Cognex Corp (CGNX) 2006 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. My name is Jessica, and I will be your conference facilitator today. At this time I would like to welcome everyone to the Cognex Corporation second-quarter 2006 earnings call. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to your host, Richard Morin, CFO. Sir, you may begin your conference.

Thank you and good evening, everyone. Earlier tonight we issued a press release announcing Cognex's earnings for the second quarter of 2006. For those of you who have not yet seen this report, a copy is available on our website at www.Cognex.com. The press release contains detailed information about our financial results, and because of that, we're not going to repeat most of that material.

Beginning in 2006, we are required to include stock option expense in our financial results. Since this expense was not included in 2005, to help listeners compare our results on a consistent basis, we will exclude the impact of stock option expense from our discussion during the call. For your reference, you can see the Company's income statement as reported under generally accepted accounting principles in Exhibit One of tonight's press release and a reconciliation of certain items in the income statement from GAAP to non-GAAP in Exhibit Two.

I would like to emphasize that any forward-looking statements we made in the press release or any that we may be making 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 will turn the call over to Bob Shillman, Chairman and CEO of Cognex.

Thanks, Dick, and good evening, everyone. Thank you for attending Cognex's second-quarter conference call for 2006. My comments this evening will omit the effects of stock option expensing. The FASB requirement to expense stock options is in my view not only an accounting nightmare that burdens companies like Cognex without providing any benefit to shareholders, but worse it weakens the very soil that has nurtured American businesses and allowed them to grow and prosper for decades. It is just impossible for me to understand why our leaders have allowed accounting theory to undermine something that has worked so well for everyone in the past.

And since we are on the topic of stock options, some of you might be thinking about dilution. I would like to take this moment to report that in the second quarter we successfully completed the repurchase of $100 million of our common stock under a plan that was approved in December of 2000. Under that authorization, Cognex purchased more than 4.4 million shares -- that is approximately 10% of the common shares outstanding -- on the open market at an average price of $22.60 per share. The majority of the repurchases were made over the last nine months as we spent nearly $75 million to repurchase a little bit more than 2.6 million shares at an average price of 27.82.

Now let's get back to the real business. The press release that we just issued showed that Q2 was a very good quarter for Cognex. Our results are in line with the guidance we gave to investors in April. We had revenue of 63 million, and excluding the artificial and non-cash expenses associated with stock options, we had earnings of $0.29 a share. These results represent significant increases over the results that we reported for the second quarter of 2005. And our net income this quarter was fantastic at 22% of revenue, which is 200 basis points higher than our target of 20%.

Now I'm going to give you some comments on our factory floor business. In the second quarter we saw nice revenue growth on a sequential basis in our factory floor business. This growth was due to ID, which I'm going to give more detailed comps in a moment into our international sales and marketing initiatives.

In Europe the sales team closed a number of large projects during the quarter, most notably in the automotive and packaging industries. As examples, a manufacturer that sells toothpaste filling machines to major European health care companies purchased 50 In-Sight systems, and one of the world's largest bottling companies purchased 35 Checker units and expects to place additional large orders in the future. And there was a nice pickup in Japan as our marketing programs in the automotive and robotics industry started to deliver results. Finally, Southeast Asia remains strong in both the LCD and disk drive areas.

In the second quarter, we had a record level of orders for our vision sensor products, which are In-Sight, DVT, DataMan and Checker. As I said on our last earnings conference call, we will no longer be reporting on these product lines individually; however, I'm going to make this one exception to offset the incorrect impression about DVT that we might have left with you a couple of calls ago. So I'm happy to tell you that DVT bookings are running at over $30 million per year rate, and this quarter they increased by 12% on a sequential basis.

Now some comments about our DataMan product. Earlier today we announced a purchase order received in Q2 worth in excess of $.25 million from the leading supplier of the Aerospace industry. That was for our DataMan hand-held ID Readers. This customer will be using DataMan to identify jet engine turbine blades so that they can be tracked not only through the manufacturing process but through their entire lifetime.

