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.

Ben Z. Rose - Battle Road Research Ltd. Jim Ricchiuti - Needham & Co. LLC Robert Burleson - Canaccord Genuity, Inc. Richard Eastman - Robert W. Baird & Co., Inc. (Broker) Grace Lee - CLSA Americas LLC Tristan Margot - Cowen & Co. LLC.

Good day, ladies and gentlemen, and welcome to the Cognex Fourth 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. And as a reminder, today's conference is being recorded.

And now, it's my pleasure to announce your host for today, Chief Financial Officer, Dick Morin. Dick, please go ahead..

Thank you, and good evening, everyone. Earlier today, we issued a news release announcing Cognex's earnings for the fourth quarter of 2015, and we also filed our Annual Report on Form 10-K. 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..

Thanks, Dick, and hello, everyone. I'd like to welcome each of you to our year-end call for 2015. As you might have seen in the news release issued a few minutes ago, we reported our fifth consecutive year of record revenue from continuing operations.

We also reported the second highest annual net income and earnings per share, but that's the bright part of the story. When you look at it more carefully, the second half of 2015 was substantially slower. That slowdown has continued, and therefore, unfortunately, our prospects for Q1 of 2016 are lower than we had hoped.

Right now, I met our R&D officers in San Diego, California. Everyone else on the call is at our Natick headquarters.

For details of the fourth quarter and 2015, I'm going to hand the microphone over to my partner, Rob Willett, our President and CEO, and I will listen intently and be available at the end of the call to answer any questions that you might have of me. Rob, the microphone is yours..

Thank you, Dr. Bob. Good evening, everyone. Looking back at 2015, we are pleased that revenue increased over a tremendous year in 2014 that many thought would be difficult to beat. Growth came primarily from Greater China, where factory automation revenue set a new annual record.

The largest contributors from an industry standpoint were consumer electronics and automotive. Good progress was made on our growth initiatives. Demand for Cognex's 3D displacement sensors, while still small, grew significantly over 2014. Penetration at the life science market began to bear fruit.

Our first customer purchased about $3 million of Cognex Vision in 2015 as their machine containing our Advantage engine was introduced to the market. We see continued progress with other potentially large life science accounts that are designing us into their equipment.

Important new products and software tools were introduced for both our In-Sight and DataMan product lines in 2015. The most important product launch of the year was our family of next-generation DataMan fixed-mount ID readers. The DataMan 150/260 and 360 high-performance readers run the latest Cognex software to achieve the highest possible read rate.

They extend our product leadership in the mid-ranged fixed-mount barcode reading market. PatMax RedLine furthers Cognex's leadership in vision algorithms for pattern matching, a critical first step in most vision tasks.

PatMax RedLine runs on three new 5 megapixel In-Sight Vision Systems, delivering higher resolution at extremely fast acquisition speeds for demanding vision applications. Also, new to our In-Sight Vision Systems family is the In-Sight 2000 sensor, a highly competitive product for simpler vision applications.

We expect its ease-of-use and affordability to expand the market for our products to customers who are more price-sensitive. During 2015, we exited the market for surface vision by selling the Surface Inspection Systems Division.

In addition to realizing an after-tax gain of $78 million, the sale sharpens our focus on our core business, where we see stronger long-term growth potential. In summary, 2015 was a good year for Cognex, and I'm proud of our accomplishments. However, I'm disappointed that second half revenue was not as high as we initially thought it would be.

Several factors contributed. As you all know, the entire global economy appears to be slowing; more specifically to us, the large projects that we expected from consumer electronics and logistics customers were pushed out, because of changes in their product roadmaps and demands on their engineering resources.

Demand in the Americas industrial market was weak, and the strong U.S. dollar reduced our growth rate by 5 percentage points. Revenue grew 11% in constant currency, but increased only 6% on a reported basis.

The lower-than-planned revenue for the year combined with continued investments in engineering and sales brought our operating and net margins below our targeted range. The outlook for 2016 continues to be uncertain, but nothing we see changes our view of the long-term potential for machine vision.

It's important to note that our investments to bring new technology to market and to help large customers implement sizable vision projects remain intact. We expect margins to improve over time as our investments drive revenue growth. Let's turn now to details of the fourth quarter.

Total revenue was $97.8 million, which was modestly above our expected range. Several reasons contributed to that, including the completion of certain projects before year-end. In factory automation, revenue was $93 million and was flat year-on-year on a reported basis, but up 5% in constant currency.

