Greetings. Welcome to Cognex Third Quarter 2018 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. During the Q&A, please limit yourself to one question and one follow-up prior to getting back in the queue. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. I would now turn the conference over to your host, John Curran, CFO. Thank you. Please begin.
Thank you. Good evening, everyone. I am John Curran, Cognex's CFO, and I would like to welcome you to our third quarter earnings conference call. With me on today's call is Rob Willett, Cognex's President and CEO. Dr. Bob Shillman, Cognex's Chairman, will not be joining us this evening. He sends his regards. He looks forward to talking with you on our next call. Please note that our earnings release and Form 10-Q are available on the Cognex website at cognex.com. Both contain 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 can change, however. 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 Rob Willett.
Thanks, John. Hello, everyone. Thank you for joining us today. I am pleased to report our results for the third quarter of 2018. We have a tough comparison to the exceptional record-setting results that we reported in Q3 of 2017. Other than that comparison, this year's Q3 results were very good. We reported the second-best revenue, net income, and EPS from continuing operations in the company's 37-year history. Revenue in Q3 was $232 million, down 13% from last year's record-setting performance and up 10% on a sequential basis. It was also slightly above our guidance for the quarter. Gross margin in Q3 was slightly higher, both year-over-year and sequentially, mainly attributable to a favorable mix towards higher margin products. We continued to invest in sales and engineering for our long-term growth.
Although the rate of increase has slowed in recent quarters, we're committed to delivering industry-leading vision and ID products to our growing customer base. We believe that we invest more in industrial machine vision and barcode reading technology than any company in the world, and it is that investment that will continue to drive our growth and profitability over the long term. In Q3, operating margin expanded on a sequential basis to 34%, demonstrating the substantial leverage that incremental revenue has on our business model. During the quarter, Cognex performed well in many end markets. Of course, one significant exception was consumer electronics, which is our largest market. As we expected, revenue in Q3 from consumer electronics was substantially below the extraordinary level reported a year ago. Excluding consumer electronics, revenue grew in mid-single digits year-on-year.
Looking at our performance in our second and third largest markets, revenue from automotive was flat year-on-year in Q3, after growing much faster than expected in many quarters. Demand softened in our major regions during the summer months. Since then, we have seen a sequential improvement in the Americas and Europe. In logistics, our Q3 comparisons do not reflect the strengths we see for Cognex products. Better viewed on an annual basis, revenue from logistics has grown more than 50% in the first nine months of this year. At this point in the year, I spend a lot of time in the field with our sales force, visiting large customers and prospects to understand their requirements and their plans for automation in 2019 and 2020.
This year, I came back more excited than ever about how Cognex machine vision and ID will improve quality and delivery and drive down costs. Many large retailers are now planning to follow the example of the world's largest e-retailers in automating their distribution centers. That should mean a lot more business for Cognex in the years to come. Interest is particularly high for our AI-based deep learning vision. Cognex deep learning vision technology allows manufacturers to perform inspection tasks that were previously very difficult or impossible for rule-based machine vision. Many of our AI customers are now moving from trials, where they train our deep learning tools to factory floor deployment in industries such as medical devices, automotive, and consumer electronics. The development of our sales force continues to be a critical part of our effort to broaden and grow our business.
In the third quarter, we recruited, trained, and equipped many sales nodes that will build the capacity we need to drive future growth. We've made good progress in increasing the reach of our sales channels to access new and growing markets for machine vision and develop closer ties with customers. I will now turn the call over to John for financial details from the third quarter.
Thank you, Rob. As we go through the financials, please note that our results reflect the retroactive adoption of the new revenue standard that took effect on January 1st of this year. The sale of certain accessories that we historically reported on a net basis are now reported on a gross basis. This has not changed our gross margin dollars, but our gross margin percentage has decreased from historical rates by one to two percentage points. Now for our Q3 highlights. As Rob noted, Q3 revenue was $232 million, a decrease of 13% year-on-year. This decline is primarily attributable to the exceptional growth we achieved in Q3 of last year across our business, led by consumer electronics. Gross margin of 75% was up slightly year-on-year and within our long-term target range. Operating expenses totaled $95.5 million for the third quarter, an increase of 10% year-on-year.
