Novanta Inc (NOVTU) 2017 Q1 法說會逐字稿

Good morning. My name is Virgil, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta 2017 Q1 Earnings Call. (Operator Instructions) Thank you. Tim Spinella, Treasurer of Novanta, you may begin your conference.

Thank you very much. Good morning, and welcome to Novanta's First Quarter 2017 Earnings Conference Call. I am Tim Spinella, Treasurer of Novanta. With me on today's call is our Chief Executive Officer, Matthijs Glastra; and Chief Financial Officer, Robert Buckley. Robert has temporarily lost his voice but will be available for questions.

If you have not received a copy of our press release issued today, you may obtain it from our 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.

Before we begin, we will need to remind every one of the safe harbor for forward-looking statements that we've outlined in our earnings press release issued earlier this morning and also those in our SEC filings. We may make some comments today, both in our prepared remarks and 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 statement made today represent our views only as of today. 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 today's forward-looking statements as representing our views as of any date after today.

During this call, we'll 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 financials, GAAP measures in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our website.

I am now pleased to introduce the Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Tim. Good morning, everybody, and welcome to our call. We're off to a very strong start in 2017, with record revenue and EBITDA performance meeting both our revenue and profit guidance in the first quarter. Our company delivered 21% reported and more than 10% organic revenue growth with strong profitability. Our revenue was $109 million, operating income was $10 million and our adjusted EBITDA was $20 million, which is up 48% year-over-year. We expanded our EBITDA margins year-over-year by 340 basis points to 18.4% of sales. Our GAAP earnings per share was $0.98 and our adjusted earnings per share was $0.31, which was up 72% from $0.18 in the first quarter of 2016.

We believe that the strength of our team, our robust business model of providing proprietary, mission-critical functionality in diversified end markets and our increasing exposure to the medical markets are serving us well. In the quarter, we saw broad-based growth momentum across the company with all 3 operating segments demonstrating double-digit year-over-year reported revenue growth. Bookings performance was solid with a book-to-bill of 1.11 for the quarter. You will hear more financial details on the quarter in the outlook for the second quarter later in this call, but the strong first quarter results give us high confidence in our full year 2017 outlook.

As mentioned in the previous earnings call, we closed 2 exciting acquisitions in the beginning of 2017. We acquired ThingMagic, a provider of ultra-high frequency RFID modules and readers, and we increased our stake in Laser Quantum from 41% to approximately 76%. As you will recall, Laser Quantum is a provider of optical light engines, solid-state continuous wave and femtosecond lasers. These acquisitions further our strategy to increase our presence in medical markets. Including these acquisitions, our revenue in medical markets has now increased to approximately 45% of total pro forma revenue, up from 10% a few years ago. Both acquisitions are performing very well and integration has been smooth.

Now let me switch to what we're seeing in our core markets. The medical market continued to be robust. The life sciences and minimally invasive surgery segments are doing well, with new design win opportunities continuing to grow. Within the life sciences segment, with the Laser Quantum acquisition, we now have a very strong position in the double-digit growth DNA sequencing application. Finally, robotic surgery is another application where we see strong double-digit growth, driven by increased clinical acceptance and higher Novanta content.

We saw an improving environment in our advanced industrial markets, and our growth there has been helped by new products and commercial execution. Strong applications for us in the first quarter were marking and coding, satellite communication, advanced laser material processing and warehouse automation. In the first quarter, our design wins increased by more than 50% year-over-year, and new product revenue increased by over 40% year-over-year, a strong indication that our investments in innovation and commercial resources are paying off. Our revenue in the quarter from China increased by more than 25% versus last year as we are expanding our direct sales force in that region.

Now let me turn to our operating segments. Our Precision Motion segment continued to be a strong growth engine with 21% year-over-year revenue growth and a book-to-bill of 0.98 in the quarter. In particular, our Celera Motion business is taking advantage of structural growth dynamics, driven by favorable macro trends for precise and dynamic motion control in automation, robotics, satellite communication and minimally invasive surgery markets. Additionally, we see solid expansion potential as our share today is relatively small, these attractive markets are fragmented and growing at high single-digit rates.

