Novanta Inc (NOVT) Q4 2019 Earnings Call Transcript

Novanta Inc (NOVT -2.00%)
Q4 2019 Earnings Call
Feb 26, 2020, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Ailey, and I will be your conference operator today. At this time, I would like to welcome everyone to Novanta Incorporated's 2019 fourth-quarter and full-year 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.

Ray Nash -- Corporate Finance Leader

Thank you very much. Good morning, and welcome to Novanta's fourth-quarter and full-year 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've 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, I 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 also be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP measures in the earnings press release, we will provide reconciliations promptly on the investor relations section of our website after this call. I'm now pleased to introduce the chief executive officer of Novanta, Matthijs Glastra.

Matthijs Glastra -- Chief Executive Officer

Thank you, Ray. Good morning, everybody, and thanks for joining our call. Novanta performed very well in the fourth quarter of 2019, with both revenue and adjusted EPS exceeding the top end of our guidance and revenue up nearly $6 million sequentially versus the third quarter. Company delivered nearly $160 million in revenue, representing 2% year-over-year revenue growth on a reported basis and 2% decline on an organic basis.

For the full year of 2019, we delivered $626 million in revenue, which represents reported growth of 2% year over year on a reported basis and organic growth of approximately 1%. Adjusted EBITDA was $31 million in the fourth quarter and $121 million for the full year. Adjusted EPS was $0.55 in the fourth quarter and $2.14 for the full year. Our team executed very well in an industrial capital spending market, which has been in recession for the past few quarters.

Our book-to-bill was 1.07 in the fourth quarter and was exactly 1.0 for the full year. In the fourth quarter, we saw strong bookings across the board, up sequentially by 6% versus the third quarter and up 4% year over year with each of our segments showing positive book-to-bill ratios on the back of strong commercial execution and solid demand, especially from some of our medical customers. 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 and secular growth applications, such as robotic surgery, minimally invasive surgery, DNA sequencing, advanced material processing and precision automation and robotics. In 2019, we saw excellent momentum and success in our efforts to introduce new innovations to our customers. On the back of the innovation investments we've made, we view our innovation pipeline as the strongest it's ever been with significant opportunities in the growth applications highlighted earlier. As a result, we are raising our R&D investments in 2020 from 9% of sales to 10% of sales to bring these innovations to market in the back end of 2020 and in 2021.

For the full year of 2019, new product revenue grew 27% year over year. Our vitality index, which is revenue from new products launched in the last four years, was at 26% of sales versus 22% in 2018 and mid-single-digit percentages a few years ago. Design wins grew over 20% for the full year as our teams executed on the strong funnel of design win opportunities. We are seeing many customer platforms openings with opportunities to gain share on the back of our strong innovation pipeline.

All in all, I'm very proud of the strong performance by our commercial and R&D teams in 2019 despite the market circumstances. An important element in our capital deployment strategy is M&A. In 2019, we closed three acquisitions Ingenia, Med X Change and Arges, one in each of our operating segments. Each of these acquisitions significantly accelerates our strategy to sell more content to our customers in the form of intelligent subsystems, which include an increased software content.

We are specifically targeting to sell these subsystems to customers who play in high-growth markets, such as additive manufacturing, minimally invasive surgery, robotic surgery and other high-growth areas. The engineering capability we've acquired via these acquisitions is tremendous, and we see strong sales and technology synergies by applying these capabilities through the Novanta sales channels. As we look at it right now, through these acquisitions, combined with our own R&D investments, we will be able to accelerate our innovation pipeline in a very meaningful way with multiple products hitting the market toward the end of 2020 and in 2021. For the full year of 2019, the percentage of our revenue coming from intelligent subsystems is above 25% of sales, and we expect this to steadily increase over time.

From an M&A pipeline perspective, we remain very disciplined on strategic fit and returns. Our balance sheet is strong, and we will move quickly if an opportunity arises that we feel accelerates our strategy and delivers attractive returns. 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 for the full year of 2019. And 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 innovations, and we expect that momentum to continue in these areas. I would also like to point out that we're achieving double-digit growth in our medical business despite a full year double-digit decline in DNA sequencing.

Representing approximately 55% of our revenue, we expect our medical business to continue to serve as our growth engine in 2020 in an uncertain macroeconomic climate. In the fourth quarter, we saw a stabilizing industrial capital spending climate but at a continued weak level. We also saw our revenue in China bounced back to growth of approximately 15% versus the fourth quarter of 2018 on the back of 5G infrastructure and semiconductor markets. Obviously, the coronavirus has changed this, an event that will not be unique in the way we will be affected.

I will let Robert explain in more detail the implications of the health epidemic to our financials, but I would like to say, first and foremost, that we're very pleased that all our 200 Chinese employees are safe and that our Chinese operation in Suzhou is running at 90% production capacity. Despite this, our Chinese-based customers and suppliers are still slowly coming back online, and therefore, the situation remains uncertain. The effects of the health epidemic are expected to impact our first quarter and perhaps first half results that are clearly temporary in nature. In this environment, we focus heavily on our customers and what we can control.

