Cognex Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.29.13 | About: Cognex Corporation (CGNX)

Cognex (NASDAQ:CGNX)

Q2 2013 Earnings Call

July 29, 2013 5:00 pm ET

Executives

Richard A. Morin - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration

Robert J. Shillman - Executive Chairman and Chief Culture Officer

Robert J. Willett - Chief Executive Officer, President, Chief Operating Officer, President of Modular Vision Systems Division and Director

Analysts

James Ricchiuti - Needham & Company, LLC, Research Division

Ben Z. Rose - Battle Road Research Ltd.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

Thomas L. Hayes - Thompson Research Group, LLC

Operator

Good day, ladies and gentlemen, and welcome to the Cognex Second Quarter 2013 Earnings Call. [Operator Instructions] And as a reminder, today's conference is being recorded. And now I would like to turn the call over to Dick Morin, the company's Chief Financial Officer.

Richard A. Morin

Thank you, and good evening, everyone. Earlier tonight, we issued a news release announcing Cognex's earnings for the second quarter of 2013, and we also filed our quarterly report on Form 10-Q. For those of you who have not yet seen these materials, both are available on our website at www.cognex.com. They contain highly detailed information about our financial results.

During tonight's 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. For your reference, you can see the company's income statement as reported under GAAP in Exhibit 1 of the earnings release and a reconciliation of certain items in the income statement from GAAP to non-GAAP in Exhibit 2. I'd like to emphasize that 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, and actual results may differ materially from those projected or anticipated. You should refer to the company's SEC filings, including our most recent Form 10-K for a detailed list of these risk factors.

Now I'll turn the call over to Cognex's Chairman, Dr. Bob Shillman.

Robert J. Shillman

Thanks, Dick, and hello, everyone. I'd like to welcome each of you to our second quarter conference call for 2013. As you might have been able to see in the news release that we issued earlier today, we reported strong financial results for the second quarter of 2013, with revenues of $86.5 million, which was not only above the high end of our expected range but which was also record quarterly revenue for our company. Right now, I'm in the R&D center in San Diego, and the team is at -- the financial team is at our Natick headquarters.

For the details of the quarter, I'm going to now hand the microphone over to Rob Willett, my partner and our President and CEO. I will be available during the call and at the end of the call to answer questions that you may have for me. But I think Rob will be able to answer in far more detail any of the operating issues. Rob, take over.

Robert J. Willett

Thank you, Dr. Bob. Good evening, everyone. I'm pleased to report our results for the second quarter of 2013. Revenue of $86.5 million set a new record for Cognex. Reported growth was 3% year-on-year. The increase was 6%, including currency exchange rates, which reduced second quarter revenue by $2.4 million.

Revenue growth was driven by strong execution in the factory automation market, particularly in the Americas and China. From a product standpoint, revenue from ID products grew faster than the rest of our business year-on-year and set another record for Cognex. In recent years, we stepped up our investments in engineering and sales to drive future growth. The contribution from these efforts was meaningful in the quarter, helping to offset the sluggish market conditions we see in Europe, still soft SEMI market and the impact of a weaker yen on reported revenues.

We had strong margin performance in the second quarter. Gross margin was 76%, consistent with the gross margin reported a year ago and in the prior quarter. This reflects the high value of Cognex products, both the unique hardware and leading-edge software. Operating margin is lower year-on-year due to our investments in new product development and sales channel expansion. We feel good about these investments, and we are pleased to see them begin to deliver for us. Operating margin increased 100 basis points on a sequential basis due to leverage from the revenue growth, primarily in ID products and China.

Earnings were $0.38 per share in the second quarter, $0.01 higher than the Thomson Reuters First Call consensus estimate of $0.37. I want to point out that our results for last year's second quarter included an investment gain of $1 million or $0.02 per share that did not repeat this quarter.

