Cognex - Q3 2014
October 27, 2014
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the Cognex Q3 2014 Earnings Call. At this time, all participants will be in a listen-only mode, but later there will be a chance to ask questions and instructions will be given at that time. If anyone should require audio assistance, you can press star, then zero, and an audio operator will assist you. As a reminder, today's conference is being recorded. Now I would like to turn it over to your host, CFO Dick Morin.
Dick Morin (CFO)
Thank you, and good evening, everyone. Earlier today, we issued a news release announcing Cognex's earnings for the Q3 of 2014, 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 that 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 in the Form 10-Q.
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)
Hey, thanks, Dick, and hello, everyone. Welcome to our Q3 conference call for 2014. As you can see in the news release that we just issued today, it was spectacular, a spectacular Q3. It's our best quarter ever, driven by revenue growth of 87% over the prior year's Q3. Right now, I'm at our R&D office in San Diego. Everyone else on the call is in Natick at the Headquarters. For details of the quarter, in a moment, I'm going to hand the microphone over to my partner, Rob Willett, our President and CEO. I'll be available at the end of the call to answer any questions that you may have for me.
But before I hand the phone, the microphone over to Rob, I want to remind each of you that we are not providing any details about the large customer that we referenced in today's earnings release beyond what's in that release. We have a strict nondisclosure agreement with that customer, and we intend to fully stand by that agreement. Having said that, the microphone is now yours, Rob.
Rob Willett (President and CEO)
Thank you, Dr. Bob. Good evening, everyone. I'm pleased to report that Cognex achieved the highest quarterly revenue, net income and earnings that have ever been recorded in our 33 years of business. Revenue was a record $169 million, representing substantial growth over both the Q3 of 2013 and the prior quarter. This strong performance was driven by record revenue from the factory automation market and includes $65 million of revenue from a single customer. Gross margin was 74%, slightly lower than in recent quarters. Volume pricing and services in support of our largest customer were somewhat dilutive to our overall margin. Operating margin expanded to 35% and net margin to 30%. Both represent significant increases year-on-year and sequentially, reflecting the substantial leverage that incremental revenue has on our business model.
We delivered earnings of $0.57 per share, setting a new quarterly record that is almost double the prior record of $0.29 per share set just last quarter. Turning to the details of the quarter, factory automation revenue was a record $146 million, which is a dramatic increase both year-over-year and sequentially. We were pleased to see an already strong quarter for factory automation made even better by the $65 million of revenue from our largest customer. Let's now look at factory automation excluding that customer. Revenue increased 18% year-over-year, with growth in each major geographic region. Asia, excluding Japan, was our best performing region in terms of percentage growth, increasing 30% year-over-year. Growth was led by China, where we continued our strong progress in the broad automation market.
In the Americas and Europe, factory automation revenue grew in the mid-teens over Q3 of 2013. Strong performance across several industries, including automotive, logistics, consumer products, and food, drove factory automation growth in these two regions. In Japan, we were pleased to see factory automation grow north of 20% in constant currency. On a reported basis, revenue continued to be negatively impacted by the weaker yen. Moving on, revenue from the surface inspection market was $16 million in the Q3, which is a substantial increase year-on-year. We continue to perform well in surface inspection and demand remains at a high level. Revenue from the semiconductor and electronics capital equipment market, or Semi, as we call it, was $8 million in Q3. Semi increased year-on-year but declined on a sequential basis.
That fact, combined with news from the field, leads us to believe that we've passed the high point in our sales for this cycle, and that Semi revenue will soften in Q4. In regard to operating expenses, RD&E and SG&A totaled $65.6 million for the Q3. This level of spending represents a significant increase over both Q3 of 2013 and the prior quarter. It's indicative of our commitment to innovation and our willingness to invest in our business for the long term. Some costs will fall off in Q4, but we intend to continue certain investments to realize the substantial growth opportunities we see in front of us. During Q3, we added and trained new salespeople. We invested in our service infrastructure to support certain large customers in logistics and other high-growth markets.
