Greetings. Welcome to the Cognex fourth quarter 2017 earnings conference call. Our call today will be 60 minutes. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, John Curran, Chief Financial Officer. Please go ahead.
Thank you. Good evening, everyone. I'm John Curran, Cognex's CFO. I'd like to welcome you to our fourth quarter earnings conference call. With me on today's call are Dr. Bob Shillman, Cognex's Chairman, and Rob Willett, Cognex's President and CEO. Please note that our earnings release and Form 10-K are available on the Cognex website at www.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 the company's 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.
Thanks, John. Hello, everyone. Thank you for joining us today. As shown in today's news release, Cognex reported fantastic results for 2017. We set new records for annual revenue, which grew in excess of 40% year-over-year, net income, excuse me, and earnings per share from continuing operations above records, too. That's despite the very high tax that we accrued in Q4 due to the new tax law. Now I'm going to hand the call over to my partner, Rob Willett, who will provide further details. I'll be available at the end of the call to answer any questions you may have for me. Rob, the microphone is yours.
Thank you, Dr. Bob, and good evening, everyone. I am pleased with Cognex's very strong performance in 2017. We reported our eighth consecutive year of record revenue and the highest annual net income and earnings per share from continuing operations in Cognex's 37-year history. As Dr. Bob just stated, the record net income and earnings per share that we reported includes $83 million of unanticipated tax expense due to the new tax law. Market conditions were very strong, the best we have ever experienced. Growth came from all geographic regions, all major product categories, and a wide range of industries, including a substantial contribution from consumer electronics. Growth in consumer electronics was driven by the introduction of new devices, new functionality, and the wider use of new technologies, including OLED displays. Importantly, our spectacular growth in 2017 was not limited to consumer electronics.
Even outside of that industry, Cognex revenue increased by more than 30% year-over-year. Notably, revenue from two areas with high long-term potential, logistics and 3D products, continued to grow very quickly. Combined, they represented approximately 15% of our total business in 2017, and we expect both to grow at roughly 50% a year for the foreseeable future. Operating margin was 35%, compared to 31% in 2016. Excellent fall-through on incremental revenue expanded operating margin by 400 basis points in a year when Cognoid headcount increased by 25%, and we made substantial investments in IT and other systems to support growth in the years ahead. Our success in 2017 was the result of the hard work and dedication of Cognoids around the world. They personify our unique entrepreneurial culture in everything they do. The loyalty of Cognoids and their sense of company pride and ownership fuel our growth.
We cannot overemphasize how much our investments in them, including employee stock options, contribute to our long-term success. Our standards for employer recruitment are very high, particularly around cultural fit. We believe it is the primary reason why our employee retention is above 90%, a rarity among high-tech companies. This strength drives our ability to develop industry-leading technology, which is a significant competitive advantage for Cognex. In 2017, we asserted our leadership in the machine vision market with the introduction of powerful new products, including The next generation of a highly successful In-Sight 7000 vision systems product line. Delivering market-leading performance, simple setup, and flexible capabilities, the In-Sight 7000 is ideal for today's increasingly complex production processes. The In-Sight Laser Profiler, our first 3D product to leverage the intuitive In-Sight EasyBuilder interface, bringing our 3D capabilities to a larger audience.
The DataMan 370 series of high-performance barcode readers, which address the need for improved read rates at lower price points in both factories and distribution centers. Supplementing our engineering efforts, we acquired ViDi Systems, a Swiss-based startup with an experienced team of engineers specializing in deep learning AI software for industrial applications. ViDi's proven technology finds and categorizes things that are difficult to define, such as surface scratches and blemishes. By applying deep learning to Cognex's machine vision, we are solving inspection applications that were not possible just a few years ago. I will now turn over the call to John for details of the fourth quarter.
Thank you, Rob. In addition to the full-year achievements just mentioned, I am very pleased to review our best fourth quarter ever. Before I get into the details of the quarter, I wanted to spend a few minutes discussing the impact of the new tax legislation on our Q4 and full year 2017 results. We recorded a one-time charge of $83 million, or the equivalent of $0.46 per share in the fourth quarter, related to the new tax legislation. I should point out that this charge is our best estimate based on all the information available to us today. The charge has three major elements: a $101 million charge for the estimated transition tax on repatriated foreign earnings, a $13 million charge related to the revaluation of our deferred tax positions, and a $31 million benefit associated with the recharacterization of certain income under the new law.
We are in the process of analyzing the implications of the new tax law from a capital allocation standpoint. Given both the magnitude of the changes involved and that we expect further clarification with regard to the application of certain provisions of the legislation, we are not prepared to make any strategic decisions with regard to our capital allocation at this time. Now that we have the tax discussion out of the way, let's talk about the highlights from the fourth quarter, all from continuing operations. Revenue was $180 million, which represents a new fourth-quarter record. Growth came from many industries, including consumer electronics, which increased substantially year-on-year. Outside of electronics, the broad factory automation market grew by more than 35%. Gross margin was 77%, down two percentage points year-on-year.
