Good morning. My name is Eileen and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Incorporated's 2019 Fourth Quarter and Full Year 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 like to turn the conference over to Ray Nash, Corporate Finance Leader for Novanta. Please go ahead.

Thank you very much. Good morning and welcome to Novanta's fourth quarter and full year 2019 earnings conference call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our 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'm now pleased to introduce the Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Ray. Good morning everybody and thanks for joining our call. Novanta performed very well in the fourth quarter of 2019 with both revenue and adjusted EPS exceeding the top end over guidance and revenue up nearly $6 million sequentially versus the third quarter. The company delivered nearly $160 million in revenue representing 2% year-over-year revenue growth on a reported basis and 2% decline on an organic basis. For the full year of 2019, we delivered $626 million in revenue which represents reported growth of 2% year-over-year on a reported basis and organic growth of approximately 1%. Adjusted EBITDA was $31 million in the fourth quarter and 121 million for the full year. Adjusted EPS was $0.55 in the fourth quarter and $2.14 for the full year. Our team executed very well in an industrial capital spending market which has been in recession for the past few quarters. Our book-to-bill was 1.07 in the fourth quarter and was exactly 1.0 for the full year. In the fourth quarter, we saw strong bookings across the board up sequentially by 6% versus the third quarter and up 4% year-over-year, with each of our segments showing positive book-to-bill ratios on the back of strong commercial execution and solid demand especially from some of our medical customers. Novanta's positioning is favorable with over half of our revenue in medical markets that are structurally growing. We remain laser focused on growing faster than the market with proprietary motion, vision and photonics capabilities in a diverse set of applications driven by secular industry 4.0, precision medicine and healthcare productivity trends. We are strongly investing in innovation and commercial capabilities through business cycles to enhance our proprietary technology position, and long-term sustainable growth, potential and secular growth applications such as robotic surgery, minimally invasive surgery, DNA…

Good morning. My name is Eileen and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Incorporated's 2019 Fourth Quarter and Full Year 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 like to turn the conference over to Ray Nash, Corporate Finance Leader for Novanta. Please go ahead.

Thank you very much. Good morning and welcome to Novanta's fourth quarter and full year 2019 earnings conference call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our 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'm now pleased to introduce the Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Ray. Good morning everybody and thanks for joining our call. Novanta performed very well in the fourth quarter of 2019 with both revenue and adjusted EPS exceeding the top end over guidance and revenue up nearly $6 million sequentially versus the third quarter. The company delivered nearly $160 million in revenue representing 2% year-over-year revenue growth on a reported basis and 2% decline on an organic basis. For the full year of 2019, we delivered $626 million in revenue which represents reported growth of 2% year-over-year on a reported basis and organic growth of approximately 1%. Adjusted EBITDA was $31 million in the fourth quarter and 121 million for the full year. Adjusted EPS was $0.55 in the fourth quarter and $2.14 for the full year. Our team executed very well in an industrial capital spending market which has been in recession for the past few quarters. Our book-to-bill was 1.07 in the fourth quarter and was exactly 1.0 for the full year. In the fourth quarter, we saw strong bookings across the board up sequentially by 6% versus the third quarter and up 4% year-over-year, with each of our segments showing positive book-to-bill ratios on the back of strong commercial execution and solid demand especially from some of our medical customers. Novanta's positioning is favorable with over half of our revenue in medical markets that are structurally growing. We remain laser focused on growing faster than the market with proprietary motion, vision and photonics capabilities in a diverse set of applications driven by secular industry 4.0, precision medicine and healthcare productivity trends. We are strongly investing in innovation and commercial capabilities through business cycles to enhance our proprietary technology position, and long-term sustainable growth, potential and secular growth applications such as robotic surgery, minimally invasive surgery, DNA…

Thank you, Matthijs and good morning everyone. We delivered 159.7 million in revenue in the fourth quarter of 2019, an increase of 2% year-over-year on a reported basis and the decline of 2% on organic basis. For full year 2019, we delivered 626 million in revenue, an increase of 2% on a reported basis and organic growth was positive 1% year-over-year. While the industrial capital spending environment and the economic climate in Europe and China remain weak, we are pleased with the organization's ability to deliver on our financial commitments for the quarter. The better than expected revenue growth was driven by strong growth in our medical business, and higher growth in new product revenue, which now represents 26% of our sales. Our medical sales were up mid teens in the fourth quarter and full year. This was despite not seeing a meaningful contribution from the DNA sequencing market in the fourth quarter, and experienced roughly 10% decline for the full year. Overall, we're pleased with how we managed through the economic environment and with the strength and resilience of our portfolio. Turning to profit, our fourth quarter GAAP gross margin was 66 million or 41% of sales compared to 64 million or 41% of sales in the fourth quarter of 2018. For the full year of 2019 GAAP gross profit was 262 million or 42% of sales compared to 261 million or 43% of sales in 2018. On a non GAAP basis fourth quarter adjusted gross profit was nearly 70 million or 44% of sales compared to 67 million or 43% of sales in the fourth quarter of 2018. Full year of 2019 adjusted gross profit was 274 million or 44% of sales compared to 272 million or 44% of sales in 2018. For the full year of 2019,…

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Lee Jagoda with CJS Securities.

