Cognex - Q2 2016
August 1, 2016
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the Cognex second quarter 2016 earnings call. Now I'd like to turn the call over to your host, Chief Financial Officer, Dick Morin.
Richard Morin (Director of Finance and CFO)
Thank you, and good evening, everyone. Earlier today, we issued a news release announcing Cognex's earnings for the second quarter of 2016, and we 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.
Robert Shillman (Chairman and CEO)
Thanks, Dick, and welcome, everyone, to our second quarter conference call for 2016. As you can see in the news release, just issued earlier, we reported very, very good results for the second quarter, which were better than our expectations, and our expectations were pretty good. Right now, I'm in San Diego. Everyone else is at our Natick headquarters, and for details of the quarter and the outlook, I'm gonna hand the microphone over to my partner and our CEO, Rob Willett. I will be available at the end of the call to answer any questions that you may have for me. Rob, the microphone is yours.
Robert Willett (CEO)
Thank you, Dr. Bob. Good evening, everyone. I am pleased to report that we set new records for second quarter revenue and earnings per share from continuing operations. These were also the second-highest revenue and EPS that we have ever reported for any quarter in our company's history. Revenue was $147 million, which was $7 million higher than the top end of the range we gave to investors back in May. Demand was stronger than anticipated across several industries, including consumer electronics, automotive, and logistics. Gross margin was 76%, slightly lower year-on-year and sequentially. Somewhat dilutive to our overall margin were product mix and inventory charges. Operating margin doubled to 34% from 17% in the prior quarter. This significant increase reflects the substantial leverage that incremental revenue has on our business model.
We delivered earnings from continuing operations of $0.50 per share, compared to $0.49 reported for last year's second quarter and $0.17 in the prior quarter. Earnings also exceeded the Thomson Reuters First Call consensus estimate of $0.43 per share. Now, turning to the details of the second quarter. In factory automation, revenue was $141 million. This level represents strong sequential growth led by major contributions from consumer electronics and logistics. Growth was modest compared to Q2 a year ago. Higher sales across a number of industries this year were largely offset by lower revenue from consumer electronics. As we discussed in our May call, large electronics orders are split this year between Q2 and Q3. Last year, the majority of these orders were recognized in Q2.
Looking at factory automation year-over-year from a geographic perspective, Greater China was our fastest-growing region in terms of percentage growth. Importantly, the growth rate accelerated as compared to the rate in Q1. Americas set a new quarterly revenue record and provided the largest contribution to growth in absolute dollars. These achievements were largely the result of higher sales to customers in the logistics industry. European factory automation revenue declined significantly year-over-year due to lower revenue from consumer electronics. Outside of that, our European region grew faster than in recent quarters. In the semiconductor and electronics capital equipment market, revenue was $6 million in the second quarter, down high single digits year-over-year. Demand from semi has been relatively flat on an annual basis for the past several years.
Our expectation for growth in this very small piece of our business continue to be low. Moving now to operating expenses, RD&E and SG&A totaled $62 million for the second quarter. This level was slightly more than we expected due to the higher revenue level. Looking year-on-year, operating expenses were relatively flat....Our investments in engineering and sales personnel were offset by $3.5 million of costs related to the resolution of patent disputes in last year's Q2. In summary, Cognex had an exceptional second quarter, and we expect another strong quarter in Q3. In regard to specific guidance for Q3, we believe that revenue will be between $142 million and $147 million. This range represents substantial growth over Q3 a year ago, due particularly to higher revenue from consumer electronics.
Outside of that industry, we think revenue will grow year-on-year, despite continuing challenging market conditions. Gross margin is expected to be in the mid- to high-70% range, relatively similar to the gross margin reported today for Q2. Service will represent a higher percentage of revenue in the third quarter. Operating expenses should remain relatively flat on a sequential basis and increase by approximately 10% year-on-year. Last year, we adjusted our bonus and commission accruals downwards during Q3 to reflect softening business trends. This year, business is improving, and we are increasing investments in growth areas. The effective tax rate is expected to be 18%, excluding discrete tax items. Now, let's open the call up for your questions. Operator, we're ready to take questions.
Operator (participant)
Okay. So ladies and gentlemen, at this time, if you do have a question or comment, press the star followed with the one key on your touchtone telephone, you'll be placed into a question queue. So again, for questions, it's star followed with the one key at this time. Okay. Again, ladies and gentlemen, for questions, for questions, press the star followed with the one key, and we'll take our first question from Jeremy Capron from CLSA. Jeremy, your line is open.
Jeremie Capron (Director and Equity Research)
Thanks, and, good evening, everyone.
Robert Willett (CEO)
Hello, Jeremy.
Jeremie Capron (Director and Equity Research)
My question is around the trends you're seeing in consumer electronics. You sounded a lot more cautious entering 2016, and clearly things have been better than anticipated, and your third quarter guidance seems to suggest a significant improvement. So can you give us a little more color around what you've seen, what you think is driving this change in the outlook? Thank you.
Robert Willett (CEO)
Coming into the quarter, we expected to receive, you know, substantial orders from consumer electronics, but overall market concerns led us to be cautious in estimating what projects would be funded. So demand in Q2 came in stronger than we expected, and then we've also been successful in winning account share in that market. We have, we have much better visibility into consumer electronics demand than at the time of our May call, and we now expect consumer electronics will grow in 2016, although the rate of increase will be slower than in recent years. So I'd say, Jeremy, you know, our visibility improved, and our-- I think we've executed better and probably won more share in that market among its major players than we expected to when we last spoke.
