Cognex Corp (CGNX) 2014 Q2 法說會逐字稿

,>> Operator Good day, ladies and gentlemen, and welcome to the Cognex second quarter 2014 earnings call.

(Operator Instructions)

As a reminder, today's conference is being recorded. And now I would like to turn it over to your host, CFO Dick Morin.

Thank you and good evening everyone. Earlier tonight we issued a news release announcing Cognex's earnings for the second quarter of 2014. And we also filed our quarterly work on Form 10-Q.

For those of you who have not yet been these materials both are available on our website at www.cognex.com. They contain highly detailed information about our financial results. During tonight's call, we may use a non-GAAP financial measure, if we believe it is useful to investors or if we believe it will help investors better understand our results or business trends.

For your reference, you can see the Company's income statement as reported under GAAP in Exhibit 1 of the earnings release and a reconciliation of certain items in the income statement from GAAP to non-GAAP in Exhibit 2.

I'd like to emphasize that any forward-looking statements we made in the earnings release, or any that we may make during this call, are based upon information that we believe to be true as of today. Things often change and actual results may differ materially from those projected or anticipated. You should refer to the Company's SEC filings, including our most recent Form 10-K for a detailed list of these risk factors.

Now I'll turn the call over to Cognex's Chairman, Dr. Bob Shillman.

Thank you, Dick, and hello everyone.

I'd like to welcome each of you to our second-quarter conference call for 2014. And as you can see in the news release issued earlier today, we reported fantastic results for the second quarter with the highest revenue, net income, and earnings that we have ever reported in our 33 years of business.

Right now I'm in San Diego, the headquarters of our R&D facility and everyone else on the phone is at the Natick headquarters. For details of the quarter, I'll be soon handing the microphone over to my partner, Rob Willett, who's our President and CEO.

But before I do that, I want to remind each of you that we will not be providing any details about the major customer that we referenced in both our news release issued on April 23 and also in tonight's earnings release. We have a strict nondisclosure agreement with that customer and we intend to fully respect that agreement.

I'll now hand the mic over to Rob for his presentation and I'll be available at the end of the call to answer any questions that you might have for me.

Rob, the microphone is yours.

Thank you, Dr. Bob. Good evening, everyone.

I'm pleased to report our results for the second quarter of 2014. Revenue was a record $108.8 million, representing significant growth over both the second quarter of 2013 and the prior quarter. It was also higher than the guidance we gave investors in April.

This strong performance was driven by record revenue from the factory automation market and higher than expected revenue from semi. The quarter also benefited from some surface inspection revenue that had been deferred.

Gross margin was strong at 76%, even with our less profitable surface inspection products reporting a record quarter. Operating margin was 28% and net margin was 24%. These two important ratios showed a strong increase over both Q2 of 2013 and the prior quarter illustrating the substantial leverage that incremental revenue has in our business model.

Reported earnings for Q2 were $0.29 per share and they set a new quarterly record and were $0.07 higher than the Thomson Reuters first call consensus estimate.

Turning to the details of the quarter, factory automation revenue was $83.8 million in Q2 and accounted for 77% of total revenue. Factory automation grew 25% year on year and 12% on a sequential basis due to strong performances by both ID and vision products.

Looking at factory automation from a geographic perspective, our strong execution drove growth year on year in each region. Europe showed the largest increase in both percentage growth and absolute dollars over a sluggish year in 2013.

Accelerating growth in automotive, consumer products, food, and electronics drove factory automation revenue from Europe to a record quarterly level. Currency exchange rates also contributed somewhat to the increase.

The Americas had another strong quarter reporting a substantial increase in factory automation revenue over Q2 of 2013. Sales to customers in logistics and consumer products drove growth in the Americas over the record quarter reported a year ago.

In Q2 we saw a significant increase year on year in factory automation revenue from Asia, excluding Japan. The automotive industry was the largest contributor to growth in Asia, which demonstrates our strong progress in this high potential region.

