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Cognex Corp  (NASDAQ:CGNX)
Q3 2019 Earnings Call
Oct. 28, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Cognex's Third Quarter 2019 Earnings Conference Call. [Operator Instructions]

It is now my pleasure to introduce Susan Conway, Senior Director of Investor Relations. Thank you. Please begin.

Susan Conway -- Senior Director of Investor Relations

Thank you, and good evening, everyone.

With us today are Cognex President and CEO, Rob Willett; Vice President and Corporate Controller, Laura MacDonald; and Cognex Treasurer, Chris Stagno.

I'd like to point out that our earnings release and quarterly report on Form 10-Q are available on our Investor Relations website at investor.cognex.com. Both contain highly 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 often change, however, and actual results may differ materially from those projected or anticipated. You should refer to our SEC filings, including our most recent Form 10-K, for a detailed list of these risk factors.

With that, now I'd like to turn the call over to CEO, Rob Willett.

Robert Willett -- President and Chief Executive Officer

Hello, everyone. Thanks for joining us today.

I know most of you are used to hearing Cognex's Chairman, Dr. Bob Shillman, welcome participants to our earnings call. Dr. Bob is unable to join us this evening due to a prior commitment. He sends his regards, and he looks forward to talking with you on our next call.

Cognex delivered Q3 results in line with our expectations, with revenue at the top end of our July guidance. That said, our revenue was down both year-on-year and sequentially as a result of the ongoing slowdown in manufacturing investment. The decline can be almost entirely attributed to consumer electronics, which decreased by approximately $50 million, roughly 50% from Q3 of 2018. The automotive and the broader industrial sectors also continue to weaken due to persistent global economic uncertainty and trade conflicts, particularly in Europe and China. That deterioration was partially offset by growth in logistics, which increased by approximately 50% year-on-year. We have confidence in our logistics strategy, and we believe we can continue to grow at that 50% rate over the long-term.

In logistics, well-known traditional brick-and-mortar retailers are starting to invest heavily in logistics automation to compete more effectively with their e-commerce competitors. They are changing their supply chain, and they are looking to Cognex's industry-leading products to help them implement an automation strategy to fulfill orders rapidly, reliably and cost effectively. Near-term market conditions notwithstanding, the long-term potential for machine vision and for Cognex is unchanged. Our long-term operating model remains intact, and with a target of 20% compound annual growth, mid-70s gross margin and 30% operating margin.

Now, I'd like to say a few words about our recent acquisition of Sualab, an outstanding technology company specializing in deep learning software to automate inspection tasks that are currently done by human visual inspectors. Sualab is the type of acquisition that we like to do. It has an excellent engineering team, I'll expand on this in a few moments, and also is a great cultural fit. We believe that deep learning technology will be a major growth driver for Cognex in the years ahead. For the first time, machine vision is reaching a level of performance that allows it to replace tens of thousands of humans globally, whose work it is to perform highly repetitive, visual inspection tasks, to identify cosmetic flaws and defects on products during their manufacture.

The market we serve today for machine vision using deep learning and factory automation is estimated at $100 million of annual revenue and is growing rapidly, we believe, by 75% per year. The largest and fastest growing segment of that market is the replacement of human inspectors in Asia, particularly for electronic components and finished products where Sualab is well positioned. The acquisition of Sualab not only extends our deep learning capabilities for inspection application, it more than triples the size of the Cognex team dedicated to developing and applying deep learning technology to industrial inspection tasks.

Upon closing, we welcome the approximately 100 smart, ambitious and energetic new employees who share our passion for machine vision, the majority of whom are in engineering departments and are highly skilled in both contemporary programming techniques and applying deep learning to inspection tasks in the manufacturing process. Led by co-founder Song Kiyoung, the Sualab engineering team will continue to operate from its headquarters in downtown Seoul. They will work closely with our team based in Cambridge, Massachusetts, which is led by Reto Wyss, a co-founder of ViDi systems, which we acquired in 2017. The ViDi acquisition established our deep planning development efforts and is the reason for our success in this area to-date.

Here are a few more details on the acquisition that I'd like to share with you. The purchase price was $195 million. We paid $171 million in cash at closing. Payment of the remaining $24 million is deferred until a later date. Although Sualab's revenue is modest, the price is justified by the high value of the company's substantial engineering team, its core technology developed over the last six years, and its experience applying that technology at very large companies in Asia. We expect technology acquisitions to be accretive within two years, and it looks like Sualab will fit within that model.

Moving on to the next topic. We have published an updated view of our served market. You can find it on our Investor Relations website at investor.cognex.com. Our new estimate of Cognex's total served market for machine vision is $4.2 billion. This is a narrow definition of what we can serve with our current product offering. This estimate is 20% higher than our previous estimate as a result of both growth in the underlying market and new opportunities that are now addressable with Cognex products. Despite near-term challenging market conditions, we believe our served market will grow in the low teens over the long term, and we expect to continue to outperform market growth as a result of our superior technology and the strength of our customer relationships.

Now I will turn the call over to Laura for financial details from the third quarter. Laura, the microphone is yours.

Laura A. MacDonald -- Vice President and Corporate Controller

Thank you, Rob, and hello, everyone.

Revenue in Q3 was $183 million, at the high end of our expected range. Revenue declined 21% year-on-year due to lower sales in consumer electronics, particularly smartphone manufacturing. Revenue from automotive and the broader factory automation market also declined from Q3 '18, partially offsetting the shortfall with growth in logistics.

