Novanta Inc.

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 may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of this time. We disclaim any obligation to update forward-looking statements in the future, even if our estimates change, so you should not rely on any of these forward-looking statements as representing our views as of any time after this call. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent 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, Matthias Glostrom.

Thank you, Ray. Good morning, everybody, and thanks for joining our call. Noventa started 2023 with a strong first quarter. In the quarter, we delivered $219 million in revenue, representing 7% year-over-year revenue growth on a reported basis and 8% growth on an organic basis. Our adjusted EBITDA was $47 million, and adjusted diluted earnings per share was 74 cents. These results are better than our expectations and guidance, and reflect excellent operating performance by our teams in an evolving macroeconomic environment. We feel the strong performance in the first quarter puts us on track to achieve our full-year outlook, and it will help drive a more balanced performance in the first half of the year. The Noventa business model with diversified exposure to high-growth medical and advanced industrial markets have 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, focused on where we play and how we win, drives our performance no matter the environment. Now let's turn to what we're seeing in our markets in our customer activity. We continue to see strong ongoing demand from our customers in many application areas. We made great progress, reducing our backlog to customers by more than 25% sequentially, while still maintaining a near-record backlog of $604 million, nearly flat with the prior quarter. Our book-to-bill in the first quarter was 0.96, in line with our expectations, and two of our three segments had book-to-bill greater than one times in the quarter. As we discussed in the last earnings poll, we continue to reduce our lead times for our products back to historical averages and customer expectations. And yet, we continue to see strong demands from customers represented by our strong backlogs, giving us further confidence in our outlook. In the first quarter, sales to medical markets were very robust, growing 22% versus the prior year, making up approximately 54% of total November sales. During the quarter, we saw very strong orders and shipments to many of our medical OEM customers with noteworthy strength in minimally invasive surgery equipment and consumables, in vitro diagnostics and patient monitoring equipment, DNA sequencing, and ophthalmology. These categories all saw strong double-digit growth in sales year-over-year. These applications are seeing structural growth based on underlying secular growth drivers, such as patient surgical procedure growth rates and advancements in biopharma technologies, including advancements in next-generation DNA sequencing technologies. As we discussed in the fourth quarter earnings call, we continue to expect to see these growth drivers for the remainder of 2023 and in 2024. Turning to the advanced industrial markets, our sales in the quarter, excluding microelectronics applications, were up 1% year-over-year and made up approximately 38% of total Noventa sales. The slower growth was in line with our expectations and is the result of a tighter industrial capital spending and macro environment, which you can see in macro indicators like the PMI indices. Yet, we continue to see resilient sales performance in many of our industrial and markets, including multiple automation and robotics applications, as well as precision manufacturing applications driven by continued underlying demand for factory automation, battery and electric vehicle production, Increased overall adoption of automation-enabling technologies offset by more GDP-sensitive applications, such as engraving and laser cutting. Overall, our industrial exposure is steadily geared towards the secular markets mentioned above. The dynamics in just our microelectronics markets, which represented less than 9% of sales, largely remained unchanged from our last call. We continue to see double-digit declines year over year from the cyclical downturn in these markets. Consistent with the last quarter, the largest decline manifested in our technology offerings for the PCBA vehicle drilling equipment market. The overall drop in the macroelectronics market remains a 200 to 300 basis point headwind on total Noventa sales growth for the full year. Yet, despite these macroelectronic headwinds, Noventa's diversified end-market exposure shows the strength of our strategies. enabling the business to grow strongly in the first quarter and still be on track to deliver a solid full-year outlook. From a regional perspective, in the first quarter, sales to North America grew 26% year-over-year and sales in Europe declined by 1%, which reflects the macroeconomic slowdown this region is working through and its connections with the China market. Sales in China, which represents about 8 percent of total