In Japan, we continue to make progress reporting factory automation growth in the mid-single digits over Q2 of 2013 in constant currency. On a reported basis, revenue continued to be negatively impacted by a weaker yen.

Moving on, surface inspection revenue was a record $16.5 million in the second quarter and 15% of our total business. This level represents a substantial increase of 36% year on year and 72% over the prior quarter. Our surface inspection division had an outstanding revenue quarter with the metals industry accounting for most of the growth.

As expected, we were able to report revenue related to a new software release that had been deferred until final testing at customer sites. That higher revenue translated into significant operating margin expansion for surface inspection.

Revenue from the semiconductor and capital -- and electronics capital equipment market, or semi as we call it, was $8.5 million in Q2, increasing 20% year on year and 38% over Q1. This marks the first year on year and sequential increase in five quarters, which may be a signal that the market is beginning to recover from its slump.

Although this is encouraging semi represented only 8% of revenue in Q2 and is less significant -- less significant to the overall performance of Cognex.

You may notice that we invested a significant amount of working capital during Q2, which was for our major customer and is expected to result in significant revenue in Q3. We are encouraged by the relationship that's developing with this customer and we believe it will bring substantial revenue in future years.

In summary, Cognex had an outstanding quarter in Q2 and if you like that just wait until you see Q3. We expect revenue to increase by more than 50% over the record level reported tonight for Q2, due in large part to the major customer that I just referenced.

Our expected revenue range for Q3 is between $165 million and $170 million. Gross margin is expected to be in the mid-70% range, slightly lower than it has been trending in recent quarters. Operating expenses are expected to increase by approximately 25% on a sequential basis . Part of this increase is due to expenses that we expected to record in Q2, but will now occur in Q3.

During Q3 we intend to continue to invest in areas where we see opportunities for long-term growth. Some of those incremental costs are not expected to repeat in Q4. As a result, we expect that operating expenses for Q4 will be approximately 10% higher than the level reported tonight for Q2. The effective tax rate is expected to be 19%, excluding discrete tax items.

Now let's open up the call for your questions. Operator, we are ready to take questions.

(Operator Instructions)

Jim Ricchiuti, Needham & Company.

Hi, good afternoon.

I was wondering if you can help us with the amount of SISD deferred revenue. Is it possible for you to provide that number just so we know what the business might have grown ex that?

Well, part of the problem is that every quarter SISD has deferred revenues for different reasons or whatever. And we don't intend to get into the discussion of any deferred revenue for that specific reason.

Is it fair to say that the SISD business ex that though was again -- you guys have talked about what you think the growth rate for that business is. I'm just trying to get a sense if there was anything unusual in addition to that deferred revenue component that drove the growth in the business.

The business did grow during the quarter. It benefited from two things. It benefited from basic growth and also from some of that deferred revenue that we had talked about relative to getting the software release tested in actual real word conditions.

Got it.

The factory automation business clearly grew at a much faster rate. Both I think -- at least what I was expecting in North America and Europe. Rob, you highlighted some of the areas that contributed to the growth in Europe.

Is there any reason to think that some of the drivers that you saw and I don't know if you can elaborate on maybe the growth also in the US portion of the factory automation business -- what contributed to that? And is there any reason to think that wouldn't continue to be the case in Q3?

I think we're seeing a lot of broad growth across different markets certainly we're seeing strength in some of the markets I referenced, notably logistics and consumer products.

But a lot of the new markets that we're starting to -- where vision is starting to get traction I think we see continued growth and good prospects in those markets that you've referenced. But I would point out that we traditionally see a slowdown in Europe in the third quarter due to just the cyclicality and the summer vacation periods over there. And we do expect that to happen again this year.

You've been seeing that in the US to some extent as well, do you anticipate that as well in the US?

No. Not to the same degree at all and we really haven't been seeing that kind of slowdown in the US market.

Okay. Thanks for clarifying that. I'll jump back in the queue.

Ben Rose, Battle Road Research.

