Cognex Corporation (CGNX) Q4 2019 Earnings Report, Transcript and Summary

Greetings. Welcome to the Cognex Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, that this conference is being recorded. I will now turn the conference over to our host Susan Conway, Senior Director of Investor Relations. Thank you. You may begin.

Thank you, and good evening, everyone. I’m Susan Conway, Senior Director of Investor Relations. 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 – annual report on Form 10-K are available on our Investor Relations website at www.cognex.com/investor. Both contain highly detailed information about our financial results. During the quarter, 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 business results. You can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the earnings release. Any forward-looking statements that 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, now I’d like to turn the call over to Dr. Bob.

Thanks, Sue and hello everyone. Welcome to our fourth quarter of 2019 year-end earnings conference call. Normally, I’d say I was pleased to report record fourth quarter net income earnings per share. But this time records in net income and EPS were only achieved because of a substantial discrete tax item in Q4 that combined, there are a number of them, to benefit net income by $61 million. Unfortunately, without those discrete items, Q4 revenue net income and EPS all decreased both year-on-year and sequentially due to ongoing weaknesses in many of the industrial markets that we serve. I’ll now turn the call over to my partner and Cognex’s CEO, Rob Willett who will provide details on our 2019 results. Rob, the microphone is yours.

Thank you, Dr. Bob and good evening everyone. Looking back at 2019. Annual revenue declined by approximately $80 million or 10% due to a simultaneous reduction in spending by customers in our two largest markets consumer electronics and automotive, which together represented approximately half of our revenue. As we discussed on previous calls during 2019, customers in consumer electronics reduced and deferred investments on large automation projects that included machine vision, primarily related to smartphone manufacturing. In particular, no significant new technology or form factors for smartphones entered the market in any major way in 2019. As a result, revenue from consumer electronics contracted by about 30% year-on-year. In automotive revenue declined by approximately 10% from 2018. In this market manufacturers scaled back and delayed capital spending in response to three forces; changes in consumer trends, the cooling off of cost sales and evolving product roadmaps. Automotive was also impacted by a lack of business confidence related to trade uncertainty, particularly in China. Despite lower revenue, gross margin remained consistent with 2018 at 74%. We reported growth in newer high potential markets for Cognex products, including logistics, which was our third largest market in 2019. We also saw a growth in medical-related applications and in food and beverage. Revenue from applications that utilize our deep learning technology nearly doubled year-on-year. While, deep learning represents a small percentage of revenue today, we believe it has the potential to be a major contributor to growth in the future. Consumer electronics and automotive are large markets for machine vision that we believe will resume the growth in the future. It’s unclear, however, when we will see that increase. These markets are between major technology shifts. Consumer electronics is transitioning from 4G to 5G and automotive from combustion engines to electric vehicles. Manufacturers aren’t expected to meaningfully expand their capacity as they wait for these changes. Revenue for Cognex is expected both from the building of new lines and from the upgrading of existing lines in order to increase both productivity and product quality. Of the two markets, consumer electronics is the faster moving market and we believe it will recover more quickly. Cognex’s technology and sales force can be applied across many markets. We are prioritizing new frontiers by machine vision, including logistics, which is a market that’s undergoing a major transformation due to the rise of online shopping. Traditional brick and mortar retailers are now the fastest growing segment for Cognex in logistics, reducing our concentration of revenue from e-commerce companies that were the early adopters of machine vision. Our customer base is also broadening geographically, we’re receiving larger orders from several companies in Asia. And revenue from logistics is beginning to diversify into more applications, including package dimensioning and inspection. Now I want to give you some details about logistics. We have ambitious plans to grow revenue from logistics at a target rate of 50% over the long-term and to do so at high gross margins. However, growth can be volatile over shorter periods. For example, our logistics revenue grew by only 15% in 2019. The slower growth rate in logistics was the result of a major customer focusing more on facility upgrades in 2019 then on new build-outs, where we play a larger role. After building adequate capacity, this customer then delayed the delivery of large orders for new sites at year end. We have most of those orders in hand and we expect to deliver them this summer. Excluding that major customer, revenue from logistics grew by approximately 50% year-on-year, which is our long-term target. Now let’s talk about deep learning. We see strong potential in the application about deep learning-based software to automation. I’m pleased to report that the integration of Sualab, the Korea-based deep learning company that we acquired in October is going well. While it’s revenue contribution in 2019 was small, the acquisition tripled the size of the Cognex team dedicated to developing and applying deep learning technology to industrial applications. I joined the combine team in Seoul two weeks ago, where we reviewed our progress and formalized our plans for deep learning. The advantage technology that Sualab brings to classification and the application of convolutional neural networks to industrial machine vision allows us to solve higher precision deep learning applications. This will enable us to accelerate our product roadmaps and to address new areas of the market. Our work together in the first three months and the Sualab’s teams embracing of Cognex culture of validating the assumptions that we made when we acquired the business. Cognex is engineering relationships with customers and the additional tools and technology we acquired with Sualab are expected to be a powerful combination. We’re in the process of introducing Cognex customers to Sualab’s technology and demonstrating how we can improve their manufacturing process through its implementation. We’ve already hosted multiple engineering teams from world leading technology companies that are working on plans to evaluate and implement the combined Cognex Sualab technology. Moving on to new products, we have significant introductions planned in the coming months. And in 2019, among other products, we introduced two high-performance snapshot sensing platforms with the 3D vision market, the Cognex 3D-A1000 Dimensioner for logistics and the 3D-A5000 for general manufacturing, and PatMax 3D, a breakthrough part-locating vision tool for our entire 3D product range. Well, also new in 2019 with a line of DataMan 370 fixed-mount barcode readers for reading different sized and challenging codes on packages inside high-volume logistics scanning tunnels. Before I pass the microphone to Laura, the details from the fourth quarter, I’d like to update you on our new CFO that’s announced tonight. I’m pleased to report that Paul Todgham will join Cognex in early March. Paul is joining us from Levi Strauss & Company, where he was the Senior Vice President of Finance. He will be a great partner and will be joining me on future calls. I want to take this opportunity to thank Laura for serving as our Principal Financial and Accounting Officer on an interim basis. Following Paul’s onboarding, she’ll continue as our Vice President and Corporate Controller. Laura, the microphone is yours.

