Good afternoon, everyone, and welcome to the FARO Technologies' Fourth 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 afternoon. With me today from FARO are Michael Burger, Chief Executive Officer; and Allen Muhich, Chief Financial Officer..

Today, after market close, the company released its financial results for the fourth quarter and full year of 2021. The related press release and Form 10-K 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 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. .

Thank you, Mike. Good afternoon. Welcome to our call. Our fourth quarter demand continued to improve throughout the quarter, which enabled reported revenue to grow 27% sequentially and 8% year-over-year to approximately $100 million despite a strong dollar exchange rate and supply chain challenges, which muted our overall revenue level for the quarter.

We remain encouraged by our demand recovery, the strong market acceptance of our next-generation Quantum Max ScanArm and the traction we're seeing in our Holobuilder software application targeted at construction and facilities management..

In addition, in the fourth quarter, we're pleased to have demonstrated the operating leverage that's been built into our business over the last few years. Our reported 14% fourth quarter EBITDA margin is nearly twice our historical profitability on similar revenue levels.

We expect to see additional profit upside as demand continues to recover, and we approach our stated success model of 20% EBITDA margin on roughly $110 million of quarterly revenue..

Since our launch in July of 2021, we have continued to receive extremely positive customer feedback and a wide acceptance of our new Quantum Max ScanArm across nearly every geography.

As a result, fourth quarter volumes increased 43% sequentially as customers realize greater value from the speed, accuracy and versatility of the Quantum Max, which dramatically increases their productivity in metrology grade scanning applications.

We are seeing signs of accelerated legacy tool replacement as well as customers new to FARO, embracing our differentiated solution.

We view this as a positive indicator and validates our strategy of nearly -- of early customer engagement to better understand their needs, leading to differentiated solutions that generate higher customer value and additional product demand..

Also in the fourth quarter, we continued to see strong demand for our photogrammetry based solution, which we acquired through the Holobuilder acquisition in June of 2021.

Holobuilder's unique workflow, which combines hardware agnostic image capture, artificial intelligence-based task automation, along with an easy-to-use time-phased image viewer, delivered via a SaaS business model has a wide-ranging application across a broad set of markets.

We are initially focusing on construction and facilities management markets, but expect to broaden our focus as capabilities in this area continue to expand and mature..

We continue to believe there is a large untapped market potential for FARO's technology that combines our long-held high-accuracy laser scanning expertise, along with Holobuilder's easy-to-use photogrammetry based solution.

Bringing these capabilities together into the FARO Sphere, our soon-to-be-released cloud-based platform is an area where we are placing increased levels of focus and investment as we believe together with our other software applications form the tip of the Sphere for FARO's broad digital reality offering into the Metaverse.

The market potential for digitizing the physical world is enormous, and we're excited our technology and expertise position us well over the long term..

Illustrating the potential for this solution, in the fourth quarter, we signed a mid-6-figure annual recurring revenue deal with one of the world's largest retailers, who is deploying Holobuilder across all U.S. stores as a part of a new space management initiative.

As a frame of reference, the single recurring revenue deal with a 3-year term is FARO's largest single transaction in the last 3-plus years. Even more exciting is the magnitude of the potential applications we are just beginning to explore..

Last quarter, we indicated our first set of capabilities with FARO Sphere have begun customer beta testing. Those tests continue to go well, and we expect to have formal product announcement in the second quarter of 2022.

We believe our strategic transition to 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. We are encouraged by the underlying market demand for our products.

And while we expect to experience typical seasonal softness in the first quarter, we believe the combination of new product introductions and the launch of FARO Sphere will strengthen demand as we move through 2022..

Before Allen provides an overview of our fourth quarter financials, let me provide a brief update on our manufacturing outsource initiative with our partner, Sanmina. Our 2 teams have been working exceptionally well together, and the foundation is set for the manufacturing transition to be complete by the end of the first half of 2022.

We continue to believe in the long-term financial and operational benefits we previously outlined and expect to realize $12 million in annualized savings, primarily from supply changes. That said, today's unprecedented supply chain environment has resulted in short-term material cost headwinds and delayed long-term savings..

