Afternoon, everyone, and welcome to the FARO Technologies' First Quarter 2022 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 first quarter 2022. The related press release and Form 10-Q 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 Burger. .

Thank you, Mike. Welcome to our call. While broad-based demand across our served markets remained healthy in the first quarter, several headwinds impacted our performance driving results below our expectations. As many of you are aware, at the end of the first quarter, the Chinese Government mandated a COVID lockdown throughout the Shanghai area.

Shanghai is FARO's lone logistics hub for all Chinese shipments..

As a result, the lockdown prevented the shipment of booked orders at the end of March. This lockdown, which was originally planned to last one week, remains in effect today and continues to challenge both our own logistics operations as well as those of our Chinese customers.

Ultimately, these disruptions could potentially last into the second half of 2022 or beyond. Our logistics operations teams are continuing to work on short-term plans to mitigate this situation..

Beyond this specific challenge, in the first quarter, supply chain constraints and component shortages continue to impact our overall material availability, limiting the amount of inventory of certain goods we had available to ship. Our supply chain team continued to work hard to mitigate disruptions.

However, at this point, we expect these challenges to continue to impact second quarter shipments..

Lastly in the first quarter, we experienced softer than expected demand for our previous generation laser scanner, particularly in the European AEC market, brought on by anticipation of our launch of a new laser scanner..

Despite our overall disappointment with our first quarter revenue and profit performance, we remain excited about the continued progress toward our long term strategic goals.

Our manufacturing outsource initiative with Sanmina remains on track as we have now moved manufacturing of both our ScanArm and Laser Tracker product lines to Sanmina's Thailand facility. All future shipments of these 2 product lines will now be sourced from Sanmina and shipped through our existing logistics center..

We have stopped manufacturing activities in both of our U.S. sites as of the end of Q1. We expect to complete this transition of the remaining laser scanner product line by the end of this current quarter.

We continue to believe in the long-term financial and operational benefits of this transition that we've previously outlined, including the realization of a $12 million in annualized savings. However, the timing of these savings continues to be pushed out as our teams wrestle with both cost increases and supply limitations..

Earlier this month, we launched our new 3-dimensional digital reality capturing collaboration platform, which includes our next generation FARO Focus Premium Laser Scanner, our mobile FARO Stream app as well as FARO Sphere.

Sphere is a cloud-based environment which enables full 3D model creation, storage and collaboration and will be the platform for all future FARO workflow and software applications, including HoloBuilder..

While each of these offerings take an individually increased customer value, the combination of all 3 can decrease customer standing and processing time by over 50%, effectively doubling productivity.

Also, the interplay between new Stream app's functionality and our new laser scanner has enabled several enhancements including remote scanner control, real time on-site scan validation and pre-registration, as well as remote software upgrade capabilities..

It is these types of step function performance changes in which we are keenly focused on delivering in the years ahead. While it's early days, feedback from both our beta and early post-launch customers has been overwhelmingly positive.

With the launch of our new Focus Premium Scanner, combined with the recently launched Quantum Max ScanArm, we have now refreshed 75% of our high volume hardware product lines with products that have resulted from our maniacal focus on voice of the customer.

We believe that differentiation of these products will continue to push FARO to the forefront and the industry to new levels of productivity..

In addition to these exciting new offerings, we continue to see strong demand for our HoloBuilder application and its construction progress management workflow. HoloBuilder's unique 360 degree photo-based technology coupled with software as a service business model continues to have wide ranging applications.

The HoloBuilder application and its associated workflows will be integrated into our Sphere platform by the end of this calendar year.

We continue to believe there is a large untapped market potential for FARO's technology that leverages our high accuracy, fixed laser scanning expertise along with HoloBuilder's easy-to-use Photo-based solutions coupled ultimately to our mobile scanning solution..

With the launch of FARO Sphere, which centralizes the collection and management of 3D data projects, we are now bringing these capabilities together to provide a one-stop user experience across FARO's application software, workflow insights and customer support tools..

