Good morning. My name is Andrea, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Inc. 2022 First Quarter Earnings Call. [Operator Instructions] Please note this event is being recorded. . I would now like to turn the conference over to Ray Nash, Corporate Finance Leader for Novanta. Please go ahead.

Thank you very much. Good morning, and welcome to Novanta's First Quarter 2022 Earnings Conference Call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our Chair and Chief Executive Officer, Matthijs Glastra; and our Chief Financial Officer, Robert Buckley. If you have not received a copy of our earnings press release issued today, you may obtain it from the Investor Relations section of our website at www.novanta.com. Please note, this call is being webcast live and will be archived on our website shortly after the call. Before we begin, we need to remind everyone of the safe harbor for forward-looking statements that we've outlined in our earnings press release issued earlier today and also those in our SEC filings. We may make some comments today both in our prepared remarks and in our responses to questions that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations, any forward-looking statements made today represent our views only as of this time. We disclaim any obligation to update forward-looking statements in the future, even if our estimates change. So you should not rely on any of these forward-looking statements as representing our views as of any time after this call. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP measures in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our website after this call. I am now pleased to introduce the Chair and Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Ray. Good morning, everybody, and thanks for joining our call. Novanta delivered another outstanding quarter to start off 2022. We hit new all-time highs for revenue and adjusted EBITDA and saw double-digit growth in bookings, adjusted EBITDA and adjusted EPS. For the first time ever, we delivered over $200 million in quarterly sales and ended the quarter with another record level of backlog of $586 million. We continue to see very robust demand from our customers in the medical and advanced industrial markets we serve. Novanta's portfolio is well-positioned to benefit from medical and advanced industrial applications that have long-term secular tailwinds such as robotics and automation, health care productivity and precision medicine. And we continue to invest to strengthen our competitive advantage and manufacturing capacity to capitalize on these tailwinds. In the first quarter, our company delivered $204 million in revenue, representing 26% year-over-year revenue growth on a reported basis and 7% growth on an organic basis and up 3% on a sequential basis. In addition, our operating performance in the first quarter was excellent with adjusted EBITDA of $44 million, up 33% year-over-year and adjusted diluted earnings per share of $0.73, up 26% versus prior year. We saw strong demand in healthy orders in many of our applications and across all our segments, with each segment having solid book-to-bill in the quarter. In the first quarter, our overall book-to-bill was 1.12 with year-over-year bookings growth of 11% versus the first quarter of 2021. We are extremely pleased with and proud of our teams drove this exceptional operating performance using the Novanta Growth System tools in incredibly uncertain and unpredictable environment. Let me take a moment to give an update about the global macroeconomic dynamics we're seeing. First, our thoughts are with the people of Ukraine, and…

Thank you, Matthijs, and good morning, everyone. First quarter non-GAAP adjusted gross profit was $93.8 million or a 46% adjusted gross margin Compared to $73.1 million or 45% adjusted gross margin in the first quarter of 2021. For the quarter, adjusted gross margins increased approximately 90 basis points year-over-year and increased nearly 150 basis points sequentially. Considering the environment around inflation supply chain shortages, we feel really good about this outcome. While we continue to experience supply chain shortages and inflationary pressures, most notably with semiconductor parts, we are also seeing solid productivity from the deployment of the Novanta Growth System, and we're seeing the benefits of our pricing initiatives. Despite numerous challenges affecting our manufacturing performance in the first quarter, our manufacturing teams did an incredible job at mitigating these impacts and continue to drive overall productivity improvements in our factories. In addition, we also successfully passed along some of the inflationary pressures to our customers, helping us to deliver a solid first quarter outcome. Moving on to first quarter R&D expenses were up $20.9 million or roughly 10% of sales. First quarter SG&A expenses were $39.4 million or 19.3% of sales. The sequential increases in operating expenses were in line with prior guidance -- the result of the seasonal impact of variable compensation programs and their associated payroll taxes as well as the planned R&D investments. Adjusted EBITDA was approximately $44 million in the first quarter of 2022 or a 21% EBITDA margin. Our adjusted EBITDA performance beat our expectations and previously issued guidance. On the tax front, our non-GAAP tax rate for the first quarter of 2022 was 14%. This differed from the statutory rate driven mainly by a jurisdictional mix of income. Our non-GAAP adjusted EPS was $0.73 in the quarter compared to $0.58 in the…

[Operator Instructions] And our first question will come from Lee Jagoda of CJS Securities.

