Good morning, my name is Debbie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta, Inc. 2018 First Quarter Earnings Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Ray Nash, Corporate Finance Leader. Please go ahead.

Thank you very much. Good morning, and welcome to Novanta's First Quarter 2018 Earnings Conference Call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our 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 live 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 responses to questions, that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of this time. We disclaim any obligation to update forward-looking statements in the future, even if our estimates change. So you should not rely on any of these forward-looking statements as representing our views as of any time after this call. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call, that are not reconciled to GAAP measures in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our website after this call. I am now pleased to introduce the Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Ray. Good morning, everybody, and thanks for joining our call. Novanta continued its strong 2017 momentum and delivered another great quarter, beating both our revenue and profit guidance. Our company delivered $147 million in revenue, representing 35% year-over-year reported revenue growth and 9% year-over-year organic revenue growth. This is our 6th consecutive quarter of high single-digit or double-digit organic growth. Our adjusted EBITDA was $28.4 million, which is up 41% versus last year. We expanded our EBITDA margins year-over-year by 80 basis points to 19.3% of sales. Our adjusted earnings per share was $0.47, which was up 52% from $0.31 in the first quarter of 2017. In addition, we delivered solid cash flows with operating cash flow growing by 60% year-over-year to $20.4 million in the first quarter. At Novanta, our mission is to deliver innovation that matters providing mission-critical functionality to our OEM customers, while improving end-user productivity, enhancing people's lives. We believe that the strength of our team and our robust business model and diversified applications with a balanced exposure to medical and advanced industrial markets are serving us well. In the quarter, we continue to see broad-based growth momentum across the company with all 3 operating segments, demonstrating double-digit year-over-year reported review growth. We also had a very strong order book performance with an overall book-to-bill of 1.14, with all our businesses showing a positive book-to-bill performance. As we've reported in previous calls, we are experiencing broad-based strengths within a majority of our end markets, including life science, minimally-invasive surgery and advanced industrial. Key growth applications where we deliver innovation that matters are DNA sequencing, robotic surgery, endoscopy, advanced laser material processing and precision automation. We continue to make good progress on our strategic growth priorities driving long-term organic growth through commercial excellence and innovation.…

Thank you, Matthijs, and good morning. We delivered $147 million in revenue in the first quarter of 2018, an increase of 35% on a reported basis. The net effect of our acquisitions resulted in increased revenue of $24.6 million or 22.6% and foreign currency exchange rates favorably impacted our revenue by $3.6 million or 3.3%. Consequently, organic growth was 9% year-over-year. Reported and organic growth in the quarter came in higher than expected based on stronger growth in our WOM and Laser Quantum businesses, both are newly acquired business units. The higher volumes compared to our original estimates in these business units was largely associated with customer timing, as certain orders received and shipped in the quarter were originally anticipated in later quarters in 2018. We expect this rebalancing of sale to result in a more linear year for the overall company. First quarter 2018 GAAP gross profit was $62.2 million or 42.3% of sales. This compared to $46.1 million or 42.3% of sales in the first quarter of 2017. On a non-GAAP basis, first quarter 2018 adjusted gross profit was $64.6 million or 44% of sales compared to $48.8 million or 44.8% in the first quarter of 2017. Adjusted gross margins came in at expectations, which was down slightly from the prior year as a consequence of lower margins in the Vision segment. The Vision segment margins were driven by higher medical consumable sales and higher production costs associated with the launch of a new medical consumable product within the WOM business. As mentioned previously, the first quarter will represent the low point in gross margins for the overall Novanta for the year, and we expect to see gradual improvements in gross margins and continue to anticipate nearly 100 basis points improvement in gross margins for the full year…

[Operator Instructions] Our first question comes from Lee Jagoda with CJS Securities.

So starting with the full year guidance, what if any impact other than a little bit higher interest expense, does Zettlex play into your updated guidance?

So we did not disclose the specific contribution we expect Zettlex to make to sales or EBITDA of the company, largely because the impact is not material. But our raising guidance does factor this in. Yes, and as we mentioned, Lee, we're very excited about the Zettlex acquisition, its technology is not only very complementary to our own, but also it helps us better address the industrial robotics market. And then Zettlex's inductive encoder technology operates better than our optical encoder technology in extreme and contaminated environments. And therefore, in addition, its attractive price point helps us to address a wider addressable market, particularly in industrial robotics. And today the business sells through surgical robotics, which also helps drive additional content in those markets as well. So we're very excited about it, but in terms of contribution, it's factored into our full year guidance.

Okay. And assuming you're not going to give us more insight on the revenue or the margin structure of the business, is there anything around any customer concentration, end market concentration, and then whether these products are growing faster or slower than your legacy encoder business, would be helpful?