We continue to have the confidence to invest in our innovation pipeline and drive our businesses to capture emerging new customer opportunities. These opportunities are significant and should solidify and even strengthen our long-term growth in 2020 and beyond and our opportunities available to us only if we act fast and decisively. In addition, we recently held a two-day off-site meeting with company leaders, which focused on institutionalizing the Novanta growth system operating model across our business units and deep into the cultural fabric of this company. The Novanta growth system 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.

We feel that by rigorously applying the Novanta growth system, it will assist us enormously achieving our goals for 2020, especially in areas of customer satisfaction, speed to market, gross margin expansion and inventory optimization. Now let me turn to our operating segments. Starting with the vision segment. This segment had phenomenal performance in 2019 with excellent execution by the team.

As a reminder, the vision segment predominantly serves the medical market. Large applications include minimally invasive surgery, in vitro diagnostics and other medical devices. For the full year of 2019, our vision segment delivered excellent 17% year-over-year revenue growth. Growth was driven by new products and new product launches at customers.

In the vision segment, new product revenue for the full year grew over 60% versus 2018, and total new product revenue maintained at about 35% of sales. The book to bill in our vision segment for the full year was at 1.03. The vision segment predominantly serves the medical market and as previously mentioned, we saw solid market momentum as well as new product launch momentum, which we expect to continue as we progress through 2020. Within the vision segment, our MIS business again performed extremely well in the fourth quarter of 2019 as it did throughout the full year.

We continue to see nice momentum in our WOM business unit on the back of the smoke evacuation technology we reported on earlier. We couldn't be more pleased with the innovation strength and customer relationship depth of this business unit and expect to further gain share in endoscopy as well as expand into adjacencies, such as arthroscopy and robotic surgery. We estimate the size of these adjacent market segments to be roughly $200 million. And as a result, we are stepping up our R&D investments in the MIS business.

We are also pleased with the trajectory of our NDS business unit as it gains more significant exposure to the attractive integrated OR segment with a strong new product lineup for 2020 held by our Med X Change acquisition in 2019. This acquisition has brought to Novanta not only an expanded product portfolio, but also a differentiated OEM software solution for our customers, which we believe drives increased stickiness with our customers at a more attractive margin profile. In addition, the NDS business unit continued to substantially improve its profitability for the full year of 2019. in the fourth quarter, we completed the production transfer from San Jose into our MIS manufacturing component center, which will significantly improve scale and efficiency in 2020 and beyond.

Finally, our detection & analysis business unit continued to show solid momentum around new product launches of medical-grade RFID and machine vision product offerings. For the full-year 2019, we introduced five new products and saw strong double-digit growth in its RFID and machine vision revenue. We're also pleased with the gross margin expansion in this business unit. Our precision motion segment revenue declined 6% for the full year of 2019 where growth momentum in robotic surgery could not offset 20% declines in microelectronics, semiconductors and industrial markets.

In the fourth quarter, we did see the first signs of recovery in the microelectronics and semiconductor end markets given the uptick in demand for 5G and cloud-based infrastructure. The precision motion book to bill improved to 1.4 in the fourth quarter, with bookings improving sequentially by 19%, also providing a positive leading indicator heading into 2020. We like our position in precise and dynamic motion control technologies serving markets with structural growth dynamics such as precision automation, robotics and robotic surgery markets. As it relates to the surgical robotics markets, we continue to see our technology to be validated and our position grow with the largest players.

The ingenia acquisition, which added software-based motion control solutions to our product portfolio has opened up new opportunities to the company, both in medical and industrial robotics markets. And consequentially, is on a path of growth to more than double in revenue in 2020, albeit from a small base. Within the precision motion segment for the full year of 2019, new product revenue grew 40%, and our design wins grew more than 60% versus last year as we bring new innovations to market and are expanding our commercial teams. Turning to the performance of our photonics segment.

For the full year of 2019, revenue was down 8%, driven by laser quantum in a deteriorating industrial capital spending climate. Laser quantum revenue had a double-digit decline for the full year in 2019, as expected, and as previously communicated, due to the dynamics in DNA sequencing, which we have widely discussed in the last few quarters. We believe the lumpiness we experienced in 2019 is temporary and not correlated with long-term multiyear market demand nor our competitive position. And while we do not expect DNA sequencing to contribute to growth in 2020, we remain excited about the long-term growth prospects and our leadership position of this business.

The full-year performance of the photonics segment was also impacted by the deteriorating macroeconomic headwinds in industrial capital spending markets that we just discussed. However, our teams has been extremely resilient and have worked to counteract many of the challenges in the market and, in fact, gained share with our customers during this downturn. The photonics segment, in the fourth quarter, bookings improved sequentially by 2% with book-to-bill of 1.06. Design wins continued their momentum and grew over 40% year over year in the fourth quarter.

