Good morning, everyone, and welcome to the FARO Technologies Second Quarter 2020 Earnings Call. For opening remarks and introductions, I will now turn the call over to Michael Funari at Sapphire Investor Relations. Please go ahead..

Thank you, and good morning. With me today from FARO are Michael Burger, Chief Executive Officer; and Allen Muhich, Chief Financial Officer. Yesterday after the market closed, the company released its financial results for the second quarter of 2020.

The related press release and Form 10-Q for the second quarter are available on FARO's website at www.faro.com. In order to help you better understand the company and its results, management may make forward-looking statements during the course of this call.

These statements can be identified by words such as expect, will, believe, anticipate, plan, potential, continue, goal, objective, intend, may and similar words. It is possible the company's actual results may differ materially from those projected in these forward-looking statements.

Important factors that may cause actual results to differ materially are set forth in yesterday's press release and in the company's Form 10-K for the year ended December 31 and Form 10-Q for the quarter ended June 30, 2020.

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. I'd like to start by providing a brief update on how our business is faring through the recent economic downturn.

I am pleased to report that our global manufacturing facilities remain open, and our supply chain, logistics and operations teams have continued to serve and support our customers at the level they have come to expect from FARO. Our customers continue to pursue 3D measurement initiatives they've had in place at the beginning of the year.

However, many have chosen to delay projects, given the ongoing uncertainty caused by the global pandemic. That said, we do not believe that we have lost market share in this challenging demand environment.

From an industry perspective, the aerospace market remains the most cautious in placing new orders, while we're beginning to see signs that other markets are slowly moving forward on a region-by-region basis. It remains difficult to predict how the demand environment will unfold in the coming quarters.

All current signs are pointing toward a measured demand recovery in our markets, with the second quarter marking the bottom of the downturn for FARO. However, conditions could deteriorate as countries, respond to new or accelerating outbreaks adversely affecting our customers' near-term purchase decisions.

Shifting to areas within our control, we are continuing to make progress on our strategic initiatives we outlined in February. Our sales force has embraced our new go-to-market strategy. And while it is still early in the transition to claim success, the team's optimism is strong and growing.

We continue to capitalize on existing virtual infrastructure we have in place coming into the year. With most customers preferring to limit in person interactions, the sales team quickly shifted to virtual product demos and sales calls. Virtual demos grew 66% in the second quarter on a year-on-year basis.

We have found success in the use of this critical and scalable tool, not only as a stand-alone introduction to our products, but also is an exceptionally effective and efficient way to prequalify customer interest ahead of personal demos.

The combined virtual experience we've all gained over the last few months will continue to be an important tool in our sales arsenal going forward. Our marketing and service organizations have also adapted to the current virtual environment.

We have seen a 3- to fivefold increase in attendance of our virtual training and product information seminars, as companies take advantage of the opportunity to remotely educate themselves on our capabilities and how FARO solutions can solve their 3D problems.

This is another example where we've learned how to more effectively and efficiently interface with our customer and communicate that we intend to leverage and grow in our future business practices. Turning to our products. In the second quarter, we increased our target market focus with the divestiture of our open tech and our Photonics businesses.

While these 2 product lines only represented approximately 2% of revenue in 2019, they took up a considerably larger amount of the organization's time and attention. By divesting these businesses, we are able to reallocate resources to serve our core markets. In Q2, we announced 3 exciting new solutions aimed at our core markets.

First is the Freestyle 2, which is a differentiated, intuitive, portable and easy to use handheld scanner. This tool, targeted primarily at the public safety market allows nontechnical operators to capture photorealistic 3D images in real time.

The second product we announced is our Swift laser scanner, which is a unique portable solution that enables color 3D scans up to 10x faster than competing devices and is targeted primarily at the AEC market. Finally, the new FARO Gage is our most accurate and versatile articulating arm product aimed at 3D metrology.

This measurement tool allows small and medium-sized machine shops to perform demanding 3D inspections in record time. The core value proposition shared amongst these products is the enablement of capturing better data faster.

We believe these products, when combined with our software solution capabilities, have the unique ability to quickly transform our customers' 3D data into usable information.

As we continue to bring new solutions to market that are highly aligned with our customers' workflow, we will not only create long-term differentiation in the market, but also increase software content, leading to higher levels of reoccurring revenue and improved financial performance.

Having passed my 1-year anniversary at FARO in the middle of June, I am pleased with the progress that we've made as an organization. We've established our new success model. And through the combination of restructuring actions taken earlier this year and the savings that we've captured by leveraging a virtual sales and service model.