Thank you, Rob, and hello everyone. Revenue in Q4 was $170 million, which is above the top end of our October guidance. As expected, revenue declined year-on-year, due to the timing of delivery on large orders in logistics and lower volume from automotive and consumer electronics. The sequential decline is due to the seasonal timing of revenue from customers in the consumer electronics industry. Despite lower revenue, gross margin of 74% increased slightly over Q4 2018 and was consistent with Q3 2019. Operating expenses increased by 13% year-on-year. Over the past year, we have added Cognoids in engineering and sales. They were also incremental employee expenses and other recurring costs related to the Sualab acquisition. Compared to our guidance for Q4, we reported higher than expected expenses related to our incentive compensation plan. That included expenses related to stock options as well as sales commissions resulting from the better Q4 revenue performance. Operating margin in Q4 was 10%, representing a decline both year-on-year and sequentially, due to the lower revenue level and higher expenses. Regarding the tax provision, we recorded a net discrete benefit of $61 million or the equivalent of $0.35 per share in the fourth quarter, which consisted of two major elements. The first item involved changes to our corporate tax structure, which came about because of legislation passed by the European Union. For that we recorded a net benefit of $88 million. The second item relates to our decision to move acquired Sualab technology out of Korea to align with our corporate tax structure. That resulted in $29 million of additional tax expense. Excluding discrete tax items, the tax rate was 18% in Q4 2019, compared to 16% in Q3 2019. The increase was due to non-deductible tax expenses incurred in Q4. Looking at the change in revenue for Q4 year-on-year from a geographic perspective, China increased by mid single digits, because of revenue from consumer electronics, some of which was previously reported in our Europe region. Revenue from the rest of Asia grew mid-single digits over Q4 2018, also due to consumer electronics. In the Americas, revenue declined by high-single digits, primarily due to delayed shipments and logistics that were previously discussed. The impact of this quarters lower contribution from automotive and consumer electronics was most noticeable in Europe, where revenue declined by roughly 30% year-on-year. As mentioned, the decline in Europe would have been less extreme if not for revenue from certain customer purchases that shifted to China from Europe. Turning to our balance sheet, we ended the quarter with $845 million in cash and investments and no debt. Even with cash payments of approximately $171 million in Q4 to acquire Sualab. We have enough capital to support our growth objectives and to share our ongoing success with our shareholders through stock buybacks and dividends. Now I’ll turn the call back to Rob.