Looking at factory automation trends from a geographic perspective, growth from Asia, excluding Japan, continued to outperform our overall business. Although the growth rate has slowed from earlier in the year, we are confident about long-term prospects in Greater China.

In Japan, revenue from the region's factory automation market showed modest improvement both on a reported basis and in constant currency. In the Americas, spending, by U.S. manufacturers in most industries we serve, continued to disappoint. Q4 reflected the first year-on-year decline in Americas quarterly revenue since Q3 of 2009.

And factory automation revenue from Europe declined significantly year-on-year due to the slower economy and the weaker euro. In the semiconductor and electronics capital market, revenue was $4.7 million in the fourth quarter, down 8% year-on-year. Demand from semi follows the market's cyclical trends.

Our expectations for growth in this small piece of our business continue to be the low. In regard to operating expenses, we continued to invest in our business, but at a slower rate than in recent quarters. RD&E and SG&A for the fourth quarter totaled $55 million, up 5% on a sequential basis, as expected.

Incremental costs related to additional engineering resources, new product development activities and our sales and support organization. Turning now to our outlook, we expect revenue for Q1 of 2016 to be in the range of $91 million to $94 million.

Unfortunately, even the high-end of that expected range is below the $101 million of revenue we reported for Q1 of 2015. Unlike last year, the tone of business is more muted today. You can see that reflected in our starting backlog of $27 million, which is substantially lower than the $36 million we had in backlog at the beginning of 2015.

Gross margin for Q1 is expected to be in the mid 70% range. Operating expenses are expected to increase by approximately 5% year-on-year, mainly due to our investments in engineering. The effective tax rate is expected to be 18% excluding discrete tax items. Now, let's open up the call for your questions. Operator, we are ready to take questions..

Okay. So we will take our first question from Ben Rose from Battle Road Research. Ben your line is open..

Thank you. Thank you and good evening. In the press release, Rob, and in your prepared remarks, you noted the slowdown in industrial markets, implying that most markets had slowed down.

Could you speak specifically about the automotive market both in China and around the rest of the world? And also, whether any of the verticals that you do serve or holding up better than others in this environment?.

Yes. Hi, Ben..

Hi..

Yeah. So automotive is a large market for Cognex. And it had a very strong year in 2015. It is our second-largest vertical market representing more than 25% of our total revenue.

I think what we saw as we moved through the second half of the year is that although business remains at a high level, spending becomes slower, and our outlook is more cautious. And it's difficult, frankly, to predict how the market will play out over the next few quarters.

Automotive customer roadmaps are quite lengthy, going out normally around three years that we're involved with. Putting the plan shared by our larger customers, we expect continued growth from automotive over the medium- to long-term, but certainly, we are seeing a slowdown in the nearer term. You asked about other markets.

I think we expect our consumer electronics business to grow this year. We see a lot of good activity in that space that we think is positive for us as we move into the year. And I would say, overall, we do expect some growth to Cognex, but there are no particularly strong markets.

I would say, overall all of our markets they are showing some general weakening as we move through time, not anything that's particularly standout in terms of a strengthening trend..

Okay. And then, if I may, just one follow-up question. I noted in the 10-K that your largest customer in 2015 was up from 2014 as a percentage of sales.

And given that particular company's intention to substantially increase their capital expenditures this year, do you think that Cognex will participate in that spending?.

So as reported in our Form 10-K that customer represented about 18% of our revenue in 2015, up from 16% in 2014. We feel our relationship with that customer is excellent.

And they and many other large manufacturers see the value of our vision technology and our ability to solve problems, but it's very limited, really under legal obligation what I can say beyond that only that we've had a positive relationship and we see large consumer electronics opportunities continuing for Cognex with, I hope, multiple players in the industry over time..

Okay. Thank you. Thank you very much..

Okay. Thank you for your question. We'll take our next question from Jim Ricchiuti from Needham & Company. Jim, your line is open..

Thanks. Good afternoon. Just wanted to ask about the planned increase in engineering expense in the quarter of up 5% year-over-year. In the past, when you've made investments like that, it has been in anticipation of at least in the more recent past, projects – larger projects.

Is that the case here that you anticipate some potentially larger deals in the near-term?.

Hi, Jim. I think you're right. You see an increase in our engineering expense for Cognex. And it's really for two reasons I would say, one is that we have some very exciting technology that we're working on developing and we'll be bringing to market over the coming quarters.

