Novanta Inc

NASDAQ:NOVT

Earnings Call Transcript 2022-Q2

[Operator]

Good morning. My name is Andrea and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Inc. 2022 Second Quarter 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.

[Ray Nash, Corporate Finance Leader]

Thank you very much. Good morning and welcome to Novanta's Second Quarter 2022 Earnings Conference Call. I am Ray Nash, Corporate Finance Leader of 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 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 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 am now pleased to introduce the Chair and Chief Executive Officer of Novanta, Matthijs Glastra.

[Matthijs Glastra, Chair and Chief Executive Officer]

Thank you, Ray. Good morning, everybody. And thanks for joining our call. Novanta achieved impressive results in the second quarter of 2022. We delivered another quarter of terrific financial performance with double-digit growth in revenue, bookings, adjusted EBITDA, and adjusted EPS. And we ended the quarter with another record level of backlog.

We continue to see very robust demands from our customers in the medical and advanced industrial markets we serve. Novanta's portfolio is well positioned in medical and advanced industry applications, with long-term secular tailwinds such as robotics and automation, healthcare productivity and precision medicine.

We continue to invest for growth in a disciplined manner to strengthen our commercial teams, our innovation pipeline and manufacturing capacity to capitalize on these tailwinds.

In the second quarter, the company delivered $215 million in revenue, representing 29% year-over-year revenue growth on a reported basis and 13% growth on an organic basis and up 5% on a sequential basis.

In addition, our operating profit in the second quarter was fantastic, with adjusted EBITDA of $45 million, up 22% year-over-year and adjusted diluted earnings per share of $0.78, up 26% versus prior year.

We saw strong demand and healthy orders across all our segments and in many of our applications, with each segment having solid book-to-bill in the quarter.

In the second quarter, our book-to-bill was 1.34 with year-over-year bookings growth of 25% versus the second quarter of 2021. We ended the quarter with a record backlog of $653 million, up 11% sequentially as demand continues to be gated by supply constraints.

The excellent year-to-date financial performance gives us confidence to raise our financial guidance for the full year, which Robert will cover in detail in a few minutes. We're doing this in the face of significant amount of uncertainty and macroeconomic and supply chain challenges. We feel that where we play and how we win is an important part of our success.

We build and grow quality businesses with proprietary EPI in attractive secular growth markets with vibrant culture and great people. And I just want to say how proud I am of our teams around the world and how extremely pleased we are with the team's exceptional operating performance using the Novanta growth system tools in this uncertain environment.

Now let's turn to what we're seeing in our markets where we see ongoing strength and multiple application areas. In the second quarter, our sales to advanced industrial markets saw 42% growth year-over-year and 5% growth sequentially.

We continue to experience higher demand in automation and robotics markets, and specifically factory automation, battery and electric vehicle production, EUV and increased adoption of automation-enabling technologies.

We believe that the penetration of robotic and automation applications is still relatively low with adoption increasing due to multiple drivers, such as increased productivity, higher robot utility, onshoring and labor shortages.

Turning to our medical end market. For the second quarter of 2022, sales to medical applications grew 16% versus the second quarter of 2021 and 6% growth sequentially. During the quarter, we saw very strong orders and shipments to many of our medical OEM customers with particular strength in surgical robotics, DNA sequencing and medical consumables for minimally invasive surgery, all of which saw strong double-digit growth in sales year-over-year. We believe that the penetration rate of these technologies is still low with an attractive long term growth trajectory, and with Novanta content steadily increasing.

It was also encouraging to see the strength in medical consumables which supports a broader improvement in elective surgical procedures. Expected medical sales and minimally invasive surgery procedures will continue to rebound gradually throughout 2022 as hospitals are battling staff shortages.

Our longer term outlook on the minimally invasive surgery market remains bullish, particularly with our playbook of expanding share with our unique product offering of integrated smoke evacuation insufflators.

From a regional perspective, we saw strong demand across all our major geographies in the second quarter. We saw 27% year-over-year revenue growth in China, helped our ATI acquisition, which saw strong electric vehicle production and robotic demand.