Good morning.

Hey Lee.

Hey Lee.

So can we start with all the opportunities you're seeing in terms of new products and maybe give us some detail around the end markets and the product applications that are causing you to accelerate your R&D spend this year?

Yeah. Good morning Lee. I've commented on most of that in my prepared remarks, but let's go one by one. I mean, we see tremendous opportunity in our minimally invasive surgery end markets. I commented that we see opportunity in endoscopy as well as arthroscopy and robotic surgery within our minimally invasive surgery business. So that's a combination of our entire product portfolio in that segment, and that's a multi-year expansion opportunities that we see and I commented that that's roughly a $200 million market, adjacent market opportunity that we're currently not serving. Then in our Photonics segment, I commented that we are accelerating product introductions, particularly around beam delivery, but also in other parts over Photonics segment. So we're basically doubling the product introductions from three to six, six in 2020 that is. And those products will be introduced in the latter part of 2020 and will have more material impact in 2021. And we're basically seeing on the back of these innovations and that's both in Photonics as well as in minimally invasive surgery, extremely active customer engagements right now. And to win kind of slots, they're opening up in the next, say 12 to 24 months. In addition, we see on the back of our acquisitions, I've commented on that they have really – and that's across our entire portfolio. They've really helped to accelerate and rejuvenate our innovation pipeline, particularly around intelligent subsystems, so maybe one other thing to comment on is that we're very excited about the motion control capabilities that we've added last year that we see to be particularly targeted in robotic as well as industrial precision automation segment. So I think all in all, it's a pretty broad based set of opportunities. I think on the Photonic side maybe just to comment on the type of markets I realized I forgot to mention that is a combination of laser additive manufacturing, which is driven by both aerospace as well as medical end markets, rapidly growing market, where we feel we can gain share with our new capabilities micromachining which is building into the trend of automation on the back of laser based production technologies, let's say advanced converting applications, both textile as well as other converting based applications. And finally, an emerging opportunity for us, but obviously very relevant is electric vehicle battery welding. Yeah. So as demand increases in that market, for obvious reasons, more sophisticated production technologies are needed to get the throughput up and a cost per part down and those are typical trends that play into our favor with more precise, let's say technologies. And with the latest edition of both our acquisitions as well as our innovation investments we've made in the past, we are, yeah, we're very excited about playing a more substantial role into those markets.

That's great. And then just focusing in on the one business specifically, I think that business has been growing something in order of magnitude in the 20% range already driven by the adoption of the smoke evacuation stuff.

Yeah.

With further adoption of that, as well as the new market opportunities, how do we size the growth rate, call it from the 20% level over the next several years, does it accelerate from that level or just stay there longer?

Yeah, it's a great question. I mean, we have not specified that Lee, but I think giving you an order of magnitude of a $200 million adjacent additional market opportunity of course, we're not capturing 100% of that market. But it should give you a point of view that we're seeing expansion potential well beyond what we originally thought was possible. I mean, that business has fantastic innovation pipeline, very deep customer relationships and also capabilities that can expand into new markets. So their capability is not only around call it gas management and control, it's also around fluid management and control and, and that plays very well into, for example the arthroscopy market. So basically taking the capabilities, repackaging those and then targeting those capabilities into new markets, building off already strong customer relationships and that's a multi-year trend. And then as you know, medical markets are not moving very fast from kind of introducing new technology. So this you can expect and maybe it is a short answer, sustained growth in this business in the foreseeable future, multi-year.

Okay. And then just one for Robert and I'll hop back in queue. Do you have any goals that you're willing to share on working capital reduction for 2020 and then maybe just touch on the CapEx forecast for this year?

Yeah, so on the goals, I always find it hard to come out with like what our internal goals are around this stuff when we have not been able to demonstrate the amount of progress that we've wanted to achieve. So we are – what we've decided to do this year, is get a lot more specific around the inventory reduction. So we've deployed a problem solving techniques that we use and tools that we've used as part of the Novanta growth system to attacking inventory and we've deployed some additional corporate resources around that effort to really kind of attacking this in a very methodical discipline type of manner that gets reviewed on a monthly basis. And then to add that extra incentives, historically we've had incentive comp paid on overall networking capital managed and then this year we've decided to get very specific and tie a portion of it to just the inventory because the reality is we've done an excellent job from the inventories and accounts payable side, we've been able to control that more through process and disciplines over at a higher level basis. So now time the individual business units to really managing their inventory and bringing that down. That's a key element of our compensation structure as we get into 2020. So it is the driver of our cash flow going into 2020. So my hope is to get back to the normalized rates of where we were in 2018 as our cash flow conversion as a percent of EBITDA. If you look back at that that would be my desire to get there through that inventory reduction, and that's the biggest lever that we have. Now from a CapEx perspective, we do see CapEx ticking up temporarily in 2020. We've talked about that a little bit in the past. We had exited around $10 million in '19 that has a little bit of investments in facilities, but for the most part was spent on our production capabilities, some of the fit out of tooling and whatnot. This year, in 2020, that's probably going to get close to double, depending upon the timing, somewhere close to $20 million because we have a pretty sizable investment that we're making into a new facility in the UK. That facility is somewhere in the order of magnitude of $8 million to $10 million, so that's a one off that won't repeat thereafter. But it is something that we're expecting to impact us in 2020, as we fit that out and add some capability that I think is – that our competitors, frankly, don't have, and then give us a little bit more scalability in the operations there because we're seeing some nice growth come out of it.

