Good morning. My name is Judith, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Incorporated 2019 Second Quarter Earnings Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Ray Nash, Corporate Finance Leader.

Please go ahead..

Thank you very much. Good morning, and welcome to Novanta's Second Quarter 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 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. Novanta performed well in the second quarter of 2019, delivering on both our revenue and profit promises to our shareholder. Our company delivered $155 million in revenue, representing 4% year-over-year revenue growth on an organic basis and 3% on a reported basis.

Our adjusted earnings per share was $0.54, which was up 6% from $0.51 last year. Adjusted EBITDA was $31 million. Our team executed very well in a deteriorating industrial capital spending climate. 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 in secular growth applications such as robotic surgery, minimally invasive surgery, DNA sequencing, advanced material processing and precision automation and robotics.

In the second quarter, we continued to see solid momentum and success in our efforts to introduce new innovations to our customers.

To date, we have introduced 3 RFID products of the 5 planned this year, launched a new integrated OR product with a large medical customer, expanded into multiple new robotic surgery platforms and see tremendous momentum with our latest insufflator products with smoke evacuation functionality.

New product revenue year-to-date grew over 30% year-over-year. Our vitality index, which is revenue from new products launched in the last 4 years, in the quarter exceeded 25% of sales for the first time versus mid-single-digit percentages a few years ago.

Our year-to-date design wins increased by over 20%, and we are expecting accelerating design new momentum in the second half of 2019.

All in all, I'm proud of the strong performance by our team in the second quarter as we continue to see the early benefits of implementing our Novanta growth system, driving sustained long-term growth and operating performance. An important element in our capital deployment strategy is M&A.

In the second quarter, we saw opportunity to accelerate our strategy of expanding into intelligent subsystems with proprietary technologies. We closed 2 tuck-in acquisitions, Ingenia and Med X Change in the second quarter, and we just closed the third one, Arges. Let me touch on each of them briefly.

In the last earnings call, we already reported on the small tuck-in technology acquisition of Ingenia. Ingenia provides OEM customers with intelligent motion control solutions on high-performance, high-power servo drives.

The acquisition of Ingenia's GaN-based motion control solutions is a strategically important step forward in developing and selling intelligent subsystem solutions through our precision motion customers in precision robotics and automation applications.

The Ingenia team is phenomenal, and the reception of Novanta's customers through Ingenia's technology is tremendously encouraging. In June, we closed another small tuck-in acquisition of Med X Change, which expands the position of our MIS segment further into the integrated operating room market.

The integrated OR, also referred to as digital OR, is a growing opportunity for Novanta where data-generating devices surrounding the patients during surgery need to be connected to each other and the hospital information systems such that data, images and video can easily be stored, sent and controlled by the user.

This acquisition adds important 4K recording capability to our portfolio and aligns well with our strategy to build out our medical portfolio in high-growth markets. Med X Change is part of the Novanta family for a little over a month now, and we couldn't be more pleased with the team and the business.

End of July, we closed our third acquisition of this year, Arges. This very innovative company develops and manufactures intelligent laser scanning subsystems for advanced industrial and medical applications.

Arges is located 1 hour north of Munich, Germany and dramatically accelerates our intelligent subsystem strategy into high-growth markets such as additive manufacturing, micromachining and medical applications in our Photonics segment.

This acquisition doubles our engineering capabilities in laser beam steering and adds a phenomenal breadth of proprietary IP and knowhow to our Photonics segment. We see strong sales and technology synergies of applying these capabilities through to Novanta photonic sales channels.

I visited Arges a few days ago, and I'm very excited about the strong funnel of opportunities, which we will -- which will materially contribute to our growth in 2020 and beyond. From an M&A pipeline perspective, we see strong and increasing activity.

While we remain very disciplined on strategic fit and returns, we will move quickly if an opportunity arises that we feel accelerates our strategy. Now let me touch on what we're seeing in our markets and the overall macroeconomic climate. Our medical markets continue to be very robust.

We saw double-digit growth in our medical businesses in the second quarter and expect that momentum to continue for the full year of 2019. Momentum is broad-based, but we are particularly pleased with our momentum in robotic and minimally invasive surgery. Novanta is gaining share in these markets, driven by innovation.

We announced a new integrated OR product with a large medical customer, expanded into multiple new robotic surgery platforms with multiple technologies and see tremendous momentum with our latest insufflator products with smoke evacuation functionality.

I would also like to point out that we're achieving double-digit growth in our medical businesses, despite a double-digit year-over-year decline in DNA sequencing. Representing over 50% of our revenue, we expect our medical business to serve as a growth engine in 2019 in an uncertain macroeconomic climate.

