Richard A. Morin - Executive Vice President of Finance & Administration and Chief Financial Officer Robert J. Shillman - Chairman Robert J. Willett - President, Chief Executive Officer & Director.

Robert Burleson - Canaccord Genuity, Inc. Ben Z. Rose - Battle Road Research Ltd. Jonathan David Wright - Nomura Securities International, Inc. Holden Lewis - Oppenheimer & Co., Inc. (Broker) Jim A. Ricchiuti - Needham & Co. LLC Richard C. Eastman - Robert W. Baird & Co., Inc. (Broker) Joseph Giordano - Cowen & Co. LLC Grace Lee - CLSA Americas LLC.

Good day ladies and gentlemen, and welcome to the Cognex Third Quarter 2015 Earnings Call. At this time, all participants will be in a listen-only mode. Later, there will be a chance to ask questions and instructions will be given at that time. As a reminder, today's conference is being recorded.

And now, I'll turn it over to your host, Chief Financial Officer, Dick Morin..

Thank you, and good evening, everyone. Earlier today, we issued a news release announcing Cognex's earnings for the third quarter of 2015, and we have also filed our quarterly report on Form 10-Q. For those of you who have not yet seen these materials, both are available on our website at www.cognex.com.

They contain highly detailed information about our financial results. During tonight's call, we may use a non-GAAP financial measure, if we believe it is useful to investors or if we believe it will help investors better understand our results or business trends.

For your reference, you can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the earnings release. I'd like to emphasize that any forward-looking statements we made in the earnings release or any that we may make during this call are based upon information that we believe to be true as of today.

Things often change and actual results may differ materially from those projected or anticipated. You should refer to the company's SEC filings, including our most recent Form 10-K for a detailed list of these risk factors. Now, I'll turn the call over to Cognex's Chairman, Dr. Bob Shillman..

Yeah. Thanks, Dick, and hello, everyone. I'd like to welcome each of you to our third quarter conference call for 2015.

As you might have been able to – as you might have seen in the news release that was issued earlier today, we reported the third highest quarter in the company's history, for revenue, for net income, and for earnings per share from continuing operations.

But even though, it was the third highest quarter in our history, unfortunately those results also represent a significant decrease from Q3 of 2014 and Q2 of 2015 due to those prior quarters' orders being our first and second highest quarters in our history respectively.

Right now, I'm at our R&D office at San Diego, everyone else on the call is at Natick headquarters. The details of the quarter, I'm going to hand the microphone over to my partner Rob Willett, our President and CEO, and I will be available at the end of the call to answer any questions that you may have for me. Rob, the microphone is yours..

Thank you, Dr. Bob. Good evening, everyone. As Dr. Bob said a moment ago, revenue of $107.6 million represents a substantial decline from both the third quarter of 2014 and the prior quarter. Both of those quarters included more revenue from large projects than in this year's Q3.

Of course, we love large projects, but they do cause this kind of unevenness in our quarterly results. Gross margin was 76%, slightly lower than in the prior quarter due to product mix and higher support services. Operating margin was 26%.

While most companies will be pleased with such a high level of profitability, we are not, because it was below our 30% long-term target. Earnings per share from continuing operations were $0.29, which included $0.02 per share from favorable discrete tax items.

Turning to the details of the quarter, factory automation revenue was $102.6 million and accounted for 95% of total revenue. Looking at our factory automation business year-on-year from a geographic perspective, we had another strong quarter in Asia, excluding Japan. In fact, factory automation revenue from Asia set a new record.

Growth was led by Greater China, where we continued to make strong progress in the broader automation market. Although, we are confident about the long-term prospects in this region, we see uncertainty in the near-term. In the Americas, lower demand and project delays have slowed growth since the beginning of the year. Spending by U.S.

manufacturers in most industries we serve was disappointing in Q3, and we don't expect to see any meaningful change this year. As excepted factory automation revenue from Europe declined significantly year-on-year. Europe reported a remarkable quarter in Q3 of 2014 due to large orders from the consumer electronics industry.

In 2015, more large orders came earlier in the year, while others were delayed until 2016. The weaker euro also contributed to the decline, reducing factory automation revenue from Europe by $4.2 million. And, in Japan, revenue from the region's factory automation market continued to disappoint.

