Dick Morin - EVP Finance & Administration and CFO Dr. Robert Shillman - Chairman Rob Willett - President and CEO.

James Ricchiuti - Needham Ben Rose - Battle Road Research Richard Eastman - Robert W. Baird Jeremie Capron - CLSA Americas, LLC Holden Lewis - BB&T Capital Markets.

Good day ladies and gentlemen and welcome to the Cognex Second Quarter 2014 Earnings Call. At this time, all participants will be in a listen-only mode. (Operator Instructions) And as a reminder, today's conference is being recorded. And now I would like to turn it over to your host, CFO, Dick Morin..

Thank you and good evening everyone. Earlier tonight we issued a news release announcing Cognex's earnings for second quarter of 2014 and we also filed that quarterly report on Form 10-Q. For those of you who have not seen these materials, both are available on our web site 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 earnings 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 call over to Cognex's Chairman, Dr. Bob Shillman..

Thank you, Dick, and hello everyone. I'd like to welcome each of you to our second quarter conference call for 2014, and as you can see in the news release issued earlier today, we reported fantastic results for the second quarter, with the highest revenue, net income and earnings that we have ever reported in our 33 year of business.

Right now I am in San Diego, the headquarters of our R&D facility, and everyone else on the phone is at the Natick headquarters. The details of the quarter, I will be soon handing the microphone over to my partner Rob Willett, who is our President and CEO.

But before I do that, I want to remind each of you, that we will not be providing any details about the major customer that we referenced in both our news release issued on April 23rd, and also in tonight's earnings release.

We have a strict non-disclosure agreement with that customer, and we intend to fully respect that agreement I will now hand the mike over to Rob for his presentation, and I will be available at the end of the call, to answer any questions that you might have for me. Rob, the microphone is yours..

Thank you, Dr. Bob, good evening everyone. I am pleased to report our results for the second quarter of 2014; revenue was a record $108.8 million, representing significant growth over both the second quarter of 2013 and the prior quarter. It was also higher than the guidance we gave investors in April.

This strong performance was driven by record revenue from the factory automation market, and higher than expected revenue from semi. The quarter also benefited from some surface inspection revenue that had been deferred. Gross margin was strong, at 76%, even with our less profitable surface inspection products reporting a record quarter.

Operating margin was 28% and net margin was 24%. These two important ratios showed a strong increase over both Q2 of 2013 and the prior quarter, illustrating the substantial leverage that incremental revenue has in our business model.

Reported earnings for Q2 were $0.29 per share, and they set a new quarterly record, and were $0.07 higher than the Thomson-Reuters' First Call consensus estimate. Turning to the details of the quarter; factory automation revenue was $83.8 million in Q2, and accounted for 77% of total revenue.

Factory automation grew 25% year-on-year and 12% on a sequential basis, due to strong performances by both ID and vision products. Looking at factory automation from a geographic perspective, our strong execution drove growth year-on-year in each region.

Europe showed the largest increase in both percentage growth and absolute dollars over a sluggish year in 2013. Accelerating growth in automotive, consumer products, food, and electronics drove factory automation revenue from Europe to a record quarterly level. Currency exchange rates also contributed somewhat to the increase.

The Americas had another strong quarter, reporting a substantial increase in factory automation revenue over Q2 of 2013. Sales to customers in logistics and consumer products drove growth in the Americas over the record quarter reported a year ago.

In Q2, we saw a significant increase year-on-year in factory automation revenue from Asia, excluding Japan. The automotive industry was the largest contributor to growth in Asia, which demonstrates our strong progress in a high potential region.

In Japan, we continue to make progress, reporting factory automation growth in the mid-single digits over Q2 of 2013 in constant currency. On a reported basis, revenue continued to be negatively impacted by a weaker yen. Moving on, surface inspection revenue was a record $16.5 million in the second quarter, and 15% of our total business.

This level represents a substantial increase of 36% year-on-year and 72% over the prior quarter. Our surface inspection division had an outstanding revenue quarter, with the metals industry accounting for most of the growth.