Jeremie Capron (Director and Equity Research)
Excellent. And what about other end markets? You also sound today more positive on the outlook here, despite what I would characterize as continued deterioration in industrial spending out there.
Robert Willett (CEO)
Yes. Well, logistics certainly is going very well for us this year. We've seen substantial pickup in our logistics business in America, particularly, but also in Europe. And you know, we continue to make good progress with all different sizes of accounts in logistics. Smaller and medium-sized logistics accounts, we're spreading you know, our base of customers in that area, and they're really benefiting from our technology. But also you know, larger big players in e-commerce and parcel and package delivery certainly are really seeing the benefit of what we have to offer, which is you know, very gratifying.
So, you know, we've talked about, Jeremy, our 2, you know, 2 of our 3 big markets, so consumer electronics and logistics, and the one we haven't talked about is automotive. I think back when we last updated you 13 weeks ago or so, I think we were more cautious about automotive and, you know, I think it's been slightly better, that market, than we expected at that time. Our performance in automotive, particularly in Asia, including, you know, China and the rest of Asia, has been stronger than we expected, and the market seems to be responsive, more responsive than we had expected. And, you know, we've seen good growth also in Europe.
The slower growing part of automotive for us is in the US today, but still, you know, we're seeing growth in that market as well. And you know, we reported our largest quarter ever in US automotive or Americas automotive, I should say, in the quarter we just completed. So... You know, I'm not. Don't take this to mean that market conditions are good. I don't think they are. I just think they're slightly better than we expected them to be, and I think our execution has been pretty good.
Jeremie Capron (Director and Equity Research)
Congratulations. Thanks, and, I'll get back in the queue.
Robert Willett (CEO)
Thank you.
Operator (participant)
Okay, thank you. Our next question comes from Joseph Giordano from Cowen and Company. Joe, your line is open.
Joseph Giordano (Managing Director)
Hi, guys. Good evening.
Robert Willett (CEO)
Hey, Joe.
Joseph Giordano (Managing Director)
I wanted to ask about overall growth relative to total CapEx across your industries, because right now, clearly, you guys are outpacing a pretty static CapEx growth rate across these industries. And if we get to a position where CapEx at your customers, I mean, well, I guess, clearly, the spending on this type of investment is growing as a percentage of CapEx at your customers. When gross CapEx finally starts growing at your customers, how should we think about this type of directed spending? Will that maintain, like, that kind of percentage of total spend, or will your spending kind of move a little bit lower as a percentage as growth comes back? How do we think about it in a better CapEx environment for your customers?
Robert Willett (CEO)
Well, Joe, I would say, as the environment improves, we would expect our outlook to improve as well. You know, the growth we're reporting now is obviously better than we all expected, but it's still, you know, for the year, not looking like we'll grow at the 20% growth rate that we expect, you know, that we're targeting for our business. And the reason for that is that, you know, we think the industrial markets that we serve are conservative in terms of, and they're concerned about overall macro conditions today. So, our market, machine vision, in the markets we serve is, you know, growing high single or low double digits over the long term, is how we think of it.
We expect to outpace that growth based on initiatives like ID products, where we're gaining large share in new adjacent markets we're entering, investments in new product development, the overall advantage and of our technology and the recognition of our brand. So, you know, that's why we expect to grow significantly faster than the market overall. As CapEx becomes kind of a constraint, our growth rates diminish, you know, as certainly they did last year and even this year, below what we expect. But as CapEx comes back, we would expect to see our overall growth rate grow as well.
Joseph Giordano (Managing Director)
If I'm thinking about automotive, just in light of the U.S., you said, was slower growth than the others, but still up, and I think you said your largest quarter ever in gross terms there. Given commentary from some of the major players in that industry, are you thinking about that moving sequentially lower now? Same in Europe, I'm just curious as to what your discussions have been like in light of, you know, Brexit and all, and all that having a more of an impact on the broader European economy.
Robert Willett (CEO)
Yep. So automotive is, you know, is our second largest market at the moment, and, you know, one where we have, you know, very strong share and a very, you know, long-standing relationship with the major players, both the brand owners and the Tier 1 players. I think what we see out there at the moment is we, we see some, you know, some relative strength, compared to our expectations in Asia, some slowing down in, in the U.S., but still growing. And then I think as you kind of rightly asked in your question, Europe is maybe more of a wild card. We've seen some very, you know, very good results out of Europe automotive, in the last quarter.
In fact, we grew double digits year-over-year in Q2 Europe automotive, despite the region's news headlines. But, you know, your question goes to what do we see in the future in Europe, and I think that's a difficult call at this point. You know, where Brexit obviously is a concern, it's not really a concern from Cognex in terms of the UK. We do very little business in the UK. We only have about 11 Cognoids based there, and it's not a significant part of our supply chain. However, the knock-on impact on European investment, European automotive spend, that's more difficult to call, how that's gonna play out, you know, in the back end of this year or into next year. So I really, you know, can't speak with much authority on what I think is really gonna happen there.
Joseph Giordano (Managing Director)
And just maybe last for me, one for Dick. You mentioned some inventory charges. What were those related to?
