Novanta Inc. (NOVT) Q4 2015 Earnings Report, Transcript and Summary

Good afternoon. My name is Kyle and I will be your conference operator today. At this time, I would like to welcome everyone to the GSI Group 2015 Q4 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Robert Buckley, Chief Financial Officer. Sir, you may begin your conference.

Thank you, Kyle. Good afternoon and welcome to GSI Group’s fourth quarter 2015 earnings conference call. I am Robert Buckley, Chief Financial Officer of GSI Group. Before we begin, we need to remind everyone of the Safe Harbor for forward-looking statements that we have outlined in our earnings press release issued earlier this afternoon and also those in our SEC filings. We may make some comments today both in our prepared remarks and in responses to your questions that may include forward-looking statements. Those 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 today. 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 today’s forward-looking statements as representing our views as of any date after today. 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 in the financial tables included in 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. I am now pleased to introduce Chief Executive Officer of GSI Group, John Roush.

Thank you, Robert. Good afternoon, everybody and welcome to our call. I am pleased to report that GSI delivered a solid Q4, which in turn enabled us to achieve all of our major objectives for 2015. And I am referring to both our major financial goals as well as the strategic progress of the company during the year. So for the full year, we had adjusted revenue of $368 million, adjusted EPS of $0.93, and adjusted EBITDA of $61 million. We completed three acquisitions and one divestiture during the year that improved our technology portfolio and our market position. We also launched a number of new products and won numerous programs that will strengthen us in the coming years. We also made significant progress on the organizational front and we are a more talented and capable company than at any point in the past. All these factors lead me to be optimistic about the prospects for the company in the coming years. In fact, we see a company and a set of opportunities that are so distinctly different from the past that we are re-branding the company as Novanta. I will make some more comments on the new name in a few minutes. From a Q4 perspective, I will provide a few highlights and as usual, Robert will go into more detail in his section. In the fourth quarter, we had sales of $90.2 million, up 3% on an adjusted basis. Adjusted EPS was $0.29 in the quarter and adjusted EBITDA was $14.4 million. All these figures were consistent with our own expectations and enabled us to achieve all of our full year goals. Q4 book-to-bill was 1.0, with all of our reporting segments very close to 1. Our full year book-to-bill ratio was 1.01. As we have indicated in the past, we increasingly see our OEM customers operating on fairly short lead times, with limited forward order coverage. So, our book-to-bill ratio generally stays pretty close to 1 in most periods. As I said, we feel we accomplished our major goals for the company in 2015 and we did it in spite of an industrial market that’s slowed down in the latter part of the year. Our organic revenue growth was 4% for the full year, which is significantly up from the 1% we achieved the prior year and we did it in a worse economy. We are able to increase adjusted EBITDA by $4.6 million and grow our adjusted EPS by 15% versus 2014, while increasing our R&D spend by $2.1 million from the prior year and actually, its closer to $4 million increase if you were to adjust for the JK Lasers divestiture. We used this increased funding to develop and launch new products in a number of areas which I will cover in a few minutes. In 2015, we also opened our first R&D center in Asia, located in Suzhou, China in our site there. And the team is already at work developing new products for both China and other markets. Staff increases are planned for the China development team in 2016. We also increased our investment in sales and marketing expense by over $1 million in 2015, again adjusting for the divestiture of JK. We put in place some additional medical sales and application staff in China and reinforced our sales and product management resources in NDS, Cambridge Technology and Celera Motion. During the year, as I said we made three acquisitions with an aggregate cash outlay of $26 million, but we had strong operating cash flow for the year and we divested JK Lasers generating gross proceeds of over $30 million. So, we are able to reduce our net debt to $38 million by year end, down from $64 million at the end of 2014. So, we were able to make the company stronger and better positioned for sustainable, profitable growth while improving our balance sheet. So, we are making the key investments across the company that will enable us to continue to drive and accelerate growth. We are able to fund the investments by driving productivity across GSI. Through our lean manufacturing and strategic sourcing initiatives across our sites, we were able to generate $5.5 million of total productivity in 2015. Now, we had set a goal for the year of $6 million and we didn’t quite get there, but frankly, we are pleased with the outcome. It’s the first time we attached the sites with concrete measurable goals for our productivity and they responded well. So now, with a full year of learnings and experience