So just starting with the Medical segment. I think you mentioned surgical robotics and DNA sequencing were built up more than 50% in the quarter. And I know you cited the JADAK issue in terms of one of the headwinds. Can you talk to the things that may be declining and whether that decline is just a function of demand or if there's any supply chain at all -- or excuse me, a function of supplier if there's any demand change at all?

Yes. So -- Lee, so I commented that there's multiple drivers, right? So you rightly are quoting that. We're very excited about the surgical robotics and the DNA sequencing demand, which is up 50%. And then the minimally invasive part -- surgery part of our business. Let's say, the demand and supply chain -- demand was good, but it was still relatively subdued versus, I think, previous levels. But we see it's starting to recover and rebound in the remaining part of the year as hospitals learn how to work better in the endemic situation. So it's basically electric procedures coming back online, and I think multiple players commenting on that in their prepared remarks. I think probably the biggest headwind was basically the JADAK supply chain shortage, right? So that's really where we're mostly gated. And Robert, I think in his prepared remarks covered that extensively. We expect the supplier to gradually improve on that situation as well. Robert, do you want to add anything else?

Yes. So I mean, definitely, Lee, in the first quarter, MIS and JADAK both declined. That will change as we get into the second quarter where only JADAK is declining. So I think -- and then that's of course, temporary to second quarter, will probably be their toughest comparable until the supply really starts coming in, in the third quarter. And the company that supplies us has been public about that.

Got it. And then in terms of -- I guess you've sort of reiterated that full year guidance, and we're looking at the top end. Is the best way to think about it, given that demand continues to outstrip supply that we should expect book-to-bill to continue to run above one through the balance of the year, which I would think sets you up for an acceleration of growth in 2023?

Yes. So a tough question to answer. I would say that's where things are currently trending. You don't know how things will unfold as the year progresses. I mean, it's fair to say, we're covered for the year already in terms of backlog. And so we feel very good. That's all l non-cancelable backlog. We feel good at what we can deliver, and that's why we're biased towards the upper end of the range. Does it position us stronger? I don't want to get into 2023 with all the dynamics happening. The last time we spoke to you, in between that period of time, there was a war started in the Ukraine, right? So I think we have to just be mindful that the environment is constantly changing.

Well, I'll just sneak one more in, and let others ask. But in terms of the understanding that the backlog is non-cancelable, are we thinking that customers are still ordering to current levels of demand? Or are they kind of overordering -- ordering ahead a little bit here?

Well, let me put it this way. We don't feel our customers are actually putting our products on the shelf. I mean they're putting very, very hard and for the majority of our customers when we deliver basically on their demands, I mean, the products basically get included in their systems, and they got moved immediately to the end market. So that's what we're seeing right now. We don't see any channel inventory buildup or something.

The next question comes from Rob Mason of Baird.

My question was around the second quarter guidance around gross margin, which implies basically flat to down sequentially. And I'm just wondering where you would isolate or direct us to look where we could potentially see some degradation in gross margin. And I'm curious if any of the segments would be expected to improve sequentially also?

Yes. I mean, effectively, the gross margin guide is really is a mirror of the first quarter, right? So all else being equal, the dynamics in the segments and the dynamics for the total company will mirror that of the first quarter in the second quarter, right? So I think the variability in the guide is really driven by the COVID-19 lockdowns in China and the potential disruptions that might have, we've been mitigating them to date, but they keep rolling around. And so I think we are prudent when it comes to adding a little contingency around that. We had a little contingency around some worsening of supply chains from where things are looking in the first quarter. I'm not sure things are materializing that way right now. But we just want to get some prudent guidance out there that says that environment does exist. And so there's a range as a consequence of that. All else being equal, it should be relatively similar to the first quarter.

