Novanta Inc. (NOVT) Earnings Call Transcript & Summary

Good morning, and welcome to the Novanta Inc. conference call. [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 conference call. I'm Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is Robert Buckley, Chief Financial Officer; and Matthijs Glastra, Chairman and Chief Executive Officer. Earlier this morning, we issued a press release announcing that we have reached an agreement to acquire privately held ATI Industrial Automation. The press release also includes replay information for today's call. In addition, we have prepared slides to accompany today's call, which are available on the Investor Relations section of our website at www.novanta.com. Before we begin, we need to remind everyone of the safe harbor for forward-looking statements that we've outlined in our 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 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 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 will be referring to certain non-GAAP financial measures. The reasons why we use these measures and a reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our first quarter 2021 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 first quarter 2021 earnings press release, we will provide reconciliations promptly on the Investor Relations section of our website. As always, we will leave ample time for your questions at the end. So with that, I am now pleased to introduce the Chief Executive Officer and Chairman of Novanta, Matthijs Glastra.

Thank you, Ray, and good morning, everybody. Welcome to our call, and thanks for joining us on such short notice. Today, we announced an exciting milestone for Novanta, the acquisition of ATI. And I'm joining this call from the ATI location in North Carolina today. And this acquisition significantly advances our long-term strategy by expanding our presence in high-growth applications and adding a market-leading business, which sells products for industrial, collaborative and medical robotics applications. In today's call, we will be referring to the announcement presentation, which you can find in the Investor Relations section of our website. So let's start with Slide 3. ATI Industrial Automation, or ATI in short, is a leading supplier of intelligent end-of-arm technology solutions to original equipment manufacturers in the robotics space. As a leader in the robotics space, they have more than $70 million in revenue in a high single-digit growth industry. Their focus on robotic applications has positioned them to win in a marketplace with strong long-term secular tailwinds, driven by continued penetration of automation and robotics in both advanced industrial and medical markets. ATI was founded in 1989, has grown to over 350 employees, including over 100 engineers and has a long-tenured technical workforce with deep expertise and know-how in the robotics space well recognized in the industry. Turning to Slide 4. ATI develops, manufactures and sells robotic changing systems, force/torque sensors and collision sensors for industrial, collaborative and medical robotic applications. These products enable OEMs and end users to increase safety, versatility and productivity of the robotic systems. A robotic changing system is a high-technology device that automates a task to switch tooling during the middle of a process. That process could be a sophisticated manufacturing process, a [ lab-based ] process or even a medical robotic-based process. These changing systems allows for increased reliability, more versatility, higher throughput and higher productivity of the robotic system. A force/torque sensor is a mission-critical sensor-based technology essential for high-precision robotics application. It uses extremely sensitive sensors to provide 6 dimensional feedback for linear and rotary forces creating haptic feedback for a robot system. Haptics is expected to be the leading solution for providing close to real-life tactile feedback and sensing through robots or their operators like surgeons. Approximately 90% of ATI's revenue comes from these robotic changing systems and force/torque sensors. The rest of the business consists of other end-of-arm products, such as collision sensors and other end-of-factor solutions. Turning to Slide #5. ATI really is a fantastic business and a strong fit with Novanta. They offer a proprietary intellectual property in attractive and growing robotic applications, giving Novanta a significant foothold in mission-critical robotic applications and allowing us to expand content with our customers while also serving new customers and applications. We are particularly excited by deepening presence for Novanta in electric vehicle production, where Novanta has an emerging position in laser beam steering for electric vehicle battery processing, the broader industrial robotics market in general as well as medical and collaborative robotic applications. Including ATI, Novanta will now have a nearly $250 million revenue precision motion platform, offering some of the most sophisticated technology solutions around the precision motion and robotics space. ATI offers Novanta unique capabilities and strong IP, including a staff of roughly 100 seasoned engineers and approximately 60 patents as well as a strong manufacturing center at their North Carolina location where I'm at today. We believe that these capabilities, combined with Novanta's capabilities, position us well in one of the strongest secular growth applications over the next decade. On to Slide 6. We increasingly see the need for robotics to perform complex tasks and to more effectively interact with their environments, including intelligent capabilities to see, feel, touch, grip and move in an increasingly sophisticated fashion. ATI and Novanta are bringing together a unique set of converging technologies in the robotics space to enable this. We believe that the combination of Novanta's vision technologies, alongside with a unique set of sensor and motion control-based technologies tailored to robotic applications, positions us strongly to offer our customers custom and distinct solutions to their most difficult and demanding robotic applications. We feel these core competencies will make as a preferred partner across advanced industrial and medical robotic markets. If you now please to Slide #7. Novanta today has one of the leading positions in precision motion solutions for the medical robotic space. We solve our customers' problems through proprietary sensor, motor and motion control technologies by offering our customers customized solutions to help them differentiate and solve some of the world's most complex challenges for robotic applications. With the acquisition of ATI, we can now add to our toolbox of solutions new technologies that increase the safety of these systems, their productivity and throughput while also helping to increase their flexibility. In addition, as I discussed previously, we believe haptics are a critical need in surgical robotics as well. And with the ATI acquisition, we can provide solutions for improved haptics experience of surgeons. Therefore, we believe bringing our deep application knowledge to ATI's leading technology offers us the opportunity to develop something truly unique for our customers and medical surgeons. As we turn to Slide #8, one area where Novanta has not had as much presence due to technology and channel has been in industrial collaborative robotics. This marketplace has seen significant secular growth prior to the pandemic and further strengthened by and after the pandemic. Clearly, robotics is a key enabler of the Factory 4.0 strategic road map, particularly around improving safety, quality and productivity through automation. ATI offers differentiated, highly engineered and intelligent technology solutions in this space with a strong brand recognition. By integrating Novanta's leading precision motion and vision-based technologies, we believe we can offer new solutions to customers in a growing market as well as leverage each other's channels. If you now please turn to Slide #9. ATI brings to Novanta a strong culture around continuous improvement in a production environment that is very common to our own manufacturing processes and competencies. We're thrilled to combine their foundational strength to the Novanta Growth System tools and disciplines to drive the same level of margin expansion and return on invested capital growth that overall Novanta has experienced and is expected to continue to deliver. In addition, we feel confident that by blending ATI's engineering collaboration culture into our own, this will further our innovation pipeline and allow us to develop deeper relationship with customers and growing applications. We strongly believe the combination of competencies and cultures will create better opportunities for our customers, our employees and our investors. We're extremely excited and thrilled for ATI's employees to join the Novanta family, and we look forward to collaborating together to help bring world-class solutions to our OEM customers. I will now turn the call over to Robert to provide a few details on the financial aspects of this acquisition. Robert?

