Cognex Corp (CGNX) 2002 Q3 法說會逐字稿

Please stand by. Good day, everyone. Welcome to the Cognex third quarter earnings release conference cal. Today's conference is being recorded. At this time, I would like to turn the conference over to the CFO of Cognex. Mr. Richard Morin. Please go ahead, sir

Thank you. Good evening, everyone. Before I turn the conference call over to Robert Shillman, I want to emphasize that during this call, we will be talking about expected or anticipated future events. Any forward-looking statements are based on 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 files for a detailed list of risk factors. And now, I'll turn the call over to Robert Shillman.

Thanks, Dick. Hello, everyone. Welcome to Cognex's third quarter conference call for 2002 and I really mean welcome because we're happy to have you there. We have some nice results to report. As you saw in the press release, issued a short while ago, you know, why am I saying that? I am assuming you saw it. So can you raise your hand if you haven't seen it? Okay. There are some people there who haven't seen it. Well in the press release, which you should get from now on before you to listen to the conference call because I'm going to assume that you have read it from now on, we did report revenue for the third quarter of nearly $32 million and net income of $781 thousand, which comes down to two cents a share. I would like to point out that even after excluding the positive impact and its unusual for us to have a positive impact on anybody, but we did have positive impacts of unusual items in this Q3 we were still profitable and had a net income, not a lot, of $53,000. This is the first quarter since Q3 of last year that we returned a profit to shareholders. Our financial results represent an improvement over the prior quarter and they are in line with the guidance that we gave to investors on August 1st. In the third quarter, bookings were essentially flat on a sequential basis. And our book to bill was greater than one. Later in this call, I'll talk more of the order rate and what it means for our business outlook, but first I'll turn the call over to Dick, who will walk you through the income statement and balance sheet.

Thanks, Bob. As Bob said a moment ago, Cognex reported revenue for the third quarter of 31.8 million.

Why is - I just said it a moment ago. First of all if they read the press release, from now on let's not have that in the script. Sorry to be editing this on line, but what the hell. In the future we'll save your time. Go ahead.

Which was in line with the guidance that we provided to investors last quarter.

I said that too.

Revenue in Q3 decreased 6% from thethird quarter of 2001, primarily due to lower sales to end user customers in the electronics industry. As well as lower sales to original equipment manufacturers in the semiconductor industry. On a sequential basis revenue increased 19% from the prior quarter. This increase is due to a pickup in business with certain manufacturers of semiconductor capital equipment based in Japan as well as higher sales to end users in a variety of industries around the world. Revenue from our OEM customers in Q3 was $10.5 million, and represented 33% of total revenue. In absolute dollars, OEM revenue decreased 13% from the third quarter of 2001 primarily due to lower sales to customers who make capital equipment for semiconductor industries. On a sequential basis, OEM revenue increased 24% from the prior quarter, primarily due to an increase in business with some of the very same customers. In the third quarter, revenue from end user customers was $21.3 million and represented 67% of total revenue. Revenue from end user customers decreased 3% from Q3 of last year, primarily due to lower sales to customers who make electronic products. End user revenue increased 17% from the prior quarter primarily due to a pickup many business from customers in the electronics industry, as well as higher sales in general manufacturing industries such as automotive, medical and paper. Geographically, revenue in the United States represented 38% of total revenue for the third quarter. Japan accounted for 32%, and Europe 24%. In absolute dollars, revenue in all three of the primary geographic regions we serve decreased as compared to the third quarter of 2001. On a sequential basis, revenue was essentially flat in the U.S. and increased from the prior quarter in both Japan and Europe. In Japan, the sequential increase in revenue was due to higher sales to certain OEM customers. In Europe, revenue increase as compared to Q2 across that region's end user customer base. In the third quarter, we reported a gross margin of 65%, which includes a benefit of nearly $1.2 million or three percentage points relating to inventory that we had reserved in 2001. Of the total $1.2 million benefit, in Q3, nearly $300,000 relates to inventory we sold in Q3 that had been fully reserved in 2001. The remaining $900,000 relates to inventory purchase commitments that were in dispute with the vendor and which have been resolved in our favor. Excluding the inventory benefit in Q3, our gross margin was 62%, which is down from the 67% that we reported in the third quarter of 2001. The decline in gross margin year on year is primarily due to a much lower margin on MBSD service revenue in Q3 of 2002, as well as lower product volume. To understand the service margin when Cognex sells a machine vision system the customer pays for a bundled package that includes the product and technical support services. These services can extend for up to one year and we recognize that service revenue over that period. As product sales have decreased, the allocation to service revenue has also decreased but our costs have not been able to reduced by the same percentage. On a sequential basis, gross margin was consistent with the gross margin of 62% that we reported in the prior quarter, excluding a similar inventory benefit. Looking forward, we expect the gross margin to be in the low to mid 60% range for Q4. Our DNE spending in the third quarter of 2002 decreased 11% from Q3 of last year. Primarily due to lower head count as well as the timing of outside expenses for product development and patent-related costs that did not repeat this year. On a sequential basis, RDNE spending increased from last quarter, primarily due to severance costs in Q3 related to the work force reduction that took place on August 1st. As a percentage of revenue, our RDNE spending was 21% in 2002, which is down from 22% in Q3 of last year, and from 24% in the prior quarter. The decrease in our DNE spending as a percentage of revenue from the prior quarter is because revenue increased at a faster rate than expenses did. Looking forward, we expect that our RDNE spending in Q4 will decline by approximately 5% or so as compared to the Q3 level. In SGNA spending increased 9% from the third quarter of 2001 and 8% from the prior quarter. The increase in spending year on year is due to higher severance and related costs in Q3 of 2002 than in the third quarter of last year, as well as higher marketing expenses in the impact of foreign exchange rates on our international operations. On a sequential basis, the increase in SGNA was due to impact of foreign exchange rates and severance and related costs in the third quarter as well as higher sales commissions. As a percentage of revenue, SGNA spending was 49% of revenue, which is a decrease from 53% in the prior quarter, because as I just stated for RDNE, revenue increased at a faster rate than did expenses. In Q4, we expect SGNA spending to be essentially flat with the Q3 level. Savings from the work force reduction in August will likely be offset by the impact of foreign exchange rates, as well as increased spending in specific areas such as advertising for the end user business. As mentioned earlier in this call, we had a profit of $53,000 in Q3, after excluding the inventory benefit. Although this is down from earnings of five cents per share last year, it is an improvement over the prior quarter in which we reported a loss of three cents per share, excluding unusual items. In addition this is also the first quarter since Q3 of last year that we were profitable at the bottom line. Now, I would like to turn to the balance sheet. Our financial position remains very strong at the end of the third quarter, with $384 million in total assets and $350 million in tangible net equity. Our cash in investment balance was over $270 million and we continued to have no debt. Our cash balance is down since the end of 2001 because while we generated $7 million in cash from operations in first nine months of 2002, we spent approximately $26 million to repurchase nearly $1.8 million shares of Cognex stock. Our current approved plan gives us authorization to purchase up to $100 million of our stock on the open market. Days outstanding for the third quarter were 60 days compared to the 64 days that we reported at the end of the prior quarter and the 58 days that we reported at the end of last year's third quarter. DSO remains within our targeted range. Inventory turned at a rate equivalent 2.4 times per year, which is first time since Q4 of 2000 that our inventory turns exceeded two. At this point, I'd like to turn the call back over to Robert Shillman:.

