Novanta Inc. (NOVT) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Nicole, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Incorporated 2017 Q2 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] It is now my pleasure to hand the conference over to Mr. Robert Buckley, Chief Financial Officer. Please go ahead, sir.

Thank you, Nicole. Good morning, and welcome to Novanta’s Second Quarter 2017 Earnings Conference Call. I’m Robert Buckley, Chief Financial Officer of Novanta, and with me on today’s call is Chief Executive Officer, Matthijs Glastra. If you’ve not received a copy of our press release issued earlier 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. 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 this morning and also those in our SEC filings. We may make some comments today, both in our prepared remarks and in 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 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’ll 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’ll provide reconciliations promptly on the Investor Relations section of our website. I’m now pleased to introduce Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Robert. Good morning, everybody, and welcome to our call. Novanta delivered a record second quarter, beating both our revenue and profit guidance. Our company delivered $119 million in revenue, representing 22% year-over-year reported revenue growth and 7.4% year-over-year organic revenue growth. In addition, we expanded our EBITDA margins year-over-year by 380 basis points to 21.5% of sales. Adjusted EBITDA was $25.6 million, which is up nearly 50% versus last year. Our adjusted earnings per share was $0.41, which was up 52% from $0.27 in the second quarter of 2016. In the quarter, we continued to see broad-based growth momentum across the company, with all three operating segments demonstrating double-digit year-over-year reported revenue growth. Bookings performance was solid with a book-to-bill of 1.13 for the quarter. We believe that the strength of our team, our robust business model of providing proprietary, mission-critical functionality in diversified end markets and our increasing exposure to medical markets are serving us well. You will hear more details on the quarter and the outlook for the year from Robert, but the strong first half results give us confidence to raise our full year 2017 outlook. We continue to make good progress on our strategic priorities. Year-to-date, our design wins increased by more than 40% year-over-year in dollars and number of design wins, while new product revenue increased by over 30% year-over-year. Our revenue year-to-date from China increased by more than 20% versus last year as we continue to expand our direct sales force in that region. We believe these indicators support our medium-term organic growth guidance of 5% to 7%. As we’ve announced before, we closed the WOM acquisition on July 3. This acquisition significantly advances our long-term strategy of expanding our presence in medical markets with a market-leading business in the minimally invasive surgery segment. With the WOM acquisition, our revenue from medical markets will be more than 50%. Together with existing Novanta businesses, we have now created $120 million revenue platform in the attractive minimally invasive surgery segment with deep relationships in endoscopic and robotic surgery applications and an ability to cross-sell to each other’s customers. Close to 40% of WOM’s revenue consists of a proprietary disposable business, which is bundled with the pumps and insufflators. This disposable business creates a steady recurring revenue stream, driven largely by patient procedure growth rates. WOM integration is going smoothly with an integration team fully staffed and off to a great start. And as we’re starting to work more closely together with the WOM team, we are impressed with its strong demand expertise, solid innovation pipeline and the long-term growth potential of this business. We also see opportunities to strengthen our mutual customer relationships in minimally invasive surgery. It’s also good to see that the two acquisitions we closed in January of 2017, ThingMagic and Laser Quantum, are performing extremely well. Laser Quantum revenue doubled year-over-year, driven by increased content in the high-growth DNA sequencing market. And whereas ThingMagic helped Novanta accelerate, the rate of overall RFID design wins with year-to-date has doubled year-over-year as we now have a more complete RFID portfolio with strong demand in the healthcare market. Now let me switch to what we’re seeing in our core markets. The medical markets continue to be robust for us, and we have solid positions in high-growth applications in this market. The life sciences and minimally invasive surgery segments are doing well. DNA sequencing and robotic surgery applications are strong growth engines for us, driven by increased clinical acceptance and higher Novanta content. We continue to see an improving environment in our advanced industrial markets, augmented by solid commercial execution of our team. Strong applications for us in the second quarter were satellite communication, advanced laser material processing and warehouse automation. Now let me turn to our operating segments. Our Precision Motion segment continued to be a strong growth engine for us with 17% year-over-year revenue growth and a book-to-bill of 1.07 in the quarter. As we discussed before, the Celera Motion business within the Precision Motion operating segment is taking advantage of structural growth dynamics, driven by favorable macro trends for precise and dynamic motion control in automation, robotics, satellite communication, autonomous vehicles and minimally invasive surgery markets. Additionally, we