Earnings Call Transcript - CGNX Q2 2025

Operator, Operator

Greetings, and welcome to the Cognex Second Quarter 2025 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Greer Aviv, Head of Investor Relations. Thank you. Please go ahead.

Greer Aviv, Head of Investor Relations

Thank you, operator. Good morning, everyone, and thank you for joining us. Our earnings release was published yesterday after market closed, and our 10-Q was filed this morning. The earnings materials are available on our Investor Relations website. We are joined here today by Matt Moschner, our CEO; and Dennis Fehr, our CFO. Today, we plan to share several key messages with you, including how we're positioning Cognex for long-term success, an update on our technology leadership and end market trends, our performance in the second quarter and our expectations for the third quarter. After prepared remarks, we'll open the lines for Q&A. Both our published materials and the call today will reference non-GAAP measures. You can find a reconciliation of certain items from GAAP to non-GAAP in our press release and earnings presentation. Today's earnings materials will contain forward-looking statements, including statements regarding our expectations. Our actual results may differ from our projections due to the risks and uncertainties that are described in our SEC filings, including our most recent Form 10-K. With that, I'll turn the call over to Matt.

Matthew Moschner, CEO

Thanks, Greer. Good morning, everyone, and thank you for joining us today. I'm excited to speak with you as the new CEO of Cognex. While this is my first earnings call in this role, I've had the privilege of being a Cognoid for over 8 years. Since I joined in 2017, I've worked alongside many of the talented individuals who continue to drive our success. And I've developed a deep understanding of our business, technology, culture and the values that make Cognex so unique. At Investor Day last month, I outlined 3 strategic objectives that will guide Cognex's future, which can be seen on Slide 3 of the earnings presentation. For those who could not join us at Investor Day, I will briefly recap those strategic objectives and how I'm positioning Cognex for long-term success. First, we will target to be the #1 provider of AI technology for industrial machine vision applications. Our continuous innovation in this area will help customers solve increasingly complex vision problems like cosmetic defect inspections, faster, more accurately and with less setup time. Second, we're committed to providing the best customer experience in our industry. Our goal is to deliver a seamless engagement from first interaction to full-scale deployment for our direct sales model, a unified product ecosystem and upgraded global customer support capabilities. And third, we're focused on doubling the number of customers that we serve by scaling our go-to-market engine to reach new markets and geographies while better serving small and midsize manufacturers. Our sales force transformation is already generating good results and is an important component of this strategy. To support the execution of our strategic objectives, I announced my newly formed leadership team on July 17 as outlined on Slide 4. This team has decades of experience in our industry and with Cognex. And together, we will drive an ambitious profitable growth agenda, delivering even greater value to our customers and further strengthening our leadership in industrial machine vision. Q2 represents an early but meaningful step forward in this journey marked by continued adjusted EBITDA margin expansion and strong free cash flow generation. Turning to Slide 5. Let's begin with a few financial highlights from the second quarter. The momentum we saw in Q1 continued in Q2 with revenue of $249 million, increasing 4% year-on-year representing our fourth consecutive quarter of organic growth. Broader factory automation was stronger in Q2 driven by consumer electronics and packaging. Our commitment to bottom line profitability is reflected in our strong Q2 performance, with adjusted EBITDA increasing 9% year-over-year and our adjusted EBITDA margin expanding by 80 basis points to 20.7%. This is the highest quarterly margin we've achieved in the past 2 years. In addition to the strong financial performance in Q2, we are executing against our strategic objectives. First, we continue to reach new customers through our sales force transformation and expansion, and we're seeing promising gains, including increased revenue growth in key verticals such as packaging. Second, we continue to drive AI innovation which I will talk more about in detail as we turn to Slide 6 of the presentation. At Cognex, we have over 4 decades of technology leadership, and this remains the core to our identity. As we shared with you at Investor Day, we're proud to continue that legacy with OneVision, a cloud-based platform designed to transform the way manufacturers build, train and scale AI-powered vision tools with unmatched ease of use. OneVision reflects our commitment to making advanced machine vision easy, not just powerful, but practical and scalable. Although still in early stages, feedback from initial OneVision adopters has been positive. A standout example is Paldo, one of Korea's largest noodle manufacturers. Paldo's noodle production includes a multi-step inspection process with the final step focused on verifying the width of the packaging seal, a critical factor in preventing package rupture. Paldo wanted to further enhance their quality control inspection performance by driving down false reject rates to very low levels, which can be difficult to achieve without moving to more complex PC-based systems. But with OneVision, Paldo was able to collect images directly from their production line, train a powerful new model in the cloud and seamlessly deploy it back to the edge. This streamlined approach eliminated the need for a new complex system. It expanded our device footprint with Paldo and positioned us to support their growth across additional lines. With OneVision, we're setting a new benchmark for how game-changing AI vision tools are deployed, one that simplifies complexity without compromising performance. As we expand this capability to additional Cognex products in the future, we expect it will further strengthen our position as the technology leader in our industry. Turning now to an update on our end markets, which you'll find on Page 7 of the earnings presentation. Our discussion of 2025 trends is based on current observations while acknowledging ongoing macroeconomic uncertainties. Strong second quarter growth in consumer electronics, logistics and packaging, was somewhat offset by a modest slowdown in semi and ongoing weakness in automotive. Starting with Logistics. Revenue continued to grow double digits year-over-year, marking our sixth consecutive quarter of growth in this market. Importantly, growth was across a broad base of customers. For the full year, we continue to expect strong growth in logistics, driven by ongoing investments by large e-commerce players and further penetration of the broader logistics market. Next is Automotive. As expected, automotive continued to decline year-over-year as it remains our most challenged vertical, reflecting broad headwinds to this industry. Looking to the full year, we remain cautious about the outlook for auto, as we have previously discussed and continue to anticipate a more modest decline in 2025 relative to last year's 14% contraction. Turning to Packaging. Our business showed positive momentum in Q2 with revenue up mid-single digits year-over-year. Growth was driven by contributions from both healthcare and fast-moving consumer goods. Our sales force transformation is delivering impactful results, helping us reach a broader cross-section of packaging customers. For the full year, the outlook for packaging is incrementally more positive. Turning to Consumer Electronics. Q2 revenue increased year-over-year, reflecting broad-based strength. We continue to expect electronics revenue to be relatively similar in Q2 and Q3, implying another quarter of strong year-over-year growth in Q3. As a result, our full year growth outlook for electronics has improved. Moving to Semi. We saw a slowdown in Q2 with semi revenue declining modestly year-over-year against a strong comparison. This result is in line with the cautious full year outlook we adopted last quarter, due to the uncertainty from trade policy and tariffs. In summary, we're focused on executing against our strategic objectives and delivering on our long-term financial framework to drive shareholder value. I'm confident in our direction, proud of our team and excited about what's ahead. Let me now hand it over to Dennis to walk through the financial results and the outlook for the third quarter.