Gross margin of 74% was down slightly from Q3 '18 and consistent with Q2 '19 despite lower revenue. Operating expenses declined from both Q3 '18 and the prior quarter, reflecting reduced expenses for incentive compensation plans. We continue to be prudent with discretionary spending without changing product development plans. Operating margin in Q3 was 24%, representing a decline both year-on-year and sequentially due to the lower revenue environment. Excluding discrete tax items, earnings per share were $0.23 in Q3 '19 compared with $0.39 in Q3 '18 and $0.27 in Q2 '19.

Looking at revenue growth year-on-year from a geographic perspective, the Americas was the best performing region, increasing mid-teens year-on-year due to strong growth in logistics. The impact of this quarter's substantially lower contribution from consumer electronics was most noticeable in Europe, where revenue declined by more than 45% year-on-year.

Customers in Greater China continue to defer their capital spending plans, resulting in low double-digit revenue decline year-on-year. This decline would have been greater in Greater China and less extreme in Europe if not for procurement changes made by certain customers in consumer electronics, shifting their purchases from China -- to China from Europe. In the rest of Asia, revenue was relatively flat with Q3 '18.

Turning to our strong balance sheet. We ended the quarter with $918 million in cash and investments and no debt. Even after purchasing Sualab, we have enough capital to support our organic growth objectives and M&A plans and for sharing our ongoing success with our shareholders through stock buybacks and dividends. In that regard, our Board of Directors has increased the quarterly cash dividend by 10% to $0.055 per share. The dividend is payable on November 29 to all shareholders of record on November 15.

Now I'll turn the call back to Rob.

Robert Willett -- President and Chief Executive Officer

Thank you, Laura.

Moving next to guidance. We expect revenue for the fourth quarter will be between $155 million and $165 million, making it the lowest revenue-generating quarter this year compared with revenue of $193 million reported in Q4 of 2018. Industrial markets are significantly weaker today and continue to deteriorate, led by automotive. The contraction is most pronounced outside of the United States and particularly in business that relates to China.

Unlike Q3, we don't expect growth from logistics to offset the overall revenue shortfall in Q4. Even though logistics revenue grew by approximately 50% year-on-year in Q3, we expect it to decrease year-on-year in Q4. This is the result of a major customer delaying delivery of large orders for new sites.

Gross margin for Q4 is expected to be in the mid 70% range, consistent with the gross margin for Q3. Operating expenses are expected to increase by mid to high single digits on a sequential basis. Approximately 4 percentage points are attributable to incremental costs for the Sualab team, estimated amortization of intangibles and expenses associated with the acquisition.

The effective tax rate is expected to be 16%, excluding discrete tax items. I'd like to make you aware of two discrete tax items expected to be recorded in 2019. The first item involves changes to our corporate tax structure, which came about because of legislation passed by the European Union. For that one, we expect a discrete tax benefit of between $100 million and $125 million and a slight increase to our 16% effective tax rate, excluding discrete events going forward.

The second item is our decision to move acquired Sualab technology out of Korea to align with our corporate tax structure. This is expected to result in a discrete tax expense of between $27 million and $33 million. These items continue to be evaluated, and because of that, we do not have more detail at this time.

With that, we will open the call for questions. Operator, please go ahead.

Questions and Answers:

Operator

[Operator Instructions] Thank you. Our first question comes from the line of Joe Giordano with Cowen and Company. Please proceed.

Joe Giordano -- Cowen and Company -- Analyst

Hey, guys. Good evening.

Robert Willett -- President and Chief Executive Officer

Hi, Joe.

Joe Giordano -- Cowen and Company -- Analyst

Rob, could you size that big order that was pushed? And is it something that you just found out recently? Is it something that you have visibility into, like, just delivering it after the quarter or something? I'm just trying to see how indicative it is of the logistics environment in general, or this is just kind of a one-off thing that gets fixed in a few weeks.

Robert Willett -- President and Chief Executive Officer

Yeah. So it's a pretty substantial order. Let me give you a bit of color on it. So, overall, our logistics funnel is strong and growing, but we expect lower revenue year-on-year from logistics in Q4 as a result of this major customer delaying delivery of large orders to new sites. And this same customer did take substantial deliveries in Q4 of last year. So many of these orders are on our books, awaiting delivery, which we now expect to result in revenue next year and not in Q4. Visibility of that is quite recent for us, but we see probably that some major integrators may have had some more specific understanding of that situation earlier. So, we continue to see strength in our logistics business, particularly among a broad base of customers who are growing very, very well indeed and remain confident that we can grow it 50% over the long run. But we now just don't expect to grow at that rate for the full year in 2019.

Joe Giordano -- Cowen and Company -- Analyst

Can I just clarify one thing there? So, this is an order you have received, right? This is not an order that you thought you might get that didn't materialize, this is an order that you already have though?

Robert Willett -- President and Chief Executive Officer

So it's an order that's coming in in many pieces, it's very substantial, right. So we don't have all of it, but we have many, much of it.

Joe Giordano -- Cowen and Company -- Analyst

Okay. And then I guess my follow-up. Yeah, go ahead please.

Robert Willett -- President and Chief Executive Officer

I was going to sort of state it. I think it's really to do with changes at the customer, about their plans and the timing of their plans, which unfortunately for us is moving revenue out of this year and slowing down our overall growth rate in Q4 and for the full year for logistics.