see solid expansion potential as our share today is relatively small, these attractive markets are fragmented and growing at high single-digit rates. Celera Motion showed double-digit year-over-year growth in new product revenue and design wins. This business also saw the sixth consecutive quarter of sequential growth from the Applimotion motor product line business acquired in 2015. This product line is a leader in satellite communication, among others, delivering smooth and accurate motion of satellite antennas on airplanes, enabling improved live performance on aircrafts. Another exciting application with secular growth dynamics is warehouse automation, driven by the rapid increase of online retail. We’re pleased with the strong performance of Celera Motion and see tremendous growth potential in this business. Consequentially, we’re accelerating investments in Celera Motion to drive further sustained organic growth in future years. Turning to our Photonics segment now, which delivered revenue growth in the quarter of 25% year-over-year and a book-to-bill of 1.19. Growth was primarily driven by the Laser Quantum acquisition as well as by commercial execution in an improved industrial climate. Our Cambridge Technology team, again, delivered record bookings with broad momentum across multiple applications. And Cambridge Technology is the largest business in our Photonics group and a world leader in laser beam steering for medical and advanced industrial applications. We have extended our performance lead in this business with the recent introduction of the Lightning II Plus scan head system, and we’re taking share in applications such as via hole drilling, laser additive manufacturing and converting. Revenue growth in Cambridge in the quarter was hampered by material shortages, which we believe will be largely resolved in the third quarter. With a record backlog position entering the third quarter, we expect solid revenue growth in the second half in this business. Our Synrad business line booked a record revenue quarter, driven by recovery in industrial markets and new product introductions in low-power pulse CO2 lasers. As we discussed in prior calls, Synrad is a leader in profitable niche market of low-power CO2 lasers focused on fine material processing of organic materials. These applications are structurally growing as production techniques are converting from mechanical to automated laser production processes. The star of the Photonics operating segment this quarter was Laser Quantum. As mentioned before, this business doubled year-over-year, driven by increased clinical acceptance and higher Novanta content in the fast-growing DNA sequencing market. Laser Quantum has an excellent and motivated team, and we’re proud of how they’re executing on such a steep ramp while continuing to develop a strong innovation pipeline. Following this year’s ramp in new-generation DNA sequencing machines, we believe growth in this business will likely return to market growth of 10% to 15% a year. Second quarter design win dollars in the Photonics segment were up more than 25% year-over-year for the first half of 2017, primarily driven by Cambridge Technology. Applications with strong performance were laser additive manufacturing, marking and coding, converting, via hole drilling and micromachining. Turning to our Vision segment, which helps to reduce medical errors, improve workflow and patient outcomes in applications such as minimally invasive surgery, patient monitoring, life sciences and clinical lab equipment. In the second quarter, our Vision segment delivered 20% year-over-year revenue growth, driven by our ThingMagic and Reach acquisitions and improving organic growth in our JADAK and NDS businesses. In the quarter, the book-to-bill in our Vision segment was 1.07. And we’re pleased to see gross margins in this segment approach our company average with a strong improvement in operating income. We continue to see great design win momentum in RFID on the back of our ThingMagic and SkyeTek acquisitions. In the quarter, 50% of the overall design wins in our JADAK business were RFID-based in a wide variety of medical applications. And as discussed before, ThingMagic enhances our detection technology capabilities in the high-growth, $200 million RFID market for identification and tracking in medical applications. RFID demand in health care is increasing as there’s a growing need to identify track-and-connect devices, medications and patients for optimal workflow and patient safety. Being a technology leader in RFID for healthcare has a very positive effect on the broader JADAK business with a strong funnel of 2017 opportunities. In the quarter, we experienced our second consecutive quarter of year-over-year organic revenue growth in our NDS endoscopic displays business line, driven by new products. We expect the business to be a net contributor to our revenue and profit growth in 2017. In wrapping up my section, we’re very pleased with the organic revenue growth and profitability that we achieved in the second quarter as well as the performance of our recent acquisitions. Novanta’s leadership position’s across key medical and industrial markets, combined with our disciplined approach to M&A is proving a solid foundation for sustainable, profitable growth. On the back of very strong first half results and a strong outlook for 2017, we are increasing investments in our growth areas, with focus on innovations, sales and operations. Our acquisitions are performing very well, and although our M&A pipeline continues to be active, our short-term focus is on integration of the three acquisitions we have closed so far this year. So with that, I will turn the call over to Robert to provide more details on our financial performance. Robert?