sales, declined 34 percent year-over-year, which was predominantly caused by the decline in microelectronics revenue. Right now, our China exposure is heavily weighted towards these microelectronics applications, but with our ongoing design and activity and focus on high-growth end markets, we expect to better diversify and grow our presence in attractive end markets in the China marketplace in the coming years. Now, let me touch on some of Noventa's strategic growth metrics. For the first quarter, our vitality index was about mid-teens percentages of sales, which is down versus the prior year, but in line with our expectations. As a reminder, we track new products in the vitality index for the first four years after their production launch. Starting in 2023, several top products, such as our first-generation smoke evacuation products, reached this four-year cut-off milestone. And so we're no longer tracking them in the index, although they continue to contribute significantly to our overall sales growth. We expect our fatality index to stay at roughly this mid-teens level for most of 2023, representing a bit of a transition year on this metric. But we do expect this index to rebound in 2024 as we launch and ramp up multiple new product platforms. The investments we made in our plant and optics facility, our new Manchester optical subsystem manufacturing facility, and our new Czech Republic medical consumables manufacturing facility are all being done to support this future growth. As such, we also continue to invest heavily in R&D in order to solidify the on-time launch of these platforms. While we've seen some delays in new product launches as a consequence of shifting resources, to deal with the microelectronic part shortages over the last two years, we feel confident these milestones will be achieved. Moving on to designments, for the first quarter, we experienced a expected year-over-year decline, which is mainly timing-related. We had a tough year-over-year comparison from large designments achieved in the first quarter of 2022, mainly in our middle-middle-middle-invasive surgery business associated with our second-generation smoke evacuation insufflators. In this business, we want large new product platforms in 2021 and 2022 with both existing and new customers, which we expect will contribute significantly to our revenue growth in 2025 and beyond. Despite this tough comparison in the first quarter, from a percentage growth perspective, we feel good about the absolute wins in dollar terms, and we expect to return to growth and design wins year over year as the year progresses. Next, I'd like to give you a brief update on Noventa's acquisition integration activities. Our integration of MPH medical devices continues to progress well. The site is ramping up its capabilities to produce Noventa's own proprietary medical consumable products. We successfully implemented a new ERP at the site in the quarter and began ramping production activity support to support product qualifications with our customers. And finally, we're changing the names of our three reportable segments, photonics, vision, and precision motion. We're changing the names of these reportable segments to better reflect our strategic focus and focus on applications. These names also better align with our customers' focus and how our customers see these businesses. The photonic segment will change its name to precision medicine and manufacturing, which more closely fits with the segment's focus on laboratory analytical equipment and technologies, including advancements in next-generation DNA sequencing technologies and on precision manufacturing technologies, including sophisticated laser-based optical subsystems for 3D printing, EUV, micromachining, and e-mobility manufacturing. The Precision Motion segment will change its name to Robotics and Automation, which more closely fits with the segment's focus on industrial and medical robotics technologies, robotic end-of-arm technologies, and laboratory automation subsystems. And finally, the Vision segment will change its name to Medical Solutions, which better fits the segment's focus on medical components, subsystems, and systems, including smoke evacuation insufflators, endoscopic pumps, integrated operating room technologies, machine vision technologies, and advanced RFID detection technologies, all custom-made for the rigors of an FDA-registered medical environment. As a reminder, this segment does not represent all of Noventa's medical and market exposure. In summary, we had a very solid first quarter, with excellent sales growth driven by strong demand in medical and markets. We also delivered very healthy operating performance and profit growth, which is based on a great progress in deploying the Noventa growth system and continued success at further establishing a thriving company culture. We believe LaVenta's long-term strategic positioning continues to be extremely strong, and we're staying the course on executing our strategy and capital deployment model. With that, I will turn the call over to Robert to provide more details on our operations and financial performance.

