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 Incorporated's 2023 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 2023 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've 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 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'm 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 started 2023 with a strong first quarter. In the quarter, we delivered $219 million in revenue, representing 7% year-over-year revenue growth on a reported basis and 8% growth on an organic basis. Our adjusted EBITDA was $47 million and adjusted diluted earnings per share was $0.74. These results are better than our expectations and guidance and reflect excellent operating performance by our teams in an evolving macroeconomic environment. We feel the strong performance in the first quarter puts on track to achieve our full year outlook and it will help drive a more balanced performance in the first half of the year. The Novanta business model with diversified exposure to high-growth medical and advanced industrial markets have proven resilient under multiple geopolitical and macroeconomic scenarios. Our proprietary products and technologies are well positioned in medical and advanced industrial applications with long-term secular tailwinds such as robotics and automation, health care productivity and precision medicine. We feel that the strength of our portfolio and business model, combined with our winning growth strategy, a focus on where we play and how we win, drives our performance no matter the environment. Now let's turn to what we're seeing in our markets and our customer activity. We continue to see strong ongoing demand from our customers in many applications and areas. We made great progress reducing our past due backlog to customers by more than 25% sequentially, while still maintaining a near record backlog of $604 million, nearly flat with the prior quarter. Our book-to-bill in the first quarter was 0.96, in line with our expectations and 2 of our 3 segments had book-to-bill greater than 1x in the quarter. As we discussed in the last earnings call, we continue to…

Thank you, Matthijs and good morning, everyone. The first quarter non-GAAP adjusted gross profit was $101 million or 46% gross margin compared to $94 million or 46% gross margin in the first quarter of 2022. For the quarter, adjusted gross margins were up sequentially over 100 basis points and flat year-over-year. This outcome was better than our expectations and represents strong execution by our teams to achieve this result. This achievement puts us on a solid track to achieving a full year goal of expanding gross margins by 100 basis points. Moving on to operating expenses; R&D expenses were roughly $23 million or approximately 10% of sales. The first quarter SG&A expenses were $41 million or roughly 19% of sales. Overall, operating expenses as a percent of sales were up sequentially in the quarter as a result of the impact of variable compensation programs and the seasonal payroll taxes as well as the increased R&D investments. Adjusted EBITDA was approximately $47 million in the first quarter of 2023 or 21% adjusted EBITDA margin versus $44 million in the prior year. On the tax front, our non-GAAP tax rate in the first quarter of 2023 was 12%. This differed from the statutory rate due to jurisdictional mix of income and the seasonal impact of equity compensation windfall benefits. Our non-GAAP adjusted earnings per share was $0.74 in the quarter compared to $0.73 in the first quarter of 2022. While adjusted EBITDA grew in the high single-digit range, EPS was muted due solely to higher interest expense. First quarter cash flow was approximately $7 million which was up 28% versus the prior year. As previously mentioned and communicated, the first quarter typically has a lower cash flow due to the timing of incentive compensation payments, equity compensation, vesting events and the timing…

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

So just starting with the microelectronics business. Can you talk about how much of the current run rate today is tied to EUV lithography and how we should think about the growth there? And then sort of secondarily, just comment on the Westwind business? Is this a similar situation to the situation we were in probably 8, 10 years ago where the Westwind business went down close to 0 just because capacity in the space wasn't getting utilized and as capacity gets utilized again, we should expect that business to come back at some point?

Yes. I mean on the last question, you're right. I mean, I think there is a tremendous capacity build as a result of the microelectronics boom. And so we'll have to work through that capital utilization, let's say, trough for a little while. And that's why we don't expect that business to come back this year and then microelectronics to stay down for the year. On your first question, we basically in our last call what we outlined was more of a forward-look view that in, let's say, 2 years from now, we expect actually the makeup of microelectronics to fundamentally change, more geared towards EUV rather than the exposure to the Westwind business.

So I think we said in the fourth quarter earnings call that we've probably declined to somewhere around 7% of revenue. So overall microelectronics exposure is somewhere close to 8% to 7% of total revenue and the majority of that would be in the EUV, deep EUV application area. So as it gets to the end of the year, then we're actually in a territory where we have a secular growing piece of microelectronics.

Okay. That's helpful. And then just on the Czech facility, I think it sounds like you're making some good progress on the qualification of the new products. But just looking at that facility, I think when you bought it, there were some product lines in there that you were trying to get out of there and wind down. Can you give us an update on the progress there and whether that's been a margin headwind or tailwind as a result of the actions you've taken?