Thank you, Laura. Moving next to guidance, we expect revenue for the first quarter will be between $155 million and $170 million. This range represents a decline both year-on-year and sequentially due to continued weakness in the broad factory automation market led by automotive. Outside of logistics, deep learning, and other new markets for our products, our outlook is cautious. We are concerned about what’s happening in China around the coronavirus outbreak. Our Q1 revenue guidance includes an estimated $10 million impact. We also widened our range to account for this uncertainty. We’ll continue to monitor the situation closely. Gross margin for Q1 is expected to be in the mid-70% range, similar to the gross margin reported for Q4. Visible in Q1 will be the higher operating expenses, we expect for 2020. We believe operating expenses in Q1 2020 will increase by approximately 10% over Q1 2019 and will be approximately flat with Q4 2019. The increased year-on-year is the result of an annual reset of company bonus and other incentive compensation plan. The Cognoids we added over the past year in engineering and sales and the impact of the Sualab acquisition. Higher expenses to stock-based compensation will also contribute to the increase. For the year, we estimate that the reset of incentive compensation and incremental expenses related to a full year of owning Sualab will add approximately $25 million of operating costs in 2020, assuming our financial results for the year are as planned. The effective tax rate is expected to be 19% excluding discrete tax items. The increase from 16% in 2019 is due to changes in our corporate tax structure and the expectation that more of the company’s profits will be earned and taxed in higher-tax jurisdictions. With that, we will open the call for questions. Operator, please go ahead.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Josh Pokrzywinski with Morgan Stanley. Please state your question.

Hi. Good evening, all. First question on the logistics business, Rob, if you wouldn’t mind just kind of level setting and so 50% growth over the long term, you will have some revenue shifting from 2019 into 2020. Should we expect then that 2020 kind of looks like a 50% plus just given that there’s some revenue transferred? Or are you more comfortable with starting it kind of a 50% growth rate, we’ll see how the year plays out?

Well, I think the first thing to point out is, we don’t give annual guidance and we don’t do guidance by specific segments. But let me kind of add some color on our logistics business to help us all think about it. So logistics is in the early stages of adopting machine vision. And we’ve seen great growth in that market and we continue to see great prospects. We have ambitious plans to grow the revenue at 50% over the long term, right. I think as we look about what’s going on in the business side, I discussed some of the changes in my prepared remarks, but a major customer delayed large orders for new sites at the end of 2019, after achieving meaningful improvements from earlier implementations. A lot of results I think of work we’ve done with them at Cognex. Most of the delayed orders we have from them are in backlog and we expect to deliver on them this summer, right. And that major customer did place substantial orders for us in 2019. But nevertheless, they represented less than half of our logistics business overall excluding that major revenue from logistics grew by about 50% year-on-year. So there’s lots of good underlying growth to report. But I think what I would point out is growth in this market can be volatile. It can be large customer deployments and specific customers can deliver between $10 million and $20 million of revenue in a specific quarter. So it’s sometimes quite hard as you’ve seen from us over the last six months to kind of commit to – or give you solid guidance on the timing of revenue over longer periods.

Got it. That’s helpful context. And I guess for those of us who have picked through the 10-K a little bit, just as a follow-up, I noticed we no longer have the material customer that needs to be reported. So I want kind of dropped off the radar there. I guess anything that you would comment on from a share perspective or anything that you think could be an impediment to getting back to prior peak revenues with some of your larger electronics customers as the function of product cycles or anything else to changing? If we’ve see, $100 million of revenue come off of one customer because of what’s happened in the cycle? Or what’s happened with product cycles with the economy? Is there anything preventing you from getting back to that or exceeding that over time? Thanks.

Well, I come so many on your speed reading of our 10-K. I’m amazed, how you guys seem to be able to dissect a lot of information very quickly. But you’re absolutely right. No customer accounted for more than 10% of Cognex’s revenue in 2019 and there were candidates, I think as we started out the year, both electronics and logistics that might have made that. But I’m reminded about 2016 annual report featuring Sherlock Holmes. And I’m reminded that the story of the dog that didn’t bark. And there was no particular customer that made it above that level, last year. So you’re right, we’ve had large – particularly one large customer in the past that’s had revenue of $150 million in a specific year. And things that really drive that I think are big changes and investments in technology and growth plans, right. And we see the potential for those really, particularly in electronics and logistics going forward. And I think the things that would drive those kinds of implementations, so to kind of large growth opportunities with individual customers would be big investments in distribution and technology to outperform in the e-commerce market around delivery or plans they may have to compete on things like same day delivery, and in different geographies and different segments of the market. And I see tremendous momentum in those areas with a number of customers. And I’m not saying how quickly or how big they come grow, but there are certainly potential for that. And I think the other area, where we could see large customers in electronics really grow to be very sizable again and possibly more than 10% of our revenue, of course, it’s in the area of new technology implementations in electronics. And that specifically becoming of 5G, becoming of other augmented reality type technology, different screen technologies and foldable screens and other things. I think if those things were really come together with a big new kind of technology rollout that has the potential to do that. But it’s very difficult to know and see if and when those technology changes are going to come and are going to hit. But certainly 5G would be one. I think that has the potential to drive a lot more momentum and growth back into our consumer electronics business.