Demand from our new Veratus product is steadily increasing with multiple design wins booked. As discussed before, Veratus is a new compact optical encoder that expands our performance leadership in Precision Motion to new advanced industrial markets. We expect the revenue contribution from new products to be more meaningful in the second half of 2017 and 2018 as we're ramping this product into production.

Turning to our Photonics segment. Revenue growth in the quarter accelerated to 26% year-over-year, and book-to-bill was 1.13. Growth was driven by an improving industrial climate, global expansion and the Laser Quantum acquisition. Our Cambridge Technology team delivered record bookings and high single-digit revenue growth, with growth momentum with new and existing customers across a broad set of applications.

Cambridge Technology is the largest business in our Photonics group and a world leader in laser beam steering for medical and advanced industrial applications. Key applications are ophthalmology, microscopy and fine material processing applications such as laser additive manufacturing, converting, via hole drilling, marking and coding and micromachining.

All these markets are structurally growing as conventional production processes convert to laser-based processes, driven by needs for higher precision, throughput and automation. We have extended our performance lead in Cambridge Technology with the recent introduction of the Lightning II Plus scan head system, and we're taking share in applications such as via hole drilling, laser additive manufacturing and converting.

In our Synrad business line, organic growth was 9% in the first quarter, driven by a recovery in industrial markets and new product introduction in low-power [pulse] CO2 lasers. We launched a new 40-watt product, the vi40, targeted to extend our lead in the coding market, which is experiencing solid double-digit growth. Synrad is a leader in a profitable niche market of low-power CO2 lasers focused on fine material processing of organic materials such as plastics, textile and carbon materials using electronic devices, apparel, the food and beverage and packaging industries. These markets are structurally growing as mechanical production techniques are converting to laser-based production processes. And unlike high-power CO2 applications, which are above 1 kilowatt and focused on metal cutting and welding, our Synrad business is not affected by the migration to fiber lasers.

Our Photonics segment continues to be a strong contributor to our overall growth. First quarter design wins in that segment were up more than 50% year-over-year, a strong indication that our investments and commercial teams are yielding results. Applications with strong performance were laser additive manufacturing, marking and coding, via hole drilling and micromachining.

Turning to our vision segment, which helps to reduce medical errors, improve workflow and patient outcomes in applications such as minimally invasive surgery, patient monitoring, life sciences and clinical lab equipment. In the first quarter, our vision segment delivered 14% year-over-year revenue growth, driven by our ThingMagic and Reach acquisitions, both of which are performing ahead of our expectations on revenue and profit. In the quarter, the book-to-bill in our vision segment was 1.17.

We are seeing great design win momentum in RFID on the back of our ThingMagic and SkyeTek acquisitions. In the quarter, 50% of the design wins in our JADAK business were RFID based in a wide variety of medical applications. As discussed in the previous call, ThingMagic enhances our detection technology capabilities in the high-growth $200 million RFID market for identification and tracking in medical applications. RFID demand in health care is increasing as there is a growing need to identify track-and-connect devices, medications and patients for optimal workflow and patient safety. Being a technology leader in RFID for health care has a very positive effect on the broader JADAK business with a strong funnel of 2017 opportunities.

In the quarter, we were encouraged to see year-over-year and sequential revenue growth in the NDS endoscopic display business line, driven by new products. We launched a total of 10 new products in 2017 -- or 2016 which contributed to the roughly 3% sequential revenue increase. We feel we're turning the corner in this business, and although there's more work to be done, we're very pleased with this result and expect the business to be a net contributor to our revenue and profit growth in 2017.

In wrapping up this initial section, we're very pleased with the organic revenue growth and profitability that we achieved in the first quarter. We will continue to invest in innovation and commercial capabilities to accelerate our growth and are aiming to increase our R&D spend to 9% of sales in 2017. In addition, we're very excited about the 2 acquisitions we closed in January 2017, which greatly strengthens our presence in attractive medical markets.

