Cognex Corp (CGNX) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Cognex first quarter 2007 earnings call. [OPERATOR INSTRUCTIONS] As a reminder, today's call is being recorded. I would now like to introduce your host for today's conference, Mr. Richard Morin, CFO. Sir, you may begin.

Thank you and good evening, everyone. Earlier tonight, we issued a press release announcing Cognex's unaudited earnings for the first quarter of 2007. For those of who you have not yet seen this report, a copy is available on our web site 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're required to include stock option expense in our financial results. To help listeners compare our results on a consistent basis versus historical information, we'll 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 GAAP 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 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 Bob Shillman.

Thanks, Dick. As you can see from the press release, that we issued today, revenues were $51 million for the quarter and earnings excluding stock options were $0.15 a share. These results are down both year on year and on a sequential basis. And are below the guidance we gave to investors in January. Of course, I'm very disappointed with these results and frankly, even my mother would be unhappy.

Early in this quarter, we implemented a number of steps that should get our revenue back on track and since taking back the reins of the day to day operation at Cognex three weeks ago, I've been very involved in additional steps that are anticipated to drive revenue growth. The shortfall in revenue for the quarter as compared to our guidance was primarily in the factory automation and in the surface inspection markets.

First in factory automation, revenue fell short of our expectations for the following three reasons. First, orders were much slower than expected in January and February leading up to our annual sales kickoff meeting. This was true for both the direct sales channel and for distribution, and we believe it appears to be because of settling in that was needed within the sales organization associated with the changes that we implemented in January. This adjustment period seems to have dissipated after the sales meeting and I'm happy to tell you that orders picked up significantly in March. And I'm just reviewing the early results from April and they're dramatically better. Unfortunately, the pickup in March that we saw was not enough to make up for the earlier shortfall in January and February. And much of the business that did come in March was too late in the quarter to turn into revenue.

Lastly, factory automation fell short because of software revenue accounting rules. Strict interpretation of these rules dictates that in certain instances where multiple items are ordered on one PO all of the revenue needed to be delayed until all of the items delivered. Didn't make sense to me. Doesn't make sense to most people. The customers understood and obtained useful products for certain projects and paid for those useful products, nevertheless, we were not able to count them in revenue for the quarter because of accounting rules.

In surface inspection, as a matter of fact, some companies are now showing shipments and revenue as two different line items. You can ship it and it is not revenue anymore. It is a strange thing, especially in our business, it doesn't seem to make sense. In surface inspection, our level of business was within a relatively consistent range on an annual basis. However, every quarter can vary somewhat depending upon three things. The lumpy order trend, when the customer wants to take the system and install it in the plant and third, when revenue can be recognized under accounting rules. We believe the year is still going to be right for surface inspection though the quarter was low.

A combination of all of these three issues in surface inspection led to very low revenue of only $5.8 million. While Q4 of 2006 in surface inspection was very strong bookings quarter, Q1 of 2007 was not so there was less business that was booked and less that was shipped in the quarter. Many of the orders in Q4 and Q1 were from new lines, and because of that the system delivery dates were much further out than we typically see for retrofits. In some instances there were multiple systems ordered on one PO which means that even though some of the systems may have been delivered in Q1 the software revenue accounting rules dictate that all the revenue for that order needed to be delayed until all of the systems were shipped. The good news is the revenue has not gone away. It has just shifted to the future. But here was a case where we got POs from one major steel company and couldn't recognize the revenue the system we shipped because we didn't ship two systems even though each system was going to a different plant and had nothing to do with one another.

I want to point out that there are some bright spots in factory automation which should be but has not recently been a growth engine for Cognex. We've received some large orders in Q1 and the sales team tells me we have a large number of new projects that we're quoting on and expect to win. Also, an example of that is yesterday we issued a press release announcing that a leading Japanese industrial robot manufacturer standardized on Cognex, this relationship is expected to generate more than $300,000 of revenue for us. And our new products to starting to gain traction. In particular, the Industrial I.D. market increased our business, increased more than 50% year on year in Q1, primarily due to sales of the DataMan 7500 hand-held reader which was introduced in early '06. In addition, in February, of this year, '07, we introduced DataMan 100 which is a tiny vision system that is fix-mounted and is able to read codes and it is emerging as the leader in this part of the business and it has enabled us to expand our business and applications such as the postal and document handling and machines in the medical area that need to have codes read on paper labels.

Turning now to the third market that we serve, which is selling to the semiconductor and electronics capital equipment makers, we refer to that as semi, as those of who you follow the industry know, it has been in a slowdown since mid 2006 and for Cognex, Q1 was slightly below our expectations but not significantly so. We're not getting any indications of any further drop-off and rather we believe it is most likely to see a pickup by the end of the year as the new equipment for new Cognex customers starts to go into production.

As I said at the beginning of tonight's call, my goal is going to be revenue growth. And to accomplish that goal we're looking at a number of different tactics such as expanding our direct sales force, and introducing more new products to market more quickly by reducing the development time. We hope that these initiatives and others that are already in place will start to bear fruit in the second half of 2007. For Q2 we believe that revenue will be between $50 and $55 million and at that revenue level, earnings are expected to be $0.07 and $0.12 a share but without stock option expenses between $0.11 and $0.16. So, we don't expect any of these initiatives to bear fruit until later in the year. We would like to open up the conference call for any questions you might have and any criticism that we deserve. Operator, we'll take calls.

[OPERATOR INSTRUCTIONS] Our first question comes to us from Jed Dorsheimer of Canaccord Adams.

Interesting question. I'm not sure how to respond to that.

We'll move on. Our next question is from Antonio Antezano from Bear Stearns.