The innovation pipeline in our photonics segment is the best it has ever been and it has accelerated by our recent arges acquisition and beam delivery. We are anticipating introducing six new product platforms in 2020, which is double the amount we introduced in 2019, and which are expected to help us gain share in adjacent high-growth application segments. Target applications include laser additive manufacturing, micromachining, advanced material converting and electric vehicle battery welding, all of which are an overall additional market opportunity of about $150 million. The revenue impact of these new product launches will be more material in 2021 and beyond, but we do expect to begin to see some sales in the back end of 2020, as these new products come online.

To wrap up, we are very pleased with our positioning and performance in our medical end markets and are very proud of the performance, resilience and agility of our teams in an uncertain environment. At Novanta, we believe that a healthy company culture is the ultimate competitive advantage in the face of opportunity and adversity. This means trusting each other, being comfortable with constructive conflict for the good of the company and holding each other accountable to deliver. Our version of a healthy performance culture is the Novanta way, which institutionalizes how we work together in cohesive and trusting teams, how we behave and interact through our five core values and how we execute through the Novanta growth system.

We feel Novanta is very well positioned despite the near-term challenges in the broader economy. Our design win momentum continues to be high. Our bookings are recovering. And new product introductions and innovation pipelines are as strong as they have ever been.

Novanta's leadership positions across diversified medical and advanced industrial markets, combined with our disciplined approach to M&A, continues to provide a solid foundation for long-term sustainable profitable growth. Therefore, we remain focused on our strategy to expand in growing medical markets and are not wavering in our conviction of innovation investments to expand our proprietary technology positions. So with that, I will turn the call over to Robert to provide more details on our financial performance. Robert?

Robert Buckley -- Chief Financial Officer

Thank you, Matthijs, and good morning, everyone. We delivered $159.7 million in revenue in the fourth quarter of 2019, an increase of 2% year over year on a reported basis and a decline of 2% on an organic basis. For the full year 2019, we delivered $626 million in revenue, an increase of 2% on a reported basis, and organic growth was positive 1% year over year. While the industrial capital spending environment and the economic climate in Europe and China remain weak, we are pleased with the organization's ability to deliver on our financial commitments for the quarter.

The better-than-expected revenue growth was driven by strong growth in our medical business and higher growth in new product revenue, which now represents 26% of our sales. Our medical sales were up mid-teens in the fourth quarter and full year. This was despite not seeing a meaningful contribution from the DNA sequencing market in the fourth quarter and experienced a roughly 10% decline for the full year. Overall, we're pleased with how we managed through the economic environment and with the strength and resilience of our portfolio.

Turning to profit. Our fourth quarter GAAP gross margin was $66 million or 41% of sales compared to $64 million or 41% of sales in the fourth quarter of 2018. For the full year of 2019, GAAP gross profit was $262 million or 42% of sales compared to $261 million or 43% of sales in 2018. On a non-GAAP basis, fourth quarter adjusted gross profit was nearly $70 million or 44% of sales compared to $67 million or 43% of sales in the fourth quarter of 2018.

Full-year 2019 adjusted gross profit was $274 million or 44% of sales compared to $272 million or 44% of sales in 2018. For the full year 2019, our adjusted gross margin was roughly flat compared to 2018. The lack of gross margin expansion was largely impacted by significant growth in our medical consumables product line, which drove unfavorable mix effects during the year. We also faced temporary cost headwinds caused by redundant manufacturing facilities for our NDS business unit as we shifted production from San Jose, California to our Germany facility.

The San Jose manufacturing facility is now closed, creating a healthy tailwind as we move forward into 2020. Moving on to operating expenses. Fourth quarter R&D expenses were $15 million or 9.2% of sales compared to $13 million or 8.5% of sales in the fourth quarter of 2018. For the full year 2019, R&D expenses were $56 million or 9% of sales compared to $51 million or 8% of sales in 2018.

As seen in our new product revenue and our design win activity, we are making progress with our innovation engine and pipeline. The current economic climate, in our view, provides the opportunity to take market share and capture significant growth opportunities to drive our growth in 2021 and beyond. Fourth-quarter SG&A expenses were $29 million or 18% of sales compared to $28 million or 18% of sales in the fourth quarter of 2018. For the full year 2019, SG&A expenses were $118 million or 19% of sales compared to 19% of sales in 2018.

GAAP operating income was $13 million in the fourth quarter of 2019 compared to $16 million in 2018. For the full-year 2019, GAAP operating income was $55 million compared to $71 million in 2018. Non-GAAP operating income in the fourth quarter was $25 million or 16% of sales compared to $25 million or 16% of sales in the prior year. For the full-year 2019, non-GAAP operating income was $100 million or 16% of sales compared to $105 million or 17% of sales in 2018.

Adjusted EBITDA was $30.5 million in the fourth quarter of 2019 compared to $30.8 million in the fourth quarter of 2018. For the full year 2019, adjusted EBITDA was $121 million compared to $123.8 million in the prior year. Interest expense in the quarter was $2.1 million versus $2.5 million in the prior year. For the full year of 2019, interest expense was $8.5 million compared to $9.8 million in 2018.