Now let's turn to the details of the quarter. In the factory automation market, revenue was a record $67.2 million in the second quarter. This is 6% higher than the prior record set just last quarter. Factory automation grew 9% year-on-year on a reported basis, 11% in constant currency. Looking at factory automation from a geographic perspective, Asia, excluding Japan, was our best-performing region in terms of percentage growth. In the second quarter, factory automation revenue from Asia grew 26% year-on-year and 19% over the prior quarter. Growth was led by particularly strong sales to manufacturers of consumer electronics in China where revenue set a new quarterly record.

In the Americas, factory automation revenue also set a new record, with revenue increasing 17% over the second quarter of 2012 and 8% over the record revenue reported in the prior quarter. The underlying strength we see in the Americas is encouraging. This is particularly true in logistics, where we're beginning to receive large project orders after lengthy evaluation trials. As you may have seen in the news release issued last week, we received orders totaling more than $1 million from a major retailer who will purchase Cognex ID readers for their U.S. distribution centers. We expect to receive other substantial purchase orders for logistics applications in the next few weeks.

Factory automation revenue in Europe was essentially flat, both year-on-year and sequentially, while there was a slight increase on a constant currency basis. We're thankful to our European team for their hard work keeping the business stable in what are difficult market conditions.

Currency exchange rates had a negative impact on sales to the Japanese factory automation market. Reported revenue decreased 18% from the second quarter of 2012 and 5% from the prior quarter. However, in constant currency, Japanese factory automation grew 1% year-on-year and 5% sequentially.

Revenue from the semiconductor and electronics capital equipment market, or SEMI as we call it, was $7.1 million in the second quarter. SEMI decreased 28% or $2.7 million from a strong quarter a year ago. On a sequential basis, SEMI increased 2%.

In the surface inspection market, second quarter revenue was $12.2 million. This represents decrease of 5% year-on-year. On a sequential basis, surface vision increased 16% off a low base in Q1. Surface inspection revenue can be uneven due to the timing of deliveries and installations and the impact of revenue deferrals. We continue to perform well in surface inspection, and demand remains at a high level.

Moving on to new products development. We were pleased with the productivity and innovation of Cognex engineering. During the second quarter, we released our next-generation advantage engines for integration into OEM equipment. Target customers for these products are in new markets for Cognex such as life sciences, printing and kiosks. You'll hear more about these opportunities at our Analyst Day in September.

We introduced In-Sight Track & Trace 2.0. This new version of our identification and label verification software brings additional features and functionality to pharmaceutical and medical device manufacturers seeking to comply with new regulations and to reduce counterfeiting and other illegal activities. Our advanced code-reading algorithms reported to our industry-leading DataMan 8000 ID reader, making it the most powerful and reliable industrial handheld ID reader available today. And new lighting and optics features that enable easier setup were added to our DataMan 300 series of fixed-mount ID readers.

In summary, we had a strong second quarter, and all indications from our sales team are that the momentum will continue to build in the second half of the year. In regard to Q3, we believe that revenue will surpass the record level reported tonight for Q2 and be between $88 million and $91 million. Growth in ID products, driven particularly by customers who are now placing volume orders for logistics applications, as well as the shipment of orders booked late in Q2, is expected to more than offset the seasonal softness we typically see in the factory automation market.

Operating expenses are expected to increase by less than 2% on a sequential basis, and the effective tax rate, excluding discrete tax items, is expected to be 19%.

Now let's open the conference call up for questions. Operator, we are ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Jim Ricchiuti from Needham & Company.

James Ricchiuti - Needham & Company, LLC, Research Division

I'd like to start off with the opportunity in the logistics market. Rob, you say -- it sounds like you see some additional follow-on business. Do you expect that from the same customer in terms of the substantial activity you're seeing? Or do you see new customers coming on?

Robert J. Willett

Well, Jim, as you know, we've been moving into the logistics market for some time, and we've been in some lengthy evaluation trials with many customers. The customer we reported winning the large order from is one of many significant customers we expect to have in that market. I would say it was the first breakthrough, but we expect more orders from that customer but perhaps, more importantly, from other large players in that market to come over the next quarters.

