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Novanta Inc.  (NASDAQ:NOVT)
Q4 2018 Earnings Conference Call
Feb. 27, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, and good morning. My name is Chad, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Incorporated 2018 Fourth Quarter and Full Year Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks their will be a question-and-answer session. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Ray Nash, Corporate Finance Leader. Please go ahead, sir.

Ray Nash -- Corporate Finance Leader

Thank you very much. Good morning, and welcome to Novanta's fourth quarter and full-year 2018 earnings conference call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our Chief Executive Officer, Matthijs Glastra; and our Chief Financial Officer, Robert Buckley.

If you have not received a copy of our earnings press release issued today, you may obtain it from the Investor Relations section of our website at www.novanta.com. Please note, this call is being webcast live and will be archived on our website shortly after the call.

Before we begin, we need to remind everyone of the safe harbor for forward-looking statements that we've outlined in our earnings press release issued earlier today and also those in our SEC filings. We may make some comments today, both in our prepared remarks and in responses to questions, that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations.

Any forward-looking statements made today represent our views only as of this time. We disclaim any obligation to update forward-looking statements in the future even if our estimates change, so you should not rely on any of these forward-looking statements as representing our views as of any time after this call.

During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP measures in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our website after this call.

I'm now pleased to introduce the Chief Executive Officer of Novanta, Matthijs Glastra.

Matthijs Glastra -- Chief Executive Officer

Thank you, Ray. Good morning, everybody, and thanks for joining our call. I'm going to start with a brief overview of 2018 and what we expect to see in 2019. 2018 was an excellent year for Novanta delivering record results in most financial metrics and delivering on both our revenue and profit promises to our shareholders.

Our Company delivered $614.3 million in full year revenue, representing 18% year-over-year reported revenue growth and 7% year-over-year organic revenue growth. Our full-year book-to-bill was 1.07 and our organic bookings grew 9% versus 2017.

Our adjusted EBITDA was $123.8 million, which is up 17% versus last year. Our adjusted earnings per share was $2.16, which was up 35% from $1.60 last year. In addition, we delivered outstanding cash flow performance with operating cash flow growing to $89.6 million, which was up 41% from last year. Our free cash flow to GAAP, net income for the full year of 2018 was over 150%.

We continue to feel good about the positioning of our businesses around secular macro growth drivers with over half of our revenue in medical markets that are structurally growing. We see a converging trend and a need for motion and vision and photonics capabilities in a large variety of applications on the back of macro trends of industry 4.0, precision medicine and healthcare productivity. Particularly, we remain excited about our position in applications such as robotic surgery, minimally invasive surgery, DNA sequencing metrology, advanced material processing and precision automation and robotics. We see excellent momentum and success in our efforts to penetrate high growth markets and introduce new innovations to our customers.

New product revenue for the full year grew over 55% year-over-year. Our vitality index, which is revenue from new products launched in the last four years move to above 20% of sales for the full year, up from 15% of sales in 2017.

Our full year design wins increased by nearly 30% and our full year revenue from China increased by more than 18% versus last year. All in all, fantastic performance by our team and we feel we see the initial results of implementing our Novanta grow system, driving sustained growth and operating performance.

Looking ahead to 2019, we continue to see robust growth in our medical end markets with half of our revenues coming from these end markets and with strong leadership positions we feel good about further penetrating the space with our suite of technologies.

On the industrial market side, the overall global economic and geopolitical environment remains a bit fluid. Industrial spending, particularly in China, Europe and the United Kingdom is experiencing a moderate pull back and while microelectronics market exposure is small, we see some softness there.

Despite this microeconomic backdrop, we feel good about our full year revenue growth commitments due to our diversified portfolio of applications with secular and long-term growth dynamics.

Let me briefly touch on tariff and inflation, our businesses through the Company's continuous improvement program continues to do a tremendous job to address the effects of both. And while we are seeing the effects of inflation and tariff on our material spend. I'm proud of the -- execution by the team delivering solid productivity contributions to our operations, net of these defects.

We remain on track to completing most of our tariff mitigation steps by the end of the second quarter. Now, let me turn to our operating segments. Our Precision Motion segment was a fantastic growth engine for us in 2018 with 25% year-over-year revenue growth and 22% year-over-year bookings growth.

In the fourth quarter, revenue grew 24% versus the fourth quarter of 2017. We continue to like our position in precise and dynamic motion control functionality in multiple markets with structural growth dynamics such as precision automation, robotics, metrology and robotic surgery.

Our Zettlex acquisition continues to perform well and we are extremely pleased with the quality of the business, the team and with the progress of the integration. The premise of this transaction was that we could expand its technology into medical robotic applications and use it as a wedge to penetrate industrial robotic applications, our existing technology base could not serve as well. And after the first year of ownership this is proving out, so we could not feel more excited about what this technology will do for us long term.

Within the Precision Motion segment for the full year, our new product revenue grew by more than 60%, of our design wins grew more than 80% versus last year. As we bring new innovations to market and are expanding our commercial teams.

