Cognex (NASDAQ:CGNX) Q2 2019 Earnings Call

0:00 Greetings and welcome to Cognex's second quarter 2019 earnings conference call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Susan Conway, Cognex's second senior director of investor relations. Thank you, Ms. Conway. You may begin.

0:20 Thank you and good evening, everyone. With us today are Cognex's chairman, Dr. Bob Shillman, president and CEO, Rob Willett, Vice President and Corporate Controller, Laura MacDonald, and Cognex's Treasurer, Chris Stagna. I'd like to point out that our earnings release and quarterly report on Form 10-Q are available on the investor information section of our website at www.cognex.com. Both contain highly detailed information about our financial results. During the 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.

1:07 You can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the earnings release. 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, however, and actual results may differ materially from those projected or anticipated. You should refer to our SEC filings, including our most recent Form 10-K, for a detailed list of these risk factors. With that, I'd like to turn the call over to Dr. Bob Shillman.

1:49 Thanks Sue and hi everybody. Thanks for joining us. Overall, our Q2 results were in line with our expectations and we were highly profitable. However, it's very frustrating to report a year-over-year decline in both revenue and profits as a result of the current downturn in both consumer electronics and automotive markets. Even so, we're confident about the future of Cognex and the role of machine vision and automation, and it turns out that distribution remains strong, logistics. Right now, I'm in San Diego, and everyone else is at our Natick headquarters, so for more details, I'll turn the call over to my partner, Rob Willett, and I'll remain on the call for any questions you may have of me.

2:41 Rob, the microphone is yours.

2:44 Thank you, Dr. Bob. Good evening, everyone. As Dr. Bob said, our Q2 results were as expected, with revenue at the top of our guidance range. The lower spending by customers in consumer electronics and the automotive sector in the Americas that we discussed last quarter played out as expected. The broad factory automation market in Europe was considerably softer than we anticipated in Q2, and the impact of this will be more noticeable in our Q3 results. Demand for many end markets is declining, notably in automotive, which is one of our largest markets in Europe.

3:29 Customers, particularly those that are exposed to the slowdown in Greater China, are reducing and deferring large projects. Asia has also weakened. This is due to a continuation of the challenges that we have been experiencing broadly across China and to softness observed in industrial markets elsewhere in Asia. These dynamics obscure our continued strong performance in logistics. In that market, a growing and broad base of well-known e-retail and traditional retail companies are investing in automation to improve the speed and the efficiency of their fulfillment operation.

4:14 And they are turning to Cognex Machine Vision as a key enabling technology in their distribution centers. We also continue to make strong progress in other industries we serve that are currently relatively small, but are growing quickly. Putting it together, consumer electronics and automotive are two largest markets that, combined have recently been responsible for more than 50% of our revenue are both contracting simultaneously for the first time in many years. Broadly speaking, it's due to a widespread lack of business confidence amid falling demand, changes in customer preferences, and the timing of transitions to new technologies.

5:00 Heightened uncertainty and the distractions around trade tensions are also a problem. However, we are confident in our business strategy and are keeping a long-term perspective. We continue to fund our engineering projects and the development of impressive new products continues to plan. We are reallocating resources toward faster growing areas, such as logistics and deep learning, and markets where the adoption of machine vision is still in its infancy. The skill sets of our engineers and salesnoids are highly transferable and can be applied to a variety of opportunities. Before we move on to details of the quarter, as you may know, we're actively recruiting to fill the CFO role. In the meantime, we're especially fortunate to have Laura MacDonald serving as our Principal Financial and Accounting Officer.

5:53 Laura is a 25-year Cognoid and has led Cognex's finance, and the accounting and reporting teams as vice president and corporate controller since 2007. Laura, the microphone is yours.

6:08 Thank you, Rob, and hello, everyone. Revenue in Q2 was 199 million, representing a decline of 6% year-on-year due to a reduction in revenue from the consumer electronics and automotive market. The decline was 3% in constant currency, Logistics continued to be a strong performer and offset much of the decline in the manufacturing sector. Gross margin of 74% was consistent with Q2 2018 despite the lower revenue and was up 1 percentage point from Q1 2019. Operating margin in Q2 was 26% down from 30% in Q2 2018.

