John J. Curran - Cognex Corp. Dr. Robert J. Shillman - Cognex Corp. Robert J. Willett - Cognex Corp..

Jagadish K. Iyer - Summit Redstone Partners LLC Paul Coster - JPMorgan Securities LLC Joe Ritchie - Goldman Sachs & Co. Richard Eastman - Robert W. Baird & Co. Joseph Giordano - Cowen & Co. LLC Jim Ricchiuti - Needham & Company, LLC Robert Joseph Burleson - Canaccord Genuity, Inc. Karen K. Lau - Deutsche Bank Securities, Inc. Ben Z.

Rose - Battle Road Research Ltd..

Good day, ladies and gentlemen, and welcome to the Cognex First Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and answer session and instructions will follow at that time. As a reminder, this conference is being recorded.

I'd like to introduce your host for today's conference, John Curran, Chief Financial Officer. Sir, you may begin..

Thank you and good evening, everyone. I'm John Curran, Cognex's new CFO. With me on today's call are Dr. Bob Shillman, Cognex's Chairman; and Rob Willett, Cognex's President and CEO. I'd like to point out that our earnings release and quarterly report on Form 10-Q are available on the Cognex website at www.cognex.com.

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

You can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the earnings release. Any forward-looking statements we made in the earnings release or any that we may make during this call are based on 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'd like to turn the call over to Dr. Bob..

Yeah. Thanks, John, and hello, everyone. Welcome to our First Quarter Conference Call for 2017. As shown in the news release that we issued just today, Cognex reported simply outstanding results for Q1 of 2017.

We set new records for first quarter revenue, net income and earnings per share, and we were highly profitable, reporting an after-tax margin of an incredible 34%, helped of course by significant tax savings. Right now, I'm in our San Diego office, and everyone else on the call is in our Natick headquarters.

So for details of the quarter, I'm going to hand the microphone back to my partner, Rob Willett. And I will stay on the line and I'll be available to answer any questions you may have for me at the end of the call during the Q&A. Rob, the microphone is yours..

Thank you, Dr. Bob. Good evening, everyone. I'm pleased with our start to 2017. Our results were significantly better than the already strong guidance we gave to investors in February. Demand from all major regions strengthened even more than expected, as we moved through the quarter.

We also made substantial progress by increasing the number of large customers in consumer electronics and logistics. As a result, Q1 revenue grew 40% year-on-year, and we reported operating margin expansion and an earnings increase. Revenue also grew on a sequential basis, which is contrary to our typical seasonal experience in Q1.

Our willingness to consistently invest in R&D is paying off. Since the beginning of the year, we introduced important new products that will help drive future growth. The new Cognex products hitting the market today are more powerful and easier to use than ever before.

We launched the new In-Sight 7000 Series, the next generation of our highly successful vision systems product line. We're pleased with the very positive early reviews the In-Sight 7000 is receiving from initial customers and distributors.

Incorporating our most advanced vision tools like PatMax RedLine, the In-Sight 7000 delivers market-leading performance, is simple to set up, and has flexible image acquisition capabilities for today's increasingly complex production processes.

We also introduced In-Sight Profiler, our first 3D product to leverage the successful In-Sight Software platform. In-Sight EasyBuilder is an intuitive interface that can be used to broaden our 3D customer base beyond the vision experts currently applying our 3D technology.

This significant launch brings Cognex 3D products to a larger audience and sets the foundation for future easy-to-use 3D products.

And we expanded our ID product portfolio with the DataMan 70 Series, delivering our latest barcode reading algorithms in a compact package ideal for mounting in tight spaces, the DataMan 70 is the highest performance value line reader available.

Supplementing our engineering efforts, we continued our recent activity in M&A, closing two acquisitions in April. First was ViDi Systems, a Swiss-based startup specializing in deep learning software for industrial applications.

ViDi's proven technology significantly improves our machine vision capabilities for defect inspection, which is increasingly important to our customers.

ViDi's tools are based on artificial intelligence in that they learn the rules for finding defects on the surfaces of discrete items, such as cellphone cases, by being shown examples of those defects.

ViDi not only brings to Cognex exciting technology that complements our industry-leading vision algorithms, it also adds to our team four highly skilled engineers with significant experience in applying deep learning to machine vision.

In April, we also completed the acquisition of GVi Ventures, a small solutions provider for common automotive applications. This acquisition helps increase our ability to serve some of our larger automotive customers with – automotive customers, with a product that leverages the power of Cognex VisionPro.