The Precision Motion full year book-to-bill was 1.08 and 0.95 in the fourth quarter due to medical robotics order timing and some micro-electronics market softness.

Turning to the full-year performance of our Photonics segment. Two of the three business units experienced solid mid single-digit performance, driven by laser additive manufacturing, advanced material processing and micro machining. For the full year new product revenue in photonics was robust and up double digits versus last year. Design wins increased by nearly 20% versus last year and revenue from China for the full year was up over 20%.

We're pleased to see the continued growth execution in our technology -- Cambridge Technology business, which delivered strong full-year revenue growth with broad momentum across multiple applications. We are winning in the Cambridge Technology business due to our proprietary beam steering technology packaged with customer or application specific solutions enabling our customers to win with the fastest most accurate and highest performing solutions.

In addition, we're also very pleased with the performance of our Synrad business which delivered solid organic growth in the quarter. Finally, as we indicated before in prior calls, our Laser Quantum business continues to face challenging year-over-year comparisons. After a customers lines of new product in the DNA sequencing market last year.

Laser Quantum revenue in the fourth quarter declined double-digit year-over-year. This is an expect -- any event, we expect to repeat in the first half of 2019. As a reminder this lumpiness of sales is related to temporary customer launch dynamics in DNA sequencing which is unrelated to end market growth.

In fact, we feel we are now security positions on multi-generational platforms in this space and therefore foresee a multi-year growth path in this market and business. As a result of the Laser Quantum dynamics, the fourth quarter revenue in our photonics segment was essentially flat year-over-year. For the full year, the photonics segment showed solid growth of 7% with a book-to-bill of about 1.

Turning to our Vision segment, which includes two businesses Minimally Invasive Surgery technologies or MIS, for short and Detection & Analysis. For the full year, our vision segment delivered 27% year-over-year revenue growth driven by full year of results from the WOM business. We are especially pleased with our Minimally Invasive Surgery business which turned in solid growth despite tough comps at WOM related to 2017, which we have discussed in prior calls.

In the vision segment, new product revenue for the full year, more than doubled versus last year. And the book-to-bill in our vision segment was 1.14 with solid bookings across the Board. The vision segment predominantly serves the medical market and as previously mentioned, we see solid market momentum as well as new product launch momentum, which we expect to continue in 2019.

Our one business performed better than we expected in the fourth quarter of 2018, despite the tough comps in the second half of 2017 and despite the fact that we exited some medical product lines. This is a testament both to the high demand for WOM's product offerings as well as commercial execution by the WOM team.

In addition, we are very pleased with the continued momentum of our NDS product line. In the fourth quarter, NDS delivered its eighth consecutive quarter of year-over-year core revenue growth driven by new products such as 4K displays, wireless products, and our new video image management and acquisition product or VIMA, which addresses the integrated operating room market.

In addition, the business substantially improved its profitability and was a net contributor to our full year revenue and profit growth in 2018. Finally, our Detection & Analysis business continues to show solid momentum with new product launches around medical grade RFID and Machine Vision product offerings.

In 2018, the business broadened its portfolio of product offerings of Machine Vision Technologies after purchasing the intellectual property and hiring the engineering team of a small Worcester-based business focused on medical grade embedded technologies.

While for the full year of 2018, we saw a decline of this business. We expect the business to return to growth for the full year of 2019. Overall, we are very pleased with the organic growth and profitability that we achieved in 2018 and how strongly we position ourselves for sustainable growth going into 2019 and beyond. Our teams performed well in the fourth quarter and delivered outstanding results for the full year of 2018.

We are well positioned to achieve another year of solid growth and sustainable long-term success, driven by our fantastic employees and by the Novanta growth system operating model.

Despite the macroeconomic climate, we are confident about our 2019 outlook as Novanta's leadership positions across diversified medical and industrial markets. Combined with our disciplined approach to M&A is providing a solid foundation for sustainable profitable growth.

In wrapping up my section, I would like to make a comment around M&A. Our organization is working hard at cultivating and evaluating several transactions and we continue to see our pipeline of opportunities grow. But we also want to remain disciplined around financial returns and only move forward when the strategic fit and financial returns are right. Our balance sheet is very strong finishing the year with gross leverage of 1.7 times and net leverage with 1.0 times giving us the flexibility we need to act.

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 a $156.2 million in revenue in the fourth quarter of 2018, an increase of 6% on a reported basis. Our acquisitions resulted in increase in revenue of $3.3 million, or 2.2% of foreign currency exchange rates adversely impacted our revenue by $1.6 million or 1.1%. Consequently, organic growth was over 5% year-over-year.

For the full year 2018, we delivered $614.3 million in revenue, an increase of 18% on a reported basis and organic growth with a positive 7% year-over-year.

Fourth quarter 2018, GAAP gross profit was $64.5 million, or 41% this compared to $62.2 million, or 42% of sales in the fourth quarter 2017. For the full year 2018, GAAP gross profit was $261.5 million, or 43% of sales this compared to $220.5 million, or 42% of sales in 2017.