Yes. I mean, we don't feel there is any meaningful customer concentration. We see a tremendous opportunity actually to help the Zettlex business and team to expand into either regionally or other applications that the Celera Motion serves today. So we see big expansion potential. And it's -- from a small base, it's a fast-growth business. So -- and those rates are faster than I think our encoder product line, but it's from a small base. Yes.

A lot of small numbers.

Got it. And then one more and I'll hop back in the queue. As it relates to Laser Quantum, obviously, you've continually written up your ownership there just based on the growth trajectory. Does that have any impact on the non-GAAP tax rate that you've been reporting? And then just as a follow-up on the non-GAAP tax rate, is that basically a proxy for the cash tax rate?

In the quarter, no. I would say, the full year guidance of around 22% is probably a pretty good proxy on the cash rate, somewhere around that 22%, 23%. The quarter, no. There are some discrete items artificially depressing that a little bit more so than would expect for the full year. In relation to the income generated by Laser Quantum benefiting the overall tax rate, absolutely. The jurisdictional mix of income kind of comments relate to, not only the U.S., but our operations in the U.K. The U.K. has had a lower effective rate than the U.S. and so income generated would, obviously, be beneficial to us.

The next question comes from Richard Eastman with Baird.

Yes. Could I just ask, Matthijs, maybe you could provide a little bit of color around the JADAK business, I think we've been consistent about that business returning to growth in the second half of '18, given some of the diabetes care headwinds that have impacted the business. The question maybe would be around the visibility you have on the growth, is that in the second half? Is that supported by wins? And is it also maybe a shift in JADAK's technology uptake, meaning, more RFID verse Vision? Or just maybe a little color around those metrics?

Yes. Good question, Rick. Yes, I think the major effect is that we will lap the full year of a decline, right? So in the second half, you'll see that, basically, we've worked through that decline. And with the rest of the business growing, basically, that's the majority of the effect. Now we did comment that RFID as a category is growing faster double-digit, it's still a relatively small base. So we're excited about that. We don't see necessarily a technology shift, but it's fair to say that RFID as a category has grown faster, yes. So I think that that's the dynamic we continue to see. And so therefore, yes, I mean, from a second half growth perspective, those are the main, I think, drivers, Rick, that I would comment on.

Yes. And does, again, did the wins support kind of a second half growth rate that would be more -- just kind of more in keeping with the 5 to 7 core for the entire business? Or is that -- are we still going to be a little bit below that until we get some uptake in the RFID?

Yes, we didn't comment on specific -- the exact growth number in JADAK for obvious reasons, but I would say, yes, both -- the combination of that, we basically lapped the full year of decline, this one-off effect in diabetes care versus in addition to wins as well as the growth of the markets that we serve. The combination of those 3, we feel confident we'll return back to growth in that business in the second half.

The second, okay. And then can I ask, Robert, was the WOM business revenue just as a contribution in the quarter? Are we in the, call it, $21 million, $22 million range, just so I can get a sense of what the contribution is there?

I will say it stepped up from the run rate it was at in the back half of the year. So there was a -- and that was kind of the comment I made. There was a little bit of pull-in effect there with some customers wanting to get delivery of some product that they originally had scheduled in for later quarters. They had pulled that into the first quarter. And so there was a little bit of a step up as a consequence of that.

But what -- did the revenue step up from the fourth quarter to the first? Or it probably was a bit below the fourth quarter? Was it not?

It was not. It was more in line with the fourth quarter.

Okay. Okay. Fair enough. And then also just a quick question in the Photonics business. Given the overall growth rate here in the quarter, in Photonics, we had a little bit of kind of stubbed contribution from the Laser Quantum business and the step up there in the equity value. But can I ask, with Laser Quantum and the DNA sequencing, just trying to keep track a little bit of how unit volume shipments impacted last year for the primary customer there? How does that business look for the second, third and fourth quarter? Does the growth moderate? Do we even get the mid-single-digit growth out of Laser Quantum in the back 2/3 or 3/4 of the year?

Yes, so the first comment I'll make is that, in the first quarter there really wasn't a stubbed period effect because we closed it in the second week of January. And so there wasn't really a meaningful revenue contribution. The step up in revenue was really kind of cognizant of the fact that the ramp with our major customer happened in the second quarter, right? So the first quarter revenue was more where it was in the first quarter -- the fourth quarter of '16. So yes, it had -- this is the last quarter of that, where it's now lapped that product launch. As we get into later quarters, the growth rate will moderate. We'll still -- it will still be a decent growth rate for the organization, but it will definitely moderate, particularly in the back half of the year as it has some tough comparables.

Okay.

Now in terms of the question around its major customer. It tends to have like a 1 quarter delay in relation to -- because it's part of the supply chain. It's always shipping about a quarter in advance.

Okay, okay. Understood. And then maybe just the last question. Matthijs, you had mentioned design wins in the quarter were plus double-digits. Was that a reference to Novanta overall? And...

Yes. That was.

Yes. And could you just -- is there a 1 in front of the double-digits or 2 in front of the double-digits, which would be more accurate?