Our Q2 non-GAAP operating expense of $37.7 million beat our stated objective, a full 6 months earlier than expected. I am confident when revenue returns to historical levels, our new scalable operating model will deliver profitability in line with our targeted success model of 20% EBITDA.

I'm extremely proud of the entire FARO team as they have shown tremendous resiliency and dedication as we transform our company in the wake of our current global situation. With that, I'll turn the call over to Allen for an overview of our second quarter financial results..

Thank you, Michael, and good morning, everyone. Second quarter non-GAAP revenue was $61.2 million, down 38% when compared to $99.3 million in the second quarter of 2019 as a result of its full 3 months of soft end market demand related to the COVID-19 pandemic. GAAP product sales were $42.3 million as compared to $71 million in Q2 of 2019.

Broadly speaking, this decrease was experienced across all served markets. GAAP service revenue of $18.3 million was down $4.1 million when compared to Q2 of 2019 as a result of our inability to perform on-site training and a reduction in non-contract break fix activity.

In the second quarter of 2020, we took an additional charge of $600,000 related to the previously disclosed GSA matter. Including the impact of the GSA sales adjustment, GAAP net sales were $60.6 million. At this time, we have no further update on the status of our self-reported GSA pricing issue, as we await a response to our proposed solution.

New order bookings were $61.4 million for the second quarter of 2020, down 42% as compared with $106 million for the second quarter of 2019. GAAP gross margin was 47.7%. Non-GAAP gross margin was 48.4% for the second quarter of 2020 as compared with 57.2% for the same prior year period.

The reduced gross margin is a result of the overall reduction in revenue, which adversely affected our product fixed cost absorption. GAAP operating expenses were $40.9 million and included approximately $2.5 million in acquisition-related intangible amortization and stock compensation expenses as well as $600,000 in restructuring costs.

Non-GAAP operating expenses of $37.7 million were $13.3 million or 26% lower than Q2 of 2019, as the company benefited from the full quarter's worth of cost savings related to our restructuring actions as well as lower travel expenses given the current environment.

As Michael mentioned, with the demand expected to remain at depressed levels through at least the third quarter, we would expect third quarter operating expense to remain similar to the second quarter.

GAAP operating loss was $12 million for the second quarter of 2020 as compared with an operating loss of $4.9 million for the second quarter of 2019 as a result of the lower demand environment. Adjusted EBITDA was negative $5 million. Our GAAP net loss was $8.9 million or $0.50 per share.

Our non-GAAP net loss was $6.3 million or $0.36 per share for the second quarter of 2020 compared to non-GAAP earnings of $0.27 per share in Q2 2019. We continue to maintain a strong capital structure with a cash balance of $173.7 million and no debt.

In the second quarter of 2020, we generated $500,000 in cash, primarily driven by collections of outstanding receivables. This concludes our prepared remarks at this time. We'd be pleased to take any of your questions..

[Operator Instructions]. And we'll take our first question from Greg Palm with Craig-Hallum Capital..

I guess, firstly, looking back in the quarter, I'm curious what you saw maybe in the last 2 weeks of June, which typically the strongest part of the quarter? Was activity consistent with your expectations? Anything that surprised you?.

Actually, it was -- it accelerated. So we kind of left Q2 much stronger than we came into Q2. And you're right, seasonally, it gets kind of crescendo toward the end of the quarter, but we were surprised how strong the activity was in June in general, which I think is a real-- which we think is the real positive sign..

And any maybe geographies or end markets that really sort of stood out as from like a recovery standpoint?.

Yes. I think we saw China and Japan, relatively strong in -- at the end of June. Europe was I would say, average and North America was stronger. So we kind of saw Asia kind of bouncing back, and we were surprised by the strength out of the U.S..

Okay. Makes sense. Just kind of shifting gears on your go-to-market strategy.

I'm curious whether your views on this have maybe changed, whether these web demos can become a major part of the sales cycle, even in a post COVID world? Or do you think this is a temporary phenomenon? And I guess, if so, how might change the potential cost structure? When you might have a lot less travel expense and other expense that's flowing through the P&L?.

Yes, it's a great question, Greg. I think we do believe that this is a much more efficient way of prequalifying opportunities and having conversations that are more meaningful in person than we would normally do. I think as you recall, the company had previously been very much focused on the activity of doing demos almost at any cost.

And I think we believe that, that's not the correct approach. I think understanding where the customer is in the buy cycle. Introducing them to our products or our technology or our software, whatever the demand calls for. In a virtual environment, prior to actually spending the resources to travel to the customer we think is the most efficient way.

We are in the process of collecting data that verifies that, albeit this market environment is strange to say the least, but I do believe that having this capability has given us an advantage through this downturn. And we have taken full advantage of it. As we said, activity is up big time in terms of the virtual side.

