Cognex Earnings: Why the Numbers Are Better Than They Look

Cognex Corporation (CGNX) did pretty much what it had said it would do in its bumper third quarter. However, on closer inspection, there is one number that suggests its full-year earnings growth is going to be stronger than many think. It's time to look in more detail at the earnings, and the commentary on the earnings call.

Cognex reports record earnings
Readers should note that there is an earnings preview of Cognex on the Motley Fool website that outlines the key things for investors to look for. Now to the numbers:

• Third-quarter revenue of $169.4 million vs. analyst expectations of $168.2 million, and internal guidance of $165 million-$170 million.

• Third-quarter non-GAAP adjusted diluted EPS of $0.59 vs. analyst expectations of $0.56.

• Gross margin of 74% vs. internal expectations of a mid-70% range.

• Effective tax rate of 19% vs. internal expectation of 19%.

• Fourth-quarter revenue guidance of $111 million-$114 million vs. analyst expectations of $113 million.

• Fourth-quarter gross margin guidance as being similar to the third quarter, at 74%.

The revenue is at the top of the internal range and above analyst estimates, while EPS is clearly ahead. Gross margin and the tax rate were in line, and the revenue guidance for the fourth quarter is pretty much in line with analyst expectations. So where is the upside that I mentioned in the lead?

Operating expenses lower than expected
This was always going to be a tricky quarter for expenses, because the company had to service a $60 million contribution from one customer -- a very large order for Cognex that will be a hard comparison to beat next year. In addition, management had already stated its aim to increase its investment in order to service future growth.

However, Cognex did better than expected on operating expenses, and its forecast for the fourth quarter is similarly positive. Going back to the guidance in the previous quarter, Cognex's management had forecast that operating expenses would increase by 25% on a sequential basis in the third quarter, and then decline 12% sequentially in the fourth quarter. As it turned out, operating expenses increased 22%, and the new guidance is for a 15% sequential decline in the fourth quarter. Here is how the old and new guidance plays out.

Source: Cognex Presentations, author's analysis.

In essence, it's an overall decrease in expenses of around $3.8 million from previous expectations, which goes straight into the operating income line. After a 19% tax rate is taken out, the $3 million that's left represents around $0.035 in EPS. It doesn't sound like much, but it's 2.6% of the forecasted full-year EPS of $1.33 in 2014.

Gross margin, currency effects, and ID products
Elsewhere, there were three other numbers of note in the earnings and conference call. First, gross margins are predicted to stay the same, at 74% -- a level lower than the 76.8% recorded in the first quarter. While this is somewhat disappointing, management disclosed that it had some lower-margin surface inspection work expected in the fourth quarter. In other words, it's not an indication of inexorably declining gross margin

Second, CEO, Rob Willett disclosed that the fourth-quarter guidance was taken down by $3 million due to the currency effect of the strengthening dollar -- indicating that Cognex's underlying performance is better than analysts previously expected. Third, analysts asked management whether ID products were continuing to grow at around the 30% rate it had discussed in the past, and management confirmed that this was, indeed, the case.

The takeaway
Cognex's numbers beat on the revenue and earnings lines, and the guidance and commentary were positive. Operating expenses are forecast to be less than previously expected, even as a strong dollar is holding back growth. Meanwhile, Cognex's ID products growth continues as expected. A solid report.