This was primarily a result of higher service revenue driven by our growth in consumer electronics and logistics. Operating expenses for Q4 were $88 million, which is slightly above our expectations, primarily due to higher sales commissions related to our strong finish for the year. In keeping with our strategy of investing to support our long-term growth opportunities, spending in RD&E increased 39% year-on-year. We continued to recruit top technical talent, and we also added a number of great engineers through our acquisitions. Overall, in 2017, we added 350 new Cognoids, which represents the largest one-year increase in our history. We now have more than 1,700 employees worldwide. Operating margin in Q4 was 29%, which is down two percentage points when compared to 31% in the fourth quarter of 2016.
This decrease is driven primarily by the gross margin decline, as well as by our continued investments in engineering and sales. On a GAAP basis, we reported a loss of $0.16 per share for Q4 due to the impact of tax reform. However, excluding all discrete tax items, earnings for Q4 were $0.25 per share, an increase of $0.05 per share year-on-year, or 25%. Looking at revenue year-on-year from a geographic perspective, Europe delivered the largest contribution to growth, both in absolute dollars and in percentage terms, and grew by more than 50%. Growth was led by substantially higher revenue from consumer electronics and the logistics market, as well as higher sales to customers in several other verticals, including automotive, food, and consumer products.
Our Greater China region continued to deliver strong growth, increasing by more than 45% over Q4 of 2016, with automotive and consumer electronics leading the way. In Americas, revenue grew by 40% year-on-year. Growth was primarily driven by logistics, along with higher revenue from automotive, food, and consumer products. Finally, revenue from our other Asia region was flat when compared to a very strong quarter a year ago, particularly in Korea. Before we turn to our outlook for Q1, I want to discuss the new revenue standard that took effect on January 1st. For Cognex, the primary impact is on how we account for sales of certain accessories. Which we historically reported on a net basis and going forward, we'll report on a gross basis. This change will result in our revenue and cost of goods sold increasing by the same amount.
Our gross margin dollars won't change, but our gross margin % will decrease by 100 to 200 basis points. We have provided Exhibit 5 in tonight's earnings release to show the impact of the new standard on 2017 by quarter. Footnote two of our 10-K includes a schedule that shows the impact on the last three fiscal years. Our guidance for Q1 includes our estimate of the impact of these changes on the quarter. Now, I'll hand the microphone back to Rob.
Thanks, John. While we are sad to say goodbye to an outstanding year in 2017, we're optimistic about 2018. Revenue for Q1 is expected to be between $165 million and $175 million, reflecting growth of approximately 20% year-on-year. Gross margin is expected to be in the mid 70% range. Operating expenses are expected to increase by mid-single digits on a sequential basis as we continue to invest in our long-term growth. The effective tax rate is expected to be 14%, excluding discrete tax items, and reflects our interpretation of the new U.S. tax regulations. We will now open the call to questions. Operator, please go ahead.
Thank you. At this time, we will be conducting a question and answer session. During the Q&A session, please limit yourself to one question and one follow-up prior to getting back in 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 a 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 pull for questions. Our first question comes from the line of Jim Bruschi with Needham & Company. Please proceed with your question.
Thank you. Good afternoon, and congratulations on the year.
Thanks, Jim.
Looking at 2018, you clearly have some tough comparisons in the consumer electronics market, but I'm just wondering, just based on the current trends that you're seeing in the market across the different areas, including OLEDs, can we assume that this business, the consumer electronics portion of the business, can show reasonable growth again in 2018?
Yeah. Hi, Jim, it's Rob.
Rob.
I think it's a little early for us to give our overall view on that. I'm reminded of this time last year where we thought consumer electronics might not grow, and then it grew more than 40%. I think a lot depends on the product rollout and introduction among major consumer electronics companies. The number of phone models, the number of new technology features that customers are going to apply. I think if we assume that they're going to go on innovating and investing, then I think there is the potential for us to grow. Obviously, we're coming off an outstanding growth year. I think it's a little too early to call that one.
Okay, just my follow-up question just relates to a comment, John, I believe you were calling out increased service revenue, not only in consumer electronics but also in logistics. My question is this, does that increase in service revenue associated with the logistics market suggest that there are larger deals that you're pursuing in that market as you work more closely with some of the larger logistics customers?
Oh, yeah, Jim, it's Rob again. I think I'll handle that. I think as we move into the newish market for us of logistics, particularly with new large customers that we're bringing on board, we're doing more service with them than probably we would expect to do in the longer term. That can have a dilutive effect on our gross margin in the near term. Our model ultimately is to follow the Cognex tried and true model where we focus on selling technology and the service support we supply or the solutions and applications engineering we apply becomes a lower mix of our overall revenue.
Thank you.
