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Edited Transcript of CGNX earnings conference call or presentation 29-Apr-19 9:00pm GMT

Q1 2019 Cognex Corp Earnings Call

NATICK May 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Cognex Corp earnings conference call or presentation Monday, April 29, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John J. Curran

Cognex Corporation - Senior VP of Finance & Administration, Treasurer and CFO

* Robert J. Shillman

Cognex Corporation - Founder, Executive Chairman & Chief Culture Officer

* Robert J. Willett

Cognex Corporation - CEO, President & Executive Director

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Conference Call Participants

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* Andrew Edouard Buscaglia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Andrew Sherman Haroldson

D.A. Davidson & Co., Research Division - Research Associate

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Paul Chung

JP Morgan Chase & Co, Research Division - Analyst

* Joseph Alfred Ritchie

Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst

* Joseph Craig Giordano

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Joshua Charles Pokrzywinski

Morgan Stanley, Research Division - Equity Analyst

* Karen Lau

Gordon Haskett Research Advisors - Research Associate of Industrials

* Richard Charles Eastman

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to Cognex First Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Cognex' CFO, John Curran. Thank you. You may begin.

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John J. Curran, Cognex Corporation - Senior VP of Finance & Administration, Treasurer and CFO [2]

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Thank you, and good evening everyone. I'm John Curran, Cognex' CFO, and I'd like to welcome you to our first quarter earnings conference call for 2019. With me on today's call are Dr. Bob Shillman, Cognex' Chairman; and Rob Willett, Cognex' President and CEO. Please note 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 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 will now turn the call over to Dr. Bob.

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Robert J. Shillman, Cognex Corporation - Founder, Executive Chairman & Chief Culture Officer [3]

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Thank you, John, and welcome, everyone. As shown in the news release issued earlier today, our Q1 results were in line with our expectations with revenue near the top end of our guidance and in fact, Cognex set a record for Q1 revenue. Well, that's the good news. The bad news is that year-on-year growth was slower than we would have liked, reflecting today's lower growth environment. Right now I'm in San Diego, and everyone else on the call is at our Natick headquarters. So for further details, I'm going to pass the call over to my partner, Cognex' President and CEO, Rob Willett. Rob, take it away.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [4]

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Thank you, Dr. Bob. Good evening, everyone. As Dr. Bob said, revenue in Q1 grew just 2% year-on-year due to market conditions that we discussed in our Q4 call in February. Lower spending by customers in China and in the automotive sector in the Americas offset most of the strong growth that we achieved in logistics. Given these conditions and the greater visibility we now have into consumer electronics, we expect our overall revenue will shrink slightly in 2019.

Let's take a closer look at what's happening. In consumer electronics, we now expect customers to defer investments in automation and machine vision, particularly in smartphone manufacturing. As a result, we expect that revenue from consumer electronics will decline by approximately 1/3 in 2019, marking the second consecutive down year for this major piece of our business.

While there's inherent volatility in consumer electronics as we've witnessed over the past 3 years, we remain confident that we are not losing share in this market and that Cognex machine vision is a key element of manufacturers' long-term plans, both to bring new products to market and to realize productivity and quality gains. Considering the significant decline expected for consumer electronics, we believe that automotive will be our largest end market in 2019.

However, we are anticipating challenges in the automotive market as well. After 3 years of strong growth, revenue from automotive is relatively flat due to lower sales in China and the Americas. Manufacturers are scaling back and delaying large automation projects in responses to change in consumer purchases, declining unit sales and evolving product road maps.

On the positive side, there are trends shaping automotive that will benefit Cognex over the long term, including a ramp-up in electric vehicle production by mainstream automakers, the relocation of manufacturing facilities and the increased use of sophisticated electronics in automobiles, all of which will require more machine vision and barcode reading.

Turning to logistics, I'm pleased to report continued strong growth year-on-year in Q1 driven by a broad base of customers that includes many well-known e-retail and retail names. As the e-commerce sector grows, forward-thinking customers are recognizing the need for automation to improve the speed and accuracy of delivery, and they're turning to Cognex vision and barcode reading as key enabling technologies in their distribution centers. Many of the other industries we serve also continue to grow strongly as our products become easier to use and our sales team reaches more customers.

Cognex has always viewed market slowdowns as an opportunity to reallocate existing resources to high-potential areas of our business in order to take market share. Our long-term approach includes developing technology to address fast-growing areas that can bring significant revenue over time, such as logistics, deep learning, 3D, mobile terminals and life sciences.

Turning to new products, we recently introduced the DataMan 370 series of fixed-mount barcode readers for general manufacturing and logistics customers. More accurate and twice as fast as competitive readers, the DataMan 370 simultaneously reads different sized, challenging 1D and 2D codes even if the codes are positioned at varied angles and distances from the reader, such as on packages inside high-volume logistics scanning tunnels.

We also introduced several 3D products that outperform what's available today in the 3D vision market. DSMax is the world's fastest and highest resolution 3D displacement sensor, ideal for precise measurement of fine details on very small parts, such as electronic components smaller than a dime. 3D-A5000 delivers highly accurate 3D point cloud images from over 1.5 million data points. And when combined with powerful Cognex 3D vision tools, performs highly precise assembly verification, in-line measurement and robotics guidance in factories 10x faster than current methods.