Joe Giordano -- Cowen and Company -- Analyst

Okay. My follow-up would be around China. Obviously, a lot of talk around trade war and what a Phase 1 agreement might do. How much of this stuff -- do you attribute like any of this weakness to that specifically? And if there is some sort of like Phase 1 of 3 kind of deal coming out, does that change anything on the ground for you guys do you think any -- on the near term?

Robert Willett -- President and Chief Executive Officer

It's difficult to call but I have to say, yes. I mean, certainly, China is our softest region at the moment, and after being a real engine of growth for us for so many years, with customers there have a real wait-and-see mindset and they're very slow to place orders, and they continue to reduce and delay capital expenditures. So that's what we're seeing. And I think Laura pointed out also the revenue from China in Q3 benefited from purchases from certain consumer electronic customers that have started to purchase our products in China, when previously they bought them out of Europe. So that's also maybe making our China numbers or the situation in China look better than it really is.

So how quickly will that turnaround? Well, my experience with China, my experience with our business in general, is that when things do change, the business can come back very quickly. I've seen that on a number of occasions. I don't know whether this is really a different long-term situation, unlike what we've seen before, but I do happen to think if confidence can return, we see momentum in the other direction, we could see a quick recovery, but I just have no way of gauging if and when that will come.

Joe Giordano -- Cowen and Company -- Analyst

Fair enough. I have some others. I'll jump in queue though. Thanks.

Robert Willett -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Richard Eastman with Robert W. Baird & Co. Please proceed.

Richard Eastman -- Robert W. Baird & Co. -- Analyst

Yes, Good afternoon. Rob, could you put a little color around Sualab. When we looked at their website, they have a pretty impressive customer list, and all the big majors on the consumer electronics side, it appears. And I'm curious, with very modest revenue presently, how is their product deployed? Is it still kind of in a piloting phase? Or is it deployed at a central location? Or is it deployed on equipment itself? Just kind of walk me through that, maybe just a little bit, and how quickly the revenue expectations can inflate, given the implication.

Robert Willett -- President and Chief Executive Officer

Sure, sure. Sualab has a business model, some -- very like ViDi, right. So they sell SuaKIT, a sophisticated deep learning machine vision software. And they have a very strong team of application engineers who help customers apply it, right. So the majority -- the vast majority of that business today, over the trailing 12 months, is related to that, right. And -- but I think more excitingly, I think what we see the potential is to take that technology, and they're already working on this, and to deploy it through machine builders to help it scale much in the way that we have in our consumer electronics business over the last five years or so.

We, of course, have a great network of machine builders and integrators who can help them speed that up. And then they have some very nice application-specific related products in their pipeline that we think will be very powerful in changing this market. So there's a base kind of business that I would describe very much like ViDi, very, very good technology with some relative strengths and differences compared to ViDi, and then some very interesting opportunities to apply more application-specific products through machine builders in a form that should be more scalable in the coming years and where we are very well positioned to help them.

Richard Eastman -- Robert W. Baird & Co. -- Analyst

Okay. All right. And then just a follow-up on this issue that you raised about a consumer electronics customer purchasing in China for China versus prior. It was purchased -- product was purchased out of Europe. What predicated that switch? Is it a currency issue? Why is there a shift there and where the purchases are occurring for presumably the same application?

Robert Willett -- President and Chief Executive Officer

Yeah. I'm sort of limited into of what I can say specifically about the internal workings of our large customers. But I think, certainly in that case, perhaps due to some of the trade situations we're seeing and tax consequences and other things, they've decided they want to purchase from us locally in China rather than out of a subsidiary in Europe. It doesn't really change the nature of the work we do nor does it really change our profitability on the business, generally speaking, but it just does mean where you see it show up in region is different.

Richard Eastman -- Robert W. Baird & Co. -- Analyst

Okay. And that had started this quarter?

Robert Willett -- President and Chief Executive Officer

Laura?

Laura A. MacDonald -- Vice President and Corporate Controller

Materially this quarter, yeah.

Richard Eastman -- Robert W. Baird & Co. -- Analyst

Okay. Okay, very good. Thank you.

Operator

Thank you. Our next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Please proceed.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Hi, good evening guys.

Robert Willett -- President and Chief Executive Officer

Hi, Josh.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Just want to follow up on the logistics comment, maybe some more color about some of the lumpiness there. I guess, first of all, can you talk us through kind of the concentration from a customer perspective? In that case, it sounds like there was some large order that got pushed. But is this going to be something kind of analogous to the electronics side with your large customer there, where we do see lumpiness just related to one customer really driving kind of the quarter-to-quarter cadence?

Robert Willett -- President and Chief Executive Officer

Yeah, OK. So you have two questions that are sort of what's that kind of customer mix in logistics and how does that play out in terms of lumpiness in the business. In our logistics business today, we have a handful of large important customers, right, who can be ordering a substantial amount from us in the order of $10 million to $20 million in a quarter. It would not necessarily be unusual, I think, in terms of how we see them playing out. And those orders are based often on their automation plans, that's how they roll them out, right? So I think that does have the potential to move revenue in and out of quarters. And I think that's probably going to become -- that is probably a reality of our logistics business going forward. And then, we have many, many smaller customers who might be buying very small amounts, up to a few million dollars. And there's a good base of that business that looks much more consistent overall.

