Q4 2019 Earnings Call
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Good morning, ladies and gentlemen, thank you for joining today's Faro technologies fourth quarter in fiscal year 2019 earnings release conference call and webcast hosted by Michael Berger.
Next I will turn the call over to Mr., Mike sorry at Sapphire Investor Relations. Please go ahead.
Thank you I'm good morning, with me today from fair or Michael Berger, Chief Executive Officer, and Alan You Rich Chief Financial Officer.
Yesterday after the market close the company released its financial results for the fourth quarter and full year of 2019.
Related press release, and form 10-K, but fourth quarter and full year or rail was faros website at www Dot Pharrell dotcom.
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 gold objective intend may and similar words.
As possible the Companys actual results may differ materially from those projected the forward looking statements.
Important factors that may cause actual results could differ materially are set forth in yesterday's press release of the company's form 10-K for the year ended December 31st 2019.
During today's conference call management will discuss certain financial measures, they're not presented in accordance with U.S. generally accepted accounting principles or non-GAAP financial measures.
A press release, you will find additional disclosures regarding these non-GAAP measures, including reconciliations to comparable GAAP measures.
Well not recognized under GAAP management believes these non-GAAP financial measures provide investors with relevant pureed appeared comparisons of core operations.
However, it should not be considered in isolation or to substitute for a measure of financial performance aired in accordance with gap now I'd like to turn the call over to Michael.
Thank you Mike.
Good morning, and welcome to our call.
As you're aware of joint barrel approximately eight months ago.
We immediately embarked on the strategic planning process that included extensive conversations with employees customers investors and suppliers as we sought to identify both where the company can provide sustained and differentiated customer value and where opportunities exist it to improve operating efficiencies.
With the underlying objective of enabling long term shareholder value.
Well, we provided some early insights on our last call with the completion of our strategic planning process. We're now in a position to communicate our plans in future expectations for the business.
Included in this is our new targeted success model of delivering a 20% adjusted EBITDA margin.
Without the need for material revenue growth from current levels. This dramatic improvement would represent a profitability level, which is more than doubled the highest annualized level achieved in our recent history.
What has become clear to me during this planning process because that ferro has a meaningful market share in large and growing markets driven by a legacy of technology differentiation the customers value.
Also for it is very fortunate to have an exceptional and talented employee base, we're passionate about what we do.
This is a solid foundation from which to bill.
As we began to implement our strategic plan. It is important as an organization that we continue to focus on protecting and increasing our market share in the large and growing core markets. We presently we serve.
We strongly believe these markets and close the Jason cities will provide the base from which we can deliver strong shareholder returns for the foreseeable future. Let me touch on each of these markets.
In Threed metrology, where we estimate the total available market at $4.2 billion. In 2019, we expect to continued demand for precise threed measurement driven by automotive aviation and other capital intensive manufacturing environments that will enable annual market growth up roughly 6% through <unk>.
22.
In the architecture.
Engineering and construction market, we estimate the total available market to be about $1.1 billion and growing at 6% given the accelerating adoption of advanced Threed measurement solutions.
Finally in public safety analytics, we estimate the overall technology spend to be about $6 billion and growing at a 16% cumulative rate through 2022.
However, our solutions currently only serve about 80% $80 million of this large and vibrant market.
We believe that the adoption of our technology related to capturing analyzing and displaying accident and crime seem data in three D creates a compelling opportunity for accelerated growth.
Taken together and after markets return to was a level of normalcy, we expect our target markets or grow between six and 8% annually through 2022.
It is in these markets where barrel has the largest concentration up it's roughly 15000 active customers and where we're focused virtually all of our attention in the foreseeable future.
Building upon the strength in our core markets and leveraging our extensive customer base. Our first strategic initiative is to increase the value of products through our software solution strategy.
We will continue to focus on enabling our customers with high reliability hardware products that have differentiated performance. However, we believe this is no longer enough as an organization, we're increasing our focus on understanding what problems. Our customers are trying to solve and in turn providing them with a solution that not only captures or provide.
The three data, but also gives them the ability to easily turn the captured data into work flow based information.
In other words, we need to move up the boot Jay.
And transition from a hardware centric company to one that provides complete solutions, which enables our customers to realize the full potential of a virtualized world.
We have a long legacy of developing software products at Faro with multiple teams working on multiple hardware centric <unk> software platforms. I believe we have a unique opportunity to transform these discrete software platforms into a common environment in which faro customers can easily make use of the data collect.
By their Faro device.
By doing so we have an opportunity to increase the value we provide to our customers. While also enabling us to capture new revenue streams without cannibalizing our traditional revenue sources.
This initiative will have the added benefit streamlining our software development efforts and yield greater productivity from our talented global R&D resource.
