Good morning. My name is Laura, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Inc. 2020 Second 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, sir..

Thank you very much. Good morning, and welcome to Novanta's second 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 it 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.

And 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..

one, how we work together in cohesive and diverse teams; two, how we behave and interact through our five core values; and finally, three, how we execute through the Novanta Growth System. Now let me briefly turn to our operating segments. Starting with the Vision segment.

This segment predominantly serves the medical market and saw a revenue decline of 2% year-over-year. The book-to-bill in our Vision segment for the second quarter was 0.92, with bookings down 5% year-over-year in the quarter.

This decline in sales and the low bookings are a clear reflection of the dynamics in the medical end markets, where the deferral of elective surgical procedures has caused a delay in capital investments.

The vitality index in this segment remained above 30% of sales, with new products being a key driver of the strong growth we've seen in this segment over the previous several quarters.

Within the Vision segment, we continue to see nice momentum in our WOM business unit on the back of the smoke evacuation technology, we've reported on for the last few quarters. And this growth comes despite a temporary downturn in overall demand due to the pandemic.

Our WOM consumables product offering saw double-digit growth in the second quarter even as some of the other MIS products saw declines. The smoke evacuation insufflator technology is, in particular, high demand in today's climate.

Medical staff around the world are demanding a safe COVID-free work environment, and our smoke evacuation tube set innovation helps provide hospital staff with an operating room free from contaminates during laparoscopy procedures.

In addition, we continue to invest in the R&D pipeline of WOM, where we have secured very exciting opportunities in insufflator and pump technologies through design wins and development agreements with multiple minimally invasive and robotic surgery OEM platforms.

These platforms are expected to launch in the next two to three years as they make their way through the regulatory process. And while we need to thoughtfully manage the near-term demand drop in the segment, we could not be more excited about the long-term potential for our MIS business.

We're also very pleased with our Detection & Analysis business, which grew mid-single digits year-over-year in the second quarter and had fantastic profit performance driven by the Novanta Growth System. This business unit primarily serves the diagnostic testing and patient monitoring markets with RFID, barcode and machine vision technologies.

The counter cyclical growth in the second quarter is being driven by the rapid uptake in PCR molecular testing and patient monitoring equipment, which is being somewhat offset with the decline of non-COVID-19 related diagnostic tests. Turning to our Precision Motion segment.

This segment saw 4% growth in revenue in the second quarter of 2020, with a book-to-bill of 1.07, and bookings growing 32% versus the second quarter of 2019.

In the second quarter, we saw very strong demand for 5G and cloud-based infrastructure as well as autonomous ground vehicles, which was partially offset by a reduction in industrial, satellite communications and robotic surgery. This led to excellent top line performance for this segment, which helped offset some of the challenges elsewhere.

Much of this growth is coming from our OEM customers based in China, which is seeing the majority of the 5G base station demand right now. Sales to China nearly doubled year-over-year in the quarter.

We continue to like the long-term secular trends of the Precision Motion segment, serving markets such as precision automation, robotics and robotic surgery markets. As it relates to the surgical robotics market, we will continue to expand our content and our position with the largest players in the coming years as new platforms come to market.

In the short term, recovery of big capital expenditures in hospitals are expected to take some time. But the surgical robotics market remains an attractive and long-term growth opportunity for the company.

Within the Precision Motion segment, in the second quarter, new product revenue grew more than 70% and now makes up a strong double-digit percentage of total sales in the quarter. Turning to the performance of our Photonics segment for the second quarter of 2020, our revenue was down 18%, which was in line with our expectations.

It's fair to say that the Photonics segment is feeling the most significant impact from the economic downturn caused by the pandemic. The depressed industrial capital spending is driving a decline in sales of our beam delivery and laser products.

Further, the deferred demand in medical markets is also having lower sales, particularly in the ophthalmology segment and production-scale sequencers in the diagnostic and research space as doctors' offices and labs were closed most of the second quarter.

We expect the COVID-19 pandemic to dampen demand for these type of capital investments in the short term, in line with the overall decline in hospital visits, procedures and diagnostic tests due to the pandemic. The Photonics segment in the second quarter saw bookings decline year-over-year by double digits with a book-to-bill of approximately 0.8.

Despite this near-term slowdown, the design wins continued their momentum and grew over 50% year-over-year in the second quarter. We continue to feel very confident in the robust innovation pipeline of our Photonics segment.

