Good morning. My name is Chuck, and I will be your conference operator for today. At this time, I would like to welcome everyone to Novanta Incorporated 2020 First 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. Please go ahead, sir.

Thank you very much. Good morning, and welcome to Novanta’s first quarter 2020 earnings conference call. I’m 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 have 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 also 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. I hope all of you and your families are healthy and safe. Before we start our normal quarterly results review, I would like to first talk about the topic on everybody’s mind which is the COVID-19 pandemic. I want to take a moment to thank our employees, our customers and our suppliers all of whom are making extraordinary efforts to maintain supply of our mission critical products to the people who need them most. I have been extremely impressed and I could not be more proud of how my colleagues around the world have stepped up and pulled together in the face of adversity. Obviously, the world has changed dramatically since our last earnings call. Novanta is not immune to the impact of the pandemic but we are well positioned to weather the COVID-19 crisis. Our balance sheet is strong, our innovation engine is strong. And our portfolio is diversified across 45 different applications with exposure to long-term secular growth trends in robotics and automation, healthcare productivity and precision medicine. In a high uncertainty climate like this, we feel it is best to stay focused on what we can control and what we have invested in over the years. Our employees, our culture and delivering mission critical technologies to our customers. Our four guiding principles in managing through the pandemic follow this focus. One, keeping our employees, their families and our community safe. Two, ensure business continuity for our customers. Three, ensure a bright future and emerge out of this crisis stronger. And four, deliver values. Let me dive a bit deeper in each one of these. First a primary goal at Novanta continues to be the safety and wellbeing of our employees, their families and the communities…

Thank you, Matthijs. And good morning everyone. We delivered $155.5 million in revenue in the first quarter of 2020, a decrease of 1% year-over-year on a reported basis and a decline of 4% on an organic basis. As Matthijs already indicated, demand in the first quarter ended up being slightly better than we previously guided largely under the basis that some of our customers were concerned with disruptions in supply chains, and hence requested early shipment of product to build finished goods safety stock to weather the pandemic. In the first quarter, our revenue continue to shift more towards our OEM customers who serve medical end market. Sales to these end-markets rose to 58% of total sales and increased by 6% year-over-year in the first quarter. This was despite a double-digit decline in the DNA sequencing market in the first quarter. Key end-markets have performed well include our medical consumables business with integrated smoke evacuation and our integrated RFID and barcoding products. We also saw continued strong growth in new products introduced into the medical end-markets such as our new integrated OR Informatics products. The industrial capital spending environment and the overall economic climate saw declines, as evidenced by the latest PMI trends. Novanta’s sales to all industrial markets was 42% of total sales and declined 10% year-over-year in the first quarter. The decline was broad based across the majority of industrial end-markets, with many seen high double-digit declines which is consistent with our expectations and what our industrial OEM customers are seeing in those same markets. One area we are seeing increased demand is with our semiconductor microelectronics customers based on the adoption of 5G, high-speed networking and cloud-based infrastructure. This market is still are a low-single digit decline in the first quarter. But that is a significant improvement…

Thank you. We will now begin the question and answer session. [Operator Instructions] And our first question will come from Lee Jagoda with CJS Securities. Please go ahead.

Hi, good morning.

Hey, Lee.

Hey, Lee.

So I really appreciate you trying to give us a shape for the year in terms of Q3 likely being the worst of it from a revenue perspective. From a gross margin perspective, typically, your margins have been driven more by product mix versus overall volume. Can you talk about the current expected mix and how that might impact your gross margin? Understanding that a lot of the incremental costs from COVID probably hit the cost of goods sold line.

Yes. So that would be the larger variable that it would be impacting the gross margins as we get through the year. So it is relatively small in the first quarter, as I talked about, about 300,000. But as we get into the second and third quarter, or at least in the second quarter that could be upwards of 10 to 20 times higher than that. So, it is a significant headwind that we need to still kind of work our way through, which is the variable that really prevents us from going out there with any sort of build guidance on the profitability side. The gross margin in the first quarter generally lower. We would hope to improve from here we are focused on driving the performance of the business to maximize our EBITDA. You can’t do that through operating expenses alone. And so we do anticipate driving gross margins in order to achieve our goal here of maximizing cash flows and EBITDA. To get into specifics I would rather not just because there is just too many variables right now that are outside of our control.

That is fair. And then switching gears to R&D. Has the R&D budget in dollars changed versus prior expectations? Or should we just think about it as the same dollars you are looking at spending to kind of capture some of these opportunities. And it will just end up being a higher percentage of current sales?

Yes, Lee, this was Matthijs. I mean directionally, as I commented in the prepared remarks. I mean, all our NPI programs are actually on-track, despite people working-from-home as well as our customers working-from-home. What we do see is that the mix of programs might shift around a little bit in terms of priorities, because for some customers are actually accelerating, some others are delaying. And so I would say as an aggregate, we are shooting for a similar amount. Being at that the mix might slightly change and we have also intensified our focus on what we call priority programs given let’s say that certain markets are expected to have more tailwinds and others in this climate.