James Ricchiuti - Needham & Company, LLC, Research Division

And just the way I think we've discussed this, I think you've identified this as a potentially $250 million market opportunity. I don't know if that's changed at all, but it does seem as though, clearly, you're getting some real validation in the marketplace. And at this point, do you see the ability of the DataMan product to really have a more significant penetration into the market, perhaps at a faster rate than you were anticipating?

Robert J. Willett

Sure. I mean, I would say that we're at the beginning of the adoption of Cognex vision and logistics, right? And if it's kind of an S-curve, we're still pretty near the bottom of the S-curve, and we're beginning to make our way up it. And I would say that's probably pretty typical. I would say we have a very minimal share in that market. You sized it at $250 million, as I have in the past. I think we think that's the total opportunity. And it's quite a long journey for us into that market, but we're really still very early in the stage of developing. To put a little more color on that, I'd say we think the ID market that we serve today is north of $1 billion. And we probably -- we have less than an 8% share in that market, but we're growing it substantially and we think we can go on growing it at 30% a year. Logistics will be part of helping to penetrate that as we get more, but I think it's emblematic of kind of where we are in our journey in ID. Still pretty early on with a lot of market to penetrate and a really great set of products behind us and a really now much more capable sales force in order to take us along that journey.

James Ricchiuti - Needham & Company, LLC, Research Division

Dick, can you say what ID represented in terms of total revenue -- percent of revenue in the quarter and what the increase was?

Richard A. Morin

Yes. Let's see. ID products was approximately 24% of total revenue in the quarter, and it was about, let's see, over Q2 of last year, almost an 18% increase.

James Ricchiuti - Needham & Company, LLC, Research Division

And does that exclude currency?

Richard A. Morin

No, it does not.

Operator

And we'll take our next question coming from Ben Rose from Battle Road Research.

Ben Z. Rose - Battle Road Research Ltd.

For the large order that you recorded in the logistics area from the retailer, could you tell me if it is primarily being used in newer fulfillment centers or in existing fulfillment centers?

Robert J. Willett

Yes. The customer is purchasing DataMan readers for their new U.S. distribution centers that were built in 2013, but we'll also retrofit their highest volume facilities still in the U.S.

Ben Z. Rose - Battle Road Research Ltd.

Okay, great. And is it -- Rob, is it primarily the DataMan 503 or the DataMan 50 that they'll be deploying?

Robert J. Willett

No, it's primarily the DataMan 300 but also the 503 as well. I think we see the 503 as kind of an important wedge in getting into that customer. Our ability to be able to serve the whole part of the market has obviously pulled through a lot more of DataMan 300 readers than we otherwise would have seen.

Ben Z. Rose - Battle Road Research Ltd.

Okay. And as far as the additional retailers that may be deploying the ID products during the course of 2013, are they also primarily in the United States?

Robert J. Willett

Yes. We're really seeing -- getting a lot of traction here in the U.S., and that's correct. You said retailers, some of them are major retailers. You would recognize the names, but there are also other -- players in other industries such as courier providers or post offices.

Ben Z. Rose - Battle Road Research Ltd.

Okay, great. And then just one other case. I know that you are in the process of introducing your first major 3D Vision system, and I was just curious to get your feedback as to what you're seeing in terms of early use cases. Is it primarily automotive or some of the other industries that you serve?

Robert J. Willett

Yes, Ben, it's a good question. That's where the beginning also of that market -- entering that market, and we're seeing pretty wide range of applications, I would say. We've had some of our first major wins in automotive, and -- as you would expect, but -- and then other markets we expected like electronics. But interestingly enough also, we're seeing some pretty interesting opportunities on our pipeline in consumer products and even in food.

Operator

And we'll take our next question coming from Richard Eastman from Robert W. Baird.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Rob, how did China -- or Dick, how did China perform in the quarter in FA? I think you had talked a little bit about Asia. Japan was down. So China must have been pretty substantial, plus 25 or something or...

