Cognex Corp (CGNX) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cognex Second-Quarter 2011 Earnings Call. At this time, all participants will be on a listen-only mode, but later we will conduct a question-and-answer session, which instructions will be given at that time.

(Operator Instructions)

And, as a reminder, today's conference is being recorded. Now, I would like to introduce your host for today, Richard Morin.

Thank you and good evening, everyone. Earlier tonight, we issued a press released announcing Cognex's earnings for the second quarter of 2011, and we also filed our quarterly report on Form 10-Q. For those of you who have not yet seen a copy of these reports, both of them are available on our website at www.cognex.com. They contain detailed information about our financial results and, because of that, we are not going to repeat most of that material.

During tonight's call, we may use a non-GAAP financial measure if we believe it useful to investors, or if we believe it will help investors better understand our results or business trends. For your reference, you can see the Company's income statement as reported on the GAAP in exhibit 1 of the earnings press release and a reconciliation of certain items in the income statement from GAAP to non-GAAP in exhibit 2.

I would like to emphasize that any forward-looking statements we made in the press 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.

Thanks, Dick, and hello, everyone. I would like to welcome each of you to our second-quarter conference call. I'm here in sunny San Diego, the neighborhood of Rancho Santa Fe. The rest of the team, headed by my partner Rob Willet, who is Cognex's CEO, are back in Natick with all the books and records to answer your questions.

As you can see in the press release that we issued earlier today, Q2 of 2011 was just an outstanding quarter for Cognex that exceeded even our expectations. Now, I'm going to be available at the end of the call to answer any questions that you may have for me, but here to give you the details on our results is my partner and Cognex's Chief Executive Officer, Rob Willet. Rob, take it away.

Thank you, Dr. Bob. Good evening, everyone. I'm delighted with the results we reported tonight for the second quarter of 2011. Revenue was $83.4 million, representing significant growth over both the second quarter of 2010 and the prior quarter. It's also higher than the guidance we gave to investors in May.

Our strong performance was due to record revenue from our factory automation market. We reported margin expansion at the gross margin, operating income, and net income line. All 3 increased significantly over both the second quarter of 2010 and the prior quarter. Gross margin was very strong at 77%. This represents an increase of more than 280 basis points year on year, and nearly 150 basis points on a sequential basis.

From an operations standpoint, we were able to significantly increase unit volume with only a minimal increase in overhead costs. Operating margin was 29% of revenue, as compared to 27% in the second quarter of 2010, and 23% in the prior quarter. Operating income grew at a faster rate than revenue, despite our investments in engineering and sales to drive future growth. And we delivered net income equal to 23% of revenue. Our reported earnings were $0.45 per share, which far exceeded expectations.

Now, let's turn to the details. First, factory automation -- revenue from the factory automation market, which accounted for 74% of total revenue in the second quarter, was a record $61.5 million. Factory automation demonstrated solid growth, with a 24% increase year on year, and an increase of 18% over prior quarter.

Looking at the business regionally, on a sequential basis, Europe was the largest contributor in absolute dollars. Growth was helped by strong performance in the automotive industry and favorable foreign exchange rate. However, we observed slower orders from certain large European factory automation customers as the quarter progressed. Our best performing region, net at the impact of currency translation, was Asia, which includes China. Asia factory automation revenue increased by 43%, to a record $10.5 million. Our investment to expand our market presence in this fast-growing region is paying off.

In the Americas, factory automation set a new quarterly bookings record and the revenue was at its second highest level. The fundamentals appear to be good, although we have experienced some delays in closing a few larger POs. Factory automation revenue from Japan was in line with our expectations. We did a good job of managing the business, despite the slower market overall following the earthquake. Demand is anticipated to come back toward the end of the year.

From a product perspective, each of the primary product lines that we sell into factory automation, which are machine vision systems, ID products, and machine vision software experienced double-digit growth over both the second quarter of 2010 and the prior quarter.

Let me now turn to semi -- revenue from the semiconductor and electronics capital equipment market was $11.3 million in the quarter. This represents a decrease of 2% from the second quarter of last year and a decrease of 11% from the prior quarter. As you know, semi is one of our more volatile markets. While difficult to predict, the current order trend is tracking moderately lower.

