Good day ladies and gentlemen and welcome to the Cognex Third Quarter 2014 Earnings Call. At this time, all participants will be in a listen-only mode, but later there will be a chance to ask questions, and instructions will be given at that time. (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 today, we issued a news release announcing Cognex's earnings for third quarter of 2014 and we also filed our quarterly report on Form 10-Q. For those of you who have not yet seen these materials, both are available on our web site 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 that it will help investors better understand our results or business trends. For your reference, you can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit II of the earnings release and the Form 10-Q. 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.

Hey thanks Dick and hello everyone. Welcome to our third quarter conference call for 2014, and as you can see in the news release that we just issued today, it was a spectacular, spectacular third quarter, it's our best quarter ever, driven by revenue growth of 87% over the prior year's third quarter. Right now, I am at our R&D office in San Diego, everyone else on the call is in Natick at the headquarters. For details of the quarter in a moment, I am going to hand the microphone over to my partner Rob Willett, our President and CEO. I will be available at the end of the call to answer any questions that you may have for me. But before I hand the microphone over to Rob, I want to remind each of you that we are not providing any details about the large customer that we referenced in today's earnings release, beyond what's in that release. We have a strict non disclosure agreement with that customer, and we intend to fully stand by that agreement. Having said that, the microphone is now yours Rob.

Thank you, Dr. Bob, good evening everyone. I am pleased to report that Cognex achieved the highest quarterly revenue, net income and earning that had ever been recorded in our 33 years of business. Revenue was a record $169 million, representing substantial growth over both the third quarter of 2013 and the prior quarter. This strong performance was driven by record revenue from the factory automation market, and includes $65 million of revenue from a single customer. Gross margin was 74%, slightly lower than in recent quarters, volume pricing and services in support of our largest customer were somewhat dilutive to our overall margin. Operating margin expanded to 35% and net margin to 30%, both represent significant increases year-on-year and sequentially, reflecting the substantial efforts that incremental revenue has on our business model. We delivered earnings of $0.57 per share, setting a new quarterly record that is almost double the prior record of $0.29 per share set just last quarter. Turning to the details of the quarter, factory automation revenue was a record $146 million, which is a dramatic increase both year-on-year and sequentially. We were pleased to see an already strong quarter, but factory automation may [ph] even better by the $65 million of revenue from our largest customer. Let's now look at factory automation excluding that customer; revenue increased 18% year-on-year with growth in each major geographic region. Asia, excluding Japan was our best performing region in terms of percentage growth, increasing 30% year-on-year. Growth was led by China, where we continued our strong progress in the broad automation market. In the Americas and Europe, factory automation revenue grew in the mid-teens over Q3 of 2013, strong performance across several industries including automotive, logistics, consumer products and food drove factory automation growth in these two regions. In Japan,…

(Operator Instructions). So we will take our first question from Ben Rose from Battle Road Research. Please go ahead, sir.

Good afternoon. Question for Rob and question for Dick. For Rob, with regard to Europe, there has been some rumbling from some vendors in the space that Europe looks to be slowing down a bit. I know that you noted currency impact potentially in Q4 and just wanted to see if there was anything else going on, and then a follow-up question for Dick?

Yeah, hi Ben.

Hi.

So yes, we see a lot of good automation projects in the funnel and our European sales team is quite bullish. But we do see the recent strengthening of the dollar having the largest impact on our results, so our revenue guidance for Q4 was reduced by about $3 million to account for the weakening euro and yen, both of those, relative to the U.S. dollar, but we see good pipeline of business in Q3 and in markets such as automotive, logistics, food and pharmaceuticals. Automotive is important to our business in Europe, and there we see business remaining at a high level, particularly driven by customers in Germany and Eastern Europe. So we read the things that you do, but at the moment, we are remaining pretty positive about the outlook for Cognex in Europe.

Okay, thanks. And then just a quick question for Dick. Notice in the balance sheet pretty big rise on billed receivables -- I am sorry, on billed revenue, and I would assume that it might be tied to the large customer, but in any event, is this an account that we could see decline in subsequent quarters, as that has worked out?