Great, thanks very much.

Yeah, thanks Lee.

Our next question comes from Richard Eastman with Robert W. Baird.

Yes. Good morning.

Good morning Rick.

Hey, just a really quick clarification, Robert you had mentioned that the gross margin in the first quarter sequentially would be up or down 100 bps?

Up a 100 basis points.

Okay. Okay, perfect.

That's a good clarifying question.

Yeah, I'm thinking with the OpEx numbers that you tossed out there. It probably had better be up to cover some of that. And then Matthias just a question – a big picture question, as we roll into '20 here, the industrial portion of the business, which I think you said was maybe 45% of sales in '19. You made some reference to stabilization in the fourth quarter, perhaps some momentum, let's just ignore the first quarter here, but some momentum around the semi market, maybe 5G kind of driven. But how do you feel about potentially delivering some growth off of a pretty modest base for the 45% of the businesses industrial in 2020? Do you feel comfortable that we can potentially grow – return to growth there?

Yeah. Yeah, it's a good question, Rick. I mean, listen, I think that remark I made was around the fourth quarter prior to the coronavirus right. So let me be clear with that because it basically – with the coronavirus, a lot is up in the air, quite frankly. So, if you look at the fourth quarter, we saw China bouncing back at 15% on the back of 5G infrastructure and cloud based infrastructure and microelectronics markets in general, right. So and I don't think we have been any different than what other players are seeing quite frankly. So I think that's consistent with what others are seeing and so we saw that as well. And if you look at regionally for example, US was up and Germany was down, rest of Europe was actually doing – was hanging in there, of course anybody's guess what that will be with imminent coronavirus threats coming into Europe at the moment. I would suggest that let's say, yeah, from a Germany perspective, we expect that to be a little lackluster, particularly the first half. I mean, the original kind of idea and view prior to the corona virus is that macro economically the industrial markets would remain subdued in the first half and then we would return back to growth in the second half. It depends on the scope and the length of the coronavirus impact if that's going to change, but that that was the original viewpoint off of our guide and of course we have some modest, but nevertheless some impact of new product introducing in the second half of the year as well that should help that a bit.

Okay. Okay. And then just – I just want to follow up with a gross margin question. In the Vision segment of the business now we've got San Jose closed, we've got things – NDS integrated, I think there was a reference to 2 million of savings expected in 2020 there. And so when I look at, in particular within Vision, we've got kind of the self help initiatives and we got volume growth. We've got the benefits of maybe some of the consumables internalization here later this year. But is 200 plus basis point improvement in gross margin in the Vision segment, pretty much a layup at this point; a right handed layup at this point?

Yeah. So I would say that the 200 basis points should be fairly easy, right from that perspective. We're obviously trying to drive more and the only real risk in the Vision segment to gross margin expansion is some sort of significant uptick in the medical consumables which create that negative mix effect. Absent that we are really – we have all the actions in place, the teams have all the actions in place and some stuff already done in the consequences of San Jose manufacturing closing down to really drive margin expansion in that segment, so we feel pretty good about that. We feel we got the right sort of levers already pulled to drive the expansion there.

Okay. And overall, the adjusted gross margin then, you're still feeling reasonably comfortable around 200 basis points for Novanta? I know we got a little bit of a hurdle here in the first quarter with volumes, but.

Yeah, so I would say internally we're looking at that second half being 46 plus percent. And I think that really is kind of based upon the first quarter being more of a temporary impact and then starting to recover as we get into the second quarter. Hopefully, people calm down with the flu here and we can get back to business and so that's really the big issue.

Got you, okay. Great, thank you again.

Thanks Rick.

[Operator Instructions] And our next question will come from Brian Drab with William Blair.

Hi, good morning. Thanks for taking the questions. Just first, following up on that last question around the one consumables, where are we with the prospect of getting that production and brought in house?

Yeah, so listen and we are tracking there. I think there is like with any multi-year transformational program and initiative there's some pluses and minuses. I think the pluses is that we've significantly strengthened the local teams and these teams are able to drive higher volume out of the existing facilities and infrastructure than we expected. So therefore, the overhead leverage and the productivity out of the factory, our own factory of existing products should actually be better than expected. And that gives us a little bit of time to figure out the best manufacturing footprint. As I commented earlier, we see the growth opportunity in the one business and minimally invasive surgery as well as the adjacent markets, I commented on very bright and as a result, it's important that we properly adjust our capacity and our footprint strategies accordingly with more new products coming in. So I think the short answer is we can get more out of the existing setup and that will drive gradual gross margin expansion. And the real step up in gross margin and step down and cost will happen in a few years. So we think it's around 2022, 2023 when – probably more likely 2023 when we put a more sustainable infrastructure in there, yeah. So what we will use in the meantime, all the aspects of the Novanta growth system to really drive and lean out the existing facility which again it looks more favorable than we initially expected.

