Earnings Call Transcript
NOVANTA INC (NOVT)
Earnings Call Transcript - NOVT Q1 2020
Operator, Operator
Good morning. My name is Chuck, and I will be your conference operator for today. At this time, I would like to welcome everyone to Novanta Incorporated 2020 First Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Please note, this event is being recorded. I would now like to turn the conference over to 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 first quarter 2020 earnings conference call. I’m 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 have 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. 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, CEO
Thank you, Ray. Good morning, everybody. And thanks for joining our call. I hope all of you and your families are healthy and safe. Before we start our normal quarterly results review, I would like to first talk about the topic on everybody’s mind, which is the COVID-19 pandemic. I want to take a moment to thank our employees, our customers, and our suppliers, all of whom are making extraordinary efforts to maintain supply of our mission-critical products to the people who need them most. I have been extremely impressed, and I could not be more proud of how my colleagues around the world have stepped up and pulled together in the face of adversity. Obviously, the world has changed dramatically since our last earnings call. Novanta is not immune to the impact of the pandemic, but we are well positioned to weather the COVID-19 crisis. Our balance sheet is strong, our innovation engine is strong, and our portfolio is diversified across 45 different applications with exposure to long-term secular growth trends in robotics and automation, healthcare productivity, and precision medicine. In a high uncertainty climate like this, we feel it is best to stay focused on what we can control and what we have invested in over the years: our employees, our culture, and delivering mission-critical technologies to our customers. Our four guiding principles in managing through the pandemic follow this focus. First, keeping our employees, their families, and our community safe. Second, ensuring business continuity for our customers. Third, ensuring a bright future and emerging from this crisis stronger. And fourth, delivering value. Let me dive a bit deeper into each one of these. First, a primary goal at Novanta continues to be the safety and well-being of our employees, their families, and the communities in which we operate. Our China facility was the first to have operations impacted by the Coronavirus outbreak, and we were able to swiftly implement the learnings of our Chinese teams to our other sites worldwide. Globally, the majority of our non-production employees are working from home. We have enacted rigorous safety measures in all of our sites, including temperature checks, social distancing protocols, providing masks to those employees who must be physically present, spreading work over more shifts, and frequently disinfecting our workspaces. To date, out of the roughly 2,200 employees at Novanta, we have had two employees who contracted the virus and who fortunately have fully recovered since. Our absenteeism is low at around 1%. We will remain very vigilant and mindful of our employees' safety as societies around the world gradually reopen. We are also committed to providing non-monetary support to our communities. For example, we donated 10,000 facemasks that were sourced from our factory in China to a local U.S. hospital. Our second guiding principle is to maintain business continuity so we can support our customers. With the COVID-19 outbreak, our vision and purpose to deliver innovations that matter is more relevant than ever. We take great pride that our mission-critical technologies are embedded into diagnostic and antibody test equipment detecting COVID-19 into ICU and patient monitoring equipment, DNA sequencing equipment to sequence different mutations and strains of the virus, laser coating equipment for critically packaged food supply or production of PPE and cloud infrastructure equipment. As a result, all of our production sites have been qualified as essential manufacturing operations. Once the pandemic hit, we immediately established global and local response teams. I’m pleased to say that our operations and supply chains have experienced minimal disruptions thus far. Another critical aspect of our business continuity plans is to ensure proper liquidity and cash flow. We have decisively implemented additional actions and processes to improve cash flow, and Robert will provide further details here. Our third guiding principle is to ensure a bright future and emerge from this crisis stronger. We have invested aggressively over the years to build great capabilities and a great culture with incredibly talented teams. We are committed to keeping these capabilities in place. If anything, we believe that our long-term secular growth drivers are even more relevant post-pandemic. We have the best innovation lineup that we have ever seen to catch the secular growth waves, and we are staying the course on priority innovation programs. Finally, our fourth principle is to live our core values. Now more than ever, 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 called the Novanta Way, which institutionalizes how we work together in cohesive teams, how we behave, and interact through our five core values, and how we execute through the Novanta growth system. The proactive cost measures we have taken are reflective of our values in a shared gain, shared pain approach that Robert will further elaborate on. But what I can say here is that I’m very proud and excited that through our approach, all Novanta colleagues are now shareholders in the company, which we feel is driving a tremendous engagement and alignment of our teams. Now, let’s move to our normal quarterly review. As you can read in our press release, in the first quarter of 2020, we exceeded the top end of our guidance in