Richard Morin - Executive Vice President of Finance Chief Financial Officer Robert Shillman - Chairman Robert Willett - President, Chief Executive Officer & Director.

Jeremie Capron - CLSA Americas Joseph Giordano - Cowen & Co. Jim Ricchiuti - Needham & Co. Ben Rose - Battle Road Research Ltd. Richard Eastman - Robert W. Baird & Co., Inc. Bobby Eubank - Chevy Chase Trust Co..

Good day, ladies and gentlemen, and welcome to the Cognex Second Quarter 2016 Earnings Call. And now, I'd like to turn the call over to your host, Chief Financial Officer, Dick Morin..

Thank you, and good evening, everyone. Earlier today, we issued a news release announcing Cognex's earnings for the second quarter of 2016, and we also filed our Quarterly Report on Form 10-Q. For those of you who have not yet seen these materials, both are available on our website at www.cognex.com.

They contain highly detailed information about our financial results. During tonight's call, we may use a non-GAAP financial measure if we believe it is useful to investors, or if we believe it will help investors better understand our results or business trends.

For your reference, you can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the earnings release. 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..

Thanks, Dick, and welcome everyone to our second quarter conference call for 2016. As you can see in the news release I just issued earlier, we reported very, very good results for the second quarter which were better than our expectations and our expectations were pretty good.

Right now, I'm in San Diego, everyone else is at our Natick headquarters and for details of the quarter and the outlook I'm going to hand the microphone over to my partner and our CEO Rob Willett. I will be available at the end of the call to answer any questions that you may have for me. Rob, the microphone is yours..

Thank you, Dr. Bob. Good evening, everyone. I am pleased to report that we set new records for second quarter revenue and earnings per share from continuing operations. These were also the second highest revenue and EPS that we have ever reported for any quarter in our company's history.

Revenue was $147 million which was $7 million higher than the top end of the range we gave to investors back in May. Demand was stronger than anticipated across several industries including consumer electronics, automotive and logistics. Gross margin was 76%, slightly lower year-on-year and sequentially.

Somewhat dilutive to our overall margin were product mix and inventory charges. Operating margin doubled to 34% from 17% in the prior quarter. This significant increase reflects the substantial leverage that incremental revenue has on our business model.

We delivered earnings from continuing operations of $0.50 per share compared to $0.49 reported the last year's second quarter and $0.17 in the prior quarter. Earnings also exceeded the Thomson Reuters first call consensus estimate of $0.43 per share. Now, turning to the details of the second quarter. In factory automation revenue was $141 million.

This level represents strong sequential growth led by major contributions from consumer electronics and logistics. Growth was modest compared to Q2 a year ago, higher sales across a number of industries this year were largely offset by lower revenue from consumer electronics.

As we discussed in our May call, large electronics orders are split this year between Q2 and Q3. Last year the majority of these orders were recognized in Q2. Looking at factory automation year-on-year from a geographic perspective, Greater China was our fastest growing region in terms of percentage growth.

Importantly the growth rate accelerated as compared to the rate in Q1. Americas set a new quarterly revenue record and provided the largest contribution to growth in absolute dollars. These achievements were largely the result of higher sales to customers in the logistics industry.

And European factory automation revenue declined significantly year-on-year due to lower revenue from consumer electronics. Outside of that, our European region grew faster than in recent quarters. In the semiconductor and electronics capital equipment market, revenue was $6 million in the second quarter, down high single digits year-on-year.

Demand from semi has been relatively flat on an annual basis for the past several years. Our expectation for growth in this very small piece of our business continue to be low. Moving now to operating expenses, RD&E and as SG&A totaled $62 million for the second quarter. This level was slightly more than we expected due to the higher revenue level.

Looking year-on-year, operating expenses were relatively flat. Our investments in engineering and sales personnel were offset by $3.5 million of costs related to the resolution of patent disputes in last year's Q2. In summary, Cognex had an exceptional second quarter and we expect another strong quarter in Q3.

In regard to specific guidance for Q3, we believe that revenue will be between $142 million and $147 million. This range represents substantial growth over Q3 a year ago due particularly to higher revenue from consumer electronics. Outside of that industry, we think revenue will grow year-on-year despite continuing challenging market conditions.

Gross margin is expected to be in the mid-to-high 70% range relatively similar to the gross margin reported to date for Q2. Service will represent a higher percentage of revenue in the third quarter. Operating expenses should remain relatively flat on a sequential basis, and increase by approximately 10% year-on-year.