Our China revenue excluding acquisitions was roughly flat year-over-year which was remarkable given significant COVID disruptions and lockdowns in China and continued supply constraints. Our backlog and demand in China is very strong, helped by increased exposure to electric vehicle production, micromachining and electric vehicle battery production.

Moving on to other regions, sales in Europe grew 20% and sales in the United States grew 46% year-over-year.

Now let me touch on some of Novanta's strategic growth metrics. As a reminder, right now, these metrics exclude any impact from our ATI and IMS acquisitions. For the second quarter, our vitality index, which is revenue from new products launched in the last four years, continues to be healthy at above 25% of sales with year-over-year NPI revenues up low-double digits versus last year.

Despite some modest delays in some of our programs, which we've spoken to previously, we see other programs that are progressing nicely, and our new product pipeline for 2022 and beyond remains very healthy. We continue to invest in R&D with discipline in order to capture the many mega long-term opportunities with differentiated offerings in high growth markets.

Moving on, in the second quarter, design wins for the overall company increased more than 20% versus the prior year. We saw strong design wins in the majority of our business and we're excited about the platform's we're winning in attractive high growth applications, such as surgical robotics, laser additive manufacturing, micromachining, EUV, and electric vehicle battery welding.

Before wrapping up, I'd like to give you a brief update on Novanta's acquisition and integration activities. Our ATI and IMS businesses saw strong performance for sales and bookings in the second quarter. We continue to be very pleased with their contribution and strategic fit to Novanta and are very pleased to see the way their teams are collaborating with our other businesses and elevating the capabilities of the entire organization.

As for the rest of our M&A pipeline, acquisitions continue to be the primary focus of Novanta's capital deployment, and we continue to work on a very active pipeline of opportunities.

So in summary, despite the significant short term supply chain challenges and the uncertainty of the macroeconomic environment, we feel excellent about our second quarter results and we continue to see strength in the second half of the year. We believe Novanta's long-term strategic positioning is extremely strong.

We continue to broaden our exposure to medical and industrial applications that have long-term secular growth trends such as robotics and automation, healthcare productivity and precision medicine.

So with that, I'll turn the call over to Robert to provide more details on our operations and financial performance. Robert?

[Robert Buckley, Chief Financial Officer]

Thank you, Matthijs. And good morning, everyone. Our second quarter non-GAAP adjusted gross profit was $98.8 million or 46% adjusted gross margin compared to $76.9 million or [Technical Difficulty] gross margin in the second quarter of 2021.

For the quarter, adjusted gross margins were flat year-over-year and sequentially. Considering the environment of high inflation, supply chain shortages and currency exchange volatility, we feel quite good about this outcome.

We continue to experience supply chain shortages and inflationary pressures with semiconductor parts, but we're also seeing solid productivity from the deployment of the Novanta growth system and we are experiencing the impact of our pricing initiatives helping to offset the inflation.

Moving on, the second quarter R&D expenses were $21.6 million or roughly 10% of sales. Second quarter SG&A expenses were $40.5 million or 18.8% of sales. The sequential increases in operating expenses, which were in line with prior guidance, were the result of the impact of variable compensation programs as well as planned R&D investments.

Adjusted EBITDA was approximately $45 million in the second quarter of 2022 or a 21%. adjusted EBITDA margin. Our adjusted EBITDA performance beat our expectations and our previously issued guidance.

On the tax front, our non-GAAP tax rate in the second quarter of 2022 was 18%. This is different from the statutory rate, driven mainly by jurisdictional mix of income. Our non-GAAP adjusted earnings per share was $0.78 in the quarter compared to $0.62 in the second quarter of 2021, an increase of 26% year-over-year. The strong increase in adjusted EPS was achieved despite the higher financing costs and higher tax rate.

Second quarter operating cash flow was approximately $24 million, which was in line with our expectations. The second quarter cash flow continued to be impacted by anticipated increases in working capital, which was mostly driven by higher inventory purchases to mitigate some of the supply chain disruptions. And cash flow was negatively impacted by $2.5 million in higher cash taxes related to a change in US tax law, which impacts the deductibility of R&D costs.