Marking our entry into 3D dimensioning, the 3D-A1000 was recently previewed at 2 major logistics trade shows where its precise measurement of boxes, poly bags and envelopes traveling at high speeds on conveyor systems generated substantial interest. Advancing Cognex' powerful 3D tool set is PatMax 3D, a breakthrough part-locating vision tool for our entire 3D product range.

With that, I'll pass the microphone to John for financial details from the first quarter. As we announced earlier this month, John will be leaving Cognex on May 3. I want to take this opportunity to thank John for his contributions as Cognex' CFO these past 2 years especially for his work implementing our new ERP system and the further development of our finance and administration organization. We wish him all the best.

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John J. Curran, Cognex Corporation - Senior VP of Finance & Administration, Treasurer and CFO [5]

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Thank you, Rob. It has been a rewarding experience to be a part of such an exciting and financially strong company and to help lay the foundation for its continued growth. I will miss working with such a talented and dedicated group of Cognoids, and I wish everyone at Cognex all the best.

Turning now to details for the quarter. As Dr. Bob said, our Q1 results were as we expected. Revenue in Q1 was $173.5 million, representing year-on-year growth of 5% when excluding FX. Logistics continued to show strong growth, but as previously discussed, we experienced weakness broadly across Greater China and in the automotive sector in the Americas.

Gross margin was 73% compared with 76% for Q1 of '18 and 73% for Q4 '18. The year-on-year decline was primarily due to the unfavorable absorption of manufacturing overhead costs. Operating margin was 17% in Q1 of '19 compared with 20% in Q1 of '18. The dip in gross margin was the largest contributor to this decline. Also, the 2% increase in operating expenses had a slight negative impact. We benefited from a $2.7 million discrete tax item from the exercise of stock options during the quarter. Excluding all discrete tax items, earnings were $0.17 per share in Q1 of '19 compared with $0.18 a share a year ago.

Looking at revenue from a geographic perspective, overall market conditions in Q1 were generally in line with our expectations. Europe grew by low double digits year-on-year and delivered the largest contribution to growth both in absolute dollars and in percentage terms when excluding a 6-point negative impact from currency exchange rates. Growth came from several industries and was led by logistics and consumer products. Americas also grew by low double digits. Growth was led by substantially higher revenue from logistics customers, which was partially offset by lower revenue from automotive as our customers are deferring spending.

In Greater China, more so than anywhere else, we see customers deferring their capital spending plans. Continued weakness across the region resulted in lower revenue year-on-year. The negative impact of currency exchange rates contributed 6 percentage points to the decline. Revenue from other Asia declined due to lower spending by consumer electronics and semiconductor capital equipment manufacturers. Otherwise, underlying demand in the region remained solid.

Looking at our balance sheet, Cognex continues to have a strong cash position with $864 million in cash and investments and no debt. Inventory decreased by $4 million or 5% from the end of 2018. Lastly, we prospectively adopted a new lease accounting standard, which resulted in a $17 million balance sheet gross-up at the end of Q1.

With that, I'll turn the call back over to Rob.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [6]

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Thank you, John. Turning to guidance. Revenue for the second quarter is expected to be between $190 million and $200 million. While this range represents an increase over Q1 of '19, it is lower than Q2 of '18 for the reasons we have discussed. Furthermore, while it's not our practice to provide full year guidance, I will say that for all of 2019, we believe revenue will decline slightly year-on-year and be somewhere right between the levels we reported for 2017 and 2018.

We expect gross margin for Q2 will be in the mid-70% range, in line with the 73% gross margin we reported for Q1. Operating expenses are expected to increase by low single digits on a sequential basis. The effective tax rate is expected to be 15% excluding discrete tax items.

With that, we will open the call to questions. Operator, please go ahead.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Joe Ritchie with Goldman Sachs.

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [2]

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So Rob, maybe let's touch on China for a second. I saw in the Q that China was down mid-teens in the quarter. It seems like machine tool orders in electronics are kind of at all-time lows. Auto production starting to look up a little bit. But in effect, you're basically calling weaker -- weakness throughout the rest of the year. Are there any green shoots that you're seeing throughout your business? I know that you're expecting a little bit of a pickup in 2H. Just any color around that would be helpful.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [3]

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So China has been a great growth market for Cognex for many years, and we believe it will continue to be in the long term. But near term, as you rightly point out, it's broadly soft more so than anywhere else. And what we see is a lack of confidence, among other issues that's causing capital expenditures to be delayed. So to speak to your question specifically, I think if that confidence comes back suddenly or quickly, that's what is likely to change things around. And I would say China has a habit, in my experience, of turning around as a market quite quickly when it does turn, but that's not what we're assuming is going to happen currently. Our largest end markets in China are electronics and automotive and both are notably softer.

I would say as we look forward, there's still just so much manual labor performing basic tasks that can be better performed by machines, and smaller China manufacturers are coming up the curve and the logistics infrastructure also is in stages of modernizing and investing. So I think all of those bode well for Cognex in the longer term. The question is how quickly will it turn around and we've assumed in our words to you, not soon.

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [4]

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Fair enough. And I guess one of the things that we've noticed in some of the trade shows we've been to, it seems like competition on the 3D vision and logistics products piece is increasing. Now look, given the growth rate has been incredible for you guys over the last several years, I guess, are you seeing any of that increased competition? Do you need to do anything additional from an investment perspective? I know you've launched new products recently, but maybe talk to us about how you're penetrating that market on a go-forward basis specifically as it relates to 3D vision.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [5]

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Yes. So Cognex has been in the 3D vision business now for a few years, and we see it as a very high-growth area for us. In previous years, I've talked about 3D vision being around 5% of our business with the potential to grow at 50% a year. I think in the long run, we still have that view. Growth for 3D vision for us was stifled last year by consumer electronics, and I expect we'll see a similar dynamic this year based on the softness of that market. However, your question relates to logistics, and I think the potential for Cognex 3D in logistics is very significant.