Revenue from Japan declined year-on-year, both on a constant currency and reported basis. In the semiconductor and electronics capital equipment market, revenue was $5 million in the third quarter or 5% of total revenue. Demand from semi follows the market cyclical trends.

Because of that, our expectations for growth in this small piece of our business continue to be low. In summary, revenue was as expected in Q3, however, we were disappointed this demand softened as the quarter progressed, notably in Greater China and among our automotive customers globally.

Slower demand from these two areas, combined with modest growth in the Americas, led us to focus on tightening expenses and increasing productivity. We continued to hire employees and invest in our business, but the rate of increase will be significantly slower than in the past several quarters.

In regard to operating expenses, RD&E and SG&A totaled $52.8 million for the third quarter, representing a significant decrease from both Q3 of 2014 and the prior quarter. Meaningful savings came from lower bonus and commission accruals, lower expenses related to patent lower sales (7:06), and a reduction in discretionary costs.

Turning now to our outlook, we expect revenue for Q4 to be in the range of $94 million to $97 million. Unfortunately, even the high-end of our expectations is lower than the $98.5 million reported for last year's Q4. While this is disappointing, recall that we just finished 24 months of growth that was nearly double our long-term target.

Q4 will also be the only quarter this year that we don't see any large shipments contributing over $2 million of revenue. Gross margins for Q4 is expected to be in the mid-70% range. Operating expenses are expected to increase by approximately 5% from Q3. The effective tax rate is expected to be 17.5%, excluding discrete tax items.

Now, let's open the call up for your questions. Operator, we are ready to take questions..

Okay. So our first comes from Bobby Burleson. Bobby, your line is open..

Thank you. I wasn't expecting to be first.

I think just to kick it off here, I'm wondering on China, you mentioned things slowing down there, and I'm wondering if you have a sense for whether or not it's end demand related or some type of inventory reduction by customers? And then also kind of what your sense is for when you could expect to see some firming or a bottom? Thanks..

Yeah. Hi, Bobby. So, I spent quite a lot of time in China last month. I mean what I observed there is that the pace of growth in China has slowed notably during the quarter, and it seems that tighter credit has become an issue. Also, I think it's pretty well documented to sort of overcapacity that we see in the automotive industry in China.

So, we expect our business in China to continue to grow, but it's clearly a growth rate that's slowing down based on those factors..

Okay. Thank you and just one more quick one. I'm wondering competitive environments, you have some competitors based in Germany and Japan, I'm wondering if the strong USD is leading to any maybe pricing action that those guys are taking, any heightened competition based on FX and kind of relative currencies. Thanks..

We don't notice specific competitors trying to take advantage of the strength of the dollar or weakening currency to drop price I would say.

So generally, we have one competitor that we consider our main competitor in the market, (10:32), Japanese company, it's a very well managed company and one that reports very high gross margins and I don't think their strategy is to try to take share with lower price. So generally, I would say, we don't see that.

However, of course, we are pricing locally in euros and in renminbi in China. So we do take a hit to price when we maintain local prices as we've been doing in those markets..

Okay. Thank you..

Okay. Thank you. And we'll take our next question from Ben Rose from Battle Road Research..

Good afternoon. Rob, I wondered if you could comment on what you're seeing in terms of demand both in the U.S and abroad in terms of other industries outside of automotive, I know you mentioned automotive in your remarks, but is there any additional color you can provide there, noticing that the U.S.

was up modestly year-over-year? I guess a follow-up would be again relating to the duration, what's your sense of the North American outlook?.

Yeah. Hi, Ben. So, in general, we've had a very strong year in automotive and we've been reporting very strong quarters and our strongest quarters ever really this year as we've moved through. But now, we're starting to see that growth rate slowdown. We're still seeing growth, but we're seeing it slowdown in automotive.

In other industries, we're seeing – in the U.S., I think, we're seeing very broad-base of slow growth or no growth across many of the industries we serve. And I think that's due to a number of factors that are pretty well documented by other companies at this point, including the strength of the U.S. dollar.

So, I would say, it's a broad-based slowdown. I think affecting our U.S.

growth rate is the fact we haven't seen the kind of large orders we expected in America from logistics companies that generally have been seemed to have been delaying some of their spend whether its postal or e-retail companies, which may be reprioritizing or just deferring spend based on the current conditions.