Yes. The other thing I would say, Rob, is that -- yes, it's more timing than anything else. We're now gated by demand, right? And so it's more of the short-term disruptions. I think we were very specific in our view for the full year, reiterating the upper end of the guide range there despite taking some revenue out of Russia and despite, let's say, that short-term volatility that we see. We're very confident about the full year's outlook.

Sure. With respect to China, how is that impacting your -- impacted you to date? Is that more direct impact on your own facilities, ability to produce in country? Or is it around getting supply into those facilities or other areas of your business?

Yes. Well, in the first quarter, it was more of an impact of sales into China. In the second quarter, it's more of an impact on our operations. Our manufacturing in China is in-China for-China strategy. And so it's about the products we produce there being sold to customers in China. And so you can scale it from that perspective. We've had workers sleeping and living in our facility in order to keep production up and running in our Suzhou factory. The Suzhou factory in particular, has been really good at mitigating the impacts, been very creative about getting products built and getting product out the door. We have a smaller manufacturing facility, really small in the Beijing area. They've struggled a lot more, thankfully not as material to us. And so I think overall, we've done an excellent job at mitigating it. Where we worry is the lockdowns rolling across different regions and how that might affect supply chains of materials that we need in the factories that we have in China itself. So we're working our way through that right now. I think we feel pretty good that we've been able to mitigate that to date and that we feel like we can still mitigate it to date. It just comes down to, and if there's any more surprises to deal with.

Sure. Okay. Just last question. So obviously, a very tight supply environment. Virtually every company is talking about doing redesigns on their products, qualifying second sources, just to provide more flexibility around that. Historically, Novanta has been sole sourced on many of your design wins? I'm curious if that dynamic is opening up -- are you seeing more opportunities as a result of that second source opportunity? And conversely, I'm just curious around your own sole-source position if that's evolving as well, what you're seeing on that front?

Yes. So listen, the best offense and defense is innovation, right? It's just having the best product and innovation out there and having close collaboration with our customers. I mean, everybody understands. And by the way, we're not the only ones, right? Gaining supply. So -- and actually, in a lot of cases, our customers are helping to find parts, and we're working very collaboratively across the value chain. So I would say we're feeling very good about the relationship we have with our customers. Actually, in many cases, we're expanding our exposure and winning designs. I mean, last year, we double design wins. So that keeps suggesting that you we're winning share in this environment, and that's on the back of having just great innovation, which is why we continue to invest in strengthening our competitive advantage and also our manufacturing capacity. I mean, that's one thing that you'll see is we're putting quite a bit of expansion investments into multiple production facilities as we speak to make sure we can keep up with demand. So that's how I would answer it.

Matthijs, are you seeing any opportunities, though, to go back into maybe pieces of business that didn't come your way, where now customers needing a second...

Yes. Always. I mean, what we do see maybe -- let me answer it this way, strategically that multiple customers have come to us and said, listen, "We don't want to deal with the complexity of the supply chain anymore of individual components. You guys have intelligent subsystems. Can you guys help us, really manage that complexity for us." So basically, what you do see is a trend towards higher levels of integration that customers are asking us to so that we can manage that complexity for them. So that we definitely see and we're engaged in multiple exciting conversations around capabilities, both in the medical side, but also in the advanced industrial side. So that we definitely see as a result of this environment. They want to do more with us, given our capabilities.

The next question comes from Brian Drab of William Blair.

Just first, can you give me a sense for what the organic revenue growth is that's embedded in the guidance for second quarter and for the full year?