Our spending was slightly above guidance, mainly due to the higher-than-expected revenue in the quarter. While we continue to be prudent in terms of discretionary spending, investing for the future remains key to our success. This includes maintaining our strong commitment to engineering and the continued expansion and development of our sales team. Turning to our new ERP system, we successfully implemented SAP in Q3 and used it to close the quarter. There is still more work to be done to fully implement the new system, but we believe it provides an excellent foundation for future growth. Operating margin in Q3 was 34%, an increase of four percentage points compared with Q2 of 2018, and driven primarily by the higher revenue level. The eight-point decrease in operating margin from a year ago mainly reflects last year's record-breaking revenue and our previously mentioned investments in engineering and sales.
Moving next to taxes. If we exclude discrete items, our tax rate was 16%, as expected. Our discrete items in the quarter fell into three categories, with the largest related to the Tax Cuts and Jobs Act of 2017. In finalizing our 2017 tax returns, we recorded a net benefit of $7.7 million based on new regulatory guidance for the 2017 Tax Act. We also recorded $2.8 million in benefits associated with the exercise of employee stock options and $1.7 million in benefits primarily related to the release of tax reserves. On a GAAP basis, we reported earnings of $0.45 per share for Q3 of 2018. This compares with $0.57 per share in Q3 of last year. Looking at revenue year-on-year from a geographic perspective, in the Americas, revenue increased over Q3 of 2017 due to growth in several end markets, including logistics, automotive, and life sciences.
Internationally, revenue declined because of this quarter's substantially lower contribution from consumer electronics. Lower spending by large customers in OLED display and smartphone manufacturing was most noticeable in Europe and, to a lesser extent, in our other Asia region. It was partially offset by growth in automotive and other industries. Also impacted by lower OLED smartphone-related revenue was our greater China region. Moving on from the income statement, our balance sheet remains very strong. We exited the quarter with $809 million in cash and investments and no debt. We continue to have sufficient capital to support our organic growth objectives, our M&A plans, and for sharing our ongoing success with our shareholders through stock buybacks and dividends. In that regard, we repurchased nearly 400,000 shares of Cognex stock in Q3, and we plan to continue to buy back stock in Q4, subject to market conditions and other factors.
As announced tonight, the board has authorized a new $200 million stock repurchase program, which will begin once our current $150 million plan is completed. About $53 million remains available under the existing plan. Our board of directors has increased the quarterly cash dividend to $0.05 per share. This is payable on November 30th to all shareholders of record on November 16th. With that, I will turn the call back to Rob.
Thank you, John. In terms of guidance, we expect that fourth quarter revenue will be between $180 million and $190 million. At the midpoint, that range represents a slight increase year-on-year. We expect a $15 million headwind from last year's high level of investment in OLED display and smartphone manufacturing. We will be glad to have those tough comparisons behind us as we move into next year. Excluding this OLED smartphone reduction, we expect year-on-year growth in Q4 of approximately 10%. That's slower than we'd like due to softness we're seeing in China, where customers are becoming more cautious and slowing their spending plans. Gross margin for Q4 is expected to continue to be in the mid 70% range and lower than we reported tonight for Q3. Operating expenses are expected to be roughly flat on a sequential basis.
We expect the effective tax rate will be 16%, excluding discrete tax items. We will now open the call to questions. Operator, please go ahead.
Thank you. We will now be conducting a question and answer session. We ask that you please limit yourself to one question and one follow-up prior to returning to the queue. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we poll for questions. Thank you. Our first question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed.
Hi, good afternoon. I wonder if you could talk a little bit, Rob, about the business ex-consumer electronics, which is clearly going to be more volatile. Just, I wonder if you could talk about what you're seeing in the market, just in light of some of the concerns. The concerns being some slowing in the automotive market, and it looks like that cuts across geographic regions as well as potential implications from the trade tariff issues in China as it may relate to demand in some of your other regions.
