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Cognex Corporation (NASDAQ:CGNX)

Q2 2008 Earnings Call

July 28, 2008 5:00 pm ET

Executives

Richard Morin - CFO

Bob Shillman - CEO

Analysts

Rick Eastman - Robert Baird

Jim Ricchiuti - Needham & Company

Jonathan Raceland - Barrington Asset Management

Jim Margaree - David J. Green

Alexander Paris - Barrington Research

Chuck Murphy - Sidoti & Company

William Pike - Pine Street Securities

Operator

Good day, ladies and Gentlemen and welcome to your Cognex Second Quarter 2008 Earnings Call. At this time all participants are in a listen-only-mode. Later we will conduct a question and answer session and instructions will follow at that time. As a reminder today's call is being recorded.

I would now like to turn the call over to Mr. Richard Morin. Sir, you may begin.

Richard Morin

Thank you, and good evening, everyone. Earlier tonight we issued a press release announcing Cognex's earnings for the second quarter of 2008. For those of you who have not yet seen this report, the copy is available on our website at www.cognex.com. The press release contains detailed information about our financial results and because of that we are not going to repeat most of that material.

During tonight's call we may use non-GAAP financial measures that we believe is useful to investors or if we believe it will help investors better understand our results of business trends. For your reference, you can see the Company's Income Statement as reported under GAAP in Exhibit 1 of the earnings press release, and a reconciliation of certain items in the income statement from GAAP to non-GAAP in Exhibit 2.

I would like to emphasize that any forward-looking statements we made in the press 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 companies SEC filings including our most recent Form 10-K for a detailed list of these risk factors.

Now, I will turn the call over to Bob Shillman.

Bob Shillman

Thanks, Dick, and good afternoon or good evening everyone. It happens to be afternoon. I am in our office in San Diego, California, and Dick and his staff, Sue Conway, are all in Boston. Welcome to the call.

Well, as you can probably see from the press release, we reported revenues of 67 million in Q2, and income from continuing operations of $0.21 a share. I am pleased to say that these results represent a nice increase over the prior quarter and a substantial increase over the second quarter of 2007.

Let's now go down the P & L now. First revenue, in the semiconductor and electronic capital equipment market which we call semi, revenue was approximately 12.5 million in the second quarter. That group has been in steady decline since early '06 and that trend continued in Q2. Revenue was down by approximately 5% from both Q1 and the prior years Q2.

In the Surface Inspection market, revenue was nearly $9.5 million which was a very good quarter for our Surface Inspection systems division which we call SISD. This represents an increase of 50% over Q1 and 40% over the Q2 of '07. Business is currently quite good in this market, particularly in the metals area where we are winning many new accounts particularly in China and elsewhere in Asia, and in fact, if you have not seen it, there is a very exciting press release about a major account win in Taiwan. It was a China Steel, which is the largest steel manufacturer in Taiwan.

They recently placed a multi-million dollar order for multiple smart new Surface Inspection Systems. I am sorry I can not give you the exact dollar amount for competitive reasons, the customer China Steel asked us not to do that. This is the largest single Surface Inspection order we have ever received on a dollar basis. It is for seven smart new systems that are scheduled to all be installed during the second half of this year. These smart new systems are going to be used to inspect steel surfaces at various stages of production to ensure that the steel meets their highest quality standards. Just for your information, a lot of the steel is used in automotive applications, hoods, trunk, lids, and decks and visible parts of the car.

Moving on to Factory Automation, that is our largest market segment. We reported record revenue of $45 million in Q2, and it represents an increase of 10% over the old record, $41 million which was just set last quarter. It is an increase of 30% over the equivalent quarter a year ago in '07.

Most of the revenue increase in Factory Automation was from Europe, where revenue increased by 3.5 million or 21% over just the last quarter, and by 6 million or 43% over Q2 of '07. These increases were due to strong demand during Q2 in that region, as well as the impact of foreign exchange rates, but even if you exclude those foreign exchange rates, Factory Automation revenue would have increased business in Europe by approximately $2 million or 13% on a sequential basis and approximately $3 million or 23% on a year-on-year basis, so the sales team is doing great job in Europe.

On the cost side, there are three special items in Q2 that I would like to give you some more insight in. First, we recorded a loss of $3 million, about $0.08 a share, related to the sale of our lane departure warning business, which we described in our press release which was issued earlier this month I think it was on July 2nd. The second special item was the loss of $647,000 due to FX changes and unfortunately hedging these balances is not an exact science and this quarter we had a loss due to the exchange rates. Third special item in Q2 was a higher than expected effective tax rate.

We plan to have a rate of 24% in Q2 which is the same rate that we had in Q1; however the actual rate was 25% due to a change in our estimate, of where income will be recognized for 2008, from a tax standpoint. This is continually re-evaluated throughout the year and there are a number of assumptions that go into it, many of which are not under our control. So our current expectation is to have an effective tax rate of 25% in '08 and that is the rate we recorded in Q2 and there was an additional catch-up amount for the lower rate that we recorded in Q1. Excluding the FX loss and the higher taxes, income from operations for Q2 would have been $0.22 a share.

