Novanta Inc. (NOVT) Q3 2022 Earnings Report, Transcript and Summary

Good morning. My name is Keith, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Inc. 2022 Third Quarter Earnings Call. [Operator Instructions] Please note, this event is being recorded. I'd 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 Third Quarter 2022 Earnings Conference Call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our Chair 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 web 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'm now pleased to introduce the Chair and Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Ray. Good morning, everybody, and thanks for joining our call. Novanta achieved record results in the third quarter of 2022. We delivered another quarter of terrific financial performance with double-digit growth in revenue and adjusted EBITDA as well as solid growth for adjusted EPS. We ended the quarter with our backlog still at near-record level as we continue to see strong demand from our customers in the medical and advanced industrial markets we serve. In the third quarter, we delivered a new record high $223 million in revenue, representing 25% year-over-year revenue growth on a reported basis and 21% growth on an organic basis and up 4% on a sequential basis. In addition, our operating profit in the third quarter was fantastic with adjusted EBITDA of $49 million, up 22% year-over-year and adjusted diluted earnings per share of $0.81, up 8% versus tougher comps in the prior year. The excellent year-to-date financial performance means we will once again raise our full year 2022 financial guidance, which Robert will cover in detail in a few minutes. We are extremely pleased with our company's performance and the resilience of our portfolio in an ever-changing and challenging macro environment. November's portfolio is well positioned in medical and advanced industrial applications with long-term secular tailwinds such as robotics and automation, health care productivity and precision medicine. We feel good about our strategy, and we're staying focused on where we play and how we win. We continue to build and grow quality businesses with proprietary IP and attractive secular growth markets with a vibrant culture and great talent. And I continue to be very proud of our teams around the world who are using the Novanta growth system to drive exceptional operating performance, no manner of the environment. Now let's turn to what we're seeing in our markets and our customer activity. We continue to see strong ongoing demand from our customers in many application areas, and we ended the quarter with still near-record backlog of $626 million. At the same time, and as indicated in our last call, we have started to see a return to more normalized ordering behavior from our customers. This was expected after a period of record orders and a 7 consecutive quarters of positive book-to-bill, which resulted in a cumulative book-to-bill of approximately 1.3 over that time. We're also seeing some easing of supply chain shortages and this gradual improvement of delivery lead times is consistent with the normalizing of customer order patterns. While our year-to-date book-to-bill is well above 1 at 1.12, the third quarter book-to-bill normalized to 0.91 in the quarter for Novanta overall. In the third quarter, our sales to advanced industrial markets saw 33% growth year-over-year and 5% growth sequentially. In the quarter, we continued to see strong sales performance in automation and robotics markets, driven by continued underlying demand for factory automation, battery and electric vehicle production, extreme UV lithography and increased overall adoption of automation enabling technologies. We believe that the penetration of robotic and automation applications is still relatively low with adoption increasing due to multiple drivers, such as increased productivity, higher robot utility, onshoring and labor shortages. In the quarter, we did start to see a rapid downturn in the microelectronics market, which is now being widely reported on by other companies. Only approximately 10% of Novanta sales are in this area, and we delivered terrific operating results in the third quarter despite the impact of this downturn. Although it's clear that overall industrial output is decelerating across most major economies, it matters where you play. Novanta's portfolio is geared towards secular growth trends and our sales so far have been nicely resilient, and we continue to see strong pull-through from our OEM customers to fulfill our backlog to them as they continue to sell through to their end markets. Turning to our medical end markets. For the third quarter of 2022, sales to medical applications grew 19% versus the third quarter of 2021 and 6% sequentially. During the quarter, we saw very strong orders and shipments to many of our medical OEM customers with noteworthy strength in surgical robotics, DNA sequencing and minimally invasive surgery equipment and consumables. This category has also strong double-digit growth in sales year-over-year. It was positive to see further growth in our minimally invasive surgery product categories, which is tracking with the broader gradual improvement in elective surgical procedures. While demand signals demonstrate that this market continues to accelerate heading into 2023, it is important to recognize that hospitals are still battling staff shortages to some extent. Therefore, some near-term volatility in ordering should be expected. Our longer-term outlook though on the minimally invasive surgery market