Feb 9, 2012
Operator
Good day, ladies and gentlemen, and welcome to the Cognex Fourth Quarter 2011 Earnings Call. [Operator Instructions] And as a reminder, today's conference is being recorded.
And now, I would like to introduce your host for today, Richard Morin, Chief Financial Officer of Cognex.
Richard Morin
Thank you, and good evening, everyone. Earlier tonight, we issued a press release announcing Cognex's earnings for the fourth quarter of 2011, and we also filed our annual report on Form 10-K.
Those of you who have not yet seen these materials, both are available on our website at www.cognex.com. They contain highly detailed information about our financial results.
Richard Morin
During tonight's 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. For your reference, you can see the company's income statement as reported on the GAAP in Exhibit 1 of the earnings press release and a reconciliation of certain items in the income statement from GAAP to non-GAAP in Exhibit 2.
Richard Morin
I'd like to emphasize that any forward-looking statements we made in the press release or any that we may make during this call are based upon information that we believe to be true as of today. Things often change, and 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.
Richard Morin
Now I'll turn the call over to Cognex's Chairman, Dr. Bob Shillman.
Robert Shillman
Thanks, Dick, and hello, everyone. I'd like to welcome you to our year-end conference call for 2011.
As you can see from the press release earlier -- that we issued earlier today, we had an outstanding year in 2011. In fact, it was another year of breaking records.
Robert Shillman
Here to give you the details on our results is my partner and Cognex's Chief Executive Officer, Rob Willett, and I'll be available at the end of the call to answer any questions that you may have for me. So Rob, take it away.
Robert Willett
Thanks, Dr. Bob, and hello, everyone.
I'm delighted to report our financial results for 2011. Highlights of the year include record revenue, net income and earnings per share.
Robert Willett
Strong financial performance was driven by record revenue from customers in factory automation, which is the largest market that we serve. Revenue from the surface inspection market also set a new record in 2011.
From a product standpoint, ID products continue to be our leading growth driver, increasing 38% over 2010.
Robert Willett
Reported margins for 2011 tracked at or above our long-term targets. Gross margin was very strong at 76% for the year, reflecting the value that Cognex customers recognize in our technology.
The 250-basis point increase over 2010 is due to significantly higher unit volumes with minimal change in overhead costs.
Robert Willett
Also contributing were improved surface inspection margins, resulting from lower-cost sourcing initiative, higher average selling prices and operational improvements. Operating margin was 27% as compared to 26% in 2010 despite our investments in new product development and expanding our sales teams to drive future growth.
Robert Willett
We also felt the impact of unfavorable foreign exchange rate fluctuations and higher stock option expense.
Robert Willett
We delivered net income equal to 22% of annual revenue. And in a year when we significantly stepped up investments in both engineering and sales, our reported earnings per share for 2011 were $1.63, which exceeded EPS of $1.52 in 2010.
Robert Willett
Now turning to the quarter. We ended 2011 on a very good note.
Revenue for the fourth quarter was $84 million, which exceeded our guidance. In the factory automation market, revenue was a record $63 million and accounted for 75% of total revenue.
Robert Willett
This level represents an increase of 7% year-on-year, if you exclude the $6.5 million service revenue recorded in 2010 from a single customer that had been deferred for several years until the contract was completed.
Robert Willett
Factory automation revenue increased 6% over the prior quarter. Looking at the business geographically on a sequential basis, our best performing region was the Americas, which reported record revenue in the fourth quarter.
The Americas was the largest contributor in absolute dollars to factory automation growth, helped by strong performance with automotive and ID customers.
Robert Willett
In Europe, factory automation revenue increased over the prior quarter and was at its second highest level ever despite the negative impact of foreign exchange rates. European factory automation revenue increased 3% sequentially.
But on a constant currency basis, that growth was 9%.
Robert Willett
Factory automation revenue from Japan increased on a sequential basis for the first time following the earthquake and tsunami. We're optimistic that this is an early indication that business there is coming back.
Good forward momentum in the broad factory automation market in Japan and elsewhere in Asia, including China, continued to be overshadowed by a slowdown in the electronics industry.