Part tracking is needed both for internal process control purposes, as well as to comply with Department of Defense regulations that require that a permanent mark be placed on every item purchased by the DOT that is either serialized or mission-critical or which has a value greater than $5000. Reading codes that are directly marked on the services of manufactured items, which is known as direct part marketing and which we often refer to as ID, is a fast-growing area for Machine Vision. For many years, of course, we have been the leader in ID for the semiconductor industry, and recently many of the leading automotive and Aerospace manufacturers have standardized on Cognex and have started to purchase our ID Readers in volume as they too recognize the benefits of part traceability. Cradle to grave traceability will soon be a reality for all companies in those industries.

In Q2 of 2006 our ID revenue was up over 120% year on year and increased more than 30% sequentially. And much of this growth is due to our new DataMan 7500 reader, which to use a pun really fits the mark for our customers. We are already the leader in this ID business, and we expect to remain the leader as the opportunity expands.

Now some comments on the semiconductor and electronics capital equipment market. Revenue in Q2 in that segment was down slightly from Q1, primarily due to some last time buys that we received in Q1 for end of life products. And although revenue increased in Q2 in this segment from sales of our products in the front end in wafer prober areas, that increase was offset by softness in the back-end.

Overall we believe that our Semi business peaked in Q2 and that it will not be as strong in the remaining quarters of this year.

Regarding Surface Inspection, our largest increase in revenue on a sequential basis was in the Surface Inspection market where we saw revenues increase 34% over Q1. This increase was primarily due to higher sales to the paper industry where we are selling very well versus the competition. And I'm happy to say that we shipped our 700th SmartView system in Q2, which is the largest number of single generation product ever sold by any vendor in this business. The second place would be held by Asea Brown Boveri, which has only sold 400 or so units.

And the last item to discuss with you today is one that I'm particularly excited about, and that is our entry into a totally new business for Machine Vision. In Q2 we acquired AssistWare, a leading developer of vision systems for use in vehicles. These are specialized vision systems and sensors that are installed directly into vehicles to automatically provide assistance to drivers and at some point in the future to actually drive the cars themselves.

For example, today we are selling products to alert drivers if they are about to cross inadvertently into another lane or if they are drifting off the road due to drowsiness or inattention and that is called lane departure awarding or LDW. Another application is to warn drivers when there is a vehicle in the driver's blind spot. But in addition to those two important applications, there are seven more. Adaptive cruise control under which your car will keep a fixed distance between the car in front when you have the cruise control set. There is obstacle detection. There is intelligent headlights, which means using Machine Vision to automatically dim your lights and to automatically aim your lights as you enter a turn. Intelligent windshield wipers that know when it is raining out. Automated parking whereby the car will automatically park itself, even parallel parking -- something my wife will be very happy with. Another feature is automatically controlling a car during heavy traffic. This is called Creeper Keeper so that you can be freed up to use your cellphone or read the newspaper.

So these are futuristic things, but they are already being introduced on certain -- some of these are already being introduced on some high-end vehicles. The in-vehicle market represents a very large and exciting opportunity for Cognex in the future. Initially our focus is to serve the heavy truck market, which with nearly 300,000 heavy trucks sold per year in the U.S. alone represents a significant potential for us. But over time as we expand the product's capabilities and as we lower the manufacturing cost, we anticipate that these systems will become standard in many consumer vehicles. Our goal is to become the world's leading provider of Machine Vision for in-vehicle driver assistance, and we formed a new business unit called the In-Vehicle Vision Sensors Business Unit to get us to that goal.

Dr. Dean Pomerleau, Chief Science Officer and Founder of AssistWare, joined the Cognex team as Director of R&D for that unit. He is a recognized expert in lane departure warning and in in-vehicle vision systems, and he has led several multimillion dollar studies in the U.S. Department of Transportation. Dave Schatz, who has been with Cognex for over 20 years in a variety of senior management roles, is currently managing that business for us. Within a few weeks following the acquisition, we are contacted by a number of Tier 1 suppliers to the automotive industry, and all of them want our assistance to design the hardware and develop the software for them to integrate into their products for shipment to the automotive companies.