But you asked it more broadly, and I would say in Europe, you sort of see the flipside of that where you think – I think the weak euro has really helped a broad-base of industries report growth so far this year.

So, in Europe, we saw growth excluding large orders, factory automation revenue from Europe in Q3 grew double digits year-on-year in local currency and growth came from a range of industries, including automotive, pharmaceutical, food, and logistics.

Your second part of the question, Ben asked, the sort of duration that we expect the slowdown to last for. I think that's very difficult to call, but I would say, I don't think we see any change really in the environment or after Chinese New Year.

So I think we are in a period as our guidance gives you that impression that we're not optimistic about the near-term and I think we'll see how things progress as we move through the first quarter..

Okay. Thanks very much for the thorough answer..

Okay. Thank you. And our next question comes from Jonny Wright from Nomura..

Good evening guys. This might be going down kind of a dead end, but on the large projects when you're talking about the fact that there was none of these $2 million plus projects in the 4Q guide. I know you don't want to give much detail around the large projects.

Could you frame either what you might have expected three months ago in terms of large projects in 4Q or what a typical run rate might be for a quarter, without mentioning any specific projects, obviously?.

Yeah. So I think as we came through the first half of this year, we saw a lot of significant revenue coming from larger orders, specifically in the consumer electronics industry. And also we saw opportunities in our funnel of significant size and logistics.

And I think, we would have expected those to keep playing out into the second half of the year, but what we saw is generally projects got delayed for a variety of reasons, some of which included delays in product roadmaps, perhaps due to changes in company strategy or due to the availability of engineering resources and other priorities.

And in other cases, I think, we saw our customers trying to cut their spending, based on the environment that they saw. So, as a result, we went from significant revenue in the first half from those large kind of orders.

I'm not sure, I want to put a specific number on that, but then really drying up into much less than Q3, and as we said nothing over $2 million in Q4. And I think, that's preempting your second part of the question you might ask would be when do we think that's going to change.

And I think, it's the same answer I just gave Ben Rose, which is really not until after Chinese New Year at the soonest..

Okay, great. And given that comment and kind of the near-term bearish outlook, I think, you talked about the – still adding head count to support the business growth, but at a slower rate than before.

I mean, should we consider to – continue to think the SG&A goes up in 2016, or is this conterminously cost base in advance of a relatively tough year?.

Well, I think, it's – it's a little early to start giving guidance on 2016.

But, I would say in general, the Cognex is a growth business, even though this has been a challenging second half of the year, we're still going to report in the midpoint of guidance, we'll report mid-single digit growth for the year, after having grown on the order of 40% last year.

So, we're a company that believes in our technology, believes in our market, and believes in our growth prospects. So, we're going to continue to invest and develop the business, not try to cut our way to greatness as we go forward.

But, that said, yes, we're going to try to make sure that particularly our R&D spend, which for the first time in a while popped up over 15% of revenue is controlled within the rate of long-term revenue growth that we expect to see as the year plays out, and we'll be keeping an eye on those costs carefully as certainly through this period of slower growth..

Great. Thanks for your time..

Thanks..

Okay. Thank you. And our next question comes from Holden Lewis from Oppenheimer..

Great. Thank you very much. Perhaps, shifting over a little bit to sort of the gross margin question. I guess, in the absence of any sort of large orders in Q4 and in the absence of any SISD in the business now, I mean, it seems like that would be an environment that you would expect to see a higher than mid-70%s operating margin.

I mean, you're certainly reporting I think high-70%s on the factory automation business standalone before the split.

So, I'm just sort of curious why we're looking at that mid-70%s still instead of something closer to the factory automation norm in fourth quarter?.

Sure, Holden. Yeah. So, I think, as you pointed out with the sale of SISD, our gross margin target has been adjusted upwards to the high-70% range. The reported gross margin can move depending on a number of factors including volume, obviously, in this case, I think, as we see lower revenues, volume is important.

The amount of service that we provide to large customers, so we may have in the case of this year big deployments that we did earlier in the year, where we're now having service to support those deployments, which will be at lower than fleet average gross margin. And of course, the impact of currency exchange rates on revenue is another reason.