We have actually closed orders from beginning to end virtually now. And I think if you were to ask us a year ago, if that was possible, I think most of the guys who have been here a long time would say, no, it's not possible. But I think we've now proven it is.

Will that be the norm going forward? Probably not, but we will absolutely leverage the virtual capabilities that we have in terms of prequalification go forward..

So I think, yes, from an operating spend standpoint, I think that will provide downward pressure, as Michael indicated. And at a minimum, though, it's certainly going to enable additional scalability to the model that we built..

And we'll take our next question from Jim Ricchiuti with Needham & Company..

Just, Michael, you mentioned the pickup in activity the last couple of weeks of June. What were the trends like or what have they been like so far in in Q3? And I know typically, you see a lot more of the activity later in the quarter..

Actually, the momentum has we do go through a seasonal cycle within the quarter, as you know, right, Jim? We're loaded toward the end of the quarter. And so we had a really weak March or April, May, right? And so we kind of crescendoed into June, which felt really good.

And we've seen a lot of build in the funnel, which is a good indication for us that demand is becoming real again and that there's visibility on when that's going to happen. We're nowhere near where we were in terms of the funnel size say, Q4 of 2019. So a lot of the funnel has been pushed out.

And as I mentioned earlier in the call, we don't believe that we've lost any share. And a lot of these projects have not been canceled, they've just been pushed out. So we're seeing now some of that funnel build, again, which is very encouraging for us. And the early trends are positive in Q3.

But again, we were going through a seasonal build as we do toward the end of the quarter..

And just speaking of seasonality, typically, Q3 has been a more seasonally weak quarter, but we're in a different world. And I don't know how to think of that Q3..

Well, typically, Europe takes a vacation in the August time frame. And so we've heard kind of anecdotally a number of different stories. Some customers obviously have been down for some period of time and have foregone shutting down during the summer months.

Others have actually -- some of the automotive guys have talked about extending vacations because of the low demand environment. So I'm with you. I'm not really sure what to expect in Q3. We do believe, and we've said this in the script that Q2 will be the bottom for us.

Q3 and Q4, we should crescendo out of it, but we don't believe that it is V recovery Jim. We think it's -- we refer to it kind of as a swish, if you will, in the context of Nike. We think it's going to be a gradual and steady build, hopefully, back to historical levels..

Are you guys seeing any change from competitors in terms of pricing? Or is this just such a weak market that the environment is such that no one's doing anything more aggressively from a pricing standpoint to win business that may not be there?.

Yes. I think the latter is true. We've not seen stupid pricing, and that's a technical term. We -- because, again, I think all of us realize, I'm talking about our competitors, a lower price doesn't create demand, right? And so I think at the end of the day, if demand is not there is not there.

But we are seeing an interesting trend where some customers, particularly smaller companies, are interested in buying certified preowned versus new. And so that's a trend that has really -- it's a new one, and we haven't really seen an update to say that it is a trend that's going to continue, but it's an interesting data point..

Okay. Last question for me, and I'll jump back on the care. You've Just -- you've talked about if the environment were to be weak somewhat on a more extended basis, that there was still some levers to pull, but you still think you could get to adjusted EBITDA breakeven at lower levels of revenue, in some cases, as low as $58 million, $60 million.

Is that still what you're looking at? Or have you rethought any of this?.

No, we haven't thought it. We have very detailed scenarios that say, if we thought, for example, that revenues were going to dip below Q2 levels and be protracted for some time, we have other things that we could be doing.

That said, I think the assumptions that we have made and our Board has made is that this situation that we're in today is a temporary one.

And so the objective is to optimize the company, continue to deal with the restructuring and finish it, continue to focus on new products and new solutions, which we're doing, and we've demonstrated in Q2 with the launch of 3 new products, but not cut to the bone just to cut to the bone.

Our objective is to come out of this when the market recovers, much stronger than we went in. And I think we've made a lot of progress toward that. So the objective for us and the management team is really kind of walking that thin line, Jim, between 1 quarter making big impact in terms of profitability and the long-term health of the company.

And we think we've walked that line pretty well..

And we'll take our next question from Andrew DeGasperi with Berenberg.

I just wanted to quickly asking a follow-up to Jim's question earlier on competition. I mean, you've undergone restructuring, some of your competitors, all have underresourced. I mean, one a big international one is undergoing one right now through the end of the year. You have also one in the AEC market that's doing that.

I'm just trying to -- wondering if you've seen any pullback from their perspective in terms of how -- we talked about pricing, but I'm thinking more in terms of the product refresh that they've had seen any kind of slowdown from that perspective?.