You're absolutely right, it is tied to the large customer, and we would expect -- while most of the increase is tied to that large customer, we have always had some unbilled revenue tied to our surface inspection business. But clearly, we would expect a fairly significant decline in that number to occur here in Q4.

Okay. Thanks very much.

Okay. Thank you. And our next question comes from Holden Lewis from Oppenheimer.

Thank you. Good afternoon. Was sort of curious about the guidance, talking about Q4 gross margin kind of coming in around the Q3 level, and I guess, when you -- obviously when you look at Q3, its easy to understand why the gross margin was down, but if you step out of Q3 and look at the prior six quarters, you were pretty consistently in that high 75%, high 76% range. Guess I am just curious why with the big order out, the gross margin is not going to return to sort of pre-big order levels?

Hi Holden. There are a few things going on there; one is, we are expecting a large surface inspection quarter and our margins in that business are more in the mid-50s, gross margins, right; so that's one aspect. The second aspect is, we do still have some service revenue related to the large customer relationship that will continue into Q4, and that will be about a few million dollars. So those are the main factors that again dilute the gross margin; I would suggest you, on a temporary basis in Q4.

Okay. So when we think about -- I know you don't forecast obviously 2015 quarter or anything, but conceptually, we should think about entering 2015 kind of in the same level of gross margin as we had seen previous to the order? I mean, they will be all cleared out by that point?

Well, we say we expect gross margin in the mid 70s. We have reported some very high gross margins in the first half of this year, but I don't think the margin profile of Cognex is changing particularly, what may change you know is the mix of business related to how much spending is there, which is generally high gross margin, how much surface inspection is in the mix of any quarter, and then how much large customer business, where we may be getting larger discounts or having more service related to it. So those factors are all [indiscernible] too soon to say the mix we are going to see going into next year. But broadly, I think our long term guidance of mid-70s still applies.

Okay. Thank you.

Thank you. And our next question is coming from Jim Ricchiuti from Needham and Company.

Hi. Thanks. Good afternoon. Rob, I wonder if you can comment a little bit about the ID products business. Is the growth that you're seeing in that market consistent with what you've seen in the past, and I think you've talked in the past about 30% or so growth?

Yeah, hi Jim. Yes it is. We continue to perform very strongly in the ID market; our long term expectation, which we have been achieving now consistently for a number of years is 30% growth. We see that as a large market, more than $900 million of addressable market that we are serving today, and our share is still relatively small, and our products are highly advantaged. So we are certainly seeing that continue. I mean, there are some very nice things going for us, as you know in logistics, where we are really penetrating that market and that's driving growth. Also, as we have told you in the past, we did have some revenue from the large customer also in the ID space. So yes, we are seeing very strong performance from our ID business, and we don't see signs of that changing.

So you have been excluding the revenue from the large customer that did ripple into this. You're still seeing that kind of growth rate?

Correct.

And a question just regarding the overall level of demand in China, just in light of concerns folks have had about some slowing; what are you seeing in China?

Business in China is holding up very well. I am reading the same things you are. But as I said in my prepared remarks, business in Asia grew 30% year-on-year in the quarter, led by growth in China. So we see more growth than that even in China. I think what one needs to bear in mind when thinking about Cognex's business in China, there are a lot of really great fundamentals that are driving the growth of our business, you know, there is a big drive towards automation going on, where the labor costs are rising, and the number of people entering the workforce, in manufacturing jobs is declining, and products are getting smaller and harder to manufacture, and these are some fundamentals that I don't think are really being impacted by whether the gross domestic products are growing 12, nine or seven. I think they are really underlying themes that are essential for the evolution of Chinese manufacturing, and where Vision is center stage. So will slowdown in the Chinese economy reduce our growth rate? Possibly. But it doesn't change the fundamental story that we see, where we are reporting more than 30% growth in this quarter. The other thing to bear in mind though is the Chinese market, like a lot of our markets, is seasonal, generally Q2 and Q3 are very strong, Q4 ahead of, and then coming into the new year, tend to slow down ahead of Chinese New Year. So not necessarily, you're going to see that growth every quarter, that year-on-year, we are certainly very-very positive about -- despite what we are reading.