remains bullish, particularly with our unique product offering of integrated smoke evacuation insufflators and also next-generation endoscopic pumps. From a regional perspective, we saw strong demand across all major geographies in the third quarter. Sales in Europe grew 15%, and sales in the United States grew 36% year-over-year. We experienced 9% year-over-year revenue growth in China, help our ATI acquisition, which shows strong electric vehicle production and robotic demand. Our China revenue, excluding acquisitions, was down double digit year-over-year, which reflects the microelectronics downturn I spoke to earlier, as we have several large customers in microelectronics who are based in China. As a reminder, our China revenue is relatively low percentage of total Novanta revenue. Now let me touch on some of Novanta's strategic growth metrics. For the third quarter, our Vitality Index, which is the revenue from new products launched in the last 4 years, continues to be healthy at about 25% of sales with year-over-year NPI revenues up high-single digits versus the last year. Our R&D teams continue to make good progress on our new product pipeline, which remains very healthy. And we continue to invest in R&D in order to capture the many and mid- and longer-term opportunities with differentiated offerings in high-growth markets. Moving on, in the third quarter, design wins for the overall company increased more than 20% versus the prior year. We saw solid design wins in the majority of our businesses, including another exciting win in our minimally invasive surgery business. We're excited about the platforms we're winning and attractive high-growth applications such as minimally invasive surgery, surgical robotics, laser additive manufacturing, micromachining, extreme UV and electric vehicle battery welding. Now I would like to spend a moment on our minimally invasive surgery business, which is part of our Vision segment. In the last few years, we have secured a leading position in insufflator and pump technologies through design wins and development agreements with multiple minimally invasive and robotic surgery OEMs who have platforms which we expect to launch in the next 2 years. We're gaining share in our smoke evacuation insufflator in the endoscopy market, while also expanding in robotic surgery. In addition, we're successfully expanding into arthroscopy with our proprietary pump technology. As indicated in prior calls, these business wins are why we have stepped up our R&D investments in the MIS business. Based on the business won to date, we expect the incremental business opportunity to be approximately $50 million revenue in 2025, with consumables picking in exponentially after that. We believe that the penetration rate of these technologies is still relatively low with an attractive long-term growth trajectory and with November content steadily increasing in these attractive applications. Based on the anticipated growth and our gross margin expectations for this business, we expect to significantly expand our medical consumables manufacturing capacity and capability in a lower-cost region. To that extend, I'm pleased to announce that in the third quarter, we closed a small, but important acquisition called MPH Medical Devices. This is a single site medical consumables manufacturing company located in the Czech Republic, which will be integrated into our MIS business. MPH manufactures medical consumable tube set products, very similar to the products that already get sold alongside our insufflator and endoscopic pumps in the MIS business. This new FDA registered factory offers us a lower cost option with well-trained talent, available talent and a state-of-the-art facility to manufacture more of our proprietary medical consumable products in-house, improving our margin profile and creating much needed capacity expansion as we ramp up volumes over the next few years. The near-term sales contribution for the site is negligible, but will grow rapidly in the coming years. We are thrilled to welcome the MPH employees to be part of the Novanta family, and we are excited for the way this new site will help us achieve our long-term strategic goals for gross margin expansion and sales growth. Next, I'd like to give you a brief update on Novanta's other acquisition and integration activities. Our ATI and IMS businesses have now passed their first anniversary of being part of Novanta. Both businesses saw strong performance for sales and bookings in the third quarter. We are extremely happy with the contribution of these businesses and their strategic fit with Novanta. At this point, a large portion of the integration activities have been successfully completed. We're now focused on capitalizing on the mid- and longer-term opportunities these businesses have brought to us. As for the rest of our M&A activities, acquisitions continue to be the primary focus of Novanta's capital deployment. We continue to work on an active pipeline of opportunities, and we'll share updates as we make progress on new opportunities. In summary, we feel terrific about our third quarter results, and we continue to see strength in the remainder of the year. We believe Novanta's long-term strategic positioning is extremely strong. And we'll continue to broaden our exposure to medical and industry applications that have long-term secular growth trends, such as robotics and automation, health care productivity and precision medicine. So with that, I will turn the call over to Robert to provide more details on our operations and financial performance. Robert?