And that business actually is -- when we look at it, it's growing faster than our overall business. We expect that probably to go on as our technology becomes easier to integrate, more widely known and accepted, and as we develop our own capability and our integrated network to deliver it. But in kind of answering your question here, we have a handful of customers, and I think the one we reference not by name but today, and I could certainly think of others, may mean that our revenue, as it plays out in the coming quarters, will be lumpy in logistics, and we'll just try to give you a heads up to that. We're really in this for the long term. We see a big change going on, and our 50% long-term growth strategy is all based around that. So I think we're relatively comfortable with the fact that may change, but we realize we need to explain it to you as soon as we see it, as we are doing now. And sometimes, that can -- it can move.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Understood. That's helpful. And then, just taking a step back from consumer electronics, obviously weakness there has been perpetuated for a couple reasons. Obviously, the tough comp coming off of some of the -- the OLED roll-outs a couple of years ago, and then your general weakness in the electronics industry in 2019. But we are starting to see kind of select green shoots from folks in the broader definition of capital equipment, maybe products that will come off a lot different from what Cognex is supplying, but some kind of early indicators that 2020 will be better. I guess from your perspective, you guys don't get a lot of that color until more of the 2Q time frame, but is there anything you can share with us either on kind of product roadmaps, any kind of technology shifts that you see out there, that would maybe help define important things to watch for 2020, understanding now that you have kind of a couple of years of easy comp starting to build out?

Robert Willett -- President and Chief Executive Officer

Yeah. Okay, Josh. I think I'll point to a few things, but these are really just reprising what I've said before. We really get a better view of our consumer electronics business in Q2 when we're reporting the Q1 next year. I think that's when we'll have a real read on how it's shaping up.

Always, I would say, at this stage, there's a lot of interesting stuff in the consumer electronics pipeline that we have some visibility on. The question is sort of how well it's funded and able to be implemented as we get into the year. I mean obvious kind of things that could really help and be a big tailwind for the business overall next year, 5G, is a very obvious one. To what degree that is implemented and the technical challenges around implementing it, there are always new features. We have a line of sight on coming in, in the electronics market. So that can really drive, but again, it's interesting to see which ones make it in each year.

And then as you mentioned, the roll-out of OLED, specifically as it relates to high-end phones, foldable screens, that definitely has the life in it as I think you can see by reading the paper, but that's some technology where -- but there's a lot of value that Cognex can add. And then I think the headwinds would remain those still -- now there is -- one of the largest smartphone companies in the world is one we can't sell to. So that certainly is an ongoing headwind and I'd like that situation to change and I think so would they. But at the moment, that's a potential problem for us.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

And just one final one I'd like to squeeze in there. Were you doing business with that company before and now you can't? Is there any way to size kind of what that missed opportunity was? And I'll leave it there.

Robert Willett -- President and Chief Executive Officer

Yeah. I think we don't really like to talk about customers by name specifically, but you can assume -- I mean, we're the leading machine vision manufacturer in the world. So any company that's performing advanced discrete manufacturing is likely a Cognex customer. And you would expect a big electronics company to be doing -- certainly to be doing a few million dollars or more with us.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Understood. Thanks.

Operator

Thank you. Our next question comes from the line of Joseph Ritchie with Goldman Sachs. Please proceed.

Joseph Ritchie -- Goldman Sachs -- Analyst

Thanks. Good afternoon, everyone.

Robert Willett -- President and Chief Executive Officer

Joe.

Joseph Ritchie -- Goldman Sachs -- Analyst

So Rob, just a few quick ones. Maybe just following up on that question on electronics visibility in 5G, how much visibility will you have as the year progresses? And what do you think the timing of that visibility will be? Will it be kind of early next year? Would you know by 1Q? I'm just trying to get a sense for timing and visibility.

Robert Willett -- President and Chief Executive Officer

Yeah, I think we'll be in a position to give you a clear view of that as we have in past years when we report our Q1 results. I guess that is end of April -- end of April. We may have -- we'll probably have visibility earlier than that. I think it's -- my experience now, having been through a number of cycles, is there's a lot of stuff there in the funnel, but in reality, the overall view of the market and what gets rolled out really doesn't crystallize until that kind of time frame. And that's very different than our other markets. We sometimes liken [Phonetic] it to they're building the airplane as it's going down the runway in that industry. So, we do have quite late visibility as to what really makes it into the final build.

Joseph Ritchie -- Goldman Sachs -- Analyst

Yeah. That's fair enough. And then just, I know we've been talking about this topic a little bit on the call already, but the customer delaying the decision on large orders to new sites. Can you maybe give us a little bit of color on why there was a deferral?

Robert Willett -- President and Chief Executive Officer

It has to do with their plans to roll out automation, their automation plans and delays are changing that, right? And those are delays that are related to that company and their plans, not to do -- not related to Cognex vision and our ability to meet that demand, but I don't -- I can't get more into specifically what and where that customer is finding those issues.

Joseph Ritchie -- Goldman Sachs -- Analyst

Okay. Got it. I guess I was just trying to get a sense for whether it was like liquidity issue from a customer perspective or whether it was just managing too much and having the capacity to roll this out?