Dennis S. Fehr, CFO

Thank you, Matt. Today, I want to share 3 key financial highlights for the quarter that can be found on Page 8 of our earnings presentation. First, adjusted EBITDA margin of 20.7% expanded 80 basis points year-over-year and was above 20% for the first time since Q2 of 2023. Second, adjusted EPS increased 12% year-over-year, the fourth consecutive quarter of EPS growth. Third, our free cash flow conversion rate on a trailing 12-month basis strengthened to 130% of adjusted net income. These results highlight our focus on profitable growth and cash flow generation. The pillars of our long-term through-cycle financial framework we shared at our Investor Day in June. We are encouraged by the progress we see here, but we also acknowledge there is still work to do and remain committed to executing against our priorities with discipline and focus. Taking a closer look at our second quarter results on Page 9. Revenue of $249 million expanded by 4% year-over-year or by 3% on a constant currency basis. Looking at geographic revenue trends on a year-over-year constant currency basis. Europe expanded 13% primarily due to certain consumer electronics customers ordering through entities based in Europe instead of China. This change of ordering entities does not reflect any underlying change in business mix or customer demand. Excluding this procurement change, Europe grew slightly, led by strength in packaging. The Americas grew 8%, led by continued strength in logistics and growth on packaging. Other Asia increased by 5%, driven by strength in consumer electronics, where we saw evidence of supply chain shifting out of China. Lastly, Greater China declined by 18%. Excluding the procurement change and ordering entities, Greater China revenue declined modestly due to shifts in consumer electronics supply chain. Looking now at gross margins. Adjusted gross margin of 68% was in line with our guidance. The 230 basis point year-over-year decline was primarily due to a less favorable industry mix. As expected, tariffs had a modest negative impact on gross margin this quarter. Our continued focus on disciplined cost management resulted in a 2% year-over-year reduction in adjusted operating expenses or a 3% reduction on a constant currency basis. As we mentioned on prior quarter calls, we will remain laser-focused on tight cost management as this is a key lever on our path to profitable growth. We expect operating expenses to continue to grow slower than revenue. Revenue growth, combined with this disciplined cost management drove 80 basis points of adjusted EBITDA margin expansion year-over-year to 20.7%, our highest quarterly margin since Q2 of 2023. Diluted earnings per share on a GAAP basis were $0.24, up 15% from $0.21 a year ago. Adjusted diluted EPS was $0.25, representing 12% growth from $0.23 a year ago. This growth was driven by an expanded top line and cost discipline as well as a 2% year-over-year reduction in our average diluted share count. Free cash flow generation was strong again this quarter, totaling $40 million which included a one-time $16 million payment for a transition tax we noted last quarter. Trailing 12 months free cash flow generation of $180 million is up 138% compared to the 12-month period ended Q2 2024 and represents free cash flow conversion rate of 130%. We remain firmly committed to a disciplined capital allocation strategy, where returning capital to our shareholders is an important component. Over the past 12 months, we have made significant progress on this journey returning over $200 million to shareholders, or over 110% of our free cash flow through share repurchases and dividends. These actions have contributed to a reduction of more than 4 million shares and our average share count year-over-year. Turning to Page 10. I will now walk you through our financial guidance for the third quarter. As we shared with you at our Investor Day, we will be guiding to the following 3 metrics going forward. First, revenue; second, adjusted EBITDA margin; and third, adjusted earnings per share. We believe these metrics best reflect our increased focus on profitable growth. Starting with revenue. In Q3, we expect revenue between $245 million and $265 million. This range reflects 9% year-over-year growth at the midpoint, with both our logistics and broader factory automation businesses contributing to the expansion. As noted last quarter, we expect consumer electronics to be relatively evenly weighted across our seasonally strong second and third quarters this year. Next, adjusted EBITDA margin is expected to be between 19.5% and 22.5%. The midpoint of this range represents approximately 340 basis points of margin expansion compared to last year, reflecting solid revenue growth and continued cost discipline. Lastly, adjusted earnings per share are anticipated to be between $0.24 and $0.29, with the midpoint of this range representing 35% year-over-year EPS growth. This outlook represents another meaningful step forward on our journey of profitable growth. A few other noteworthy items to consider as part of our outlook. First, as we look ahead to the remainder of the year, we anticipate Q4 revenue to return to more typical seasonal patterns, which historically have shown a sequential step down in the high-single-digit range. The fourth quarters of both 2023 and 2024 were exceptions to this trend. In 2023, this was mostly driven by our acquisition of Moritex, which closed in October of that year. While in 2024, we saw accelerated demand late in the fourth quarter. Second, while the tariff landscape remains fluid, the recent trade agreement with China, Indonesia and Vietnam do not change our previous commentary on the expected full year impact of tariffs. Specifically, we continue to expect no material impact on adjusted EBITDA margin and earnings per share and continue to estimate a 50 basis point dilution to gross margin. Third, during the third quarter, we entered into a commercial partnership with a strategic channel partner to better serve OEM customers in the specialized field of medical lab automation. This arrangement is expected to result in a one-time benefit to revenue and profit in Q3, which is excluded from our guidance. We currently expect the benefit to revenue to be between $8 million and $14 million in Q3. Lastly, let me touch on the One Big Beautiful Bill Act recently passed by Congress. We are in the early stages of evaluating the impact of U.S. tax law changes and currently anticipate the following tax implications for our business. First, the bill is expected to be neutral to adjusted EPS in 2025. We expect an insignificant impact to adjusted EPS in 2026 and beyond. Second, we currently expect a one-time higher reported tax rate in 2025, and we'll update you when we have more clarity into the final impact on the rate. However, we do not anticipate any change to our adjusted effective tax rate. And third, the provision to fully expense U.S. research and development costs is expected to result in a cash tax benefit of $12 million to $15 million this year, which is expected to step down annually and phase out over the next 5 years. Now Matt and I are ready for your questions. Operator, please go ahead.