both revenue and earnings. Our company delivered over $155 million in revenue, representing a 1% year-over-year revenue decline on a reported basis and a 4% decline on an organic basis. Adjusted EBITDA was $28 million in the first quarter, down 2% versus the first quarter of 2019. In the first quarter, our book-to-bill was 1.06, and we saw strong bookings across the board, mostly driven by customers who wanted to secure inventories and protect against COVID-19 supply disruptions. In the first quarter, 58% of our revenue came from our medical markets that are structurally growing long-term, which grew 6% year-over-year in the quarter. On the back of the innovation investments that we have made, we feel our innovation pipeline is as strong as it has ever been with significant opportunities and growth applications highlighted to you before. Despite having a large portion of our engineering teams working from home, our NPI programs haven’t slipped. In the first quarter of 2020, our new product revenue grew double digits year-over-year. Our vitality index, which reflects revenue from new products launched in the last four years, continues to be healthy at over 25% of sales versus mid-single digit percentages a few years ago. Design wins grew over 10% in the first quarter of 2020. While some customers have temporarily delayed new platforms, we are seeing others accelerate. As we look at it right now, we will be able to accelerate our innovation pipeline with multiple products hitting the market at the end of 2020 and in 2021. We continue to have the confidence to invest in our innovation pipeline and drive our businesses to capture emerging new customer opportunities. I will let Robert explain the implications of the pandemic on our financials and our outlook for the rest of the year. But let me briefly touch on what we are seeing in our markets. Obviously, the environment is highly uncertain, but there are a few high-level observations we can share. First, it is important to realize that Novanta’s revenue might lag our customers by 60 to 90 days, or sometimes even more. So the declines that our customers are reporting in their second quarter will likely be a third quarter effect for Novanta. Second, with close to 60% of sales in the medical market, we feel that Novanta is well positioned for a post-pandemic world. While in the short term, elective minimally invasive and robotic surgery medical procedures have been deferred, most of these procedures cannot be deferred for very long given the often chronic and progressive nature of the conditions impacting these patients. In diagnostics and ICU markets, we are seeing a relatively stable business overall, as a rapid uptake in PCR molecular testing, patient monitoring, and critical care equipment is being offset by a decline of non-COVID-19 related diagnostic tests. On the industrial side, the bright spot so far is our electronics-related business, which is growing as a result of 5G, high-speed networking, and cloud-based infrastructure. The rest of our industrial businesses are expected to move with overall PMI trends but with different demand curves, with, for example, coating for packaged foods being relatively stable and converting for textile end-markets being deferred with shelter in place. While short-term, the industrial capital spending climate is depressed, we believe that in the mid to long term, our thesis of secular growth in factory automation remains intact. Now let me turn to our operating segments, starting with the vision segment. This segment predominantly serves the medical market and delivered a 5% year-over-year revenue growth. The book-to-bill in our vision segments for the quarter was 1.11, and the vitality index, in the second, remained well above 30%. Within the vision segment, we continue to see nice momentum in our one business unit on the back of the smoke evacuation technology we reported on earlier. The smoke evacuation insufflator technology is in particular demand in today’s climate as medical staff around the world are requiring a safe COVID-free work environment. We secured our leading position in insufflator and pump technologies through design wins and development agreements with multiple minimally invasive and robotic surgery OEM platforms, which we expect to launch in the next two to three years. As a result, we are stepping up our R&D investments in the one business. In the short term, however, the MIS business will be affected by the deferral of elective procedures. Our detection and analysis business unit within the division segment primarily serves the diagnostic testing and patient monitoring markets with RFID barcode and machine vision technologies. We are seeing a relatively stable business overall, as a rapid uptick in PCR molecular testing and patient monitoring equipment is being offset with the decline in non-COVID-19 related diagnostic tests. Moving to precision motion, our precision motion segment revenue declined by 22% in the first quarter of 2020, with a book-to-bill of 1.09 and bookings growing 15% versus the first quarter of 2019. In the first quarter, we did see an upward trend in demand for 5G and cloud-based infrastructure as well as autonomous vehicles, offset by a reduction in industrial aerospace and robotic surgery. We believe that the long-term secular trends with the precision motion segments are very much intact. We like our position and precise and dynamic motion control technology serving markets with restructuring dynamics such as precision automation, robotics, and robotic surgery markets. In relation to the surgical robotics markets, we continue to see our technology being validated and our position grow with the largest players. In the short term, however, surgical robot procedures are mostly deferred and recovery of big capital expenditures in hospitals are expected to take some time. Within the precision motion segment in the first quarter, new product revenue more than doubled from a small base and our design wins grew more than 