Thanks. While Dick was reading this, I came -- I realized that some of you, a lot of you are taking various notes and trying to listen at the same time and this is being recorded, you might have to play it back. I'm wondering if you would instead of us reading this text to you, if you would like us to send it to you either along with the press release. We can make it public or put it on our web, or E-mail it to you afterwards. So as you ask a question, if you'll just respond to that. And then what I would think we would do, instead of reading this as a conference call, we would just take questions. I think that would be a better use of everybody's time, but there may be reasons why that Dick isn't kicking me yet, so probably okay with him. So I wanted to respond to that. When you get the chance to ask questions. Here are my comments now, which would also be available ahead of the call. In this quarter, we signed 256 new customers compared to the 287 new customers that we added last quarter, Q2. Of these 256 new accounts in Q3, 26 were OEMs and 230 are end user customers. Although the number of new accounts signed in Q3 has decreased slightly on a sequential basis, adding over 250 new customers in one quarter is still very significant number that we're very pleased with. Some of the decreases due to seasonal slow down during the summer months, but my sales team tell me it's also due to the fact that they're focusing their time on penetrating more of large -- potential large accounts instead of spending their time on signing up many, new smaller accounts. Of the 256 new accounts in Q3, 11 of them represent significant customers which we have always defined as customers that we expect to generate more than $100,000 of ongoing annual revenue. Of those 11 significant accounts, five are OEMs and six are end users. Let's turn now to an updated insight. That's our very successful family of vision sensors, low cost easy to use high margin vision censors. The news on insight continues to be good. We had a record level of orders for insight. Bookings increased 25% from the third quarter of last year and 3% from the prior quarter. We're continuing to receive recurring orders for multiple units of insight from large customers. In fact, nearly half of the insight revenue so far in 2002 is from customers who are first signed in earlier years. One real highlight in the third quarter, a customer that is new to us gave us a purchase order for 150 insight units and I think that's deliverable over quite a short time frame. And we expect to receive follow-on orders from the same customer for an additional 60 to 80 units. This manufacturer is a leading manufacturer of diesel engines and trucks, and they will integrating insight into their production lines to track a wide variety of different engine parts through the manufacturing process. In addition to this customer buying those insights, that manufacturer is also requiring its outside vendors to add Cognex vision on to their lines as well. We were selected over a detailed competitive runoff against two other vision suppliers, but with but we were chosen because of insight superior technical capabilities as well as Cognex's worldwide sales and support organization. Unlike most other vision suppliers, we're able to supply customers with support at multiple plants at various locations around the world. We created insight as a way to broaden our company beyond the semiconductor and electronics industries. Unlike our traditional business, which is concentrated in the high-tech industries, insight is being sold to manufacturers across a broad range of industries. In fact, approximately 70% of insight orders are from customers in industries such as automotive, consumer packaging, pharmaceuticals, having nothing to do with semiconductors or electronics. Some comments about smart view. Our other factory floor product that is doing quite well is Smartview. That's Cognex's family of service inspection systems for the continuous process market. Bookings are up 12% year to date as compared to the first nine months of last year. And because of weak economic conditions, this market is not growing, but the increase in our business is due to the fact that we're gaining market share from our competitors. Our sales organization has had a number of major wins at manufacturing sites throughout 2002 and earlier today we announced one of Europe's top producers of high-grade steel whose name I can't pronounce will integrate smart view into the plant for the inspection of defects. This order represents a win for Cognex against an entrenched competitor who has been installed in those plants. Smart view is being installed on one line and we're in active discussion with this customer for many other projects. We have also received several substantial orders from some of the world's largest paper companies. More than half of the top ten paper companies in the world have now purchased Smartview, and we have entered into corporate agreements with two of them as well. Orders from these customers have surpassed $5 million since the beginning of the year and we expect to receive follow-on orders for additional units. Last topic in my prepared remarks is a general business update, as I said at the beginning of the call, bookings in Q3 were essentially flat with the prior quarter and it appears that we like many other companies are bouncing along the bottom. We expect demand of the non-high-tech industries will continue to increase. However, the rate in the near term is likely to be lower than what our long-term growth rate has been, because of economic conditions. In light of this environment of lower growth potential, we eliminated 85 positions from our organization in the third quarter. Incidentally, that comes out as 75 employees and ten open requisitions that were not yet filled. And we did that to further reduce our costs. Our first goal was to return to profitability as soon as possible, and we have done that. Our next goal is to return to profitability at the operating profit line as well. Going forward, we intend to take some of the savings from the work force reduction and invest in specific areas to grow our business, such as marketing for our end user products where we believe there are nice growth opportunities. Looking forward at Q4, we believe that revenue will increase slightly on a sequential basis. Somewhere around 32 to $34 million. And given that level of revenue, we expect to report profits anywhere up to three cents a share. At this point, we'll open up the conference call to any of -- for those of you who have questions. If you would care do comment on whether or not you'd like to receive this information electronically ahead of the call I'd appreciate that.