It's a great question. And I got to tell you, and it's anecdotal, right? We have a lot of data. So we track now. We're laser focused, no pun intended, on every opportunity that our salespeople have identified. And we use salesforce.com, and we basically track the funnel by sales guys.

So we're maniacally focused on truly understanding every customer's opportunities. And we've not seen pricing moves by competitors. We still see that our competitors -- but I must tell you the intensity is been different. And I would argue less than we have experienced, for example, in Q4 of 2019 from some of the traditional players in this space.

I can't explain that, I have no real data. I'm aware of the same thing you just mentioned, restructuring going on. And I'm not sure if they've -- if that's caused a slowdown in their selling activity. I'm not sure I'd understand how that could happened. But we have not seen, for example, a lot of new products from any of our competitors.

And that's why we took this opportunity in Q2 to really kind of double down. We're bringing 3, I think, very significant products to market. And the objective is to really do as much as we can to get our customers excited about these products so that when their demand environment returns, they're in place to actually place orders.

And so that's been our strategy, and we've executed to it..

Great. That's helpful. And I know you mentioned that earlier in the quarter that you disposed of 2 assets that were noncore.

Could you maybe let us know if there's anything else that right now looks -- well, maybe not specifically, but do you have any other assets that you might be interested in potentially exiting? And then maybe secondly, I know that you've mentioned in the past, the potential for some software releases coming up in the -- towards the end of the year.

Is that still the case? And what in terms of timing, should we think more at the end of this calendar year or early next year? Any comment on that would be great..

From a software perspective, it's actually -- that's ongoing. And yes, we will be releasing new versions of software almost on a continuous basis. So the answer to your last question is yes. We'll be continuing. And we are doubling down on terms of our investments in software. So that hasn't changed. If anything, it's intensified, and so yes.

As it relates to disposing of businesses, we have no other plans to divest of any businesses like the Photonics business or the open tech business. We're always looking at opportunities to optimize the company in terms of specific assets. But short term, we don't have anything on our radar that would affect, for example, Q3..

And we will take our next question from Richard Eastman with Baird..

Just a couple of things, Michael, is it possible you could just put a little bit of color around the three maybe business groups or end markets, 3D measurements or potential E&C and then public safety. And just did any of those performed less bad in the quarter.

And I'm kind of thinking about just where the funding comes from for these different end market buckets? And how quickly it could recover?.

Right. It's a great question. So our biggest market is 3D metrology, and we are aligned and have been aligned with the aerospace business and the automotive business. And they're going through some tough times.

The automotive business seems to be a lot of noise about recovery, et cetera, although I'm not convinced that their demand environment is going to drive a lot of capital purchases early or in the second half of this year, but we'll see. It's positive, positive signs.

The other big part of 3D metrology is really these smaller companies that are doing metal work of some sort. And in general, that demand, we've actually seen kind of resurge, particularly in America and in Asia. So that's a positive sign.

And that is when you talk about 15,000 customers, a big part of that 15,000 are these smaller businesses that are kind of spread -- machine shops or heavy metal working types of places.

And so that's kind of been our core, and we are seeing a lot of these smaller businesses coming back and projects being put back on the docket, which I think is very positive. Public safety was a nice surprise for us, and that seems to be coming back particularly in North America. So that's a positive sign as well.

I think during the early days of the pandemic, it was hard to get anyone's attention, if you will, talking about capital purchases in law enforcement. And I think that's changing, and I think we're kind of leveling out in terms of the new norm. The construction business, AEC, we are -- we're seeing signs of life in North America.

Europe has actually been surprisingly slow for us in the construction space, even though there are some construction projects going on, but I think that there's an apprehension to place capital. So through metrology driven by the metalworking seems to be on the mend and there's good signs in automotive.

Public safety seems to be coming back, and construction in America is making the right noise. So I don't know if that's what you were looking..

Okay, we need noise. We need more noise. Noise is positive these days. And just 1 other question maybe around the restructuring. I can't -- I think given the initial maybe restructuring commentary that you gave, I think you talked to $12 million to $22 million of planned restructuring kind of in a range. We're at the kind of lower end of that.

And I'm trying to maybe just gauge, what does the second half look like? And where is that restructuring targeted? Have you started to look at the footprint at all or taking any additional steps? Or is it still primarily focused around that headcount number?.

Well, pretty much the headcount situation is done. We had some lingering issues in some of the European countries where the government has mandated that you're not able to do any restructuring until a certain point. But the bulk, the large percentage of the headcount situation is done. I'll let Allen talk to where we are financially.