We -- most of our logistics business today is primarily in barcode reading. We're seeing it expand into vision more for various tasks like inspecting packages and looking for damaged packages or looking at numbers or letters on packages and symbols such as hazardous symbols on packages. So it's expanding into vision. And then now we're really starting to move into 3D vision and logistics, which is something we weren't really doing up until last year. And so there's potential for that to grow significantly.

A product we did preview at the 2 largest logistics trade shows for our industry this year, ProMat and LogiMAT, was the 3D-A5000, and that's a 3D vision system which has superior technology over time of flight and laser-based dimensioning. So dimensioning is something that happens a lot in logistics increasingly where customers are more often being charged for the size of packages not just the weight. So this is a great growth market, and we have advantaged technology which gives a much cleaner image of what's being studied as it moves down a production line. It's also a technology that's much easier to integrate and much easier to manage than laser and time of flight-based products. So we see that as, I think, shorter term perhaps during the second half and then on growth driver for us at 3D and logistics.

Then there's another market, and I think probably many of you on the call went to the trade show in Chicago and you would have seen a lot of companies doing kind of robot vision-enabled tasks. We see a lot of companies spending a lot of money in that space, but we think the technology is still relatively in its infancy. And we have great technology in that space, but we still think it's some time before we see the kind of random bin picking replacing humans in logistics that I think is creating a lot of excitement today. So I think that market is still some way off. When it does come, I think we're very well positioned because we really are working with the leaders in this space, looking at what's going on. But we realize that I think a lot of money is going to get lost in that market for quite a long time before it finally turns into a profitable venture. So we're being thoughtful about how we're approaching it.

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [6]

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If I could just ask one quick clarification. You mentioned earlier that auto is going to be your largest end market this year from a revenue perspective. Is logistics going to be as large, if not larger, than electronics?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [7]

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I don't think we're going to give specific input on that at this point, Joe.

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Operator [8]

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Our next question is from Josh Pokrzywinski with Morgan Stanley.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [9]

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Just to maybe take the -- some of the near-term weakness in auto electronics a bit further, Rob. I think over the last couple of years, clearly there's been a big accumulation of automation technologies in both of those industries particularly in China. I think if you were to look at robot installations over the past decade, they probably don't look too far below your own growth rates.

You mentioned that there's still a lot of runway and a lot of manual tasks that are being automated. But how far along do you think we are in kind of the penetration of automation into some of those markets? Do you think we're halfway there, a quarter of the way there, 80%? I know it's kind of a tough question, but just trying to think of, coming off of a long period of growth now, how much of this is a deceleration that could stick with us for a while versus a reset year and back off to the races?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [10]

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Okay. So I think how I approach that question as I think about it is what's the ultimate end point, and I think it's what I would call lights-out manufacturing, right? And where do we see the closest to that in automation today? Possibly in semiconductor and perhaps some -- closer but no way near in automotive. Other industries, I'd say, are so far away from full automation of their processes. And I would say certainly less than 25% penetrated as I look around the industries that we serve.

And to give you an example, we talked about a slowing in consumer electronics. But if one is to wonder, the China market, which is perhaps the most difficult market today in terms of growth, the number of people that we see in manufacturing, literally millions of people assembling electronics as an example, that really can be replaced by products, robotics and vision that will do a better job in the long run and more consistently, gives me a sense that this market still has a very, very long way to run. And of course, we're a technology company, so our products are getting more powerful, easier to use, easier to integrate, less expensive.

And we're bringing new technologies to market in vision that can expand the boundaries of what we do, perhaps the best example being our new deep learning technology, which really does allow us to replace more and more basic visual inspection in production. So not only are we gaining share from non-automation to automation, we're also expanding the boundaries of what automation will do. So -- and then we see new markets continuing to adopt automation as an example. Food was very underpenetrated from robotics and vision perspective a few years ago, but we now see it being a fast-growing market for us and there are many other markets to which that applies. So I'm viewing this as a temporary phenomenon in a slowdown of the move of automation into a lot of markets.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [11]

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Got it. And I guess within that, and this is my follow-up, given maybe some broadening of the application set beyond kind of the traditional 2 large markets for you guys, electronics and auto, what does that mean for mix? Is that mix positive? Is that mix negative? Does it matter? Because obviously, the type of buyers of the applications will change as you kind of run around application to application.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [12]

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When you say mix, Josh, presumably you mean profitability?

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [13]

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Yes. Product mix if you want to think about it in gross margins or ASP, whatever makes the most sense to you and we could kind of contextualize.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [14]

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Yes. I mean I think -- to speak in generalities, I think generally, smaller customers who don't require much support from us tend to have low service components to their revenue. So then we often put the business through partners. So we often see them having higher margins overall and they use discrete vision system technologies like In-Sight, for instance. So that can be margin accretive for us overall. We tend to see certain industries, where customers are large and adoption is complex, requiring more support from us. So we see that particularly in the smartphone market and the logistics market currently where we have some very, very large customers and potential customers who need more application engineering support from us.