As expected, we were able to report revenue related to a new software release that had been deferred until final testing at customer sites. That higher revenue translated into significant operating margin expansion for surface inspection.

Revenue from the semiconductor and electronics capital equipment market, or Semi as we call it, was $8.5 million in Q2, increasing 20% year-on-year and 38% over Q1. This marks the first year-on-year and sequential increase in five quarters, which may be a signal that the market is beginning to recover from this slump.

Although this is encouraging, semi represented only 8% of total revenue in Q2, and is less significant to the overall performance of Cognex. You may notice, that we invested a significant amount of working capital during Q2, which was for our major customer, and is expected to result in significant revenue in Q3.

We are encouraged by the relationship that's developing with this customer, and we believe, will bring substantial revenue in future years. In summary, Cognex had an outstanding quarter in Q2, and if you like that, just wait until you see Q3.

We expect revenue to increase by more than 50% over the record level reported tonight for Q2, due in large part to the major customer that I just referenced. Our expected revenue range for Q3 is between $165 million and $170 million. Gross margin is expected to be in the mid 70% range, slightly lower than it has been trending in recent quarters.

Operating expenses are expected to increase by approximately 25% on a sequential basis. Part of this increase is due to expenses that we expected to record in Q2, but will now occur in Q3. During Q3, we intend to continue to invest in areas where we see opportunities for long term growth.

Some of those incremental costs are not expected to repeat in Q4. As a result, we expect that operating expenses for Q4 will be approximately 10% higher than the level reported tonight for Q2. The effective tax rate is expected to be 19%, excluding discrete tax items. Now, let's open up the call for your questions.

Operator, we are ready to take questions..

(Operator Instructions). We will take our first from Jim Ricchiuti from Needham and Company..

Hi, good afternoon. I was wondering if you can help us with the amount of just the deferred revenue.

Dick, is it possible for you to provide that number, just so we know what the business might have grown [indiscernible]?.

Well, part of the problem is every quarter, SISD has deferred revenues for different reasons or whatever, and we don't intend to get into the discussion of any deferred revenue for that specific reason..

Is it fair to say that the SISD business, X that though [ph] was again -- you guys have talked about what you think the growth rate for that business is, and I am just trying to get a sense if there was anything unusual, in addition to that deferred revenue component that drove the growth of the business?.

The business did grow during the quarter, it also benefited from two things; it benefited from basic growth, and also from some of that deferred revenue that we had talked about, relative to getting the software release tested in actual real world conditions..

Got it. The factory automation business clearly grew at a much faster rate, both I think -- at least, and I was expecting in North America and Europe.

Rob, you highlighted some of the areas that contributed to the growth in Europe, is there any reason to think that some of the drivers that you saw, and I don't know if you could elaborate on maybe the growth also in the U.S.

portion of the factory automation business, what contributed to that, and is there any reason to think, that wouldn't continue to be the case in Q3?.

I think we are seeing a lot of broad growth across different markets, certainly now we are seeing strengths in some of the markets I referenced, notably logistics and consumer products, but a lot of the new markets that we are starting to -- Vision is starting to get traction.

I think we see continued growth and good prospects in those markets that you referenced. But I would point out, that we traditionally see a slow-down in Europe, in the third quarter, due to just the cyclicality and the summer vacation periods over there, and we do expect that to happen again, this year..

You have been seeing that in the U.S.

to some extent as well, do you anticipate that as well in the U.S.?.

Not to the same degree at all, no, and we really haven't been seeing that kind of a slowdown in the U.S. market..

Okay. Thanks for clarifying that. I will jump back in the queue..

Okay. Thank you for your question. And we will take our next from Ben Rose from Battle Road Research. Ben, please go ahead..

Yes, good afternoon.

With regard to the revenue mix, thinking about the third quarter, services revenue hasn't traditionally been a significant portion of the company's revenue, but should we expect that to uptick considerably in the current quarter?.

Hey Ben..