The last topic in my prepared remarks, concerns our guidance for Q3 in the current tone of business in each of the three primary markets that we serve.

In the semiconductor and capital equipment business that we serve, where we sell our products to capital equipment makers, demand continues to be soft and the timing of a pick up is uncertain. In Surface Inspection, the order rate has been very good for the past three quarters. I believe every quarter, well I can not tell you what every quarter was but I will tell you, very strong bookings like we have never seen in the past, for three quarters, in each quarter.

We are continuing to close new accounts and we believe we are increasing our market share. For Q3, we believe the revenue will reflect the higher level of business that we are seeing in the marketplace as we convert orders that are on our books and backlog into shipments.

Lastly in Factory Automation, we are planning for Q3 revenue to be down on a sequential basis due to the seasonality that we typically see during the summer months. This year however that decline may be steeper as the slower business trends we have been experiencing in the US now appear to be spreading into Europe, where we have recently seen some softening.

We expect the Factory Automation revenue will increase year-on-year but not as much or not as great as it would have mainly due to economic or only due to economic headwinds. Taking all of these above factors in consideration and many more that we have not talked about, we now expect total revenue for Cognex in Q3 to be somewhere between $62 million and $65 million, and at that range of revenue we are now expect the earnings somewhere between $0.14 and $0.18 per share.

That is it for our prepared comments. We will open the phone now for any questions you may have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Robert Eastman with Robert Baird.

Rick Eastman - Robert Baird

This is his brother Rick.

Richard Morin

Hi, Rick.

Rick Eastman - Robert Baird

Just a couple of things. One is, could you just give us the Fx impact on the quarter in revenue?

Richard Morin

In total, the Fx impact relative to both Euro and yen on revenue was approximately $3 million. Then there was an increase in OpEx of about $1.4 million and an increase in COGS of about 600K.

Richard Eastman - Robert Baird

Okay, thanks. And then a question I have on the geographies. Bob Shillman, could you just walk us through perhaps maybe in local currency or just in revenue dollars, what pieces of the business were driving the growth in the various geographies?

Bob Shillman

Okay.

Rick Eastman - Robert Baird

If it is impossible to do, first is the Americas was down 1.3, did most of that come in I don't know vision for ID products or can you give us a sense of just kind of overlap the revenue by product with the geography?

Bob Shillman

I have a revenue and a breakdown by geography and another one by industry and by product, but I don't have it, curtain bind, in other words. I can't tell you that.

Richard Morin

Yeah, we don't have that. I mean it's available within the system but we haven't really put together the analysis for the call here that shows by region, by specific industry.

Richard Eastman - Robert Baird

And then, can I ask a question on service? Is that -- the fact that service was down year-over-year double digits, is that a timing issue? Does that have anything to do with the SISD business or what are we looking at there?

Richard Morin

There are combination of factors there, one of which of course relates to SISD and the acceptance and installation as they do. The other thing two is that relative to some of our products that are getting easier to use or whatever, we no longer because they are easy to use we no longer have to differ revenue at the time of sale and we record the support cost as an ongoing cost with no revenue.

Rick Eastman - Robert Baird

Alright. So that likely is to kind of stay around the same dollar level until our SISD installs jump up and then we'd have more service?

Richard Morin

Yeah I think to a certain degree on the MVST side, we'll continue to see the service -- their level of service revenue decline probably through -- slightly through the second half of this year and then it will reach if you will steady, a steady level Rick. The SISD really is almost impossible to predict because a lot of times its not only tied into when we in fact complete the installation but when in fact the customer gives us the sign off and the final approval.

Rick Eastman - Robert Baird

Okay. Alright. And then just last question. In Europe, you commented that you're seeing some of the US owners may be carryover into Europe, what industries -- is that Europe Auto or--?

Richard Morin

Yeah actually, it was principally in the auto industry and certainly in some of the machine tool builders and system integrators that we sell to, so we saw it from auto companies. But on the integrators and machine tool builders, some of that may have been auto; some may have gone into other industries; it's impossible for us to tell because we don't know specifically where these integrators may be selling their final product.

Rick Eastman - Robert Baird

All right, very good. Just one last comment I think Dr. Bob

Bob Shillman

Yeah.

Rick Eastman - Robert Baird

Nice choice on Bob Willett.

Bob Shillman

Oh, thank you very much.

Rick Eastman - Robert Baird

Thank you.

Operator

Our next question comes from Jim Ricchiuti with Needham & Company.

Jim Ricchiuti - Needham & Company

Hi, thank you. I just wanted to question on the Americas, get a sense as to how that business looks in Q3 do you expect further weakening just as a result of the economy softening in Europe, I'm sorry softening here?