In the surface inspection market, revenue in the second quarter was $10.6 million. As we have said in the past, surface inspection is a lumpy business, and this was apparent in the second quarter. Revenue decreased by 2% year on year, but increased 11% over the prior quarter. Our surface inspection business had record bookings in the quarter and reported significant margin expansion. We had an important win in the metals industry, where we received an order for more than $900,000 from an existing customer for their new steel mill in Thailand; and we received another order of approximately the same amount from a US-based tissue paper supplier for our smart advisor web monitoring system.

In regard to new products, RD&E expense during the second quarter was $10.5 million. This level of spending is much higher than where we were a few years ago. It is indicative of our commitment to innovation and our willingness to invest in our business for long-term growth.

During the quarter, we added new features and functionality to our In-Sight product line to expand its use in the factory automation market. We ported our 3-D vision tools to our vision for software library, making this technology more accessible to a broader range of customers, and we launched a new high performance wafer ID system for the semi market that offers improve lighting, faster processing, and enhanced reading software.

Overall, we feel very good about how our products are performing in the marketplace. We are also excited about the pipeline of new products we have under development that will be introduced over the next 12 months. Another bright spot is the continuing progress we see in our China business. Orders from the China -- Chinese factory automation market in the quarter were up more than 150% year on year. China manufacturing is still early in its adoption of machine vision. With our investment to more than double the number of quota-carrying sales engineers over the past year, we are positioning ourselves well for leadership in the China market.

Despite our growth investments, operating expenses increased by only 3% over the prior quarter. This reflects our continued disciplined approach to spending.

In summary, Cognex had a great second quarter, and we expect to have an excellent third quarter. We are confident in our team's ability to continue to out perform. Our outlook calls for third-quarter revenue to be between $78 million and $81 million. We typically experience softness in factory automation during the summer, and we see no reason to believe that this year will be different. We also think it will take the Japan automation industry a few moments to return to growth, and we expect to see softness continue in semi.

On the other hand, we expect solid growth from surface inspection, continued increasing demand from Asia, and good business trends in most of the vertical industries that we serve. Gross margin should remain solid, although it will be somewhat lower percentage-wise than in the second quarter. This is primarily due to product mix. The surface inspection is expected to represent a higher percentage of revenue in the third quarter.

Operating expenses for the third quarter are expected to remain relatively flat on a sequential basis. And the effective tax rate is expected to remain at 23%. The third quarter of last year included a benefit to tax expense of approximately $700,000 or $0.02 per share, for discrete tax items.

Now, let's open the conference call up for any questions you might have. Operator, we are ready to take questions.

(Operator Instructions) Jim Ricchiuti, Needham & Co.

The question I have relates to bookings. You had record bookings in the SISD business, record bookings in factory automation. At the same time, it sounds like you have seen a little bit of slowing in factory automation in Europe. I wonder if you could talk to the vertical markets, what you are seeing in Europe, as well as what you are seeing in the US? Particularly if you can give some color as to how bookings have been trending in July, just given some of the weakening macroeconomic data points we are seeing?

Sure. Hi, Jim. As you said demand was very strong in the second quarter. We set a new bookings record for the total company in both factory automation and surface inspection. In factory automation, emerging markets leading the way, particularly China. And I think we also saw a strong push by our sales team in the Americas to end the quarter with a record order level and Europe reported their second highest quarterly bookings.

I also see as you point out strong momentum in our surface inspection business. They had an outstanding bookings quarter, and then as we said demand in the semi business have softened during the quarter. Overall the sales funnel remains healthy, but there are trends we are watching carefully and factory automation customers in the Americas are noticeably taking longer to approve POs. So then as we look back trend-wise, although the growth rate was good, it moderated slightly as the quarter progressed. Some more color on that. Automotive has been a big driver of our business this year, and particularly European automotive and that seems -- and the US automotive market seems to be continuing to perform strongly. We see no slow down there. If there are pockets where we are seeing a slow down, which I referred to, some European OEM customers look like they are slowing down, particularly in the areas of solar, where we have seen strong orders for the last five quarters, there appears to be some slowing down in that market and then also in the security and document printing industry, where we've seen some slowing. So I would say that might give you an overall picture of it, Jim.

That is actually very helpful. Rob, can you also -- I'll jump back in the queue -- but could you comment about the auto ID portion of the business, excluding semi? And maybe just an update on how DataMan 500 is going? It looks like you have expanded that now into some other areas of the factory automation market in addition to logistics.

