Welcome everyone to the Novanta Incorporated. 2023 Fourth Quarter and Full Year 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 Fourth Quarter and Full Year 2023 earnings conference call. I am Ray Nash, Corporate Finance Leader for 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, I 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'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 delivered solid performance in 2023 in the fourth quarter and for the full year. I'm very proud of how our team has delivered revenue and profit performance above our expectations in a dynamic market environment. For the full year of 2023, we achieved a record $882 million in revenue, expanded adjusted gross margins by over 100 basis points to 47% and expanded adjusted EBITDA to $196 million, a 100 basis point improvement in EBITDA margins. Our sales grew 2% year-over-year on a reported basis and 1% on an organic basis. Excluding microelectronics applications, our growth for the full year was up high single-digits. For the fourth quarter, we delivered $212 million in revenue, which represents a decline of 3% on a reported basis and a decline of 4% on an organic basis. Excluding microelectronics, our organic growth was down approximately 1%. Adjusted EBITDA was greater than $45 million beating our expectations and prior guidance, operating cash flow was very strong for the second straight quarter at approximately $39 million, which represents more than 300% conversion to net income. This operating performance reflects excellent execution by our teams in a challenging market and economic environment. In addition to all of this in 2023, we signed an agreement to acquire Motion Solutions which will enhance our portfolio and further expand our presence in the highly attractive medical and precision medicine space. We're happy to have completed the acquisition at the beginning of January 2024. The sticky Novanta business model with diversified exposure to long life-cycle customer platforms in secular high-growth markets has proven resilient under multiple geopolitical and macroeconomic scenarios. Our proprietary technologies are well positioned in medical and advanced industrial applications with long-term secular tailwinds such as robotics…

Thank you, Matthijs and good morning, everybody. Our fourth quarter non-GAAP adjusted gross profit was $100 million or 47% adjusted gross margin compared to $98 million or 45% of adjusted gross margin in the fourth quarter of 2022. For the quarter adjusted gross margins were up 220 basis points year over year. For the full year of 2023, non-GAAP adjusted gross profit was $413 million or a 47% adjusted gross margin compared to $392 million or 46% gross margin in the prior year. 2023 adjusted gross margins were up 120 basis points year-over-year, which exceeded our goal. This represents a fantastic outcome for our teams especially considering the slight drop in volumes in the second half of the year. Our success with gross margin expansion in the year was largely driven by the deployment and adoption of the Novanta Growth System productivity tools in our factories and in our operating teams. Moving on to operating expenses. For the fourth quarter R&D expenses were roughly $23 million or approximately 11% of sales. For the full year R&D expenses were roughly $92 million or approximately 10% of sales. Fourth quarter SG&A expenses were slightly below $42 million or roughly 20% of sales. For the full year SG&A expenses were $164 million or roughly 19% of sales. Adjusted EBITDA was approximately $45 million in the fourth quarter or a 21% adjusted EBITDA margin versus $46 million in the prior year. For the full year 2023 adjusted EBITDA was approximately $196 million or a 22% adjusted EBITDA margin versus $184 million in the prior year. EBITDA margins expanded by roughly 100 basis points year-over-year. On the tax front our non-GAAP tax rate for the fourth quarter was 21%. This differed from the statutory rate due to jurisdictional mix of income. For the full year…

[Operator Instructions] Our first question will come from Lee Jagoda of CJS Securities. Please go ahead.

Hi, good morning.

Good morning, Lee.

Good morning, Lee.

So starting with the first half guidance, Robert can you parse out how much of that guidance relates to the general macro in microelectronics and advanced industrial versus the piece that we're customers are basically pausing in anticipation of the new product later in the year?

Yeah. I would say less positive more phasing out of legacy products. So effectively, ramp down any product that's going to be replaced with the new products to ensure you have a more successful launch on the new product launches. So I would say for overall Novanta roughly half of it is related to that and half of it is the macroeconomic environment.