So we see that in logistics at the moment, and that's dilutive and that is an impact to our gross margin year-on-year, which I think we've spoken about already with you. So we see some of that. So I think the smaller customers that are adopting, let's say, that will stay under sort of 10% of our revenue for longer periods have the potential to adopt our technology themselves. We have very easy to use, easy-to-adopt technology. I'd hazard to say the easiest in the industry, and I think that bodes pretty well for our margins.

Another thing to bear in mind is that as these new customer sets kind of develop, that means we have to call on a lot more plants globally as the industries we serve broaden. And that's one reason we've added a lot of salesnoids over the last few years is to extend our reach. And as we develop products such as our In-Sight 2000 or the DataMan 370 we just launched, it means those salespeople can call on plants and close business relatively quickly, so we need more coverage to do that. That's going to be great for our margins over long term as the business grows. But right now it certainly means that we're carrying more expense than we would have if we were just serving a few industries.

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Operator [15]

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Our next question is from Richard Eastman with Robert W. Baird.

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Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [16]

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Robert, could you talk just a second or 2 about the auto business? And I'm thinking you have another big second quarter comp from last year. But if you think of the business in dollars that come from the auto industry, I'm just -- I'm curious from a dollar perspective, are we near what you might think of as a bottom or when you think of the business sequentially? Or how do you see that playing out for the year perhaps, comps aside?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [17]

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Okay. Rick, yes, I think that depends on what's going to happen in various markets. So I'll kind of give you an overview and try to put some color on that. So the China market is broadly soft more so than anywhere and uncertainty, among other issues, is causing capital spend to be delayed. The American automotive market is noticeably slower than it was. Manufacturers are scaling back large automation projects as they focus on reducing production rates. Europe has been performing relatively well this year. Brand owners in Europe seem to be more optimistic coming into the year. And then in the rest of Asia, the automotive business is more solid, delivering some better growth for us particularly around automation, new technologies and electric vehicles.

So kind of with that as backdrop, I think what I would say, I do see some sequential growth for Cognex as we move through the year on automotive, but whether that's very limited growth or stronger growth depends on how some of the uncertainty plays out. I think the uncertainty is quite consumer-driven in China where we're going to see more stimulus. And then I think to some degree, the trade uncertainty that's hanging over America and China and potentially for Europe, too, is an issue. And if that, I think, loosens up, we'll see some capital break free and we should see better growth rather than just very limited growth as we go through the year year-on-year.

I would add that in terms of automotive, I spent substantial time last month in the southern states of America visiting automotive companies and their suppliers. I did see a lot of uncertainty and stagnation there. I saw big automotive plants reducing their shifts from 3 to 2 shifts in some cases, and I saw a slowing down of investments going on among Tier 1 suppliers, notably Japanese suppliers as an example. So I don't think that's a long-term phenomenon. I think it's a temporary phenomenon, and how quickly it changes will determine the answer to your question about whether we're sort of rather stagnant or returning to growth.

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Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [18]

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Okay. All right. And then just my follow-up actually, I wanted to bounce a question off to Dr. Bob, if he's live on the call.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [19]

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Dr. Bob, are you on mute perhaps?

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Robert J. Shillman, Cognex Corporation - Founder, Executive Chairman & Chief Culture Officer [20]

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Exactly. I was on mute. Thank you. I am now back and fully here. I was on mute.

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Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [21]

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My question is around this -- the robotic guidance market and this path towards automating bin picking. And it seems like the early vision market here is kind of 2 pieces. One is around the movement of the pick itself, and the other is kind of movement around the arm. And I'm curious if we end up in a situation where we have one bit of software that's maybe 3D software that can do both tasks because it seems to me the movement of the pick itself might be somewhat commoditized at some point. Am I thinking about that right? Just your thoughts on that, Dr. Bob.

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Robert J. Shillman, Cognex Corporation - Founder, Executive Chairman & Chief Culture Officer [22]

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Okay. The general bin picking problem has been around since I was a graduate student 40 years ago. But at that time, it was presented as a tub of identical parts lying in any random array, and the goal was to find the one that was on top and that pretty much is solvable. But the problems that customers want to solve today is quite a bit more difficult than that. The problem, as I understand it, the customers want to solve is there's a bin someplace in a rack even, not necessarily on a laboratory floor, there's a bin in space and it contains numerous items, not all the same, matter of fact.

Now if you ask a human, "Reach into this bin without even looking, your hand over your head, and pick out the pen -- the package with a pen in it instead of the packages that have calculators in them or whatever," a human can do that. And having been in this field for 40 years now, every day I am more and more impressed by what humans can do, even a low-paid human: the ability to find things, to grasp them. And if they grasp it, they grasp it appropriately and hard enough so they won't drop it even if they're moving their hand quickly. So the problems we're faced with today are that there's a bin somewhere and there are mixed parts in there in various orientation and the goal is to pick out the calculator out of that bin which contains other things as well as calculators.

Now the problem, even though humans can do it by a sense of touch and understanding what things feel like and how hard they are, how much they weigh, the problem requires today from automation to be solved, it does require machine vision to look into the bin, the first thing to do, to look into the bin, try to find the part that's there and then more importantly or as importantly, locate the point to pick it up. Because if a robot arm goes in there and picks it up from the end, let's say, let's say it's a piece of wood measuring a foot long, if it picks it up by the end, by the time the hand moves back to put it in the shipping carton, it will have dropped that because it turns out the robots have to move quickly to justify this entire system. So not only does the vision have to determine where the part is that it's supposed to pick up, but also where to pick it up. Then that's the vision problem. Very complex. Very complex.