With that, I'll turn the call over to Allen for an overview of our fourth quarter financial results. .

Thank you, Michael, and good afternoon, everyone. Before I discuss the first quarter -- fourth quarter results in greater detail, I'd like to take a moment to highlight 2 new metrics we are introducing this quarter.

As we continue to emphasize, our current software and solutions offerings and expand our platform capabilities with both organic and inorganic investments. We believe both software revenue and recurring revenue will become increasingly important investor metrics.

As such, beginning this quarter, we will report both software and recurring revenue, the latter of which includes software subscription and software maintenance revenue as well as the recurring portion of our hardware repair contracts..

For fiscal year 2021, software revenue was $45.1 million or 13% of total revenue and recurring revenue was $64.1 million or 19% of total revenue.

While as a percentage, software and recurring revenue may increase or decrease from quarter-to-quarter due to the seasonality of our hardware revenue, on an absolute dollar basis, we expect both revenue types to continue to grow at accelerated rates over time..

Turning to the fourth quarter, revenue of $100.2 million grew 8% when compared to the fourth quarter of 2020 as a result of continuing market demand improvement compared to last year's market softness caused by the pandemic. On a year-over-year basis, hardware revenue of $64.7 million was up 8%.

Software revenue of $13.7 million was up 14% and service revenue of $21.8 million was up 3%. Recurring revenue of $16.5 million was up 10% when compared to Q4 of 2020. Partially muting our revenue performance was a strong U.S.

dollar as well as limited material availability that prevented us from shifting all the 3D metrology demand customers placed on us..

GAAP gross margin was 55.6%, and non-GAAP gross margin was 55.8% for the fourth quarter of 2021. Gross margin increased year-over-year, largely due to volume increases with prior periods -- from prior periods that was somewhat offset by material cost increases resulting from today's inflationary pressures.

Given the ongoing impact of inflationary pressures on material costs, we continue to expect to operate near the lower end of our stated success model of 55% to 60% gross margin with some quarters depending upon revenue levels, dipping below the low end of the range.

GAAP operating expenses were $51.8 million and included approximately $4 million in acquisition-related intangible amortization and stock compensation expenses and $3.7 million in restructuring costs..

Non-GAAP operating expense of $44.2 million was $1.3 million higher than Q4 of 2020 as we continue to increase our software investments, both as a result of our Holobuilder acquisition as well as our organic initiatives and as a portion of the travel-related expense savings realized during the pandemic return..

GAAP operating income was $3.9 million in the fourth quarter of 2021 compared with an operating income of $2.7 million in the fourth quarter of 2020, primarily due to fourth quarter 2021 revenue growth..

Non-GAAP operating income was $11.7 million in the fourth quarter of 2021 compared to $8.1 million in the fourth quarter of 2020. Fourth quarter adjusted EBITDA was $14.2 million or approximately 14.2% of revenue..

Our GAAP net loss was $31.7 million or $1.74 per share, which included $27 million of income tax expense that resulted from the creation of a valuation allowance against deferred tax assets, that was required given our 3-year cumulative U.S. loss position that resulted from historical restructuring charges..

Our non-GAAP net income was $8.7 million or $0.48 per share for the fourth quarter of 2021 compared to $6.3 million or $0.35 per share in Q4 of 2020. We continue to maintain a strong capital structure with a cash balance of $122 million and no debt. Our accounts receivable balance increased nearly $20 million sequentially compared to last quarter..

In closing, we're pleased with our fourth quarter financial performance. We returned to 2019 Q4 revenue levels when adjusted for currency and material availability challenges, and we have nearly doubled our underlying profitability on similar historical revenue levels.

The initial commercial success of our Quantum Max has exceeded our expectations, and we've made significant progress on our vision for leveraging FARO's differentiated technology to capitalize on the enormous potential of the digital reality market. We closed a meaningful Holobuilder deal with a large retailer customer.

