Cognex - Q1 2016

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Cognex Q1 2016 Earnings Conference Call. Currently, at this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. Should anyone require assistance at any time during the conference, please press star and zero on your touch-tone telephone. Also, as a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Richard Moran. Sir, you may begin.

Richard Moran (Director of Investor Relations)

Thank you, and good evening, everyone. Earlier today, we issued a news release announcing Cognex's earnings for the Q1 of 2016, and we've also filed our quarterly report on Form 10-Q. For those of you who have not yet seen these materials, both are available on our website at www.cognex.com. They contain highly detailed information about our financial results. During tonight's call, we may use a non-GAAP financial measure if we believe it is useful to investors, or if we believe it will help investors better understand our results or business trends. For your reference, you can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the earnings release.

I'd like to emphasize that any forward-looking statements we made in the earnings release, or any that we may make during this call, are based upon information that we believe to be true as of today. Things often change, and actual results may differ materially from those projected or anticipated. You should refer to the company's SEC filings, including our most recent Form 10-K, for a detailed list of these risk factors. Now, I'll turn the call over to Cognex's Chairman, Dr. Bob Shillman.

Bob Shillman (Chairman)

Thanks, Dick, and hello, everyone. I'd like to welcome each of you to our Q1 Conference Call for 2016. You've probably seen in the news release issued earlier today, we reported better-than-expected results for the Q1 of 2016, despite challenging market conditions. Right now, I'm at our R&D office in San Diego. Everyone else on the call is at our Natick headquarters. For details of the quarter and outlook, I'm going to hand the microphone over to my partner, Rob Willett, our President and CEO, and I'll be available at the end of the call to answer any questions that you may have for me. So, Rob, the microphone is yours.

Rob Willett (President and CEO)

Thank you, Dr. Bob. Good evening, everyone. I'm pleased that the year started off slightly ahead of our expectations. Q1 revenue was $96 million, which was $2 million higher than the top end of the range we gave to investors in February. Notably, demand was higher than expected from logistics customers, where we saw more activity than in 2015. Gross margin was also stronger than expected at 78%, helped by higher-than-expected product revenue. These positive items combined to deliver earnings for the quarter of $0.17 per share, exceeding the Thomson Reuters First Call consensus estimate of $0.11 per share. Let's now turn to the details of the Q1. Factory automation revenue for Q1 was $90.4 million. We typically experience a revenue decline from Q4 to Q1, and that seasonal trend held true again this year.

However, revenue was also lower than a year ago, which is not typical. Notably, we saw lower revenue from large consumer electronics orders than in Q1 of 2015. Revenue outside of that industry did grow year-over-year, although the rate of increase was small. Looking at factory automation from a geographic perspective, we now find it is more meaningful to separately report to Greater China, which we define as mainland China, Taiwan, and Hong Kong. We are also combining smaller countries in Asia, including Japan and Korea, into a category titled Other Asia. Looking at the trends year-over-year in our three largest geographic areas, Greater China was our fastest-growing region in terms of percentage growth, even though the rate of increase has slowed. A large contribution to growth in absolute dollars came from the Americas, where factory automation revenue grew faster than in recent quarters.

In Europe, factory automation revenue declined significantly year-over-year due to lower revenue from the consumer electronics industry. Outside of electronics, revenue showed modest growth, even with the negative impact of currency exchange rates. In the semiconductor and electronics capital equipment market, revenue was $5.8 million in the Q1, down 10% year-over-year. Demand from semi follows the market's cyclical trends. Our expectations for growth in this small piece of our business continue to be low. Next, let's turn to exciting news. We have entered two new markets this year that increased our total addressable market by more than 25%. Consistent with our long-term strategy, we are deploying Cognex's vision into adjacent markets that are poorly served by outdated technology. First and most important is our entry into a $500 million segment of the ruggedized mobile terminal market.

