Good morning, everyone, and welcome to today's FARO Technologies' Second Quarter 2021 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 close, the company released its financial results for the second quarter of 2021.

The related press release and Form 10-Q for the second 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 industry projections or subsequent events.

Various factors could cause the actual result to differ materially. Some of these factors have been set forth in yesterday'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'll 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, welcome to our call. Demand for our products in the second quarter reflected a return to a seasonal growth and -- following the typically soft first quarter. On a geographic basis, the Asia-Pacific market and, in particular, China, performed well, while U.S. and Europe markets continue to recover, albeit at a slower pace.

With the second quarter improvement across our served markets, we continue to believe the demand environment will improve throughout 2021 as our customers' activities normalize. Taken together with our ongoing flow of new product introductions, we believe year-end demand levels will be similar to those experienced in the fourth quarter of 2019.

That said, we remain cautious as market uncertainties, such as the continuing softness in commercial construction starts, the prioritization of capacity expansion over quality control initiatives and the ongoing steps local governments take to combat the pandemic, may adversely impact the ultimate slope and the timing of our recovery.

We remain focused on laying the foundation for expanding the breadth and depth of our product offerings, while streamlining our operations to continue to capture the long-term opportunities ahead.

As discussed in our prior calls, FARO is in the process of transitioning to a marketing-led organization focused on understanding our customers' problems and delivering hardware and software solutions to meet their needs. As an example of these efforts -- an example of this effort could be found in our recently announced Quantum Max ScanArm solution.

Quantum Max was conceived by identifying our customers' need for both speed and accuracy. As a result, we have developed an advanced portable measurement solution, which features 3 purpose-built, hot-swappable Laser Line Probes, each of which offer distinct advantages for specific use cases.

The xR Pro provides 30% better accuracy and resolution for high-precision measurement tasks. The xS increases scanning speeds by over 65%, and the versatile xP offers a balance of the xR's resolution and the xS' speed.

Unlike prior physical arm solutions, the Quantum Max allows customers to swap laser heads on the fly, creating a versatile tool, which meets a wide spectrum of speed, accuracy and resolution needs in a single solution. This unique solution results in a productivity and value increase of over 30% compared to prior generation devices.

Another critical component, the ScanArm solution was the launch of our latest version of CAM2, our metrology software, which greatly improves scanning with our new laser probes. Through the combination of our new arm, probes and the latest software, we believe we've set a new standard in the industry for metrology-grade measurement solutions.

While we continue to introduce new solutions throughout the year, it's worth highlighting that between launching a workflow solution and generating meaningful revenue takes time. That said, we are very encouraged by our recent customer feedback.

In addition to our internal product development road maps, we continue to expand the breadth of our offering through acquisitions. Building off last year's ATS acquisition, which focused on high-precision digital twin applications.

In the second quarter, we expanded our capabilities with the acquisition of HoloBuilder, a leading photogrammetry-based 3D platform, which delivers hardware-agnostic image capture registration and viewing.

With an initial focus on construction management, HoloBuilder's platform provides general contractors a solution to efficiently capture and virtually manage construction progress using off-the-shelf panoramic cameras.

HoloBuilder's SaaS platform adds a fast and easy reality capture photo documentation and remote access capabilities to FARO's highly accurate 3D point-cloud based laser scanning to create an industry's first end-to-end digital twin solution.

The combined solution will provide a comprehensive scanning and image management capabilities for digital twin market aimed at robotic assembly simulation, construction management, facilities' operation and management and incident preplanning in the public safety market.

Ultimately, these digital twin capabilities will be brought into our soon to be announced cloud-based solution, which we call FARO Sphere, with this underlying subscription model representing FARO's future long-term software to market. Shifting to operations.

2 weeks ago, we announced the signing of an agreement to outsource our manufacturing to Sanmina Corporation. As the next step in our business transformation, we plan to transition FARO production from 3 manufacturing sites in Lake Mary, Florida; Exton, Pennsylvania; and Stuttgart, Germany to a Sanmina facility based in Thailand.

Following a rigorous selection process, we chose Sanmina as our partner based upon their proven ability to deliver quality products on the required timelines. Together, we are very confident in our ability to meet our customers' demand throughout this transition process.