It's a great question. Well, probably -- yes, the effort is to slowly wind that business down. It is a margin headwind. The margins are significantly lower than anything we saw in the company. I would equate it as overall cash neutral because there are some significant qualification costs and then cash outlays associated with bringing our own production up there. And so we're attempting to time that so that as we ramp that business down, it's covering the cost of our qualification efforts. That will largely be behind us by the end of the first half. And in the second half, the qualification steps remaining for our production facility rely on the sterilization process. And getting through the final stages there with an expected ramp of production start in the fourth quarter with real volume on a material level starting to come out next year. Now, we've implemented SAP in this site. We've actually started testing some production runs. We've done significant training. We've had equipment moved into the facility. And so overall, we feel we are well on track to ramping up production in medical consumables on our second-generation smoke evacuation products in 2024. And the impact that we're seeing are headwinds on the gross margins associated with the old NPH business will largely be gone by the end of the first half.

Got it. That's helpful. I'll hop back in queue.

The next question comes from Brian Drab of William Blair.

First, on the new product launches. The way that you've been communicating some of the opportunities related to new product launches for 2025, $50 million in revenue opportunity. And I'm wondering if some of the launches that you're talking about coming later this year and in 2024 are opportunities you've had visibility to for some time now? Or are there some new ones? And how do those fit into the context of this 2025 opportunity for $50 million annual revenue that you've been talking about?

I mean, these comments are consistent with that level of $50 million in 2025. And of course, we're ramping also other new product launches but those are consistent with what we've been communicating in our overall growth outlook, right? So we do feel the second half really starts to mark a momentum building up to the levels that you mentioned in 2025 and that's why we made those comments.

One thing, Brian, I'd mention is when you think about why we guided a 2025 number instead of 2024 number, is that with a lot of these products launching at the end of this year, it means 2024 volumes are going to be harder to predict with a high degree of accuracy because there are different cycles of OEMs coming online at different times throughout the year and different qualifications that they need to engage in with the hospital environment and the medical practitioners. And so as a consequence, we can get very accurate with 2025. In 2024, it will be a larger range and will look funny. So we're being a little bit more cautious on 2024. But all those launches are consistent with that. And I would say that the continued investment in the manufacturing facilities in Manchester and Taunton and in the NPH business are signs of that confidence that we wouldn't be outlaying as much of an investment in those facilities if we didn't believe the growth was on track and materializing in the pace in which we thought it would materialize.

Got it. Okay. So this is not a situation where -- I guess, at the extreme end of the spectrum. It will be like a bunch of new product or platforms launching at the end of '24 contributing revenue of $50 million in 2025. It's more of -- it's ramping somewhat in 2024, hitting that run rate in 2025.

Correct.

That's right.

So it takes the risk out of the numbers a little bit, right -- if you think about it from that perspective.

Yes. Okay. And roughly -- I mean, can you talk a little bit in more detail about how many opportunities you're talking about? I mean, is there one that accounts for more of that $50 million than others? And any granularity you could give us in terms of number of opportunities?

I think we've been consistent in our earnings remarks on this but let me kind of rephrase it and or summarize it. So in the minimally invasive surgery area, we've won basically many second generation insufflator businesses, both for endoscopy as well as for robotic surgery markets. And in addition, we've won endoscopic pump business all with multiple OEMs. So that's where the majority of that $50 million is that. And then in addition, we see based on the R&D investments that we've made in other areas such as our beam steering, laser beam steering business, for example, our precision -- formerly known Precision Motion business, Robotic and Automation segment, you see a ramp in new products happening as well in both Robotics and Automation as well as Precision Manufacturing. So electric vehicle, for example, micromachining, EUV, laser additive manufacturing, those are applications that we're primarily targeting with subsystems. And so you see that percentage of the business increasing as well with the launching of new products in those areas. So multiple applications we've talked about and where we're gearing our NPI towards.

Okay. And then just lastly for now. How are you handling pricing lately in this environment? And can you talk at all about how much you expect price to contribute revenue growth maybe and/or margin expansion in 2023?

I won't get into the specifics. We've been very consistent with our customers on the narrative that effectively, the increase in price is helping to offset the inflationary pressures that we're seeing and it's the sharing arrangement that we have, right? So I think we've been -- that's the message that we've signaled to our customers, that's the message we've been on externally and I think that's reflective of the actual efforts that we've engaged in. Now it's fair to say that there's a bifurcation happening in 2023, where the material cost or capital goods are actually seeing some ability to take costs down. Microelectronics may be a bit of an exception to that in certain areas. But yet then services and third-party services and utilities and other types of ancillary services that we pay to support the manufacturing efforts are still in an inflationary environment. And so we expect inflation in 2023 to be a headwind. We expect price to be a lever to offset that, at least help offset that. And we feel like, ultimately, at the end of the day, our goal is to expand gross margins 100 basis points. A lot of that will come through helping us launching some new products and driving Novanta growth system into our facilities and we feel good about that. We delivered a solid gross margin in the first quarter. We'll deliver a solid gross margin in the second quarter and we'll continue that march throughout the course of the year and to drive that 100 basis points.

Got it.

The next question comes from Rob Mason of Baird.

You had mentioned that you made some good progress reducing your past dues on the backlog. I'm just curious what percent of your backlog now is in that past due category?