Thank you, Matthijs, and good morning, everyone. Our third quarter non-GAAP adjusted gross profit was $101.7 million or a 46% adjusted gross margin compared to $80.3 million or 45% adjusted gross margin in the third quarter of 2021. For the quarter, adjusted gross margins were up year-over-year and close to flat sequentially. We continue to have good success counteracting the high inflationary pressures, which further demonstrates the resiliency and overall strength of our business. In addition, we also continue to make strong progress in institutionalizing the Novanta growth system across our factories and in our commercial channels. The deployment of Kaizen essential tools, particularly around standard work, problem-solving, value stream mapping and the 80-20 principle are taking root and explains our ability to continue to deliver strong financial results despite the macroeconomic environment. Third quarter R&D expenses were about $21.3 million or roughly 10% of sales. Third quarter SG&A expenses were $40.3 million or 18% of sales. Overall operating expenses were roughly flat sequentially, which is slightly better than expected due to the timing of new hires, which were later in the quarter than expected and project spending delays. Operating expenses on a percent of sales also improved with a better-than-expected revenue performance. Adjusted EBITDA was approximately $49 million in the third quarter of 2022, a 22% adjusted EBITDA margin. Our adjusted EBITDA performance beat our expectations and our previously issued guidance due to higher-than-expected revenue, timing of the new hires and the associated project spend. On the tax front, our non-GAAP tax rate for the third quarter of 2022 was 19%. This differed from the statutory rate due to jurisdictional mix of income. Our non-GAAP adjusted earnings per share were $0.81 in the quarter compared to $0.75 in the third quarter of last year, an increase of 8% year-over-year. While adjusted operating income and adjusted EBITDA grew more than 20% year-over-year, EPS was impacted by higher interest expense and a higher tax rate. Third quarter operating cash flow was approximately $15 million, which is up versus the prior year, but lower than our expectations. The third quarter cash flow continued to be impacted by higher inventory purchases we've made to mitigate some of the supply chain disruptions as well as higher accounts receivables due to strong sales performance and larger than normal shipments in September, which was the final month of the quarter. And to a lesser extent, cash flow was negatively impacted by roughly $3 million of higher cash taxes related to the change in U.S. tax law. We ended the quarter with gross debt of $448 million, and our gross leverage ratio was less than 2.5x. Our net debt was $363 million. I'll now turn to update our performance on the operating segments. First, I'll start with the Photonics segment. For the third quarter of 2022, this segment saw revenue growth of 28% year-over-year. This segment continues to experience strong customer demand in their advanced industrial applications and medical applications. The book-to-bill in this segment was 1 in the third quarter. We are very pleased with this outcome, especially considering this business experienced a significant fire as primary PCBA vendor in Indonesia. It was able to recover quickly, benefiting our customers and our shareholders. Our supply chain and manufacturing teams demonstrated an extraordinary resiliency to deliver these strong results. Within Photonics, new product revenue stayed strong at greater than 20% of sales in the third quarter, while design wins were up double-digit year-over-year as our sales teams continue to win excellent new customer platforms in attractive high-growth medical industrial applications. The Photonics segment adjusted gross margin was approximately 50%, which was up nearly 300 basis points year-over-year, in line with our expectations in our prior guidance. The team continues to make terrific progress ramping our Newton production facility, mitigating the cost and shortages of our primary PCBA vendor in Indonesia who had the fire and embracing the Novanta growth system disciplines. Turning to our Vision segment. This segment predominantly serves the medical end market and saw