Thank you, Matthijs, and good morning, everyone. We delivered $119 million in revenues in the second quarter of 2017, an increase of 22% on a reported basis. The net effect of acquisitions resulted in an increase in revenue of $15.4 million or 15.8%, whereas foreign exchange rates adversely impacted our revenue by negative $1.3 million or 1.3% in the second quarter of 2017. Consequently, organic growth was up 7.4% compared to the second quarter of 2016. Second quarter 2017 GAAP gross profit was $53.5 million or 44.9% of sales. This compares to $41.5 million or 42.5% gross margin in the second quarter of 2016. Included in gross profit for the second quarter of 2017 was the impact of $1.7 million or 1.4% of sales of amortization of purchased developed technologies and inventory fair value adjustments associated with the acquired businesses. On a non-GAAP basis, second quarter 2017 adjusted gross profit was nearly $55.2 million or 46.3% of sales compared to approximately $42.5 million or 43.5% in the second quarter of 2016. The increase in gross margins year-over-year was driven by higher revenues and more favorable mix of higher-margin products. R&D expenses were $9 million or 7.6% of sales versus $8 million or 8.2% of sales in the prior year. SG&A expenses were $23.9 million or 20% of sales. This compared to $20.2 million or nearly 21% of sales in the second quarter of 2016. While SG&A expenses as a percentage of sales declined, the SG&A dollars increased, primarily due to acquisitions and higher variable compensation expense associated with better financial performance. GAAP operating income was $15.6 million in the quarter compared to $7.6 million in the second quarter of 2016, whereas non-GAAP operating income was $22.2 million or 18.7% of sales compared to $14.3 million or 14.7% of sales in the prior year. Adjusted EBITDA was up nearly 50% year-over-year at $25.6 million or 21.5% of sales in the quarter versus $17.3 million or 17.7% of sales from the prior year. Interest expense in the quarter was $1.4 million versus $1.2 million in the prior year. The weighted average interest rate of our senior credit facility was 3.8% in the quarter. On the tax front, our GAAP tax rate was 31.9% for the quarter. This differed from the Canadian statutory rate of 29%, primarily due to the mix of income earned in jurisdictions with varying tax rates. On a non-GAAP basis, our tax rate was 29.5%. Looking at the full year 2017, we continue to expect a 30% non-GAAP tax rate. Our diluted earnings per share on a GAAP basis from continuing operations were $0.16 in the quarter compared to $0.14 in the second quarter of 2016. It is important to note and call out that in the second quarter of 2017 we increased the carrying amount of the redeemable non-controlling interest at Laser Quantum by $3.7 million to reflect the estimated redemption value as of quarter end. The adjustment was recognized in retained earnings as a net $0.11 reduction in earnings per share on a GAAP basis only. Adjusted diluted EPS was $0.41 in the second quarter compared to $0.27 in the second quarter of 2016. The increase in earnings year-over-year was driven by strength in all three operating segments as well as from the acquisitions. We ended the second quarter of 2017 with 35.5 million weighted average diluted common shares outstanding and this compared to 34.9 million weighted average diluted shares outstanding as of the end of the second quarter of 2016. Our operating cash flow was $16.8 million for the quarter versus $15.5 million in the second quarter of 2016 and operating cash flow was positively impacted by an increase in profit. This was partially offset by higher net working capital as a result of acquired