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

We remain focused and committed to our strategic transition toward developing differentiated solutions and insights through a deeper understanding of our customers' workflows, while at the same time adjusting our operating structure to generate leverage..

While the ongoing uncertainties in the market, including the lingering effects of COVID as well as the current geopolitical tensions create risks to our near-term results, the long term opportunity for FARO remains stronger than ever..

With that, I will turn the call over to Allen for an overview of our first quarter financial results. .

Thank you, Michael, and good afternoon everyone.

First quarter revenue of $76.7 million was approximately equal to the first quarter of 2021, primarily driven by increased demand for our Quantum Max ScanArm, offset by impacts from the Shanghai lockdown and ongoing supply chain shortage as Michael mentioned earlier, as well as a nearly 3% currency headwind that resulted from continued U.S.

dollar strengthening. .

On a year-over-year basis, hardware revenue of $46.5 million was up 5%. Software revenue of $10.3 million was up 1% and service revenue of $19.9 million was down 8%. Recurring revenue of $16.5 million was up 6% when compared to Q1 of 2021, primarily due to the increase in subscription revenue.

We have begun to see a modest flattening of overall software revenue, as we convert customer purchases of previously perpetual licenses to subscriptions..

Additionally, we've made meaningful product quality enhancements over the last 12 to 18 months. It is improving our customer experience, but adversely impacting revenue realized from time and material repair billings. GAAP gross margin was 53.5% and non-GAAP gross margin was 53.8% for the first quarter of 2022.

Gross margin increased incrementally year-over-year, largely due to a shift towards higher margin products that was somewhat offset by material cost increases..

Given the ongoing impact of inflation 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 $48.2 million and included approximately $3.4 million in acquisition-related intangible amortization and stock compensation expenses and $600,000 in restructuring costs.

Non-GAAP operating expense of $44.2 million was $1.4 million higher than Q1 of 2021 as we continue to increase our investments, both because of our HoloBuilder acquisition as well as our organic initiatives as a portion of the -- and as a portion of the travel-related expense savings realized during the pandemic return..

GAAP operating loss was $7.2 million in the first quarter of 2022 compared with an operating loss of $6.4 million in the first quarter of 2021. Non-GAAP operating loss was $3 million in the first quarter of 2022 compared to $2.3 million in the first quarter of 2021..

Adjusted EBITDA was negative $700,000 or 0.9% of revenue. Our GAAP net loss was $9.7 million or $0.53 per share. Our non-GAAP net loss was $2.5 million or $0.14 per share for the first quarter of 2022 compared to a loss of approximately $600,000 or $0.03 per share in Q1 2021..

We continue to maintain a strong capital structure with a cash balance of $107 million and no debt. I should note that our accounts receivable balance remained relatively high despite the reduced quarterly revenue levels.

This is due to several factors that include continued high shipment levels in the third month of the quarter as well as certain collection challenges that are well understood. We have not changed any payment term policies or practices and do not have concern about the ultimate collectability of our outstanding receivables..

Moving on to guidance. We are extremely disappointed to have missed the lower end of the range, following the first quarter in which we provided guidance. Unfortunately, we did not see coming the hard Shanghai lockdown and its effect on our ability to ship product from our lone Chinese logistics center.

China in 2021 was 12% of revenue and accelerating. Our early Q2 Chinese demand remains strong. And while our logistics team is working on alternatives, we remain concerned about our ability to ship to Chinese customers. Further, we continue to have general material availability challenges that limit our customer -- our other customer shipments..

As a result, in the second quarter of 2022, we expect revenue of between $77 million and $85 million, which at the midpoint represents a typical sequential increase from the first quarter. We expect non-GAAP earnings per share between negative $0.17 and positive $0.04..

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

[Operator Instructions] And our first question will come from Greg Palm with Craig-Hallum. .

Yes. I guess kind of getting right into it. On the China impacts, can you maybe quantify exactly what kind of impact you saw? Maybe I don't know, ask it a different way.

How important are those last 2 weeks in a typical quarter?.

