Bob Shillman – Chairman Rob Willett – President & Chief Executive Officer Dick Morin – Chief Financial Officer.

Ben Rose – Battle Road Research Jim Ricchiuti – Needham & Company Richard Eastman – Robert W. Baird Jeremie Capron – CLSA Americas Holden Lewis – BB&T Capital Markets.

Good day, ladies and gentlemen, and welcome to the Cognex Q1 2014 Earnings Call. (Operator instructions.) And as a reminder, today’s conference is being recorded. Now I would like to turn it over to your CFO, Dick Morin..

Thank you and good evening, everyone. Earlier tonight we issued a news release announcing Cognex’s earnings for Q1 2014 and we have also filed our Quarterly Report on Form 10(q). For those of you who have not 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 I of the press release and a reconciliation of certain items in the income statement from GAAP to non-GAAP in Exhibit II.

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 conference over to Cognex’s Chairman, Dr. Bob Shillman..

Thank you, Dick, and I’d like all the participants to also check with their Sky Mall catalog for this quarter and be sure to order those items before they get out of stock. Well hello, everyone.

I want to welcome each of you to the Q1 conference call for 2014 and as you’ve probably seen in the news release issued earlier today we reported really great results for Q1.

Right now I’m on the road but everyone else, at least everyone else who’s on the call is in our Natick headquarters, so for the details of the quarter I’m going to hand the microphone over to my partner Rob Willett, Cognex’s President and Chief Executive Officer, and Dick Morin and his staff.

But before I do that I want to remind all of you about our recent decision to share less detail about our business on conference calls and during investor presentations.

We were forced to make this change because we are now addressing very large markets with breaking technology where we have significantly entrenched international competitors who are defending their turn with their own but older products and technology.

So for that reason we have to be a bit more closed-mouthed about certain wins and certain applications, and even the prospects in certain geographies. We will continue to talk about our successes and the challenges we face but we just won’t be able to go into nearly as much detail as we have in the past, and I apologize for that.

In addition we expect today some questions relating to our recent news release regarding the record orders, totaling more than $40 million, that we received from a single customer. I’ll tell you now that we will not be giving you any additional information beyond what we’ve disclosed in that press release.

We have entered into a very strict non-disclosure agreement with this particular customer and we intend to fully respect that agreement. With that I’ll now hand the microphone over to Rob Willett and I will remain on the call if there are any questions specifically for me during the call or at the end of the call. Rob, the microphone is yours..

Thank you, Dr. Bob. Good evening, everyone. We had a very good start to 2014. Revenue, net income and earnings per share all set new Q1 records and were a result of our investments in new product development and sales. We also closed business that we had been working on for some time that will drive growth later in the year.

In particular, as previously announced we received the largest purchase orders ever from a single customer in Cognex history and we received substantial orders from customers in the logistics market, including $3 million from an automation provider for a well-known retailer.

Looking at our Q1 results, revenue increased 12% year-on-year to $91 million. We were pleased to see the acceleration in revenue growth that began in the second half of last year continued in Q1. Growth was driven by the factory automation market where revenue increased 19% year-on-year.

From a geographic perspective the Americas and Europe were our top performers. From a product standpoint both vision and ID products increased strongly over Q1 a year ago. Gross margin was strong at 77%, reflecting the substantial percentage of revenue that comes from high-margin factory automation sales.

We reported an operating margin of 25%, up 300 basis points over Q1 2013 due to the leverage incremental revenue has on our profitability. And we reported earnings of $0.21 per share, which is $0.03 higher than the $0.18 per share reported for the prior year’s Q1. It’s also $0.01 above the Thompson-Reuters First Call consensus estimate.

Now let’s turn to the details of the quarter. In factory automation revenue was $75 million in Q1 and accounted for 83% of total revenue. As I said a moment ago, factory automation revenue increased 19% year-on-year which is just below our 20% long-term target.

Typically we see a decline in factory automation revenue from Q4 to Q1 due to seasonality and this year was no exception. Factory automation revenue declined 6% from Q4 and a decline was experienced in each geographic region. Despite this seasonal trend factory automation revenue in Q1 was the second-highest ever for our company.