We saw further decelerating momentum in the industrial capital spending climate in the second quarter, consistent with the low-risk PMI in these days since 2012 for most geography.

The uncertainty we reported on in our last earnings call has turned it to a more broad-based softening in our advanced industrial markets in the latter part of the second quarter with customers hesitant to place orders. This is purely a macroeconomic phenomenon as we're actually gaining share in this tough environment.

We also feel this is temporary as we see strengthening bookings for the fourth quarter. Slowing bookings for the third quarter were particularly felt in our Photonics and Precision Motion segments. Microelectronics and semiconductor markets further deteriorated to declines of 25% to 30%.

We expect these markets to bottom in the second half with a modest uptick in 2020. As a reminder, 10% of Novanta's revenue is exposed to microelectronics, and strategically, we aim to reduce our exposure to the microelectronics markets further organically and through M&A.

Geographically, the trade wars with China and the resulting customer uncertainty were particularly felt in the Asia Pacific region and Germany. Our revenue through China year-to-date declined by 10%, where our growth in medical sales was more than offset by microelectronics and industrial material processing market declines in our Photonics segment.

As a reminder, our China exposure is 10% of overall Novanta revenue. And while Microelectronics and China contributions are relatively modest, declines are meaningful enough to have an impact at the Novanta level for year-over-year comparison. Our teams did a tremendous job in Europe, growing in a declining industrial market environment.

While we are technically trimming manufacturing costs in weak area, we do see this weakness as temporary or not waving in our -- wavering in our conviction of innovation and growth investments to expand our proprietary technology positions through the business cycle.

As a matter of fact, we feel we are very well positioned and see an opportunity to gain share through the cycle. Now let me turn to our operating segments. Starting with the Vision segment this time, which was, again, the absolute growth star this quarter with strong momentum carrying into the rest of the year.

As a reminder, the Vision segment predominantly serves the medical market. Large applications include minimally invasive surgery in future diagnostics and better medical device. For the second quarter, our Vision segment delivered excellent 22% year-over-year revenue growth.

Growth continue to be driven by new products and new product launches at customers. In the vision segment, new product revenue year-to-date grew over 75% versus last year, design wins increased 60%, and total new product revenue increased to about 35% of sales year-to-date. The book to bill in our vision segment was 0.94, mainly due to order timing.

The vision segment predominantly serves the medical market, and as previously mentioned, we see solid market momentum as well as new product launch momentum, which we expect to continue as we progress through 2019. Our WOM business performed extremely well in the second quarter of 2019, continuing its momentum from the last few quarters.

We couldn't be more pleased with the innovation, strength and the customer relationships and depth of this business. The WOM team did a superb job in keeping up with the tremendous demand for one of their new product innovations, the FM300 insufflator with integrated smoke evacuation.

Surgical smoke is a dangerous by product of the vaporization of tissue with energy-based devices during approximately 95% of all surgical procedures. Inhaling the smoke equates to smoking 20 to 27 cigarettes per day. Worldwide, and in the U.S., laws have been passed or are pending requiring smoke evacuation devices.

For example, laws are being passed in Canada, the U.K., Australia, Denmark and in Colorado and Rhode Island in the U.S., with Massachusetts and California pending. Our FM300 insufflator product innovation integrates smoke filtering and evacuation functionality in the insufflator, optimizing workflow and not requiring a separate smoke-evacuation box.

Our WOM business is uniquely positioned to capitalize on this market opportunity, which we believe represents a market growth of 20% per year.

Finally, Robert and I just visited the WOM facilities, and we are extremely excited about the overall business and innovation opportunity funnel of WOM and the broader minimally invasive surgery and robotic surgery markets. Moving on, we're very pleased with the continued momentum of our NDS product line in the second quarter.

NDS delivered its 10th consecutive quarter of year-over-year core revenue growth, driven by new products such as 4K displays, wireless products and our new video image management and acquisition product, or VIMA, which addresses the integrated operating room market. In addition, the NDS business substantially improved its profitability.

As mentioned earlier, the Med X Change acquisition superbly fits from a technology and a customer complementarity perspective, and we feel it will further improve our position in the integrated OR market.

Finally, our Detection & Analysis business continues to show solid momentum around new product launches of medical-grade RFID and machine vision product offerings.

In the second quarter of 2019, the business continued to see strong double-digit growth in its RFID and machine vision revenue, while expanding its product offerings with 3 new RFID product introductions to date with 5 expected in total for the full year.

Our Precision Motion segment revenue declined 5% year-over-year in the second quarter, where fantastic growth momentum in robotic surgery could not offset steep declines in microelectronics and semiconductor.