Thank you very much sir. At this time if you do have a question, please press star one on your touch-tone keypad that's star one to ask a question. And our first question comes from Jim [inaudible] with Needham and Company.

Good afternoon. Bob, I would welcome the script ahead of time, especially if you saw how my note taking ability is.

Right. Right. Yes, I mean, I never figured it out I mean the professors in college and I went to many lectures, right, everybody is taking the same thing down that the guy is writing on the board. Might as well pass it out. I think it's from the pen companies probably.

Yeah. The pen and paper companies. Okay, thanks, Jim.

Question. On the pickup that you noted in Japan, how much of that do you think is just them maybe rebuilding some inventory or is it some real pickup that they're seeing in their business with these O -- I was wondering what you can character size what you're seeing from the Japanese OEMs.

Right. The customers toll me that things were picking up, they did have more orders, which is why they ordered from us and those orders are now declined. Very simple.

Okay. Okay. The -- did you -- I don't think you did give any insight revenue number. Can you give that? In case you did in the quarter? And then while we're doing that, Dick, I wonder if you have -- at your fingertips what the severance costs were in the quarter?

Yes. Severance costs were approximately $1.3 million.

Okay.

Insight revenue for the quarter is $8.4 million. So we're currently running in excess of $30 million bookings rate and that was our plan.

Okay. Great. One last question. Before Iturn it over to somebody else. I wonder, Dick, if you have this if you just break out the revenues by the normal way you break out for some of the major markets.

Sure. I was dying for somebody to ask that question.

I know. You can put that in the script too, you know.

We may.

All right. Semiconductor was about 25%. Electronics, 19. Automotive, 12. Paper, 13. General manufacturing, 4. Metals was 3. Packaging, 4. Non-wovens, 4. And I guess consumer products was 4 as well, and then the rest whatever the difference is.

Okay. Thanks for now.

You're welcome.

And moving on, we'll go to Janet [inaudible]with Quadra Capital.

I would also like the script.

Thanks, Janet.