Robert. Thank you, Matthias, and good morning, everyone. The first quarter non-GAAP adjusted gross profit was 101 million or 46% gross margin compared to 94 million or 46% gross margin in the first quarter of 2022. For the quarter, adjusted gross margins were up sequentially over 100 basis points in flat year-over-year. This outcome was better than our expectations and represents strong execution by our teams to achieve this result. This achievement puts us on a solid track to achieving a full year goal of expanding gross margins by 100 basis points. Moving on to operating expenses, R&D expenses were roughly $23 million or approximately 10% of sales. The first quarter SG&A expenses were $41 million or roughly 19% of sales. Overall operating expenses as a percent of sales were up sequentially in the quarter as a result of the impact of variable compensation programs and the seasonal payroll taxes as well as the increased R&D investments. Adjusted EBITDA was approximately $47 million in the first quarter of 2023 or 21% adjusted EBITDA margin versus $44 million in the prior year. On the tax front, our non-GAAP tax rate in the first quarter of 2023 was 12%. This differed from the statutory rate due to jurisdictional mix of income and the seasonal impact of equity compensation windfall benefits. Our non-GAAP adjusted earnings per share was $0.74 in the quarter compared to $0.73 in the first quarter of 2022. While adjusted EBITDA grew in the high single-digit range, EPS was muted due solely to higher interest expense. First quarter cash flow was approximately $7 million, which was up 28% versus the prior year. As previously mentioned and communicated, the first quarter typically has a lower cash flow due to the timing of incentive compensation payments, equity compensation vesting events, and the timing of seasonal tax payments. We expect cash flows to continue to improve during the rest of the year as we gradually bring down our inventory to more historical levels and continue to drive strong profitability. We ended the quarter with gross debt of $428 million, and our gross leverage ratio was 2.3 times. Our net debt was $345 million, putting the company in a great position to fund further acquisitions. Now turned an updated performance of our operating segments. As Matthias mentioned, we did change the names of our reporting segments in the quarter. We renamed photonic segment precision medicine and manufacturing. Our vision segment is now renamed to medical solutions. and our precision motion segment is now renamed to robotics and automation. I'll start by sharing details about precision medicine and manufacturing segment, formerly known as photonics. For the first quarter of 2023, revenue grew 11% year-over-year. This segment continues to experience very strong customer demand in the traditional medical applications and the planned uptick in next-generation DNA sequencing. The book to bill in this segment was 1.06 in the quarter. Again, driven by strong demand in our medical markets and resilient demand from multiple industrial applications focused on productivity enhancing equipment in the manufacturing floor. In the quarter, bookings in this segment were up 28 percent and roughly flat year over year. The strength in orders puts us in a strong position with good backlog coverage for the remainder of 2023. Within precision medicine and manufacturing, new product revenue stayed strong at greater than 20% of sales in the first quarter. Our sales teams continue to win excellent new business and attractive high-growth medical industrial applications, winning new content, winning new customers, and winning in new applications. Design wins in this segment were down year over year, but this was really driven by timing, particularly around the new wins in our intelligent light engine subsystem business, branded as Laser Quantum. For the full year, we expect solid design wind growth year over year. The precision medicine and manufacturing segment adjusted gross margin was 50% in the quarter, which was up nearly 400 basis points year over year. This is a great outcome and reflects the efforts and successes this team is having in deploying an advanced growth system deep into the organization and overcoming some of the operational supply chain challenges they experienced in the prior year. Turning to our medical solution segment, formerly known as vision, this segment saw reported revenue growth of 25% year-over-year, which was stronger than expectations. Growth in this segment continues to be driven by strength in elective surgical procedures and continued success in our first-generation smoke evacuation insufflator technology, as well as our JDAAC business strategy. where the business continues to catch up from past due backlog after supply chain challenges of 2022. The JNAC business is also seeing solid demand in new life science equipment applications. The medical solution segment saw a book to bill of 1.03 in the first quarter, with bookings up 7% sequentially and 12% year over