We continue to like our position in precise and dynamic motion control technologies, serving multiple markets with structure growth dynamics such as precision automation, robotics, metrology and robotic surgery markets.

We, therefore, remained focused on our strategy, invest to gain share in these markets through innovation and M&A as we are excited about the mid- and long-term potential in this segment.

Within the Precision Motion segment, year-to-date, new product revenue grew over 75%, and our design wins grew more than 45% versus last year as we bring new innovations to market and are expanding our commercial teams.

The Precision Motion book to bill was 0.84 in the second quarter due to the microelectronics and industrial market softness that we mentioned earlier, partly offset by strong momentum in robotic surgery.

As stated before, we are excited about the Ingenia acquisition, which adds a critical motion control capability that now allows us to offer intelligent subsystem solutions to our customers. Turning to the performance of our Photonics segment, revenue was down 9%, driven by laser quantum and the deteriorating industrial capital-spending climate.

Laser quantum revenue in the second quarter declined double-digit year-over-year as expected due to the dynamics in DNA sequencing we widely reported on in the last few quarters.

As we look at the second half, the extent of Brexit risk mitigation through safety stock by our customer in DNA sequencing was more pronounced than we modeled and anticipated. And DNA sequencing is now expected to be down double-digit in the third quarter, recovering to flat growth in the fourth quarter.

We believe this short-term lumpiness is temporary and not correlated with long-term market demand, nor our competitive position.

We reiterate our excitement about the long-term growth prospects of this business as DNA sequencing is still in the very early stages of penetration into clinical applications with numerous positive catalysts on the horizon.

The performance of the Photonics segment was also impacted by some of the macroeconomic headwinds in industrial capital spending that we just discussed, and which our Synrad business is particularly sensitive to. We expect this to be a drag on our growth in the third quarter with gradual improvement in the fourth quarter.

The headwinds mentioned above temporarily impacted our strategic growth KPIs in the Photonics segment. Year-to-date, new product revenue in Photonics declined, primarily driven by laser quantum and Synrad. Design wins also declined mid-single-digits year-to-date, but we expect this to be temporary.

As a matter of fact, we have line of sight on strong double-digit full year design and growth as a few strong design wins were already booked in July.

Overall, we're pleased with the organic revenue growth and profitability that our teams achieved in the second quarter of 2019, and I'm very proud of the agility of our teams in a more uncertain industrial capital-spending environment. To wrap up, we feel Novanta is very well positioned in an uncertain macroeconomic environment.

Novanta's leadership position across diversified medical and advanced industrial market combined with our disciplined approach to M&A is providing a solid foundation for long-term sustainable growth.

Therefore, we remain focused on our strategy to expand and grow in medical markets and are not wavering in our conviction of innovation investments to expand our proprietary technology positions through the business cycle. 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 $155.1 million in revenue in the second quarter of 2019, an increase of 3% on a reported basis. Our acquisitions resulted in an increase in revenue of $1.7 million or 1.2%, and foreign currency exchange rates adversely impacted our revenue by $3 million or 2%.

Consequently, organic growth was 4% year-over-year. We are pleased with the performance of our teams in delivering our promised revenue guidance in the second quarter, especially after a weak June booking month that coincided with elevated rhetoric around global trade and tariff.

Despite this unexpected delay in bookings, which I should mention, we are already seeing some recovery in the third quarter. The strength of our portfolio and our position in secular growth markets, such as medical, are very strong counterweight to the challenges in industrial and microelectronic market.

From an end-market perspective, sales in microelectronic applications were down more than 25% year-over-year. Sales into the industrial markets, excluding the microelectronics, was down mid-single-digits, and sales in the medical-end markets was up close to 20%.

Growth in medical was achieved despite experiencing year-over-year declines in our DNA sequencing application and laser quantum. Turning to other financial results, the second quarter 2019 GAAP gross profit was $65.8 million or 42% of sales. This compares to $65.2 million or 43% of sales in the second quarter of 2018.

On a non-GAAP basis, second quarter 2018 adjusted gross profit was $68.4 million or 44% of sales compared to $67.7 million or 45% in the second quarter of 2018.

Our gross margins expanded sequentially, albeit at a lower rate than we anticipated after seeing significantly higher growth in our medical consumables business and a temporary pullback in our higher-margin Precision Motion and Photonics sales to the advanced industrial markets.

In addition, the double-digit growth in our MIS segment has taken significant effort and resources to ensure we do not disappoint our customers. This has caused us to shift resources in the quarter to meet this demand away from production transfer initiatives, namely the closure of our San Jose manufacturing facility.