This proof point of the broad applicability of this solution into the metaverse positions us well to double Holobuilder revenue over the next 12 months. We're providing investors greater transparency in our performance by reporting both software and recurring revenue levels..

And finally, those of you looking carefully at the press release, will note the inclusion of first quarter guidance. In the spirit of providing greater transparency to not only past performance, but future performance as well, this quarter, we will begin providing quarterly guidance on revenue and profitability.

In the first quarter of 2022, we expect revenue of between $80 million and $88 million and non-GAAP earnings per share of between negative $0.08 and positive $0.12. Note that included in our first quarter expectations are approximately 200 basis points of unfavorable material cost that are adversely affecting gross margins.

While we do not intend to provide annual guidance, we do continue to expect our revenue seasonality to approximate historical patterns..

This concludes our prepared remarks. And at this time, we'd be pleased to take any of your questions. .

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

I wanted to start with Q4. You mentioned supply chain impacts. The book-to-bill wasn't that far off of 1, and it was actually quite a bit lower than kind of your long-term average in Q4. So I just wanted to kind of better understand your comment of maybe inability to ship some products in the quarter. .

We had back -- we basically had backlog, we couldn't ship primarily due to the fact that mix had changed throughout the quarter. And we felt like, as you know, we had some backlog pushing into Q1 or pushing into Q4 from Q3.

So we were able to ship that, but we had upside associated with the end of the quarter, and we weren't able to actually capitalize on it. Not all of it was booked in the quarter, because we couldn't ship, it wasn't booked all in the same quarter, but now actually, we've since booked it and reshipped it. So it's -- it was a timing issue, Greg. .

Got it. Okay. That makes more sense. And as you kind of think back on the quarter, I guess, what stood out to us maybe from a geographic standpoint was looks like EMEA or Europe look pretty weak again relative to the other geography.

What do you sort of -- I guess, maybe broader, what are you seeing geographically? And what are you seeing from like an end market perspective?.

The effect that we've seen in EMEA was largely due to 1 market segment, which was AEC. Many of the construction -- many of the GCs that we're doing business with in Europe have basically had issues in terms of coming back to work, et cetera. So the AEC market in Europe was really what drove that miss in Europe.

Also, when you compare it back to last year at the same time, Europe had a killer quarter. So I think it's a mix of both, but frankly, it's primarily driven by the weakness in the AEC market in Europe. North America has recovered very nicely in actually all 3 market segments. And Asia, as we talked about last quarter, is just continuing to just roar.

So we're very excited by that. We've got signs that Europe's recovering, and we're hopeful, but we still got very close to our number despite the weakness and that was driven and offset by the strength in China and the strength and recovery of the 3D end market in North America. .

The other thing I would add, Greg, is the comment around the strong U.S. dollar would affect primarily the EMEA market as well. So that's another contributor to kind of some of the optics there. .

Yes. No, that's a good point. And then, Allen, on the gross margin comment, just to be clear, is the 200 basis points off of what you did in Q4 or off of what you would normally do on a seasonally lower quarter.

And should we expect that impact to mostly come in Q1? Or will that linger on to future quarters?.

It's a comment that is an absolute number. So it's what we expect on an absolute basis, not relative to what we just delivered in the fourth quarter, i.e., between the lines, there's a little bit included in -- there's a reasonable amount of it also included in the fourth quarter.

And it's more meant to help guide you relative to that 55% to 60% range because that did not include any of that material headwind. .

Okay.

And is it going to linger on past Q1?.

Yes. On a serious -- we've not seen it. We've kind of dodged the bullet, I would think, for 2020 and most of 2021. It kind of bit us in Q4 of 2021. And it's -- I think it's getting worse. I don't think it's getting better. And it's very much like whack-a-mole. When we have a problem in a particular commodity, we end up working it out.

But we continue to be surprised by new shortages and commodities that we thought we recovered. So our supply chain team, ops team, coupled with the Sanmina team have done a phenomenal job to keep us kind of hold to this point. But I'm -- I've never seen it this bad, Greg. It's very concerning. And I think hence our cautious guide associated with that. .