Finally, in the second quarter, we purchased approximately $10 million worth of Novanta shares at an average price of $119 a share when the stock weakened due to macroeconomic conditions.

We ended the quarter with gross debt of $413 million and gross leverage ratio of 2.4 times. Our net debt was $312 million.

I'll now turn to update about the performance of the operating segments. First, I'll start with the Precision Motion segment. This segment experienced 93% year-over-year revenue growth in the quarter. Reported growth was heavily impacted by the API and IMS acquisitions.

In the second quarter, these businesses contributed approximately $35 million of sales, which was in line with our expectations. These businesses continue to perform very well. Their integration is proceeding on schedule, and they continue to offer very exciting near-term and long-term growth opportunities for Novanta.

Excluding acquisitions, Precision Motion still grew 9% year-over-year. The overall book-to-bill ratio in this segment was 1.1 in the quarter.

Excluding the impact of ATI and IMS, the Precision Motion new product revenue grew 40% year-over-year and was over 25% of total sales for the segment. And design wins for the second quarter were up double digit versus the prior year.

Adjusted gross margins for the segment came in around 50%, which was down year-over-year, but in line with the expectations and came as a result of some dilution from the new acquisitions. This segment continues to show a very strong impact from deploying the Novanta growth system to structurally improve gross margins.

Turning to our Vision segment. This segment predominantly serves the medical end market and saw revenue growth of 3% year-over-year, which was slightly better than our expectations.

As we said in the last call, the volume of elective surgical procedures has gradually started to return which helps sales performance and our minimal invasive surgical business. Offsetting this was the supply headwind in our JADAK business which experienced significant parts shortages that temporarily caused a decline in their sales, but not in their demand. The net impact of these dynamics was modest growth that we saw in this segment. Although the supply shortages at JADAK are resolving, we expect these dynamics to persist for at least another quarter.

The Vision segment saw a healthy book-to-bill of 1.32, with bookings increase 18% year-over-year. The vitality index in this segment remains around 30% of sales. Design win activity in the segment increased strong double-digits year-over-year in the quarter as the segment continues to deliver strong customer wins in attractive application areas.

Finally, turning to the Photonics segment for the second quarter of 2022, our revenue was up 11% year-over-year. This segment continues to experience strong customer demand in the advanced industrial applications and DNA sequencing. The book-to-bill in this segment was a fantastic 1.63 in the second quarter, with bookings growing 25% year-over-year.

The excellent results demonstrate the sustained demand we see in our beam steering and light engine products. Although the production move of our Taunton, UK facility is now fully complete, resulting in more supply of optics for our products, recently, one of our critical electronics vendor experienced a fire in their factory, reducing our supply of parts. However, we expect to mitigate the majority of electronic parts shortfall due to the fire and continue to show strong growth in the third quarter. I cannot be more impressed with our supply chain and manufacturing teams performance, demonstrated by the extraordinary efforts to overcome yet another challenge.

Within the Photonics, new product revenue stayed strong at 25% of sales in the second quarter. Design wins year-to-date are up double-digit year-over-year, driven by excellent platform wins in applications such as laser additive manufacturing, micromachining and EUV lithography.

The Photonics segment experienced adjusted gross margins of approximately 46%, which was down year-over-year, but in line with our expectations. Gross margins experienced temporary pressure from the Taunton move and our electronics vendor who had a fire, but we expect gross margins in this segment to continue to expand in the second half of the year, both sequentially and year-over-year as we recover from these issues.

Turning now to guidance. Overall, we expect macroeconomic environment continuing to follow the prevailing trends. We expect inflation, supply shortages, particularly around electronics, and volatility with foreign currencies to continue.

And clearly, there are signs of economic and manufacturing activity slowing, particularly in China and Europe, as well as some moderation in certain parts of the semiconductor market.

Despite all these factors, Novanta has a healthy outlook for the remainder of the year, supported by our record backlog and the ongoing excellent execution of our committed teams.

So, starting with revenue guidance for the third quarter of 2022, as we stand here today, we expect GAAP revenue in the range of $214 million to $216 million, which will imply revenue growth of 20% to 22% year-over-year. The overall range and guidance is driven by both electronic parts shortages and foreign exchange headwinds and not underlying demand.