Robert J. Willett

Yes. We had a great quarter in China. Our factory automation business in China was $10 million in the quarter. It was a 41% increase year-on-year, driven primarily by consumer electronics. But also, we're getting real traction in the automotive market also in China. And then in ID, we saw substantial growth in ID products in China also growing more than 50% year-on-year in the quarter.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

And was the consumer electronics rebound -- was that market-related? Or is there any new application share gains there?

Robert J. Willett

Well, consumer electronics can be kind of -- it can depend on product development cycles by major consumer electronics companies. So I think it's fair to say we had some pretty significant success with major players in that industry which fed through and look like will continue to do well for us in the coming quarters. So I think it was a little bit of share gain and -- but also just a design cycle where I think we've been working for a while and saw things doing well for us.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay, great. And then I just have a question. On the SEMI OEM business, I know how we try not to give any kind of guidance on this. However, looking at SEMI back-end equipment bookings, they largely -- from February of this year through May have largely doubled, and that's just data from the SEMI association. And I'm curious, does that give you a positive vibe 6 months out towards the end of this year? It was pretty substantially increase in bookings for SEMI back-end equipment, guys. I mean, do you feel better about that business 6 months out?

Robert J. Willett

Well, Rick, I agree with your opening statement that you are always asking, and we're not giving you guidance on that. But, I mean, yes, I think we all read the same reports you do. I think it's -- we're not seeing a broad-based recovery in orders from our customers. The improvement in SEMI that we've experienced over the past few quarters has been limited to higher sales to just certain customers, the customers I'd say that look like they're winning in this market from the research we all read. But so far, we've not seen a broad-based recovery from the market downturn. So I think we're not necessarily predicting significant increases, although I think we're hopeful that the market should increase a little in the back -- in the second half.

Richard A. Morin

We're feeling better than we did 6 months ago.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. Well, you know what, it's very comforting to know that we read the same things, that we're well-read. And then just one last question. I'm curious on the In-Sight, this Track & Trace 2.0 product, again, kind of targeted at this pharma market and the counterfeiting side of this. Does that product address any of the issues that you may have bumped into with 1.0?

Robert J. Willett

Well, as you'd expect, with any product development at Cognex, our products are better and better with each generation. So certainly, issues like ease of use, speed, OCR, optical character recognition, and barcode read rates and performance are substantially better. So as much as of those issues are -- were holding back 1.0, they've been addressed in 2.0. But I would say this market for pharmaceutical Track & Trace, it's one with a lot of potential but still pretty hung up by government regulation. Regulations seem to be on the way and have been on the way forever. So we've seen some pretty nice moments where governments such as the one in France passed CIP 13 regulation over a year ago that did feed through into some nice business for us. And I think we're hopeful that, that will occur also in other markets. But it's still difficult to predict.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Wasn't one of the issues in the Track & Trace market on the pharma side, that the route to market was more through engineering shops or most consulting firms to get product or components into that market? And I just -- is this product like easier to network or easier to use or...

Robert J. Willett

Well, I mean, that market is served by a lot of integrators, and large pharmaceutical companies generally are implementing middleware from many, many companies to service that -- those Track & Trace needs. And I would say over the last 2 years, we've signed up with a lot of those integrators. And what they've seen, and they see our products now more powerful, easier to use, but I think they've also recognized as lots of companies do that try to produce -- try to get into the Vision market is that vision's really difficult. And it requires a lot of R&D and engineering expertise, and they realize that's not a core competence. And now we've been able to pick them up as customers of Cognex. So certainly, that has occurred in at least 3 occasions that I'm thinking of over the last 18 months.

Operator

And our next question is from Jagadish Iyer from Piper Jaffray.

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

Two questions. Can you guys talk about the logistics business? I was wondering it's all U.S.-centric. Have you had any penetrations or kind of serious engagement with non-U.S. players and where you are in terms of the logistics business?