Good afternoon, everyone.

Good afternoon, Antonio.

I guess the question is Dr. Shillman, what gives you confidence because you mention here that you still expect a good 2007, just by looking at results in Q1 and the guidance for Q2 seems to be very conservative, especially considering the fact that you're introducing new products, you're implementing these changes and also seen from what you were saying about these accounting rules, that there is a timing impact here in terms of some revenue that should have been recognized in Q1 will be recognized later in the year. So why the guidance been so similar to Q1 and in terms of your confidence that would still be a good year in 2007.

Thank you, Antonio. That's a good question. First of all, when I say a good year, I mean we're going to make money. This company, even when we don't grow, we make money and we are very cash flow positive. So, it is going to be a good year. Not a great year. It is going to be a -- hard to be a great year with this poor start in Q1. So, that's why -- that's why I'm not -- I don't want to be overly bullish. The results are terrible. Terrible results.

We have taken the steps but I'm not sure those steps are going to kick in that quickly, the sales team seems very enthusiastic and I'm meeting on a daily basis with Eric Ceyrolle who is a great guy. But we've been burnt in the past. About giving guidance. This gets to your second point. Why is the guidance so conservative. I would rather be conservative and be able to at least meet or beat the guidance and we've had some quarters in the past where, for the first time in many, many years, we either missed the revenue or I think we've always made the earnings, is that correct?

Yes.

We've always made the earnings.

Except for this first quarter.

Except for this quarter. I just want to exceed expectations and therefore I'm setting expectations lower. That doesn't mean we're not going to try harder to be honest with you. Of course we're going to try harder. Why do you think I'm sitting here in Boston in this horrible weather as opposed to Rancho Santa Fe, California which is heaven, because somebody has got to do it. That's what I'm trying to do.

I can tell you the products seem fine. The major issues that we faced I think is screwed in the handling of the DVT of integrating the sales force on DVT and Cognex. I'm reviewing that now again and I'm convinced that we made a dramatic error in -- I guess it was two years ago, by putting our sales force in charge of distributors. I hate to say it wasn't my decision. I'm CEO so I'm responsible. The buck stops here, but we're undoing that. The products are fine. We should have left those sales -- the distributor force separate from the sales force. And we didn't. And that is taking time to unwind and it is unwound but there is still lingering effects of that major mistake in distribution that we made. So, that's why I'm back.

As a follow-up, I think you also mentioned now, it seems that according to the new strategy you probably will hire new direct sales people as opposed to signing new distributors. Is that a good interpretation from what you just said?

Well, distributors are still important to us, okay. So, I don't want to give the impression that we're going to get rid of distributors. Distributors did a great job for DVT. And they did a great job last year. It is just the sales force didn't do a great job, all right. Our own sales force, because, not because they're not capable, it is because we didn't give them the right thing to do. We should have told them to keep on selling In-Sight and we should have told the DVT distributor force to keep on selling DVT and we would have had 1 plus 1 is 2.5 or something like that. It would have been accretive in that regard.

Instead, we distracted the sales force. Had them work with the distributors and we're not doing that now. I will tell you what we're doing now. We have -- and I will also answer your question, too, by the way. But we have an entire different team of distribution management people. We have 26 people working for us, our employees who are managing 162 distributors. That's what they do. That's all they do. And they're quota based and the distributors are quota based. The distributor have to work or they are never going to be distributed. I believe we've done a very good job at motivating the distributors, training the distributors. Now what we've done is taken all of our salesmen and put them back onto direct selling. By the way, we have 100 direct salesmen selling vision sensors. We have 11 direct salesmen now selling expert sensors and we have 18 salesmen around the world selling products to the semi group.

So, to answer your question, are we going to hire more people, I don't think you meant it this way but the answer is yes. We're going to and this is a major change for the Company right now. I've decided to lighten up on the bottom line of the Company which our goal has always been 20% or more net and we've generally achieved that goal. In many, many quarters and the vast majority of quarters. But I believe that to fix the problems that we have and to get back on to the growth track, that we have to be willing to spend more in salespeople and more in engineering to get products done faster and more products. So we are going to -- my goal now is to grow revenue, hold margins, but increase spending both in engineering and mainly in sales. I looked at the sales plan for China and I said that's not nearly enough people. I want double or triple that number of people. Now the only reason -- the sales force was happy to do that, the sales managers. They were tied to a certain -- we had to hit a 20% bottom line and I've relaxed that now.

For sure, we have to be profitable and very profitable. But in the shorter term, we're now going to sacrifice some of that profitability for growth to make sure that we're going to be the leader in these emerging markets. And we're not. Problems that we face in this company are that we are North American centric. If we look where all the, mainly the head count is, we will look where the engineering is done, we will look where most of the salespeople are, it is North America. Unfortunately, North America, when it comes to factory automation isn't building many new factories. Unfortunately, factories are being built in other parts of the world and that's where we have to concentrate if we're going to grow. So, it means a shift in the demographics of the Company as we grow, and we'll hire more people in those geographies. That's what we're going to do. We're going to hire more sales people in those geographies, we're going to hire more engineers in those geographies. That's a major change.

Thank you.

One thing I would like to comment on, Antonio, is relative to the software revenue recognition rules or whatever, these rules have been in place for a couple of -- for a number of years. I shouldn't say a couple of years. We've been following them. The issue that came about this particular quarter is that because of the mix of some of the orders that we got and shipped, the amount of revenue that got deferred this quarter normally if you look at a particular quarter that ranges, the net change in the deferral amount will change by a couple of hundred grand or whatever, this quarter it was significant in that it was a little over $1 million. That had a big impact when revenues are only $50 million. This is no change to the accounting rules that we've been following.