Last year we adjusted our bonus and commission accruals downwards during Q3 to reflect softening business trends. This year, business is improving and we are increasing investments in growth areas. The effective tax rate is expected to be 18% excluding discrete tax items. Now let's open the call up for your questions.

Operator, we're ready to take questions..

Okay, sir. [Operator Instructions] And we'll take our first question from Jeremie Capron from CLSA. Jeremie, your line is open..

Thanks and good evening, everyone..

Hello, Jeremie..

My question is around the trends you're seeing in consumer electronics. You sounded a lot more cautious entering 2016 and clearly things have been better than anticipated. And your third quarter guidance seems to suggest a significant improvement.

So can you give us a little more color around what you've seen, what you think is driving this change in the outlook. Thank you..

Coming into the quarter, we expected to receive substantial orders from consumer electronics, but overall market concerns led us to be cautious in estimating what projects would be funded. So demand in Q2 came in stronger than we expected and then we've also been successful in winning account share in that market.

We have a much better visibility into consumer electronics demand than at the time of our May call, and we now expect consumer electronics will grow in 2016, although the rate of increase will be slower than in recent years.

So I'd say Jeremie, our visibility improved and our – think we've executed better and probably won more share in that market among its major players than we expected to when we last spoke..

Excellent. And what about other end markets? You also sound today more positive on the outlook here despite what I would characterize as continued deterioration in industrial spending out there..

Yes. Well, logistics certainly is growing very well for us this year. We've seen substantial pick up in our logistics business in America, particularly, but also in Europe. And we continue to make good progress with all different sizes of accounts in logistics, smaller and medium size logistics accounts.

We're spreading our base of customers in that area and they're really benefiting from our technology, but also larger big players in e-commerce and parcel and package delivery, certainly are really seeing the benefit of what we have to offer, which is very gratifying.

So, we talked about, Jeremie, two of our three big markets, so consumer electronics and logistics and the one we haven't talked about is automotive. I think back when we last updated you 13 weeks ago or so. I think we were more cautious about automotive and I think it's been slightly better, that market, than we expected at that time.

Our performance in automotive particularly in Asia including China and the rest of Asia has been stronger than we expected, and the market seems to be responsive, more responsive than we had expected. And we've seen good growth also in Europe. The slower growing part of automotive for us is in the U.S.

today but still we're seeing growth in that market as well. We reported – we'll have seen our largest quarter ever in U.S. automotive or America's automotive I should say in the quarter we just completed. So, I'm not – don't take this to mean that market conditions are good. I don't think they are.

I just think they're slightly better than we expected them to be, and I think our execution has been pretty good..

Congratulations. Thanks, and I'll get back in the queue..

Thank you..

Okay, thank you. So, our next question comes from Joe Giordano from Cowen & Company. Joe, your line is open..

Hi, guys. Good evening..

Hi, Joe..

I wanted to ask about overall growth relative to total CapEx across your industries, because right now clearly you guys are outpacing a pretty static CapEx growth across these industries.

And if we get to a position where CapEx at your customers, and they will – I guess clearly the spending on you, on this type of investment is growing as a percentage of CapEx at your customers.

When growth CapEx finally starts growing at your customers, how should we think about this type of directed spending? Will that maintain like that kind of percentage of total spend or will your spending kind of move a little bit lower as a percentage as growth comes back.

How do we think about it in a better CapEx environment for your customers?.

Well, Joe, I would say as the environment improves, we would expect our outlook to improve as well. The growth we're reporting now is, obviously, better than we all expected, but it's still for the year not looking like will grow at the 20% growth rate that we expect, that we're targeting for our business.

And the reason for that is that we think the industrial markets that we serve are conservative in terms of – and their concerned about overall macro conditions today. So, our market machine vision, the markets we serve is growing high single or low double digits over the long-term is how we think of it.

We expect to outpace that growth based on initiatives like ID products where we're gaining large share in new adjacent markets we're entering, investments in new product development, the overall advantage of our technology and the recognition of our brand. So, that's why, we expect to grow significantly faster than the market overall.

As CapEx becomes kind of constrained, our growth rates diminish, and certainly they did last year and even this year below what we expect. But as CapEx comes back we would expect to see our overall growth rate grow as well..

And then if I'm thinking about automotive just in light of the U.S. you said was a slower growth than the others, but still up, and I think you said your largest quarter ever in gross terms there.