With that as backdrop, let's now turn to John for details of the first quarter..

Thank you, Rob. I have to say that I couldn't have possibly picked a better quarter for my first earnings call as CFO. The company is setting new records, and I should thank Rob and the Cognex team for making my job so easy this quarter. Without further ado, let's get into the numbers.

Our revenue of $135 million was $10 million above the top end of the range we gave to investors in February. Sales were better than expected across a range of industries, including consumer electronics and automotive.

Gross margin was strong at 79%, representing an increase over last year's Q1 due to manufacturing efficiencies resulting from higher volume. Total operating expenses for Q1 were $69 million, an 18% increase year-over-year.

We invested in engineering and our sales organization, absorbed costs related to four acquisitions we closed in 2016, and recorded higher commissions as a result of our revenue growth. Operating margin expanded to 28% from 17% a year ago. This increase reflects the substantial leverage that incremental revenue has on our business model.

Net income benefited from a $13 million discrete tax credit from the exercise of stock options during the quarter. Excluding all discrete tax items, earnings were $0.36 per share, which is $0.09 higher than the Thomson Reuters First Call consensus estimate.

This excellent result was driven by our top line performance and excellent fall through to the bottom line. Looking at factory automation, which is our largest market, revenue grew by 42% year-on-year. From an end market perspective, growth was led by consumer electronics and automotive. Geographically, all major regions increased over Q1 a year ago.

Asia was, by far, our fastest-growing region, with factory automation revenue doubling year-on-year. Our business in Greater China and the rest of Asia demonstrated exceptionally strong performance. Europe made a large contribution to our factory automation revenue growth, increasing more than 20% year-on-year.

And, finally, in the Americas, factory automation revenue increased mid-teens year-on-year, as the business improvement that began at the end of 2016 continued in the first quarter. Now, I'll hand the microphone back to Rob..

Thanks, John. In summary, Cognex had an exceptionally strong start to 2017. In regard to specific guidance for Q2, we believe that revenue will be between $165 million and $170 million. This range represents mid-teen growth year-on-year despite less revenue from consumer electronics.

Additional larger consumer electronics orders are expected to turn to revenue later in 2017, unlike last year, when large electronics orders were evenly split between Q2 and Q3. Gross margin is expected to be in the mid to high 70% range, somewhat lower than reported for Q1.

Operating expenses are expected to increase by up to 10% from Q1, as a result of our continued investments in engineering and sales. The effective tax rate is expected to be 18%, excluding discrete tax items. Now, let's open the call up for your questions. Operator, we are ready to take questions..

Thank you. And our first question comes from Jagadish Iyer from Summit Redstone. Your line is open..

Yeah. Thanks for taking my question, Rob and Dr. Bob and John. So, my first question is on large orders that you talked about on the consumer electronics. Is it just the timing? Or can you give some more color in terms of what kind of magnitude are we looking at compared to last year? And then I have a follow-up, please..

Sure. Hi, Jagadish. Welcome back to your coverage of Cognex. So I would say the underlying demand is very strong, particularly in Asia from consumer electronics devices that we're seeing. And it looks like our consumer electronics growth will be strong this year.

We don't discuss specific customers, but we have a nice portfolio of large consumer electronics customers developing. And we also have a good base business consisting of many customers who are supplying components and other items for electronic products. We've seen a strong demand, particularly from those component suppliers, early in the year.

And we have a good visibility later in the year that gives us confidence that we'll see some good revenue growth from consumer electronics this year. Now, just to reiterate, large orders from consumer electronics are typically recognized as revenue in the middle of the year.

But unlike last year when revenue from large orders was more evenly split between Q2 and Q3, we expect large consumer electronics orders to turn to revenue in the second half of this year..

Okay. Fair enough. Then as a follow-up on the topic of automotive, we've been hearing some kind of a mixed bag in terms of things are starting to beat. So I just was wondering, what are your thoughts as we progress through the year in terms of how your exposure to autos are going to be changing. Any insight would be great. Thank you..

Yeah. Thanks. So, we see automotive as a large and important market for Cognex. It represents about a third of our business in terms of end user markets. And, overall, we think of that business in the long-term as sort of a more steady grower, maybe around our 10% growth rate over the long run.