Richard Morin

I guess, we're expecting a couple of things, I think, in the second quarter, Jim, one of which is, in the third quarter rather, one of which is clearly you'll see the typical slowdown in Factory Automation that comes from the summer months with European countries and their vacations. The other thing that we are thinking or we are expecting to see based upon what we saw late in the second quarter is that there may be a slowdown on top of that related to the general economic condition.

Jim Ricchiuti - Needham & Company

Great. Dick, I'm also trying to just get a sense of the economy has taken a bigger bite out of the Americas business in Q3 and specifically what markets have things really began to soften and even further?

Bob Shillman

Well, first of all, let me interrupt. I'm looking at revenue in Americas and FAA, and compared to Q1, we are up about almost 12% in the Americas so.

Jim Ricchiuti - Needham & Company

Okay, and Bob, is some of that, in the Americas you've made certainly some real improvements within that operation over the last couple of quarters.

Bob Shillman

Yes.

Jim Ricchiuti - Needham & Company

To what extent is it the internal improvements you have made? I'm trying to get an idea just do we see the economy maybe taking a bigger hit going forward in that part of the business even with the improvements you've made in the business or do you feel that you still have enough momentum from some of the changes you've made within the organization?

Bob Shillman

Well, my expectation, and I have to look more at the model that Dick has created that Americas are not going to go down anymore substantially. We've already seen, I'm looking at a chart that shows automotive bookings which started declining in about Q2 '05 and I think they are stabilized now; however, Europe, we are concerned of Europe. Europe showed an increase, revenue wise in Factory Automation from Q1 to Q2 of about 20%, little over 20%, and we're concerned that that will be slowing if indeed or when, I should say when the economy slows down in Europe and we're already hearing signs of that now.

Jim Ricchiuti - Needham & Company

Okay. One final question if I may. Bob, how is the reception to some of the newer products going and can you comment a little bit about some of the investments you've made in Asia, particularly in China and Japan and to what extent can you see that perhaps helping business going forward or do you see, are you a little concerned about the economy in that part of the world as well?

Bob Shillman

No, really the economy is now the worry that we have of the products, all of the new products that we've announced. There are still some in testing that aren't released to the general sales force, some new versions of check-up and that aren't generating any revenue because they rally not in the hands of the sales force so we don't know enough about those products yet. But the products that we introduced, the In-Sight minis, the new version of Checker is are all doing very, very well, DataMan is doing very well, our readers, we seem to be dominating at least the high end business for ID, so the products are fine and the sales force is now back to where it should be and the distributors are all aligned now and it seems to be satisfied with the way we are managing it, under Eric's role [ph]. The biggest issue now is the price of oil and the economy and all with these countries; however, we have not seen any change in China. We're doing very nicely in China and in Asia, both MVSD and SISD.

Jim Ricchiuti - Needham & Company

So are you going to continue to invest in sales infrastructure in that part of the world or you do you feel it's just kind of a?

Bob Shillman

Absolutely.

Jim Ricchiuti - Needham & Company

So it has continued to raise increased headcount amount for is that correct?

Bob Shillman

That's correct.

Jim Ricchiuti - Needham & Company

Okay, okay thank you

Bob Shillman

And also in Eastern Europe.

Jim Ricchiuti - Needham & Company

Okay, terrific. Thank you.

Bob Shillman

You're welcome.

Operator

Our next question comes from Jonathan Raceland with Barrington Asset Management.

Jonathan Raceland - Barrington Asset Management

Good afternoon.

Bob Shillman

Hi.

Jonathan Raceland - Barrington Asset Management

Bob, a question. There seems to be a substantial increase in the amount of contamination of food products, either grown in this country or coming in from overseas. Wondering if there are any opportunities in the product tracking area, for anything in that field for you?

Bob Shillman

Well, the first comment is that I would think that there is not a substantial increase in these things. It's probably like everything else, it's a substantial increase in the reporting of these things.

Jonathan Raceland - Barrington Asset Management

Okay, that's fair.

Bob Shillman

You know, I think there is probably just as many change in the top or slightly just as many kidnappings today as there were, 1950, you just hear about them everyday now so you feel there are more of them and more are missing this and more Salmonella, I think probably the same or less because though we have better controls. Nevertheless it makes people much more aware of the situations of contamination and that is a good thing for machine vision.

Now the contamination that we've been hearing about recently is of salmonella for example and bacteria and the Cognex machine vision isn't going to help with that. However, certainly in the food processing area for baby food, there are always big concerns about glass and proper labeling and in the medical area about mislabeling, things like that. So these are very good areas of opportunity for Cognex, and where we have recently been spending more of our sales and marketing time.

Jonathan Raceland - Barrington Asset Management

Good. Okay. Thank you.

Bob Shillman

Yeah, you're welcome.

Operator

Our next question comes from [Jim Margaree] with David J. Green

Jim Margaree - David J. Green

Good evening, gentlemen.

