Cognex Corp (CGNX) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cognex second-quarter 2007 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions on how to participate will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Richard Morin, Chief Financial Officer. Sir, you may begin.

Thank you, and good evening, everyone. Last night, we issued a press release announcing Cognex's earnings for the second quarter of 2007. 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.

To help listeners compare our results on a consistent basis versus historical information, we will exclude the impact of stock option expense as well as onetime tax items from our discussion during tonight's call. For your reference, you can see the Company's income statement as recorded under GAAP in exhibit one of the earnings press release, and reconciliation of certain items in the income statement from GAAP 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 will turn the call over to Bob Shillman.

Thanks, Dick. Welcome, everyone. As you know, our Q2 earnings release was delayed quite a bit due to irregularities that the Company by itself discovered in certain transactions originating at our Japanese subsidiary, Cognex KK. And for the rest of this call, I refer to it as CKK.

The delays were unfortunate, and I know raised a lot of anxiety on many of our shareholders. But I am sure you can understand that until a full and thorough investigation was completed, we just couldn't provide any details about the situation or about the quarter.

The very good news is our internal investigation has been completed -- that as well with the independent investigation, which was under the direction of the audit committee. The results of both those reviews were in agreement, and the findings are that the reported revenue was overstated by $303,000 in the first quarter of 2007 and by $757,000 in Q4 of 2006 due to those improper bookings. The adjustment to correct for these overstatements was recorded in the second quarter of 2007 -- that's the quarter that's in front of you.

The situation that led to this adjustment was isolated to Cognex KK. There were unsubstantiated customer orders that were booked by a former employee -- and I underline former -- of that office. When those orders became due for shipments, they were fulfilled and turned into revenue.

As soon as we discovered this matter, an internal review was put into action, as was the independent investigation. And upon completion of our internal review, we have implemented a number of additional controls over bookings and credit policies in Japan, including increased involvement by key personnel at our headquarters here.

I am extremely disappointed in the individual who was responsible for this problem. And we have no idea why this individual did what he did. It doesn't appear to be of a financial gain. Perhaps it was because he was promoted most recently to a senior management position, and wanted to make the number happen -- the bookings number happen.

But this is not a Company that puts undue pressure on people to do anything like that. Integrity is a key value of Cognex, and we do our best to maintain the highest ethical standards. His actions were against our corporate code of conduct, and were done completely without regard to the possible -- not the possible negative impact; the negative impact that it did have on Cognex and his fellow [Cognoids] and all of our shareholders.

I want to assure you that the inventory that resulted from those erroneous shipments was fully recovered. It was recovered immediately. And the matter was brought to light before the amounts were material to our financial results.

We proactively disclosed what we discovered to the audit committee, and we all worked hard together with our accountants and forensic people and lawyers to resolve the matter as quickly as possible, and it is resolved.

Let's now turn to our Q2 results. The second quarter, we reported revenue of $54.7 million and earnings -- again, excluding stock option expense and the onetime tax item -- of $0.14 a share. These results are in line with the guidance we gave to you in April, and that is despite the revenue adjustment which we recorded in Q2, as well as a significant increase to our excess inventory reserve, which I'll allude to or talk about in just a minute.

First, I would like to report that reported revenue increased by 7% on a sequential basis. The increase was due to higher sales in the factory automation market, which increased 15% over Q1, mainly as a result of higher revenues in Europe and Japan.

We experienced excellent growth in the automotive industry in Europe, where revenue increased by more than 30% compared to Q1, and was at its highest level ever. However, that's not the rosy picture at the U.S. auto suppliers, which continue to be quite soft.

Contributing also to the higher revenue was our surface inspection, which increased 16% on a sequential basis -- however, from an exceptionally low level and Q1. And other industries, such as pharmaceutical and medical devices and food and beverage, also increased.