Our next question comes from the line of Bobby Burleson with Canaccord Genuity. Please proceed with your question.
Yeah, good afternoon.
Hey, Bobby.
Hi. I was just curious, you were seeing substantial disruption in apparel and now food, and I'm wondering what kind of growth you see in food and which product in particular you're seeing a nice uptake for.
I'm sorry, Bobby, I think you kind of cut out there. I'm going to ask you to repeat your question, please.
Oh, sorry. I was just referencing the disruption that we're seeing in apparel and now in food, and I'm wondering what type of growth you're seeing, in particular in the kind of food industry, either in the U.S. or Europe or where have you, and which applications that's thriving for you?
I'll take a shot at answering your question, I encourage you to clarify it even further. You're talking about disruption in the food market. That's not something that I wake up in the morning thinking a lot about. I will tell you that we're seeing good growth among our food customers, where particularly they're bringing more track and trace type technology to their products, where they want to have more security in their supply chain and the ability to track products in that supply chain. We do a bit of business with apparel, you mentioned as well, in the logistics space, where certainly there's a lot of investment in e-commerce type channels for that. It's not a significant part of our business, nor is it really a significant driver of growth last year or going forward. Is that what you were getting at?
I think you called it out as a bright spot at one point in your official comments. I was referring to the Amazon effect.
Okay. Yep. I think we're referring to food as another good vertical for Cognex where vision is being applied. It would certainly be much less than 10% of our business overall.
Okay, great. It sounds like you have good visibility on 3D, and being able to kind of call out 30% growth. I'm wondering if you can frame maybe some of your other markets and/or products against that 30% growth expectation. Where do you see growth kind of commensurate with that, lagging, leading?
I think what we said about 3D, which is an exciting market for us, is that it's a product that's growing at about 50% a year, actually. We see it as accretive to our overall growth, but represents about 5% of our business today. We expect it to represent substantially more in the future. Applications for 3D vision are very broad. You asked maybe if there are other areas where we see growth. The one kind of that's twice the size of that and growing at the same 50% rate or more going forward is logistics. We really see that as a key growth driver for Cognex. I think we have other markets that are sort of earlier stage, where we're very enthusiastic about growth.
One, of course, is deep learning, the application of deep learning technology, to help us in the area of inspection, where we are able to do applications now we weren't in the past. The other would be mobile terminals. Still a pretty new business for us, where we have significant competitive advantage, and we have many trials underway and are starting to win decent orders from substantial companies, from Fortune 500 type companies who are starting to adopt our technology. Early stage, but something I expect over the years to come you'll be hearing a lot more about from Cognex.
Great. Sorry, I misheard that 50%. Just how concentrated is that 3D business right now, overall? I know it's only 5%, but is it concentrated around one or two customers, or is it pretty broad-based at this point?
It would be broadly mirroring our overall business. A good amount in consumer electronics, but substantial amount in automotive and other markets we serve.
Okay, great. Thank you.
Our next question comes from the line of Richard Eastman with Robert W. Baird & Co.. Please proceed with your question.
Good afternoon, wow, congrats on a really good year.
Thanks, Rick.
When I look at the fourth quarter and I look at the Asia ex-China revenue, again, we saw that slow down to a single point of growth maybe year-over-year. Also, it slowed down in $ sequentially from Q3 to Q4. My question is it a slower spend environment given any application specifically, or do you view that as somewhat of a seasonal slowdown just kind of into year-end? That's my primary question.
Yeah. Hi, Rick. I think the sort of sequential and even year-on-year changes that you're seeing probably have most to do with spend in OLED manufacturing, where we've seen revenue tends to be lumpier. I think we're seeing more of a recovery in automotive in that market, which was perhaps one of the laggards in automotive growth last year. I think it's more to do with lumpy business, where we have a great team there. We're optimistic about our overall performance. In fact, I think I'm right in saying it was our fastest-growing area last year.
Yes, correct. China, in Asia as well, can I just ask, we had a spectacular year in China, I think that was more auto and, again, consumer electronics. My question is, some of the investments that we put in there have been a little bit more around kind of feet-on-the-street investments. I am curious if you could just kind of tease out the growth rate a little bit and say how much of that was due to our investments into either verticals or just feet on the street in general. How should we think about China next year or this year in 2018? Can we sustain rapid growth, I don't know about 50%, but can we sustain that kind of growth?
Our underlying business in China, excluding large electronics customers, which generally I think and what you see aren't even shown in our China business.
Right.
Our underlying business there is broad, very broad. We have a lot of Salesnoids on the street calling on a lot of customers. The average account size is not skewed towards any particular large customer or of course, there's a lot in electronics, but automotive was the fastest growing in China in anywhere in the world of Cognex last year, and is broad and like the rest of our business, mostly to tier 1 suppliers, to give you a sense of the breadth. There's a lot of concern, as you probably know, in China about security, supply chain security for food, for pharmaceuticals. When I review our sales funnel in China, it's very broad-based, and we're adding a lot of feet on the street, which are producing very well for us.