Once complete, our new operational model greatly simplifies operations, reduces cost and allows our management team to focus on the development and sale of differentiated solutions to customers in our target markets. Allen will discuss the financial impact of these changes in a few minutes.

Taken together, these actions form the basis of our strategic transition, namely developing a deep understanding of our customer workflows, which allow us to further differentiate our capabilities in the marketplace, while at the same time, placing a solid operating structure in place to ensure incremental top line growth translates to greater operating leverage and higher shareholder value over time.

Finally, we announced the election of 2 new members to our Board of Directors. As previously disclosed, a key element of enabling our successful transformation is ensuring that we maintain the right experience set on our Board to help guide us. I am particularly pleased with the addition of Moonhie Chin and Alex Davern to the FARO Board.

They each have demonstrated success in leading hardware and cloud-based software businesses in markets that are closely aligned with our strategic direction. I very much look forward to their contributions as they officially join us on October 1. 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 revenue of $82.1 million grew 36% when compared to the second quarter of 2020 as a result of continuing market demand improvement compared to last year's market softness caused by the pandemic. Product revenue of $60.3 million was up 43% and service revenue of $21.8 million was up 19%.

Bookings of $88.2 million grew 44% year-over-year and were slightly ahead of revenue in the quarter, signaling a modest fielding of backlog. GAAP gross margin was 55.4% and non-GAAP gross margin was 55.7% for the second quarter of 2021. Gross margin increased year-over-year and sequentially largely due to volume increases versus prior periods.

Our second quarter material costs did not reflect inflationary pressures prevalent in today's market. That said, we do anticipate material cost headwinds to modestly affect gross margins in the near term.

GAAP operating expenses were $46.1 million and included approximately $3.6 million in acquisition-related intangible amortization and stock compensation expenses, and $800,000 in restructuring costs.

Non-GAAP operating expense of $41.8 million was $4.1 million higher than Q2 of 2020 as we continue to increase our software investments and as a portion of the travel-related expense savings realized during the pandemic began to return.

GAAP operating loss was $700,000 for the second quarter of 2021 compared with an operating loss of $12 million for the second quarter of 2020, primarily due to lower volumes in the prior year period. Non-GAAP operating income was $3.9 million in the second quarter of 2021 compared to an $8.1 million loss in the second quarter of 2020.

Adjusted EBITDA was $6.5 million or approximately 8% of revenue. Our GAAP net loss was $1.2 million or $0.06 per share. Our non-GAAP net income was $2.2 million or $0.12 per share for the second quarter of 2021 compared to a non-GAAP net loss of $0.36 per share in Q2 2020.

We continue to maintain a strong capital structure with a cash balance of $133 million and no debt. The second quarter decrease in cash was primarily a result of the acquisition of HoloBuilder for which we paid $34 million in cash.

With the addition of HoloBuilder and ongoing investments in our core software platform, our quarterly non-GAAP operating expenses is expected to increase to a mid-$40 million run rate.

As a result, to achieve our target model of 20% EBITDA margins, our quarterly revenue level has increased to $110 million versus the $100 million objective previously set. Given the long-term opportunities within the digital twin market, we believe these are the right investments to ensure future growth.

Offsetting this spend over the mid-term, we recently announced our plans to consolidate and outsource our manufacturing. The phased transition to Sanmina is expected to be completed over the next 12 months and result in approximately $12 million in annualized labor and material savings when complete.

We believe the expected savings will have a negligible impact on 2021, followed by steady improvement through 2022 with the full benefit to be realized in the first quarter of 2023. The company expects to incur a cash charge of approximately $6 million in the second half of 2021, primarily consisting of cash severance.

Total pre-tax charges of $15 million to $20 million are expected through the first half of 2022, when including the impact of facility and other asset write-down. With these charges, the company expects it will fully realize the $75 million to $85 million in restructuring charges announced in February 2020.

We're pleased in the continued end market demand improvement 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.

With the addition of HoloBuilder, our end-to-end solution for digital twin management positions us well to capitalize on this large and growing market. We have line of sight to completing the transformation of our cost structure with our new manufacturing partner, Sanmina.