Okay, got it. Thank you. And then just this dynamic of relatively softer than expected first quarter guide given the corona and soft environment, but the maintenance of the full year guide, can you just talked about what drives that and what results in pent up demand rather than demand destruction here and maybe from – if you could just discuss some of the – what you're seeing from some of your customers and are they having to push out their sales to second quarter and then you'll just support them in the second quarter and make up for it? How's that going to play out?

Yeah, so I want to tack in this a little bit with a tie. So when we look at the – if you look at the sequential or the year-over-year it's 60% of like the magnitude of the drop in I'll talk to EPS is really the coronavirus impact. This is a flow through of that impact and not taking the cost actions. What I would say, we normally would just say, okay, given that there's a reduction in volume let's adjust the variable portion of our cost structure to deal with that. Take the heads out, or furlough them or whatever that might be. We haven't taken that action and the guide in Q1 because we see that opportunity is really being very, very temporary. It's not something that we think is going to be structurally inherent in the business on a go forward basis but last a couple of quarters. When you look at the year-over-year 20% of it is also increasing of the R&D that's going up about a million, million and a half. And then the variable comp element is the other 20% impacting the SG&A line. So that's kind of the walk in the thought process around it. And what are some of the things that give us some positive, Matthijs – or some excitement, as Matthijs talked a little bit about the bookings, he talked a little bit about the design win activity, he talked a little bit about the new product introductions. We did exit the fourth quarter with growth in China and grow in a number of our markets, Germany being really the only one that was really disappointing. And then – but yeah, we're also seeing a significant uptick in the amount of quoting activity even in places like China where people are really looking at their next generation of platforms to drive their own growth in the second half of the year and into 2021. And that was something that we talked a little bit about the last quarter where people were willing to pick their heads up, they are now willing to pick their heads up and that activity is still ongoing. So despite the fact that there is a coronavirus outbreak right now in China, we are still actively quoting even in that marketplace.

Yeah. No, and I can add to that is that so ironically, what you read in the news and what we feel on the ground, in terms of our customer activity in China particularly is very different. So we do see on the back of our capabilities a lot of strong interest. Now, of course, that will start to have more material impact in the second half of the year and in 2021. But we're engaging across the board, across all these applications that I mentioned with the leaders in those segments that are really pulling for innovations. And so then it takes another, let's say, 12 months to work with those customers to really bring or sometimes longer, right, in case of medical, it might take 24 months or longer to bring these innovations to markets with our customers, but the opportunity is now. And so what I commented on in the in the prepared remarks is that, yeah, if you look beyond kind of the call it the short-term noise you see in multiple high growth markets that have structural growth dynamics for the next decade, or plus you see slots opening with leaders that we could do more business with and gain share in the next 24 months and we're acting very decisively and fast. And yeah, that might mean that short-term there – we're forgoing some profit potential, but long-term, we feel that puts the company in a really good position. So that's why we're doing it and then it's anybody's guess, quite frankly. I mean, our views are as of today, in terms of the scope and the length of the coronavirus, it's anybody's guess how long it's going to take. In the meantime, we're going to stay focused on what we can control, be focused on our customers. Our customers are telling us give us more, give us more faster and that's where we're acting on.

Got it, thank you. Hey, Robert, just to be clear, when you're talking about 60%, 20%, 20% what – you're comparing first quarter '20 to what, to the first quarter of '19. What was the 60%?

You're right, if you – year-over-year, so take the first quarter of 2020 to the first quarter of '19, 60% of the impact is the coronavirus and then 20% is R&D and 20% is variable comp.

Yeah. And that variable comp is up year over year materially because?

We didn't get paid out a bonus last year for all types of purposes.

Got it, okay. Okay.

Yeah, if you don't hit your goals, right, your comp goes down. That's how this thing works.

Yeah, I just didn't know how that plays out through the year if that was accrued through the year and why it was accruing year-over-year markets. It wasn't – I'll take up targets on a detail offline to make sure I've got it. Just one more question for now. So this is going to be – at least the beginning of the year looks to be pretty challenging. And then you've got these – it sounds like some incredible opportunities in front of you that start to be driven by new product introductions later this year and into 2021. And so given the momentum you're going to have entering 2021 and fairly easy comparison, it looks like on 2020, is there any reason why in 2021 you wouldn't grow above this long-term average growth rate expectation of five to seven.

Yeah, I mean, we're not sitting here commenting on with the 2021 guide because we even don't know what our first half of 2020 baseline is going to be to be perfectly frank, but yeah, I mean, listen, I mean, that's of course, what we were shooting for absolutely and beyond, right. So the new product introduction should have a much more material and significant impact in 2021 and particularly 2022 even. So it's a multi-year impact to the business we feel. And so yeah, I mean, and that's why we're investing because we see the next two years as being – taking control of our destiny by driving more growth through innovation and share gains.

