Greetings, and welcome to Cognex' Second Quarter 2019 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Susan Conway, Cognex' Senior Director of Investor Relations. Thank you, Ms. Conway, you may begin..

Thank you, and good evening, everyone. With us today are Cognex's Chairman, Dr. Bob Shillman; President and CEO, Rob Willett; Vice President and Corporate Controller, Laura MacDonald, and Cognex's Treasurer, Chris Stagno.

I'd like to point out that our earnings release, and quarterly report on Form 10-Q are available on the Investor Information section of our website at www.cognex.com. Those 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 upon information that we believe to be true as of today. Things often change however and actual results may differ materially from those projected or anticipated.

You should refer to our SEC filings, including our most recent Form 10-K for a detailed list of these risk factors. With that I'd like to turn the call over to Dr. Bob Shillman..

Thanks Sue, and hi, everybody. Thanks for joining us. Overall, our Q2 results were in line with our expectations and we were highly profitable. However, it's very frustrating to report a year-over-year decline in both revenue and profits as a result of the current downturn in both consumer electronics and automotive markets.

Even so, we are confident about the future of Cognex and the role of machine vision and automation and turns out that distribution remains strong, logistics. Right now, I'm in San Diego and everyone else is at our Natick Headquarters.

So for more details, I'll turn the call over to my partner, Rob Willett and I'll remain on the call for any questions you may have with me. Rob, the microphone is yours..

Thank you, Dr. Bob. Good evening, everyone. As Dr. Bob said, our Q2 results were as expected with revenue at the top of our guidance range. The lower spending by customers and consumer electronics and the automotive sector in the Americas that we discussed last quarter played out as expected.

However, the broad factory automation market in Europe was considerably softer than we anticipated in Q2 and the impact of this will be more noticeable in our Q3 results. Demand for many end markets is declining, notably in automotive, which is one of our largest markets in Europe.

Customers, particularly those that are exposed to the slowdown in Greater China are reducing and deferring large project. Asia has also weakened. This is due to a continuation of the challenges that we have been experiencing broadly across China and to softness observed in the industrial markets elsewhere in Asia.

These dynamics obscure our continued strong performance in logistics, in that market a growing and broad base of well-known e-retail and traditional retail companies are investing in automation to improve the speed and the efficiency of their fulfillment operations and they are turning to Cognex machine vision as a key enabling technology in their distribution centers.

We also continue to make strong progress in other industries we serve that are currently relatively small but are growing quickly.

Putting it together, consumer electronics and automotive, our two largest markets that combined have recently been responsible for more than 50% of our revenue, are both contracting simultaneously for the first time in many years.

Broadly speaking, it's due to a widespread lack of business confidence amid fully demand, changes in customer preferences and the timing of transitions to new technologies. Heightened uncertainty and the distractions around trade tensions are also a problem. However, we are confident in our business strategy and are keeping a long-term perspective.

We continue to fund our engineering projects and the development of impressive new products continues to plan. We are, we allocating resources toward faster growing areas such as logistics and deep learning and markets where the adoption of machine vision is still in its infancy.

The skill sets of our engineers and salesnoids are highly transferable and can be applied to a variety of opportunities. Before we move on to the details of the quarter, as you may know, we're actively recruiting to fill the CFO role.

In the meantime, we're especially fortunate to have Laurie McDonald serving as our Principal Financial and Accounting Officer. Laura is a 25-year Cognoid and has led Cognex's finance, accounting and reporting teams as Vice President and Corporate Controller since 2007. Laura, the microphone is yours..

Thank you, Rob, and hello, everyone. Revenue in Q2 was $199 million representing a decline of 6% year-on-year due to a reduction in revenue from the consumer electronics and automotive market. The decline was 3% in constant currency. Logistics continue to be a strong performer and offset much of the decline in the manufacturing sector.

Gross margin of 74% was consistent with Q2 2018 despite the lower revenue and was up one percentage point from Q1 2019. Operating margin in Q2 was 26%, down from 30% in Q2, 2018. On a sequential basis, operating margin increased by nine percentage points due to seasonal growth in revenue and prudent management of discretionary expenses.