No, but it is certainly more rigid interpretation. We never had this problem before.

We did. We just didn't--.

You didn't tell me about it.

It was never that significant in a particular quarter.

I see. Well, let me just state -- I'm not answering anybody's questions, but now I have a microphone, with the world listening. The problem, we are spending a disproportionate amount of management and senior executive time on accounting rules and on SEC regulations. A disproportionate amount of time. Which is hurting not own Cognex but hurting America. Every American company is doing the same thing. We're no different and if anything, we do it less than other people while focusing on these things.

This is going to hurt the American economy, the fact that we -- the fact that we ship two products under two separate POs, you tell me if I'm right about this. We ship two large systems, surface inspection systems under two separate POs to two different facilities but it is one owned by one company. We couldn't recognize the revenue on the one that we shipped. Because POs were issued in about the same time frame. Is that correct? Am I telling the story right?

The contract was for the two POs to be negotiated at the same time, yes.

The contract was negotiated at the same time but they're two separate POs, they're two different factories, the customers probably even paid us for one of them. It wouldn't matter. We can't consent. Nope. We have to defer. Now, does this make sense to anybody? Not to me. And the fact that we have to worry about these things and try to meet this quarter or that quarter, gets me sick. Okay? And that's all I can say.

That I think if entrepreneurs are founding companies today they would be crazy to do it in the United States with the system -- with the bureaucratic systems that we have today and the regulations that we have today and I think what's going to happen is people around the world are going to be starting and investing in plants in other companies around the world primarily in China. Where there's no regulation. I'm not saying that's good. But it is the other extreme and it is one world we're competing in. Okay? It is one world we're competing in and our government is penalizing just Americans. That's the problem. Okay. Next question?

Thank you.

You're welcome.

Our next question comes from Jim Ricchiuti of Needham.

Hi, good afternoon.

Jim, I'm going to ask you to hold that for a second because this is a follow-on to Antonio's question about a good year and conservative guidance. We are now thinking that because we're going to be varying our schedules of hire, we're going to hire a lot more people earlier than we had planned and we don't know when we're going to get them on board. It is going to be very difficult for this company to therefore predict with any accuracy the quarterly earnings. We haven't decided this and wed like to hear from some of you, those of you, we are thinking about not giving quarterly guidance but giving annual guidance with an update every quarter.

That's a topic not for this discussion now, of course but later on, if you want to voice your opinion and call Sue or me or Dick, we believe that the Company should focus more on annual goals that, doesn't mean we won't have internal goals. We have weekly internal goals but it means we would like our shareholders to view us as a longer term company that one quarter here or there shouldn't matter and what matters is an annual basis. Some other companies go to extremes and say measures on a five year. For the year is reasonable. We should be able to run the Company and predict something for about a year with quarterly updates on how the year looks. But that's -- we're thinking of doing that because we spend a lot of time coming up with quarterly estimates. A lot of time.

Now, other people have suggested to me Bob, what everybody is doing because nobody is getting the estimates. Everybody is just giving a larger range. Well, if the range is so large then it is meaningless anyway, right. We spend a lot of time should it be $0.15 or $0.14 and that time should be better spent by me and everyone else doing other things or having less people involved and shrinking head count. All of these things that we do cost money. And they have no benefit on the product, okay?

Giving you a quarterly estimate has no effect, no benefit to my customers and that's what I want to focus my money on. Jim, thank you for that question. We'll take your follow-on.

Okay, here is my follow-up. I'm sure you'll get some feedback on that, Bob. But with respect actually to the pickup you saw in the March, April time frame, was that both direct and distribution in the factory automation business?

The numbers I have it here in front of me, don't have that granularity. But I can tell you the pickup in April compared to the same time prior quarter is dramatic. A dramatic pickup. But don't forget, yes, the prior quarter was very low. It will be of course January compared to April. So, we can tell you if it was distributor or direct.

Based upon the information. We don't have it broken out quite that way. We have it broken out by product line. By taking a look at the product lines though, it would be in both areas. Both direct and the distribution.

Okay. As you build up the direct sales force, maybe you could also tell us what extent, how many people would you expect to be adding? What did you say your number was?

Thousands. Thousands. We're going to hire -- because in China, each one costs 1/1,000 what it does here. They work twice as many, they work 48 hours a day. It is just incredible how they do that. It is different time zones, I think that do that.

No, Jim, I can't tell you yet but I've asked my team to put together their wish list. I asked Eric Ceyrolle, Eric, how many sales -- if budget wasn't a constraint, how many salesmen would you want to hire? How many could you hire? Right? If we need 20, let's hire 40 and then we'll narrow it down to the best 20. We'll keep 30. We have not -- we're in a different game now. When we were -- when we were -- our salesmen were calling on semi customers. Our salesmen were calling on to sell vision sensors, different breed of salesmen.

We're coming out with other products like Checker which can be sold by people with much less experience. I'm not going to say they're not smart. They're just less experienced and we have a new model which I'm not going to share with you right now about how to find those people and there is a boot camp right now with ten of them downstairs from around the world, hiring different sorts of people, less expensive. Younger and with a lot of energy. That's what we're trying and I just can't tell you what the numbers are. It is probably 20 or 30 people we're going to hire. 20 or 30 extra.

Okay. That leads to a follow-up question I had, Bob, just with respect to when you've added direct sales people in the past, there has been a certain amount of time that they have to go through the learning curve.

That's right.

Is that going to be different with the -- as you go forward?