The strong start makes us feel very confident about the 2017 outlook and guidance of double-digit reported revenue and earnings per share growth versus 2016. Our acquisitions are performing well, and our M&A pipeline continues to be active with good opportunities for 2017. Novanta's leadership position across key medical and industrial markets, combined with our disciplined approach to M&A, is providing a solid foundation for sustainable and profitable growth.

Now as mentioned by Tim at the top of the call, Robert has temporarily lost his voice, so let me delve into the financial performance in a little bit more detail. We delivered $109 million in revenue in the first quarter of 2017, an increase of 21% on a reported basis. The net effect of our acquisitions and divestitures resulted in an increase in revenue of $10.6 million or 11.5%, whereas foreign currency exchange rates adversely impacted our revenue by $1.2 million or 1.3% in the first quarter of 2017.

Consequently, organic growth was up 10.5% compared to the first quarter of 2016. First quarter 2017 GAAP gross profit was $46 million or 42.3% of sales. This compared to $37 million and 40.8% margin in the first quarter of 2016. Included in gross profit for the first quarter of 2017 was the impact of $2.7 million or 2.5% of sales of amortization of purchased developed technologies and inventory fair value adjustments.

On a non-GAAP basis, first quarter 2017 adjusted gross profit was nearly $49 million or a 44.8% of sales compared to approximately $39 million or 43.7% in the first quarter of 2016. The increase in gross margins year-over-year was driven by higher revenues and a sales mix of higher-margin products.

R&D expenses were $9 million or 8.5% of sales versus $8 million or 8.9% of sales in the prior year. SG&A expenses were 23% or 21% of sales. This compared with $21 million or 23.5% of sales for the first quarter of 2016. SG&A expenses increased in terms of total dollars, primarily due to the current and prior year acquisitions and from investments in sales and marketing resources. Despite the increase in dollar spend, SG&A as a percentage of sales dropped by 240 basis points as we better leveraged the spend.

GAAP operating income was $10.2 million in the quarter compared to $2.6 million in the first quarter of 2016, whereas non-GAAP operating income was $17 million or 15.2% of sales compared to $10 million or 11.3% of sales in the prior year. And as I mentioned before, adjusted EBITDA was up nearly 50% year-over-year at $20 million or 18.4% of sales in the quarter versus $13.5 million or 15% of sales in the prior year. Interest expense in the quarter was $1.3 million versus $1.2 million in the prior year. The weighted average interest rate on our senior credit facilities was 3.7%.

In the quarter, we also recorded a $26.4 million nontaxable gain following the acquisition of Laser Quantum. This gain represented the excess fair value of our previously-held equity interest in Laser Quantum over its carrying value.

On the tax front, our GAAP tax rate was 3.1% for the quarter. This deferred from the Canadian statutory tax rate of 29%, primarily due to the mix of income earned in jurisdictions with varying tax rates and the impact associated with establishing control of Laser Quantum. On a non-GAAP basis, our tax rate was 28.5%. Our non-GAAP tax rate excludes the impacts associated with establishing control over Laser Quantum.

Looking at the full year 2017, we continue to expect a 30% non-GAAP tax rate and just over 35 million shares outstanding. Our GAAP diluted earnings per share from continuing operation was $0.98 in the quarter compared to $0.05 in the first quarter of 2016. Our adjusted earnings per share were $0.31 in the quarter, up from $0.18 in the prior year. The increase in adjusted earnings per share year-over-year was driven by stronger operating results from all 3 operating segments and from acquisitions. We ended the quarter with 35.1 million weighted average diluted shares outstanding compared with 34.9 million weighted average diluted shares outstanding as of the first quarter of 2016.

Our operating cash flow was $12.8 million for the quarter versus $8.3 million in the first quarter of 2016. Operating cash flow was positively impacted by an increase in profit, which was partially offset by lower net working capital performance as a result of acquired businesses and the production ramp of a key customer in the life sciences market segment. Despite the stronger year-over-year performance, we believe our inventory turns of 3.6x remain too high for our business model. Our focus in 2017 will be on improving inventory turns through improving our supply chain disciplines and our production and material planning processes.