Next, there's the gripper problem. What kind of gripper is going to be used to pick up the part? Well, there are a variety of different kinds of grippers. There are mechanical ones, suction ones. And how hard do they squeeze on it so that when they move quickly, they won't drop the part? Very hard problem. Then there's the robotic mechanics problem, which is how do you move the arm in the gripper in such a way to get into the bin, not knock the bin over, not hit the other staging that is holding the bin and compute the path to pick it up and then to retrieve it and put it back in the box.

So this is a very, very difficult problem. I would say it's almost equivalent to self-driving cars, which is again, a very difficult problem. And although we have pieces of that puzzle, I don't believe that anyone yet has put the entire -- all those pieces together into a solution. And we've been working with a variety of companies to try to solve this problem, but I'm afraid that it is beyond the technological state-of-the-art and will remain so for a few years.

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Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [23]

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And just to be clear, the way you're seeing it currently is more around 2D vision to identify the problem. Is that how Cognex is approaching? Or is it 3D?

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Robert J. Shillman, Cognex Corporation - Founder, Executive Chairman & Chief Culture Officer [24]

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No. No. In the most difficult case, we need 3D because you have to determine which part is on top because that's the one you're going to pick up. We have been using some advanced snapshot 3D sensors of our own design, our own technology, to work on this problem. But I believe it's going to be a long time before these major e-tailers can lay off or repurpose the people who are now doing the bin picking. It's going to be a long time.

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Operator [25]

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Our next question is from Jim Ricchiuti with Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [26]

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I may have missed it, but did you provide a growth rate for the logistics business in the quarter? I know you've been historically talking about it growing 50% or better. But I was just wondering, this past quarter, what was the growth rate?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [27]

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Jim, we're not going to give quarterly growth rates on any specific market that we serve. I'm going to say that we are very happy with the growth rate we achieved in logistics in the quarter.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [28]

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Okay. Rob, I wonder if we could look at the consumer electronics business and the kind of decline that you're anticipating for this year. I'm trying to understand a little more about the dynamics in that market right now. Is it just market weakness? Are some of the customers, potentially the larger customers, also perhaps repurposing some of the existing machine vision? I know in other times as companies -- some of your customers transition to new products, it ended up being a significant investment in all new vision, and I'm trying to get a better sense as to what might be happening in some of these factories.

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [29]

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Yes, Jim. So what we're seeing is large customers in consumer electronics are deferring investments in machine vision and particularly in smartphone manufacturing. Broadly speaking, a number of customers are focused on upgrading their existing lines, and they're not making heavy investments in new capabilities this year as far as we can see. And as we said, we expect the business to decline by about 1/3 this year, and you'll see the impact most notably in our, strangely, in our European region because some large customers purchase us -- from us there, but also in China and in the rest of Asia.

So consumer electronics remains a growth opportunity for Cognex and companies have product plans that require automation and machine vision to implement. So new innovations that we all read about in the newspapers, such as foldable screens, wireless charging, virtual reality, will certainly require more complex manufacturing processes in the long run. And although we may see some of those technologies in various companies' products today, they're still really being tested and not rolled out in any massive hardware sense this year and the focus is more on retrofitting existing lines and improving productivity.

Certainly, rising wages and current processes are still very labor-intensive, and so there's certainly focus on those areas to reduce cost. And then another factor that's going on certainly is new facilities are being built as companies diversify away from China to other emerging areas. I mean we even read about electronics manufacturers here in the U.S. and -- but certainly also in India and other markets, we're seeing some investments, too, just start to begin.

So I'd say it's a great transitional year. It's one where the new technology is not here yet, where there's a lot of focus on cost, and that's kind of certainly having its impact on our business. There is business for us for retrofitting and improving lines. But as you can see from our guidance, it's much less exciting and growth oriented than when major new lines are being implemented or new features are being brought to market.

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Operator [30]

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Our next question is from Joe Giordano with Cowen and Company.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [31]

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I guess maybe -- wondering if you had an update on integration of some of the deep learning capabilities into the In-Sight platform. I've seen some of your guys at trade shows, and that's something you guys have been working towards. I think some of your competitors are close to launching something similar to that. So just any update there on being able to put all that technology onto a single platform?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [32]

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Well, generally, Joe, we don't give a comment or we don't comment about future product launches which may or may not be coming from Cognex. So that's not something that I would comment on. Certainly, we're very excited and we're seeing some excellent growth in our deep learning business, and it's an area we think we're leading in from a technology point of view. And of course, making that technology more accessible and easier to use would be what one would expect a product road map to include, but I'm not going to get specific about when and in what form we might launch future products with that technology.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [33]

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Okay. When I think about where your balance sheet is and what you've done over the last couple of years, you've obviously -- you were hiring like crazy to meet demand. So how do you feel you guys are positioned now in terms of like -- is your capacity too high from a human capital perspective? And in terms of the financial capabilities, I was a little surprised to see no buyback this quarter. Just how should we think about that going forward?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [34]

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Yes, Joe. I'll talk about the sort of capacity issue then I'll invite John to comment on the buyback. So you're right. We've been investing very heavily in the businesses. We saw some phenomenal growth and phenomenal potential in the business. Obviously, 44% growth in 2017. We were, in a sense, under capacity as we -- we didn't have the capacity to support that level of ongoing business as we exited the year. So we were doing some catch up in '18.