Richard Morin (Director of Finance and CFO)
Yeah, well, every quarter, we have some inventory charges. In this particular quarter, we in fact discontinued a particular product line development, and that probably cost us close to 100 basis points in gross margin. We don't expect that to recur in the rest of the year.
Joseph Giordano (Managing Director)
Great. Thank you.
Operator (participant)
Okay, thank you. We'll take our next question from Jim Ricchiuti from Needham & Company. Jim, your line is open.
James Ricchiuti (Senior Analyst)
Thank you. Good afternoon. I'm wondering if you could help us, maybe understand what the growth rate is, in factory automation, excluding consumer electronics and logistics, where you know, there are some different dynamics there.
Robert Willett (CEO)
Jim, your question is in the quarter? What-
James Ricchiuti (Senior Analyst)
Yeah, in the quarter, Rob. Sorry. Yeah, I'm just trying to get a sense as to, you know, what kind of conditions, excluding logistics and consumer electronics, just to give a picture on how we should think of the business ex that?
Robert Willett (CEO)
Mm-hmm. Yeah, yeah, I think, we, you know, we saw a good quarter, you know, in terms of growth rate in factory automation. I'm not sure I can split out logistics for you, because that's sort of pretty broad. But if I lump logistics back into it, and I exclude consumer electronics, you know, our growth rate there was about 20%. So we were right at, you know, long-term target of 20% growth, but I'm including logistics-
James Ricchiuti (Senior Analyst)
Got it
Robert Willett (CEO)
in that. And if I took that out, it would be lower, right? But, you know, that's a, that's the market we're in.
James Ricchiuti (Senior Analyst)
Okay. And within logistics, I wonder if you could talk about the type of customer concentration you're seeing in that market. And presumably, that logistics piece will seasonally fall off in Q4?
Robert Willett (CEO)
Right. Yeah. So, you know, we've been in this logistics market now for a few years, and like a lot of our markets that we enter, it's kind of like an S curve. We see it takes a little while to get established. Industrial, you know, markets are, you know, more conservative in their adoption of products. But we're now moving, you know, well up into the main part of the S, and we're seeing, you know, really strong growth and adoption, and customers really understanding our competitive advantage. And through that, you know, we've also invested significantly in our logistics sales force. And so we have, you know, in America and Europe, significant feet on the street there as well. And so we're reaching a lot of broad customers, you know, some much smaller logistics customers.
And, you know, and by and large, our, you know, our business there is direct. It's not really through partners for the most part. So, and then, so we're seeing a good adoption. Then also, as part of how we think of logistics, we have the new market for airport baggage handling coming along as well. And, there we see, you know, our product becoming recognized and adopted by a number of major airports around the world, which is also helping, will help, I think, going forward, lift our growth rates further. So Jim, I don't know if that answers your question at all?
James Ricchiuti (Senior Analyst)
But from a volume standpoint, Rob-
Robert Willett (CEO)
Mm-hmm.
James Ricchiuti (Senior Analyst)
Is there a high level of customer concentration within logistics? Are you seeing a higher level of customer concentration within logistics? You know, is it an 80/20 rule or so?
Robert Willett (CEO)
No. I mean, we do have some larger customers in logistics, you know, who may purchase more than $10 million from us this year, you know, for a larger customer. And then we see many, many customers, you know, at smaller levels, who may have an average purchase of $50,000 or less. So it's quite dispersed. It's not overly dependent on any one customer at this point.
James Ricchiuti (Senior Analyst)
Okay. And Dick, just a final question, if I may, just that big spike in unbilled revenues, the bulk of that converts over to revenues Q3?
Richard Morin (Director of Finance and CFO)
Well, it's unbilled revenue, so it is revenue that was included in Q2, that we have not sent an invoice to the customer.
James Ricchiuti (Senior Analyst)
Got it. And so-
Richard Morin (Director of Finance and CFO)
Yeah, I was gonna say, what happens is, sometimes with these contracts, whether it's logistics or in consumer electronics, you have the contracts provide for milestone payments that differ from revenue recognition under U.S. GAAP. So that either creates unbilled revenue or deferred revenue. But this, this deferred, this unbilled revenue, we expect to bill and collect in the third quarter.
James Ricchiuti (Senior Analyst)
Your R&D level being down as much as it was, sequentially, anything going on there?
Richard Morin (Director of Finance and CFO)
I think that relates more to the fact that a lot of the engineers were working on undefined—well, I shouldn't say undefined, but projects that were not supported by purchase orders in the first quarter. And now in the second quarter, what we found is a lot of them were working on very specific projects. We had purchase orders, so a lot of that work then gets classified into cost of goods sold.
James Ricchiuti (Senior Analyst)
Okay, thank you.
Operator (participant)
Okay, thank you. So our next question comes from Ben Rose of Battle Road Research. Ben, your line is open.
Ben Rose (President)
Thank you, and good evening, Rob and Dick, and Dr. Bob.
Robert Willett (CEO)
Hi, Ben.
Richard Morin (Director of Finance and CFO)
Thank you, Ben.
Ben Rose (President)
Question, regarding the performance in North America being strong in this second quarter. Are there any other industries beyond automotive, Rob, that you could call out within North America?