Got it. And Dick, tax rate for Q4, how should we think about tax rate?

Yeah, we think we had some discrete items in Q3, which occur as we true-up our estimated tax provision from last year compared to the tax return that's filed, and also the statute of limitations expiring. But Q4, we would expect our base tax rate to be at 19% Jim.

Okay, thanks. Congratulations on the quarter.

Thank you.

Thank you. And our next question comes from Richard Eastman from Robert W. Baird.

Just a clarification; on China, in factory automation, does the business still skew pretty heavily towards consumer electronics?

Hi Rick. Yes, the majority of our business today is still in consumer electronics, but the mix is changing, and the amount of consumer electronics proportionately is reducing and we are seeing much more diversity and breadth in our business there, particularly with automotive, ID, medical devices and others, that are of course becoming increasingly important to the mix.

Okay, okay. And then also just in terms of the residual or tail on this large customer revenue as it extends into the fourth quarter here, you mentioned that its service -- and I presume that some of the cost of that service falls interest the cost of sales line, are these people?

So it does fall in the cost of service line, yeah, and some of them are people related, whether they are [indiscernible] or people, we have retained the contractors.

Okay. And then so, as we again large project, large contract, we have had some service that extends into the fourth quarter. Any indication -- is there a tail on that business that would extend into 2015, or does the business that extends into 2015, would it be new contract business? I guess -- there isn't like a one-year service contract or something that would extend out and give us visibility into 2015 on the large project of that customer order, is there?

No Rick. I think we said a few million dollars of service support into the fourth quarter. I think we are not ready to give any guidance beyond that. But anything that would occur, wouldn't be significant.

Okay. Fair enough. And then Rob, you'd mentioned in your commentary earlier about new products and introductions, does the extension of this 3-D product line, displacement sensor, is the extension in the products that you introduce here, are they targeted at any -- a broader end market? As that product was originally targeted, I think maybe at the auto market, but does it extend the market breadth of your 3-D products?

It serves many different end user markets Rick, but generally markets that are generally served by Cognex. So large protocols would include automotive and electronics, but extend into markets like food and medical devices and such as those. Generally, the customers that are called on by our salespeople; and I think what you're asking here, does it take us into new markets, possibly, but we don't think that's going to be a significant part of where this product is going to sell over the next few years.

And is there any product strategy on the 3-D side, the sensor side, that puts you marketing that product at OEMs, in other words, more of as an embedded vision product?

Absolutely; we are seeing lots of opportunities at machine builders or as you might call, an OEM for those products, where they are embedded into the product. Yes, absolutely.

Understand. Okay, thank you.

Okay. (Operator Instructions). So our next question comes from Jeremie Capron from CLSA.

Thanks. Good afternoon. Question on the Asia business; I am trying to reconcile what you said earlier in your prepared comments; a 30% increase n revenues from that region. Yet, when I look at the Q, it seems like the bulk of the increase in revenue came through Europe, while Asia was virtually flat. So just trying to get my head around this?

Yeah. Well let me answer that Jeremie. The revenue from the single large customer, that particular customer is located in Europe and it has been our policy consistently that as we do, we report revenue by geography. We report the revenue in the geography where our customer is located. You can imagine that as we sell through system integrators or distributors, we may not know here, our equipment eventually ends up. So in the past, we have always selected what we do know, which is the geographic location of the customer that places the order. Building on that too, the results we report tonight for Asia include FA, SEMI and surface vision. For 30% number we put out that has to do with the FA business actually in Asia.

Okay. That's clear. And Rob, if you could give us an update on your situation for the ID business as it relates to logistics market, where are you in terms of trying to address the big customers in that market. Are you seeing increased penetrations across large number of different customers, or are we still fairly concentrated on -- with just a few customers?