But what you're seeing now is we're going to be slowing down significantly on hiring and expense growth, and we're reallocating resources because we're -- Cognoids are very talented and capable individuals that we take great effort to hire, have a cultural fit with our business and train and develop. So they're great assets for us that we're going to or are in the process of redeploying towards high-growth areas of the business such as logistics.

So we think it gives us extra capacity for what we want to do in the future, but we certainly are slowing down expense growth and hiring based on what we see and we've been discussing on this call. Now I'll turn it to John on the buyback in Q1 question.

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John J. Curran, Cognex Corporation - Senior VP of Finance & Administration, Treasurer and CFO [35]

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Yes, Joe. As you mentioned, we weren't in the market in Q1. Last year, we got -- our purchases, we got pretty far ahead of our dilution. So we kind of paused on the buyback at the end of last year and into Q1, but we plan to be in the market in Q2. We've had a significant grant during the quarter, so we'll be back in the market. And just as a data point, we have about $190 million authorized by the Board, so we're ready to go.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [36]

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If I could just sneak one quick one in on just a math clarification. Just on your consumer electronics business, you mentioned down 1/3 or so this year. I think it was down a similar amount last year. Can you just maybe frame how much dollars in that business versus the 2017 base is going to be gone and effectively has been made up by other parts of the business because revenue on a full basis will be above 2017?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [37]

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Yes. I think directionally, revenue in that market was down about $65 million last year, right? I think we would expect to see it down about 1/3 this year, right? So a similar amount generally. Your question kind of was what was it in '17 and what's it going down. And I think we may struggle to answer that question, but we might do a little work offline and answer a little later in the call. [So we'll go to the next] question and we'll try to address it.

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Operator [38]

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Our next question is from Andrew Buscaglia with Berenberg.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [39]

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Quick question on some of your machine vision peers, some being customers, are mostly calling for a flattish to up mid-single-digit year in 2019. So you mentioned you don't think you're losing share. But why -- what's the -- how do you triangulate the commentary out of some of your publicly traded peers? Is it they're playing in different niches that maybe they're growing differently? But can you comment on what's the delta there?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [40]

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Yes, Andrew. I think there aren't really any like-for-like publicly traded peers of Cognex. I think there are different data points in the market from publicly traded companies, but none of them really map very well to what Cognex is. Certainly, our largest competitor is Keyence, and I think they may see similar phenomenon we do. But their exposure to market's may be different and of course, their business is much larger and much more diverse than ours, right? And then there may be other companies, smaller publicly traded companies that deal specifically with electronics or other markets, so you may see them affected in different ways.

So I think when we talk about share, we think about the accounts that we serve. Bear in mind that Cognex is the largest and most respected machine vision provider in the automation world. So pretty much all of the major companies that use machine vision do use Cognex, whether we have the biggest part of their business or not. It may depend. But certainly, we have a very good feel about what's going on with their plans and if and where we might be losing or gaining share.

I think my comment related specifically to the consumer electronics vertical where we obviously have some very, very large business and deeply penetrated businesses in certain accounts. So certainly, that's driving our confidence that although our business is severely down, we're not losing share or account share in that market per se.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [41]

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Got it. And if you could comment -- you're spinning out a lot of cash here. Free cash flow is still strong. We're in kind of a down year. Will you consider or are you looking harder like at inorganic growth opportunities? And maybe if you could comment on what M&A valuations are like and things you're looking at. Are you getting more comfortable there?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [42]

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So we look at acquisitions for growth opportunities on an ongoing basis regardless really of whether our business is growing fast or, in this case, not growing at the moment. So that's -- it's not really a growth-driven activity. We have a very structured approach to acquisitions with a corporate development team that maps markets, looks at our own market and what represents good bolt-on opportunities for us in our existing markets and what adjacent markets we might enter through acquisition. We've made 6 smallish acquisitions in the last couple of years or so. Generally, they've been acquisitions we really like a lot, which is great engineering and technology companies with a small number of employees and a lot of talent and growth potential, and we've seen that flow through particularly in the areas of deep learning and 3D.

So we -- that's the type of acquisition that we like. There are, I think perhaps to speak more directly to your question, some larger opportunities out there to acquire competitors. And certainly, we have what I would refer to as a shopping list. And as those companies become available, then we certainly look at them. And those could take larger amounts of capital to acquire, right? So certainly, we do look at those. But we are highly selective in what we choose to acquire, and a big factor for us is our culture. We don't want to bolt on some kind of underperforming or less-than-excellent culture to Cognex because we believe that's so essential to our long-term success as a business. But there certainly are companies that we would like to acquire if and when they become available, and that might consume hundreds of millions of dollars of cash to do so.

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Operator [43]

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Our next question is from Karen Lau with Gordon Haskett.

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Karen Lau, Gordon Haskett Research Advisors - Research Associate of Industrials [44]

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Rob, I want to start it out with China. You mentioned longer-term adoption still very robust for machine vision end market. Can you talk about how big of your China business is still oriented towards consumer electronics and auto? And are you seeing any benefits from like other industry adopting machine vision benefiting the Chinese business in any way?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [45]

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Yes, Karen. So you're right that our 2 largest vertical markets in China are electronics and really only in recent years, automotive. We've seen very, very strong growth in our automotive business in China over the last 3 years where it's rivaling consumer electronics in terms of its size. And then we have a lot of other markets just as in other geographies that we serve in China, and we see very widespread and fast adoption in markets like that. So pharmaceuticals, medical device, solar, for instance. We're putting up some very good growth numbers even in this type of an environment. So I'd say those are more big, big growth opportunities off small bases that we see, and it's certainly a reason that we've built the sales force to be able to reach all those potential customers.