Yes. Just like our products have a much lower learning curve, whether it is DataMan or whether it is Checker or whether it is DoorMan, those products have a very fast learning curve for the customer. The customer gets it and puts it in an hour or two, the same thing, it should be sold by a different kind of person. So, the training is one week, let's see how they do. They better deliver within one quarter or close two quarters. That's correct. These products are easier to sell. So, we need more people to sell them.

I'll turn this over to somebody else. I just had one other question. You alluded to, I think a new customer or new customers in the semiconductor business. Can you shed any more light on that?

Yes, sure. We haven't been touting this. We have been successful at closing new OEMs in the semi electronics industry. Now they -- so far, they haven't been the very large OEMs. But we're still active and we still have how many salesmen, we still have 18 salesmen out there mainly I think in Japan. I can tell you what they are. They're spread evenly every place with a little bit of emphasis in Japan but also in Asia. And probably we should hire more in Asia because they're starting to build more equipment in Asia. That would be an area for growth, too. But Sue, do you happen to have how many new OEMs we closed this quarter?

We have about 12 to 15 that we closed this quarter.

12 to 15 OEMs this quarter.

How soon would you start to see the ramp in that business?

It will probably take about a year or so.

In the past it has been a year. Six months to a year.

Okay.

The cycle is going up, rather than down. But I don't think I mentioned that in my discussion. I did mention we have a number of large orders that we're going to start announcing and there is a lot of good news. We haven't been announcing the good news. One thing that we have closed, I just remembered on two very large OEMs that we won over an existing competitor over ESI, two very large OEMs. Those are going to ramp up later this year, as a matter of fact. I can't tell you the names of those yet. It hasn't been announced.

Thank you.

So, we're still doing good stuff here.

Thank you. [OPERATOR INSTRUCTIONS] Our next question comes to us from Richard Eastman of Robert W. Baird.

Bob, could you put some color around the PC-based vision category? It has been kind of in a three, four, quarter decline. Presumably, some of that is for the semi industry. But are there any other dynamics there, price or is it all unit volume and is it all the semi industry or are there some other end markets there that are perhaps using other products that would have previously used PC-based?

Well, I can tell you that the PC vision, I'm looking at the numbers now, year-to-date, is down substantially in the PC-vision for semi electronics. And is down by just a slight amount in factory automation. I'm not going to give you the numbers. But the PC vision is down primarily because the semiconductor cycle.

Okay.

But we're still selling a lot of PC vision.

Okay. And there isn't -- there isn't -- the potential here for any cannibalization with , the inside product or some of the other

No, as a matter of fact, there is potential for growth. We have -- have we announced?

No.

Potential for growth because we have some sensors that we're developing, expert sensors that we're going to sell into the semiconductor equipment area. So, the PC product is not going to be replaced. Those are very complex products that are doing a lot of things for the OEMs whether it is software or software and hardware. In addition, those OEMs are telling us in one particular live U.S. company, U.S. capital equipment supplier with three letters, is now testing out a new sensor that we're coming out with that is a hand-held, basically -- I shouldn't say hand-held, a very small sensor, an inside kind of product that's additive to the revenue that they're already buying. It is going to do something new for them.

Okay. All right. And then just -- a question on the semi category, the OEM business, the semi OEM business, is it your general sense from the tone of business, I realize there is not a lot going on but do you feel that it has kind of hit bottom here in the first quarter and we bump along until we begin to see some improvement in the end market or do you think there is another step or two down yet?

Well, I used to be more in touch with this when I went to Japan because that's where most of the business is. I haven't been there for probably six months now. I just can't tell you but I can tell you what the people at Cognex are telling me and what they're telling me is what the customers are telling them, those customers and they believe that the business will pick up the second half of the year. That's what they told them. Who knows. Who knows. The blind leading the blind.

And then, Bob, could you -- one other thing. We're starting to see more of these lane departure warning systems in the automobile market. They're high-end luxury items. Cognex has obviously taken a little bit of different approach there with the acquisition kind of targeting the class eight trucking market. Do we have a product for the automotive market? Are we interested in that? Or are we specifically chosen class eight market?

Rick? It's a very good question. For various reasons, I'm not going to answer it specifically but I can tell you that we take this business seriously. That we did hire recently, I don't know if we had a press release. We did. Pascal Dorster out of TI, very, very eager. Bright, hard working, knowledgeable guy who was in TI's DSP group selling sophisticated products like their DSPs to automotive OEMs and Tier ones so he knows exactly who to call on. He has been on the road, I think he's been on Cognex like a month and I've seen him like three days because he's always at customer sites. We are viewed now as a major source of technology by some of these Tier ones. Tier ones for those of you who don't know are the large manufacturers who sell directly to the OEMs. OEMs in this case means original equipment manufacturers, car manufacturers. We would never sell to car manufacturers. We're just not in that position that we could sell directly to them. They require a different business structure, different kind of support but we are in a position to sell to Tier ones who will then incorporate our technology whether it is software or hardware into a product that they then sell, turnkey into the car manufacturer.

You have seen, indeed, there is a lot of marketing, a lot of ads about all of these new features that are coming on cars. And in my view, and it's not a studied view yet, but it is pretty knowledgeable, it is all crap, okay. I would never buy a car based on these kinds of features. The reason why these features are in the high-end cars is because people who buy high-end cars step up and they say I want it loaded. Okay. So, you can get a very high price from people who buy high-end cars, me being one of them by the way. That's another story for another time. So, you can deliver these to high-end cars and you can experiment. You can see if people like it. If they use it and that's why these things are high end cars. Most of this stuff is not in any functional mode. Not nearly what you would be led to believe by watching the advertisements.