Yeah. Hi, Jim.
Hi, Rob.
You're asking a broad question there.
I know.
I'll start answering it and perhaps in your follow-up, you can go to specific areas.
Sure.
I'd say, in Q3, we performed well in most end markets against some tough comparisons. We had some good growth in America from logistics. Automotive grew, but not as quickly as it has been from life sciences. In Europe, I think we saw some slowing down in automotive. Greater China, we saw broad slowing down. I think really Europe, China, and Asia in Q3 were down year-on-year a lot due to the decline in consumer electronics. I think when one strips that out, we saw general growth across all of our major regions, with the exception of China. That's a bit about the industries overall. You asked a little bit, Jim, about automotive, so let me speak a little to automotive. Automotive was slower than normal in the Americas and Europe.
It's always slower in summer in Europe, but it was slower this year. What we've seen in both Americas and Europe is it has improved in recent weeks. I think Europe may have been slower in automotive, through the summer, partly to do with some of the new emissions regulations that I think was causing a bit of a bottleneck in automotive production and probably spending and work in automation. We saw that happening. We've seen a lot of growth in automotive over the years, over the last few quarters, I should say. In the long run, we expect it to grow at 10%, and it's been growing faster than that, but in the last quarter, it grew more slowly than that. I would say in the long run, though, automotive isn't showing any signs of saturation. I think it's just more, tentativeness among customers.
Jim, if I turn to sort of Q4 outlook and we think about markets. We still have obviously, as I talked about, lingering headwind from some OLED smartphone, and you were asking specifically not about that. I think other than China, we expect decent but not exceptional growth among many of our end-user markets, and I think as we said, excluding that smartphone OLED business, we would expect about 10% growth for the rest of the business. I think we're going to see slowing in China, so you can think better than that across the other regions in general. I don't know if that answers your question.
No, that's helpful, Rob. I have one follow-up. It's suggested, I think the logistics portion of the business, you might have experienced somewhat slower growth than normal in Q3, and yet, if I heard you correctly, you're expecting that to pick up again. I'm just wondering what occurred in Q3 that was somewhat unusual relative to recent quarters?
Yes. I want to be clear. Our logistics business is growing really quickly, and we just happened to have a lower revenue quarter in Q3. Really, it was a matter of timing. It's not to do with the overall growth. The business in logistics is growing very quickly. It has grown more than 50% in the first three quarters of this year, and we expect it to go on growing very rapidly.
Okay. Thank you.
Thank you. Our next question comes from the line of Joshua Pokrzywinski with Morgan Stanley. Please proceed.
Hi, good evening, guys.
Hi.
Just maybe to follow up on that question. I think, probably lower visibility in auto and consumer electronics more broadly than when we entered the quarter. You mentioned some tough comps in auto, I think, the industry dynamics there have maybe changed a little bit more recently in terms of willingness to spend, some production misses. Maybe the same thing on the consumer electronics side. We've seen a bit more weakness there than just the tough comps. When you guys look out into, I guess, beyond 4Q and kind of the next year at large, would you say your visibility is at a normal place or maybe a little tighter than usual? Because I'm just trying to understand how much of the blip we're seeing here is tough comps versus a bit more of a macro deceleration.
Sure, Josh. You'd like me to talk about both auto and consumer electronics in that regard?
I think that's probably where we've seen the most demand interruption, and are clearly important markets for you guys. Those would be helpful, Rob.
Yeah. I think our automotive market, we have lots of tight customer relationships with major brand owners and tier 1 automotive parts suppliers in automotive. We have a pretty good view out three years. What we tend not to be able to call so well are shorter-term interruptions, whether it's around regulatory things or some of the dislocation we've seen around emission standards, diesel problems, even supply chain parts shortages and interruptions that have been going on in that market. That's why I think our business can perform more or less well in a given quarter. I think in the long run, assuming kind of a reasonably stable trading environment, we expect that business to grow 10%. I think, your question was more about next year and beyond. I mean, that's how we overall think of that market in general. Right?
