And in China? Is it about the same? Or has it gotten better or worse since last quarter?

Peter Lau: Yes. I would say, Greg, we expect it to be -- to not recover in the first quarter, as we said. And obviously, there's initiatives in China that we're looking at doing. The Chinese government has done some things over there, and we've not seen it take hold. We don't expect it to get any better in the first quarter, but I think time will tell, and we'll continue to be vigilant about taking opportunities that we do see over there and acting with urgency to close as many deals as we can.

Greg Palm: Okay. And just last one on gross margin. I think you talked about still realizing some significant improvements this year. Any help with kind of the cadence of those improvements as we progress throughout the year? And I'm assuming that the gross margin bridge from Q4 to the guidance in Q1 is solely sort of revenue or volume driven. And as the volumes recover, that's when you see better absorption. Is that right?

Matt Horwath: Yes. I think that's the right way, Greg, to think about it. The seasonality that we baked in from Q4 to the Q1 guide, naturally, you've got the fixed cost absorption kind of headwind as you kind of sequentially go from Q4 to Q1. And as we mentioned in the prepared remarks, that negative purchase price variance kind of pretty much behind us exiting 2023. You'll see a little bit of that, but it's not going to be linear, but most of it is due to volume, and that step down from Q4 to Q1 guide.

Greg Palm: Yes. And remind us that unfavorable impact of a couple of million a quarter. Was that what the broker by impact was?

Matt Horwath: Yes. I think what we said externally is about 300 basis points. And kind of the way to think about it is more at the lower end of the gross margin range in the 20 -- kind of first half of 2023. And so with that behind us, there's not adding much sequentially as you exit Q4 to Q1.

Operator: We have no further questions in the queue at this time. I will turn the program back over to Peter Lau for any additional or closing remarks.

Peter Lau: Okay. Thank you very much for your time today and continued interest in FARO. We look forward to speaking with you again soon as the year progresses, and thanks again.

Operator: This does conclude today's program. Thank you for your participation, you may disconnect at any time.