We also spent more on product development than in any other quarter in the company's history. While many of our investments are long-term initiatives, we were pleased to introduce a number of very innovative new products during Q3. We expanded our series of 3D displacement sensors, adding three new models that offer higher resolution and a larger field of view, robust new 3D vision tools, and an easy-to-use software for faster application development. All can be bundled with the powerful new Cognex VC5 industrial vision controller, making this technology more accessible to a broader range of customers. We launched the next generation DataMan 8600. These are high-performance handheld readers for part traceability in harsh environments. We announced Cognex Explorer Real Time Monitoring, which enables customers to improve their distribution processes by better utilizing the wealth of data provided by our ID readers.
Cognex Explorer RTM uses machine vision to automatically evaluate images of packages that can't be processed and determine the root cause of the problem. The system then categorizes them and stores the information in a database, allowing facility managers to access and analyze data for an entire facility from any web-enabled device. We introduced the In-Sight Micro 1500 for high-speed vision tasks on the fastest production lines, particularly in food, beverage, and consumer products industries. In summary, Q3 was a strong quarter, made spectacular thanks to the $65 million of revenue from our largest customer. While that business will not repeat in Q4, factory automation continues to perform well. Our expected revenue range for Q4 is between $111 million and 114 million, somewhat negatively impacted by the weakening euro and yen, and softer semi market.
Gross margin is expected to be similar to our reported margin for Q3. It will reflect a higher proportion of revenue coming from service and surface inspection products. Operating expenses are expected to decrease by approximately 15% from Q3. As just discussed, our investments took a step up in Q3. Some of those costs are expected to fall off in Q4. The effective tax rate is expected to be 19%, excluding discrete tax items. Now, let's open up the call for your questions. Operator, we are ready to take questions.
Operator (participant)
Okay. So, ladies and gentlemen, at this time, if you do have a question, you can press the star followed with the one key on your touch-tone telephone, and that will place you into a question queue. So again, for questions, press the star followed with the one key to be placed into a live Q&A. If for some reason your question has been answered and you wish to remove yourself from the queue, you can press the pound key. So we'll take our first question from Ben Rose, from Battle Road Research. Please go ahead, sir.
Ben Rose (President)
Good afternoon. A question for Rob and question for Dick. For Rob, with regard to Europe, there's been some rumbling from some vendors in the space that Europe looks to be slowing down a bit. I note that you noted currency impact potentially in Q4, and just wanted to see if there was anything else going on, and then a follow-up question for Dick.
Rob Willett (President and CEO)
Yeah. Hi, Ben.
Ben Rose (President)
Hi.
Rob Willett (President and CEO)
So yes, we see a lot of good automation projects in the funnel in Europe, and our European sales team is quite bullish. But we do see the recent strengthening of the dollar having the largest impact on our results. So our revenue guidance for Q4 was reduced by about $3 million to account for the weakening euro and yen, both of those, relative to the US dollar. But we see a, you know, good pipeline of business in Q3 in markets such as automotive, logistics, food, and pharmaceuticals. You know, automotive is important to our business in Europe, and there we see, you know, business remaining at a high level, particularly driven by customers in Germany and Eastern Europe. You know, we read the same things you do, but at the moment, we're remaining pretty positive about the outlook for Cognex in Europe.
Ben Rose (President)
Okay, thanks. And then, just a quick question for Dick. Noticed in the balance sheet a pretty, pretty big rise in unbilled receivables. I'm sorry, unbilled revenue, and would assume that that might be tied to the large but in any event, is this an account that we could see decline in subsequent quarters as that's worked out?
Dick Morin (CFO)
Yeah, you're absolutely right. It is tied to the large customer, and we would expect, well, most of the increase is tied to that large customer. We've always had some unbilled revenue tied to our surface inspection division. But clearly, we would expect a fairly significant decline in that number to occur here in Q4.