Got it. Thanks for the color, Rob.

Our next question comes from Richard Eastman with Robert W. Baird & Company. Please state your question. Richard Eastman, your line is open.

Thank you. A quick follow-up on that, Rob, when you look at the potential for 5G to be a driver, given that Cognex’s position would be a long production lines themselves and driving throughput. How do you feel about the timing of that business? So if I recall in the past, in the anniversary year for a big customer, we saw that lead time, maybe be in the order of four months, is that – would that still be the expectation? Or is there capacity that can be reused for instance in the system itself?

Rick, to clarify is it question about kind of Cognex? Or is it about how the timeline and the requirements of the market and the customer’s deployment?

Yes. It’s really just a macro question, but obviously the position you play there is in the production supply chain, if you will, for content and components. But when – what would be the timing of that – of orders relative to shipments there from your vantage point, given where you play in that ecosystem or supply chain?

Yes, I think, from now five plus years of experience, working with big players in that market, you pick, it does come together quite late. And we will be in a better position in our April conference call to really give you a read on how the year’s consumer electronics market is shaping up for Cognex. And then I think you’re right, we can find those maybe we get visibility possibly four or five months before major revenue hits our P&L. I think something, probably we’re going to end up talking about during the conference call is the coronavirus and the impacts of that. But I think that’s the challenge where we may be working with customers in Asia and particularly in China, who have plans to deploy. But right now, those plans are can’t move forward as quickly as they need to because we need to – we need an engineers working on problem solving to implement features or solve problems within a customers’ ramp-up plan. So I think it’s not clear to me what the impact of that is going to be. Is that going to just push everything to the right? Is it going to mean that certain features and plans for deployment don’t occur this year and get pushed out to next year? Those are kind of extra wildcards I’m seeing this year. In addition to just what the plans are rolling out different features in new technology that we confront every year as we look at that market.

Okay. And then just a quick question on the auto market, lots of activity around EVs, in Europe, some mandates going in place. They’ve kind of adopted the same CAFE standards here that we have in the States. But I’m curious, with the pause in the market and kind of the shifting of spending between EVs and traditional hydrocarbon vehicles. Is there, is there a dynamic there that can accelerate auto investment in 2020, even if the SAAR count stays fairly weak, just as kind of shift in spend towards EVs and the assembly both on the battery side as opposed to vehicles.

I think the issue with EV is, major investment, I think is still a little ways off. We certainly see no good, really good growth and nice pick up in our business that relates to a battery manufacturer for sure and other features that relate to new models of electric vehicles that are coming. But it’s certainly, relatively small part of our business overall. So I think we do expect that to continue. And like, we definitely are in touch with and working with all the major battery manufacturers and the electric vehicle manufacturers on their plans. I think. So I expect that to be kind of a long and good journey for Cognex. Now but the countervailing kind of wind in that situation is the general kind of legacy automotive market, if you like. And what I do see is, really big challenges customers have has in Tier 1 automotive and end users are facing on that. So kind of that certainly I think offsets any optimism one might feel in the near term about spend on electric vehicles. And I think added to that and I don’t wish to sound overly negative, but I think if we were expecting our rebound in automotive as we entered the year, we thought that might come later in the year. And I now think with the coronavirus, I think the challenge that puts on parts manufacturers and I think on the Chinese consumer being able to afford to kind of get back into the market and buying new cars makes any kind of recovery, we’re going to see an automotive probably a longer term prospect and quite possibly pushing out into next year.

Okay, very good. Thank you. Thanks for the thoughts.

Our next question comes from Joe Giordano with Cowen. Please state your question.