I would expect it to be a strong driver of growth and outperform Cognex's overall growth for years to come.
I see. Okay, perfect. If I could just sneak in one more question for John real quickly. As we look forward, the weaker dollar here, the impact in 2018 on Cognex's business, I mean, revenue translation could be as much as 3% revenue growth. Any other benefits from a pricing standpoint or that we should be aware of?
No, not from a pricing perspective. It does help us on the top line offset a bit by the expenses going the other way.
Yes
revenue outweighs expenses, so it's net positive.
Okay. All right. Thank you.
Our next question comes from the line of Joseph Giordano with Cowen and Company. Please proceed with your question.
Hey, guys.
Hey, Joe.
I was wondering, you mentioned OLED a couple of minutes ago. I was wondering, can you frame out the magnitude of growth? I know you said it's not the fastest growing sub-sector for the year, but how large is that? How big a contributor is that, either to the company or consumer electronics or however you'd like to frame that?
I don't think we're going to be breaking out specifically the size of our business in OLED just for competitive reasons. It certainly was a big driver of growth for us. It's also kind of multi-part really because there's the sort of the OEMs that produce machines that help with things like vapor deposition in a kind of base material. There's actually the process of aligning and then moving material in the supply chain. Of course, there's the actual application of OLED screens to smartphone technology and other consumer electronics. It's a pretty complex thing, but it's an overall driver of growth for our business. It was substantial. It drove certainly more than $10 million of growth for Cognex last year. If you include its influence in other areas of electronics, it was possibly multiples of that.
Okay. Fair enough. Maybe a broader question on robotics. As that market continues to expand, how do you see yourself positioned? It seems like some of the upstarts using computer vision and I'm just curious how are you broadening with the market with some of the smaller upstart companies versus some of the larger, more established, big global players?
I think it's a good segmentation you're making because I think there are, say, five large robot companies in the world, and we are the supplier of choice for four of them. Even that one that we're not the supplier of choice for them because they have their own internal vision, generally we're very often specced in with their robots just based on our performance. That, I think, is more the legacy robot business market for automotive and even some degree in logistics too. I think that the other segment you're referring to is really small collaborative robots that work alongside people in production lines, and I think that's where we all see huge potential for growth. Cognex is very well positioned in that market.
Generally, we're either specced in where our vision is helping to sit above or next to those robots and guide and help with their operations or in some cases, actually integrated into the product itself. I can think of at least two very well-known, perhaps the two most famous collaborative robots where Cognex vision is actually inserted into the arm of the robot to guide and monitor what's going on with the gripper. I would say we stand to benefit more than any other company in the vision business from the growth of that area of robotics.
Great. I know auto was very strong for you guys this year. As you look at some of the production outlooks and CapEx outlooks, how do you see that framing out at this point in time? I guess out of all your businesses, that might be the most visible. How do you kind of see this year playing out kind of versus last year?
Well, I think last year was surprisingly strong. Automotive is a large and important market, and it grew by about 25% year on year, last year. In the long run, we're expecting growth of vision in automotive to be sort of around 10% or a little more. This was an outstanding year. It's difficult to say whether that degree of kind of investment is going to continue. Elements in that market, like vehicle model changes towards SUVs, and then the adoption of electronic and hybrid engines, and then the increasing use of electronic components and systems give us confidence that we're going to go on seeing good rates of growth in automotive over the next year or two, I would say. I don't think we're going to see quite the level of growth that we saw last year.
Fair enough. Thanks, guys.
Our next question comes from the line of Karen Lau with Deutsche Bank. Please proceed with your question.
Hi, good afternoon, everyone.
Hello, Karen.
Rob, I was wondering if you could expand a little bit on the headcount addition, especially in sales force. I think you added over 200 people over there last year. Maybe you can provide a little bit of color of, in terms of where you're adding your resources, in terms of geography and markets or product vertical. What's the expectation for this year?
The first part of that question is easy. Yes, we're investing a great deal in bringing in and adding new Cognoids. As in my initial remarks I made, that's perhaps harder than it sounds because we're very selective about who we hire and making sure they're a strong cultural fit. Possibly as much as half of those incremental headcounts were in sales and people in the field. They probably mirror kind of the overall growth rates that we're seeing and expect in our markets. Skewed quite heavily towards China and the rest of Asia, where we see extraordinary growth. Also in all regions, we added headcount.
Those Salesnoids help us get closer to customers and understand their needs and increasingly sell Cognex vision to a broader range of customers who are starting to adopt vision, companies that didn't in markets that didn't use vision only a few years ago. We're seeing a lot of that. Also, a great deal of engineers. We continue to add engineers both through acquisitions, where we added more than 20 engineers to Cognex last year. We continue to invest in systems and processes. As I think you know, we're going live on SAP shortly, and we've really come a long way in improving the management information systems at Cognex, which is allowing us to understand our business much better. Going forward, we're not going to give projections on hiring for this year.
