Novanta Inc. (NOVT) Q2 2021 Earnings Report, Transcript and Summary

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 performance in the second quarter of $23 million at a ratio of 200% of GAAP net income. So all-in-all, very strong results. We saw record bookings momentum in the second quarter with sequential bookings growth of 12% versus an already strong first quarter and year-over-year bookings growth of 77% versus second quarter of 2020. We saw bookings strength across all our segments, with each segment having positive book-to-bill in the quarter. In the second quarter, our overall book-to-bill was 1.37. We saw very healthy momentum in many of our advanced industrial applications as well as many medical applications and expect to be well above pre-pandemic revenue levels in the remainder of 2021. Now let's talk what we're seeing in our markets, where industrial and microelectronics continue to lead the Novanta recovery. Novanta sales to advanced industrial applications were 48% of total sales in the second quarter, and our sales continue to rebound across multiple application areas with sequential growth of 9% and year-over-year growth of 24%. We also continue to experience high demand specific to microelectronics investments in 5G, high-speed networking and cloud-based infrastructure as well as higher demand from EUV-based applications. We continue to expect the increased microelectronics demand to be sustained throughout 2021 and likely into 2022. And the advanced industrial business also have an increased tailwind from new products, which I will talk to in a second. In the second quarter of 2021, 50% -- 52% of Novanta's total sales went into medical applications. Overall, sales to medical applications grew 9% versus the second quarter of 2020, but slightly down sequentially. During the quarter, we did see a healthy rebound in orders and shipments to many of our medical OEM customers as hospitals slowly start to return to making capital investments. However, we're still seeing a slow recovery in some surgical applications, with capital spending continuing to delay -- to experience delays, particularly in light of the delta variant resurgence in multiple parts of the world. Despite this delay, however, the majority of large medical OEMs are increasing their demand and multiple application areas are now starting a strong market rebound. DNA sequencing, for example, is catching up to pre-pandemic levels with a healthy outlook for the full year. Also, robotic -- surgical robotics and lab diagnostics are showing strong year-over-year and sequential growth with good outlooks. All of this supports our view that medical sales should continue to grow as we progress further into the year, barring any further setbacks in the global recovery from the virus. From a regional perspective, we saw growth across all geographies in the quarter. Our strongest growth continued to come from China, Brazils grew 35% year-over-year, and sales in Europe grew double digits, and sales in the United States grew 9% year-over-year. Now let me touch on some of Novanta's strategic growth metrics. Our vitality index, which is revenue from new products launched in the last 4 years, continues to be healthy at above 25% of sales for the second quarter. We continue to invest in our innovation pipeline with terrific results. Year-to-date, we launched 8 new products, and we are on track for 25 launches for the full year with multiple new products in the queue for the second half for 2021, with focus on industrial and surgical robotics, minimally invasive surgery, precision motion and diagnostics and industry 4.0. We are very excited about all of these products and see a healthy uptick in technical evaluations requested by existing and new customers. Let me highlight one of the products launched in the second quarter, which is called Evo4K. This product serves our medical OEM customers, and it's a software-based 4K medical-grade video recording system. It takes live video from surgical cameras and then records and converts images and videos into usable digital formats for secure use by the hospital. This product furthers our strategy to deliver more embedded software-based functionality in an increasingly digital operating room environment. Design wins in the second quarter were up over 50% versus the prior year, with multiple wins in most of our businesses, continuing the significant momentum we built in the first quarter. We expect to see continued success with our design wins during the remainder of the year. Moving on to other updates. The deployment of the Novanta growth system continues to produce favorable financial results as evidenced by the gross margin expansion of over 300 basis points and strong cash flow in the second quarter of 2021. We are very pleased with how our teams are adopting this common way of working, and we see excellent opportunities during the rest of 2021 and beyond to continue to transform our operations and customer engagements using the Novanta growth system. We also continue to build and invest in our inclusive and diverse Novanta Way culture with the appointment of Anna Fain as our Vice President, Leadership Development and Diversity, Equity and Inclusion, or DE&I. In partnership with myself and the Novanta leadership team, Anna will help build a diverse talent pipeline and embed DE&I deeper into our culture, our systems and processes, so everyone regardless of their background, can succeed at Novanta. Finally, we continue to be active in the M&A market. We recently announced 2 acquisitions, Schneider Electric Motion or SEM and ATI. Both SCM and ATI are fantastic businesses, which will be excellent strategic additions to Novanta, expanding our positions in high-growth markets. As of now, we expect both transactions to close in the third quarter, and Robert will give you more details on both businesses in just a few moments. So in summary, our second quarter was stellar, with record sales and bookings and excellent operating performance. We feel good about our long-term strategic positioning of both medical and industrial applications with long-term secular growth events in robotics and automation, healthcare productivity and precision medicine. And we're confident in our outlook for the year, a strong year-over-year growth, and we feel good about our momentum with a strong innovation pipeline and balance sheet. So with that, I will turn the call over to Robert to provide more details on our operations and financial performance. Robert?