Now, I know there's a lot of concern over growth, and not only in the shareholder base, but in the management base. And I'm looking now at a chart which shows Q2 '07 versus Q2 '06 by industry. And I can tell you significant growth year on year in the aerospace, consumer product, document processing, food and beverage, pharmaceutical and medical devices -- in those combined areas, there's 30% growth year on year.

The distribution growth is flat. I shouldn't say distribution growth; there was virtually none -- 33% growth through distributors, but the direct sales are growing very nicely. Even in automotive -- is an 18% growth from about 1,022,000 -- excuse me; from $4.95 million to $6.7 million, a growth of 18%.

What hampered the growth was a significant decline in electronics, electronic assembly and semiconductor. Combined, those fell short by $8.6 million in the quarter compared to Q2 of '06.

And that led to the revenue being down, not including SISD here, I believe -- that's right -- revenue from MVSD being down by $6 million. But it was mainly due to the semielectronics being down, and also to about $2.2 million of deferred revenue in MVSD due to changes in accounting rules.

The gross margins reported for Q2 appears to be disappointingly low -- 67%, but it was due entirely to a $2 million charge that we recorded in the quarter for excess inventory. I want to assure you in our view that this inventory is still useful. We have gone through this in the past, and we've discussed it with our auditors, though the new rules are very stringent -- but we have not scrapped, to my knowledge -- is that correct? -- any of this inventory, any of the $2 million.

Now again, in the past, we have had inventory reserves that were required. And we used every bit of it. So not only wasn't it scrapped; we have no plans to scrap those $2 million.

The rules are we just had too much on hand, which was consistent with our original production plan, which assumed of course higher orders that we're actually receiving. The inventory charge alone decreased gross margins by 400 basis points. And if you exclude that charge and exclude stock option expenses, the gross margin calculates to 72% in Q2, which is the same as our gross margin was in Q1.

Turning now to new products, in the second quarter, we introduced Checker 200. It's the next generation of our inspection sensor that enters into the photosensor market. The Checker 200 has some additional features that I won't go into. But most importantly, it's much smaller in size. It's less than three inches tall, half the size of its predecessor. And most important on a financial basis is that it has higher margins than the prior version, even at the same selling price.

As many of you know, in early 2007, we implemented a new sales strategy to develop the market for Checker. And it's still in its early phase. The strategy includes using special salespeople who are hired just to sell Checker. We call them the Checker-only direct sales team. We've been hiring them over the past two quarters to supplement direct sales and distributors.

We are on schedule with that hiring. We currently have 20 or so direct, Checker-only salespeople through the U.S., Europe, Japan and China. And we expect to add to that team in the second half of the year.

Also talking about the sales team, since we are on that now, I would like to let you know we did not announce it, [I don't think], internally. But we brought sales -- we brought [Chris Nelson], who has been with the Company -- 10, 15 years? (multiple speakers) about 15 years, and who, until a year or so ago, was head of North American sales -- we brought him back into that role.

He did a great job that at that. He wanted to try product management. He was a business unit manager for our vision sensors. And because of the lack of apparent growth in bookings, we decided that that was the right time to bring Chris back into that role and let someone else do the product management. And Chris agreed to do that enthusiastically and wants to get back into selling.

Changing continents to China, we have been building a direct sales organization in China to sell all of our MVSD products. Of course we have been selling SISD products there for some time. And as of the end of July, we now have 17 sales and sales support people there. And I'm happy to say we are already starting to see results from that investment.

We recently won our first significant order in China that had not been a previous Cognex customer. And this win is even more impressive to us because it was a key account that we took away from an entrenched Japanese competitor. This new customer is going to be using In-Sight in the packaging equipment that they manufacture -- it's an OEM. And the first order was for approximately 50 units. And we believe that this customer will buy 300 or more each year. They make, again, packaging equipment for consumer products. And I hope it doesn't have lead paint on it or any magnets in it. (laughter)

My last comment before we open up the call for your questions is about our Q3 guidance. Our outlook right now is for Q3 revenue to be between 50 and $55 million, which is flat to down compared to Q2 results we reported last night. But I can tell you we have already looked at our backlog, shippable backlog, and shipments already that have been made. And we have high confidence in getting into that range, perhaps even the high end of that range.