Thank you, Matthijs. If you please turn to Slide 10. We have agreed to acquire ATI for $172 million upfront. This represents a multiple of 2.5x their pro forma annual sales, which we expect to be more than $70 million for the full year of 2021. ATI's actual revenue contribution to Novanta's 2021 financial results will depend on the ultimate date of the closing of the transaction. In addition to this upfront purchase price, the transaction includes additional contingent cash payments structured as an earn-out based on the 2021 EBITDA performance. If the 2021 EBITDA performance is achieved, we would expect the overall consideration pay to equate to an EBITDA multiple in the mid-teens. Also, we will be granting performance stock units, or PSUs, as an additional way to incentivize the broader ATI team to continue to deliver strong financial performance while creating an ongoing ownership mindset that has served us well at Novanta over the past few years. This transaction is financially accretive to us and represents a very attractive cash return profile. We are financing this transaction using cash on hand and our revolving credit facility. After completing this transaction, we expect our gross debt leverage ratio to be between 2.7x and 2.9x at year-end 2021, depending on the earn-out achievement. This estimate assumes no incremental paydown of our current debt balance. We expect to close the transaction sometime in the third quarter of this year. Following the close of the transaction, we will be in a position to update our financial guidance for the full year of 2021. Finally, ATI will be reported as part of our precision motion segment after close. With that, I'll turn the call back to Matthijs.