6:57 On a sequential basis, operating margin increased by nine percentage points due to seasonal growth in revenue and prudent management of discretionary expenses. The effective tax rate for the first six months of the year was 16% before discrete tax items, up from our expected rate of 15% due to a shift of income from lower to higher tax jurisdictions. The true-up of the tax rate reduced net income for Q2 by approximately $925,000. Excluding all discrete tax items, earnings per share were 27 cents in Q2 2019 compared with 31 cents in Q2 2018 and were up from 17 cents in Q1 2019.

7:52 Looking at revenue from a geographic perspective, The Americas performed the best of any region, increasing by high single digits year on year. Strong growth continued in logistics and was partially offset by lower revenue from the automotive sector, where spending continues to be slow. Revenue from Europe declined by mid-teens year on year, and that includes a six percentage point negative impact from currency exchange rates. Consumer electronics declined substantially as expected. We also saw growth soften in the factory automation market. In Greater China, revenues declined by low teens year-on-year, also due to consumer electronics, and a negative impact of 6 percentage points from currency exchange rates.

8:48 Manufacturers across our customer base in China continue to cut back their capital spending plans. Revenue from the rest of Asia declined by mid-single digits, principally due to reduced spending in the electronics and semi-markets, which are dependent upon demand in China. Turning to our balance sheet, Kleinex continues to have a strong position. We ended the quarter with $862 million in cash and investments and no debt. During the quarter, cash provided by operations was $59 million. We repurchased shares of Cognix stocks, totaling $62 million, and we paid $9 million in dividends to shareholders.

9:36 Inventory decreased 6 million, or 8%, from the end of Q1, as expected. As noted last quarter, we prospectively adopted a new lease accounting standard this year, which resulted in a balance sheet growth up of assets and liabilities of approximately $18 million at the end of Q2. Now I'll turn the call back to Rob.

10:02 Thank you, Laura. Moving next to guidance, revenue for the third quarter is expected to be between $175 million and $185 million. Compared to $232 million reported in Q3 of 2018, the decline is due almost entirely to substantially lower revenue from consumer electronics. As discussed last quarter, this is particularly related to smartphone manufacturing. Otherwise, we believe that continued growth in logistics and a few smaller high potential markets that are performing well will be offset by decreased revenue from the automotive sector and other industrial markets.

10:52 We expect gross margin for Q3 will be in the mid-70% range and slightly lower than the 74% gross margin we reported for Q2. Operating expenses are expected to be relatively flat with Q2. The effective tax rate is expected to be 16%, excluding discrete tax items. And with that, we will open the call for questions. Operator, please go ahead. At this time, we will be conducting a question and answer session.

11:41 If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from the line of Karen Liu of Gordon. Please proceed with your question.

12:08 Good afternoon, everyone. Rob, you mentioned logistics was still growing at a pretty healthy pace. There were some other companies that called out some push-out in large projects, I guess, over the course of the past few months. I guess, can you comment on the growth rate you're seeing in 2Q and what you're expecting in 3Q, and if you're seeing any push-out in projects in your pipeline?

12:37 Yeah, hi. Thank you, Karen. Our logistics business continues to be very healthy. We're growing at a good clip, and baked into our Q3 guidance is continued growth right around that 50% growth rate that we're targeting. So there's a fair bit of seasonality in logistics, and as we get into this market more and understand it better, Generally, what we tend to see is higher revenue quarters for us in Q2 and Q4, and lower revenue quarters in Q1 and Q3. But the growth rates we're seeing continue to be very strong, and we expect that to continue.

13:27 Okay, thank you. Yeah. Okay, thank you. There are factors I can go to in more detail if that's of interest.

13:35 Yeah, sure. I guess, do you think that's a function of you have been adding so much more resources in that market that, you know, that allows you to outgrow that market? Or are you somehow just, you know, more penetrated in, like, smaller projects these days? So, you know, any kind of deferral in the larger, you know, project areas doesn't affect you as much?

13:57 Yeah, I mean, we're new-ish. to this market and we have some very advantage technology that we're bringing and certainly the technology leaders in this market, particularly in the e-commerce space, recognize that and I would say we're being very much recognized as technology leaders. So I think that's the reason we think we can keep growing. We have been and we think we can keep growing this market at 50% growth rate over the long term. So I think I see that continuing. We're also introducing some exciting new products. We introduced the 3D A1000 for dimensioning, which will be very advantaged over time of flight and laser-based dimensioning systems that are currently in that market. And we're reallocating resources, as you note, to make sure we have the capacity to go on growing.