Good afternoon.

With regard to the revenue mix thinking about the third quarter. Services revenue hasn't traditionally been a significant portion of the Company's revenue, but could we expect that to uptick considerably in the current quarter?

Hey, Ben.

I think -- I think we may see some growth in service revenue but I don't think substantially in the quarter. Dick, would you like to comment?

In answering your question. There will be substantial growth in service revenue Q3 over Q2. If you take a look at the percentage of service revenue to the total revenue when we're looking at a revenue range of getting up to $165 million to $170 million.

Most of that revenue growth in fact is going to come from FA product revenue, as opposed to service revenue. But service revenue will clearly increase fairly substantially over Q2.

Okay. Thank you.

And then Rob, I know in the first quarter you had referenced some seasonal factors that would impact growth in China -- that had impacted growth in China in the first quarter. As you look out to the second part of the year, are you seeing some normalization or pick up in demand in that country in particular?

Ben we're really talking more about Asia overall in China. But business activity in Asia picked up as expected during Q2. Factory automation revenue from Asia was at a record level, led by growth in automotive and consumer electronics. We would expect that kind of trend to continue in Q3, where we would normally expect revenue to be seasonally high in Asia and we see no reason to expect anything different this year.

So I think what we saw was what we expected. A soft Q1, which we've seen and I think many companies in similar in similar industries see around Q1 in Asia and particularly in China, Chinese New Year. And then a strong rebound in Q2 and Q3. So, I think we expect the same this year.

Okay. Thanks very much.

Richard Eastman, Robert W Baird & Company.

Good afternoon.

Robert could you just speak -- I just want to double back on Asia Pac, the suggestion is very good growth. And you had mentioned auto as part of Asia Pac. I presume -- is the auto piece of that in China? Same with the consumer electronics? I mean was their growth -- if you take China out of Asia Pac, how was the growth than?

So I think we saw a strong return to growth in Q2 in Asia, as I said. And automotive is certainly -- it's Cognex's largest end-user market. It's one where traditionally the market in China and in Asia has been smaller, but where there's a lot of growth. And certainly we expected that and we saw it and we keep seeing it.

Okay. And then it was noted in the press release that the revenue for this large customer increased about 50% from $40 million to $60 million in the third quarter is the expectation.

Can you just put any color around that step up? Was that -- again more content? Is it more service related to that? I'm just curious. Is that contract expanding before we even deliver the first units?

We're very restricted in terms of what we can say about that customer. But as the relationship with them develops we're seeing more -- we've seen more business come our way. We're pleased with the way it's developing and we do expect to see substantial revenue from that customer in future years.

Again I'm trying to just be intuitive here. But we kind of have a pretty good sense of what scaling up into that magnitude but I still would think that, going forward we would have more of a product line extension type follow-up than anything of that size.

Because I think of if we were at $40 million, we're now at $60 million -- on this contract that's still related to the scale up project, I would think. Relative to a typical follow on order here, correct?

Sorry that's kind of an odd question. The typical follow on order in out years would be sizable, but not $20 million, correct?

We've never had a single -- until this order came around, we never had a single order that was $20 million, Rick. Rick, I would take us at are words, which we've crossed it carefully and with some thought.

In answer to some of the first part of your question, subsequent orders increased the total amount above our initial purchase orders. And we don't believe this is a one-time deal, rather it's the beginning of a long-term relationship with a potential for substantial revenue in future years.

Okay. Fantastic.

Dick could you just without really speaking to -- in the Q1 we're talking about SISD. Sorry, in the Q, the text in the Q suggest that virtually all of the upside or all the growth in SISD, was this deferred piece. That's just text around the description.

Could you just explain or just remind me, when we account for the profit on the deferred revenue, is it 100%? Again we defer the revenue --

Well we defer cost as well.

Okay. So it would be at more of a typical profit -- would be the deferred profit contribution as well, profit margin?