The effective tax rate for the first six months of the year was 16% before discrete tax items, up from our expected rate of 15% due to a shift of income from lower to higher tax jurisdiction. The true-up of the tax rate reduced net income for Q2 by approximately $925,000.

Excluding all discrete tax items, our earnings per share were $0.27 in Q2 2019 compared with $0.31 in Q2 2018 and were up from $0.17 in Q1 2019. Looking at revenue from a geographic perspective, the Americas performed the best of any region increasing by high single-digits year-on-year.

Strong growth continued in logistics and was partially offset by lower revenue from the automotive sector where spending continues to be slow. Revenue from Europe declined by mid-teens year-on-year, and that includes a six percentage point negative impact from currency exchange rates. Consumer electronics declined substantially as expected.

We also saw growth soften in the factory automation market. In Greater China, revenues declined by low-teens year-on-year, also due to consumer electronics at a negative impact of six percentage points from currency exchange rates. Manufacturers across our customer base in China continue to cut back their capital spending plans.

Revenue from the rest of Asia declined by mid single-digits, principally due to reduced spending in the electronics, and semi markets, which are dependent upon demand in China. Turning to our balance sheet, Cognex continues to have a strong position. We ended the quarter with $862 million in cash and investments and no debt.

During the quarter, cash provided by operations was $15 million. We repurchased shares of Cognex stock, totaling $62 million and we paid $9 million in dividends to shareholders. Inventory decreased $6 million or 8% from the end of Q1 as expected.

As noted last quarter, we prospectively adopted a new lease accounting standard this year, which resulted in a balance sheet gross up of assets and liabilities of approximately $18 million at the end of Q2. Now I'll turn the call back to Rob..

Thank you, Laura. Moving next to guidance. Revenue for the third quarter is expected to be between $175 million and $185 million. Compared to $232 million reported in Q3 of 2018, the decline is due almost entirely to substantially lower revenue from consumer electronics.

As discussed last quarter, this is particularly related to smartphone manufacturing. Otherwise, we believe that continued growth in logistics at a few smaller high potential markets that are performing well will be offset by decreased revenue from the automotive sector and other industrial markets.

We expect gross margin for Q3 will be in the mid 70% range and slightly lower than the 74% gross margin we've reported for Q2. Operating expenses are expected to be relatively flat with Q2. The effective tax rate is expected to be 16% excluding discrete tax items. And with that, we will open the call for question. Operator, please go ahead..

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Karen Lau of Gordon. Please proceed with your question..

Good afternoon, everyone. Rob, you mentioned logistics was still growing at pretty healthy pace. There were some other companies that called out some push out in large projects, I guess over the course of past few months.

I guess, can you comment on the growth rate you're seeing in 2Q and what you're expecting in 3Q and if you're not seeing any – if you're seeing any push out in projects in your pipeline?.

Yes, hi. Thank you, Karen. Our logistics business continues to be very healthy. We're growing at a good clip and we baked into our Q3 guidance that is continued growth right around that 50% growth rate that we're targeting.

So we haven't – there is a fair bit of seasonality in logistics and as we get into this market more and understand it better, generally what we tend to see is higher revenue quarters for us in Q2 and Q4 and lower revenue quarters in Q1 and Q3. But the growth rates we're seeing continue to be very strong and we expect that to continue..

Okay. Thanks..

Okay. Thank you. There are other factors that I didn't go to in more detail, if that's of interest..

Yes, sure. I guess, do you think that's a function of you have been adding so much more resources in that market that allows you to outgrow that market or are you somehow just more penetrated in like smaller project these days.

So any kind of deferral in larger project areas doesn't affect you as much?.

Yes. I mean we are newish to this market and we have some very advantage technology that we're bringing and certainly the technology leaders in this market, particularly in the e-commerce space recognize that and I'd say we're – I would say we're being very much recognized as technology leaders.

So I think that's the reason we think we can keep growing, we have been and we think we can keep growing this market at 50% growth rate over the long-term.

So I think I see that continuing, we're also introducing some exciting new products, we introduced the 3D-A1000 for dimensioning which will be very advantaged over time with light and laser-based dimensioning systems that are currently in that market and we're reallocating resources as you note to make sure we have the capacity to go on growing.