Yes, well, let's say, the high-teens, I would say, right? So yes. And so listen, we see decent momentum across the board, that's why we didn't sort of specify it.

Yes, that's fine. And was the high teens design wins? Were they concentrated in any of the -- either of the 3 businesses?

No, no, what I've said is, it's basically -- it's pretty much across the board. And with those things through, it's only one quarter of data, right. So what I would say, Rick is, is that as we progress through the year kind of a year-to-date number will be more meaningful to compare going forward. Yes, in the first quarter, it was -- there was nothing kind of material jumping out like there was one area of concern or remarkable contribution.

Understood.

And you can also see that in the bookings numbers, right? It was -- Rick, which often actually pretty much, I'm not saying tracks design wins, but there is a correlation there we feel. You see the bookings numbers were very strong across the board in all our businesses, right? So it's kind of -- it's a similar type of theme here.

[Operator Instructions] Our next question comes from Brian Drab with William Blair.

Could you give us any more granularity to surround the $0.07 increase in the EPS guide at the midpoint in terms of impacts from the tax rate, impacts from the interest expense and impacts from Zettlex or the organic growth in the overall business?

[indiscernible] bottom of the range basically is just flowing the beat-in from the first quarter, right? I mean is the way to kind of think about it, and the top end of the range includes the higher revenue growth as well as the profit flow through as a consequence of that. The Zettlex acquisition itself is not a meaningful contributor overall. We did say that there were some timing differences in WOM and LQ resulting in the first quarter being a little bit higher. I think the reason why you see us just flowing that through the revenue is that Zettlex kind of offsets that back half of the year. So that's kind of overall, I think in terms of the guidance I've provided, the specifics around minority interest and specifics around interest expense, I can certainly repeat that, but interest expense would be around $10 million for the full year. It's been running at something closer to $9 million and that's really a consequence of the step up in the borrowing rate itself. There is a -- the tax rate delta is going from 25.5% that we guided in February down to 22% or 23%, and I feel pretty good about that as it currently states and that's really a benefit of a better jurisdictional mix of income that we're seeing. A little bit more in income in the U.S. and the U.K. than we anticipated initially as well as the discrete items helping us a little bit more so. Those weren't forecasted originally.

Okay. That's helpful. And then, I think Robert, you said the WOM business is down sequentially in the third quarter. Did I hear that correctly?

No. No, yes, when you -- the -- effectively what happened in the WOM business is that bookings or orders that customers wanted in the later quarters got pulled into the first quarter. And so it's -- in the first quarter of 2018, its revenue is very similar to, let's say, the fourth quarter of 2017. When it gets into the second quarter, it will step down a little bit on an absolute basis. It's still growing in the second quarter, but it's -- on an absolute basis, it will drop down a little bit.

Okay, so it steps down in the second quarter. And does that mean that -- would we model then, the Vision segment overall, then stepping down sequentially?

We haven't kind of gotten into kind of specifics around that. I would say that there is -- there's puts and takes there. Overall, I think that we are going to start seeing growth in the Vision segment in the back half of the year. It is -- it's obviously -- the JADAK business sees the lap, it's comparable to the second quarter. So without getting into specifics, it's probably a little kind of flattish with the first quarter, and then it begins to step up, thereafter.

Okay. And then just one last question, just -- because I'm looking at the model here, you did 9% organic revenue growth in the first quarter. The second quarter you're implying 7% or 8%. And then for the balance of the year, can you give me any help modeling the third and fourth quarters, it looks like -- is it both quarters kind of in the 3% or 4% range for organic? Or is 1 a little bit better growth than another before, I guess, and then will reaccelerate into 2019?

Yes, so in the back half of the year, Q3 and Q4, are going to have the largest -- the largest impact on it will be the WOM business, which will not be a contributor to our organic growth in the back half of the year. And that's because of that regulatory change that artificially benefited us in the second half of 2017. For the full year, I think the upper end of the range kind of factors in something closer to the high end of the organic growth range. And so you can probably do the math, I think the third quarter and fourth quarter will be very similar to each other. But the -- if you're forecasting at the higher end of the range from an absolute revenue basis, it's more likely going to be at the higher end of the range on an organic basis as well.

This concludes 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. So to summarize, the first quarter of 2018 was another great quarter. Our focus on accelerating profitable growth and the diversity and strength of our businesses was evident in our strong financial results. We're well on our way to execute on our 2020 strategic direction and our growth strategy is sound and focused on multiple growth drivers, focused on establishing leading market positions in growth markets, expansion of our served markets through innovation and disciplined M&A with focus on expanding our medical presence; deeper market penetration globally, through a stronger and larger commercial team, and all of this, while maintaining our commitment to disciplined execution and continuous improvement. In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support. I'm particularly thankful for the strong contribution and execution of our teams of committed Novanta employees. It's a true pleasure and honor to lead this great company. 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 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.