year, further indicating the building demand we see in this end market. The vitality index in this segment reduced versus prior year. As Matthias mentioned, this is largely driven by first-generation smoke evacuation insufflator products reaching its four-year milestone. And so we are no longer tracking it as part of our official vitality index. As a result, this segment had a vitality index in the mid-teens in the first quarter, which is in line with our expectations. We expect this metric to stay at this level for 2023, but increase thereafter as we launch multiple new second-generation smoke evacuation insufflaters, which will start to have a significant impact on our sales in the coming years. Design wind activity in this segment also declined in the first quarter of the year solely from very difficult comparisons from the record-breaking design wind progress in 2022 from our second-generation smoke evacuation products. Finally, turning to robotics and automation segment, formerly known as precision motion, this segment experienced a revenue decline of 9% year-over-year in the quarter. This was in line with our expectations and prior guidance. This decline continues to be driven by steep year-over-year decline in microelectronics applications, particularly in the PCB-AV-A-Holt drilling applications, which declined nearly 70%. Excluding this decline, the remainder of the segment grew single digits in the quarter. This decline in PCBA drilling is causing a sales growth headwind for overall Novanta of approximately 200 to 300 basis points of the full year. The overall book-to-bill ratio in this segment was approximately 0.8, again driven by the microelectronics decline in exposure. Microelectronics experienced a negligible level of bookings in the quarter. New product revenue was roughly 10% of sales for this segment in the quarter. This ratio is lower than prior year because it now includes product sales from our ATI business lines, which had minimum new products in its revenue, and therefore is having a dampening effect on the overall segment ratio. However, as we mentioned in the fourth quarter, we are working hard at ramping the new product development in this business, and we expect to launch multiple new products in this business in the second half of this year. Adjusted gross margins for the segment came in at 47.5 percent, which was down year over year and down sequentially. This is again being driven by the sharp downturn in factory output caused by the decline in the microelectronics market. We expect margins to recover in this segment as the year progresses, both as we manage our cost structure and as other productivity gains gain further traction. Now turning to guidance. As Matthias mentioned, we expect to see order behavior from our customers returning to historical patterns as our product lead times drop. Our prior lead times have been as high as 12 months or more, and we are seeing them come down to a quarter of that level in many cases. which is closer to our historical lead times. We do not see this having any impact on our sales growth outlook for the quarter or for the full year. And the strength of our backlog is a reflection of our innovations in the applications in which we participate with strong demand signals still represented in the larger application areas. From an end market perspective, we see similar dynamics in the second quarter as we did in the first quarter. We expect demand in our medical end markets to remain very strong, and we see solid growth coming from our medical capital equipment and medical consumable sales. In our advanced industrial end market, we expect our traditional industrial end markets to stay resilient in the second quarter, but with the continued moderation that we saw in the first quarter, in line with the overall macroeconomic and industrial spending environment. We continue to expect our continued disciplined focus on secular growth applications and new product introductions to allow our business to experience growth and whether or more on certain macroeconomic environments. In our microelectronics end market, we expect continued double-digit declines in the PCBA via whole drilling applications year over year and also some declines in semiconductor wafer fab equipment. As mentioned before, this end application will continue to be a revenue headwind for Novanta in the second quarter in a similar magnitude as we experienced in the first quarter. So starting with revenue guidance, for the second quarter of 2023, we stand here today with GAAP revenue in the range of $222 million to $225 million, which represents revenue growth in the mid-single-digit territory on a year-of-year basis. To exclude the impact of the microelectronics headwinds, our revenue growth in the second quarter would be low double digits. On a segment level, in the second quarter, we expect precision medicine and manufacturing segment to grow revenue in the 6% to 8% range on a year-over-year basis. Customer demand remains resilient in this segment