Sure. And then one last one and then I will hop back in queue. You are one of the few companies that is out there continuing to pursue acquisitions in this market. What are you seeing from a I guess a price a competition and then probably more importantly, a seller willingness perspective at this point?

I would just say Lee I mean, overall, I mean, acquisitions are and remain a vital part of our strategy and our capital allocation in the Company. And we do feel that this climate is going to create opportunities for M&A. But, you also I’m sure seeing this elsewhere that that the first half of the year we will not expect much activity, basically for two reasons. One is we want to be make sure that we stay focused on our own company health and our employees and until the pandemic stabilizes a bit. And second, sellers are also in pause mode right now for essentially the same reasons right. But we expect that as the year progresses, that there will be more openness from sellers to consider potential transactions. And one of the major reasons that we why we switch to pursue the actions to reinforce our liquidity position as Robert mentioned, including the additional capacity of our credit facility is to be ready to take advantage of the M&A markets, right. So when an opportunity arises, you can expect us to aggressively lean in during the second half of 2020 and 2021. So, we are staying very active yet disciplined in the M&A space, that is a way to characterize it.

Okay. Thanks very much.

The next question will come from Richard Eastman with Baird. Please go ahead.

Yes, good morning Matthijs and Robert. Thank you.

Good morning Rick.

Matthijs just to maybe think through the three platforms. And again, we are impacted here with the 60 to 90-day lag. But including new products that you hope to ship in the fourth quarter expect to ship in the fourth quarter. How would you look at the cadence of improvement among the three platforms, photonics vision and precision motion? Slowest to recover and kind of -.

Yes. It is a tough question, Rick. Let me just answer it directionally in terms of the overall markets and kind of market based and then not necessarily in the tree platform space. I’m just so basically what we will be setting our prepared remarks is that, our medical markets, which are close to 60%, of current sales, of course are impact a tour current. And you see our customers being impacted pretty materially in their second quarter. We expect that to be a third quarter event for us. Yes, but we also as we speak, you see actually hospitals reopening. And so we do expect that hospital procedures to recover at the end of the second quarter and into the third quarter. And as you will first see, basically medical consumables picking up as a result. And then followed by capital equipment as hospitals are first want to generate let’s say cash flow with procedures. So that is kind of at a high level from kind of a surgical perspective. 70% of our medical business, and our customers are based on the elective and emergency procedures in endoscopy robotic surgery or fluoroscopy and ophthalmology, right. So we will follow I think a very well articulated trends that our customers have reported on. There is a smaller market of ophthalmology that is slightly different. It is not the super high percentage of our revenue and ophthalmology is of course, eye doctors and I surgery. 50% of that market is private practice based. So that will that will follow a different trajectory kind of similar to dentist offices and so much. So that is the only exception I would say to the trend of elective procedures. If you then look at the remaining part of the medical business. It is primarily…

No. That is very good. You have a pretty good model, but I don’t actually model the 45 different demand curves. So, I tightened that up a little bit.

Yes, you do.

Just want one last question. Robert, your comments about the COVID related expenses of 300,000 in the quarter, and maybe that spikes to three million to six million in the second quarter. Is that being absorbed in the cogs line?

Yes. Predominantly in the cogs line. It would be between like $3 million and let’s say $4 million, I think. It is really where we kind of end up a few percentage points of the total revenue. And then what portion of that kind of gets recovered remains to be an open question meaning, being some of that cogs is likely absorbed by our customers. But it is what we are seeing in terms of like, higher costs associated with logistics, sometimes that is paid for by the customer, which is an advantageous situation. And then there are situations where we have a higher decontamination cleaning or higher PPE cost and whatnot. So, we are trying to manage that as best we can and we are also looking at sharing some of that costs with our customers.

Okay, alright. And does that $3 million to $4 million, is it going to be kind of a quarterly run rate, does that carry into the third?

Well, it is really it is tied mostly to disruption, from the lockdowns and the disruptions in the airline industry, specific around how you move freight to and from location. So, to the degree of lockdowns begin to let up and the restrictions begin to ease and things begin to normalize doesn’t need to normalize that much frankly but just needs to normalize more than the costs begin to fall back off. So no, I don’t think it is something that will go with us for the remainder of the year, absent some sort of resurgence of the pandemic in the back half of the year. So, I think it is something that is definitely temporary, for us to deal with and moving stuff around in particular down in the United States, but with our supply chains spread out globally, dealing with how to get product out of countries is sometimes in an expensive endeavor.

Got you. Okay, great. Thanks again for the questions.

Yep.

Our next question will come from Brian Drab with William Blair. Please go ahead.

Hey good morning. Thanks for taking my question.

Hey good morning Brian.

Can you just in spirit of housekeeping here the small questions, but you have an idea for us how much was pulled forward from the second quarter is it hard to parse that?