But we have seen significantly higher growth rates in the last couple of quarters. So we've certainly seen that. It's difficult to say how long that kind of higher growth rate, in this case in the last quarter, slightly more than 20%, how much that kind of growth rate is sustainable over the long run.

We don't think it is, but we're certainly experiencing strong growth right now. Perhaps I'll give you a little more detail. If you look at automotive by region, Europe provided the largest contribution in absolute dollars. Asia automotive grew at the fastest rate, led by China.

And our Tier 1 automotive suppliers in the Americas are spending at a higher rate than in recent years. So those trends we're seeing are often driven by electric vehicles, for instance, and supplying of electric components specifically into automotive. We're seeing those pretty widespread across all regions.

But I think rather like you, by the sound of it, we were surprised by quite how strong the demand was in the quarter that we're just reporting..

Thank you..

And our next question comes from Paul Coster from JPMorgan. Your line is open..

Yes, just a little bit of color please on the consumer electronics space.

What is – how do you define a large customer? What are the applications that these customers are taking? Is it uniform across the industry? And is this starting to be a sort of trickle turning to a flood, meaning they're coming to you rather than you having to kind of evangelize at this point in the adoption cycle?.

Yes. Hi, Paul. So, we sell those to component suppliers and to large brand owners in that space. And I'd say, we see a broad-based strengths across those customers. Historically, over the last few years, we've had one extremely large customer in the space.

But we're now seeing other customers develop in that space that have the potential to be bringing tens of millions of dollars to our business on an annual basis. So, we're seeing that. We're also seeing the adoption of new technologies, as in other years where we've seen new technologies coming into smartphone design.

Obviously, there's a great deal of spend going on an investment going on in displays, organic LED displays and other displays certainly, which is helping and where Cognex can just add future value with the performance and precision and speed of applications like inspection and alignment of those materials. So, all of that looks good.

We've seen but more of that component level investment earlier in the year, with signs of continued strength in the end user application, more in the final assembly part later in the year, I'm shaping up to make this another good growth year for Cognex in consumer electronics..

Got it. Okay, and two other really quick questions. First off, the OpEx was up 10%. And you said it was investment in engineering and SG&A and so on.

It was unrelated to the acquisition, so this isn't just expenses kind of jumping up owing to taking on new staff from the acquired company's question?.

Yeah, this is John. Yeah, there was absolutely some increase in our operating spend due to the acquisitions we closed last year. That was one of the elements of our growth in expenses from Q4 to Q1. So there was some impact to that..

With seasonally stronger sequential growth in OpEx than we typically see, is there any reason for that? Is it just that you view prospects in the second half justify?.

It's part of our investment cycle. We are continuing to invest in sales and engineering resources. Our future prospects look good, and we're investing to support it..

And this is Rob, I mean, obviously, when we're growing the top line, 40%, we're going to see extra sales, commissions and expenses kind of coming in there, extra around bonus kind of accruals.

So, I think those are kind of normal things we expect, plus we're seeing – we have a lot of confidence in near term and longer-term capabilities, giving us confidence doing that..

Got it. And my last question is In-Sight Software platform. You said it's broadening the markets for you by some investments you've made there.

Can you elaborate little bit, so we can understand why it's broadening adoptions?.

Yes. So we've had a very, very successful product range known as In-Sight, which is, at this point, I believe about 20 years old. And it's much the most widely used environment in factory automation for programming vision systems. And it's very user-friendly and very well-understood and used, it's kind of the industry standard.

So, we're doing a number of things and investing in that to make it easier to use, better design, but also better functionality. And what I mentioned earlier was we're bringing that user interface from the 2D environment, where it's very strong, into the world of 3D. And traditionally, 3D has been much more difficult to program.

But we launched a product which is a Profiler. So instead of a full 3D picture built up, it's a slice kind of cross-section of what's being looked at. And then it uses the EasyBuilder In-Sight environment to make it – to program, and it's very, very easy to do. So it kind of makes it much easier.

And it's not only easier to implement, it's also a lot easier to sell. So we expect the sales cycles and the capabilities of our sales team to be much enhanced with that easy user interface..

Got it. Thank you very much..

And our next question comes from Joe Ritchie from Goldman Sachs. Your line is open..

Thanks. Good afternoon, everyone..

Hey, Joe..

So, I guess, my first question, was there – in Q1, clearly the growth rate was very strong. I was just wondering, was there any pull forward in demands into 1Q? And then maybe talk a little bit more about your confidence on the consumer electronics, large project orders.

