Machine vision company Cognex (NASDAQ:CGNX) is one of the most exciting long-term growth stocks in the industrial sector. And its second-quarter results coming in early August promise to reveal much about the company's future prospects. As ever with growth stocks, there is some uncertainty as to how revenue and order growth will translate to the bottom line. Let's look at three things to monitor regarding the company's long-term business trends in the upcoming earnings report
Cognex makes a disposal
First, look for any commentary on Cognex's recent agreement to sell its surface inspection systems division, or SISD, to Ametek. Analysts are likely to ask questions during the quarterly conference call about whether this will free up management resources to take on additional orders within its factory automation operations. Does the deal signal that Cognex is poised to sign more large orders such as the one with Apple?
The SISD Deal highlights Cognex's intent to focus on on its factory automation solutions, specifically its fast-growing ID products business. For reference, factory automation sales are reported within its modular vision systems division, or MVSD.
As outlined by CEO Robert Willett in the press release on the sale, Cognex is disposing of SISD because "it doesn't fit Cognex's long-term objectives and business model. With this sale, we can focus all of our efforts on discrete manufacturing where we see continued strong growth for our vision and ID products."
It's hard not to see the logic behind this move. The SISD provided 12% of the company's revenue in 2014, but investors are surely focusing on growth prospects within MVSD. Indeed, the sale of SISD would leave the company generating more than 90% of its sales from factory automation, with the rest coming from semiconductor and electronics capital equipment sales.
Factory automation growth prospects
Second, monitor management's commentary on factory automation, because management has decided to give much less outright disclosure on the area. For example, for competitive reasons, it no longer discloses sales from its ID products within factory automation-based sales.
However, management has a target of 30% annual growth in ID products sales. Based on my interpretation of previous statements, it appears likely Cognex will generate at least 50% of its factory automation sales from ID products by the end of the calendar year. Look for management to affirm that ID products sales are growing at the 30% annual target rate.
Moreover, on the last earnings call Chairman Bob Shillman said management might not tell investors about large orders in the future. Essentially, the company might have signed some large orders since the last quarter and not disclosed them.
However, management would surely upgrade its guidance in order to reflect new sales expected as a consequence of any orders. Don't be surprised if that update occurs; it would be a sign that significant new orders have been signed.
Third, rapid growth usually comes at a price -- in Cognex's case, the price is pressure on margins. The last earnings release said the year-over-year gross margin decline of 200 basis points (where 100 basis points equals 1%) was due to "volume pricing discounts on certain large orders and a shift in mix to relatively lower margin maintenance and support services."
As you can see in the following chart, gross profit margin has come under pressure as Cognex signs larger orders.
In addition, operating margin is pressured partly by increased research and development expenses (up 19% year over year in the last quarter) intended to aid product development and potential high-volume opportunities. The increase helped reduce operating income margin to 21% in the first quarter from 25% in the same quarter last year.
It's easy to get carried away with focusing on each quarter's results, but Cognex is carrying out a long-term expansion in its ID products sales. The sale of SISD is part of the process and should result in an increased focus on signing large deals for its ID products.
As such, margins could come under pressure in future quarters, and you should follow guidance on the issue closely. It's somewhat frustrating that management is likely to disclose less than it previously did on orders. All of this means following the nuance of what management says about earnings is as important as the metrics reported. Cognex is in growth mode, and you should expect some margin turbulence going forward.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple and Cognex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.