Bob Shillman

Hello, Jim.

Jim Margaree - David J. Green

Hi. Reading the third quarter preview of what you expect, it looks to me Bob you're ramping up R&D and SG&A pretty substantially. Could you give us some sense as to what you're seeing, why that ramp up?

Bob Shillman

Well, I can tell you the R&D ramp up is not related to headcount. Dick will give you some more details on the R&D, but it's not related to additional headcount, which we are being very careful about, especially in higher expense areas around the world. If we do expand, we are hoping to do that in places that are closer to our growing customer lists, which are in Asia and Eastern Europe. The SG&A ramp up is due mainly to opening new offices and adding to the sales force. But I'll ask Dick to give you more detail on that if he wants.

Richard Morin

The principal increases that we're expecting in OpEx for Q3 will not be in the G&A area. There will be some in R&D. We're looking -- we've got a couple of projects where we're going to be using some outside services. We will be adding some headcount, but most of those additions will be occurring in lower cost regions. And in the selling side, its mainly adding additional sales people, their related travel and expenses and also as we are opening new sales offices, the rent etcetera that's incurred there.

Jim Margaree - David J. Green

But do you have, maybe highlight where the new sales offices are going to be located?

Richard Morin

Sure. We are opening another one and for a fact, another one in China.

Bob Shillman

That will be our fourth or fifth, Dick.

Richard Morin

This will be our third major, fourth major office if you will. We have various offices where the salesman is essentially working out of his home or whatever.

Jim Margaree - David J. Green

Yeah.

Richard Morin

We are, will have, we are looking to open an office in Vietnam, are also planning a somewhat larger office in Hungary.

Bob Shillman

…and expanding the office in Shanghai?

Richard Morin

Yes.

Jim Margaree - David J. Green

Very good. Thank you.

Bob Shillman

You're welcome.

Operator

Our next question comes from Alexander Paris with Barrington Research.

Alexander Paris - Barrington Research

Good afternoon.

Bob Shillman

Hi Alex.

Richard Morin

Hi Alex.

Alexander Paris - Barrington Research

Could I get a little more feeling for the Factory Automation in the second quarter the dollar sales of the US versus Europe, can you give that out?

Bob Shillman

Sure. I can tell you that. In the Americas, I don't have it broken down by north and south its mainly north, it's North America including Canada but it's mainly Spain with the US. So let's see, I can tell you, well I have to add up some lines here. It's approximately $17.9 million, was the revenue in North America

Alexander Paris - Barrington Research

And Europe is--?

Bob Shillman

Europe turns out to be almost $22.5 million.

Alexander Paris - Barrington Research

And then Asia is pretty small relative to those two.

Bob Shillman

Asia not including Japan is about $6 million.

Alexander Paris - Barrington Research

Okay.

Bob Shillman

And Japan, since we're going through it, Japan is about $11 million.

Alexander Paris - Barrington Research

And then traditionally is US about the same size as Europe, is it just a lot lower just because your economy is down and there is no….

Bob Shillman

It has been in the past our major area, but now Europe is the most fruitful area for Cognex.

Alexander Paris - Barrington Research

Okay. And just another question. In the ID business, some of that goes into SEMI and some is in Factory Automation, is that correct?

Bob Shillman

That's correct. We have a product called Wafer ID, and that is separate. I don't think we lump in with our ID, although one could. We sold about $4 million of Wafer ID in Q2.

Alexander Paris - Barrington Research

So most of the ID is in Factory Automation.

Bob Shillman

That's correct. That's correct and let's see if I have an industrial ID, DataMan. Yeah, I would say that if I total up the other IDs that we have non-wafer ID, in Q2 we sold approximately $9.5 million of ID.

Alexander Paris - Barrington Research

Is that one of your still your fastest growing product area?

Bob Shillman

Fantastic. I can tell what that growth is. Yes, just In-Sight Industrial ID, was about 23% growth over Q1, alright.

Richard Morin

So one thing that I would comment on that is there is a possibility that we don't truly capture the total amount of In-Sight that is being used for ID purposes because lot of times we will be selling In-Sight and we are not exactly sure what the end application is and those would get lumped into In-Sight Factory Automation so the number that Bob just reported relative to ID is that is where we specifically know that it is going into an ID application.

Bob Shillman

Yeah, let me expand on that a little bit, Alex. It turns out we have a line called In-Sight Factory Automation which means our general purpose In-Sight product and which has many, many tools including in many cases ID, but we don't know whether the individual, whether the customer bought it because of ID or whether they bought it because of (inaudible) or whatever, so when we don't know it, we put it in the general pool of which we sold $23 million in Q2 but when we know it specifically we put it under In-Sight industrial ID, and that was about almost $4 million last quarter. So in reality what we are saying is that the ID numbers I give you might – they are the most conservative. There might be more money than that in that bucket if we actually knew.