under our belts, we expect to see similar or even greater benefits in 2016. So at this point, I would like to provide some commercial updates on our progress around the company and I will start with the Precision Motion segment, which had a very strong year in 2015. Sales of Precision Motion products increased 23% in Q4 and 24% for the full year. The Applimotion precision motor acquisition, which closed last February, drove a significant portion of the growth. We continued to be pleased with the performance of this acquisition, which exceeded its plan for the year and has an excellent funnel of new programs that will be going into production over the next year. We also had strong growth in our optical encoders, which were up high-teens in Q4 and mid-teens for the full year, driven by strong demand in robotic surgery and data storage applications. We are now going to market jointly with the precision motor and encoder products under the Celera Motion brand name. We have a number of new motion products in the market for 2016 that will drive our growth. These include our new low profile rotary motors for satellite communications, our Optira line of miniaturized encoder products for robotics and other space-constrained applications, as well as our Veratus encoders that delivered best-in-class resistance to dirt and contamination in demanding operating environments. These products all enhance our current market capability to provide the best submicron motion control in the market in the smallest available footprint. The sales of our air bearing spindles products were down 25% in Q4 and 15% for the full year driven by lower demand from mechanical PCB via hole drilling OEMs. This softness is directly correlated with the weaker industrial sector activity in China. In recent years, we have developed several spindle applications outside the PCB industry. These new applications grew low-teens in 2015, but were not large enough to offset the declines in the PCB sector. So, in reaction to this lower spindle demand, we undertook some restructuring actions in Q4 of last year to reduce costs in the spindle sites. Thus going forward, we expect solid profitability in this product line despite the lower revenue. Turning to our Laser Products segment, we had adjusted revenue growth for the full year of 5% with both CO2 lasers and scanning products, delivering solid growth for the year. The challenge we had was that demand from industrial customers began to weaken around Labor Day of last year. As previously discussed, we had only a 0.85 book-to-bill ratio for lasers in Q3. The majority of that slowdown was China-driven with some impact in Europe. Those low Q3 bookings resulted in a Q4 sales decline of 1% year-over-year for the laser segment. The Q4 decline was mid single-digits in industrial applications, but was partially offset by some strong growth in medical applications, such as OCT retinal scanning and dental. The good news is that the laser customer demand has started to improve. Q4 book-to-bill in the segment recovered up to 0.98. And through the first 7 weeks of Q1, book-to-bill is running above 1 and we are getting more positive demand signals from our industrial laser OEMs. We did have 28 laser design wins in Q4, customer engagement and interest remains high, so we believe the worst of the slowdown may be behind us and that we will see laser demand increase as we move through 2016. New product launches will definitely benefit us in 2016. Our new Lightning II Plus scanner, which offers increased scanning speed particularly for laser via hole drilling, is seeing significant customer interest. Our P-series post CO2 laser product launches at 150 watts, 250 watts and 400 watts are all seeing significant customer interest and the opportunity funnel continues to build. Turning to the Vision Technology segment, we are pleased to see the JADAK business deliver very strong growth. You recall that this business had strong orders in Q3 and they were able to translate that into low-teens revenue growth in Q4 in both the core JADAK data collection products as well as the thermal printers product line that is now part of JADAK. We received 48 design wins in the year for JADAK products with annualized revenue potential of over $12 million when these programs come online over the next couple of years. Though JADAK did experience a couple of quarters of revenue decline in 2015, we are pleased that they ended the year on a strong note and we are positioned for solid growth in this business in 2016. You may have also seen that in December, we acquired SkyeTek, which is a small RFID player with very good technology but minimal revenue that was in need of strong sales channels. So this was a perfect fit for JADAK. We integrated the SkyeTek team with JADAK and we are already seeing a promising funnel of new medical RFID projects. The JADAK team has taken the lead thus far in managing our company wide medical cross-selling program. As previously discussed, as we have broadened our potential product offering to medical OEMs, this initiative is intended to ensure we get maximum exposure of our full product offering throughout all of the R&D and product teams within a given customer. So it’s all about leveraging existing close relationships that may be currently based on a single product to ultimately broaden and deepen our penetration and share within these accounts. For 2016, we have appointed a dedicated leader for the medical cross-selling program. In fact, the individual is one of the JADAK founders. This year, we