Good morning. My name is Gary, and I will be your conference operator today. At this time, I would like to welcome everyone to Novanta Incorporated's Third Quarter 2024 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 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 third quarter 2024 earnings conference call. This is Ray Nash, Corporate Finance Leader for 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 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 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 any of these forward-looking statements as representing our views as of any time after the 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..

one, launching and ramping a record set of new products; two, expanding margins and cash flows through the Novanta Growth System; and three, acquiring additional companies that align with our strategy and offer attractive returns. Now 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. Our third quarter 2024 non-GAAP adjusted gross profit was $113 million or a 46% adjusted gross margin compared to $105 million or 47% adjusted gross margin. Adjusted gross margins were down year-over-year.

However, excluding the impact of Motion Solutions acquisition, our adjusted gross margins were up roughly 70 basis points. Our gross margin performance was lower than as expected as a result of unplanned decline in sales volume in our precision medicine and manufacturing segment. This brought down overall company margins versus expectations.

Despite the decline in sales volume in this segment, we have chosen to maintain our current level of factory capacity and costs in anticipation of sales rebounding in 2025. Therefore, we expect this unfavorable margin impact to continue into the fourth quarter, but ultimately, we rebounded as sales volumes improve next year.

For the third quarter, R&D expenses were roughly $23 million or approximately 10% of sales, and third quarter SG&A expenses were approximately $44 million or 8% of sales. SG&A expenses were sequentially lower in the quarter due to adjustments in this compensation based on the revised full year outlook.

Adjusted EBITDA was approximately $57 million in the third quarter of 2024, a 23% adjusted EBITDA margin versus $52 million in the prior year. On the tax front, our non-GAAP tax rate in the third quarter was 21%. Our tax rate for the full year now appears likely to end at around 19%.

Our non-GAAP adjusted earnings per share was $0.85 in the third quarter, flat versus the prior year. Our EPS growth remains muted due to the higher interest rate on higher debt balance. Third quarter operating cash flow was approximately $23 million.

Our cash flow performance for the quarter was impacted by the timing of monthly revenue shipments, with more products getting shipped in the last month versus normal, resulting in a higher-than-normal increase in accounts receivable. This is a temporary timing impact that is expected to correct in the fourth quarter.

Year-to-date, we are still seeing very strong cash flow performance, with operating cash up 20%, and we expect to finish the year with very strong cash flows. We ended the third quarter with a gross debt balance of $460 million and a gross leverage ratio of approximately 2.3x. Our net debt was $368 million.

We remain on track to reducing gross leverage to 2 or below, and net closer to 1.5% by year-end. For the third quarter, Novanta's book-to-bill was 0.89.

Weakness caused by customers deferring purchases in life science and advanced industrial applications was partially offset by booking strength in our minimally invasive surgery business line, which had a book-to-bill of nearly 1.4 in the quarter as our OEM customers have started to place larger orders for their product launches in 2025.

Turning to the operating segments. Precision Medicine and Manufacturing third quarter sales declined by 15%, which was weaker than our prior expectations due to the miss in the precision medicine markets.

The book-to-bill in this segment was 0.73, which reflects the revised outlook for our DNA sequencing applications as we see our customers pushing orders into 2025, affecting near-term bookings. Adjusted gross margins in this segment were down year-over-year driven by lower factory utilization, which I commented on.

Design wins in the segment were up 30% year-over-year, driven by good execution of our sales team to win new stock in upcoming customer platforms. New product revenue was approximately mid-teens percent of sales in line with expectations.

Our robotics and automation segment experienced a revenue increase of 20% year-over-year in the quarter, and bookings grew 25% year-over-year. Our outlook for second half of 2024 is playing out largely as expected, with end markets improving versus the first half of the year, both in the U.S. robotics market and the microelectronics applications.

The book-to-bill was 0.83, in line with expectations, and we expect sales to continue to gradually for improve into 2025. Adjusted gross margins increased 120 basis points year-over-year, driven by better factory efficiency on increased volumes.

New product revenue in this segment grew strong double digit and was roughly 12% of total sales for the segment. Design wins in this segment were up strong double digit in the quarter and year-to-date. Finally, medical solutions experienced reported revenue growth of 24% year-over-year and declined on an organic basis 1%.

This was slightly better than expected as strong sales from our new product launches almost fully offset the near-term impact of discontinuing our surgical display products. The segment saw a book-to-bill of 1.04, and bookings were up 50% year-over-year.