This, in turn, has delayed that production move to midway through the fourth quarter of 2019, and therefore, is expected to result in redundant cost structures in the second half.

That being said, Matthijs and I just finished the visit of our new production lines in Germany and could not be more pleased with how well the team is prepared for production and how well they have structured the manufacturing line to deliver volume production at a lower cost.

Consequently, we are truly looking forward to ramping production in this facility. Second quarter R&D expense was $13.4 million or 9% of sales compared to $12.6 million or 8% of sales in the second quarter of 2018. We cannot be more pleased with our investments in R&D and our ability to accelerate our innovation engine.

In addition to our organic investments, the last 3 acquisitions in 2019 brought with them significant technology and engineering talent, furthering our ability to serve our customers and capitalize on the emerging intelligent subsystem opportunities.

Despite the third quarter challenges, you should expect us to protect our investments in innovation and take advantage of the environment to strengthen our competitive position. SG&A expenses in the second quarter was $29 million or 19% of sales, which was flat to the prior year and slightly improved as a percent of sales.

GAAP operating income was $15 million in the second quarter of 2019 compared to $17 million in 2018, whereas non-GAAP operating income was $45.8 million or 17% of sales, which is roughly flat to the prior year on a dollar and percentage basis.

Adjusted EBITDA was $31 million in the second quarter of 2019 as compared to $30 million in the second quarter of 2018. Interest expense in the quarter was $2.2 million versus $2.6 million in the prior year. The weighted average interest rate on our senior credit facility was 3.5%.

On the tax front, our GAAP tax rate was 19.5% for the second quarter of 2019. It differed from the Canadian statutory rate of 29%, driven largely by jurisdictional mix of income. On a non-GAAP basis, the tax rate for the second quarter of 2019 was 18.3%, mostly in line with the full year expectations of 17.5%.

Our GAAP diluted earnings per share was $0.29 in the second quarter of 2019 compared to diluted earnings per share of $0.32 in the second quarter of 2018. On a non-GAAP basis, adjusted earnings per share was $0.54 in the quarter from $0.51 in the prior year.

We ended the second quarter of 2019 with 35.5 million diluted weighted average shares outstanding, which was flat to 2018.

Second quarter operating cash flow was $15.4 million compared to $28 million in the second quarter of 2018, despite the fact that cash flow sequentially and free cash flow as a percent of GAAP net income was greater than 100%, we were disappointed.

Overall, net working capital was 24% of sales, driven by an increase of inventory to 115 days outstanding. The increase in days was driven by the redundant manufacturing facilities and by the delay in bookings in June. As we look in the second half, we are focused on driving down our inventories to improve our cash flows.

We ended the second quarter of 2019 with gross debt of $215 million, and our gross leverage ratio was 1.7 times, defined as gross debt divided by rolling 12-month pro forma EBITDA. Our net debt was $150 million as of the end of the second quarter of 2019 or roughly 1.2 times. Finally, our balance sheet is strong with ample acquisition capacity.

We're excited about the three transactions that we recently closed and see them as strong contributors to our growth in 2020 and beyond. In addition, despite the recent acquisition activity, we continue to build a very healthy acquisition pipeline, particularly around the medical end market.

You should continue to expect us to be disciplined about maximizing cash flow returns and ensuring future transactions will accelerate our strategic and financial goals. Turning to guidance, given the market dynamics that we have discussed, we think it'd be meaningful to provide guidance for both the third quarter and the fourth quarter of 2019.

As Matthijs mentioned previously, our third quarter is impacted by a temporary softness in shipments to a large laser quantum customer, which will recover in the fourth quarter and from a temporary slowdown in June bookings caused by the global trade uncertainties impacting the industrial capital equipment market.

Our bookings are already recovering in the third quarter, positioning us for a stronger fourth quarter. For the third quarter of 2019, we expect GAAP revenue in the range of $154 million to $156 million, down 4% to -- 4% to 3% on a reported basis.

Adjusted gross margins are expected to be around 45%, R&D expenses for the third quarter of 2019 will remain around 9% of sales, and SG&A expenses in the third quarter is expected to be around 19% of sales. Depreciation expense, which was about $3 million in the second quarter of 2019, will be similar in the third quarter.

Amortization expense, which was $6 million in the second quarter, will be about $7 million in the third quarter. Stock compensation expense, which was around $2 million in the second quarter of 2019, will be similar in the third quarter.

Interest expense in the third quarter is expected to be between $2.3 million and $2.4 million following the closure of the Arges acquisition. We expect to see a non-GAAP tax rate of 20% in the third quarter. For adjusted EBITDA, we expect a range of $29 million to $31 million.