Alexander Paris - Barrington Research

Okay just one other thing. The new products, I think you mentioned quickly, the ones that are already out and selling is the In-Sight mini, a new Checker?

Bob Shillman

That's right and there is there are two new versions of DataMan. Not new – well they are new versions and they are targeted at less complex but more price sensitive applications.

Alexander Paris - Barrington Research

And that's for (inaudible).

Bob Shillman

That's correct and those are all called DataMan. There are three versions of DataMan on the market.

Alexander Paris - Barrington Research

Those are up and you have good reception in all of those right?

Bob Shillman

I believe so. I have not looked most recently may be Dick has.

Richard Morin

I've got the numbers comparing Q1 to Q2 and we've seen excellent increases. Granted that Q1 was when we first issued those products or whatever, but in Q2, the In-Sight micro did

Bob Shillman

What about the ID, the three different ID products?

Richard Morin

It was about on the new ID products we did about 10 times as much in Q2 as we did in Q1.

Bob Shillman

Yeah, modest growth.

Alexander Paris - Barrington Research

Just one other question if you don't mind, maybe difficult to answer but particularly with your new mini products and new Checker products, as you would get a little bit more pessimistic about the economic impact, could you see or have you seen or would you visualize some essentially trading down while the consumer goes from high end to discount stores, manufacturers under pressure would trade down to Checker and In-Sight just to try to get some many very quick efficiency improvements at a modest price?

Bob Shillman

No, no. We haven't seen that ever happen and we designed the product so that they would not. Every time we come out with an inexpensive product, it is designed in such a way with the marketing in mind that it does not cannibalize the higher price product. Let me give you an example. The obvious example is In-Sight. In-Sight can do many, many, many different kinds of vision problems, whereas Checker can only do a very small, very specific kind of problem. So if someone needs an In-Sight, they have to buy an In-Sight. You can't buy a Checker to do an In-Sight problem it just doesn't work.

So it's not as if people are going to stop buying the Hummer, I don't need that image anymore but I still need to get around town and they are going to buy a Camry or something, it is not that way. The market is very interestingly segmented by those who need many tools and those who need only one tool and if they only need one tool, they have been buying only one tool. Similarly in the data acquisition area, in the area of DataMan, reading marks, that the high end DataMan, I forget the model number, reads very complex, hard to read marks, and if that's what you are marking, if you are marking on engine blocks and pistons and cylinders and parts of cars or metal, you need that high end DataMan because it has very specific lighting that works every time and you could not make that change to save a grand by buying the next version down which won't leave those marks. Just won't do it.

Alexander Paris - Barrington Research

That was a good answer. But my question was a little bit different in that you're going to these smaller products so you can increase the penetration of the market by getting people you didn't have before.

Bob Shillman

No, no, that's a different. Yes, okay maybe I answered the wrong question.

Alexander Paris - Barrington Research

But would that be accelerated because of the slower economy? May be the people -- I'm talking about the people that never bought Vision, now certainly hey things have--

Bob Shillman

Oh, yes, yes certainly. If companies are looking for ways to cut costs, automation is generally the way to do that and our product is a very small cost aspect, cost element of automation, a very low cost aspect, so if it's headcount that people are worried about and labor costs then certainly they automate and once you automate there is more opportunity for machine vision, so and even in low labor areas, okay? We are seeing tremendous reception for our products even in lower labor rate areas because they know that inflation is going to raise those labor rates where it doesn't raise the cost of automation. In addition, you get much higher quality so although countries like the Far east, let's say China, were making lower quality items and competing just on price, well people want higher quality.

They don't want flaws in things, and so even if the machines are more expensive than direct labor which is not the case, they would still have to turn to automation to meet the quality standards that people now expect. You buy a DVD player today for $30, you still expect it to be perfect, and if you can't get that from China you'll buy it from Korea, So, in a way what you're saying, what I'm saying is a softening economy should in some sense should increase the need for machine vision though there are other aspects of course that diminish the need for anything, and I don't know which one is going to better.

Alexander Paris - Barrington Research

Alright, thanks very much.

Bob Shillman

You are welcome.

Bob Shillman

Overall I would say, bad economy is bad for everybody.

Operator

Our next question comes from Chuck Murphy with Sidoti & Company.

Chuck Murphy - Sidoti & Company

Good afternoon, guys.

Bob Shillman

Good morning, Chuck.

Chuck Murphy - Sidoti & Company

Yes Bob, could you just talk a little bit about the SEMI business, I mean, I'm sure part it is just to take kind of general market conditions but, is there something more going on there, should we expect it to rebound sharply whenever the market turns in it's favor, how should we look at that?

Bob Shillman

Well we view the SEMI business, what we call the SEMI business, as a cyclical declining business. Was up and down but it's overall declining, and at least are positioned in it, And it is declining because of the customers who use to buy on average $4,000 per unit from us that included hardware and software, and cameras, and lighting and also other things, now have moved to just -- many of them have moved just buying software alone, buying cameras that are cheaper, cheaper supplier and hardware they'll do themselves.