50% versus last year. Turning to the performance of our photonics segment. For the first quarter of 2020, our revenue was down 7%, driven by laser quantum and a deteriorating industrial capital spending climate. Laser quantum revenue had a double-digit decline for the first quarter of 2020, as expected and as previously communicated, due to dynamics in DNA sequencing which we have widely discussed in the last few quarters. We expect COVID-19 to dampen demand for DNA sequencing capital equipment in the short term as research labs have largely been closed and clinical tests reduced in line with the overall decline in hospital visits, procedures, and diagnostic tests due to the pandemic. The photonics segment in the first quarter saw bookings decline year-over-year by 4% in the first quarter with a book-to-bill of 0.99. Design wins continued their momentum and grew over 50% year-over-year in the first quarter. As we reported in our previous earnings call, the innovation pipeline in our photonics segment is the best it has ever been and has been accelerated by our recent Arges acquisition in beam delivery. We are still anticipating to introduce 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. To wrap up, we are very proud of the performance, resilience, and agility of our teams in this uncertain environment. Novanta’s overall position is favorable, and our portfolio is resilient to weather the COVID-19 pandemic. Close to 60% of our revenue comes from medical markets that are resilient and structurally growing long-term. Our balance sheet is strong, as is our innovation pipeline, and our portfolio is diversified with exposure to long-term secular trends in robotics, automation, healthcare productivity, and precision medicine. We believe that the secular trends will be even more relevant post-pandemic. In summary, we feel we are well positioned to emerge strong from this crisis with a strong innovation pipeline and in a good position to execute on M&A opportunities, which remains our first priority for capital allocation. So with that, I will turn the call over to Robert to provide more detail on our financial performance.
Robert Buckley, CFO
Thank you, Matthijs, and good morning, everyone. We delivered $155.5 million in revenue in the first quarter of 2020, a decrease of 1% year-over-year on a reported basis and a decline of 4% on an organic basis. As Matthijs already indicated, demand in the first quarter ended up being slightly better than we previously guided, largely based on the fact that some of our customers were concerned with disruptions in supply chains and hence requested early shipment of product to build finished goods safety stock to weather the pandemic. In the first quarter, our revenue continued to shift more towards our OEM customers who serve medical end markets. Sales to these end-markets rose to 58% of total sales and increased by 6% year-over-year in the first quarter. This was despite a double-digit decline in the DNA sequencing market in the first quarter. Key end-markets that performed well include our medical consumables business with integrated smoke evacuation and our integrated RFID and barcoding products. We also saw continued strong growth in new products introduced into the medical end-markets such as our new integrated OR Informatics products. The industrial capital spending environment and the overall economic climate saw declines, as evidenced by the latest PMI trends. Novanta’s sales to all industrial markets was 42% of total sales and declined 10% year-over-year in the first quarter. The decline was broad-based across the majority of industrial end-markets, with many seeing high double-digit declines which is consistent with our expectations and what our industrial OEM customers are seeing in those same markets. One area where we are seeing increased demand is from our semiconductor microelectronics customers based on the adoption of 5G, high-speed networking, and cloud-based infrastructure. This market is still a low-single digit decline in the first quarter, but it is a significant improvement compared to the declines we saw in 2019. Sales specific to the microelectronics market made up a little less than 10% of our total company sales in the first quarter. Geographically, our first quarter sales to China were actually up 2% year-over-year despite the disruptions caused by the pandemic. Sales to the U.S. and Europe were down 3% year-over-year reflecting the weakening industrial climate in those countries. Our overall mix of revenue shifted with only 38% of total sales in the U.S. versus 41% in the first quarter of 2019. As a reminder, the locations of our sales are based on where the product is shipped to, which can sometimes be different than where a customer is headquartered. Nevertheless, we feel these figures represent channel directional trends. Turning to profit. Our first quarter GAAP gross profit was $64.4 million or 41% of sales, compared to $66.3 million or 42% of sales in the first quarter of 2019. On a non-GAAP basis, adjusted gross profit was $67 million or 43.3% of sales, compared to $69 million or 43.6% in the first quarter of 2019. For the first quarter of 2020, our adjusted gross margins were roughly flat compared to 2019. The lack of gross margin expansion was mainly impacted by continued growth at our medical consumables product line, which drove unfavorable mixed effects during the quarter. We are seeing record demand for medical consumables, particularly those that incorporate our smoke evacuation technology. This is a key innovation which will keep doctors and hospital staff safe from infection in the operating room. Thanks to the incredible efforts of all our employees, all of our factories remained open and produced products for our customers, despite significant challenges around lockdowns, supply chain disruptions, travel restrictions, and logistics challenges. As of today, we are maintaining an extremely low absenteeism from our employees and a high level of engagement. Moving on to operating