Got you. And then looking at your full year revenue guidance. Obviously, second half weighted. Can you talk to the range of that guidance? And how much of the lower high-end of that range is based on the macro getting better, and how much is based on the timing of the product launches at your customers?

Yeah. So we're not relying on a, I would say, an improving macroeconomic environment to get to a billion dollars. The billion dollars represent the things that we can control. So, obviously, there's more stabilization in the market, and you'll see sequentially improving environment. But we're not betting on a very large improvement in the macroeconomic environment in the second half in order to hit the top of the range. The bottom end of the range represents a deterioration of the macroeconomic environment. So, the way we see it today is we're sort of trending towards that billion dollars. If things worsen for geopolitical reasons or some other shoe drops on a macroeconomic perspective, then that's where we see ourselves trending to the lower end of the range. There's nothing that we see today that would necessarily deliver that, but we want to be prudent in the guidance for the full year.

All right. That's fair enough. One more, and I'll hop back in queue. Obviously, world of medicine is driving a lot of the growth coming in late 2024 and into 2025. Can you talk to some of your customers' product roadmaps as you look out to 2025 and maybe speak to any other significant products or specific drivers of growth beyond the world of medicine that we should start to think about?

Yeah, Lee, this is-- so this is Matthijs. Yeah, so I spoke about that the amount of products that we're launching this year is 50% larger than last year. And so, that's a record amount of new product launches, and they're pretty broad-based. So, it's not all world of medicine, right? So, we've spoken a lot about I think the smoke evacuation side of course that we think is going to be a standard-of-care for the next decade as well as the pump side of that business that we're getting into and we're getting successful design wins. But beyond that, I've talked before but let me repeat that. We're gaining content in the Deep UV EUV lithography side of the business. That is an exciting application for us and we expect that to show some first revenue later in the year and then strong momentum in 2025. We see a lot of intelligent subsystem momentum in precision medicine spatial biology and multiomics on the back of our MoSo, or Motion Solutions acquisition. What we're seeing is Motion Solutions has a lot of them in Korea a great customer base in the segments that we were eyeing and they already know the people there. So, we can accelerate our strategy there that way and vice versa we can help Motion Solutions to accelerate and customers that we are in there. Now, that we see beam delivery subsystems for advanced micromachining electric vehicle battery welding converting. We've spoken about this as well in the past and these products are launching as we speak. Are being launched in the second half of the year in 2025. I mean you'll see an overall trend of more precision more curiosity at super high throughput and yes we have leading technology there. So, whenever you see applications that will drive next-generation manufacturing technologies to achieve these securities we have like 3D printing like electric vehicle battery welding like let's say precise medical manufacturing rate at a submicron level chances are we're in those machines and there's a trend more towards intelligent subsystems that we're excited about. And then we've got the whole robotics and automation space of course on the back of our ATI acquisition, but also on the back of our own let's say regional core business where we see both the sensing the four-stroke sensing as well as the positioning and the intelligence that drives all gaining momentum in robotic surgery but also warehouse automation and general industrial robotics markets, right? So, it's basically we are enabling a sense of touch and motion control and these applications with unique proprietary technology. So, in other words, the list as long the impact is a bit more consolidated in one business for sure but you see a large breadth of new products and applications. And therefore that's why we feel confident and are excited about that breadth and that potential.

That's great color. Thanks very much. I'll hop back in queue.

Sure.

The next question comes from Brian Drab of William Blair. Please go ahead.

Good morning. Thanks for taking my questions.

Morning Brian.

Robert -- morning. You ran through a lot of numbers really quickly in terms of the guidance. I sorry if I missed this but can you aggregate all the dynamics that are occurring in the second half and tell us what you expect for overall company revenue growth in the second half?