The weighted average interest rate of our senior credit facility was 2.9% for the fourth quarter. On the tax front, our GAAP tax rate was 11% for the full year 2019. It differed from the Canadian statutory rate of 29% driven largely by favorable tax credits and jurisdictional mix of income. On a non-GAAP basis, our tax rate was 16%, which was driven by favorable tax credits in the United States and the U.K.

and more favorable jurisdictional mix of income. Our GAAP diluted earnings per share were $0.26 in the fourth quarter of 2019 compared to diluted earnings per share of $0.33 in the fourth quarter 2018. For the full year of '19, diluted earnings per share was $1.15 compared to $1.43 in the prior year. On a non-GAAP basis, adjusted earnings per share was $0.55 in the quarter, flat versus the prior year.

For the full year of 2019 adjusted EPS was $2.14 compared to $2.15 the prior year. And we ended 2019 with 35.5 million diluted weighted average shares outstanding. Fourth quarter operating cash flow was $35.4 million compared to $21.9 million in the fourth quarter of 2018. This result was in line with our expectations.

As we discussed in our last call, it was mostly driven by timing of net working capital. For the full year of 2019, operating cash flow was $63.2 million compared to $89.6 million in 2018. This full-year performance, which we also discussed in prior quarters, was driven in part by the uptick in inventory, an area of focus for us in 2020. We ended 2019 with gross debt of $225 million and our gross leverage ratio was 1.9 times defined as gross debt divided by rolling 12 months pro forma EBITDA.

Our net debt was $146 million as of the end of 2019 or roughly 1.2 times. We continue to build a very healthy acquisition pipeline, particularly around our medical end markets. You should continue to expect us to be highly disciplined around maximizing cash flow returns and ensuring future transactions will accelerate our financial goals. Turning to the full year of 2020.

There are a lot of exciting aspects of our business where we're seeing momentum building particularly around new products and design win activity and around our medical business. Prior to the ongoing public health epidemic, which originated in China, we saw industrial capital spending markets stabilizing and some early signs of growth returning, particularly around 5G infrastructure investments. However, as we stand here today, it's clear that coronavirus is going to temporarily delay and disrupt our business in the first quarter. This epidemic is expected to have a temporary impact on our sales of products sold directly to China, which represent just over 10% of our company's total sales.

We also expect it to impact our supply chain, specifically products sourced from China to feed our global factories. And finally, we do expect to see some impact on demand for our non-China-based customers due to their own dependencies on the China market. The effects of our supply chain and sales to our non-China-based customers are currently expected to be smaller impacts at this stage of the epidemic. The consequences of the virus further spreading outside of China is still too early and uncertain for us to estimate if there is any impact, but this is something we are carefully monitoring and currently attempting to mitigate.

The effects of the coronavirus outbreak represents our views as of today based on our current expectations regarding the timing of business resumption of our operations and our customers and our Chinese supply chain. A significant worsening of the situation is currently not anticipated in our guidance. Regardless, we believe this disruption to only be temporarily and that overall, we remain fundamentally strong and well positioned for growth and success in 2020. Consequently, we are not updating our full-year guidance, which we issued in January.

It is our expectation that the financial weakness we are seeing in the first quarter will be recovered before year end. The first quarter of 2020, we expect GAAP revenue in the range of $144 million to $154 million. This represents an expected year-over-year decline in sales in the range of low to mid-single digits on a reported basis. This weakness in the first quarter is directly correlated to the disruption being caused by the coronavirus outbreak, an impact on revenue in the range of $10 million to $15 million at this time.

First quarter gross margins are expected to decline roughly 100 basis points from the fourth quarter of 2019. The largest contributor to this is the close of our San Jose manufacturing facility and a slightly better mix of higher-margin sales. As mentioned before, we're very excited about our innovation pipeline, and therefore, expect R&D investments of $15 million to $16 million in the quarter, representing over 10% of sales, but largely due to the drop in revenue. SG&A will climb in the first quarter to around $33 million.

The uptick in spending of greater than $1 million is a consequence of higher variable compensation accruals and the seasonality of payroll taxes. Depreciation expenses are expected to be close to $3.1 million, while amortization of intangibles is around $5.3 million. First quarter stock-based compensation expense will be around $3.2 million. The first quarter of 2020, we expect adjusted EBITDA to be in the range of $23 million to $26 million, which should be mid-teens on a percent of sales basis.

This lower EBITDA margin is a reflection of the temporary decrease in volumes as we are seeing -- as we are investing into the headwind. We expect to be able to recover from this lower profit margin in the first quarter during the remainder of the year. Interest expense is expected to be around $7 million for the full year versus $8.5 million in 2019 as a consequence of both the more favorable terms under our new credit facility and some interest rate arbitrage strategies we've been implementing, where we're trading U.S. borrowing for Europe borrowing at a lower interest rate.