We do expect to grow and go on investing in our sales force and our engineering workforce, because we see so much potential for our business in the long term.
Is it fair to say it's not going to be in the same magnitude as the amount of people that you added in the previous year?
It's too soon to say.
Okay. I just want to follow up on other Asia. You mentioned in the previous quarter there was some lumpiness, with regards to the flat year-over-year and some lumpiness with OLED projects maybe. I was just curious, what has been dialed into your first quarter outlook? Do you expect some of these projects to come back? Are you dialing in anything at all? How volatile could the outlook be given some of these projects could get delayed or come back? How should we think about the sensitivity on that front in your first quarter outlook?
Yeah. I think, generally for Cognex, I think as you know, electronics is generally a Q2, Q3 phenomenon for us.
I think this time last year, we were seeing some very strong growth in more OLED-based kind of material manufacturing and OEMs to support that. You would have seen that in our other Asia region. We're not seeing so much of that right now. I think this is more of a cyclical phenomenon or is really cyclical. I think we would expect to see the next wave of that, not until the second half of the year at the earliest. I think it's a bit of a wild card for us, the timing of that sort of next wave of investment. I'm very confident it's coming. I know it's not the first quarter. I know it's not the second quarter, but watch this space.
Got it. Very helpful. Then just housekeeping, the 21% exposure direct and indirect to Apple, would that include any OLED stuff?
Well, we really don't talk about our largest customer, but if I talk more broadly about electronics, certainly the adoption of OLED screens to smartphones is a well-known phenomenon driving growth, it's a well-known innovation that is still relatively early on. Cognex vision is just the best at aligning, applying, and inspecting that kind of material. In that respect, certainly.
Okay, got it. If I can squeeze just one more in for Dr. Bob. There is, I guess, a lot more technology adoption on the 3D side in consumer electronics. I was just curious, how would that impact the cost of the components? Because I think right now, your 3D product is still probably maybe 5 to 10 times more expensive than the 2D products. As we see more consumer electronic smartphones using 3D scanning, having 3D scanning capabilities, how are you thinking about the cost of components and the impact on your 3D product from the cost side and also from the revenue side?
Well, you brought up a couple points. Excuse me, I have some allergies that I'm dealing with here. You brought up 3D scanning on smartphones, but that kind of scanning is not very applicable to the kinds of applications that we run into and solve in factories. By and large, it's very low resolution and probably much too slow. Even though those components may be coming down in price because of the high volume of smartphones, I doubt that we're going to make use of those components anytime in the next few years. I don't expect those kind of components to ever generate the kind of accuracy and speed that we need in factories. There's no need for that in a smartphone, typically. They're using it to do very interesting things, like recognize faces, but the kind of accuracy it requires is way off.
Regarding the price of 3D, yes, 3D is very expensive. It is very difficult to make. It's very challenging. The technology is challenging, but that's exactly the kind of product that Cognex likes to tackle. Simple things, there's no way we can do simple things better than anybody else, or very inexpensive things better than anyone else. We really enjoy the challenge of a high accuracy, high resolution, high speed 3D. Of course, those prices will come down as volumes go up. Right now, we're buying things in very low volume, we expect our costs to go down and therefore probably the price to go down. Really, we sell based on value. We always have sold our products based on the value that they deliver, and I'm happy to see that most of our competitors, at least the largest one, also feels the same way.
I think that the margins can increase in 3D in the coming year or two, because we can probably hold price at what the customers consider to be a fair value.
Got it. Thank you.
Does that answer your question?
Yes, very much so. Thank you for the color.
You're welcome.
Our next question comes from the line of Jairam Nathan with Daiwa Capital Markets America. Please proceed with your question.
Hi. Thanks for taking my question. Just on the mobility of products, I kind of wanted to understand what's the main driver behind share gains. Is it just a mobility platform, which I think one of your competitors has built, started introducing some products around a mobile product, or is it something more than just a mobile platform?
Hi, Jairam.
Yes. Hi, it's Rob. Our mobile terminal product is unlike any other competitors'. What it is, it integrates the major smartphones from the leading suppliers, and then it has a very powerful vision engine on the front of it in a very rugged case and environment. Some of our competitors do sell kind of rebadged, ruggedized smartphones. Generally, that's not the main part of our product. Although, we came out initially with a product called the MX-1000, which is kind of a mid-range product used in factories and markets like logistics and life sciences and other markets. Now we've extended the product range on the high end with a product which is called the MX-1502, which allows, due to our very powerful vision and optics, to scan barcodes a long way away, perhaps 30 feet away in a factory, and also very close up.