Lastly, 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 expense, 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 at this time, and we'd be pleased to take any of your questions..

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

I guess, just starting off with the orders, it looks like orders outpaced revenue by a decent amount in the quarter. So was there anything supply chain-related? Or was that just simply orders received late in the quarter that weren't able to ship? Just kind of curious if you're seeing any kind of supply chain-related logistics issues out there..

Yes. We've experienced some. Yes, the order rate was back-end loaded for the quarter, and so we ended up basically pushing some of the booking over into Q3.

It's hard to say if that was really supply chain-related from a customer perspective, but we didn't -- we've seen some logistics issues throughout the quarter, but it really didn't impact the end of quarter revenue. It was more around when we actually received the order..

Okay. Makes sense. And Allen, I think you said something about elevated material costs.

I don't know if that was an impact at all in the June quarter, but how should we be thinking about that impact going forward?.

Yes. Greg, good question. Not much of an impact in the second quarter. We do expect to see some material increases in the third quarter. That said, we do have some opportunity to be able to pass those along to our customers.

And so as I indicated in our prepared remarks, we would expect some modest impact to our gross margins here over the near term, depending upon ultimately how the length and duration and depth in changes of these material costs.

But again, at this point in time, we think it's relatively modest, but maybe a little bit more towards the lower end of the range versus the middle of the range, which is where we've been operating..

Okay. Got it.

And then, in terms of the kind of increasing OpEx, some of the investments, I think most of us understand what the opportunity is, but maybe for those that don't, can you just go in a little bit more detail on sort of the excitement and opportunity around digital twin? Because it certainly seems like a kind of a theme that lots and lots of companies are starting to talk about?.

Yes. I think digital twin is a manifestation of, I think, many of our customers' desire to plan both facility changes or facility layouts or in some cases, in public safety, pre-incident planning, to be able to actually have a very accurate model in a virtual environment that allows you to plan. And I think, the better you plan, the less waste.

And I think we all know in the construction space and frankly, running factories, one of the biggest issues you have is how do you minimize waste? And digital twin is becoming a catch-all, if you will. And digital twin means different things to different people.

But our digital twin is a physical representation of the space and the ability to take that space and it's as close to accurate, as close to the truth as you can and then change it virtually and plan, all in the context of reducing waste.

It seems that it is, to your point, kind of a catch-all, but it definitely -- it's a conversation we're having with a lot of customers. A lot of customers that we didn't really anticipate having that conversation with..

Got it. That's interesting. And then, just last one. So the EBITDA 20% run rate with the revenue increasing to $110 million to achieve that.

What would that number look like if you were to be able to capture all of the savings from the manufacturing outsourcing? Would that number be closer to the number you've been alluding to in the past? Just sort of curious how that will affect that number once those are -- those costs are fully realized at those stages, I guess?.

Yes. It's a very good question.

And I think that the timing -- and you picked up on the nuance, right? The timing difference between the expenses coming on with the HoloBuilder acquisition versus our ability to be able to realize the savings with our outsource manufacturing does cause over the next, call it, 12 to 18 months, an adverse impact on our model.

I do think that there is a path towards getting to that 20% EBITDA on a lower revenue number or at the higher revenue number, overachieving the 20%, but we're not ready to commit to that just yet..

Our next question comes from Jim Ricchiuti from Needham & Company..

Question just about the seasonality that you're seeing -- you normally experience in this quarter. And I'm wondering if there's anything that you've seen in the first month -- and that may not be a fair question, just given how back-end loaded, typically the quarters are.

But is there anything that you're seeing that you might be able to share with us that give us a little better sense as to how the momentum might be entering Q3?.

Actually, we've started Q3 pretty -- in typical fashion as we have probably most quarters. We're typically back-end loaded within the quarter. And I think the concern that we all have around Q3 is typically the vacation -- the broad-based vacations that our customers are experiencing in Europe, which typically starts in August.

So the first part of the quarter is kind of as expected. But again, we're not really -- we traditionally see August kind of take a sideway step, and that's born out in our history, Q2 to Q3 over the last several years. So I think, started off pretty normal, and we're anxious to see how August stacks up..