One of those suppliers recently said to me, Bob, adding vision capability to cars is happening much faster than anyone anticipated. It is literally a stampede. While another leading supplier said, to be honest, Bob, there are not many resources in the world that we can turn to for this technology, and we hope that you will seriously consider working with us.

The business model that we are going to use to capitalize on our current and future in-vehicle vision technology is to market products directly to truck fleets and more importantly to license our hardware designs and our vision software to Tier 1 companies which are the leading suppliers of products to the automotive manufacturers. And these Tier 1 will manufacture the in-vehicle vision systems and deliver them to the automotive manufacturers, and for every one they deliver, we anticipate we will get a license fee.

And that way Cognex will be able to achieve very high gross margins and net margins above our current levels and at the same time will be insulated from dealing directly with the automotive manufacturers.

But irrespective of my enthusiasm for this new business, I have learned that there is a very long process from the design-in to the receipt of significant revenues and profits in the automotive sector. Typically it takes three years. So please don't expect this acquisition to deliver much to the bottom line in the near future.

In closing, it was a very good quarter for Cognex, and we see very exciting times ahead for us as we develop new products and as we enter new markets beyond the factory floor, the semiconductor fab and Surface Inspection. Cognex is not just vision for industry anymore.

Now I would like to open up the conference call for any questions you might have. Because I'm currently spending most of my time on acquisitions and longer-term strategic issues and future product developments, Jim Hoffmaster and his team will address all of your questions other than those where I have something unique to add.

(OPERATOR INSTRUCTIONS). Suresh Balaraman, ThinkEquity.

In terms of the semiconductor fab segment, you said the future revenues will not be as good as what we have seen in the last two quarters. Any sense of where the revenues will will kind of bottom out in your estimate? And then I have a follow-up question on something else.

What we are expecting is during the second quarter we did, in fact, see a softening in the order level coming from the semiconductor and electronics capital equipment customers that we have. As we talk with them, they are giving us an indication that what they expect for the rest of the year is for their business to be flat or softening a bit. So what we do expect is that the next two quarters, the second half of the year will not quite be at the same level as what we experienced in the first half of the year. What we have not seen yet is any cancellations or pushouts or whatever, and we did not get any indication of that from the customers with whom we spoke. So it seems in that respect that at least we will be able to hold onto a certain level of business through the second half of the year.

Is that likely to be within 10% of the current business levels, or do you anticipate a downturn or a downturn that is higher than that?

At this particular point in time, we don't expect a major decline.

Okay. And then to Dr. Bob, you talked about the in-vehicle sensor opportunities but can you give us a sense of what revenue opportunity per truck or per car can you potentially look at in a three-year timeframe for the market?

We are currently selling products to the truck market. It ranges at approximately somewhere around $1000 per unit.

Okay. And is the car market likely to be similar --?

No, the car more market is likely to be far larger in units, far lower in cost.

Okay. Great and just a final question for Dick. What should we expect the share count to be for Q3?

For Q3? Hang on one second here. I'm trying to -- (technical difficulty)

Antonio Antezano, Bear Stearns.

In the Factory Automation business because it seems like the revenue growth (indiscernible) this quarter was mainly driven by the OEM. In Factory Automation, could you give us a sense what was the base revenue growth if we were to measure apples-to-apples versus last year? The nominal is 5%, but is the apples-with-apples number different from that 5%, very different?

Before Jim addresses that, I would like to make one correction to your initial comment. I think you said that the majority of the revenue increase quarter on quarter --

No, no, year-over-year.

Okay. I'm sorry. Okay. Fine.

Year-over-year.

I'm sorry, could you --?

I was trying to understand what the base revenue growth was for year-over-year for Factory Automation business. The nominal growth is 5% year-over-year, and I wanted to understand whether that was close to what it should be that base revenue growth if we were to measure apples-with-apples because of the presence of DVT I guess in their revenue. Last year I think DVT was only two months.

That is correct.

That is correct.

So --

It is about 2% if you correct for that.

It is about 2%.

Yes.