Hi..

I think we may see some growth in service revenue, but I don't think substantially in the quarter.

Dick, would you like to comment?.

I think it -- in answering your question, there will be substantial growth in service revenue, Q3 over Q2.

If you take a look at the percentage of service revenue to the total revenue when we are looking at a revenue range of getting up to $165 million to $170 million, most of that revenue growth is in fact going to come from FA product revenue, as opposed to service revenue; but service revenue will clearly increase fairly substantially over Q2..

Okay, thank you.

And then Rob, I know in the first quarter, you had referenced some seasonal factors that had impacted growth in China in the first quarter, and as you look out to the second part of the year, are you seeing some normalization or pickup in demand in that country in particular?.

Ben, we are really talking more about Asia role than China, but business activity in Asia picked up as expected during Q2.

Factory automation revenue from Asia was at a record level, led by growth in automotive and consumer electronics, and we would expect that kind of trend to continue in Q3, where we would normally expect revenue to be seasonally high in Asia, and we see no reason to expect something different this year.

So I think what we saw was what we expected, a soft Q1, which we have seen, and I think many companies in similar industries see around Q1 in Asia, and particularly in China, in Chinese New Year, and then strong rebound in Q2 and Q3. So I think we expect the same this year..

Okay, thanks very much..

Thank you. And our next question comes from Richard Eastman, from Robert W. Baird. Richard, your line is now open..

Good afternoon..

Hey Rick..

Robert, could you just speak -- I just want to double back on Asia-Pac, the suggestion is very good growth, and you had mentioned auto as part of Asia-Pac; I presume, is the auto piece of that in China, same with the consumer electronics? I mean, was there growth? If you take China out of Asia-Pac, how is the growth then?.

So I think we saw a strong [indiscernible] growth in Q2 in Asia, as I said, and automotive, its certainly -- its Cognex's largest end user market, its one where traditionally, the market in China and in Asia has been smaller, but where there is a lot of growth, and certainly we expected that, and we saw it and we keep seeing it..

Okay. And then, it was noted in the press release that the revenue for this large customer increased about 50% from $40 million to $60 million in the third quarter, is expectation.

Can you just put any color around that step up? I mean was that, again, more content? Is it more service related to that? I am just curious, I mean, is that contract expanding before we even delivered the first units?.

Well we are very restricted in terms of what we can say about that customer, but as the relationship with them develops, we have seen more business come our way, and we are pleased with the way it's developing, and we do expect to see substantial revenue from that customer in future years..

When -- and again I am trying to just be intuitive here, but I mean, we kind of -- I have a pretty good sense of what's scaling up to that magnitude, but I still would think that going forward, we would have more of a product line extension type follow-up than anything of that size.

Because I think of -- if we were at $40 million, we are now at $60 million on this contract that's still related to the scale of projects, relative to a typical follow-on order here, correct? Sorry, that's kind of an odd question? A typical follow-on order in out years would be sizable, but not $20 million, correct?.

So, we have never had a single -- until this order came around, we never had a single order that was $20 million, Rick.

Rick, I would take this at our words, which we have crafted carefully, and -- in answer to some of the first part of your question, subsequent orders increased the total amount above our increased purchase orders, and we don't believe this is a one time deal, rather, its the beginning of a long term relationship with the potential for substantial revenue in future years..

Okay. Well fantastic.

Dick could you just, without really speaking to, in the Q, when we are talking about SISD -- sorry, in the Q, it does -- the text in the Q suggest that virtually all the upside or all the growth in SISD was this deferred piece? I mean, that's just text around the description? And could you just explain or just remind me, when we account for the profit on the deferred revenue, is it 100%? Again, we defer the revenue --.

We defer costs as well..

Okay.

So it would be more of a typical profit, would be the [indiscernible] profit contribution as well, profit margin?.

What we do -- whether its -- for whatever reason, whether its at SISD or MVSD, when we defer revenue, we also defer the costs, and if you take a look at the balance sheet that's in Exhibit III of the press release, you will see that other assets, at year end, I think were $42 million, right now they are around $59 million, and that includes, the life of the deferred costs, relative to all the contracts that we have deferred revenue on..