Our new MX-1000 series combines Cognex's powerful barcode reading capabilities with user-friendly smartphones for performing tasks such as inventory management and field service. This innovative approach will replace less capable and more difficult-to-use products that rely on laser-based technology and Windows operating systems. We've already seen initial sales to several Fortune 500 companies and are currently undergoing trials with a wide range of prospective users. We also entered the $50 million market for reading barcodes on airport baggage. The market is served almost exclusively by laser-based barcode reading products and will benefit from the higher read rates and better reliability offered by Cognex's vision technology. One of the largest international airports in Europe is already deploying Cognex DataMan ID readers, and two major airports in North America are in the process of installing our products. My last topic is our outlook.

For Q2 of 2016, we expect that revenue will be in the range of $135 million-$140 million, reflecting a substantial increase over the $96 million reported tonight for Q1. Looking year-over-year, we expect a slight decline in revenue due to large orders from the consumer electronics industry. Unlike last year, when the majority of orders were recognized in Q2, this year we expect them to be split between Q2 and Q3. Outside of that industry, we expect our business to grow year-over-year. Gross margin for Q2 is expected to be in the mid- to high-70% range. Operating expenses are expected to increase by up to 4% from Q1 due to our investments in engineering and sales and to the timing of marketing initiatives. Operating expenses are expected to be essentially flat year-over-year.

The effective tax rate is expected to be 18%, excluding discrete tax items. Now, let's open up the call for your questions. Operator, we're ready to take questions.

Operator (participant)

Thank you, sir. Ladies and gentlemen, if you have a question at this time, please press star and one. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. All right, DeShawn, our first question comes from Jim Ricchiuti of Needham & Company.

Jim Ricchiuti (Senior Analyst in Equity Research)

Hi, thank you. Good afternoon. The strength that you saw in the logistics market, can you talk about that relative? Was it stronger in the U.S. market, Europe, and to what extent do you see the demand in that area continuing to be strong in Q3? Because there's a seasonal aspect to that business as well.

Rob Willett (President and CEO)

Yeah, hi, Jim.

Jim Ricchiuti (Senior Analyst in Equity Research)

Hi.

Rob Willett (President and CEO)

It's Rob. Yeah, so we've definitely seen a significant improvement in our logistics business in the Americas, or in the United States, really. And you rightly point out that that business is a little cyclical, but I think, or seasonal, I would say. And we expect the outlooks of the logistics business to be good in Q2 and Q3. We're less sure about Q4, where seasonality can affect, and particularly retailers tend to stop spending and focus on delivering around Thanksgiving, Christmas, and Chinese New Year. But I think we're pretty optimistic about the outlook for our logistics business everywhere. America is our largest market in logistics at the moment, and we expect that strong conditions to continue through Q3 of this year.

Jim Ricchiuti (Senior Analyst in Equity Research)

Hey, that's helpful. And Rob, when you talk about the consumer electronics business, the split between Q2 and Q3, any feel for how that splits? Do you expect a larger contribution in the June quarter versus Q3?

Rob Willett (President and CEO)

It's a little difficult to make a call on that at the moment because sometimes where revenue will land for particular opportunities that we're working on, they can move. I would think we would probably expect Q2 to be a little higher than Q3, although that's not a certain thing.

Jim Ricchiuti (Senior Analyst in Equity Research)

If I could, one final question, I'll jump back in the queue. The airport opportunities, could you maybe size that for us in a normal large-sized international airport? What kind of a revenue contribution could that be for you? Is the deployment, I assume, as you mentioned, it's being deployed in 2 airports in the U.S. currently?

Rob Willett (President and CEO)

Sure. Yeah. So we think it's a $50 million market overall, where there's one pretty big player today selling mostly laser-based, or almost all laser-based opportunities. So we think we have a lot to bring to the party. These are capital projects that occur not on an even regular basis as companies upgrade their lines. I think an average system for one baggage line might be in the range of $60,000, but it's also possible that they'll be outfitting multiple lines at the same time. So certainly those accounts we've won so far, the opportunity at each airport is in the range of $250,000. And then I think you asked Jim something about where two in North America, one in Europe is what we've said.

Jim Ricchiuti (Senior Analyst in Equity Research)

Okay. Thanks very much.