Capital expenditures were approximately $1.8 million in the quarter, down from $2.3 million in the first quarter of 2016. We went live on Oracle and our recent ThingMagic acquisition in our Celera Motion businesses. Both implementations went very well, and the businesses are running at full steam. As we mentioned before, we expect to implement Oracle in a few more businesses over the course of 2017.

In the quarter, we paid $15 million -- $50.2 million of cash for the ThingMagic and Laser Quantum acquisitions. However, net of cash acquired in Laser Quantum of $15.3 million, our net purchase price was $34.9 million. This was reported on the cash flow statement under investing activities.

We completed the first quarter of 2017 with total debt of $121.4 million and $80 million of cash. Our net debt as we defined in our earnings press release as of the end of the first quarter was $41.4 million. This brings our consolidated gross leverage to 1.5x pro forma EBITDA in the quarter.

Our strong first quarter performance positions us well to deliver at the high end or likely above our previously issued full year guidance. But we believe the best time to revisit our full year outlook is after we report our second quarter results. For now, we are continuing our practice of issuing quarterly guidance.

For the second quarter of 2017, we expect GAAP revenue between $110 million and $112 million. This represents 12% to 15% reported growth and mid-single-digit organic growth compared to the second quarter of 2016. I will note that our organic growth metric does not include the organic growth of the acquired businesses, both of which are delivering high double-digit organic growth on a pro forma basis. We expect adjusted gross margins to increase 150 to 200 basis points compared to the first quarter of 2017 and R&D expenses to be around 9% of sales. Minority interest expense is expected to be between $500,000 and $1 million in the quarter.

For the second quarter, we expect adjusted EPS to be in the range of $0.30 and $0.33, presuming no significant gains or losses from foreign exchange rates. And finally, adjusted EBITDA is expected to be between $21 million and $22 million. As we mentioned previously, we continue to be very active from an acquisition perspective and see significant opportunities over the course of 2017. We continue to remain focused and disciplined around driving the continuing transformation of Novanta's business, increasing financial returns and achieving our 2020 vision. Overall, we feel very good about our results in the first quarter and the progress we're making as a company. As we look at the full year, we see opportunities and continued progress on our strategic and financial goals.

This concludes our prepared remarks. We will now open up the call for questions. Operator?

(Operator Instructions) Your first question comes from the line of Lee Jagoda from CJS Securities.

So starting with the organic growth in the quarter and the organic growth implied in your guidance, can you talk about how much new products in the new product pipeline is contributing to the organic growth?

Yes. We're not splitting out the details, Lee, in terms of the percentage of sales, but it was a pretty significant impact. So -- and we have commented in the call where we see impacts in growth percentages. So yes, we'll continue to comment on that in that manner.

And you made a comment earlier that you expected new products performance to benefit the back half, I think, more than it will in the first half. And your organic growth guidance for Q2 is pretty strong. Obviously, Q1 benefited from easy comps. But to the extent new products are going to be more beneficial in the back half, is that to say that organic growth is likely to accelerate in the back half as well?

Where I made the remark, Lee, was primarily in our Precision Motion segment with the Veratus product where we've launched that product. We're seeing good bookings for it and we're ramping the product as we speak, so we see a more significant contribution of that product in the Precision Motion segment in the second half. So that was what the remark was about.

Got it, understood. So then just switching gears to the Laser Quantum business. I guess, given the trends in DNA sequencing and the growth that you expect this year, why did the prior owners of Laser Quantum decide to sell now? And was there a piece -- was there a right of first refusal written into the Laser Quantum agreement? And then just as a follow-up to that, on any future transactions, do you have a right of refusal to buy the rest?

So first, about the timing, well, of course, we should direct the question to, let's say, to the founders. But we know them well, and it was the right time for them, as they're ramping their business in a pretty significant way, as you can kind of see in our financial results. And they felt that with the Novanta strength, we could actually help them with that ramp and add more credibility to the ramp as well as further grow their business in other areas outside DNA sequencing. So for them, it felt good. For us, it felt great. The timing for us is indeed very good. But they still own 25% in the business, and therefore, they're very eager to continue to see their business do very well.

And then on the right of first refusal, do you have the right to buy the rest when and if they're ready to sell?

Yes.