Finally, we expect adjusted EPS to be in the range of $0.50 to $0.52 compared to $0.61 in the third quarter of 2018. Diluted weighted average shares outstanding should be around 35.6 million. Moving on to the fourth quarter of 2019, we expect GAAP revenue in the range of $166 million to $169 million, up 6% to 8% on a reported basis.

Adjusted gross margins are, again, expected to be north of 45%. R&D expenses for the fourth quarter of 2019 will remain around 9% of sales, and SG&A expenses in the fourth quarter are expected to fall below 19% of sales given the uptick in revenue.

Depreciation, amortization and stock compensation expense will be at the same levels in the fourth quarter as they will be in the third quarter. Interest expense in the fourth quarter should be in line with the third quarter, absent a significant debt paydown. We expect to see a non-GAAP tax rate of just over 20% in the fourth quarter.

We expect fourth quarter 2019 adjusted EBITDA to be in the range of $34 million to $36 million, with the current view that we're trending towards the upper end of the range. Finally, we expect fourth quarter 2019 adjusted diluted earnings per share to be in a range of $0.61 to $0.63.

Diluted weighted average shares outstanding to be around 35.6 million. As always, our guidance does not assume any significant impacts of foreign exchange rate changes.

While the lumpiness in the second half results was unexpected and caused by macro events unrelated to our competitive position, we feel confident in the ability and the strength of our portfolio to mitigate the lumpiness going forward. As we stand here today, we continue to build momentum for a stronger fourth quarter.

We are seeing stronger backlog, our medical business is continuing a strong growth trajectory, and we are expecting sequentially improving shipments to our DNA sequencing applications.

Our design win activity and new product introductions are accelerating in the second half, giving us confidence that we'll exit the year with strong momentum and are positioned well to deliver on our 2020 financial goals. And the acquisition activity completed thus far in 2019 further cements this view.

Finally, we strongly believe the investments we continue to make in R&D are driving further innovation and growth opportunities. We are pleased with our position in medical end markets, which is giving our portfolio resilience and helping us to weather the difficult industrial environment.

We're very proud of the performance of our employees as evident in the second quarter's performance and looking forward to continuing to deliver on our commitment to our employees, our customers and our shareholders. This concludes our prepared remarks. We'll now open the call up for questions..

[Operator instructions] The first question is from Lee Jagoda with CJS Securities..

So starting on your gross margin, obviously you called out the redundant cost and the delay in moving the San Jose facility as one of the impact to gross margin this year. So we probably don't get to that 100 basis points or so of improvement that we previously talked about.

That being said, as you look out to 2020, what are the things that kind of gives you confidence in the gross margin expansion there? And should we see the catch-up from the redundant costs going away plus incremental activities in 2020?.

Yes. That's what we hope for. So I think the San Jose manufacturing facility, we're running full production. And we're also got the redundant costs in Germany right now. So that overall closure plan is just south of $2 million worth of savings. So we'd have a pretty good impact on our gross margin going into 2020.

And then the teams are actually making some great progress on the productivity programs that we have across each of the individual manufacturing sites as well as our overall growth system. So there's some good progress on combining there..

Okay. And then just switching gears to the laser quantum lumpiness.

If I look at the Q4 guidance, does that imply a catch-up or just sort of return to more normal growth in that product line in Q4? And then beyond Q4, how should we think about growth in that product line given the relatively easy comps they're up against in the first half of 2019?.

Yes. So to answer your first question -- it's Matthijs, Lee. We expect them to return to more normal patterns in Q4. I will -- this is a reminder. I mean this is the capital equipment part of the -- this is not the consumable part, and the capital equipment part can be more lumpy from a quarter-to-quarter perspective.

So long term, if you look kind of over multiple years that this is an absolute growth engine in any particular quarter, it could be lumpy. So for our perspective, we expect this business to return to more normal, let's say, particularly in the second half of 2020. And yes, we're in a close contact with our customer on this..

Okay. Just one more on the acquisitions that you talked about earlier in the call. Understanding that they're all pretty low revenue contributors at the moment, although I assume we expect them to be nicely additive to organic growth going forward.

Can you talk about sort of the margin structure of each of those as it relates to their segment average margins? So when they start to grow, what should we see margins doing there?.

Yes. I would say from a gross margin perspective, they're all a little bit north of where our existing businesses are. And so they should be additive from that perspective.

I don't want to get into kind of the specifics around that, but given the Ingenia acquisition, it's really hardware -- software-in-a-box, and the Arges acquisition is really very similar to that. They do come with better gross margin profiles. Overall, those businesses will be contributors to organic growth in 2020.