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

Just on that last point, Michael or Allen, are you -- as you look at the material costs coming up, are you taking any pricing actions? Have you taken any, or you're considering?.

We have taken pricing actions as it relates to some of the new products that we've introduced. We are considering revisiting particularly based on what's happened to us in Q4.

So we are looking at -- seriously looking at how do we actually offset some of this price increase through -- pricing increase that we're seeing from the supply chain to our customers. I will say I'm cautious about it because, frankly, we've got a lot of growth opportunities, and I would rather take share.

And that's been kind of our guiding principle through 2021. But the rate at which these prices are coming at us now, we may not have a choice. We may end up having to pass it on. And so we -- grudgingly, we are looking at it. .

Are you seeing any pricing actions from your major competitor as a result of some of the pressures that are out there, are they're seeing the same thing?.

It's spotty. I wouldn't say that we've seen one of our larger competitors kind of wholesale just raise prices. We've seen them on certain deals and particularly through different channels. So no, we've not seen kind of a wholesale move. And I think that's probably a prudent way to do it as well.

There are some markets that can accept a change better than others, and particularly based on certain products and certain applications. And that's the process that we're in right now is reviewing that. .

Got it. I wanted to turn to the win that you highlighted with Holobuilder, congratulations on that. Is there any color you can provide in terms of either -- of number one, the type of retailer. And what's the sales cycle like in a deal like this? This is -- presumably, I may have missed some of the commentary, an entirely new customer. .

It's an entirely new customer, a customer that FARO has never done business with traditionally. It is a large retailer, and I can't really -- I'm not allowed to divulge from. The application is they are looking at all their U.S.

facilities, and they've got different facilities in different stages of use, and they're looking at either relaying out, remodeling or building completely new and they're using Holobuilder as a methodology of one, taking status of what the current facilities are.

And so Holobuilder's a very easy to use, almost intuitive software package that allows you to document what you currently have..

And then through the software enhancements that have been made, it also allows you to track the progress of the changes that you decide to make within that facility. So the sales cycle for an enterprise company like this is relatively long. It is probably 9 months to a year in terms of pilots and trials, et cetera.

That said, as an individual, we could get you up and running on a Holobuilder application in the span of 2.5 hours. So as an individual, it's very quick. But as you can imagine, for a large enterprise company that's using this as kind of a standard for all their facilities, it's a longer sales cycle.

Did that answer your question, Jim?.

Yes, it did. And when you mentioned facilities, it's not clear we're talking about distribution centers or stores. It sounds like you're talking about distribution centers, but I may just... .

No. No, no, we're talking about, in this situation, stores. .

Okay. Got it.

Is this -- is there a pipeline that you might be able to develop and leverage off of this win?.

Absolutely. And why we bring it up and we don't normally talk about it in this level of specificity. But I think the market is, I think, very ripe for the operational maintenance side of the world to embrace this digital technology. And we've got some new competitors in this space, companies like Matterport, companies like NavVis. The market is massive.

And many companies have not really made the switch to a digital management, cloud-based management of their facilities digitally.

And I think we're really -- I don't believe the market has hit a tipping point, but I think we are well positioned, and we do believe that we need to develop both a construction management pipeline for Holobuilder as well as the ownership operation and maintenance side of it. So we're very excited about it..

I think it's early days for us. We are expanding the team. We're expanding the development resources behind the team. And we are working diligently to get our current the legacy FARO selling organization up to speed on how to actually sell the product. So it's a lot of activity and early wins. It's encouraging. .

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

Just wanted to maybe quickly ask on first the Holobuilder. You mentioned earlier that you were thinking of expanding to new areas.

I'm wondering if -- do you think like the 3D metrology area -- space or do you think there's areas beyond the -- that's your -- the 3 that you're normally involved in?.

No. Well, I do believe the O&M space is an area where we had not participated in at FARO. When I say not, in the context of FARO traditional.

So the building ownership, the property owners, this is an amazing tool for them to, one, timestamp changes that are happening in their facility, a great way to do inventory, a great way to actually put it into a digital format, a virtual view of their building. All of that is new. And I think we've not participated in that space at all.