You would never -- I don't think in most of these cases you would trust the systems to do anything for you except you show your friend then you forgot how to use it. However, that being said, there is an enormous potential for vision systems in cars. I don't think it is going to exist for five to ten years. Probably more like -- more in the range of five to ten years. It is going to take a long time to develop those relationships. For example, if you have a product today and it is working, and you show it to the Tier ones, they'll say hmm, they'll test it and they'll say we'll put this on the 010 -- 2010 model year. Even if it worked today. '010, three years down the road. That's the best you can hope, that you're going to be designed into the 2010 model year and it would probably be in the high end of the Porsche or this or that. Not a lot of units.

The hope is that you'll get in there and every year you'll get on the '10 and the '11 then you have an annuity with these companies but it is a hard business. We bought AssistWare not because of the truck business, because its a rather small business. We believe that ultimately, cars will have these features and they will work and at that point, of course, the prices will be very low and the truck manufacturers will install them at that point, not buy them from small companies who are going to stick them on the windshield. So, the reason why we're in the truck business is because the Company we bought had a product and it has one today and trucks do need them. And they can pay a lot more money than the automobile companies hope to pay for them which is zero. They want to pay zero. As a matter of fact, you have to pay then to put it in. You can't believe the difficulty in the automotive industry.

So, we are hiring people into that group. We may be announcing. We may be signing some deals with Tier ones rather shortly. I have personally visited them and those negotiations are starting. But this is unlikely to generate any significant revenue for anyone for anyone, not Cognex, not the competitors, there are two or three competitors out there that we compete with who are experts in the technology and it is not going to generate any significant revenue and as a matter of fact, losses I would imagine for a number of years. We are going to be very careful and cautious how we do this and not lose a lot of money or any.

Okay, thank you.

You're welcome.

Thank you. Our next question comes to us from Jonathan Raclin of Barrington Research.

Good afternoon, I'm subbing in for Alex Paris who is on another call. How are you today, Bob? Let me ask you three questions that have come up. Number one, can you quantify what the result of the new software or the software rules, you have alluded to the fact that this basically caused significant problems with regard to revenues during the quarter. If those rules had not been in place, what would the numbers have been?

As I indicated, talking to -- in response to Antonio's question earlier, we've been deferring revenues along these lines for years now. The increase in this particular quarter was about $1.3 million.

Okay.

Which was a significant swing in a single quarter.

Okay. That's fair enough.

I don't think in the future we're going to say shipments in revenue but there are companies, companies that do capital equipment now because it is so complicated to convince the auditors that, indeed, a sale happened.

I understand.

It seems to me a sale happens when a customer gives you the money. Hello. That's a cash basis thing but certainly if they gave you the money you should be able to count it as a sale and that's not the case.

What's the status of a replacement for the departed COO?

You're looking at him.

Is there going to be -- oh, I guess. You're back from Rancho Santa Fe, which quite frankly, the fact that you were living out there came as somewhat of a surprise to some people.

Oh, no. I've been very public with that. That my intention, five years ago, I was thinking about moving to California. I've been running the Company at that point for 21 years and gee, I wanted -- even though I love work, I also -- there are some other things. I have a young family that I want to grow up and know what the sun looks like. And you don't see that in Boston. I've been very up-front with people. That's why Jim was hired to run the day to day. I was of course still involved. I was spending one week a month here and also traveling to other facilities so I was still very involved but spending more of my time in Rancho Santa Fe. That has been true for the past three years.

Okay.

But with Jim's resignation, we needed somebody to be the boss.

Good.

So, I came back. Though my intention is still to go back to focusing on acquisitions and longer-term issues, not run the day to day. I don't think I'm very good at the day to day, to be honest with you. So, we have retained a search firm and we're working with them and I'm already seeing paper and interviewing people to be the next COO or President of Cognex.

Good. Can you talk a little bit about if any stock buyback during the quarter occurred?

I don't know if it did. How much did we buy back?

We bought back about 125,000 shares at approximately $2.6 million.

Okay. Can you talk a little bit. You talk about the difficulties with the automobile industry but that seems to be mostly domestic. What kind of penetration do you have with overseas manufacturers?

Well, have to be careful. To make it clear. There are two kinds of automotive [Inaudible] industries. We sell our expert sensors and vision sensors to manufacturers including mainly automobile companies in their Tier one suppliers. So, if somebody is making brakes, they want to inspect the brakes, we sell that company products and so that's the automobile industry and that has -- that accounts for about 15% of our revenue or something like that. That's close to about 13% to 15% of our revenue.

Less than that because of the decline in the U.S.

Right. So that business has been declining because our sales force is focused primarily in the United States. We don't have quite the right product in Japan. That's under development now. It will be announced in my lifetime. So, that's one part of the auto industry. The other part that I'm talking about that's very difficult to do business with is the machine vision in cars, not machine vision to build cars. That's easy. That's our business. That's a real large focus of us. We know how to do that. That's not difficult.

It's going through a slowdown in the United States because of the slowdown in the U.S. auto industry has caused that to happen so they're not putting on new lines and if there are no new lines for car manufacturing then they're not buying new vision systems so -- and the Tier ones are pushed to the wall when it comes to profitability and they're hesitant to invest in new capital. Capital equipment. So, that hurts us because if they don't invest in new capital equipment and new lines then they don't buy machine vision. So, there are two aspects of the car industry. One that we're in and we know about and the other one that we just started getting into and that's providing machine vision for use in vehicles after they're sold.

Okay. You say in the release that the medical, et cetera, other lines were very solid during the quarter. Can you quantify that for us?

I don't know, do I want to get into that granularity? No. Sorry, because then the question will be -- no, it is too granular.