Given commentary from some of the major players in that industry, how are you thinking about that moving sequentially lower now same in Europe? I'm just curious as to what your discussions have been like in light of Brexit and all of that having a more of an impact on the broader European economy..

Yeah. Automotive is our second largest market at the moment and one where we have very strong share and a very long-standing relationship with the major players both the brand owners of the Tier 1 players. I think, and what we see out there at the moment is we see some relative strength compared to our expectations in Asia, so slowing down in the U.S.

but still growing. And then I think as you kind of rightly asked in your question, Europe is maybe more of a wildcard. We've seen some very good results out of Europe automotives in the last quarter. In fact, we grew double-digits year-on-year in Q2, Europe automotive, despite the region's news headlines.

But your question goes to what do we see in the future in Europe, and I think that's a difficult call at this point, where Brexit obviously is a concern. It's not really a concern for Cognex in terms of the UK. We do very little business in the UK. We only have about 11 Cognoids based there and it's not a significant part of our supply chain.

However, the knock-on impact on European investment, European automotive spend, that's more difficult to call how that's going to play out in the back end of this year or into next year. So I really can't speak with much authority on what I think is really going to happen there..

Just maybe last for me, one for Dick.

You mentioned some inventory charges, what were those related to?.

Yeah, well, every quarter we have some inventory charges. In this particular quarter we in fact discontinued a particular product line development and that probably cost us close to 100 basis points in gross margin. We don't expect that to recur in the rest of the year..

Thank you..

Okay. Thank you. And we'll take our next question from Jim Ricchiuti from Needham & Company. Jim your line is open..

Thank you. Good afternoon.

I'm wondering if you could help us maybe understand what the growth rate is in factory automation excluding consumer electronics and logistics, where you – and there is some different dynamics there?.

Jim your question is in the quarter – what?.

Yeah, in the quarter, Rob sorry. I'm just trying to get a sense as to what kind of conditions excluding logistics and consumer electronics just to give a picture on how we should think of the business ex-that..

Yeah, yeah. I think we saw a good quarter in terms of growth rate in factory automation. I'm not sure I can split out logistics for you, because that's sort of pretty broad, but if I lump logistics back into it and I exclude consumer electronics, our growth rate there was about 20%.

So we were right at our long-term target of 20% growth, but I'm including logistics in that..

Got it..

And if I took that out it would be lower. Right? But that's a market we're in..

Okay.

And within logistics I wonder if you could talk about the type of customer concentration you're seeing in that market and presumably that logistics piece will seasonally fall off in Q4?.

Right. Yeah. So we've been in this logistics market now for a few years and like a lot of our markets that we enter it's kind of like an S-curve. We see it takes a little while to get established. Industrial markets are more conservative in their adoption of products.

But we're now moving well up into the main part of the S and we're seeing really strong growth and adoption and customers really understanding our competitive advantage. And through that we've also invested significantly in our logistics sales force and so we have in America and Europe significant feet on the street there as well.

And so we're reaching a lot of broad customers. It's a much smaller logistics customers. And by and large our business there is direct. It's not really through partners for the most part. So and then – so we're seeing a good adoption and also as part of how we think of logistics, we have the new market for airport baggage handling coming along as well.

And there we see our product becoming recognized and adopted by a number of major airports around the world, which is also helping – will help I think going forward lift our growth rate further. So, Jim, I don't know if that answers [indiscernible]..

But from a volume standpoint, is there a high level of – are you seeing a high level of customer concentration within logistics, is it an 80%, 20% rule or something?.

No, I mean, we do have some larger customers in logistics who may purchase more than $10 million from us this year for a larger customer, and then we see many customers at smaller levels who may have an average purchase of $50,000 or less. So it's quite dispersed. It's not overly dependent on any one customer at this point..

Okay.

And Dick just a final question if I may, just that big spike in unbilled revenues that will – can bulk of that converts over to revenues Q3?.

Well, it's unbilled revenue, so it is revenue that was included in Q2 that we have not sent an invoice to the customer..

Got it. And so....

I was going to say what happens is sometimes with these contracts whether it's logistics or in consumer electronics, you have the contracts provide for milestone payments that differ from revenue recognition under U.S. GAAP so that either creates unbilled revenue or deferred revenue.

But this deferred – this unbilled revenue we expect to bill and collect in the third quarter..

And your R&D level being down as much as it was sequentially, anything going on there?.

I think that relates more to the fact that a lot of the engineers were working on undefined – and I shouldn't say undefined, but projects that were not supported by purchase orders in the first quarter. And now in the second quarter, what we found is a lot of them were working on very specific projects.