What we do whenever -- for whatever reason, whether it's at SISD or MVSD, when we defer revenue we also defer the costs. And if you take a look at the balance sheet that's in Exhibit 3 of the press release, you will see that other assets at year end I think were $42 million right now there are around $59 million.

And that includes a lot of the deferred cost relative to all of the contracts that we have deferred revenue on.

I see. All right. I can make some assumptions from there. Great.

Maybe just if Dr. Bob's on -- could you just give us a little bit of an update or could you please give us a little bit of an update on any kind of acquisition pipeline? Is there anything out there that you're exploring?

Hi, Rick.

Unfortunately -- we are exploring but unfortunately we have not found any candidates that meet our exceptionally high standards for potential profit or technology or market share or culture. So we continue to search for this.

We have 1.5 people full time searching not only on websites but going to trade shows, looking for interesting acquisitions. Because now would be a great time to add more bench strength, more technology, more markets, more new products to our salesmen's bags. But to answer your question there is nothing that is on the front burner.

Okay. Great. Thanks so much. Very nice quarter.

Thank you.

Jeremie Capron.

Good evening. Bob, Rob and Dick and congratulations on this outstanding growth that you delivered again.

I wanted to follow-up on Rich's question regarding the large customer order and how we should think about how that will affect or even distort your growth profile going into next year. Do you still expect that we'll see substantial revenue growth in 2015 given the high base that you're establishing here?

Hey, Jeremie. I think it's a little early to talk about 2015 at this point.

What I would repeat is we don't believe this is a one-time deal, rather it's the beginning of a long-term relationship with this customer that has the potential of a substantial revenue in future years.

On top of that I would say, we do expect currently to grow the top line of Cognex next year.

Okay. Great.

And could you give us a little more color on the long-term investments that you've talked about for the next couple of quarters. Any specific targets here or areas of investment in particular?

[Generally] speaking we're very excited about the opportunities we see for Cognex and for vision in general. We're investing behind those opportunities in general. They're in new product development so we're picking up the pace in terms of our R&D efforts and our investments in technology and in sales channel.

We're certainly adding a significant number of salespeople to Cognex currently. Particularly in ID and particularly in markets where we see a strength, such as logistics. In general we're investing in growth opportunities.

Okay. And as for the gross margin going into Q3 -- you called out somewhat of a decline compared to previous quarters and should we think that this is related to that large customers order?

Well the downward pressure comes from the mix in the business that we expect to see in Q3. So it's not necessarily one specific thing.

We will expect another strong surface inspection quarter. But there are a number of different factors that will result in that slightly lower than recent quarters reported gross margin.

Okay. And maybe finally on the ID product line -- what sort of growth are you seeing right now, here?

I know you don't want to disclose the details anymore, but just to get some color here in terms of whether the business is growing in line with your earlier targets of 30% per annum.

What we said is the ID products grew in excess of 30% in 2013. We're seeing strong continued growth in ID.

Logistics is part of ID and that's certainly a very high-performing part of our business. We're very -- we're pleased and we continue to invest behind growth.

ID Products are our leading performer and an important focus for Cognex. And we have growing momentum in the ID market where we are gaining share. So from a geographic perspective, ID products have the strongest momentum in the Americas, currently.

And we've also been launching a number of new products into that market, notably the DataMan 8050, which expands the market we serve for hand-held readers to lower price points and more broadly in the market.

So -- and the market for ID Products we size at about $900 million. So our share in that market is not much more than 10% currently. So we still think we have a lot of headroom to keep growing at that 30% rate or more for a number of years.

Excellent. All right. I'll jump back in the queue. Thank you.

Thank you.

Holden Lewis, BB&T Capital Markets.

Thank you good evening.

Could you just let us know, was there -- what was the effect of the single large order in Q2, either on revenue or cost? And then what was sort of the expected impact in Q4? Do any of the revenues carry into Q4? Are there costs that carry over into Q4? How do we view that in sort of the [book end] quarters?