Yes, good evening. Just to start, Rob, you scaled logistics for us, you said minus moved 15% in the year. Are you willing to give a similar kind of scale for auto and CE?

So just to be clear, so we said logistics grew 15% in the year, right? Yes. Sorry, I just wasn’t sure from your question. You made sense to me. So then I think, yes, I think, in general in a full pass, I think we’ve said that electronics frank – 30% and just give me a second here. So consumer electronics really represents about 25% of our total revenue last year. And then automotive declined about 10% last year and it accounts for roughly 30% of our total revenue.

Perfect. Then on the coronavirus, you called out of $10 million impact to 1Q. Just curious about how you kind of calculated that. Is it mostly auto that’s being impacted and how do you kind of weigh the chances of that bleeding into later in the year, past 1Q and is that already in your thought process?

Well, I’d say, it’s a developing situation, right? And I think nobody knows the answer to how long and how severe it’s going to become. But I’d like to give you a little color on it. So as you currently pointed out for Q1, our guidance reflects an estimated $10 million reduction in revenue. And we’ve also put a wider range out there due to what we’re seeing. And I think we have pretty good visibility of things given the vast number of Cognoids we have in China, the customers we do within that market and the suppliers who supply us with products from that market. So let me kind of break it down for you. But it supposed to very importantly for me to say is that, our China Cognoids are currently safe and most of our employees are working from home. And we’ve asked Cognoids outside of China to postpone travel to and from China for now. So that’s the first thing to say. I think in terms of how this impacts revenue, I think how quickly a production line in China get back up and running, obviously, will impact revenue this year. What we’re seeing right is most customers will not take sales visits from us at this time, right? So really Cognoids are working from home, they’re making sales calls that dealing with things of electronic, media, or et cetera. But that certainly is, it’s a challenge. Machine vision is a technology that often needs to be sold. At an engineering level, it needs to be demonstrated and explained and work for team of customers. So certainly that’s the challenge. And then we’re also concerned that comp out companies, who we serve and consumers in China are going to face liquidity issues, right? Whether there’ll be able to afford buying new cars, as I talked about with Rick just earlier. And then obviously, making sure that they still sold them to supply us as well in the case of supplier is important. But I think some of those issues likely to be a challenge for our automotive customers both inside and outside of China. Okay. So I think there, I’m talking about revenue and I think we’ve probably size that and I said is we kind of moved through the quarter. We took our guidance down specifically related to revenue by about $10 million. Let me talk about the supply chain, which I think is the other aspect that kind of does impact tool set on us. So we have consent to see our China suppliers pushing out delivery day. Now we haven’t seen much evidence of that, but production delays constrain our supply chain. Cognex products are manufactured by a contract manufacturer-based in Indonesia. So not affected by this currently, but various custom components and electrode, mechanical and electronic components come, of course, from China. Our supply is the concentrated mostly in the Guangdong Province with some in other cities. And but none are located in the Wuhan, at the center of the Hubei Province a large. So I think we’re feeling relative comfort and where we’re not seeing specific supply challenges currently. But – and then what we observe, and I think we all accept, this is, we see announcements from both top customers and contract manufacturers and from the companies that supply us saying, they’re going to open on Monday. But a lot of them said, they were going to open last Monday too. When we just see that shifting out and we’re also concerned that when they do open, it doesn’t necessarily mean they’re going to be scaling up. It may be a small crew in there. It may be people who are going there. So they go through quarantine so they can stop production a week or more later. So we were watching this carefully and we think we thought it scoped correctly. And will they bleed into the second quarter and the third quarter, I mean I think the answer is quite probably.

Thank you. Our next question comes from Jim Ricchiuti with Needham & Company. Please state your question. Jim Ricchiuti, your line is open.

I’m sorry. Can you hear me now? Sorry.

Hi, Jim. We can hear you.

Hi, Rob. If we think about the logistics business in 2020, given the fact that some of these larger shipments deployments with your large customer may not take place until the summer and it sounds like the efforts you are making in China maybe get pushed out a little bit. Just given, I assume that some of the logistics applications in China are not going to come to fruition in the near term. Is there enough growth in the brick-and-mortar area where you are seeing momentum to help that business show reasonable level of growth in the early part of 2020?