Are those orders enhanced? And what's causing that shift into a later portion of the year?.

Yes. So certainly, there was some pull forward on our part. I think probably our customers, from what I can see, felt more confident about investing. So in less good economic environments, we see customers deferring orders or delaying investment decisions.

We're sort of seeing the opposite now where I think they're moving to accelerate and they have more confidence about the outlook. But certainly from our perspective, no, while we don't talk about backlog, I would say that we exited Q1 with a very, very healthy backlog.

In relation to your consumer electronics question, really our – the timing of revenue recognition depends on really what's going on in that market concerning when technology is being adopted and deployed, and that has to do with when we recognize revenue, and there is certain criteria we have to fulfill to – in all of our business actually, to recognize revenue.

And that historically, if we go back to 2014, has meant we've recognized large pieces of consumer electronics revenue from large customers in different quarters. In 2014, Q3 was the big quarter. In 2015, I believe Q2 was. And last year, 2016, it was evenly spread, the big chunks, broadly speaking between Q2 and Q3.

This year, we're telling you, second half of the year is when we expect that larger consumer electronics revenue to hit, really has to do with what's going on with our customers and our own revenue recognition criteria..

Got it. That's very helpful, Rob. And I guess, maybe one more follow-on question, if we just kind of focus on 1Q for a moment. And you talked a little bit about the automotive end markets. But would be helpful to have some additional color on the type of growth rates that you saw both in electronics and also in logistics as well..

Yes. So, in automotive, we saw our stronger growth than we've seen historically on the order, a little over 20%, which is very strong. Electronics, we saw our huge growth. I don't think we're going to talk about specific numbers. And then we also saw a growth in logistics.

I think our logistics business looks like it's – while it was decent in Q1, the timing of revenue looks like it's coming more in Q2. So we do expect some strong logistics revenue flowing through in revenue that we'll recognize in the second quarter..

Perfect. Thank you very much..

And our next question comes from Richard Eastman from Robert W. Baird. Your line is open..

Yes. Thank you, Rob, Dr. Bob, John.

Just to be clear, Rob, can you tell us – or perhaps John, could you just tell us if the large customer that you have identified in the past through the 10-K filings, was the revenue to that customer up or down in the first quarter year-over-year?.

Yeah. Rick, we really can't give you specific information on that, only really what's in the 10-K, which is annual in nature. But we wouldn't be able to report you information on quarterly situations..

Is it directionally? Okay. And then Other Asia, ex-Japan, ex-China was up substantially.

Can you just maybe flag the country that that came out of, and maybe also the end market?.

Yes. So, Other Asia is a region that includes Korea, actually Japan as well, India and ASEAN, which includes countries like Thailand, et cetera. So, though we've seen strong growth broadly across those regions, but certainly, the market that's really moved its results is Korea.

And that's been very responsive as we've invested in it over the last two years. We got a great sales team making big inroads in both consumer electronics and automotive in that market..

Okay. And then maybe just for Dr.

Bob, this bidding system, could you just kind of speak to the opportunities set in this deep learning algorithms or software? On the website, you can see they kind of started in the factory automation market, but I'm just curious as to what the opportunity set is there?.

Sure, Rick. Thanks for the question. And it's an important one. Up until now, the vast majority of our bookings and revenue came from companies who had problems that we call the something somewhere problem. In other words, well, let me back up. And machine vision can be broken into – every machine vision problem can be broken into two types of problems.

They're both difficult. One is the something somewhere problem. And the other is the anything anywhere problem. Our expertise from the founding of the company was in this something somewhere problem. And an example of that is when a razor blade is made, the customer, the manufacturer wants to know if the edge of the blade is in the correct position.

Our systems are trained by our engineers to know what an edge – what the cutting edge looks like. And we train the system. We write software when the customer configures a system, to tell it where approximately that cutting edge should be.

Then the camera captures the image and the software goes in, finds the edge, and measures the angle of the edge and the position of the edge very accurately and determines if it's within spec or not. So that's the something somewhere. We know what it is we are supposed to be looking at. It's the cutting blade.

And we know approximately where it's supposed to be, something somewhere. Most machine vision problems, until this time, on discrete items, items that you can pick up, are the something somewhere problem in manufacturing.

Are the buttons on the cellphone in the right place? The system is trained to know what the buttons look like and where the button's supposed to go. But very recently – most recently, in variety of factory automation applications, in particular consumer electronics, the manufacturers are very much concerned with the aesthetics of the product.