expenses. First quarter R&D expenses were $15 million or 9.9% of sales, compared to $14 million or 8.9% of sales in the first quarter of 2019. We continue to lean into the headwinds and invest in our innovation pipelines. The current economic climate, in our view, provides us with the opportunity to take market share and capture significant growth opportunities to drive our growth in 2021 and beyond. The more significant customer programs remain on track both within Novanta and our customers despite the challenges. First quarter SG&A expenses were $31 million or 19.8% of sales compared to $32 million or 20% of sales for the first quarter of 2019. Moving on to other financial results, GAAP operating income was $13 million in the first quarter of 2020 compared to $14 million in 2019. Non-GAAP operating income in the first quarter was $21 million or 14% of sales compared to $23 million or 14% of sales in the prior year. Adjusted EBITDA was $27.6 million in the first quarter of 2020, compared to $28.2 million in the first quarter of 2019. On the tax front, our GAAP tax rate was nearly zero for the first quarter of 2020, differing from the Canadian statutory rate of 29%, driven largely by the jurisdictional mix of income and the windfall tax benefits from stock-based compensation awards. On a non-GAAP basis, our tax rates in the first quarter were 8%. This is more favorable than we anticipated as a result of windfall tax benefits from stock-based compensation awards. This only impacts the first quarter and will not reoccur for the rest of the year. On a GAAP diluted earnings per share was $0.34 in the first quarter compared to diluted earnings per share of $0.35 in the first quarter of last year. On a non-GAAP basis, adjusted earnings per share was $0.51 in the quarter compared to $0.53 in the prior year. First quarter operating cash flow was $17.8 million compared to $5.5 million in the first quarter of 2019. This result was driven by good operating profit and a moderate reduction in net working capital need. At the end of the first quarter, we had growth of $217 million and our gross leverage ratio was 1.8 times. Our net debt was $143 million as of the end of the first quarter, or roughly 1.2 times. Following our December 2019 amendment and extension of our credit facility, we extended the maturity date until the end of 2024, while also reducing our interest expense. At the end of March 2020, we amended our credit facility again and exercised the accordion option to our revolving credit facility. This amendment increased the revolving credit facility committed under the credit agreement by $145 million from $350 million to $495 million and reset the committee's accordion features to $200 million for potential future expansion. Because of all these actions, our overall liquidity is now $449 million which consists of more than $73 million of cash on hand and nearly $375 million of unused revolver capacity. This gives us capacity to weather the economic climate and provides immediate capacity quickly should the right acquisition opportunity present itself. The consequence of this actual result in our full-year 2020 interest expense being slightly more than $7 million, and our weighted average interest rate is anticipated to be around 2.6%. I’ll now take a moment to speak to what we are seeing beyond the first quarter results. Due to the impact of the COVID-19 pandemic and Novanta’s business, the uncertain duration and scope of that pandemic, and the uncertain timing of the global public health and economic recovery, we are not able at this time to reliably estimate the future impact of the current environment on operations and other financial results, including for the full-year 2020. Though we can give you at least some perspective around what we are seeing today in terms of demand. As we look at the second quarter, the implications of customer behaviors in the first quarter and the economic closures of the worldwide economies in March and April are clearly going to impact our second and third quarters more than our first quarter. Novanta’s revenue could lag our customers’ revenue by 60 to 90-days. While we were expecting second-quarter revenue to be weaker than our first quarter, the majority of the impact will rationally be felt in the third quarter. As we stand here today, we expect second-quarter revenue to be in the range of $130 million to $142 million. The bottom end of the range reflects the risks of supply chain disruptions and/or customer disruptions at their factories, more than it does demand risks from our customers. In other words, from a customer demand perspective, we are trending to the upper end of the range. As we discussed before, the majority of our products are sold in the capital equipment market, which caters either to advanced industrial markets or to the more prevalent medical end-markets. Over the last few years, we have relentlessly focused on applications we feel have secular growth and longevity to them, given that we have two-year design win cycles and because we want to maximize our return on investment. As a consequence, we do feel that most of the revenue drops we expect to see are best characterized as demand deferrals as our customers experience push-outs of capital expenditures to conserve cash. Absent a resurgence of the public health measures taken in April, we do expect a majority of our customers to rebound and return to growth. Despite the challenges, there are many exciting aspects of our business where we see momentum building, particularly around new products and design win activities. We are seeing China’s industrial capital spending markets stabilizing and some early signs of growth returning, particularly around 5G infrastructure investments and laser-based material processing applications. As mentioned previously, despite the pandemic impacting China in our first quarter, we still managed to show growth there. While we are expecting to see the second or third quarter drop in our medical business tied to