We had purchase orders, so a lot of that work then gets classified into cost of goods sold..

Okay. Thank you..

Okay. Thank you. Your next question comes from Ben Rose from Battle Road Research. Ben, your line is open..

Thank you, and good evening Rob and Dick and Dr. Bob..

Hey, Ben..

Hey, Ben..

Thank you, Ben..

Question regarding the performance in North America being strong in this second quarter.

Are there any other industries beyond automotive Rob that you call out within North America?.

Well, Ben, the primary reason we did very well in America in the second quarter was logistics, right and that certainly is what's lifted our business. Growth in the broader Americas market as I think we all probably see remains lackluster. Demand from U.S.-based manufacturers outside logistics is stable but it's not improved meaningfully this year.

Growth in automotive is slower in the Americas than in other regions even though automotive demands set a new record in Q2. We're seeing better growth out of Asia and Europe than we are out of Americas..

Okay.

And can you speak specifically to your expectations for the relatively new MX-1000 ruggedized ID readers, whether they could be – whether they will be a meaningful revenue contributor in this calendar year?.

So to answer the second part of your question no, we've said I think all along that it's a journey for us with that kind of S-curve. We've learned where we're establishing ourselves in that market and proving ourselves to customers. That said, the mobile terminals is an exciting market where we expect to bring significant change to the market overall.

We size it as a $500 million market with an installed base that's under transition away from Microsoft operating systems more towards Android and iOS operating systems.

So we are moving into that market with what we continue to believe increasingly is a very advantaged product and early adopters of the product so far have been innovative companies who can see the benefits of using Android and iOS platforms combined with Cognex vision.

So we have had a first volume order from a new Cognex mobile terminal customer and it came from a delivery service company. A really great kind of new economy, e-commerce leader that, you would recognize the name of, who is using the MX-1000 to scan orders and pack boxes for customer delivery.

It was a relatively small order of around $100,000 initially as they start to fit out a few of their warehouses and we expect to see follow-on business from them. It's not particularly material to this year, to your point, but it's indicative of the kind of customers we expect to delight with this product.

And also importantly I think as people have been thinking about it in that mobile terminal market, Ben, is we've got good prices for that product and we're going to be recording Cognex-like margins.

I think that's something that's not well understood still about our journey into that market as the – when – at the cost of what we sell which is really a rugged enclosure with powerful Cognex vision on the front and a lot of powerful software. The cost of it is relatively low.

Customers combine and integrate smartphones into it and when they do so they can come with a product that's much more competitive and below the cost of the leading players in the marketplace and we can still make the high gross margins that we expect from ourselves.

So everything so far that we're seeing in the market is validating our position there and we're making a nice progress, but don't expect it to move the needle on the P&L this year..

Okay. Fair enough. I thank you for the complete answer. One final question, I guess, for me is with regard to the consumer electronics orders that you're expecting in this quarter.

Could you speak to – would it to be correct to assume that the bulk of that is coming from Greater China?.

Well, we report a lot of substantial consumer electronics orders in Europe, right, because basically the product is – for some of our customers purchase in Europe and then deploy it into China. So you'll see that – we would expect you to see that showing up in our European region..

Okay. Thanks very much..

Okay. Thank you. And our next question is from Richard Eastman from Robert W. Baird. Richard, you're now open..

Yes. Good afternoon, and fantastic quarter. Nice work..

Thank you, Rick..

Thanks, Rick..

Just quickly, with Cognex's China business, the strength there and I think you touched on the end markets, but has Cognex continued to build out their distribution network or feet on the street in China.

I know we went through a period of about three years, it might have been two years ago where you added a lot of people there, feet on the street, is this about leveraging those people or have we continued to build out the distribution there along with the demand?.

We certainly made a lot of progress adding or perhaps more importantly improving our distribution network in China. We've done that with by working very closely with our distributors there and adding new ones.

And I would say and I visit them and spend a lot of time with them particularly in the spring of each year and just the quality and capability of these teams and the number of people they've added is impressive, really impressive to the point of – where their ability to execute and the quality of the people in their teams are as good as anywhere around the world.

And then we also have our direct team and there – you're right Rick that we certainly added a lot of Cognoids to the sales force in China back in, I think from memory, the middle of 2014. The rate of increase has slowed more in line with how we saw demand developing and their productivity improving.