with continued growth in multiple medical and industrial applications, including DNA sequencing, ophthalmology, and micromachining. Our robotics and automation segment is expected to be flat sequentially and down approximately 10% year-over-year. The year-over-year decline is driven by the downturn in the microelectronics market. Excluding the microelectronics decline, this segment will be growing from demand in industrial robots, medical robots, electric vehicles, and battery production applications. Finally, our medical solutions segment is expected to demonstrate revenue growth in the 18% to 22% range in the second quarter and is expected to be up sequentially as well. Medical end markets continue to be very strong driven by return of elective surgical procedures globally. Moving on to overall Novanta's adjusted gross margin, we expect gross margin this second quarter to be approximately 46% to 46.5%, which is up sequentially and will continue to demonstrate good expansion year over year. The precision medicine and manufacturing segment gross margin is expected to be flat sequentially, whereas the robotics and automation segment is expected to be up sequentially. The medical solution segment is expected to see gross margins slightly down sequentially due to a higher mix of medical consumable sales. We believe our team's efforts to use an advanced growth system will help us sustain and expand gross margins as we progress deeper into the year. Turning to R&D and SG&A expenses, they are expected to be approximately $65 million to $66 million. The increase in cost year-over-year and sequentially is driven by labor cost increases tied to our annual cycle, further investments in innovation, particularly investments in our medical solution segment tied to the aforementioned development of our second-generation smoke evacuation insufflator products, and some further investments in our commercial engine. Depreciation expense, which was about $4 million in the first quarter, will be about the same in the second quarter. Stock compensation expense, which was over $6 million in the first quarter, would be roughly similar in the second quarter. For adjusted EBITDA for the second quarter of 2023, we expect the range of $47 million to $49 million. Interest expense, which was over $6 million in the first quarter, is expected to be about $7 million in the second quarter of 2023, driven by the continued rise in interest rates. We continue to focus on paying down the debt to mitigate the impact of rising rates. We expect our non-GAAP tax rate to be around 18% for the second quarter. The sequential rise in the tax rate from 12% to 18% is driven by our expectations around jurisdictional mix of income, as well as timing caused by our first quarter equity compensation windfall benefits. It should be noted that that the tax rates across a variety of geographical regions have increased, and hence we're working to minimize the impact of Novanta. But clearly, rates will be a little higher than 2022. Diluted wage average shares outstanding will be approximately 36 million shares. For adjusted diluted earnings per share, we expect a range of 70 cents to 74 cents in the second quarter. and we expect cash flows to improve sequentially due in part to the seasonal effects mentioned previously and from our continued efforts to bring down our inventory levels. We are also continuing to invest in manufacturing facility expansion projects, such as our new Taunton Optics Facility, our new Manchester Optical Subsystem Manufacturing Facility, and our new Czech Republic Medical Consumables Manufacturing Facility. These investments are all critical to support our growth outlook for the next several years. As always, this guidance does not assume any significant changes to foreign exchange rates. In summary, Novanta's performance in the first quarter of 2023 was excellent. We beat our own expectations and the guidance for sales growth, for margins, and for profit performance. We saw tremendous growth in our medical and markets, which more than offset a known headwind in microelectronics. This dynamic is yet another testament of the balance and resiliency of this business portfolio. Our teams continue to deliver great results helping the company work through a difficult operating environment while still winning new customer platforms and progressing our innovation pipeline. And we continue to see great success at attracting and retaining top talent. Despite a more uncertain macroeconomic environment, the higher interest rate environment, we believe we're on track to achieving our outlook for the full year of 2023. And we see our growth remaining strong well past this year, on the back of exciting new product launches starting later this year. We remain very grateful to the outstanding performance of our employees and their tireless efforts to help us be successful in this dynamic environment. We look forward to continuing to deliver on our commitments to our employees, our customers, and our shareholders.