The summer, as you know, is typically soft in factory automation. And that's nearly two-thirds of our business. And that's one of the reasons why the target is low.

In addition, we continue to see rather lukewarm capital spending by manufacturers in the semiconductor, electronics, and U.S. automotive industry which have been large users of Cognex.

At the 50 to $55 million revenue level, earnings are expected to be between $0.05 and $0.10 a share, or if you exclude stock option expensing, between $0.09 and $0.14. That also includes, by the way, approximately -- somewhere between $1 million and $1.5 million that we believe bills will come in the investigation of CKK. A little unfortunate that we have to spend that kind of money on a problem that did not cost us that kind of money.

We remained confident in our product; the engineering team, the sales team -- things are clicking in most of the parts of the Company. We're still suffering from the organizational issues in the sales department, but those are being cleared up. And with Chris back in the saddle, and I spoke to him today, things are going to look much better in Q4.

We have confidence in the Company, and we have purchased in Q2 $30 million of our stock -- about 1.3 million shares. I guess we should have held on that; we could have gotten better deal had we bought it today. Our average price was $23.

Okay, that's it for my prepared remarks. And some of my unprepared remarks. And I will open up the conference call for your questions. Operator? Operators are standing by to take your order! (laughter)

(OPERATOR INSTRUCTIONS) Jim Ricchiuti, Needham & Co.

A question on the strategy in the distribution channel where sales still appear to be kind of weak. Bob, going forward, what is the strategy to maybe get some stronger growth in that area?

(technical difficulty) I will try to answer that question, but one second; I'm going to put this on mute. (technical difficulty)

No, I have nothing new to add, Jim, other than Chris Nelson is taking a hard look at this. And he's eager to make changes. And some changes are going to be in the works, but it hasn't been rolled out to the field yet, so it's nothing we can talk about.

Okay, let me just shift over to the automotive market and perhaps semielectronics. As you look out at Q4, I think the [compassions] in those markets get a little easier for you guys. Is that true? Is that when we really started to see the [teeth] in the downturn?

I think we started to see -- I think Q4, especially for the U.S. automotive, was about the worst that it got. And certainly, the consumer electronics factory automation was fairly low in Q4, as well.

Okay, and -- I may have missed it. I think, Bob, you had a comment about the expense associated with the investigation. What was the expense level in the current quarter that you have incurred?

In Q2, nothing that we have booked in the quarter. It was less than $100,000, I think.

Yes, and most of that, I think, was for Tums and Maalox used here. (laughter)

No, but the expense level in the current quarter -- there's nothing? I'm sorry; that's what I was asking -- the September quarter.

No, in giving the guidance, we have estimated that the costs of the investigation will be between 1 and $1.5 million.

-- which is not going to be there in Q4, obviously. That's it for me for now. Thank you.

Richard Eastman, Robert Baird.

Just as a quick follow-up to the question that you chose not to answer, is Chris Nelson overseeing North American sales, both direct and distribution?

Yes.

Okay, so he will have both?

Yes.

Okay, and just so I understand the number you had mentioned earlier, distribution sales for North America were up 3% year over year, or --?

No, they were about 3% globally. And I don't quite have the break down -- that was year over year, globally.

And then could I just explore for a second -- the semielectronics piece of the business -- can you differentiate the electronics from the semi? We have seen some of the subcontract manufacturers consolidating in Asia. Do you think that is playing into this, or is this just more end-market demand driven?

No, I think it's end-market demand. We usually -- in the prior year's Q2, we had a number of large orders for disk drives and cellphones, as the disk drives were for iPods, I believe --

He's addressing the OEM business, I think (multiple speakers)

Ask the question again -- I'm sorry, Richard.