Rob Willett (President and CEO)

Sure.

Operator (participant)

Thank you. Our next question comes from Ben Rose of Battle Road Research.

Ben Rose (President)

Good evening, Rob and Dick. Question regarding North America. The pickup that you saw this quarter, I think I surmised from your commentary at the opening that that was mostly in logistics. Could you confirm that that was the case? And regardless, could you talk a little bit about various manufacturing sectors in the U.S. and what you saw this quarter?

Rob Willett (President and CEO)

Sure. Hi, Ben. It's Rob again. Yeah, so I think the Americas market is an interesting topic. Yes, certainly we saw logistics picking up, and that's been a particularly bright spot for our business in the Americas. We tend to talk about the Americas, so not necessarily the United States, and I would say, but North America is really obviously where all the action is. In terms of some specific markets, so yeah, logistics would be our best performing. The automotive market continues to perform pretty well for us in the United States also. And then other markets where growth seems healthy moving into this year, particularly consumer products and food and beverage are strong-performing markets for us at the moment.

Ben Rose (President)

Okay. Just a follow-up with regard to Europe, exclusive of the change in revenue from the large customer in last year's Q1, are the same trends in terms of the end markets similar in Europe as they are in the Americas?

Rob Willett (President and CEO)

Yeah, so I think the answer to that is broadly yes. Automotive continues to contribute for us. Logistics looks strengthening off a smaller base in Europe. And then, yes, consumer markets looking pretty good.

Ben Rose (President)

Okay. I'm sorry. And just one final question for me. In the press release, you specifically cite the expectation for consumer electronics customers' orders in the Q2. I'm wondering if exclusive of the large customer that's called out in the 10-K, are there any specific manufacturers that you can mention at this point?

Rob Willett (President and CEO)

Well, Ben, I think it's fair to assume Cognex is the world's leading supplier of machine vision, and we're working with really all the major brands in consumer electronics and automotive. So yes, certainly we're working with all of those. We do see some very good growth opportunities with a number of consumer electronics manufacturers. That's certainly the case. I think it was our largest vertical in 2015. Aside from the one large customer that we report in our 10-K, we do have a number of other significant customers in that space.

Ben Rose (President)

Okay. Thanks so much.

Operator (participant)

Thank you. Our next question comes from Bobby Burleson of Canaccord Genuity.

Bobby Burleson (Managing Director and Senior Equity Research Analyst)

Hey, good afternoon. Thanks for taking my questions.

Rob Willett (President and CEO)

Hey, Bobby.

Bobby Burleson (Managing Director and Senior Equity Research Analyst)

Hi. So I think just the first one on the mobile terminals, the MX-1000 business, is that appreciably different in terms of gross margins once it ramps to kind of scale versus the corporate average?

Rob Willett (President and CEO)

No, we expect Cognex-like gross margins in that business.

Bobby Burleson (Managing Director and Senior Equity Research Analyst)

Okay, great. It sounds like that's gotten off to a nice start here. Are you going to break it out over time as a separate or at least kind of call out how the revenue is doing in that business? And curious when you think it becomes meaningful.

Rob Willett (President and CEO)

Yeah, we have no plans currently to call that out. It's going to be part of our ID business, and it's going to help us achieve that 30% growth rate for ID as this business gets bigger. New markets like the 2 we've reported tonight, both ID markets, are going to help us continue to grow that pretty substantial business, now more than a third of our total revenue at the kind of growth rates that we expect. I would say in terms of expectations, this is a new market we're entering. We have a very innovative approach, but it's a market that I think, like other markets we've entered, will probably grow in sort of an S-curve, where right now we have a lot of units out with a lot of customers, and they're interested in it.

But I don't think we're going to see very large revenue this year. I think probably relatively small revenue this year, and I expect to see a meaningful contribution next year. And then perhaps we'll revisit the topic of how to report that as we move along that S-curve.

Bobby Burleson (Managing Director and Senior Equity Research Analyst)

You mentioned that you've got a pretty broad offering into consumer electronics besides the large customer in the 10-K. And I'm wondering in terms of large orders kind of broadening out by OEM, do you expect that to start happening next year in terms of a broader base of customers driving the larger consumer electronics orders? Thanks.