Okay, and then in terms of the guidance for this year, for the full year, you're not – unless I missed it, you're not making any comment today regarding lower end is more likely or mid points more likely or any update in terms of that range, right.

I didn't want to get kind of specific around the range. We put a broader range out there knowing that there was some risk back in January and that risk is now materializing maybe a little bit more so than we anticipated. But I think I don't want to kind of get into any sort of updates on high low probabilities and all that.

Yeah. Let's see how this thing further develops and then we can get back with more specifics.

Yeah, it makes sense. Okay. Thank you very much.

Thank you, Rob.

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

Thank you, operator. So to summarize, in the fourth quarter of 2019 Novanta delivered a solid performance in a uncertain macro environment. We're very pleased with our positioning and performance in our medical businesses and proud of the performance and agility of our teams in a weak industrial capital spending environment. Our design win momentum continues to be high. New Product introductions and innovation pipelines are as strong as they've ever been. And Novanta's leadership position across diversified medical and advanced industrial markets, combined with our disciplined approach to M&A is providing a solid foundation for long-term sustainable, profitable growth. While the short-term outlook is uncertain with a health epidemic, we're investing into the headwinds and remain focused on the long-term growth drivers in our business and back to macro trends in industry 4.0, precision medicine and minimally invasive surgery. In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support and particularly grateful for the strong contribution and agility and execution of our teams of committed Novanta employees that are just showing tremendous dedication and agility. We appreciate your interest in the company and your participation in today's call. Very much look forward to joining all of you in several months on our first quarter 2020 earnings call. Thank you very much. This call is now adjourned.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Novanta's leadership position across diversified medical and advanced industrial markets, combined with our disciplined approach to M&A continues to provide a solid foundation for long-term sustainable, profitable growth. Therefore, we remain focused on our strategy to expanding growing medical markets that are not wavering in our conviction of innovation investments to expand our proprietary technology positions. So with that, I will turn the call over to Robert to provide more details on our financial performance. Robert?

Thank you, Matthijs and good morning everyone. We delivered 159.7 million in revenue in the fourth quarter of 2019, an increase of 2% year-over-year on a reported basis and the decline of 2% on organic basis. For full year 2019, we delivered 626 million in revenue, an increase of 2% on a reported basis and organic growth was positive 1% year-over-year. While the industrial capital spending environment and the economic climate in Europe and China remain weak, we are pleased with the organization's ability to deliver on our financial commitments for the quarter. The better than expected revenue growth was driven by strong growth in our medical business, and higher growth in new product revenue, which now represents 26% of our sales. Our medical sales were up mid-teens in the fourth quarter and full year. This was despite not seeing a meaningful contribution from the DNA sequencing market in the fourth quarter, and experienced roughly 10% decline for the full year. Overall, we're pleased with how we managed through the economic environment and with the strength and resilience of our portfolio. Turning to profit, our fourth quarter GAAP gross margin was 66 million or 41% of sales compared to 64 million or 41% of sales in the fourth quarter of 2018. For the full year of 2019 GAAP gross profit was 262 million or 42% of sales compared to 261 million or 43% of sales in 2018. On a non GAAP basis fourth quarter adjusted gross profit was nearly 70 million or 44% of sales compared to 67 million or 43% of sales in the fourth quarter of 2018. Full year of 2019 adjusted gross profit was 274 million or 44% of sales compared to 272 million or 44% of sales in 2018. For the full year of 2019, our…

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Lee Jagoda with CJS Securities.

Good morning.

Hey Lee.

Hey Lee.

So can we start with all the opportunities you're seeing in terms of new products and maybe give us some detail around the end markets and the product applications that are causing you to accelerate your R&D spend this year?

Yeah. Good morning Lee. I've commented on most of that in my prepared remarks, but let's go one by one. I mean, we see tremendous opportunity in our minimally invasive surgery end markets. I commented that we see opportunity in endoscopy as well as arthroscopy and robotic surgery within our minimally invasive surgery business. So that's a combination of our entire product portfolio in that segment, and that's a multi-year expansion opportunities that we see and I commented that that's roughly a $200 million market, adjacent market opportunity that we're currently not serving. Then in our Photonics segment, I commented that we are accelerating product introductions, particularly around beam delivery, but also in other parts over Photonics segment. So we're basically doubling the product introductions from three to six, six in 2020 that is. And those products will be introduced in the latter part of 2020 and will have more material impact in 2021. And we're basically seeing on the back of these innovations and that's both in Photonics as well as in minimally invasive surgery, extremely active customer engagements right now. And to win kind of slots, they're opening up in the next, say 12 to 24 months. In addition, we see on the back of our acquisitions, I've commented on that they have really – and that's across our entire portfolio. They've really helped to accelerate and rejuvenate our innovation pipeline, particularly around intelligent subsystems, so maybe one other thing to comment on is that we're very excited about the motion control capabilities that we've added last year that we see to be particularly targeted in robotic as well as industrial precision automation segment. So I think all in all, it's a pretty broad based set of opportunities. I think on the Photonic side maybe just to comment on the type of markets I realized I forgot to mention that is a combination of laser additive manufacturing, which is driven by both aerospace as well as medical end markets, rapidly growing market, where we feel we can gain share with our new capabilities micromachining which is building into the trend of automation on the back of laser based production technologies, let's say advanced converting applications, both textile as well as other converting based applications. And finally, an emerging opportunity for us, but obviously very relevant is electric vehicle battery welding. Yeah. So as demand increases in that market, for obvious reasons, more sophisticated production technologies are needed to get the throughput up and a cost per part down and those are typical trends that play into our favor with more precise, let's say technologies. And with the latest edition of both our acquisitions as well as our innovation investments we've made in the past, we are, yeah, we're very excited about playing a more substantial role into those markets.