I see, okay. All right. I can make some assumptions from there. Great. And then, maybe just if Dr.

Bob's on, I just -- could you just get us a little bit of an update, or could you please give us a little bit of an update on any kind of acquisition pipeline, or is there anything out there that you're exploring?.

Hi Rick. We are exploring, but unfortunately we have not found any candidates that meet our exceptionally high standards for potential profit or technology or market share or culture. So we continue to search for this.

We have one -- probably one half people full time, searching not only on web sites, but going to trade shows, looking for interesting acquisitions, because now would be a great time to add more bench strength, more technology, more markets, more new products to our salesman's bags, but to answer your question, there is nothing that is on the front burner..

Okay. Great. Well thanks so much..

You're welcome..

Very nice quarter..

Thank you..

Okay, thank you. And your next question comes from Jeremie Capron. Please go ahead, Jeremie..

Good evening, Bob, Rob and Dick and congratulations on this outstanding growth that you deliver again.

I wanted to follow-up on Richard's question, regarding the large customer order, and how we should think about how that will affect or even distort your growth profile going into next year? Do you still expect that we will see substantial revenue growth in 2015, given the high base that you're establishing here?.

Hey Jeremie, well I think it’s a little early to talk about 2015 at this point. What I would repeat is, that we don't believe this is a onetime deal, rather it’s the beginning of a long term relationship with this customer that has the potential for substantial revenue in future years.

On top of that, I would say though you know, we do expect currently to grow the top line of Cognex next year..

Okay, great.

And could you give us a little more color on the long term investments that you've talked about for the next couple of quarters? Any specific targets here or areas of investment in particular?.

Well broadly speaking, we are very excited about the opportunities we see for Cognex and for Vision in general, and we are investing behind those opportunities. In general, there are new product developments, so we are picking up the pace in terms of our R&D efforts in our investment and technology, and in sales channel.

We are certainly adding a significant number of salespeople to Cognex currently, particularly in ID, and particularly in markets where we see a strength, such as logistics. But in general, we are investing in growth opportunities..

Okay.

And as for the gross margin going into Q3, so you called out somewhat of a decline compared to previous quarters, and should we think that this is related to that large customer's order?.

Well the downward pressure comes from the mix in the business that we expect to see in Q3. So it's not necessarily one specific thing. We will expect another strong surface inspection quarter, but there are a number of different factors that will result in a slightly lower and recent quarter's reported gross margin..

Okay.

And maybe finally on the ID product line, what sort of growth are you seeing right now here? I know you don't want to disclose the details anymore, but just to get some color here in terms of whether the business is growing in line with your earlier target of 30% per annum?.

So, what we have said is ID products grew in excess of 30% in 2013. We are seeing strong continued growth in ID. Logistics is part of ID, and that's certainly a very high performing part of our business. So we are pleased, and we are continuing to invest behind growth.

ID parts are a leading performer, and an important focus for Cognex, and we have growing momentum in the ID market, where we are gaining share.

So from a geographic perspective, ID products have the strongest momentum in the Americas currently, and we have also been launching a number of new products into that market, notably, the DataMan 8050 which expands the market we serve for handheld readers, to lower price points and more broadly, in the market.

And the market for ID products, we size at about $900 million. So our share in that market is not much more than 10% currently, so we still think we have lot of headroom to keep growing at that 30% rate or more for a number of years..

Excellent. All right. I will jump back in the queue. Thank you..

Thank you..

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

Great. Thank you. Good evening.

Did you just -- what was the effect of the single large order in Q2, these are in revenue or costs? And what is sort of the expected impact in Q4? Only the revenues carry into Q4, are there costs that carry over to Q4, how do we view that in sort of the [indiscernible] quarters?.

That was not significant, and I think it's too early to comment on Q4, but we do anticipate it to be particularly significant in Q4 either, currently..