Actually, I was going to ask the revenue break down as well so you already gave that. But just a clarification on the previous question. Did you say that things picked up in Japan and then it started slowing down again?

Yes. It was either -- I don't know the exact month, but they told me that -- whenever we saw the orders increase was August and September?

We saw some increase earlier. In the second quarter, and then in the August/September time frame it slowed down.

Okay. So the same thing, it was not building inventory. Our bookings and revenue increase were due to actual customers ordering things, of course, and they had customers for things. But whatever blip that was, it has slowed down.

Any sense at all, you know, whether this slow down in Japan specifically is driven by a liquidity crisis? In other words, they finally decide odd to deal with the --with the problem, that situation and perhaps customers might have problems getting financing for simple things like inventory?

The two customers that I visited, most of their sales do not go into Japan. Although they're Japanese -- large Japanese companies, someone a surface-mount device assembly company, one is a wire bonding company. Most of their sales are elsewhere, different places, but I don't think it's their sales going up or down had anything to do with the Japanese macroeconomics climate.

Last one, if I may. Any sense of how much of your product is ending up in China?

Yes. I believe that -- I don't think any of our end user product is ending up in China. That was -- that we're pretty sure of. We don't yet have an operation there selling activity in China, and that's soon to change, I hope. But the OEM product, I believe are ending up in China. Many people that we have been speaking to are moving manufacturing to China. Many people we are speaking to are moving manufacturing to China. It's a general philosophy, general trend.

But if you were to venture a guess, any sense of, you know, is it yet like, you know, 5% of revenues?

I wouldn't know.

I don't know. Even though people are moving their manufacturing to China, I believe that those machines that are going to be built, those pieces of capital equipment, some of them will be in China, I suppose. But there are many people are moving to China for lower manufacturing costs and expect to ship around the world from there. So they're doing it not necessarily to serve the Chinese market, but for lower manufacturing costs.

Okay. I'll get back in queue and give somebody else a chance. Thanks.

You're welcome.

And our next question comes from Stewart Neuter with Adams, Harkness and Hill.

Thank you. Good afternoon. Bob, I would welcome the script.

Okay.

A couple questions. One, in terms of the semi-market beyond just Japan, I welcome your comments on what you're seeing and what your customers are telling you.

They were crying, most of the time. They weren't talking much.

Okay. At least hay they're not hitting you.

No, not me. I'm a vendor to them and they know that their suffering is shared by us. The companies I visited of course are OE Americas who only serve the semiconductor and electronics industry and they --doom and gloom. One of them actually said that he doubted his company would ever see the levels that they saw during 2000. Again.

Okay. On that note --

When things were going great in 2000, nobody said it was going to rain either. So --

That's true.

And even smart businessmen tend to be, you know, like everyone else. We're only human and we're affected by what we read in the paper general dismal reports. So everyone is doom and gloom and we are less doom and gloom because we have products for other industries, and they are doing very, very well. We're so fortunate to have those products and those engineers and marketing people who convinced management to go in -- to go into the other industries. Two-thirds of our business is not OEMs, and it's fabulous.

Bob, on that note, would you hazard a guess what you think your long-term growth rate would be in this general industrial market?

20%.

Right. Thanks very much.

That's what we'd like to do.

And Alexander Paris has the next question.

Good afternoon. And I would like the script also. I think that's a good idea.

Okay. I wonder if you all want the same script. I mean, we can sort of fine-tune it.

Give us a different one as you get more variety in the report.

That's not what Bob said. We have it right here. It's not even different drafts because I won't tell you how many drafts we go through. Would all of you like the Q4 script next week? We can send that out probably, right? As long as we have that forward looking statement there, I guess we're protected.

Sure. Yeah. You mentioned a few years ago you were talking about end user market was probably 70% of the total potential market and you would love to get up to 50% of a business and now you're up to 70%.

For one for the wrong reason, Alex.

For the wrong reason. When things normalize -- I don't know what normal is in the OEM electronic semi-market, but do you think you'd be at 50% now due to the moves or something on the way closer to 50%?

Well, we have had that discussion, and some people have commented in the company, senior people, that the OEM will never again be greater than 50% because the end user is growing nicely and the OEM business has less growth potential it appears. Yep.

Okay. An just in terms of the cyclical upturn, I don't know -- what kind of a connection there is between the industry numbers, but I have noticed semiconductor global billings have been, in a slow, but city steady upturn since January in the semi- --equipment is booked to bill -- looks like six months straight now. Do you see -- if you do track them, in the past, did it look like your -- this just coming from a very low base or there's a greater than normal lag between what you would see happening in the industry numbers and what your orders would be?