Yes. I don't think we've disclosed that but the fact that we've reduced past due backlog by 25% sequentially, we feel is very meaningful. And then maybe more importantly, the lead times to our customers have come down -- I think Robert put this in his prepared remarks -- from, in some cases, over a year to now less than 12 weeks or sometimes even less than 6 weeks. So you see a dramatic reduction in lead times as a result of really strong efforts from our operations teams. And so yes, we feel good about basically catching up on the demand that our customers are expecting us to deliver. So that's really, I think, the takeaway is that we're starting to catch up substantially. The lead times are coming down to kind of pre pandemic historical averages. Well, by the way, our backlog as a percentage of look forward revenue for the next, let's say, 12 months look forward is still at that record territory of mid- to high 60s percentages versus historical levels of, let's say, mid-30s percentages, right? So you still have that historically very high backlog but past due coming down rapidly and lead times coming down rapidly.

Matthijs, would you expect that backlog percentage eventually on next 12 months' revenue to work towards that historical level? Or is there anything structurally different in the way that your customers are going to order or that you would view your backlog?

It's a little hard to say but we expect -- yes, I think this is, the mid-60s is unusually high, right? So we expect that to come down. I mean, our customers, when we have lead times of 6 weeks, they really don't need to order for like a full year, right? And that is what historically used to be the case. So we used to be a book-to-bill business of about 1 on average and we expect that to come back to those levels on average over time. But in order before that happens, we first have to work that backlog down and ship to our customers. So, I do expect it to come down to closer to historical levels but maybe a little bit more elevated than in the past. It's hard to say though.

Yes. I think if you look back in the fourth quarter, I gave some rough guidance on that. We'll never be back to where we were where there's only a quarter's worth of backlog but we won't be at these levels either. So I think, hopefully, down -- our past dues will largely be behind us, hopefully, if everything executes as planned by the end of the second quarter. Then you're dealing with marginal levels of past due. And therefore, really what you're looking at is that there's a significant amount of future demand that's still being placed on us and people getting ready for production ramps of new products in 2024 and beyond. And so we will have an elevated level because of that. There's a lot of new products coming online. And so it will be above the historical levels but below maybe a little bit of what caused the past due issue.

I see. And you made some commentary around the -- some of your second-generation products coming out. Certainly, we would assume, I think you secured some new customers, new OEMs there. But if you think about the growth there, is there also new -- is that weighted more towards new customers or added content at a high level?

It's a great question. That's a great -- it's a combination. When we won -- we believe our second-generation smoke evacuation insufflator technology will become a standard of care which means that it will be standard in all minimum evasive surgical procedures on a go-forward basis. It takes time to get real penetration in the global market for that. And so why we think we make the commentary around that, why we believe that is largely because we won new customers, we've won new application areas and we've obviously replaced older technologies that we've had in place. We've done a combination of things. The first-generation spoke of auction [ph] insulator was relatively limited in launch. It went ahead with a single large customer. And I think on a go-forward basis, you'll see the breadth of that of our new offering being sold to a multitude of customers, including some that we've never served before.

Just last question around the microelectronics business. If I understand you correctly, it sounds like that business probably trends out -- or you expect it to trend out -- kind of flattish revenue-wise in dollars for the remainder of the year. Is that correct? Do you think it's stabilized?

Yes, that's absolutely the math. So by -- you effectively just keep it flat, the percentages go down because you start to face the easier comparisons once you get to the back half of the year. But the revenue itself is relatively flat in our forecast for the full year right now. Now that doesn't mean -- like there's some underlying dynamics there. You got EUV, deep EUV growing and then you got other areas that's still seeing some weakness in back-end semiconductor type of equipment. And so there's a dynamic there. But as you exit 2023, you're now predominantly in a growth category. And we expect that then to grow in 2024 as we penetrate with additional content and additional penetration into EUV applications.

Got it. Thank you.

[Operator Instructions] This will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Matthijs Glastra for any closing remarks.

Thank you, operator. And so to recap, Novanta had a very impressive first quarter 2023. We saw good sales growth despite the headwinds that we mentioned in microelectronics and beat our own expectations for margins and profit. We've maintained a very robust level of backlog while reducing our lead times and our past due backlog and we continue to see strong tailwinds in our medical businesses. We're progressing our innovation pipeline and we're excited for the large product launches happening later this year and next year. We feel we're on track with our full year 2023 outlook. Novanta remains well positioned in the medical and advanced industrial end markets with diversified exposure to long-term secular market trends in robotics and automation, precision medicine, minimally invasive surgery and industry 4.0. In 2023 and beyond, we will continue to focus on new product development, design wins and high-growth applications, driving cash flows and institutionalizing the Novanta growth system. In closing, as always, I would like to thank our customers and our employees and our shareholders for their ongoing support. I continue to be especially grateful for the dedicated efforts of all our Novanta teammates who work diligently every day to tackle new opportunities and manage through new challenges. 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 2023 earnings call. Thank you very much. This call is now adjourned.

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.