As I already mentioned, our minimally invasive surgery business line had a book-to-bill of nearly 1.4 as we started to see customers placing large orders for new product launches. This strong result was partly offset by continued market weakness in the Precision Medicine business line, we saw a book-to-bill below 1.

The weakness in Precision Medicine continues to come from weaker-than-anticipated capital environment in life sciences, multiomics and bioprocessing markets. Vitality Index in this segment increased to high teens percent of sales, which is in line with expectations as we start to ramp our new products.

Design wins in this segment are down year-over-year, driven by large wins in minimally invasive surgery business in the third quarter of 2023. But excluding those larger platform wins in the year, design win growth in this segment is a strong double digit year-to-date.

Adjusted gross margins in this segment increased roughly 60 basis points year-over-year. Excluding the Motion Solutions acquisition action, the margin expansion in this segment was over 450 basis points. Now turning to guidance.

With organic growth continues to sequentially improve, returning to low single digit in the fourth quarter, the stronger ramp in demand that we expected in the fourth quarter is being deferred into 2025. To get into a bit more detail.

First, in our DNA sequencing products, nearly all shipments originally expected to ship in the fourth quarter were rescheduled by our customers to the first half of 2025 due to customer specific challenges. However, we expect this issue to be resolved in early 2025 and resume shipments at a normal rate in the first quarter.

The long-term prospects of this application and our products continue to remain strong and even accelerating. Next, we expect the launch of a new product within DUV and EUV lithography applications.

However, while our new product is designed in now, unfortunately, due to end market conditions, our customer deferred the ramp into the second half of 2025.

Similar to my prior comment, the long-term prospects of this application and our position in it continue to remain strong and accelerating, as EUV lithography is in the early adoption and remains a critical enabler of GenAI, electrification and smaller, more powerful and efficient electronic devices.

Third, one of our customers launching a robotic system with a new integrated smoke evacuation insufflator rescheduled shipments into early 2025, after updating FDA filings to make enhancements to their overall system.

This product has broad market acceptance and is expected to see stronger-than-expected demand, which is expected to materialize in our results in 2025.

And finally, our customers and the overall life science and bioprocessing market broadly continue to see deferrals and capital spending by their customers, despite the uptick in consumables and service spending by their customers. Based on this activity, demand for capital equipment is clearly returning, but is most likely recovering in early 2025.

Unfortunately, this implies that the fourth quarter revenue will be weaker from this dynamic, compounded by customers' desires to manage their inventory balances down in the fourth quarter. The net impact of all these customer and market changes has led us to revise our sales outlook in the fourth quarter by approximately $25 million.

Despite this rescheduling of revenue into 2025, we do expect to demonstrate sequentially increasing organic growth in the fourth quarter versus the third quarter.

We continue to be optimistic about an improving environment in 2025 and are very confident that our new products will drive better-than-market growth with more attractive secular growing end markets.

Based on these dynamics as well as customer demand signals, second half 2025 revenue is clearly expected to be strong double-digit growth under a number of scenarios, which leads us to expect up to 10% organic growth for the full year of 2025.

For the fourth quarter of 2024, we expect GAAP revenue in the range of $237 million to $242 million, which represents reported revenue growth of 12% to 14%, and organic revenue growth between 2% and 4% on a year-over-year basis.

This revenue range is a bit wider than normal given the near-term macroeconomic and geopolitical uncertainty, and how that continues to impact the life science and industrial capital spending markets and our OEMs' customers' behavior, particularly as it comes to managing year-end inventory levels.

For the full year of 2024, we now expect GAAP revenue to be in the range of $948 million and $953 million. This represents reported revenue growth of approximately 8%. Revenue from current year acquisitions is expected to be slightly above $80 million.

On a segment level, in the fourth quarter, we expect precision medicine and manufacturing revenue to decline double-digit percent year-over-year, impacted by the pushout in demand in the DNA sequencing applications.

Our robotics and automation segment continues to expect to grow greater than 20% in the fourth quarter, as end markets continue to improve and also from easier year-over-year comparisons. This growth comes from an improvement in demand in robotic applications as well as an improvement in microelectric applications.

And our medical solutions segment is expected to show approximately 30% year-over-year reported revenue growth in the fourth quarter. On an organic basis, we expect mid-single-digit growth year-over-year. While this growth outlook is solid, it's less than we previously expected from the before-mentioned rescheduling of a surgical robotics customer.

Moving on to adjusted gross margin in the fourth quarter. We expect to be approximately 46%. This outlook includes the impact of lower factory utilization, and we maintain -- as we maintain the capacity of our factories to help us be ready for the growth that our customers are seeing in their end markets as the demand environment improves in 2025.

