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.’s Fourth Quarter and Full Year 2020 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 fourth quarter and full year 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 am 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 review of the company’s results, I would like to thank all Novanta employees again for everything they are doing to deliver to our customers. Our operations teams are doing a great job in being agile in this environment, and I admire how our R&D teams are finding creative ways to bring innovations to market, all while maintaining a relentless focus on keeping our teams safe. It’s great to see that the Novanta spirit is alive and that our culture has been a strong foundation to help weather this crisis. We take great pride in knowing that our mission-critical technologies are embedded into diagnostic and antibody test equipment, detecting COVID-19; into ICU and patient monitoring equipment used in hospitals to help in the fight against the pandemic; or in DNA sequencing equipment, helping to detect and monitor new virus variants. Now let’s move on to our normal results review. I will focus my remarks on the overall company, and Robert will speak to more specifics on the segments and then our overall financial results. We are pleased with Novanta’s performance in the fourth quarter of 2020. Our teams executed very well in the face of challenging circumstances and delivered above our expectations for revenue and profit with record cash flows. Our company delivered approximately $147 million revenue, representing an 8% year-over-year revenue decline on a reported basis and a 10% decline on an organic basis. For the full year of 2020, we delivered $591 million in revenue, which represents a year-over-year revenue decline of 6% on a reported basis and an 8% decline on an organic basis. We are extremely pleased with how our teams drove exceptional operating performance throughout the year using the…

Thank you, Matthijs and good morning everyone. I’ll start by giving some details on our operating segments, starting with the Vision segment. This segment predominantly serves the medical end market and saw a revenue decline of 9% year-over-year in the quarter. The book-to-bill in our Vision segment in the fourth quarter was 0.92. Our large medical OEMs experienced a temporary pause of demand corresponding to the rise in COVID hospitalization rates and the resulting deferral of elective medical procedures. Clearly, this is a temporary impact, but we anticipate this will put pressure on the first half of this year. However, the vitality index of this segment remained above 30% of sales with new products being a key driver of the resilience we have been seeing in this business unit. Within the Vision segment, we continue to see solid sales from our smoke evacuation technology and from the associated medical consumables offering. Smoke evacuation continues to be in high demand in today’s climate with medical staff around the world demanding safe, COVID-free work environment during laparoscopic procedures. We remain very excited about the continued progress with this product offering and continue to see this platform as a long-term growth opportunity, particularly as we work with a multitude of customers on their next-generation platforms. We are also very pleased with our Detection & Analysis business, which continued fantastic performance in the fourth quarter. This business unit predominantly serves the diagnostic testing and patient monitoring markets with RFID, barcoding and machine vision technologies. This business benefited from the rapid uptake in PCR molecular testing as well as patient monitoring equipment purchases tied to the pandemic. Turning to our Precision Motion segment, this segment saw a 6% growth in revenue in the fourth quarter of 2020, bookings growing 50% sequentially versus the third quarter…

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

Hi, good morning.

Good morning, Lee.

So starting with the new product introductions and sort of the cadence of those this year and next year, how should we think about that in terms of additions to organic growth? And obviously, COVID will impact the organic growth in terms of a catch-up in 2021. But given that these new products don’t usually hit revenue for, call it, 12 to 18 months after launch, kind of putting COVID aside, shouldn’t that accelerate your core organic growth in 2022 and 2023 versus what it’s historically been just given the ramp of these new products?

Yes. Thanks, Lee. Yes, we’re very excited for the launches we’ve lined up. And as I mentioned, it’s approximately 25 different products that we’re bringing to market. And these products are spread nicely across our 3 segments with some significant opportunities in beam steering, machine vision, motion control, integrated OR technologies. And so while we’re not going to specifically quantify the amount of 2021 sales, I’ll repeat what we said in our prepared remarks that we feel these launches will contribute to the overall trajectory of the company starting in 2021 and beyond. And so like you said, it’s important to keep in mind that with the normal product life cycle of capital equipment, that year 1 of any launch is typically smaller as the OEMs start to see the market and then gradually ramp up production. So you’re right that from that NPI perspective, the larger contribution in sales is more often seen in year 2 and beyond, right? So – and we expect that our launches this year will follow a similar pattern. So yes, while these launches contribute to our growth, the more significant opportunity indeed will become visible in the outer years. That’s – we agree with that, but we’re not going to be specific at this stage on the amount.

Okay. One more on new products and I’ll hop back in and let others ask some. But in terms of the product – the new product portfolio that’s coming, can you talk to sort of the percentage of products that are geared towards subsystems versus components? And maybe speak to how the percentage has shifted towards subsystems over the last couple of years. And if you could maybe speak to the margin differential between a component and the subsystem that you guys would sell.