the halt of elective surgical procedures for two plus months, we feel strongly that this will rebound quickly. The term elective might imply that this type of surgery is optional; however, an elective procedure is simply one that is planned in advance, rather than one that is done in an emergency situation. Surgical suites are the profit centers of hospitals, and when we reemerge from these lockdowns, the pent-up demand for patients will start to drive our consumable growth and then the new equipment growth. More than 70% of our medical end market sales are tied to surgical procedures, both elective and emergency-based, meaning this business is expected to come back faster than some of our industrial markets. It is possible that sales to medical end-markets will finish the year at 60% or more of their total sales. However, despite our confidence in the business, our strategy, and the long-term growth prospects of the company, we recognize we need to take measures to control our costs, improve our cash flows, and maximize our profitability without impairing our capabilities, disenfranchising our employees, or damaging our ability to recover quickly. Therefore, we have taken the following actions. First, the officers of Novanta have agreed to a $1.6 million or approximately 50% reduction in our 2020 cash compensation. This includes the elimination of our cash bonus plans and reduction in base salaries. Second, across the entire company, we have eliminated our planned annual base pay increases for 2020. Most importantly, we have eliminated the annual bonus plans across all roles. For every single employee of Novanta, other than the four officers, we have made a special one-time restricted stock unit grant in April totaling $14.4 million, which will fully vest in February of 2021. We decided on the equity grants because we strongly believe this grant will keep employees focused during this time of crisis, create an ownership mindset amongst our employees, and allow us to maintain our talent, culture, and capabilities so we can quickly recover from the inevitable end of this pandemic. We also strongly believe this equity grant helps to keep our factories running and our employees actively engaged, even from work-from-home environments while maximizing the company’s adjusted EBITDA and minimizing cash outlays. I should note that because of the accelerated investing, our earnings per share will be impacted by the amortization of this one-time grant. For the full-year of 2020, we now expect stock compensation expense to be approximately $22.5 million. These changes to employee compensation is one way we are working to strengthen the profitability and cash flow of the company during the economic downturn. In other areas, we have also implemented travel bans for our staff globally, reduced discretionary spending across our business lines, frozen non-critical new employee recruiting and hiring activity for the year, deferred upwards of $10 million in capital expenditures, including the expansion of our time in the UK manufacturing facility that we mentioned in the last call, and executed a companywide furlough program. We are deferring cash payments of certain U.S. payroll taxes in accordance with the new Cares Act. Finally, we have temporarily halted the company’s share repurchase program since the end of March. Our focus over the next few months will be on protecting our capabilities in terms of our employees, innovation, and our customers, while preserving our priority R&D programs, all whilst maximizing adjusted EBITDA and cash flow. This focus is critical to help us navigate the temporary impacts of the pandemic on our customer demand, as well as the incremental cost to operate in these extraordinary times. In the first quarter, we spent a little less than $300,000 in incremental costs specifically to mitigate the challenges stemming from the COVID-19 outbreak. These costs were incurred to ensure the safety of our employees, keeping our factories open, and continuing to ship our products to our customers. As we look to the second quarter, we expect these costs may be materially higher. We recognize that predicting the potential disruptions remains a moving target, and therefore have analyzed a multitude of potential financial scenarios in the company. The actions we have taken thus far were aimed at protecting the company under the worst-case scenarios we can conceive, while recognizing that the economic consequences of pandemics are temporary. Based on this, we strongly believe that our more than $73 million of cash on hand and nearly $375 million of available borrowing capacity under our revolving credit facilities, as well as the anticipated cash flows from operating activities would be more than sufficient to meet our needs over the next 12 months. In addition, we believe that the global economic recovery is secure, and we now have ample cash available to continue executing and aggressively pursuing acquisition strategies. We are thankful for our customers, as they represent some of the financially strongest companies in the world, with more than 3,500 customers selling into more than 45 different niche application areas. The diversity of our portfolio positions us well to weather the current environment. Finally, in the spirit of never letting a crisis go to waste, we have aggressively institutionalized and progressed 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 common set of 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 in achieving our goals in 2020, especially in areas of customer satisfaction, speed to market, gross margins, and inventory optimization. In summary, we are very proud of the performance of our employees and their commitment to helping us weather this difficult environment. Most importantly, we are excited about our future and look forward to continuing to deliver on our commitments to our employees, our customers, and our shareholders. This now concludes our prepared remarks, and we will open the call up for questions.