But because of the extreme price pressure that these OEMs, these machinery builders are being put under primarily because of China, they have discovered and they have found that they're determined they want to do it themselves and in the past four years or so if technology has moved to a point where they can do it themselves. So whereas in the past, these products could only really be purchased from the vision company whether it was Cognex or one of our good company competitors because we had all of these components and only we have these components.

Now, these companies are finding well. The key element is vision but we're going to buy these other things elsewhere. So that made our -- and we looked every year at our average sale to these customers and the average sale was getting lower. And fortunately we saw this seven years ago or eight years ago and that's when we started our factory floor business, which completely has made up for, more than made up for any decline in the SEMI business.

Chuck Murphy - Sidoti & Company

Okay.

Bob Shillman

So, our play in the SEMI business is primarily at this point, at this point, primarily software. However, we see that turning in our favor when we start introducing product based on our new vision chip called VSOC, which is a very expensive and complex product to bring to market to manufacture, to design; and that's what I'm doing manufacturing in San Diego, putting in place the plans to start introducing this product.

This will get us back into the hardware plus software business because this VSOC can not be readily duplicated certainly by the OEM that can't be and probably by our competitors will have very big difficulty. So we hope to be in the business of once again supplying unique hardware, very small, very specific hardware, including the CMOS sensor and processing right on it to do things that you can't do any other way.

Chuck Murphy - Sidoti & Company

And so, that, excuse me, the hardware is only good with your software?

Bob Shillman

That's correct.

Chuck Murphy - Sidoti & Company

Okay.

Bob Shillman

That's correct.

Chuck Murphy - Sidoti & Company

Okay.

Bob Shillman

But the customer will once again want to buy them both from Cognex.

Chuck Murphy - Sidoti & Company

Okay. And what is the difference in performance or what you have you between your existing hardware and the new VSOC?

Bob Shillman

Well, first of all, not every customer will need the advantages of VSOC, but we believe it will open up many new opportunities. VSOC has the ability to acquire images and analyze them at perhaps a hundred times the rate that current cameras and software can do it, a hundred times the rate. So in those applications, and people will always increasing the throughput of wire-bundle of or di-bundles of probers always trying to increase the throughput and this will mean that there is no limit. You couldn't move the product quite first enough.

Chuck Murphy - Sidoti & Company

I got you.

Bob Shillman

Okay. But if, let me say that if the OEMs don't add -- want to add more features that they are happy with the features and performance they are getting then there is no advantage to these things. We are introducing these new technologies and probably in applications where they are currently not able to use machine vision, just not fast enough or not powerful enough.

Chuck Murphy - Sidoti & Company

Okay. Alright.

Bob Shillman

Just to be clear, what I'm saying is that the old SEMI business that Cognex was in will not rely, will not rely. We will find new businesses either in SEMI or elsewhere, but that business is almost at this point a commodity business.

Chuck Murphy - Sidoti & Company

Okay, yeah, I got you. Alright. And my other question was in regard to the competitive environment in Asia -- I'm thinking, before you had started to talk about I guess how machine vision might compare to other types of technology, I mean are you seeing more competition from the photoelectric sensors in Asia than you might another parts of the world?

Bob Shillman

Yes, to answer to that question. The new competitors on the factory floor are primarily not vision companies, alright. If you really want vision, if you just look and try to find the vision company, there aren't many that have revenue over $20 million a year and we are really the leader when it comes to machine vision. However on the lower end, on he Checkers and perhaps on some versions of In-Sight that we're coming out with, we do find that we are competing with the [Key Inc.], Banners and Omrons of the world. And they have a distinct advantage and that they know how to make low cost products very cheaply and they've been doing it for years.

They have very good distribution organizations, primarily third-party distribution except the Key Inc. And so they have the feet on the street and that is going to be the challenge. The challenge for us is not technology. We can always, I can say it very, very authoritatively and confidently that we always have better technology than a sensor company when it comes to Machine Vision.

Chuck Murphy - Sidoti & Company

So I guess what is kind of your comeback to them having the lower prices just that your system is more advanced and can handle higher speeds?

Bob Shillman

That's correct. Our systems will be able to do things that there's can't do and that's currently the case by the way. And in most cases, our products are able to do things where there's wouldn't work because of variations in color or lighting or illumination. So -- but the customers don't always know. And they may spend a lot of time and effort controlling the illumination for example, and if you buy our product you don't have to do that.

So it's a cost saving, but if you look at a price list you'll find their products cheaper and that's a marketing challenge to us to describe to the customer that the price isn't the whole thing. It's the installation. It's the price of ownership that's important, but some parts of the world, they may not believe that or may not understand.

Chuck Murphy - Sidoti & Company

Alright, great. Thank you.