On a non-GAAP basis, fourth quarter 2018 adjusted gross profit was $67 million, or 43% of sales, compared to $65 million or 44% in the fourth quarter of 2017. Full year 2018 adjusted gross profit was $272 million, or 44% of sales, compared to $234 million, or 45% in 2017.

It is fair to say that our full year performance for adjusted gross margins came in below our expectations. The largest factor negatively impacting our adjusted gross margins continues to be the adverse mix effects from the strong growth in our medical consumables product line, which remains far below the Company's average.

However, we are also experiencing in the quarter disappointing cost of poor quality challenges in our Celera Motion in Cambridge Technology business lines. Both issues related supply chain quality with previously purchased inventory, while frustrating it is inherently temporary and something we anticipate resolving once and for all in 2019.

Total R&D and SG&A expenses in the fourth quarter of 2018 were $42 million or 26.6% of sales, versus $39 million or 26.7% of sales in the fourth quarter of 2017. For the full year 2018, these expenses were $167 million or 27.2% of sales, versus $143 million or 27.5% of sales. The increase in full year spending was partially driven by prior year acquisitions, along with investments in R&D and our commercial engine and our productivity program.

GAAP operating income was $16 million in the fourth quarter of 2018, compared to $19 million in 2017, whereas non-GAAP operating income was $25.5 million or 16.3% of sales, compared to $25.8 million or 17.6% of sales in 2017. For the full year 2018, GAAP operating income was $71 million compared to $57.6 million in 2017, whereas non-GAAP operating income was $104.7 million or 17% of sales, compared to $90.8 million or 17.4% of sales in 2017.

Adjusted EBITDA was $30.8 million in the fourth quarter 2018, this compared to $30 million in the fourth quarter of 2017. For the full year 2018, adjusted EBITDA was up 17% year-over-year at $123.8 million, or 20.1% of sales. This compares to $106 million in the prior year. Interest expense in the quarter was $2.5 million, versus $2.3 million in the prior year. For the full year 2018, interest expense was $9.8 million, versus $7.2 million in '17. The weighted average interest rate on our Senior Credit Facility was 3.5% in 2018.

On the tax front, our GAAP tax rate was 16.7% for the full year of 2018. It differed from the Canadian statutory rate of 29%, driven largely by jurisdictional mix of income. On a non-GAAP basis, our tax rate for the full year 2018 was 17.4%. This was more favorable than we anticipated as a consequence of higher U.S. and UK-based income and more favorable benefits from tax planning.

Our GAAP diluted earnings per share was $0.33 in the fourth quarter 2018, compared to diluted earnings per share of $0.00 in the fourth quarter of 2017. Full year '18, GAAP EPS was $1.43, versus $1.13 in 2017.

On a non-GAAP basis, adjusted earnings per share were $0.56 in the quarter, compared to $0.44 in the prior year. For the full year 2018 adjusted earnings per share was up 35% year-over-year at $2.16, versus $1.60 in 2017. The increase in adjusted earnings per share year-over-year was mainly driven by strong operating results, favorable changes from the U.S. tax laws and from prior-year acquisition.

We ended the year with $35.5 million diluted weighted average shares outstanding, compared to $35.3 million in 2017. For the full year 2018, operating cash flow was $89.6 million, versus $63.4 million in 2017, an increase of 41%. For the full year 2018, capital expenditures were $14.7 million, compared to $9.1 million in 2017. We ended the full year of 2018 with gross debt of $210 million and our gross leverage ratio was 1.66 times.

Our net debt was $127.5 million as of the end of 2018, or roughly 1 time. Our balance sheet is strong with ample acquisition capacity. In addition, our acquisition pipeline is very healthy and we continue to cultivate and evaluate potential targets while remaining disciplined and focused on driving attractive cash returns and long-term growth in our target market.

Finally, after upgrading our manufacturing expertise and investing in systems and processes over the last two years, we've announced a restructuring action in the first quarter to reduce our operating costs and further position us for gross margin expansion in 2019 and beyond. While the bulk of the benefit will be seen in 2020, we believe this will further strengthen our ability to drive 100 basis points of gross margin expansion per year for the next few years.

Turning to guidance, for the full year 2019, the Company reaffirms as previously issued guidance. We expect GAAP revenue of approximately $645 million to $655 million. For the first quarter of 2019, we expect GAAP revenue in the range of $154 million to $157 million. This represents reported growth of 4% to 6% and organic growth in the range of 3% to 5% year-over-year.

The first quarter of 2018 is expected to be weaker than the full year because of a decline in revenue at Laser Quantum is impacted by product launch dynamics of the customer in the DNA sequencing market. We expect this business to return to growth in the second half of 2019 after it lapsed a difficult year-over-year comparison.

For the full year 2019, gross margins are expected to expand over 100 basis points, compared to 2018. Total R&D and SG&A expenses are expected to be between 27% and 28% of sales for the full year. Operating expenses as a percent of sales to be higher in the first quarter 2019, largely due to higher payroll taxes and higher R&D spending.