So if there is a silver lining to this very disappointing market situation we're seeing in automotive and electronics, it's that we're able to reallocate those Cognoids to some very exciting growth opportunities, notably, logistics and deep learning..

Okay, great. Thank you for the color.

And then just on consumer electronics, can you update us first this down one-third expectation that you had going into the year, what is your expectation now for that market?.

Well, I would say, we don't really want to be giving annual guidance every time we meet. We're not really changing our kind of approach to that. However, I will say things haven't really changed a lot in our outlook in that market since we last spoke.

So our guidance in Q3 reflects a $50 million a year-on-year decline in revenue from consumer electronics, that's the big change we expected to see and we're going to go on seeing. So as you try to understand our Q3, it's really not so much an electronic story. I think that's what – it's similar to what we have told you previously.

It is much more a story of a softening in automotive and Europe and the overall market we see in China..

Okay, understood. And then just lastly, I guess more broadly on CE, realized Huawei is not – probably not a big customers of yours or you have said that it's not that material of an impact, but I'm just curious, the whole episode of the ban and the ongoing trade tensions.

Does it impact your confidence or will it impact your ability at all to participate in future smartphone CapEx cycle given that I guess a lot of the infrastructure as well as manufacturers, machine OEMs are – a lot of them are in China, right.

So does that impact – I guess, does this whole trade tension impact your longer term outlook in CE at all?.

Yes, it's a difficult call to make longer term, I mean, and obviously as you rightly noted, we don't talk about specific customers. Cognex does supply all of the major manufacturers of smartphones whether directly or indirectly, through contract manufacturers.

And the current market and trade conditions make it more difficult to work with particularly some more than others as you've said, and some of the ones it's hard for us to work with perhaps one of the ones that are showing the most growth or have been in recent quarters. So that's a challenge for us, certainly.

But certainly our guidance contemplates that situation and I think we will have to see how it's going to play out from a government and trade talk point of view..

Okay, understood. I'll leave it there. Thank you..

Thank you..

[Operator Instructions] Our next question comes from the line of Andrew Buscaglia of Berenberg. Please proceed with your question..

Hi guys. I'm curious, from a high level, you made some comment that you haven't seen in quite a while consumer electronics and auto detracting simultaneously. You also would have this trade thing going on which could be impacting things further.

Given you guys have a long history in the space and experience in here, can you talk about how this compares to other downturns? Is this something you think is going to be prolonged? Or based on your history and experience, do you get a sense that things could turn quickly if we do get some sort of resolution in the trade agreement? Or any other factors, curious on your thoughts on that..

Hi, Andrew. It's not easy to kind of prognosticate on these kind of things, but I would say a few things. One is, I think the consumer electronics market can turn quite quickly, right. So I think particularly around these issues. So I think that one potentially is one that could come back more strongly.

I think the automotive market tends to be more of a, kind of a longer-term player, and it tends to take them longer to decelerate and accelerate around changes that go on, and I think I'd make that point of view. I also think – I can't quite remember exactly, I wanted to say 2015, we certainly saw some contraction in consumer electronics.

But we didn't see the same thing going on in automotive at the same time. So that's a little bit different. And I think all of us know that Cognex has grown its topline every year consecutively for the last nine years and we're not growing this year. So this is a different situation that we're seeing.

And I think it has to do with a number of factors that have – and some of which we've talked about.

The automotive industry itself is oversupplied at the moment and it's between kind of the fact it's between having the combustion engine cars in too many of the manufactured and perhaps not as competitive for consumers, as they need to be, but not yet having geared up on electric vehicles that are coming, but not yet really in the phase of major investment in automation.

So we're in that situation there. And in consumer electronics, I think we've gone through a period where we have massive investment and it's a matter of when we're going to return to that as well.

I think – as I think about this longer-term, which is how we like to think about things at Cognex, I think the story of the last many decades really has been increased spending and innovation in automation, in electronics and automotive, right.

And as I look at consumer electronics, I think I would certainly expect there will be future waves of innovation and investments that are coming. And you can see that in many areas, 5G being one example in consumer electronics or autonomous, semi-autonomous vehicles and electric vehicles in automotive.