Ben Rose (President)
Okay, thanks very much.
Operator (participant)
Okay, thank you. Our next question comes from Holden Lewis from Oppenheimer.
Holden Lewis (Managing Director of Equity Research)
Thank you. Good afternoon. Was sort of curious about the guidance, talking about Q4 gross margin kind of coming in around the Q3 level. And I guess when you—obviously, when you look at Q3, it's easy to understand why the gross margin was down, but if you step out of Q3 and look at the prior six quarters, you were pretty consistently in that, you know, high 75%, high 70%-76% range. And I guess I'm just curious, why with the big order out, the gross margin is not going to return to sort of pre-big order levels?
Rob Willett (President and CEO)
Yeah. Hi, Holden. So there, there are a few things going on there. One is, you know, we are expecting a large surface inspection quarter, you know, and our margins in that business are more in the mid-50s% gross margins, right? So that's one aspect. The second aspect is, you know, we do still have some service revenue related to the large customer relationship that will continue into Q4, and that'll be about a few million dollars. So those are the main factors that are gonna dilute the gross margin, I would suggest to you, on a temporary basis in Q4.
Holden Lewis (Managing Director of Equity Research)
Okay. So when we think about—I know you don't forecast obviously 2015 or quarters or anything, but conceptually, we should think about entering 2015, kind of in the same level of gross margin as we had seen previous to the order? I mean, is it gonna be all cleared out by that point?
Rob Willett (President and CEO)
Well, so you know, we say we expect gross margin in the mid-70s. You know, we've reported some very high gross margins in the first half of this year, you know. But, you know, I don't think the margin profile of Cognex is changing. Particularly, what may change, you know, is the mix of business related to how much semi is there, which is generally high gross margin, how much surface inspection is in the mix of any quarter, and then how much large customer business, where we may be given larger, you know, discounts or having more service related to it. So those factors are all at play. It's too soon to say the mix we're gonna see going into next year, but, you know, broadly, I think our long-term guidance of mid-70s still applies.
Holden Lewis (Managing Director of Equity Research)
Okay, thank you.
Operator (participant)
Thank you. And our next question is coming from James Ricchiuti from Needham & Company.
James Ricchiuti (Senior Equity Analyst)
Hi. Thanks. Good afternoon. Rob, I wonder if you can comment a little bit about the, the ID products business. Is the growth rate, is the growth that you're seeing in that market consistent with what you've seen in the past? And I think you've talked in the past about, 30% or so growth.
Rob Willett (President and CEO)
Yeah. Hi, Jim. Yes, it is. You know, we continue to perform very strongly in the ID market. You know, our long-term expectation, which we've been achieving now, consistently for a number of years, is 30% growth. You know, we see that as a large market, you know, more than $900 million of addressable market that we're serving today. And, you know, our share is still relatively small, and our products are highly advantaged. So we're certainly, you know, seeing that continue. I mean, there are some very nice things going on for us, you know, as you know, in logistics, where we're really penetrating that market, and that's driving growth. Also, we've told you in the past, you know, we did have some revenue from the large customer also in the ID space. So, yeah, we're seeing a very strong performance from our ID business, and we don't see signs of that changing.
James Ricchiuti (Senior Equity Analyst)
So even excluding the revenue from the large customer that, that did ripple into this, it—you're still seeing that kind of growth rate?
Rob Willett (President and CEO)
Correct.
James Ricchiuti (Senior Equity Analyst)
Just a question just regarding the overall level of demand in China, just in light of, you know, concerns folks have had about some slowing. What are you seeing in China?
Rob Willett (President and CEO)
Yeah, you know, business in China is holding up very well. You know, I'm reading the same things you are, but I, as I said in my prepared remarks, you know, our business in Asia grew 30% year-on-year in the quarter, led by growth in China. So we saw more growth than that, even in China. You know, I think what one needs to bear in mind when thinking about Cognex's business in China is there are a lot of really great fundamentals that are driving the growth of our business.