Okay.

On the transition to Sanmina, Allen, maybe this is a question for you, is there any reason why as this process really gets going, you wouldn't see some or be able to realize some supply chain benefits just from some of their buying power? I know you're talking about seeing opportunities in '22 gradually over the course of the year, but I'm wondering how to think about just some of the supply chain benefits? At what point do they'd be perhaps take a more active role on that side of the business?.

Yes. It's a good question. And again, I think, as we've articulated the savings opportunity, we have indicated that there's both a labor and a material component. As everybody knows, our manufacturing has been centered in a couple of locations in U.S. and one in Germany. And the supply chains for those manufacturing are localized to those facilities.

So as we move more towards a Sanmina, Thailand-based facility, there is an opportunity, absolutely, to enhance the supply chain from a cost standpoint, at the same time, leverage Sanmina's purchasing power.

So we do think that there is an opportunity for decreased material cost savings as time goes by, and that's built into the numbers that we've been talking about, Jim..

I would also....

Okay, but not necessarily ahead of the move to Thailand.

You really need to be there with them before you're really able to realize some of that buying -- the purchasing power that they have?.

I think that's correct, yes..

I would say from a cost perspective, correct, but Sanmina has already begun to help us in some of the hard to source materials. They've helped us in advance of actually the announcement in anticipation thereof. They've been a big help.

So we're excited about what we think they can do, maybe not for -- not short term in terms of better pricing on materials, but really access to materials..

Got it. And then, just a question on the initiatives you have underway to build out the recurring revenue on the software side.

Are there similar deals out there to HoloBuilder that you see? Which areas actually hold the most interest for you?.

I think, we -- having the ability to actually capture whatever the truth is and the truth is the actual measurement. We -- there are technologies out there that we're looking at, nothing that's burning a hole in our pocket at this juncture.

But there's quite a few companies that are kind of getting into this space, if you will, from a software perspective or a algorithm perspective that speeds up either our processing or as in HoloBuilder's case, adds a completely different technology that we didn't really have commercially.

So we're looking at all of those, Jim, but again, there's nothing burning a hole in our pocket right now..

Okay.

And Sphere on track, when should we think about this launching? And how should we think about it looking out to next year?.

Q4 is our current schedule. And I think -- as I've said, I think it will be a slow ramp from a revenue perspective as we sign up subscribers. So I would expect very much to -- probably toward the end of 2022, where we can actually start pointing to, I think, meaningful revenue impact.

That said, coincident with the launch of Sphere, we'll begin to break out our recurring revenue for you guys so that we're talking about it, and you can track us on it..

Take our question from Andrew DeGasperi from Berenberg Capital..

I had a quick one on HoloBuilder. I know you said in the -- when you announced acquisition that was generating a so -- $4 million or so of revenue per year, and it's growing on a compounded annual basis at 75% since 2019.

Just curious to know, like, with the integration, should we expect that high level of growth to continue, if not even accelerate as you potentially look at other use cases for that asset?.

We expect the growth rate to continue on its current trajectory. I don't think we're planning on talking about accelerating that at this point. It's early days for us. We've had it under our belt here for just about 6 weeks. So we're still learning from them.

We're very excited by what they offer, and we're extremely excited by the feedback that we're getting from their customer base, which we have some overlap, but frankly, they brought a different customer base to us. So the feedback that we're getting is fantastic.

So we believe that we should be able to continue the growth rate that they've already experienced..

That's helpful. And I guess when it comes to the Q4 revenue number, I think that, that's a quarter that you expect to actually reach back to what we would consider a normalized rate.

Is that still kind of the plan based on what you're seeing in the market? Or should -- has that changed at all? Or do you think that the issues that you mentioned earlier potentially in localized locked up and think that may impact that?.

Well, I think we're optimistic. I think we've said publicly, we're not really giving guidance, but what we said is we would be disappointed if we weren't back at those levels. I don't think things have fundamentally changed with perhaps the supply chain shortages.

And supply chain shortages may not necessarily affect our ability to ship product, but more our customers' ability for them to ship their products and, therefore, maybe dampen their appetite to buy capital. That's our concern. The supply chain situation is real.