14:53 If there's a silver lining to this very disappointing market situation we're seeing in automotive and electronics, it's that we're able to reallocate those cosmoids to some very exciting growth opportunities, notably logistics and deep learning.

15:08 Okay, great. Thank you for the color. And then just on consumer electronics, can you update us versus the down one-third expectation that you had going into the year? What is your expectation now for that market situation?

15:23 Well, I would say we don't really want to be giving annual guidance every time we meet. We're not really changing our kind of approach to that. However, I will say things haven't really changed a lot in our outlook in that market since we last spoke. So, you know, guidance in Q3 reflects a $50 million year-on-year decline in revenue from consumer electronics. That's the big Thank you very much. Thank you very much.

16:21 Realize Huawei is probably not a big customer of yours or you've said that it's not that material of an impact. But I'm just curious, the whole episode of the ban and the ongoing trade tension, does it impact your confidence or will it impact your ability at all to participate in future smartphone capex cycle given that I guess a lot of the infrastructure Whether it's manufacturers, machine OEMs, a lot of them are in China, right? So does it impact, I guess does this whole trade tension impact your longer term outlook in CE at all?

17:04 It's a difficult call to make longer term. And obviously, as you rightly noted, we don't talk about specific customers. Cognex does supply all of the major manufacturers of smartphones, whether directly or indirectly through contract manufacturers. And the current market and trade conditions make it more difficult to work with, simply some more than others, as you've said. And some of the ones it's hard for us to work with are perhaps one of the ones that are showing the most growth or have been. in recent quarters. So that's a challenge for us, certainly. But certainly our guidance contemplates that situation. And I think we all have to see how it's gonna play out from a government and trade talk point of view.

17:51 Okay, understood. I'll leave it there. Thank you. Thank you. At this time, I would like to update all of our participants. We ask that you please limit yourself to one question and one follow-up question prior to getting back in the queue. Our next question comes from the line of Andrew Buscology of Berenberg. Please proceed with your question.

18:16 Hey, guys. So, you know, I'm curious, you know, from a high level, you made some comment that, you know, you haven't seen in quite a while consumer electronics and auto detracting simultaneously. You also have this trade thing going on, which could be impacting things further. Given you guys have a long history in the space and experience in here, you talk about how this compares to other downturns. Is this something you think is going to be prolonged? Based on your history and experience, do you see Do you get the sense that things could turn quickly if we do get some sort of resolution in the trade agreement or any other factors? Curious your thoughts on that.

19:05 Yeah, Andrew, it's not easy to kind of prognosticate on these kind of things, but I would say a few things. One is I think the consumer electronics market can turn quite quickly, right? So I think particularly around these issues. So I think that one potentially is one that could come back more strongly. I think the automotive market tends to be more of a longer term player and it tends to take them longer to decelerate and accelerate around changes that go on. So I think I'd make that point of view. I also think, I can't quite remember exactly, I want to say 2015, we certainly saw some contraction in consumer electronics, but we didn't see the same thing going on in automotive at the same time.

19:52 So that's a little bit different. And I think all of us know that Cognix has grown its top line every year consecutively for the last nine years, and we're not growing this year. So this is a different situation that we're seeing. And I think it has to do with a number of factors that have, you know, and some of which we've talked about. The automotive industry itself, you know, is over-supplied at the moment, and it's between having combustion engine cars and too many of them manufactured and perhaps not as competitive for consumers as they need to be, but not yet having geared up on electric vehicles that are coming, but not yet really in the phase of major investment in automation. So we're in that situation there.

20:42 And in consumer electronics, I think, you know, we've gone through a period where we have massive investment and it's a matter of when we're going to return to that as well. I think as I think about this longer term, which is how we like to think about things at Cognex, I think the story of the last many decades really has been increased spending and innovation and in automation in electronics and automotive, right? As I look at consumer electronics, I think I would certainly expect there will be future waves of innovation and investment that are coming. And you can see that in many areas, 5G being one example in consumer electronics or autonomous, semi-autonomous vehicles and electric vehicles and automotive.

21:31 So I think it's a matter of when those come and how they play out and how much of a lift they bring

21:37 to automation.