Operator, Operator

Our first question is coming from Jacob Levinson of Melius Research.

Jacob Frederick Levinson, Analyst

This is the first quarter I remember where revenues have increased and costs have decreased, which is certainly positive. You have mentioned some margin targets at the Analyst Day, but could either Matt or Dennis explain what internal changes or incentives are contributing to improved margins?

Matthew Moschner, CEO

Yes, Jake, this is Matt. I'll start and then pass it to Dennis. Thank you for your observation. Our main goal is to grow the business, as we know that doing so leads to significant improvements in profitability. We are intensely focused on identifying ways to achieve growth and ensuring we are investing adequately in those initiatives. This encompasses not only product development but also our approach to channels, and you can see some of that reflected in our numbers. At the same time, Dennis, I, and the broader leadership team are dedicated to managing our cost structure. This focus is not new; it began several months ago when I assumed the Chief Operating role earlier this year. We've organized our efforts to approach this thoughtfully. Over the past five years, we've made substantial investments in the business, and we are leveraging those investments to enhance our efficiency and productivity across various areas, including engineering, sales, back-office functions, and facilities. Our aim is to take a comprehensive view and ensure we are implementing cost reductions in appropriate areas without hindering our growth trajectory. While I believe we are managing this well, we must also reach the margin targets we outlined on Investor Day. Dennis?

Dennis S. Fehr, CFO

Yes. In that regard, I'm really pleased to see kind of this meaningful step in that regard. And to your question what changed I think one thing Matt highlighted to us, I think really a programmatic approach to it that we're really focused across the entire P&L and across the entire organization. And put that program in place to really think about like very thoughtful where we can optimize costs. And then I think at the same time, Matt also alluded a little bit to a focused effort of the entire leadership team. And I think there's a clear sense in the organization of the direction where we want to go, and we feel really positive about how the organization is responding and how everyone is pulling into this direction. So we're pleased with that.

Jacob Frederick Levinson, Analyst

That's all really helpful color. Just on a separate topic. I know one of your larger electronics customers has some new products coming out next year, I think, that are foldable different form factors. Can you help us understand what does that mean when you've got a change, and I assume it means there's a change in manufacturing technique and maybe you've got retooling of lines and what not, but what is when you have some new technology, if you will, what does that really mean for you folks in terms of machine vision?