So I think it's a matter of when those come and how they play out and how much of their lift they bring to automation.

But when I think it'd be million literally millions of people involved in manufacturing, consumer electronics and the major investment and challenges and margin pressure on automotive to automate, I'm very optimistic about the long-term, but much less optimistic about this year..

Okay, that's helpful. Maybe just turning to your balance sheet, that's something I asked last quarter you guys have this pile of cash.

Do you think – does your appetite change in the last three months, given some of your peers, and your machine vision peers are a little bit weaker now and also just curious maybe the second part of that question, would you ever consider vertical integration with any specific pieces of your business?.

So I would say we have a long-term strategy and some very strict and thoughtful criteria around acquisition if you're getting at that, so that doesn't really change based on short-term considerations. We obviously have a lot of firepower in our balance sheet to make acquisitions as and when they become actionable. So that will continue.

I didn't really understand your vertical integration question. Perhaps you could explain that to me..

Just some of your suppliers that you use, is there – does it ever make sense or does that ever thinking longer-term? Yes, on the camera side, makes sense to bring those in-house..

So I now understand your question. Okay. So I think there are various technologies that we have Cognex work with and an example might be in the area of high-performance liquid lenses.

So what a wonderful technology partner that we have in that space, where we've used our ability to invest to get some exclusivity around that technology without having to acquire the company. But it shows you what we're willing to do where we find advantage technology that we want to secure and whether it's through exclusivity or acquisition.

We would do that, but I don't think you're going to see us acquiring what I would consider more commoditized businesses like cameras, right, as an example..

Okay, all right. That's helpful, thanks..

Our next question comes from the line of Joe Ritchie of Goldman Sachs. Please proceed with your question..

Thanks, good afternoon, everyone..

Hi, Joe..

So Rob, just your comments on the auto market and electronics market notwithstanding, you did also say that like you experienced the broad factory automation market, particularly in Europe slowing down.

And so I was just wondering like if there you can provide a little bit more color on what really factored into that comment and what you guys are seeing specifically in Europe..

Sure, Joe. I think it's pretty well known fact that the Purchasing Managers' Index or PMI for manufacturing in Europe was recently fell to a number of 46.4, which is a 79-month low, but I think generally we're seeing pretty under a confident manufacturing environment broadly in Europe right now.

We saw that emerge really kind of after our European organization came back from sort of the Easter vacation timeframe, right, right after the call we had last with you. So I would say and we really noticed a lot of pulling back I would say on investment.

I think another thing that perhaps might have crowded the view to that was I think at automotive we sort of saw Q4 of last year from memory or certainly the second half, which didn't look very good. It wasn't good last year in Europe. And there was a bunch of that had to do with regulation, right.

Around emissions and some other factors that they were dealing with, which kind of held up demand in the end of last year and then we saw that kind of break free. And I think it made Q1 in Europe look better than probably it was on an underlying basis.

So then we had to really try to recalibrate on really where are we as we came through into Q2 and we realized it was weaker than we were expecting.

And as I look around at other companies I see similar thing, particularly in automotive, I would point to the very large Tier 1 automotive supplier, Continental recently said they have revised view about the automotive industry this year from being flat, not their business, but the industry in total, on a global basis, not flat, but down 5% and they provide that down in a similar time period, so I would say, we see that.

The other thing I think it's probably, I know you many of you on the call cover many companies, I'd say difference between Cognex and some of those companies is our distributors don't really carry almost any inventory and that's kind of part of our supply chain model.

We really like to work in a situation where we tell our distributors we will supply you quickly and we don't want you tying up your cash holding Cognex inventory. So as a result, we have a pretty clear line of sight with what's going on in the marketplace.

So I think while other companies might be later to see that where the kind of sell-through of inventory may cloud that in some ways. Anyway, those are my own views about what's going on in European manufacturing and automotive..

That's really a helpful commentary. And if I just could ask follow-on there, I guess as you think about the CapEx cycles that you guys are Tier 2 and how decisions are made, you referenced project deferrals earlier.