And regardless of what we see externally, we're very committed to bringing that to market and we think it's key to the future of the company. The second is, though, that we have been investing more in engineering resources to support larger customers. And generally, those tend to be in the consumer electronics and logistics space.

And certainly, we've gone on investing in those areas and that's driving up some of our engineering expense in the near term, because we do expect to see substantial revenue from those types of opportunities here in the coming quarters..

Is this something that we should consider could be several quarters of higher engineering expense? Or could the engineering outlays be lumpy over the course of 2016?.

Well, I think, overall, we target engineering spend to be between 10% and 15%. And I think in quarters of lower our revenue, you can see it bump-up over that higher level as you've seen. And then, in some cases, where we see revenue really high on a percentage basis, it can fall.

But I do think you're seeing engineering expenses run higher at the moment in anticipation of some larger opportunities. And as those come to market, I think you'll see our engineering spend reduced as a percentage of revenue. And then, I think, obviously, a significant part of that engineering increase can be around supporting large customers.

And as we see those large customers come through as traditionally they have in quarter two or quarter three, you can see spend continuing behind those. But as a percentage of revenue, probably lower than you've seen in recent quarters..

Okay. If I may, one final question on the logistics market. We go back to last year, it looked like you were anticipating some larger orders in that market; sounded like multiple customers, that didn't play out.

Would you anticipate that some of those orders could come to fruition this year in which case you would see deliveries in Q2, Q3? What's the pipeline like with your logistics customers?.

Yeah. I would say our journey into the logistics market continues to proceed well. We made progress during last year, gaining traction in Europe. I'm seeing very significant growth in revenue there and winning systems integrators who support a broader range of logistics customers in the U.S.

There are substantial projects with large logistics customers in our sales funnel. And we're off to a good start this year with one significant order set for delivery in the first half, already booked.

We're optimistic about growth in the Americas logistics market, following a difficult year last year where we didn't see, as you pointed out, larger orders from some of our previously larger customers that we had expected. We see the potential for those to come in in 2016..

Okay. Thank you..

Okay. Thank you. And our next question is from Bobby Burleson from Canaccord Genuity. Bobby, your line is open..

Hi, Bobby..

Hi. Thanks for taking my question. So I was just wondering in terms of the consumer electronics growth you guys are expecting, and it sounds like you're gearing up for some potentially larger projects.

I'm wondering if the customer base for those types of projects is expanding somewhat this year, where you're going to be working on larger projects from multiple consumer electronics customers?.

So I think it's important to understand Cognex is the world's leader in sophisticated vision technology, which is central to automation in advanced production of consumer electronics. So you can pretty much assume that most, if not, all of the major consumer electronics manufacturing processes that are going on, mostly in China, involve our products.

So we are in with those customers. The question is to what degree they're rolling out more ambitious plans with vision, and to what degree they're utilizing our technology in some of the more difficult and demanding applications and they're gearing up capital spend around automation.

I think we've made progress in recent years, where we're seeing larger deployments of vision at customers. Obviously, we have a very large customer in that space, then, we have other large customers as well. They have the potential to invest very heavily in machine vision and automation. And we're making progress.

But it's difficult to judge necessarily which quarters those opportunities will come in and how significant they'll be..

Okay. Great. And then, you mentioned earlier that consumer electronics should grow for you this year, and overall, you're expecting growth even though some – all of your verticals are somewhat subdued.

And I'm wondering just logistics demand this year or growth logistics versus consumer electronics, are you expecting more growth out of logistics versus consumer?.

Well, logistics percentage-wise, we would expect significant growth. We've said in the past that we expect over the long run our ID business to grow 30%. Obviously, in the current market conditions, that's not likely to happen, but that we've said logistics will grow faster than our ID market overall.

So it's definitely a market where we see very significant opportunities for large percentage growth. But in terms of dollars, our consumer electronics represents more than 25% of our revenue, and therefore, growth in consumer electronics can add more on a dollar perspective to the Cognex top line..

Okay. And then, just one last quick one. In terms of gross margin, is there any update on whether or not there is much of a difference between the gross margins for consumer electronics, large projects versus some of these logistics projects that are potentially ramping? Thank you..

I mean, it can depend on the project really. And I think we can report very strong gross margins in both those fields. So I wouldn't assume that our gross margins are higher in one particular market or type of deployment than another..