In the segments, we expect gross margins to be roughly flat compared to gross margins that we delivered in the third quarter. For the full year 2024, we now expect adjusted gross margins to be approximately 46%.

For the full year, excluding dilutive impact of the Motion Solutions acquisition, we expect to deliver approximately 100 basis points of margin expansion in our core business. We expect R&D and SG&A expenses in the fourth quarter to be approximately $70 million to $71 million.

This represents a sequential increase in the third quarter due to the timing of R&D project spend and also incentive compensation adjustments. For the full year, these expenses will be approximately $271 million to $272 million. Depreciation expense, which was roughly $4 million in the third quarter, will be similar in the fourth quarter.

And stock compensation expense, which was approximately $6 million in the third quarter, should be approximately $7 million in the fourth quarter. For adjusted EBITDA in the fourth quarter, we expect the range of $50 million to $52 million, which represented double digit growth year-over-year.

For the full year 2024, the adjusted EBITDA, we now expect to run $208 million to $210 million. Interest expense, which was $8 million in the third quarter, it is expected to be slightly above $7 million in the fourth quarter. We expect our non-GAAP tax rate to be around 20% in the fourth quarter and approximately 19% for the full year.

Adjusted earnings per share will be in the range of $0.70 to $0.74 in the fourth quarter and $3.02 and $3.06 for the full year. Finally, we expect cash flow to return to year-over-year growth in the fourth quarter, and we expect to demonstrate double-digit growth for cash flows for the full year 2024.

We continue to use Novanta Growth System to help improve our net working capital levels as evidenced the strong improvement in inventory levels in the third quarter. These efforts have allowed us to substantially pay down our debt balance so far this year.

As always, this guidance does not assume any significant changes to foreign exchange rates, nor does it include any anticipated acquisitions at this time. In summary, we remain optimistic about our long-term prospects, and we continue to work diligently to support our customers with their successful launch of multiple new product platforms.

The long-term secular growth outlook of our end markets remains intact, and we feel well positioned to grow and gain share as the market recovers in 2025.

The fundamentals of the business is strong, and we're impressed with the team's adoption of the Novanta Growth System operating model, which is the ability to consistently execute and deliver on our promises as evident in the strong results in the third quarter, which were delivered at the high end of the guidance despite our challenging marketplace.

In addition, we also continue to work to compound our cash flows through a combination of organic growth and deployment of capital towards acquisitions.

As Matthijs mentioned, our acquisition pipeline has more than doubled in revenue and number of potential targets, but we also remain disciplined on the cash-on-cash returns, which means being disciplined about pricing. We remain focused on controlling what we can control and executing with excellence, no matter the business environment.

This concludes the prepared remarks. We'll now open the call up for questions..

[Operator Instructions] The first question is from Lee Jagoda with CJS Securities. Please go ahead..

I guess just starting with the Q4 revenue guidance and that $25-or-so million delta relative to our expectations. Can you speak to how much of that delta is the macro and then how much of that delta is specific customer launches into 2025? And then I've got a follow-up..

Yes. So yes, as you can imagine, giving detailed specifics is a bit sensitive as it pertains specific customers. But if you read through the guidance per segment, you can actually calculate the impact. It's fair to say that it's a mix of customer-specific and market challenges.

Yes, for customer specific, it's really primarily DNA sequencing, DUV, EUV lithography, robotic surgery. And of these, DNA sequencing was the biggest single impact, which we expect to rebound in 2025. And the biggest end market is in life sciences tools. So hopefully, that's helpful..

Yes. And then, I guess the follow-up is, on last quarter's call, I think there was a lot of talk around sort of a 10%-ish growth rate for 2025. And sitting here today, we're talking about deferring an additional $25 million into 2025, yet the guidance is only up to 10% growth in 2025.

So, is there something else moving? Or are you just building in more conservatism for the macro? Or how should we think about this?.

Yes. So, nothing else is moving. We're not losing any market share anywhere. Those product launches are still scheduled to be launched in 2025, as we talked about. And as your -- the DNA sequence side will start to normalize into the first quarter already. We are being cautious.

Obviously, there's a very contentious election happening today, and there continues to be a lot of uncertainty around the geopolitical as well as macroeconomic environment. And our customers are kind of unwilling to have deeper discussions around that until this cycles through. So, we are planning on the fourth quarter being what it is.

But if the environment improves from a macro and geopolitical perspective, then our business should improve because we're not losing any market share, and we're effectively free-riding off of our customers' growth expectations..