You know, there is, you know, a big drive toward automation going on, where, you know, labor costs are rising and, the, the, number of people entering the workforce in manufacturing jobs is declining, and, you know, products are getting smaller and harder to manufacture. And, you know, these, these are some fundamentals that, I don't think are really being impacted by whether the, gross domestic product is growing, you know, 12, 9 or 7. You know, I think there are really underlying themes that are essential for the evolution of Chinese manufacturing and where vision is center stage. So, you know, will, you know, will slow down in the Chinese economy, reduce our growth rate?
You know, possibly, but it doesn't change the fundamental story that we see where, you know, we're reporting more than 30% growth in this quarter. The other thing to bear in mind, though, is the Chinese market, like, like a lot of our markets, is seasonal. You know, generally, Q2 and Q3 are very strong. Q4 ahead of, and then coming into the new year, tend to slow down ahead of Chinese New Year. So, you know, you're not necessarily going to see that growth every quarter, but year-on-year, we're certainly very, very positive about it, despite what we're reading.
James Ricchiuti (Senior Equity Analyst)
Got it. And, Dick, tax rate for Q4, how should we think about tax rate?
Dick Morin (CFO)
Yeah, we think, you know, we had some discrete items in Q3, which occurred, you know, as we true up our estimated tax provision from last year compared to the tax return that's filed and also the statute of limitations expiring. But Q4, we would expect that our base tax rate to be at 19%, Jim.
James Ricchiuti (Senior Equity Analyst)
Okay, thanks. Congratulations on the quarter.
Dick Morin (CFO)
Thank you.
Operator (participant)
Thank you. And our next question comes from Richard Eastman from Robert W. Baird.
Richard Eastman (Managing Director and Senior Analyst)
Just a clarification. On China, in factory automation, does the business still skew pretty heavily towards consumer electronics?
Rob Willett (President and CEO)
Yeah. Hi, Rick, yes, you know, the majority of our business today is still in consumer electronics. But—
Richard Eastman (Managing Director and Senior Analyst)
Okay.
Rob Willett (President and CEO)
The mix is changing and, you know, the amount of consumer electronics proportionately is reducing, and we're seeing a much more diversity and breadth in our business there, particularly with automotive, ID, medical devices, and other verticals becoming increasingly important to the mix.
Richard Eastman (Managing Director and Senior Analyst)
Okay, okay. And then, also, just in terms of the residual or tail on this large customer revenue as it extends into the Q4 here, you mentioned that it's service, and I presume that some of the cost of that service falls in the cost of sales line. Are these people?
Dick Morin (CFO)
It does fall into the cost of service line, yeah. You know, some of them are people-related, whether they're, you know, Cognoids or, or people we have retained as contractors.
Richard Eastman (Managing Director and Senior Analyst)
Okay. As we, again, large project, large contract, we have some service here that extends into the Q4. Any, you know, indication, is there a tail on that business that would extend into 2015, or does the business that extends into 2015, you know, would it be new contract business? I guess, is there—there isn't, like, a one-year service contract or something that would extend out and give us some visibility into 2015 on the large project, that customer order, is there?
Dick Morin (CFO)
No, Rick, I think, you know, I think we said, you know, a few million dollars of service support into the Q4. I think we're not ready to give any guidance beyond that, but anything that would occur wouldn't be significant.
Richard Eastman (Managing Director and Senior Analyst)
Okay. Fair enough. And then, Rob, you had mentioned in your commentary earlier about new products and introductions. Does the extension of this 3D product line, you know, the displacement sensor, is it the extension and the products that you introduced here, are they targeted at any, you know, a broader end market? Is that product, you know, was originally targeted, I think, maybe at the auto market, but, does it extend the market breadth of your 3D products?