But we do continue – we certainly continue to add head count on a regular basis to our China sales team. Just a few kind of data points to sort of help us think about that, revenue from Greater China in 2015 was $54 million, up more than 40% from 2014. It was – China was our fastest growing region in Q2 this year and increased 25%.

So that rate has slowed down and the rate of head count that we think required to deliver on the market potential is, the rate slowed down but we're still adding and that's largely a result of kind of what we see going on more in the macro environment there, which I think everybody is seeing..

Rob, when you look at Cognex's channel to market and we talk about the ID products or at least the logistics piece doing very well.

We've talked a little bit about auto, but when you look at your mix of business distribution versus direct, on the distribution side of the business for total Cognex, does the growth rate look closer to what we're seeing in other factory automation companies or data points like maybe low to mid-single-digit growth.

I guess what I'm getting at is you had tremendous success on direct sales in certain verticals where you put the emphasis and the emphasis in R&D, but do you look at the balance of your business that goes through distribution? And is that where there's a little bit more caution, a little bit more hesitancy?.

It's an interesting question, Rick, so let me kind of share some data with you. So overall approximately 60% of Cognex's sales generally come through our channel partners and 40% come through our direct sales force. Last quarter it was more direct mostly because we saw more larger orders in electronics and logistics, which tend to be direct.

I think our growth rate with partners, growth rate in general we'd expect and certainly with partners is definitely outperforming what you're seeing in the rest of factory automation. So in Q2, in direct bookings, the bookings through partners was up high single-digits is what we saw, right.

And that would not include any of the kind of consumer electronics and logistics upside that we've seen sequentially, so that's it. The growth rate on the direct business was higher than that and I'm talking their bookings not revenue..

I understand. But a good testimonial here that again suggestive of machine vision gaining share within the broader automation market I guess, that's where I was going with that..

Yeah. And to build on that Rick, I've got and spent a lot of time with distributors. They're very excited about machine vision. They see it as one of their fastest-growing and most profitable markets. Technically demanding but gives them competitive advantage.

So there's a sort of excitement that you don't see in almost any other element of their product lineup that they still have around machine vision..

I understand. If I look at, and again, let me phrase this in this context. I think often the Street looks at Cognex and their consumer electronics business is maybe and your comments about it is maybe your proxy for your largest customer revenue.

And if I estimate what you did, Cognex did with their largest customer in the second quarter and then try to fill in with your commentary about the third quarter, I don't get close to the $81 million in calendar 2015 revenue that you disclosed in your K.

So the question is, is that my bad math or is there another larger C&E – CE customer or two?.

Yeah, yeah. So I'm pretty limited as to what I can say. I'd point you to the data which we've reported which is our Form 10-K. Our largest customer represented 18% of revenue in 2015, up from 16% in 2014. We really can't – we're under very strict confidentially about that customer.

In terms of consumer electronics in general, what we've told you is, revenue is going to be split this year between Q2 and Q3. And so, that's why we saw a decline year on year and we expect to see an increase year on year in Q3, right.

So, beyond that I really – but I think we've also told you that or perhaps I think we said we expect our consumer electronics business to grow this year, which we didn't previously when we spoke with you. But we now expect to grow. But I think you can make the math work on all of that..

The one comment that I would add is [indiscernible] sequentially we did see an increase in total consumer electronics business and in non – that single large customer business as well. So that might be part of the issue that you have in trying to reconcile the two..

Okay. That's fair. And I'm sorry, just one last question.

In the second quarter, Dick, I think you had mentioned that the higher mix of hardware content in the sales may be pulled in gross margin a little bit and then for the third quarter we're going to see a higher content of service, so do those two kind of "offset each other" so that our Q2 and Q3 margins should essentially be similar?.

Yeah. I think what I – I wouldn't say that those two would be the offsetting ones. I would say – I would suggest that the offsetting might occur to the fact that in Q3 we do expect to have more service revenue which will create a dampening in the reported gross margin.

But as I mentioned earlier, we had in Q2, we took a charge against product margins that caused us to lose about 100 basis points because of this project that got discontinued and we don't expect that to repeat in either Q3 or Q4.

So we'll pick up a little bit on the product side because of the lack of the inventory charge and we'll lose a little bit, because we'll be doing more service revenue as opposed to product revenue..

I got you. I understand. I'm with you. Okay. Well, thanks and very nice quarter again guys. Good job. Thank you..

Thank you..

Thank you..

Okay, thank you. And our next question – we have another question from Jeremie Capron from CLSA..