On a segment level, in the third quarter, we expect Photonics segment to be largely flat sequentially on a dollar basis, representing organic growth of greater than 25% year-over-year. Customer demand remains very high in this segment and hence this business is governed solely by electronic parts shortages.

The Vision segment is expected to be up slightly on a dollar basis in the third quarter, seeing similar dynamics as we experienced in the second quarter. The minimum invasive surgery business line is expected to continue to see growth in medical consumables due to the recovery of elective surgical procedures, whereas our JADAK business line continues to improve from its parts availability issues, albeit slowly.

Finally, our Precision Motion segment is expected to be down slightly on a sequential basis due to seasonality with the ATI business line, but up significantly on a year-over-year basis. We continue to see strong organic growth in our Celera Motion business line and the ATI business line despite significant parts shortages in both businesses.

For the full year of 2022, our strong first half and continued strong backlog gives us confidence to raise our guidance. We now expect GAAP revenue in the range of $848 million and $852 million, which implies revenue growth of 20% to 21% year-over-year.

Moving on to overall Novanta's adjusted gross margins. We expect gross margins in the third quarter to be approximately 46%, which would be robust margin expansion versus prior year.

We expect third quarter gross margins to see similar dynamics sequentially, although there may be some segment by segment variations as teams tackle unique impacts from the multitude of challenges related to supply chains.

For the full year of 2022, we expect Novanta's adjusted gross margins to be approximately 46%, which represents close to 100 basis points of expansion year-over-year. In this challenging environment, expanding margins would be a huge accomplishment. Thanks to our continued focus on new products which are launching with gross margins above the company average, as well as significant investments and progress with the Novanta growth system across our business units and a pricing strategy focused on sharing the inflationary pressures and supply chain disruptions with our customers, we feel confident we are on a path to continued and sustained gross margin expansion this year and the next.

Turning to R&D and SG&A expenses, which were up $62 million in the second quarter, we expect – are expected to be approximately $63 million to $64 million in the third quarter, which is higher mainly as a consequence of recent acquisitions and higher variable compensation and timing related to investments in new product development.

We continue to invest in R&D even with the macroeconomic uncertainty because of our confidence in near-term customer opportunities we are pursuing and the expected launch cycles of our customers' new products.

Depreciation expense was $3 million in the second quarter and should be very similar in the third quarter; stock compensation expense, which was $5 million in the second quarter, to be similar in the third quarter.

For adjusted EBITDA, for the third quarter of 2022, we expect a range of $43.5 million to $45.5 million. For the full year, we now expect adjusted EBITDA in the range of $177 million to $180 million, higher than previously issued guidance.

Interest expense, which was $3 million in the second quarter, will be approximately $4 million in the third quarter, driven by rising interest rates and higher debt balances.

We expect non-GAAP tax rate to be approximately 16% in the third quarter, absent significant changes in the jurisdictional mix of income or other variability in our eligible tax benefits.

Diluted weighted average shares outstanding will be approximately 36 million shares. For adjusted diluted earnings per share, we expect a range of $0.71 to $0.76 for the third quarter. For the full year, we now expect adjusted diluted earnings per share to be approximately $2.95 to $3.02.

Finally, we expect operating cash flows to improve sequentially in the third quarter versus the second quarter as we stabilize our inventory buys.

Also, of note, in July, we closed the earnouts to shareholders of ATI resulting in additional payment of $45 million for a total purchase price of $214 million. We intend to finance this with both cash on hand and our credit facility.

As always, this guidance does not assume any significant changes in foreign exchange rates. However, it's worth noting that the currency markets have been very volatile recently, and this has impacted the second quarter results, including material impact on our reported revenue growth and cash flow.

Given the continued swings in currency, exchange rates will likely impact our growth in the third quarter at a similar order of magnitude. And this is factored into our guidance.

In summary, Novanta's performance in the second quarter of 2022 was excellent. We saw double-digit growth in sales, bookings, adjusted EBITDA and adjusted earnings per share.

