Good morning. My name is Andrea, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Inc. 2021 Second Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. [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 second quarter 2021 earnings conference call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our Chairperson 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, we need to remind everyone of the safe harbor for forward-looking statements that we've outlined in our earnings press release issued earlier today and also those in our SEC filings. We may make some comments today both in our prepared remarks and in our responses to questions that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of this time. We disclaim any obligation to update forward-looking statements in the future even if our estimates change. So you should not rely on any of these forward-looking statements as representing our views as of any time after this call. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent 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 Chairperson and Chief Executive Officer of Novanta, Matthias Glastra.

Thank you, Ray, and good morning, everybody, and thanks for joining our call. Novanta delivered fantastic results in the second quarter of 2021. We delivered above our expectations for revenue, profit and cash flow. We delivered new all-time highs for revenue and bookings and excellent operating performance with adjusted EBITDA growth of 20% year-over-year. And on top of all of this, we were very excited to announce 2 upcoming acquisitions in the past month, both of which will be a great strategic fit for Novanta, and together, will contribute significantly to Novanta's long-term growth and our presence in attractive high-growth application areas. These 2 transactions are both expected to close in the third quarter and we will speak to them in more detail in a few minutes. Speaking in more detail to our second quarter results, our company delivered approximately 180 -- $168 million in revenue, representing 16% year-over-year revenue growth on a reported basis and 11% on an organic basis. This is the highest ever single quarter sales for Novanta, which comes on the strength of rebounding markets and exceptional execution by our teams. We are also pleased to show healthy reported revenue growth of 8% versus the second quarter of 2019; a sign, we are emerging stronger out of this pandemic. In addition, in the second quarter, we had excellent operating performance with adjusted EBITDA of $37 million, which is up 20% year-over-year. This represents an EBITDA margin of 22% of sales, which is also up 80 basis points year-over-year. We are extremely pleased with, and proud of, how our teams drove exceptional operating performance using the Novanta growth system tools despite widely reported supply chain challenges. Adjusted diluted earnings per share was $0.62, which is up 29% versus 2020, and our teams delivered strong free cash flow…

Thank you, Matthias, and good morning, everyone. Before walking through our operating results, I'll share some more details on the 2 acquisitions, Matthias just mentioned. First, we've agreed to acquire SEM for $115 million in cash. SEM is a leader in innovative motion control solutions, specifically around brushless motor technologies, integrated motor drives and electronic control. The addition of SEM's technology will expand our precision motion control portfolio, furthering our ability to serve customers with unique high performance solutions. SEM develops key solutions for applications demanding highly precise controlled movement in areas, including medical instrumentation, lab automation, robotics and other advanced manufacturing applications. SEM is expected to help our expansion into automation robotic applications through advanced motion control solutions. The business is also anticipated to increase Novanta's exposure to life sciences and medical end markets, while broadening our access to sophisticated automation integrators. The business has approximately 60 million -- 60 employees and is headquartered in Marlborough, Connecticut. Next, we've also agreed to acquired ATI for $172 million upfront, along with additional contingent cash payout structured as an earn out. We held a separate call on the ATI acquisitions, but I'll repeat a few highlights from this exciting acquisition. ATI is a leading supplier of intelligent end-of-arm technology solutions to original equipment manufacturers in the robotics space. As a leader in the robotics space, they have more than $70 million in revenue in a high single-digit growth industry. Their focus on robotic applications has positioned them to win in a marketplace with strong long-term secular tailwinds driven by continued penetration of automation, robotics in both advanced industrial and medical markets. ATI develops, manufactures and sells robotic changing systems, for storage sensors and collision sensors for an industrial collaborative and medical robotic applications. These products enable OEM and end users to…

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

So just starting with precision motion and the margins there. Can you talk about the sustainability of the margins there just because I think it may be the highest gross margin you've ever had in that segment?

Yes. There's a little bit of mix benefit there happening in the second quarter. But I do think something with a 5 in front of it is somewhat sustainable as we get to the second half of the year.

Got it. And then on the vision side, I know you mentioned there was headwinds and medical kind of is slower to recover. That being said, it took a pretty material step down versus Q1. And historically, other than last year, which was clearly COVID related, you don't have that seasonal step down in Q2 versus Q1. Is it just short-term demand fluctuations or is it -- there's some seasonality because of some acquisitions you've made in the past that are causing the Q1 to Q2 step down? And how should we think about that going forward?