I think if we turn more to consumer electronics, it's almost like everything I've said, but kind of more extreme and more volatile, right? There, we tend to see companies implementing and executing their roadmaps on a much shorter term basis, more in a 6 to 9-month kind of window. They may be planning rollouts of new products now that we'll be seeing in the market next spring and summer, or fall. We expect their investment in automation and in machine vision to be growing much more quickly than automotive. There, we think 20% long-term growth or above is what we expect in that industry. The volatility in those markets can come from the readiness and the adoption of new technologies. Obviously, we've all spoken a great deal over the last few quarters about OLED technology.
There was massive investment in that, in capacity in 2017, really for vision anyway, we're seeing a much slower year this year. It's a difficult call to say when the next round of capacity expansion and major investment would go on. There's still a great deal of investment going on in yield, to improve the yield of screen production, where there are still many people involved visually inspecting. There's ongoing business in that area, but in terms of the volatility and the timing and the investment, that's what can drive some to spend.
Obviously, in the smartphone market, where we serve really all the major players, and of course the big ones, a lot have to do with the timing and the number of new products introduced in that space and the number of features, new technologically complex and difficult to manufacture features that go into those products. Again, that can drive what's going on in that space. Obviously, we don't comment on specific customers and their plans, but more features, more models, more changes to form factors or technology will drive higher growth for us. We remain very confident about our growth potential in that market over the next few years.
Got it. Just as my follow-up, Rob, you've added a lot of new sales talent in the last call it four quarters. How do you view kind of the ramp time on those folks getting out there in the field, and are you starting to go a lot more direct, maybe, to mirror your big competitor a bit more in terms of the path to market?
We have been adding a lot of sales nodes, as we call them, over the last few years. They allow us to reach more customers, and particularly service larger, more sophisticated customers, better and understand their needs. We see about 60% of our business going direct, although it may vary quarter by quarter and about 40% through partners. Partners are very important to Cognex's go-to-market strategy. Some of them are systems integrators who have very sophisticated technology and application skills for our vision. They do business that we, as a company, don't wish to undertake directly ourselves, particularly for small and medium-sized customers. In other cases, they serve regions or industries that they can serve better than we can. Thirdly, I would say, we are a vision-specific company, but we sell products into a broader factory automation ecosystem.
Very often our products are sold with motion control robots, PLCs. We have no intention of selling those products. We may be selling only one vision system or sensor with a number of those other products. Those partners have the economies of scale and have the customer relationships to sell those into smaller accounts. That works well. Our market is growing quickly and we've continued to invest in Cognex salespeople as we harvest all the great R&D product development that we're bringing to market. They're allowing us to do that better and faster than we were able to before.
Got it. That's helpful. Because I know it's a big deal around there, happy Halloween.
Thank you.
Thank you. Our next question comes from the line of Richard Eastman with Robert W. Baird. Please proceed.
Yes, good afternoon. Rob, you had mentioned earlier when you were kind of speaking of the fourth quarter revenue guide and kind of suggesting, at the midpoint of that guide, call it $185 million, without the smartphone and OLED, the business would be up maybe 10% at the midpoint. I'm curious, again, we tend to target 20% and we talked a little bit about automotive, but the general slowdown, if we're talking about 10% without the troublesome areas of smartphone and OLED, is the thought is that automotive is still against tough comps or there's still tough comps in the underlying revenue number, or are we just expecting somewhat of a drag on the macro industrial spend into Q4?
Hi, Rick. The slowdown as we kind of size it out, there is a $15 million headwind around OLED and smartphone. Right? We are going to get to at the midpoint, as you say, we would see about a 10% growth rate net of that slowdown. Why is that not 20? The biggest single reason would be China. We are seeing slowdown in the business in China, really across all industries in that space. It is not we can point to electronics or automotive as the main part. It is a broad slowing down in that market. I would point out, as you look at Cognex and you look at other companies, that we really sell and have close relationships on a direct basis with our end users, even if we sell through partners. Generally we know where well north of 90% of all of the business we sell goes.