It is hard to parse it out, but you know, we gave a range and we beat the range a little bit and I think, why we came in, beating the range and is more as a consequence of that. Again, I made a comment on as we looked at that second quarter, you know our demand profile would say we are at the upper end of that range. Meaning that the bookings are there, the support is there, backlog is there to deliver on that upper end of the range. We provided a broader range, because, it is sort of what I just comment with Rick. There has been a lot of disruption on moving product around, logistics, getting products in and out of countries. And then sometimes with some of our customers, they have had a COVID case in their factory and have shutdown the factory. And we get caught in that in between a stage where we can’t ship the product out to them. And so it is really kind of taking that into account. So if you think about it from that context, if you even out those two quarters a little bit more maybe that is a better perspective on the overall demand.

Yes, I think that is a good way to look at it. And the other thing that I would say, Brian is that yeah. I mean again our book-to-bill was 1.06 for the first quarter. We typically comment on that on average it is going to be - you can expect that to be one. I mean, certain quarters can swing around a little bit. But if then look into the three segments, you basically see that precision motion and vision had book-to-bills of higher than one in photonics of about one actually 0.99. So that is another clue on where and how much of kind of maybe a pool forward that we saw. But I think what Robert is saying is right, you just need to look at the kind of those two quarters combined to kind of really make your judgment.

Okay, thanks. Now that is really helpful. And then, can you talk a little bit more about the business that may have arisen specifically from the outbreak? You talked about some of the COVID related testing, you mentioned some other categories. Is this revenue related to the crisis activities meaningful and some of it is sustainable and creating new long-term opportunities for the Company.

Yes. I mean that is a question right? We feel let’s say first and foremost, we are extremely excited about the smoke evacuation insufflator technology we have. Even pre-pandemic we commented on this because we feel with eruptive technology where we are the technology leader. We see penetration in adjacent markets, including robotic surgery. So pre-COVID, we commented on that this is a multiyear growth engine for us. And as a result, we are stepping up our investments in this area. And now during COVID-19 and as we are in the middle of this crisis, I mean what customers are telling us and actually hospitals is that staff is demanding the smoke evacuation technology because it basically guarantees it filters out CO2 gas that comes out of the patient right. So it is a way to keep medical staff safe. And you could kind of understand that this might become a part of a requirement and actually there are independent medical bodies that are highly recommending or even strongly suggesting that this should become a standard part of care going forward. So there are signs that this type of category might be here to stay and actually that that becomes part of a new normal. Now on the other hand, of course, you see demand on patient monitoring and ICU related equipment that particularly is related to COVID-19. That we feel is more temporary. Of course countries will increase their strategic stockpiles of ICU capacity and maybe that has some positive field, but we are not going to count on that. So, I would just say that that has helped, basically the way to think about it in the diagnostics and ICU business and detection and analysis business that has helped to stabilize the business as the large chunk of…

Okay. Thanks for all that detail. And just one more question. I have in my notes and I can’t remember, specifically or an impression that have. The first quarter we are expecting about 33 million in SG&A, you did about 31 million. And I was just wondering if you can give us any insight into - I know, you mentioned some cost cutting in limiting costs, but what part of that discrepancy between my estimate and what you ended up doing was related to cost cutting and kind of what should we expect for the run rate going forward, including the stock count that you mentioned?

Yes. I mean, obviously, I know you want to fill out your model, but I want to be -.

Directionally it is all I would expect. Yes.

So like, there is a cost cutting that we have done. It was most of those actions started at the end of March and therefore benefit of on a Q2, Q3 basis. So will SG&A step down as we get into the second quarter, most likely, as the consequences some of the cuts in discretionary spending, some of the reductions in travel and the bands around that as some of the reductions in compensation expense. Offsetting that would be the grant, but for the most part, you should expect it to tick down a little bit.

Okay. Thanks and I will just mention too, I think the issues with that grant was really a brilliant idea. It is great move for the company too.

Thank you Brian.

Yes. We agree. Thanks Brian.

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

Thank operator. So to summarize, in the first quarter of 2020 Novanta delivered a solid performance in an uncertain macro environment. We are very pleased with our positioning and performance of our portfolio and proud of the performance and agility of our teams. Novanta is not immune to the impact of this pandemic, but we are well positioned to weather the COVID-19 crisis. Our balance sheet is strong, as is our innovation lineup. And our portfolio is diversified with exposure to long-term secular trends in robotics and automation, healthcare, productivity and precision medicine. While the short-term outlook is uncertain with a health pandemic, we are investing into the headwinds and remain focused on the long-term growth drivers in our business on the back of the macro trends in industry [Indiscernible], precision medicine and minimally invasive surgery. In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support. I’m particularly grateful for the dedication and strong contribution all of our teams have committed and Novanta employees that are showing tremendous agility and resilience during these unprecedented times. 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 in the second 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.