We expect to see non-GAAP tax rate of about 18% for the full year of 2020 and approximately 15% to 16% for the first quarter. Finally, we expect diluted earnings per share will be around $35.6 million, and therefore, we expect first quarter of 2020 adjusted earnings per share to be in the range of $0.34 to $0.42. Overall, we feel confident in the ability and strength of our portfolio to manage through the temporary disruptions caused by the coronavirus outbreak. Our medical business is continuing its strong growth trajectory with tremendous demand across various products in multiple end markets, which is giving our portfolio resilience.

Our design win activity is very strong and our new product introductions are as robust as we've ever seen. In addition, we feel great about the impact of institutionalizing the Novanta growth system across the company, to drive sustained gross margin expansion and inventory reductions. An example of our commitment around this is we've recently aligned the company's short-term incentive compensation structure around sustainment and improvements in gross margin and reductions in inventory. Despite the health epidemic, we're confident that we are well positioned to deliver on our 2020 financial goals.

We are very proud of the performance of our employees and their commitment to helping us weather this difficult environment. We remain excited about our future and look forward to continuing to deliver on our commitments for our employees, our customers and our shareholders. This concludes our prepared remarks. We'll now open up the call for questions.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Lee Jagoda with CJS Securities.

Lee Jagoda -- CJS Securities -- Analyst

So can we start with all the opportunities you're seeing in terms of new products? And maybe give us some detail around the end markets and the product applications that are causing you to accelerate your R&D spend this year?

Matthijs Glastra -- Chief Executive Officer

Yes. Good morning Lee. I commented on most of that in my prepared remarks, but let's go one by one. I mean, we see tremendous opportunity in our minimally evasive surgery end markets.

I commented that we see opportunity in endoscopy as well as arthroscopy and robotic surgery within our minimally invasive surgery business. So that's a combination of our entire product portfolio in that segment. And that's a multiyear expansion opportunity that we see. And I commented that, that's roughly a $200 million adjacent market opportunity that we're currently not serving.

Then in our photonics segment, I commented that we are accelerating product introductions, particularly around beam delivery but also in other parts of our photonics segment. So we're basically doubling the product introductions from three to six in 2020 that is, and those products will be introduced in the latter part of 2020. We'll have more material impact in 2021. And we're basically seeing, on the back of these innovations, and that's both in photonics, as well as in minimally invasive surgery, extremely active customer engagements right now, and to win kind of slots that are opening up in the next, let's say, 12 to 24 months.

In addition, we see, on the back of our acquisitions, I've commented on, that's across our entire portfolio. They've really helped to accelerate and rejuvenate our innovation pipeline, particularly around intelligent subsystems. So maybe one other thing to comment on is that we're very excited about the motion control capabilities that we've added last year that we see to be particularly targeted in robotics, as well as industrial precision automation segment. So I think all in all, it's a pretty broad based set of opportunities.

I think on the photonics side, maybe just to comment on the type of markets, I realized I forgot to mention that it's a combination of laser additive manufacturing, which is driven by both aerospace as well as medical end markets, rapidly growing markets where we feel we can gain share with our new capabilities, micromachining, which is building into the trend of automation based -- on the back of laser-based production technologies, let's say, advanced converting applications, both textile as well as other converting-based applications. And finally, an emerging opportunity for us but obviously very relevant is electric vehicle battery welding. Yes, so as demand increases in that market, for obvious reasons, more sophisticated production technologies are needed. To get the throughput up and the cost per part down.

And those are typical trends that play into our favor with more precise, let's say, technologies. And with the latest addition of our -- of both our acquisitions as well as our innovation investments we've made in the past, yes, we are very excited about playing a more substantial role into those markets.

Lee Jagoda -- CJS Securities -- Analyst

That's great. And then just focusing in on the WOM business specifically I think that business has been growing something in order of magnitude of the 20% range already, driven by the adoption of the smoke evacuation stuff. With further adoption of that as well as the new market opportunities, how do we size the growth rate, call it, from the 20% level over the next several years? Does it accelerate from that level? Or just stay there longer.

Matthijs Glastra -- Chief Executive Officer

Yes, it's a great question. I mean, we have not specified that, Lee. But I think giving you an order of magnitude of $200 million adjacent additional market opportunity. And of course, we're not capturing 100% of that market.

But it should give you a point of view that we're seeing expansion potential well beyond what we originally thought was possible. I mean, that business has a fantastic innovation pipeline, very deep customer relationships and also capabilities that can extend into new markets. So their capability is not only around, call it, gas management and control, it's also around fluid management and control. And that plays very well into, for example, the arthroscopy market.

So basically, taking the capabilities, repackaging those and then targeting those capabilities into new markets, building off already strong customer relationships. And that's a multiyear trend. I mean, as you know, medical markets are not moving very fast from kind of introducing new technologies. So this, you can expect maybe in a short answer.

Sustained growth in this business in the foreseeable future, multiyear.

Lee Jagoda -- CJS Securities -- Analyst

OK. And then just one for Robert, and I'll hop back in queue. Do you have any goals that you're willing to share on working capital reduction for 2020? And then maybe just touch on the capex forecast for this year?