Sure. Yes, as you know, ID Products is a major growth driver for Cognex. We saw revenue from ID Products grow 36% year-over-year for the second quarter. We continue to see that momentum going very well. In terms of DataMan 500, we are very pleased with how that product is performing. We've received a number of large orders and what we are seeing now is we are winning initial business at new customers and we are very confident about the product, particularly we are seeing a lot of interest and initial trial at large E-retailers and postal accounts.

Auto ID, is that about 15%, 16% of overall revenues?

Dick?

Yes.

Okay. Thanks very much. Congratulations on the quarter.

Richard Eastman, Robert W. Baird.

Just maybe a couple of quick questions. On the geographic split, you did talk to Europe and it sounds like Europe was particularly strong on the auto side. I noticed it was strong sequentially, so is that -- is Europe one area that you are looking closely at for sequential sales trends there? We have the summer effect but we also have, it sounds like some specific industry related slow down?

Yes, I'd say we are looking at a lot of the business right now, but the US and Europe, I think are, and Japan also, are facing certain challenges. Yes, we watched the European businesses perform pretty well, sequentially, and we expect it to go on doing so year-over-year, as we go forward. As I said, there are perhaps some industries where we are seeing some trends that look like we see some slowing down.

Are you seeing -- in the US, is there any discernible difference between sales growth rates in the direct channel versus the distributor channel? I'm thinking more sequentially?

Dick?

Sequentially, in all honestly, I think if you take a look, we have the percentage of our factory automation bookings coming out of the distribution channel is relatively the same as it was in the prior quarter. So there has been essentially no change in the percentage relationship.

Okay.

The sales through the distribution network, however, are a little bit better this year, year-to-date if you will, than they were last year.

Yes, just to build on that you know, I think we've seen the growth rate of our distribution business slightly outpace our direct business in the quarter.

Okay. And on the SISD business, given record bookings that we saw in this year's second quarter, is it possible that some of that business can flow through the P&L yet this year? Or is that business more a 6- to 12-month window?

No, we would expect a substantial part of it to flow through the business in the next two quarters.

Okay and then lastly, we bumped into something as we were scanning around, it came up on Cognex. And I was curious, it has to do with Cognex being issued some patents for a swipe scanner?

Yes, sure.

And I'm just curious. You know, this has -- at least offers the suggestion that maybe your product ID Products are at least addressing a bigger addressable market? Is that the right read on this, or is this less significant?

Yes. Let me, first of all, the patent itself. A couple of years ago we investigated the retail scanner market and decided that customers weren't yet ready for the high performance machine vision that we offer. However as part of that effort, we came up with a unique approach and we decided to patent it. To go to your broader question, Rick, I think we are always looking at adjacent markets and near adjacencies. Obviously you have seen us move into logistics, which is where we are bringing our technology to bear. You have seen us move into life sciences, where we are selling image engines, and that is the process we are in while looking at adjacencies. I think it was too early for swipe scanning but I think they'll come around to machine vision in time and I think you are going to see us looking at other adjacencies too.

Nothing imminent in terms of having a product into this market and acceptance rate, but we do have it patented?

Correct.

Okay and then lastly, Rob, what is your general feel? We are tracking a few soft spots in the business here. Maybe Europe, or US, you had mentioned Japan hopefully comes back to more realistic volumes later this year. What is your feeling at this point in the year that fourth quarter's spend can show a seasonal uptick as it might normally? In factory automation?

Yes, I would say our outlook for the second half of the year is quite good. Our business is solid despite recent weaker economic data. I might refer you back to last year, let's say, where we saw really good growth in our business more due to retrofitting of existing lines rather than necessarily new plants. So I think in that respect we can expect Cognex to out-perform the industrial market in general. That said, I would kind of point out to some difficult comparisons that we are looking at year-over-year. If you look back, Q3 of last year was exceptional for Cognex. So factory automation revenue from Europe in the third quarter was surprisingly strong, even though there is normally the seasonal softness going on. Semi, was still strong a year ago, and Japan was doing well prior to the March earthquake.

Okay.

So, facing those comparisons over the year, it is difficult but we are still, as you can see, projecting some pretty healthy growth. Also looking back to Q3 in our operating expenses probably hadn't kicked in as much -- still in Q3 and we still had the benefit of some tax benefits that I alluded to. And then, looking at the fourth quarter, obviously we are not going to have -- one thing I can say for sure is we are not going to have the $6.5 million of one time service recognized in the fourth quarter of this year as we did a year ago.