Not just are all the parts in the right place and is the assembly correct and the screen correct and the screen brightness right, but are there flaws or defects on the case, either inside the case before the items are being put into the case, because that's very important if there are flaws in the surfaces of the inside of the aluminum or plastic or whatever is the case.

They can make very big changes and the phone won't operate. They could perhaps damage the battery if there are bumps some place. So, they've come to us. Our customers have come to us, many customers, and asked for the ability to detect anything anywhere. Now anything anywhere means a scratch or a flaw.

If you look in the dictionary of the definition of flaw, it can be anything. It's something that isn't supposed to be there.

In our cases, the manufacturing, it's typically a surface defect on a discrete item, such as the cellphone case or any kind of consumer item that – it could be a watch face, and it could be a scratch or a defect, extra paint or something that's not supposed to be there.

And until now, we didn't have very good technology or tools for defining those defects to tell the computer what to look for. So, fortunately, we found these very, very smart guys in Europe called ViDi and there are many applications of deep learning and AI.

But most of them or the ones that we have, the most of the ones we've seen, have nothing to do with really machine vision. They have to do with recognizing faces and photographs. Is this really my dog, not your dog? Is this a cat? And those are very interesting, but they don't apply to factories.

ViDi, on the other hand, we found specialized in the application of AI, deep learning, self-learning systems, specifically to the kinds of things our customers want. So in the way this operates is, the customer, it shows various examples of what they consider defects, what they consider defects.

And the system then trains on these and by itself through this very, very intensive software, determines what it means. Is it a scratch of this length? Is it a whip? All sorts of things that our engineers used to pull their hair out to actually write code for and now they don't have to.

The code exists in this deep learning system, self-learning system, to automatically look at this range of defects that the customer's shown and by itself come up with the descriptions for what it is. And then it uses those – that's called the training phase and then it uses those in the run mode of the system.

So, once it's been trained by the factory engineers – not by Cognex. We're not going to be doing that. We ship standard products, as you know.

Once the system has been trained by the manufacturer on what those defects are, the system then is set to run mode and operates and we believe in our tests far better than any human could do and far better than our own engineers could previously do writing their own software.

So, it's – this is truly a breakthrough for us because it adds this kind of capability. And it opens new opportunities for us where we previously couldn't go. So now, we have a full suite of tools, I shouldn't say full suite, we're always expanding them. We have tools that cover the something somewhere problem which we've been selling since 1981.

And now, we will be able to offer the anything anywhere for discrete manufacturing items around the world. Does that answer your question? It's a long answer, but it's an educational one. I used to be a professor, so sorry for the long-winded response.

Did you get it?.

I don't know what happened..

Maybe Rick get muted..

Did you guys get it at least?.

We got it. We loved it..

Okay.

Operator, what's the next question?.

And our next question comes from Joe Giordano from Cowen. Your line is open..

Hey, guys. Thanks for the questions. Dr. Bob, the rest of us did hear what you just said. So thanks for that..

Thank God, thank you, because it's too hard, I give this lecture and nobody answers, right? Thank you..

Just kind of related to that though, is solving an anywhere anything – anything anywhere problem a higher revenue, higher margin type of problem from a Cognex perspective than your more traditional software packages?.

Well, we haven't yet decided on a price for it, though it is very valuable. It will be an add-on, I believe at some point to our In-Sight product. It will probably be a special software purchase, and it is very valuable. Regarding the size of the market, I can't tell you yet.

I don't think it's as large, of course, as the something somewhere, but it's going to be growing. And we're going to look for more opportunities outside consumer electronics for using this..

Great. I also wanted to talk on 3D. It seems like there's a lot more buzz around moving to 3D. And I don't know if there's potentially more competition in that space now.

So I was just curious to see what your trends are specifically there, whether you're seeing upselling your existing customers, moving some applications from 2D to 3D, and how you kind of view the competitive landscape today maybe versus when we talked at Investor Day or something like that, or maybe over the last couple years?.

So, Rob, why don't you get that? It's a great – good question..

Yes. Yes. Yeah. Okay. Thank you, Joe. So, yes, so 3D is an important space for Cognex and one we're investing heavily in, both in our own engineering of products but also through acquisitions. And like a lot of Cognex business, in the early days of business, it's slow and then it starts to really pick up.