I think we've talked about this in previous calls. But we typically ship, and Allen, correct me if I'm wrong. But in the typical last 3 weeks of the quarter, we are shipping probably 30% to 40% of our total quarter. .

Correct. .

It would help explain, I guess, some of the shortfall, but clearly not nearly the entirety. So I guess it sounds like the AEC market was equally as soft or challenged.

Is it across all geographies? Is it mostly EMEA related? Maybe a little bit more color on what's going on there?.

Actually the second biggest impact, Greg, was actually material availability. We continue to get surprised throughout the quarter with what is able to be shipped from our supply chain. So I would argue that of the 3 factors, the largest was China, followed by material shortage or availability and then finally the EMEA market in the AEC space.

And frankly, we believe largely, again, we track opportunities. We've not seen opportunities canceled, but we've seen a push. And we think this was largely due to -- I think there was some press about us potentially offering a new laser scanner. And I think that actually stall shipments in EMEA, at least that's our sense.

Our number of opportunities, our win rate and our funnel continue to be very, very robust. So I don't think it's -- I think that is our perspective in terms of why EMEA and the AEC market. .

I guess the more important question with the new product, the new laser scanner product, what types of demand are you seeing with that now that that's been released to the market?.

Very positive. We track a number of leads generated, the number of inquiries, the number of web hits. On the day that we announced the product was our single largest or single busiest day on our website. I think we had 23,000 views. The teaser video for the product itself is the largest or the most watched FARO video on YouTube.

So it seems that there's a great deal of excitement and kind of pent-up opportunity for us. So the funnel has grown since we've launched that pretty nicely. And what we learned from Quantum Max launch, which was in July, is there is a bit of a delay between the time that you actually launch it, people get it in their hands and test it.

But so far it looks really, really good. .

And then, last one, just a housekeeping item.

Did you guys give a bookings number, I didn't see that in the release?.

No, I don't think we have. .

We have not, and yes, frankly, we're not providing it any longer because we think that as we continue to shift towards more of a subscription model that bookings becomes less of a valuable leading indicator and can be misleading. And so we are reporting revenue at this point in time. .

Our next question will come from Jim Ricchiuti with Needham & Company. .

Just wanted to spend a moment on the EMEA region, only a couple of things there. So the AEC market was softer. But I'm wondering if you're seeing the effects of any slowing as it relates to the concerns, the macro concerns over in Europe.

Are you seeing that in either the metrology business or other parts of the scanner business?.

No, I think overall, EMEA as a region for us did probably better than we expected actually. I think that the one downside was the AEC space. 3DM and public safety continue to be relatively robust in the EMEA region. What we've seen, Jim, is that we've seen a lot of projects kind of be pushed, not canceled, but pushed.

And I think it's probably a mix of anticipation waiting for the new scanner. And I do believe that some projects are being pushed by virtue of something, nothing to do with us at all. But again, we're not seeing cancellations, we're just seeing delay. .

And when we think about the relationship with Sanmina, as you move further along this path, how soon do we think do you see that the whole challenge of that you're facing, you cited probably is the second biggest factor, the materials availability issue.

When do you see that gradually improving with Sanmina?.

Yes. I think we've mentioned in previous calls, Sanmina, once we've actually inked the deal with them and even before we had actually transitioned manufacturing to them, they've been helping us with supply chain. So they're in the middle of it now.

And certainly we've been kind of a benefactor of the relationship for probably the last quarter and a half. But it really hasn't completely mitigated the problem. And I don't expect it really to mitigate the problem. They have got similar issues with other vendor or with other customers that they're building for.

And I think it's -- like we've said before, it's very much a whack-a-mole. What was our problem in the beginning of the quarter is no longer our problem. And we're concerned about particularly semiconductors and some plastic resins and things like that, that we've talked about recently.

So Sanmina has helped, but they haven't completely mitigated the problem. .

Okay. And last question for me. It's very early days with Sphere.

But I'm wondering if there's any color you could provide on what you're seeing in terms of initial market reception?.