Sure.

But, excluding all those one time things, the underlying momentum, we think, is still very good in the second half.

Okay. Very good. Thank you.

Thank you.

Ben Rose, Battle Road Research.

Just a question to further explore the vertical market strength in the quarter in your outlook. I know you had mentioned European automotive and US automotive performing strongly in the quarter. Could you talk about some of the other strong performing end-user markets, particularly as we look out into the second half of the year?

Sure. Well I think as you know a very nice thing about our factory automation business is it serves a pretty wide range of end-user markets, some of the end-user markets where we saw a lot of strength in the quarter and we expect continued strength would include aerospace and defense. Electronics, they look strong and medical devices also had some very -- a lot of strength, in addition to automotive that I spoke about.

Okay, thanks. And then one follow-up question would be; I know you introduced or just announced the VisionPro 3D software package for 3D imaging applications. Could you talk a little bit about your future plans in the 3D area and whether that might be a source of new products over the next 12 months?

Sure. What we recently announced is -- Cognex makes the worlds leading vision tools -- the very best machine vision tools. And what we did recently was take some of those 3D tools and make them available in VisionPro, which is our easier way to use machine vision in a PC environment. And so we've introduced those tools, and they are particularly good for locating elements in a 3D space. Markets they address would include automotive and electronics would be great examples. Where for instance a large car manufacturer would use them to help robots align car doors in the manufacturing process. So, we are kind of leading that space as we lead a lot of machine visions. I think you can expect more from us in the 3D space over time. But I don't anticipate it being a very large part of our business. What, perhaps, it does do is it sort of shows our technical leadership and perhaps leads and pulls through more business with it.

Okay, thanks.

Gus Richard, Piper Jaffray.

Yes, can you hear me?

Yes. Hey, Gus.

Thanks. Just quick -- the increase in surface inspection. You also mentioned that you had an improvement in gross margins and I was just wondering if you could help us extend the trajectory of the margins over the next couple -- I know Q3 will be down due to mix. (inaudible) be a little bit stronger than the fourth quarter?

To clarify your question, you are asking for the trajectory of margins in the SISD business, is that correct?

Correct.

And perhaps what's driving those?

Yes.

We have been focusing on that business on growth and margin improvement. And I think we are seeing the work that we have been making there coming through. Particularly, I think we have had some good pricing initiatives in that space. Also purchasing initiatives that are reducing our bill of materials. Particularly sourcing more from Asia in electronics and other parts of the product. We had a new president or new general manager of that division take over at the back end of last year. And I think a lot of his very strong management is coming to bear in improving the margins there. So I do expect continued margin improvement as we move through the next few quarters.

I would like to add one comment. Gus, you mentioned the expected decline in the gross margin in the third quarter. And that's not on a surface inspection basis, that's what we expect on a consolidated basis. And the reason for that is that we are expecting in Q3 that we will see a greater percentage of the total consolidated revenue coming from surface inspection, which has margins in the 50% range as opposed to our modular systems division which has margins in excess of 75%. So I want to make sure that there is no confusion between those two separate comments.

No. I understood. I just wanted to see what the margin improvement in the business if it would help a little bit more and mix shift to the lower margin product.

Okay.

Okay that covers it for me. Thank you.

(Operator Instructions) Jim Ricchiuti and Needham & Co.

Dick, just on that last point you had a higher percentage of SISD revenue in Q3 last year, at least relative to what you just experienced this quarter. Would you expect your gross margins to be up year-over-year, however?

I think, I don't even remember what the -- I'll have to take a quick look here. Give me two seconds.

Sure, and maybe while you are doing that -- Rob, can you talk a little bit about China? Just because it appears to be a fairly big driver for you guys. I don't know if you would be willing to give us a sense as to how big a market it is for you? And maybe, if you are seeing specifically the growth areas within China that you are seeing in factory automation?