Yes. Yes. So heading into, let’s say, the COVID pandemic, what we commented on is – so pre-COVID, call it that way, we commented on that 30% of our revenue was originating from intelligent subsystems, and that’s up versus 5%, let’s say, in 2016. So we’ve gradually increased our exposure to intelligent subsystems. And yes, I’m not going to get into specifics in terms of the exact percentages of the NPI, but there is a large chunk that is geared towards intelligent subsystems, particularly around beam steering, but also other things we’ve commented on. So strategically, Lee, you’re correct that, that is where we’re gearing a large chunk of our investment dollars because we see the opportunity there. And we also – I think we’ve said in the past that we expect gross margins to be accretive in those intelligent subsystems.

And I lied because I have one more based on that answer. Just would you have a long-term target for percentage of revenue from intelligent subsystems if you were at 30% today or 30% pre-COVID versus 5% in 2016?

Yes. Also there, we have not given a number, but it will be – our target is to be substantially higher than that 30% for sure.

I would say, Lee, it’s also part of the path to – we have a multitude of levers that we can pull. But as we migrate more and more new products into the marketplace and migrate into more intelligent subsystems that helps us get to the ultimate target of 50% gross margins.

Sure. That makes sense. Thanks very much.

Alright. Thanks, Lee.

The next question comes from Richard Eastman of Robert W. Baird. Please go ahead.

Yes, good morning and thanks for the questions. Just a quick question around the gross margin in the Vision business, could you just maybe dissect that just a little bit and speak to maybe the opportunity there from a cost standpoint versus a mix standpoint as we move forward?

You mean why were the gross margins lower in the segment or not really?

Yes, that’s a more straightforward question. But I guess I’m – yes, I’m kind of thinking about just the benefit here as we see elective procedures start to pick up. Is that volume going to be significantly incremental to the gross margin? Or just maybe talk about the opportunity set in Vision from a gross margin standpoint. What’s volume driven versus mix driven?

Yes. So I would say that the majority of the gross margin expansion that occurs in this segment will be less from a volume uptick and more from some of the cost actions that we’re taking as well as driving additional leverage in our consumables production. So I think the combination of those things really kind of drive the gross margin expansion in 2021. From a volume perspective, this is – it’s fair to say that elective procedures will be a little bit weaker in the first half of the year they will be stronger in the second half of the year. And so we wouldn’t necessarily bank on that for our gross margin expansion.

Yes. Yes. And if you think about – Matthijs, I know you’re not going to speak specifically to any kind of revenue guide. But if I think about ‘21 here, I look at Photonics and some of the momentum there and certainly Precision Motion and the momentum there. Vision – would one expect Vision – the Vision business to be kind of a plus mid-single-digit type of revenue growth in ‘21 with, again, some headwinds in the first half, but the second half rebounding more strongly? Or – because you’re going to get a fair amount of gross margin leverage out of the growth rates here between segments, I presume, in ‘21.

Yes. Well, there is multiple things at play, of course, Rick, right? So you have some tougher comps potentially at the medical consumable side and the – also the diagnostic equipment side, yes? But then – of course, then the positive is you have a recovery in the markets, as you suggest, in the second half of the year, and that’s going to be a positive. So how exactly that play out in kind of the overall segment, yes, we’re probably not prepared to comment. But I think the overall drivers that you’re highlighting, we agree with. And yes – and then on top of that, we have, in the second half, some momentum from new products as well that hopefully will further support that acceleration in the second half. So yes, definitely, to Robert’s point, a stronger second half and a bit of choppy waters in kind of medical markets in the first half.

Okay. Okay. Fair enough. And just my last question. Robert, when we think of the OpEx here in the first quarter, just when you load the incentive comp in there, the options, expense number, does the first quarter represent a reasonably kind of straight-lined operating expense number for the balance of the year? Or is there some loading issues there around the first quarter being bigger or smaller than...

Yes. The first quarter would generally be a little bit bigger than the preceding quarters, and that’s mostly tied to some of the taxes that are paid out as well as the loading of the incentive comp schemes. But I would say that it will tick down a little bit as we get into the second quarter, not – mostly in SG&A perspective. That’s probably the way you should think about it.

Okay. Okay. Fair enough. Great, thank you.

Alright. Thanks, Rich.

The next question comes from Brian Drab of William Blair. Please go ahead.

Hey, Brian.