Okay.

What particular company and what this -- no. We didn't see a slowdown in the other areas. We know the product is right. We're not hearing anything about that. We're not losing orders to competition. The slowdown in factory automation is due to two things. I think primarily the sales force was managed incorrectly and secondarily, there is a slowdown in the auto industry.

Okay. All right. Well, number one, personally, I'm glad to have you back.

Well, thank you, Jonathan. But you don't know me.

Secondly, I'm on the portfolio management side so I deal with the actual owners of the stock on the -- I run a fund, okay.

Yes.

I'll just give you a little gratuitous feedback from the clients and the owners of the business, I think I would cease and desist with the funny annual reports it is not funny anymore.

Well, you know what? Nothing is funny when you're not making as much money.

That's my point.

I understand. But believe me--.

It is not as well received as it used to be.

Well, that's right, everything -- believe me. Nothing is well received when you're not growing. That's what it comes down to. Nevertheless, it takes just as much time to put together a stodgy annual report than an interesting one so people enjoy it more and it costs the same thing so why not do it. It doesn't mean that we're in a happy mood every day. Believe me, we're not.

It is a question in people's mind about how much time is being spent is necessarily how much money is being spent.

I agree with you.

Fair enough.

Thank you, Jonathan. I do not dismiss the comment lightly. We'll think about that.

Okay.

Yes.

Thank you. Our next question or comment comes from Ali Irani of AI Capital Management.

Hello, Ali.

Okay.

I think Ali is a mime at Capital Management perhaps.

Our next question comes from Jed Dorsheimer of Canaccord Adams.

Can you hear me?

I can. Can you hear me now?

I can. Sorry about that. I'm actually over in Taiwan and I think there was some lost in translation on my first question.

Yes, probably. But we answered it.

Yes, you did. Did a good job. So, question for you is Bob, you talked a lot about sales force to increases. One last question on that. Can you give us any metrics as far as what the quota is to sort of make the grade at Cognex? Is there a matter of hitting a million or hitting two million or a million and a half per head? Is there any sort of--?

Very interesting question. Very good question. And my understanding is the quota really is set based on the territory. So, a great salesman in a new territory might have a quota of $500,000. Of only $500,000 whereas a weaker salesman in a good territory would have a quota of 1 million. We're very careful about setting these quotas to be something that is a stretch but something that could be made in that territory and then the commissions go up or when they hit that quota it goes up, so not every salesman has the same amount of quota. I will say that we currently expect each salesman to do about $1 million in the factory floors. That's about the right number that we are using now.

Great. That's helpful. And then lastly, just the other comment you made was the fact that you wanted to increase the product development and I was wondering if you could give us maybe some tangible metrics there. Do you have a number of engineers that you're looking to hire, is there a particular cycle time that you would like to be bringing products to market, what was that? And what do you think it will be? How can we judge your success on the increased R&D efforts? Thanks.

Very good questions. I wish I had answers that are as articulate as your question, to be honest with you, Jed. The thought about this. Justin Testa, who is our group business manager, came into my office and we were talking about different products that are on the road map. And he pointed out to this product, that I won't go into detail, that they want to add something to this product. Not a vision capability. They want to add a keyboard on top of the product for a strange reason but it is an important reason, okay. To make it more of a data entry terminal, for large class of customers. It was on the calendar as I recall for 2011. I said Justin, if we had that product now, could we ship that product now? He said absolutely. So, I said well, we're going to miss four years of revenue? Because we're waiting for it in 2011? The answer was well, we don't have the resources to get it done now. And it wasn't a vision problem even. It is a straightforward engineering.

So, I'm getting involved in these and with the business managers and the group business manager to say, let me get into a calculation here. It is a simple matter. How much would we make if we sold it. We got to hire, if we got it early, we have to hire more engineers, not necessarily hire them but do outsourcing, perhaps. This is not vision which we would never outsource. This is adding a switch here and there or something like that. Help. Maybe $100,000 will get it done. You'll get the product four years earlier. That is the sense that I'm responding to.

I can't give you specific numbers but I will tell you my goal is that from inception of a product to first shipment, I would like that to be 12 months. When you think of a product, by the time -- and getting it to the market should be 12 months. And I don't know if it is reasonable or unreasonable. That's my goal. And I think most of our products are far more than that. Now, very complex products I can understand. But we're coming out with some very simple products that -- complex side, but we know about them. We should get them to market in 12 months.

Now, at first I pointed to engineering as the problem and it turns out it is more detailed than that. The engineering could get done but if the test fixtures aren't done, if the protocols aren't done, if the brochures aren't done, we're now learning of course, we should know by now that to introduce a product, there are many steps, the vendors have to be lined up for all these parts. Running is a business is complicated, okay. It is not just that I'm going to lean on engineering but we're going to come up with methods for getting products to market sooner. Because we're missing market opportunity. It is not that we're losing the competitors but we know if we had x, y, z product we could sell it today and we don't have it.

Great.

I can't give you any guidance. That's why I'm thinking about not giving quarterly guidance because we just don't know yet. Now, we might know in a quarter when this analysis is done, how many more engineers we're going to hire and the effect on the P&L, but then I don't know when we're going to actually find them and when they're going to actually hit the P&L. That's why I'm thinking of a -- not 12 month rolling but an annual target. I'm sorry -- Jed, your questions are right. They're legitimate. I just can't answer them. I just don't know.

I'll pass it on. I appreciate your candor and I would also like to -- I would say don't change the reports. It always brings a smile to all of our faces when we do see them. We just want to see the profitability increase a bit.