Bob Shillman

You're welcome.

Operator

[Operator Instructions]. We do have a follow-up question from Jim Ricchiuti with Needham & Company.

Jim Ricchiuti - Needham & Company

Yes. Just a question with respect to the share buyback. I wonder if you could just bring us up-to-date on the status of that right now?

Bob Shillman

Well, Dick will tell you what we bought back in Q2.

Richard Morin

In Q2, let's see, we spent approximately $12.9 million to buyback just under 500 thousand shares.

Jim Ricchiuti - Needham & Company

And Dick, how much is left on the buyback?

Richard Morin

We have two open buyback programs. One of which being the 10b5-1 program that the Board established and that had $30 million in it. And the second one was an open program totaling $50 million. Out of that 890 million, we have approximately 77 million left to spend. Of authorization left.

Jim Ricchiuti - Needham & Company

Thank you.

Richard Morin

Yup.

Bob Shillman

Do I have to push 1 to ask a question?

Richard Morin

No, Sue is going to delete you from the question queue.

Bob Shillman

That might be wise. I have a question for the listeners. Why hasn't there been one question about the dividend? Any listeners want to comment?

Operator

[Operator Instructions]

Bob Shillman

Are there any listeners?

Alex Paris - Barrington Research

Hello?

Bob Shillman

Yes?

Alex Paris - Barrington Research

Yeah, Alex Paris.

Bob Shillman

Hi, Alex.

Alex Paris - Barrington Research

I think there's always an inherent fear when a growth Company starts raising their dividends, the fear that their growth is not going to be as good as they had hoped.

Bob Shillman

Well, guess what?

Alex Paris - Barrington Research

Right.

Bob Shillman

Guess what? There aren't that many growth companies around.

Alex Paris - Barrington Research

It's a great way for a major principal to take out money at a 15% rate.

Bob Shillman

Well I'm a shareholder too, aren't I?

Alex Paris - Barrington Research

I know, alright, yes.

Bob Shillman

I think any shareholder would, well you can always see the glass as being half empty I suppose, but the fact is that in today's difficult world we haven't seen many people make much money in stock appreciation.

Alex Paris - Barrington Research

Right.

Bob Shillman

And I'm not just speaking about Cognex stock.

Alex Paris - Barrington Research

Yeah.

Bob Shillman

Right. It has a lot to do with other factors other than the Company itself and we sat around and thought about this a lot, talked about it a lot, and asked some consultants and asked other peoples opinion and the conclusion is well, gee, you know, if we have no particular, if we have plenty of gas in the tank, and we do, then why do we have to keep on topping it up? Why don't we just give this money back to shareholders? And I would say that whether or not, I was a shareholder. It just makes sense to me.

Alex Paris - Barrington Research

Well, they have an inherent hope that you'll found a super acquisition.

Bob Shillman

Well, that's not going to happen. That's not going to happen. We had a super acquisition, I mean, if something was so super out there, it wouldn't want to be acquired.

Alex Paris - Barrington Research

Right.

Bob Shillman

Right, I mean, we keep looking, but our history is of 11 small acquisitions, 10 of them were useful, one was not and we got rid of that. We didn't spend too much time thinking about it after we saw the difficulty in that business. But this is, we don't see any major acquisitions.

We've been doing this for many, many years. And even if we do, hopeful it we do, we'll find one but we still have money from that. So I don't know why it wouldn't be a great thing to give people a 2.5% return or today it might be even higher if the price goes down.

Alex Paris - Barrington Research

That's great, but high growth investors kind of look first in terms of excitement in acquisitions and repurchase than as an afterthought on dividends.

Bob Shillman

Yeah, well, most companies that acquire things don't do too well after awhile.

Alex Paris - Barrington Research

Right.

Bob Shillman

Right?

Alex Paris - Barrington Research

Anyway, thanks for a good quarter.

Bob Shillman

You're welcome and thank you for the comment and giving me the opportunity to explain in a bit more detail, our thought process on the dividend.

Operator

Our next question comes from William Pike with Pine Street Securities.

William Pike - Pine Street Securities

Well, I was going to ask about the dividend but somebody beat me to it and it seems you've given an adequate answer.

Bob Shillman

Okay. Give me your opinion.

William Pike - Pine Street Securities

Yeah, Alex asked the right question. Sometimes there is a fear that implies less growth opportunity but it doesn't seem appropriate in your case since even in a bad quarter, as you say you top off the tank a little bit higher.

Bob Shillman

Right

William Pike - Pine Street Securities

The real question is why not more. Frankly, at a stock price at the screen right now, you're 16. 40 bid, 16.80 offered as we speak on your [street looks], one would hope that you buyback more stock than increase the dividend, but what was the thinking? Why not increase it more than it was? I'm not criticizing at all, I just kind of am getting at your thinking here.