Robert Willett
Turning next to surface inspection, revenue in the fourth quarter was a record $16 million. This represents a substantial increase of 27% year-on-year and 35% over the prior quarter.
Robert Willett
Our surface inspection division obviously had an outstanding revenue quarter with the paper industry accounting for most of the growth. The higher revenue, along with cost initiative, translated into significant margin expansion for surface inspection products.
Robert Willett
Revenue from the semiconductor and electronics capital equipment market was $5 million in the fourth quarter. This represents decreases of 55% year-on-year and 41% from the prior quarter.
Customer demand in SEMI is, as you know, highly cyclical, and the quarter-on-quarter decline in SEMI revenue continued throughout 2011.
Robert Willett
Moving on to operating expenses. Our investment in engineering produced tangible results.
We launched a record number of new products in 2011, and we have a strong pipeline of products slated for an introduction in 2012.
Robert Willett
In the fourth quarter, new features and functionality were added to our Checker product line that expands its use in factory automation applications. The Cognex Vision Library is now compatible with Linux-based factory equipment, which means more machine builders can use Cognex software.
And, we added a wireless version to the DataMan 8000 Series of handheld ID readers, making it the only industrial direct part mark reader to support WiFi.
Robert Willett
A very important new product launched in January of 2012 was our DataMan 300 fixed-mount ID reader. The DataMan 300 handles difficult to read 1D and 2D barcodes that are presented at any angle on a high-speed line.
This functionality will open new opportunities for Cognex in both markets and manufacturing and logistics.
Robert Willett
The DataMan 300 features groundbreaking new technology named Hotbars, which was developed by Cognex co-founder and senior fellow, Bill Silver. We believe Hotbars set the new standard for 1D barcode reading and will benefit Cognex for many years to come.
Robert Willett
Our investment in sales and marketing also contributed to the bottom line. We saw tremendous growth in 2011 from the expansion of our market presence, particularly in China.
Our growth rate slowed in the Chinese factory automation market in the second half of the year, but ultimately, we believe you have a great strategy to capitalize on this high potential region of machine vision. We've been gaining momentum over the past 2 years, and Cognex is now recognized as the #1 machine vision brand in China.
Robert Willett
We plan to continue adding engineers and salespeople in 2012, although we do not expect to make the same level of incremental investment as we did in 2011. Of course, we intend to continue our disciplined approach to spending.
Robert Willett
In regard to our outlook, I believe Cognex is well-positioned to deliver on our strategic initiatives in 2012. Although we're expecting little revenue growth in the first quarter because of downturns in SEMI, electronics and solar, we remain optimistic about growth for the entire year.
Robert Willett
Now let's open the conference call up for your questions. Operator, we are ready to take questions.
Operator
[Operator Instructions] We'll take our first question from Zach Larkin from Stephens Incorporated.
Zach Larkin
There's been a lot of discussion recently in news and news pieces out regarding automotive and the capital expenditures that are expected to go on there, and obviously, was a good contributor this quarter. Can you maybe give a little bit more color about what your expectations are in auto in particular, maybe as we go into 2012?
Robert Willett
Sure. You're right that Cognex has seen a lot of very positive response division products in automotive, and that we saw very strong growth out of that vertical market last year.
And, yes, we do expect to see continued growth in automotive this year. We see a lot of projects for vision, particularly in the U.S., but also in Europe, and in Asia and Japan, where companies are investing heavily in vision.
I mean, a lot of -- there's a lot of investments certainly in for fuel-efficient drive, hybrid products as well. And so, yes, we remain pretty confident about the outlook for automotive, certainly for the next quarter and beyond.
Zach Larkin
And I wondered if you could also touch on margins a little bit? We did -- margins are still very robust but did drop down a little bit Q-over-Q and we're looking for kind of flat gross margins.
Do you expect margins to kind of tick back up to what we were seeing earlier in 2011 as we move through 2012? Or do you have any guidance or thoughts on that?
Robert Willett
I think when you look at Cognex's margins, you really need to think about the different parts of our business, right? So factory automation and SEMI both have very, very, very strong margins.