We have a pretty good sense of the funnel playing out. I think other companies that may be reporting are more insulated from that end user position as a factor of distributors buying and holding inventory. Slightly my take on it there is we may have a better view about what is going on in China than some of the other automation players reporting who rely on partners and don't see end user business. I think, going back to your question, there is the $15 million OLED headwind, and then there is the China situation driving a lot of our slowdown.
Do you think that the China situation, was there any pull forward of business relative to any concerns over tariffs kicking in in the fall? Speaking to China in particular, because we had second quarter 50, if my memory serves me right, 55% growth in auto in China. Is it your sense, I mean, we all saw the PMI slow down in September in China. I mean, it has been slowing, but it hit the 50 mark. I am curious, is there any way to tease out, is that tariff benefit and did you benefit from any kind of pull forward in sales relative to tariff concerns in China?
I think, as I said, we don't have a situation where customers, particularly partners, pull forward and hold inventory. They don't sort of stock up and de-stock. It would be hard, though, however, to know whether our customers were buying ahead of tariff issues. It is possible that they may have been. I was with the China sales force. We did kind of drill into and discuss those types of issues. I think the answer is possibly, but not something I can say definitively to you.
Yes, I understand. Lastly, just to finish off the train of thought. If, again, some of these concerns, whether they're auto, whether they're CE, whether they're OLED, if trends continue through the fourth quarter and you're looking at 2019 where perhaps maybe we get off to a mid to high single-digit type of revenue growth rate, are you prepared at this point to slow investment in the business just to accommodate if that pause is short-term, midterm, or longer term?
Well, your question, Rick, relates to 2019 outlook, and I think it's a little early to kind of call that one. We're going to meet as a leadership team for a bottoms-up detailed review of our product line and geographic plans for next year. There's opportunity for us to prioritize investments into faster-growing areas, certainly, and to taper investments from slower-growing areas. At the moment, that's kind of how it looks to me as sort of a steady state. We'll be watching very closely to see how the outlook is, and what goes on in the meantime. We've successfully managed through turbulent times in the past, and I've had a lot of experience with that, both at Cognex and before. Our revenue at Cognex has grown organically in nine of the last 10 years. We're certainly not heading to the bunkers at this point.
You can see as you look at our sequential spending patterns over the last few quarters, that we have been slowing down and matching more closely expense rate growth to revenue growth. That said, Cognex is a technology and growth company. We're bringing a lot of really exciting technologies and products to market over the next year and a half. We don't want to inhibit the growth and adoption of those technologies based on hitting some sort of shorter-term expense growth constraints. We're bearing all that in mind, I guess, is what I would say. You can bet we're going to think very carefully and act on it.
Got you. Okay, great. Thank you for answering the questions.
Thank you. Our next question comes to our line of Matt Summerville with D.A. Davidson. Please proceed.
Thanks. Couple questions. First, can you comment on your inventory levels coming out of Q3? You mentioned that some of that was the result of perhaps some safety stock in advance of this standing up of the SAP ERP system, and talk about kind of what you think about the potential timing of draw down, and then I have a follow-up as well.
Sure. Thanks, Matt. Our inventory balance at the end of Q3 included some strategic purchases we made for our ERP implementation, that were really not needed in the end, because it went smoother, I think, than we were expecting in that regard. We also have a fair amount of inventory related to new product introductions that we'll be seeing this quarter and next quarter. Where we're building up product in-house, rather than through a subcontract manufacturer. We're building that. That's why it went up, and we do expect to see inventory balance come down in the fourth quarter. We do expect to report lower inventory balance at year end than you saw at the end of Q3.
Just a follow-up on China, can you maybe talk about when during the third quarter you started to see your business there, and outside of consumer electronics? When you started to see your business tail off, and do you feel that it's now stabilized at a lower level, or is it still in the process of rolling over?