Operator, Operator
Thank you. We will now begin the question-and-answer session. Our first question will come from Lee Jagoda with CJS Securities. Please go ahead.
Lee Jagoda, Analyst
Hi, good morning.
Matthijs Glastra, CEO
Hey, Lee.
Robert Buckley, CFO
Hey, Lee.
Lee Jagoda, Analyst
So I really appreciate you trying to give us a shape for the year in terms of Q3 likely being the worst of it from a revenue perspective. From a gross margin perspective, typically, your margins have been driven more by product mix versus overall volume. Can you talk about the current expected mix and how that might impact your gross margin? Understanding that a lot of the incremental costs from COVID probably hit the cost of goods sold line.
Robert Buckley, CFO
Yes. So that would be the larger variable impacting gross margins as we move through the year. It is relatively small in the first quarter, as I talked about, about $300,000. However, as we get into the second and third quarters, that could be upwards of 10 to 20 times higher than that. So, it is a significant headwind that we need to navigate, which prevents us from going out there with any sort of build guidance on the profitability side. The gross margin in the first quarter was generally lower. We would hope to improve from here; we are focused on driving the performance of the business to maximize our EBITDA. You can’t do that through operating expenses alone. We do anticipate driving gross margins to achieve our goal of maximizing cash flows and EBITDA. To get into specifics, I would rather not, just because there are too many variables right now that are outside of our control.
Lee Jagoda, Analyst
That is fair. And then switching gears to R&D. Has the R&D budget in dollars changed versus prior expectations? Or should we think about it as the same dollars you are looking at spending to kind of capture some of these opportunities? And it will just end up being a higher percentage of current sales?
Matthijs Glastra, CEO
Yes, Lee, this was Matthijs. I mean directionally, as I commented in the prepared remarks, all our NPI programs are actually on track, despite people working from home as well as our customers working from home. What we do see is that the mix of programs might shift around a little bit in terms of priorities, because for some customers, some are accelerating, while others are delaying. So, I would say as an aggregate, we are shooting for a similar amount, despite the mix changes and we have also intensified our focus on what we call priority programs, given certain markets are expected to have more tailwinds than others in this climate.
Lee Jagoda, Analyst
Sure. And then one last one, and then I will hop back in queue. You are one of the few companies out there continuing to pursue acquisitions in this market. What are you seeing from a price perspective and then, probably more importantly, a seller willingness perspective at this point?
Matthijs Glastra, CEO
I would just say, Lee, overall, acquisitions are and remain a vital part of our strategy and our capital allocation in the company. We do feel that this climate is going to create opportunities for M&A. However, you may have seen that the first half of the year will not boast much activity for two reasons. One, we want to ensure that we stay focused on our own company health and our employees until the pandemic stabilizes a bit. Second, sellers are also in pause mode right now for essentially the same reasons. However, we expect that as the year progresses, there will be more openness from sellers to consider potential transactions. One of the major reasons we switched to pursue actions to reinforce our liquidity position, as Robert mentioned, including the additional capacity of our credit facility, is to be ready to take advantage of the M&A markets when an opportunity arises. You can expect us to aggressively lean in during the second half of 2020 and 2021, so we are staying very active yet disciplined in the M&A space; that is a way to characterize it.
Lee Jagoda, Analyst
Okay. Thanks very much.
Operator, Operator
The next question will come from Richard Eastman with Baird. Please go ahead.
Richard Eastman, Analyst
Yes, good morning, Matthijs and Robert. Thank you.
Matthijs Glastra, CEO
Good morning, Rick.
Richard Eastman, Analyst
Matthijs, just to maybe think through the three platforms. Again, we are impacted here with the 60 to 90-day lag. Including new products that you hope to ship in the fourth quarter, how would you look at the cadence of improvement among the three platforms, photonics, vision, and precision motion? Slowest to recover and kind of.