Thanks for taking my follow-up question. It relates to the comment you made Rob around winning account share in consumer electronics. I wonder how you feel about future or potential share gains in consumer electronics at your top customer and beyond..

Well, I think as I've said many times I'm not going to speak about any specific customer, but if we talk more generally about consumer electronics, I think there's still a lot of technology and innovation being put into those products and the challenges that are faced for manufacturers in terms of productivity, labor costs, the diminishing size of the products, which are becoming less and less possible for human hands to assemble play pretty well into the adoption of machine vision, we now have a lot of great experience, arguably the best experience of any company in the world implementing machine vision in this type of products, and there's plenty of demand out there.

So I think – and our capacity to fulfill our demand has improved significantly both in terms of the products that we're delivering and in terms of Cognoids' capabilities and engineering knowhow. So I think we're pretty well positioned to see some continuing growth in that market.

What we do know about that market is it tends to be in Q2 and Q3, that's when we see the revenue. And there can be some pretty large pieces of business within our revenue mix and some large customers coming in and out, so it may not always be a smooth ride but we think it's going to continue to be an upward ride for some time..

Great.

And when you look at the competitive landscape in this particular end market, what are some of the key winning factors for Cognex against maybe some of your larger competitors out there?.

Well, this is a very sophisticated market with very sophisticated customers who are deploying billions of dollars of automation capital every year. So, when they meet with Cognex, they really benefit from our phenomenal technical know-how. Our competitors tend not to have that level of capability and know-how and engineering knowledge and experience.

So this is where we can play really well and we do and the level of trust and integration and value that we can bring to them, really makes us and them shine. And there really isn't a company that can come close to that at the moment.

And then there are also adjacent kind of markets from those we serve today that we're interested to move into where I think we can take our value and deliver further growth in the future. So that's why I think we continue to do well and we'll continue to do well as they address the challenges in their production and put out road maps..

Excellent. Well, congratulations and good luck..

Thank you..

Thank you..

Thank you. And our next question is from Joe Giordano from Cowen & Company. Please go ahead..

Hey, guys, thanks for letting me jump back in here. Quick on logistics, so on the ID markets you have more competitors than you do on the vision side and given you’re really positive comments here on the logistics market, I'm curious as to what that suggests about win rates.

Are your competitors seeing the same level of growth in that market do you think or is it just a rising type of thing everyone or are you significantly outpacing, do you think your customers in that market?.

Well I think the market is relatively buoyant at the moment. I think there's a lot of deployment of automation into logistics based on what's going on with the e-commerce supply chains and the challenges and disruption that's going on in those industries.

That said, I think we are certainly outpacing the growth rate of any other substantial player in that space. And I think, because we're relatively new, we've got really advantaged technology and we're still really getting that sort of socialized with the customers that are out there and they're benefiting from it. So market condition is pretty good.

Cognex outperforming and really growing very substantially. As you know we're targeting 20% growth rate for factory automation over the long-term and for our ID business, we're looking to achieve 30%, which is one of the reasons we think we can achieve that 20% is we have a sizable part of the business growing faster.

And for logistics, we expect, we believe that we can grow in excess of 30% per year over the long term. We're doing that now and that's certainly faster than I think anyone would suggest the market is going to grow..

Yes. That is definitely a true statement. And then, one last one for Dr. Bob if he's still on the line..

I am, indeed..

Has your view on autonomous cars shifted at all in the past year? There's been some high-profile problems there, but also seems like people on the manufacturing side still pushing in that direction.

Is this something that you still want to be, like, a late follower when it becomes more mass-market in terms of production volumes, or is this something that you look at as problems that Cognex can help solve?.

Well, Cognex is already participating in the market for autonomous vehicles. I'm not going to name any particular manufacturer right now. But automotive manufacturers in general rely on Cognex to manufacture vehicles and to ensure that all the components that go into them are proper and that they go into the right place on each vehicle.

So we are already involved. But if you mean our involvement with regard to the actual technology of guiding cars.....

Exactly. Yeah..

Yeah, then we are not very positive – well, let me put it this way, at some point probably 10 years, 20 years from now, people will get into vehicles and there won't be a steering wheel. But that's going to be a long haul from now. There are significant problems that have to be solved.

I won't – over drinks I'll be happy to give you examples of those things that are very difficult to solve. What cars can now do is, yeah, they can park in a parking lot and they can drive on various highways where there are no trees, no kids with balls and no dogs and nothing else.

But it's going to be a long time before the legislation and litigation and all the regulation about it is in place to allow it to be a very big market. So the combination of us viewing that the market is way in the future and realizing that the technological challenges are significant and are not directly in our area of expertise.