And that's why we highlighted the win that we did because it's an example of that..

Other areas that we're looking at, we're exploring Holobuilder in public safety because we think that there are -- it's a great way to document and timestamp changes in both crime scenes, changes in terms of facilities, in terms of event preparedness. So we think that there's some applications in public safety.

The digital twin market, particularly in the 3D metrology market, I believe, is ripe for this for us to be able to do a very high -- ultra-high definition scan with our laser scanners and then to be able to overlay these photogrammetry images as a way of actually documenting changes to the facility that's done both on top of the bend drawing as well as on top of the high-definition scan.

No one can really do that. And we're -- I think we're uniquely positioned to do that. .

That's great. And then just on the quarterly guidance. Obviously, Jim was hounding for it.

But I guess the question would be today is, has visibility improved to a degree that you now feel comfortable in providing it? What's like changed as of the fact that you now have a recurring -- a base of recurring revenue, which gives you that comfort? Or is there something else that kind of gave you that -- exactly that comfort to issue that guidance?.

Well, I don't think visibility has changed much. I think we still start a quarter with not a great deal of backlog. That said, if you look at our track record as it relates to where -- how we've been able to forecast our business, and I think it ends up basically being relatively predictable.

Certainly, there's a plus or minus 10% spread based on what's happening in the market. And certainly, nobody saw COVID coming, and we certainly didn't..

That said, I think when you look historically at our seasonality, particularly in the hardware side of it, I think we're feeling comfortable that we directionally can tell you where it's going to be.

As reoccurring revenue continues to grow, obviously, that gives us more and more confidence, particularly as it relates to what we're starting the quarter with. It's early days for us, as you can tell from the numbers that Allen 's talked about.

But we promised that as we get close to launching Sphere, we'll be much more transparent about our software, our recurring revenue, et cetera. And this is a per substantiation of that. I don't think we could be more transparent without giving guidance. .

Right. And that helps. And maybe just a follow-up on Allen on the metrics you gave. And I guess you talked about before that the -- exiting '22 with 25% recurring level. The software growth, if I remember correctly, you said it was 13%.

Just wondering if any -- I assume if Sphere launches, we should expect some acceleration, or was this something in Q4 that we shouldn't assume as a trend line at this point? In other words, is this kind of -- was this just a really excellent quarter? Or was it some -- is this potentially like your base level of growth as that part of the revenue grows in size?.

So I think twofold. One is that I think you're absolutely right. When Sphere comes live, we absolutely expect a knee in the curve from a software and recurring revenue growth perspective. At the same time, Michael spent a lot of time talking about Holobuilder.

I think we expect the Holobuilder revenue to continue to grow at a meaningful level as we make some of the investments that he referred to. And I think those are -- again, those are the 2 points that I think we would point to. There was nothing extraordinary about the fourth quarter in terms of software content or recurring revenue content.

And so that's a good base from which -- for us to grow from given those 2 vectors. .

And we'll take our next question from Rob Mason with Baird. .

Just 1 clarification around the guidance. The low end of your revenue guidance, the $80 million, would be directionally down seasonally, but maybe at a steeper rate.

Does that -- would that assume primarily supply chain challenges? Or I'm just curious maybe what your thoughts around book-to-bill would be at an $80 million level?.

Well, we don't typically forecast publicly our book-to-bill. I would expect our book-to-bill to be positive even -- certainly at $80 million, but I would expect it to be positive for the quarter.

I think the supply chain, it affects us certainly in our ability to generate revenue, but it also -- it has, in many cases, affected our customers' willingness to buy capital because as they're going through supply chain issues, it also meets their revenue.

And so this conservative approach from our customers around them buying discretionary capital has had an effect. In fact, I think it was the primary effect through the COVID situation. So it's kind of a double whammy.

Certainly, it affects us to -- affects us on our own ability to actually generate revenue, but it also affects our customers' confidence around placing capital buys..