Okay Excellent. So the growth that you saw, obviously the upside surprise that you saw in Q2 to revenue, that's all market based.

Can you just comment on what markets you're seeing that are strong versus weak, if there is any way to sort of characterize those, broadly?.

So we saw strong performance from factory automation during Q2, and that was well above our 20% growth target. We saw particular strength, really across the broad range of markets.

Logistics, as you would expect, consumer products, markets like diapers, tobacco products, toys, well we are seeing certainly strong adoption of machine vision and markets, in some of those markets where machine vision is perhaps starting to reach production lines, in large degree for the first time. So we are certainly seeing that.

We saw good strength in automotive in the quarter, slightly below our overall factory automation growth rate, but still very strong and very sizable for us. So I would say that the growth was pretty broad-based Holden..

Okay. So lastly, on some of the operating percentage, you talked about investing in new products, investing in personnel, and that of course we think is pretty boilerplate.

My question was that, you referred to coming off a period of usually high spend and you were sort of in farm [ph] mode, and so we are looking at Q2, which is primarily operational, doesn't have a lot of discrete order, and you're already kind of at a 28% operating margin, which in recent years has kind of marked their peak.

Are you at a point where you think you have to rekindle more aggressive spend, and therefore this type of margin, Q3 aside, is still something we should view as a peak, or are you comfortable with the idea that 28% is not a peak, and you can probably go north of 30%, based on the investments you have already in the book and the growth that you're seeing?.

We invest in the business where we see opportunity. Right now, we see lots of opportunity, both in the near and long term. So we are investing behind our great technology and leading sales channel, in order to achieve that. Operating margins were very strong at 28% in Q2. We saw a significant expansion both year-on-year and sequentially.

Due to this substantial leverage that we have in our business model, I would say there is room for expansion of up to 28% operating margin reported for Q2. But we really keep eye on the long term, and we don't plan to shy away from investing.

We are really very pleased by the kind of growth and the opportunities we see and the response in the market to our products, and to our salesforce, and the way we are improving both of those, and we are going to go on investing for growth.

I think there is potential for margins to move higher, but not necessarily always consistently, because we are going to go on investing with the long term future of Cognex in mind..

Okay. All right. Thank you..

Thank you. (Operator Instructions). Our next question is coming from Jim Ricchiuti from Needham and Company. Jim, please go ahead..

Rob, you mentioned that ID was a particular driver in the Americas and the performance in the quarter, is that true that logistics as well -- was logistics a major driver of the growth in the ID business in the Americas in the quarter?.

Well our ID business is growing very well overall, but logistics is making substantial contributions, and we are seeing outstanding growth in logistics, particularly in the Americas, where we are really getting great traction in our logistics business, but also now increasingly in Europe..

Can you give us a sense of the growth that you are seeing in ID, and probably more so in logistics? Is it a case of -- it sounds like it’s a case of market share gain, is that a fair way to characterize it? The market is not that healthy?.

Absolutely right. It’s a $900 million market that's probably growing in the mid single digits, and we are expecting to and achieving 30% growth.

So we have disruptive technology, just the best barcode reading technology in the world, and we are investing heavily behind it and taking lot of market share, and we have been doing that for quite a few years, and we are going to go on doing it, expanding into new adjacencies like logistics, and continuing to drive growth in that core ID market..

Within logistics, can you say whether the share gains, whether the growth that you're seeing in that market is uniformly across the market? And by that, I mean, both large customers, as well as potential small customers, smaller customers?.

Well, we are certainly selling to large and medium sized customers, in the logistics market. Well I would say, the most savvy consumers with logistics, barcode reading technology, recognize the performance of our products and are adopting them, and they are integrators to serve the mid-sized customers in that market.

I wouldn't say we are selling a lot of that business to small onesie-twosie customers, its more to the mid and large customers I would say at this time..

Yeah, and that's actually what I meant is, I am thinking in terms of retail, the distribution centers. Are you seeing traction, maybe the larger mid-sized retailers if you will, where you're gaining ground there? We know there have been some very large orders, and presumably with some very marquee type customers.