Not significant in Q2. I think it's too early to comment on Q4, but we don't anticipate it to the particular significant in Q4 either, currently.

Okay. Excellent.

So the growth that you saw obviously the upside surprise that you saw in Q2 to revenue, that's all market based? Can you comment on what market you are seeing that are strong versus weak if there's any way to characterize those, broadly?

So we saw strong performance from factory automation during Q2 and that was well above our 20% growth target. We saw particular strength really across a broad range of markets. Logistics, as you would expect. Consumer products, markets like use of diapers, tobacco products, toys where we're seeing certainly strong adoption of machine vision in markets.

And some of those markets where machine vision is perhaps starting to reach production lines in large degree for the first time. So we're certainly seeing that. We saw good strength in automotive in the quarter. Slightly below our overall factory automation growth rate, but still very strong and very sizable for us.

So, I would say that the growth was pretty broad based, Holden.

Okay. On sort of the operating percentage you talked about investing in new products, investing in personnel. That of course I think that is pretty boilerplate.

My impression was that you were sort of coming off a period of what usually high spend and you were in sort of in farm mode. So I'm looking at Q2, which is primarily operational, doesn't have a lot of this sort of discreet order event in it. And you're already kind of at a 28% operating margin, which in recent years has marked a peak.

Are you at the point where you think you have to rekindle more aggressive spend and therefore this type of margin, Q3 aside, is still something we should view as a peak? Or are you comfortable with the idea that 28% is not a peak and you can probably go north of 30%, based on the investments you've already got in the book and the growth that you're seeing?

We invest in the business where we see opportunity. And right now we see lots of opportunity, both in the near and long term. So we're investing behind our great technology and our leading sales channel in order to achieve that.

Operating margins were very strong at 28% in Q2. We saw a significant expansion, both year on year and sequentially, due to the substantial leverage that we have in our business model.

I would say there is room for expansion above the 28% operating margin reported Q2. But we really keep our eye on the long-term and we don't plan to shy away from investing. We're really very pleased by the kind of growth and the opportunities we see and the response in the market to our products and to our sales force.

And the way we're improving both of those. And we're going to go on investing for growth. I think there's potential for margins to move higher, but not necessarily always consistently. Because we're going to go on investing with a long-term future of Cognex in mind.

Okay. All right. Thank you.

(Operator Instructions)

Jim Ricchiuti, Needham & Company.

Rob, you mentioned that ID was a particular driver in the Americas and the performance in the quarter. Is that true of logistics as well? Was logistics the -- a major driver of the growth in the ID business in the Americas in the quarter?

Our ID business is growing very well overall. But logistics is making substantial contributions to it and we're seeing outstanding growth in logistics. Particularly in the Americas, where we're really getting great traction in our logistics business. But also now increasingly in Europe.

Can you give us a sense of the growth that you're seeing in ID and probably more so in logistics? Is it a case of -- it sounds like it's a case of market share gain. Is that a fair way to characterize it? The market's not that healthy, right?

You're absolutely right. It's a $900 million market that's probably growing in the mid-single digits and we're growing -- we're expecting to and achieving 30% growth. We have disruptive technology. It's just the best barcode reading technology in the world.

We're investing heavily behind it and taking and a lot of market share. We've been doing that for quite a few years. And we're going to go on doing it, expanding into new adjacencies like logistics, and continuing to drive growth in that core ID market.

And within logistics can you say whether the share gains -- the growth that you're seeing in that market, is uniformly across the market? And by that I mean both large customers, as well as potential small customers -- smaller customers.

We're certainly selling to large and medium-sized customers in the logistics market.

Yes I think -- I would say the most savvy consumers of logistics barcode reading technology recognize the performance of our products and are adopting them. And there are integrators too that serve the midsize customers in that market.

I wouldn't say we're -- we're selling a lot of that business to small onesie-twosie customers. It's more to the mid and large customers, I would say at this time.

That's actually what I meant. I'm thinking in terms of retail. Distribution centers -- are you seeing traction in maybe the large or mid-sized retailers, if you will, where you're gaining ground there?