It has real competitive advantage in that space. We've also launched the MX-100, which is an accessory that transforms smartphones into better barcode readers. That's probably more like the competitors that you might see in this space on the lower end of the market. There's a number of reasons customers are really interested in adopting our platform. One is that they get to leverage all the technology that's in a smartphone, whether that's GPS or great phone connectivity or wireless connectivity and great user interfaces, which of course, are being continually updated by those big companies that make them. It's a platform that stays very current and is less expensive to maintain and operate. Also the power of Cognex vision, which allows for much improved performance in terms of barcode reading initially and perhaps other things in future.
When I look at the competitive set, particularly for many of the larger players in this space, I don't think of those products being analogous to ours at all. I think of ours being different and disruptive. That makes it perhaps a little bit more difficult for customers to assimilate and adopt, but those who are, I think, are really starting to understand its power, and I think we can expect good growth in years to come.
Okay, thanks. As a follow-up, just with regard to the increase in the sales force, typically, how much of a lag is there in terms of training and stuff before they start contributing to the top line?
Yeah. What I would say, we bring in new Salesnoids, we train them. I would say it's three months, really, until we sort of let them out in front of customers alone and start to sell. Six months, we would start seeing them to be relatively productive, and within a year, we would expect them to be operating at a rate similar to the sales force in general.
Okay. Thank you. That's all.
Our next question comes from the line of Josh Pokrzywinski with Wolfe Research. Please proceed with your question.
Hi, good evening, guys.
Hi, Josh.
Just to ask a follow-up on some of those comments about sales productivity and when these guys start to be accretive, they come on. I guess maybe a broader question, because we've seen some of these investments pick up over the past couple of quarters. What do you view structurally now, given that the opportunity set is widening, should be your kind of normalized incremental margin? 4Q is probably a little lower than you would have expected, because 2017 as a whole was so strong. 1Q, you're making some of these investments in a bit of a low volume quarter, so probably not to be extrapolated there either. Just wondering if there's a bigger structural change to the way you're thinking about operating leverage and sales force productivity.
Right. Josh, you used the word incremental margin, which I think are you really talking about flow- through on incremental revenue? Is that correct?
That's correct. Yep.
what we're getting at? Okay. Yeah. I think the first thing I'd really say about Cognex is we're interested in winning in the long term, right? We see great potential for Cognex and the adoption of vision over the long term. Generally, our operating model is that we expect to be able to grow this business 20% a year, the factory automation piece, the constant currency, 20% a year, over the long run. Right? We kind of have our eye on that. At times like last year, we're doing more than double that, we're investing more heavily. In general, we expect that growth to occur. We're making very good gross margins, in the mid-70s now, under the new accounting rules. The fall through on that is very good.
When we're growing 20% and we're making those kind of gross margins, we're investing towards R&D in the range of 10%-15%, more on the high end, where we see great opportunities. We're spending a certain amount on the sales force and developing that. We still think we can see very substantial fall through to the bottom line. John might like to comment on the number, but probably in the long run, it's going to be likely in the range of 50%-60%.
Yeah, on the incremental. Yep.
Yep.
Got you. Is that a fair medium-term target? I don't want to be myopic around 1Q, and I don't want people, myself included, to extrapolate that too far. In the absence of full year 2018, which I know isn't really your game here, is that something that should be something that we return to sooner than later?
I think over the long run, that would be our overall model. Yeah. Exactly. I think you're dead on when you say Q1. Generally, this is my 10th year at Cognex, Q1 is almost always our lowest quarter, not one to draw conclusions about the long term from. What I would say is, when you see us investing, particularly in engineering and sales resources, it's testament to the confidence we have about the long-term potential of the machine vision and what we do.
That's helpful. Just on the logistics market, I think there are a few larger folks, particularly in the U.S., who don't really seem to have gotten around to adopting vision solutions quite yet. Have you gotten any sense from some of the bigger shipping companies, I think the names are pretty obvious. I know you don't like to talk about specific customers, but have you gotten any sense that in any of these applications, there's a sole source supplier? If one of these bigger guys got exposure from your biggest competitor first, is that a binary outcome and some of this push to make sure that you get your foot in the door with those guys?
Yes. Well, I think when we think of our logistics business, where we're most penetrated and where we see the most growth potential is more in the e-commerce kind of retail part of the market, right? They're aggressive, there's fast investment going on and a lot of change going on in that space. Generally, we see so much activity, and it's with really big consumer brand names and e-commerce type organizations that are driving a lot of our growth. I think the market you're getting at is more the parcel and post kind of package delivery type companies, where Cognex is generally less penetrated. Those organizations are moving less quickly, investing less towards automation, and generally, they tend to rely on quite a lot of in-house capabilities and systems integration.
I don't think that in the long run is going to be a winning strategy for them, I think their tolerance for investment is lower than the companies that we're really doing business with more. I also think potentially our product range will grow to encompass more their needs, and we'll be able to demonstrate more competitive advantage. Our penetration of that parcel, post, and package delivery part of the market is pretty small at the moment.