I guess how do we think about the timing on when we could see an improvement in CapEx? We're halfway through the year this year, will budgeting decisions continue to be made this year or is this kind of more of like we'll get that further insight sign on an improving business condition as we had really kind of towards the end of the year?.

I'd say very good question. Not one I'm sure I can answer all that well. I'll give you my views which are, I think I don't think we're going to see improvement in the situation this year, right. Although it's possible, right. As they start to budget next year, there are going to be some factors that are going to change things.

I think one factor is just very significant momentum and investment around electric vehicles and hybrid electric vehicles and autonomous features with very many new models plan to come to market in the next three, five years. And at some point, I think there's going to be a race to get those products to market and to gear up in automation.

When does that begin I think is a critical question? Of course, we're seeing investment in lithium-ion batteries and capacity in that space and that is a good market, which growing well for us at the moment.

But I think we have to see more of those products, those new cars come into production and I think we'll have a better view of that probably as we exit the year..

Okay, thank you..

Our next question comes from the line of Joe Giordano of Cowen and Company. Please proceed with your question..

Hi, guys. Thanks for taking my questions..

Hi, Joe..

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

Well, yes, I was alluding to I think factors that we've probably mentioned, but let me try to sort of wrap them up to the group.

So I think in automotive, we have this factor where we globally companies have produced a lot of combustion engine cars and consumer is really less interested in buying those and we see that particularly in markets like China where capacity particularly for foreign automotive companies is that, no, it's a fraction of utilization.

So you see those kind of trends going on, which means they're really, no pun intended slamming on the brakes. But then you have – and yet as I was saying just previously the electric vehicle investments normally flowing through in automotive.

Yes, so I think, I think those changes we see coming and some of the government incentives and some of the trade conflict that's going on, isn't helping that situation. Okay. So those are the factors there.

I think in consumer electronics what we see is we're seeing waves of investment, we saw our major wave obviously in 2017 around OLED technology and new sensors and many new products right? And now we're seeing overall sales of unit slowdown, but there will be more features and technology coming and the most obvious example there I think is 5G, right? I think there's a lot of virtual reality and other sensor technology that we can expect to see coming in future, right? And I think inevitably, there will be also new form factors, new case technology, new products targeting, new geographies and markets that have the potential to grow, as an example, markets like India and Indonesia and markets such as that.

So I think all of those give us confidence that we will see a return to investment and growth again, but none of that appears to be coming in the short-term..

Are you seeing any material evidence of your customers looking to retool outside of China, given what's happening there? And starting to build our production bases in other parts of the world?.

I would say is that that's been something that I think many companies we work with particularly in consumer electronics have had under consideration or have been activating on for quite a long time now.

Certainly, some of the larger Korean manufacturers in the smartphone space and others certainly have scaled up manufacturing and are producing lower price point models in India as an example. So that's not new.

I'm certainly hearing rhetoric around the ability to accelerate that and contract manufacturers data they are able to pivot into that space, but I don't have anything specific to tell you..

Okay, thanks..

Our next question comes from the line of Richard Eastman of Robert W. Baird & Company. Please proceed with your question..

Yes, good afternoon. Robert, can I just follow-up on the last kind of comments that you made there? One of the things that we have been seeing is just again in the smartphone market this movement of production outside of China. And you even mentioned India yourself. And we've been kind of paying attention to that.

In a scenario like that, have you seen your customers literally relying on capacity, subcontract capacity that's already in place or why is, is there not any demand coming from that incremental capacity that's being built outside of China to accommodate that movement? I mean, have you seen any indication of demand on your business? I mean it doesn't appear that way, but why should we not or why would we not expect to see that?.

I think, here's what I do see for a number of companies we work with in the consumer electronic space. Focusing on the India market, which is they are generally relying on their machine builders that they work within the existing capacity in China or in Asia to fulfill that demand. So they're not scaling up.

Machine builders in India for instance they are more shipping product over and then opposed to that in some cases moving lines and commissioning and bringing them up on older models there. So I think that's the overall strategy that they are following and I think it's pretty small scale at the moment.

And I think it couldn't – be much bigger in future..