We know there have been some very large orders and presumably with some very marquee type customers. But -- at the medium-size retail customer, maybe distribution center, are you making inroads in there as well?

Yes, we're definitely -- if I look at the customer lists and our pipeline, were saying lots of mid-sized retail companies, the kind of companies, whose names you see at the mall. I would also add that we have strong and growing pipeline of ID products, the logistics that include, not only well-known retailer's, but package delivery companies and postal accounts.

Those are the three pillars of the logistics market, retailers, package delivery companies and postal accounts. And the funnel is developing nicely with all those three types of prospects.

And one final question and I'll jump back in the queue. You alluded to obviously the size of the order with this large customer. But in general order sizes -- it appears that some of the orders have been growing for Cognex over the past year, 1.5 years.

Just looking at what you're seeing in the market, for instance, is there something unique about the orders that you're getting of late that are perhaps going to make it challenging to maybe go to other verticals and be able to or even with the same verticals, be able to generate orders? Not necessarily of the size you just announced, but just larger orders in general?

So I would say over the last couple of years we've seen some larger customers emerge for Cognex. Obviously the major one we've been referencing, but also quite a few larger customers in areas like logistics, specifically.

I would say we see the markets emerging in these areas and are what we can do for those markets. And we're building teams of people and products to serve those markets. That is driving some of our investment, obviously.

I would say nothing we've seen to date is overly problematic, but it's a matter of building that capability and understanding those markets and building our reputation in those markets. Because obviously very large customers don't -- they don't give huge amounts of business just immediately.

There's a lot of trials that go on and a lot of requirements. I think we're doing a nice job of building our capabilities to serve that. I'm not talking specifically about any one customer, but quite a few customers that we're starting to work with now, who have the potential to be very sizable for us in the future years.

Okay. Thanks for a much. Congratulations on the quarter.

Thank you.

Richard Eastman, Robert W Baird & Company.

Round two here.

Just two quick things. One, is I was kind of looking at the Op expense and per the commentary post the first quarter, the operating expense came in below target. And it sounds like some of that was maybe pushed into the third quarter a little bit.

But when I look at the second half of the year, we're giving up some operating leverage there. Third quarter's going to be fine because we've got a boat load of revenue coming in on this large order. But when we get out to the fourth quarter, it appears it's going to take away a little leverage out of the model in the fourth quarter. And presumably then as we roll into next year we'll we be looking for the sales gains to kind of satisfy and justify the cost investment?

Okay. I think as we look at the business we're investing behind the growth opportunities that we see in the market. Obviously, we have substantial assets and substantial capabilities behind us. We very much believe in these growth prospects.

We're going on investing behind them. And I think the growth that you've seen in this quarter and the one we expect next quarter -- say that, that's a good strategy. That said, there will be times when we're investing ahead -- we're growing expenses ahead of revenue growth.

I think we're comfortable with that because we see the long-term potential for major top line organic growth and margin expansion. That's how we're looking at it rather than trying to manage any particular quarter, on a short-term basis.

And beyond again the third quarter and the mix issue, again there's no it reason that our gross margins don't continue to maybe drift higher with the new products once we get beyond this large order?

Yes. I think -- I think we've reported some pretty nice gross margins in the last few quarters. And we've kind of highlighted some mix issues and other issues that may hit us in the third quarter.

But I would say in the long run -- in the long run we do expect to keep reporting margins in the mid-70s -- mid-70% range.

Sure. One last question Rob. On the logistics business in general, it sounds like again we're just maintaining excellent traction we have there.

Has there been any shift -- as you've rolled out the ID product targeting logistics with some of these new products that we've seen at some of the trade shows. Has there been a shift in your ability to sell more of that product through the indirect channel, the systems integrator channel?

We've been in the logistics market for about a couple of years now and I think we've been learning a lot, as we've moved forward.