Looking at factory automation year-on-year from a geographic perspective, the Americas was our fastest-growing region. It was also the largest contributor in absolute dollars to factory automation growth. We saw particularly strong performance in medical devices, logistics, and consumer products.

Europe had another strong quarter, reporting a substantial increase in factory automation revenue over Q1 2013. Sales to customers in the food & beverage and consumer products industries drove revenue growth in this region following a sluggish 2013.

In Asia excluding Japan, factory automation revenues declined year-on-year due to the timing of large projects. We’re confident about the high potential that this region offers in terms of long-term growth.

Factory automation revenue from Japan continued to be negatively impacted by the weaker Yen on a reported basis; however, revenue in constant currency increased in the mid-teens over Q1 2013. Revenue from the semiconductor and electronics capital equipment market, or Semi as we call it, was $6.2 million in Q1.

That revenue represents a decrease of 12% year-on-year but an increase of 19% over the prior quarter. While we are pleased with the sequential improvement it’s too soon to say whether it signals the beginning of a market recovery. In the surface inspection market, Q1 revenue was $9.6 million, which is below both Q4 and Q1 2013.

As discussed in our last call, revenue related to a new software release was deferred until we could test new functionality at customer sites. We made good progress during the quarter and expect the deferred revenue to start coming into the P&L in Q2. Total operating expenses increased in Q1 by 9% year-on-year.

This increase was due to our investments in new product development and in our sales channel that are targeted at longer-term initiatives. Revenue increased year-on-year at a faster rate than expenses as these efforts paid off. In summary, Cognex had a very good start to 2014.

In regards to guidance for Q2 we expect revenue for our first $100 million quarter to be between $101 million and $105 million. This range represents an increase of 11% to 16% over the revenue reported tonight for Q1. Gross margins are expected to be in the mid-70% range and will reflect a higher level of surface inspection revenue.

Operating expenses are expected to increase substantially by up to 15% on a sequential basis. This increase is due to support capabilities we are building for the $40 million business wins which will be recognized as revenue further out.

We are making additional investments in growth areas and we will have incremental legal fees related to our patent lawsuit against one of our competitors that went to trial in Q2. The effective tax rate is expected to be 19% excluding discrete tax items. Now let’s open the call up for your questions. Operator, we are ready to take questions. .

Okay, sir. (Operator instructions.) Our first question comes from Ben Rose with Battle Road Research..

Good evening. With regard to some of the competitors in the ID space, SICK seems to be revitalizing its product line with some new image-based scanners and not relying as much as they have in the past on lasers.

Can you comment on what you’re seeing in the marketplace from them specifically?.

Yeah sure, hi Ben. We’re addressing the logistics market with highly-advantaged proprietary technology while our competitors are generally defending their market with older products. You’re probably referring to the interestingly-named SICK Lector product that we’ve seen a lot in tradeshow stands and with customers recently.

I think it’s interesting to us. I think we have a number of thoughts on it. One is I think it’s interesting to see them starting to legitimize image-based readers in the logistics market.

Generally they’ve used lasers and I think even they are starting to see, and others ,that imaging is what’s going to win out and machine vision is what’s going to win out in this market. The Lector may look similar in packaging to our DataMan readers but differs greatly in the software.

You know, Cognex technology such as Hotbars and our ability to read low-resolution codes and to read codes at very high speeds give us tremendous advantage over products such as that one, and it’s very hard for a competitor, any competitor to duplicate these capabilities we believe certainly for a number of years.

Cognex will either outperform the SICK products that you’re seeing with the DataMan 300 at a similar price point where our performance will be way superior, or it can match the performance with a lower price point DataMan 303 product. So we’re seeing them respond.

We’re feeling it’s legitimizing our strategy and we’re very, very confident about – and our customers seem to be confident about – our outperformance of those products..

Okay. And also, Rob, with regard to the Far East, notwithstanding this very large and significant order that you’ve announced and won’t provide additional details on, there does seem to be some debate as to whether the Far East, China in particular is starting to weaken just from kind of a macro standpoint.