It's been really positive. As we talked about in previous calls, we've gone through several beta arrangements. I think we had 18 customers that participated in beta, all very positive feedback. We have not announced yet. And I think going forward we'll begin to talk about kind of the metrics around the user base.

It's early days, clearly, but feedback has been really, really good, fantastic actually. .

And Jim, I think it's important to keep in mind that it's not just Sphere, right? It is the interplay between Sphere, the new mobile stream app and the new laser scanner. And how they work together and how they enable a much more efficient process for scanning and capturing the information and then ultimately working with the information on the web.

So it's the combination of those that I think has really been obviously received well. .

Our next question will come from Rob Mason with RW Baird. .

Michael, I just wanted to be clear on the second quarter guidance.

You're assuming what for China revenue, 0, just assuming no shipments into that region?.

No, I don't think that's completely accurate. That said, we're handicapping it pretty hard. I think we're not in control. And certainly we got bit this quarter. So we are approaching Q2 guidance very conservatively. .

But the -- I guess, the countermeasures, if this doesn't alleviate itself, you have the ability to, I guess, export into that region, would be….

Yes. In fact we are exploring and actually shipping through other logistics centers that are not our own. What we can't control is what's happening in other cities within China, as you probably have all read. And so we're very conservative. And I will say, and I think Al said this in his remarks that demand in China is still very robust.

In fact, we're trending higher than, frankly, we -- I think we've ever achieved in terms of kind of a crawl chart, if you will, in terms of bookings. But it's about getting the product to them, getting through. So for today, for example, if we ship through Beijing, it's a 10-day quarantine on products. So it's challenging.

And because we haven't used these centers into other cities, we're establishing and setting them up, and we're working it. And I think Sanmina is trying to help us. But the reality is we still want the product to go through our logistics center because it's early days.

In Sanmina, we want to make sure that we're shipping quality product all the way through. .

And could you just, I guess, take -- you discussed Europe, but maybe touch on Americas and broader Asia as well.

Without some visibility on the bookings, I'm just curious how did bookings fare towards the end of the quarter? That's when things got noisy from a macro perspective, just what you saw and how you trended in April in those regions?.

From a forecast -- internal forecast perspective, Asia got very close even despite what was going on in Shanghai. And of course, many of the customers that we deal with are -- were affected by the lockdown themselves. So not really, I don't know if you've read much about it. But they literally didn't allow anybody into the facilities, et cetera.

So that had, I think, a muting effect on Asia's bookings. North America was as pretty much expected. And as I mentioned, I think Europe, EMEA, in general, was very healthy with the exception of the AEC business. .

Just last question, the service business did drop down year-over-year as well as sequentially. I know the installed base has some impact on that. But just the sequential drop stepped out as well.

Is that the trend line level that we should think of the first quarter through this year? Or can that -- was that step down sequentially indicative of something else?.

Al, do you want to take that one?.

Sure. As I indicated in my prepared remarks, one of the things that we've been working very diligently on is to improve the quality of our products that we're shipping. And I think we are beginning to see some benefit from that.

And so our time and material billings that we've had in the past for repairing products that are not under contract took a little bit of a dip. I think some of that has to do with the dynamics that are happening in Shanghai.

And I think some of it has to do with just overall improvements in the quality of the product, which from a service revenue standpoint, is not great. But from a customer experience standpoint is exactly what we're trying to do. So I think that there will be some rebound in the service revenue.

But I think that it will be lower than it has historically run because of those quality changes that I referred to, quality improvements. .

[Operator Instructions] And we will take our last question from Ben Rose with Battle Road Research. .

With regard to North America, which did look to be something of a bright spot this quarter.

Could you comment at all on the product mix? Is there anything to call out from that standpoint?.

Yes. No, I think we were pretty pleased with what we're seeing in the recovery of 3DM and that's been very positive. I think we've talked about last quarter, the automotive business or the aerospace business continues to be very strong for us. In automotive, we're seeing glimmers of hope and very encouraging. AEC market in North America was strong.