Robert Willett -- President and Chief Executive Officer

No. This is a very, very substantial company. It's not -- it's really much more about engineering and automation product roll-out and plan rather than anything to do with financial or anything to do with Cognex's ability to fulfill those orders that we have on our books and are expecting to complete on our books soon.

Joseph Ritchie -- Goldman Sachs -- Analyst

Got it. Okay. And then one quick one. I may have missed it earlier, but you mentioned on Sualab, the accretion within two years. What's the expectation then from a financial perspective for next year?

Robert Willett -- President and Chief Executive Officer

I don't think we've -- so generally we have a policy of not talking about the forecast for next year, for the full year. So we're not currently disclosing that. But obviously, we're looking for some significant growth from that. And obviously based on what I've said, it would be dilutive to us next year.

Joseph Ritchie -- Goldman Sachs -- Analyst

Okay. Got it. Thank you.

Robert Willett -- President and Chief Executive Officer

Yeah. And accretive in two years, and I think we'll be in a better position to give you more detail on that when we report the full year as well. It's still a relatively recent acquisition for us.

Operator

Thank you. Our next question comes from the line of Paul Coster with JPMorgan. Please proceed.

Paul Chung -- JPMorgan -- Analyst

This is Paul Chung on for Coster. Thanks for taking our question. So just another follow-up on the Sualab acquisition. Why now on this? And is this kind of customer-driven demand? Or is this part of your vision for capturing some incremental offerings across your verticals? And if you could also talk about some of your cross-selling benefits here with their existing consumer base. I have a follow-up.

Robert Willett -- President and Chief Executive Officer

Yeah. Sure. I mean I think the right way to view it is at Cognex, we pride ourselves on having a deep understanding about the technology and the application for machine vision. And we spent a great deal of time studying those. And we've talked about logistics and how we see that's kind of hitting -- has hit a tipping point where the need for automation is changing. There's another tipping point going on currently in the world of machine vision, and it has to do with the deep learning technology and it's progress, and it's huge technology development going on in that space. And the potential it provides to replace human visual inspectors in electronics, of whom there are tens of thousands in Asia. And the technology is getting to the point where it's really now a very attractive market opportunity, and large customers really see that.

And they're very interested to work with us. They face a lot of challenges around finding people to staff, human visual inspection, visual inspection not being very effective. Human visual inspector might be 85% effective in their work in catching defects while machine vision has the capability to be 99.9% effective. So, there's a very good return on investment. That, I think, pretty clear to us and to the big electronics customers that we see in Asia. So I think that's the reason why this is happening now and why we're so positive about it. I think we're also fortunate in that we acquired VIDi 2.5 years ago, and we really had the chance through owning them to see the potential, but seeing that potential also made us realize that we needed more engineers and we needed more reach and engineering capability in Asia, where this market really is.

So as we looked at that and we worked on it, we really realized that Sualab is really right in the sweet spot of all of that. Then we got to know them. I think we've developed a lot of mutual respect for one another. And we were so pleased to see a fantastic cultural fit, which for us is really important at Cognex because we like to buy acquisitions. We like to buy companies that have great engineers and great growth potential. And the amount of excitement that, that creates in us and in them is something that works very well for us. And we did that with ViDi. We've done that with Chiaro and other acquisitions we've made over the years.

So the more we drill, the more we got to know each other, the more we understood the market, the more we talk to large customers in the space and saw where Sualab is working, the more exciting we got and easier it was in our minds to justify making this for us a pretty substantial acquisition.

Paul Chung -- JPMorgan -- Analyst

Okay. Thanks for that. And then switching gears, on free cash despite material lower revenues and earnings. Can you just talk about the puts and takes of what's driving your working cap conversion benefits this year relative to last. Is this kind of temporary in nature or is there some things more structural going on and how you see working cap trends over the next six months? Thanks.

Robert Willett -- President and Chief Executive Officer

Yeah. Let me ask Laura MacDonald to answer that. Do you need more clarification?

Laura A. MacDonald -- Vice President and Corporate Controller

Well, let me see if I can answer. You let me know if you need more clarification. But one of the noticeable changes in our balance sheet is our decline in our inventory balance, which has come down in Q3 as we delivered on large opportunities and ship recently introduced new products, and we've worked that down nicely from the end of the year. We believe we now have enough inventory balance at an appropriate level. So that was one noticeable change in working capital, is -- did that answer your question?

Paul Chung -- JPMorgan -- Analyst

Yeah, somewhat. Thank you.

Operator

Thank you. Our next question comes from line of Matt Summerville with DA Davidson. Please proceed.

Matt Summerville -- DA Davidson -- Analyst

Hi. Thanks. Maybe just two quick questions. First, with respect to the Americas, can you provide a little bit more granular detail in terms of what you're seeing across the different end markets there? You mentioned logistics. But I could have missed it, just any more color in terms of what you're seeing there would be helpful.

Robert Willett -- President and Chief Executive Officer

Sure. Hi, Matt. Yeah. So pretty much like all of our end regions, the Americas region is soft, but particularly in automotive. But I would say, relative to other regions, I think we saw that softness early this year, and now it's more stable. It's not -- we're not seeing declining rates we're seeing elsewhere. The -- I think as we look at the market overall, we're seeing a lot of uncertainty and delays. And automotive is our

biggest market in the Americas. And we're not anticipating a sort of a significant budget flush in Americas or anywhere, really, that we might expect at the end of the year. So that's kind of baked in our guidance.