And with great technology that really recognized in the market. The SISD business generally has lower margin.
But we've seen some strong improvement in those margins. But as you kind of thinking about our margin mix going forward, our margin position going forward, you have got to think about the mix of business there.
And I think, obviously, if you're seeing any deterioration in our margins, it's really to do with the SEMI and the reduction that we see in the high-margin SEMI being replaced by, on a short-term basis anyway, to the SISD business.
Zach Larkin
Okay, that's very helpful. And then just one final question, if I may.
I wondered if you had any updates in the life science initiative, or if anything there that you can give us some color on?
Robert Willett
Sure. I mean, I think the important thing to understand is that the life science market is a highly regulated market with a very long sales cycle.
So we're -- it's a market that's very open and responsive to Cognex technology, where our image engine can be installed inside the customers' machine and they might be doing things like looking at test tubes of blood or other fluids and are tracking those through. And vision can provide a lot of technology to that, whether it's simply reading barcodes or doing reading numbers, but also looking at the colors of stoppers on test tubes or looking at the fill level on a test tube.
So we like that market a lot. What's going on there is we're working on getting specified into new machines that are getting designed and those machines get approved by the FDA and then they begin to scale up.
So we're in that process and we've had some design wins last year, and we expect to have more design wins coming through. And then we expect to see that turn into revenue for us.
But I wouldn't expect any substantial revenue this year, just basically the initial kind of sales of products. But then we expect to see it build over a longer period after that.
I think the other point worth mentioning is the life of these machines is pretty long and they're pretty regulated. So once we're spec-ed into that machines, it -- there should be some nice solid consistent revenue for us in the future.
Operator
And we'll take our next question from Jim Ricchiuti from Needham & Company.
James Ricchiuti
I think you gave some figures for the ID business for the year as a whole. Do you have any detail on the ID business in the quarter, what it represented in revenues and approximately what it was up for the year?
Robert Willett
Yes. So I think we said a few -- commented that we had 38% growth in ID for the year.
Just looking here, Dick, if you can give us the quarterly ID growth number.
Richard Morin
Yes, let's see, ID. I've got to add a couple of numbers, Jim.
Give me couple of seconds here.
James Ricchiuti
Sure. And maybe while -- Dick, while you're looking for that, Rob, can you talk about the momentum you're seeing for DataMan in terms of the 8000 -- sorry, the 800 for -- in the logistics market?
Any large wins? I know you can't always talk about customers, but can you talk a little bit about the success you're having in terms of penetrating some larger customers?
Robert Willett
Yes, Jim, let me clarify your question. You said the DataMan 8000?
That's a handheld direct parts mark reader. Is that what you're asking about?
Are you asking about the DataMan 500?
James Ricchiuti
I actually meant the 500, and I know you've been trying to go after the larger logistics customers. To what extent are you penetrating?
Robert Willett
Sure. Yes, so we're very pleased with the progress that we've made in logistics in the DataMan 500 over the year.
We launched that product at the beginning of last year. And we have a large funnel of business that we're working on closing, particularly some large e-retailers, package delivery companies and postal accounts.
We expect you to see that business kind of ramp as we went up through the year and it did. But we've learned quite a lot about that market.
I would say one thing we've learned is that big retailers and logistics companies generally don't make big capital investments right before the Christmas period, right? So although we saw the business build nicely and we sold more than $6 million of DataMan 500 over the last year, we didn't see some of that business close at the end of the year.
But we're now looking optimistic about closing some pretty significant business from some very major names through this year.
James Ricchiuti
Okay. So is that business that you think you have a fair shot at closing in the first half of the year?
Robert Willett
Yes, I would say closing. But I think these are going to be customers that will buy over quite a long period from us.
Certainly over multiple quarters. But yes, we're -- we expect to see some of that business coming in here in the first half.
Richard Morin
And, Jim, to get back to your question on the ID product, revenues was approximately $16.8 million in the quarter, which is a 9% increase over Q3 and a 33% increase over Q4 of last year.
James Ricchiuti
Okay. And then one other question, and I'll jump back in the queue.