Robert Willett (CEO)
Well, Ben, the primary reason we did very well in Americas in the second quarter was logistics, right? And, you know, that certainly is what lifted our business. You know, growth in the broader Americas market is, I think we all probably see, remains lackluster. You know, demand from U.S.-based manufacturers outside logistics is stable, but it's not improved, you know, meaningfully this year. Growth in automotive is slower in the Americas than in other regions, even though automotive demand set a new record in Q2. We're seeing better growth out of Asia and Europe than we are out of Americas.
Ben Rose (President)
... Okay. Can you speak specifically to your expectations for the relatively new MX-1000 ruggedized ID readers, whether they will be a meaningful revenue contributor in this calendar year?
Robert Willett (CEO)
So the answer to the second part of your question is no. We've said, I think all along that, you know, it's a, it's a journey for us. It's that kind of S-curve we've, we've learned where, you know, we're establishing ourselves in that market and, proving ourselves to customers. That said, you know, the mobile terminals is a exciting market where we expect to bring significant change to the market overall. It's, we size it as a $500 million market, with, with a, with an installed base that's under transition away from, you know, Microsoft operating systems, more towards Android and iOS operating systems. So we're moving into that market with what we, you know, continue to believe increasingly is a very advantaged product.
Early adopters of the product so far have been innovative companies who can see the benefits of using Android and iOS platforms combined with Cognex vision. So we have had a first, you know, volume order from a new Cognex mobile terminal customers, and it came from a delivery service company, a really great kind of new economy, e-commerce leader that if you would recognize the name of, who is using the MX-1000 to scan orders and pack boxes for customer delivery. You know, it was a you know relatively small order of around $100,000 initially, as they start to fit out a few of their warehouses, and you know, we expect to see follow-on business from them.
It's not, you know, particularly material to this year, to your point, but it's indicative of the kind of customers we expect to, you know, to delight with this product. I think also importantly, I think as people have been thinking about us in that mobile terminal market, Ben, is, you know, we've got good prices for that product, and we're gonna be recording, you know, Cognex-like margins. I think that's something that's not well understood still about our journey into that market, is that, you know, when at the cost of what we sell, which is really a rugged enclosure with powerful Cognex vision on the front and a lot of powerful software, the cost of it is relatively low.
Customers can buy and integrate their smartphones into it, and when they do so, they can come with a product that's much more competitive and below the cost of the leading players in the marketplace, and we can still make the high growth margins that we expect from ourselves. So everything so far that we're seeing in the market is validated, is validating our position there, and we're making a nice progress, but don't expect it to move the needle on the P&L this year.
Ben Rose (President)
Okay, fair enough. I thank you for the complete answer. One final question, I guess, from me is, with regard to the consumer electronics orders that you're expecting in this quarter, could you speak to would it be correct to assume that the bulk of that is coming from Greater China?
Robert Willett (CEO)
Well, we report a lot of substantial consumer electronics orders in Europe, right? Because basically, the product is for some of our customers purchased in Europe and then deployed into China.
Ben Rose (President)
Okay.
Robert Willett (CEO)
So you'll see that, we would expect you to see that showing up in our European region.
Ben Rose (President)
Okay. Thanks very much.
Operator (participant)
Okay, thank you. Our next question is from Richard Eastman from Robert W. Baird. Richard, you're now open.
Richard Eastman (Managing Director and Senior Analyst)
Yes, good afternoon, and a fantastic quarter. Nice, nice work.
Robert Willett (CEO)
Thank you, Rick.
Richard Eastman (Managing Director and Senior Analyst)
Just quickly, with Cognex's China business, you know, the strength there, and I think you touched on the end markets, but has Cognex continued to build out their distribution network or feet on the street in China? I know we went through a period of about three years, that might have been two years ago, where you added a lot of people there, feet on the street. Is this about leveraging those people, or have we continued to build out the distribution there along with the demand?
Robert Willett (CEO)
We've certainly, you know, made a lot of progress, adding, but perhaps more importantly, improving, our distribution network in China. We've done that with, by working very closely with our distributors there and adding new ones. And I would say, I visit them and spend a lot of time with them, particularly, in the spring of each year, and just the quality and capability of these teams and the number of people they've added, is impressive, really impressive, to the point of view that where their, you know, their ability to execute and the quality of the people in their teams are as good as anywhere around the world.
And then we also have our direct team, and, there, you know, you're right, Rick, that we've, we've certainly added a lot of, you know, Cognoids to the sales force in China back in, I think from memory, or, you know, the middle of 2014. The rate of increase has slowed, more in line with how we saw demand developing and their productivity improving. But we do continue. We certainly continue to add, headcount on a regular basis to our China sales team. You know, just a few kind of data points to sort of help us think about that. You know, revenue from Greater China, in 2015 was $54 million, up more than 40% from 2014.
You know, it was China was our fastest growing region in Q2 this year, and increased 25%. So you know, that rate has slowed down, and the rate of headcount that we think we required to deliver on the market potential as the rates slow down, but we're still adding. And you know, that's largely a result of kind of what we see going on more in the macro environment there, which I think everybody is seeing.
Richard Eastman (Managing Director and Senior Analyst)
Rob, when you look at, you know, Cognex's channel to market, and, you know, we talk about the ID products, or at least the logistics piece doing very well. We've talked a little bit about auto. But when you look at your mix of business, distribution versus direct, on the distribution side of the business for total Cognex, does the growth rate look, you know, closer to what we're seeing in, you know, other factory automation companies or data points like, you know, maybe low to mid single-digit growth? I guess what I'm getting at is you've had tremendous success on direct sales in certain verticals where you put the emphasis in R&D.