Complex question. I'm not sure I understood it, but the book to bill may be over one, but that's because the build so small. All right? I think -- and we looked very carefully at the plots of the semiconductor equipment sales or the assembly equipment sales in Japan, and there, you know, there bouncing around the bottom. The bill is so small it doesn't matter. So --

I think the other thing, too, is that a number of our OEM customers while the semi-book to bill may have been increasing, they were living off a lot of our inventory that they had purchased back in 2000, and they had a lot of our boards on hand that they needed to work through before they would come back and order new product from us, which also helped on the lag side, Alex.

Okay. You mentioned you made some nice bids against competitors in your smart view order. Who are your major competitors for smart view?

The major competitors are Sea of Brown Bavary, ABB and to a lesser extent a company in Germany called Parsytech. Those are the two major competitors. In Japan in the paper industry, you know, we're in three different markets with smart view. We're in paper, we're in metals and we're in non-wovens. Each one has different competitors, so I'm giving a global -- you know, an overall view. In Japan, we have competitors called Omron and Foo-tech. But we seem to be winning quite handily against either of those, on technology. WEdon't win on price. Our price is guaranteed. I say to every customer this is the most expensive vision system you're going to buy, but it's going to be the best value you ever had.

And if you're with your new Smartview product that was redesigned, have you made significant penetrations into all three of those end markets?

Yes. Yes. Smartview is unlike the prior product line which was the result of an acquisition, and wasn't modified for a couple years. Smartview is an architecture that is easily expanded to do everything from the low end, non-wovens or plastics, all the way up to steel, which is the highest and most complicated. So the same hardware, different software modifications give you those results and those margins. Yeah.

One question on acquisitions. I know you have been always, it seems like you made the small ones, mostly looking for good technology or people, but it seems that some parts of the industry competitors are so --there's some where you can buy a piece of a market that you're not already in. I guess I hesitate to get specific, but I think robotic vision has announced that it seems like that hay had the coplenarity test market I think they have like 80% of the market I presume it's decent product. Not talking about that one specifically, but are you now maybe considering acquisitions like that? Getting into --

Not that specific one, because frankly we wouldn't touch our RBSI with a ten meter pole or a ten mile pole. For a variety of reasons. But, yes, there are more companies to buy at lower prices. Or they appear that you should be able to buy them at lower prices. That doesn't mean you can, but yes, we have expanded our scope to include public companies not our BSI.

One other question. Looking at the automotive industry, do you see that as a pretty big long-term potential area? I think the one thing I have learned from working with the auto industry that they're very, very slow to adopt to new technologies. And you have to beat them over the head, I think sometimes.

Alex, you are exactly right, and we -- you know, smart people learn from their mistakes. Really smart people learn from other people's mistakes. So what we did, we were looking at an acquisition, a specifically a very, very exciting piece of technology really a product. Don't want to say too much about it that can do many things in the automotive industry. And it another been around for four years, they have been hitting their head against the wall. And we wanted to buy that company and the company wants to be bought by Cognex. The product sellers to about 150 grand, it's very expensive, it's machine vision. It's not very expensive for what it does, but it's not small dollars. Not an expense item, and after a lot of meetings with auto companies and various other people, we concluded that it could be the greatest thing since sliced bread, it just takes too long to sell to the automotive industry for a whole number of reasons. So we decided after tremendous -- yeah, a fair amount of work and a lot of travel not to do the deal. We could have bought the company for free, for free, and it was a company that $30 million of venture had gone into. $30 million. Very unique technology. So we decided against it. However, having said that, that doesn't mean we don't want to have products to the automotive industry. It just -- they have to be products that are priced right and easy to install and easy to use, and that don't require some sort of organizational change or structural change in the way the auto companies do things. And we have found that the automotive is probably our largest single market for insight right now. So we not have problems selling to the insight, because the price point and what it does and how it integrates to the factory is very straightforward, doesn't require union issues or EPA issues or D.O.T. issues or whatever the hell. That's what we'll continue to do. So we don't steer away from any particular industry, but we sit back and say, this product, how are we going to sell it, how long is it going to take? We were thinking of acquiring that company, either the people in the automotive industry would have loved it. It was a six-year-old, hello, we're going make money, we can't afford five years of continuous losses to promote a product that so that in six years we'll be successful with the product. So that's too much risk, too much uncertainty. We don't do that. But we do have products and we want to continue to design products for the automotive industry because it's a big industry. And you can make money selling to the automotive industry if you have the right kind of products and they're unique. The problem many people face selling to automotive companies is that automotive companies are extremely shrewd negotiators, and extremely powerful and they hate to pay a lot of money for anything. And they have the clout to enforce that and so if you have just a product that's competitive product, you're not going make money selling to the automotive industry is my view. Our products are superior in many ways and I believe that that's going allow us to be very profitable in the automotive industry and so far belief is backed up by good data.