Okay. And then my last one, just regarding the NDS profitability, can you give us a sense of the current revenue in that business and maybe the current gross margin run rate, understanding they're probably not profitable yet, just so we can understand the drag that it might have had on gross margins in 2016 and Q1 and going forward in the next couple of quarters?

Yes. I mean, the drag in the past was more than it is today. I mean, we're not splitting out the detailed financials, Lee, but it was a much larger business a few years ago. And at that time, it had a much bigger drag on our financial results than what it has today. And what you see right now, there are 2 effects. One is the business is much smaller and it turns back to growth. So it's now accretive to our business, yet it's less material, right? So that's the key thing, yet we're, of course, very pleased with the fact that we finally see that business turning around and based on the pretty heavy investments that we've made. So we're pleased with that, and that's why we made the remarks we made.

Got you. So assuming it's gross margin positive today, over time, is this the type of business that should achieve corporate average margins, less than corporate average margins, more?

Yes. We think if corporate average EBITDA -- EBITDA or gross margin? I mean, gross margin should be, yes, should be similar. I think EBITDA margin is -- probably will be lower than the 20%, right, going forward. But nevertheless, that's much improved from a loss-making situation last year and the year before.

Your next question comes from the line of Jared Berlin of Thames Capital Markets.

It seems like the recent acquisitions are off to a great start. And I -- looking at the balance sheet, clearly, there's additional capacity. And I just wonder how you balance, making sure these acquisitions continue to execute well or fully integrated versus executing on incremental acquisitions over the coming quarters and years.

Yes. So first of all, on the integration of acquisitions, both these acquisitions fit very well in our existing businesses. And ThingMagic was fully integrated in our JADAK business literally within a week. They're physically relocated to our Bedford facility, and the teams are working really well. So it's a fairly small business and a small team but with very high caliber people, so retention was key. And yes, we're proud to say that, that is off to a great start. And yes, the joint businesses are growing very rapidly, so people are excited to work together. So that one was, I would say, a classic tuck-in acquisition with fairly straightforward integration. Laser Quantum continues to be run by their founders. As mentioned earlier on the call, they still have 25% stake or 24% in the company. And yes, they report into the Photonics segment, and transition has been very smooth. And the opportunity there is really about leveraging the Novanta sales channel for their products. And yes, I'm pleased to say that, that collaboration is going really well, and particularly, our Cambridge Technology business has a vast set of customers that are very interesting for the Laser Quantum business. So as far as kind of integration for those -- both businesses, we're very pleased, and it's almost a nonevent. It's -- people are focused on the business and are doing well. In terms of, let's say, acquisitions on the horizon, yes, we made a remark that we are -- continue to be very active. As you say, we have some further capacity. Having said that, we're disciplined as we always have, and so we're picky. And the companies that fit us well are leaders in their respective markets. They have a sustainable competitive advantage. They showed consistent financial performance, typically asset-light in terms of operating structure and with strong management teams that are focused on long-term growth. So there's a set of pretty stringent criteria that we adhere to and we've adhered to. Yet with those criteria, we do see a very active pipeline, and you expect us to be active in the remainder of the year.

There are no other questions at this time. I will turn the call back over to the presenter.

Thank you, operator. So to summarize, it's a great time to be part of Novanta. We're off to a very strong start to the year. Our focus on accelerating profitable growth was evident in our strong financial results. The diversity and strength of our businesses have served us well, and I'm proud of the execution by our team. We also believe that our strategic direction with an increasing exposure for medical markets positions us well for sustainable and profitable growth.

As discussed before, we are now entering the growth phase in our transformation journey, focused on multiple growth drivers. We have leading positions in growth markets. We're expanding our served markets through innovation and disciplined M&A, with focus on expanding our medical presence. We're achieving deeper market penetration globally with a stronger and larger sales force, all of this while maintaining our commitment to disciplined execution and our continuous improvement business system.

In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support. We appreciate your interest in the company and your participation in today's call. I look forward to joining all of you in several months on our second quarter earnings call. Thank you very much. This call is now adjourned.

This concludes today's conference call. You may now disconnect.