I think if you do the range, you do the math. If you base it off of what I've given guidance for the first quarter and then look at the full year, let's say you're trending up towards $1 billion for the full year, you'll probably see growth return to our long-term growth averages in the third quarter and then in the fourth quarter, getting to double-digit type growth as the new products really kick in in a number of different areas including in the medical solutions being the magnitude of that. With that signals the first half of the year being down organically with it being down more in the first quarter and really less in the second quarter. So, that's the dynamics. And I would say that the first half performance is more complicated than the second half. The second half performance is really just the stabilization of the market driven by new product introductions driving growth above let's say macroeconomic conditions. In the first half of the year, you have some customers pulling back on any sort of legacy products to make their launches more successful in the back half of the year. And so that's a you've got inherent weakness into the Life Science space continued weakness in the Industrial Space, strength on the Medical side being somewhat offset by the fact that they are scaling or phasing out those legacy products. But the overall year we feel pretty good about. So as I said before to the last caller, we're trending right now closer to that $1 billion level, based upon the economic conditions. We're not banking on the economic conditions are improving in order to get there. We're really just assuming that the current stabilized market environment that we're operating in will continue on in our new products will accelerate our growth in the second half.

Right. And you made this comment, I think pertaining to one specific segment. But you said that, if we can get to low-double digit growth in the second half, expect to be able to sustain that as you enter 2025. I think that was for one segment that wasn't for the company overall? Or does that kind of comment probably pertained to the company overall as well?

Yeah. I think it gives us the greater and most of that was the relation to the Medical Solutions area, because you have a larger above average ramp in new products, effectively we've talked about this before within the MIS space we have won a multitude of new customers for our Next-Generation the Second-Generation smoke evacuation products. And so that's all, that resulted in that double-digit growth in the fourth quarter. And then in that stable that continued momentum goes into 2025, because of those new product launches. That's a dynamic that team has talked about and around that $50 million of incremental new product revenue being driven from that. There's an element of that also benefiting our Precision Medicine and Manufacturing segment. So there should be a little bit stronger growth in 2025 as well. I didn't want to kind of get into that as much. There's some other dynamics in play that are a little bit more complicated to forecast at this point, but clearly ramping up in Next-Generation Lithography. And the continued strength of recovery that we expect from Next-Generation DNA sequencing will help that segment driver strong growth as we exit 2024.

Okay. And my last question for now. I'm just not going to push this line of questioning just a little bit further. But how important is the consumables revenue stream that's going to follow should follow the introduction of the new inflator that some of these platform wins with consumables? It's been a relatively small part of the business but does that get bigger following these interests?

Yeah. It absolutely does. So I don't want to get into like how big it is, because that would be the question you're asking us. But it effectively will double as well. And so the medical consumables, the great attractiveness around that is that it's a consumable. It's not tied to capital cycles. It will be very tied to Surgical Procedure rates. Surgical procedure rates are around 6% on a global basis. And so you drive this very steady annuity of around 6% in the medical field, tied to our Proprietary Second-Generation Smoke Evacuators. And it allows us to drive a real sustainable cash flow stream. Now even though we've talked about it before. We've ramped and completed our Czech Republic manufacturing facility. We are pushing volumes through that now. It is complete and qualified. And so confident that we will begin to in-source that that will drive the higher gross margin expansion in that segment for the next few years. It also allows us to really drive a higher EBITDA margin because of the medical consumables don't have the operating expenses, there a lever off of the capital equipment sales. And then, think of it, it's reoccurring as soon as we get the system in place. We have that annuity stream lasting up to 10 years off of those systems. Matthijs.

Yeah. No that's great color, Robert. I would just say underneath right Brian, it's about winning capital equipment swaps right? So you can kind of drive the installed base or rather to customers can derive. So we've won new slots that we never had before and that we've won slots that where we didn't have prior to the consumable revenue stream. So towards the percentage of business where we've won basically attach rates with consumables has increased with those designs. Secondly, there's a trend towards more I would say sophisticated consumables, which means higher ASPs, right? We're solving more-and-more complex problems to make sure that more-and-more, I would say indications can be served with our consumables. And then third, our entry into pumps, which in a way kind of a greenfield opportunity for us, where we didn't have a position to begin with. So all these things together, you can kind of see where we win more installed base that will drive more consumables that we have higher ASPs and that will then drive of course additional growth. And over time, I think in this business you can expect that consumable business to be larger yet than our capital equipment business.

