Cognex - 10-Q quarterly report FY

 

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ                      No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ                      No o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o                      No þ

     As of October 28, 2005, there were 47,298,147 shares of Common Stock, $.002 par value, of the registrant outstanding.

 

 

CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

The accompanying notes are an integral part of these consolidated condensed financial statements.

CONSOLIDATED BALANCE SHEETS
(In thousands)

The accompanying notes are an integral part of these consolidated condensed financial statements.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(In thousands)

The accompanying notes are an integral part of these consolidated condensed financial statements.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)

The accompanying notes are an integral part of these consolidated condensed financial statements.

As permitted by the rules of the Securities and Exchange Commission applicable to Quarterly Reports on Form 10-Q, these notes are condensed and do not contain all disclosures required by generally accepted accounting principles. Reference should be made to the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

In the opinion of the management of Cognex Corporation, the accompanying condensed consolidated unaudited financial statements contain all adjustments, which are of a normal and recurring nature, necessary to present fairly the Company’s financial position at October 2, 2005, and the results of its operations for the three-month and nine-month periods ended October 2, 2005 and October 3, 2004, and changes in shareholders’ equity and cash flows for the periods presented.

The results disclosed in the Consolidated Statements of Operations for the three-month and nine-month periods ended October 2, 2005 are not necessarily indicative of the results to be expected for the full year. Certain amounts reported in prior periods have been reclassified to be consistent with the current period presentation.

The Company recognizes compensation costs using the intrinsic value based method described in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Net income and net income per share as reported in these consolidated financial statements and on a pro forma basis, as if the fair value based method described in Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” had been adopted, are as follows (in thousands):

For the purpose of providing pro forma disclosures, the fair values of stock options granted were estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions:

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123R, “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123R requires companies to recognize compensation cost for all share-based payments to employees (including stock option and employee stock purchase plans) at fair value. SFAS No. 123R will be effective for public companies no later than the beginning of the first fiscal year after June 15, 2005. The Company will adopt SFAS No. 123R beginning in the first quarter of 2006 using the modified prospective method in which compensation cost is recognized beginning on the effective date.

The Company currently recognizes compensation costs using the intrinsic value based method and, as such, generally recognizes no compensation cost. Accordingly, the adoption of SFAS No. 123R’s fair value based method will have a significant impact on the Company’s results of operations, although it will have no impact on its overall financial position. The impact of the adoption of SFAS No. 123R will depend upon levels of share-based payments granted in the future. Had the Company adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and net income per share in Note 1 to the Company’s consolidated financial statements.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an Amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4.” SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing” to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current-period charges. In addition, SFAS No. 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005. The Company has adopted the provisions of SFAS No. 151 and its adoption did not have a material impact on the Company’s financial condition, results of operations, or cash flows.

In October 2004, the American Jobs Creation Act of 2004 (the “AJCA”) was passed. The AJCA provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. The AJCA also provides for a two-year phase-out of the existing extra-territorial income exclusion for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production.

Activities Provided by the American Jobs Creation Act of 2004.” FSP No. 109-1 treats the deduction as a “special deduction” as described in SFAS No. 109. This special deduction has no effect on deferred tax assets and liabilities existing at the enactment date and the effect of this deduction will be reported in the same period in which the deduction is claimed in the Company’s tax return.

The AJCA also creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. This deduction is subject to a number of limitations. Whether the Company will ultimately take advantage of this provision depends upon a number of factors, including reviewing future Congressional guidance. Until a decision can be made, the Company will not change its current intention to indefinitely reinvest the accumulated earnings of its foreign subsidiaries.

Cash, cash equivalents, and investments consist of the following (in thousands):

On June 30, 2000, Cognex Corporation became a Limited Partner in Venrock Associates III, L.P., (Venrock) a venture capital fund. A director of the Company is a Managing General Partner of Venrock Associates. In the original agreement with Venrock, the Company committed to a total investment in the limited partnership of up to $25,000,000 with an expiration date of January 1, 2005. In January 2005, the Company signed an amendment to the original agreement, which reduces its total commitment to $22,500,000 and extends the commitment period through December 31, 2010. The Company does not have the right to withdraw from the partnership prior to December 31, 2010.