I may be wrong or may be mislead by companies who focus on 3 D technology and machine vision, but are there or aren't there a lot of potential applications in the automotive industry and elsewhere where maybe the bigger field vision or something where it is a market more specifically for 3-D vision as opposed to 2-D? And if that's true, is this an area where you could find somebody who is relatively, you know, skilled in the software, you know, back log in the 3-D where you could, you know, suddenly substantially widen your market focus?

Alex, you're asking the right questions. You know, you should be an analyst in this business.

Too many conflicts of interest.

It turns out that this company that we looked at is exactly that. It's 3-D for shapes and it's marvelous 3-D for shapes, but so what? We love technology, but we only love it if it can make us money. That's how we measure things. We're simple. We're really simple here. Engineers come into my office all the time, Dr. Bob, we should do that. Great idea and the guy walks out of the office, and I say don't you dare touch a keystroke until you bring me a customer. You can't do it until you bring me a customer and an application I believe in. We don't spend a penny on things until we know that people going to buy it. Unfortunately, I don't know anybody who is making money in 3-D. Maybe, there are niche applications in the electronics industry and electronics. Even those are going away. I'll talk to you in more detail, because components do not have hundreds of leads on them. Those bumps don't have to be inspected too often. Maybe once when they're made, but don't have to be inspected along the lines. So we have never seen people making a lot of money on 3-D. Those that did made it on leader components are going the way of the buggy whip. So we have seen 3-D for cars. I don't know of one company that has made money on 3-D.

Excuse me for one quick question. What kind of tax rate are you accruing for going forward?

We expect that our tax rate will be declining in fiscal '03, having finalized all of our budget yet and where the revenues are going to come from, but I would expect that it would probably go from the current 30% to maybe somewhere in the 25% range.

Okay. Thank you very much.

Don't leave. I told you stuff, you tell me stuff. We're talking of 3-D for measuring shapes, was that for automotive applications you were thinking about, Alex?

Yes. There's one company I'm sure you know it that measures the entire auto body. I don't know if that could be done with 3-D or not.

Right. How are they doing, Alex?

They're not losing money -- as much money as they were.

Well put. You beat the plan.

And almost back up to getting on the Nasdaq again.

There you go. There's an example of something to shoot for. Well, you know, when we looked at this particular company, we said, yeah, we could put precepter out of business, so what?

Okay.

Okay. I don't know. That's my answer. Next?

And our next question comes from Rob Mason with Robert W. Baird.

Yes. I would echo the prior caller's comments about the transcript as well. What was the currency impact in 3Q?

It was probably I think about a half a million dollars, give or take, on expense levels because both the Euro and the yen strengthened during the quarter against the dollar.

Okay. And then you saw a nice quarter-to-quarter increase in sales, but adjusting for the benefit it looked like gross margin held flat. I was curious if you could comment on the pricing dynamics that you are seeing in the respective end user and OEM markets and why we didn't see any leverage in the sales?

Yeah. The principal reason for the decline was we had a big drop-off in service revenue from VMSD that came from the bundle services as I was explaining. So the costs were essentially there because we have relatively the same tech support staff. We weren't able to make significant cuts in the tech support staff because we still have customers that need help and we're committed to providing that, you know, for the year. So compared to the prior year, that was -- that was the major difference. On quarter by quarter, you know, we were roughly at the same place and theirs was due to mix and we also had some additional period costs related to some swap outs of components on a couple of systems for surface inspections group.

And when you refer to mix, are you primarily referencing sisty or is there a mix dynamic within the --

No, it's principally the mix between sisty and MDSD and product service.

Okay. Thank you.

And we'll now go back to Jim [inaudible]. Bob, you talked about what you're not buying.

Yep.

Can you shed a little light on the level of activetive in terms of things that you're pursuing?

It's interesting, because I walked into the VP of corporate development and does a lot of work and I walked in to him and I said, Dave, I want to thank you for last quarter for not buying anything. It turns out that buying things is complex, first of all. Anything we want to buy we do buy. We are able to do a deal and buy but just because we have a lot of money and just because our stock is trading better than our people's stock doesn't mean we should go out and buy things that aren't going to be --aren't going to be accretive to us and add shareholder value. Sure, you can fly around and smoke some nice cigars, but the day after you negotiated the deal an you feel good about it , you have to now integrate the operation and do something with it to add shareholder value to make money. Our goal here has never been to have a large company a large top line. Our goal is always a bottom line oriented. So it's just hard to find companies that are profitable or that are going to be profitable after we fold them in. And it's very complicated now, companies that focus on the semiconductor and electronic industry, and there are some of our competitors or related companies that are trading very low, they're trading at cash or below, stuff like that, well, their prospects aren't very good. That's why they're trading so low. Because their entire companies depend on the semiconductor electronic industry turning around at some point. Well, when is it going to turn around and if it does turn around, are those companies able to retain the customers that they now have, are they closing new business or just going to cash cow the existing product line? We're not going to buy companies that are just cash cows because pretty soon the utter runs dry. So we are looking at companies and I expect that we will announce this quarter, Q4, small acquisition in a competitor. And we're working on two deals right now. One on -- I'm quite comfortable will happen, and the other will be in Q1 of next year.