Okay. Thank you..

Okay. Thank you. And our next question comes from Rick Eastman from Robert W. Baird. Rick, your line is open..

Yes. Good afternoon.

Robert, when we look at these engineering investments in support of the CE business, can you explain maybe is there much leverage there? I mean, is this – add a field engineer per x-million-dollars a potential? I'm maybe a little bit surprised that we can't leverage the investments we've made to-date relative to our near-term outlook..

Right. For some of our larger customers, particularly in consumer electronics, but also in logistics, they have very sophisticated requirements and they need to scale up quickly, right. And in order to do that, it does require significant engineering resources and they look to vision expertise to help them deploy that.

So from our point of view, from engineering spend, that's a lot of where we're investing. We're investing generally based on future opportunities that we see in those markets, right. And then, there is a support factor, which is less sophisticated, but does involve application engineering-type support for ongoing deployments.

And there's good potential for productivity improvement where we may have more engineers initially, but as we and our customers get more confidence about that, we're able to be more productive. So I would say, engineering investment around large customers does have leverage.

And generally, where you see us investing more, it's around future opportunities, and perhaps, new technologies that we're working with them to deploy. And then, there is a productivity gain on the backend where we can deploy more systems with fewer people..

Okay. And then, also did the math on the large customers while the 18% and the 16%. And was somewhat curious, is the dollar amount just works to $81 million versus $68 million.

And I'm maybe a little bit surprised at the dollar amount in 2015 exceeding 2014's, but was there any sizable amount of that revenue recognized in the fourth quarter? Because I think coming into the fourth quarter, the thought was there was some trailing service revenue that might be accounted for, but was there a substantial chunk of that large customer business that was recognized in Q4?.

I don't think we can comment on that specific quarter revenue.

Dick, did you want to comment?.

Yeah. We're limited as to what we can say about that particular customer. But I can say this that there was – most of the significant revenue occurred in – most of it was in Q2, and then, following in Q3, but no big tail in Q4..

I see. Okay. Okay. And just maybe two last questions. One is on China, could you just maybe be a little bit more specific in terms of the China – how did China perform in the fourth quarter in constant currency? And how did it perform for all of 2015? Just trying to gauge the slowdown there..

Yeah. Yeah. I think as I mentioned revenue from China was up more than 40% from 2014, but we definitely saw us slowing going on in Q4, still growing, but slowing to roughly around half that rate in general.

I think when we look at our business in China – not just last year, but in any year, generally, Q1 and Q4 are slower and Q2 and Q3 are stronger, right. But I think if we look back year-on-year, we would have still seen – we did still see growth in our business in China in Q4, but at a slower rate and we see that rate slowing..

Okay. And just the last question.

What would be the forecast? Can you help us a little bit with the forecast for options expense in 2016 relative to 2015? What would be the percent increase?.

That's difficult to come up with at this particular point since we haven't granted the annual options yet, and it'll depend a lot on what the prices on the date that the options are granted.

I would essentially say that because the annual grant, the exercise price will be lower than it was last year, I would expect that it would be relatively flat with maybe a slight increase..

Okay, all right. Fair enough..

Okay. Thank you..

Okay. Thank you. So we'll take our next question from Grace Lee from CLSA. Grace, your line is open..

Hi. Thanks for taking my question.

I was wondering whether you can give us an update on life science in terms of design wins and if this is already a meaningful contributor to the revenue?.

Yeah. Hi, Grace..

Hello..

So we've been focusing on this life science market for Cognex technology for a number of years now. And we think it's a very good market for Cognex, because these machines generally stay in the market and are produced for seven to 12 years, right. But, however, it's a long design cycle to get specified in.

So we were pleased last year to see our first real major customer deploy product into the marketplace and purchase approximately $3 million. We do have other smaller customers in that space. The revenue in that market for us is still not very large, certainly, less than $10 million. But we do believe it will be a larger contributor in future years.

I think we can expect it to ramp in terms of like an S-curve where we're still pretty early on. And we think we can see as more and more customers deploy our product and more and more have our engines in their machines, that we should see it ramp nicely over the coming years. But it's still really not particularly significant..

Sure. Thank you. Another question was on the gross margin.

So in light of potentially incoming larger orders from consumer electronics, how should we think about the gross margin trajectory over 2016?.

Yeah. I mean, our gross margin target is in the mid-to-high 70% range. And I think we've seen some dilution to gross margin mostly around currency in the last quarter. But I think we're holding to that idea that over the balance of the year we're still targeting the mid-to-high 70% range.