also changed the sales force compensation program to award the behaviors and outcomes we are seeking from this strategic initiative. We are regularly reviewing the funnel of opportunities we develop and we are encouraged by what we are seeing. The NDS business has had a strong focus on product development and its pipeline there. Our new 27-inch Radiance Ultra surgical display has the most advanced technology in the industry and is being designed in as we speak, by several major surgical OEMs. The new EndoVue 21-inch display is also seeing strong customer demand, particularly in the U.S. We also launched the Zerowire G2 wireless video transmitter, which provides real time full HD video in the OR with unnoticeable display and an easy to use interface. We are also now offering battery powered displays with embedded wireless capability mounted on portable stands with wheels. This product enables a truly untethered display, providing greatly improved viewing flexibility for a variety of OR settings. We are seeing strong customer engagement on these new products and a number of additional products are planned to launch throughout 2016. The business is still in transition with the surgical product lineup and is still working through the phase down of our radiology display product line. These factors led to revenue decline in 2015 and we are encouraged by the market reaction to our office and we expect the surgical business to grow revenue in 2016. At this point, I would like to make some comments on our business outlook for 2016. Robert will give the specific guidance in his section. But I wanted to offer some color on the end markets. We are currently seeing increasing customer demand and revenue growth in the vast majority of our medical applications. It’s generally single-digit growth, but we are currently seeing demand growth in most medical customers. Based on the detailed forecast we get from our OEMs, we expect that growth to continue throughout 2016. As we discussed, it’s the industrial end markets that have been the challenge and it’s mainly in two areas industrial laser applications and air bearing spindles for PCB via hole drilling. This dynamic we have seen with slower order patterns from many of the industrial customers has been fairly well correlated with the macro industrial data, including PMI indices. The slowdown certainly impacted our Q4 growth as I discussed earlier and we see that impact continuing in the early part of 2016. There are some preliminary signs that things have bottomed out. Some of the PMI numbers stabilized or improved in February, though China isn’t one of them, so we need to watch of that. But there are some encouraging signs. A number of our customers that have been particularly slow placed meaningful orders in February. Both the laser segment as a whole and the air bearing spindle business have book to bill ratio significantly above one, thus far in 2016. And there certainly is growth to be had based on specific application areas that are independent of macro factors. We are seeing that in robotics and automation applications, next-generation in-flight Wi-Fi, alternative internet services and even laser-based via hole drilling. There are always opportunities and the key is to focus our resources where the opportunities are the greatest. So overall, I am optimistic we will see improving market conditions as we move through 2016. Though our real tangible order visibility is only about three months, customers are giving us positive comments about demand for the year. So we expect to grow both revenue and profit this year. The growth is likely to be weighted towards the second half of the year, but we do see full year revenue growth and profit growth at this point. And it’s worth noting that unlike most years, the comps actually get a bit easier as we move through 2016. So now I would like to comment on our decision to re-brand the company, which I did mention earlier. We plan to seek shareholder approval at our May 2016 Annual Meeting to change our corporate name to Novanta Incorporated. We don’t plan to change the product brands that we use in the market, but we increasingly realize that the overall strategic direction of the company was new, different and exciting enough that we had outgrown our old corporate identity. So we decided to re-brand at the corporate level in a way that is more consistent with our vision for the company. We have positioned ourselves as a leading provider of precision component and subsystem technologies to OEMs in the medical and advanced industrial markets, while shifting away from our legacy focus on the semiconductor equipment market. Therefore, we are renaming the company Novanta to emphasize our new direction and we intend to build a globally recognizable brand that reinforces that vision and strategy. The name Novanta is based on the Latin root word Nova, meaning new. To us, Novanta really means the innovation advantage. As innovation and technical collaboration with our customers has always been and always will be the core of the company’s value proposition. Assuming the name change is formally approved by shareholders, we will implement the change beginning in May. Our NASDAQ ticker symbol will change from GSIG to NOVT. The timing of that ticker symbol change will be announced at a later date. And our corporate web domain will also change to www.novanta.com. This is all very exciting stuff for us. So with that, I want to turn the call over to Robert to give more details on the financial performance. Robert?