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Karen Lau, Gordon Haskett Research Advisors - Research Associate of Industrials [46]

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So if you parse out consumer electronics, which obviously has its own dynamic in China, have you seen any improvement in sort of CapEx investment sentiment in the past month or so after Chinese New Year? Because there seems to be so much stimulus going on like people cutting prices in cars or cutting manufacturing taxes. So it sounds like from your guide you're not seeing any improvements. But are you seeing any stabilization improvement at all in China outside of CE?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [47]

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No. I mean I'm reading the same things that you are, Karen, but I'm not really seeing the market turn and the investment come back on yet. That's what I would say.

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Karen Lau, Gordon Haskett Research Advisors - Research Associate of Industrials [48]

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Okay. Got it. I guess more broadly you -- I guess you guys started the call calling out slower business conditions. But aside from electronics and auto, have you detected any hesitancy in like other types of customers towards investing in automation like anywhere and in any verticals at all?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [49]

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I mean I would say it's more of a geographic phenomenon is what I would refer to. I think as I look across our Americas business, I would say in general it's not -- there's not the sort of level of buoyant investment in automation right now that we did see, say, back in a year ago or in 2017. So I would say that's the case. I think there's also Europe. You see and read a lot about a lot of hesitancy in that market, too. I think we've -- our European business has done better than we expected so far this year, and we're still seeing some stronger trends there than we expected to at the start of the year. But even there you can see some hesitancy particularly, I think, in Southern Europe where financing may be more difficult to come by. Customers are a little bit less bullish in terms of their investment plans.

And then I think another thing to appreciate about the automation market, which maybe many of us do, is it's quite global and there are certainly big machine builders in Southern Germany or in Italy or in Japan or Taiwan or Korea that are very dependent on global customers, particularly in China. So if those customers are paring back their investments or waiting, it can hurt the order books of companies in those very distant geographies.

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Karen Lau, Gordon Haskett Research Advisors - Research Associate of Industrials [50]

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Okay. That makes sense. And then just one last one, quick one on consumer electronics. I understand that you mentioned you're not losing shares. But if you compare what you're guiding to, the down 1/3 number, that's pretty drastic after a down 20% last year, right? And I think some of your, to the earlier questions, your peers or some business partners kind of talked about their consumer electronics market expecting to be like not down as much this year. I realize the trend can change very quickly. But I'm just curious, you're not losing share, but are you in any way maybe suffering from some sort of trade repercussions from like Chinese smartphone makers towards like U.S. suppliers maybe temporary? Is that like -- has that been any impact to your business at all?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [51]

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So I think what I want to do, Karen, is I want to qualify what I said is I don't think we're losing any account share overall, although we may have exposure to some larger customers, greater exposure than other companies do. So I think that may be part of the confusion in this overall. So I would say as I look at accounts and I look to the business we're having and I look at our sales funnel and our CRM system, the business we seem to have -- we're working on. We're not losing at a rate that seems different than in the past.

But I think when all is said and done and we have -- we look back on the year, we may find our electronics business is down 1/3, and that's more than other customers based on where our exposure is. We're more exposed to certain end-user customers and we have less exposure, as one -- you might expect us to say, to Japanese businesses, and more exposure in some other areas. So let me say that that's the case. I think on a dollar-for-dollar basis on the overall market, we may find our share decrease while our account share is maintained.

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Karen Lau, Gordon Haskett Research Advisors - Research Associate of Industrials [52]

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Okay. Any comments on any potential -- any, like, trade repercussions that may be impacting your consumer electronics business in China?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [53]

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It's not clear to me but that's obviously -- it's very hard to parse out what's consumer-led, government stimulus-led, anxiety-about-investment-led. So the answer to that is I think I just don't know.

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Operator [54]

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Our next question is from Paul Coster with JPMorgan.

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Paul Chung, JP Morgan Chase & Co, Research Division - Analyst [55]

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This is Paul Chung on for Coster. So just on add backs, your spend has slowed in 1Q. It looks like it's extending into 2Q. And I guess your pace of hiring has slowed as you mentioned. But how should we think about the second half given the slowdown in top line for the full year? I did notice some comments you mentioned on outsourcing some engineering costs. Is that something new that you're doing? And is there kind of like a bigger focus now here on kind of costs?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [56]

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So we -- A, we don't give expense guidance for the full year, but you can see we're slowing down our expenses. And as I mentioned to an earlier question, we're allocating resources into higher-growth areas. So I think we should think of this as a pivoting of talent and resources towards higher-growth areas. It's certainly not a kind of a serious reduction, cost-cutting environment like we might have seen, say, in 2008. That's not where we are. We're not heading for the bunkers by any means. But we're just starting to focus a bit more on allocating resources to high-growth areas and driving some productivity through the business we invested last year in bringing a lot of new Cognoids on board, so getting them up to speed. And we invested a lot in our new ERP system, which can drive a lot more productivity for us. So I think of it as a pause and a reallocation rather than a reduction. So I wouldn't expect to see us reporting reduced expenses quarter-on-quarter as we get through the second half of the year. But any growth rates, I think, will be relatively modest.