reported revenue growth of 12% year-over-year, which was better than our expectations. Growth in this segment was driven by strengthening and elective surgical procedures and continued success with our smoke evacuation insufflator technology. While our JADAK business line continues to show year-over-year declines due solely to supply chain shortages, these shortages, and therefore, the revenue decline continued to moderate as supply from our vendor continues to increase, and we are able to deliver to our customers. The Vision segment saw a book-to-bill just under 1 as customers started to decrease their ordering in line with our reduced lead times. The Vitality Index in this segment remained greater than 30% of sales and design win activity in the segment increased strong double digits year-over-year, driven by another strong win in the minimum invasive surgery business. Finally, turning to Precision Motion segment. This segment experienced 38% year-over-year revenue growth in the quarter. Excluding acquisitions, Precision Motion grew 2% year-over-year. Our Celera Motion and ATI business lines experienced 6% organic growth in the quarter. However, the segment's overall growth was impacted by a significant downturn in the China-based PCBA electronics market, which is served through our Westwind product line. This product line fell nearly 40% in the quarter and is expected to stay depressed for a few quarters. As a reminder, the largest share of Novanta's remaining exposure to microelectronics is in this segment. The overall book-to-bill ratio in this segment was 0.78, which was also largely driven by the Westwind product line. Excluding this business, the book-to-bill was closer to 0.9. On a year-to-date basis, the book-to-bill ratio in this segment was 0.98. And excluding the Westwind product line, the book-to-bill was 1.04 on a year-to-date basis. Precision Motion NPI revenue was 18% of total sales in the segment. Including ATI and IMS, NPI sales grew 22% year-over-year. Adjusted gross margins for this segment came in about 49%, which was down year-over-year, but in line with our expectations and was the result of margin dilution from the decline in the Westwind product line. Turning now to guidance. Overall, we expect the fourth quarter to start to return to a more typical industry and business dynamic and ordering pattern away from the pandemic fuel recovery. In the near term, this could mean further slowing in some microelectronics applications and some industrial capital applications. However, we also expect our medical applications to continue to strengthen helping to offset the headwind in those applications. Microelectronics applications, which represent approximately 10% of our sales, which declined to 9% of sales in the fourth quarter or nearly 20% reduction sequentially, whereas medical applications, which represent approximately 48% of our sales year-to-date, will represent 50% of sales in the fourth quarter. Despite these dynamics, our customer demand and business performance has been resilient, and we continue to expect to exit 2022 with near-record backlog and accelerating demand trends in the medical markets. Our strong financial performance in the third quarter means our full year 2022 guidance will be raised. So starting with the revenue guidance. For the fourth quarter of 2022, we stand here today, we expect GAAP revenue in the range of 215 and $217 million, which represents revenue growth in the range of 7% to 9% year-over-year. For the full year 2022, we now expect GAAP revenue in the range of $857 million to $859 million, which implies revenue growth of 21% to 22% year-over-year, representing approximately 12% organic growth for the full year of 2022. On a segment level, in the fourth quarter, we expect the Photonics segment to grow revenue in the 25% to 30% range year-over-year. Customer demand remains solid in this segment with growth in a number of industrial and medical applications. The Vision segment is expected to demonstrate revenue growth in the range of 8% to 10% year-over-year. While we continue to see strong demand from the medical end market, electronic part shortages are primarily caused of the range in the revenue. Finally, our Precision Motion segment is expected to be down 8% to 10% year-over-year due solely