And as a result, we continue to invest into the headwinds here, and we still anticipate introducing multiple new product platforms in 2020 and 2021, which are expected to help us gain share in adjacent high-growth application areas. To wrap up, I'm very proud of the performance, resilience and agility of our teams in an uncertain environment.

The team managed profit decrementals and cash flow extremely well, while not sacrificing our innovation. Strategically, Novanta's position is favorable, and our portfolio resilience to weather the COVID-19 pandemic. Close to 60% of our revenue, year-to-date, comes from medical markets, which are robust and structurally growing long term.

Our balance sheet is as strong as our innovation pipeline.

And finally, our focus on portfolio diversification allows us to both increase our exposure to long-term secular growth trends in robotics and automation, health care, productivity and precision medicine, which are becoming more relevant post the pandemic, while giving us the resilience to weather the economic environment caused by the pandemic.

You can also expect us to lean in on acquisition opportunities, which is the primary focus of our capital deployment, provided they fit our stringent financial returns and strategic criteria. 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 $144.7 million in revenue in the second quarter of 2020, a decrease of 7% year-over-year on both a reported and an organic basis.

As Matthijs already covered, despite the year-over-year decline, we are pleased with our sales performance in the second quarter, beating our own expectations and our previously issued guidance. To give some additional details on our sales, our revenue continues to shift towards our OEM customers who serve medical end markets.

Sales to these end markets in the second quarter, were at 55% of total sales and declined 5% year-over-year. On a year-to-date basis, sales to medical end markets were 57% of total sales.

Considering the significant deferral of elective surgical procedures, along with laboratory delays in capital spending for specialized life science equipment, such as production-scale DNA sequencers, our sales to medical end markets were actually better than expected.

We continue to see pockets of strength during the downturn such as our medical consumables business, with integrated smoke evacuation, integrated data collection products for clinical test equipment and new products, such as integrated operating room informatics.

The industrial capital spending environment and the overall economic climate continues to face high levels of uncertainty, resulting in significant impacts on demand as evident in the latest PMI trends. While there are pockets of growth and recovery, there are also pockets where uncertainty has increased.

Novanta sales to advanced industrial markets was 45% of total sales in the second quarter declined 8% year-over-year. The decline was broad-based across the majority of industrial end markets, which is consistent with our expectations and what our industrial OEM customers are seeing in those same markets.

One area within advanced industrials, where we continue to see solid demand is within our microelectronics customers, specific to China investment in 5G, high-speed networking and cloud-based infrastructure.

In the second quarter, this end market still saw a strong double-digit increase and returned to approximately 10% of total company sales, but largely as a result of the broader industrial decline.

Overall, we are proud of the application and the end market diversity we have created over the years with our portfolio of technologies, which has clearly proven its resilience in one of the worst economic downturns in history.

In addition, on a geographical basis, our second quarter sales to China were actually up 14% year-over-year, despite the disruption caused by the pandemic. Sales to the U.S. and Europe were down 8% year-over-year, reflecting the impact of the pandemic in those countries.

As a reminder, the location of our sales are based on where the product is shipped to, which can sometimes be different than where a customer is headquartered. Nevertheless, we feel those figures represent general directional trends. Turning to our operating results.

Our second quarter GAAP gross profit was $59 million or 41% of sales compared to $66 million or 42% of sales in the second quarter of 2019. On a non-GAAP basis, second quarter adjusted gross profit was $61 million or 42% of sales compared to $68 million or 44% in the second quarter of 2019.

For the second quarter of 2020, our adjusted gross margins were down over 150 basis points compared to 2019. A significant driver of this margin decline is higher operating costs in our factories worldwide, which has come as a result of the pandemic.

To support a safe working environment, our factories are conducting multiple sanitizing cleanings per day, conducting daily health screening of all workers entering the facility, proactively testing employees whenever there is a risk, implemented changes to our HVAC systems to better filter the air and increase outside air circulation, running multiple shifts to create social distance and allow better air circulation and deploying personal protective equipment daily to all employees in our facility to be worn at all times.

These efforts are materializing as labor inefficiencies and higher overhead costs. In addition, in the second quarter, we continued to experience vendor disruptions in the form of longer lead times and logistics disruptions driving higher freight and handling costs.

While these disruptions are slowly subsiding, we still expect it can take another quarter or two to completely mitigate the effects. The combination of our safe working environment protocols and the higher logistic costs are costing us approximately 200 basis points of gross margin in the second quarter.