I think we really began to see the slowdown as we came out of August and we moved into September. We saw that continue into October. The answer is no, we don't know what's going to happen now. We're watching it very closely. I think we're trying to tailor our internal forecast to what we're seeing in our sales funnel and spending patterns. I wouldn't say that necessarily it's settled, and I think it could go up or down relatively rapidly on a week-to-week or month-to-month basis. I just want to revisit a question that Rick mentioned as well about concerning Q4 demand and our thoughts about Q4 demand. I think it's fair to say at the end of every year in industrial companies, there's what's referred to as the budget flush.
We have, particularly in strong years, there's a kind of a move to spend capital at the end of the quarter, at the end of the year. I would say in that regard, we're taking a relatively prudent view about what's going to happen at the end of this year, and certainly at the end of last year, we saw a pretty significant budget flush, and had a lot of our sales nodes maxing out their quotas and booking a lot of business with customers who wanted to spend budget. We don't expect that kind of wave of strength at the end of the year this year based on what we're seeing in the marketplace.
Thank you.
Thank you. Our next question comes to the line of Jairam Nathan with Daiwa Capital Markets. Please proceed.
Hi, thanks for taking my question. It's Daiwa Capital Markets, actually. You guys mentioned consumer electronics, you have a long-term view of it increasing the 20% range. I just wanted to kind of understand what are some of the drivers behind that you're seeing, smartphone sales kind of not growing too much. The feature set is probably, you're not seeing a lot of innovation coming from the smartphone manufacturers in the feature set. I just wanted to try to understand what gives you the confidence? I had a follow-up.
Sure. Yeah, thanks for your question. I think we all see the handset unit production rates and the increases in average sales price at the high end of the market. We sort of see those dynamics going on. I think we all have foresight into those. What really is going to drive Cognex vision sales, though, in the market. One in the long term is there's a lot of labor still in the production of smartphones that the large manufacturers want to take out. In many cases, the products are becoming too small for human hands to manufacture. The yield and quality that can be achieved with humans versus automation, and particularly vision, makes vision a long-term focus of investment for their engineering teams. That's certainly part of it.
The other part of it is, and that's where I take issue with what you said, is I think there's still many advanced technology features that are being planned for introduction in the smartphone market. As we look across, and we really do deal with many of the large players in that market, many of the players overall, certainly there are technology features that are in their roadmaps which make the use of vision in implementing them very important and give us the sense that we could see strong future growth from that market. We spoke also about the OLED screens and the investments in screens, which are very important to long-term roadmaps in that industry and very difficult and investment intensive to manufacture.
All of those give us a sense, our sense of why we expect long-term investment and growth in machine vision in that market.
Thanks. Just finally, with regard to competition, as you're seeing the environment kind of getting a little more sensitive here, are you seeing customers asking for more, being a lot more price competitive, or does that open up an opportunity for lower cost competitors?
The answer to that is no. Machine vision is very difficult to do, and the competitive advantage of advanced products from us and a few of our competitors is very substantial. In general, this is not a market driven by price, it's a market still driven by technology. Of course, we could drop price to try to win share, but that's never been something that we've wanted to do. It's not what we're about as a company, nor I believe, is it really what our major competitors are about.
Okay. Thank you. Bye-bye.
Thank you. Our next question comes from the line of Paul Coster with JP Morgan. Please proceed.
Yes, thanks for taking my question. I just want to follow up on James Ricchiuti's question from earlier on regarding logistics. Although I take your point that year-to-date it's been very strong, there was something in your prepared remarks, Rob, that just alerted us to some recent change. What was the point of the intro remark on logistics?
Yeah, Paul, the point was really there was no point. It was just a timing of revenue for logistics, in Americas in the quarter, was slower than we've seen, and it really has just to do with the timing and a few customers where bookings turn into revenue. Simple as that. The market is great and growing strongly, and we have reported growth year-to-date in the first nine months of over 50%, and we see no change in that profile going forward.