At October 2, 2005, the carrying value of this investment was $11,575,000 compared to an estimated fair value, as determined by the General Partner, of $12,835,000.

In the fourth quarter of 2001, the Company recorded a $16,300,000 charge in “Cost of product revenue” on the Consolidated Statements of Operations for excess inventories and purchase commitments resulting from an extended slowdown in the semiconductor and electronics industries, as well as the expected transition to newer Cognex hardware platforms by the Company’s OEM customers. A total of $12,500,000 of this charge represented reserves against existing inventories and was accordingly included in “Inventories” on the Consolidated Balance Sheet at December 31, 2001. The remaining $3,800,000 of the charge represented commitments to purchase excess components and systems from various suppliers and accordingly was included in “Accrued Expenses” on the Consolidated Balance Sheet at December 31, 2001.

The following table summarizes the changes during the current year in the inventory-related reserves that were established in the fourth quarter of 2001 (in thousands):

A favorable settlement of the remaining purchase commitments may result in a recovery of a portion of the remaining $1,400,000 accrued at October 2, 2005.

Amortized intangible assets consist of the following (in thousands):

Aggregate amortization expense for the three-month and nine-month periods ended October 2, 2005 was $1,418,000 and $2,868,000, respectively, and $376,000 and $1,136,000 for the same periods in 2004.

Estimated amortization expense for the current fiscal year and succeeding fiscal years is as follows (in thousands):

The Company has two reporting units with goodwill, the Modular Vision Systems Division (MVSD) and the Surface Inspection Systems Division (SISD), which are also reportable segments.

The changes in the carrying amount of goodwill during the nine-month period ended October 2, 2005 are as follows (in thousands):

The Company warrants its hardware products to be free from defects in material and workmanship for periods ranging from six months to two years from the time of sale based upon the product being sold and the terms of the customer’s contract. Estimated warranty obligations are evaluated and recorded at the time of sale based upon historical costs to fulfill warranty obligations. Provisions may also be recorded subsequent to the time of sale whenever specific events or circumstances impacting product quality that would not have been taken into account using historical data become known. Warranty obligations are included in “Accrued expenses” on the Consolidated Balance Sheets.

     The changes in the warranty obligation are as follows (in thousands):

Except as limited by Massachusetts law, the by-laws of the Company require it to indemnify certain current or former directors, officers, and employees of the Company against expenses incurred by them in connection with each proceeding in which he or she is involved as a result of serving or having served in certain capacities. Indemnification is not available with respect to a proceeding as to which it has been adjudicated that the person did not act in good faith in the reasonable belief that the action was in the best interests of the Company. The maximum potential amount of future payments the Company could be required to make under these provisions is unlimited. The Company has never incurred significant costs related to these indemnification provisions. As a result, the Company believes the estimated fair value of these provisions is minimal.

The Company accepts standard limited indemnification provisions in the ordinary course of business, whereby it indemnifies its customers for certain direct damages incurred in connection with third-party patent or other intellectual property infringement claims with respect to the use of the Company’s products. The term of these indemnification provisions generally coincides with the customer’s use of the Company’s products. The maximum potential amount of future payments the Company could be required to make under these provisions is always subject to fixed monetary limits. The Company has never incurred significant costs to defend lawsuits or settle claims related to these indemnification provisions. As a result, the Company believes the estimated fair value of these provisions is minimal.

The Company also accepts limited indemnification provisions from time to time, whereby it indemnifies customers for certain direct damages incurred in connection with bodily injury and property damage arising from the installation of the Company’s products. The term of these indemnification provisions generally coincides with the period of installation. The maximum potential amount of future payments the Company could be required to make under these provisions is limited and is recoverable under the Company’s insurance policies. As a result of this coverage, and the fact that the Company has never incurred significant costs to defend lawsuits or settle claims related to these indemnification provisions, the Company believes the estimated fair value of these provisions is minimal.