So for the second quarter, it'd be similar to that of the first quarter depending upon where the range is. You're probably looking at something closer to a repeat of 7%, 8%. 8%, maybe a little bit at the higher end and then 7% -- somewhere around that 7% to 8% range for the second quarter. The back half of the year organically should continue to hold at that. If you take the guide range, we'll hold it that for the back half of the year. We should deliver something close to 8% for the full year as well. And then really the only gating factor there is just the -- is supply parts. But I think we feel pretty good right now by [Indiscernible] range.

Got it. Okay. And then just to be clear on your comments on the high end of the range, does that apply to revenue specifically? Or is it all of the above revenue, EBITDA and EPS?

All of it. So I think that reinforces that we feel good about expanding the gross margin still at 100 basis points. We finished off last year at 45%, we'll be 100 -- at least 100 basis points higher than that.

Okay. And then -- just one last topic to touch on here. I think that -- did you say, first of all, that DNA sequencing and robotics revenues were both up more than 50%, 5-0?

That's right. 5-0.

Okay. And then just follow-up questions on that. And how do you expect that growth to trend throughout the year? Can you give us any sense for maybe even on like a combined basis, like roughly how much those business lines account for in terms of percentage of total revenue?

Yes. I mean, we're not going to guide on kind of individual businesses, obviously. But I mean, what I think is important, Brian, is just to -- they will be up double digits, for sure, right? But I think what is strategically more important, I would say, in the long run is that penetration of both these modalities is less than 10%, actually closer to 5% of the market, right? And so -- and we see strong adoption, right, of both modalities with DNA sequencing, I commented on that we're really moving from, let's say, research to clinical applications such as oncology testing, right? Which is a very strong amount of the demand right now. And another fast developing area is the integration of genomic data into drug development and clinical trials. And so you see that modality moving rapidly into, I think, an expansion mode, which is good. So we expect it to be a strong contributor for the year, but also -- it supports our growth thesis longer term. And the same is true for robotic surgery. Of course, multiple other players are getting in that do see this as well, and we see many different aspects of the anatomy of the human body being covered by robotic surgery and that all forms a great opportunity for Novanta to put content into those platforms and further increase the content where there is a demand for Precision motion, for sensing, haptic feedback for vision-enabling technologies like smoke evacuation, insufflation and so on. So you see increasing content of Novanta in multiple platforms in robotic surgery that are adopting rapidly into the medical area. So also there, we're very positive about the long-term growth thesis here.

And when you talk about the multiple other players, you continue to be well-positioned with players throughout the industry that are developing...

That's right. Yes, that's right. Yes. We work with the leaders in the business. Of course, we cannot comment names, but we -- yes, we have strong partnerships with multiple people.

Okay. The call, I think it usually ends with me, so I'm going to feel okay asking one more maybe. But can you, Matthijs, just elaborate a little bit on the comment you made on the endemic, hospitals adjusting to operating within the endemic as it pertains to the smoke evacuation and the opportunity there. I think I understand the dynamic, but can you just elaborate on that?

Yes. Yes. Well, there were 2 separate points, right? So hospitals [Indiscernible] So hospital is getting used to the endemic, meaning that -- we expect, as a result, elective surgical procedures to continue to rebound and be less affected by COVID surges going forward. I think that's a widely held consensus view in the medical device area. And so we share that view. So -- and therefore, with the rebound of the surgical procedures, of course, there will be a pull for our products. Yes. So therefore, it will be commented that we expect -- therefore, that demand to rebound probably in the second half of the year starting already this coming quarter. Yes. So that's one remark. The other remark was around smoke evacuation in particular that we see increased or continued legislative efforts in the U.S., but also outside the U.S. about requiring smoke evacuation in operating room because, again, if you are a hospital staff, OR staff, you will smoke the equivalent of one pack of cigarettes if you're inhaling the surgical plume or smoke that is caused by the energy-based devices and that smoke is toxic, and that smoke therefore needs to be evacuated. And there's more and more laws being passed that it's mandatory for hospitals to evacuate that smoke. We feel the best way to do that is by integrating that smoke evacuation through an already existing modality called insufflation in which we are the market leader. And by integrating smoke evacuation, with insufflation, you can actually, basically guarantee a stable cavity of the -- of basically the patients. So you're not putting the patient in jeopardy. It's much better in the workflow. It's more -- it's higher productivity and it's going to be cheaper. So it's cheaper, better, faster to do it in the smoke evacuation and insufflation way. And therefore, the penetration of the amount of hospitals that are -- that have smoke evacuation is still relatively low. We see the legislative and the, let's say, the functionality requirements pool, and therefore, long term, we're also bullish on further growth in this area.