Matthew Moschner, CEO

Yes, sure. I'll take that. It's important to remember that these products are quite complex to manufacture. It often takes months or even years to bring new technologies to the market. While there may be a new product potentially launching next year, our involvement in manufacturing design typically starts years in advance. This is a long-cycle, project-based business, particularly with large suppliers. We have seen growth in consumer electronics primarily due to our efforts in adding value and providing more comprehensive solutions in this sector. A significant factor has been our acquisition of Moritex in the fall of 2023. We are collaborating with many players in the industry as they navigate geographic shifts in manufacturing, which is beneficial for us as a global company. However, regarding new product releases or phone designs, I cannot provide any comments. I just want to emphasize that these processes take time, and we usually start our engagement well before those product launches.

Dennis S. Fehr, CFO

Maybe just to add on that, like on the revenue side, when we are engaged over a longer cycle revenue, you would really see probably in the year where new products are being released and less than kind of many years ahead.

Operator, Operator

The next question is coming from Damian Karas of UBS.

Damian Mark Karas, Analyst

Congratulations on the progress. I don't think we've heard about broadening factory automation improvement in a while. So maybe you could just provide a little bit more color around the trends that you are seeing in packaging and consumer electronics. Are you maybe able to give us a sense of how much of that is new customer-driven versus how much is just the underlying market improving and existing customers kind of replacing or augmenting systems in their installed base? And just I guess your confidence that some of this improvement isn't just one-off activity, but rather a more sustainable trend?

Matthew Moschner, CEO

Yes, I'll start by saying that we have a strong presence in consumer electronics, where we collaborate with excellent partners. Our focus is on increasing our share of wallet by providing more complete solutions. We're expanding our customer base in this sector and observing broad-based growth. Additionally, there is a geographical aspect as technology providers consider relocating production to new areas. Regarding packaging, it has become our third-largest vertical, encompassing healthcare, which includes medical devices, pharmaceuticals, life sciences, and fast-moving consumer goods. Each of these areas has distinct dynamics. We see growth in packaging driven by investments we've made in our sales channel, primarily among regional manufacturers and brands in healthcare and fast-moving consumer goods. The demands of these areas are fueling the need for vision technology. In healthcare, particularly in medical devices and pharmaceuticals, we are witnessing significant capital expenditures, especially following the release of popular drugs related to obesity and cancer, along with demographic shifts in various regions. We are pleased with the trends in healthcare. In terms of packaging, our Cognex Vision solutions have been crucial for traceability, especially in food regulation, and brands are increasingly focusing on quality. We maintain strong relationships with many machine builders in the packaging sector and recently launched products, such as the In-Sight 8900, that fit well in this market. Overall, we are encouraged by our advancements in both packaging and consumer electronics.

Damian Mark Karas, Analyst

That's really helpful. And as a follow-up, you talked about new products. I mean you showcased the AI devices and OneVision at your Investor Day, I'd be curious to hear what kind of early feedback you've been getting on the AI technology and solution set and any sense for when you might open up OneVision to the broader customer base?

Matthew Moschner, CEO

Yes, we're really excited about OneVision. Hopefully, the example we gave today is helpful to the group to understand it's very indicative, I think, of how OneVision is helping our customers and letting us drive simplicity in delivering more advanced vision capabilities. So we're trying to be very thoughtful about how we engage the market on it. It's a very new style of designing vision and we want to make sure that our customers understand it, are comfortable with it as well as our sales channel being able to adequately sell and promote it. So yes, you're going to see us take a methodical phased approach throughout the year and into next year. It's an area we're going to continue to invest and what you'll see is that it will have greater compatibility with a broader set of Cognex Vision Systems, and I'm quite excited about it.

Operator, Operator

Our next question is coming from Joe Giordano of Cowen.

Joseph Craig Giordano, Analyst

Yes. I'm curious on logistics. Are you seeing that more on like the greenfield side coming back, the brownfield like kind of investment in existing facilities? Like what's driving that now? And where are you seeing kind of the most inflection?

Matthew Moschner, CEO

Yes. Our growth strategy in logistics is multifaceted. It's not solely focused on adding new capacity. While we experienced significant growth 4 to 5 years ago during COVID, today we are witnessing a more balanced growth approach. The introduction of new facilities certainly helps drive demand for Cognex machine vision, but we are also gaining considerable traction in vision technology. As mentioned at Investor Day, a significant portion of our business is currently in traceability. With our latest generation of AI vision tools, we are effectively scaling both 2D and 3D vision in logistics, and customers are responding positively. Additionally, as our technology evolves and our relationships with operators deepen, we are revisiting existing facilities to enhance processes and improve efficiencies within their fulfillment networks. This is an exciting development for us, as it involves a diverse customer base and reflects our efforts to drive sales across both new capacity and existing facilities, as well as entirely new technology areas.