That's great. And then just focusing in on the one business specifically, I think that business has been growing something in order of magnitude in the 20% range already driven by the adoption of the smoke evacuation stuff.

Yeah.

With further adoption of that, as well as the new market opportunities, how do we size the growth rate, call it from the 20% level over the next several years, does it accelerate from that level or just stay there longer?

Yeah, it's a great question. I mean, we have not specified that Lee, but I think giving you an order of magnitude of a $200 million adjacent additional market opportunity of course, we're not capturing 100% of that market. But it should give you a point of view that we're seeing expansion potential well beyond what we originally thought was possible. I mean, that business has fantastic innovation pipeline, very deep customer relationships and also capabilities that can expand into new markets. So their capability is not only around call it gas management and control, it's also around fluid management and control and, and that plays very well into, for example the arthroscopy market. So basically taking the capabilities, repackaging those and then targeting those capabilities into new markets, building off already strong customer relationships and that's a multi-year trend. And then as you know, medical markets are not moving very fast from kind of introducing new technology. So this you can expect and maybe it is a short answer, sustained growth in this business in the foreseeable future, multi-year.

Okay. And then just one for Robert and I'll hop back in queue. Do you have any goals that you're willing to share on working capital reduction for 2020 and then maybe just touch on the CapEx forecast for this year?

Yeah, so on the goals, I always find it hard to come out with like what our internal goals are around this stuff when we have not been able to demonstrate the amount of progress that we've wanted to achieve. So we are – what we've decided to do this year, is get a lot more specific around the inventory reduction. So we've deployed a problem solving techniques that we use and tools that we've used as part of the Novanta growth system to attacking inventory and we've deployed some additional corporate resources around that effort to really kind of attacking this in a very methodical discipline type of manner that gets reviewed on a monthly basis. And then to add that extra incentives, historically we've had incentive comp paid on overall networking capital managed and then this year we've decided to get very specific and tie a portion of it to just the inventory because the reality is we've done an excellent job from the inventories and accounts payable side, we've been able to control that more through process and disciplines over at a higher level basis. So now time the individual business units to really managing their inventory and bringing that down. That's a key element of our compensation structure as we get into 2020. So it is the driver of our cash flow going into 2020. So my hope is to get back to the normalized rates of where we were in 2018 as our cash flow conversion as a percent of EBITDA. If you look back at that that would be my desire to get there through that inventory reduction, and that's the biggest lever that we have. Now from a CapEx perspective, we do see CapEx ticking up temporarily in 2020. We've talked about that a little bit in the past. We had exited around $10 million in '19 that has a little bit of investments in facilities, but for the most part was spent on our production capabilities, some of the fit out of tooling and whatnot. This year, in 2020, that's probably going to get close to double, depending upon the timing, somewhere close to $20 million because we have a pretty sizable investment that we're making into a new facility in the UK. That facility is somewhere in the order of magnitude of $8 million to $10 million, so that's a one off that won't repeat thereafter. But it is something that we're expecting to impact us in 2020, as we fit that out and add some capability that I think is – that our competitors, frankly, don't have, and then give us a little bit more scalability in the operations there because we're seeing some nice growth come out of it.

Great, thanks very much.

Yeah, thanks Lee.

Our next question comes from Richard Eastman with Robert W. Baird.

Yes. Good morning.

Good morning Rick.

Hey, just a really quick clarification, Robert you had mentioned that the gross margin in the first quarter sequentially would be up or down 100 bps?

Up a 100 basis points.

Okay. Okay, perfect.

That's a good clarifying question.

Yeah, I'm thinking with the OpEx numbers that you tossed out there. It probably had better be up to cover some of that. And then Matthias just a question – a big picture question, as we roll into '20 here, the industrial portion of the business, which I think you said was maybe 45% of sales in '19. You made some reference to stabilization in the fourth quarter, perhaps some momentum, let's just ignore the first quarter here, but some momentum around the semi market, maybe 5G kind of driven. But how do you feel about potentially delivering some growth off of a pretty modest base for the 45% of the businesses industrial in 2020? Do you feel comfortable that we can potentially grow – return to growth there?