Finally, we did take the opportunity in the quarter to review our broad range of products to identify opportunities to rationalize any low profit or low-returning products so that we can allocate or better allocate our resource and efforts in a more focused and higher-returning way.

This effort resulted in about $1.5 million of inventory write-offs for discontinued products. As a technology company, we're always going to have some products that fit this criteria that we manage through on our product life cycle processes.

However, given the economic climate, we wanted to take the opportunity to get more focused, so we are better positioned in 2021 and beyond. Moving on to operating expenses. Second quarter R&D expenses were $14 million or 10% of sales compared to $13 million or 9% of sales in the second quarter of 2019.

We continue to lean into the headwinds and invest in our innovation pipeline. The current economic climate, in our view, provides us with the opportunity to take market share and capture significant customer opportunities to drive our growth in future years.

While we are seeing some customers push out their product launches into mid-2021 to create more distance from the effects of the pandemic, we made the decision to bring our R&D teams back into the facilities, so they can continue their progress and momentum and also look for opportunities to accelerate programs.

Engagement with our customer remains very high despite the environment, and our sales team are doing an excellent job of creating new opportunities. Second quarter SG&A expenses were $25 million or 17% of sales compared to $29 million or 19% of sales in the second quarter of 2019.

The majority of this $4 million year-over-year savings can be attributed to the cost actions that I outlined in the first quarter earnings release that we've taken in response to the pandemic. We are very pleased with the flexibility our business teams have demonstrated in responding to the current market conditions.

Moving on to other financial results. GAAP operating income was $14 million in the second quarter of 2020 compared to $15 million in 2019. Non-GAAP operating income in the second quarter was $22 million or 15% of sales compared to $26 million or 17% of sales in the prior year.

Adjusted EBITDA was $31 million in the second quarter of 2020 and 21% EBITDA margin compared to $31 million in the second quarter of 2019 or 20% EBITDA margin. On the tax front, our GAAP tax rate was nearly 0 for the second quarter.

It differed from the Canadian statutory rate of 29%, driven largely by jurisdictional mix of income and from a onetime release of a valuation reserve. On a non-GAAP basis, our tax rate for the second quarter of 2020 was 15%.

This differed from the statutory rate driven by jurisdictional mix of income and some tax benefits related to our temporary cost actions. We do not expect our, we do expect our tax rate to climb in the year, but the environment has made it very difficult and challenging to predict specific rates.

Our GAAP diluted earnings per share was $0.33 in the second quarter of 2020 compared to diluted earnings per share of $0.29 in the second quarter of 2019. On a non-GAAP basis, adjusted earnings per share was $0.48 in the quarter compared to $0.54 in the prior year.

Our adjusted earnings per share were down year-over-year, due primarily from the higher stock compensation expense from the all employee equity grant. Second quarter operating cash flow was $33.8 million compared to $15.4 million in the second quarter of 2019.

This result was driven by strong profit, continued improvements in net working capital and a variety of actions we took to preserve cash in response to the pandemic. We entered the second quarter, we ended the second quarter with gross debt of $222 million. Our gross leverage was 1.9 times, and our net debt was $124 million or roughly 1 time.

We are very pleased with our cash flow and financial position in the second quarter.

Based on these results, we believe that our more than $97 million of cash on hand and nearly $375 million of available borrowing capacity under our revolving credit facility as well as the anticipated cash flows from our operating activities will be more than sufficient to meet our needs for the duration of the economic downturn and most importantly, position us well for acquisitions.

Now before I move on to guidance, I'd like to give a short update on the Novanta Growth System or NGS. As a reminder, NGS is a common way of working through a set of common tools and processes vigorously applied to accelerate and drive sustained growth and operating performance.

As mentioned on our last call, we are actively embedding the NGS operating model across our business units. During the second quarter, we had 100 employees receive training on various tools and processes that will become the cornerstones of this operating model.

As an example, we trained approximately 90% of the total organization on structured problem-solving and value-stream mapping tools and disciplines.

We are confident that by rigorously applying NGS, it will assist us enormously in achieving our goals this year and beyond, especially in areas of customer satisfaction, speed to market, gross margin and inventory optimization.

We are very pleased with how our employees have stepped up to adopt the tools and mindset of the Novanta Growth System, which in turn will help us to instill a strong, consistent culture more deeply across the entire company. Turning to guidance.