Yes, I think so Jim. I think obviously, most of our logistics business is really in the U.S., right? I don’t think, it’s not obviously impacted in a big way from the issues we just discussed around China. So I think that’s very positive. We also see a lot more of a growth. I should start by saying our logistics business, the majority of it has been around reading barcodes and that’s continues to be a great and a strong growing business, right for us. But increasingly, we’re seeing more and more applications in the vision area. As I mentioned, some of those – we’re having a lot of success in various markets with those products. So that’s certainly helping to drive growth. We certainly, we do expect our business to grow in logistics in the first quarter. And yes, and we’ve becoming less dependent on large e-commerce players. And we’re really seeing a lot of investment – lot of investment plans from the large, very well known brick-and-mortar retailers, particularly in America, but also in Europe, and some in Asia, who are really starting to invest more heavily. So yes, we’re very confident about the future. And we do see some near-term drivers helping us and we do see those larger orders teeing up for the summer. So we continue to be very, very positive about what we see, although it can be lumpy.

Got it. And as a follow-up question, just on the deep learning efforts. You’re obviously very excited about the opportunities there. How do we from the outside really begin to evaluate the progress you’re making in this area? Are there any either applications or types of customer wins that you can maybe highlight for us that maybe help us understand why you’re so excited about it?

Well, I think the first thing to point out is, what the comments I made really which is, we’ve only been in the deep learning market really for less than three years and we’re already seeing – we’ve seen phenomenal growth already in that market with a small team that we have as we’re applying the technology. Those of you who came to our Investor Day, I think we certainly showed you some of the technology and applications and certainly gave you a preview of some of the products that we’re planning to launch into that market. But we’re seeing a substantial contribution to the business from deep learning. And then, what we observed with Sualab and certainly their customers gives us a lot of confidence that it’s there. In terms of application, I mean, the applications are pretty broad-based. And I think if you go to a website that where you can see examples where we’re applying deep learning to automotive, to life sciences, of course, to electronics. And there’s certainly material about Sualab’s technology and how it’s applied to replace human inspectors in visual inspection, particularly in electronics. So I think, from our point of view, we see very positive things happening in that market. And I think you’ll see more of it as we continue to report in future quarters.

And regardless of some of the issues that you’re seeing in other parts of the business. In other words, it sounds like you still expect this business this year to be a pretty good growth opportunity regardless of some of the pressures you’re seeing in some of the markets.

Yes, we do.

Okay. Thank you.

Thank you. Our next question comes from Karen Lau with Gordon Haskett. Please state your question.

Thank you. Good afternoon, everyone. Rob, appreciate your color on the potential impact on the coronavirus. But I want to flip it around a little bit and try to understand hopefully all of these will pass at some point. What do you see as the constraints towards the supply chain industry ramping back up to hopefully, maybe try to make up for lost time. Is there a constraint of people or engineering capacity? Because, putting aside the consumer impact on automotive, there is still a lot of hope and talk about like 5G implementation and whatnot and some people do expect projects move forward. So what do you see from your standpoint to the constraints for the supply chain to ramp back. And also along those lines given what’s going on with the labor shortage and uncertainty. Do you see automation, machine vision actually playing a bigger role or having additional opportunity because of this situation?

Yes. I’m not sure, who that was speaking, but Karen, it’s Rob. Let me speak. I think I’ve got your question. So basically, I think a lot of activity is just not occurring right now at our customers and with our suppliers. So I think, the longer that goes on the more delay that is the plan, the more stress companies come under, the more will suffer from liquidity challenges, labor shortages, problems, right? So I think it’s a simple as that in many cases. And I think particularly when one thinks about the electronics timetable, I mean, the way that this market works it’s extremely intense. It’s not like those a lot of extra kind of flat time built in there. So either products will get delayed or features and other capabilities of the product will not be in this year’s release. But I think that’s kind of how I dimensionalize that issue. In terms of the supply chain, in Cognex we have a policy of carrying quite a lot of component inventory, strategic inventory. So in a way, I think we feel we’re very well prepared to go on supplying customers around the world if we can’t in the short-term get inventory from a Chinese supplier. But at some point, that’s the challenge too where if certain companies are unable to manufacture components, we have to find out the suppliers and get them ramped up to a level to supply us. So, that’s a lot of a challenge to do so. But the longer that goes on in a sophisticated business like Cognex or I can only imagine with a large Tier 1 automotive supplier, that they face similar problems. That’s going to be a challenge for them. So I think I would deserve that. And then I think the third part of your question was sort of the long-term. So I think if I’m draw to optimism, from what is obviously a very bad situation. It’s like, it does underscore the potential of machine vision really to robotics and machine vision to replace human automation and to make human automation free of geographical constraints. So certainly machine vision systems and robots don’t get a coronavirus. So I think that’s not lost on companies that they think about their supply chain and all the trade and tariffs situations we’ve had where – I’ve always been pretty skeptical about lots of manufacturing coming back on shore necessarily. But these kinds of things I think really do raise the potential more for that to happen and for much more automation to happen. And I think automation is starting to get better and machine vision to the point where much more of that is possible and economically. So it makes me long-term even more optimistic about advanced automation and machine vision, but short-term, lot of challenges to overcome.