Full year depreciation expense is expected to be around $12 million and amortization expense is expected to be around $24 million. We continue to expect full year 2019 adjusted EBITDA to be in the range of $131 million to $135 million, or around 20% of sales. In the first quarter of 2019, we expect adjusted EBITDA to be in the range of $27 million to $29 million. The guidance factors in the impact of any incremental tariffs costs -- for tariffs already implemented and announced.

Full year, interest expense is expected to be around $9 million, absent any significant debt pay down or additional borrowings to fund acquisitions. We expect to see, full year non-GAAP tax rate of approximately 20%. This is slightly up from 2018 as we except slightly less favorable jurisdictional mix of income in 2019, specifically more income in Central Europe and Asia.

Consequently, we expect full year 2018 adjusted earnings per share to be in the range of $2.30 and $2.36. Diluted weighted average shares outstanding will be around $35.5 million and we expect first quarter of 2019 adjusted earnings per share to be in a range of $0.44 to $0.49. As always, our guidance does not assume any significant impacts from foreign exchange rate changes.

Finally, as a consequence of our business growth and further facility improvements, we anticipate maintaining our level of capital expenditures $14 million to $16 million in 2019, similar to the prior year.

As we have further into 2019, we are very optimistic. We see very strong medical markets, which will be a significant driver of our top line growth. We are not slowing down on our investments and innovations as we believe the opportunity is now to continue to introduce leading edge products, which will continue to benefit our customers and our end market. We are truly proud of the progress our organization has made and the strong performance they have delivered in 2018 and we look forward to delivering our commitments to our employees, our customers and our shareholders in 2019.

This concludes the prepared remarks, we'll now open the call up for questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). The first question will come from Lee Jagoda with CJS Securities. Please go ahead.

Lee Jagoda -- CJS Securities, Inc. -- Analyst

Hi, good morning.

Robert Buckley -- Chief Financial Officer

Hi, Lee. How are you? Good morning.

Lee Jagoda -- CJS Securities, Inc. -- Analyst

Good. Very good. So first, I guess, Robert you mentioned some increased costs and for supply chain quality, and the idea that there should be a remedy once and for all in 2019. Can you give us some background on the steps you've taken to fix it and how we should think about the fixed kind of unfolding as we go throughout the year?

Robert Buckley -- Chief Financial Officer

Yeah, well first of a lot of the impact that we're seeing in the back half of the year of 2018 was really a consequence of buying a lot of inventory to fix some of the issues and buy us some time to fix some of the issues. And so what I think it's been disappointing us is the amount of, let's say, poor quality, we're finding in those purchases that we made.

And that's leading its way through as we're building the products, its not identifiable thing and so that's been something that's been really frustrating. The inventory levels have come down in the organization. You can see that our net working capital performance for 2018 and so as we start buying from those new qualified vendors, that's going to lead a large chunk of the progress that we're making.

We've also allocated some additional resources on our supply chain, we've elevated that to an executive level, but we have, we have a very senior person now focused on supply chain and the quality of our supply chain and we've added some additional resources into the organization that really kind of focus on that both from a commodity by perspective as well as improving the overall operational efficiencies and driving more robustness around that supply chain.

Lee Jagoda -- CJS Securities, Inc. -- Analyst

And then as we look out to 2019. Is it more of a rolling kind of gradual fix or should we expect to see, kind of run through everything by mid-year?

Robert Buckley -- Chief Financial Officer

I think the first quarter looks a little weaker in the gross margins or similar to what we've really kind of delivered and that's as a consequence of really kind of mix effects and that we're seeing with the big drop, double-digit decline and our Laser Quantum business, but as you get into second, third, fourth quarter, you'll start to see the improvement in those gross margin so it'll tick up from where it was in 2018 really kind of starting in the second quarter.

Lee Jagoda -- CJS Securities, Inc. -- Analyst

Sure. And then one more from me, just in terms of the, on the last call you give us sort of a $4 million potential tariff impact to gross margin in the first half if things kind of happened as they were going to happen back then, obviously timing has shifted and who knows what the eventual outcome will be, but how should we think about your new guidance in relation to that $4 million that you had thrown out last quarter?

Robert Buckley -- Chief Financial Officer

Yeah, so I would say currently it's not impacting us at that level. It's more impacting us at the levels that we've seen in the fourth quarter in the back half of the year. So there is tariffs hitting our P&L right now without getting to quantifying it, but it's nowhere near the $4 million we are anticipating.

So that does in some degree provides some opportunity for upside, but for the most part is offsetting some of the other issues that we're seeing as it provides us with really just kind of greater confidence in delivering on our full year results. There's a lot of things going in the right direction, internally for Novanta. I think there's a lot of opportunities we're seeing a lot of, a lot of potential benefits that we're seeing. There's a lot of clouds in the general economy and we're just trying to be mindful that some of those things need to be mitigated and we feel we have enough levers to do that.

Lee Jagoda -- CJS Securities, Inc. -- Analyst

Okay, great. I will hop back in queue. Thank you.