Joseph Craig Giordano, Analyst

And when you think about something like OneVision, I'm just curious like what does that mean for you from like is it sold differently? Is it a different pricing mechanism? It seems like a nice improvement on how the products are used. But I'm just curious like what it means for you in terms of like driving a different type of sale.

Matthew Moschner, CEO

Yes, it's a very different type of technology. I mean I think what we said at Investor Day was we weren't prepared yet to really talk in detail about the pricing model of OneVision, and I don't think we're ready yet. But the way you can think about how we go to market is very much as part of the bundle of technology that we would today. And so when we engage a customer on a new application, we really start at the edge. And we have designed our technology to work very well on the device so that there's no need for any sort of separate PCs or clouds. But OneVision very much complements that sales activity when the customer needs more advanced vision. And we like to say OneVision is helping us bridge edge to deep learning, and it does that quite well. So yes, our go-to-market right now, I would say, is more familiar to how we've gone to market in the past. To the extent that evolves in the future, I think we are thinking about that, but nothing to go into detail today.

Operator, Operator

The next question is coming from Tommy Moll of Stephens.

Thomas Allen Moll, Analyst

Dennis, I wasn't sure if I heard you correctly, when you started giving some insight into fourth quarter, that's more than 1 quarter forward. But pretty sure I did hear you offer a comment there. And so I just want to clarify. For the base quarter and third quarter, should we use the revenue that includes or excludes the one-time payment? So I think I heard you say typical seasonality would be a high-single-digit quarter-over-quarter decline. I just want to get the third quarter base right?

Dennis S. Fehr, CFO

Yes. No, great question, Tom. Yes, it's based on the guidance, which is excluding the one-time effect.

Thomas Allen Moll, Analyst

Okay. As a follow-up on logistics, I wanted to ask about the planning cycle there. As I understand a lot of this business, you have decent visibility on and the planning cycles are pretty methodical. Are you having any conversations regarding projects into next year at this point? Or how would you characterize the level of visibility that you have for what's ahead versus what the typical would be?

Matthew Moschner, CEO

Yes. Sure, Tommy. Yes. No, you're right to say it is a longer cycle business, right? These are big investments and build-outs of new CapEx. We have great relationships with customers in this area. And so you would imagine that we would have multiyear discussions on their plans and to the extent that they can align what we're delivering to them. So yes, I think it's fair to say we engage on customers' plans across many years. But typically, you wouldn't see ordering activity until those facilities are committed, the CapEx is approved, and that still is more within the 3- to 6-month period of visibility for us. So yes, but I wouldn't say necessarily that we're seeing that trend change one way or another. I don't think we see it getting longer. I wouldn't say we see it getting shorter but we are engaged on the multiyear plans of our customers and we continue to stay very tightly linked with them in that way.

Operator, Operator

The next question is coming from Andrew Buscaglia of BNP Paribas.

Andrew Edouard Buscaglia, Analyst

Maybe on logistics and some of the other markets like consumer electronics and packaging sort of picking up. Would you not say some of that might be due to some pull forward on tariffs and maybe in logistics around tariffs. Do you see any clarity from tariffs helping customers move forward with some decision-making or any change there, if you can comment?

Matthew Moschner, CEO

Yes, we're monitoring the situation closely as it's quite dynamic. Our team has been actively tracking developments and our responses since last fall. We have made significant efforts to manage costs, particularly concerning tariffs. I believe your question focuses more on demand and what customers are experiencing. Dennis might provide additional insights on any potential demand pull forward due to tariffs. I wouldn't say there's been a significant surge; however, our forward sales pipeline remains solid and appears normal in light of recent tariff updates. We are consistently engaging with our customers, and while the increased costs may affect them, we are open and transparent about it. It's important to note that as costs rise, companies are actively seeking ways to offset these expenses, and automation and machine vision have proven to be effective solutions. On the one hand, they might view us as a factor in increasing their costs, yet on the other hand, they recognize us as a viable means to enhance efficiency and reduce overall expenses within their manufacturing and supply chains. While it's challenging to quantify demand currently, I remain optimistic that the ongoing tariff and trade situation will ultimately provide a positive boost to our business, as we continue to help improve efficiency and diversify supply chains.

Dennis S. Fehr, CFO

Yes. And maybe to add on that. So I think in the second quarter, in particular in the U.S. and packaging and maybe in logistics, there have been a couple of projects where we thought they could have been accelerated due to tariffs, don't always exactly know. So I would say really maybe a low-single-digit million dollar number. At the same time, we haven't really seen the funnel for Q3 then changed in that regard. And now right being here already at the end of July, we also haven't seen like any demand trends and booking trends changing throughout July, that kind of offsets that a little bit. And then at the same time, right, we had some commentary about consumer electronics, that shift happening in Asia, right, from China to other Asia. So we are seeing, I would say, probably some of these early signs of some of this relocation of manufacturing happening. And I think, as Matt also said, I mean, long term, that's really a great trend and a great opportunity for Cognex.