Can you comment at all about what you’re seeing there just kind of on a day-to-day basis and just whether anything there portends more challenges generally speaking for the second half?.

Well I think, Ben, the macro concerns in Asia, particularly in China are something we’ve all been reading a lot about and know well.

We saw a little softness primarily in surface inspection in Q1 and we’re watching that closely, but based on our sales funnel and investments we’re confident that Asia is going to go on delivering very strong growth for us particularly in the second half of this year.

You always see a very soft situation in advance of Chinese New Year, nothing new there – we saw that. And we did see a very good pickup in business immediately following Chinese New Year. So I’d say the indicators for us continue to look very good but we also do see some of that nervousness that you’re referring to..

Okay, thanks very much..

Sure..

Thank you, and we’ll take our next question coming from Jim Ricchiuti from Needham & Company. Please go ahead..

Hi, good afternoon. Again, you may or may not be able to answer any of these questions, but just on the expense side is there any way we can think about OPEX in Q2/Q3 related to this order? If you can help at all..

We should have said we’re not going to comment more on….

That’s fine, I just wanted to make sure on the expense side if you were going to be giving any kind of help on that. If I can switch gears a little bit and talk about the broader factory automation market in North America and Europe, it seems like we’re seeing some mixed signals just in terms of factory automation in North America.

Can you talk about what you’re seeing? Did you see any pause in the quarter or have you seen any acceleration more recently?.

In general and as I said in my opening remarks the Americas is our strongest performing region in the quarter, and the order momentum was strong across the board – a broad base of customers and industries..

But [you’re normally strong], Rob.

You didn’t see any pockets? It’s fairly broad-based?.

Correct, yeah. Here’s what I will say – a lot of broad-based industries, consumer products, medical devices, pharmaceuticals, etc. And also of course for us logistics is performing very, very well.

I think as we’ve mentioned in the past automotive is a very significant market for us in the Americas and I would say it performed okay but perhaps automotive in general I think we saw perform more strongly in other markets in Q1.

And you know, I don’t know to what degree that relates to some of the news on quality and other issues coming out of the US automotive market at the moment, whether this is some deferred capital spend around that.

It wasn’t troubling to us but if you parse the growth by industry automotive is one that generally we would have expected to see a little more growth out of the Americas than we did..

And if we separate the logistics portion from the ID business, is there any additional color you can provide on that business in some of your geographic regions? How would you characterize the ID business excluding some of the work you’re doing in logistics?.

I’d characterize it as great across the board. We’ve now been reporting a number of years of 30% growth in ID and we continue to see that growing.

Of course logistics is helping that but the underlying business in ID is growing well and we have a now pretty substantial business in ID in most regions and we’re seeing great growth rates and order momentum in that. So yeah, I mean that’s overall very, very positive.

And I think as I’ve said in the past we’re still a relatively small share player in a pretty large market – a $900 million plus market for ID. And maybe take $250 million out of that for logistics, still a large market, and so we think we have a lot of headroom for continued growth.

And we just have a lot of great technology that we’re bringing to bear and a great sales force that we’re growing quickly and training well and they’re performing well. So yeah, I mean really very, very positive by all regions. There’s really no exception to that on the ID side..

Thanks a lot. Congratulations, by the way..

Thank you..

Thank you. And we’ll take our next question from Richard Eastman from Robert W. Baird..

Yes, good afternoon. Dick, can I just ask you to maybe clarify – I’ll address this to Dick because I’m looking at the OPEX and there’s commentary that Q2 will increase up to 15%, starting to stage the cost for this Asian order.

So if we build that out 15%, just go to the max, obviously we’ll carry that cost into Q3 because this business ships in Q3 primarily.

What happens in Q4 with that OPEX number?.

Let me just clarify one thing relative to that 15% increase. That up to 15% increase included three pieces, one of which was some incremental work or expenses that we were going to incur relative to supporting this particular project order that we were talking about.

Secondly we also said that we intended to continue to invest in some of our growth initiatives which is some of the engineering and development work and expanding our sales force. And the third thing was we have a lawsuit that is in trial in New York City where we are suing Microscan for patent infringement.