Robert Buckley -- Chief Financial Officer

Thanks, Lee.

Operator

Our next question will be from Richard Eastman with Baird. Please go ahead.

Richard Eastman -- Robert W. Baird -- Analyst

Yes, good morning.

Matthijs Glastra -- Chief Executive Officer

Good morning, Rick.

Richard Eastman -- Robert W. Baird -- Analyst

Just a last maybe some point around the gross profit margin commentary that you gave, you did suggest 100 basis points a year, you'd be back on track is, is that kind of a statement around '19 and '20 and '21. In other words, do we do we expect or should we expect an adjusted gross margin improvement of 100 basis points in '19?

Matthijs Glastra -- Chief Executive Officer

Yes. That I specifically stated that in the script, you'll read about it, I guess in the -- when it gets transcribed. But yes, that we expect 100 basis points improvement in gross margin and '19 and then we're taking enough actions to make sure that we maintain that momentum going forward.

Richard Eastman -- Robert W. Baird -- Analyst

Okay. And the point you made Robert about -- in the first quarter, around the sequencing -- kind of new product introduction in the Photonics segment, is your point there that you have a tough comp in the first quarter of '18 because I believe your primary customer there anticipates introducing a newer version of that so of that -- of that product?

Matthijs Glastra -- Chief Executive Officer

Yeah, yeah. We're not going to get into specifics on customers rate, but listen, I mean we've been clear on previous calls that this launch dynamics was going on and we basically had a spectacular 2017 and kind of a bit of our holding pattern in '18 and that will then lap in the middle of '19. Right. That's kind of how you need to think through this, this translates itself as a temporary headwind of double-digit declines. If you look at our Photonics kind of growth that was basically flat, right, whereas actually you know, the other core businesses we're growing very nicely, but you had this temporary headwind.

So if anything. Right.

Richard Eastman -- Robert W. Baird -- Analyst

Yeah.

Matthijs Glastra -- Chief Executive Officer

If you want to look at our growth projected in the first quarter and actually in the first half of the year. No, of course, we see some, we see some softness in microelectronics, but that's a relatively minor component of our business. Actually that temporary headwind of DNA sequencing is as big of an effective not bigger. Right. So, so, but that will subside in the second half, right. It's not market related. It's not execution related. It's just temporary comps that will subside in the second half.

Robert Buckley -- Chief Financial Officer

And I just want to accentuate those points that Matthijs made in the script. I think we feel very good about our position in that space, and so that area, that space, that platform is something that we feel has got multi-year growth trajectory to it. So that's something that we feel good.

Matthijs Glastra -- Chief Executive Officer

Yeah, because the penetration of this higher throughput DNA sequencing is still in its infancies. Right, so as these platforms get rolled out to more applications the use will grow and therefore our business will continue to grow and we have a very, very solid leadership position there. So these are all kind of temporary lumpiness, we have to explain it because it, it and we want to be transparent about it, but it's not like a long-term issue.

Richard Eastman -- Robert W. Baird -- Analyst

Understood. And when you took your -- you're kind of guide for '19 and we got kind of this 5% to 7% core guide (ph) for revenue. And you made some comments early in your script, Matthias around the industrial side, maybe, seeing a few pockets of softness. When I think of the the Vision and Precision Motion, Photonics business what strikes me is in Precision Motion and Photonics roughly half more than half of the business as industrial. Vision is mostly the medical side, but the question, is at a 5% to 7% core growth forecast which of these pieces I presume it's still be Precision Motion that would be the leader in the growth. I mean, how about the three segments lined up against the Precision?

Matthijs Glastra -- Chief Executive Officer

Yeah, good question. I mean, so actually what you see is that -- so as I started by saying that we see a very, very solid growth, actually accelerating growth on the medical side and our medical markets are very strong. So, Vision being predominantly medical focus will be a significant contributor to growth in 2019 and so we expect all the businesses in there to be a solid contributor. Right, so let's start with that and so then Precision Motion, of course comes off a spectacular year right at 25% growth, I mean that's, so we have tough comps and it's hard to continue that in addition, there is some softness there in certain microelectronics markets.

Right, so overall at the Company level microelectronics is less than 10% of our revenue. Right, but that market is soft or down. Right, so that's a modest headwind for us a bit more of a headwind, I would say in Precision Motion. So in other words, Precision Motion will -- growth will moderate as a result of both the tough comps as well as -- that this microelectronics, call it softness. But we still anticipate that there will be a solid contributor to -- to Novanta's overall growth rate, right, we're not getting into numbers, but we still think it's a solid contributor.