So, I would say, those are the main factors that we're forecasting or projecting gross margin to be lower than our current high-70% target..

Okay. But forex is fairly stable here sequentially over most of the last three quarters or four quarters. And where we're sort of several quarters now beyond the placement of those orders in Q2.

So, is it primarily just a volume issue and those other two things are sort of out in the wash or is there something that's really sort of lingering and dragging on for some reason?.

Yeah. Yeah. So, I think, a number of factors, one includes volume, as you said, I think also mix in all of our products.

So, in quarters like in Q2, we had a higher amount of software specific deployments, which come with higher gross margin, and then that amount of service revenue – the amount of service revenue that we report can also be dilutive, right. So, I would say these are sort of quarter specific in nature, and that's what you're seeing in Q3 and Q4..

Okay. And then just as my follow-up, the – so I clearly think the slowdown at an increasing rate as we've gone into Q3 and then into Q4. And I know, you don't guide for 2016, but I mean normally you expect that the first quarter 2016 revenue would be somewhat below the fourth quarter revenue from the previous year.

Is there any reason that we wouldn't expect that to happen, I mean, do you think that the sort of the Chinese New Year passing would have that big an impact or have these logistics customers said, look, we just need to turn the calendar then we're spending, or is there any reason to think that the issues that you're citing in Q3 and Q4 are really going to be relegated to this, so does this feel like a broader longer economic slowdown to you?.

Yes. That's difficult to call. I would say we're cautious based on what we're seeing right now, and particularly the news out of China in terms of that market. So, I think, when is that going to turn and how does that relate around the – that period of Chinese New Year is difficult to say.

So you could have said, what could turn it, yeah, sure, we could see improvements in some of our end user markets, and we could see larger orders hitting and coming in, but I think we're not currently feeling that it's an environment to expect that based on the kind of macro-envelops that we see. But it's too early to be giving you guidance on Q1..

Okay. Great. Thank you, guys..

Thank you..

Okay. Thank you. Our next question comes from Jim Ricchiuti from Needham & Company..

Rob, I was wondering, how would you characterize the ID business, overall the ID products business in the quarter?.

Yeah. So, our ID products business continues to perform well. I would say, I would characterize it as performing very well in Q3 even with the delay in large logistics orders. So, I think, in – within our ID, we have our base business in ID and then we have logistics. The base business is performing very well at the moment.

And logistics less well in the Americas based on deferred orders – deferred large orders that we've seen. And we've launched a number of very important new products in our ID business.

This year, we launched the DataMan 150/260, which reasserts our technology leadership in the mid-range fixed-mount part of our business, which is very significant, it's really our core market. So, we continue to be optimistic.

Now, in logistics, some projects that we expected to see this year in the Americas were pushed out due to customers juggling multiple priorities in advance of that peak shipping season. But in Europe, traction has come along nicely.

There's a large long-term potential in China as well for logistics that continues to make us very optimistic about the long-term prospects for ID. So, generally, we continue to be very positive about our ID business..

Is the base business growing 20% or better?.

I don't think, we give specific outline on that, but I would say, it's definitely performing at our expectations right now even in the current environment..

And, with respect to the projects that were pushed in the Americas, are you getting any further sense from those customers, how they're looking at potentially 2016 in terms of getting reengaged in that process?.

I think their need for what we do is still considerable, and certainly we have lots of engagement with those large customers. So, we believe that – we're still very optimistic about the long-term prospects and the prospects as we go into 2016 for our logistics business in America..

If you look at the logistics business in the Americas, we know you have your core customers that you've been selling to. And then, potentially some new e-commerce or traditional brick-and-mortar retailers that are expanding into doing more e-commerce.

How do you look at that market opportunity, are you seeing some of those newer customers hesitant or are they still do you feel moving forward with plans?.

No, we see sort of those base of new customers coming in replacing $50,000 to $200,000 orders with us. We see plenty of new customers coming over to Cognex. And, these are names that are all famous to all of us, particularly in the retail space. So, that part of the business looks strong, and developing well.

I think, where we've seen – where we've seen – been disappointed in our growth this year has been more around the very large customers that we've been bringing along and have seen business from in prior quarters, where they seem to have been deferred or delaying projects based on some of the issues I outlined..