Due to the continued impact of COVID-19 pandemic on the Novanta businesses and the uncertain duration and scope of the pandemic and the uncertain timing of the global public health and economic recovery, we are not able at this time to reliably estimate the long-term impact of the current environment on our operations and financial results for the full year 2020.

However, we do believe we have enough visibility in our customer demand and operational performance to give you partial guidance for the third quarter of 2020. For the third quarter of 2020, as we stand here today, we expect GAAP revenue in the range of $135 million to $142 million.

As we discussed in the first quarter earnings release, we believe that the consequences of the economic closures in March through June time frame will impact us most significantly in the third quarter. We continue to expect this to be the case, and the guidance reflects this.

We are seeing signs of some markets strengthening, such as the return of elective surgical procedures, but the resurgence of the virus in parts of the United States and Europe are reasons to remain vigilant and conservative.

We participate in markets driven by capital investments, capital investments by their very nature benefit a buyer in the long term. Therefore, a buyer needs to have confidence in their growth plans and strategies and a reasonable level of certainty in the economic climate.

It's fair to characterize this economic climate as still uncertain as the effects and duration of the spread of the virus remain uncertain. But we also remain confident that the capital spending markets, we participate in, are not seeing demand permanently destroyed, rather just delayed.

So as confidence builds, the effects of the virus recede, our business is expected to recover, and we hope, stronger than it was before we went into the crisis. The question remains when the effects of the virus fully recede. Moving on to other guidance.

Adjusted gross margins are expected to improve sequentially in the third quarter, but this could be negatively impacted if revenue comes into the lower end of the, of our expected range, driven by the tougher decremental margins. R&D expenses for the third quarter of 2020 will remain roughly flat sequentially on a dollar basis.

SG&A expenses in the third quarter are expected to increase sequentially on a dollar basis, largely driven by higher stock compensation due to a full quarter of all the employee equity grant. However, it's important to mention that both R&D and SG&A expenses will be flex if we start to see significant changes in our sales or gross margin outlook.

So this estimate could vary depending upon how the monthly results turn out. Moving on to the remainder of our guidance. Depreciation expense, which is about $3 million in the second quarter, will be similar in the third quarter. Amortization expense, which is $6 million in the second quarter will be similar as it was in the third quarter.

Stock compensation, which was around $5 million in the second quarter, will be nearly $7 million in the third quarter. Interest expense, which was $1.7 million in the second quarter of 2020 is expected to be similar in the third quarter. Adjusted EBITDA, we expect in the range of $25 million to $29 million.

Because of the short-term uncertainty we are seeing in our jurisdictional mix of income and therefore, our tax rate, we will not be providing EPS guidance. Finally, as Matthijs mentioned, two of our guiding principles are to maintain business continuity and to ensure a bright future.

To achieve those goals, our focus right now remains on protecting our capabilities in terms of our employees, our innovation and our customers; and two, preserving our innovation and our priority R&D programs; and finally, three, maximizing adjusted EBITDA and cash flow to weather the uncertain environment.

This focus is critical to help us navigate the temporary impacts of the pandemic on our customer demand as well as the incremental cost to operate in these extraordinary circumstances.

Ultimately, our view has not changed since our last call, that the economic consequences of pandemic are temporary and a rebound of demand in both our medical and industrial markets will occur. Although the trajectory of the recovery remains uncertain.

We are thankful that during these difficult times, our customers have shown tremendous partnership with us, both with current sales and delivery of products as well as our innovation pipeline, we are a partner -- where we are partnering with our customers to bring future innovations to market.

We remain very proud of the performance of our employees and their commitment to helping us weather the difficult environment. And most importantly, we remain excited about our future and look forward to continuing to deliver on our commitments to our employees, our customers and our shareholders. This concludes our prepared remarks.

We'll now open the call up for questions..

Thank you. We'll now begin the question-and-answer session [Operator Instructions] And our first question will come from Joe Jagoda of CJS Securities..

So I guess to start, relative to the 14% increase in China and then the declines of 8% in the U.S.

and Europe collectively, can you speak to the trends you're seeing in those geographies in July? And if you have it for early August?.

I mean, I made some generic remarks around not geography-wise, but more end market-wise, that we -- our customers in the medical end markets have reported that the -- let's say, the elective surgical procedures, depending on the exact modality are at 80% to 90% of pre-COVID levels.