Got it. Just one more for me, and I'll hop back in queue. It sounds like -- or some of your comments sort of pointed to a faster growth inflection in the back half of 2025 versus the front half as we look out to next year.

What's your visibility look like into your Q1 deliveries? And relative to your Q4 organic growth, how should we think about organic growth in Q1?.

Yes. So, I would just say organic growth should continue to sequentially improve and stay positive, right? So, we're not going to get into like the specific ramp at this time because we'll have detailed discussions with our customers in December after the election cycles and a couple of other situations kind of unfold.

But I would say that the reason why the back half is definitely stronger is, obviously, there's some easier comparisons, but then we have new product launches happening more in Mass. We talked a little bit about EUV, DUV being scheduled for the back half of the year. We're starting to get the purchase orders on that.

And so, we'll start to feel more and more confident about what that looks like. It is possible there is a bigger shift into the first half, but we don't want to get into that as we -- at this stage. We can have another discussion around that in January..

The next question is from Brian Drab with William Blair. Please go ahead..

Just a simple question first, and I might have missed the information that explained this. But -- so revenue is down in the guidance just slightly sequentially in the fourth quarter. And just I'm wondering, in addition to any impact from slight negative operating leverage, I guess, on that slight sequential decline.

Why would EPS be down more materially in the fourth quarter? What's happening there?.

Well, you got an increase in tax rate that we -- higher than we anticipated because of the jurisdictional mix. So effectively, you got more medical sales happening. They're happening out in our German operations at a higher tax rate. So that's one piece of it.

And then, you have a sequential uptick in your operating expenses as well that I kind of guided on. That is some expenses kind of ramping up for changes of compensation as well as project timing..

Okay. All right. And then, you mentioned EUV, DUV, I think I caught that you said our new product is designed in.

Can you just talk about -- can you talk about what type of technology you were supplying for that application and what the new product is? Is it in a different -- is it a different type of technology or just more of the same technology? Any comments?.

Yes. I mean, it's -- of course, we -- this is Matthijs, Brian. So, what we have commented on in the past is that we are supplying a new type of technology that we did not supply before. We owe -- so that's the incremental part that is deferred. And I think it's pretty widely reported kind of how that particular player is seeing the world lately.

And so, it's basically consistent with that view. Again, the customer is excited because we are seeing a particular problem that is very valuable to them. We're designed in, and this is really about launch timing and nothing else..

Okay. And then just one more for now, I guess.

On Motion Solutions, I think in the second quarter we talked about lowering the expectation for Motion Solutions revenue for the year by $10 million, right? And just wondering, has that -- did you comment today on whether that's changed with some of the softness that you're seeing in the fourth quarter related Motion Solutions? Or should we still think about that as down $10 million from -- just like it was last quarter?.

No, it's still the same. So, you're absolutely right. It's -- and I kind of got it to about $80 million is the expectation. So, it used to be $90 million, it went down to $80 million..

Okay..

But clearly impacted by the same market dynamics in life sciences tools, right?.

The next question is from Rob Mason with Baird. Please go ahead..

I don't want to belabor the point here, but just want to be clear. So, around the revenue that shifted out of the fourth quarter related to new product launches and into '25, we had been talking about $50 million of incremental revenue there, and still $50 million.

So, I guess just to confirm, was there anything that you're now assuming on the new product launch side that slips from '25 into '26?.

No, not from a new product at all. No, those things are -- so if you think about how we [indiscernible] them a little bit. So, the EUV, DUV, we talked about that launching slipping out of 2024 into 2025, it has gone into the back half of the year. We're designed in and we're starting to see the trajectory around that.

As it comes to the next-generation insufflator in the surgical, player that shifted into early 2025 as they finalized their 510(k) on their system, and then begin normalizing shipments again for us. And then lastly, there's the -- on the DNA sequencing side, we see orders coming back into the first quarter.

The ramp of that is a little less uncertain the timing, and so we've been more conservative there.

So, what I think what we have done is we've taken the life science industry and we've said, all right, in that area of the marketplace, until customers start giving us firm orders and commitments around that, we're going to anticipate that's a little bit later than we originally planned, but eventually is coming back.

And you can see that, as Matthijs talked about, the leading indicator is their consumable and service spend in their factories. So, our customers' customers are seeing significant upticks in their consumables and services, which is indicating the capacity is being utilized and their customers are starting to spend money.

And that generally you will have capital spending follow that in somewhere in the range of six to nine months. And so that's what we're carefully monitoring at this point..

Yes. And maybe another way said, Rob, so while, let's say, DUV, EUV has shifted into the second half, the overall number is staying the same because other parts are doing slightly better.