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

We will now begin the question and answer session.

To ask a question, you may press star, then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. And our first question will come from Lee Jagoda of BJS Securities. Please go ahead.

Good morning, Lee. So just starting with the microelectronics business, can you talk about how much of the current run rate today is tied to EUV lithography and how we should think about the growth there? And then sort of secondarily, just Comment on the Westwind business and, you know, is this a similar situation to the situation we were in probably, you know, 10 years ago where the Westwind business went down close to zero just because capacity in the space wasn't getting utilized and as capacity gets utilized again, we should expect that business to come back at some point?

Yeah, I mean, on the last question, you're right. I mean, I think there is a tremendous capacity build as a result of the microelectronics boom. And so we'll have to work through that capital utilization, let's say trough for a little while. And that's why we don't expect that business to come back this year and the microelectronics to stay down for the year. On your first question, we basically in our last call, what we outlined was more of a forward look view that in, let's say, two years from now, we expect actually the makeup of microelectronics to fundamentally change more gear towards EUV rather than the exposure to the Westwind business.

Yes, I think we saw in the fourth quarter earnings call that we probably declined to somewhere around 7% of revenue. So overall microelectronics exposure to somewhere close to 8% to 7% of total revenue. And the majority of that would be in the EUV, DBUV application area. So as it gets to the end of the year, then we're actually in a territory where we have a secular growing piece of microelectronics.

Okay, that's helpful. And then just on the check facility, I think it sounds like you're making some good progress on the qualification of the new product. But just looking at that facility, I think when you bought it, there was some product lines in there that you were trying to get out of there and wind down. Can you give us an update on the progress there and whether that's been a margin headwind or tailwind as a result of the actions you've taken?

It's a great question.

The effort is to slowly wind that business down. It is a margin headwind. The margins are significantly lower than anything we sell in the company. I would equate it as overall cash neutral because there are some significant qualification costs and then cash outlays associated with bringing our own production up there. And so You know, we're attempting to time that so that if we ramp that business down, it's covering the cost of our qualification efforts. That will largely be behind us by the end of the first half. And in the second half, the qualification steps remaining for our production facility rely on the sterilization process and getting through the final stages there with an expected ramp of production start in the fourth quarter with real volume on a material level starting to come out next year. Now, we've implemented SAP in the site. We've actually started testing some production runs. We've done significant training. We've had equipment moved into the facility. And so overall, we feel we are well on track to ramping up production and medical consumables on our second-generation smoke evacuation products in 2024. And the impact that we're seeing or headwinds on the gross margins associated with the old MPH business will largely be gone by the end of the first half.

Got it. That's helpful.

I'll hop back in queue. Thanks. Thanks, Lee. The next question comes from Brian Drab of William Blair.

Please go ahead.

Hi. Thanks for taking my questions. First, on the new product launches, the way that you've been communicating some of the opportunities related to new product launches for 2025, $50 million in revenue opportunity. And I'm wondering if some of the launches that you're talking about coming later this year and in 2024 are opportunities you've had visibility to for some time now? Are there some new ones? And how do those fit into the context of this 2025 opportunity for $50 million annual revenue that you've been talking about?

Yeah, I mean, these comments are consistent with that level of 50 million in 2025. And, of course, we're ramping also other new product launches, but those are consistent with what we've been communicating and our overall growth algorithm, right? So we do feel the second half really starts to mark a momentum building up to the levels that you mentioned in 2025, and that's why we made those comments.

So one thing, Brian, I'd mention is, you know, when you think about why we guided a 2025 number instead of a 2024 number is that with a lot of these products launching at the end of this year, it means 2024 volumes are going to be harder to predict with a high degree of accuracy because there are different cycles of OEMs coming online at different times throughout the year. and different qualifications that they need to engage in with the hospital environment and the medical practitioners. And so as a consequence, we can get very accurate with 2025. In 2024, it would be a larger range and look funny. So we're being a little bit more cautious on 2024. But all those launches are consistent with that. And I would say that the continued investment in the manufacturing facilities in Manchester and Taunton and in the MPH business are signs of that confidence, that we wouldn't be outlaying as much of an investment in those facilities if we didn't believe the growth was on track and materializing in the pace in which we thought it would materialize.

Got it. Okay. So this is not a situation, though, where I guess at the extreme end of the spectrum would be like a bunch of new products platforms launching at the end of 24, contributing revenue of $50 million in 2025. It's ramping somewhat in 2024, hitting that run rate in 2025. Correct.