businesses and increases in inventory levels, particularly within our Photonics segment. Capital expenditures was approximately $1.4 million in the quarter down from $2.9 million in the second quarter of 2016. We signed the World of Medicine acquisition in June and closed the transaction on July 3. This acquisition was funded by drawing down on our revolving credit facility. We completed the second quarter with total debt of $111.5 million and $89.1 million of cash. Our net debt as defined in our earnings press release as of the end of the second quarter was $25.4 million. With the momentum in our business as we head into the third quarter and with the closing of the WOM acquisition we are raising our 2017 financial outlook. For the full year 2017, we now expect GAAP revenue of approximately $497 million to $502 million. This represents 30% reported growth year-over-year and an expectation of 6% to 8% organic growth in the second half. We expect adjusted diluted earnings per share to be in the range of $1.40 to $1.46 and adjusted EBITDA to be approximately $96 million to $98 million. It is important to mention that our adjusted EPS and EBITDA guidance assumes no significant foreign exchange gains or losses. For the third quarter of 2017, we expect GAAP revenue of approximately $130 million to $135 million, and we expect adjusted diluted EPS to be in the range of $0.34 to $0.39 and adjusted EBITDA to be approximately $25 million to $27 million. Our third quarter and second half forecast incorporates WOM's financial results coupled with integration costs associated with bringing the business into our fold as a public company business line. In addition because of our confidence in the strength of the businesses, both in the short term and their long-term outlook, we are increasing investments in the business to better position us for continued growth and to further accelerate organic growth in future years. You will see this manifest in higher R&D and sales and marketing expenditures in the second half of this year. We expect adjusted gross margins to be in the 46% range, similar to the second quarter of 2017; and R&D expenses to be around 9.5% of sales representing the increased investments in the business to accelerate organic growth in future years. Minority interest is expected to be approximately $700,000 reduction to net income attributed to Novanta in the quarter and interest expense should be around $2.4 million to $2.5 million. The non-GAAP tax rate is expected to be around 30%. We also entered into an amendment to our credit agreement in July. The amendment increased the revolving credit facility commitment under the credit agreement by $100 million to $325 million and reset the accordion feature to $125 million for future potential acquisitions. Additionally, the amendment increased our current term loan balance by $25 million from $65.6 million to $90.6 million. We believe this credit agreement gives us sufficient capital to execute on our near-term acquisition pipeline while maintaining our future discipline around capital deployment. As we look out to the third quarter and following the completion of the WOM acquisition, we continue to expect pro forma gross leverage of 2.5 times, where our net debt leverage should be closer to 1.5 times at quarter end. We feel good about our results in the quarter and the progress we're making as a company. We continue to see significant opportunities to invest organically and inorganically. And because of the talent and advanced rate in our businesses, we're confident in our ability to execute against our strategic goals and our 2020 strategic vision. This concludes our prepared remarks. We'll now open the call up for questions.