Rob Willett (President and CEO)

Yeah. So as I say, I think we sell into really pretty much all of the major players in consumer electronics. They all have kind of different supply chain models and different projects that we work with them on. So it can be a little difficult to nail when larger chunks of business will come from companies in that industry. We certainly do have some pretty exciting and large potential projects we continue to work with on them. But in terms of kind of trying to tell you when those chunks of revenue will arrive or with whom or in which region, we really can't give you any more color than that.

Operator (participant)

Thank you. Our next question comes from Rick Eastman of Robert W. Baird. Question, sir?

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Yes, thank you. Good afternoon. Robert, can I ask you, the Europe number that you disclosed was down 19%. Is that constant currency, or is that a reported number?

Rob Willett (President and CEO)

That's a reported number.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

That's reported? Can we get a constant currency number?

Rob Willett (President and CEO)

Let's see. Constant currency. Hang on one second, Rick. Constant currency year-over-year in Europe, we probably lost about $1 million due to currency compared to last year.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Okay. So the revenue impact of currency in Europe was $1 million. And then I guess maybe if I look at your factory automation business, and I take our currency and I make an assumption on the large customer, it looks like perhaps that in constant currency, the factory automation maybe was up low single digits. And I guess what I'm getting at is, is there any discernible improvement around the factory automation business without currency, without customer noise? Do you view that business as having kind of stabilized, or how do you look at it in terms?

Rob Willett (President and CEO)

So yeah, so Rick, I think your assumption about up a small amount is correct. I think I would say it's kind of operating in a relatively weak set of market conditions currently. I spent quite a lot of time in the last few weeks with our sales channel in Europe and in America, actually. And I would say, yeah, the European business is probably, as you described, it's sort of stable at a low-ish level. Automotive continues to look relatively healthy, but obviously there's still a lot of uncertainty. And I wouldn't say the market conditions for industrial products like ours in Europe are particularly good at the moment, but they're not deteriorating or getting appreciably better as far as I can see right now.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Okay. And then just one last question on the large customer side of the business. I mean, the reference here is to a much better Q2 and then Q3. Is it still a solid guess to assume that the large customer revenue is tracking higher in 2016 than it was in 2015? That's still just a solid guess?

Rob Willett (President and CEO)

So yeah. So Rick, we're under a lot of legal obligation not to discuss that customer specifically, so we can't really give you much more color on that.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Okay. All right. Thank you very much.

Rob Willett (President and CEO)

Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, if you have a question at this time, please press star and one. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our next question comes from Joe Giordano of Cowen.

Joe Giordano (Senior Equity Research Analyst)

Hey, guys. Thanks for taking my questions. First, on auto, I'm curious, are you seeing your customers actually spending more money, or are you just taking a larger share of the overall CapEx spend?

Rob Willett (President and CEO)

Well, I think our automotive business was up in the Q1, sort of double digits, just. I would say we're probably holding share or maybe taking small amounts of share in that market. There's a lot of investment in automation going on in automotive. There's also a lot of new stuff in automotive, whether in growth areas of automotive for Cognex specifically, electric cars and investment in electric drives. China, although we're all reading a lot about the slowdown in China, certainly the automotive market for Cognex, and I think in general continues to invest pretty heavily in China. Then we have new products in the areas of 3D, which is a new area for us. That's certainly helping to drive some growth into automotive as well.

So I think automotive is never going to be a super fast grower for Cognex, and it's our second largest market currently, but it is contributing nicely doing so.

Joe Giordano (Senior Equity Research Analyst)

I think it's funny that you say 10% is not a super fast grower considering what we've heard across the street on most of these end markets so far. I think that's pretty good. Can you maybe discuss in terms of your consumer electronics, not relative to any specific customer or anything like that, but I feel like there's a lot of confusion about your customers' reported volumes of products and how that relates to Cognex demand for products. Can you kind of talk about sales volumes at your customers versus the capacity that you're really selling into and how that kind of interrelates?