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 increase safety, versatility and productivity of the robotic systems. Applications include electric vehicles, robotic surgery and collaborative robots. ATI really is a fantastic business with a strong fit with Novanta. They offer proprietary intellectual property in these attractive and growing robotic applications, giving Novanta a significant foothold to allow us to expand content with our customers while also serving new customers and applications. ATI was founded in 1989, has grown to over 350 employees, including 100 engineers and a long-tenured technical workforce with deep expertise and know-how in the robotics space, well recognized in the industry. We are very excited to have both SEM and ATI join the Novanta family. We are currently in a customary waiting period on both transactions, which includes a regulatory review. After they close, both of these transactions will become part of the precision motion segment, offering some of the most sophisticated technology solutions available in the precise motion and robotics space. We look forward to working with SEM and ATI teams with their talent, the expertise and their unique capabilities. Even after these 2 excellent transactions, acquisitions will continue to be a primary focus of excess capital deployment. We continue to work on very active pipeline of opportunities, and we feel good about the progress we are making in this area. I'll now turn to give our normal update about the performance of our operating segments. Starting with our photonics segment. For the second quarter of 2021, our revenue was up 30% year-over-year and up 7% sequentially. This strong performance reflects the continued rebound in advanced industrial applications and DNA sequencing. Bookings were up 148% year-over-year, giving us confidence in the business outlook for the remainder of the year. The book-to-bill was 1.46 in the second quarter. New product revenues stayed strong at greater than 25% of sales in the second quarter, and total NPI sales were up 76% year-over-year. Design wins were up over 60% year-over-year. And finally, the sales to customers in China grew more than 50% in the second quarter as we continue to see strong momentum in our photonics products in the China market. Turning to the precision motion segment. This segment saw 30% year-over-year revenue growth and 14% sequential growth in the second quarter of 2021, with bookings nearly doubling year-over-year, giving us a book-to-bill ratio of 1.6 in the quarter. Within the Precision motion segment in the second quarter, new product revenues grew by over 40% and was over 20% of total sales for the segment. Design win activity in this segment was up 30% on a year-to-date basis versus the prior year. And finally, the segment saw another quarter of more than 30% growth year-over-year from its customers in China. Finally turning to the vision segment, this segment predominantly serves the medical end markets and saw a revenue decline of 2% year-over-year, in line with expectations for the business given the difficult comparisons to prior year. While revenue growth continues to be delayed due to deferred hospital spending cost by COVID hospitalization rates, our customers continue to see surgical procedure growth recover to pre-pandemic levels in the United States, China and the European health care markets. The continued progress with surgical procedure growth points to a second half of 2021 recovery in the business. With that being said, the pandemic is not behind us and additional COVID infection rates remain a concern, we are carefully monitoring. Despite the near-term pause in sales growth, the vision segment saw bookings grow 23% year-over-year and a book-to-bill of 1.15. The vitality index in this segment remained about 30% of sales, with new products being a key driver of the resilience we've been seeing in the business. Design win activity was especially good in the quarter, more than double the amount of activity from the prior year, and the business closed on some significant wins with several large medical OEM customers. This is a huge accomplishment and further solidifies the exciting growth prospects of this segment over the next several years. I'll now turn back to the overall company results. Our second quarter non-GAAP adjusted gross profit was $76.9 million or a 46% adjusted gross margin compared to $61.4 million or 42% adjusted gross margin in the second quarter of 2020. In the second quarter, adjusted gross margins increased more than 340 basis points year-over-year and up 90 basis points sequentially. This strong result was in line with our expectations and comes as a result of ongoing work from our operating teams to drive the Novanta growth system deeper into our day-to-day work, allowing the factories to better leverage their cost and drive supply chain efficiencies despite the significant challenges. Novanta continues to experience significant supply chain disruptions manifesting primarily around electronic material shortages and logistics disruptions. As we discussed in the first quarter earnings call, we expect supply chain disruptions and shortages will continue to remain our number one challenge in 2021. In the second quarter, we were extremely proud of our manufacturing team's execution and ability to mitigate these challenges. Second quarter R&D expenses were nearly $17 million or roughly 10% of sales. As demonstrated in Novanta's 150% growth in design wins year-to-date, our investments in innovation are making significant progress. Second quarter SG&A expenses were $31 million or 18.6% of sales. SG&A expenses were down slightly in the second quarter of 2021 on a sequential basis as a consequence of lower compensation-related taxes. Adjusted EBITDA was $37 million in the second quarter of 2021 or a 22% EBITDA margin. Our adjusted EBITDA performance beat our expectations and our previously issued guidance, mainly driven by strong gross margin and higher sales volume flowing through to profit. On the tax front, our non-GAAP tax rate for the second quarter of 2021 was 18.2%. This differed from the statutory rate, driven largely by jurisdictional mix of income. On a non-GAAP basis, adjusted earnings per share were $0.62 in the quarter compared to $0.48 in the second quarter of 2020. The favorable result for our adjusted EPS were driven by strong profit and higher sales. Second quarter operating cash flow was nearly $29 million. This good result was driven by strong profit and by