Novanta Inc. — Q2 2018 Form 10-Q
Business context and period. Novanta supplies precision photonics, vision and motion technologies to medical and advanced industrial OEMs. This unaudited quarter ended June 29, 2018; comparisons are with the quarter ended June 30, 2017. Dollar amounts below are U.S. dollars.
Financial performance
- Q2 revenue: $150.4 million, up 26.3%. Acquisitions contributed $21.8 million (18.3 percentage points) and foreign exchange added $2.1 million (1.8 points).
- Q2 profitability: Gross profit was $65.2 million; gross margin was 43.4%, down from 44.9%. Operating income was $17.1 million, up from $15.7 million, while operating margin declined to 11.4% from 13.2%. Net income attributable to Novanta was $11.0 million versus $9.4 million; diluted EPS was $0.32 versus $0.16.
- First half: Revenue was $297.4 million, up 30.4%; gross margin was 42.8% versus 43.7%; operating income was $34.3 million versus $26.1 million. Net income attributable to Novanta was $22.9 million versus $43.7 million, and diluted EPS was $0.50 versus $1.13. The prior-year period included a $26.4 million non-taxable gain on the Laser Quantum acquisition.
- Cash flow and liquidity: First-half operating cash flow was $40.4 million versus $29.5 million; investing cash outflow was $34.6 million, including Zettlex acquisition spending and capital expenditures of $7.3 million. Cash increased to $107.3 million from $100.1 million at year-end. Unused and available revolving-credit capacity was $168.6 million.
- Debt: Senior credit facility borrowings totaled $237.4 million at quarter-end, including $156.4 million drawn on the revolver. Cash less reported debt was approximately $130.2 million net cash. Debt matures in May 2021; the company reported compliance with covenants, with actual leverage of 1.99 against a 4.00 maximum and fixed-charge coverage of 5.02 against a 1.50 minimum.
Material changes and drivers
- Vision revenue rose 58.2% in Q2, principally from the WOM acquisition; Vision gross margin fell to 38.0% from 42.4%, and operating income declined to $0.4 million from $2.5 million. Management cited unfavorable mix, acquired-technology amortization and restructuring costs.
- Photonics revenue rose 10.7%; segment gross margin improved to 48.0% from 46.1%, with productivity and factory utilization cited as contributors.
- Precision Motion revenue rose 19.6%, including Zettlex contribution and stronger demand in certain products. Segment gross margin declined to 45.2% from 46.9%, with cost-of-poor-quality impacts noted.
- On May 1, Novanta acquired Zettlex for approximately $31.2 million, financed with cash and revolving borrowings. Zettlex contributed $1.8 million revenue and a $0.6 million pretax loss for the six months; the purchase-price allocation remains preliminary.
- Interest expense increased to $2.6 million in Q2 and $4.9 million in the first half, primarily due to higher average debt from acquisitions. First-half R&D spending rose to $24.5 million from $18.2 million.
Outlook, risks and unusual items
- No numerical revenue or earnings guidance is provided in the supplied filing text. Management said operating cash flows should be sufficient for operating and capital needs for at least the next 12 months.
- Management’s strategy includes growing medical-market exposure, developing products for targeted applications, improving margins and pursuing complementary acquisitions. Revenue was approximately evenly split between advanced industrial and medical markets in 2018, versus 60% and 40%, respectively, in the prior-year periods.
- Key risks include cyclical OEM capital spending and demand, acquisition integration, tariffs and geopolitical conditions, foreign exchange and interest-rate movements, supply interruptions, product quality, medical-device regulation, and the ability to service debt and meet covenants.
- Novanta began a 2018 restructuring program and recorded $1.0 million of related charges in Q2. The Bedford headquarters lease was extended to May 2031, with annual rent of $1.8 million and total future minimum payments of $26.8 million.
- The Laser Quantum put/call arrangement could require purchase of remaining minority shares in 2020; its reported redeemable noncontrolling interest was $51.6 million. Tax accounting under the U.S. Tax Reform Act remained subject to finalization, which could affect reported tax amounts.
- The company reported ordinary-course legal claims but did not expect them to have a material adverse effect; it cautioned that outcomes cannot be assured. No material changes to reported risk factors were disclosed.
Important facts for investors to verify
- How much future growth is organic versus acquisition- and currency-driven, especially given WOM’s contribution to Vision.
- Whether Vision margins recover and whether the cited mix, amortization and restructuring pressures persist.
- Zettlex integration progress, final purchase-price allocation and performance relative to its initial contribution.
- Debt, covenant headroom and financing needs, including the effect of acquisitions and the 2020 Laser Quantum redemption mechanism.
- Final tax effects of the Tax Reform Act and any changes in effective tax rate or provisional estimates.