I think initially we thought we could rely on integrators and third-parties to sell the product. We then realized we really needed to get the major players and end-users in the market to recognize our technology. And when we did that we started to see real traction. That's when you started to see real traction about a year ago.

And I think now that we had that traction and that recognition and the recognition from the industry in general that we have superior products, now we're able to get integrators to really take on the sale of our products more themselves. And that then takes us more broadly in the market.

So I think it begins with the big end users and the big influencer's and some of the big integrators and then it builds from there. And I think that's kind of where we are in the evolution right now.

I see. Okay. Thanks so much.

Jeremie Capron.

Thank you.

Can you talk a little bit about Japan? I think there were some concerns that the VAT hike over there could maybe depress the market a little bit in Q2. Obviously you've grown nicely there. So what are you seeing in Japan? And maybe give us an update on your relationship with Mitsubishi over there.

Sure. Yes, Jeremie.

We didn't see a notable impact from the VAT thing. We thought we might. We studied it very carefully, but didn't see a big pulling forward or change in order patent around that event.

Our business in Japan has performed better in recent quarters -- the recent quarter has quite a lot to do with the semi market where we're seeing a large improvement. And in fact improvement in semi, Japan is probably the leader in what we're seeing there.

Our FA business, our factory automation business in Japan it's -- I would say it's building strength and capability, but there's a couple particularly one very strong local competitor in Japan and our market share is still relatively small.

You asked about Mitsubishi. We continue to see sales through the Mitsubishi channel and some growth through our relationship with them. Our relationship with Mitsubishi continues to go very well and both firms are firmly committed to its success.

They certainly give us significant additional reach into the Japanese market. And it's a relationship that been building over now more than four years and continues to grow.

Okay. And speaking of Japan. Your Japanese competitor also reported pretty impressive growth in the US. In Q2 I think over 50%. Is it the case that you see them more than before in your core factory automation market here in the US?

Well you're referencing a competitor KEYENCE. And I think KEYENCE's business is much more broad than Cognex is. So I'd caution against drawing conclusions about their results, specifically into our part of the market. Maybe we only compete a head-to-head within 10% of their business.

But what I would say is, yes, I would say both Cognex and KEYENCE are investing in these markets. We clearly both see the opportunity for growth and are executing on it.

Clearly we're the market leader in vision and industrial ID in the Americas and in Europe. They are clearly the market leader in Japan and we're head-to-head in the Japanese market.

Okay.

And finally a question on capital allocation. There's now almost $0.5 billion of cash and investments on the balance sheet. And even with the increase in the investment intensity that we've seen in the past two years or so, the business is still generating a lot of cash. To the point that the balance sheet is starting to look over capitalized. And return to equity sort of capped that cash.

So what's the thinking in terms of what will be an appropriate cash level and how to get there going forward?

We really haven't set any specific cash level targets. Our primary goal would be to use cash for acquisitions. And the availability of our cash provides us with good firepower any particular acquisition that we might have.

It was also a good benefit to us in this past quarter in that we were able to invest in all of the working capital needs that we had to satisfy the major customer contract that will be revenue here in Q3. So we don't have any particular targets.

But as Dr. Bob mentioned earlier, there's nothing really on the acquisition front at this point. But we continue to be in the market buying back Company shares.

This is Dr. Bob. I just want to expand a bit on that. There is certainly no upper limit as to how much cash we have or want to have.

Cash is just a positive result and a measure of how effective we are at running a growing Company. And we're very proud of the cash that we have. The best use of cash is of course would be, as Dick just alluded to, to buy -- to do acquisitions and we would like to do acquisitions. And if -- if we find them, we've done them. We've done about 13 to date.

The next good use of cash, and I don't know if it's in direct order, but is to buy stock back. As you know, as most Cognex shareholders know, we believe in the value and the power of stock options. And we understand that some shareholders leave that they are dilutive to earnings and in respect to that -- with respect to that we are using cash to buy back stock to compensate for any possible dilution.