Yes, right. Okay. Got you. Thank you very much.

[OPERATOR INSTRUCTIONS] Our next question is from Ben Alexander of Alexander Capital.

Yes, good afternoon. I wanted to ask you, I didn't quite follow the explanation relative to April with when you said orders picked up. I wanted you to talk a little bit more about that. Secondly, wanted to ask you if you're very dependent on the auto industry, what can you do about -- I mean I don't necessarily think that that industry is going to experience a robust recovery in the U.S. any time soon. So, is it just trying to get more business abroad? Is that the strategy? Or do you have some other way to address that and then thirdly for someone who is somewhat new to the Company, can you talk about new products for new markets or how you can extend the opportunity set for Cognex?

I think--.

That's a lot of questions.

I think that was a long one question by the way.

It was.

One question, three parts. I understand. I'm going to talk fast because I know there are some other people on the line. First of all, what I said about April is that the first three weeks or four weeks are dramatic increase. I'll tell you, over 40% increase over the same time last quarter. So, in January. Very dramatic increase and it looks like it is across the board in every product line. But, that's three weeks. Let's hope we can get it continued and Eric Ceyrolle, thank you too, it's going to be a great Q2, but he's a sales guy.

Next, the auto industry. What can we do about the auto industry? We can quickly go to where the auto industry is healthy which is other parts of the world. I understand Mercedes is doing well. I understand that the Japanese are doing well. We don't happen to have the right product for Japan and I have been leaning on the team to come out with this product sooner and it doesn't look like it is going to come out as soon as I want, okay. I won't give you the name of the product. It is a product. It is an In-Sight like product. It is a vision system designed specifically to meet the needs of the Far East. Specifically to meet the needs of the Far East. We know what those needs are. There are competitive products there when we can do much better.

Nothing in the short term. We can't do anything in the short term. But what we can do -- we can't do anything in the short term about the auto industry. But what we can do is target the sales guys to other industries. They're in that -- wherever the sales guys are. They have to knock on other doors, they have to make their quota. New products to new markets, the new products to new markets are in the -- are in building automation. We're still involved in this DoorMan product. That has not yet hit the market. We expect that to happen quite soon. And so building automation and also in in vehicle vision sensors. We're investing in that. And there are other very interesting areas of security that we're starting to look at. And those are the only ones I want to talk about now. But none of those, whether the building automation or the in vehicle vision, those are not going to generate -- I should say the building automation may generate significant revenue quickly, but the automotive in vehicle vision will not. Sorry. That's the best I can do in that short a time. Next question.

Our next question comes to us from Eric Ende of First Pacific.

Hi, Bob.

Hello.

Particularly in view of the increase in direct sales force, could you remind us how you draw the line between distribution customers and direct sales customers, how you're avoiding channel conflict?

Yes, what we -- we've thought about this quite a lot and we've met with the distributors and we have named accounts now where the salesmen go in and the distributors don't go in. That's it and we have a list and in each territory so we're trying to minimize conflict and if they both go in, their regional managers were going to sort out that problem. But there are lists now and what we want the distributors to focus on, are those accounts we never heard about. We would never go into. That's what DVT was doing. DVT was very successful going where we weren't. We weren't stepping on other each other's toes. They knew that it was too difficult to compete against us. We'll delay the order, all sorts of problems, they went elsewhere. That's what we want the distributors to do. To focus on those accounts that they were focusing on before. The DVT.

Is there a theme? Are you designating accounts with larger size potential for direct sales or is there something else that's driving the--?

That would be logical. I'm not going to give you or my competitors who are listening all of the details. But that would be a logical first assumption that large accounts would be called on, but there are cases, I have to say there are cases in Detroit in particular where very large accounts where there are very good distributors who know how to sell to the various plants at general motors so it is not only that.

Presumably, you protect existing distribution customers.

I think so. For a certain amount of time. I think that's the case. But here is the problem. We gave them all the accounts, okay? That's the problem.

Okay.

Getting them back. We over protected them. We gave them all of our accounts and now we got to get some back. I think everything is copacetic now. The sales force knows what they have to do, go back to selling. It was a dumb mistake that I was head of and it was my fault. Dumb mistake.

One quick comment. Don't get too stodgy, please.

It is okay to have annual reports funny.

You bet.

Thank you.

Thank you. Our next question comes from--.

I'll tell you, who was it? Jonathan. It was Jonathan, right? We'll send you boring ones. As a matter of fact, we'll send you IBMs or somebody, or AT&Ts, we'll send you theirs. Go ahead.

Our next question comes to us from Ali Irani of AI Capital Management.

Can you talk now?

Hi, thank you for taking my question.

Sure.

Sorry we got cut off. I'm calling you late from Europe.

No problem.

If you can help me understand, the distribution issue seems to be a mistake made corrected and from your comments, it would be fair to say we're off the bottom from that mistake.

Yes.

So looking at the growth side of the business, penetrating the obvious manufacturing growth in Asia and with all due respect to management, that's not exactly a new trend. How fast can we get on that ship and how fast can we get that going and if I could just add this comment, please give us quarterly results so we can compare your progress from one quarter to another. Wherever the bottom is, knowing where it is will be very helpful to us. So that's my opinion on that one idea. Thank you.

We're still going to give you quarterly results, we just weren't going to give you quarterly estimates. We're still going to report the results, right Dick, I think we're required to do that.

Yes. We don't have a choice.

I would like to not. This is for ten years. I'll send you a letter.

Just as a portfolio manager's opinion who's been on the sell side as an analyst for a decade, it just makes it very hard for us to judge your progress or your appreciation of the business. We don't have quarterly expectations, even wide ones like the one you provided for the second quarter to go off of.