Andrew Edouard Buscaglia, Analyst

Yes. Okay. And then my other question is why not include the one-time potential benefit from the channel agreement? Is it because you don't know the timing, it might slip, and you don't want to rely on it, or is there another reason for not including it?

Dennis S. Fehr, CFO

Yes. Let's first clarify what it actually entails. It's a partnership that includes a multiyear software license agreement. This means that we will recognize some minimums over a few years in a single quarter, and we are also transferring some component inventory. It's not just a one-quarter event; it represents figures that will impact future quarters, but accounting standards require us to recognize it at once. Therefore, we wanted to present this separately to maintain focus on the underlying business performance. At the same time, we provided you with estimates that include this information to enhance clarity.

Operator, Operator

The next question is coming from Jamie Cook of Truist Securities.

Kevin Samuel Wilson, Analyst

This is Kevin Wilson speaking for Jamie. Regarding mergers and acquisitions, you discussed your new capital allocation framework at the Investor Day. You mentioned the possibility of exploring non-vision adjacencies as potential acquisition targets, particularly in areas like sensing components or other automation technologies. Given this new framework, could you elaborate on the adjacencies you are considering beyond your core Vision business? Additionally, how has the pipeline for M&A or discussions with potential targets evolved since the introduction of your new framework?

Matthew Moschner, CEO

Yes, Kevin, this is Matt. We certainly did at Investor Day, provide some guidance in terms of how we're thinking about M&A, what its contribution to our growth outlook is. But I think what we also said was we were going to be very thoughtful and continue to hold a very high bar in terms of how and where we would pursue M&A. Cognex over the last 10 years or more has always viewed M&A as a way to add capability to the business. And Dennis and I and the broader leadership team continue that belief. I think with the acquisition of Moritex, that was a bit of a different move for us. It was a larger deal that brought with it products, technology, revenue around the world. And I think we all view that as going very well and adding the value that we wanted it to. And I think should give us all some confidence that those are plays we can run as well beyond just maybe the smaller bolt-on technology acquisitions that we've done more so in the past. So what are we looking for, right? We're looking for a really good strategic fit and alignment with the objectives that I shared. That's number one. We're obviously looking for clear evidence that we can drive value that we are the preferred owner that we can leverage the assets of Cognex and drive advantaged value for our shareholders and affect the bottom line quickly. And to that end, we're holding a very high bar. So yes, we have and we'll continue to have a very rigorous M&A process. We're as a leader in our industry, we know a lot of the key players, and we plan to stay in touch with those players. And as we have updates, we'll share them.

Dennis S. Fehr, CFO

And I think we also said around Investor Day that what we said it's like 3% plus kind of on an annualized basis through the cycle, additional growth has been also very clear, like this could be a single deal, which maybe happens in 3 years and 4 years, right? So in that regard, I'm not feeling like kind of any deal mode where we think like we need to execute a deal right now just coming out of this Investor Day. As Matt said, we'll take the time to find the right target. We'll be disciplined about it to find something which makes sense. And at the same time, we also have work to do in the operating business. We like the meaningful step forward, which we took, but we also clearly said we still have work to do.

Kevin Samuel Wilson, Analyst

That's helpful. And then just a follow-up on the medical lab automation item in the third quarter. Is that type of licensing arrangement? Are there other opportunities that have a similar profile that you're looking at moving forward? Or is that sort of just a one-time opportunity with that specific strategic part and then I'll pass it on.

Matthew Moschner, CEO

Yes. Maybe I'll give you a bit of context on why we did it, right? So as a management team, we're always looking at ways to better allocate our resources, right? And in this case, we're in a market of lab automation that is a great application for our vision. We've had a lot of success there. But for us, in many ways, it was a bit subscale, particularly from a channel perspective. And so we found a channel partner that had a better presence in that area, had better scale, had good relationships that maybe could manage that channel and those customers more effectively than we could. And so that's maybe the playbook behind the deal. And so we have a partner that plans to continue to use Cognex vision and sell it through to the customers that we have but has a broader portfolio of offerings for those customers. And so it felt like a very, very good fit. So to the extent there are other opportunities, we're being very thoughtful, right? As you'd imagine, one of the things I'm doing is taking a very broad look across the portfolio to say, are we as focused as I'd like, are we deploying our resources in the ways that have the best impact for the business that we want to run. And in many cases, the answer is yes. There's some areas that the answer is weaker. And when you see that we really go after it. And this is one of those areas.

Dennis S. Fehr, CFO

And more considering it like perhaps even doubling down on the existing strategies that we want to have a strong direct sales channel in the markets, which we really think are very important for us. So we are redeploying resources there. So it's not a shift in strategy. I would more think about doubling down on what we already said in the past.

Operator, Operator

Our next question is coming from Ken Newman of KeyBanc Capital Markets.