to a year-over-year decline in our Westwind product line, which will fall more than 60% in revenue in the fourth quarter. Excluding the Westwind product line, our Celera Motion and ATI business lines are expected to grow in the mid-single-digit year-over-year basis. Moving on to overall Novanta's gross margin, we expect gross margins in the fourth quarter to be greater than 46%, which is expected to lock our 46% gross margin target for the full year of 2022. Gross margins by segment are expected to see similar dynamics that we experienced in the third quarter. Finishing off the year at an adjusted gross margin of approximately 46% represents a nearly 100 basis points of expansion year-over-year and is an excellent accomplishment given the difficult dynamics we've had to manage throughout the year. Thanks to our progress with the Novanta growth system across our business units, we feel confident we are on a path to continue and sustain gross margin expansion this year and the next. Turning to R&D and SG&A expenses, which were $62 million in the third quarter, they are now expected to be approximately $63 million to $64 million in the fourth quarter. We continue to invest in R&D because of our confidence in the near-term customer applications we are pursuing and the expected launch cycles with customers' new products. We are particularly excited about the new insufflator wins, which are effectively solidifying our value proposition of an integrated smoke evacuation insufflator technology in the medical markets. Depreciation expense was $3 million in the third quarter and should be similar in the fourth quarter. Stock compensation expense, which was $6 million in the third quarter, will be just over $5 million in the fourth quarter. For adjusted EBITDA for the fourth quarter of 2022, we expect a range of $45 million to $46 million. For the full year, we now expect adjusted EBITDA in the range of $183 million to $184 million, higher than previously issued guidance. Interest expense, which was $4 million in the third quarter to be approximately $5.5 million in the fourth quarter, driven by rising interest rates and a slightly higher debt balance. We expect our non-GAAP tax rate to be around 18% in the fourth quarter, absent significant changes in jurisdictional mix of income and other variability of our eligible tax benefits. Diluted weighted average shares outstanding will be approximately 36 million shares. For adjusted diluted earnings per share, we expect a range of $0.70 to $0.74 in the fourth quarter. And for the full year, we now expect adjusted diluted earnings per share to be between $3.02 and $3.06. Finally, we expect operating cash flows to improve sequentially in the fourth quarter versus the third quarter as we stabilize our inventory levels and drive a more linear production process, and therefore, shipments in the quarter, resulting in a lower accounts receivable balance. As always, this guidance does not assume any significant changes in the foreign exchange rates. However, it's worth noting that the currency markets have continued to be historically volatile in the past few months, and this has had an impact on our third quarter results, including a nearly 8 point negative impact on our reported revenue growth. In summary, Novanta's performance in the third quarter of 2022 was excellent. We had our highest level of quarterly sales. We saw double-digit growth in sales and adjusted EBITDA, along with solid growth in adjusted earnings per share. Our teams continue to execute extremely well, helping the company manage through the difficult supply chain challenges, while still winning new customer platforms and progressing our innovation pipeline. We continue to see below-market attrition rates and are seeing great success at attracting top talent. And we continue to deliver strong financial results with a very solid full year outlook despite significant macroeconomic challenges in the marketplace. We remain very grateful for the outstanding performance of our employees and the tireless efforts to help us be successful in this challenging environment. We look forward to continuing to deliver on our commitments to our employees, our customers and our shareholders. This concludes the prepared remarks. We'll now open the call up for questions.