Thanks, Robert. So to wrap up, we're very excited about the ATI acquisition, and it's a strong fit to our strategy. The signing of this agreement to acquire ATI signifies an important milestone in our strategic vision for Novanta. We're excited to expand our content in attractive robotics applications, with intelligent technologies that give Novanta the ability to play at the convergence of multiple robotic applications. The ATI team is extremely talented and shares the passion for innovation and deep application knowledge and customer success. Novanta continues to invest in innovation and commercial capabilities to accelerate organic growth, combined with disciplined M&A. We're well positioned in medical and advanced industrial sectors with diversified exposure to long-term secular macro growth trends in robotics and automation, precision medicine, minimally invasive surgery and Industry 4.0. The ATI acquisition fits in extremely well with this overall market strategy, and so we could not be more pleased. Thank you very much. We would like now to open it up for questions.

[Operator Instructions] Our first question comes from Lee Jagoda of CJS Securities.

Congratulations. I guess, first, can you talk about how the transaction came about? Was it an auction? Was it a process? And how did we get to this point?

Yes, why don't I take that. So it was a proprietary basis type of transaction that we pursued in 2020. However, there's an ESOP ownership, which is really an employee stock ownership plan that has a significant percent of the overall company. And so at some point, during the transaction discussions, that required a market check for them to validate the valuation that we were offering. That had an element of competitiveness to it. But ultimately, I think our approach, the culture, our overall business model and the speed in which we were able to operate really allowed us to stay as the preferred owner of this business.

Got it. And then maybe on the customer side, can you talk about any customer overlap with ATI, if any and then how you view this as an opportunity to integrate your products with theirs to create intelligent subsystems and drive growth and margin expansion? And I guess the next part of that is in terms of the earn-out, how much of it is reliant on some of that synergistic selling versus just straight selling their products to their customer base?

Yes, Lee. I will take the first part of the question, and Robert will take the second part. So on the customer side, yes, pretty obviously, robotic surgery is a very important synergistic -- customer synergy that I think we can help each other, leading technologies from ATI and the Novanta. The strength of both the relationship and technology and application in robotic surgery, I think that's an obvious one. But also, I would say, in the industrial automation sense and electric vehicles. For example, Novanta is -- it has an emerging position and actually leading position in electric vehicle battery welding and processing through its leading beam steering technology group. And ATI is the leader in tool changers and robotic changing systems and force/torque sensors for electric vehicle production, including battery handling. So there is an obvious channel and customer solutions play there. We further see the need to integrate sensors into our mutual solutions. And so that intelligence piece, we definitely see both from the Novanta side to ATI and verse versa. So we talked about that convergence play. And I think in general, ATI's brand recognition in industrial robotics is really, really strong. So we actually expect some pull-through of Novanta technologies through those channels over time as well. So there are quite a lot to work with. And then Robert will answer the second part of the question.

Yes. So in regards to the earn-out, the earn-out is based on the 2021 EBITDA numbers. So frankly, anything that we do related to the sales synergies or channel or commercial engine synergies is not going to be an impact on 2021. What we can have an impact on 2021 is around mitigating their supply chain disruptions that they are experiencing, just like we are experiencing; helping onboard and hire at the rate they need in order to scale to the production requirements that they have; and offering some additional leverage opportunities. But overall, I would say that the earn-out is really based on the 2021 performance as you're seeing a fairly sizable uptick in opportunities and growth this year.

Got it. So I'll just ask one more and then hop back in. I guess -- so with the 2 transactions you've now completed in the last -- or announced in the last 2 weeks, they're both sort of targeting higher-growth end markets. If I look at these and look at the revenue you're adding from them, how does that ultimately change, if at all, the sort of the long-term 5% to 7% organic growth expectations you've had for the full company? It would seem it would increase them, but I'll kind of leave it to you to give us some color.