At the medium size retail distribution centers, are you making inroads there as well?.

Yes, we are definitely -- if I look at our customer list and our pipeline, we are seeing lots of kind of -- mid-sized retail companies. The kind of companies, whose name you see at the mall.

I would also add that we have strong and growing pipeline of ID products for logistics that include, not only well known retailers, but package delivery companies and postal accounts. So those are the three pillars of the logistics market, retailers, package delivery companies, and postal accounts.

And the funnel is developing nicely with all those three types of prospects..

Got it. And one final question, and I will jump back in the queue; you alluded to, obviously the size of the order with this large customer. But in general, order sizes are -- it appears that some of the orders have been growing for Cognex, over the past year, year and a half. Just looking at what you're seeing in the market.

For instance, is there something unique about the orders that you're getting of late, that are perhaps going to make it challenging to maybe go to other verticals and be able to -- or even within the same vertical, to be able to generate orders initially of the size that you have just announced, but just larger orders in general?.

So I would say over the last couple of years, we have seen some larger customers emerge for Cognex. Obviously the major one we have been referencing, but also quite a few larger customers in areas like logistics, specifically.

I would say, we see the markets emerging in these areas, and are -- what we can do for those markets, and we are building teams of people to serve -- and products to serve those products, and that is driving some of our investment obviously, and I would say nothing we have seen to-date is overly problematic, but it’s a matter of building that capability and understanding those markets and building our reputation in those markets; because obviously very large customers go to -- they don't give huge amounts of business just immediately, there is a lot of trials that go on and a lot of requirements, and I think we are doing a nice job of building our capabilities to serve that.

I am not talking specifically about any one customer, but quite a few customers that we are starting to work with now, who have the potential to be very sizable for us in future years..

Okay. Thanks very much. Congratulations on the quarter..

Thank you..

Thank you. And our next question is from Richard Eastman from Robert W. Baird..

Sorry, round two here. Just two quick things; one is, I was kind of looking at the op expense, and for the commentary post the first quarter, the operating expense came in below target, and sounds like some of that was maybe pushed into the third quarter a little bit.

But when I look at the second half of the year, we are giving up some operating leverage there. Third quarter is going to be fine, because we have got a [indiscernible] of revenue coming in, on this large order.

But we get up to the fourth quarter, it occurs as though its going to take away a little leverage out of the model in the fourth quarter, and presumably, then as we roll into next year, we will be looking for the sales gain to kind of satisfy and justify the cost investment?.

I think as we look at the business, we are investing behind the growth opportunities that we see in the market. Obviously we have substantial assets and substantial capabilities behind us, and we very much believe in these growth prospects.

So we are going on investing behind them, and the growth that you have seen this quarter, and the one you expect next quarter, say that that's a good strategy.

That said, there will be time to when we are investing ahead, where we are growing expenses ahead of revenue growth, and I think we are comfortable with that, because we see the long term potential for major top line organic growth, and margin expansion.

That's how we are looking at it, rather than trying to manage any particular quarter, on a short term basis..

Sure.

And beyond again the third quarter and the mix issue, again, there is no reason that our gross margins don't continue to maybe drift higher with the new products, once we get beyond this large order?.

I think we have reported some pretty nice gross margins in the last few quarters, and we have kind of highlighted some mix issues and some other issues that may hit us in the third quarter. But I would say in the long run, we do expect to keep reporting margins in the mid-70% range..

And then just one last question Rob, on the logistics business in general, it sounds like again, we are just maintaining the excellent traction we have there.

Has there been any shift, as you have rolled out the ID product, targeting logistics, with some of these new products that we have seen at some of the trade shows, has there been a shift in your ability to sell more of that product through the indirect channel, the systems integrator channel?.

Well we have been in the logistics markets for about a couple of years now, and we have been learning a lot, as we move forward. I think initially we though we could rely on integrators and third parties to sell the product.