Now within Factory Automation, what is what you see for because we discussed last quarter about the situation in the automotive sector, also I guess the performance of distributors. And if you can give us an update on those two issues, that would be great.

Okay. I am glad you mentioned automotive because that is the dominant factor for us right now. We have taken a careful look at that, and let me step back and put it in perspective.

About three years ago we undertook a very focused initiative to be a major supplier to the automotive companies worldwide. That effort was lead out of the U.S. We were very successful with it both in the U.S. and worldwide. And so unfortunately when we entered this current downturn in the automotive industry in the U.S., it had a major impact on our bookings on our business. Automotive if we compare the first half of this year to the first half of last year in the Americas, automotive we lost about somewhere between 4 and $5 million worth of business in Factory Automation in the automotive sector. And when I say we lost it, we lost that to curtailed spending, not to competition.

The good news is outside of the Americas our business with automotive suppliers continues to grow. We continue to do well, but not fast enough to fill the hole that exists in the Americas. And I don't see that situation changing soon in the Americas. The U.S. suppliers I think still have a lot of sorting out to do before they will be back on a growth track with -- before we will be on a growth track with that envisioned.

Now Bob mentioned earlier that ID is a bright spot, and we are seeing some ID growth in the automotive sector. But again that is not fully offsetting the loss of the general-purpose vision business.

The second part of your question was on the impact of the distributors, and I guess let me give you maybe a little broader answer than the specific question you asked. When we acquired DVT, we were very concerned and very concerned about the fact that we had limited experience with distribution, and we were really buying a business that sold through distribution. So we focused on that and put a lot of energy into that.

The good news is that that has gone quite well. By every measure we have, I would say we're doing a better job with the distributors, and that includes objective feedback from the distributors to tell us that. The problem has been that during the period of time that we have paid all that attention to managing distributors and building the right relationships with them and sorting out the situations post-acquisition, we were not doing as much of the new account prospecting and the blocking and tackling of direct selling because the same people were worrying about the distributors. And that is definitely -- that is the second most important impact on our -- or reason for our lack of growth in Factory Automation right now.

Right. Now I remember in prior conversation it was mentioned that there could be some changes in the way you managed the distribution network. Is there anything you can share with us there or --?

There is nothing we have done that I would not be willing to share with you. It is just that we're getting into a fairly fine level of detail. We did not make any fundamental changes in our relationships with them. What it was was much more a matter of going through territory by territory and looking at the responsibilities of the people on the Cognex team -- who is responsible for the distributor, who should be focused mainly on direct sales and making sure that people were not overlapping those responsibilities.

So I would not say it is so much a change as it was a clarification. I guess that is what I would say. So we did not make any fundamental organizational changes or fundamentally change the way we work with distributors. What we did do is spend a lot of time clarifying to everybody in that process, including the distributors, what the roles of the individuals were and who should go to who for what.

Right. Just one last question. What is the run-rate for Checker right now whether you continue to expect a run-rate of 10 million at year end -- I'm sorry, between 6 and 8 million I believe it was?

Right. We still expect to do between 6 and 8 million. Checker is also impacted by the automotive slowdown. It is a particularly good product for automotive customers, so that will have -- that is a headwind that we're selling into, and we won't do as well as we might have. But our current outlook is still to be within that 6 to 8 million range, which by the way will be more than 100% growth over last year.

Richard Eastman, Robert Baird.

Yes, I wanted to circles back for a minute on the Factory Automation business. If I adjust for an incremental contribution from DVT, I guess I come up to your 2% or 0 growth in Factory Automation. And even adjusting for a few million dollars of automotive decline year over year, I'm still struggling to figure out exactly why the growth is only low single digits. Again, is there some end markets there, or is all attributed to the direct selling slowdown? I mean the numbers are -- the Factory Automation number, even accounting for auto and DVT, has slowed appreciably year over year in this quarter. So the question is, what end markets are that slow?

Yes. I don't know that other than -- well, let me say it this way. Other than automotive, there is no particular sector where we are seeing a slowdown. What we did have -- again, automotive, if we take the automotive delta, that would add about 5% to the year-over-year growth, which still is well below our target. I don't want to either overemphasize or underemphasize the importance of the sales issues in North America. There is no question that that has had a significant impact here in the first half of this year.