That's right.

That's correct.

That's right.

So it takes the risk out of the numbers a little bit, right, if you think about it from that perspective.

Yeah, okay. And roughly, I mean, can you talk a little bit more detail about how many opportunities you're talking about? I mean, is there one that accounts for more of that 50 than others and any granularity give us in terms of number of opportunities?

Yeah, I think we've been consistent in our earnings remarks on this, but let me kind of rephrase it and or summarize it. So in the minimally invasive surgery area, we've won basically many second generation insufflator businesses, both for endoscopy as well as for robotic surgery markets. And in addition, we've won endoscopic pump business, all with multiple OEMs. So that's where the majority of that $50 million is at. And then in addition, we see, based on the R&D investments that we've made in other areas, such as our laser beam steering business, for example, our formerly known precision motion business, robotic and automation segment, You see a ramp in new products happening as well in both robotics and automation as well as precision manufacturing. So electric vehicle, for example, micromachining, EUV, laser additive manufacturing, those are applications that we're primarily targeting with subsystems. And so you see that percentage of the business increasing as well with the launching of new products in those areas. So multiple applications we've talked about and where we're gearing our MPIs towards.

Okay, thanks. And then just lastly for now, how are you handling pricing lately in this environment? And can you talk at all about how much you expect price to contribute? to revenue growth maybe and or margin expansion 2023?

Yeah, I won't get into specifics. We've been very consistent with our customers on the narrative that, you know, effectively the increase in price is helping to offset the inflationary pressures that we're seeing. And it's the sharing arrangement that we have, right? So I think we've been, that's the message that we've signaled to our customers. That's the message we've been on externally. And I think that's reflective of the actual efforts that we've engaged in. Now, it's fair to say that there's a bifurcation happening in 2023 where the material costs or capital goods are actually seeing some ability to take costs down. Microelectronics may be a bit of an exception to that in certain areas. But yet then services and third party services and utilities and other types of ancillary services that we pay to support the manufacturing efforts are still in an inflationary environment. And so we expect inflation in 2023 to be a headwind. We expect price to be a lever to offset that, at least help offset that. And we feel like ultimately at the end of the day, Our goal is to expand gross margins 100 basis points. A lot of that will come through helping us launching some new products and driving Novanta's growth system into our facilities, and we feel good about that. We delivered a solid gross margin in the first quarter. We'll deliver a solid gross margin in the second quarter, and we'll continue that march throughout the course of the year to drive that 100 basis points.

Got it. Okay. Thank you very much. The next question comes from Rob Mason of Baird.

Please go ahead.

Yes, good morning. You had mentioned that you made some good progress reducing your past dues on the backlog. I'm just curious, what percent of your backlog now is in that past due category?

Yeah, I don't think we've disclosed that, but the fact that we've reduced pass-through backlog by 25% sequentially, we feel is very meaningful. And then maybe more importantly, the lead times to our customers have come down, I think Robert put this in his prepared remarks, from in some cases over a year to now less than 12 weeks or sometimes even less than six weeks. So you see a dramatic reduction in lead times as a result of really strong efforts from our operations teams. And so, yeah, we feel good about basically catching up on the demand that our customers are expecting us to deliver. So that's really, I think, the takeaway is that We're starting to catch up substantially. The lead times are coming down and to kind of pre-pandemic historical averages. Well, by the way, our backlog as a percentage of look forward revenue for the next, let's say, 12 months look forward is still at that record territory of mid to high 60s percentages versus historical levels of let's say, mid-30s percentages, right? So you still have that historically very high backlog, but, you know, past due coming down rapidly and lead times coming down rapidly.

Matthias, would you expect that backlog percentage eventually on next 12 months' revenue to work towards that historical level, or is there – Anything, you know, structurally different in the way that your customers are going to order or that you would view your backlog?