Do you look at the balance of your business that goes through distribution, and is that where there's a little bit more caution, a little bit more hesitancy?
Robert Willett (CEO)
It's an interesting question, Rick, so let me kind of share some data with you. So, you know, overall, approximately 60% of Cognex's sales generally come through our channel partners, and 40% come through our direct sales force. Last quarter, you know, it was more direct, mostly because we saw more larger orders in electronics and logistics, which tend to be direct. I think our growth rate with partners, you know, growth rate in general, we'd expect, and certainly with partners, is definitely outperforming what you're seeing in the rest of factory automation. So in Q2, in direct bookings, the bookings through partners was up high single digits.
Richard Eastman (Managing Director and Senior Analyst)
Okay
Robert Willett (CEO)
- is what we saw. Right, and that wouldn't, that would not include any of the kind of consumer electronics and logistics, upside, you know, that we've seen sequentially. So that's, you know, that's, that's it. The, the growth rate on the direct business was higher than that, and I'm talking now bookings, not revenue.
Richard Eastman (Managing Director and Senior Analyst)
No, I understand. But a good testimonial here that, again, suggestive of machine vision gaining share within the broader automation market. I guess that's where I was going with that.
Robert Willett (CEO)
Yeah, and to build on that, Rick, you know, I go out and spend a lot of time with distributors, you know, they're very excited about machine vision. You know, they see it as one of their fastest growing and most profitable markets, technically demanding, but gives them competitive advantage. You know, so there's this sort of excitement that you don't see in almost any other element of their product lineup that they still have around, machine vision.
Richard Eastman (Managing Director and Senior Analyst)
I understand. If I look at. And again, let me phrase this in this context, I think often the Street looks at Cognex and their consumer electronics business is maybe, and your comments about it, is maybe a proxy for your largest customer revenue. And if I estimate what you did, Cognex did with their largest customer in the second quarter, and then try to fill in with your commentary about the third quarter, I don't get close to the $81 million in calendar 2015 revenue that you disclosed in your K. So the question is: Is that my bad math, or is there another larger C&E, CE customer or two?
Richard Morin (Director of Finance and CFO)
I'll comment on that.
Robert Willett (CEO)
Yeah, yeah. Yeah, yeah. So I, you know, I'm pretty limited as to what I can say. I mean, I, you know, I'd point you to the data which we've reported, which is our Form 10-K. You know, our largest customer represented 18% of revenue in 2015, up from 16% in 2014. You know, we really can't. We're under very strict confidentiality about that customer. You know, in terms of consumer electronics in general, what we've told you is revenue's gonna be split this year between Q2 and Q3. And so, you know, that's why we saw a decline year-on-year, and we expect to see an increase year-on-year in Q3, right? So-
Richard Eastman (Managing Director and Senior Analyst)
Okay.
Robert Willett (CEO)
Beyond that, but I think we've also told you that, or perhaps I think we said we expect our consumer electronics business to grow this year, which we didn't, you know, previously when we spoke with you.
Richard Eastman (Managing Director and Senior Analyst)
Correct.
Robert Willett (CEO)
We now expect to grow. I think-
Richard Morin (Director of Finance and CFO)
Yeah.
Robert Willett (CEO)
I think you can make the math work on all of that.
Richard Morin (Director of Finance and CFO)
Yeah, well, the one comment that I would add is-
Robert Willett (CEO)
Dick Morin.
Richard Morin (Director of Finance and CFO)
Yes.
We did see an increase in total consumer electronics business and in non-that single large customer business as well. So that might be part of the issue that you're having, trying to reconcile the two.
Richard Eastman (Managing Director and Senior Analyst)
Okay, that's fair. And I'm sorry, just one last question. In the second quarter, Dick, I think you had mentioned that the higher mix of hardware content in the sales maybe pulled in gross margin a little bit. And then for the third quarter, we're gonna see a higher content of service? So do those two kinda, quote, "offset each other" so that, you know, our Q2 and Q3 margins should, you know, essentially be similar.
Richard Morin (Director of Finance and CFO)
... Yeah, I think what I wouldn't say that those two would be the offsetting ones. I would say I would suggest that the offsetting might occur to the fact that in Q3, we do expect to have more service revenue, which will create a dampening in the reported gross margin. But as I mentioned earlier, we had in Q2 we took a charge against you know product margins that caused us to lose about 100 basis points because of this project that got discontinued, and we don't expect that to repeat in either Q3 or Q4. So we'll pick up a little bit on the product side because of the lack of the inventory charge, and we'll lose a little bit because we'll be doing more service revenue as opposed to product revenue.
Richard Eastman (Managing Director and Senior Analyst)
I gotcha. I, I understand. I'm, I'm with you. Okay! Well, thanks, and very nice quarter again, guys. Good job. Thank you.
Richard Morin (Director of Finance and CFO)
Thank you.
Robert Willett (CEO)
Thank you.
Operator (participant)
Okay, thank you. Our next question. We have another question from Jeremy Capron from CLSA.
Jeremie Capron (Director and Equity Research)
Thanks for taking my follow-up question. It relates to the comment you made, Rob, around winning account share in consumer electronics. I wonder how you feel about future potential share gains in consumer electronics at your top customer and beyond?