We're certainly seeing our 3D business grow substantially at the moment. Our 3D vision products grew nearly 140% in 2016, but we're still a small player in the $200 million market for 3D Displacement Sensors. So, and 3D is less than 10% of our overall business and will be this year as well.

We've made a recent acquisition, the EnShape and Chiaro, which brings us powerful data acquisition technology as called snapshot sensors that are complementary to our 3D Displacement sensing products.

And we see a lot of growth potential in both those displacement sensing products, but also snapshot sensing, and we see the technology being applied broadly to many different applications.

As I mentioned early, too, our In-Sight Profiler brings that 3D technology to our 3D Displacement products to a larger audience by making it much easier to program and sell. So this is a major growth area for us, one where we are expecting and seeing substantial growth and expect to continue that journey..

And if I could just sneak in one more, you mentioned logistics maybe more of a 2Q growth than 1Q. But that's been growing kind of in the 40%, 50% range on a full-year basis for you.

Is that something that's realistic this year or for the next few? And then, just maybe if you wanted to bring any comments out on the MX-1000, I know we spoke about it in the last couple quarters. So....

Sure, yeah. So our journey into logistics is a few years underway at this point, and it's a market where we have the potential to grow at 50% per year for the foreseeable future. And we're confident about that currently in the current market we're in, and we expect strong sequential growth from logistics to come in Q2, as we mentioned.

Growth will come both from large orders and smaller and medium-sized logistics accounts. We made meaningful progress in Q1 to increase the number of our large customers in logistics, certainly in that space. And we see a number of our customers emerging who could represent many millions of dollars of revenue annually for Cognex in the logistics space.

So, revenue can be a little lumpy in that space. There can be some larger orders that can hit in some quarters, and not in others. So although Q1 was good, it wasn't exceptional. We expect Q2 to be pretty significant and more exceptional, I would say, in terms of that – the logistics business.

Now you asked also about the MX-1000, our breakthrough product for the mobile terminal market. That's a product we launched last year, and have been showing to customers in the market.

As I think of kind of when Cognex enters a new space, just like when we entered 3D or when we entered logistics, it takes time to kind of win the confidence and understanding of customers. So we're still in the stage with that product where we're showing it and demonstrating it and having early orders from customers who are evaluating the product.

We have had some significant wins that we told you about in the past. But at this point, we're more evaluating the technology with customers. And what we're hearing is very encouraging, and we're hearing that from a broad base of customers who could be very significant in future.

So, I think we're still near the bottom at that sort of S-curve of adoption, but we're very confident we're going to be moving up that curve in the future..

Thanks, guys. Appreciate all the color..

And our next question comes from Jim Ricchiuti from Needham & Company. Your line is open..

Thank you. Good afternoon..

Hey, Jim..

Rob, I just wanted to follow up on the comments you made about the logistics market. It sounds like you're seeing broader coverage in that market. Is there any way – and I realize you can't name customers.

But can you give us a sense if you look at the top 5, 10 or so players in that market, to what extent you're penetrating them?.

Yeah. I think we're known to all, I think, the large logistics purchases, particularly in the e-commerce space, which is where really most of our growth and success is occurring at the moment. We're known to those players really in America and Europe. And we're having good success of winning the majority of that business, I would say.

And yeah, in terms of numbers, yes, we have some very large customers, both significant customers and others that we see developing into that kind of field, where we can have – be doing millions of dollars per year. I don't think I can really get specific about, obviously, customer names or specific dollar numbers for customers..

Understood.

Does that opportunity extend into Asia as well into some of the newer players there? Or is that more challenging?.

Well, I think as often with Cognex, we're kind of learning and rolling out our technology in America, and then we extend to Europe. We're now making very significant inroads in China, where clearly there would be many – or a number of very, very significant e-commerce logistics purchases at machine vision technology.

They're earlier in their adoption of technology, and we're well-known to them and in evaluation, but certainly, in terms of bookings or revenue, the China business is still relatively small in comparison to the success we're seeing in Americas and Europe..

Okay. And looking at the consumer electronics market, you've talked on a number of occasions about seeing opportunities as it relates to the OLED market. We're in a fairly significant investment cycle in that market that extends not just in Korea, but into other Asian display makers outside of Korea.

To what extent is this becoming a real meaningful driver for you in the consumer electronics market? And is your competitive position as strong as it is in some other areas of the business?.