Yes. Listen, I think we're trying to do 2 things. We're obviously trying to bias our growth profile to that kind of high single-digit profile. But the second is we're trying to grapple on to additional secular growth opportunities to add that more predictability and sustainability around our revenue streams. We are always managing the portfolio of end markets and applications in which we serve as portfolio managers. And so trying to balance out ups and downs associated with customer cycles or overall industrial cycles, and therefore, I think a business like this just adds to that portfolio mix that we have and with a little bit more of an emphasis on driving a higher single-digit type of growth environment.

Yes. And I would add, Lee, is that, obviously, the need to automate and increase penetration of robotics is an obvious to win in this business. This business has historically grown prior to the pandemic and prior to the 2019 downturn with high single-digit growth. So with the secular tailwind that is happening around automation, around electric vehicle production penetration and around also robotic surgery, yes, we see no reason why this can't continue. So yes, that's why we're buying the business, and we feel that we can also help this business continue to grow sustainably. So yes, a lot to like here.

The next question comes from Rob Mason of Baird.

Congratulations. I wanted to see, if you could provide a little more color on their customer mix and end market mix. In particular, I noticed you mentioned some end user exposure. What percent of their business is OE versus the end user -- selling to the end user direct?

Yes. We've not given exact split. But Rob, the -- basically the way ATI works is, of course, they're a little closer to the end user than maybe the typical Novanta business. So they will partner with the OEMs, which basically the robotic manufacturers in the world, whether it's collaborative, whether it's warehousing, whether it's industrial automation in general or medical. In the case of the medical side, it's 100% OEM-focused. In case of the industrial automation side, it depends on the application. But typically, they work both with the end user because you basically can see it, it's a necessary, call it, accessory or element that is part of the robot that's not made by the robotic OEM. Yes. So they both need to work with the OEM to basically get endorsed and qualify as part of the OEM ecosystem as well as work with specific end users. And end users in this case could be automotive manufacturers or it could be electronics manufacturers or any larger automation-related factory that requires their technology. So it's a combination of both. There's push and pull. And this is what we like because we can get also more application-specific know-how, particularly around electric vehicle battery processing and/or handling that we can, of course, leverage with other technologies. So it's a combination.

I see. I see. Is -- can you give us maybe a rough split of what part of their business is medical versus industrial?

Yes. We have not split that out. I would say the majority of their revenue is currently industrial. The medical business is on the smaller side but rapidly growing. And with the further penetration of medical robotics, we expect the percentage to further improve over time. So that's what I would say. But I would also say that the industrial side has grown very rapidly. And of course, with tailwind of electric vehicles and collaborative robots and warehouse automation, of course, that's a very interesting area as well in the next decade.

Rob, this is Robert. Let me just kind of like -- it's roughly 10-plus percent. It's not -- it wasn't the kind of the easiest number to get to. And it's predominantly the force/torque sensor-based technologies in which the exposure is. It is the -- when you take a look at the product line basis, that is going to be the highest growth product line in the portfolio. And so it's going to quickly ramp up from a medical exposure perspective.

I see. Okay. And there is, I guess, within the deal structure, the issuance of some performance shares, will those -- is that contingent on just '21 performance? Or how does that factor in? I don't know if you can quantify the potential amount there.

Yes. So that's actually going to be paid out over a 3- to 4-year period depending upon the employee population. It is performance-based. It is definitely, therefore, contingent upon achieving certain milestones. None of it pays out in the first 3 years. So it's more like a year 3, year 4 type of event. Not that dissimilar from equity that we grant, frankly, a lot of the executives in the organization, so it doesn't have a short vesting cycle. I can give you more specific numbers around that in the second quarter earnings call on August 10. I think it'd be a little bit more appropriate at that time. But it's definitely meant to be a long-term incentive. Many of the shareholders of Novanta are employees now. And so we're trying to drive a similar mindset within the ATI business.

[Operator Instructions] And our next question is a follow-up from Lee Jagoda of CJS Securities.

Phone's on mute, operator. He's not coming through appropriately.

That's me. I'm sorry. My fault. The -- I guess, a couple more. One is on the tax side, when you're adding in this and Schneider, I guess, both predominantly U.S. assets, how should we think about what it could do to your non-GAAP tax rate? And how are you guys looking at that?