Moving beyond product innovation, we also have an opportunity to significantly streamlined how we run our business.
As I outlined last quarter, our second strategic initiative is to change our go to market strategy. This change enables our sales resources to sell the breadth of the product line, while increasing the ownership of our customer base. This change is made possible by leveraging a large and very talented pool of application engineers globally.
We plan to support this industry tested sales model with a refocus marketing function, our new marketing leadership team is focused in two areas first and product marketing our priority is to gain and increased understanding of customer applications and workflow then translating that knowledge into value based positioning which consists.
Bidders and Optimizes, our customers total cost of ownership.
We aim to have a deep understanding of the problems. Our customers are trying to solve so that we can more effectively deliver full solutions that meet or exceed those needs.
And secondly, we are transforming our lead generation process to utilize best in class technology to provide our sales organization with higher quality leads which in turn are expected to drive higher sales productivity.
We believe that pivoting to this well established sales model supported by a retooled marketing engine, we'll focus our sales team on better understanding our customer base.
It also provides a foundation for a significantly lower cost and scalable sales model that will enable us to cost effectively grow revenue faster than our markets.
Starting today, we're transitioning to this new sales model led by our new senior VP of sales and service Kevin Beatle.
Finally, our third strategic initiatives centered on organizational optimization.
The company has a long legacy of strong geographic organizations with decentralized decision, making.
On top of this was overlay to business units structure.
This matrix structure with the requisite infrastructure to support each led to an overly complex structure that is simply too expensive for our business.
Therefore, as part of our strategy, we're eliminating our vertical business units structure and moving to a globalized functional organization that enables centralized management and clear process ownership, while eliminating layers of management and redundant resources.
When looked at as a whole I strongly believe these strategic initiatives combined with our solid foundation, our core markets will generate long term growth while at the same time, enabling a significant improvement in profitability.
While shifts in product strategy, often take time to go momentum. We believe our operating initiatives will result in dramatic reductions in business complexity in the near term and will enable $40 million an annualized cost savings when our transformation is complete.
These improvements are key to achieving our target targeted success model, a 55% to 60% non-GAAP gross margins.
40% to 43% non-GAAP operating expenses, which will yield and approximately 20% adjusted EBITDA margin.
With that I'll turn the call over to Alan for an overview of our fourth quarter financial performance.
Thank you Michael and good morning, everyone.
Total sales were 104.1 million for the fourth quarter of 2019 as compared to 112.8 million for the fourth quarter of 2018.
As a reminder, non-GAAP Q4, 2018 revenue, which excludes a 4.8 million dollar reduction for our previously reported GSK matter was 117.6 million.
Similar to what others in our space have indicated this 11% year over year reduction on a non-GAAP basis is primarily the result of continuing softness in many of the company's served markets.
Particular softness in the automotive and broader Asian markets.
Product sales were 80.3 million as compared to 95.3 million in Q4 of 2018 on a non-GAAP basis.
This decrease was primarily a result of the previously mentioned softness in the automotive and broader Asian market.
Additionally, we received approximately $3 million bookings late in the quarter than we were unable to ship given customer request and ship dates.
Service revenue at 23.9 million grew 12% when compared to 21.3 million in Q4 2018, as a result of continuing efforts to ensure customers maintain calibrated tools through paid annual maintenance.
New order bookings were 116.9 million for the fourth quarter of 2019 down 4% as compared with $122.2 million for the fourth quarter of 2018.
As a result of today's announced strategy and business transformation, we expect to incur approximately 75 to 85 million nonrecurring charges, beginning with 49 million booked in the fourth quarter and the remaining amounts to be incurred in the first half of 2020.
This overall charge includes about 18 to 22 million of cash charges with the remaining balance being non cash and comprised of tangible asset write offs of about 21 million and the remaining balance related to intangible asset and goodwill impairments.
GAAP gross margin was 41.9% and included approximately 15 million in inventory write downs.
Non-GAAP gross margin was 55.7% for the fourth quarter as 2019 as compared with 57.7% for the same prior year period.
The reduced gross margin as a result, and the overall reduction in revenue, which adversely affected our fixed cost absorption.
GAAP operating expenses were 91.8 million and include approximately 35 million of the previously mentioned restructuring charges as well as 3 million and acquisition related intangible amortization and stock compensation expenses.
Non-GAAP operating expenses of 53.3 million were 1 million lower than Q4 2018, as a result of lower commission expenses associated with lower revenue.
GAAP operating loss was 48.2 million for the fourth quarter 2019, as compared with operating income of 5.8 million for the fourth quarter of 2018, driven by the lower demand environment.
Adjusted EBITDA was 8.1 million or 8% of sales in the fourth quarter of 2019.