Robert J. Willett

Yes. Absolutely. So I'd say we're seeing the most kind of penetration and adoption of our product in the U.S., but we are certainly seeing trials and initial orders in Europe coming through from major retailers. And, in fact, the major order we got from this very major retailer also placed a small first order in Europe as well. So I think we're seeing that. I'd say, typically, it's our experience with new products that America is earlier to adopt than other places. But we've also -- and we've also seen though the beginning of some orders and some initial orders from logistics businesses in China as well and in Japan. So we're seeing the seeds of business beginning, but it's still some way behind, obviously, the adoption rate that we're starting now to see in the U.S.

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

Yes. And what was actually the reason for the wins there, given that it's a long evaluation cycle? Can you give us some highlights in terms of what were the winning criteria and how you did it in terms of winning against the competition?

Robert J. Willett

Right. Yes. So Cognex Vision wins in ID because the technology is just vastly superior. Why is it superior? Well, read rates are much higher. Typical read rates on a Cognex Vision System would be well north of 99%, and on the product it's replacing, which are often lasers or line scan Vision Systems, those read rates are frequently around 95%. So if you think of a big logistics factory that's producing and shipping thousands and thousands of boxes a day, that means that with Cognex readers, they are reading significantly more boxes that don't need to be reworked, held up, slowed down going to customers. So that's the #1 reason. Our read rates are substantially better. There are also other reasons, including the fact that our products have no moving parts. So they're much more reliable. They tend to break down much less frequently. And finally, the price point now of Cognex Vision is, in some cases, significantly lower than what our competitors are charging for laser-based or line scan-based Vision Systems. So it's pretty easy decision once a customer really evaluates, gets their head around issues involved and seize our performance to see that this is pretty majorly disruptive and superior technology. And that's what this customer is seeing, and that's what other customers are starting to see in the space.

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

Okay. Fair enough. One last thing on the -- if you have to look at the second half of this year between your 3 segments, SEMIs, web inspection and the third segment, how would you basically describe the kind of -- the trajectory one would see between these 3 segments in the second half of this year?

Robert J. Willett

Yes. Well, I think factory automation we see, obviously, it's the biggest part of our business, and it's the piece that -- where we're investing most and we see we're most optimistic about. So you may have seen some nice performance, and I think we're positive about seeing that continue. Surface inspection, typically, the second half of the year is better for surface inspection. The first, we expect that to be the case here. We have a strong order book in that business, and so we're very positive about the outlook of that. And as Rick Eastman, one of the former callers, asked and I replied, SEMI is much more difficult to predict. So I'd say that's the area where we're least informed, I would say, or least capable of saying what we expect to happen in the second half.

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

Okay. And this is a question, sorry, for Dr. Bob. Just quick thoughts on why stock split now. Any thoughts on that besides catering to different investors? Why now?

Robert J. Shillman

Well, as you probably know, most institutional investors don't care about the price of the stock, they care about the quality and the company behind it. And that's true for I think all investors care about quality of the company and the quality of the management team, the quality of the earnings and the likelihood those earnings and financial statements will continue to impress. However, there are people who wish to buy 100 shares of stock or 200 shares of stock, and to them, the price per share does matter. And we would just as soon include all those shareholders, including retail, which are more sensitive to the style of the price of stock. And we envision the company continuing to do very well under management's leadership. And we are confident that the stock will continue to maintain itself in the double-digit price range. But when you looked at other -- when we looked at other high-tech companies, the price typically is some way between high-teens and the high-20s. And we felt that we will be doing those retail shareholders a favor by keeping the price at that range.

Operator

And we'll take our next question coming from Jeremie Capron from CLSA.

Unknown Analyst

This is Grace [ph] sitting in for Jeremie Capron today. I have several questions. First, investment in new products and distribution have had a sustained impact on operating expenses, we think. And then it has -- we noted that it has outgrown revenue for a couple of years now. How should we think about these going forward?