Got you. That's helpful. If I can just sneak in one more. I think in broad terms, a lot of people tend to think about your growth algorithm as having, at least at the factory automation level, some correlation to robotic demands. I guess what goes missing in that is how other inferior sensing technologies, say like a proximity sensor, comes off the robot in favor of a vision-based solution. Do you get a sense for how much of a driver that's been or will be, or how your customers are moving within that? Just kind of content on product advancing versus your customers selling more robots.
Yeah. I've got to ask you to repeat the question because I really didn't understand it. I apologize. Please try again.
Sure. Understanding that there are multiple solutions a customer can use to guide a robot, not just vision, are you seeing vision capture a larger share of that wallet where maybe historically you were growing at some small multiple of robotic demand with those customers, and now that multiple is expanding because they're using vision more? Is that more clear?
Yeah. Thank you. I would say that maybe through the history of automation, there's been much more sort of mechanical processes to deliver things to robots. Kind of vibration, kind of buckets that deliver parts in a certain way, orientation to a robot that picks them up. We've seen that. I would say over certainly my 10 years in this industry, I've seen customers moving away from that more to vision, because it's easy to implement and becomes less expensive.
Perhaps in future, I think a trend we're going to see is customers are going to want to have robots pick up things that are not uniform in terms of size, in terms of orientation, and that's something that they've been limited to do today because vision finds that difficult and vibration kind of, and mechanical means to deliver products are not able to do that either. Generally, when you go to a trade show or whatever, you see often, for years and years, you've seen kind of demonstrations of kind of screws in a bucket being striped by a laser striper from one of our competitors and picked up by a robot.
I mean, it looks kind of cool, it's really not a competitive application because if you really want to do that, you're going to use a mechanical means to do it. I think we're at the dawn of a really major change, which is robot-guided 3D vision. Robots guided by 3D vision, picking up non-uniform parts. I think that's a very exciting market for us. We're certainly seeing our customers interested in it and some of the acquisitions we've made over the last few years and our knowledge about robotics and now 3D vision, I think put us in a very good position for what could be, I don't think in the near term, but I think in the longer term, very exciting.
Great. Thanks for the call, Rob.
Thanks.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. One moment, please, while we pull for questions. Our next question comes from the line of Paul Coster with JP Morgan. Please proceed with your question.
Hi, this is Paul Chung for Coster. Thanks for taking my question. Just a follow-up on mobile terminals. Thanks for the update there, how would you say you're winning customers from two of the big competitors in the space initially? Would you say you're being competitive on price? How should we think about the margin profile for this product?
Yeah, I would say that we're not competing with those customers of very large accounts at the moment, particularly large package and postal type accounts where some of them are announcing 100,000 unit orders. That's not really the kind of market where we're targeting or customers we're targeting initially, because those customers generally are not innovative. They tend to be more wedded to sort of existing platforms and technologies. The customers we're really seeing a lot of penetration with tend to be kind of more innovative, perhaps more based around kind of e-commerce, logistics models, they're interested in adopting more contemporary technology and are seeing that advantage.
I think it's probably a truism that some larger kind of industrial type companies, package delivery companies, you tend to have people in engineering and controls who've been there a very long time, and IT, and are wedded to sort of the existing technology. Those people we're going to have less success with initially. They're going to want to buy the more established platforms, as costly and as unsupported as they're going to be in future. Where we're seeing penetration, I think, is more with innovators, that's where we're starting to see good penetration. That said, we're also seeing some success in vertical markets like airlines.
A number of airlines are starting to buy small quantities of our products and to use them because they really offer great competitive advantage in terms of connectivity, image capture, things like that, as luggage is being delivered through the process. We're still finding our way, but generally it's not the big post offices of the world that are going to start buying our mobile terminal initially.
Got you. How would you say the margin profile is for these products?
Similar to Cognex overall. It's very good. Generally, we're not selling the phone, right? Customers or integrators buy the phone and they integrate basically what is Cognex vision system with a robust sled really, or exterior, in some ways much like our handheld ID products today.
Got you.
Right.
Okay. Lastly on your intended use of cash, besides your updated $150 million share buyback and dividend, where do you see other opportunities for capital allocation? Should we expect some of these more small tuck-ins? Thank you.
Sure. Hey, this is John. M&A is always front and center, right behind our organic investment in engineers and salespeople. Below that would be M&A, buyback and dividends would follow up behind that. Tuck-ins would be the more volume side of our M&A activity, but there's always a couple of larger companies we'd be interested in when and if they're available.
Thank you.
Our next question comes from the line of Joseph Giordano with Cowen and Company. Please proceed with your question.
Hey, guys. Thanks for taking the follow-up here. Just a quick clarification for John. Inventory up quite a bit. Is there anything specifically driving that? How should we think about that relative to guide or anything like that?