We're pretty excited about that, specifically, the Arges and Ingenia acquisitions should be seeing above-average growth rates in relation to our overall portfolio..

Yes. And all of them are about unique technology capability with proprietary IP that we can help to accelerate growing through the Novanta sales channels, right? So it's a very similar kind of way of driving synergies..

The next question is from Richard Eastman with Baird..

Yes.

Could I just get a book-to-bill for the Photonics business in the quarter?.

It's 0.9 and that's off a very weak laser quantum number. And I would just say, an average kind of rest of the business number, right? And the weak laser quantum number is linked to the DNA sequencing pause for the third quarter that we commented on..

Yes, yes.

Is the -- and is that also the reference to the in vitro diagnostics customer?.

Yes. It's the same..

Yes. Okay. That's the end user. And then maybe, Robert, if I look at the second half revenue guide. I'm kind of coming up with something like a $16 million -- at the midpoints of the guides, maybe $16 million to as much as $20 million of revenue kind of slip out of the second half.

And I'm trying to -- just maybe apportion that by the segments, is that primarily in the Precision Motion? Is that more industrial slippage of revenue or -- and the majority of that actually comes in the third quarter.

So I'm thinking maybe that is around the Photonics business?.

Yes. It's almost as if the third quarter took a pause in the year. So within Photonics, it'll be impacted by double-digit declines in laser quantum in the third quarter, and then it generally has some weak industrial capital spending. So we expect that to be down about mid-single-digit in the third quarter.

Our Precision Motion segments will be down about 15% to 20% in the quarter, and that's hit hard by the microelectronics downturn and the broader industrial capital spending market. Our medical sales in that segment are up double digit. So the decline in microelectronics, it's just more than offsetting it.

And then our vision segment is expected to be up low double-digit, again, in the third quarter. As we get to the fourth quarter, then you see Photonics returns to growth, vision continues its double-digit growth, and then Precision Motion will stabilize to flat. So that's how it will kind of unfold..

And then maybe just around the EBITDA decline, maybe around $11 million -- again, EBITDA for the -- guide for the full year declines by about $11 million, again, at the midpoint.

And my thought is, with the $16 million decline in sales, is that a mix issue? Or is that, again, go back to the capacity that maybe doesn't get eliminated until late in the year? Where's the negative leverage there?.

All of the above. So definitely, there's a mix impact there when you're losing Precision Motion and Photonics revenue. As you think about where we're losing in Photonic, it's an intelligent subsystem platform in the laser quantum segment.

So you're losing some very high-margin business, but you're losing it also at a time where it was more of a sudden drop in bookings. And so you couldn't adjust your manufacturing cost structure quickly enough to adjust for that. And then, simultaneously, you're in the middle of a production move, and so you're dealing with the redundant costs there.

And so as you exit the year, we were thinking more we're trending at the upper end of that EBITDA range exiting the year. And then you're getting the benefit going into 2020 of eliminating that redundant cost structure and then recovery to really kind of a more of a stable profile in the laser quantum business.

You get a better mix effect going into 2020 as well as eliminating some of the manufacturing cost. So the combination of things like really kind of puts us back on track in 2020 that makes Q3 an anomaly..

Yes. And I would say, Rick, of course, you -- what we didn't do or we're not going to do is pullback our innovation investments, right? So we're just looking at this Q3 kind of dip or pause. We're looking into 2020, right, where we see a tremendous opportunity of customers in needing our innovation.

So we're basically doubling down on the innovation, and we're maintaining that innovation spend fixed. As you -- so we're not adjusting for that. So that's maybe the other kind of detail that is..

I got you. Okay. And then just my last question here. In the Precision Motion segment, again, given the -- your comments, Robert, around maybe the growth rate there, or lack of in the third, and flattish in the fourth.

Will we be able to make any progress on the second half gross margin there? I mean first half was a little over 44%, second half without any real revenue driver there. It feels like that might be flattish as well in the second half, first the first..

Yes. I think well, obviously, it'll be challenged in Q3. I think Q4 gross margins will be higher than where they were in Q2. So I do think you'll get a little bit of an uptick there as you go from Q2 to Q4. Q3, it's just -- you can't adjust for it quickly enough..

Yes. You have short-term manufacturing absorption challenges, right? But in Q4, we can kind of optimize for that much better..

Yes, yes. And your comfort level, Matthijs, around the industrial business in the fourth quarter. Where does that come from? You said -- we've seen better bookings maybe in July and early August.

But just curious, do you have line of sight? And do you have a high confidence level around the industrial piece of the business in the fourth quarter?.