All of it is associated with just the surgical end market demand right now. So it's not -- we guided around this in the first quarter, but I would say that it's all related to just where we sit in the supply chain on the surgical market. So despite the fact that surgical procedures are picking up, we will -- we have a bit of a delayed impact on that on our own results. And that is more likely to manifest or start to manifest in the second half of the year.

Got it. Just one more quick one. The vision gross margins, I assume that's just a greater mix of consumables given the lower OEM equipment sales?

That’s correct.

Next question comes from Rob Mason of Baird.

Yes. The bookings strength in the quarter and really year-to-date has been outstanding. And so, I understand the supply constraints as you think about your outlook, but how should we be thinking about the backlog conversion here? And any changes in your customers' order patterns? Are they -- how much are they discounting, maybe more extended lead times versus just their overall end demand?

Yes. So I would say for the most part, we have not shipped anything that has filled anybody's stock, right? So everything that we've been shipping out the door has been subsequently going out the door from our customers. So to the degree that there's some sort of building happening, we have not kept up with that demand environment yet. And that's represented a little bit in that book-to-bill. In fact, the book-to-bill is so much higher, it's really -- we're not at a position yet where we're exceeding their shipments, and therefore, they're building up some safety stock. We expect something in the bookings in the range of about 10% of it is maybe a little bit of planning around safety stocks because there is some replenishment that needs to occur in a couple of customers, it's just this year, we're not expecting to fill that up due to supply chain shortages.

Yes and macro-wise, Rob, this is Matthijs, you basically see that the markets in which we operate. I mean, it's well reported, the rebound in particularly advanced industrial markets, which we're benefiting from. So we're operating well above 2019 levels, actually. And so that -- it's going back very healthily, and we have additional tailwinds from new products there as well, so yes, we feel very good about that. And on the medical side, you see surgical robotics and DNA sequencing coming back to pre-pandemic levels and that's exceeding that with a very strong outlook for the year as well and probably beyond 2021. So yes, we feel good. I mean, it's -- our teams are working hard to fill the demand. Like Robert said, there's part of it maybe is customers wanting to make sure they get in line. But most of it, actually, the vast majority is structural, sustained demand as we can see it.

And just to speak to photonics specifically a minute, that's where you probably had your greatest, at least year-over-year bookings growth. How did the mix of orders there look between the industrial side and the medical side where you do have more of a mix in that segment?

Yes. I would say largely balanced because the big chunk of the medical exposure there is either tied to the DNA sequencing market, which is doing fairly well right now or some laser-based eye procedures that are actually doing okay as well. So looking at the book-to-bill ratios of industrial and medical within that segment, they're actually pretty comparable to each other.

And maybe just a last question. It sounded like you said you did a very -- it felt like you did a very good job in the second quarter, mitigating some of the supply challenges in terms of being able to recognize shipments and maybe that gets a little more challenging in the third. I'm just curious, what -- if there was a revenue or a built-in backlog maybe in the second quarter, what that might have been related to the supply challenges and what you're maybe assuming for the third quarter on that front as well?

Yes. What I'll say is the third quarter is hedged down for stuff for supply chain shortages that we don't think that we can mitigate before the end of the quarter. And then the range itself is really kind of the risk profile around the pluses and minuses of supply chain disruptions that we might experience or that of our customers, right? So from a demand perspective, yes, we are seeing demand above the top end of the range that we provided for the third quarter. But we've already kind of hedged back for what we know are material shortages that we're not going to get back in time in order to ship the product out. The way to think about what we leave on the table a little bit is that we generally run a book-to-bill of 1. And so we're always -- the fact that we're seeing order growth coming in at a higher rate than revenue, that's demand that we're -- part of that demand is sitting on the table still. I wouldn't get into how much better can we do right now just because the demand environment is robust, the supply chain environment is not robust. And so, we're just mitigating this as best we can, but I will say that if you look at the 2019 levels, we're performing at kind of a high single-digit growth rate in the back half as a consequence of what we can deliver.

I see. And was there any under-delivering to speak of in the second quarter?

There was. There are certain situations where we did not get the parts and time into order to meet customers’ expectations. So that is happening a little bit in the second quarter. That’s already factored into the third quarter, but I don’t want to kind of get into specifics around it.