Good afternoon, everyone. I am now going to provide you with the summary of our financial results and give you an update to our financial outlook. Highlighting our major accomplishments for the year, GSI Group reported adjusted revenue growth of 7% for the year, adjusted EBITDA growth of 8% year-over-year and adjusted EPS grew 15%. We closed on a total of three acquisitions in 2015, totaling $26 million of cash outlays, acquiring three strong technology companies that both did nicely into our existing businesses. We also sold our last major non-core business marking the end of our significant divestiture activities, while bringing in nearly $30 million from the sale. And we exited the fourth quarter with our medical end markets sales turning the corner and experiencing mid single-digit growth year-over-year in the quarter. In the fourth quarter, sales were within our guidance range despite the weakness in the industrial manufacturing capital spending markets. Those markets did weaken further in the fourth quarter from the third quarter. Adjusted EBITDA came in above our initial guidance and adjusted EPS came in much higher than anticipated, thanks to the stronger profitability and to the reestablishment of the U.S. R&D tax credit. GAAP revenue was $90.2 million, down 4% from $94 million in the fourth quarter of 2014 due to the divestiture of the JK Laser’s business earlier this year. However, adjusted revenue growth in the quarter, which excluded the JK Laser’s revenues for both years, was up 3% to $90.2 million from $87.9 million. Our organic revenue growth, which excludes acquisitions, divestitures and the impact of foreign exchange, was down 1%. From a segment perspective, our Laser Products adjusted revenue was down 1% year-over-year, filling the full brunt of the downturn in the industrial manufacturing capital spending environment. Our Precision Motion adjusted revenue was up 23% year-over-year and our Vision Technologies adjusted revenue was down 3%, driven by continued challenges in the NDS business line. However, the JADAK business reached a turning point in its demand growing approximately 10% as the medical capital equipment market returned to growth in the quarter. I would also like to note that the company has decided to exit the radiology product line branded as Dome by the end of the first quarter of 2016. We do not view this product as strategically or financially attractive this day in and in fact, feel this is distracting from our core surgical business, which has much more attractive opportunities and financial returns. Finally, from an end market perspective, sales in the advanced industrial markets, which represent approximately 55% of the company’s revenue, was up slightly whereas our sales into the medical end markets, which represent approximately 45% of our revenue, was up mid single-digits. Fourth quarter GAAP gross profit was $36.6 million or 40.6% gross margin compared to $39.7 million or 42.2% gross margin in the fourth quarter of 2014. On a non-GAAP basis, fourth quarter adjusted gross profit was $38.1 million or 42.2% gross margin compared to adjusted gross profit of $39.5 million or 45% gross margin during the same period last year. Gross margins were impacted primarily due to foreign exchange, the recent acquisitions and to a lesser degree unfavorable mix. Research and development expenses were $7.3 million or 8.1% of sales compared to $7.8 million or 8.3% of sales in the prior year. SG&A expenses were approximately $19.1 million or 21% of sales. This compared to $21.8 million or 23% of sales for the fourth quarter of 2014. Adjusted operating income was $11.7 million or 13% of sales in the fourth quarter compared to $12.5 million or 13.3% of sales in the fourth quarter of 2014. Similarly, adjusted EBITDA was $14.4 million in the fourth quarter. GAAP diluted earnings per share from continuing operations, was $0.18 in the quarter compared to a loss of $0.82 in the fourth quarter of 2014. Adjusted earnings per share was $0.29 in the quarter compared to $0.24 in the prior year. Operating cash flows from continuing operations in the fourth quarter, was $8 million and above $33 million for the full year 2015. Capital expenditures were $1.4 million in the quarter, which continues to reflect investments in our ERP system. As previously mentioned, we have embarked on a multiyear implementation plan to bring all our businesses insights to a single instance of Oracle. We expect to complete this initiative at the end of 2017. Finally, our calculated net debt as defined in the non-GAAP reconciliation tables as part of our earnings release was $37.5 million, which is after $13 million of cash outlays for two businesses acquired in the fourth quarter. We also acquired roughly $600,000 worth of shares in the quarter through our share repurchase program. As we mentioned in the third quarter of 2015, we initiated a restructuring program targeting annualized savings of $4.5 million to $5.5 million after the program is fully executed. We expect to incur charges of $4.5 million to $5.5 million related to this program, which will largely be associated with severance and facility related costs. We anticipated completing restructuring program during the second quarter