Robert J. Willett

Yes. So I think what I would say about that is, obviously, over the last couple of years, we've seen a situation, and I would say more like last year, we've see a situation in the market where the market hasn't been that responsive. But we've seen -- we've noted our very positive outlook about where Vision is going ultimately. So Cognex is a company that recognizes that we're bringing very powerful technology to a market that has very substantial growth potential over the long term. We size that growth potential in factory automation to be around 20% compound annual growth; ID, 30% compound annual growth. And we're investing behind our vision that we can accomplish that. So we're not ones to think about the short term to be cutting growth programs or investment opportunities based on shorter-term considerations. We also -- we see great opportunities for Cognex. But we're really delivering on now around China and ID, and these are areas where we've invested substantially in our sales channel and in our products. And, again, we see those investments coming through. I'd say going forward, if you look at what we just told you in the call today, we're expecting sequential growth in Q3 to be higher, almost double the rate, if you take the middle of guidance from what we're saying we see expenses increasing at. So, obviously, you can see that trend potentially unwinding going forward starting in Q3.

Unknown Analyst

I see. And then second question is about buying backs. I mean, starting buying backs is definitely good news, even though the share price is a little bit elevated. And should we expect a similar pace of buying back for the rest of the year?

Robert J. Shillman

This is Bob, Dr. Bob, speaking. And the objective of our buyback is to counteract the effect of stock option dilution. We strongly believe that even after 32 years in business, that stock options remain a valuable way of attracting and retaining employees, and from the shareholders' perspective, it maintains -- stock options offer us the opportunity to hold salaries at a reasonable level. The overall package that we offer our employees we believe, we hope is the best of all, but it generally does not include the highest salaries. We hold salaries somewhere around 70 to 80 percentile, and we make up for that by stock options. Now there are many shareholders in the past institutions who were reticent to sign up or to give us permission to increase the number of options that we grant or to renew the plans. And as a nod to them, what we're doing is putting in place our plans to continue buying stock back irrespective of price. Now that may not be always be true, but pretty much irrespective of price to buy back the dilution caused by options that previous year. So that the argument that stock options are dilutive will no longer be in place.

Unknown Analyst

I see. And the last question is about North America. Are you seeing any changes in sort of a competitive dynamic in North America, because, Keyence, which you referred as a key competitor in previous call, we noted that it reported phenomenal growth in U.S. in recent quarters? We are wondering what are -- this affects Cognex to any degree. If you can give us some color on what this aspect, that would be great.

Robert J. Willett

Sure. I think -- so we're seeing nice performance from our Americas business. Factory automation in Americas is $25 million in the second quarter, up $3.7 million or 17% year-on-year. So we're seeing some nice acceleration in that business. The -- in terms of our market share in the U.S., we have very substantial Vision market share in the U.S. And we are seeing other competitors -- we do see other competitors coming and going in that marketplace. Some certainly are losing share. The one you referred to, Keyence, is certainly a serious competitor. Their share at the U.S. Vision market is still very small, but their company is quite large. And Vision represents less than 10% of their overall revenue. So I think the numbers you're referring to certainly -- if you have any specific Vision numbers on Keyence sales in the Americas, I'd sure like to see them, but I don't think they are readily available. But I would tell you that they're pretty small.

Unknown Analyst

I see. Yes. We don't have a specific number for U.S., but we just realized that overall number looks good. So -- but you don't see any sort of changes and competitive dynamics for this?

Robert J. Willett

Well, no. We see them investing significantly in the market, but obviously, as your first question referred to we're investing too pretty significantly. I think we both see this as a great market with a lot of growth and high-margin potential going forward.

Operator

And our next question is coming from Tom Hayes from Thompson Research Group.