Rob Willett (President and CEO)
It serves many different end user markets, Rick, but generally, markets that are already served by Cognex. So large verticals would include automotive and electronics, but extending to markets like food and medical devices and such as those. Generally, the customers that are called on by our salespeople. And I think what you're asking, you know, does it take us into new markets? You know, possibly, but we don't think that's gonna be a significant part of where this product is gonna sell over the next few years.
Richard Eastman (Managing Director and Senior Analyst)
Yeah. And is there any product strategy on the 3D side, the sensor side, you know, that puts you, you know, marketing that product at OEMs? In other words, more of as an embedded vision product?
Rob Willett (President and CEO)
You know, absolutely. We're seeing lots of opportunities at machine builders, or as you might call them, OEMs, for those products where they're embedded into the product. Yes, absolutely.
Richard Eastman (Managing Director and Senior Analyst)
Understand. Okay. Thank you.
Operator (participant)
Okay, so again, ladies and gentlemen, for any questions, you can press the star followed with the one key, and that will place you into a question queue. So again, for any further questions, press the star followed with the one key to be placed into the question queue. So our next question comes from Jérémie Capron from CLSA.
Jérémie Capron (Director of Equity Research)
Thanks. Good afternoon. Question on the Asia business. I'm trying to reconcile what you said earlier in your prepared comments, a 30% increase in revenues from that region. Yet, when I look at the Q, it seems like the bulk of the increase in revenue came through Europe, while Asia was relatively flat. So just trying to get my head around this.
Dick Morin (CFO)
Yeah, well, let me answer that, Jeremy. The revenue from the single large customer, that particular customer, is located in Europe, and it has been our policy consistently that as we do report revenue by geography, we report the revenue in the geography where our customer is located. You can imagine that as we sell to system integrators or distributors, we may not know where our equipment eventually ends up. So in the past, we've always selected what we do know, which is the geographic location of the customer that places the order.
Rob Willett (President and CEO)
And building on that, too, you know, the results we report tonight for Asia include FA, Semi, and the division. The 30% number we put out there has to do with the FA business, specifically in Asia.
Jérémie Capron (Director of Equity Research)
Okay, okay, that's clear. And, Rob, if you could give us an update on your, the situation for the ID business as it relates to logistics markets. Where are you in terms of trying to address the, big, customers in that market? Are you seeing increased penetrations across a large number of different customers, or are we still fairly concentrated on, with just a few customers?
Rob Willett (President and CEO)
We're also making a very, very strong headway in that market, and we're seeing, you know, large increases of the number of customers that we're serving. The business is, you know, coming along strongly in the Americas, where I think we're building significant share. We're earlier in Europe, but in Europe, obviously, this is coming along nicely. The markets that we serve in there include the postal services, carrier type businesses, and then retailers. You know, we're penetrating each of those different segments quite strongly in the Americas, starting to get into them in Europe. We're very early on in China, but we do think China has huge potential for these products.
I, you know, every quarter, you know, we see the significant wins we're having, and, you know, there are many new, you know, famous high street names or brands appearing as customers of Cognex for the first time as a result of this this foray into logistics. Then I would also say that, you know, that we we see that market. We told you, I think a year ago, it was about $250 million. You know, it's slightly larger than that now and growing. And, you know, our share is, you know, approximately 10%, and we think we have a lot further to go, thanks to some highly advantaged products.
Jérémie Capron (Director of Equity Research)
Okay, thanks very much.
Operator (participant)
Thank you. And I'm showing just one final question coming from Holden Lewis from Oppenheimer.