Okay. And then just somewhat related, there is a lot of puts and takes right now going on in the small display OLED display market? There's a ironically some tariff issues between Japan and Korea and some of the specific materials that go into small displays or even large.

But the Chinese are building out their capacity around OLED displays both small and large and we've talked maybe for the last 18 months about Cognex broadening its exposure to in the CE market and I think one of those was OLED.

But has Cognex experienced any of that demand? I mean just a shift in share and do we count all of the OLED display manufacturers in Asia as customers?.

Right. So we are seeing growth among – with business that we're doing with Chinese OLED customers, right? So certainly, I think you're right in thinking that those manufacturers are seeing growth and investment.

And in many cases, we're supplying those companies through machine builders in countries such as Korea or Japan, right? So that's why we are generally seeing that business increase.

But to me it looks like it's sort has been incremental and there's still a lot of capacity that was built out in 2017 among the big players that still isn't being utilized. So I don't – I think we were expecting some major increased investments as soon as next year, right? And I think maybe that's a little optimistic now depending on what happens.

But I do think at some point, it is going to come..

Okay. And a related question, and then I'm done. This may be counts as 3, but I'll think it 2.5, but was the reference you made earlier that the automotive industry, I think you explained of thought maybe coming out of the first quarter would be flattish for the full-year.

And now with the incremental weakness that we've seen, are we thinking down mid single-digits or we're down double-digits now for auto for the year?.

I think we are now thinking down around 10%. .

I got you. Okay, very good. Thank you. Thanks for the extra question..

Yes, thanks. I'm going to ask the audience, I mean the participants to try to keep their conversations, sorry their questions to one or two and I will also try to end up my questions because we're getting well into the hour and there's a lot of you want to ask questions..

Our next question comes from the line of Josh Pokrzywinski of Morgan Stanley. Please proceed with your question..

Hi. Good evening, guys. I'll try to keep it seven questions or fewer. So I guess just first one more of a clarification than anything else Rob, it looks like a lot of their consumer electronics decline shows up in the third quarter, which is just more seasonality than anything else I think going back prior third quarters had the same phenomenon.

Any other big end markets that show up third or fourth quarter that we should be aware of that are kind of seasonally larger, you mentioned logistics a little bigger in 2Q and 4Q, is auto weighted to some quarter in particular that we should keep in mind with – on the decline or when that comp gets easy?.

Yes. So I think Q4 can benefit from larger logistics, a seasonally larger logistics. So I would anticipate that again this year. And then Q4 can benefit from automotive and in general, kind of budget flush in the path that goes on, but I'm really not anticipating that in the current environment we're in.

So I think – and then sequentially from Q3, obviously Europe tends to be very slow in Q3 and then get back up to speed as they come back from vacations and make more investments in Q4. So those are normal phenomenon that we see in our markets..

Got it. That's helpful. And then just kind of thinking back to the secular growth model here, I know cycles get in the way in those are shorter maybe medium-term phenomenon.

But when you talk about penetrating customer's facility and having kind of more content there, if they're not spending money, there is no ability to gain content, but when that turns on, do you kind of catch-up from where you were, so maybe rephrase differently.

You'll have a couple of years of easy comps in consumer electronics and auto heading into next year? Can you kind of catch what you didn't get during that time period because customers wanted to spend they just weren’t? Or is it just a question of the cycle comes back and we start from kind of a reset base? That question makes sense?.

Yes, it does. I would say in my 11 years with the company, I've seen difficult market conditions turn around and in times there can be very strong growth.

I'm not predicting that here, please don't get me wrong, but in 2009 we grew going into 2010 by 65%, we had other – we have obviously 2017, where we saw are after some years of a slow, I think 2015 and 2016, we grew 44%. So ours is a kind of market where you can see those kind of turns around.

And I'll just say again I'm not predicting anything there, I'm just saying that we see those kind of things can change quite quickly in our markets and we want to be sure when those things happen that we have the capacity and the products to keep our momentum going. The slow situation we have now is, it's unusual.

As we said, we've grown for the last nine consecutive years. So we're in a bit of a new space here and it's hard to know when that will turn around and when we will return to growth and when we do, how quickly it will come..

Understood. Appreciate the color..