Hey, good morning. It’s Brian Drab. The first quarter guidance obviously indicates a nice sequential improvement. Can you – and I don’t know if you did say, but should all 3 segments improve sequentially? And I guess that implies still maybe a year-over-year slightly down in maybe Photonics and Vision year-over-year and a pretty strong year-over-year growth rate in Precision Motion for the first quarter. Is that right?

Well, we didn’t get that specific. What we said was Photonics and Precision Motion would certainly continue to trend upwards. You’ll see the result of that, obviously, in Precision Motion is that it will demonstrate some year-over-year growth in the first quarter. In the case of Photonics, without – if it’s going to trend up, I don’t want to get kind of too specific, it can trend itself into growth as well. The Vision segment is where there will be some challenges. On a year-over-year basis, you could actually have a little bit better top line on a sequential basis, but the reality is, on the year-over-year, it’s going to be a tough comp.

Right. Okay.

Recall that in the first quarter of last year, there was quite a bit of, I’d say, pull-in but pull-forward from – just to secure the supply chain, particularly in the Vision segment. So these comps are a little tougher.

Right, right. Yes. Okay. Yes. Thanks for that reminder. And then as you move through the balance of ‘21, and I hesitate, I guess, because you will probably just say we’re not guiding here, but it sounds though like from what we’re talking about is sequential improvement is the expectation, though, across the three segments as you move through ‘21. Am I kind of connecting the dots correctly there?

Well, I think what we’re saying is the business will – from a growth perspective, the overall company will continue to get better. So as we migrate into the second quarter, you’ll start to get into organic growth profiles again, and I think the gross margins will also continue to perform. So I think there is a lot of positives from a demand environment, there is a lot of momentum that we have in the Novanta Growth System on some of the programs there. The one caveat which is why we’ve kind of steer clear of the full year guide right now is that the disruptions in logistics continue to stay with us and then the electronic material shortages. Now we are working hard to counter that and including understanding where the potential risks might lie and then pre-buying or building up safety stock of any sort of parts that we are worried about. But those are disruptions that we need to plan on in the first half of the year and just get ourselves better – get a little more confidence around that, I should say, before we go out with a full year comparison. So it’s not a demand perspective that we have right now. It’s just more dealing with the hand-to-hand combat around buying the right materials and getting the product out to our customers without any sort of logistic disruptions.

Right. Okay. And then just the last question around M&A, with the market where it is and where valuations where they are, I’m just wondering, are you seeing still a pipeline of opportunities with reasonable valuations that you can execute on? Because I would imagine some of the companies that were in your pipeline 18 months ago, like those same companies probably have 2x to 3x the valuation that they had just given what’s going on in the market?

Yes. I mean, listen, we’re actually very active in terms of discussions, and we have a strong pipeline of opportunities, which we feel has good potential. Yes, you’re right that we, of course, see, in some cases, valuation expectations to be high. And the market overall, you can characterize as maybe hot. And so it’s really important to stay disciplined and focused in where you want to move and where you maybe need to pause and wait. The other thing that I would say is, of course, yes, corporation and diligence efforts are not necessarily straightforward in this environment, right, because you cannot meet easily face-to-face. Now we are using and we are evaluating all kinds of creative ways on how to keep progress in these cultivation efforts, but yes, so that’s another note to keep – yes, to keep in mind. But overall, Brian, listen, I think, yes, we feel good about the amount of conversations we’re having versus the, let’s say, what is it, the first part of last year. So you clearly see intensity increasing. It remains a top capital allocation priority. But you can also expect us to stay very disciplined in this environment so that we can meet our return surplus, right? So it’s – so yes. So nothing necessarily different from, I think, our approach we have shared with you in the past.

Okay. Thanks very much.

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

Thanks, operator. So to summarize, it’s fair to say that the year 2020 was an unprecedented year with the global pandemic causing a significant economic downturn. We’re pleased to see early signs of markets rebounding and the economies of the world beginning to return to growth. Despite this very difficult macro environment, Novanta delivered a very solid performance. We’re extremely pleased with our positioning and performance of our portfolio. I’m proud of the performance and agility of our teams. Novanta’s balance sheet is strong. We have an exciting innovation pipeline. Our portfolio is diversified with exposure to long-term secular macro trends that we’ve shared with you before, such as robotics and automation, precision medicine, minimally invasive surgery and Industry 4.0. And we continue to invest in our innovation pipeline and are very excited about the record number of product launches that will be happening in 2021, which we believe will contribute meaningfully to our growth trajectory this year and beyond. So 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 such tremendous agility and resilience during these difficult times. And 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 first quarter 2021 earnings call. Thank you very much, and this call is now adjourned.

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