We then realized, we really needed to get a major player as an end user in the market to recognize our technology, and when we did that, we started to see real traction -- that's when we started to see real traction, about a year ago.

And I think now that we have that traction and that recognition, and our recognition from the industry in general, that we have superior products, now we are able to get integrators to really take on the sale of our products more themselves, and that then takes us more broadly in the market.

So I think it begins with the big end users and the big influences, and some of the big integrators, and then it builds from there. And I think that's kind of where we are in the evolution right now..

I see. Okay, great. Thanks so much..

Thank you. And our next question comes from Jeremie Capron. Please go ahead, sir..

Thank you. Can you talk a little bit about Japan? I think there were some concerns that the VAT hike over there could -- maybe depress the market a little bit in Q2? Obviously, you've grown nicely there.

So what are you seeing in Japan, and maybe give us an update on your relationship with Mitsubishi over there?.

Sure, yes Jeremie. So I would say, we didn't see a notable impact from the VAT. We thought we might, we studied it pretty carefully, but didn't see a big pulling forward, or change in order patterns around that event. Our business in Japan has performed better in recent quarters.

The recent quarter has quite a lot to with the semi market, where we are seeing a large improvement, and in fact, improvement in Semi, Japan is probably the leader in what we are seeing there.

But our FA business, our factory automation business in Japan is -- I would say its building strength and capability, but there are a couple of, there is particularly one very strong local competitor in Japan, and our market share is still relatively small.

You asked about Mitsubishi; we continue to see sales through the Mitsubishi channel and some growth for our relationship with them, and our relationship with Mitsubishi continues to go very well, and both firms are firmly committed to its success.

They certainly give us significant additional reach into the Japanese market, and it’s a relationship that's been building now more than four years, and continues to grow..

Okay. And speaking of Japan, your Japanese competitor also reported pretty impressive growth in the U.S., in Q2, I think over 50%.

Is it the case that you see then more than before in your core factory automation market here in the U.S.?.

You're referencing our competitor Keyence, and I think Keyence's business is much more broad than Cognex's. So I would caution against drawing conclusions about their results specifically into our part of the market. Maybe we only compete head-to-head within 10% of their business.

What I would say is yes, both Cognex and Keyence are investing in these markets, we clearly both see the opportunity for growth, and are executing on it. Clearly we are the market leader in Vision and industrial ID in the Americas and in Europe. They are clearly the market leader in Japan, and we are head to head in the Japanese market..

Okay. And finally, a question on capital allocation.

There is now almost $0.5 billion of cash and investments on the balance sheet, and even with the increase in the investment intensity that we have seen in the past two years or so, the business is still generating a lot of cash, to the point that the balance sheet is starting to look overcapitalized and return on equity is sort of capped by that cash.

So what's this thinking in terms of, what would be an appropriate cash level, and how to get there going forward?.

We really haven't set any specific cash level targets. Our primary goal would be to use cash for acquisitions, and the availability of our cash provides us with good firepower, any particular acquisition that we might have. It was also a good benefit to us in this past quarter.

In that, we were able to invest in all of the working capital needs that we had to satisfy the major customer contract that will be our revenue here in Q3. So we don't have any particular targets, but as Dr.

Bob mentioned earlier, there is nothing really on the acquisition front at this particular point, but we continue to be in the market buying back company shares..

This is Dr. Bob, I just want to expand a bit on that. There is certainly no upper limit as to how much cash we have or want to have. Cash is just a positive result and a measure of how effective we are at running a growing company, and we are very proud of the cash that we have.

The best use of cash of course, would be, as Dick just alluded to, to do acquisitions, and we would like to do acquisitions, and if we find them, we have done them. We have done about 13 to-date. The next good use of cash, and I don't know if it's in direct order, but is to buy stock back.

As you know, as most of Cognex's shareholders know, we believe in the value and the power of stock options, and we understand that some shareholders believe that they are dilutive to earnings, and then with respect to that, we are using cash to buy back stock to compensate for any possible dilution.