Our company has focused on particular kinds of machine vision problems, where every one of our product is looking at something and the product knows what it's supposed to be.

We look at whether it's a cell phone or a keypad or a Q-tip or a toothbrush, we know what it's supposed – the vision system has been trained to know what it's supposed to be and we're looking for flaws or defects or we're looking to place that item somewhere in a fixture. So that's our particular expertise.

There are so many applications of that in factories that where we have lot of runway in our own marketplace and in adjacencies to grow. And it doesn't give us – and we don't have to look at these other areas, which are somewhat more speculative in my view both from the opportunity standpoint and from the profit standpoint.

I'll go into that a little bit, we did pursue automotive guidance.

We purchased a company called AssistWare it must've been, I don't know 10 years or so ago that had excellent software for lane tracking to ensure that cars were staying in the lane and that's something that's extremely important, and I think is quite well solved now by a variety of companies.

We thought that that would be the right thing to do and we started selling it to truck companies and was somewhat successful because long-haul trucks need that. But when we approached OEMs or the companies that manufacture vehicles, we found that we didn't have a business structure to be able to deal with large OEMs.

We were told we that had Tier 1 and Tier 2 suppliers and when you look at – when we studied the business case for it and the price that the OEM ultimately wanted to pay, which is very different from what an OEM pays for vision to build a car when it's talking about tools to build cars to make sure they're built correctly and safely it's a different calculation then when something actually is a part of the bill of materials that goes in a car.

So, when we couldn't make a business case for foreseeing a very profitable picture of providing a technology to actually control vehicles.

So, I won't say that we'll never be in that business, but so long as we have great opportunities in the areas where we're already in and adjacencies to those areas, I see no reason for us to be distracted into these other areas that have a lot of hype associated with them, no question. Everybody's excited about it.

But we've seen things like that in the past where people are very excited about things and it just didn't present an opportunity for Cognex. I'm not saying that it's not an opportunity for anyone else.

It's certainly an opportunity for the manufacturers of those vehicles who can't build them fast enough, although I'd question why you'd want to build something when you lose $5,000 per piece part. But that's a different story.

So, I think that we have a great runway ahead and as today's results are showing you that even when the macro economy and the CapEx spending is languishing, that Cognex can do not just well but great..

That's great color and thanks so much..

You're welcome..

Okay. Thank you. And our next question is from Bobby Eubank of Chevy Chase Trust. Bobby, your line is open..

Hi. Good afternoon, guys. Thank you for the question. Great quarter. Two parts to the first question and a follow-up.

First question, last year at the beginning of the year you had a high expectation and you increased your investments in your head count expecting the growth to continue and it didn't materialize, so kind of what gives you confidence that this growth will materialize as you increase investments? And then two, what gives you an ability to see beyond one quarter.

How close are we to kind of having more steady-state business that gives you better predictability behind one quarter? And then second question just on cash balance and the M&A environment if you see anything out there that you expect to deploy cash with? Thanks..

Sure. Thanks Bobby. Okay, so I think our long-term confidence comes from the value that our customers see in our technology and our history of deploying vision to factory automation. This is a business that has grown 9% out of the last 10 years in terms of revenue growth, so the supply of machine vision to – Cognex machine vision in factory automation.

So we think we've got the long-term perspective that says this is a great market and we can grow. And we – our investment generally is based on long-term potential that we see. It's not based on particular quarters or a short term perspective.

That said, if we see the market turning down or we think, over the coming quarters things look less good we do trim our expenses or increase our expenses based on what we see.

Then I think the second part of your question Bobby was sort of how do we see that? What do we see? And we have visibility with our customers through product roadmaps, discussions we have with them about what they want to do and how our technology is developing.

We have exciting new products we're bringing to market, things like the mobile terminal or other technologies that we're bringing to market that we can see potential for further out. We have a very good CRM system that looks at order activity and how that's tracking.

So, we do have some visibility out there, certainly that gives us a view of how it's developing. But that said I think we all know that factory automation and capital deployment in factory automation can turn down relatively quickly for everyone. So and the kind of forward view that we have is not that clear as we move further out.

So I think we remain relatively cautious about the market, relatively cautious about Q4, but relatively optimistic about what we see with our customers and at what we see particularly over the long-term and that's why we continue to invest behind those initiatives. The third part of your question had to do with cash and how we deploy cash.