Then, one final question if I may, just on the new product front, looks like you're keeping a pretty healthy level of R&D? It's early yet, but, how active a year is it going to be in terms of new products 2016?.

Well, we – first of all, you're right, this year has been important, and we've introduced some really breakthrough technology in terms of PatMax RedLine.

So, much of Cognex's technology is based around machine vision tools, and PatMax RedLine is the feature-location technology that re-invents PatMax with tremendously more speed and performance on the same hardware. So, that's exciting and it's the kind of tool that you see from Cognex and that's really outperforming everybody else.

We've also introduced two important hardware platforms In-Sight 5700 series, which is a very high-performance, high-resolution product range, and then our new DataMan 150/260.

But, you're also asking about next year, again it's early to talk about next year, but we have very full and vigorous pipeline of new technology and products we're bringing to market, and I think, you may also hear us talk about even some new markets we'll be entering next year to broaden our served market.

So, I think, as you'd expect from Cognex, the technology leader and the company that's investing most in this space, we got a pretty fulsome pipeline that we'll be looking forward to sharing with you next year..

Thank you..

Thank you. And our next question comes from Richard Eastman from Robert W. Baird. Richard, please go ahead..

Very good afternoon. Robert, could you just speak to a one minute or two minute about maybe your sales in China.

Can you just, with maybe two buckets or three buckets, just give us a sense of where your end market exposure is there? So, in other words, in China, is auto approximately half the business or more, or – just curious about couple other end markets that you have exposure to there?.

Yeah, sure, Rick. So consumer electronics traditionally is the – is Cognex's largest market in that space. So, electronics broadly including contract manufacturing, electronic components, and consumer electronics, in general. So that would be our largest market, and that would be – let's broadly say approximately half of our business.

And then, automotive is the – our second largest market. We've seen a lot of growth in the automotive space and that might be approximately a quarter of our overall business there, and then the rest is very broad based.

And particularly we see a lot of growth more in machine builders serving a broad range of industries in all kinds of markets like food and consumer products..

Okay.

And when you go to market in China and you have the auto exposure there, are you going to market through the traditional robotics or automation vendors or are you basically marketing your products in China directly to the end user?.

All right. So domestically in China, we go to market much as we do everywhere else in the world, which is we go – we have a direct sales force that sells to strategic accounts and large businesses. And then we have a pretty well-developed network of distributors and machine builders.

And broadly speaking, the direct is a little less than 50% and the rest of the business is a little more. The partners are little more than 50%. And that gives us great coverage across what is a very large market..

Okay, okay. And then just as we – again, not to be specific on new products and opportunities for 2016.

But are we – how do you feel about, as we move into 2016 and through 2016, some of the new end market opportunities or product opportunities that we've been talking about for few years like medical, maybe on the food side, can they drive some noticeable growth, I mean, points of growth next year.

Are we – do we have enough traction here late in 2015 to maybe deliver on some of these other opportunities in 2016?.

What I would say whether we really outperform on growth next year is likely to be more a function of how successful we are within IT and logistics broadly, right, and how successful we are in electronics broadly based on some very significant opportunities that we see in those markets.

We're making a lot of progress in terms of percentage growth rates in some of those markets that you cited. We can have multi-million dollar customers in markets like food and pharmaceuticals.

But in terms of really moving the needle I would be cautious about saying that we're going to see a breakout year in those types of markets that will be noticeable on a dollar basis to you. It's more of a broad base of business..

Okay. And just the last question, I'll toss this one at Dick, but I'm just curious, the accounts receivable number, it has come down sequentially, I think in the second quarter, the unbilled piece was rather large. Now we're – we didn't seem to disclose the unbilled.

But, is that tied to the tag end of your large customer? In other words, is the visibility on collections by year-end very high there, on the receivables?.

Yeah. You're absolutely right that the big amount in unbilled revenues at the end of the quarter was tied – at the end of the second quarter was tied principally to a very large customer. All of that was essentially invoiced in Q3, much of it has been collected, and we would except that all of it would be collected by year-end..

Okay, okay.

And, one thought, in the Q, there was a bit of a disclosure on a really, really small acquisition, this Manatee Works, just prospects there or potential there, or interest there?.