And we’ve been in the court in New York City last week and this week so there’s a significant increase in the amount of legal fees that we are spending in that regard. So the up to 15% increase was based upon those three factors..

I see, okay. And the presumption is that at some point the legal winds back down – I mean we’ll make the assumption timeline.

And then obviously the incremental expenses on the large order would continue through Q3 but presumably some of that is temporary? Is it variable? Does it go away in Q4?.

Well, without getting into too much detail because we’re not going to be talking about that particular order, at some point in time when that order is completed some of those costs will go away..

Okay, they’re variable. Okay..

We’re certainly hoping that this is not just a one-time bluebird but that we can expect follow-on business..

Okay.

And then can I also ask the Q2 revenue guide, the $101 million to $105 million, does that include any portion of that large order?.

It does not..

Does not, okay. So that order – I’m glad we’re not talking about this but that order then ships largely all in Q3..

What I said in the press release is we do not expect any of that revenue to fall into Q2..

Okay. But this is an installation deferred revenue except this is, revenue is recognized when the product is shipped..

Rick, you’re going way over what I’m willing to talk about..

Okay, alright. That doesn’t help me (inaudible) customers but nonetheless.

And then just on the [installation] business can I just ask, did the deferred revenue piece there grow? I think when we exited Q4 I think it was $2 million – are you implying that that $2 million will come in later or has that deferred number grown from the $2 million?.

I don’t know where you got that $2 million number, Rick, but the deferred revenue on some of these instillations that we needed to test in the field did in fact grow in Q1 and we expect to start to see, based upon some of the results that we’ve seen in the month of April… Again, we’re talking about different installations, different industries, different things that we need to test, we do expect that starting in April we’re going to start to see some of that deferred revenue start to come into actual revenue during Q2..

you had mentioned we saw in Europe some substantial increases on the machine vision side.

Can you just repeat or just flag the couple industries there that might be the driver?.

Sure, Rick. Europe factory automation, we had a good start to the year. We saw growth year-on-year across a range of industries including food & beverage, consumer products, electronics, pharmaceuticals and automotive..

Okay, alright. Great. Okay, thank you very much..

Sure..

Thank you. (Operator instructions.) Our next question comes from Jeremie Capron from CLSA..

Good afternoon. Congratulations on an impressive start to the year. It looks like a lot of exciting new orders coming through the door and also I’m quite happy to see that there’s some operating leverage coming back into the business and margin expansion. And on that point you’ve talked about that OPEX increase going into Q2.

I’m wondering if you back out those temporary items – legal fees, the increase in costs related to that large order over in Asia – are we seeing a continuation of that, meaning that revenue is increasing but essentially the bottom line is growing faster?.

Hi, Jeremie. You know we don’t give guidance for the full year and we’re trying to paint a picture of a Q2 situation to put it in context.

I think we did say coming into the year, though, that we expect revenue to grow faster than expenses going forward; and I think with the exception of some of these one-time situations we’re talking about that’s still the picture that we see. And we see strong revenue growth as we move through the year with a lot of great prospects.

We see ourselves continuing to invest in the long-term growth of the business but we do expect revenue growth to outpace expense growth over the medium term..

Okay, great. And then the Semi business, yes it was up sequentially but we’re still at a very, very low level, and I’m a little bit surprised to see that given what we’re hearing from the semiconductor capital equipment manufacturers.

Is this weakness in the business really driven by market demand or are you seeing a change in new customers’ behavior in terms of the vision products they buy or what they do in-house? Any color on that would be helpful..

I think Semi for us, we see it as a cyclical, probably long-term declining business as more technology can be put through – you know, customers can put through more capacity on existing lines. So we think it will cycle but probably not in the long term provide a lot of growth.

I would say there’ll be opportunities for innovation and growth for us, specifically around new specifications such as the 450 mm technology that’s coming at some point – and we can see some initial interest in that. And that’s where Cognex innovation perhaps could drive some significant business, but it’s very hard for us to see when that’s coming.