The other thing is that we had a boomer of a second quarter last year. If you look at last year's second quarter, there were a couple of particularly large projects in there. The time that we get from time to time, they typically don't repeat. These were $1 million plus projects. And I think it is those three things pretty well account for the situation.

Can I also ask you, the sales as we have shifted sales through distribution, presumably we have -- are we selling that product now at a wholesale price versus a list price? I mean is your unit volumes tracked the same as your reported revenue?

There are two different questions there, and the answer to the first one is yes. We sell to the distributors at a discounted price, a wholesale price if you will. So there is some impact of the increased volume going through distribution. Dick and Sue are going to have to help me on how well unit volumes tracked. I don't think we have that data handy.

We don't have it available here in the room.

But I would think --

We're going to see -- it seems to me that you are going to see as you move product through distribution, which is the intent here, that we're going to continue to see the revenue line depressed as we are selling at wholesale price.

No, we should not continue to see that because that only is a factor to the extent that there is a change in the proportions. In other words, once we are comparing apples-and-apples year-over-year where the same percentage of business -- let me be careful about that. Let me not say focus on --

No, I understand the concept, but I mean you are no -- you would presumably expect a year or two from now to be selling more through distribution. I mean that was one of the goals of acquiring DVT and having a broader base of distribution, correct, for Factory Automation?

Yes, that is correct.

Okay.

And, in fact, that has happened already to an important extent. But the thing not to lose sight of is, as we take a look at doing this, this is going to result in incremental unit volume that we would not otherwise have gotten because the distributors get into a lot of territories and a lot of customers that we were not able to address with our direct sales force in the first place. And in the second place, the gross margin percentage that we are selling through distribution is comparable to our normal margins anyway.

And so you are implying, though, that your end markets outside of auto because the auto decline offsets the DVT incremental contribution, are your end markets stronger than plus 5% year over year?

Are you talking about on just specifically comparing Q2 to Q2?

Yes, Factory Automation to Factory Automation Q2 to Q2.

Okay. If I exclude automotive and DVT, yes, it was closer to 10%.

Okay. And then quickly I won't monopolize the call here, but I could I just have the book-to-bill? Would you be willing to do that in Factory Automation, OEM and SISD?

We're not going to disclose book-to-bills anymore.

[Paul Steff], [Capital Flow].

A question for Dick. Dick, shareholder equity went down in the quarter. Could you discuss the components that contributed to that change?

Yes, there were two major components to the decline, one of which was the payment of the dividend, and the other one was, in fact, the stock buyback. During the quarter we paid, let's see -- in dividends we paid $3.7 million in dividends and spent about $37 million in buying back stock.

(OPERATOR INSTRUCTIONS). Jim Ricchiuti, Needham & Co.

Without giving out book-to-bill, Dick, would you be willing to just give a little bit more color on how the orders track sequentially and the three business units -- Factory Automation, SISD and the Semi/Electronics?

What do you --?

Just in terms of sequentially were bookings up?

No, this is Bob Shillman. We have just made the decision to not talk about bookings anymore.

Okay. On the --?

And I don't want you to think or other people to think that that is because bookings were weak this quarter. I'm not going to make a statement either way. Just that we feel that it is giving too much information to our competition, and there is no need to do it. We will describe what happened in revenue, and to see how the bookings went, you are going to have to see the results next quarter.

In terms of the guidance for Q3, range you are giving is 5 to 10%. You talk about the 5% year-over-year growth. I wondered if you could talk a little bit about at the lower end of that revenue range are you anticipating any potential for slowing in some of the other commercial markets, or is it more concerned on the Semi/Electronics and the automotive side?

We also mentioned that the summer months, August in particular, are very slow for factory floor, and that contributes to the uncertainty as well.

Right, but I'm thinking more in terms of your year-over-year growth, which presumably the seasonality (multiple speakers)

Sure, would be cancelled.

Yes.