Well, the highest tax jurisdictions that we have in the company today are Germany and Japan. So we actually pay a fairly lower tax rate in the United States. I think in the short term, it probably doesn't have a meaningful impact on us. It will probably drive a little bit more of a bias, obviously, towards the U.S. rate, and therefore, keep the rate closer to where it's been trending now. Long term, that remains a bigger question. There's no certain future around what the U.S. tax rate structure is going to look like. But I would just say, generally speaking, our structure allows us to optimize and always keep a lower rate than what the U.S. statutory reported rate is.

Got it. And then I know you mentioned 2.7, 2.9x gross leverage, but you're also going to be using some of your cash on hand versus financing all of it. So is there a way to look at this on a net basis or some assumption around how much revolver versus how much cash you use?

Yes. It's -- the reason we were a little cagey about net versus growth was around just how we wanted to position cash around U.S. and Europe. I would say -- and then how much debt paydown we want to do between now and the year-end as well as also just being careful. We haven't reported our earnings for the second quarter yet. So we didn't want to kind of get too specific there. I can provide an update. Obviously, net ratio -- net leverage ratio is going to be lower than the gross. But I can provide an update on that in the second quarter earnings call. I think it's more appropriate then because we'll give you an update on the full year guide as well.

Sure. And then just one last one, and I'll let you go. So 2 deals in 2 weeks, which is awesome. Can we talk about sort of what the pipeline looks like at this point and then expectations for additional transactions, call it, between now and year-end?

Yes. Well, Lee, it's -- you know us. I mean we're looking at M&A as the most important aspect of our capital allocation strategy. We're very active even after this transaction. We're also very, very disciplined. We're very picky. And we'll only press the button at the moment that it really adds to the strategy and it's financially attractive with the returns you've come to expect from us. So I would say the M&A market is very active. And with this, after this acquisition, we can still participate. And you will hear when we have come and selected a great other target. But yes, it's obviously -- it continues to be a focus for us.

The next question is a follow-up from Rob Mason of Baird.

Yes. Just I wanted to know if you could speak to how this fits -- this transaction fits within your ROIC time line around M&A, just in terms of expectations around getting to your target level?

Yes. So it's free cash flow accretive in the first full year. It returns its cost of capital in under 4 years. And I say, under 4 years because there's an earn-out payment here, and so that there's some variability around that. But it's -- in all scenarios, it's under 4 years. So from a financial return perspective and a cash return perspective, we're feeling pretty good about the transaction. It is -- it adds considerable scale through our precision motion segment, along with the Schneider transaction. And so it gives us a lot of presence to scale there that can be leveraged further on a go-forward basis. Now we didn't factor in any sort of significant events around it. We are taking into account supply chain synergies and manufacturing synergies as a result of applying the NGS process. But we do expect over the long run, we like their manufacturing presence in North Carolina. So we see an opportunity to lever that at some point. But overall, it's in line with where we're expecting from an ROIC perspective, if not a little bit better.

Okay. And just maybe last question. Is there a way to frame out what the addressable market opportunity you're adding with this transaction or maybe even combine it with the Schneider transaction from last week, what you think you're picking up in terms of incremental new market opportunity?

Yes. I mean I don't think we've specified it. But if I would got it back in here, I mean, it's $300 million to $500 million easily, so up to $500 million of accessible market that we're adding globally. And of course, we cannot go after that all at once. But it's an interesting space that we can further expand into.

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

Thank you, operator. So to summarize, the ATI acquisition is an excellent fit strategically for Novanta. It will create a nearly $250 million precision motion segment, with a significant presence in automation and robotics application areas which have a strong secular growth trends. We're excited to have the ATI's team's passion and expertise into Novanta. And in closing, I would like to thank our customers, our employees and our shareholders, as always, for their ongoing support. We appreciate your interest in the company, your participation in today's call. I look forward to joining all of you soon for our second quarter earnings call. And thank you very much. This call is now adjourned.

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