Our next question comes from the line of Jim Ricchiuti of Needham & Company. Please proceed with your question..

Hi team. This is Mike Cikos on the line for Jim Ricchiuti. Thanks for taking the questions.

First question was around the gross margins that we're looking at for Q3, I guess the slight deterioration coming off of Q2, and I just wanted to get a better sense, is that gross margin compression we're looking at tied to revenue mix coming from logistics more than the consumer in the auto piece or is it more just the reduced revenue base that you're looking for?.

Yes. So gross margin in Q3 is going to continue to be in our mid 70% target range, a little lower than we've reported tonight. We did have for Q2 some higher margin revenue in the service area that hit the P&L that won't repeat in Q3.

And then some of it can have to do with the mix of business right as well, which can effect our gross margins, but I don't think there is a tremendous amount of noise going on in our gross margin in Q3 relative to Q2 that you need to understand it's not that material..

Understood. And then can you also help us better understand the reallocation of resources when we're looking at your OpEx.

Is it a function of investing more in some of these smaller businesses that show potential for growth in the logistics business to help offset some of the larger markets where you're experiencing weakness? Or how are we thinking about those expenses?.

So we have very talented engineers and salesnoids that we recruit and develop over time and they are great assets. So in times when we see the market slowdown and rather than remove them, our culture is very important to us and we take a long-term view. So we're moving them, we tend to move them into areas where we see longer-term growth potential.

An example would be we're relatively under-penetrated in the logistics market in China. But clearly, that's a large and high potential market for us. So while we're seeing a slowdown in those areas, we're able to leverage those Cognoids we have and move them over would be one example.

And that also applies areas like deep learning and life science where we see a lot of long-term potential and the need for talent. So that's really what we're doing. And at the same time as we're doing that, we are being much more conservative about incremental spend that we're making and discretionary spend that we're making at this time.

Because obviously when the business isn't growing, we want to try to keep the expenses relatively flat..

That's helpful. Thank you very much..

Our next question comes from the line of Matt Summerville of D.A. Davidson. Please proceed with your question..

Thanks. Within the U.S., you talked about factory automation, a bit more from a regional standpoint with respect to Europe and maybe Asia.

But with PMI sort of decelerating, industrial production decelerating arguably against pretty tough comparisons, have you started to see factory automation in North America start to roll over? And is that an incremental concern for you going forward into 2020?.

Right. I think due to the Americas region, I’m really in the United States, so I would say is soft particularly in automotive where investment plans continue to be delayed and there's too much capacity and too many cost produced certainly.

And I would say we as a company, I think we understood that pretty early and we kind of – we right-sized our efforts and I think our guidance or our forecasting around the Americas market quite early. So I would say this is not really surprising us.

The other factor we have in the Americas is we have, it's our largest region for logistics and that's growing very, very strongly, right. So that's certainly helping to on a region-by-region basis make up for the slower areas in general, factory automation that we see in the Americas. So overall, I think that's what we're seeing..

Thank you..

Our next question comes from the line of Jairam Nathan of Daiwa Asset Management. Please proceed with your question..

Hi. Thanks for taking my questions, it’s Daiwa Securities.

So I just wanted to get some more color on operating expense and we saw in the Q you had mentioned that some of the declines year-on-year came from ERP, a lesser expense on the ERP side, and just trying to – and with respect to R&D at this rate it could be – it could imply your R&D expense might be flat year-over-year.

So just wanted to try to understand how should we think about those for rest of this year and next?.

I would say generally we don't give guidance around operating expense beyond what we've already told you. I'll just make a few general comments.

I think operating expenses in Q2 were slightly lower than our expectation given the environment where as we talked about reallocating resources to higher growth areas, and we continue to manage expenses without disrupting any major products under development, our long-term growth plans remain intact.

And in the environment we're in it gives us a good opportunity to focus on driving productivity.

We did make a major investment in implementing an ERP system last year and there's plenty of opportunity to improve our processes and we're doing a lot of work in that area, which I think will put us in good standing when the market comes back and were able to grow without necessarily adding much capacity..

Okay. And then just as a follow-up, which is – we have seen some of the mobile terminal competitors starting -- talking about an over inventory under distribution side.