[Operator Instructions] And our next question will come from Brian Drab of William Blair.

Another question on the gross margin, which was just outstanding in the quarter. Maybe a couple of questions on gross margin, but did you say if you could quantify specifically what the challenges related to supply chain might have been in terms of basis points of headwind on gross margin? And then like the other question I have on gross margin is just -- is this maybe -- I guess, the third quarter might be challenged a little bit relative to 2Q, but is this sort of the floor now for gross margin? And can you see it going up above 46% as we move into next year?

Yes. So let me answer the second question first. The guidance that we've provided for the back half of the year is roughly a 46% gross margin. We said for the full year, $45.5 to 46%. That's over 200 basis point improvement over 2020. So at least the next 3 quarters, the gross margin is very sustainable. We still fundamentally believe that we can drive about 100 basis points of gross margin expansion per year. So as we get into 2022, we would expect that our businesses are expecting to drive continued gross margin expansion. And we still see that opportunity, both as looking at the productivity programs that we have underway as well as looking at the new product launches and the mix of products in which we expect to launch. So, I think we feel pretty good that this is a sustainable floor that we can build off of and continue to make progress. Overall, I'd be careful getting a little bit into what more could you've done, had you not had all these costs hitting you. I would say that, that kind of gets into selective disclosures around only talking about the negatives, and therefore, your number could be higher. It's still an impressive gross margin expansion over the 2020 numbers, and it gives us confidence we can continue to do it into 2021 -- 2022.

Got it. Are you able to tell us which acquisition the earn-out was associated with?

The one that's hitting our operating cash flow in the third quarter is the Zettlex acquisition. So that's in the conductive coder business within the precision motion segment.

Got it. And then speaking of Zettlex and the other acquisitions that you've done now with SEM and ATI, just kind of zooming out and thinking about the strategy that you've talked about in terms of expanding the addressable market in each of the segments through subsystems and software, et cetera. How many pieces of the puzzle are still missing to do what you want to do in terms of that expansion? What percentage of the pieces maybe have you added in the last couple of years now that -- of the total that you need?

My goodness, I don’t know about percentage of the pieces, but what I do know is, yes, if you look at where the industry and the market is going, obviously, there is a tremendous need for robotics and automation and robots that work side-by-side humans and need to operate more almost like humans, so they need to touch, feel, move around, sense, see like humans. And there’s a long way to go still before that is a reality, but we’re definitely making strong progress. So we want to be the enabling technology provider towards that trend. We think that the acquisitions we’ve just made are helping us tremendously. Both getting deeper in lab automation or in cobots, industrial robots for electric vehicle production, for example, but also deeper into robotic surgery, again, with the four stroke sensing capability that enhances just the haptic feedback, right, of the surgeon while operating. So these sensors and these feedback mechanisms as well as other sensing capabilities will be in continued focus for the company and you’ll see us making more moves down the line. We think the market – you’re probably watching this as we do, has grown tremendously. The explosion of e-commerce, you see mobile robotics, see more side-by-side improvement of safety that is really important and of course, to be able to work together side-by-side robots. So all these things require sophisticated technology that we want to be part of. So it’s billions and billions of addressable market at some point, and we’re just scratching the surface. So yes. So we’re excited, and we see some follow-up opportunity with particularly the ATI acquisition.

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

Thank you, operator. So to summarize, Novanta’s performance in the second quarter of 2021 was excellent. We had all-time highs for sales and bookings, and we beat our own expectations for profit and cash flows. And our innovation programs are healthy and progressing after strong investments in the last few years and we saw another quarter of fantastic growth in design wins. We signed agreements for 2 acquisitions we talked about just now, and which we believe align very well with Novanta strategy, and will open up more opportunities for us in attractive high-growth markets in the future. We’re excited to see the continued strength and recovery in the global economy, in the advanced industrial sector and also in the medical sector. And Novanta is very well positioned in these sectors. We invested for it. And we – with diversified exposure to long-term secular macro trends in robotics and automation, precision medicine, minimally invasive surgery and industry 4.0. So in closing, I would like to thank our customers, our employees and our shareholders for their ongoing support. I’m very grateful for the dedication and strong contribution of our teams and of committed Novanta employees and particularly, our supply chain and operations teams, who are working tirelessly to successfully mitigate shortages. 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 the third quarter 2021 earnings call. Thank you very much. This call is now adjourned.

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