We do see, I think, as recently as today that within Europe, you see Germany rebounding from a factory orders perspective, but other parts of Europe, not so much. And both medical and industrial activity in China is -- has, of course, picked up.

Semiconductor microelectronics, very strong; medical procedures, back to pre-COVID levels; and in those, some of the industrial markets still lagging a little bit because demand for Chinese-based production is often driven by Europe and the U.S. So that's kind of high level as we see it.

And in terms of dynamics, I don't think I'm going to say anything unusual here that, of course, the declines in the U.S. were probably the steepest, but you see recovery being relatively quick. What is, of course, uncertain is, yes, the resurgence of the virus, and you do see some signs of pausing actually of the recovery as a result of that.

Europe was less steep. But the recovery is also slower, yes? So those are kind of the dynamics I can comment on. Those are more end market dynamics. How they work their way through the supply chain and the timing and the impact to Novanta is uncertain, yes? So, but that's what we're seeing today..

So then just going at it a different way then, related to the medical elective surgical market being at, 80% to 90% of pre-COVID levels, can you sort of give us the slope of the recovery in terms of how bad it got in April? And then where we were in June versus July, if July is 80% to 90%?.

Well, it got really bad for our customers..

Yes. So I think our customers have reported minus 55.0%. Certain procedures, so it ranges, Lee, what type of procedures, right? So let's say, ophthalmology procedures in doctors' offices, those were disclosed. There were no procedures done. So those were kind of down 80%. And then, of course, elective procedures that were critical in a way.

They're called elective, but still critical, let's say, cancer related, that could not be deferred. They were down maybe 25%, 30%, right? So there's a range on the type of procedures. But on average, in the U.S., it was probably down 40%, 50% and then a quick snapback.

I think what is unclear, and I think it's pretty consistent across different customers and geographies, et cetera. What is unclear is the trajectory from here, the 80% to 90%, to actually back to pre-COVID levels. So that's where the uncertainty is..

I guess the second question would be, is there any information that you're getting from your customers as it relates to their level of component inventory that we can kind of use to say, either they're over inventoried or they're under-inventoried relative to the current shipment levels on their side?.

Yes. Listen, I think as you look at the third quarter and you take the range, we provided a range of $135 million to $142 million. The upper end of that range reflects the demand that we're seeing right now. And the lower end of the range is any sort of disruptions that we might see in our supply chain.

So I think from a demand profile perspective, though, we're kind of at that upper end of the range there. So if you think about that in the context of the quarter, it's organic growth, very similar to what we saw in the, organic decline, I should say, similar to what we saw in the second quarter.

So it's fair to say, there's two things happening there. One is the diversification of the portfolio, it's helping to mute the overall impact. So it's not that we're not seeing the declines in elective procedures or the shutdowns of OCT-type markets, it's just the diversification is helping us a little bit.

The other is the customers themselves did not whipsaw their vendors as extreme as what they saw in those months. But that being said, the bulk of the impact is really hitting us in the third quarter as a consequence of the shutdowns in April and May.

So as you get into the fourth quarter, does that mean we're going to see some sort of V shape? I think the answer to that is clearly no. It's not going to jump up in a V-shaped type recovery as we get into the fourth quarter. But what it looks like, still, is a lot of question marks and a lot of uncertainty..

Yes. And we're in very close contact, Lee, with our major customers in terms of their inventory levels. And of course, that has been tuned as we speak, what we want to be careful with is that we're not sitting in the chain, in the kind of excessive amounts of inventory.

On the other hand, customers are actually, let's say, trying to position themselves as well for the recovery, and they don't want to be out of product, right? So there's kind of a daily management of that..

Last one from me. Robert, I think you made the comment that your SG&A and R&D, depending on how the quarter plays out, could be flex. I assume that's both up and down.

And in terms of flex to the upside, I mean, if you do get a snapback or see a rapid increase in demand, are we looking at a situation where there could be some negative operating leverage on the upside of this thing? Just because costs have to come back so quickly because you cut so hard..

I wouldn't be able to flex it that much in that scenario. Meaning that, what you're implying is a significant reinvestment back into the business. And if you consider that the bulk of the spending is really on personnel, that wouldn't necessarily be feasible.

So there's a range of what I can flex there, but I can, I certainly have more flexibility to flex down than I have, to go up..