And Photonics is basically a tale of two stories, right. One is continued solid performance and actually our Synrad and Cambridge Technology business and then we're just fighting that headwind in the first half of Laser Quantum, that will subside in the second half, right. And for the full year -- right, so that's kind of have the story there. But I think underlying the message that we want to -- want to make is that actually even within industrial, right. There are many segments that are growing very, very nicely and we're part of those, right. So there are certain packets like we indicated that are softer or down, but the beauty is we -- is our -- the diversification of our portfolio, right. We're firing on multiple cylinders and if one cylinder is not as firing as rapidly we have multiple orders to compensate and you kind of see the power of the model here, that in any particular moment there might be some launch dynamics there might be certain softness, but then there's other markets or other technology cycles that will help lift us again. So you kind of see, see us compensating very nicely, and I think the Company is pretty resilient in kind of some of these macroeconomic backdrops.

Richard Eastman -- Robert W. Baird -- Analyst

Understood. And could you -- just one last -- follow-up. In the Vision business, the Vision segment, JADAK -- you referenced some RFID wins and having some product now in market. Could you give a example or two of where in application there that you have taken a win and put it and commercialized it. Can you give any examples there and specifically the RFID?

Matthijs Glastra -- Chief Executive Officer

Yeah, I mean, it's such a vast space why -- with so many applications. But you basically as a big picture, Rick. You're talking about identifying or connecting, for example a consumable to a piece of equipment, right, in the medical space. So wherever you need to read a consumable and it's hard to read that with a Machine Vision solution, because there is the line of sight is obstructed. Then you could better do that with RFID. You see another example of wins is on patient monitoring, right, where you have -- actually a combination of barcode and RFID at the identification station. Again patient monitoring is happening and typically, in terms of care and emergency setting. So there's not a lot of time to type in data and identifying people or medication, right. So, the quicker you can point and shoot and get that data into the system, the better it is.

Sometimes it's -- actually those levels are nowadays RFID labels and it's actually much easier to scan and identify, for example, a nurse, then a medication, then the patient, then you have to actually do it with barcoding. So that's another application that we like and I know, you can combine that actually with access control as well in the hospitals. So we do see that. So applications that we like are kind of access control surgical consumables parts as well as in-vitro diagnostics. Those are kind of core applications we kind of have momentum into, but there is many other applications. Yeah, and the other thing, I want to point out is that I'm -- we're expanding our Machine Vision portfolio as well. And we do see an increased need for smarter Machine Vision -- embedded Machine Vision solutions in kind of these applications as well.

Richard Eastman -- Robert W. Baird -- Analyst

Okay, great. Thank you. Thanks so much.

Robert Buckley -- Chief Financial Officer

Yes.

Operator

(Operator Instructions) The next question comes from Brian Drab with William Blair. Please go ahead.

Brian Drab -- William Blair -- Analyst

Good morning. Congrats on a great year.

Robert Buckley -- Chief Financial Officer

Thanks, Brian.

Brian Drab -- William Blair -- Analyst

This might fall into the category of splitting hairs. But I just wanted to see if there's something that we should understand here. Your midpoints of guidance for 2019 imply 20.5% EBITDA -- adjusted EBITDA margin and that will be up 40 basis points from 2018. And can you just help me reconcile that with the comment that gross margin should expand 100 basis points in 2019. Is there something going on, in terms of operating expense as a percentage of sales or am I just splitting hairs here?

Robert Buckley -- Chief Financial Officer

You got. Can you repeat -- what you're saying, is the midpoint is 50 basis points?

Brian Drab -- William Blair -- Analyst

On a 40 basis. I mean it gets you to like 20.5% EBITDA margin. Where you get 20.1% this year?

Robert Buckley -- Chief Financial Officer

Right. So, to withstand the growth margin is 100 basis points. Then where -- what element of your operating expenses are kind of going up -- you know it kind of...

Brian Drab -- William Blair -- Analyst

Yeah, yeah.

Robert Buckley -- Chief Financial Officer

Yeah, So you were expecting Q4 at 8.5%. R&D spend, we expect to be closer to 9%. So that compares to like something closer to 8% and overall full year 2018. So if there's one element that -- I think we've been pretty consistent with -- we really think the portfolio should be closer to 9% off and it's just -- it's taking time to kind to ramp that up. In the first quarter, it will ramp up a little bit because of material spend. And then for the full year, we should be kind of sitting close to (inaudible) percent level, little bit lower.

Matthijs Glastra -- Chief Executive Officer

Yeah, and the reason being, Brian, is that you hear us reporting on the benefit side, right, that the increasing of the revenue from new products by over 50% last year. We see tremendous momentum. We actually see windows of opportunity in certain core growth markets that we want to capture and so we're actually very confident about capturing those where we need to drive -- continue to drive innovation to maintain and our leadership -- innovation leadership there. So we're -- so that's what is behind us.

Brian Drab -- William Blair -- Analyst

Got it, thanks. And on the gross margin kind of putting together everything that I've heard so far here. It sounds like gross margin was down year-over-year in the first quarter, but up -- maybe more than 100 basis points later in the year to get you to that 100 for the full year. Is that a fair assessment?

Robert Buckley -- Chief Financial Officer

I'm not sure down year-over-year, but it is, its not the strong quarter and the full year.

Brian Drab -- William Blair -- Analyst

Okay. And is there any way that you can quantify somewhat in terms of basis points or headwind that impact of this cost of supplier quality issue in the fourth quarter?