Just with respect to the guidance, the sequential decline that you're forecasting for Q1, it would seem like the SEMI business was already pretty much at a bottom, same thing with solar. So I guess what I'm asking is, are you seeing also some seasonality or some weakness in general in some other parts of the business, including factory automation?
Robert Willett
No, but let me speak to that. I think you're right in that the SEMI business declined sequentially quarter-on-quarter through last year.
It was $13 million in the first quarter of last year. And by the end of the year, it was $5 million in the fourth quarter.
So I think that's certainly some headwind. Your question is about sequential.
I think we're thinking that SEMI revenue is kind of not likely to grow sequentially Q4 to Q1. But when you look at sequential trends in our own business, you have to remember that factory automation typically declines from Q4 to Q1.
And we have no reason to believe that that's going to be any different this year. Also, it's worth noting that surface inspection is expected to be lower than the record $16 million that we reported in Q4.
James Ricchiuti
Okay. But the trends you're seeing in the factory automation business Q4 versus Q1 appear to be more than normal seasonality as opposed to any weakness you're seeing from some end markets?
Robert Willett
Correct.
Operator
And our next question comes from Ben Rose from Battle Road Research.
Ben Rose
A few questions. Could you talk a little bit on the surface inspection side?
It sounds like there may have been perhaps a large deal in the paper industry in this quarter. And I think you were kind of addressing this in the last question.
But I guess, the general question is do we think the surface inspection can carry the day while some of these other markets that you pointed to might be a little bit soft in the first quarter?
Robert Willett
So well I -- first thing to say, surface inspection has generally has large--larger deal sizes, right? And if you look back, we had great order momentum through the last 3 quarters of last year, record bookings in Q2 and then you beat that again in Q3, still very healthy in Q4.
But no one particular deal kind of skewing those kind of results. I think -- so we're seeing that flowing through in revenue.
We don't expect SISD to have higher revenue in Q1 as it did in Q4, for sure. We don't expect to see that.
So and we expect FA, factory automation, to continue to deliver nice growth. Although on a sequential basis, as I said, that's going to be down Q4 to Q1 as traditionally it always is.
So then it really comes down to SEMI, and with SEMI is kind of down at the moment, $5 million in the last quarter. We don't expect something significantly different in the first quarter.
That's how I would characterize it.
Ben Rose
Okay. And then just on the European situation.
Is there anything that you could opine in terms of your general sense as to how things are going in Europe? And what's your outlook there is given all of what we read in the papers these days, it would be great to have your perspective on how strong you think the region is from a demand standpoint.
Robert Willett
Yes. Well, I think our European factory automation business is holding up well considering the region's economic news.
But kind of as you drill down on that, revenue from Europe is struggling with SEMI, electronics and solar downturn, particularly if you look year-over-year. European factory automation revenue in Q4 increased 9% over Q3, excluding the negative impact of foreign exchange rates.
And if you strip out the very large deal that we had a year ago, that we recognized, the $6.5 million of service revenues, some of which was in Europe and that growth would have been 11%. So -- and that's sort of -- the euro, obviously, is providing some headwind.
So the euro negatively impacted growth in Q4 by $1.4 million on a sequential basis; dollars, that is. So there's a little bit of a headwind there, too.
But overall, we still have a good funnel of the business in Europe and particularly ID and automotive continuing to look pretty robust, as do markets like medical devices and pharmaceuticals.
Operator
And we'll take our next question from Richard Eastman from Robert Baird.
Richard Eastman
Just a question on the product ID side within FA, factory automation. Dick, can you just give us a general sense.
I think that target has been kind of a 20% growth rate for that category? I mean, we have some momentum with DataMan 500.
We have the 300 introduced. Is that still a decent target, this 20% or better growth in '12 for FA?
Robert Willett
Well, Jim, you've traditionally -- I'm sorry, Rick, I'm sorry. I beg your pardon, Rick.
What we've said is we expect ID to grow at 30% over the long term. It did grow at 38% last year, and we continue to be very, very bullish about our ID business.