Robert Buckley -- Chief Financial Officer

Yes. So on the goals, I always find it hard to come out with like what our internal goals are around this stuff when we have not been able to demonstrate the amount of progress that we wanted to achieve. So what we've decided to do this year is to get a lot more specific around the inventory reduction. So we've deployed a problem-solving techniques that we use and tools that we've used as part of the Novanta growth system to attacking inventory, and we've deployed some additional corporate resources around that effort.

So really kind of attacking this in a very methodical, disciplined type of manner that gets reviewed on a monthly basis. And then to add that extra incentive, historically, we've had incentive comp paid on overall net working capital management. And this year, we've decided to get very specific and tie a portion of it to just the inventory because the reality is we've done an excellent job from the inventories and account payable side. We've been able to control that more through process and disciplines over at a higher-level basis.

So now tying the individual business units to really managing their inventory and bringing that down. That's a key element of our compensation structure as we get into 2020. So it is the driver of our cash flow going into 2020. So my hope is to get back to the normalized rates of where we were in 2018 as our cash flow conversion as a percent of EBITDA.

If you look back at that, that would be my desire to get there through that inventory reduction, and that's the biggest lever that we have. Now from a capex perspective, we do see capex ticking up temporarily in 2020. We've talked about that a little bit in the past. We exited around $10 million in '19, that had a little bit of investments in facilities, but for the most part, we spend on our production capabilities and some of the fit out and tooling and whatnot.

This year, in 2020, that's probably going to get close to double, depending upon the timing, somewhere close to $20 million because we have a pretty sizable investment that we're making into a new facility in the U.K. That facility is somewhere in the order of magnitude of $8 million to $10 million. So that's a one-off that won't repeat thereafter. But it is something that we're expecting to impact us in 2020, as we fit that out and add some capability that I think that our competitors, frankly, don't have, and then give us a little bit more scalability in the operations there because we're seeing some nice growth come out of it.

Lee Jagoda -- CJS Securities -- Analyst

Great. Thanks so much.

Operator

Our next question comes from Richard Eastman with Robert W. Baird.

Robert Buckley -- Chief Financial Officer

Yes. Good morning, Rick.

Rick Eastman -- Robert W. Baird and Company -- Analyst

Hey. Just a really quick clarification. Robert, you had mentioned that the gross margin in the first quarter sequentially would be up or down 100 bps?

Robert Buckley -- Chief Financial Officer

Up 100 basis points.

Richard Eastman -- Robert W. Baird and Company -- Analyst

OK. Perfect.

Robert Buckley -- Chief Financial Officer

That's a good clarifying question.

Rick Eastman -- Robert W. Baird and Company -- Analyst

Yes. I'm thinking with the opex numbers that you tossed out there, it probably would better be up to cover some of that. And then, Matthijs, just a question -- big picture question. As we roll into '20 here, the industrial portion of the business, which I think you said was maybe 45% of sales in '19.

You made some reference to stabilization in the fourth quarter, perhaps some momentum let's just ignore the first quarter here in COVID, but some momentum around the semi market, maybe 5G kind of driven. But how do you feel about potentially delivering some growth off of a pretty modest base for the 45% of the business that's industrial in 2020? Do you feel comfortable that we can potentially return to growth there?

Matthijs Glastra -- Chief Executive Officer

Yes. Yes, it's a good question, Rick. I mean, listen, I think the remark I made was around the fourth quarter prior to the coronavirus, right? So let me be clear with that because it basically with the coronavirus, a lot is up in the air, quite frankly. So if you look at the fourth quarter, we sold China bouncing back 15% on the back of 5G infrastructure and cloud-based infrastructure and microelectronics markets in general, right? And I don't think we have been any different than what other players are seeing, quite frankly.

So I think that's consistent with what others are seeing. And so we saw that as well. If you look at regionally, for example, U.S. was up, and Germany was down.

Rest of Europe was hanging in there. Of course, anybody's guess what that will be with imminent coronavirus threats coming into Europe at the moment, I would suggest that, let's say, from a Germany perspective, we expect that to be a little lackluster, particularly the first half. I mean, the original kind of idea and view prior to the coronavirus is that macroeconomically, the industrial markets would remain subdued in the first half, and then we would return back to growth in the second half. It depends on the scope and the length of the coronavirus impact if that's going to change.

But that was the original viewpoint of our guide and, of course, we have some modest, but nevertheless, some impact of new products introducing in the second half of the year as well that should help that a bit.

Rick Eastman -- Robert W. Baird and Company -- Analyst

OK, OK. And I just want to follow up with a gross margin question. In the vision segment of the business, now we've got San Jose closed. We've got things in NDS integrated.

I think there was a reference to $2 million of savings expected in 2020 there. And so when I look in particular within vision, we've got kind of the self-help initiatives, and we've got volume growth. We've got the benefits of maybe some of the consumables internalization here later this year. But is a 200-plus basis point improvement in gross margin in the vision segment pretty much a layup at this point? A right-handed layup at this point?