[Operator Instructions] And today's first question comes from Lee Jagoda with CJS Securities.

Just starting with the Vision segment, can you kind of parse out the mix of consumables versus capital equipment in the quarter? And then how we should think about the lag between increasing consumables and capital equipment purchases kind of bouncing back in medical?

Yes, I would say that both were roughly the same in the third quarter. So they both had a very, very strong period of growth. As we get into the fourth quarter, I think that's where the volatility might lie from an ordering pattern behavior. It's the hospital systems still have some labor shortages, which impact their ability to take deliveries of some products. And so that results in some volatility that could be expected. I would still expect consumables to be growing in the double-digit rate in the fourth quarter. So that should still hold relatively steady, but the volatility will be more on the pumps in the insufflator side.

Yes. The other thing that I would say, Lee, is that we see the environment improving sequentially, also on the capital. And actually, some of the volatility is also related to our OEMs not finding all the right components, right? So there's going to be some timing effect there. But if you look past that immediately, we feel very good about 2023 also on the capital side.

Got it. And in terms of just the consumables portion of the growth, is all of that being used relatively quickly? Or is there some restock that has to take place of consumables coming out of the pandemic?

There's always a -- I wouldn't say that there's a big element of restocking per se, but there's always an element of shipping the product to distribution centers that serve as their safety stock. So it's fair to -- you're asking a question more on the double-digit growth, how is that aligned to surgical procedure rates. I think surgical procedure rates, which have historically been somewhere around 6% are definitely growing at a higher rate right now. And so there is a little bit of a combination of both, but this is something we expect to hold relatively steady not only for the remainder of this year, but going into 2023 as well. So that same level of demand profile is still expected for a little bit, just not on elevates.

And then I appreciate the announcement on the new facility that you guys acquired. How do you view its current capacity relative to your current consumables production outside of that facility and sort of the time line to get things moved over there?

Yes. So of course, yes, they -- first of all, we're indeed very, very excited about this acquisition. We talked about this for a few years now that we would need at a lower cost, highly capable production side and we had multiple options either to kind of greenfield it or acquiring. We're very pleased we were able to agree to add MPH to our portfolio, very, very experienced, very capable team, state-of-the-art facility. Now they're making certain products today that they have a certain capacity. We obviously need to expand their capacity with our production processes, et cetera. So we are using 2023 predominantly to transfer production lines, qualify production lines and then start to ramp these production lines towards the latter part of 2023. So then, therefore, in 2024 and beyond, you will start to see a more gradual, but increasingly significant contribution of this site.

Got it. One last one for me and I'll hop back is embedded in your Q4 revenue guidance, what's the headwind from currency that you're assuming?

The same that we experienced in the third quarter.

Okay. So that's 7%, 8% range. Okay.

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

So just kind of building on that last question, just to be clear, was it embedded in the 4Q guidance for organic revenue growth overall?

The organic revenue growth that I spoke to, I think it was 7% to 9% in the fourth quarter. So yes, there's still similar FX headwinds expected in the fourth quarter that we experienced in the third quarter. But despite that, I think from an organic basis, we'll be up about 12% for the full year and in the range of 7% to 8% -- 7% to 9% for the quarter, 7% to 9%.

Okay. And we're lapping the larger acquisitions of Schneider and ATI we have already. So that's not to be -- is there acquisition revenue in the -- how should we think about the acquisition that you just made in revenue related to that, I don't know if you said -- but that's in the revenue?

Yes. You're trying to get at the reported growth versus the organic reported organic should be at themselves. The only difference is the impact of foreign exchange. So the acquisition we did was not material from a revenue perspective. It was -- obviously, we didn't bid for that, but that -- whatever revenue comes with is not going to have an impact on us. And you're right, we lap IMS and ATI, so won't have that revenue growth anymore in the top line.

Okay. Got it. And then I don't know how I can go about getting you to make some comments on 2023, without upsetting you. But I'm going to track -- I think in the prepared remarks, correct me if I'm wrong. You made a comment about expecting continued acceleration. I think you can use the word acceleration in procedure volumes. Or what was the comment you made about that market?

Yes. I think what we're seeing right now is microelectronics, which will represent about 9% of our sales in the fourth quarter is decelerating at a double-digit rate. But the medical -- on the medical side, we see acceleration. So we're seeing double-digit type of growth in some of the medical consumables that we have right now and even some of the capital equipment, while there's some volatility expected there. Overall, that's an area that continues to strengthen as we get into 2023. So the big question is the effects on the rest of the industrial piece of the portfolio and then haven't that all pulled out. I would just say that as we look out in 2023, we expect microelectronics to be weak, and we expect the medical markets to more than offset that. And then it's a question that we'll talk about in January where the rest of it is. But overall, we feel like the cylinders in the engine are appropriately balanced.

So the expectation is that the medical market collectively for you would grow in 2023, just to see that.

That's correct.