And while I don't see it coming to an end in the next quarter or 2, our sales force is very optimistic about customer demand in general. And as we said in our script, our new products are really beginning to gain traction. So we're -- everything is headed the right direction. It's just -- it's been a pretty -- it's been a crazy year.

So we're just -- we're cautiously optimistic, how's that?.

That's helpful. And I guess the last one I have and just a follow-up to Jim's question in terms of the Sanmina, I guess, transition.

Do they have a better supply chain, like access to [indiscernible] from materials perspective than what you would have had with your own 3 sites?.

Absolutely. And I think Allen alluded to it. FARO had not really integrated many of the supply chains that were attached to each of the factories -- to each of our factories. And as a result, we weren't really even internally gaining any buying power, if you will, by consolidating our internal demand.

By transitioning to Sanmina, not only do we get their manufacturing expertise, but we actually get to leverage their supply chain. And as I mentioned to Jim, we've already seen some benefit of that even prior to the announcement in helping us source some hard to get material.

So we're very confident that they'll be able to help us on the supply chain side. In this environment, however, where supply is really tight, you're really not talking about getting price reduction, you're more talking about getting access to materials. And that's where Sanmina has helped us short term.

I think long term, they should be able to help us with cost. And the way our contracts are written, they're very motivated to help us with cost. It's a big part of the -- of their business model and that industry's business model.

So we're very -- I think, we're very fortunate to have Sanmina, and we're looking forward to a streamlined and probably healthier supply chain than we currently have..

[Operator Instructions] We'll take our next question from Rob Mason from Baird..

Michael, if you think about where your targets may be -- may reside for getting back to these 2019 levels by the fourth quarter.

I'm just curious, in terms of your sales force and its productivity level, how much capacity does the existing sales force have beyond that level? Or do we need to consider adding more resources once you get back to, call it, $100 million a quarter or type revenue level?.

We don't believe that we need to add sales to get to the $100 million, and we're feeling really good about our productivity metrics of our selling organization as we kind of come out of the COVID situation. I don't anticipate that we would need to add any dramatic resource much beyond, I would say, probably the $130 million to $140 million a quarter.

So I think, we've got a lot of gas in the tank, if you will, with our current sales force. What's -- it's the demand environment that's precluded us from getting to those levels. I don't believe it's the number of salespeople..

Okay, okay.

Just on that point, I mean, could you offer some perspective on how you're seeing the 3D metrology versus your AEC markets perform as you came through the second quarter and into the third, any distinctions either by geography or again between those 2 key markets that you'd call out?.

Yes. We've seen the automotive space recover a bit, which is very encouraging. 3D metrology in Asia, I think, we've been underserved in that market, and so we've seen a really nice gain, if you will, particularly in China in 3D -- led by 3D metrology.

I think, North America, other than automotive, is been slower than we'd hoped in -- particularly in some of the smaller machine shops, which provide a long tail in terms of the number of customers that we have. So it looks like the big guys are buying again, maybe not at the rates they were, but they are buying again, which is super encouraging.

In Europe, we've seen 3D metrology bounce along. We haven't seen a huge recovery yet, and we're hopeful that will be a driver for Q4. So summarizing 3D metrology in general has been slower than, for example, in 2019, but we're seeing nice signs of recovery..

Just within AEC, you had made a reference to commercial construction starts.

Is that still maybe the trigger point for uptake on the AEC product? Is the new starts comes at the front end?.

We believe so. Many of our customers actually buy capital based on the project that they are actually working on. So they actually build out our -- or charge against the project, some of the equipment costs that they buy from us. And so as new projects start, there's opportunity for us to actually add equipment.

But it's been relatively slow, particularly in commercial. We don't really participate as a company much on the residential side. That's changing, albeit it's relatively small. So really, commercial starts is really kind of, I think, should be the bellwether for us. Hey, congratulations on your new position..

And it appears that we have no further questions at this time. I will now turn the program back over to Michael Burger..

Well, we're excited. We're very pleased with where we are in terms of momentum, and we're making a lot of progress to our stated plans. So we appreciate everyone's interest and look forward to giving you an update next quarter. Thank you..

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