Sure. As you know, the fundamentals of our China business is strong and we are seeing good underlying momentum. And we expect that to continue for the foreseeable few quarters. So, I think to your question of kind of where, I think this is the broad-based adoption of machine vision in factory automation. I think that is what we are seeing. And it is still pretty early in China for that. As I visit China, I see it becoming much more sophisticated in its manufacturing and there are trends such as rising labor cost that are helping to drive the benefits of machine-vision home in that market. It is pretty broad-based across a lot of different industries, and a lot of different cities in China and we have opened now four offices in China. And added many sales people, to give you some color on that. Today, we have about 37 quota carrying sales people in China, that's up from 13 a year ago. And they are really ramping in terms of their performance, to serve a broad business in general. So I think we can expect the overall business to mirror Cognex as we go forward, but right now, certainly electronics would be a major market in China.

I was going to say in getting back to your margin question last year Q3, was a record for SISD. This year, as we are taking a look at -- they're representing they will in fact beat the revenue number, we expect them to beat that revenue number. So the downward impact on the margins on an overall basis, because they will, in fact, represent a greater percentage of the total consolidated group. But with the improvement in their gross margin that we saw here in the second quarter expecting that to continue. I don't expect that there will be a major shift in the gross margin percentage compared to last year.

Okay, that is helpful, Dick, thanks. Lastly, I wonder if you can give us an update on the Mitsubishi relationship? It sounds like you have lost some time because of the earthquake but maybe how do you see that shaping up for, perhaps, 2012?

Yes, so our relationship with Mitsubishi is very strong and is founded on a great principle where we are both benefiting one another's business substantially, they, by giving us penetration into the factory floor in Japan and we, by giving them technology which is helping them sell more and many of their products, particularly motion control and PLCs. So the fundamentals of that are great and our relationship is great. And we understand the earthquake is a setback. But I think what we all see, is we are going to see growth resuming here at the back end of the year. And yes, it's been a bit of a timeout, while we deal with some of the disruption. But the relationship is strong or stronger as a result of the earthquake.

Okay great, thank you.

(Operator Instructions) Richard Eastman, Robert W. Baird.

Just as a follow-up on Japan and maybe the revenue impact from the disaster there, I might be doing the numbers incorrectly. But it looks like your Japan revenue is down about, call it $3 million year-over-year? And what I was curious about was, does any of that show up in the semi, in the OEM space? Or is that all the factory automation?

Now, actually, I'm going to jump in here very quickly. I think a good chunk of that decrease, $3.7 million of that year-on- year decrease is in the surface inspection group.

To give you more color on that, Rick. Some of the customers in metal and paper were in that earthquake-affected area so that did kind of slow them down there in their investment. We've seen some of that come back already and we are expecting to see more of it come back in the second half of the year.

Okay.

But with more of the OEM space, you could figure on that being flat to only slightly down through this process. And I think we were expecting our plans were for some pretty major growth in Japan this year, which I think has taken a timeout because of the earthquake. But we expect it to resume.

When I look at the semi OEM piece of the business and I look at it sequentially, down modestly, a million bucks or so, is there any impact from Japan in there? I mean in delayed orders? Or is that the market?

No, that is more the market. Because Japan was essentially flat sequentially.

I see. Okay. And then lastly, in China, you just comment on the sales people that you have today relative to a year ago. Is there a dual distribution strategy in China that emerges here? Is part of that Mitsubishi or even Rockwell distributors or direct versus your sales people?

Yes. Our channel strategy in China is very similar to what it is in other markets. So it has some major customers being served direct.

Okay.

And then distributors which we call automation solution providers and then systems integrators also, and then in China, we have signed up a number of Mitsubishi factory automation distributors. But we already have a network of approximately 30 distributors, Cognex factory automation distributors in China.

I see. Okay.

Yes, that really gives us the penetration and allows us to sell to some of the smaller customers in industries we couldn't reach on our own.

I see. Very good. Okay, thank you again.

Thanks.

(Operator Instructions) At the moment, I'm showing no questions. I would like to turn it back to your host.

Okay. This is Dr. Bob here and I just want to summarize that we had a great quarter. We are doing a great job in maintaining our margins, increasing margins and holding expenses, even though you saw we spent quite a bit of money in engineering. Nevertheless our margins continue to increase on profitability. So, we are optimistic about machine vision, even if there may be some glitches down the road in factory automation or in the world economy, there is no question that the need for machine vision is growing. That's it from here and we hope to report back to you very, very good results for this coming Q3. Take care. Good night.

Okay. Ladies and gentleman, this does conclude your conference. You may now disconnect and have a great day.