The Americas has a relatively better growth profile than elsewhere, also as a result of a higher weight in logistics. It's a home market where we have relatively more business in logistics than anywhere else, and that's a business that is growing very, very strongly. So that's also helping our results in this region. Other industries in the Americas, just out of interest, that -- other industries that are holding up well, medical-related business, food and beverage, and packaging. There, we're doing OK. They're -- I think they're all growing currently despite the difficult market conditions, but -- and logistics is growing well. But then certainly, automotive is much more challenging overall.

Matt Summerville -- DA Davidson -- Analyst

Got it. And then are you able to parse out between what the year-over-year revenue changes would have looked like had that customer not changed geographic, I'll call it, procurement strategy, just to try and bridge that instead of Europe being down mid-40s, maybe what would that have been down instead of China being down low teens, maybe what would that have been down, if that change didn't happen?

Robert Willett -- President and Chief Executive Officer

Yeah, there's still quite a lot of moving parts as we come through the end of the quarter. So, I don't think we're going to try to do that, per se. Laura, do you want to add...

Laura A. MacDonald -- Vice President and Corporate Controller

Yeah. I think we -- and that's kind of pro forma information that we haven't prepared to disclose.

Robert Willett -- President and Chief Executive Officer

Yeah. So we're not really ready to give you a read on that yet.

Matt Summerville -- DA Davidson -- Analyst

Okay. Got it. Thank you, guys.

Operator

Thank you. Our next question comes from the line of Karen Lau with Gordon Haskett. Please proceed.

Karen Lau -- Gordon Haskett -- Analyst

Thanks. Good afternoon, everyone. Just a quick one on opex. I think you mentioned about 4 points of the sequential increase is due to Sualab, but you also mentioned there is some amortization there. I just want to clarify how much of that would you say is sort of one-time that shouldn't really continue into next year? And how much should we really put in the base number as we project forward?

Laura A. MacDonald -- Vice President and Corporate Controller

Sure, I can answer that, Karen. So the 4 percentage points represents the Sualab team ongoing operating expenses in addition to an estimate of amortization of intangibles, but we're still in the process of finalizing the purchase price allocation. So we don't know exactly what those numbers will be. But I can tell you that we expect the majority of $170 million that we'll allocate to be assigned to goodwill. So that 4% there was a small percent that I would say is non-recurring. Most of the 4%, like 3% of the 4%, I'd say, would be recurring. And again, we expect most of the purchase price will be allocated to goodwill.

Karen Lau -- Gordon Haskett -- Analyst

Okay. Got it. So parsing out the 4 points sequential increase that is related to Sualab, the core spending would be the remaining 4 points. I noticed that in the third quarter, you -- in terms of opex, it looks like you underspend a little bit versus your guide. Is the sequential uptick more -- in the core opex spending more of a timing issue? Or should we read into that as maybe some of the pent-up investment coming back or maybe you're positioning for some projects next year? How should we think about that?

Laura A. MacDonald -- Vice President and Corporate Controller

Yeah, I think what you saw us underspending a little compared to the guidance in Q3 related primarily to adjustments to our incentive compensation plans.

Karen Lau -- Gordon Haskett -- Analyst

Okay. I guess -- OK. Thank you. And then just, I guess, taking it more broadly into next year, Rob, let's say, for whatever reason, whether it's stabilization or consumer electronics start to turn next year, I would imagine you've been doing -- you guys have been doing a good job in quote unquote cutting the crap, but also, there is probably some pent-up spending that might have to come back at some point. So let's say the end markets start to turn next year, would you expect sort of a normal type of incremental margins to be realized? Or do you think that given so many things have been kind of -- investment and spending-wise -- have been delayed this year because of the environment, there is more sort of catch-up spending that needs to happen next year if things start to get better? I'm just trying to get a sense of the incremental that you would expect.

Robert Willett -- President and Chief Executive Officer

Yes. Okay. It's an interesting question, Karen. At the moment, I'm not expecting sort of that kind of our markets to recover very strongly going into next year, but it's obviously -- I think it's really too early to talk about next year. But here's what I can say, I think we run Cognex for the long term. So we're not kind of cutting back on important things that are essential to our three-year growth strategies. In fact, we go on investing in those things that we consider essential. And I think through what is, obviously, a much lower rate of increase in spending, we've been able to keep our new products on track and our plans intact. So, I'd say that's the case.

Now if I then go back and I look at times when we have seen a big recovery in our markets or a big incremental step-up in growth that I'm talking about years like 2010, 2014, 2017, where we had growth in excess of 30%, the pull-through in those years is awesome, right? Given our kind of gross margins, and there isn't a great need to add an additional incremental expense related to growth like that. So I would expect if and when our markets recover. And if they come back strongly, as they had, we should see very, very good fall-through on incremental revenue.

Karen Lau -- Gordon Haskett -- Analyst

Okay. So there is no kind of delay in spending that what have to be catch-up, kind of regardless of how much end market come back next year?

Robert Willett -- President and Chief Executive Officer

Well, I think the thing to point out would be incentive compensation really, so that is -- this is a year where we're not achieving our budget, and we're certainly paying out much less incentive compensation. So if we went back to a normal year, then it will be a step-up in that, and we'll get back to a strong year, it will be a significant step-up in that.

Karen Lau -- Gordon Haskett -- Analyst

Okay. Thank you.