Matthijs Glastra -- Chief Executive Officer

In the fourth quarter, I would say, it was the bulk of the -- of the myth -- in our expectations. So it was, both businesses happened to simultaneously go through it. I guess, in hindsight, it may not be surprising, year-end you try to bleed through all the inventory that we purchase before, but it was the bulk of it. So that was a -- that's what I can associate with. Q3 was already being impacted by the higher mix of our medical consumables. Q4 drop down from Q3 and that was all driven by across quality issues.

Brian Drab -- William Blair -- Analyst

Okay. So, I mean your gross margin was down. I mean we have the WOM issue going onto. So, I'm trying to parse this out. I mean your gross margin was down 200 basis points sequentially. Is it fair to like roughly estimate like -- this is like a 100 basis point issue this cost per quality?

Matthijs Glastra -- Chief Executive Officer

Yeah, yeah. Little higher, but yes. Its balanced.

Brian Drab -- William Blair -- Analyst

Okay. And then on the other issue that you said is affecting gross margin and the other WOM consumables business -- this kind of ongoing challenge. Where are you in -- adjusting how and where you make those WOM consumables and done? What sort of headwind do you think goes away and what's the opportunity for gross margin when you fix that is the question?

Matthijs Glastra -- Chief Executive Officer

Yeah. So I think the MIS segment and therefore Vision overall is a growth driver in 2020 and beyond. So, I think you'll see gross margins expand some Photonics and in the precision motion segment in '19 and '20. But as you get outside of that, then the big driver is really kind of the Vision segment. We are taking actions now to improve the margin profile of that business. So we do expect to start getting at this in '19. But like any quarter real meaningful changes are really like a 2020 and beyond kind of effect. So one of the first things we're doing is that we're putting more into our German factories. So we're trying to leverage the cost structure there. We're doing that, both by consolidating NDS production into that facility, as well as expanding the production capacity of our medical consumables in that time.

And then third is identifying a low-cost manufacturing facility to manufacture the higher volume products and in store our supply chain on that. We're still working our way through those elements of it that latter kind of Phase II approach, but we feel good about the progress that we made and we think we're on the right track.

Brian Drab -- William Blair -- Analyst

Yeah. So, thanks for that. But in the end, when you get that through that Phase 2 and you've got the manufacturing adjusted. Is this -- like on a consolidated basis, is this 100 basis points plus opportunity for gross margin?

Matthijs Glastra -- Chief Executive Officer

So, I think, the next, you know, two years of growth margin expansion is which is overall Novanta about 100 basis points a year is really driven by Photonics and Precision Motion. And then as you look at where you going to get that 100 basis points of expansion thereafter. It's going to come from the Vision segment. Where do they cap out, I think is where you're kind of leading overall, it's difficult to say because of the acquisition pipeline you're constantly changing that mix profile, if you assume all being constant we believe overall this Company should be kind of closer to a 50% gross margin. So, that's the overall opportunity that we're going after. But that can change depending upon the types of acquisitions, you do.

Brian Drab -- William Blair -- Analyst

Okay, got it and then just one more from me. Robert, at the end of your comments -- like the second to last sentence in your trans -- in your script, you made a comment that you expect -- that you very optimistic about the second half for -- later in 2019. Can you add any color to that. I think we've got a sense now from listening to the call what segment and business lines you're expecting that in -- but can you -- put a final point on where you expect to see that step-up which end-market later in 2019? (Multiple Speakers)

Matthijs Glastra -- Chief Executive Officer

Well, what -- I don't mean to, by first or second -- I think the big issue in Q1 and then also going into Q2 is really the headwinds that we're seeing in our, in our Laser Quantum business. And then, that business returns to growth in the back half of the year. And so that has a big impact on the Photonics segment overall, because I think the overall businesses is underlying are performing extremely well, particularly given the climate. So, I think that it's really an indication of that business has got a big headwind right now as the overall Company and on that segment and that we lapped that by the time we get to Q3 and Q4. It's less no longer an issue.

I will say that medical in general is kind of growing very robustly. And so there and there's a lot of opportunities that we're seeing, that we're embedded on. So, I think we feel good overall, about the stability of the portfolio as a consequence of our exposure in that. So even though we see things like microelectronics not doing too well or small segments of industrial we have that kind of covering for us and enabling us to continue to deliver.

So, internally we have a lot more positives going on and there's a lot of different things that we can. There's a lot of different levers that we can pull. We're also just mindful that externally the noise level is getting louder and louder. And so we want to be careful about getting too ahead of ourselves and we think being prudent, being conservative is sort of the right approach at this stage.

Brian Drab -- William Blair -- Analyst

Okay, great. Can I ask, are there people in the queue after me because I don't want to ask another question -- but I've got one more important one.

Matthijs Glastra -- Chief Executive Officer

You will be surprised that we don't know, so you can go ahead.

Brian Drab -- William Blair -- Analyst

I just, I think people would be interested in -- and you only got, you don't have enough analyst yet. So, wondering...