The semi OEM -- the semielectronic OEM business and the fact that that has stepped down in the second quarter versus the first quarter; I'm curious, is that -- the sales to any of the subcontract manufacturers, the fact that they are consolidating our sales and equipment to them -- has that impacted you? Or is it strictly demand has fallen off? Do you follow my question?

Yes, I do, and my sense is it's a combination.

So that would have some impact?

Yes.

And the other thing -- the metric we have been able to watch over time has been the back-end book to bill, but more importantly, the bookings number. And it has sequentially improved really since January, maybe December. And I'm wondering why we're not seeing that improvement. In fact, again, I'm looking sequentially at down number (multiple speakers) any kind of increase.

I don't have the answer for it, but that's what we're looking into also.

Okay, that's helpful. And then lastly, just on the same mindset, the same trend here, the question is, do you expect as you look out into the second half that the semi OEM business would bottom in the third quarter -- just not only seasonally, but also any visibility you might have on the fourth quarter? So should we think that that business is bottoming in Q3?

Yes, Eric Ceyrolle, who runs worldwide sales, believes there will be a slight increase in Q4, that the trend will be up in Q4 compared to Q3.

Okay, and Dr. Bob, when I look at this number stepping down like this, and I look at the back-end orders kind of increasing, and you are going to look into this. But do you sense that this is supportive of the argument that perhaps on a secular basis, our content into the back-end is declining? And are we seeing that play out here?

Yes. Now maybe not in units, but in the back-end, we're shipping more of our software-only product to customers. We used to ship hardware and software at a higher price. And now, it's software only at a lower price.

Antonio Antezano, Bear Stearns.

On the surface inspection business, you said that Q1 was exceptionally low, and there was a good recovery in Q2. What kind of run rate should we expect now going forward?

I think we should be able to expect that the -- let's see; I'm trying to look to see what we did actually (technical difficulty) [here]. In Q2 and I would guess that the run rate -- we should be at an annualized run rate of -- (multiple speakers) on an annualized basis of about a $30 million run rate for the second half.

Sorry, could you repeat?

(multiple speakers) Revenue should be at about a $30 million run rate.

-- run rate for the second half.

On new products, how should we think in terms of the ramp of new products, because you got the Checker in mid-May, and also several new products in February. And of course, it does take some time to get a full ramp up, but should we expect a much higher contribution of those new products in the second half of the year?

No.

All right. Of those new products -- I don't know that you could expand on Checker, because you said that we have a dedicated sales team for this Checker.

Yes.

That's right.

Therefore, what kind of revenue target do you have for that new version this year?

We believe Checker overall is going to deliver 8 to $10 million in revenue this year. And I don't know -- I don't have it broken out by which version of Checker.

Yes, we're still -- because even with the introduction of new 200 series, we continue -- there are still a number of applications where the customer is asking for the 100 series because they have purchased it before and like its functionality.

(OPERATOR INSTRUCTIONS) Alexander Paris, Barrington Research.

Just a couple of quick ones. The Checker 200 -- can you say about what the selling price in a reasonable volume order?

We can do that. I'll tell you what (technical difficulty) price, okay? The 201, which is a replacement for the 101, has a list price of $1,245. And the 202 has a list price of $1,445.

And the new order that you got from the In-Sight, the sizable order -- is that for the newest version?

You know, I don't have it in front of me what version of In-Sight it was. I just don't know.

63% for factory automation -- that's probably high, because electronic is down. And you have said in the past -- at one time, you said factory automation would never get below 50% again. What is it -- in a normal -- I don't know if you normalize the volatile cycle. But is it 50/50 -- what would you guess?

I'm sorry; ask the question again.

I'm just -- forward run rate, kind of normalized for the volatility of the electronics, semiconductor -- is factory automation going to continue to be over 50% of your business?

Yes, of course, even excluding the surface inspection -- excluding surface inspection.