And we still are very much from a hardware perspective, a discretionary capital spend. And so we're just having to deal with that. And as I said, for us, personally, Q4 was probably the worst quarter that we've had to endure since COVID in terms of supply chain issues, and they're not over, and they continue to kind of move in terms of commodity set.

I believe our customers are battling with that same effect. .

That kind of feeds into my next question, Michael. I just wanted to get maybe some clarification. It sounded like though, I think of that dynamic that you spoke of being more pronounced in your 3D metrology business, at least from the customer perspective. But it also sounds like you're very pleased with the performance there.

Obviously, new product help, but how would you rate the -- just the overall backdrop there as well as in your other 2 verticals? I know you mentioned AEC in Europe, but public safety as well. .

Well, I think from a parts shortage perspective, 3D metrology customers, the manufacturing customer base, would probably be hit first and hardest. And as you know, that's our largest market segment.

AEC, there has been shortage, but primarily, the issue that we're hearing, particularly in Europe around shortage has been around labor and their ability to hire for the jobs at hand, and that's been a big issue for many of our GCs in Europe. .

Public safety is less impacted. And frankly, we're seeing really nice traction in public safety, both in North America and Europe -- or North America and Asia. So yes, I think the manufacturing side of the house, which is where our 3D metrology applications are, will be hit hardest..

We are pleased -- just to finish, we are pleased with Quantum Max, and I do believe that because of the value that it brings compared to what's available in the market, we've seen -- actually, as we said, I think in our script, we were -- it's exceeded our expectations, which is fantastic.

But as you know, I think 3D metrology specifically was hit the hardest during the COVID situation. And so I'm cautiously optimistic that what we saw in Q4 will continue throughout 2022, but it really took us by surprise. It was a very positive experience. .

And Allen, you mentioned the savings around the Sanmina transition would be pushed out.

Any thoughts on when you can get to the $12 million run rate?.

I think it's a hard thing to predict simply because of the uncertainty in the supply chain environment. And I think that as we've commented on earlier, there will be some savings. They're coming from a higher level, and we're trying to net all of that out into some of the numbers that we're providing.

And so again, when will we get to the level that we had anticipated will depend a lot on the environment, and that's pretty uncertain at this point in time. .

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

Michael, question for you regarding the commercial aerospace market. There's been a lot of discussion around the great space race and specifically projects that are ongoing at various manufacturers.

How much has this segment been a contributor to the bounce back on the Arm side?.

Quite a bit. Quite a bit. We're actually very pleased to see it coming back. Actually, it's come back stronger than we anticipated, which is positive. And I think in many cases, some of the subcontractors are at production capacity. So we're helping them out with expanding capacity, which is a great opportunity for us.

But yes, it's been really positive, Ben, and it looks like it's roaring right now, both in North America and in Europe. .

Okay. Great. And you made a comment, I guess, a couple of quarters back with respect to the automotive sector, and that you were seeing a lot of investment in terms of capacity expansion, line expansion, but not so much on the offline -- in terms of offline inspection.

Are you seeing that pick up a little bit in the automotive sector?.

It's -- I think it's still muted from where it was in 2019. It is not as robust as what we just talked about in terms of commercial aerospace. But there are a lot of expansion plans, we've all read about them. And I think that bodes well.

Many of them have not started yet in our plan for the end of 2022, so we're hopeful that we'll get our unfair share of that, particularly based on some of our new product offerings. So we're cautiously optimistic, but we haven't actually seen it yet. It was not a huge part of the Q4 recovery. .

Okay. Great. And then just a quick question for Allen, since you're opening up so much on guidance, which is nice to see, unprecedented for FARO, but definitely great to see.

Any thoughts on tax rate for 2022 for modeling purposes?.

Yes. On a non-GAAP basis, we still expect to be in that 20% to 22% range. .

And it does appear there are no further questions at this time. I'll now turn it back to Michael Burger to close this out. .

Thank you very much. We appreciate everyone's attention, and we're excited about giving you updates next quarter. Thank you. Good bye. .

This does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful evening..