Are you seeing a similar trend and can you just give – update us on the progress you have made in that field?.

Yes. So we have our journey into the mobile terminal market. I think it is similar to other markets that we've entered over the last 15 years or so and where we're leveraging our technology and strengths. And certainly it continues to be an area for growth for us. The activity that we're seeing is encouraging.

And while the business is still small in mobile terminals, we expect their revenue this year to grow substantially. And so I think we're seeing that. And yes, our customers are broadening. We've got some large well-known company that are evaluating our product and particularly in areas of e-commerce and actually in airports and airlines.

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

Okay, thank you..

Our next question comes from the line of Ben Rose of Battle Road Research. Please proceed with your question..

Hi.

How is it going, Rob? Question, just to clarify in terms of the European factory automation market, understanding your comments that one of the differentiators with North America is in that market, logistics is stronger, is it fair to say that factory automation in Europe is more heavily tied to the automotive market, than it is perhaps some of the other verticals in your other geographies?.

Well, I think the European market is – has a large automotive piece to it, as does America and Asia tends to be more consumer electronics, right. That would be a broad brush. America is becoming less dependent on automotive as we broaden into logistics more quickly.

I would say, but overall automotive is probably the biggest market for us in both America and Europe or has been..

Okay..

And I'm just going to exercise a little this question here on the call, we've got about 10 minutes I think till the top of the hour. And we have quite a lot of people in line. So Ben, would you mind my being rude and limiting you to only one question and moving on to the next call..

Sure. I only have one. Sure. Why don't you go ahead? Thanks, Rob..

Thank you. Thanks a lot, Ben. Appreciate it. Thank you..

Our next question comes from the line of Paul Coster of JPMorgan. Please proceed with your question..

Thank you. Hey, this is Paul Chung on for Coster. Thanks for taking my questions. I'll just be fairly brief. So just on your OpEx spend, you're embedding less into business.

So, but you're still generating pretty healthy cash flows, so should we expect some kind of accelerated pace of buybacks or maybe a higher dividend or is that $60 million per quarter the right kind of pace of buybacks we should expect. Thank you..

Right, so – we announced we're staying with the same dividend currently, but I'm going to – I'll just pass it over to our Treasurer, Chris Stagno.

Can you answer that?.

Hi, this is Chris. Thanks for the question. I think if you take a look at the buyback program, we do have about $130 million – available under the plan. We did about $104 million repurchase during Q2.

In terms of future purchases, I would expect us to continue to purchase, but the timing would be subject to market conditions, the potential uses of cash going forward..

Our next question comes from the line of Joe Giordano of Cowen and Company. Please proceed with your question..

Hey, just one quick follow-up for me. Just a sequential cost guidance on the OpEx. It's basically – it's kind of in line with last year's 3Q I think, which was a huge revenue number.

So I'm just curious if you can talk us through – that spending like what it's actually going towards change, I mean – gross level dollar is still pretty high relative to the revenue? Thanks..

I think our R&D investment is probably pretty consistent and across those two periods and then certainly we have added considerably in terms of sales headcount, particularly in Europe through that period, so – and in logistics.

So I think we're seeing that and certainly and anybody want to add more color to that, Laura?.

No, I'd say it's consistent with bridge in our MD&A and our 10-Q where you've seen the impact of the personnel additions that we've had at both in engineering and sales over the past year..

Thank you..

At this time, we have reached the end of the call. I will now turn it back over to Dr. Shillman for closing remarks..

Yes. Thanks a lot for passing it back to me. And okay look, the outlook is clearly not what we expected and despite the fact that we know that automation and machine vision are key for the future for making everything from chocolate chips to computer chips and those are real examples, it's unsettling to see the slowdown that we're seeing now.

We're hoping for better times and not only hoping for it, management is working very hard, looking at as Rob mentioned, reallocating to those growth areas and that's reasonably easy for us to do. And also we're looking at some very exciting acquisition opportunities in the future to add to our growth. That's it from here.

I wish we had better news to report and I'm sure in the future we will. Thanks again for paying attention to Cognex and for participating in today's call. Good night..

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time. And have a wonderful rest of your evening..