Good morning. My name is Keith, and I will be your conference operator today. At this time, I would like to welcome everyone to Novanta Inc. 2022 Fourth Quarter and Full Year Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session [Operator Instructions]. 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 fourth quarter and full year 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 Web site at www.novanta.com. Please note, this call is being webcast live and will be archived on our Web site 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. If 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 Web site 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 delivered record results in 2022. For the full year, we achieved all-time highs for sales, adjusted EBITDA and adjusted EPS, with each showing strong double digit growth over prior year results. We continue to see strong demand from our customers in the medical and advanced industrial markets we serve, and our teams are delivering great results. In the fourth quarter, we delivered $218 million in revenue, representing 10% year-over-year revenue growth on a reported basis and 14% growth on an organic basis. Our operating profit in the fourth quarter was also strong with adjusted EBITDA of $46 million and adjusted diluted earnings per share of $0.75. For the full year, we delivered $861 million in revenue, representing 22% year-over-year revenue growth on a reported basis and 14% growth on an organic basis. Adjusted EBITDA for the full year was $184 million, up more than 20% versus 2021 and adjusted EPS was $3.07, up 17%. I'm incredibly proud of how our team exceeded our financial objectives and progressed our strategic initiatives, driving strong operating performance in an evolving macroeconomic environment. At Novanta, our mission is to deliver innovation that matters. We serve as a trusted sole source technology partner to our OEM customers, providing unique mission critical functionality that enables our customers to differentiate. The Novanta business model with diversified exposure to high growth medical and advanced industrial markets has proven resilient under multiple geopolitical and macroeconomic scenarios. Our proprietary products and technologies are well positioned in medical and advanced industrial applications with long term secular tailwinds such as robotics and automation, healthcare productivity and precision medicine. We feel that the strength of our portfolio and business model, combined with our winning growth strategy, focus on where we…

Thank you, Matthijs, and good morning, everyone. Our fourth quarter non-GAAP adjusted gross profit was $97.9 million or 45% adjusted gross margin compared to $88.3 million or a 44% adjusted gross margin in the fourth quarter of 2021. For the full year, non-GAAP adjusted gross profit was $392 million or 45.6% adjusted gross margin compared to $319 million or a 45% margin in 2021. For the quarter, adjusted gross margins were up year-over-year but down sequentially. For the full year, adjusted gross margins expanded approximately 50 basis points year-over-year. It's fair to say that while this performance was strong, the gross margin expansion missed our expectations. In the fourth quarter, there were two dynamics that caused this to occur. The first was revenue increased more than expected in our Vision segment driven largely by our minimum evasive surgery business line, which has lower gross margins than our Photonics and Precision Motion segments. The second dynamic was that our anticipated uptick in revenue margin in our Photonics and Precision Motion segments was interrupted by a regional outbreak of COVID in China. This outbreak not only resulted in us shuttering our factory for December and January, but it also broadly impacted supplier deliveries of electronic parts for our products as well as our customers' ability to take receipt of our shipments. On the bright side, the China situation has now resolved and therefore, we expect to be back on our trajectory for the long term gross margin expansion as we head into 2023. Overall, gross margins were still relatively healthy in the fourth quarter given the inflationary pressures and the COVID disruptions. We continue to have good success counteracting the inflationary pressures on raw materials, labor and even overhead costs such as energy, which demonstrated the overall strength of our technologies, our…

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

So just starting with the Vision segment. Robert, can you speak to sort of your expectation of the mix of products within the Vision segment, meaning MIS versus the rest of the stuff, for both Q1 and for the full year and how that might impact your margin guidance there?

I'm expecting solid growth out of the JADAK business, so there will be margin -- if you're trying to get a gross margin expansion in the Vision segment, I think the overall gross margin will improve in the Vision segment on a year-over-year basis. So there will be continued growth coming out of the JADAK business, which is serving predominantly medical markets and to the IVD based applications and other laboratory based technologies. And so there will be a positive headwind from a gross margin perspective.

And then I know you had made the comment earlier that MIS is below corporate average on both the consumables and the hardware piece. As you look out to late '24 and into '25, when you start to see that $50 million of incremental revenue ramp on the new smoke evacuation product lines, how do those margins compare to both the current MIS margins and then the segment average margins within Vision?