Yeah. Yeah, it's a good question, Rick. I mean, listen, I think that remark I made was around the fourth quarter prior to the coronavirus right. So let me be clear with that because it basically – with the coronavirus, a lot is up in the air, quite frankly. So, if you look at the fourth quarter, we saw China bouncing back at 15% on the back of 5G infrastructure and cloud based infrastructure and microelectronics markets in general, right. So and I don't think we have been any different than what other players are seeing quite frankly. So I think that's consistent with what others are seeing and so we saw that as well. And if you look at regionally for example, US was up and Germany was down, rest of Europe was actually doing – was hanging in there, of course anybody's guess what that will be with imminent coronavirus threats coming into Europe at the moment. I would suggest that let's say, yeah, from a Germany perspective, we expect that to be a little lackluster, particularly the first half. I mean, the original kind of idea and view prior to the corona virus is that macro economically the industrial markets would remain subdued in the first half and then we would return back to growth in the second half. It depends on the scope and the length of the coronavirus impact if that's going to change, but that that was the original viewpoint off of our guide and of course we have some modest, but nevertheless some impact of new product introducing in the second half of the year as well that should help that a bit.

Okay. Okay. And then just – I just want to follow up with a gross margin question. In the Vision segment of the business now we've got San Jose closed, we've got things – NDS integrated, I think there was a reference to 2 million of savings expected in 2020 there. And so when I look at, in particular within Vision, we've got kind of the self-help initiatives and we got volume growth. We've got the benefits of maybe some of the consumables internalization here later this year. But is 200 plus basis point improvement in gross margin in the Vision segment, pretty much a layup at this point; a right handed layup at this point?

Yeah. So I would say that the 200 basis points should be fairly easy, right from that perspective. We're obviously trying to drive more and the only real risk in the Vision segment to gross margin expansion is some sort of significant uptick in the medical consumables which create that negative mix effect. Absent that we are really – we have all the actions in place, the teams have all the actions in place and some stuff already done in the consequences of San Jose manufacturing closing down to really drive margin expansion in that segment, so we feel pretty good about that. We feel we got the right sort of levers already pulled to drive the expansion there.

Okay. And overall, the adjusted gross margin then, you're still feeling reasonably comfortable around 200 basis points for Novanta? I know we got a little bit of a hurdle here in the first quarter with volumes, but.

Yeah, so I would say internally we're looking at that second half being 46 plus percent. And I think that really is kind of based upon the first quarter being more of a temporary impact and then starting to recover as we get into the second quarter. Hopefully, people calm down with the flu here and we can get back to business and so that's really the big issue.

Got you, okay. Great, thank you again.

Thanks Rick.

[Operator Instructions] And our next question will come from Brian Drab with William Blair.

Hi, good morning. Thanks for taking the questions. Just first, following up on that last question around the one consumables, where are we with the prospect of getting that production and brought in house?

Yeah, so listen and we are tracking there. I think there is like with any multi-year transformational program and initiative there's some pluses and minuses. I think the pluses is that we've significantly strengthened the local teams and these teams are able to drive higher volume out of the existing facilities and infrastructure than we expected. So therefore, the overhead leverage and the productivity out of the factory, our own factory of existing products should actually be better than expected. And that gives us a little bit of time to figure out the best manufacturing footprint. As I commented earlier, we see the growth opportunity in the one business and minimally invasive surgery as well as the adjacent markets, I commented on very bright and as a result, it's important that we properly adjust our capacity and our footprint strategies accordingly with more new products coming in. So I think the short answer is we can get more out of the existing setup and that will drive gradual gross margin expansion. And the real step up in gross margin and step down and cost will happen in a few years. So we think it's around 2022, 2023 when – probably more likely 2023 when we put a more sustainable infrastructure in there, yeah. So what we will use in the meantime, all the aspects of the Novanta growth system to really drive and lean out the existing facility which again it looks more favorable than we initially expected.

Okay, got it. Thank you. And then just this dynamic of relatively softer than expected first quarter guide given the corona and soft environment, but the maintenance of the full year guide, can you just talked about what drives that and what results in pent up demand rather than demand destruction here and maybe from – if you could just discuss some of the – what you're seeing from some of your customers and are they having to push out their sales to second quarter and then you'll just support them in the second quarter and make up for it? How's that going to play out?

Yeah, so I want to tack in this a little bit with a tie. So when we look at the – if you look at the sequential or the year-over-year it's 60% of like the magnitude of the drop in I'll talk to EPS is really the coronavirus impact. This is a flow through of that impact and not taking the cost actions. What I would say, we normally would just say, okay, given that there's a reduction in volume let's adjust the variable portion of our cost structure to deal with that. Take the heads out, or furlough them or whatever that might be. We haven't taken that action and the guide in Q1 because we see that opportunity is really being very, very temporary. It's not something that we think is going to be structurally inherent in the business on a go forward basis but last a couple of quarters. When you look at the year-over-year 20% of it is also increasing of the R&D that's going up about a million, million and a half. And then the variable comp element is the other 20% impacting the SG&A line. So that's kind of the walk in the thought process around it. And what are some of the things that give us some positive, Matthijs – or some excitement, as Matthijs talked a little bit about the bookings, he talked a little bit about the design win activity, he talked a little bit about the new product introductions. We did exit the fourth quarter with growth in China and grow in a number of our markets, Germany being really the only one that was really disappointing. And then – but yeah, we're also seeing a significant uptick in the amount of quoting activity even in places like China where people are really looking at their next generation of platforms to drive their own growth in the second half of the year and into 2021. And that was something that we talked a little bit about the last quarter where people were willing to pick their heads up, they are now willing to pick their heads up and that activity is still ongoing. So despite the fact that there is a coronavirus outbreak right now in China, we are still actively quoting even in that marketplace.