The third use of cash that we have used it for, is to reward our shareholders with dividends. And we did such about two years ago. We paid two years of dividends in advance. And I can tell you that at every Board meeting we discussed whether or not to restart that. I can't predict when or if we well, but that's another good use of cash.

So it is not something that worries us. It's something that we are very happy to have and are very happy if we just accumulate it.

All right. Thanks for a much.

You're welcome.

(Operator Instructions)

Holden Lewis, BB&T Capital Markets.

Thanks again.

A couple things first you talked a lot about logistics, I think we get the sense of that. But are there any updates, traction anything that we can talk about on some of your other big cost initiatives? The [image] engine, the 3-D side, anything to report there in terms of progress, customer traction, anything of that sort?

Yes, so those two new markets that you referenced the displacement sensor 3-D market is moving along well for us. The business is still small but we've -- we're in many trials and our product is performing well. And we're very optimistic about what that product can do for us in the long term.

It's not going to make much of a contribution to this year's revenue, a few million dollars possibly. But I think the next year we do expect some growth contribution to start coming from that product. Similar in some ways the image engine business.

As I've referred to many times, this is a business where we're targeting the life science market and the name of the game at this point is design wins. We now have several design wins with large manufacturers of OEM equipment. And some of this equipment is in the final development stage with production units expected to ship next year.

So that's the $100 million market. Our share is very small today. But as these machines from large suppliers start to come out into the market, we think it's going to be a nice stable and growing source of revenue for Cognex.

When I joined the Company and a lot of people ask me, hey, does Cognex have any consumables revenue? I'd come from an industry where we use to sell printers and ink, and the answer was, no. But I'd like to figure out how to get consumables revenue.

I think these image engines are about the nearest thing to consumables revenue where essentially every time a large customer sells a piece of machinery, we can sell a number of these image engines over what should be a 7 to 12 year life of that product.

Since these customers are FDA regulated, most of the time there's very little change that goes on to those machines. We continue to see it as a very good source of stable revenue for us in future years. And the traction is on schedule, I would say.

So this year we've had a lot of contribution from logistics. We still feel like next year you're going to begin to fold in meaningful revenue from these two new products.

Perhaps as the comps get harder for logistics these things begin to kick. So we can sort of think about that in terms of how this thing sort of pulses through your results?

Yes, I think you'll see the beginning of it turning to come next year, yes. I think -- if you think of it's an S-curve, I still think it's pretty low down on the S-curve and we'll start to see it ramp possibly a little bit next year but I would think more in outer years.

Okay. And I just wanted ask a question -- if you sort of take your order for this quarter over the third quarter, which is going to be $60 million plus and you look at your guidance. Is it possible, just thinking about sort of the sequential change that you're looking at a Q3 revenue stream that is below the Q2 revenue stream?

In a market, which seems like it's strong maybe getting stronger where you're seeing increasing contribution from new products. Should we read anything into the potential of a sequential decline in revenues from Q2, Q3? Or is there's am rational explanation for why you have a sequential step down?

No I wouldn't read anything into it. The sequential increase in factory automation, excluding the large customer, is harder to predict given the softness we see, particularly in Europe during the summer months. I think that's the key thing.

I think -- I would encourage you to look at it more year on year. And if you look at last year I think you should see significant growth in the base business, excluding the large customer. Certainly. And yes -- and then of course surface vision had a strong second-quarter again, which is unlikely to increase in Q3.

Okay. Great. Thank you.

I'm showing no further questions in the queue at this time. I'd like to turn the call back to Dr. Bob Shillman for closing remarks.

Yes. Thank you. It's a simple thing to wrap up.

We reported outstanding results tonight for the second quarter and we expect to deliver even more spectacular results to Q3 with another record-breaking quarter for revenue, net income in earnings. And I look forward to reporting on that, with the team, next quarter at about this time.

Thank you very much for your continued interest in Cognex and for joining us tonight.

Ladies and gentlemen this does conclude your conference. You may now disconnect and have a great day.