Dick, do you want to take that?

Yes. Well, what I don't have is, I don't have information relative to the third quarter, the details in the third quarter of 2005 here with me. I brought information relative to the first couple of quarters of '06. Clearly we expect that the automotive industry will be down from last year's third quarter. I just don't have the information to be able to really comment on what we did for the semiconductor in the third quarter last year.

Yes, I think Semi, it looks like Semi/Electronics did about 15.7 million of revenue last year. And --

That would be a lower level than what we have been running at in the first two quarters of this year. So Sue was able to get something here for me, so let me take a quick -- a quick --. Yes, Semi was at approximately -- just under 16 million last year. So we may not be -- I mean it is not going -- it does not look like it will be much off of -- we don't expect it to be too much off of that level. Factory Automation year-on-year we do expect it will grow other than in the automotive sector because you're right, the same seasonality will affect both years, except for the fact that the automotive industry in the U.S. does not appear to be yet picking up. We did well in the second quarter in the automotive industry in both Japan and in Europe, but it was still very soft in the U.S.

And just on the expense side, OpEx appears to be tracking a little bit higher than at least I was modeling it. I'm wondering if you could talk a little bit about perhaps increased R&D associated with some of the newer projects and newer markets you are targeting, particularly AssistWare for instance?

Yes, the AssistWare R&D while we will be adding staff there to help with the development of the commercial product, I don't know that as you take a look at Q3 compared to Q2 of the current year, it should not have a major impact on the final results for the quarter. It should not be that much of an increase. We will be adding staff, but just one quarter's worth of added expense should not have that much of a significant change in the numbers.

No, and also counterbalancing that is some R&D revenue coming in from the contracts that AssistWare has closed with the University and the government.

Yes, I was talking about the commercial side, Bob.

Oh, I see. Sorry.

And because on the people that we're adding to AssistWare to deal with that contract through the University of Michigan and the Department of Transportation, those costs will be fully recovered, but there won't be any increase there. But there will be some on the commercial.

Correct.

So last question is maybe directed toward you. Just in terms of additional acquisitions, acquisition activity, are you still looking at further expansion into this market, or are you looking at some other areas of interest?

Well, I don't want to say at this point for obvious reasons or obvious to many of us. I don't want too many competitors chasing those same acquisition targets.

Fair enough. Any thought to another buyback here?

Well, I can tell you we have a board meeting coming up very soon, and that is going to be on the agenda.

Antonio Antezano, Bear Stearns.

Yes, I was just wondering regarding the new products in the pipeline, is there any change in timing? You mentioned a new expert sensor and a door sensor for late this year. Is there any change for that?

No, those are on -- Antonio, this is Jim. Those are on track, and there is no change in that outlook.

Because now we're talking about three new with the AssistWare plus expert sensor plus door sensor because those are, of course, we're talking about three different products, could you give us a sense of what type of incremental sales you're expecting for them?

In what period are you asking?

For next year, for 2007.

I don't think we want to give any 2007 guidance at this state of the game, Antonio.

A little too early.

All right. Then when I look at the revenues by geography outside Japan and Asia, that order category, that grew 73% year-over-year. Is that just because of the cycle in the electronics industry, or is there something else that drove that growth?

The major impact was, as you pointed out, Antonio, was the growth in the revenues to the OEMs in the semiconductor and electronics. But they -- our (inaudible) into Factory Automation in those regions have also done better this year than they did last year. They faired better than North America has. It is principally in North America that we have seen the shortfall in the automotive industry.

And, Antonio, I might add that Asia outside of Japan is an area that we felt had more growth potential than we had been tapping historically. So last year in particular and this year we have beefed up our organization there and put some emphasis on that, and you are seeing the results of that.

(OPERATOR INSTRUCTIONS). [Chor Wong], Lotus Investment Management.

I apologize if this has already been covered. I have been popping in and out of calls. Did you give a headcount number for the end of June? And I have (inaudible) that maybe headcount by the end of 4Q '06 would be around 780. Is that still reasonable?

Second, any comments on the inventories? Thank you.