Okay. And your backlog and you're going -- you're likely going to enter 2023 with significant backlog maybe at least double, I would imagine, maybe almost triple what you've had in the past. How does that break down across the different segments? And how does that help you weather some of the pullbacks that you're seeing on the industrial side?

Yes, I don't think we're -- we have ever broken down backlog by segment. But obviously, it's helping to buffer, right, whatever potential headwinds, there might be heading towards us. So yes, we feel good about where we play, the markets that we play. You see the diversification of our portfolio and the resilience of portfolio really playing out also in this part of the cycle. And on top of that, we have a strong backlog position that could be used as a buffer for potential shocks. So we'll leave it at that in terms of the further breakout.

Okay. And then, one last one on 2023. So we've made the acquisition, and congrats on that. Now my understanding, I think maybe you'll correct me on how to phrase this exactly, but is that -- that should significantly help the margins, the gross margin that you're able to generate on the consumables within the WOM business. And bring it up, I think, in line with the segment average, so that in any case, what I calculate it at one point, this is potentially going to get to -- when you get it ramped up with 100 basis points to consolidated gross margin, and I'm just wondering if you can comment on that and the timing, given now we know when you close the acquisition?

Yes. So your commentary is directionally accurate. It's -- we -- this facility serves 2 purposes. One, it allows us to facilitize and capacitize ourselves so we can get all the volume out that we're expecting. Matthijs spoke about how the wins in MIS drive about $50 million worth of incremental revenue in 2025. Well, now we've solidified that, and this facility is needed in order to drive that volume in. And then by moving it in-house versus having an outsource, we're able to improve the gross margins. Now it takes about, I would say, a year to get the facility fully capacitized and qualified manufacturing needs medical consumables or obviously FDA-registered products. And so we expect roughly this time at the end of next year that, that facility will be fully qualified and then we'll be driving the margin expansion thereafter.

Okay. So the margin expansion associated with that is really more to come in 2024 before it's fully realized. Is that fair?

Yes, because it closely -- it's going through a qualification period in 2023. And so therefore, you're not going to really drive material margin improvement or material volumes until you get to 2024.

Okay. All right. I'll save my other questions for later.

And the next question comes from Andrew Buscaglia with Berenberg.

In the Precision Motion segment, you guided 8% to 10% in Q4. Just want to get a little bit more than I was expecting. First, that's an organic growth number in there. And then, I guess, beyond Q4, I guess, talk about how -- I know you don't give 2023 guidance, but how should we expect that to trend? Or maybe you can talk about like an absolute level or something related -- some baseline start to grow that off?

Yes. So what I said was that the overall segment is expected to be down 8% to 10% in the fourth quarter and that is being driven by our Westwind product line. The Westwind product line itself is down 60%. The Westwind product line serves the China PCBA drilling market. And so it is by definition a microelectronics based application. So if you exclude the Westwind product line, the Celera Motion and the ATI businesses are expected to grow mid-single digit year-over-year in the fourth quarter. And I don't see any of that kind of changing as we get out further from here. So I think those are growth businesses, and they're expected to stay in a growth category. There's just a little bit of a headwind on the Westwind business. I think the Westwind will have a larger headwind in the fourth quarter versus any other period. And I think most likely is again to 2023 look more similar to the dynamics of the third quarter.

Okay. And then overall, you're talking about microelectronics, not depriving down double digits and into next year too. What will electronics be as a percentage of total sales when you finish the year? What's the expectation built into the guide?

Yes, 9% of sales.

9%, down double digits. And then 50% roughly is medical, and that's going to continue to grow and offset that kind of the idea.

Correct.

Okay. And then one more, if I may. You talked about that you've been spending a lot of R&D to capture that minimally invasive surgery opportunity. And you talk -- correct me if I'm wrong, you talked about $50 million incremental revenue through 2025. Will that continue? Will that require a similar level of R&D spend? Or should we expect overall R&D spend to kind of taper?