Ken Newman, Analyst

Congrats on the solid quarter. Yes. Maybe first, sorry if I missed it, Dennis, but I'm curious if you just had any color on what price contributed to the organic revenue this quarter and kind of what's implied in the new 3Q guide. Really, I'm just trying to get a sense of what you think is potentially sustainable from price pass-through into next year if all the current policies on tariffs stay in place as they are today?

Dennis S. Fehr, CFO

There are two main aspects to consider: one relates to the U.S. and the specific tariffs, and the other looks at the broader global situation. On the U.S. side, we've been actively working on our supply chain, with the team in place since last year making significant progress. This has helped us maintain our outlook without any substantial impact on adjusted EBITDA margin or adjusted EPS, despite a slight increase in tariffs from recent trade deals. Our team has done a commendable job in managing the supply chain, and while we do have some exposure to China, it's not substantial. We are also engaging with our customers to find solutions, but I wouldn’t say it has caused a significant impact on the Q3 guidance. Looking at the broader global context regarding tariffs, over the past year, we've discussed pricing challenges in China affecting our gross margin to some extent. However, we believe pricing pressures have eased somewhat, and we are effectively working on our supply chain to counter these pressures. Overall, I would characterize the pricing situation as shifting from negative to neutral over the past year. We will continue to explore opportunities in this area and provide updates in the upcoming quarters.

Ken Newman, Analyst

Yes, no, that makes sense. For my follow-up here, maybe just to approach the margin guide or maybe the longer-term view on margin guide a little differently. Given all the work that you've done on leveraging costs, I think the midpoint of your 3Q guide is implying an incremental EBITDA margin of above 50%, closer to 60%. Do you feel like this is a decent baseline going forward given how the markets are recovering? Or are there any one-time things that we should kind of be aware of as we think about more normalized operating leverage into '26?

Dennis S. Fehr, CFO

I mean, see, first of all, I think we said that we are pleased with the progress. It's a meaningful step forward. It comes really two things together, revenue top line is growing and OpEx side is decreasing on a year-over-year basis. And I think that's clearly there is some really underlying work which we're doing. We talked a bit about the programmatic approach, which we are doing there. So it's really kind of in that sense. It's sustainable on the cost side. At the same time, it made us comment about the fourth quarter, right? So keep in mind, there's seasonality in the business. So I really want you to think on the top line side, that we have the strong Q2, Q3 driven by consumer electronics and certainly, that drives leverage and deleverage, right? So in that regard, if you think back about Q1, Q1 was a strong quarter, if you think about it from a year-over-year comparison, but it was somewhere at a 16.8% adjusted EBITDA margin, right? So that means not yet in the 20%. So think about it when you think about Q4 that you will see some deleverage. And then, of course, at the same time, when we think about what we said at Investor Day, our target of achieving greater than 20% adjusted EBITDA in 2026. We feel that we are on the path to that on this work which we are doing and the cost structure is really bringing us there. So I would say, short term, keep in mind, Q4 seasonality. But then if you think about 2026 and generally, we're making really meaningful progress.

Operator, Operator

Our next question is coming from Piyush Avasthy of Citi.

Piyush Avasthy, Analyst

Well, can you guys like drill down on auto's EV end market? I understand you mentioned lower project activity. But from your vantage point, can you maybe update on what your customers are telling you with regards to their CapEx plans beyond 2025? Just trying to understand where we are in the CapEx cycle? And also if there is anything different that you're seeing in EV versus like the traditional ICE, that would be helpful.

Matthew Moschner, CEO

Yes, I’ll begin. I recently returned from a trip to Detroit where I spent the week discussing this very topic with many of our automotive customers. Overall, there's a significant amount of uncertainty in the macro environment, and conditions remain weak, primarily due to ongoing uncertainties and rising costs from trade and tariffs. This is well documented. However, I am optimistic about the potential of machine vision, and our customers share this sentiment in several areas. First, it serves as a crucial way to offset some of those cost increases, helping them operate more efficiently. They have a greater need for our solutions now than ever before. Secondly, quality is a top priority for all of them. Despite the substantial cost increases due to tariffs, maintaining high quality remains their focus. This year, many have faced increased recall activities, and the financial impact of poor quality is a significant concern for our automotive customers. Cognex's machine vision is well recognized for its role in ensuring quality throughout their supply chain. The third issue they face is labor scarcity. Many have reported high turnover rates in their facilities and ongoing challenges in finding skilled labor for their manufacturing operations. So, despite the weak overall macro trends in the auto sector, the fundamentals driving machine vision adoption in automotive remain strong, and we are actively engaging with our customers in this area. I won't speculate on future capital expenditures as that remains quite uncertain. Regarding electric vehicles, we continue to explore various exciting applications in the EV battery sector. Last year posed challenges for us and the industry because of significant overcapacity in battery production. Although that situation is starting to stabilize, OEMs still have plans to introduce EVs and hybrid vehicles, and we are involved in several projects related to these developments.

Piyush Avasthy, Analyst

Dennis, I'll ask Ken's question in a slightly different way. Regarding margins, as you mentioned, you are currently achieving around 20%, and your target for 2026 is to exceed a 20% EBITDA margin. Considering that most of your end markets are improving, why can't margins reach the 25% to 30% range, which you highlighted as the next goal during your Investor Day?