So one thing let me clarify. So when we get very strong growth in our medical consumables piece of the portfolio, that's the piece that's been driving the lowest gross margin, and therefore, that's the headwind that we see. That's why we bought the MPH site in the Czech Republic and why we're ramping it. The actual capital equipment piece of the product offering is a much more attractive gross margin profile. When we go about launching our new smoke evacuation technologies, those products, both on the consumable side as well as the capital equipment side, improve gross margins. And so we're intending to launch those products at a much higher gross margin. And then you compound that with the fact that the facility in the Czech Republic will be running product through it beginning in 2024. And so the combination of those two events will allow the gross margin expansion for the overall company, which gives us that confidence of why margins will expand from, let's say, 47% this year to something closer to 50% over the next few years.

And just to be -- is there any quantifiable impact from the facility coming online impacting the margins in either the first half of the year or all of 2023?

It did impact a little bit in the fourth quarter, and it's impacting a little bit in the first quarter, but it beings to -- that begins to get more and more muted as we progress over the course of the year. I wouldn't kind of get into the qualification of it. But certainly, when you see the 38.5% -- 38.9% gross margin in the fourth quarter, an element of that was the MPH acquisition impacting that segment. Not all of it was the medical consumables, but it's all -- we tie that together into a single bow. So I think that headwind will eliminate by the end of the first quarter. It's largely on the basis that they had -- some sales were running off. So as we get into the back half of the year, even Q2, that becomes a nonissue from our gross margin story.

And the next question comes from Brian Drab with William Blair.

Just a follow-up on that one. So MPH, just so I understand the timing, that volume of the WOM consumables is ramping throughout 2023, and then you'll reach like the full run rate volume in 2024. Is that how to think about it?

No, there's some -- so MPH will -- the facility in the Czech Republic, I should say, will not have any revenue coming out of it associated with our medical consumables in 2023, at least not until the fourth quarter. That is product that's all being qualified and ramped in the facility, but it won't be used for sale purposes. The negative gross margin headwind in the fourth quarter and the first quarter is, if you remember, we bought a business with revenue. And so we're bleeding off of that revenue, discontinuing those products. And so there's some last time buys that impacted the fourth quarter, will impact the first quarter a little bit from a mix profile perspective, but that goes away by the time we get into the second and third quarter. And so it will no longer be an issue. By the time we get to the fourth quarter, we're ramping up production of our own medical consumables. And the margin profile, what we ramp out of there will be better than what we've been shipping out of the Ludwigsstadt facility. It won't be meaningful in the fourth quarter, but it will begin to get very significant in 2024.

So your gross margin benefit from this move of bringing the consumables in-house is going to be -- it's going to show up in the financial statements in 2024, right, is that…

Predominantly yes. And so you will see gross margin expansion in the Vision segment in 2023, that's largely coming from continued growth in our JADAK business and solid growth coming from the capital equipment portion of the business.

And how do you expect your backlog and the book-to-bill ratio to track throughout this year sequentially as we move through the year?

We are seeing a little bit of that correction, let's say, in reducing lead times. There's two elements of lead times, there's what our lead times actually are and then what I would think the customers are forecasting or perceiving them to be, and I think there's a healthy tension between those two numbers. So as we get into the first quarter, the EBITDA -- the book-to-bill will be below 1, again, I expect the same in Q2, and then it will begin to moderate by the time we get to Q3 and probably return to 1 in Q4. That's how we built our forecast right now. Things can change because the Vision segment is obviously continuing to grow very solidly. It could pick up beyond our expectations. The Photonics segment, we still continue to see strong demand signals being sent to us, both on the DNA sequencing side as well as our overall industrial customer base. And so I think we've forecasted, I think, a little conservative here, just -- that's our tendency, that's what we tend to typically do over the course of the last few years. But we feel like there's some good positive tailwinds associated with the applications in which we're participating in.

Brian, to add, this is Matthijs. I mean just recall that our backlog coverage for the next, let's say, 12 months, exiting the year was in the high 60%, we’re close to 70%. That is an absolute record, right? It's actually double pre-COVID levels, right? So just to put things in perspective. So as you kind of normalize that unusually high backlog coverage, Robert stated in his prepared remarks, like 45% to 50%, right, that normally, kind of if you do the math, it means that orders will be more muted because customers has placed substantial orders on us and there is no need to add more to it, right? So that's really the majority of the dynamic. And then, of course, the only area where you see an end user demand impact is in the kind of our smallest segment, which is the microelectronics side, which we commented on. But the rest is all normalization related, yes?