Robert Buckley -- Chief Financial Officer

Yes. So I would say that the 200 basis points should be fairly easy, right, from that perspective. We're obviously trying to drive more. And the only real risk in the vision segment to gross margin expansion is some sort of significant uptick in the medical consumables, which create that negative mix effect.

Absent that, we have all the actions in place, the teams have all the actions in place, and some stuff already done in the consequence of San Jose manufacturing closing down to really drive margin expansion in that segment. So we feel pretty good about that. And we feel we got the right sort of levers already pulled to drive the expansion there.

Rick Eastman -- Robert W. Baird and Company -- Analyst

OK. And overall, the adjusted gross margin, then you're still feeling reasonably comfortable around 200 basis points for Novanta? I know we got a little bit of a hurdle here in the first quarter, with volumes, but...

Matthijs Glastra -- Chief Executive Officer

Yes. So I would say internally, we're looking at that second half being 46-plus percent. And I think that really is kind of based upon the first quarter being more of a temporary impact and then starting to recover as we get into the second quarter. Hopefully, people calm down with the flu here and we can get back to business.

And so that's really the big issue.

Rick Eastman -- Robert W. Baird and Company -- Analyst

OK. Great. Thank you again.

Robert Buckley -- Chief Financial Officer

Thanks Rick.

Operator

[Operator instructions] And our next question will come from Brian Drab with William Blair.

Brian Drab -- William Blair & Company -- Analyst

Good morning. Thanks for taking the questions. Just first following up on that last question around the WOM consumables. Where are we with prospect of getting that production and brought in-house?

Matthijs Glastra -- Chief Executive Officer

Yes. So listen, we are tracking there. Like with any multiyear transformational program and initiative, there are some pluses and minuses. I think the pluses is that we've significantly strengthened the local teams, and these teams are able to drive higher volume out of the existing facilities and infrastructure than we expected.

So therefore the overhead leverage and the productivity out of the factory or our own factory of existing products should actually be better than expected. And that gives us a little bit of time to figure out the best manufacturing footprint. As I commented earlier, we see the growth opportunity in the WOM business and minimally invasive surgery as well as the adjacent markets I commented on, very bright. And as a result, it's important that we properly adjust our capacity and our footprint strategies accordingly with more new products coming in.

So I think the short answer is, we can get more out of the existing setup, and that will drive gradual gross margin expansion. The real step up in gross margin and step down in cost will happen in a few years. So I really think it's around 2022, 2023 be more likely 2023 when we put a more sustainable infrastructure in there. Yes.

But we will use, in the meantime, all the aspects of the Novanta growth system to really drive and lean out the existing facility, which, again, it looks more favorable than we initially expected.

Brian Drab -- William Blair & Company -- Analyst

OK, got it. And then just this dynamic of relatively softer-than-expected first quarter guide given the corona and soft environment, but the maintenance of the full-year guide. Can you just talk about what drives that? And what results in pent-up demand rather than demand destruction here and maybe from -- if you could just discuss some of the -- what you're seeing from some of your customers? And are they having to push out their sales to second quarter and then you'll just support them in the second quarter and make up for it. How is that going to play out?

Robert Buckley -- Chief Financial Officer

Yes. So I'm going to attack team this a little bit with the tide. So if you look at the sequential or the year over year, 60% of like the magnitude of the drop in. I'll talk to EPS is really the coronavirus impact.

This is a flow through of that impact and not taking the cost actions. What I would say, we normally would just say, OK given that there's a reduction in volume, let's adjust the variable portion of our cost structure to deal with that, take the heads out or furlough them or whatever that might be. We haven't taken that action on the guide in Q1 because we see that opportunity as really being very, very temporary. It's not something that we think is going to be structurally inherent in the business on a go-forward basis that last a couple of quarters.

When you look at the year over year, 20% of it is also increasing of the R&D that's going up about $1 million, $1.5 million. And then the variable comp element is the other 20% impacting the SG&A line. So that's kind of the walk and the thought process around it. And what are some of the things that give us some positive? Matthijs or some excitement.

Matthijs talked a little bit about the bookings. He talked a little bit about the design win activity. He talked a little bit about the new product introductions. We did exit the fourth quarter with growth in China and growth in a number of our markets, Germany being really the only one that was really disappointing.

But yet, we're also seeing a significant uptick in the amount of quoting activity, even in places like China, where people are really looking at their next generation of platforms to drive their own growth in the second half of the year and into 2021. And that was something that we talked a little bit about the last quarter, where people were willing to pick their heads up. They are now willing to pick their heads up. And that activity is still ongoing.

So despite the fact that there is a coronavirus outbreak right now in China, we are still actively quoting even in that marketplace.

Matthijs Glastra -- Chief Executive Officer

Yes. No, and I can add to that is that so ironically, what you read in the news and what we feel on the ground in terms of our customer activity in China, particularly, is very different. So we do see, on the back of our capabilities, a lot of strong interest. Now, of course, that will start to have more material impact in the second half of the year and in 2021.