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

Hi good morning and good quarter.

Good morning, Lee.

Hi Lee.

So if I look at R&D spend, you're saying it's going to be higher in the back half. We've kind of looked at it for a while saying it was supposed to be around 9% and you never quite can spend enough, which, I guess, is a good thing. If I look at where the additional spend is going to be targeted, can you talk about some of the end markets you're going after or some of the new products you're looking at?

Yes I, good morning Lee. So thanks for the question. Yes I commented in my prepared remarks that one of the areas we're accelerating investments in is in the Celera Motion business or the Precision Motion business, which as I noted has been performing in a stellar way. That is driven by trends in automation and need for precise motion control in both medical markets or surgical robotics as well as advanced industrial automation-related markets. So we're excited about the prospects in that business. We're also investing more on the RFID side, given on the back of the acquisitions that we’ve made. And Laser Quantum is doing really well, and we’ll continue to invest in that business for future growth. So those are a few areas. But as we commented, we’re very pleased with the momentum across the company. And so we’re looking at R&D investments, engineering investments as well as sales investments in those areas where we see growth.

Okay. And then with regards to Laser Quantum, can you talk about the percent of that business that's currently tied to DNA sequencing today and then potential opportunities you see outside that market for Laser Quantum, specifically?

Yes. We're not splitting out the percentage, but it's a large chunk of their business, as you know. It's more than 50%. We're actively looking to invest and that's one of those investment areas outside the DNA sequencing area to accelerate growth there. And mind you, the business outside DNA sequencing and Laser Quantum has been growing very nicely as well just that the DNA sequencing growing at market and business has been growing much faster right? So it's almost like a luxury problem there. But yes, the reason why we bought the business is that we're bullish for - on their potential across many applications and yes you will see us over time in clinical analysis and other markets you will see us make some strides there.

Okay. And then again on Laser Quantum, it looks like based on your first six months results, you're on more of a run rate to be at $37 million of annual revenue versus the $25 million estimate when you consolidated the entity. Is there a lumpiness related to that that would hold back the run rate from continuing in the back half?

Yes. We did disclose in the Q that it did for the first six months around $18.6 million, which would definitely put them above the forecast that we initially gave on that business. And so yes, there’s an expectation that they’re going to be beating that. But one of the things I will say is that the first half of the year, they’re seeing a significant ramp-up as a consequence of one of their customers launching a new product platform. And so there will be a little lumpiness as a consequence of that. The typical process would be more product being built for that ramp-up and then will start to level off thereafter.

So should that continue with a similar rate in Q3 and then drop off in Q4? Or how should we think about it?

I wouldn't expect this business to be dropping off organically anytime soon. So in terms of the rate of growth rate, that will certainly slow from 100% right? So it's not going to correct itself. But I think - it won’t be as strong – it’s fair to say it won’t be as strong in the fourth quarter as it was in the first half.

Okay. I was more thinking about it in dollars on a sequential basis.

Yes.

So next, turning to the NDS business, it’s been a turnaround. And can you give us an update on where the profitability stands there? And over the next 12 to 18 months, where you could see that profitability going compared to sort of corporate average?

Yes. We’re more or less breakeven in that business and we show year-over-year organic growth. So we’re very pleased with that. So it’s a net profit and revenue contributor to the company. I think more importantly, they continue to win design wins with 4K displays and wireless solutions, differentiated proprietary technologies that they have and we’ve invested in over the last two, three years. So we’re seeing fruits of our labor with those technologies. Medical market adoption is slower than, let’s say, consumer electronics, but it’s steady, and we’re pleased with what we’re seeing. So we don’t think this business is going to be a drag anymore for the company.

Okay. One last one for me. You mentioned Cambridge Technology was held back a little bit in the quarter by some delays in, I guess, product. Can you quantify that? And has that been fixed and should we expect that in Q3?

Yes. So what I've said was material shortages as we - particularly around a product that I mentioned, the Lightning II Plus. The reception and the adoption of that product and market demand has been stronger than we expected. So our supply chain was kind of put on the back foot a little bit. And but we've resolved most of those shortages right now. And we're entering the third quarter with a record backlog, so yes we think this business will be returning to mid- to high single-digit growth in the second half.

Got it, that’s all from me. Thanks very much guys.

Great.

And there are no further audio questions. I would now like to hand the conference back to Mr. Matthijs Glastra for closing remarks.

Thank you, operator. So to summarize, it's a great time to be part of Novanta. Our focus on accelerating profitable growth was truly evident in our strong financial results this quarter and in our outlook. The diversity and strength of our businesses have served us well, and I'm proud of the execution by our team. We're well on our way now in executing on our 2020 strategic direction to double the company in revenue to $750 million with 20% EBITDA margin, growing organically 5% to 7% with market leadership positions in our businesses while generating more than 50% of the revenue from medical markets. Our growth strategy is focused on multiple growth drivers. We have leading positions in growth markets. We're expanding in served markets through innovation and disciplined M&A with focus on expanding our medical presence. We are achieving deeper market penetration globally through a stronger and larger sales force, and all of this while maintaining our commitment through disciplined execution and continuous improvement. In closing, I would like to thank our customers and our employees and our shareholders for their ongoing support. 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 in our third quarter earnings call. And thank you very much. And this call is now adjourned.

This does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.