Rob Willett (President and CEO)

Gosh, I could talk a great length about that. Let me sort of think. I think, Joe, I'd say in general, we sell to consumer electronics customers for a number of reasons. One is where they're trying to implement new features and technology in their product ranges, and they really need really advanced automation and support from Cognex in order to do that. So that's kind of one area. And then another area where we see a lot of demand for vision and automation in electronics manufacturing is in terms of productivity and taking cost out of the supply chain because there are literally hundreds of thousands, if not millions, of people deployed to manufacture consumer electronics in China as we speak. Those labor costs are going up, and the products are becoming smaller and more difficult for human hands to assemble.

So there's a lot of use of vision and robotics to try to address that issue. I would say as we read about the consumer electronics market, there's obviously differing emphasis on those two aspects. But I think there's going to be plenty of demand for vision among all the leaders in that industry for some years to come to address those two issues.

Joe Giordano (Senior Equity Research Analyst)

Okay. That's very helpful. Thank you. And then maybe last for me just on costs. I mean, typically we see a ramp in costs ahead of large orders. Not to try to pull guidance for 3Q out of you, but how much of that typical incremental cost do you think you'll get through just based on your guidance of 2Q?

Rob Willett (President and CEO)

Okay. Joe, your question is about expenses in Q2?

Joe Giordano (Senior Equity Research Analyst)

Yeah. You typically have a ramp up in expenses to kind of prep for large orders that you're getting. And now you've kind of indicated that you're going to have large orders through 3Q, and I just wonder how much of that cost associated with that is going to come through. How much of that kind of prep work have you done already? What will you have completed by the end of 2Q?

Rob Willett (President and CEO)

Right. So reiterating a little what I said. So operating expenses are expected to increase by up to 4% from Q1 in Q2. I think it's a little early to talk about specific expenses for Q3. However, I would say at the moment we have a pretty strong focus on discretionary cost management and productivity without changing our engineering plans. And as a result, we expect that operating expenses will increase at a slower rate than revenue this year. So I think that's how we're looking at the year overall. I really can't give you anything specific about Q3.

Joe Giordano (Senior Equity Research Analyst)

Fair enough. Thanks a lot.

Operator (participant)

Question comes from Jim Ricchiuti of Needham & Company.

Jim Ricchiuti (Senior Analyst in Equity Research)

Yes. Rob, is it fair to assume that broadly speaking, you would expect your consumer electronics business to be up for the year as a whole versus last year?

Rob Willett (President and CEO)

No. I don't think so.

Jim Ricchiuti (Senior Analyst in Equity Research)

Okay. That's helpful. And since you're not breaking out Japan, and it is a smaller piece of your business, can you talk about what you are seeing there in that market?

Rob Willett (President and CEO)

Yeah. I'd say overall this year, Japanese business has performed a bit like the rest of Cognex. We've seen sort of moderate growth overall and pretty strong performance in ID. We have really advantaged products in ID, and I'm glad to report that our Japanese sales organization is starting to sell them more aggressively. And so we're seeing some nice growth in that area. But low- to high-single-digit kind of growth in Japan is, I think, what we're currently looking at. And there, I'm talking about factory automation. I'm not talking about semi.

Jim Ricchiuti (Senior Analyst in Equity Research)

Okay. Thank you.

Operator (participant)

Thank you. Our next question comes from Rick Eastman of Robert W. Baird.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Sorry. Sorry to come back to you. Just two things. For the Q2, just so I may be understanding the pacing here a little bit on the large customer revenue relative to the gross margin guidance, is the mid- to high-70s range for the gross margin guidance, I presume that maybe mid-70s captures more service revenue. And would the pacing of the service revenue fall more towards Q3? Is that how we should think of the cadence on the gross margin line?