21:39 But, you know, when I think of the millions, literally millions of people involved in manufacturing consumer electronics and the major investment and challenges and margin pressure on automotive to automate, you know, I'm very optimistic about the long term, but much less optimistic about this year.

21:58 Okay, that's helpful. You know, maybe just turning to your balance sheet that, you know, that's, you know, something I asked last quarter, you guys have This pile of cash. Does your appetite change in the last three months given some of your peers, some of your machine vision peers are a little bit weaker now? And also just curious, maybe a second part of that question, would you ever consider vertical integration with any specific pieces of your business?

22:31 So I would say we have a long-term strategy and some very strict and thoughtful criteria around acquisition, if you're getting at that. So that doesn't really change based on short-term considerations. We obviously have a lot of firepower in our balance sheet to make acquisitions as and when they become actionable. So that will continue. I didn't really understand your vertical integration question. Perhaps you can explain that to me.

22:58 Just some of your suppliers that you use, does it ever make sense or is ever thinking longer term on the camera side make sense to bring those in-house?

23:17 I think there are various technologies that we at Cognix work with. and, you know, an example might be in the area of high-performance liquid lenses, you know, so the wonderful technology partner we have in that space where we've used our ability to invest to get some exclusivity around that technology without having to acquire another company. But it shows you what we're willing to do where we find advantage technology that we want to secure. and whether it's through exclusivity or acquisition. We would do that. But I don't think you're going to see us acquiring what I would consider more commoditized businesses like cameras, right, as an example.

24:00 Okay. All right. That's all. Thanks. Our next question comes from the line of Joe Ritchie of Goldman Sachs. Please proceed with your question.

24:11 Thanks. Good afternoon, everyone. Thank you. So Rob, just your comments on the auto market and electronics market notwithstanding. You did also say that you experienced the broad factory automation market, particularly in Europe, slowing down. And so I was just wondering if you can provide a little bit more color on what really factored into that comment and what you guys are seeing specifically in Europe.

24:42 Sure, Joe. I think, you know, I think it's pretty well known in fact that the purchasing managers index or PMI for manufacturing in Europe recently fell to a number of 46.4, which is a 79-month low. So I think generally we're seeing a pretty underconfident manufacturing environment broadly in Europe right now. We saw that. emerge really kind of after our European organization came back from sort of the Easter vacation timeframe, right? So right after the call we had last with you. So I would say, and we really noticed a lot of pulling back, I would say, on investment.

25:29 I think another thing that perhaps might have clouded the view to that was I think in automotive, We sort of saw Q4 of last year from memory, or certainly the second half, which didn't look very good. It wasn't good last year in Europe. And there was a bunch of that had to do with regulation, right, around emissions and some other factors that they were dealing with, which kind of held up demand, you know, in the end of last year. And then we saw that kind of break free, and I think it made Q1 in Europe look better than probably it was on an underlying basis. So then we had to really try to recalibrate on really where are we as we came through into Q2, and we realized it was weaker than we were expecting.

26:17 And as I look around at other companies, I see similar things, particularly in automotive. I would point to the very large tier one automotive supplier, Continental, recently said you know they've revised their view about the automotive industry this year from being flat not their business but the industry in total on a global basis not flat but down five percent and they've revised that down in a similar time period so I would say we see that the other thing I you know I think it probably I know you many of you on the cool cover many companies I'd say difference between Cognex and some of those companies is our distributors don't really carry almost any inventory, and that's kind of part of our supply chain model.

27:02 We really like to work in a situation where we tell our distributors, we'll supply you quickly, and we don't want you tying up your cash holding Cognex inventory. So as a result, we have a pretty clear line of sight with what's going on in the marketplace. So I think while other companies might be later to see that where the kind of sell-through of inventory may cloud that. in some ways. Anyway, those are my own views about what's going on in European manufacturing and automotive.

27:33 That's really helpful commentary. If I just could ask a follow-on there. I guess, as you think about the CapEx cycles that you guys are tied to and how decisions are made, you referenced project deferrals earlier. I guess, how do we think about the timing on when we could see an improvement in CapEx? We're halfway through the year this year. Will budgeting decisions continue to be made this year, or is this kind of more of like we'll get further insight on an improving business condition as we head really towards the end of the year?