The company is seeing strong demand across its applications and markets, and we hit another new record high for sales, order backlog and also our adjusted EBITDA. Our teams continue to impress with new innovations as well as their ability to help the company manage through difficult supply chain challenges and COVID lockdowns. We also continue to see below market labor attrition rates and we are seeing great success at attracting top talent.

And we continue to deliver strong financial results with a very solid full year outlook despite some fairly significant challenges with global supply chains, semiconductor shortages, inflation, China COVID lockdowns, war in the Ukraine, currency fluctuations, some slowdown the microelectronics and general macroeconomic uncertainty.

We remain very excited and motivated about our ability to serve our top customers in medical and advanced industrial end markets and the innovation pipeline we're developing in partnership with our customers. We remain very grateful for the outstanding performance of our employees and their tireless efforts to help us be successful in a very challenging environment. We look forward to continue to deliver on our commitments to our employees, our customers and our shareholders.

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

[Operator]

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

[Lee Jagoda, CJS Securities, Inc.]

So just starting with the sequential increase in backlog, can you kind of parse out how much of that is volume from existing OEM products that your customers are trying to get out the door versus potentially some initial sell in for some of the new products in the pipeline?

And to the extent it's any of the latter, is there a quarter – one quarter, two quarter, three quarters out from now – where you expect that backlog to release? Or is it really just supply chain constraints holding everything back?

[Matthijs Glastra, Chair and Chief Executive Officer]

Lee, this is Matthijs. It's primarily supply chain constraints holding the backlog back. Demand is just outstripping our ability to supply. And despite all that, we delivered very, very strong results. So let me start by saying that.

The other question, we haven't really disclosed the split in our sequential backlog in kind of existing customers and new opportunities. But it's fair to say that, as we continue to report on design wins that are incremental to our business, so it will be a mix. And of course, also the increased, let's say, exposure of our business to high growth application. So it's being both in the right spot, which then drives the existing business to move faster, as well as winning gradually new business and increasing content in those high growth markets.

[Lee Jagoda, CJS Securities, Inc.]

I think I know the answer to this question, but I have to ask it anyway. In terms of your customers' order patterns, I assume we're not seeing evidence of safety stock or over ordering, and it's just ordering to demand and you can see that in their inventories.

[Matthijs Glastra, Chair and Chief Executive Officer]

That's right. We do not see much evidence of over ordering, quite frankly. So, many of our customers has given us feedback that they're kind of hand to mouth, quite frankly, with their suppliers, including us. And they're shipping all finished units as soon as they can complete them.

Now, of course, we do have less visibility what happens further down the chain and we're watching that closely. But again, at this moment, we do not see much evidence of over ordering. So, overall, we have a large backlog, and we cannot keep up with the demand. So, yeah, our focus is quite frankly reducing that backlog to our customers because they really desperately need our products.

[Lee Jagoda, CJS Securities, Inc.]

One more for me and I'll hop back in the queue here. I know you had mentioned you're seeing an uptick in the WOM consumables just driven by elective procedures. What needs to happen to kind of see or start to see an uptick in the equipment side? And when do you see that kind of playing out?

[Matthijs Glastra, Chair and Chief Executive Officer]

That's typically the logical sequence. The procedures need to go up first. And that typically will be followed by capital purchases as hospitals need to bring more capacity online. We do see a healthy hospital capital spend environment. Our customers are reporting on that as well. So, it will be the gradual, logical next step to follow. And so, I think we're very encouraged by what we see happening. And what we expect to happening is a sequential increase of and gradual rebound of the elective procedure rates, which we expect to continue to progress in the second half of this year.

[Lee Jagoda, CJS Securities, Inc.]

And just to be clear, the big backlog you have here, if I look at the WOM equipment, which should be an important growth driver over the next two, three years, I would assume that piece is under indexed versus all the rest of the stuff in the current backlog just because we haven't seen those orders yet.

[Matthijs Glastra, Chair and Chief Executive Officer]

That's right. So, again, we expect that demand will continue to build gradually in the foreseeable future. But, again, if you look, short, mid, long term, as we commented in our prepared remarks, we feel very good about the future of that business as we're gaining share with our smoke evacuation insufflator, both in the laparoscopy as well as robotic surgery markets, and we're also expanding share in pumps for arthroscopy. So all that makes for a very exciting future of that business. And yeah, what we're just seeing right now is just hospitals just battling through staff shortages, which we expect over time will resolve itself.