Yes, it should get pretty high. That's pretty high. You need to see it. Let's say, in case, let's say, if unexpectedly, things turn for the worse, then, of course, we'll have to relook at flexing down certain expenses..

And the next question will come from Rick Eastman of Robert W. Baird..

Just a follow-up on that particular point. So Robert, again, you said SG&A might drift up a little bit sequentially.

Can we assume that, that is at the upper end of your revenue guide for the third quarter? And then flat at the midpoint? I mean, is that the range with which you're kind of talking about flexing SG&A?.

You mean in terms of the dollar or as a percent of....

Yes, just the dollars. Dollars of SG&A kind of move a bit up if you're up at the $142 million kind of mark? I mean, I presume there's more selling expense, but....

And then if it flex down, I don't think it can flex down beyond what we saw in the second quarter. So I mean I could with more dramatic actions, but we're not necessarily seeing that level of issue right now..

I think you made that clear on the revenue trends there. Okay.

And then can I just ask, did you see any pull forward of revenue into the second quarter from what might have been gone in the third, again, as these elective procedures start ramping back up? I mean, just that trend, did your customers perhaps buy a bit ahead of a third quarter that might be ramping? I mean, is that any of the upside to your revenue number?.

Well, no. What we said -- if we put ourselves back into what we said in the previous earnings call, right? So what we said is that the upper end of our guide in the second quarter would assume no major disruptions to our supply chain and demand materializing as we saw it.

And what you see is, we did slightly better, right, than the upside because we saw actually some countercyclical growth turning out better than expected. And our supply chain and operations teams just did a fantastic job.

So therefore, the downside scenario of supply chain interruptions didn't materialize, right? So that's kind of how you need to see it. So it is not like a pull forward or anything. It is just those dynamics..

And is that kind of focused a little bit more on the industrial side? I mean, your micro-e business, obviously doing well.

Would maybe some of that upside be slanted towards the industrial side where maybe you are thinking things could have been worse?.

Yes..

Yes, yes, I think that's absolutely fair. I think there's a little exception in terms of like our smoke evacuation is selling a lot better than we anticipated. So we are seeing a little bit more strength there. But it's certainly the scenario that we had planned for worse and things are not materializing..

Yes.

And the reason why I think on the medical side, I mean, what we have seen, and this is kind of what I high-level alluded to, Rick, is that we saw some pretty quick mix shifts, right? So you needed a lot of agility, right? And so you don't necessarily see that at the revenue level, but the composition of the revenue was changing a lot, right? So for example, the fact that we were able to show double-digit growth on the WOM smoke evacuation consumables, the rest of that business was not necessarily up.

So we had to pivot very quickly, and we were unsure if we could actually execute on that.

The same thing is true, for example, for our Detection & Analysis business, where, of course, demand for ICU patient monitoring and COVID-related things were through the roof, literally, whereas others were declining very rapidly, right? So you saw that bifurcation and therefore, we were unsure at the beginning of the quarter, if actually our supply chain could follow all that.

Yes..

And then just maybe one last question.

When I look into the third quarter here relative to your revenue guide, is there any of the three business groups that might see a sequential increase in revenue? And I'm kind of thinking around the Precision Motion business in particular -- but or is it better to think, seasonally plus the dynamics around the medical side of the business that all three business groups likely decline modestly sequentially in revenue?.

Or be closer to flat, it depends. I mean, you're right in that the third quarter is a lot of people are on vacation, and there's always a little bit of weakness generally as a consequence of that. Things are slower. In the pandemic, people seem to be taking 2 weeks of vacation instead of 1. So there are effects like that, we're trying to work through.

But I would say, generally speaking, it's probably closer to flat on a sequential basis..

Yes, there's no material kind of one part of the company, miraculously, kind of picking up and others kind of going down, right? Sequentially a lot. So I think on average, it's similar, I would say..

And the next question will come from Brian Drab of William Blair..

I just want to stick on the SG&A just for another second. So it's down from $31 million to $25 million. Can you just discuss a little bit further what exactly were the levers that were pulled there? And what, how that $6 million kind of breaks down? And I'm really looking forward to 2021 at the moment in the model.

And just kind of, I want to understand which of the items are going to be temporary, like incentive comp, and I know there was some cuts in incentive comp. And what comes back in 2021? So there's a huge difference in the run rate, I mean, right? Like in 2019, SG&A was $118 million, $25 million a quarter, you're at $100 million.