And just one other -- you mentioned new products. Do you have any schedule for the second half that would then impact 2008 positively?

Yes, we do have new products. But I have been instructed not to talk about them (laughter) for competitive reasons.

Just one other question -- without asking you to be an economist or anything, you have talked about tepid capital spending sentiment. I presume you're talking both about industrial and your electronic semiconductor, right? (multiple speakers) Do you sense that any of that is just kind of due to the overall concerns about credit and so forth, or are there some real fundamental reasons for that?

For example, is the capacity utilization rate in the electronics/semiconductor business such that normally, you would be expecting some orders at these levels, or --?

The decline we saw was even before the subprime mortgage debacle or issue. Other than that, you know, I'm just not a macroeconomist. I'm lucky to be a microeconomist at Cognex.

I'm just talking about what people are saying, [because] the industrial sector -- nonelectronic has been pretty decent. And this whole credit thing started because all of a sudden, the central banks decided that the world economy was growing faster than they thought. But I guess (multiple speakers)

Well, we do see growth --

(multiple speakers) is this the fundamentals of the individual end-market, or is there some sentiment there that could change suddenly?

Some of what we have seen has been a fairly substantial decline coming out of Asia in capital equipment spending in the first half of the year. That clearly was not related to subprime mortgages here in the United States. And what we have found by talking to a lot of our big customers there is that they were simply delaying capital investment. They were not making capital investments in the first half of the year. Hopefully, they would be back into the second half, and we will just have to see whether or not that plays out in Asia.

Just one other real quick question on the auto industry. Do you get any feeling of your applications with the industry that they tend to be more sensitive to the number of new models coming out as opposed to just the up-and-down of the cyclical demand?

Well, I think in the U.S., it has to do with the profitability, or the lack of profitability (multiple speakers) the manufacturers reluctant to invest. And who is investing -- who would invest in new lines when the company is for sale?

We have had, as was pointed out, we've had great results in the automotive industry. And our automotive sales in Japan have also improved. But most of that improvement is coming from selling ID products into the Japanese auto industry as opposed to Vision products.

With all of this defense spending, your ID demand must be going up since they have it mandated that significant military orders have to be marked.

There is that demand. And we're seeing a lot of customers that are looking to -- as a matter of fact that has helped our ID business quite a bit.

[Ali Ervani], AI Capital.

I'm trying to get a long-term strategic view from you, if you could, on how would get the business back to the old historic margins and the old historic growth. And looking at your own plans internally, under what kind of timeframes do you think that's possible?

Well, we are back at the historic margins. They haven't moved. The margins are in excess of 70%. And that includes -- by the way, that includes the surface inspection business, which drags the margins down to some extent. And it also includes service in both MVSD and SISD. So 72% is pretty good.

Now if you're talking about the 67%, I explained that in the earlier part of the call.

I meant more the net and operating margins.

Yes, yes -- the operating margins in my view can only go up if we increase revenue. We have -- the costs are not going to go down. But we're highly leveraged in this Company -- the P&L is highly leveraged, that if revenue goes up after certain point, the entire gross margin falls to the operating profit line.

So the way to achieve that is to -- and the greatest way to achieve that would be to increase revenue.

I think, Bob, on the last call, when you commented --

And let me expand on that. In the past, more of our business was semi OEM. Now, that business is declining. And that had very little effect on operating expenses. The same salesman who's now bringing in a $500,000 purchase were used to bring in a $3 million purchase order.

So the decline in the semi business has a major effect on that. And a pickup will have a similar positive effect when it occurs.

Sure. Just going back to your last quarterly conference call. I think on the call, you and I discussed being late a little bit to the Asian market or the Asian opportunity not being yet ready for your products, and you had expressed some optimism that that was gaining some traction. You talked about one important new customer on this call.

Could you help us appreciate what timeframe -- now that you are more involved in the business and have a good reorganization of the salesforce, what kind of timeframe will it take for you to build an Asian business that is as substantial to driving the revenue and the revenue leverage as you did in the '90s with the U.S. operations?