[Operator]

The next question comes from Brian Drab of William Blair.

[Brian Drab, William Blair]

First, I'm just thinking back to the back half of 2019 when challenges in China, Europe business slowed down, Germany was a challenge for you? And can you talk to us a little bit about comparing that market environment to what you're seeing now in China and Europe? There was a lot of differences there. I would just love to hear you talk about that and how that influences how you're viewing the second half of 2022?

[Matthijs Glastra, Chair and Chief Executive Officer]

It's hard to compare, quite frankly. But, of course, when you put yourself in the second half of 2019, we just had massive trade wars and uncertainty on where trade tariffs would land and, therefore, basically, people stopping investing, right> And that had impact in in multiple end markets.

Right now, what we're seeing is we're emerging out of the pandemic. And in areas like automation and robotics, where there are secular growth trends that are accelerated that were there already, but they're accelerating, call it, post pandemic. And we continue to see demand for our medical and DNA sequencing products that also are kind of entering into the next phase of their adoption.

So, we feel that, quite frankly, where we've put our business, including acquisitions, we have high exposure to markets that have accelerating sequential tailwinds versus where we were in 2019.

The other thing that I would say is that we have a higher percentage of new products that are coming to market. So, in 2019, if you recall, we just did some technology acquisitions, but we're now seeing the impact of the product pipeline gradually starting to appear in the latter part of this year and 2023.

I would just say, we're on our firm feet, so to speak, dealing with the challenges head on and being in the right spot. And so, where we are and where we play and how we win is really essential.

Now, of course, what is maybe similar and we're not naïve is, of course, there are signs of slowdown in some parts of the semiconductor market. Of course, everybody's reading the newspapers about the uncertainty. And of course, we're watching that very carefully. But what we can do is, of course, place our business in the right spots, so we can ultimately serve and thrive through what will surely be some additional challenges coming our way in the future.

[Brian Drab, William Blair]

Can you comment on where you are in the in-sourcing of the WOM consumables, still on target for getting the margin expansion there?

[Matthijs Glastra, Chair and Chief Executive Officer]

First, I would say that the in-house manufacturing facilities have done an excellent job at expanding margins and continuing to bring more and more volume into the facility. Because of the way their manufacturing footprint works, getting that volume in is really what's key. So pull it out of our contract manufacturers and bring it in-house, that allows us to better leverage the fixed cost structure that we have there and thereby expand the margin profile.

We are simultaneously pursuing some opportunities that are external in nature. And we have a couple of different avenues there that we are continuing to work. We feel pretty good that at least one of those will come to fruition relatively soon. And then, that will enable us to start bringing even additional products in-house to expand the margins.

At this stage, I think we feel pretty good that there's enough options in front of us that we can start to continue to bring product in-house and expand the margins.

[Operator]

The next question comes from Rob Mason of Baird.

[Robert Mason, Robert W. Baird]

I wanted to go back to, I guess, the question around the backlog. And understanding that your customers may be somewhat hand to mouth currently, but is it fair to assume there are some inventory stocking orders within your backlog, the $653 million? Is there any way to give us a percentage of what you would think would be shippable next 12 months, absent any kind of supply chain constraints?

[Matthijs Glastra, Chair and Chief Executive Officer]

Well, most of it is shippable. All of it is shippable in the next 12 months. It's all being held back with the supply chain constraints themselves. Right? We don't have any backlog that's cancellable. And we don't have backlogs that's scheduled out greater than a year being reported in that number. So, that's all 12 months kind of demand flows.

It is fair to say that there's some requests to try to build safety stocks there. We're nowhere near those levels of delivery. And so, we're not able to do that. And so, we're more than trying to prevent line downs at our customers and their manufacturing processes than we are about building stock. If we were to estimate it, I'm sure about 20% of it is definitely tied to stocking because they don't really have anything whatsoever on their shelves. But we're nowhere near the delivery of that.