We're seeing -- we're replacing a lot of outdated laser technology, and we have just fabulous technology and our rate of introduction is increasing. So if you look at the Hotbars technology we're just bringing to market now, the increase in our sales force and their ability to sell in that market, we continue to be very, very positive about ID.
And on our ID business last year, it grew from around $43 million in 2010 to around $60 million last year. And we're expecting to see that kind of good continued growth rate as we go into this year.
So certainly, well north of the 20% figure you are commenting and...
Richard Eastman
And this Hotbars software, is -- how does that get to market? Is that basically an upgrade to existing DataMan products?
And is that, again, is there ASP benefit?
Robert Willett
Yes, so Hotbars is software and it's our senior fellow and founder, Bill Silver, who's designed it. And he really went back to basics on how we read 1D barcodes.
And that's the way that we've been doing that. The world doing 1D barcode reading for more than 30 years, and he took it upon and has rebuilt it from the ground up in a much better way.
And it runs on our existing hardware. So there's no incremental cost, but the performance is outstanding.
So certainly, we expect to be able to command a premium in terms of performance and to see some margin expansion even as we get that rolled out for the market. But it's only for 1D barcode reading.
Richard Eastman
Yes, okay, I understand. And then can I ask you on the SISD business.
This may be in the K, I wasn't quick enough to read through that, but is -- how does the backlog look in SISD year-over-year?
Richard Morin
Hang on 1 second.
Richard Eastman
That in the K, Dick?
Richard Morin
No. The only things that's in the K, Rick, is the total backlog.
SISD --- actually, both divisions are entering the year with a higher backlog this year going into 2012 than they did in the prior year.
Richard Eastman
Okay. I mean, you venture a guess as to how much higher?
Richard Morin
I venture guess. Yes, I can even do better than that, but we don't disclose that, Rick.
Richard Eastman
Okay. We had really strong orders in second and third.
You mentioned orders grew, but maybe book-to-bill in the fourth, so okay, so higher.
Richard Morin
They had a hell of a revenue quarter in the fourth quarter doing $16 million. I mean, that's a business.
I think for the year we did mid-40s or whatever. And the fourth quarter was one hell of a run rate.
It's because of some of those orders that came -- in when we kept on saying that the orders are very strong, these are customers that we're looking very specifically for deliveries in the fourth quarter. I think to a certain degree, maybe they were making sure that they get their capital expenditures in the current fiscal year.
Robert Shillman
But nevertheless the backlog, even with that, the backlog is still higher than it was entering 2011.
Richard Morin
Correct.
Richard Eastman
Okay. And then the gross margin improvement we're seeing maybe from the second quarter through third and presumably, it sounds like fourth here as well in SISD.
It does nothing in there that would not be sustainable, correct? In other words, it is sustainable at that level?
Robert Willett
Yes. So we've got a great management team in place now over at SISD.
There've been in there about a year, and they're focusing on a lot of great stuff. Lower cost sort of thing.
We've moved some of our sourcing to Asia. And we're very pleased with the way that's going.
Some really good pricing work where we weren't being rewarded for what we were doing in the market, and we're now improving that. And then just operating cost improvement through a continuous improvement-type activity that we're seeing.
So yes, we think those margins in that work is very sustainable going forward.
Richard Morin
The one thing I would caution on is that they have relatively fixed manufacturing overhead costs so to the extent that you push only $12 million of revenues through in a quarter versus $16 million, you'll have those overhead costs getting spread over a lower revenue base, okay?
Richard Eastman
Okay, understand,fines, okay. And then I just -- I want to just direct one question on the semiconductor -- semi OEM side.
Just -- I want to direct this at Robert because I think I know Dr. Bob's response.
Robert Shillman
To go to 0.
Richard Eastman
That's exactly it. I know there's downside to 0, but is it -- would it be a general feeling if that business, it kind of flat lines from Q4 to Q1, is it your sense -- and if you look at SEMI back-end orders, they kind of inflected in October.
Maybe think 4 to 5 or 6 months later, I would think yours would bottom? But is there -- do you have any sense whatsoever that we're kind of bottoming there even if it stretches out 1 quarter or 2?