Bob Shillman

Okay. First of all, I want to comment on Alex's comment, which is probably right that you increase the dividend, the street looks at it negatively. So maybe we should decrease the dividend? I've been told the street looks at that negatively.

William Pike - Pine Street Securities

Yeah. No. But…

Bob Shillman

I think in today's climate, there's nothing that the street looks at positively and maybe that's correct. Maybe the world is headed down the tubes I suppose and if you listen to the news you'll certainly get that impression but if I listen to my salesmen, I don't.

But the question about why not give more back, well, you could conceivably give up all your free cash flow but you're not sure if the next quarter would be a position to cover that. So there's a prudent medium and that is what we discussed at the Board meeting about okay, are we going to increase the dividend but how much should we do it by?

And the thought was if we increased it by a penny or half a penny, that wouldn't be, that's not terribly good and I'm pretty much an all-or-nothing guy. If it's good for a dime, it's good for a dollar, right? If you have a hand, and you think it's a good hand, why would you bet a dollar when you can get $10? So, I didn't see any sense that this wasn't, not every Board member felt the same way. I didn't see any sense of increasing it a penny or half a penny.

William Pike - Pine Street Securities

Well, even if you weren't going to increase cash flow sufficient to cover the dividend, it wouldn't be a crime. I mean, your tank is not only full but it's a very large tank.

Bob Shillman

Correct.

William Pike - Pine Street Securities

It would not be the end of the world as you're saying in today's market you'd be punished for anything, but it wouldn't be the end of the world if in one quarter cash was below…

Bob Shillman

You're right. But I argued for a greater dividend even, but after all of the discussion and the voting, there were some very conservative people who don't want to get caught without cash and I said well, we have a quarter of a billion, that seems to be plenty.

But I understand it and it was a discussion and negotiation and we felt that this percent, I forget what the percent turned out to be of our free cash flow but it turned out to be a very nice return based on I think a $23 stock, it turned out to be 2.5%. And we felt that especially, if you calculate, take into effect the favorable tax rate on that, that's a hell of a nice return and the people, we get more people to buy into Cognex. Why not?

William Pike - Pine Street Securities

Absolutely. Okay. Last question, do you sell anything into the Mid East and if so, do you have any insights to what's going on there or is that too basic for you?

Bob Shillman

No. We certainly do. Israel, I can't tell you, Dick can tell you how much revenue came out of Israel, but Intel has a big fab there and KLA and some other customers have R&D facilities there. So we do have a full time salesman in Israel but other than that we don't do much with sand, you know? We do a lot with process called Silicon, but we don't inspect either sand or oil or camels.

William Pike - Pine Street Securities

I'll keep that in mind. Okay. And I would presume your Israel business is really independent from politics.

Bob Shillman

Sure.

William Pike - Pine Street Securities

Yeah.

Bob Shillman

It's high-tech, its manufacturing, it's like anywhere else. Yeah, we don't do any business currently with any military organization that I know, not that we have a bias against that, it's just to do that you have to have a different kind of accounting systems.

William Pike - Pine Street Securities

Great.All right. Thank you.

Operator

(Operator Instructions). Our next question comes from Richard Eastman. Your line is open.

Bob Shillman

Hello, Richard.

Rick Eastman - Robert Baird

Just one additional bit of feedback on the dividend.

Bob Shillman

Yeah.

Rick Eastman - Robert Baird

I'm curious just from a viewpoint of, has the Board maybe also including yourself, have you guys over the last couple of years determined that investing in your own R&D and your own organic growth is a better return than acquisitions? Does that play into this?

Bob Shillman

We would prefer, we would love to do all of them, right. In particular, internal R&D but we're already investing or what does it turn out to be, 11% or 12% R&D and that's a reasonable number. Furthermore, we don't right now have any sweet spot ideas for other R&D. You don't just sit in a room and say how about this, how about that? You have to go out and talk to customers and get ideas for what to do and where to follow up. Could we spend more in R&D?

Sure. And I'm willing to do that to the extent it gets products to market sooner and that's one of the things that my partner [Rob Willett] will be addressing, how to get products to the market sooner instead of a year. Well, why should it take a year? Let's put more people on it. No. sometimes, putting more people on it slows it down. So it all depends on what you're trying to do. But we are going to be increasing our R&D effort to get the SOC to market sooner.

Rick Eastman - Robert Baird

Okay. Okay, well, very good. Well, thank you.

Bob Shillman

You're welcome.

Operator

Gentlemen, I'm not showing any further questions at this time. Dr. Bob, I'd like to hand it back to you for any closing remarks.

Bob Shillman

Sure. I want to thank everyone for listening to me preach about the economy and even say a few words about Cognex, and hopefully we'll give you at least as good a report next quarter at this time. Signing off, Dr. Bob from sunny San Diego.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude our program for the day. You may all disconnect and have a wonderful day.

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Source: Cognex Corporation Q2 2008 Earnings Call Transcript
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