Okay, it's more than building the salesforce in China. The biggest opportunity that we face -- there are three opportunities for growth that we face, that we have in front of us. One is continuing to fix and get the benefits of the sales and distribution strategy of the Company.

And that is on its way, and we are going to see that, I'm quite certain, in Q4. We're going to -- hopefully, we will see a significant increase in bookings in Q4, with the changes that Eric has made in the first half of the year and now with Chris joining that team. That's the easiest thing to fix.

The second growth opportunity is factory floor in Japan, where we still don't have the right product. And I believe that product will be available in Q1 of '08, and we have been missing that.

The third area of growth, and I'm not sure which is the biggest one, is in Southeast Asia in China. And we're building that team as quickly as we can. And hiring is difficult. You may think of about 1 billion people or 10 billion people, or whatever it is -- it's not so simple to find the right people and train them and keep them. I don't know if you know that turnover is dramatic in these areas now, so it's very hard. We haven't experienced that yet. But it seems to me that if we want to end up with 10 people at the end of the week, then we have to hire 20 of them, probably.

So those are the three opportunities for growth. And we have the right product except in Japan, and we are addressing that. We know what they need. We're well on the way with that product. That's coming out of Milwaukee and Oregon operations.

And the sales is -- Eric is in charge of growing the sales team, and he's doing it. I can't tell you when we're going to do 20% net. I don't know.

So I guess the relevant questions to ask on the future conference calls would really center on your progress in China -- more important than any of them, given the volume opportunity.

No, I think all three of those.

[Ben Alexander], [Alexander Capital].

I wanted to ask you -- you mentioned different end-markets at the beginning of the call that you said were growing. I didn't have a chance to write those down. How large are these end-markets in terms of the mix of revenue that are growing, and relatively new to the Company? That's one question.

And then secondly, I wanted to know how you felt about taking advantage of the current stock price. I believe you still have quite a bit authorized -- around $42 million on your buyback authorization. And you're very flush with cash. And so how do you feel about taking advantage of the opportunity in the market?

Let me answer the first one. I will tell you one of the [business] -- I'm looking at it now from year-over-year Q2 -- our sales into pharmaceutical and medical devices increased very substantially, 52%, from $561,000 to just about $2 million in Q2 of '07.

There's substantial growth in pharmaceutical and medical devices. So I am pleased to see that we are growing, along with our perception of what the business can be. It can be quite a big larger than that.

Another area is food -- no, food and beverage is the only one that was down, by about 14%. But [as of not] -- aerospace and defense is up 19%. Consumer products is up 35%. Document processing -- we are installed in various printing equipment to make sure that the right pages go to the right people -- that was up 38%. Other industrial equipment, which is bottling equipment, perhaps, and packaging -- 23%.

And they are up with -- the subtotal went from $4.7 million to $6.1 million. So that's rather encouraging, and it's nice to see that those are direct sales from our own salesmen.

I'm little concerned that the distribution is flat year on year -- approximately $14 million. It went from 14.1 to 15.6.

Regarding the buyback, one would think that with these prices we would be out in the market buying. And we discuss these things with the Board from time to time and determine how much to buy back and when to buy it back. And we bought back how much in the past so far, the past couple of years? 80 million -- (multiple speakers) 150 million in the past two years. Okay, 150 million. And it certainly looks like -- one would think that's right thing to do.

(OPERATOR INSTRUCTIONS) Jim Ricchiuti, Needham & Co.

Yes, I was just wondering, since we're a little further into Q3 than we normally are for this call, I was wondering if there are any discernible trends that you have seen thus far in the quarter (technical difficulty) [compared] to what you might have seen in Q2?

I can't compare to Q2. But I can tell versus our forecast for this Q3, we are well on target -- we're ahead of target.