I think overall the trend of any sort of in-house vision technology in Semi has kind of probably run its course. I don’t think we’re going to see large increases in internal vision spend among our customers.

But at the same time I think we’re not going to see the sort of growth, macro growth drivers or the drive for innovation that’s really going to mean our Semi business will grow hugely over any significant time period. So it’s a less exciting market for us in general. .

Mm-hmm, okay. One question on the world of 3D. I mean you’ve launched a 3D product last year – I think it’s on the measurement side.

I wonder if Cognex as a company is interested in the 3D market in general and 3D scanning and those technologies?.

So we have a couple of areas where we play in 3D today. We have stereoscopic machine vision that often is mounted on robots that we sell.

But then the product you’re referring to is the displacement sensor product that we launched around this time last year, and this is interesting technology taking us into 3D measurement using our machine vision tools in the context of a laser-structured light creating a 3D image of the product.

So this is an exciting market where we’re really still beginning our journey and we have more products and technology coming to market. The end users for that product, to get to your question, are very diverse. We see a lot of different end users covering our existing markets today.

It’s possible that people using 3D printing technologies would also use displacement sensors such as ours to scan products and input them for printing so that’s certainly a potential application – although it’s really not one where I would expect us to book any significant revenue this year..

This is Bob; I might want to expand on that question. In the question you may be thinking about the large business for capital equipment – pieces of capital equipment that perform 3D measurement on large objects, whether they’re car bodies or bridges or the like. And we have at the current time no interest in offline measurement.

There are two or three very strong companies in those areas that make large pieces of capital equipment that provide submicron measurements of large objects and they’re all offline. They’re generally done in a laboratory setting.

So the products that we’ve designed are specifically for online items during the manufacturing of items and even when the products [are leaving]. And the criteria and the capabilities of those products are very different from the offline ones.

But there are two separate, very distinct markets in 3D and one we have a strong interest in and that’s where we’re developing products and are gaining traction; and in the other one we don’t have products..

Excellent, thank you very much..

You’re welcome..

Thank you, and our next question comes from Holden Lewis from BB&T. Please go ahead..

Thank you, good afternoon. I just wanted to get a sense of where you think the margins are going.

I know that the next couple quarters you’re going to have some moving pieces, but as you get into Q4 and into next year what can we sort of expect aspirationally about the operating margin level? And I guess I ask because you’re talking about investing in growth initiatives again even though in the near term you’re going to [farm].

Can we expect you to get into maybe the high-20%s and then decide that the time is right to begin ramping the investment again or would you expect to sort of be done with the investment for two to three years and just let the margins fall where they may? What’s the philosophy around operating margin and its level?.

Hi, Holden. I think for us, our operating margin target is to be above 25% of revenue which is where we were in the seasonally soft Q1. There is room for margin expansion certainly in our business model. Obviously with the gross margins we report there’s a lot of leverage when we grow.

That said, we see lots of opportunity in our markets for growth and we as a company are really about high-margin, technology-driven growth in vision and we certainly intend to go on investing behind that.

So I think you should see high gross margin growth from Cognex continuing over the long-term – that’s certainly what we expect with good pull-through going on. But we don’t have specific operating targets or long-term goals beyond the plan to be above 25% of revenue and to keep seeing revenue growing above expenses over the long term.

So I think we can’t really, we’re not looking to be driven to a specific operating margin target at this point in our development as a company..

Thank you..

Okay, thank you. And that does conclude our Q&A session for today. I’d like to turn it back to Bob Shillman for closing remarks..

Great, thank you very much. Well, I just want to wrap up. It was a great start of the year and it’s going to be from what I can tell a fantastic year.

In addition to the results that we reported as we mentioned we closed some very large pieces of business including the two press releases that we talked about – one totaling $40 million, the other $3 million – which I believe are not one-time orders.

I believe these are going to be, in my expectation we can expect more such orders from these kinds of customers. And we’re going to work hard to make that happen and as it does happen we will be reporting to you on a quarterly basis and at the investor conferences.

Until then I want to thank you very much for attending and stay tuned for more work hard, play hard, moving fast..

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