Rob Willett (President and CEO)

Well, I think you're right that we can expect more service revenue in Q2 than in Q1. But I think we're going to see that, as you suggest, also spread across Q2 and Q3. So without getting too specific, I would say we'll see a little bit of gross margin erosion in Q3 as a result of more service revenue, but still mid-to-high 70% range is where we peg gross margins coming in Q2.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Okay. All right. That's reasonable. And then Dr. Bob, I want to maybe lob a question your direction here. Is there anything in this, anything on the autonomous vehicle side, any developments that maybe put that market back on the radar screen, or do we kind of stay in automotive on the production side where we've had so much success?

Bob Shillman (Chairman)

Yeah. We're very aware, of course, of the application of artificial intelligence, not only in the factory, which is where we dominate, but in other applications such as intelligent transportation and autonomous vehicles. Though our experience to date, and as you may know, you've covered us for some time, when we had acquired a company with significant intellectual property that applied directly to autonomous vehicles, that is lane guidance to make sure a car stays in lane. Our experience was that although we had had a lot of technology and a lot more is necessary to guide a car, of course, through cities, that the business model for it was very difficult. We found that it was fraught with price pressures and protection of intellectual property and also the problem of liability.

So currently, although we're looking at it and we have products that could apply to those kinds of problems, we prefer to focus our efforts on the industrial applications, which certainly in our biggest segment is in automotive. And we are involved, and I think in the production of many of the, well, there aren't that many autonomous vehicles on the market today, but the one that is on the market, we're already involved in the manufacturing end of those cars. But I don't envision us being a supplier for products or technology that will be part of the bill of materials of those cars.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Understand. And when you look at how the industry is expanding just in general, I mean, Cognex is larger, are there any inspection or measurement technologies that maybe stray somewhat from vision? I mean, because Cognex, obviously, being a software, there's other very software-intensive measurement technologies out there. And you mentioned earlier artificial intelligence. But I'm curious, is there any tendency for Cognex to think of itself as more of a software processing company than vision as you grow larger?

Bob Shillman (Chairman)

Well, certainly, if you look at our P&L, it resembles more of a software company than a hardware company. And if you were to categorize our engineers as either software or hardware, I would say that 90% of our engineers are probably 80%-90% are software engineers. So we are truly a software company, but we've seen a unique advantage and a distinct advantage in not selling software and not licensing software. We embed that software in rather high-performance, specialized hardware, and more often than not with specialized optics. So the more value we can provide to our customers, the more money we can make because the money we make is proportional to the value. I'm not sure if that answers your question, but can you follow on if you have if I haven't?

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Okay. No, that's fine. There's some things going on the non-contact laser side and, again, very software data intensive. It seems like Cognex will set things carry over.

Bob Shillman (Chairman)

Well, if you were to categorize vision, perhaps, as only optical, the capture of an image that people can see, that's one thing. But our technology does apply beyond that. We could look at thermographic images. We could look at X-ray images. The source of the image doesn't matter to us, actually. What we specialize in is the analysis of that image irrespective of the physics of how it was achieved. As a matter of fact, in our most recent 3D product, the image is captured using lasers to illuminate it. And in some cases, the laser may be visible spectrum or may be beyond the visible spectrum. So our expertise is truly analysis of images using artificial intelligence methods, which means software for doing things with those images that humans would do if they could see those images.

And so we are looking beyond, although our focus is factory automation and industrial uses of artificial intelligence such as ID, which is not really factory, but it's part of the factory because if you're going to ship it, it has to go through distribution and logistics. But we're not restricted to that. We are looking indeed at other applications. The application of machine vision to control traffic is an area that we've looked at in the past and we continue to be interested in. And you could sort of say the Internet of Things. There's cameras going to be everywhere controlling many things or reporting many things. And some of those things may be profitable. But until so far, we haven't found many markets that are as appealing to us that have the growth and profitable characteristics that the industrial applications have.

Rick Eastman (Managing Director and Senior Equity Research Analyst)

Sure. I see. Okay. Well, great. Thank you. Thanks for the invitation.

Bob Shillman (Chairman)

You're welcome.

Operator (participant)

Thank you. Our next question comes from Jeremy Capron of CLSA.