So I'll answer part of the question and I'll let Matthijs also interrupt me, but I would say that we've been floating around 10% of sales for the last 2 years. I don't see that dynamic changing in 2023 or 2024. So I still expect us to make some shifts there because I think there's plenty of opportunity to make investments even as those propanes fall off. Now I will say we're driving $50 million worth of incremental sales from those programs, but they don't all kick in at once with the same exact loan cycles. And so there will be continued spend associated with that in order to fully commercialize them.

Yes. And we just factored a number of $50 million incremental business in 2025. And of course, that will continue to grow afterwards, both on the capital side as well as on the consumables side. So the majority of that $50 million will be more capital placements, right, because you're early in the cycle and then the consumables will gradually kick in, but that will ultimately become more of an exponential growth aspects because you certainly have increased your installed base dramatically with capital equipment, right? So there is between '25 and 2030, there's going to be further sustained growth that we're super excited about.

And the next question comes from Rob Mason with Baird.

Listen, I joined the call late, so apologies if this is redundant information. But could you explain why the Vision gross margins came [indiscernible] sequentially and below what I was expecting and what maybe you're expecting on the fourth quarter?

Sorry, I had a -- sorry, I didn't hear you, kind of difficult to hear, so I didn't hear it right away. So the Vision gross margin, why they came down?

Down sequentially. The reason for that is that you're expecting for the fourth quarter there?

Yes. It's difficult to hear you, but I would say that in the fourth quarter, I expect gross margins of Vision segment to tick up a little bit. So in each of the individual segments in the fourth quarter, gross margins will pick up a little bit from the third quarter level. And in the third quarter, specifically in Vision, I would say that it was largely driven just by a little bit of a change in mix. With the medical consumables business grew at a double-digit rate, and so that has an impact on our gross margins. And so even though that's actually that same dynamic that's happening in the fourth quarter, our JADAK business will not deteriorate in the fourth quarter. And so that has a favorable mix shift for us, which helps to improve the margin profile.

Okay. And then maybe just last question. Is there any semiconductor micro exposure to peak level in the Photonics segment that we should also be aware of in terms of getting softer, another semiconductors closer there? I think it's newer content, newer wins, but just the trend line on the business in that segment?

Yes. So there is a little bit of exposure there. It's, at this stage, throughout most of 2022, it's been relatively small in the Photonics segment. And the reason being is that some of its larger exposure had been associated with flexible PCBAs and smaller PCBA type of via-hole type applications. And that market actually went down in 2021. And so it hasn't actually been a big contributor in the 2022 calendar period. So the largest element of the exposure in that segment has not manifested itself and been a growth driver in 2022. And so we don't expect the same level of impact. Overall, microelectronics is going to be about 9% of sales in the fourth quarter and probably going forward on a run rate basis. I would say almost all that exposure is really sitting in our Precision Motion segment at this point.

The other point, Rob, I want to make is that, yes, our content in extreme UV lithography is steadily increasing. And it's -- yes, public knowledge that, that application is growing double digit, actually against the microelectronics trend. So even within that 9% of sales, an increasing amount of revenue over time will be in that kind of faster secular growth trajectory.

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

Thank you, operator. So to summarize, Novanta delivered very impressive results in the third quarter of 2022. We saw a record level of sales and profitability, double-digit growth for sales and adjusted EBITDA. And we maintain a near record high backlog. We've achieved all of this, while managing a challenging market macro environment. We're excited to see the continued strength in the medical sector and also the resilience in advanced industrial sector. Novanta is very well positioned in these sectors and with diversified exposure to long-term macro trends in robotics, automation, precision medicine, minimally invasive surgery and Industry 4.0. In closing, as always, I would like to thank our customers, our employees and our shareholders for their ongoing support. I continue to be especially grateful for the dedicated efforts of all our Novanta employees who work so hard every day to tackle each new challenge. 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 fourth quarter and full year 2022 earnings call. Thank you very much. This call is now adjourned.

Thank you. As mentioned, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.