Okay, got it. Right. You also mentioned that there's a new product cycle coming. Is it across the entire range of products? Is it a new feature set at the same price points, or is it product extension, or are you reducing prices here? Just give us some sense of what you're doing here and what are you doing to mitigate the risks that, A, customers wait until the new products are available now, and/or that you have some execution challenges in bringing a product to market.
Yeah, we really don't talk about specific new product introductions that are coming up. But in general, what I can say, and as we continue to invest significantly in R&D, and we have products being launched pretty regularly in most quarters. You can expect to see new products from us this quarter, next quarter, second quarter of next year coming to market. We don't telegraph specifically what those are going to be, but when we do launch them, then we end of life other products, and that can lead to increased pricing and demand opportunities as well.
Okay, got it. Thank you.
Thank you. Our next question comes from the line of Joseph Giordano with Cowen and Company. Please proceed.
Hey, guys.
Hi, Joe.
Just quick clarification, the $15 million headwind, that's OLED, but is it also the large customer spillover from Q3 into Q4 last year? Are both of those numbers included in that 15?
Yeah. The 15 is smartphone and OLED, predominantly on the smartphone front.
Okay. On the fourth quarter guide, I'm just curious, as you look at what the trends that are happening, particularly in China, how haircut is that fourth quarter? Are you holding conditions as of today flat, or are you anticipating a continuation of a downward trend into that guide? I just want to understand the baseline and expectation in there.
Well, generally, we've never forecast specific regions and specific quarters in terms of growth. I think our message to you is we've seen a decline in that market. We look at our sales funnel, we don't expect the kind of growth. In fact, we don't expect growth in that market year on year in Q4, we've baked that into our guidance. Other than second to the smartphone OLED piece, that's the second piece that is giving us headwind and meaning we won't be reporting 20% growth. We'll be reporting more like 10% growth net of the OLED smartphone piece.
I guess that kind of gets me to the follow-up. On the 20% longer-term view, what's the baseline level of activity that you need to be able to drive that kind of growth? How do we frame your ability to outgrow markets when you think about your most important regions? Do we need some sort of certain level of, whether it's GDP or PMI in a region like China? How do you think about that?
Well, we see vision as technology that's expected to grow at about a 10% growth. The main vision markets that we serve, we expect them to grow at a 10% rate. We are the market leader, investing and bringing to market the best technology, and we have the best brand. We have some specific market segments that we're in, logistics being a good example, 3D, life sciences, some of the new markets that we've entered, mobile terminals, that can bring our growth rate well above that rate, right? Obviously, historically, looking back, our ID business has put out some awesome growth rates well north of that 20% goal over the most recent years, and we would expect it to go on doing so. That's kind of one piece.
The other piece is, if you look back over a three-year period or a five-year period, you see compound annual growth rates of in excess of 20%. We've been doing that, and we're also investing in our sales force to the point where we can reach more and more customers and grow with the business. What we've always said is, we're not going to do 20% every quarter or every year, right? In some years, as you look back on our history, we've tended to have enormous years, like we had last year, and some years slower growth, although we have grown in nine of the last 10 years. That's how we think of it.
Thanks, Seth.
Thank you. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset prior to pressing the star keys. Thank you. Our next question comes from the line of Bobby Eubank with Chevy Chase Trust. Please proceed.
Good evening, guys.
Good evening.
Could you update on ViDi? I know you mentioned strength there and customers moving from training their models to deployment. Are we over the $10 million revenue mark or expectations for that in 2019? If you could update on your acquisition pipeline. I know you guys haven't done any acquisitions this year, but is there any talent out there that you can find a more reasonable valuation or think could be complementary to your product set? Thanks.
Great, Bobby. Your questions are really about deep learning and acquisitions. We made a very important acquisition of technology in ViDi in April of last year, and we've been introducing that technology to customers and making it easier to deploy by most recently putting it inside our VisionPro system of vision software. This is very sophisticated technology that we continue to develop and make easier to use, and the reception has been very good for this technology, and it's allowing customers to perform machine vision tasks that were either extremely difficult or impossible for them to perform in the past.