Okay. I appreciate the color. And then if I can sneak one in for Laura. I think OpEx, so what’s expected to be up mid to high single digits for the fourth quarter and then it was up 16% sequentially. I realize the sales came in better than expected. But is that the primary driver? And can you remind us how much of the $25 million of OpEx increased year-over-year expected for 2020. How much of that is coming from Sualab versus just the core legacy operations?

Sure. Let me answer your second question first. Because I think we said last quarter that our Sualab expenses run us about $4 million a quarter and that includes the operating expenses and also amortization of acquisition related items. So that would be a $12 million delta related to Sualab. And then your first question, why was the expenses higher than our guidance? So yes, you hit on the higher than expected incentive compensation and we also accelerated certain products development efforts. The incentive compensation you mentioned related to sales commissions resulting from better Q4 performance. And we also had some additional costs related to the exercise of stock options.

Okay. Thank you.

Thank you. Our next question comes from Andrew Buscaglia with Berenberg. Please state your question.

Guys just want to be clear on something. You do not anticipate any revenue from that logistics deferred order practice in Q1, I mean, excuse me.

Yes. Hi, Andrew. So your question is, so we had orders from a large customer that we didn’t have last year and we expect to occur mid year. It’s possible that a very small amount like make that in earlier. But nothing really significant interrelations with our compensation.

Yes. Okay. I just want to be clear on that. Secondly, we’re seeing – Rick sort of touched on this in his question. But we’re seeing positive comments out of a lot of the semiconductors companies. You guys mentioned 5G at some point being a driver. And are you seeing other green shoots, you have a Samsung coming out with new form factor type of phone. And then you’re seeing this trend of more auto electronics in vehicles. So it seems like there are a fair amount of things that could sort of swing things one way or the other this year. But you are telling definitely sounds a little bit bearish. So why is that? Why don’t you think you’d participate in some of these green shoots that we’re seeing?

Yes. Thanks. I guess, we have a reputation of Cognex saying it like it is, right. And I think we’re concerned that currently what we’re seeing in China, now it is going to slow down. Two factors that are going on. One is the consumer electronics build that will go on particularly around smartphone technology, which delay and reduce it. And also the recovery of the general automotive business, right. So I would say that that’s probably what you’re hearing, we’re trying to communicate here. Those things that you said and I would say, if I pull back, there are a lot of very strong growth drivers at Cognex and they certainly include logistics. They include deep learning and the application of deep learning. And there is – we probably like other companies that you and we read about, we do see improvement in consumer electronics spend. We did as we came through the end of last year and into the beginning of this year, but we’re now concerned about the impact of that and the timing of that. We do see lots of strong investment in very large percentage growth rates in electric vehicles, particularly related to lithium iron battery manufacturing, that process and the use of machine vision there. But that’s really relatively small. I think even if that were to triple or quadruple this year, I think it’s still a challenge. It’s not going to make up for slowness in the automotive and consumer electronics industry where that to continue.

Would you account for auto electronics under auto or would that be more of a consumer electronics application?

Yes. When I talk about lithium ion batteries, I’m referring to it’s automotive business. It’s really, that’s where the big spend is, particularly with Korean, Japanese and Chinese manufacture this lithium ion battery machines.

All right. Okay. Thanks.

Thank you. Our next question comes from Jairam Nathan with Daiwa Asset Management [Daiwa Securities]. Please state your question.

Hi. Thanks. It’s Daiwa Securities. First question, can you kind of tell us what drove the higher than expected revenue for this quarter for 4Q? Then I had a follow-up.

Yes. I think as I mentioned, we saw some better bookings and business out of electronics. Pretty much, I think some of the things we were just discussing earlier, I think we saw some better conditions that you see out of other semi and electronics manufactures related to potential implementation of new technology in electronics. So that was certainly one contribution. I think our business in America performed relatively well. I don’t know, Laura, anything we want to add to that?