Robert Willett -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Jim Ricchiuti with Needham. Please proceed.

Michael Cikos -- Needham & Company -- Analyst

Hey, guys. This is Mike Cikos on for Jim Ricchiuti. Just a couple of questions here. The first, coming back to the delayed shipments for this logistics customer, I wanted to get a better sense. It sounds like this is one of your larger customers. And I know you kind of scoped the large customers contributing as much as $10 million to $20 million per quarter, not being unusual. Fair to assume that this customer coming in at the higher end of that range, if not higher than that $20 million bogey.

Robert Willett -- President and Chief Executive Officer

It's -- we're not sure exactly where it would come in and -- but perhaps the order of magnitude and yeah, in a range of significance, probably south -- not as much as $20 million, but -- and it all depends on how much of the orders, we would expect them to take in a particular quarter. And I do just want to clarify, you wouldn't take that number and multiply it by four to get the size of the customer, right? It would be just more like customers have plans. They rolled out at a certain cadence, and that may mean a quarterly revenue for any particular customer might be on that order of magnitude. And that might be the kind of level of challenge that we're seeing in headwind this quarter.

Michael Cikos -- Needham & Company -- Analyst

I see. Okay. And I guess, if you would say that the logistics business because of this Q4 shift is not expected to grow 50% year-on-year, how fast is it growing in 2019 then based on what you currently have in hand?

Robert Willett -- President and Chief Executive Officer

Yes, that's not a number we're going to disclose at this time, right? We've told you Q3, we're going to sort of see how things play out in Q4. And then we might have more to give you a better view of that when the year is over.

Michael Cikos -- Needham & Company -- Analyst

I see. Okay. And then just one final question, if I may, on the gross margin front, I was interested in hearing how you guys are able to maintain, call it this mid-70s percent gross margin versus Q3 on the lower revenue base is part of that mix shift? Or is there anything else we should be thinking about in that?

Laura A. MacDonald -- Vice President and Corporate Controller

Yeah. That was a result of the revenue mix in the quarter.

Michael Cikos -- Needham & Company -- Analyst

Great. Thank you guys.

Robert Willett -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Andrew Buscaglia with Berenberg. Please proceed.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Hey, guys. Quick question. So consumer electronics, can you comment if that continued to get worse from Q2? It sounds like auto is somewhat stabilized, but how would you characterize consumer electronics?

Robert Willett -- President and Chief Executive Officer

Well, I would say, consumer electronics has kind of played out as we expected this year based on what we told you in April. I think -- if I think back and we certainly -- we were unhappy to discover back at that time that our customers in consumer electronics, we're really looking at a very dry year, and I think we kind of had eyes on that and communicated at that point. And it's played out as we expected. So annual revenue from consumer electronics is on track to decline by roughly one-third this year. And it represented 30% of our business in 2018. And it's particularly as a result of smartphone manufacturing, and the decline you'll see is most notable in our European region, followed by China and the rest of Asia, but it's certainly been a year of diminished investment, and I think that as we expected.

Michael Cikos -- Needham & Company -- Analyst

And just to confirm, you said -- I think you said in the prepared remarks, it was down 50% year-over-year.

Robert Willett -- President and Chief Executive Officer

So revenue for consumer electronics in Q3 declined by approximately 50% year-on-year or nearly $50 million, due particularly to smartphone manufacturing.

Michael Cikos -- Needham & Company -- Analyst

Okay. Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Ben Rose with Battle Road Research. Please proceed.

Ben Rose -- Battle Road Research -- Analyst

Yes. Hi, Robert and Susan. Rob, can you identify the industry of the customer in the logistics -- for the logistics product?

Robert Willett -- President and Chief Executive Officer

It's a large customer of ours in logistics. So you can assume it's either e-commerce or retail.

Ben Rose -- Battle Road Research -- Analyst

Okay. Okay. I just wanted to be sure that...

Robert Willett -- President and Chief Executive Officer

It's not -- it's not airport baggage handling or bridge tool, which might be the other thing. That's why you can see some large chunks of business, but that's not what it is.

Ben Rose -- Battle Road Research -- Analyst

Okay. And then just a question on Sualab's -- are the customers today for their product, are they primarily the Korean OEM manufacturers? Do they have any penetration -- meaningful penetration thus far outside of Korea?

Robert Willett -- President and Chief Executive Officer

Yeah, their main markets are in Korea and China and Vietnam, overall, and they're really with them. Chinese and Korean electronics or electronic components manufacturers doing inspection. And -- but I -- something we like about them is they're really -- they, like us, really have close high-level engineering relationships with senior engineers at those companies. So it's not -- they're not trying to move that product through the OEM machine build there. It's being pulled by the end user who really -- many of them are employing many thousands of visual inspectors and are looking to see better cost and performance out of that aspect of their business.

Ben Rose -- Battle Road Research -- Analyst

Okay. And sorry, just one final perhaps. Has the company actually validated the technology with the kind of reduction in visual inspectors that you mentioned earlier in the call in the order of hundreds or hundreds or thousands of visual inspectors being replaced by the technology?

Robert Willett -- President and Chief Executive Officer

Absolutely. Yes, yes. I don't think we would have acquired the company had we not done our due diligence on that for sure, right? Now there is -- and we ourselves on Cognex before we met Sualab, see opportunities where our electronics customers really are very interested and have been previously unable to replace those visual inspectors with machine vision. And so, we're seeing a lot of interest from them as a result of this news.