You know, it's a little hard to say, but we expect, yeah, I mean, this is the mid-60s is unusually high, right? So we expect that to come down. I mean, our customers, when we have lead times of six weeks, they really don't need to order for like a full year, right? Right. So that is what historically used to be the case. So we used to be a book-to-bill business of about one on average, and we expect that to come back to those levels on average over time. But before that happens, we first have to work that backlog down and ship to our customers. So I do expect it to come down to closer to historical levels, but maybe a little bit more elevated than in the past. It's hard to say, though.

Yeah, I think if you look back at the fourth quarter, I gave some, you know, rough guidance on that. You know, we'll never be back to where we were, where there's only a quarter's worth of backlog. But we won't be at these levels either. So I think, you know, it'll be down to past dues. We'll largely be behind us. Hopefully, if everything executes as planned by the end of the second quarter, then you're dealing with marginal levels at best of FASU. And therefore, really what you're looking at is that there's a significant amount of future demand that is still being placed on us and people getting ready for production ramps of new products. in 2024 and beyond. And so we will have an elevated level because of that. There's a lot of new products coming online. And so it will be above the historical levels, but below maybe a little bit of what caused the past due issue.

I see. And you made some commentary around some of your second-generation products coming out. Certainly, we would assume, I think you've secured some new customers, new OEMs there. but if you think about the growth there, is there also new, is that weighted more towards new customers or added content at a high level?

That's a great question. It's a combination. When we won We believe that our second-generation smoke evacuation insufflator technology will become a standard of care, which means that it will be standard in all minimum-based surgical procedures on a go-forward basis. It takes time to get there. real penetration in the global market for that. And so why we think, you know, we make the commentary around that, why we believe that is largely because we've won new customers, we've won new application areas, and we've obviously replaced older technologies that we've had in place. We've done a combination of things. The first generation smoke evacuation insufflator was relatively limited in launch. It went ahead with a single large customer, and I think on a go-forward basis, you'll see the breadth of that, of our new offering being sold to a multitude of customers, including some that we've never served before.

Just a last question. Around the microelectronics business, if I understand you correctly, it sounds like that business probably trends out, or you expect it to trend out kind of flattish, revenue-wise in dollars for the remainder of the year? Is that correct? Do you think it's stabilized?

Yeah, that's absolutely the math. So if you effectively just keep it flat, the percentages go down because you start to face the easier comparisons once you get to the back half of the year. But the revenue itself is relatively flat in our forecast for the full year right now. Now, that doesn't mean there's some underlying dynamics there. You've got EUV, deep EUV growing, and then you've got other areas that are still seeing some weakness and back-end semiconductor type of equipment. And so there's a dynamic there. But as you exit 2023, you're now predominantly in a growth category. And we expect that then to grow in 2024 as we penetrate with additional content and additional penetration into EUV applications. Got it.

Got it. Thank you. Thank you, Rob. Once again, if you would like to ask a question, please press star, then 1.

This will conclude our question and answer session. I would like to turn the conference back over to Mr. Matthias Glostra for any closing remarks.

Matthias Glostra Thank you, operator. So, to recap, Noventa had a very impressive first quarter 2023. We saw good sales growth despite the headwinds that we mentioned in microelectronics and beat our own expectations for margins and profit. We've maintained a very robust level of backlog while reducing our lead times and our path to backlog, and we continue to see strong tailwinds in our medical businesses. We're progressing our innovation pipeline, and we're excited for the large product launches happening later this year and next year. We feel we're on track with our full-year 2023 outlook. Noventa remains well-positioned in the medical and advanced industrial and markets, with diversified exposure to long-term secular microtrends in robotics and 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 Noventa growth system. In closing, as always, I would like to thank our customers and our employees and our shareholders for their ongoing support. I continue to be especially grateful for the dedicated efforts of all our Noventa 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 second quarter 2023 earnings call. Thank you very much.

This call is now adjourned.

Conference is now concluded. Thank you for attending today's presentation and you may now disconnect.