Yes. Well, first of all, I think the overall fourth quarter, why we feel it's sequentially going to be better than the third quarter is, of course, because of multiple dynamics.

One is DNA sequencing up; secondly, Medical continued to perform well; third is new product introductions also in Photonics; and fourth, actually existing backlog that actually is building very strongly in the fourth quarter as well. So all these things give us confidence.

But it's not only kind of -- we're not betting on a massive industrial market recovery or something, if that's what you're alluding to. We're really looking at what customers are telling us and actually a continued strength in medical with a sequential uptick in DNA sequencing..

Yes. This is -- Rick. Let me just clarify. I do get Matthijs' point there. The second half, there's no real change in our view in the microelectronics and industrial markets. We think Q3 and Q4 look very similar. In a general sense, it's just portions of our business are actually going the other way, which help us..

The next question is from Brian Drab with William Blair..

First one, just -- did you give the total book-to-bill?.

For the second quarter, the total book-to-bill was 0.90. Let me just make sure it's clear. So 0.90 for Photonics, it's 0.94 for vision and it's 0.84 for Precision Motion and 0.9 for overall company. And the down -- the negative, Photonics is really all being caused by our laser quantum business.

The vision segment is more just kind of timing more than anything else. I guess we got double-digit growth happening again in the third quarter. And then in Precision Motion, it is almost all linked through microelectronics..

Okay. Yes, got it.

Can you share anything in terms of revenue for the three acquisitions that you're talking about so we can sort of model our organic revenue growth?.

Yes. The first Ingenia and Med X Change aren't really meaningful contributors. You can see that in the reported revenue that we broke out. It's only -- they're relatively small. The Arges transaction is closer to $20 million annually. We closed that at the end of July, and it's not the most linear type of business.

So -- but it's around $20 million, and so we'll see more meaningful contributions from that in 2020 and also because it's not the base business that's going to be the big contributor for us in 2020. It's really -- it's capabilities that it adds to us.

It allows us to go after some intelligent subsystem platforms that we internally have been struggling to address with our customers..

Yes, it's really about -- we're very excited about the Arges acquisition, Brian, because it gives us a totally new capability that includes basically what we've been talking about, Industry 4.0, IoT type of capability, including sensors, motion, data generation, in-process control.

And so totally new capability that adds to our current Photonics capability for current and new customers. We doubled the engineering capability so it will have a positive impact on our innovation rate going forward, and you'll see kind of the importance of innovation in our business.

And last but not least, we feel that this capability helps us to accelerate gaining share in high-growth markets like laser-additive manufacturing and micromachining and certain medical applications.

So all these 3 things, strategically -- are tremendous strategically, and I think we strongly believe in 2020 and beyond, this will have a very positive contribution to our overall Photonics growth..

Okay.

And with Arges, is this -- is it a lumpy business or a seasonal business when you say it's not the most linear type of business?.

Yes. It's a little lumpy right now because its base business is focused on a -- as more of a project orientation than some of our existing businesses. But it's got a little bit more lumpiness around it than we would like in the short term, but it actually corrects itself as we get into 2020..

Yes. At the moment, we kind of start to put this capability more in the OEM customer channel. We feel that over time, this becomes a much more predictable business, leveraging our capabilities and our customer relationships globally similar to other acquisitions that we've done, right? So -- but yes, design win -- I mean, you got to win design wins.

Design-in cycles are sometimes 18 months, right? So it will get more pronounced as the staff progresses. Short term, it might be a little bit more lumpy than what you're used to from us..

Okay.

And then your guidance implies what organic revenue growth for the third quarter and also for the fourth quarter?.

Organically, we'll be down in the third quarter. On a reported basis, we're down 3% or 4% organically, let's say, mid-single-digit. In the fourth quarter, we're basically expecting flat organically with up mid-single-digit on a reported basis.

And that swing is a little bit of -- we're already seeing, from an orders perspective, our coverage, orders coverage for the fourth quarter is higher than where it's been in prior periods of time. So that gives us some confidence there.

And then the laser quantum business recovers in the fourth quarter, not to a growth profile per se but to a more normalized where we expected it to be before. And so the combination was to drive that..

Okay. Got it. And then just my last question. You discussed it a little bit earlier, but the gross margin, as we look to 2020, you have these few positive factors. So I just want to make sure I'm understanding it correctly. If you are able to eliminate $2 million in redundant costs related to the San Jose move.

And then maybe you can give an update, secondly, on what is happening just in the -- with productivity initiatives within the factory? And then I guess, those are the -- those are just a couple of main things, but is there anything else that's driving gross margin expansion in 2020? And could that be a year where you got 150 basis points of moving gross margin?.