28:14 Well, Joe, it's a very good question. Not one I'm sure I can answer all that well. I'll give you my views, which are, I think, I don't think we're going to see improvement in the situation this year, right? Although it's possible, right, as they start to budget next year, there are going to be some factors that are going to change things. I think one factor is just very significant momentum and investment around electric vehicles and hybrid electric vehicles and autonomous features with very many New models plan to come to market in the next three, five years. And at some point, I think there's going to be a race to get those products to market and to gear up in automation. When does that begin, I think, is a critical question.

29:02 Of course, we're seeing investment in lithium-ion batteries and capacity in that space, and that is a good market. It's growing well for us at the moment. But I think we have to see more of those products, those new cars, come into production, and I think we'll have a better view of that probably as we exit the year.

29:22 Okay, thank you. Our next question comes from the line of Joe Giordano of Cohen and Company. Please proceed with your question.

29:35 Hi, guys. Thanks for taking my questions. Hi, Joe. Rob, you mentioned something. I think you said in CE and auto something about changes in customer preferences, and I just wanted you to clarify exactly what you meant there. And related to that, are you seeing any sort of noticeable shifts in market share for what you guys do in customers? markets that are impacted this much, whether it be just market dynamics or trade, or is that having any impact on who's supplying in now?

30:07 Well, yeah, I was alluding to, I think, factors that we've probably mentioned, but let me try to sort of wrap them up for the group. So I think in automotive, we have this factor where globally companies have produced a lot of combustion engine cars, and consumers really, you know, are less interested in buying those. And, you know, we see that particularly in markets like China, right, where, you know, capacity, particularly for foreign automotive companies is, you know, is a fraction of, you know, of utilization. So you see those kind of trends going on, which means they're really, you know, no pun intended, slamming on the brakes. But then you have, and yet, as I was saying just previously, the electric vehicle investments aren't really flowing through an automotive yet. So I think those changes we see coming, and some of the government incentives and some of the trade conflict that's going on isn't helping that situation.

31:11 Okay, so those are those factors there. I think in consumer electronics, what we see is we've seen waves of investment are, you know, major wave obviously in 2017 around OLED technology and new sensors and many new products, right? And now we're seeing overall sales of units slow down, but there will be more features and technology coming. And the most obvious example there I think is 5G, right? I think there's a lot of virtual reality and other sensor technology that we can expect to see coming in future. and I think inevitably there will be also new form factors, new case technology, new products targeting new geographies and markets that have the potential to grow.

32:02 As an example, markets like India and Indonesia and markets such as that. So I think all of those give us confidence that we will see a return to investment and growth again. but none of that appears to be coming in the short term.

32:20 Are you seeing any evidence, material evidence of your customers looking to retool outside of China given what's happening there and starting to build out production bases in other parts of the world?

32:37 I would say that's been something that I think many companies we work with, particularly in consumer electronics, have had under consideration or have been activating on for quite a long time now. Certainly some of the larger Korean manufacturers in the smartphone space and others certainly have scaled up manufacturing and are producing lower price point models in India, as an example. So that's not new. I'm certainly hearing rhetoric around the ability to accelerate that and contract manufacturers say that they're able to pivot into that space, but I don't have anything specific to tell you. Good, thanks. Our next question comes from the line of Richard Eastman of Robert W.

33:25 Baird and Company. Please proceed with your question.

33:29 Yes, good afternoon. Follow up on the last kind of comments that you made there. You know, one of the things that we have been seeing is just, again, in the smartphone market, this movement of production outside of China. And you mentioned India yourself, and we've been kind of paying attention to that. You know, in a scenario like that, have you seen your customers literally relying on capacity, subcontract capacity that's already in place? Why is there not any demand coming from that incremental capacity that's being built outside of China to accommodate that movement? Have you seen any indication of demand on your business? It doesn't appear that way, but why would we not expect to see that?

34:27 Here's what I do see for a number of companies we work with in the consumer electronics space, focusing on the India market, which is they're generally relying on their machine builders that they work with in an existing capacity in China or in Asia to fulfill that demand, right? So they're not scaling up machine builders in India, for instance. They're more shipping products over, and then also they're in some cases moving lines, and I'm commissioning and bringing them up on older models there. So I think that's the overall strategy that they're following, and I think it's pretty small scale at the moment, and I think it could be much bigger in future.