Well no, we are making a very strong headway in that market, and we are seeing large increases with a number of customers [indiscernible]. The business is coming along strongly in the Americas, where I think we are building significant share. We are earlier in Europe, but in Europe obviously this is coming along nicely. The markets that we serve, they include postal services, courier type businesses and then retails. And we are penetrating each of those different segments quite strongly in America, starting to get into them in Europe, and we are very early on in China, but we do think China has huge potential for these products. Every quarter, we see the significant wins we are having, and there are many new famous high street names or brands appearing as customers of Cognex for the first time, as a result of this foray into logistics. And then I would also say, that if we see that market, we told you I think a year ago, it was about $250 million, its slightly larger than that now and growing, and our share is approximately 10%, and we think we have a lot further to go, thanks to some highly advantaged products.

Okay. Thanks very much.

Thank you. And I am showing just one final question coming from Holden Lewis from Oppenheimer.

Yes, hi again. Just wanted to explore I guess the 3-D displacement sort of process here a little bit. Obviously, logistics has been a big success in 2014 in terms of the growth, because you are ready to really sort of hit that market aggressively; and I guess I am wondering, 3-D displacement, I guess I assumed that that would be more of a latter part of 2015 type of story, but it sounds like you're rolling out the next generation of products. I guess I am wondering, to what degree will displacement -- 3-D displacement products be a significant element of the story throughout 2015, or are we still talking about that being more of a late 2015 event? Just trying to get a sense of the timing of that, you might as well comment on the advantage engine as well?

Yeah Holden, as we have announced today and actually launched in the last month or so; I mean, we are now in the market with highly advantaged and very, I would say easy to integrate displacement-sensing 3-D products, and that's certainly an advantage of our products; they are fast, they have a lot of high performance Cognex algorithms operating inside them, but they are also factory calibrated, which means they are a lot easier to set up and implement than most of the other products in the market today. So we are out there. We are able to manufacture them in quantity, and our salesforce is well equipped with internal equipment to go out there, and we have a large funnel of business building. So certainly, I would expect us to sell quite a few million dollars in the back end of this year and the funnel building into next year. So in terms of the arc of our business, it may be similar to what we have seen in logistics over the next couple of years, and I don't think it’s the second half of 2015 story, I think it’s a story that should build sequentially as we move through the year.

Okay. And any comment on where we are with the advantage engine?

Yep. So yes the advantage engine, bit of a different kind of customer dynamic there, which I have less spoken about in the past, which is -- the market there is for life-science equipment builder. They generally have about a three year cycle, in which we get designed in, and then a eight to 12 year product life. So this is a long game, but when we get specked in [ph], we may be seeing thousands of units bought and adopted into large machine build of products for eight to 12 years, and the price of those maybe for a few hundred dollars, but if they are buying thousands of units per year, it will be substantial. Where are we in that process? We have had some design wins that we are recording. We are looking -- we are expecting more in the coming quarters. I think the revenue contribution next year will still be small, we are still pretty early on, on that kind of S-curve that exists in that market. But I think its going to be a very important part of Cognex's business overall, if we look two or three years out.

Okay. And on 3-D displacement, does your work in logistics streamline your ability to get with customers? Are they similar customers, the same customers, has that groundwork been done from a marketing standpoint?

Generally, the displacement sensing products are going to get sourced into our core factory automation business markets, so automotive, electronics, medical devices, food, beverage, markets such as that. The logistics market is different in that way, and although there are some applications for displacement sensing and logistics, that's not going to be a big part of the story for us, certainly not next year.

Okay, great. Thank you.

Okay. Thank you. (Operator Instructions). Okay, I am showing no further questions. So I would like to turn it back to Dr. Bob Shillman for any closing remarks

Cal, thank you very much for assisting in this call by the way, good job. Well it’s a simple thing to wrap up. We are a best quarter in the company's 33 year history. I don't know how long that record is going to hold, but I think there is a pretty good chance we may beat it next year. At any rate, I want to thank all of you for attending the call and the team at Cognex, starting from sales, marketing, engineering, finance, service, just did a spectacular job under Rob's guidance. We look forward to speaking with you again on our next quarter's call, at which time we will report our year-end results. Thank you again for joining us tonight.