Yes. There's multiple, what we call, value drivers that we're affecting, right? So first of all, it's a material productivity. Largest chunk of our costs is materials to driving material productivity, either by consolidating supply at the group level, where we have actually a centralized team working that.

So whether it's PCBs or cables or machine parts that a majority of our businesses are using. So that's a process that's well underway, and we feel will have a serious impact in 2020.

And then secondly, the impact of consolidating in manufacturing competence centers, of which you will -- you've heard the first impact, but we feel we have multiple other drivers on the way. Third is, basically, a value engineering [indiscernible] process that taking cost out of our products through engineering approach.

So these three drivers, we feel, are meaningful. They're backed up with a funnel of opportunities for our business and for the group. And they're lining up nicely for 2020 in fact, yes? So we do feel determined and confident about continuous expansion in 2020 and beyond based on structural approaches..

And I guess just one last piece to that is, can you talk about the timing of margin benefit from a change in location or structure of your WOM manufacturing?.

Have we talked about that? I mean the -- you mean the impact on the MIS segment? Or, I mean, we've -- from the slides $2 million of....

About optimizing the cost of some pieces of that manufacturing..

Well, if you're referring to the manufacturing footprint consolidation, I mean, that all has division segment. If you're referring more to the optimizing -- putting more volume through the existing manufacturing facility to drive additional overhead leverage from the medical consumables business that we haven't quantified the big impact of that.

I would say, you asked the question early on, could 2020 be a period of time where gross margins expand more than 100 basis points. I think the answer to that is yes. There is enough actions there that can lead to a better 2020 outcome, and 150 basis points is not out of the norm.

So it's really, to us, it's -- we've had a third quarter here disruption, we recover that. I think talking about it again through the fourth quarter, and then we're on a stronger trajectory going into 2020. It looks a little bit higher than normal, but that's really just the factor that we took a quarter off for all intents and purposes..

The next question is a follow-up from Lee Jagoda with CJS Securities..

Just one more regarding tariffs. I know in the past, you kind of talked about you've done a really good job mitigating the impact from the first 2 tranches.

Is there anything on this next list for that could be problematic? What are your thoughts on trying to mitigate that as well?.

There's no impact on this next tranche. In terms of the absolute tariff expense itself, it's really hitting consumer products and things unrelated to us.

So we don't -- really, what this -- one of the things I want to make sure that there's a distinction over, is the tariff rhetoric and disruption that we experienced in June coincided more with some of the rhetoric with the EU and Mexico, specifically, more so than China.

And so what it really cost manufacturing facilities or our customers who do -- is rethink their overall supply chain initiatives to deal with the more uncertain norm. So as we're looking into the recent activity that's coming out -- obviously too early to get a real good read on it. But it's to us, it's more of the same.

I don't think China is something that we're anticipating as being resolved in any sort of short term here. And it's something that we're planning as acting in the norm. We've mitigated most of the tariff impact at this point.

Don't expect any material impact from an expense perspective, but we do think that in the second half of the year, that industrial capital spending is going to continue to be weak as the consequence of this..

Yes. For us, it's more of a demand issue than it's an expense issue. And I think we've been pretty competitive about it. And you see that coming back into kind of our demand into China, which is down, particularly on the Photonics side, right, which is driven by that.

So that's the real watch out, right, is the [receptivity] will that true to deteriorate industrial capital spending from the current levels. Of course, that's hard to say, but yes, we're fortunate we have the medical part of our portfolio and the innovation part of the portfolio to counterweight that. So that's how we're approaching it..

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

Thank you, operator. So to summarize, in the second quarter of 2019, Novanta delivered a solid performance in an uncertain macro environment. Our focus on accelerating profitable growth and the diversity and resilience of our businesses was evident in our strong financial results.

We continued to feel good about the positioning of our businesses around secular macro growth drivers, with over half of our revenue in robust medical markets.

Novanta's diversification and relentless focus on leadership position across a variety of medical and industrial growth markets is providing a solid foundation for sustainable profitable growth in today's current macroeconomic backdrop.

We see a long-term need for our motion, vision or photonics capabilities in a large variety of applications from the back of macro trends of Industry 4.0, precision medicine and healthcare productivity.

We, therefore, continue to remain excited about the applications we play in and the positions we have and continue to invest in long-term organic growth, innovation and M&A. In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support.

I'm particularly thankful for the strong contribution and execution of our teams of committed Novanta employees that are showing tremendous dedication and agility. We appreciate your interest in the company and your participation in today's call. I look forward to joining all of you in several months on our third quarter 2019 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..