So this is going to have a huge bearing on the model as we're looking a little bit further out..

Yes, the reality is the majority of the actions that we had taken in the first half of the year were temporary. So the elimination of incentive comp, even the cost, the more severe cost reduction actions, such as furloughs, are inherently temporary in nature. And so they all, and we would anticipate them all coming back in 2021.

And the only thing that would prevent that is really taking some cost actions in the back half of the year, which are what we're looking at now. So we are looking at ways to better position the overall business if the duration of the pandemic is longer than anticipated. So that's not something that we're going to pull hard cord on yet.

But we are looking at actions that we might do a little bit as we get into the third quarter, just to better position us for 2021. It also remains to be seen how the overall market recovers in 2021. And we don't want to kind of get into that, but we haven't hired a ton of people.

We've had hiring freezes in place for the most part, unless the role is super critical. And so we haven't taken the cost structure up a lot more. And so in theory, if the recovery is solid, then the margin profile is going to look better across the board. But it gets into like very speculative as is nature.

So I do think, what are the actions we took? Furloughs. We eliminated the bonus, we replaced that with the stock comp grant. We cut back on, obviously, travel expenses and other discretionary expenses. We put hiring freezes in place that still are remaining today.

We have not taken significant structural actions yet, but we will look at that as we get into the third quarter and as we look at the fourth quarter, and there might be some things that we pull in. There were plans that we were doing in 2021 or even 2022 that we'd pull in into 2020 in order to start executing on that now and provide that cushion.

But then the last I would say is that our gross margins, we anticipate them going up in 2021, with the actions that we're taking, including rolling out the NGS process in a more institutionalized way and really putting a hard focus on material productivity, which is the bulk of our cost of goods sold..

And then acknowledging the limits on, your geographic breakdown of revenue because of where the customers are located versus where the revenue is recorded. I'm just curious, your comment on the EU and U.S., I interpreted as a collective, down 8%.

Are both of those regions individually down about 8%?.

Individually, they're both down about 8%. There's, it's fair to say there were pockets in Europe that showed a little bit better performance. So Germany, as an example, showed actual growth, where other parts of Europe saw declines comparable to the United States..

And then just last quick word.

What are you guys seeing in the additive manufacturing market in the 3D printing market?.

Well, yes, I mean, again, you got to look at it by end market, right? So we sell into laser additive manufacturing, players then who sell into end markets. Some of these end markets are depressed like aerospace, right? And so you can kind of see announcements there, and that should not be a surprise that, that is down.

Another part of the market that is increasing is medical implants. And that, while that, of course, short term, had an impact, the long-term trajectory of the technology penetration of additive manufacturing in the medical implants segment is growing, and investments are continuing.

So there, we are, yes, very confident that, that is a structural driver. And then you got broad industrial where it kind of depends, quite frankly. And I would even say on the aerospace side, even though short term, you saw, of course, demand pull back.

I mean, laser additive manufacturing can structurally be used to reduce cost and reduce the inventory, right? So if you look at players that are looking similar to us, you're looking at business continuity scenarios. I mean, it's a strategic tool, right, that is going to be deployed.

So listen, short term, the PMI-related kind of macro climate will kind of put some damper on the growth there. But again, we see structurally going forward, yes, we're leaning into that application because we see that to be a structural grower in the mid- to long-term, right? But short term, headwinds..

So Brian, knowing you and your coverage universes a little bit. One of the caveats, I would just add, is that most of the commentary that Matthijs just gave is focused on metals-based type marketplace..

Yes..

Yes. So I wouldn't want to construe that as on the plastic side. Our exposure on the plastics tend to be relatively minimal. Yes..

And 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 2020, Novanta delivered a solid performance in an uncertain macro environment. We're obviously, very pleased with our positioning and performance of our portfolio and very proud of the performance and agility of our teams.

Novanta is not immune to the impact of pandemic, but we are strategically and financially well positioned to weather this crisis. And our balance sheet is strong, our innovation lineup is strong and our portfolio diversified with exposure to long-term secular trends that we discussed.

And while the short-term outlook is uncertain with the health epidemic, we are investing into the headwinds, remain focused on the long-term growth drivers in our business on the back of the macro trends in Industry 4.0, precision medicine and minimally invasive surgery.

And 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 that are showing just tremendous agility and resilience during these 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 third 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..