Thomas L. Hayes - Thompson Research Group, LLC

Just a quick question. Most of my questions have been answered. I was just trying to get your thinking on the pace of the continued sales force expansion. I know it's a topic we've been talking about for the last couple of quarters. I was just trying to get a read, as you indicated in your release, maybe a slowing of the sequential SG&A growth. I was just wondering if that's a read-through on your -- change in your pace of additions for sales force?

Robert J. Willett

It's an interesting question, Tom. I mean, we're focusing a great deal on sales productivity at the moment, so we certainly added a lot of salespeople, particularly in China. And we're very focused on bringing them up to speed. We've implemented a new CRM system that gives us a lot more visibility, which we now had in the market for -- in operation for over 6 months. So our focus is on productivity, and we expect sales per salesperson to improve substantially in the coming quarters. But depending on what we see, we may go on adding salespeople as well at a good clip if we think the growth opportunities are there. But we're very mindful of sales, expenses and revenue growth and making sure that those 2 are well in line and correctly in proportion and in the long term.

Operator

And we'll take our next question coming from Ben Rose from Battle Road Research.

Ben Z. Rose - Battle Road Research Ltd.

Just a follow-up question for Rob. On the automotive market, I know that you mentioned factory automation in China was very strong this quarter, and specifically, the automotive industry you cited is one of the drivers there. Could you talk a little bit about what's happening in the European factory automation market for automotive and as well in North America?

Robert J. Willett

Yes. Sure. So in revenue from the automotive industry in Q2 increased 5% year-on-year, and we're seeing -- we think it's an important contributor, and we do see automotive revenue continuing to grow, particularly in America as we look forward into the second half of the year. But we do expect even some growth in Europe in automotive, primarily in Germany and Eastern Europe. But I would say, compared to other industries with overall growth, I would say, automotive may be slightly behind what we expect to do overall for all of our industries this year.

Ben Z. Rose - Battle Road Research Ltd.

Okay. And is that to say that you would see electronics as your fastest-growing opportunity overall? Or how would you characterize perhaps some of the other faster-growing market segments at this point?

Robert J. Willett

Yes. I'm referring to percentage growth rates, okay? So automotive is and will continue to be our largest market this year, certainly, accounting for somewhere in the mid-20 percentage points of our overall FA business. But I would say in terms of faster-growing verticals, obviously, electronics, yes, on a percentage basis, but we also see very substantial growth in consumer products on a percentage basis. This year, pharmaceuticals should well-outpace those also. So some of the smaller verticals where we're starting to see broader adoption of machine vision clearly will be contributing higher percentage growth rates. And, of course, logistics, we expect to see very high percentage growth rates in that market. So those are more, I'd say, early adopters of Vision and, hence, the growth rates we expect to be faster than in automotive.

Operator

[Operator Instructions] And we'll take our next question from Jim Ricchiuti from Needham & Company.

James Ricchiuti - Needham & Company, LLC, Research Division

Rob, can you talk a little bit about what you're doing with this new initiative, the advantage engines? I know we're only a month away or so from the Analyst Day. Is this going to be a variant of the DataMan 300 engine that you're planning?

Robert J. Willett

Right. Okay, yes. Well -- so for a while, we've been looking at the life science market, which is a market where a substantial number of barcode readers are being sold into equipment that is used to analyze a test tube with your blood in it or other bodily fluids in the life science market. So we've seen that market as interesting, and we launched our first product into that market a couple of years ago and kind of liken it in some way to logistics where we launched a product a couple of years ago, the DataMan 500, which started to get us into that market. And we learned a lot. And our second kind of foray into that market, second push, is really producing substantial results. So in a way, it's analogous. Like we launched a product into that market, we learned the life science market, and we learned about it, the first image engine. And now we've launched the second family of image engines, which are -- you'll see when you come much smaller, much more powerful, lower price point. And we're now having some significant success in that marketplace with the new product. What is the product? It's a tiny but very powerful image engine, with a lot of powerful vision tools on it, not only ID but many different capabilities. And I think an important thing to understand about that life science market though, Jim, is it's a market that has a very long sales cycle. So big producers of life science equipment are developing products over about a 3-year period before they launch them, and a substantial part of it is getting government approval for the product. So we're now seeing some design wins in that marketplace, which will feed through, we believe, into substantial opportunities in revenue in coming years. But still, the near-term opportunities, you won't see in revenue for some time.