Jeremie Capron (Head of Industrial Technology Research)

Thanks. Good afternoon. I wanted to follow up on the consumer electronics business. Clearly, a solid outlook for Q2. But Rob, I noticed your comment in the press release around the outlook for the full year being not any more bullish than a few months ago. So I'm trying to understand whether your outlook for consumer electronics is somewhat softer than when we entered the year, and we've seen that kind of development pretty much across the consumer electronics industry so far this year. So trying to reconcile this.

Rob Willett (President and CEO)

Yeah. Hi, Jeremy. It's Rob. Yeah. I think we would say that our outlook for the consumer electronics industry this year is less positive than it was when we came into the year. So I would say that's true. And that's why, in general, our outlook for the year in general that we see at Cognex is about the same. We're seeing better outlook in certain areas than I think we had originally thought, particularly logistics, some of the more consumer-based markets that we serve. But consumer electronics, specifically, a little less bullish than we were when we came into the year.

Jeremie Capron (Head of Industrial Technology Research)

Okay. And MX-1000, interesting development. I think that looks like a nice extension for you into an adjacent market. However, when I look at this industry in its current structure, the margin structure is clearly much different from what we've seen in the industrial vision applications. And also the growth rate of this mobile terminal market itself also looks significantly lower. So I'm wondering if you could explain your thinking process going into this market with large established players. How do you see that playing out for Cognex? I know you made this comment around margins probably coming in at a comparable level to what Cognex does today. But how would you achieve that?

Rob Willett (President and CEO)

Yeah. Yes. I'm glad you asked that, Jeremy. I think first thing to understand is we're approaching this market a completely different way, right? So we're basically providing vision technology and a rugged exterior into which a customer inserts a smartphone of their choice, right? We're expecting most to be Android phones, possibly iOS phones. And we're competing with customers in an established market that has not provided much innovation or change to customers in a long time. It's focused much more on consolidation and cost cutting. And they're providing Microsoft Windows-based operating systems that are expensive and customized and not evolving in the way that customers really want. So we're providing a lot of technology really on the front end of the device that brings a lot of powerful vision at a low cost to us with a lot of our technology on it to customers.

Then customers are leveraging smartphones, their own smartphones that they will buy in most cases, although we can supply if they wish. Hence, the technology, the innovation, the differentiation is there, and the margins will be there for us too.

Jeremie Capron (Head of Industrial Technology Research)

I see. And what kind of price point are we talking about here? Is this meaningfully different in terms of the solution that you provide? I understand one need to add the cost of a smartphone to be comparable here, but are we looking at a significantly cheaper solution for the end user?

Rob Willett (President and CEO)

Yeah. The MX-1000 list price ranges from $1,500-$2,500. Okay? And then customers purchase a phone separately. So we are addressing the higher-end segment of that market. But if you look at new products being introduced by the two largest players in that market, they're the same or higher than those kind of prices, even when we include the cost of a reasonably priced Android phone. So we think a lot more functionality and flexibility and kind of the operating system that customers want. I will also just mention, Jeremy, that we've been studying this market for a while, and we've been talking to a lot of customers. And they're pretty close to our handheld barcode reading business that we have today. And what we're seeing is that WinCE and Windows Mobile, the concerns around that operating system are considerable.

Microsoft is planning not to support WinCE and Windows Mobile after 2020. They've announced that. Generally, customers are already in a frame of mind where they're planning to move to Android operating systems or, in some cases, iOS operating systems. The whole industry is kind of primed for a change. Customers over the last five years have become really enamored with their smartphone. Those smartphones come with a lot of innovation and technology and power in terms of connectivity and usability that we're leveraging. We're wrapping our own or attaching our own high-performance vision to the front of that. That's kind of the vision of the product. I really encourage everybody to go to our website and learn about the MX-1000. We have some videos on there explaining the functionality.

As we've been out talking to customers that say, "I would kind of segment the customers we talk to into those who are really interested and want to do what we're doing." And literally, we have comments like, "That's what I've been looking for." And then we have others who are like, "Oh, no. We're married to the Windows operating system, and we're going to stay there." And so we have a saying, "At Cognex, lose fast." We're not going to waste a lot of time with those who want to stay on the Microsoft operating platform. But for those in the long run, they're going to need to change because any kind of custom software or integration they have based on Windows isn't going to be supported after 2020. And I think the industry is waking up to that fact.