of 2016. In 2015, we incurred just over $3 million in costs related to this restructuring program so we are well on track. To give you a little more color around this program, I will highlight three of the more significant actions. The first is the decision to move our medical printer business to Syracuse. This production and engineering shift more closely aligns the product line to JADAK, while creating a medical production center of excellence in Syracuse. The second is the decision to move our color measurement production line from the Greater Los Angeles area to Syracuse. This shift more closely aligns the future technology capabilities for the rest of our core vision technologies and also eliminates the production facility in a high cost area. The third action of significance was related to our NDS business line. We are on track to reducing our manufacturing footprint in Silicon Valley by more than one-third and have announced the consolidation of our European sales and service footprint, which is resulting in a more meaningful and integrated presence in Germany to better align with our current and future customers. For the full year 2016, we expect adjusted revenue to be up mid single-digits in the range of $375 million to $390 million. This compares to adjusted revenue of $368 million in the full year of 2015. We also expect adjusted EPS to be up 8% to 10% compared to full year 2015’s adjusted EPS of $0.93. In addition, we expect adjusted EBITDA growth to be in the mid-single to high single-digit range. Adjusted gross margins are expected to increase 100 to 150 basis points year-over-year. With some redundant costs in the first half of 2016 related to our restructuring program, we expect our margin improvements to be skewed to the second half of 2016. This trend will be compounded by the continuous improvement program savings weighted towards the second half. We expect R&D expenses of roughly 9% of sales, which will be most evident in our Vision Technologies and to a lesser degree, Laser Products, as we increased our investments to further penetrate major medical OEMs. SG&A expenses as a percent of sales are expected to be up slightly from 2015 levels as we continue to build out our sales channels, strengthen our application engineering and invest in the single instance of Oracle across our business lines. I would also like to note that if gross margin expansion exceeds our expectations, we will look to invest a portion of that upside back into our application engineering capabilities, particularly outside of the United States. Interest expense, absent any significant acquisitions, should be approximately $4 million. Because of the permanent expansion of the U.S. R&D tax credit, our non-GAAP tax rate is expected to be approximately 32%, excluding any unforeseen foreign exchange volatility or significant shifts in jurisdictional income. Our diluted shares outstanding will be flat with 2015. We intend to use our share repurchase program to offset any dilution from equity-based compensation issuances. Restructuring expenses for 2016 which will be completed by the end of the second quarter will be between $2 million and $2.5 million, excluding any additional acquisitions. For the first quarter of 2016, the company expects adjusted revenue to be relatively flat in comparison to $89 million of adjusted revenue in the first quarter of 2015. The company expects adjusted EPS to be in the range of $0.17 to $0.18, presuming no significant gains or losses from foreign exchange and assuming a 33% non-GAAP tax rate. Adjusted EBITDA is expected to be approximately $13 million, which is impacted in the first quarter by significant production line moves discussed previously, which are resulting in the company incurring redundant costs to the first half of 2016. While clearly the industrial manufacturing market for capital spending is experiencing weakness in the last 6 months, there are signs that market is stabilizing such as January’s U.S. durable good orders and February’s uptick in the U.S. purchasing managers index. While Europe and China PMI show continued weakness, there remain pockets of growth throughout the industrial markets, particularly in capital investments that drive productivity or that tied to a secular growth trend. Regardless, we feel good that we began taking actions to reduce our cost in the third quarter of 2015 and we are doing this without impeding our growth investments. We believe our restructuring actions are largely on track and we see the opportunity to accelerate projects within our continuous improvement program to drive additional savings in 2016 to adjust for economic climates. But most importantly, our strategic shift in the medical applications 2 years ago is putting us in a great position to differentiate our performance in 2016. As this critical market continues to strengthen, our new product development engine picks up steam and our acquisition focus brings us more exposure and opportunities within the medical market. The combination of these initiatives gives us the confidence to give full year guidance and deliver on another solid year of financial performance. This concludes the prepared remarks. We will now open the call up for questions.