Perfect. Okay. Thanks very much.

Thank you.

The next question comes from Rob Mason of Baird. Please go ahead.

Hi, good morning. I wanted to circle back to just trying to get clarification with Robert within the within your full guidance, revenue guidance for the year low single-digit core growth you said, so I'm assuming around $85 million, $90 million from Motion Solutions. What is the headwind from some of the product ramp down that's dialed into that low digit core growth rate?

Yes, I won't give an exact number but if you take the first half growth rates you know, I would say half of it is related to the – half of the decline is related to the macroeconomic environment and half of that decline is related to the product ramp-downs of legacy products and just management of those legacy products by our customers. So if you take that as a full year organic of that low single-digit, you'd probably be closer to something in the mid-single digit territory for the full year. So that gives you a little bit of that scaling, right. And it's mostly a first half dynamic versus second half dynamic, which is where the – where it's kind of predominantly related to the Medical Solutions side of the segments.

Okay. And if – appreciate the commentary just around medical overall, high level between the surgical exposure versus life sciences patient monitoring, how does that exposure break down on or percentage surgical versus life science patient monitors?

I think it's a question that we are delinquent on answering. You've asked us a few times that we do have to get that – get some information out on that. I apologize for not completing that by year end. It's fair to say, overall kind of medical solutions is roughly half of it is tied to more of a pure hospital, up your minimally invasive surgical business and then the other half of it tied to more of that mix of life science precision medicine and some stuff going into the patient monitoring equipment and drug dispensing equipment. So it's roughly 50-50 in the Medical Solutions segment overall.

Okay. Okay. And just maybe last question. Matthijs, you had noted ATI had seen some improvement in their bookings in the robotics space. Could you just maybe isolate on where they were seeing some of those improvements is China and part of that improvement or what's the perspective how China factors into advanced industrial in the outlook as well?

Yes. I mean China, we were seeing some modest improvement but I think it's fair to say we're not banking on improvement there for the full year, right. Because yes, I would say, that's probably the region where we have least visibility and where it's yes toughest to say when that will turn. And now having said that, we do feel that globally and particularly in the US, inventories have worked their way down or working their way down. And therefore, we think towards, sequentially basically in the year that will improve and drive momentum. So, I would say regionally probably US the strongest and Europe bottoming. And then China, is remains to be seen although we see some green shoots there as well albeit, from a low level and we're not in our guide assuming a massive recovery or so.

Okay. Very good. Thank you.

Thanks, Rob.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Matthijs Glastra closing remarks.

Thank you, operator. So to recap Novanta delivered solid performance in 2023, in the fourth quarter and for the full year. Our teams delivered revenue and profit performance above our expectations and dynamic operating environment. We achieved record revenue, actually gross margin expansion and solid profit and cash flow performance. And this came despite some challenging headwinds in the end markets we serve, and we secured the Motion Solutions acquisition, which will be an attractive growth platform for us in 2024 and beyond. So, Novanta remains well positioned in the medical advanced industrial end markets with diversified exposure to long-term secular macro trends in robotics and automation precision medicine, minimally invasive surgery and Industry 4.0. And in 2024, we're excited for the large product launches starting later this year. We will continue to focus on additional design wins in high-growth applications as well as doubling down on the Novanta Growth System to drive strong cash flows and gross margin expansion. In closing, as always I would like to thank our customers, our employees and our shareholders for their ongoing support. And I continue to be especially grateful, for all the dedicated efforts of all our employees, who work so diligently every day and taking on new challenges and striving to make the company a great place to work. We appreciate your interest in the company and your participation in today's call and look forward to joining all of you in several months and our first quarter and 2024 earnings call. Thank you very much. This call is now adjourned.

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