Well, Bob, given what you're seeing throughout and the fact that, I guess either prospects for the companies are uncertain or maybe valuations still have to come down, do you plan to maybe invest more in R&D to develop some new technology, in -- products as opposed to maybe going out what you thought you know, six months, nine months ago an buying something?

Well, we think we are investing of course in R&D.

Over and above what you're doing. I don't mean to say you're not.

Yes, it's a very good point. But the companies that we're buying interestingly enough or that we look at, have different technology that we could never develop. Not because we're not smart enough, but because it's a whole different field. Like surface inspection. We have guys that understood the theory of surface inspection, but machine vision is very application specific. Very application specific. So if you're in the inspection of surfaces, well, what kind of surfaces? Semiconductors? We have 50 people, 80 people, I don't know how many people and lots of Ph.D.s there, but they could never examine the surface of wafer. They know how to examine the surface of things moving by at high speeds like paper, plastics and steel. So it's not as if we can just say, okay, let's throw more money downstairs and invest in something. The benefit of getting a company is you only get the technology and the technologist, but you get the application knowledge which takes years to develop and you get the customers. And you get the customers. So I would say we are investing here. You see that in the RDNE line and also there are things that you don't know about that we're investing in that I can't comment about which are totally different applications and mashes than we have been in before. Let's leave it at that. Very low cost devices. We hope to come out with vision systems to sell for under $1,000 for interesting applications that are not anything we have done before. So we are -- it's not like we don't know what to do and not like we're not doing anything, but we have to be careful about those things. We'd rather buy things than invent them, because you do get the application knowledge and you do get the customers. But in this particular area, the sub$1,000 selling price, nobody is yet doing it properly. We know how to do it.

What's the time frame on something like that, Bob?

Hopefully you will see an announcement this quarter. I would hope. Depends on customer relationship and whether it will be confidentiality kind of thing. But you'll see products Q1 next year. And nice market. Nice market. Big member units. Not a small price, but a lot of units. Once we start making things that cost us $200, total cost 200 for a vision censor, we'll find lots of applications for it and it's being driven by this one customer.

Can you say what area the customer is in?

No, I don't want to for competitive reasons.

Okay. Dick, one final question. How many shares were bought back in the quarter?

You can read the press release.

I thought that was over the --

It was just under --

$8 million. No, that wasn't this quarter. He's right.

Right. This quarter.

All of the shares were repurchased in Q3, and I think it was 1,768,000. It was under 1.8 million shares.

Okay. Great. Thanks a lot.

As a quick reminder that is star one if you'd like to ask a question at this time.

Do I have to do that too?

We do have a question from William Pike from Time Street Securities.

Actually, all of my questions were answered. Sometimes the fax doesn't seem to come through and in this particular case I happen to be on vacation right now. Courtesy of the 800 number and I was in no position to receive a fax. So I would state the opposite of what the other speakers said. It would be nice if you could --it would be good to send it out first. Many companies do that, but maybe could read it faster and not go into every detail, presuming most of us had it. For example, I don't even have the pop line, so I just offer that as a --

I see. Well, now, do you have a computer?

Not where I am. I'm in a hotel in the quality suites in the middle of nowhere. Sometimes I would, but in this particular case -- I have had times when the fax doesn't get through, whether it's my machine or the queue or something. So, get another opinion.

I hear you, but, you know, we're sort of a binary company. It's either zero or one. We're going to either going to do it. Not put a half one out there. Hmm. Well, we'll discuss it because I'm thinking now that we wouldn't do faxes, we'll just post it on the website. All of you are high-tech guys except for Bill Pike who stays in a motel six and doesn't even have an Internet connection.

Quality suites or whatever. At home I have a computer. Thank you.

You're welcome.

And moving on, we'll go to Eric End with First Pacific Advisors.

Hi. I vote for sending it out as hard copy and not reading it to us.

What if we didn't send it out or post it on the website?

The website, first call, fax, E-mail. There are lots of ways.

I'm thinking out loud, that we would put it on the wire, of course, we'd have the press release. And we'd say, management's comments as a full press release with a balance sheet and this of that are available on the website for ten days. I think that's what we'll do. Forget the fax. Forget all this other stuff, right. Thank you.

At the beginning of the call, you were discussing end user sales and you referred to electronic products as an explanation. I always thought when you talked of electronic products, you were talking about surface mount electronic assembly equipment which presumably would be an OEM business. Could you just clarify that?