Okay. This is Dick, and I will handle those. The headcount at the end of the second quarter was 762. To talk about the inventory, the inventory increase was a -- for the most part was a planned increase as we were looking to increase our inventory levels as we have been moving our manufacturing operations from the U.S. over to Ireland. We wanted to make sure that we did not miss any opportunities during the transition period to be able to deliver to customers, and we have also increased some of the inventory that we keep on-hand to handle our orders from distributors, especially as it relates to some of the old Cognex product that we were not supplying to the 150 distributors that we inherited upon the acquisition of DVT.

We also had to increase some of our component inventory based upon last time by opportunities from some of the component suppliers.

Thinking back to, say, 3, 3.5 by the end of the year, Q3 or second half of '06?

To get back to what?

Inventory turns. Where do you think it might return to?

Yes, we do expect it to get back to the 3 to 3.5 turn level, probably not by the end of Q3 but by the end of Q4.

And then headcount by the end of Q4, would you be willing to hazard a guess?

We have some replacement [wrecks] to fill or whatever, but I don't know that I can hazard a guess as to where we will be at the end of the fourth quarter with total heads.

(OPERATOR INSTRUCTIONS). [William Pike], Pine Street.

Actually the question was answered, but as long as I have got you, Dr. Bob, my wife teaches at Northeastern, and she was teaching in a building called Shillman last year. Is that any relation to you?

Yes, Shillman Hall. Well, it does say Robert J. Shillman, and that is my name. And I did graduate from Northeastern, and that is a pretty good shot that it is me. (multiple speakers). I am so happy for that because it is one of the few buildings with my name on it that I don't have to change the bulbs.

It must have been a generous contribution, and all fans of Northeastern thank you for that.

You are very welcome. It was my pleasure.

Jim Ricchiuti, Needham & Co.

A question on the SISD business. I wonder how you would characterize the activity you are seeing out there and maybe a little bit more color on the strength you are seeing in some of the verticals that you're selling into?

Paper has been -- paper in North America has been particularly good for the first half of this year. Other than that, I don't think there's anything that stands out. We have also had some success in the film area, particularly films used -- electronic films used for LCDs, and we're looking at some other applications, films used for capacitors, specialized capacitors, although that has not generated any revenue yet.

This tends to be lumpy business, and it is tied very much into the overall health of the metals and papers markets. What is your sense looking out in terms of the pipelines that you see in this area?

Well, I don't see any slowdown in the business. I would not want to be more specific about what the upside might be, but I don't see -- I'm not concerned about any upcoming slowdown in the SISD business. I think the team has established an excellent market position and an excellent reputation, good solid product, and as you say there are economic cycles that impact the industries that we serve there. But certainly month to month and quarter to quarter it can be a pretty lumpy business, but right now I think we're in a good place, and I don't expect the business to -- I certainly don't expect it to shrink at all from where it is, to retract. Our long-term target is 10 to 15% growth for that business, and I would say that is still the right long-term target.

And I think you have also had a longer-term target to try to improve the gross margins in that business. Is there any update you can give us on that -- how you are progressing there?

It is progressing reasonably well. (multiple speakers). I think we have been -- we sometimes use a little more aggressive internal targets than we actually expect to achieve. So I would not say we have been achieving our internal targets, but I think we have been making nice improvements there. Dick, do you have anything to add to that?

Yes, there was some pretty significant improvements over the Q1 level, and that was due to two factors, one of which is some of the programs that Jim mentioned that we have in place in order to improve the margins, and the second thing, too, was the significant increase in the revenue level, the shipments or whatever.

So what you have there in that operation besides the operation an awful lot of the costs and the manufacturing side are pretty well fixed. So to the extent that you can pump more volume through there, it really helps in the absorption and the overall gross margin that you report.

There are no further questions at this time. I will turn the floor over to Robert Shillman for closing remarks.

Well, Bob here once again. It was a very nice quarter for us, and I look forward to reporting similar results to you in Q3. Thank you very much for attending the conference call and for your interest in Cognex.

This concludes today's Cognex Corporation conference call. You may now disconnect.