The number one area that we look to deploy our cash into is acquisitions. We are seeing more activity on acquisitions at the moment. We have a number of opportunities that we're in more advanced discussions with, but they're relatively small acquisitions, wouldn't require a large piece of our cash to deploy.

But certainly in terms of our activity and what we hope to be able to tell you that there's more of that than there has been in recent years, currently on deck.

We also are buying back shares and you can see that and we can speak to that further if you'd like and then we have – we increased the dividend when we spoke to you last and we continue to pay the dividend. So that's kind of the story on the cash..

Yeah. That's very helpful. If you could maybe talk very briefly about your buyback policy and it looks like last quarter, no buybacks. This quarter a little bit smaller than maybe some of us had modeled.

So what goes into your thinking behind the buyback? Is it because you expect to do an acquisition or is it just based on purely the share price?.

No, we – the overall philosophy is to make sure that we buyback everything that we issue through stock options, so that we can absorb all of that dilution. Last year we bought back close to 2 years’ worth of dilution. We're back in the market these days and going out on a regular basis and at levels that we feel comfortable with.

Again, considering absorbing the dilution..

Great. That's helpful. Thank you. Congratulations again..

Thank you..

Thanks..

Okay. Thank you. And we'll take our next question from Jim Ricchiuti from Needham & Company..

Rob, this just relates to the target growth for factory automation that you've alluded to, the 20%. You've had such – the success you've had in logistics and consumer electronics is pretty well documented, but what I'm wondering is some of that success been perhaps masked by just the weakness in the factory automation market.

Is there really a halo effect to what you've done in these markets, or are the used case is still somewhat specialized?.

Jim, I'm not sure I understand your question fully. I can talk to a little bit more about why we expect we can achieve the 20% growth rate over the long-term, but I'm not understanding the halo effect..

Well, I guess, what I'm looking at is some – we don't have great detail on what you're doing for instance with this large customer in consumer electronics.

I think we know the success you've had in logistics, but as we think about the opportunity to drive higher growth in some of the other factory automation markets, would we have seen that do you think in a better industrial economy.

I guess, what I'm trying to get my arms around is if we start seeing the global economy pickup, are we going to start seeing some new applications for your technology that may get adopted that we haven't just yet?.

Okay. Got it. Yeah, I mean, I think broadly the answer to your question is yes, right. I think, if you go back to sort of say 2014 when I think the market conditions were much more favorable very, very roughly and these numbers are just directional. We saw something like 40% growth rate in our business.

And we were certainly achieving 20% net of large consumer electronics customers in our base business. We were seeing that kind of 20% growth rate and then, obviously, we had sort of extra business on top.

If we saw a return to market conditions like we saw in 2014, we would expect to see the base business grow very well and then we might also have other large customers in areas like logistics or other consumer electronics large customers or there are even potential in other markets to have I think very large customers, perhaps taking us well north of that 20% target like we saw in 2014.

You kind of fast forward there you get to 2015, the constant currency growth rate that we reported in 2015 was around 11%. But dollar basis it was 6%. So taking that constant currency growth rate of 11% we didn't get – you can look in the 10-K and see what the large customer did for us.

But net of that, I think we were still reporting a decent growth rate in some very difficult market conditions. So I think if market conditions improve, we certainly would expect our own business to improve over the long-term and I think that's obviously what we'd like to see happen.

But you can see we're able to put up some pretty good numbers despite difficult conditions as we've told you tonight. And we do have – we're lucky to be in a market where our technology is getting faster, less expensive, easier to deploy and it was serving broader and broader markets.

So that means, although we spend a lot of time talking about automotive, consumer electronics and logistics, there are a lot of other markets out there who can put up some very good percentage growth rates.

I'm talking here about like food and beverage, tobacco, medical devices, life sciences where certainly as conditions improve, or as just our deployment continues, we can expect to see them I think contributing at some pretty high growth rates over the long-term..

Okay. Thanks a lot. Congrats on the quarter by the way..

Thank you..

Okay. And I'm showing no further questions in the queue. I'd like to turn it back to your hosts for any concluding remarks..

Sure, thank you very much. To wrap up, Q2 of 2016 set a record for quarterly revenue and EPS for any Q2 in Cognex's 35-year history. And in addition, it was also the second highest revenue and EPS that we've ever reported for any quarter in the company's history.

We now believe that 2016 is going to be a better year than we just thought a few months ago and we look forward to reporting the results to you on a quarterly basis. Thank you very much for attending the call and for your interest in Cognex..

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