[Operator Instructions] Your first question comes from the line of Lee Jagoda from CJS Securities. Your line is open.

Hi, good afternoon.

Hi, Lee.

So Robert, just starting with the Dome product line that you plan to wind down, what was the revenue from that product line in 2015 and is the winding down of that product line included in the revenue guidance range that you provided?

Yes. We are going to be – it’s about $9 million worth of revenue in 2015. The first quarter is the last quarter that we will be shipping product out. We will try to reduce as much of the inventories as we can in the first quarter and shut it down and all will be responsible for service work thereafter. But that is factored into that guidance range already.

Okay. And then can you provide the total revenue contribution from the three acquisitions completed during 2015. And then possibly, give us the pro forma revenue as if they were acquired January 1?

I will have to get back to you on some of that, but what I would say is that the acquisitions helps to offset, but the ones at least we completed more recently help to offset that radiology shutdown.

Okay. And then just moving to gross margins, particularly in laser products and precision motion, there was a pretty decent sequential decline, is there anything in there other than just mix of products shipped that is more structural that we need to be concerned about?

No, we actually expect that to actually come back a little bit into the first quarter and then a little more strongly in the second quarter. There was a big portion of that was related to foreign exchange. And so that should not repeat as we get to the first quarter.

Okay. And I guess lastly and I’ll hop back in queue. What are some of the increased investment areas for 2016 that are expected to be funded by the savings you are going to see on the productivity side?

More resources in China and international territories, I think building up the sales channels and some R&D capability in those markets. That’s definitely one. I mean regardless of what’s happening macro-wise in China and it isn’t great right now, but we are way under-penetrated, there is just a ton of opportunity.

Yes. The other thing I would mention is that we did give guidance that our R&D expense is going to go from 8% to 9% of revenue. And so now there is an impact of doing that and we think it’s got the proper payback associated with it.

Okay, terrific. I will hop back in queue. Thanks guys.

Thanks.

[Operator Instructions] There are no further questions at this time.

Okay. Well, if we don’t have other questions, I will go ahead and wrap up. As we move forward in 2016, we see positive outlook for the company. We made tremendous progress as an organization. We are in a better position to drive forward with our strategy and ultimately control our destiny. We position the company in better end markets and applications and we are seeing the benefit of that now. Our strength in the medical applications is helping to offset the industrial headwinds we have seen. We have a number of new product launches occurring this year as well as the strong funnel design wins we expect to close in the near future. Our acquisition pipeline is also very promising, both in medical and industrial areas. We hope to be able to close some attractive deals this year. And all of this gives us confidence in our overall growth strategy and we expect to make further progress this year on our strategy. We are also excited about the new branding of the company as Novanta. And we look forward to giving you further updates on that topic in the coming months. I appreciate all of your interest in the company and your participation in today’s call. And I look forward to joining you in early May on our first quarter earnings call. Thank you very much. The call is now adjourned.

This concludes today’s conference call. You may now disconnect.