But we're engaging across the board, across all these applications that I mentioned, with the leaders in those segments that are really pooling for innovations. And so then it takes another, let's say, 12 months to work with those customers to really bring or sometimes longer, right, in case of medical, it might take 24 months or longer to bring these innovations to markets with our customers. But the opportunity is now. And so what I commented on in the prepared remarks is that, yes, if you look beyond kind of the, let's say, the short-term noise, you see in multiple high-growth markets that have structural growth dynamics for the next decade or plus, you see slots opening with leaders that we could do more business with and gain share in the next 24 months.

And we're acting very decisively and fast. And yes, that might mean that short term, we're forgoing some profit potential. But long term, we feel that puts the company in a really good position. So that's why we're doing it.

And then it's anybody's guess, quite frankly. I mean, our views are as of today in terms of the scope and the length of the coronavirus. It's anybody's guess how long it's going to take. In the meantime, we're going to stay focused on what we can control.

We focus on our customers. Our customers are telling us, give us more, give us more faster, and that's where we're acting on.

Rick Eastman -- Robert W. Baird and Company -- Analyst

Got it. Robert, just to be clear, when you're talking about 60%, 20%, 20%, you're comparing first quarter '20 to what, to first quarter of '19? Or what is the 60%?

Robert Buckley -- Chief Financial Officer

Correct. Year over year. So take the first quarter of 2020 to the first quarter of '19. 60% of the impact is the coronavirus and then 20% is R&D and 20% is variable comp.

Rick Eastman -- Robert W. Baird and Company -- Analyst

Yes. And that variable comp is up year over year materially because?

Robert Buckley -- Chief Financial Officer

Because we didn't get paid out a bonus last year, for all types of purposes. When you don't hit your goals, right, your comp goes down. And that's how this thing works.

Rick Eastman -- Robert W. Baird and Company -- Analyst

Yes. I just didn't know how that plays out through the year if that was accrued through the year and why it was accruing year-over-year mark and see why it wasn't. I'll talk about some of that detail offline with you to make sure I've got it. Just one more question for now.

So this is going to be at least the beginning of the year looks to be pretty challenging. And then you've got these. It sounds like some incredible opportunities in front of you that start to be driven by new product introductions later this year and into 2021. And so given the momentum you're going to have, entering 2021 and fairly easy comparison, it looks like on 2020, is there any reason why in 2021 you wouldn't grow above this long-term average growth rate expectation of $5 million to $7 million?

Robert Buckley -- Chief Financial Officer

Yes. I mean, we're not sitting here, coming out with the 2021 guide because we even don't know what our first half of 2020 baseline is going to be, to be perfectly frank. But yes, I mean, listen, I mean, that's, of course, what we were shooting for, absolutely and beyond, right? So the new product introductions should have a much more material and significant impact in 2021, and particularly 2022 even. So it's a multiyear impact to the business, we feel.

And so yes, I mean, and that's why we're investing because we see the next two years as being basically taking control of destiny by driving more growth through innovation and share gains.

Rick Eastman -- Robert W. Baird and Company -- Analyst

Yes. OK. And then in terms of the guidance for the full year, unless I missed it, you're not making any comment today regarding lower end is more likely or midpoint is more likely? Or any update in terms of that range, right?

Matthijs Glastra -- Chief Executive Officer

I don't want to get kind of specific around the range. We put a broader range out there, knowing that there was some risk back in January. And that risk is now materializing, maybe a little bit more so than we anticipated. But I think I don't want to kind of get into any sort of updates on high, low probabilities and all that.

Let's see how this thing further develops, and then we can get back with more specifics.

Operator

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

Matthijs Glastra -- Chief Executive Officer

Thank you, operator. So to summarize, in the fourth quarter of 2019, Novanta delivered a solid performance in an uncertain macro environment. We're very pleased with our positioning and performance in our medical businesses. I'm proud of the performance and agility of our teams in a weak industrial capital spending environment.

Our design win momentum continues to be high. New product introductions and innovation pipelines are as strong as they have ever been. And Novanta's leadership position across diversified medical and advanced industrial markets, combined with our disciplined approach to M&A, is providing a solid foundation for long-term, sustainable, profitable growth. While the short-term outlook is uncertain with the health epidemic, we're investing into the headwinds and remain focused on the long-term growth drivers in our business in the back of the macro trends in Industry 4.0, precision medicine and minimally invasive surgery.

In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support. I'm particularly grateful for a strong contribution and agility and execution of our teams of committed Novanta employees that are just showing tremendous dedication and agility. We appreciate your interest in the company and your participation in today's call. I very much look forward to joining all of you in several months on our first-quarter 2020 earnings call.

Thank you very much. This call is now adjourned.

Operator

[Operator signoff]

Duration: 60 minutes

Call participants:

Ray Nash -- Corporate Finance Leader

Matthijs Glastra -- Chief Executive Officer

Robert Buckley -- Chief Financial Officer

Lee Jagoda -- CJS Securities -- Analyst

Rick Eastman -- Robert W. Baird and Company -- Analyst

Richard Eastman -- Robert W. Baird and Company -- Analyst

Brian Drab -- William Blair & Company -- Analyst

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