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. 2020 Third Quarter Earnings Call. [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.

Thank you very much. Good morning and welcome to Novanta’s Third Quarter 2020 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. Before we start our normal quarterly results review, I would like to thank all Novanta employees for how they continue to step up in this challenging environment. We’re very pleased and humbled with the engagement and resiliency of our teams through the pandemic. It is great to see that the Novanta spirit is alive and that our culture has been a strong foundation to help weather this crisis. Now let’s move on to our normal quarterly results review. We are pleased with Novanta’s performance in the third quarter of 2020. Our teams continued to execute very well in the face of challenging circumstances and delivered above our expectations for revenue, profit and cash flow. Our company delivered approximately $143 million in revenue, representing a 7% year-over-year revenue decline on a reported basis and a 9% decline on an organic basis. We are especially pleased with how our teams continue to manage profit decrementals. Adjusted EBITDA was $30 million or 21% of sales in the third quarter, expanding 100 basis points versus 2019. Our teams delivered record free cash flow performance in the third quarter at nearly $40 million, up over eight times year-over-year at a ratio of over 475% of GAAP net income, reflecting the rigorous management of our operations and working capital. While Novanta is not immune to the impact of the pandemic, these results show that Novanta is well positioned to weather the COVID-19 pandemic and the resulting economic weakness. Our balance sheet is strong. Our innovation engine is strong. Our teams are secure and safe. And our portfolio is resilient as a result of our diversification across approximately 45 different applications, with exposure to long-term secular trends in robotics and automation, health care productivity and…

Thank you, Matthijs, and good morning, everyone. We delivered $142.9 million in revenue in the third quarter of 2020, a decrease of 7% year-over-year on a reported basis and 9% decline on an organic basis. As Matthijs already covered, despite the year-over-year decline, we were pleased with our sales performance in the third quarter, beating our own expectations and our previously issued guidance. To give some additional detail on our sales, 54% of Novanta’s total sales went into medical end markets in the third quarter. This was despite experiencing low double-digit declines year-over-year as a consequence of the deferral of elective surgical procedures and the deferral of high-throughput instrumentation for clinical and research-based laboratories. On a year-to-date basis, sales to medical end markets was approximately 56% of total sales. Considering the significant impact of these macro events, we are actually very pleased with the resilience of our business. We continue to see pockets of strength during the downturn such as our medical consumable business with integrated smoke evacuation and our integrated data collection products for clinical test equipment. Novanta’s sales to advanced industrial markets was 46% of total sales in the third quarter. In the third quarter, we experienced higher demand specific to investments in 5G, high-speed networking and cloud-based infrastructure as well as higher demand from EUV-based applications. This application area was up more than 50% year-over-year. We did see in the third quarter broad-based declines across the rest of our industrial end markets, which were down low double digits year-over-year. This was consistent with our expectations and what our industrial OEM customers are seeing in those same end markets. The industrial capital spending environment and the overall economic climate continues to face high levels of uncertainty due to the recent resurgence of the virus in many countries. But…

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

So just on the cost side, Robert, can you talk about your customer relationships and how those relationships have evolved, given everyone’s incurring more cost because of COVID? And are you able to get or have you seen relief either through just straight price increases or surcharges?

Yes. I think we’ve had some of that. We’ve been able to partner with them, and there’s been a recognition that the cost that we’ve been incurring is higher than what we would have normally planned for. And so there has been some sharing of costs that have helped mitigate and helped us to contain the overall impact of the pandemic.

And I assume those customers aren’t tired of that yet, and we should just kind of expect that to continue until it doesn’t? But hopefully, we get through it before it doesn’t.

Well, I think it’s fair to say that as long as those costs that are being incurred, that a partnership around those costs should continue to exist.

Okay. So then in terms of the costs that are still in the system or, I guess, the – let’s put it in a different way. How about the costs that are not – that you were taking out ahead of time? And you sort of that ad said there’s these costs that are out. And as volumes come back on, we’re going to put them back in. Can you talk about how much of that is still out of the system that’s yet to return versus the permanent stuff that got taken out? And maybe some of the timing on when we should expect to see that come back in.

Yes. So if you look at the fourth quarter, we’re going to increase our gross margins 100 basis points or more. Our operating expenses are also going to increase. And that increase in operating expenses is really a termination of some of the pandemic-related cost containment actions. So we’re not investing in more things. We’re not hiring more people. It’s really just we’re stopping certain actions such as furloughing. So it’s fair to say the majority of our cost actions were temporary. And that was largely on the basis that we thought the pandemic is temporary. We believe this is to be temporary and the implication of that to be temporary. And – but we are starting to look at some structural improvements to make into the business as we go into 2021 to ensure that if there’s some, let’s say, a longer cycle around the recovery that we can contain the actual temporary actions we took and take some structural actions to reduce our costs further.