The way I think about it is these are tasks that are more like human tasks, where instead of rule-based vision, where one may be measuring something precisely, is an angle 90 degrees or 90.1 degrees, or is a hole the right width apart, or the distance from another hole? These are the sort of tasks today that human beings inspect and we are good at seeing, like are these glue lines, they may not be straight exactly because glue tends to glob and move around when it's dispensed, right? Are they continuous, and are they in the right kind of areas? Are solder balls in an electronics application, are they generally the right size and in the right place, even though their makeup and size may look different to machine vision?
Even chocolates, which may be being dispensed and don't have a regular form, if you think about them always particularly high-end, are generally correct or incorrect. These are just kind of accessible examples of what deep learning technology can do. Since we began to introduce the technology, we've seen a lot of customers taking our technology and looking at their problems with it, and it's an area that's getting a lot of attention. We've seen a lot of purchase of training licenses where customers are becoming familiar with the technology. Now we're seeing it being deployed by many of our most sophisticated customers into their production. I'm not going to give specific growth numbers or dollar numbers out at this time, but it's certainly beating the expectations we have for growth when we acquired the company, and it is many, many millions of dollars.
Your second question had to do with acquisitions. We made a significant number of acquisitions in 2016 and 2017, I think six acquisitions we made, and we haven't made acquisitions since then. We continued to engage with potential targets and look for similar things that we liked in those companies we acquired. Great technology, great engineers, great cultural fit, vision related, good growth potential that we can integrate. We've certainly engaged with, and in the end, decided not to proceed with a number of companies this year in that space. As you think of our cash on our balance sheet, certainly some of that we would like to deploy to acquire some larger companies, and we continue to cultivate and engage them.
We haven't, certainly in the last few years, been successful at convincing any of those companies to sell themselves to Cognex, but we continue to ask.
Thank you. Again, if you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Thank you. Our next question comes from the line of Joseph Giordano with Cowen and Company. Please proceed.
Hi, guys. Thanks for taking the follow-up. Curious about the integration of ViDi into the In-Sight platform and how much of that can be kind of combined and where are you now and where do you see that ultimately going?
I'll definitely talk about how we've combined it and where we see it now, but I'm not going to comment on where it's going. Only in general terms, maybe. Okay, when we acquired ViDi, we thought and still think they had the best deep learning technology for industrial applications that we'd ever seen, and we were really impressed with what they could do. They also had a number of rule-based vision tools that allowed them to do such things as find the object that they wanted to work on quickly. These are things that we do exceptionally well at Cognex through technology known as PatMax and PatMax RedLine. When we brought those two technologies together and brought them up inside VisionPro, some of our vision tools helped the ViDi technology operate better. It was complementary. The other thing is, at Cognex, we have excellent user environments.
We hear regularly from customers that they standardize, and they really like our In-Sight and our VisionPro user interfaces and environment. Bringing ViDi into that environment also makes it more accessible to all the thousands of customers today who are standardized and use those user interfaces. That's been a sort of a quick and easy win for us. In the longer term, we think this technology has a long way to run as we make it easier to use and more accessible to more and more of our customers. And of course, the actual technology profile underneath that processor development and programming techniques around deep learning, and plus our own experience of seeing more and more examples to train on, mean that our technology in that area is developing very quickly.
It's an exciting area, perhaps one we'll give you more of a preview next year when you come for Analyst Day.
Sounds good. Thanks.
Thank you. We have reached the end of the call. I will now turn it back over to Mr. Willett for closing comments.
Okay, thank you for joining us this evening. We look forward to speaking with you next quarter. Good night from Boston, home of the world champion Red Sox, and Happy Halloween. Good night.
Thank you. This does conclude tonight's teleconference. You may disconnect your lines at this time, and thank you for your participation.