Matthijs Glastra -- Chief Executive Officer

Sure.

Brian Drab -- William Blair -- Analyst

If we get the answers to some of these in the transcript, but can you just talk a little bit about your European exposure. I mean this is obviously a significant -- I've been taking a lot of questions on this with respect to your business in every one of my companies. You've got the head of the German central bank today saying that he expects GDP to be revised downward for Germany? So...

Matthijs Glastra -- Chief Executive Officer

Yes.

Brian Drab -- William Blair -- Analyst

15% of your revenue roughly is in Germany. Is that correct and then Europe is close to 30%. What is kind of the end market exposure you have and I know you said you're somewhat cautious on the region, but can you just talk through your end markets and what your exposure is in the risk there?

Matthijs Glastra -- Chief Executive Officer

Yeah, I mean, listen, we sell into players that are based in Europe and then, they sell then to players that are across the world. So it's -- I don't want to deflect the question, but it, you cannot -- one-on-one correlate our revenue numbers into Europe versus kind of GDP numbers. Now having said that, if you look in the European climate overall, of course, you see -- you need indicators softening. Right. Automotive semiconductors those stop of segments are all not doing so well, but we got for example laser additive manufacturing is growing very rapidly. Medical is doing great. So, it's very hard to comment on a generic economic indicator, you really got to be mindful of the different components of growth in the different markets. So, medical doing well, microelectronics not so much, automotive, not so much.

We don't have any major exposure in either of these markets marketing channels, less than 10%. Automotive is even included in that number, I would say. So, and that's not different from Europe. So, that's kind of how I would answer the question. We have included kind of the, we're looking at this more from a global industrial and/or medical per segment basis. And then what OEM customers are telling us that happens to be based in Europe that run a global business. And if anything, there's correlations with, not surprisingly, with the rest of the world right. So, this European OEMs do sell to the US, which is very, very buoyant. They also do sell to certain to China, which for medical is very blind for industrial, not so much. Right, so kind of, it's a bit of a mixed bag.

So far, we actually feel, we're watching the situation very carefully. We're seeing softness where we've indicated it, but we've included that in our overall guidance, Brian.

Brian Drab -- William Blair -- Analyst

Okay. Did you say how your European revenue did in the fourth quarter went up or down ?

Matthijs Glastra -- Chief Executive Officer

No, we're not, we're not, we're not splitting it out.

Robert Buckley -- Chief Financial Officer

One of the thing I want to caution you about a little bit -- I mean -- because if you look at our 10-K have disclosures around end-market being geographical end-market of sales. That's, that's a little misleading because I think, as Matthias is pointing like were those sales are two manufacturing centers spreads, that is not telling you the picture that I think you're trying to get out, which is ultimately a big chunk of our products are heading into the US and heading into Europe and more developed type of regions as the China sales are actually a little bit more specific to China market and from that perspective.

You know it's difficult for us to break out in the disclosures spend, where our products ultimately end up after our OEMs ship them out of their factories. We will say that we're seeing general strength in the medical area of the market, which is half our portfolio and we are seeing some strength in a select group of industrial and markets like laser added to manufacturing or metrology based applications that are industrial base.

So, we feel good about those things, offsetting some of the risks out there and our exposure again in microelectronics/automotive is very tiny. So that's another -- that's another benefit for us.

Brian Drab -- William Blair -- Analyst

Got it. Thanks for going through all that up. I'll leave it there. Thank you.

Operator

Ladies and gentlemen, 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, 2018 was another great year for Novanta. Our focus on accelerating profitable growth and the diversity and resilience of our businesses were evident in our strong financial results. We continue to feel good about the positioning of our businesses around secular macro growth drivers with over half of our revenue in medical markets.

Novanta's diversification a relentless focus on leadership positions across a variety of medical and industrial growth markets is providing a solid foundation for sustainable, profitable growth in the current microeconomic backdrop. We see a converging and long-term need for our motion, Vision and Photonics capabilities in a large variety of applications.

In industry 4.0, precision medicine and healthcare productivity trends. We therefore continue to remain excited about the applications we play in and the positions we have, our growth strategy is sound based on multiple growth drivers organically and through M&A and we are well on our way to execute on our long-term strategy and the 2020 direction we articulated three years ago.

In closing, I would like to thank our customers, our employees and our shareholders for their ongoing support. I'm particularly thankful for the strong contribution and the execution of our teams of committed Novanta employees. To true pleasure and honor to lead this great Company. We appreciate your interest in the Company and your participation in today's call.

I look forward to joining all of you in several months on our first quarter 2019 earnings call. Thank you very much this call is now adjourned.

Operator

Thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 55 minutes

Call participants:

Ray Nash -- Corporate Finance Leader

Matthijs Glastra -- Chief Executive Officer

Robert Buckley -- Chief Financial Officer

Lee Jagoda -- CJS Securities, Inc. -- Analyst

Richard Eastman -- Robert W. Baird -- Analyst

Brian Drab -- William Blair -- Analyst

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