And we've also, I think, been very consistent that the start of that timing is tricky, right, and we actually never formally guided a 2024 number because of the dynamics that we're actually seeing -- today see playing out. So, the '25 is just a full year ramp, and that's why we maintain confident there.

So, nothing really has changed other than the Q4 timing of the start of that ramp..

I see. Okay. Just in the precision manufacturing and medicine segment, the -- I can understand where sales mix may have had an impact here. But the decremental gross margin, at least sequentially, was really high, like almost 100%.

So, I was just curious if there's anything else going on there? And is that gross margin recovery back to maybe where it was in the first half? Is that entirely dependent on DNA sequencing?.

So, it partially would be -- there's two factors, obviously, DNA sequencing coming down. And then the second is we do have a facility that is largely fixed cost. And so, when volume in that facility drops below a certain level, then yes, it does kind of bleed through dollar for dollar.

That facility manufactures optics for a lot of our products, and so it was below normal volumes in that quarter. If we were to take out the costs associated with that, we have effectively impaired our ability to ramp the business in early 2025. We would have to push out that even further.

And so, what we decided to do is leave that cost structure in place, knowing demand is coming back in. And so that results in a higher decremental than we anticipated because we weren't anticipating the drop-off in volumes in that factory supplying optics, for both our DNA sequencing products as well as some industrial products..

Makes sense. Okay. Just last question. Just Matthijs, I mean, you talked about bottoming in the industrial area as well as microelectronics. It sounds like orders maybe support the microelectronics commentary.

Just why are you thinking we're at a bottom on the advanced industrial side?.

Well, I mean, you look at multiple indicators, right? It's a combination of customer conversation as well as the kind of short-cycle business, right, returning. So, within our industrial, we actually have one other short-cycle business that has started to turn.

So that is kind of a leading indicator for us, right? So typically, microectronics is the first to go down, followed by the short-cycle industrial business, followed by the longer-cycle industrial business. And so, the return is the, of course, the inverse of that. So, we see microelectronics turn, the short-cycle version of it.

We see the short-cycle version of the industrial starting to turn.

But it's too early to say, of course, what the exact timing of the longer cycle return is, but it gives us optimism that we're seeing the first signs of that bottoming out, right? Otherwise, the short-cycle businesses would have stayed stable or further declined, and that's not happening..

The next question is a follow-up from Brian Drab with William Blair. Please go ahead..

Well, I guess I think my question was just answered. Yes, I think my question was just answered. My question was maybe slightly different.

Just as you're looking at that guidance for '25 and the revenue expectation, are you saying up to 10% organic revenue growth, I'm wondering, what is embedded in terms of your expectation for the industrial backdrop? Obviously, like 22 months or something ISM below 50.

Just wondering, is there an expectation for improved industrial environment globally there or more of the same?.

We do have a little bit more subdued there. So, what we do have is, as Matthijs just talked about is the short-cycle business is starting to see the uptick in bookings and is starting to see the uptick in growth. So, we presume that, that kind of carries forward. The longer cycle, we presume is more of a subdued environment.

And so, to the degree that, that recovers faster, it would have a more favorable impact on our outlook. But it's, again, why today? It's a very unusual day to be reporting earnings. There's a lot of things obviously going on. And so, we're trying to be a little cautious at this stage.

Do we clear the year? And I think our customers are demonstrating the same behavior. A lot of them are trying to manage inventory down and not overextend themselves in the fourth quarter and get better positioned for a more positive 2025..

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

Thank you, operator. So, to recap, Novanta had strong operating performance in the third quarter. We achieved the high end of our guidance for sales and profit, and we made good progress on our top priorities.

Despite near-term macroeconomic dynamics, Novanta remains well positioned in the medical and advanced industrial markets, with diversified exposure to long-term secular macro trends in robotics and automation, precision medicine, minimally invasive surgery and Industry 4.0.

Looking ahead, while the macroeconomic and geopolitical climate are weighing on capital equipment purchases in 2024, we believe we are in a strong position to deliver on our recovering in the uncertain climate in industrial electronics, life science and multiomics markets.

We continue to see accelerating momentum for Novanta on the back of our new product launches as we work through the fourth quarter and into 2025. We will continue to focus on additional design wins in high-growth applications as well as doubling down on the Novanta Growth System to continue to drive strong cash flows and gross margin expansion.

In closing, as always, I'd 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 diligently every day, taking on new challenges, and striving to make the Company a great place to work.

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 2024 earnings call. Thank you very much. This call is now adjourned..

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