Robert Willett (CEO)
Well, I think as I said many times, I'm not gonna speak about any specific customer, but if we talk more generally about consumer electronics, you know, I think there's still a lot of technology and innovation being put into those products. And the challenges that are faced for manufacturers in terms of productivity, labor costs, the diminishing size of the products, which are, you know, becoming less and less possible for human hands to assemble, all play pretty well into the adoption of machine vision. We now have a lot of great experience, arguably the best experience of any company in the world, implementing machine vision in these types of products, and there's plenty of demand out there.
So, you know, I think, I think, you know, and our capacity to fulfill that demand has improved significantly, both in terms of the products and that we're delivering and in terms of Cognoids' capabilities and engineering know-how. So I think, you know, I think we're pretty well-positioned to see some continuing growth in that market. What we do know about that market is it, you know, it tends to be in Q2 and Q3. It's when we see the revenue, and, you know, there can be some pretty large pieces of business within our revenue mix and some large customers coming in and out. So it may not always be a smooth ride, but it, we think it's gonna continue to be an upward ride for some time.
Jeremie Capron (Director and Equity Research)
Great. And when you look at the competitive landscape in this particular end market, what are some of the key winning factors for Cognex against maybe some of your larger competitors out there?
Robert Willett (CEO)
Well, this is a very sophisticated market with very sophisticated customers, who are deploying, you know, billions of dollars of automation capital every year. So when they meet with Cognex, they really benefit from our phenomenal technical know-how. Our competitors tend, you know, not to have that level of capability and know-how and engineering knowledge and experience. This is where we can play really well, and we do. The level of trust and integration and value that we can bring to them, you know, really makes us and them shine. There really isn't a company that can come close to that, at the moment.
And then there are also adjacent kind of markets from those we serve today that we're interested to move into, where I think we can take that value and deliver further growth in the future. So, you know, it's... that's why I think we continue to do well and will continue to do well as they address the challenges in their production and product roadmaps.
Jeremie Capron (Director and Equity Research)
Excellent. Well, congratulations and good luck.
Robert Willett (CEO)
Thank you.
Richard Morin (Director of Finance and CFO)
Thank you.
Operator (participant)
Thank you. Our next question is from Joe Giordano from Cowen and Company. Please go ahead.
Joseph Giordano (Managing Director)
Hey, guys. Thanks for letting me jump back in here. Quick on logistics. So on the ID markets, you have more competitors than you do on the vision side, and given your really positive comments here on the logistics market, I'm curious as to what that suggests about win rates. Are your competitors seeing the same level of growth in that market, do you think, or is it just a rising tide lifting everyone, or are you significantly outpacing, you think, your competitors in that market?
Robert Willett (CEO)
Well, I think the market is, you know, relatively, you know, buoyant at the moment. I think, I think, there's a lot of deployment of automation into logistics based on what's going on with e-commerce, supply chains, and, you know, the challenges and, and, disruption that's going on in, in those industries. That, that said, I think we are certainly outpacing the growth rate of any other substantial player in that space. And, you know, I think because, you know, we're relatively new, we've got really advantage technology, and, we're still really getting that sort of socialized with the customers that are out there, and they're benefiting from it. So market conditions pretty good, Cognex outperforming and, really growing very substantially.
You know, we, you know, as you know, we're targeting 20% growth rate for factory automation over the long term, and we, for our ID business, you know, we're looking to achieve 30%, you know, which is one of the reasons we think we can achieve that 20, is we have a substantial part of the business... growing faster. And, for logistics, you know, we expect, we believe that we can grow in excess of 30% per year over the long term. We're doing that now, and, that's certainly faster than I think anyone would suggest the market is gonna grow.
Joseph Giordano (Managing Director)
Yeah, I would, I would suggest that is definitely a true statement. And one last one for Dr. Bob, if he's still on the line.
Robert Shillman (Chairman and CEO)
I am indeed.
Joseph Giordano (Managing Director)
Has your view on autonomous cars shifted at all in the past year? I mean, there's been some high-profile problems there, but also seems like people on the manufacturing side still pushing in that direction. Is this something that you still wanna be a, like, a late follower when it becomes more mass market in terms of production volumes? Or is this something that you look at as problems that Cognex can help solve?
Robert Shillman (Chairman and CEO)
Well, Cognex is already participating in the market for autonomous vehicles. I'm not gonna name any particular manufacturer right now, but automotive manufacturers in general rely on Cognex to manufacture vehicles and to ensure that all the components that go into them are proper and that they go into the right place on each vehicle. So we are already involved. But if you mean our involvement with regard to the actual technology of guiding cars-
Joseph Giordano (Managing Director)
Exactly.
Robert Shillman (Chairman and CEO)
Yeah, then, we are not very positive. Well, let me put it this way. At some point, probably 10, 20 years from now, people will get into vehicles and there won't be a steering wheel, right? But that's going to be a long haul from now. There are significant problems that have to be solved. I won't, you know, over, over drinks, I'll, I'll be happy to give you examples of those things that, that are very difficult to solve. What cars can now do is, yeah, they can park in a parking lot, and they can drive on various highways, where there are no trees, no, no, kids with balls and no dogs, nothing else.