Ben Rose -- Battle Road Research -- Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Karen Lau with Gordon Haskett . Please proceed.

Karen Lau -- Gordon Haskett -- Analyst

Hey. Thanks for taking my follow-up. Rob, I'm just curious on consumer electronics and -- or maybe broadly, more in China, there's been stories about Chinese companies kind of future proofing their supply chain. I don't know if that's the right word to use. But just sort of in light of like blacklisting or all of a sudden, they get cut off from their US suppliers. I think that is more concentrated in like kind of chips manufacturing, that sort of thing, but I wasn't sure if you are seeing any of that sentiment in areas that you participate in China. Maybe you can talk a little bit about that?

Robert Willett -- President and Chief Executive Officer

Yes, Karen. So the answer is we're looking for that, and we're really not seeing it among our customers. I can really only think of one instance that I've heard of where a Chinese company -- you didn't -- and it's not a company we would -- any of us would know readily. Didn't -- was concerned that didn't want to do business with us because we were American. So that's not widespread. And I think what you're reading about is much more components and chips technology in that way. I think the other thing important to realize is our technology basically doesn't -- isn't owned inside the US or sold from the US per se, right, in terms of how we're recognized by our customers. So I think that also somewhat insulates us from this. But clearly, what we've seen with one of the largest and some companies where we might become unable to sell to them, if that was a real threat on a larger scale, that would be a big problem for us.

Karen Lau -- Gordon Haskett -- Analyst

Okay. So nothing beyond far away that you're seeing that concerns you in terms of Chinese companies sourcing from suppliers from other geographies?

Robert Willett -- President and Chief Executive Officer

Correct.

Karen Lau -- Gordon Haskett -- Analyst

Okay. Got it. Thank you.

Operator

Thank you. Our next question comes from the line of Joe Giordano with Cowen. Please proceed.

Joe Giordano -- Cowen and Company -- Analyst

Hey. Thanks for taking my follow-ups here. On Sualab again I understand the geographic presence that bring in the engineering capabilities. Is this a fundamentally different products than BD or is this something that you foresee over time like one offering globally that's integrated as whenever you guys may call it or is it one thing or is it two kind of things?

Robert Willett -- President and Chief Executive Officer

Hi, Joe. And I should say, this is the last question I think we have time for, but I know I'll answer it. So a point from earlier, I think you might have asked the question what do we bring to Sualab, and I think what we do bring is a lot of customer relationships and a big sales footprint in the market. So I think I just still want to make that point. This is all -- this is very much complementary, I think, for both companies and the synergies on the growth side for both of us working together. But your question related to what -- can you repeat that again? I'm sorry.

Joe Giordano -- Cowen and Company -- Analyst

Like, are these two fundamental -- fundamentally different things ViDi and Sualab, or is this something that ultimately is like one team, one integrated product that Cognex offers?

Robert Willett -- President and Chief Executive Officer

Yeah. I'm sorry, yes. So they're quite similar products. So deep learning software could do various functions, and we've developed with ViDi certain functions that really relates more to our end markets where we've been focused, particularly automotive and based on our geographical presence, right? And Sualab has some strong tools and capabilities that relate to Asian visual inspection. So similar but develops in different ways, right? I would -- I would say that.

And then because they have a big footprint of engineers and application engineers in Asia, they have the ability to help unlock a lot of potential that we see in that market where we didn't have that capability. So they bring a lot of engineering and application capability, which could be applied to either ViDi or to Sualab, right? And then we have a big sales network where we have a pent-up demand that they can help unlock. So that's kind of where the complementary parts of the business go. But the product itself, ViDi and Suakit are quite similar. There's quite a lot of overlap with quite a few complementary strengths around specific tools, capabilities, user interfaces and other key elements.

Joe Giordano -- Cowen and Company -- Analyst

That's very helpful. And if you don't mind, just like a one -- you can answer it in two words if you want, but the medical, food and beverage, and consumer at verticals that we don't spend a lot of time talking about, do you expect those to be up this year?

Robert Willett -- President and Chief Executive Officer

Yes. We do.

Joe Giordano -- Cowen and Company -- Analyst

All right. Thank you.

Robert Willett -- President and Chief Executive Officer

Thank you.

Operator

Thank you. We have reached the end of the call. I will now turn it back over to Mr. Rob Willett for closing remarks.

Robert Willett -- President and Chief Executive Officer

Thank you. So while our results are not what we'd hoped for at the start of this year, we are confident in the future role of machine vision and in the long-term prospects for Cognex. Thank you for joining us tonight. We look forward to speaking with you on our next quarter's call. Good night.

Operator

[Operator Closing Remarks]

Duration: 59 minutes

Call participants:

Susan Conway -- Senior Director of Investor Relations

Robert Willett -- President and Chief Executive Officer

Laura A. MacDonald -- Vice President and Corporate Controller

Joe Giordano -- Cowen and Company -- Analyst

Richard Eastman -- Robert W. Baird & Co. -- Analyst

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Joseph Ritchie -- Goldman Sachs -- Analyst

Paul Chung -- JPMorgan -- Analyst

Matt Summerville -- DA Davidson -- Analyst

Karen Lau -- Gordon Haskett -- Analyst

Michael Cikos -- Needham & Company -- Analyst

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Ben Rose -- Battle Road Research -- Analyst

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