Thanks. It's a good question. Yeah, so display technology, including organic LEDs, is definitely seeing huge investment in automation, billions of dollars in CapEx going into the production of those – that technology, and those technologies in general. So, it's major.

And we're working both with end user companies that are manufacturing that technology, which is then consumed by companies that actually sell the products we buy, right? And but also importantly with OEMs or machine builders who take vision technology and help the manufacturing process for that technology and sell into the big plants where it's manufactured in a number of markets including Korea, Vietnam and other markets, China.

So, we're certainly seeing big, big, big pickup in that business. I think it's well understood by us, our sales teams are well-known and our application engineers and capabilities on the ground there are, I would say, with confidence, the best in the world. You asked a bit about kind of how competitive our actual technology is.

Some of the applications that are required in that space are alignments. So you're aligning very fragile and sensitive material to very high precision. Also inspection, where you're looking at what is complex matrix of material that has to be integrated and looking for defects. So, both of those are things that we excel at as a company.

And so we're very well-positioned. So, I would say, it's certainly helping our growth and our reputation and the inroads we're making into those major electronic suppliers and their machine builders..

Great. Thanks very much..

And our next question comes from Bobby Burleson from Canaccord. Your line is open..

Yeah. Good afternoon. Just going back to the MX-1000, I understand you guys are gearing up your sales force there for some – to sell more directly. And I'm wondering kind of what the progress is so far. Are you seeing results from that? And just tacking on to that just – you've got several customers that are at a kind of few hundred units each.

And they're, it sounds like, going through some kind of evaluation phase before a more broad deployment. Wondering how long of an evaluation phase you're expecting. And what a significant deployment would look like relative to the few hundred units that they're at now? Thanks..

Yeah. Thanks, Bobby. Well, building on my earlier comments, mobile terminals is an exciting market where we expect to bring significant change. We're really introducing a different design concept, which brings the power of Cognex vision and the ease of use and power of a smartphone operating system to a market that hasn't really seen that before.

And it's pretty entrenched with products really from two – the two big market leaders, Honeywell and what was the former Symbol business, Motorola. So, what we're seeing is that customers who see kind of the end of the road with the end of the Microsoft industrial operating system, which will no longer be supported after 2020.

And then also a lot of companies are using both those old industrial products and smartphones in their trucks and their supply chain and their warehouses. So they're seeing our technology which solves the problem for them and their – the response we're seeing from many is very interested and very excited and we'd like to evaluate it.

So, one of the largest retailers in America met with us last week and was very, very – bought large team to review the products and was very excited and is looking to implement it.

One of the largest trucking organizations in the country, we met with their CEO recently about the potential deployment where they're using two devices today, would like to use one. So we're really seeing a lot of high potential funnel starting to build. It's too early to say when that funnel would turn into revenue.

I think at Cognex, we're more, we believe, in sort of bringing high technology advantage solutions to a market and working kind of tirelessly until it gets adopted. And you've seen us doing that in a number of markets, logistics being a good example, 3D being another. We're confident that's what we're going to see in the MX market.

And we're going to get it right. So, watch for discussions in future quarters. I'm not quite sure which quarters we're really going to see it take off..

Okay. Great. And then you mentioned bringing 3D to a larger audience. I'm wondering that $200 million TAM you've talked about, theoretically, how do you see that expanded by some of the progress you've made there..

I don't see us resizing that $200 million market anytime soon, not certainly in the next quarter or so. We're – but that market itself is growing. So if we were to expand it, it might be the fact that we're seeing growth rate of about 20%. And we probably gave you those numbers back in December of last year.

But what I will say is, those applications within that market break down to between kind of complex applications where Cognex is very strong and has large share, and then simpler applications that use more of a Profiler approach. And those simpler applications are in fact the majority of the markets, more than half of it, right.

So we're now in a position where we can compete in that space of the market much more competitively with the new product. So, I'm not increasing the size of the market. We've given you that our ability to be competing in that space now with a much easier to use in program and much easier to sell product is certainly much greater..

Okay. And then consumer electronics, larger orders are coming later this year than last year.

Do you expect or do you have visibility, I think, to whether or not they would spill over into Q4?.

No. It's too soon to make the call between Q3 and Q4..

Okay. Great. Thanks..

And our next question comes from Karen Lau from Deutsche Bank. Your line is open..

Thank you. Good afternoon. Maybe just follow-up on the question on display. Rob, you talked about some of the applications in OLED and display manufacturing.