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Paul Chung, JP Morgan Chase & Co, Research Division - Analyst [57]

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Understood. And then lastly, I don't think you've had an Analyst Day in years. So why now? And any preview on the agenda?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [58]

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So we have an Analyst Day pretty much every 3 years and that's -- I think that's been the case for maybe 15 years. So we're right on time to have the next one and I think nothing to read really -- nothing to read into that, but we're very much looking forward to bringing many of you to Natick. You'll see so many changes, and we have a lot of exciting things to show you in September.

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Operator [59]

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Our next question is from Matt Summerville with D.A. Davidson.

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Andrew Sherman Haroldson, D.A. Davidson & Co., Research Division - Research Associate [60]

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This is Drew Haroldson on for Matt Summerville. I just have a couple quick questions. First, can you talk about specific end market trends outside of auto, consumer electronics, logistics areas such as general industrial, life sciences, food and beverage and provide some regional color?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [61]

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Yes. Thanks, Matt. Your question is very broad, so I think I'll focus on some highlights. At Cognex, we're very thoughtful about end markets where machine vision can really have a lot of value over the long term. So some of the markets you name, certainly that's the case. Life sciences is a market where we've been investing and focused on for a long time, and we're actually very pleased with the progress we're making on that. This is a market where customers make machines that generally look at human bodily fluids, such as blood, and analyze it with reagents. And they bring machines to market that require machine vision, and the market generally has used some pretty basic ID, pretty low-price point ID products from some companies in that space. And what we've seen is there's much more interest and need to do a lot more with machine vision.

So we've been focused on this market for a while. We tend to measure success by design wins when large companies that you would recognize the name of design a new machine and they include Cognex vision. And when they do, what we see is the potential to generate many millions of dollars for each machine that we specified into over a 7- to 11-year period. So one of the OEM machine projects we won with a major European life sciences company last year, we expect to generate several million dollars of revenue per year starting in 2021. And then we actually won 20 new design wins last year. So not all of them as big as that one, but has the potential to generate hundreds of thousands or millions of dollars of revenue per year for substantial periods. And it's not material to our results now, but we believe it will be a larger contributor in a few years. So that would be one example certainly. And I think if there's anything I'd want you to take away from my comments is we have a pretty long-term view about where machine version can play and the benefits it can provide.

Another market we haven't really talked about in recent calls, but I anticipate we will perhaps at the Analyst Day or in future, is our market for mobile terminals. It's a new market we entered, about 3 years ago, where we have an advantaged product that integrates smartphones into a rugged design with Cognex machine vision on the front and it's capable of doing a lot of very interesting and powerful functions for those in logistics and in manufacturing. So that's a business we expect to double this year off a relatively small base, but it's another example of a vertical market where we're seeing a lot of growth.

Maybe if there's a third market I'd point to, Cognex machine vision is very powerful in helping customers in highly regulated goods fight counterfeiting and diversion, and that's a market that is buoyant and sees a lot of investment going in and where we've seen a lot of growth in our business, those of whom who want to fight those kind of problems in markets like tobacco, for instance. So those would be examples where we see long-term growth potential and we're investing and we're seeing good results in the short term even though they may not be that visible to you in the results that we publish each quarter.

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Andrew Sherman Haroldson, D.A. Davidson & Co., Research Division - Research Associate [62]

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And maybe as a quick follow-up, my second question, in your mind, what are the things that need to happen for mobile terminals to become a meaningful part of Cognex?

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Robert J. Willett, Cognex Corporation - CEO, President & Executive Director [63]

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So I think we came to market with an innovative kind of disruptive concept, and what we've seen is a lot of customers have resonated with that and have bought small numbers of the products and have been experimenting with them and seeing what they can do with them. So as we -- what we need to do is make sure that we can convert those customers into large users because they may have bought 5 from us and that they may buy 5,000 a year from some of the large players in that market. So the key will be our ability to convert some of those customers from those who are experimenting with our technology to fully adopting it.

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Operator [64]

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We have reached the end of the call. I will now turn it back over to Dr. Shillman for closing comments.

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Robert J. Shillman, Cognex Corporation - Founder, Executive Chairman & Chief Culture Officer [65]

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Yes. Thank you very much. Look, it's obvious that things are slowing down in much of the world in manufacturing. The sale of new phones doesn't seem to be growing, and the sale of cars seems to be slowing, maybe millennials or whatever. The good news is, first of all, that even though our revenue is slowing down, we're still going to be very profitable in 2019. We expect to be still very profitable and also to have positive cash flow. And aside from that, we are highly confident that we'll be back into good times in a year or so. The world needs more products. Consumers want to buy things of high quality and low cost, and the only way to get there is through automation and Cognex plays a key role in the automation of virtually everything you buy.

So we expect to get back on a growth track when the economy improves and when vendors -- when the companies that manufacture things start manufacturing more of the stuff. Generally speaking, our products are not reused. They're not repositioned. But when a new line opens up or new products are coming to market from the manufacturers, they need more machine vision and it's generally Cognex machine vision. And as Rob pointed out, we haven't lost any customers. That is very important to us to keep track of customers and making sure that, hopefully, that we never lose a customer. So what we have seen, of course, is some customers, and in particular large ones, buying considerably less and that's what you see reflected in our comments today.

Okay. I hope to be able to report on better results in the coming quarters and to take your questions again at that time. Thank you for attending the call. Bye-bye.

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Operator [66]

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Ladies and gentlemen, thank you for your participation. This does conclude tonight's teleconference. You may disconnect your lines, and have a wonderful day.