Robert Willett
So we saw our revenue $5 million in the fourth quarter and I think our general sense is it's going to be around that again in the first quarter. So I think -- and I think you're right, what we're reading out of the industry is they're seeing signs of a recovery.
Normally, in our business, we won't see that come through for a number of quarters. So you might say we're near or approaching the bottom and than we might possibly see a pickup later in the year to that business.
Richard Eastman
Okay. And then, I'm sorry, one last question, I'll save Sue some time later.
The operating expenses that you mentioned into the fourth -- first quarter flat with the fourth quarter, but revenue, you had mentioned some continued investments in sales and R&D. If you project out for the year, can -- should we assume that maybe your operating expenses in total, R&D and SG&A included, might be up, like 6% to 8% with just the planned investments?
Robert Willett
So the rate -- I think what I can say is and I did say the rate of increase is expected to be substantially lower in 2011. We're planning for, let's say, high single digits as opposed to the double-digit increase you saw in expenses last year.
Operator
[Operator Instructions] And we'll take our next question from Jim Ricchiuti from Needham & Company.
James Ricchiuti
I think in the last call that we were discussing Mitsubishi, and Rob, you may have said this--that you expected that relationship to yield revenues of, I think $8 million to $10 million is the number you might have given. Where did you guys end up?
And what's the outlook for that business in 2012?
Robert Willett
So it was obviously a very difficult year for business in Japan in general with the earthquake, tsunami, the downturn in electronics and then Thailand kind of memory situation that occurred. But even with that going on, our relation-- our sales with the Mitsubishi channel grew by more than 30% in yen.
We ended up the year at more than JPY 750 million. So some really good progress in some pretty difficult operating conditions.
And we do -- assuming that the Japanese economy and the electronics situation continues to recover this year, we're expecting good growth again this year through the Mitsubishi channel.
James Ricchiuti
What do you -- in terms of dollars, where did you guys end up?
Robert Willett
Well, JPY 783 million and that was over the course of the year at various a little under -- its exchange-- I'd say a little under $10 million.
Richard Morin
Yes. It's definitely under $10 million.
James Ricchiuti
Okay. And so as you look at 2012, hopefully, that business should presumably, should begin to really ramp up, shouldn't it?
Robert Willett
We have great relationship with them. We're seeing some good growth coming.
So our expectation certainly -- it's a major growth initiative for us together with ID and with China, so yes.
James Ricchiuti
And did you guys see any specific slowing in China in Q4? I think you've talked about second half.
I wasn't sure if that, maybe it was a little bit more pronounced in Q4 in factory -- in the FA business?
Robert Willett
Well, we had such a white-hot pace in our business in the first half of the year in China. We were growing at more than 100% in that business, so of course we saw some slowing down as we went through the back end of the year.
But certainly, the business overall, at any a quarter, any period you choose is still outgrowing the rest of our business substantially. So yes, we're still slowing, but we're very optimistic about continued growth in China and we're investing substantially there.
James Ricchiuti
Okay. Final question, Dick.
Where should we use...
Richard Morin
There was growth, by the way, in China factory automation bookings Q4 over Q3 at the level that we were seeing earlier in the year, okay?
James Ricchiuti
Got it. And Dick, tax rate for 2012, what should we assume?
Richard Morin
I think what we've put for the first quarter, which is also what we expect for the year at this particular point in time, is a 21% tax rate.
Operator
At this moment, I'm showing no further questions. I would like to turn the conference back to Dr.
Shillman for closing remarks.
Robert Shillman
Yes, thank you, all, for attending. And we're going to go out tonight and have a couple drinks to celebrate a fantastic 2011.
Always, when we look ahead, things are always cloudier, of course, and uncertain. But we're going to celebrate 2011 and we're going to work hard to make 2012 as good a year or better.
We need to see some growth. We may not see it in Q1 of course, but we have reasonable, but positive expectations for 2012.
Robert Shillman
We'll be back on the horn with you in the next quarter and look forward to reporting some excellent results to you at that time and taking your questions. Thanks.
That's it for tonight, and thank you again for attending and good night.
Operator
Okay, ladies and gentlemen, this does conclude your conference. You may now disconnect, and have a great day.