Matthijs Glastra, CEO
Yes. It is a tough question, Rick. Let me just answer it directionally in terms of the overall markets. What we set forth in our prepared remarks is that our medical markets, which are close to 60% of current sales, of course, are impacted. You see our customers being impacted materially in their second quarter, and we expect that to be a third quarter event for us. We see hospitals reopening, and expect hospital procedures to recover at the end of the second quarter and into the third quarter. Medical consumables should pick up first as hospitals want to generate cash flows with procedures. So that is a high-level perspective from a surgical standpoint. 70% of our medical business, and our customers, are based on the elective and emergency procedures in endoscopy, robotic surgery, or fluoroscopy and ophthalmology, right? So we are following well-articulated trends that our customers have reported on. There is a smaller market of ophthalmology that is slightly different. It is not a super high percentage of our revenue, and ophthalmology, which involves eye doctors and surgery. 50% of that market is private practice-based. So that will follow a different trajectory, similar to dentist offices. The only exception I would say to the trend of elective procedures. If you then look at the remaining part of the medical business, it is primarily diagnostics, DNA sequencing, and ICU markets. The key is that products related to COVID-19 are already being accelerated due to demand. However, due to reduced hospital visits and associated tests, the non-COVID-19 related tests have declined materially. The net effect to us is that our businesses, overall, remain stable throughout the year. The industrial side shows a wide range as well. Our electronics business in the context of 5G is holding steady. However, we see diverse trends among the industrial end-markets. Laser coding for packaged foods, though down, is relatively stable, while markets dependent on aerospace are more significantly impacted. Ultimately, the takeaway is that we expect Q2 to be lower than Q1, and Q3 will be lower than Q2. It is too early to comment on a Q4 trajectory. Concerning innovation, strategically, we believe this is an asset. We comment that our customers are pulling for innovations and looking to introduce competitive products. This climate provides a chance to gain market share. However, impacts for Q4, in this climate, are hard to forecast. Strategically, we feel this positioning is beneficial, ensuring our customers' platforms remain significant to us in the long-term.
Richard Eastman, Analyst
No. That is very good. You have a pretty good model, but I don’t actually model the 45 different demand curves. So, I tightened that up a little bit. Just want one last question. Robert, your comments about the COVID-related expenses of $300,000 in the quarter, and maybe that spikes to $3 million to $6 million in the second quarter. Is that being absorbed in the COGS line?
Robert Buckley, CFO
Yes. Predominantly in the COGS line. It would be between $3 million and $4 million, I think, as we kind of end up a few percentage points of the total revenue. The ability to recover some of those costs remains an open question, meaning that some of that COGS is likely absorbed by our customers. In some situations, we experience higher costs associated with logistics and higher PPE costs, which we are attempting to manage as best as we can. We are also looking at ways to share some of that cost with our customers.
Richard Eastman, Analyst
Okay, alright. And does that $3 million to $4 million, is it going to be kind of a quarterly run rate? Does that carry into the third?
Robert Buckley, CFO
Well, it is really tied mostly to disruptions from the lockdowns and the challenges involved in the airline industry, particularly around how you move freight to and from locations. To the degree of lockdowns begin to ease and normalize, we would anticipate costs to reduce. Thus, I don’t think it will be something that will persist for the remainder of the year, unless there is a resurgence of the pandemic in the back half of the year. However, I do think it is temporary, as it's primarily tied to how we can effectively move product, especially from the U.S., globally.
Operator, Operator
Our next question will come from Brian Drab with William Blair. Please go ahead.
Brian Drab, Analyst
Hey good morning. Thanks for taking my question.
Matthijs Glastra, CEO
Hey good morning, Brian.
Brian Drab, Analyst
Can you just, in the spirit of housekeeping here, the small question but you have an idea for us how much was pulled forward from the second quarter? Is it hard to parse that?
Robert Buckley, CFO
It is hard to parse it out, but you know, we gave a range and we beat the range a little bit. I think, why we came in, beating the range, is more as a consequence of that. Again, I made a comment on as we looked at that second quarter, you know our demand profile would say we are at the upper end of that range. The bookings are there. The support is there. The backlog is there to deliver on that upper end of the range. We provided a broader range, because of the disruptions in moving product around, logistics, and getting products in and out of countries. In some cases, we had COVID-19 cases in their factory and they shut down, which resulted in us being unable to ship product to them. It is really important to take all these factors into account. I think balancing out those two quarters is a better perspective on the overall demand.