Yeah. So, right, we did make a small acquisition in Q3. Manatee Works is a leader in the space for barcode reading on smartphone platforms. Great technology, wide customer base in terms of a network of systems integrators and solutions that they provide.

So, I think, plans for that business complement broader technology end market where if it's underway at Cognex, it's too soon to say more about that. But, yeah, a nice, but as you rightly say small acquisition for us..

Understood. Okay, thank you..

Thank you. And our next question comes from Joe Giordano from Cowen. Joe, please go ahead..

Hi, everyone, thanks for taking my question.

When you look today at Cognex versus maybe six months ago on the heels of the large order, given the environment today, is there anything incremental that you – that you've identified internally that you want to focus on or maybe where you want to pinpoint allocation of capital? Anything around those lines?.

Hi, Joe. I would say, at Cognex, we have a pretty well thought through long-term growth strategy or set of strategies, and I would say those have not broadly changed over the last six months. And we're very well connected to our customers, who are the most sophisticated manufacturing technology companies in the world.

So, I think, we have a good understanding of where they want to go and the importance of vision to their roadmaps and what we bring to the party.

So, we're not likely to be changing based on shorter-term macroeconomic headwinds or other things that are going on, but we are trying to be nimble in terms of where – who the winners are and who is losing share.

So, in some cases, we're certainly making sure that we're focusing our efforts passed in different regions or with different customers who we think have the highest potential and the highest appetite for our technology.

But in terms of what the growth platforms around IDE, around kind of China and the long-term automation prospects there around some of the opportunities we see in consumer electronics and automotive. Those clearly haven't changed and nor do I think will change over the next few quarters..

Great. Thanks for that.

Are you getting a sense that any of your customers are maybe trying to like retool some of their existing lines almost in essence kind of recycling what they have in attempt to avoid near-term spending or is it more of just a, we're just holding back and this is kind of truly more of a push out?.

Well, I think we're managing this business over many years. You can see that there can be times when customers are more focused on retrofitting their existing lines....

Right..

...and other times when they're building new lines for sure. I would say, in our big end-user markets like consumer electronics or automotive, we don't really see a change in that environment over the last few quarters.

That tends to be more of a long-term strategy about when they're really introducing new innovative products or technologies and when they are in a year perhaps when they're more in a sustaining mode. So I think that's well known to us and I don't think there's a fundamental change in the dynamics of what's going on..

Okay. Fair enough. And then last one from me.

Is it a fair statement that 2Q would at least be the only Q of this year so far that contains an order with a magnitude that could potentially be disclosed on a 10-K? Anything like outside of a normal kind of run rate type size?.

The 10-K discloser isn't related to any particular quarter. It's related to any customer who purchases from us where the revenue would exceed 10% of total revenues for the year.

Sure..

And this particular customer did in fact purchase from us in Qs one, two and three, but the most significant amount of those purchases were in fact in Q2..

Okay. Great. That helps. Thank you very much..

Okay. Our next question comes from Jonny Wright from Nomura. Jonny, your line is open..

Hi, guys, (37:14).

Can you give an update on capital allocation strategy given the uptake in the share repurchase this quarter and the new authorization?.

We in fact have been consistently buying back shares over the last couple years. We want to make sure that we buy back all of the dilution that results from stock option grants which are a very important part of our total compensation package here at Cognex and which we feel very strongly is something that we need to continue to do.

We also took advantage of a lower price during the quarter and took an opportunistic approach relative to buying back some of our shares.

Given that we were left with only $16 million of authorization left and the board felt it appropriate to increase that level by authorizing an additional $100 million for purchases as deemed appropriate in the future..

Jonny, just to expand on that answer, I think our number one priority for capital allocation is acquisitions, but we're highly selective in how we think about those. So we really want to buy only really companies that we consider an extraordinary fit and of high quality that we can integrate into the business of Cognex.

So there are companies that are on our shopping lists that are not necessarily actionable, but if they were and when they are that's a priority for capital allocation. Dick talked about share repurchases and of course we continue to pay a dividend. So that's a little bit more on that..

Thanks.

I mean any sense of like a max net cash balance you guys would want to run or is it just really going to be the opportunities on the buyback and see what acquisitions come along?.

Yes. No, I don't think there is any ceiling on our capital. I think we consider our cash to be the consequence of our success, so we don't apologize for that. We think it does give us a lot of strategic options going forward..