Dennis S. Fehr, CFO

Yes. No, see it's a great question and see that's what we're working towards, right? We laid out a clear path on how we want to get there. And we're working to achieve all milestones one by one. So the first one is the greater than 20%. I think it's great that we see it first on the quarter, right? So we had now first time for 2 years in the second quarter, it's still there in the third and I talked a bit about seasonality for the fourth, but the next step is to bring it there on a 12-month basis and then work from there towards the 25%. In that regard, I think we are in the same spirit, and that's what we're driving towards.

Operator, Operator

Our next question is coming from Keith Housum of Northcoast Research.

Keith Michael Housum, Analyst

Coming back to the one-time revenue here in the third quarter from this new partner. Just trying to unpack that a little bit more and understand is this customer going to be selling your hardware going forward? Or are you going to use your software on their own hardware? So we shouldn't expect to see significant revenue coming from this partnership going forward?

Matthew Moschner, CEO

Yes, let me clarify that. It’s a mixture. On one hand, we’ve granted them the exclusive right and license to manufacture Cognex Vision Systems, which includes Cognex designed hardware and software. That’s one aspect. Additionally, they have the ability to purchase Cognex products for exclusive use in this end market. So, those are the primary elements. We are not pursuing a strategy where we would be hosting Cognex software on their hardware. That is not included, but the first two certainly are.

Dennis S. Fehr, CFO

All right. You mentioned a figure between $8 million and $14 million, which covers a minimum over five years and includes some inventory. If we analyze this, it represents a significant amount for the quarter, but when viewed over a five-year horizon, it doesn't seem that considerable. I want to emphasize that we've focused on a very specialized area where we believe a channel strategy is more advantageous than the broader approach we apply in other markets. Consequently, we chose this path. We expect to see positive outcomes from this specialized area and partnership, but I don't anticipate it making a significant impact on our financials in the coming years, especially considering that some of this revenue will be recognized over a five-year period within a single quarter. Therefore, I wouldn't classify it as having a meaningful effect on our projections for 2026 and beyond. Yes. No, I think, see, we're quite pleased with what we have done on the working capital side, right? I think over the last 12 months or so our cash conversion cycle kind of stepped down by about 60 days. And a good portion of that is coming from the inventory side. And that's kind of part of our drive towards being efficient and being a lean company, right? It's both on the organizational side as well as on how we manage working capital. In that regard, we think we have done meaningful progress there. There's still a little bit to go. But yes, overall, just happy where we are and still have a little bit of potential there as well.

Operator, Operator

We're showing time for one last question. Our final question today is coming from James Ricchiuti of Needham.

James Andrew Ricchiuti, Analyst

Could you discuss the growth in the packaging market and how much of that might be attributed to your current sales initiatives, particularly the new sales team you hired around the middle of last year?

Matthew Moschner, CEO

Yes, I think our investments in the channel are proving beneficial. As we've mentioned, this is a regionalized business with local brands and manufacturers that cater to the specific tastes of their areas. Having a sales channel that can reach these smaller, mid-sized brands is crucial. Additionally, it's important to provide the right technology for these businesses. Our edge learning-based vision systems are easy to demonstrate, set up, test, and deploy at scale. Combining these elements allows us to reach more customers with products that are user-friendly. We see this reflected in our packaging numbers. In this industry, there is also a strong presence of sophisticated machine builders and OEMs that we serve effectively with our technology. We believe these three factors are currently working in our favor.

James Andrew Ricchiuti, Analyst

And just a quick follow-up, just on the semi market. Has your view of that market changed versus earlier in the year just given the mixed signals we're hearing from the WFE market and there's that cautiousness? You don't look too far out, but does that bleed into 2026? Or is it just too early to comment on that?

Matthew Moschner, CEO

I think it's too early to make a definitive statement. The supply chain is very complex and sophisticated. We usually work with large equipment manufacturers, and what we often see is that the demand for Cognex Vision doesn't always align with the demand and use of the final products, such as chips and memory. There is potential for us to continue growing or maintaining our strength in demand for advanced AI and high bandwidth memory. However, how this demand translates into orders for Cognex from machine builders and OEMs may not match that demand perfectly. Regardless, we are quite optimistic about the market and see significant potential. As you've noted, we are being cautious about the full year and have communicated that, but we continue to engage with Cognex technology. The acquisition of Moritex has also strengthened our position, giving us valuable relationships with major semiconductor OEMs in the Asia region.

Operator, Operator

At this time, I'd like to turn the floor back over to Mr. Moschner for closing comments.

Matthew Moschner, CEO

Great. Well, thanks, everybody, for joining us this morning. We value your continued interest and engagement with Cognex, and we look forward to updating you on our progress during next quarter's call.

Operator, Operator

Ladies and gentlemen, this concludes today's event. You may disconnect your lines or log off the webcast at this time, and enjoy the rest of your day.