35:13 Okay. And then just somewhat related, there's a lot of – puts and takes right now going on in the small display, OLED display market. There's ironically some tariff issues between Japan and Korea and some of the specific materials that go into small displays or even large. But the Chinese are building out their capacity around OLED displays, both small and large. and we've talked maybe for the last 18 months about Cognex broadening its exposure in the CE market and I think one of those was OLED but has Cognex experienced any of that demand?

35:58 I mean just this shift in share and do we count all of the OLED display manufacturers in Asia as customers?

36:12 Right, so we We are seeing growth with business that we're doing with Chinese OLED customers. So certainly, I think you're right in thinking that those manufacturers are seeing growth and investment. And in many cases, we're supplying those companies through machine builders in countries such as Korea or Japan. So that's where we're generally seeing that business increase. but to me it looks like it's sort of incremental and there's still a lot of capacity that was built out in 17 among the big players that still isn't being utilized.

36:57 I think we were expecting some major increased investments as soon as next year and I think maybe that's a little optimistic now depending on what happens but I do think at some point it is gonna come.

37:12 Okay, and a related question, then I'm done. This maybe counts as three, but I'll think of two and a half. But was the reference you made earlier that the automotive industry, I think you had explained or thought maybe coming out of the first quarter would be flattish for the full year, and now with the incremental weakness that we've seen, are we thinking down mid-single digits or down double digits now for auto for the year?

37:40 I think we're now thinking down around 10%.

37:42 I got you. Okay. Very good. Thank you. Thanks for the extra question.

37:48 Thanks. I'm going to ask the audience, the participants to try to keep their conversations, I'm sorry, their questions to one or two and I will also try to limit my questions because we're getting well into the hour and there's a lot of you who want to ask questions. Our next question comes from the line of Josh Pokowinski of Morgan Stanley. Please proceed with your question.

38:10 Good evening, guys. I'll try to keep it to seven questions or fewer. So I guess just first one, more of a clarification than anything else, Rob. It looks like a lot of the consumer electronics decline shows up in the third quarter, which is just more seasonality than anything else. I think going back prior, third quarters had the same phenomenon. Any other big end markets that show up Are there any third or fourth quarter that we should be aware of that are kind of seasonally larger? You mentioned logistics a little bigger in 2Q and 4Q. Is auto weighted to some quarter in particular that we should keep in mind either on the decline or when that comp gets easy?

38:54 Yeah, so I think Q4 can benefit from larger logistics. you know a lot of seasonally larger logistics so you know I would anticipate that again this year and then Q4 can benefit from automotive and general you know kind of budget flush in the past that goes on but I'm really not anticipating that in the current environment we're in so I think and then sequentially from Q3 obviously you know Europe tends to be very and so on. So there's a normal phenomenon that we see in our markets.

39:38 Got it. That's helpful. And then just kind of thinking back to the secular growth model here, I know cycles get in the way and those are shorter, maybe medium term phenomenon. But when you talk about penetrating a customer's facility and having kind of more content there, If they're not spending money, there's no ability to gain content. But when that turns on, do you kind of catch up from where you were? So maybe rephrase differently. You'll have a couple years of easy comps and consumer electronics and auto heading into next year. Can you kind of catch what you didn't get during that time period? Because customers wanted to spend, they just weren't. Or is it just a question of the cycle comes back and We start from, you know, kind of a reset base. Does that question make sense?

40:25 Yeah, it does. It does. I would say, you know, in my 11 years with the company, I've seen, you know, difficult market conditions turn around and in times there can be very strong growth. I'm not predicting that here. Please don't get me wrong. But, you know, in 2009, we grew going into 2010 by 65%. You know, we had other – we had obviously 2017 where we saw – Some years of a slow, I think 15 and 16, we grew 44%. So ours is the kind of market where you can see those kind of turns around. And I'm not, I'll just say again, I'm not predicting anything there. I'm just saying that we see those kind of things can change quite quickly in our markets. And we want to be sure when those things happen that we have the capacity and the products to keep our momentum going.

41:18 The slow situation we have now is, you know, it's unusual. As we said, we've grown for the last nine consecutive years, so we're in a bit of a new space here, and it's hard to know when that will turn around and when we'll return to growth, and when we do, how quickly it will come.