Holden Lewis (Managing Director of Equity Research)
Yeah, good afternoon again. Just wanted to explore, I guess, the 3D displacement sort of process here a little bit. Obviously, logistics has been a big success in 2014 in terms of the growth, because you were ready to really sort of hit that market aggressively. And I guess I'm wondering, 3D displacement, I guess I assumed that that would be more of a latter part of 2015 type of story, but it sounds like you're rolling out the next generation of products. And I guess I'm wondering, to what degree will displacement, 3D displacement products be a significant element of the story throughout 2015? Or are we still talking about that being more of a late 2015 event? Just trying to get a sense of the timing of that. You might as well comment on the Advantage engine as well.
Rob Willett (President and CEO)
Yeah, Holden. So, you know, we've, as we announced, you know, today and actually launched in the last month or so, I mean, we're now in the market with some, you know, highly advantaged and very, I would say, easy to integrate displacement sensing 3D products. And that's certainly an advantage of our products. They're fast, they have a lot of high performance Cognex algorithms operating inside them, but they're also factory calibrated, which means they're a lot easier to set up and implement than most of the other products in the market today.
So, you know, we're out there, you know, we're able to manufacture them in, in quantity, and our sales force is well equipped with, internal equipment, to go out there, and we have a large funnel of business building. So, you know, certainly, you know, I would expect us to sell a few, certainly quite a few million dollars, in the back end of this year and the funnel building into next year. So, you know, in terms of the arc of our business, I, you know, it may be similar to what we've seen in, logistics over the next couple of years, and I don't think it's a second half of 2015 story. I think it's a story that should build sequentially as we move through the year.
Holden Lewis (Managing Director of Equity Research)
Okay, any comments on where we are with the Advantage engine?
Rob Willett (President and CEO)
Yep. So yes, the Advantage engine, bit of a different kind of customer dynamic there, which I, as I've spoken about in the past, which is the market there is for, life science equipment builders, who generally have about a three-year cycle in which we get designed in, and then an eight to 12-year product life. So, you know, this is a long game, but when we get spec'd in, you know, we may be seeing thousands of units, bought and adopted into large machine builders products for, you know, eight to 12 years. And the price of those may be for a few hundred dollars, but if they're buying thousands of units per year, it will be substantial. Where are we in that process? We've had some design wins, that we're recording.
We're looking, you know, we're expecting more in the coming quarters. I think the revenue contribution next year will still be small, because it's, we're still pretty early on on that kind of S-curve that exists in that market. But I think it's gonna be a very important part of Cognex's business overall, if we look, you know, two or three years out.
Holden Lewis (Managing Director of Equity Research)
Okay. And on 3D displacement, does your work in logistics streamline your ability to get with customers? Are they similar customers, the same customers? Has that groundwork been done from a marketing standpoint?
Rob Willett (President and CEO)
Generally, the displacement sensing products are going to get sold into our core factory automation business, you know, markets, so automotive, electronics, medical devices, food, beverage, markets such as that. The logistics market is different in that way, and although there are some applications for displacement sensing and logistics, that's not going to be a big part of the story for us, certainly not next year.
Holden Lewis (Managing Director of Equity Research)
Okay, great. Thank you.
Operator (participant)
Okay, thank you. So again, ladies and gentlemen, if there are any questions, you can press the star followed with the one key at this time, and that will place you into a question queue. So again, for any final questions, press the star followed with the one key at this time. Okay, and I'm showing no further questions, so I would like to turn it back to Dr. Bob Shillman for any closing remarks.
Bob Shillman (Chairman)
Yeah, thank you very much for assisting in this call, by the way. Good job. Well, it's a simple thing to wrap up. Best quarter in the company's 33-year history. I don't know how long that record's going to hold, but I think there's a pretty good chance we may beat it next year. At any rate, I want to thank all of you for attending the call and the team at Cognex, starting from sales, marketing, engineering, finance, service, just did a spectacular job under Rob's guidance. We look forward to speaking you, with you again, on our next quarter's call, at which time we'll report our year-end results. Thank you again for joining us tonight.
Operator (participant)
Okay, ladies and gentlemen, this does conclude your conference. You may now disconnect, and have a great day.