I hear you and I understand, but maybe there are other things we can provide the Street with that will give you more insight into our business in the future of the business. Really that's what we're talking about, right? We're talking about letting investors have a window to see where is this company going? And maybe there are other things we can show you or talk about or disclose that are better than earnings per share. Earnings per share--.

How about giving us both of them.

Well, the problem is it takes us a long time to come up with these estimates.

Well, so focusing a little bit on the Asia issue, and the manufacturing over there, it is an enormous market. It is growing in China, it is growing in India, it's growing in Vietnam. It seems that the Company has missed that boat.

No, no, no, no.

How do we get on it faster?

By hiring more people quicker. That's the only way. By opening operations and expanding operations. I don't know. Now, you are right that people have been manufacturing things for a long time over there but it started with jeans and sneakers. You don't need many vision systems for jeans and sneakers so there is a right time -- yes. Most of the operations that were moved overseas were manual assembly. Machines, there is no play there. So it made no sense.

And until Pat Alias and I took a trip over there into the boondocks of China and saw that even in these horrendously horrible old-fashioned factories, they were using vision and happened to be DVT, Cognex vision, I was astounded. We came back and we said hey, we've got to invest now. It is time. So, quality wasn't an issue. Three years ago, Japan -- China was making sledgehammers and car jacks. Now they are making automobiles. Different story, now we should be there. Could we have done it a year or so ago? Probably, okay. Probably right. I want to thank one of my Directors, that would be Jerry Dishman, who said Bob, I hear your opinion but get your [Expletive] over there and take a look and come back with a more knowledgeable opinion and we did that and sure enough, it motivated us to spend more in China and the rate we're going to spend is going to be much higher than the rate that was planned.

Okay. So perhaps one of those data points should be kind of where the end markets are on sales into Asia for example, versus the U.S. because it does seem that the Asia centric nature of the business has become a problem at this point?

That's correct. In Japan because of the wrong product. Which we've known about for a long time but for some reason the Company didn't respond. And in China and Thailand, those other countries, it is hiring. If people wanted to know a view of the Company, if I said -- if I wanted to know, I would say where are the salesmen? How many salesmen are you hiring? Net salesmen. How is the salesmen growth doing? That is going to be an important thing. I will look at that every quarter.

In terms of adding to the cost, I know this is a long-winded single question.

Yes.

Have you considered opening an R&D center somewhere where the cost of that are lower such as in India where not many technology companies are moving to?

Got to be careful on this question. It is under advisement now. We worry about our intellectual property. Now, Cognex, since its inception, owned everything we invent. We never sold it off. We never sold the rights. We don't hire -- we don't have consultants do it and own the technology. We own everything. And a key to our profitability and our gross margins is the uniqueness of our software. And you know that software can easily be stolen. Easily be copied. Easily be duplicated. So we are worried about expanding into those parts of the world where there's no regulation. Where there are no rules.

Now, I think China is changing. It isn't changing fast enough in my view yet, but it is happening. It is happening. So if we do do engineering, we're not going to do vision stuff in any part of the world where we can't protect it. We can't hire people, let then start developing products, teach them about our technology, give them the keys to the castle, give them the keys to the codes, and then have them open a company across the street. And that's what's been happening in much of Asia. Much of Asia. So, the answer in the longer term is yes, we will have engineering technology centers in Asia. I just don't know when.

Well, thank you for taking my questions. I appreciate it.

Thank you for your questions. I appreciate the fact that you were up this late at night in Europe. Go to sleep.

Thank you ladies and gentlemen. Our final question on today's call comes to us from Jim Ricchiuti of Needham.

Bob, any changes you've made in the distribution channel, have you lost distributors or are you planning to add more distributors?

Any distributors we lost, I think we terminated for nonperformance and they weren't adding value. I'm not aware of any that quit. A distributor typically won't. They'll stay on board because it won't cost them anything. Have we added distributors? Yes, I believe we have added them. In different territories but I don't have that kind of detail right here.

Yes, I think the net over the last 12 to 15 months, we've probably through the settling out, there is a grading system that goes through and I think through the settling out, we've probably lost 10 or 15 distributors.

At our will. We decide.

The total you have, how many do you have, do you think?

162 around the world.

Okay. And just lastly, I'll let you guys go. Just what does the pipeline or outlook look like for the [Sisne] business? It has been down, it was down last year. Down so far this year. Any sense as to how that could turn?

We still expect it to be $30 to $32 million, something like that in revenue.

Terrific. Thank you.

You're very welcome. Operator, what is your name?

My name is Matthew, sir.

Matthew, I have to tell you, you are the most proficient and articulate operator we've had and we've been doing this every quarter for the past 15 years. So, we would like you back.

Well, thank you.

You're welcome. Can you sell vision systems? Do you speak Chinese? All right, kids. That's it. Any questions you have, details, if we can tell them to you under Rule FD or revenue recognition or whatever, call Sue tomorrow. She'll be around. No, she won't be around. We're going to be at the shareholders meeting.

Finally, I want to thank all of you shareholders who voted for me to return as a Board member even though ISS said that you shouldn't. That shows how efficient some of these things can be or how silly they can be. I also want to thank all of you who voted for the stock options. Our employees are motivated by many things. Hopefully by creating great products and satisfying customers, but also they're motivated as all of us are in America by money. We don't pay our employees enough cash and the way we make up for that has been by generous stock option grants and I want to thank all of who you voted to approve that. And I believe the measure already passed but we're going to know tomorrow when all of the votes are in. Thank you again, and talk to you next quarter and hopefully with better results. Bye-bye.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.