FARO Technologies (FARO) – 3D Visionary with Macro Uncertainty
FARO is the world’s most trusted source for 3D measurement, imaging and realization technology. The company develops and manufactures leading edge solutions that enable high-precision 3D capture, measurement and analysis across a variety of industries including manufacturing, construction, engineering and public safety. Per their Investor Presentation, the company is divided into three main segments:
3D Manufacturing (66% of Revenue) – Standardized and customized measurement and inspection in industrial or manufacturing environment.
Construction BIM (24% of Revenue) – Data capturing and 3D visualization for customers in the architecture, engineering, and construction markets.
Emerging Verticals (10% of Revenue) – These include Public Safety Forensics (Captures 2D and 3D scenes for crime, crash, and fire scene investigations) and Photonics (Develop and market galvanometer-based laser steering products and solutions).
On July 24th, the company released their second quarter earnings which missed on both the top and bottom line. More specifically:
-EPS of ($0.14) vs ($0.08) estimate – Miss
-Revenue of $93.5M vs $96.31M estimate – Miss
-Total Sales of $93.5M vs $98.2M Y/Y – Lower
-New Order Bookings of $106.1M vs $106.5M Y/Y – Lower
-3D Manufacturing Sales of $59M vs $64M Y/Y – Lower
-Construction BIM Sales of $24.2M vs $23.6M Y/Y – Higher
-Emerging Vertical Sales of $10.3M vs $10.7M Y/Y – Lower
CEO Michael Burger would highlight that their 3D manufacturing segment experienced a second consecutive quarter of Y/Y decline driven primarily by a soft Asia Pacific region reflecting China and Japan customers delaying spending to future quarters. “Industrial manufacturing economic indicators, such as PMI, Automotive Production and GDP across Asia suggests challenging business conditions for our 3D manufacturing customers. Slowing their purchases of discretionary capital goods such as FAROArm and laser tracker.”
Later in the Q2 conference call, G. Research analyst Hendi Susanto would say that about three months ago, management shared some anticipation that disruption in 3D manufacturing might continue through the third quarter of 2019. “And in light of trade war that you mentioned, macroeconomic uncertainties and weaknesses in Asia, should we anticipate the disruption to stay longer beyond Q3 2019?”
CFO Robert Seidel would respond by saying, “You know, Hendi, one of the things we saw in the course of the second quarter was slowing across Asia. If you look at it from a China perspective, which we disclosed in our 10-Q, we saw decline of 2% year-over-year versus 28% in the first quarter. We continue to see that trend going forward just based on GDP, based on PMI and other indicators in the market as a feedback from our customers and discretionary capital goods spend, we continue — we would expect to continue to see headwinds in 3D manufacturing for the next two quarters at least.”
Management would comment that its sales for Q2 was $93.5M, which included the unfavorable impact of $5.8M from their GSA sales adjustment described in their earnings release:
“As previously disclosed, we have sold our products and related services to the U.S. Government under General Services Administration (“GSA”) Federal Supply Schedule contracts since 2002. On February 14, 2019, we reported to the GSA and its Office of Inspector General that our preliminary internal review determined that we may have overcharged the Government under the Contracts. On July 15, 2019, we submitted a report to the GSA and its Office of Inspector General setting forth the findings of the Review, which reflected an estimated aggregate overcharge of $10.6M and imputed interest of $1.0M under the Contracts. Based on the results of the Review, we reduced our total sales for second quarter 2019 by an incremental $5.8M and recorded an incremental $0.4M of imputed interest in other expense.”
Needham analyst James Ricchiuti was surprised to see that this GSA issue hit the emerging vertical as much as it did. He would ask management what were the products or potential applications that were impacted there?
CFO Robert Seidel responded saying that this segment is more impacted than others because of the Public Safety Forensics. This, as management described it, is selling to law enforcement and much of the sales that you would see to the law enforcement in the U.S. portion of that business is through the GSA.
Finally, Craig Hallum analyst Gregory Palm would follow up with GSA as well, asking “Should we assume that those sort of potential reductions are done? Or is there a potential for more here in the second half of the year?”
Management would comment, “So in terms of the GSA, we submitted our comprehensive report with assistance from our outside legal counsel and forensics experts and the 8-K we released on July 15. At this point in time, we’ve accrued the total liability of $11.6 million, as our best estimate based in alignment with that report. Now we will go through a process with the assistance of our advisers, the government will review that. And really at this point, it’s up to the government going through that process with our advisers. So at this time, $11.6 million is our best understanding of a liability. The 8-K does describe though more details and it does describe other risk to the company that may occur.”