Just curious how would you compare the intensity of machine vision usage in display industry versus consumer electronics or smartphone assembly? How – I guess, however, where you want to characterize it with that – with the opportunity displayed, can it ever be as big as what the dollars that we're seeing maybe from, let's say, your largest customer, would it ever get there, or is it going to be just a fraction of that?.

Well, I think ever is the key term there, but what I would say is, display technology is an area where we're seeing a lot of investments right now. I would say historically, one tends to see kind of phases of investment that go on and where machine vision gets supplied. So display is an example.

And I guess, we saw our LCD displays a number of years back on TVs or whatever was also a kind of a growth area. I think OLED displays is something we're going to see over a few years. But final assembly and test of electronic devices is something we're going to see over a much longer period.

So those final units have the potential to be very long-term substantial business, while display technology, it may be difficult to see out past the next couple of years about whether that's a market that will kind of mature or continue to grow.

In either respect, though, I would expect the kind of revenue Cognex would see from final assembly and test of smartphones and mobile and wearable electronic devices is going to be bigger than what we see from screens and displays..

Okay, got it. And then maybe just a couple of housekeeping in terms of the large order shifting to second half. Just curious, digging – just want to dig a little bit deeper into this second quarter core growth rates.

If we were to parse out the comparison in large orders year-over-year, how much would the other underlying business be growing at in the second quarter?.

Be able to maybe break that out?.

Yeah, that's a difficult thing you're asking us to break out, because I think we'll risk giving you information that's confidential. What I would say is, we're going to see much lower large orders in Q2.

So, you can really – you could take the mid-teens growth rate that we told you, and figure that's really not much in terms of large consumer electronics orders hitting in the quarter, which means the underlying growth rate is going to be well above our 20% factory automation growth rate that we expect. Well above that..

Okay. That's very helpful..

And I was – yeah, and I think....

Yeah..

...if you go back to – you look at our performance in the last couple of quarters, I think we were up 30% or so in Q4, up 42% factory automation or 40% overall in Q1.

I think we're gearing up still for strong underlying performance across broad industries in Q2, and the anomaly is much more the large orders in consumer electronics profile that's causing that growth rate to flip back into the mid-teens that we are forecasting..

Got it. I understood. And then just to confirm, so when you look at second quarter and second half combined this year versus last year, you're still expecting large orders to be up year-over-year.

Is that right?.

I think what we said is we expect consumer electronics to grow well this year. And I think we're not commenting on large orders, and certainly not from any particular customer, right? I think the message I'd like you to take away is that we see strong growth in consumer electronics in our pipeline in Q1 and for the year, but not in Q2..

Okay, got it. Very helpful. Thank you..

And our next question comes from Ben Rose from Battle Road Research. Your line is open..

Good evening, gentlemen. Thank you for taking my call. Just a quick, I guess, follow-up question for Rob in terms of what you're seeing on the automotive side.

Particularly in Asia and in Europe, are you seeing the use of the product primarily for existing manufacturing lines? Or is it for new lines as well, assembly lines?.

Hi, Ben. Thanks. Yeah. So, our automotive business performed well. I think it's well-known really about the majority of our business in automotive is with Tier 1 suppliers. And an important but smaller part is with our brand owners or end user companies.

We see good growth in both parts of that, and particularly Tier 1 automotive suppliers who are looking to develop new components for new kinds of technologies, particularly around electric vehicles. We're seeing significant spending by them, and – but also by end users.

And then particularly in China, it's a market where we're seeing very significant growth in our automotive business, but it's really broad-based, as I said earlier, across all of our regions..

You had no particular difference between existing lines and new lines?.

No, not that I would say, I mean, not a real change in the pattern over the last six months for sure. I mean, certainly, we are seeing significant investment in new lines, as we've said. But we're also seeing significant investment in components and investments in machine vision to support improved production on both existing and new lines..

Okay. Okay. Thanks very much..

And at this time, I'm showing no further questions. I would like to turn the call back to Dr. Bob Shillman for any closing remarks..

Well, thank you very much. Interesting questions, thank you. To wrap up, it was an outstanding quarter, a great start to the year. And our outlook for Q2 is also strong. We are very excited, not only – everybody can say we're excited about the long term, but we have enough data to say we're also excited about the mid and even short term.

I want to thank all of you for joining us tonight. And we look forward to speaking with you again during our next quarter conference call. Take care..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day..