Great. Thanks, guys..

Okay. Thank you. And our next question comes from Holden Lewis from Oppenheimer..

Thank you very much. You had called out sort of Europe, and specifically European automotive, as being fairly healthy.

I guess along the lines of conversation we just had on China, can you sort of give us a sense of how big automotive is in Europe, what your exposure might be to Volkswagen, and though things are strong now, are you seeing some of the issues in that industry over there, perhaps sort of causing that strength to fade.

What kind of visibility do you have on that?.

Yes. Holden, I spent some time – a few days with the European sales team last month and kind of looking at that. We have had a lot of strength and success in the European automotive business, which last year was our second largest European market after consumer electronics.

So in that market, I would say what we do see is some caution creeping in among the industry in terms of their plans, coming off of a period of very high growth.

It's difficult to say what degree that's kind of the impact of the Volkswagen situation, or it's something more broadly, whether it also relates to China and the excess capacity that exists in China with a still significant manufacturing in Europe of luxury vehicles is for China, right. So there are those aspects going on.

I think an important thing to realize about our business with automotive is the majority of it is really with Tier 1 automotive suppliers, not necessarily end-user brand owners. And those Tier 1 suppliers can be affected by end users significantly.

So it's sometimes a little difficult to call whether one particular brand owner's problem will translate into less or more business for our Tier 1 customers.

I think another thing to bear in mind is that sort of quality scandals and problems can often lead to good growth opportunities for Cognex where whether there's problems around manufacturing quality or such as the airbag problem we saw earlier in the year, that often can lead to a lot of opportunity for our machine vision to be installed.

So, I would say, we're cautions about what's going on in Europe and in automotive, but we still think the long-term prospects are good, and it's a little bit difficult to see how that plays out over the next few quarters..

Okay. Thanks.

And then lastly, can you talk a little bit about the month-to-month cadence during the quarter? Is this a case where obviously when you first gave guidance you were into the quarter and things looked good the first couple months and then it was that big last month of the quarter that was weak or did you see sort of just a softening as you went kind of thing..

I would say, we've seen a softening as we've moved forward through the year in general, right. So that's what I would say (42:46)..

Okay. Great. Thanks, guys..

Thank you. And we'll take our next question from Jeremie Capron. Please go ahead Jeremie..

Hi. This is Grace Lee sitting in for Jeremie Capron. I have a question regarding the operating expenses guidance for fourth quarter. You're guiding for 5% increase quarter-over-quarter, and that seems to put the operating expenses the highest in the fourth quarter in the past few years.

Could you give us a color around what leads to a increase in operating expenses for Q4 guidance?.

The guidance we gave was 5% of over Q3, which I don't know, so I think that's what I would point to. Probably it does mean it's a higher Q4 expenses than we've seen in prior years. I would say that, Grace, we consistently invest in innovation and in our sales channel to ensure that we're well-positioned for the long-term.

Right now we do have a stronger focus on discretionary cost management and productivity. Some of the savings that we saw in Q3 were around employee vacation times and lower bonus and commission accruals. And we wouldn't have the benefit of all of those in Q4. So that's the sequential color on that overall.

I think the overall color would be, we consider ourselves a growth business. We're still growing this year. We expect to go on growing, whether it's at the very fast growth rates we've shown you in recent years or the slower growth rates we currently are showing.

Our view of the long-term growth prospects at Cognex for our factory automation business continue to be around 20%. So as long as we consider that's the case, we're going to be investing with that price in mind, and that's our strategy..

Okay. That's very helpful. Thank you..

Okay. Well, I'm showing no further questions in the queue. I'd like to turn it back to Dr. Shillman for any concluding remarks..

Thank you. I'd like to wrap up. We wish we had reported record-breaking results earlier tonight for the third quarter, but we didn't and it looks like we won't be breaking many records for the next quarter either.

Although our growth may be slow, we are confident about the future of machine vision and of our company, which continues to be the world market leader in our business, and we will persevere just as we have during pass slowdowns. We will continue to work hard, play hard and move fast, so that we'll be ready when conditions improve.

I want to thank all of you again for joining us tonight. And we look forward to speaking with you on our next quarter's call. Good evening..

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