At least as we look at 2022, it provides us with some confidence, and then the revenue numbers should be relatively firm, regardless of some macroeconomic conditions.

[Robert Buckley, Chief Financial Officer]

And the other thing that I would say, Rob, is that we do expect kind of our bookings and our book-to-bill to normalize, right, because I do think the backlog represents very solid coverage for our customers. We need to deliver on that backlog. But, yeah, again, we expect book-to-bill and bookings to normalize from here onwards.

[Robert Mason, Robert W. Baird]

You mentioned price a couple of times, just perhaps getting a little bit better traction as that works through the backlog as well. Could you just update us where you think you are currently on a price cost metric, positive, negative, or just where we sit currently?

[Robert Buckley, Chief Financial Officer]

Our philosophy has always been one that we're leaning in hard on our Novanta growth system, which is about driving material productivity and labor productivity in our manufacturing facilities, and then coupling that with a pricing strategy that focuses on sharing some of the inflationary pressures. So, we have not taken the stance that our customers really have where they've dramatically raised price in an effort to get margin expansion on top of the inflationary pressures that they have. We have not taken that stance. What we've really done and said, okay, the Novanta growth system is going to drive X amount of productivity, pricing is going to drive Y amount, and the combination of those two things will allow us to at least neutralize the inflationary pressures, and then the introduction of new products at higher gross margins will allow us to expand those gross margins further.

And so, as a net-net, you're seeing that in the results. First half of the year, we have the 46% gross margins. If we look at the back half and the full year, we're going to drive gross margin expansion 100 basis points. That's a combination of those activities – Novanta growth system, pricing strategy that focuses on sharing some of that costs and new product introductions, and then frankly, driving some of the consumable inhouse.

[Robert Mason, Robert W. Baird]

Last question I had was, there's obviously a lot of uncertainty, particularly in Europe, and in particular, in and around their energy situation. Germany seems to be ground zero for that concern, it seems like. And given your facility there, I'm just curious how you're approaching that dynamic as we go into the back half of the year and into early next year, what perhaps you can do to make sure that you've insulated yourself, protected yourself against any kind of interruptions that may come down that way?

[Matthijs Glastra, Chair and Chief Executive Officer]

What happens if the grid goes down is not an easy thing to mitigate. So, let's presume that there's some energy production based upon what they can get in. I think we'd take a number of actions, so with everything from building in backup generation to reducing our over energy consumption. Our facility in Germany is ISO 14001 and 45001. It's probably leading the way from an ESG perspective. So, they continue to look at ways to reduce their energy consumption.

We have also built in some redundancy into our heating systems. And so, we can pivot to a multitude of different fuel sources, depending upon where the shortages might lie. So if there's a shortage of natural gas, we can pivot to oil. If there's a shortage of oil, we can pivot again. And so, there's a multitude of different angles that we've invested in to try to add that redundancy and that robustness. And we're also simultaneously trying to build, as you know, require additional capacity vis-à-vis an acquisition strategy. So there's a number of different tactics that we are taking to try to increase that redundancy in that facility.

[Operator]

Our next question comes from Andrew Buscaglia of Berenberg.

[Andrew Buscaglia, Berenberg Capital Markets]

I was hoping to focus on Precision Motion for a bit. So that's growing organically very strong on a pretty tough comp, much better than I was expecting. Now you have this M&A that's going to roll into your core growth kind of starting next quarter, but we're definitely in Q4. And I'm looking out, it's hard to – you talk a little bit about the cyclical versus secular in some of your businesses. It's hard to determine what is a long-term growth rate for this new segment as we exit the year. Can you help us think about that and what are the puts and takes going forward?

[Robert Buckley, Chief Financial Officer]

We've always kind of said that the overall end markets in which we participate in are this 5% to 7% organic growth profile. And then, as a consequence of some of the new things that we're doing, the innovation, the design wins, new product introductions, and whatnot, we've been driving that kind of higher single-digit organic growth contribution. Obviously, we've been outperforming that in a number of different areas of this environment. But structurally speaking, those tend to be where the end markets slow.