The next question comes from Andrew Buscaglia of Berenberg.

So I was hoping you could talk a little bit more about -- or make a comment on kind of some of these negative headlines we're seeing around the logistics industry and concerns around overcapacity. I know it's not huge for you, but again in your Vision -- non-medical Vision businesses, you got some exposure there, and then maybe some other areas in your business. I know as things seem okay now, but I just wonder what you're seeing and how you guys feel -- you can weather that risk?

Are you talking about as it pertains to -- just so I understand the crux of your question, as it pertains to companies like UPS, FedEx were not delivering materials to us or shipping [Indiscernible] or neither? Do you talking about them as a customer or end market?

Yes, as a customer and they've built in a big way to keep up with all this demand we're seeing, but now concerns around if demand wanes, do you see kind of a slower CapEx cycle...

Yes -- so those are not customers of ours. So we don't sell into any logistics end markets. That's not a -- we just don't have any exposure there. Our products get embedded into the systems and instrumentation that goes into either industrial markets, which we wouldn't count logistics in that, semiconductor markets and then largely in the medical markets, life science medical.

Yes. So see us more on the factory automation side and warehouse automation side, right, that require productivity enhancing technologies, right, to drive productivity in those factories.

In a factory, not in like an Amazon warehouse or something like that.

Actually to manufacturing broadly. Okay. I just saw logistics exposure with Machine Vision and your RFID, I thought probably there'd be knock-on effects or something?

Yes, we don't have exposure there.

No. So our RFID, our Machine Vision all goes into IVD medical device applications.

Medical stuff.

Yes. So drug detecting, things like that.

Okay. And then I'm wondering you -- kind of working with these acquisitions now and the market is definitely taking a hit here. I'm wondering how effects either the psychology you guys have for making more acquisitions going forward? Or do you see it presenting a good opportunity to be acquisitive or is this volatility kind of make you want to shy away near term?

Well, listen, I mean, the preferred way of acquisitions is in a proprietary manner where we're cultivating long-term relationships with potential sellers and founders of businesses. So these are typically a result of multiyear endeavors. So it's not like you snap your finger and suddenly you kind of wake up and find a company or something. It's a very thoughtful long-term process. Having said that, of course, increased uncertainty provides opportunity, right? So it's not a surprise that when Brexit was announced, that within, let's say, an 18-month period, we actually bought 2 U.K.-based companies because it did induce uncertainty at founders of businesses. So where we sit, we think that actually uncertainty creates opportunity. Now we cannot time these events, obviously, but we're very active, and you'll hear when we have an acquisition to report.

[Operator Instructions]

All right. Well, with that, I think we -- I want to thank you, operator. And so to summarize, Novanta delivered strong results in the first quarter of 2022. We saw double-digit growth for sales bookings and profit and a new record high backlog. We achieved all of this while managing supply chain disruptions, rising cost and in a more uncertain macro environment. We're excited to see the continued strength in the advanced industrial sector, and also in the medical sector. Novanta is well-positioned in these sectors with diversified exposure to long-term secular market trends in robotics, automation, precision motion, minimally invasive surgery and Industry 4.0. In closing, as always, I would like to thank our customers, our employees and our shareholders for their ongoing support and continue to be especially grateful for the dedicated efforts of all our Novanta employees who work so hard every day to tackle each new challenge. We appreciate your interest in the company and your participation in today's call. I look forward to joining all of you in several months on our second quarter 2022 earnings call. Thank you very much. This call is now adjured.

Conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.