I think the electronics was the…

Yes. That’s the main driver.

Okay. And you mentioned increasing spend on engineering and sales. In the past, I think last year I guess you guys mentioned you have kind of shifting resources from slower growing areas to higher growth areas. And it doesn’t look like that situation has changed from significantly at least in 2020. So what was – where are you investing, which areas are you investing in terms of engineering and sales headcount increase?

Well, certainly when we think about how we run Cognex, we’re taking a cutting edge new technology in machine division and we’re applying it to new growth areas. So growth areas that we see, of course, deep learning is a major area where we see huge potential and we’re investing strongly to be the leader in that area of the market. 3D certainly, talk about the launch of new 3D products certainly in that market. And then generally in logistics supply, technology to logistics. So those are all areas where we’ve been increasing spent.

Okay. And finally, if I could squeeze one more. With the logistics shifting from a large player to brick-and-mortar, does it change? Do you need to spend more on application engineering than with the large player? And could that impact gross margins?

It doesn’t really relate to where the customer is kind of coming from. I would say, the way that they deploy machine vision is similar. So, the answer is no. The difference I would point out though is some kind of leading e-commerce companies are very engineering savvy and capable often – in launching consumer. Some companies that trying to make this transition from being bricks-and-mortar companies generally don’t have that level of engineering expertise. So in that case we may have to do more application engineering to help them or we’re developing over the last few years and we made a lot of progress last year, we’re developing a network of systems integrators who can help them implement our technology. That’s key to a plans to be able to scale this business over the long-term.

Okay. Thank you. That’s all I had.

Thank you. Our next question comes from Joe Giordano with Cowen. Please state your question.

Hey guys, thanks for taking the follow-up real quick. Just curious, Rob, if you had an update on the mobile terminal business? And is that largely concentrated to your more brick-and-mortar focused customers and logistics?

Yes. So our mobile terminal business. I think we talked about this a little bit certainly at the Analyst Day, those of you who joined us. We’ve focused that business now much more on logistics and e-commerce type companies who I think a much more receptive to product which relies on an integrated smartphone and who have a much more technically savvy. So that’s where we focused and we’re starting to see. Some larger customers adopt that and roll it out. But we think the potential for us in that market is smaller than we originally thought. We think it’s a $200 million market for us. We think that market is going to grow at 10%. We’re seeing some nice growth, but it’s certainly not as material to the business as other areas like logistics or deep learning or 3D.

Fair enough. Thanks.

Thank you. Our next question comes from Bobby Eubank with Chevy Chase Trust. Please state your question.

Hi guys. Thanks for the call. Your major competitor is seeing a little bit better order flow than you guys. Can you talk maybe about the consumer electronics business and share trends in that? I think Rich Eastman was asking about that earlier. I just want to kind of clarify. How do you feel about market share? Thanks so much.

Yes. This is Bobby. So Bobby, when you talk about a major competitor, I think the other two kind of public companies that report that we keep an eye on, certainly it would be KEYENCE and OMRON. And I think they both – when I look at their results, the first thing I’d point out is that their results, a much broader. We’re a pure play machine vision company. So they may have more kind of other more resilient businesses such as microscopes or basic optical sensors or PLCs, right. That perhaps less volatile. But when I read their results, both of them seem to be recording declines in their business on the order of 7% to 10% in recent. And they reported certainly slower business in Asia electronics, as they looked back. So when one considers backlog and other factors, I think it’s in the mix as to whether they or we are growing faster or who’s gaining market share. That said, we have a high expectations of ourselves with Cognex. We invest more in R&D certainly in the vision area than any other company that we compete with. And our expectations are to outgrow all other competitors. So we’re certainly not happy even to be drawing. But I would say right now it looks like, everyone’s suffering generally similar amount.

Thanks.

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

Yes. Dr. Bob, are you possibly on mute?

Yes. Thank you. I’m sorry. While our results were clearly not what we hoped for at the start of 2019 based on the new products that we have rolling out, based on logistics, the potential that in artificial intelligence, deep learning. We still remain very confident in the future role that machine vision will play in manufacturing automation and therefore for the long-term prospects for our company. Thank you all for joining us tonight and we look forward to speaking with you on our next quarterly call.

Thank you. This concludes today’s conference. And you may disconnect all your lines at this time. Thank you all for your participation.