But I will say that we are planning on coming under the number that we announced in February, which was $75 million to $80 million of restructuring. When we're done, we'll be below that number in terms of cost of restructuring. And I'll let Al talk to kind of where we're at..

Yes. I think Michael characterized it right. So we had communicated $75 million to $85 million, and we think we are doing well relative to that number. As Michael indicated in his prepared remarks, our operating expense of $30 million -- almost -- just almost $38 million is a bit lower than we had guided to.

And so we feel very good about our cost structure and our ability to demonstrate that while we're continuing to manage the business and frankly, invest in the business in areas. And so as Michael indicated, we're pretty well done with that at this point in time outside of a couple of lingering areas that we'll continue to layer in..

[Operator Instructions]. And we'll go next to Ben Rose with Battle Road Research..

Just a question. With regard to gross margin, I wanted to, I guess, better understand the gross margin in the quarter, was there anything in particular that depressed it? And from a product standpoint, I'll start first.

And what do you think the key is to kind of revitalize it in through the second half of the year?.

Go ahead, Al..

Yes. I think the -- as we've indicated in the prepared remarks, really the reduction down into the high 40s from a gross margin standpoint for non-GAAP was driven by the reduction in revenue.

We have relatively consistent contribution margin across the product line and therefore, reductions -- and they're obviously higher than what our corporate average is. And therefore, as revenue comes down, gross margin comes down commensurate. Our success model of 55% to 60% remains unchanged at this point in time. That is our objective.

And at this point in time, our expectation is that when revenue rebounds into more historic levels, we will see a natural increase back up into the 55% to 60% range that we had been operating at for an extended period of time. As Michael indicated, pricing remains relatively steady.

We haven't seen any draconian efforts by ourselves, certainly, or any of our competitors that would have some sort of a permanent change to our gross margin. Anything from a mix standpoint would generally be more positive as we tend to focus more on software and solutions that have higher gross margins for us.

And so in general, I don't want to appear cavalier by any stretch of the imagination, we are not concerned about this 48% because of what I've just talked about in terms of really being just volume-driven..

Okay. Great. And then on the service side, I know that a big focus over the last -- in fact, more than the last year has been selling warranty service and having a pretty successful and high attach rate on that warranty service.

Were you able to continue that success even in this tough environment? And how does the outlook appear there?.

Yes. No, I think we've been very successful within terms of selling service contracts and our attach rate through this process. I think there are -- there's a phenomenon, particularly in smaller companies that are still working, but don't really have an understanding of what their demand environment.

They're taking advantage of this slower time and sending equipment back for certification and calibration. And that's -- we've seen that positive trend through this COVID environment.

I think when the demand environment gets back to where it was I -- for our customers, I think we'll see it return back to normal levels, but I think it's been positive through COVID..

Okay. Great. And then Michael, just to key in on something that you said with respect to the noise level on the factory metrology side. There's obviously been positive data coming out of some of these macro sources, the ISM, the federal, the Fed's book on industrial production and so forth.

And I'm wondering if your comments with respect to it being noise rather than substance has to do with kind of factories reopening for the first time. As if in getting things back online versus making new purchases of the equipment. And just wanted to get your thoughts on that.

When do you think we might see some of the purchase cycles for your products start to kick in?.

Yes. Well, I think we're beginning to see it now. And that's why we, in our script, we kind of said that Q2 is the trough, it's the lowest point, we believe. So the noise is positive. I think there was a lot of talk in the April, May time frame that the automotive guys, some of them were coming back to work, et cetera.

And I think there's a big difference between a factory coming back and starting to operate and guys going off and buying new equipment. There's a big difference, right? And I think new equipment is typically a sign of confidence on either capacity needs or a technology purchase.

And so we're seeing our funnel, again, and we're maniacally focused on tracking every opportunity our sales guys see. We're seeing the funnel building again, which is positive. And I think for a lot of the customers to pull the trigger and actually place an order, it really comes down to their end demand environment.

And I think automotive is a perfect example. There's a -- I don't know how many people are buying new cars right now. So I think that's -- I think as their confidence builds in the consumer and things start happening as it relates to activity, I think we'll see us returning back to where we were. The trends are positive.

And again, we're calling Q2 the trough..

And there appears to be no further questions at this time. I'll turn the call back over to Michael Burger for any additional remarks..

We want to thank everybody for your attention. We -- again, I want to reemphasize we're calling Q2 the trough, and we are better positioned today than we were a year ago to take advantage of that. 3 new products introduced this quarter, and we're continuing to focus on our solution strategy.

So we appreciate everyone's attention and look forward to talking to you next quarter. Thank you..

Thank you, and this does conclude your program. Thanks for your participation. You may disconnect at any time..