So we're pretty bullish about the innovation we offer, the way we can apply our technology into that field today. But even going forward, there's plenty more, as you well know, we can do with vision other than read barcodes. So we think we can have a pretty exciting product roadmap around the technology we're building here. So we're very excited about it.

Jeremie Capron (Head of Industrial Technology Research)

Understood. When you compare that to your entry into the logistics segment of the barcode reading and the success that you've had there, what I'm trying to get to is how do you think about the potential market share that Cognex could take in this $500 million opportunity?

Rob Willett (President and CEO)

Well, I'd say that our experience tells us that getting into new markets with a really innovative approach takes a little time. So right now, that's been the case of a number of new markets we've entered. So right now, we're really educating customers. We're learning a lot about their needs and they about our product. So I would reiterate that I don't expect large contributions of revenue this year. However, I would say what we would aspire to, and we have plans that we're working on, we would look to take a 10% share of that market starting next year over a period of years. So obviously, we won't get a 10% share of such a big market next year, but we would hope to ramp towards that.

And that's what we've seen in logistics over our time and that we aspire to do also with the 3D market that we're in the process of gaining share and entering now. So I would say if it follows the normal pattern, it'll take us a few quarters to get going. We should see some significant contributions next year. Over a 3-year period, we would ramp. We would expect towards a 10 share. And I think in the long run, we would aspire to have a higher share than that, probably approaching 20%. But this is conjecture at this point, and we're still learning a lot about the market. And it'll be interesting to see what the competitive response is also.

Jeremie Capron (Head of Industrial Technology Research)

Great. Thanks very much, and good luck.

Rob Willett (President and CEO)

Thank you.

Operator (participant)

Thank you. Our last question comes from Bobby Eubank of Chevy Chase Trust.

Bobby Eubank (Equity Research Analyst)

Thanks, guys, for taking the call. So logistics right now, I guess, would be your third largest market behind consumer electronics and automotive. Do you think that'll overtake automotive given the growth there? And have you called out the TAM specifically in the logistics market? Thanks.

Rob Willett (President and CEO)

Yeah. Hi, Bobby. It's Rob again. Yeah. So we've talked in the past about so first of all, yes, I would say logistics is our third largest market at this point. We've talked about logistics being a $250 million market. We haven't updated that number in recent quarters. We don't update our market sizes every quarter. But 250 was the kind of last size we gave as the addressable market for the logistics business. And then now, of course, we've added on to that $500 million of mobile terminals, which we would classify as logistics also, and airport baggage handling, another $50 million. So we've grown that segment significantly that we address. So was there a second part to your question?

Bobby Eubank (Equity Research Analyst)

Do you expect it to overtake automotive and kind of timeline for that, just given the relative growth differences there?

Rob Willett (President and CEO)

Well, it's an interesting question. Our automotive business is pretty significant, approximately 25% of our total revenue or a little more. But I think if we map forward where the served market, the addressable market in logistics now, which would be approaching $800 million, and if our expectations would be in the long run to gain 20% share in that, and we think the automotive market is going to keep growing at approximately 10% or so over that time period, I guess those lines would have to cross, right? But some way out there.

Bobby Eubank (Equity Research Analyst)

Yeah.

Operator (participant)

Thank you. At this time, I'd like to turn the call over to Dr. Shillman.

Bob Shillman (Chairman)

Okay.

Thank you very much. To wrap up, business conditions are difficult, and as a result, 2016 is not going to be a great year for Cognex. Nevertheless, we're still very profitable, and we remain confident about our future and that we will continue to be the world's leader in machine vision. So I want to thank you all for joining us tonight, and we look forward to speaking with you again on our next quarter's call. Bye-bye.

Operator (participant)

Thank you, ladies and gentlemen, for attending today's conference. This concludes the program. You may now disconnect. Good day.