But it's gonna be a long time before before the legislation and the litigation and all the regulation about it is in place to allow it to be a very big market. So the combination of us viewing that the market is way in the future and realizing that the technological challenges are significant and are not directly in our area of expertise. Our company has focused on particular kinds of machine vision problems, where every one of our products is looking at something, and the product knows what it's supposed to be. We look at whether it's a cell phone or a keypad or a Q-tip or a toothbrush, we know what it's supposed to...
The vision system has been trained to know what it's supposed to be, and we're looking for flaws or defects, or we're looking to place that item somewhere in a fixture. So that's our particular expertise. There are so many applications of that in factories that we have a lot of runway in our own marketplace and in adjacencies to grow. And it doesn't give us and we don't have to look at these other areas, which are somewhat more speculative in my view, both from the opportunity standpoint and from the profit standpoint. I'll go into that a little bit. We did pursue automotive guidance. We purchased a company called AssistWare.
It must have been, I don't know, 10 years or so ago, that had excellent software for lane tracking to, to ensure that cars were staying in the lane, and that's something that's extremely important, and, and I think is quite, quite well solved now by a variety of companies. We, we thought that that would be the right thing to do, and, we started selling it to truck companies and, was somewhat successful because long-haul trucks need that. But when we approached OEMs, so the companies that manufacture vehicles, we found that we didn't have the business structure to be able to deal with the large OEMs. We were, we were told we had to deal with Tier 1 and Tier 2 suppliers.
And when you looked at, you know, when we studied the business case for it, and the price that the OEM ultimately wanted to pay, which is very different from what an OEM pays for vision to build a car. When it's talking about tools to build cars, to make sure they're built correctly and safely, it's a different calculation than when something actually is a part of the bill of materials that goes in a car. So when we couldn't make a business case for seeing a very profitable picture of providing technology to actually control vehicles.
So I won't say that we'll never be in that business, but so long as we have great opportunities in the areas where we're already in and adjacencies to those areas, I see no reason for us to be distracted into these other areas that have a lot of hype associated with them, no question. You know, everybody's excited about it. But we've seen things like that in the past, where people were very excited about things, and it just didn't present an opportunity for Cognex. I'm not saying that it's not an opportunity for anyone else. It's certainly an opportunity for the manufacturers of those vehicles who can't build them fast enough. Although I do question why you'd wanna build something when you lose $5,000 per piece part, but that's a different story.
I think that we have a great runway ahead, and as today's results are showing you, that even when the macroeconomy and CapEx spending is languishing, that Cognex can do not just well, but great.
Joseph Giordano (Managing Director)
That's great, Colin. Thanks so much.
Robert Shillman (Chairman and CEO)
You're welcome.
Richard Morin (Director of Finance and CFO)
... Okay, thank you. Our next question is from Bobby Eubank from Chevy Chase Trust. Bobby, your line is open.
Bobby Eubank (Director and Thematic Research Analyst)
Hi, good afternoon, guys. Thank you for the question. Great quarter. Two parts to a first question and a follow-up. First question, last year, at the beginning of the year, you had high expectations, and you increased your investments in your head count, expecting the growth to continue, and it didn't materialize. So kind of what gives you confidence that this growth will materialize as you increase investments? And then two, what gives you an ability to see beyond one quarter, how close are we to kind of having more steady state business that gives you better predictability beyond one quarter? And then a second question, just on cash balance and the M&A environment, if you see anything out there that you expect to deploy cash with? Thanks.
Robert Willett (CEO)
Sure. Thanks, Bobby. Okay, so I think our long-term confidence comes from the value that our customers see in our technology and our history, you know, of deploying vision to factory automation. You know, this is a business that has grown nine out of the last 10 years in terms of revenue growth, so the supply of machine vision to Cognex machine vision and factory automation. So, you know, we think we've got the long-term perspective that says this is a great market, and we can grow. And our investment generally is based on, you know, long-term potential that we see. It's not based on particular quarters or a short-term perspective.
That said, you know, if we see the market turning down or we think, you know, over the coming quarters, things look less good, we can, we do trim our expenses or increase our expenses based on what we see. So then I think the second part of your question, Bobby, was sort of how do we see that? What, you know, what do we see? And, you know, we have visibility with our customers through product roadmaps, discussions we have with them about what they want to do and how our technology is developing. We have, you know, exciting new products we're bringing to market, things like the mobile terminal or other technologies that we're bringing to market that we can see potential for further out.
You know, we have a very good CRM system that looks at order activity and how that's tracking. So, you know, we do have some visibility out there. Certainly, that gives us a view of how it's developing. But, you know, but that said, I think we all know that factory automation and capital expend- capital deployment in factory automation can turn down relatively quickly, you know, for, for everyone. So, and, and the, the kind of, the forward view that we have, you know, is, is, is not that clear, you know, as we move further out. So I think, you know, we remain relatively cautious about the market, relatively cautious about Q4, but, but relatively optimistic about what we see with our customers and, what we see particularly over the long term, and that's why we continue to invest behind those initiatives.
The third part of your question had to do with cash and how we deploy cash. You know, the number one area that we look to deploy cash into is acquisitions. We are seeing, you know, more activity on acquisitions. At the moment, we have a number of opportunities that we're in more advanced discussions with, but they're relatively small acquisitions, wouldn't require, you know, a large piece of our cash to deploy. But certainly in terms of our activity and what we hope to be able to tell you, that's, there's more of that than there has been in recent years currently on deck. We also are buying back shares, and you can see that, and we can speak to that further if you'd like.