I can provide a little bit of color. On the factory automation side, it seems to be doing okay. I mean, we're seeing some of the summer slowdown or whatever, but maybe not as bad as we have seen sometimes in the past.

On the semi side, we continue to see softness there. And it's -- as I look compared to the second quarter at this point in time, it has declined further, although the rate of decline has clearly slowed down. So that might get back to the point that Q3 hopefully will be a bottoming out in that part of the business. And we should hopefully see a rebound in Q4.

And a follow-up question on the improvement that you're seeing in direct sales area. I was wondering (technical difficulty) provide additional (technical difficulty) on that in terms of this progress. Is it coming from new customers, or is it coming more so from existing customers? And have you made changes in how accounts are assigned to the direct sales force? I know you've made some -- taken some initiatives with the direct sales force. I'm just trying to understand maybe what's been contributing to the improvement?

Well, the major contribution is that direct sales force now have their own accounts. Last year, they didn't. Last year, the salesmen were directed to help distributors close business. And they had no accounts of their own.

And Bob, is it your sense that you have to (technical difficulty) to increase sales force much from these levels, or do you think they have enough capacity to really move forward into these markets that you are targeting? (multiple speakers) I know in China, you are clearly -- some of the other markets you have expanded.

That's right. In the U.S., I think there are still some open slots. We're probably going to add another region. We have three regions in the U.S., and we're likely to expand it to four regions so we can have better control and more horsepower, brain power in the field. But I don't think there are any openings now. Are there any open recs in the salesforce right now?

Oh, sure.

In the U.S., in North America?

In the U.S., I believe so. (multiple speakers)

Just a couple of places, though -- all right. Basically, we don't need any more headcount -- two or three people.

Could you give us the number of direct sales people that you had at the end Q2 and compare that to the end of Q1 -- or year-end?

Sure, I can tell you that. The total number of salespeople is 143.

Do you have it handy what it was, perhaps, at year-end?

Oddly enough, we do! (laughter) 135 -- wow, it's amazing what we can have here. Sue Conway -- I have got to tell you, it's unbelievable.

Last question, Bob -- just wondering how active you are in terms of (inaudible) [positions] and any of any potential size, and maybe specific areas you might be looking at?

Yes, that's where I'm spending a fair amount of time. And I can tell you that there is nothing of size that's on the horizon right now that's very interesting to us. We have looked at -- spent a lot of time, and there is nothing worth buying yet.

Ben Alexander, Alexander Capitol.

I wanted to ask you about the semiconductor market. You mentioned a little while ago that the average sale to that market has declined substantially because you're selling only software now versus (multiple speakers) software and hardware --

That's one of the reasons, yes.

Can you expand on what's going on in that market other than the cyclical decline?

Well, there are three possible things that are happening, and I can't tell you quite yet which one is more important. The one that we saw happening, and we know is happening, is that more and more of our customers want just our software. They don't want to buy the hardware interface that goes to a camera, because there are many companies that supply that, and various different configurations. We used to do that, and we made a strategic decision not to do that except on high-volume customers.

So we are selling more and more of what we call software only. And it ranges in price from perhaps $1,000 to $2,500, which reduces the average selling price, because we are not providing hardware. But it does help the gross margins, of course. Gross margins go up.

The second reason for the decline in cyclicality in the semiconductor and electronics assembly business. That is probably the major one.

The third reason for the decline could be -- and I can't quantify it quite yet -- loss to competition.

Alexander Paris, Barrington Research.

Just to clarify something, when you are talking about the direct sales improving and doing well because they have their own accounts, you're really just talking just about factory automation -- is that correct?

That's correct. And we believe that is the growth engine of the Company.

Certainly, the direct sales, which are only direct sales to the semiconductor electronics OEMs are not increasing.

They've always been direct, though, right?

Yes.

That's it.

Okay, well, anybody else with a final comment? Thank you very much for attending. We look forward to better times ahead. Signing off, this is Dr. Bob.

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