sustained improvements in our net working capital. Finally, we ended the second quarter with gross debt of $196 million, and our gross leverage ratio was 1.5x. Our net debt was $62 million. Turning now to guidance. As we look at the third quarter, we continue to see strong demand from the advanced industrial sector with capital spending continuing a strong recovery. With the bookings and backlog progress, it remains very clear that our #1 challenge in 2021 remains supply chain disruptions caused by electronic material shortages and third-party logistics constraints. Thus far, our manufacturing teams have been successful in mitigating the majority of these shortages. But we continue to see some of these dynamics get more complicated and difficult to mitigate in the short term, at least when it comes to meeting our customers' expectations. We are using all of our resources and tools to limit the impact and expect this challenge to remain through year-end. However, it is clearly a temporary situation and despite this, we feel we have solid visibility to not only raise our third quarter financial outlook, but also the rest of the year. Starting with the third quarter of 2021. As we stand here today, we expect GAAP revenue in the range of $165 million to $170 million. We're expecting to see year-over-year 15% to 20% revenue growth and continued bookings progress. The revenue range itself is governed by material availability of our factories, third-party logistics disruptions and possible disruptions with our customer production processes through their own supply chain challenges. It is not driven by demand, which is continuing to remain very robust. In addition, the range also factors in some part shortages, we believe, are unlikely to be mitigated before quarter end. On a segment level, we expect continued growth in both photonics and the precision motion segment comparable to the second quarter, whereas we expect our vision segment will be largely flat on a year-over-year basis and a sequential basis. While we expect bookings and backlog to continue to build in this segment, the electronic material shortages are concentrated in this segment, causing us to under-deliver to customers' demand in the third quarter. Moving on to adjusted gross margins. We expect gross margins in the third quarter to continue to hold at nearly 46% gross margin, despite the significant supply chain disruptions. While we continue to see some areas of higher cost, we also continue to be impressed with our manufacturing team's ability to find new productivity programs to mitigate these cost pressures through the application of the Novanta growth system. R&D expenses will increase from the second quarter to approximately $18 million in the third quarter as a consequence of normal fluctuations in project spending on our NPI programs. SG&A expenses for the third quarter would be approximately $31 million, similar on a percent of sales to the second quarter. Depreciation and amortization expense will be aligned with the second quarter levels of slightly more than $3 million and stock compensation expense will remain at roughly $5 million in the third quarter of 2021. For adjusted EBITDA, we expect a range of $35 million to $37 million. Interest expense, which is about $1.5 million in the second quarter will be similar in the third quarter of 2021, absent any impact from borrowings associated with the Schneider and ATI acquisitions. We expect our non-GAAP tax rate to be around 19%, absent significant changes in jurisdictional mix of income or other variability of our eligible tax benefits. Diluted weighted average shares outstanding will be approximately 36 million shares. The adjusted diluted earnings per share, we expect a range of $0.55 to $0.60 in the third quarter. Finally, we expect free cash flow to be lower in the third quarter than in the past few quarters. One factor impacting this is an $8 million cash payment we will be making in the third quarter to finalize an earn-out on an acquisition from several years ago. The earn-out payment is considered compensation under U.S. GAAP as it was conditional on employee retention and thus classified under operating cash flow. In addition, we expect CapEx to increase to approximately $9 million in the third quarter as a result of finishing our new Taunton U.K. manufacturing facility in our photonics segment. This third quarter guidance does not include the impact of closing of the SEM and ATI acquisitions. While we continue to expect these acquisitions to close at the end of the third quarter, we cannot include them in our guidance at this time. Turning to the full year of 2021. We are raising our guidance based on the continued strong demand environment and despite the significant challenges associated with global supply chains. We now expect full year revenue of approximately $660 million to $670 million. Once again, this revenue guidance excludes the expected revenue contributions from the SEM and ATI acquisitions. Therefore, we anticipate updating guidance again after these acquisitions have officially closed before the end of the third quarter. Gross margins for the full year are expected to be between 45.5% and 46%, representing 200 basis point improvement over 2020. Overall, R&D and SG&A expenses for the full year are expected to be between $195 million and $200 million, roughly 30% of sales. We expect adjusted EBITDA to be in the range of $140 million and $143 million. And finally, based on non-GAAP tax rate of 15% to 16% for the full year, we expect adjusted diluted earnings per share to be in the range of $2.30 and $2.40. All of these financials will be updated again following the close of the SEM and ATI acquisitions later this quarter. In conclusion, we continue to be extremely pleased with the quality of our businesses, the quality engagement of our teams and the strong demand environment. While we expect to face our challenges around supply chain disruptions and even rising COVID cases, we believe these are temporary challenges, and the company is well positioned to emerge stronger. We remain very proud of the performance of our employees and their tireless efforts to help us be successful in a very challenging environment. And most importantly, we remain excited about our future and look forward to continuing to deliver on our commitments to our employees, our customers and our shareholders. This concludes our prepared remarks. We'll now open the call up for questions.

[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.