Yeah, in the year-over-year, a lot of it's driven by our volume, our growth over the past year. I think the end of 2016 was one of our lower endpoints from an inventory perspective. Growth certainly is driving a lot of it. Then we're anticipating our changeover from an ERP perspective, we're trying to de-risk that transition by having some extra inventory on hand.
Even versus the huge quarters that you had, it's up pretty substantially, too. Is that still the same answer on the ERP, kind of just some safety stock kind of thing?
Yeah, it's Rob here. I think John's outlining the current situation. I would make the point that last year, we, I think a lot of companies, the challenge of sourcing electronic components was difficult. I think we saw lead times on a lot of things go out. We at Cognex fortunately have a business model where we hold a significant amount of inventory of components, right? For exactly circumstances like that where we can supply customers and sometimes our competitors can't. You saw us dipping into that last year to make sure we could supply the huge wall of demand we saw coming at us.
Now I think we're getting back to more the kind of level of inventory we need to supply our customers overall and satisfy what could be, we expect to be, continuing growth in our business without incurring sort of expediting costs and having lead times drift out. Our on-time delivery is very, very good, we're very, very proud of that. Last year, we saw it come under a little stress, we saw our competitors come under even more stress. We like to de-risk that by getting more levels of inventory and components to what we think we need in the long term. I think maybe to understand that, it's important to understand that Cognex products really are using components from the consumer electronics industry, whether it's memory chips or processors. Those have short life cycles, right?
They can be obsoleted in a matter of years, and yet we need to supply our customers for 10, 15 years sometimes. Having that on hand is a great competitive advantage for us and one that we feel good about having inventory to support.
So better-
Yeah, this is Dr. Bob.
Oh, go ahead.
This is Dr. Bob. I just want to make a comment about inventory. We always have an issue when we bring on a new head of manufacturing or a head of purchasing, I always ask them, because they comment that our inventory turns are low. I said, "Is that good or bad?" They say, "Bad, you want to turn your inventory a lot." That is not the case for our business. Inventory for us is a safety nest. We rarely, in the 36 years of the company, have written anything down. Our customers buy our products, because they have a long lifespan, that we can provide those products for many years. The inventory doesn't go bad. We're not selling cell phones, which change models every year or twice a year. We're not selling fruit, which can go bad on the shelf.
It's just better than cash in the bank, which isn't earning us much anyway. We have the cash. What's most important to us is serving our customers and being very responsive and being able to ship in many cases the next day. We can ship a vision system the next day after we get an order, a lot of that is due to having product sitting on the shelf, which doesn't go bad. I urge whoever is watching our inventory and is worried about it's not a worry. It's just not a worry at all. It's something that I urge people to buy more of.
Thanks very much.
Sure.
Our next question comes from the line of Ben Rose with Battle Road Research. Please proceed with your question.
Yes, good afternoon. Couple questions. If you look at the revenue composition in 2017, it was fairly weighted to the back half of the year with something like 59% of revenues in the last couple of quarters. Is that kind of a reasonable expectation for this current year? Rob?
Yeah, Ben, it's Rob. Here's the color I'll give you on that. Generally, Q1 is always our lowest quarter for the year. What we see is electronics revenue tends to pick up in Q2 and Q3, Q4 can be good as it was this year, where basically it tends to be a function of kind of year-end spend and good amounts of logistics and other revenue as well. Generally, Qs 2 and 3 are our big quarters. If you go back over the last few years, it tends to vary between, in 2014, it might've been Q3, in 2015, Q2, 2016, a mix between both quarters, right? That's not something we can necessarily predict.
Okay. Just taking a look at DSOs for this quarter, up around 60, I guess high relative to historic levels. Is there any commentary around that number? I guess where could we see DSOs head into the first quarter and beyond?
Yeah, our receivables ramped up a bit in the back half of the year, really driven by the timing of consumer electronics. We would expect that to kind of clear out in the first quarter and first half of this year.
Okay. Sorry, just finally, on the tax rate, the 14% tax rate for Q1, is that something, John, that you think is sustainable throughout the year? Just thinking in terms of modeling purposes, or is it too early to tell in terms of the interpretation of the new tax law? Thanks.
That's our best guess right now for the year. That's kind of where we're drawing the line in the sand, and I stress it's a line in the sand because we're still feeling our way through that massive tax law change. That's our best guess as of today for the year, 14%.
Okay, thanks very much.
Ladies and gentlemen, we have reached the end of the question and answer session, and I would like to turn the call back to Dr. Bob Shillman for closing remarks.
Yeah, thanks. Well, to wrap up, excuse me, we are very happy with our outstanding performance in 2017. 2017 is history. The future is what's ahead, and investing in our future has been and will continue to be the key to our success. Thanks again for joining us tonight, and we look forward to reporting our results to you again next quarter. Good night.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.