I would say cyclicality wouldn't impact the kind of long term growth expectations of an end market participation. So, the API business does have a little bit more cyclicality than most of our other businesses. It tends to have a weaker Q3 than Q4. And that's just because of the upgrade cycles and investment cycles associated with some of the end markets in which it participates.

Generally speaking, that business performs relatively well. And we had guided when we acquired the business that it was certainly participating in that high-single digit type of end market. Arguably, in this environment, like kind of low-double digit. And the overall motion segment itself tends to be a higher growth area as well. So, kind of a lower double digit.

We have to just be realistic here that the overall portfolio here is one of diversification. And what we try to do is diversify out the risk elements and volatility and cyclical changes and macroeconomic differences between businesses and whatnot to drive that sustained organic growth overall. So, we run the business very much like a portfolio manager would run their portfolio of stocks. We do very similar things in how we invest in our end markets and our application areas and our business units that drive a more sustained organic growth profile for the company.

[Matthijs Glastra, Chair and Chief Executive Officer]

Just to add to that, it's important to repeat what the end market exposure really is because then you can kind of get a guess for, yeah, how good we feel about this. Obviously, very strong exposure to automation and robotics, surgical robotics, increasing exposure, also with the ATI acquisition, electric vehicle production, which is going through a supercycle, EUV lithography which is a semiconductor market, but which is also going through a supercycle, [indiscernible] warehouse and logistics automation in general. This segment also has the highest semiconductor exposure, so you can kind of expect as a result, a little bit more volatility from that. Within that market, we are, as stated, geared more towards the less technical parts of the semiconductor market, for example, EUV. So, many of these applications, we feel, are still very early in their adoption cycle. We feel good about the long term growth potential in that segment for that reason.

[Andrew Buscaglia, Berenberg Capital Markets]

And what about regionally for that segment combined? Is there any greater influence of China exposure, maybe either direct or indirect?

[Robert Buckley, Chief Financial Officer]

That's a good question. I think there is an element of that. It has a little bit more China exposure than some of our other segments. We've never kind of broken that out. But it is fair to say that there is a little bit more China exposure there.

[Matthijs Glastra, Chair and Chief Executive Officer]

The other just reminder is that when we played out regional sales, it is shipped to locations. So, in other words, we could ship to a German OEM who then ships to China, right? You've got to be a little bit cautious about correlating one to one what truly is the end market exposure?

[Andrew Buscaglia, Berenberg Capital Markets]

Maybe just one last one. Any update on the legislation around smoke evacuation insufflators? And anything we should be on the lookout for to the fall?

[Matthijs Glastra, Chair and Chief Executive Officer]

I think, also there, gradually, there is continued adoption of the legislation of smoke evacuation in the US as well as abroad. So, I think that trend overall is very positive. I think the additional trend that is positive, outside the legislation per se, is how to integrate smoke evacuation as part of the workflow. So, we feel we have a very strong solution there, and that is basically confirmed by a very strong pool of multiple major customers. So, we see, as a result, that product category of ours driving strong adoption in the coming years, which was confirmed by design wins that we had last year. We also see an opportunity and we see convergence between basically laparoscopy and robotic surgeries, so that smoke evacuation will play a stronger role there as well. So, we see multiple growth drivers, both from a legislation perspective, product category, as well as adoption in new applications.

[Operator]

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

[Matthijs Glastra, Chair and Chief Executive Officer]

Thank you, operator. So, to summarize, Novanta delivered very impressive results in the second quarter of 2022. We saw double-digit growth for sales bookings, adjusted EBITDA, adjusted EPS, and we hit a new record high backlog. We achieved all of this while managing supply chain disruptions, rising costs and a more uncertain macro environment.

We're excited to see the continued strength in the advanced industrial sector and also in the medical sector. Novanta is very well positioned in these sectors, with diversified exposure to long term secular macro trends in robotics and automation, precision medicine, minimally invasive surgery and Industry 4.0.

In closing, as always, I would 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 great Novanta employees who work so hard every day to tackle each new challenge.

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 third quarter 2022 earnings call. Thank you very much. This call is now adjourned.

[Operator]

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