James Ricchiuti - Needham & Company, LLC, Research Division

And so when you talk about opportunities in kiosks and things like that, that's further out?

Robert J. Willett

Oh, no. So -- okay.

James Ricchiuti - Needham & Company, LLC, Research Division

Maybe I misunderstood.

Robert J. Willett

No, no, no, you're right. So we've been talking about life science, and life science is kind of the primary market. But this image engine really has a lot of other applications. And so because we've come out with something smaller, more powerful, easier to use, less expensive, it's opening up some other areas in that market, and some of them I referred to as printing. So we have had our first design win in the printing market, which is where you see kind of large, very expensive printing equipment that requires a lot of Vision inside it to do things like alignment and calibration of the machine. So we've seen a first substantial player adopting our engine into that market. And then a market we're targeting and we're seeing a lot of interest is specifically kiosks, the kind of thing you might see at your supermarket where you might get DVDs returned or other products like that, lottery-type opportunities as well where there's substantial image engines being sold today and the opportunity for our image engine to offer a lot more capability at a similar price to what's being offered by the current suppliers.

James Ricchiuti - Needham & Company, LLC, Research Division

Got it. So you could see potentially some revenue in 2014 from these areas?

Robert J. Willett

Sure. We're seeing small amounts of revenue even this year from some of those areas, but I think in terms of the big market opportunity, which is life sciences, we don't expect that to feed through. Although we'll see sales successes, we won't see revenue coming through, probably not until, yes, later 2015 perhaps.

James Ricchiuti - Needham & Company, LLC, Research Division

Got it. One final question relates to China and probably just because we've seen so many headlines around China. If we think of the [indiscernible] business, which is a more mature business, you've been in China, probably more traction there for a longer period of time, are you seeing any impact on that business from the potential slowing in China?

Robert J. Willett

Right. So yes, right, we do have substantial customers, particularly in the metals industry in China, and like you, I've certainly been reading about the tightening and the slowing down of the economy that's being seen in China. Here's what we're seeing in that market, which is the metals industry could be divided in -- broadly into 2 segments. One is more kind of commodity metals, and one would be more specialty metals. And the commodity metals customers, we're seeing suffering more with tight liquidity and kind of overcapacity in their industry. And they're, I think, under some pressure. But the real business that we're serving where we see much more opportunity and where we're seeing some quite nice growth potential is more in specialty metals and inspecting those metals for defects. And this is things like stainless steel used in appliances. It's also aluminum used in car bodies, which are being -- going forward for use in Chinese cars. Like you and I, we both read that China is now the #1 market in the world for new cars sold. So those opportunities for us, I think, more than outweigh the overcapacity, the liquidity issues that some of the bigger state-owned enterprises in steel are facing.

Operator

Ladies and gentlemen, I'm showing no further questions in the queue. I'd like to turn it back to Dr. Shillman for any concluding remarks.

Robert J. Shillman

Yes, thank you. Well, we reported very good results tonight for the second quarter, and we currently anticipate similarly impressive results for the third quarter based on the order book that we've put together. These results are clearly due to just the great people on the Cognex team working hard for us to develop the new products and then to manufacture them and, finally, to deliver them all over the world. Finally, as you may have seen in the news release that we issued also tonight, we declared a 2 for 1 stock dividend, and this action was done really to reflect the board's confidence in our financial strength and where we see the company and, therefore, its stock going in the future.

Thank you for joining us tonight, and I look forward to seeing all of you at Analyst Day at our headquarters in Natick, Massachusetts on September 10. That's it for now, and see you then. Bye-bye.

Operator

Ladies and gentlemen, this does conclude your conference. You may now disconnect, and have a great day.

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