You shouldn't assume that large deployments dilute our gross margins. They don't necessarily do that. And sometimes when we're deploying more technology, we can see higher gross margins in some of those larger customers..

All right. Thank you..

Okay. Thank you. I'm showing one final question at the moment coming from Joe Giordano from Cowen & Company. Please go ahead, Joe..

Hey, guys. This is Tristan for Joe today.

If I could just go back and ask one more question about your largest customer, how would you address the concern that some people may have regarding the increasing importance of that particular customer to your business?.

Hi, Tristan.

So your question is how would we address the concern about the size of that customer?.

Yes. The relative importance that it is gaining to your business..

Well, I would say, as I mentioned, we work with some of the most sophisticated manufacturing companies in the world and we learn a great deal from working together with them. And so it certainly enhances our business to work with large customers. I think that we bring a lot of value. And we're not a component supplier.

It's important to understand that we're a supplier of enabling technology for automation. I would say, if one goes back over 10 years, 20 years with Cognex, we've had other large customers in the past, famous companies in the smartphone space that are in the semiconductor space.

And we've been pretty successful in learning and leveraging from those customers. And if they've gone onto grow, we've been successful to grow with them. And when market share and other factors have changed in the industry, we've been able to find new customers. So I think that's the part of being a technology supplier in automation.

And I think that's something we understand and expect to be able to face successfully in the future..

Okay. This is helpful. And then, going back to the guidance of Q1 that you have on revenue.

Does these include any large orders – those over $2 million or is it more of a run rate level?.

I think you should think of it more like a run rate level. I mean, it's possible we may have some orders that turn into more than $2 million of revenue during that period.

But when you think about large quarters and where large orders have a significant impact on the quarter, that's more likely to happen in Q2 and Q3 at this point in the development of our business and not meaningfully in Q1..

Okay. Great. And then, one last quick one. If you could just update us on the penetration of your displacement sensors..

Yeah. So we see the 3D displacement sensor market provision as one significant potential for Cognex. So we see the market as a $200 million market. And we see ourselves as a very small player in that market. We might have an approximately 5% share today, but growing very quickly.

And we have some exciting plans in that space over time, but still very small..

Great. Thank you..

Okay. Thank you. And I'm showing just one final question coming from Rick Eastman from Robert W. Baird. Rick, your line is now open..

Yeah. Robert, I was sifting through your end-market commentary. And there was just – you had made the comment about most of your end-markets slowing.

And I'm trying to reconcile, is that a statement on the consumer electronics market as well as your other markets? I think you lump them together with auto, and I'm just trying to get a sense of more of the consumer-driven markets, are they still primed to grow some or?.

Well, as I said, I do expect Cognex to grow this year. And I think we can expect slower growth from some markets probably automotives. It's going to grow but less quickly. I think consumer electronics, it's early in the year to say whether and how much that will grow. But I think we see a lot of potential for growth in consumer electronics.

But I think my comment earlier really related to a declining rate of order growth that we saw through the back-end of the year and into Q4. And I would say that level of activity and spend is pretty muted at the moment..

So the growth – the potential to grow in 2016, in theory, would come out of logistics ID products and consumer electronics; those would be the best prospects to drive growth for the year?.

Yes. And in addition to that, some of the new markets we've been getting into such as 3D. Life sciences also helping with growth, and then geographically, although growth has slowed down from the 40% growth we saw last year in China, we do expect China to be a meaningful contributor to growth even in its current economic state..

I see. Very good. Okay. Thank you..

Okay. Thank you, ladies and gentlemen. That does conclude our Q&A session for today. I'd now like to turn it back to Dr. Shillman for any concluding remarks..

Dr.

Bob, are you on mute? I'm wondering?.

How about now?.

Yeah. Now we can hear you..

Sorry about that, everyone. Yes, just to repeat, we had a very, very good quarter, record quarter in revenue and in earnings, but the growth has slowed down. Nevertheless, we've been here for a long time. We intend to continue to pursue the year. The company is 35 years old and still acting and performing like a young agile company.

We have many engineers working on very exciting projects that have not yet been announced. And we fully expect that to continue to be the leader in this very important field and to continue to impress both our customers and our shareholders. We'll talk to you again, and hopefully, report to you better results than even we expect for Q1. That's it.

Good night..

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