Sure. And then just one more for me. Just Matthijs, in your prepared remarks, you mentioned a couple of new products and gave us a little bit of color around what they do. Is there any way for you to kind of size the market potential or opportunity around those products and when we should expect to see that potential start to kick in, in terms of your numbers?

Yes. I think we – for Photonics, we commented in the past that we see a market opportunity of about $100 million, upwards of that number. And of course, we don’t get 100% of that. But that over time, we feel we can, yes, eat into that adjacency for us. So that’s just to give you a perspective. And we’ve quoted also rough market size expansion opportunities for the minimally invasive surgery business, which is about $100 million, $150 million as well, I recall. So we’ve given – in the past, we’ve given those high level numbers. And yes, so those are things still – yes, still representative.

Okay, great thanks very much.

[Operator Instruction] And the next question will come from Brian Drab of William Blair. Please go ahead.

So continuing on the new product discussion. So do you believe that you’ll start to see the impact of that new product revenue in the fourth quarter and material contribution to revenue beginning in fourth quarter and in the first half of 2021 and to the point that, that really has an impact on accelerating organic revenue growth.

Yes. So I think in the – not yet in the fourth quarter. I think it’s fair to say it will be more pronounced in 2021 and 2022. I mean we’ve seen some delays with customers, right? Think about very complex systems that require hundreds, maybe thousands of engineers to introduce new platforms. Yes, there’s going to be some delays in introducing those types of products. But I think in the big scheme of things, we materially don’t feel that, that changes the thesis a bit, quite frankly. So there might be a little bit of a shift to the latter part of next year, but it will definitely be more pronounced around that time. And like I said, we continue to invest in those products. The products that we have launched have a good uptick, and the customers are now preparing their launches. And the timing of those launches, in some cases, are a bit delayed, but structurally, they’re not changing the growth potential of the company in the midterm. And it’s a little turn to comment on 2021, specifically.

Okay. And you said that you’re expecting sequential revenue improvement for the company overall. Does that apply to each of the three segments for the fourth quarter?

No. I mentioned in my prepared remarks that the Photonics segment will see the larger uptick on a sequential basis and that Vision and Precision Motion will be largely muted.

Muted, I would translate to about flat sequentially, but how are you thinking?

About flat, yes. It might be a – the bigger element is the Photonics element will see – the segment will see the bigger increase.

Okay. Can you talk just – and this is my last question for the call here, but the Precision Motion segment, there’s some good data out of the semiconductor market. And I’m wondering if you can talk us about your opportunity more broadly in the robotic surgery market. And then there’s clearly some recovery in industrial activity. Can you talk about why maybe we’re not seeing more of a rebound in the near term sequentially into the fourth quarter in Precision Motion?

Yes. Well, first and foremost, the Precision Motion as a group is growing 9% in the quarter, right? So there’s nothing to sneeze at, I would say so, in this environment. So – but separately, I think on the robotic surgery, I think we stated in the prepared remarks as well that you see the procedures returning to about 90% to 95% of normal on procedure, sometimes even growing that doesn’t mean that the capital investments from the hospitals are yet happening. So what we’re seeing is that’s actually being delayed, and it looks like growth will not return in the capital piece of surgical robotics until the latter part of 2021. Yes, again, the application has multiple benefits. So hospitals do want that equipment, but they first need to get back their procedure volumes so they can generate the cash so they can actually avoid – afford spending capital. So that’s kind of what we’re seeing on the robotic surgery side. In the meantime, though, we are gaining share in design wins in multiple platforms. So when that market rebounds, we’re in an extremely good position, right? So it’s just a timing thing there. And then on the – what was the other question? You had another question.

I just mentioned the semiconductor.

Okay. One caveat on the – on medical robots. If it’s a surgical-based robot, that tends to be true. There are lower-priced robots being implemented in the hospital environment that we are seeing some growth. But those are relatively new entrants into the marketplace and will take a little bit of time to build the proper traction to offset the overall growth that you see on the surgical side. On the semiconductor, we are seeing growth in elements of our portfolio there. So we are seeing it in the investments being made into G infrastructure and cloud storage. We are seeing it in EUV-based applications. We have not – as you know, we have not overly emphasized our applications within the semiconductor marketplace. And so it’s not an area that we would expect to see driving the overall growth of this company. It is an element of growth, and it’s been benefiting us in the third quarter. It will benefit us in the fourth quarter, but it won’t be oversized to the point that will drive the overall growth of the company.

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 wrap it up and to summarize, in the third quarter of 2020, Novanta delivered a solid performance in an uncertain macro environment. We’re 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 the pandemic, but we’re 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, health care productivity and precision medicine. Despite an uncertain short-term outlook with the 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 1.4, 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 of our teams of committed Novanta employees. They are showing tremendous agility and resilience during these 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 on our fourth quarter and full year 2020 earnings call. Thank you very much. This call is now adjourned.

The conference has now concluded. Thank you for attending today’s presentation. And you may now disconnect your line.