41:34 Understood. Appreciate the call. Our next question comes from the line of Jim Rishuti. of Needham and Company. Please proceed with your question.

41:47 Hi, team. This is Mike Sikos on the line for Jim Rusciutti. Thanks for taking the questions. First question was around the gross margins that we're looking at for Q3. I guess the slight deterioration coming off of Q2, and I just wanted to get a better sense, is that gross margin compression we're looking at tied to revenue mix coming from logistics more than the consumer or the auto piece, or is it more just the reduced revenue base that you're looking for?

42:19 Yeah, so the gross margin in Q3 is going to continue to be in our mid-70% target range, a little lower than we've reported tonight. You know, we did have for Q2 some higher margin revenue in the service area that hit the P&L that won't repeat in Q3. and then some of it can have to do with the mix of business as well which can affect our gross margins but I don't think there's a tremendous amount of noise going on in our gross margin Q3 relative to Q2 that you need to understand. It's not that material.

42:59 Understood. And then can you also help us better understand the reallocation of resources when we're looking at your OPEX? Is it a function of Investing more in some of these smaller businesses that show potential for growth or the logistics business to help offset some of the larger markets where you're experiencing weakness? Or how are we thinking about those expenses?

43:22 So we have very talented engineers and sales noids that we recruit and develop over time. And they're great assets. So in times when we see the markets and many more. while we're seeing a slowdown in those areas, we're able to leverage those prognos we have and move them over would be one example.

44:09 And that also applies to areas like deep learning and life science where we see a lot of long-term potential and the need for talent. So that's really what we're doing. And at the same time as we're doing that, we're being much more conservative about incremental spend that we're making and discretionary spend that we're making at this time. because obviously when the business isn't growing, we want to try to keep expenses relatively flat.

44:36 That's helpful. Thank you very much. Our next question comes from the line of Matt Somerville of DA Davidson. Please proceed with your question.

44:48 Thanks. Within the U.S., you talked about factory automation a bit more from a regional standpoint with respect to Europe and maybe Asia. but with PMI sort of decelerating, industrial production decelerating arguably against pretty tough comparisons, have you started to see factory automation in North America start to roll over and is that an incremental concern for you going forward and into 2020?

45:17 Right. I think the Americas region and really the United States I would say is soft. particularly in automotive, where investment plans continue to be delayed and there's too much capacity and too many cars produced, certainly. I would say we, as a company, I think we understood that pretty early and we right-sized Our efforts and I think our guidance or our forecasting around the Americas market quite early. So I would say this is not really surprising us. The other factor we have in the Americas is we have, you know, it's our largest region for logistics and that's growing very, very strongly, right?

46:06 So that's certainly helping to, you know, on a region by region basis make up for the slower areas in general factory automation that we see in the Americas. So overall I think that's what we're seeing.

46:27 Thank you. Our next question comes from the line of Jaram Nathan of DeWi Asset Management. Please proceed with your questions.

46:38 Hi, thanks for taking my question. It's Diver Securities. So, I just wanted to get some more calling on operating expense and, you know, we saw in the QA you had mentioned that some of the declines here on the year came from ERP, a lesser expense on the ERP side and just trying to, and with respect to R&D, at this rate it could imply your R&D expense might be flat year over year. So just wanted to try to understand how should we think about those for the rest of this year and next.

47:18 I would say generally we don't give guidance around operating expense beyond what we've already told you. I'll just make a few general comments. I think operating expenses in Q2 are slightly lower. and our expectations, given the environment where, as we talked about, reallocating resources to higher growth areas. And we continue to manage expenses without disrupting any major products under development. Our long-term growth plans remain intact. And in the environment we're in, it gives us a good opportunity to focus on driving productivity, We did make a major investment in implementing an ERP system last year and there's plenty of opportunity to improve our processes and we're doing a lot of work in that area, which I think will put us in good standing when the market comes back and we're able to grow without necessarily adding much capacity.

48:18 Okay, and just as a follow-up, we have seen some of the mobile terminal competitors starting, you know, talking about an over-inventory and redistribution side. Are you seeing a similar trend, and can you just give updates on the progress you have made in that field?