Matthijs Glastra, CEO
Yes, I think that is a good way to look at it. The other thing that I would say, Brian, is that our book-to-bill was 1.06 for the first quarter. We typically comment on that on average it is going to be around one. Some quarters can swing around a bit. But looking into the three segments, precision motion and vision had book-to-bills higher than one, while photonics was around one at 0.99. So that is another clue on how much of maybe a pull forward that we saw. But Robert’s perspective on looking at the two quarters together for a clearer judgment is correct.
Brian Drab, Analyst
Okay, thanks. Now that is really helpful. And then, can you talk a little bit more about the business that may have arisen specifically from the outbreak? You talked about some of the COVID-related testing, and you mentioned some other categories. Is this revenue related to the crisis activities meaningful and some of it sustainable and creating new long-term opportunities for the Company?
Matthijs Glastra, CEO
Yes. I mean that is a question, right? We feel let’s say first and foremost, we are extremely excited about the smoke evacuation insufflator technology we have. Even pre-pandemic we commented on this because we feel with this eruptive technology where we are the technology leader. We see penetration in adjacent markets, including robotic surgery. So pre-COVID, we commented that this is a multi-year growth engine for us. Now during COVID-19, what customers are telling us, and actually hospitals, is that staff is demanding the smoke evacuation technology because it filters out CO2 gas that comes out of the patient. It essentially provides a way to keep medical staff safe, and you can expect that this will become a standard part of care. Medical bodies are recommending it to become standard. This category might become a part of the new normal. On the other hand, demand on patient monitoring and ICU-related equipment that is particularly related to COVID-19 may be more temporary. Countries will increase their strategic stockpiles of ICU capacity and maybe that has some positive effects, but we cannot count on that. In our diagnostics and ICU business, COVID-related products have helped stabilize the business despite reduced non-COVID-19 related diagnostic tests. The net takeaway is our businesses have stabilized overall despite the challenges. Additionally, we are vigilant regarding 5G cloud-based infrastructure, but it constitutes a smaller part of our business. We expect investment in high-performance computing and cloud infrastructure to be longer-term trends. If anything, the COVID situation has illustrated the need for healthcare productivity, precision medicine, robotics, and automation for more resilient supply chains. We still firmly believe that Novanta is positioned for long-term growth post-pandemic.
Brian Drab, Analyst
Okay. Thanks for all that detail. And just one more question. I have in my notes and I can’t remember, specifically or an impression that I have. The first quarter we were expecting about $33 million in SG&A, you did about $31 million. I was just wondering if you can give us any insight into, I know, you mentioned some cost cutting in limiting costs, but what part of that discrepancy between my estimate and what you ended up doing was related to cost cutting and kind of what should we expect for the run rate going forward, including the stock count that you mentioned?
Robert Buckley, CFO
Yes. I mean, obviously, I know you want to fill out your model, but I want to be.
Brian Drab, Analyst
Directionally, it is all I would expect. Yes.
Robert Buckley, CFO
Like, there is a cost-cutting that we have done. Most of those actions started at the end of March and therefore benefit, on a Q2, Q3 basis. So will SG&A step down as we get into the second quarter? Most likely, as the consequence some of the cuts in discretionary spending, some of the reductions in travel, and the bands around that, as some of the reductions in compensation expense. Offsetting that would be the grant, but for the most part, you should expect it to tick down a little bit.
Operator, Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Matthijs Glastra for any closing remarks. Please go ahead.
Matthijs Glastra, CEO
Thank you, operator. So to summarize, in the first quarter of 2020 Novanta delivered a solid performance in an uncertain macro environment. We are very pleased with our positioning and performance of our portfolio and proud of the performance and agility of our teams. Novanta is not immune to the impact of this pandemic, but we are well positioned to weather the COVID-19 crisis. Our balance sheet is strong, as is our innovation lineup. Our portfolio is diversified with exposure to long-term secular trends in robotics and automation, healthcare productivity, and precision medicine. While the short-term outlook is uncertain with a health pandemic, we are investing into the headwinds and remain focused on the long-term growth drivers in our business on the back of the macro trends in industry, 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 the dedication and strong contribution of all our teams and the Novanta employees who are showing tremendous agility and resilience during these unprecedented times. 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 in the second quarter 2020 earnings call. Thank you very much. This call is now adjourned.
Operator, Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.