And then, we have, you know, we increased the dividend when we spoke to you last, and we continue to pay the dividend. So that's kind of the story on the cash.
Bobby Eubank (Director and Thematic Research Analyst)
Yeah, that's, that's very helpful. If you, if you could maybe talk very briefly about your buyback policy, and, you know, it looks like last quarter, no buybacks. This quarter, a little bit smaller than maybe some of us had modeled. So what goes into your thinking behind the buyback? Is it because you're expected to, you know, an acquisition, or is it just based on purely the, the share price?
Richard Morin (Director of Finance and CFO)
We, you know, the overall philosophy is to make sure that we buy back everything that we issue through through stock options so that we can absorb all of that dilution. Last year, we bought back close to close to two years worth of of dilution. We're back in the market these days and going out on a you know on a regular basis and at levels that you know we feel comfortable with again considering absorbing the dilution.
Bobby Eubank (Director and Thematic Research Analyst)
Great. That's helpful. Thank you. Congratulations again.
Richard Morin (Director of Finance and CFO)
Thank you.
Robert Willett (CEO)
Thanks.
Richard Morin (Director of Finance and CFO)
Thanks.
Operator (participant)
Okay. Thank you. And we'll take our next question from Jim Ricchiuti from Needham & Company.
James Ricchiuti (Senior Analyst)
Rob, this just relates to the target growth for factory automation that you've alluded to, the 20%. Yeah, the success you've had in logistics and consumer electronics is pretty well documented. But, you know, what I'm wondering is, you know, is some of that success, you know, been perhaps masked by just the weakness in the factory automation market? Is there really a, you know, a halo effect to the what you've done in these markets, or, you know, are the use cases still somewhat specialized?
Robert Willett (CEO)
... Well, Jim, not sure I understand your question fully. You know, I can talk to a little bit more about why we expect we can achieve the 20% growth rate over the long term, but I'm not understanding the halo effect.
James Ricchiuti (Senior Analyst)
Well, yeah, I guess what I, what I'm looking at is, you know, we, we don't have great detail on what you're doing, for instance, with this large customer in consumer electronics. I think we know the success you've had in logistics. But as we think about the opportunity, you know, to drive higher growth in some of the other factory automation markets, you know, is, would we have seen that, do you think, in a better industrial economy? I guess what we're, you know, what I'm trying to get my arms around is, you know, if we start seeing the global economy pick up, are we gonna start seeing some new applications for your technology that may get adopted that we haven't just yet?
Robert Willett (CEO)
Okay, got it. Yeah, I mean, I think broadly the answer to your question is yes, right?
James Ricchiuti (Senior Analyst)
Okay.
Robert Willett (CEO)
I think, if you go back, if you go back to sort of say, 2014, when I think the, you know, the market conditions were much more favorable, you know, very, very roughly, you know, and, you know, these numbers are just directional. You know, we saw something like 40% growth rate in our business. And, you know, we were, we were certainly achieving 20% net of, large consumer electronics customers in, in our base business. We were seeing that kind of 20% growth rate. And then, obviously, we had that sort of, you know, extra business on top.
You know, we're, if we saw a return to market conditions like we saw in 2014, we would expect to see, you know, the base business grow very well, and then we might also have other large customers in areas like, you know, logistics or other consumer electronics, large customers, or there are even potential in other markets to have, I think, very large customers perhaps taking us well north of that 20% target like we saw in 2014. You kind of fast-forward there, you get to 2015, you know, the constant currency growth rate that we're reporting in 2015 was around 11%. You know, but dollar basis, it was 6%.
You know, so taking that constant currency growth rate of 11, you know, we didn't get, you know, you can look in the 10-K and see what the large customer did for us. But, you know, net of that, you know, I think we were still, you know, reporting decent, a decent growth rate in some very difficult market conditions. So I think if market conditions improve, we certainly would expect our own business to improve over the long term, and I think that's obviously what we'd like to see happen. But you can see we're able to put up some pretty good numbers, despite difficult conditions, as we've told you tonight.
And, you know, we do have, we're lucky to be in a market where our technology is getting faster, less expensive, easier to deploy, and it was serving broader and broader markets. So, you know, that, that means although we spend a lot of time talking about automotive, consumer electronics, and logistics, there are a lot of other markets out there who can put up some very good percentage growth rates. I'm talking here about like food and beverage, tobacco, medical devices, life sciences, where certainly, as conditions improve or as just our deployment continues, we can expect to see them, I think, contributing at some pretty high growth rates over the long term.
James Ricchiuti (Senior Analyst)
Okay, thanks a lot. Congrats on the quarter, by the way.
Robert Willett (CEO)
Thank you.
Operator (participant)
Okay, and I'm showing no further questions in the queue. I'd like to turn it back to your host for any concluding remarks.
Robert Shillman (Chairman and CEO)
Sure. Thank you very much. To wrap up, Q2 of 2016 set a record for quarterly revenue and EPS for any Q2 in Cognex's 35-year history. And in addition, it was also the second highest revenue and EPS that we've ever reported for any quarter in the company's history. We now believe that 2016 is going to be a better year than we just thought a few months ago, and we look forward to reporting the results to you on a quarterly basis. Thank you very much for attending the call and for your interest in Cognex.
Operator (participant)
Okay, ladies and gentlemen, this does conclude your conference. You may now disconnect and have a great day.