Yeah. No, and I can add to that is that so ironically, what you read in the news and what we feel on the ground, in terms of our customer activity in China particularly is very different. So we do see on the back of our capabilities a lot of strong interest. Now, of course, that will start to have more material impact in the second half of the year and in 2021. But we're engaging across the board, across all these applications that I mentioned with the leaders in those segments that are really pulling for innovations. And so then it takes another, let's say, 12 months to work with those customers to really bring or sometimes longer, right, in case of medical, it might take 24 months or longer to bring these innovations to markets with our customers, but the opportunity is now. And so what I commented on in the in the prepared remarks is that, yeah, if you look beyond kind of the call it the short-term noise you see in multiple high growth markets that have structural growth dynamics for the next decade, or plus you see slots opening with leaders that we could do more business with and gain share in the next 24 months and we're acting very decisively and fast. And yeah, that might mean that short-term there – we're forgoing some profit potential, but long-term, we feel that puts the company in a really good position. So that's why we're doing it and then it's anybody's guess, quite frankly. I mean, our views are as of today, in terms of the scope and the length of the coronavirus, it's anybody's guess how long it's going to take. In the meantime, we're going to stay focused on what we can control, be focused on our customers. Our customers are telling us give us more, give us more faster and that's where we're acting on.

Got it, thank you. Hey, Robert, just to be clear, when you're talking about 60%, 20%, 20% what – you're comparing first quarter '20 to what, to the first quarter of '19. What was the 60%?

You're right, if you – year-over-year, so take the first quarter of 2020 to the first quarter of '19, 60% of the impact is the coronavirus and then 20% is R&D and 20% is variable comp.

Yeah. And that variable comp is up year over year materially because?

We didn't get paid out a bonus last year for all types of purposes.

Got it, okay. Okay.

Yeah, if you don't hit your goals, right, your comp goes down. That's how this thing works.

Yeah, I just didn't know how that plays out through the year if that was accrued through the year and why it was accruing year-over-year markets. It wasn't – I'll take up targets on a detail offline to make sure I've got it. Just one more question for now. So this is going to be – at least the beginning of the year looks to be pretty challenging. And then you've got these – it sounds like some incredible opportunities in front of you that start to be driven by new product introductions later this year and into 2021. And so given the momentum you're going to have entering 2021 and fairly easy comparison, it looks like on 2020, is there any reason why in 2021 you wouldn't grow above this long-term average growth rate expectation of five to seven.

Yeah, I mean, we're not sitting here commenting on with the 2021 guide because we even don't know what our first half of 2020 baseline is going to be to be perfectly frank, but yeah, I mean, listen, I mean, that's of course, what we were shooting for absolutely and beyond, right. So the new product introduction should have a much more material and significant impact in 2021 and particularly 2022 even. So it's a multi-year impact to the business we feel. And so yeah, I mean, and that's why we're investing because we see the next two years as being – taking control of our destiny by driving more growth through innovation and share gains.

Okay, and then in terms of the guidance for this year, for the full year, you're not – unless I missed it, you're not making any comment today regarding lower end is more likely or mid points more likely or any update in terms of that range, right.

I didn't want to get kind of specific around the range. We put a broader range out there knowing that there was some risk back in January and that risk is now materializing maybe a little bit more so than we anticipated. But I think I don't want to kind of get into any sort of updates on high low probabilities and all that.

Yeah. Let's see how this thing further develops and then we can get back with more specifics.

Yeah, it makes sense. Okay. Thank you very much.

Thank you, Rob.

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

Thank you, operator. So to summarize, in the fourth quarter of 2019 Novanta delivered a solid performance in an uncertain macro environment. We're very pleased with our positioning and performance in our medical businesses and proud of the performance and agility of our teams in a weak industrial capital spending environment. Our design win momentum continues to be high. New Product introductions and innovation pipelines are as strong as they've ever been. And Novanta's leadership position across diversified medical and advanced industrial markets, combined with our disciplined approach to M&A is providing a solid foundation for long-term sustainable, profitable growth. While the short-term outlook is uncertain with a health epidemic, we're investing into the headwinds and remain focused on the long-term growth drivers in our business and back to macro trends in industry 4.0, precision medicine and minimally invasive surgery. In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support and particularly grateful for the strong contribution and agility and execution of our teams of committed Novanta employees that are just showing tremendous dedication and agility. We appreciate your interest in the company and your participation in today's call. Very much look forward to joining all of you in several months on our first quarter 2020 earnings call. Thank you very much. This call is now adjourned.

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