In mid-February 2014, machine vision product company Cognex Corporation (NASDAQ: CGNX) delivered earnings results that caused violent stock price movements, as seen in the chart below. While such events can be a boon to short-term traders, they are not always a pleasant experience for long-term investors. With this in mind, let's look at what to expect when Cognex reports earnings after the close of trading on Feb. 12.
The numbers to expect
I'll start with a quantitative outline of what to expect from the results and guidance, and then a qualitative look at what the numbers actually mean.
- Internal guidance for fourth-quarter revenue of $111 million-$114 million versus analyst estimate of $113.2 million
- Analyst estimate for non-generally accepted accounting principles earnings per share of $0.26
- Internal guidance for gross margin near 74%
- Internal guidance for effective tax rate of 19%
- Analyst estimates for first-quarter revenue of $105.9 million and non-GAAP EPS of $0.27
First, you should look for how foreign exchange movements affect Cognex's results and guidance. For example, on the third-quarter earnings call, CEO Rob Willett outlined some issues presented by the strengthening U.S. dollar: "We do see the recent strengthening of the dollar having the largest impact on our results, so our revenue guidance for Q4 was reduced by about $3 million to account for the weakening euro and yen."
The following chart shows how the euro and yen rates versus the dollar have moved since Willett's comments on Oct. 27, 2014. The chart plots the value of one U.S. dollar; the higher the number, the stronger the dollar.
In percentage terms, the dollar has strengthened by nearly 13% against the euro, and by about 9% against the yen, since the date of the last earnings call. By way of example, if a U.S. company is expecting 1 million euros in revenue, a 13% strengthening in the U.S. dollar against the euro would reduce U.S. dollar income by 13%, even though the company still receives 1 million euros.
The issue is important to Cognex: For example, in 2013, the company generated 31% of its revenue from Europe, 11% from Japan, and 21% from Asia outside of Japan.
Sequential drop in revenue
Second, don't panic because of the sequential drop in revenue from the third to fourth quarters. Third quarter revenue came in at $169.4 million, while the midpoint of management's guidance for the fourth quarter is $112.5 million. As the following chart illustrates, in the third quarter, Cognex received a boost of $65 million in revenue booked from a single customer. The orange bar in the chart indicates the midpoint of revenue guidance for the fourth quarter; compared to last year's fourth quarter, it represents growth of 17.6%.
Gross margin guidance
Third, look out for gross margin.Here's the company's outlook in the last earnings release: "Gross margin is expected to be similar to Q3 2014. It will reflect a revenue mix that contains a higher proportion of service revenue and surface inspection products, both of which have lower margins than our modular vision systems."
The third-quarter margin was affected by the large customer deal discussed above (some service revenue from the deal is also expected to negatively affect fourth-quarter gross margin). However, CFO Dick Morin argued on the last earnings call that this impact would not last, but instead "dilute the gross margin ... on a temporary basis in Q4."
In other words, look for the company to guide toward an improvement in gross margin in the first quarter.
Fourth, it's a good idea to follow management's commentary on orders. Cognex's product ID revenue (factory automation segment) has grown at management's long-term target rate of 30% for "a number of years," according to Willett on last quarter's earnings call. Look for confirmation of this growth rate in the commentary around the results.
Furthermore, one of management's aims is to diversify the industries into which it sells. For example, Cognex is strong in the automotive sector -- traditionally early adopters of automation technology -- but expanding into areas like medical, pharmaceuticals, and food and beverage is also on the agenda. Any development on this subject would be a positive.
Another growth opportunity exists within the logistics industry, so investors should look for any news on deals or potential deals there.
All told, look for the impact of currency on revenue and guidance, but don't worry too much about the sequential drop in fourth-quarter revenue. Investors have cause to believe gross margin guidance should call for a sequential improvement. However, probably the most important aspect for long-term investors will be the commentary on deal flow and add-on orders from existing customers.
Lee Samaha has no position in any stocks mentioned. Incidentally, check out Cognex's annual reports. Highly entertaining while being informative at the same time.
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