Our GAAP net loss was 49.7 million or non-GAAP net income was 3.1 million or 18 cents per share for the fourth quarter 2019, compared to non-GAAP earnings of 62 cents per share in Q4 of 2018.
We continue to maintain a strong capital structure with high liquidity and no debt in the fourth quarter of 2019, we generated 14.5 million in cash, resulting in a cash balance of 150.9 million exiting the year.
I should note that as a result of eliminating our vertical business units structure, which was the basis for our segment reporting we will no longer be reporting segment results.
As Michael mentioned, we believe the restructuring efforts outlined today will yield approximately 40 million annualized cost savings from our 2019 expense levels that will be realized by the fourth quarter of 2020.
These reductions are expected to enable our targeted financial model of 55% to 60% non-GAAP gross margin and 40% to 43% non-GAAP operating expenses and yield adjusted EBITDA levels of approximately 20% of revenue.
We do not believe meaningful revenue growth from current levels is required to realize our new financial model.
Beyond these near term actions, we believe we're making the necessary structural changes in both product evolution and go to market led by new sales and marketing leadership in all areas to drive outsized growth in our core markets in the years ahead.
Finally, we're closely monitoring the potential impact the Corona virus outbreak may have on our business.
Given our limited operational footprint in southeast Asia, We do not present, we expect a material impact to our operations.
That said and consistent with what others are reporting it is too soon to say what impact it may have on our already relatively soft demand environment.
This concludes our prepared remarks at this time, we'd be pleased to take any of your question.
At this time, if you'd like to ask a question. Please press star and one on your Touchtone phone you can raise yourself from the question Q by pressing the pound key again that is star and one.
We'll take our first question from Jim Ricchiuti with Needham and company.
Hi, Thank you.
Thanks. Good morning, just a quick question I mean, I may have missed it.
But when you talk about some of the targets with respect to two margins it any any timeline associated with it how should we think about the timeframe.
On that particularly that 55% to 60% gross margin.
Well I think from an overall profitability standpoint, we expect again realize the targeted adjusted EBITDA or at least realize the $40 million for that savings in the back half of.
The year more towards Q4, as we indicated from a margin impact from a gross margin impact and moving towards the higher end of the range. We would expect to again see some gradual improvement throughout the year starting at the kind of president. We're presently where we are as you know our fourth quarter non-GAAP margin of 55.7 is towards the lower.
End of the range. So frankly, we don't need any improvement to to be within the range and that's that's kind of the current operating assumption there Jim.
Got it and and the company has had some previous targets as I'm sure you know.
That we're looking for gross margins in excess of 60% and clearly that's not youre your guidance.
But yeah I wanted to just kind of square that with what you're trying to do with the increased software solutions focus there anyway, maybe think about longer term how issue we might think about gross margins.
No I actually think.
The software solutions space should yield higher margins as a mix. It really comes down to the mix of revenue hardware to software and were I think we're trying to be very conservative about giving forward guidance as it relates to that but I do believe.
The software and solutions.
Strategy should be accretive to the current gross margins. So I think theres their potential upside, but we're not talking we haven't really talked about it publicly yet and I think from just in terms of that timeline around software and solutions as you probably are aware Jim.
Making that transition and making that that pivot does take some time and there and at the same time, we're going to be transitioning from a perpetual license model more towards the subscription model as we've indicated in prior calls and again everybody is aware that that creates a little bit of a drag on on or a little bit about it will temper that that saw.
Where revenue growth, so again that mix change and the impact that it might have on gross margin will likely take some time.
Okay that makes sense last question I'll jump back in the Q.
It sounds like you not necessarily seeing an impact from Corona virus, but what I'm. I'm also curious about is just what you guys are seeing we're hearing from the standpoint of any key component supply chain issues logistics issues, which while you may not have a lot of exposure.
Direct exposure revenue wise in Asia in China.
What are you seeing in the supply chain.
Actually a.
Bulk of our supply chain is pretty much focused in Europe and in North America. So were up a bit isolated from it I do believe that we are concerned about the corona virus in the impact that that will have on demand just as many of the companies that we would that would be purchasing equipment from us our has have been shut down or.
Our or delayed the delayed openings. So I think that is actually not worked its way through and as you know a big part of our revenue on a quarter is turn so it's not like we're seeing a huge effect on backlog.
It's kind of a it's a real time event for us so.
That's kind of why we've got them disclaimer and there were reading the same stuff you guys are reading our supply chain is not really impacted we don't really have a big operational footprint in China, but we are concerned about the buying habits of our current customer base.
Got it thanks very much welcome. Thank you.
And we'll take our next question from Andrew Degasperi with Berenberg. Please go ahead.
Thanks for taking my question.
First on the restructuring of your sales force or your marketing efforts.
Is there any possibility that this could potentially impact your sales near term given it seems like a relatively large change.