Public safety kind of went sideways. And I think that's primarily because end of the year, there's a lot of push at the end of the year from a budget perspective. And then you come into Q1, and it's relatively quiet. I think it's within the seasonal Sphere. So I think 3DM was strong, led primarily by some recovery in automotive, but aerospace.

And then I think AEC in North America was relatively strong. .

Maybe just to put a little bit more color on it as well. If you look at the year-on-year performance from a revenue standpoint, within the Americas, you're exactly right, Ben. Revenue was up, again, year-on-year in the quarter, about 13% based on what Michael was talking about. In EMEA, it was actually down 13%, which approximates how much the U.S.

dollar has strengthened. So on a local currency basis, relatively flat, and again, a bit worse than where the Americas was because of what Michael is talking about in terms of some of the AEC softness. And then in APAC, relatively flat year-on-year, predominantly because of the Shanghai shipments.

Otherwise we would have expected it to be in the double-digit growth rates that we saw in the Americas. So hopefully that gives you a little bit more color on what's happening by geography as well. .

Yes, that does. And I guess just one more question for Michael. You had mentioned the very sizable facilities management order in retail last quarter.

I was just curious to know whether -- how that pipeline might be shaping up, moving in here for the rest of the year?.

Very good. I think we haven't closed an order of that magnitude. But obviously there's a large number of orders closed. We're still on track to -- as we talked about last quarter, to double the size of that business this year, and we're very encouraged by the activity level overall. .

Our last question will come from Andrew DeGasperi with Berenberg Capital Markets. .

I just had one question. I think you mentioned the software revenue was kind of flattish because of the transition to subscription from, I guess, permanent license or on-prem.

Just wondering if, can you give us like maybe a little bit of timeline around when you think that transition might be less of a headwind going forward?.

I think that we will continue to see some transition towards subscription through the balance of 2022. And as we get into the early parts of 2023, we would expect that transition to be predominantly done. .

And maybe just a follow-up in terms of the Quantum Max. I think you said the delays that it has pushed out some deals.

Should we expect some kind of pent-up demand from that region as availability for the product comes in? I mean, I guess, like how meaningful could that be? Or do you have any visibility on that?.

Well, as I think we've mentioned, we haven't really seen any cancellations, including from the Chinese customer base despite the situation that they're enduring. We did push obviously some orders into the next quarter. And so, yes, we do believe, there's some pent-up demand. It's hard to quantify how that is going to ripple through.

I think our logistics team is very much concerned not so much just about our own site, but the Shanghai Port and all the kind of pent-up ripple effect of what's going on in China is a concern. This is why, Andrew, we've really handicap what we think we're going to be able to do in China. I hope we're wrong.

But it really bit us hard this quarter and it's, frankly, it's embarrassing. We didn't anticipate it. But this is the first quarter that we've given guidance. We're not proud of missing the first quarter that we give guidance. So we're not going to do that again.

And so we are very concerned about over -- getting too far over our skis and hoping that all of that's just going to go away tomorrow. I don't think that's realistic personally. .

That makes total sense. Maybe a last one in terms of the gross margin range. I think you mentioned some quarters might dip below that.

I just wonder, is it -- if I heard it correctly, you mentioned is a mix factor here? Or is it the level of revenue that you expect that would drive that gross margin?.

Yes. So I think we did comment in our prepared remarks that we have seen a shift towards higher-margin products here in the near term. And again, it can flex -- it can fluctuate quarter-to-quarter a bit.

But I think that by and large we would expect to be towards the lower end of the 55% to 60% as we commented as well as we can dip below it depending upon where revenue is just like we just reported, right, with just almost 54%, but revenue at about $77 million. .

So you can kind of get a sense for where that breakpoint is for margins being below that 55% to 60% range. .

At this time there are no further questions in the queue. I would like to turn the call back over to Mr. Michael Burger for any closing remarks. .

Thank you very much. Thank you for your time and your interest in FARO. And we will talk to you next quarter, if not before. Thank you. .

Thank you, ladies and gentlemen. This concludes today's conference. We appreciate your participation. You may disconnect at any time..