48:40 Yes, so we have, you know, our journey into the mobile terminal market is I think it is similar to other markets that we've entered over the last 15 years or so and where we're leveraging our technology and strengths. And certainly, it continues to be an area for growth for us. The activity that we're seeing is encouraging. While the business is still small in mobile terminals, we expect the revenue this year to grow substantially. So we're seeing that. And yeah, our customers are broadening. We've got some large, well-known companies that are evaluating our product, particularly in areas of e-commerce and actually in airports and airlines.

49:34 So we're certainly seeing some innovators starting to use our technology, and the growth results are very strong on a percentage basis, although off a very small base.

49:45 Okay, thank you. Our next question comes from the line of Ben Rose of Saddle Road Research. Please proceed with your question.

49:56 Hi. Hi, Ben. Hi, how's it going, Rob? Question, you know, just to clarify, in terms of the European factory automation market, understanding your comments that one of the differentiators with North America is in that market, logistics is stronger. Is it fair to say that factory automation in Europe is more heavily tied to the automotive market than it is perhaps some of the other verticals in your other geographies?

50:32 Well, I think the European market is have a large automotive piece to it, as does America. And Asia tends to be more consumer electronics. That would be a broad brush. America is becoming less dependent on automotive as we broaden into logistics more quickly, I would say. But overall, automotive is probably the biggest market for us in both America and Europe, or has been. And I'm just going to exercise a little discretion here on the call. We've got about 10 minutes, I think, to the top of the hour, and we have quite a lot of people in line. So, Ben, would you mind my being rude and limiting you to only one question and moving on to the next caller?

51:15 Sure. You know, I only have one. Sure. Why don't you go ahead?

51:18 Thanks, Rob. Thank you. Thanks a lot, Ben. Appreciate it. Thank you. Our next question comes from the line of Paul Koster.

51:27 Yeah, thank you. Please get back in the queue if anyone wants to. Sorry, Paul, over to you. Our next question comes from Paul Koster of J.P. Morgan. Please proceed with your question.

51:37 Thank you. Hey, this is Paul Chung. I'm for Koster. Thanks for taking my questions. I'll just be fairly brief. So just on your op-back spend, you know, you're investing less in the business, but you're still generating pretty healthy cash flow. So should we expect some kind of accelerated pace of buybacks or maybe a higher dividend, or is that $60 million per quarter the right kind of pace of buybacks we should expect? Thank you.

52:04 Right. So we announced, you know, we're staying with the same dividend currently, but I'm going to just pass it over to our treasurer, Chris Stagno, who can answer that.

52:18 Hi, this is Chris. Thanks for the question. I think if you take a look at the buyback program, we do have about $130 million that's available under the plan. We did about $104 million repurchased during Q2. In terms of future I would expect us to continue to purchase, but the timing would be subject to market conditions and potential uses of cash going forward. Our next question comes from the line of Joe Giordano of Cohen and Company. Please proceed with your question.

53:01 Hey, just one quick follow-up for me. just the sequential cost guidance on the OpEx. It's basically, you know, it's kind of in line with last year's 3Q, I think, which was a huge revenue number. So just curious if you can talk us through, is that spending or like what it's actually going towards change? I mean, just at a gross level of dollars, still pretty high relative to the revenue. Thanks.

53:24 Well, I think, you know, our R&D investment is probably pretty consistent, you know, across those that, Those two periods, and then certainly we've added considerably in terms of sales headcount, particularly in Europe through that period, and in logistics. So I think we're seeing that, certainly. I don't know, anybody want to add more color to that?

53:50 Laura? No, I would say it's consistent with the bridge in our MD&A and our 10Q, where you've seen the impact of the personnel additions that we've added both in engineering and sales over the past year. Thank you. At this time, we have reached the end of the call. I will now turn it back over to Dr. Shillman for closing remarks.

54:20 Yeah, thanks a lot for passing it back to me. Okay, look, the outlook is clearly not what we expected, and despite the fact that we know that automation and machine vision are key for the future, for making everything from chocolate chips to computer chips, and those are real examples, it's unsettling to see the slowdown that we're seeing now. We're hoping for better times and not only hoping for it, management is working very hard looking at, as Rob mentioned, reallocating to those growth areas and that's reasonably easy for us to do.

55:05 And also we're looking at some very exciting acquisition opportunities in the future to add to our growth. That's it from here. I wish we had better news to report and I'm sure in the future we will. Thanks again for paying attention to Cognex and for participating in today's call. Good night. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your evening.