How you are marketing these products of course, there's there's always risk anytime you.
You change and interface with the customer base I will say however.
This is not about new customers. This is really about existing customers. Our situation today as we have in some situations multiple salespeople, calling on a particular account and what we're doing is we're eliminating the multiple side of that so we're not basically uncovering any customers were.
Basically focusing and I think that has a less risky footprint. If you will then going for example from a direct salesforce to a rep or vice versa. That's not our intent where we're still a utilizing our direct salesforce, we're focusing and given clear ownership to a particular individual.
And then backing up that individual technically but but the answer is a Andrew there's always risk anytime you you make any change not just with the salesforce. The other thing I might add and again, the because of our vertical business unit structure, we essentially had four different sales teams with the requisite.
Management structure to support each and therefore, where a lot of the change comes from eliminating that redundancy that weren't necessarily calling exactly on specific customers as well.
Got it and then maybe secondly, I know you're no longer giving segment information, but from a I guess qualitative standpoint could you maybe tell us I guess really metrology, probably was weaker but how did the AC or.
Architecture engineering construction market do for this quarter and so far in Q1.
Yeah, what I would say there is again, we're not providing that information on a go forward basis, but I would say if you looked at prior quarters and what the growth rates have been there was not a lot of change in the fourth quarter compared to what we've reported recently and so where where we were soft we continued to be soft and where we had.
Pockets of strength or or at least moderate performance that remained unchanged.
That's helpful. And then lastly from me terms would be a at one of your peers.
Thinking about making their hardware kind of a recurring revenue element, where potentially sending a payment plans is that something you are considering as well.
We're looking at a lot of different models leasing is one of them.
You know our average selling prices such that leasing may make sense for some of our more expensive stuff, but but in reality, we've not seen a huge demand for it I think.
We're looking at all sorts of different recurring revenue stream ideas and but right now we were seeing not a lot of demand for for example.
Leasing of hardware today.
Got it okay. Thank you very much thanks vendor better.
And again that is star and wanted to ask a question.
And we'll take our next question from Greg Palm with Craig Hallum capital Great.
Please go ahead, yes. Good morning, Thanks for all the details around this so just following up on a previous question just wanted to make sure. We're understanding this right. So if you do the math you assume 40 million in cost savings and maybe a consistent gross margin inside the range I mean, you get close to a 20% EBITDA margin.
Just just from that alone so which is your target model. So is that what the math implies just want to swear that up that's correct.
And and so I guess the question is.
Is that a is that a starting point I mean, I guess longer term, if we assume that revenue growth.
It's more to this kind of targeted rate, where your markets are and you assume maybe some upside or incremental contribution and gross margin from from software and solutions you would obviously get upside to that so is that the right way to think about this that the 20% as a starting point.
That's the way we're thinking about it.
Got it.
And as it relates to the revenue impacts are there any product lines that you are completely walking away from and I guess, if you are what is what is the revenue level contribution of those so we can factor that into our models.
Actually the revenue contribution to our focusing on the three primary markets is de Minimis, we actually don't believe that it will have a significant revenue impact.
That being said I think from a support perspective from a focus in the field from a focus in our service organization is pretty dramatic. So I don't think Greg that it has a financial a material financial impact from a revenue perspective, but internally from a focus perspective is huge.
Okay.
And in terms of the actual head count reductions are most of those salespeople or how will the 500 number be spread out across the company I.
I think the way to think about it is it's primarily SG today.
Okay, ARINC R&D remains pretty much untouched.
And our manufacturing organization at large.
Remains pretty much untouched.
Got it I guess, just just last one I mean, you threw a lot of sorta numbers at us and there's a lot of detail here, which I think we all can appreciate but I mean, Michael you have been with the company more than eight months now. So I mean, if you could sort a wrap up what your last eight months have been answered.
So what excites you most about sort of the go forward period, I think it would be all it'd be really helpful for us.
I have never been involved in a company with 15000 customers that are asking us to do more it's a very exciting opportunity for us and I think.
Assuming that operationally, we can get out of our own way I think that there's a huge opportunity to satisfy even even within just the three markets that we're talking about assuming that we can live up to our potential I think we have a very very very bright future and now that we have a business model that is.
Scalable.
It's a great basis from which to start so actually I I'm more excited about today than it was when I joined.
Great all right appreciate the color good luck going forward. Thank you Greg appreciate it.
And there are no further questions at this time, so I'll turn it back to the speakers for any closing remarks.
Well, we're very excited about where we are we've done a lot of work and I think we have now a business model that is extremely scalable. So we look forward to updating you in future quarters on how we're doing with the changes in the strategy.
We appreciate your interest and we'll talk to you again next quarter. Thank you very much.
This does conclude today's program.
We do appreciate your patience and.
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