[Operator Instructions] And the next question comes from Joseph Donahue with Baird.

I'm on for Rob today. Just to touch on the microelectronics, do you have line of sight on that bottoming out? Should we be thinking first half '23 and then potential for some come back in the latter half, or is it still something that you're just keeping an eye on for now?

So let me kind of clarify. What we did in our forecast and the range of the forecast is that we presumed it pretty much bottomed out in the first quarter. So the revenue -- the dollars of revenue that we get hit their low in the first quarter and we keep it that way for the full year. There are some signals pointing that the second half could perhaps be stronger. We're not baking that into our forecast at this time and the reason why it's just wait and see and see how that manifests. So that's in the guidance range where I say that the overall microelectronics exposure to the company will drop down to something around 7% to 8% of sales, probably 7% of sales versus the 12% of sales that we had in 2022. So it's basically presuming it bottoms in Q1 and we keep it at that level all throughout the year. Now the mix shift changes pretty dramatically. So what you look at is inside the components of that is that the really cyclical pieces of that portfolio come down and are completely muted really kind of starting in the first quarter and there onwards. And what's remaining is actually exposure into deep EUV based applications, lithography based applications, which have a fairly long secular tailwind associated with them. So we feel good at where the product is currently positioned and what we have remaining. And that's the area that we continue to take market share in, that's the area that we continue to have design win progress in. And that's the area that we would expect that as we exit 2023 will actually become a growth story. And so the microelectronics piece of the portfolio will be a less cyclical piece on a go forward basis after this year and a higher growth characteristic to it.

And then just on the issues that you had with the factory in China. Are you able to quantify kind of the impact to the first quarter guidance on the Photonics and Precision Motion side on the [Multiple Speakers] revenue line?

Yes, that was like -- so I would -- if you were to kind of take the two dynamics I spoke to, one of which was higher growth in medical consumables and then the second was the fact that we had to shutdown the factory in December and in January, there was also implications that our customers have disruptions and some vendors had disruptions, right? So there's a couple of dynamics taking place there from just the rapid outbreak of COVID and then the burn out of the pandemic. So the implications of that really was the gross margin. So maybe half of it was tied to the 50 basis point miss and then the other half was basically coming from the higher medical consumable sales. And that's on a total Novanta basis and the largest element of exposures in there tend to be in the Precision Motion and the Photonics portion of the portfolio. So I would say that leads to weaker gross margin in the first quarter in those two segments. But then as you look into the later quarters in Q2, 3 and 4, at least for the Photonics segment, the gross margins will expand. And then overall, for the full year, that segment will see an expansion in gross margins.

And this concludes the question-and-answer session. And now I'd like to turn the floor over to Matthijs Glastra for any closing comments.

Thank you, operator. So to summarize, Novanta had a record setting year in 2022. We saw our highest level of sales and profitability, double digit growth for sales, adjusted EBITDA and adjusted EPS. We entered 2023 with a very robust level of backlog and strong tailwinds in our medical businesses. We won multiple new customer platforms, establishing a strong foundation for robust growth into the next few years. And we also completed one small but strategic acquisition that will improve our capacity for revenue growth and gross margin expansion in one of our strategic product categories. We achieved all of this while managing in challenging environment. We're excited to see the continued growth in the medical sector and also the results in the advanced industrial sector. Novanta is well positioned in these sectors with diversified exposure to long term secular macro trends in robotics automation, precision medicine, minimally invasive surgery and Industry 4.0. In 2023 and beyond, we will continue to focus on new product development, design wins in high growth applications, driving cash flows and institutionalizing the Novanta Growth System. In closing, as always, I would like to thank our customers, our employees and our shareholders for their ongoing support and continue to be especially grateful for all the dedicated efforts of our Novanta teammates who work diligently every day to tackle new opportunities and manage through new challenges. 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 first quarter 2023 earnings call. Thank you very much. This call is now adjourned.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.