Yes. We sell both OEM and end user to certain industries and electronics and semiconductor are exactly those industries. For example, and I'll make this up, I don't know if it's true, but micron technology, they made [inaudible] that's an OEM of Cognex, but we might sell to them directly. We have a vision system that reads serial numbers on wafers at high speed. The industry standard. So that's how we would sell both directly and through OEMs at the semiconductors. I assume electronics could be similar to that. Electronics could be at Nokia, we sell directly to Nokia. We call that electronics account because the device is electronic in nature, and they buy or used to buy Fuji machines for the assembly of those phones.

Right.

So we sell directly to electronics and semiconductor companies as well as indirectly to different products usually.

So the end user business is the same as general manufacturing?

The same product. That's right. I think what he's commenting, the business has either gone up or gone down.

Thank you very much.

You're welcome.

And we'll now go to Nick Moore.

Oh, it wouldn't be a conference call without good Nick.

Hi, Bob.

Hi, Nick.

I vote for the script. Can you sprinkle a few questions that you think people will ask as well?

Gee I'll do the whole thing. Just put the answers and questions.

You ought to be asking us about this. Not the answers.

Well, you sort of know which questions, that's a good point. Bob, what about the acquisitions we might do that! Things you might want to ask Bob. Or it will be more fun to answer it in real time.

It sounds like a lot of extra bother for Sue.

Yes.

--

No, because she has always comes up whenever we're with the press, she comes up with the whole thing, tough questions. You know, and I recently said to her, I said Sue, I don't read them anyway. I'm good at answering them. But now she could still give me the tough questions but she doesn't have to write the answers. There you go. So half the work for Sue.

Yes. What I was hoping to get actually, you covered most everything was actually a re-read on the revenue mix by industry.

Sure. Go on the website, Nick.

But next time.

You know it's convenient because I'm actually, coincidentally I have the last sheet of blank paper on the pad and it would have saved me --

There you go. Okay. Semiconductor 25%. Electronic, 19. automotive, 12. Paper, 13. General manufacturing, 4. Metals, 3. Consumer products 4. Packaging, 4. Medical, 3. Non-wovens, 4 and the rest is just miscellaneous stuff.

Now -- you got 40% of the revenues are pretty widely diversified in the manufacturing sector. More or less.

I'm sorry. I didn't catch you.

I'm just saying that over time, we've gotten to where the non-electronics business, the 40% of the overall revenues are now pretty widely diversified in terms of the end user industries.

Yep. That's absolutely right. And the real upside, you know, we're going to keep on doing that and then the upside is going to be the upswings in the semiconductor electronics. Not that we're not going to develop the products for the semiconductor component, we are. Hopefully you'll see those as upswings on top of a growing business. That's what we're doing and that's what we started doing five years ago. You know, we didn't get into the end user business overnight.

I think we're ready for one, Bob, if you're planning an upswing. Any time now would be good.

Well, you know, people used to talk of the V shape or U-shaped recovery and I think it was the end of 2000 when I was talking about an L-shaped recovery.

And when?

Doesn't matter. L never comes up.

That's right.

Well, that's all I had. I mean --

Okay. Nick --

The other thing possible, you were touching on the acquisition strategy at the moment. I didn't catch -- are you in negotiations with any large companies, forward divisions?

Oh, you mean large divisions --

Large divisions that might be for sale?

No.

So the last one came to conclusion with no event?

That's right. That's right. And somebody told me, Bob, what do you expect? You can't do business with the French. That's what -- and other people I have talked to said you can't do business with the French. This happened to be a French company, we're going to buy a division of the French company and do this and that.

I thought you were talking to a Swedish company.

No.

Oh, they were French. Now I can't guess who it was. Thanks. Congratulations to the sales and marketing group that brought in all the new accounts the last two quarters.

Fabulous.

Very impressive job.

Turned profitable again. It was three quarters of red ink and hopefully you won't see that again for 58 quarters. That would be any goal.

That would be most excellent. Now, you're on the hook now. Is sue hitting you with anything?

No. She's going attaboy.

Okay. Thanks very much, guys.

You're welcome, Nick.

And the final question in the queue today comes from Alexander Paris.

Sorry, my question was answered, but one final vote I would vote for E-mail as the most efficient and the least likely to be overlooked.

Thank you. Thanks a lot, guys, and hopefully we'll have good news to report in Q4 as well. Thank you very much for attending.

And this does conclude our conference call. We thank you all for participating. There will be a replay available beginning at 8:00 p.m. eastern time tonight and ending on the 21st of October at midnight eastern time. If you'd like to listen to the replay, you may dial the toll free line at 888-203-1112 or the toll line at 719-457-0820. Use pass code 403682. Once again, those numbers are 888-203-1112 for toll free. And 719-457-0820 for toll or international. Please use pass code 403682. There will also be a replay available via the web at WWW.Cognex.com. Again, WWW.Cognex.com. Thank you very much and have a nice day.