The third use of cash that we have used it for, is to reward our shareholders for dividends, and we did such about two years ago. We paid for two ears of dividends in advance, and I can tell you that in every board meeting, we discuss whether or not to restock that. I can predict when or if we will, but that's another good use of cash.

So it is not something that worries us. Its something that we are very happy to have, and are very happy if we just accumulate it..

All right. Thanks very much..

You're welcome..

Thank you. (Operator Instructions). And our next question is from Holden Lewis from BB&T..

Thanks again. Couple of things, first, you cracked a lot about logistics, I think we get the sense of that.

But are there any update, traction, anything that we can talk about on some of your other big new [indiscernible] initiatives barraging [ph] the 3D side, and anything to report there in terms of progress, customer attraction, anything of that sort?.

So those two new markets that you referenced, the displacement sensor 3D market is moving on well for us. The business is still small, but we are in many trials and our product is performing well, and we are very optimistic about what that product can do for us in the long term.

Its something to make much of a contribution to this year's revenue, a few million dollar possibly, but I think by next year, we do expect some growth contribution to start coming from that product.

Similarly in some ways, the image engine business, as I've referred to many times, this is a business where we are targeting the life science market, and the name of the game at this point is design wins.

But we now have several design wins with large manufacturers of OEM equipment, and some of this equipment is in the final development stage, with production units expected to ship next year. So that's $100 million market, our share is very small today, as these machines from large suppliers start to come out into the market.

We think its going to be a nice stable and a growing source of revenue for Cognex. When I joined the company, and a lot of people often hated that Cognex doesn't have any consumables revenue. I come from an industry where we sell printers and ink, and the answer was no, but I'd like to figure out how to get consumables revenue.

I think these image engines are about the nearest thing to consumables revenue, essentially every time a large customer sells a piece of machinery, we can sell a number of these image engines over what should be a seven to 12 year life of that product.

And since these customers are FDA regulated most of the time, there is very little change that goes on to those machines. So it should be -- we continue to see it as a very good source of stable revenue for us in future years, and the traction is on schedule, I would say..

So this year, we had a lot of contribution for logistics.

We still feel like next year, you are going to begin to pull in meaningful revenue from these two new products, perhaps the comps get harder for logistics, these things begin to kick in, so we can sort of think about that, about how this thing sort of pulls through your results?.

Yeah I think you will see the beginning of it starting to come next year, yes. But I think that's the -- if you think of it as an S-curve, I still think its pretty low-down on the S-curve, and we will start to see it ramp. Possibly a little bit next year, but I would think more in outer years..

Okay. And just wanted to ask a question, if you sort of take your order for this quarter, or for the third quarter, which is going to be $50 million plus, and you look at your guidance.

Its possible just thinking about sort of the sequential change that you're looking at a Q3 revenue stream that is below the Q2 revenue stream, in a market which seems like its strong, maybe getting stronger. We are seeing increasing contribution from new products.

Should we read anything into the potential of a sequential decline in revenues from Q2 to Q3, or is there some rational explanation for why you have a sequential step-down?.

No I wouldn't read anything in it. The sequential increase in factory automation, excluding the large customer, its harder to predict, given the softness we see, particularly in Europe during the summer months. I think that's the key.

The key think I would encourage you to t look at it more year-on-year, and if you look at last year, I think you should see significant growth in the base business, excluding the large customer, certainly, and then of course-- such as Vision had a strong second quarter, again, which is unlikely to increase in Q3..

Okay. Great. Thank you..

Okay. And I am showing no further questions in the queue at this time. I'd like to turn the call back to Dr. Bob Shillman for closing remarks..

Thank you. Well, it’s a simple thing to wrap up. We reported outstanding results tonight for the second quarter, and we expect to deliver even more spectacular results for Q3 with another record-breaking quarter for revenue, net income and earnings, and I look forward to reporting on that with the team next quarter, at about this time.

Thank you very much for your continued interest in Cognex and for joining us tonight..

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