On March 23, 2005, the Company provided standby letters of credit totaling 3,264,887,000 Yen (or approximately $28,760,000 based upon the exchange rate at October 2, 2005) to taxing authorities in Japan that are collateralized by investments on the Consolidated Balance Sheet. The Tokyo Regional Taxation Bureau (TRTB) has asserted that Cognex Corporation has a permanent establishment in Japan that would require certain income, previously reported on U.S. tax returns for the years ended December 31, 1997 through December 31, 2001, to be subject instead to taxation in Japan. The Company disagrees with this position and believes that this assertion is inconsistent with principles under the U.S. — Japan income tax treaty. The Company has filed a notice of objection and request for deferral of tax payment and intends to contest this assessment vigorously, although no assurances can be made that the

Company will prevail in this matter. In September 2003, the Company also filed a request with the Internal Revenue Service Tax Treaty Division for competent authority assistance. Until this matter is resolved, the Company is required to provide collateral for these tax assessments. These letters of credit expire in approximately one year. Should the TRTB prevail in its assertion, the income in question would be taxable in Japan and the Company would be required to pay approximately $28,760,000 in taxes, interest and penalties to Japanese taxing authorities. The Company would then be entitled to recoup the majority of this amount from taxing authorities in the U.S. The Company has not provided any additional accrual or reserve related to this matter.

Net income per share is calculated as follows (in thousands, except per share amounts):

Stock options to purchase 1,586,491 and 4,151,139 shares of common stock were outstanding during the three-month and nine-months periods ended October 2, 2005, respectively, and 2,524,951 and 1,100,184 for the same periods in 2004 but were not included in the calculation of diluted net income per common share because the options’ exercise prices were greater than the average market price of the Company’s common stock during those periods.

The Company has two reportable segments: the Modular Vision Systems Division (MVSD) and the Surface Inspections Systems Division (SISD). MVSD designs, develops, manufactures, and markets modular vision systems that are used to control the manufacturing of discrete items by locating, identifying, inspecting, and measuring them during the manufacturing process. SISD designs, develops, manufactures, and markets surface inspection vision systems that are used to inspect surfaces of materials that are processed in a continuous fashion to ensure there are no flaws or defects in the surfaces. Segments are determined based upon the way that management organizes its business for making operating decisions and assessing performance. The Company evaluates segment performance based upon income or loss from operations, excluding unusual items.

     The following table summarizes information about the Company’s segments (in thousands):

Reconciling items consist of unallocated corporate expenses, which primarily include corporate headquarters costs and patent infringement litigation. Asset information by segment is not produced internally for use by the chief operating decision maker, and therefore, is not presented. Asset information is not provided because the cash and investments are commingled and the divisions share assets and resources in a number of locations around the world.

On May 9, 2005, the Company acquired all of the outstanding shares of DVT Corporation, a provider of low-cost, easy-to-use vision sensors, for approximately $111,607,000, net of $4,702,000 cash acquired. The purchase price consisted of $110,346,000 in cash paid at closing (net of acquired cash) and $1,261,000 in transaction costs. The acquisition was accounted for under the purchase method of accounting. Accordingly, DVT Corporation’s results of operations have been included in the Company’s consolidated results of operations since the date of acquisition.

In recent years, the Company has expanded its product line by adding low-cost and easy-to-use vision products, such as its In-Sight and Checker products. However, reaching the many prospects for these products in factories around the world requires a large third-party distribution channel to supplement the Company’s own direct end-user sales force. During 2004, the Company started to build a third-party distribution channel and prior to this acquisition had signed over 40 distributors, primarily in North America. With the acquisition of DVT Corporation, the Company immediately gains a worldwide network of more than 150 additional distributors, all fully trained in selling and supporting machine vision products. The

Company plans to sell its low-cost, easy-to-use vision products, including the acquired DVT’s vision sensors, through these distribution networks.

The $111,607,000 purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values as follows: $7,532,000 to tangible net assets, $38,060,000 to distribution networks to be amortized over a weighted-average period of 11.6 years, $4,740,000 to customer relationships to be amortized over twelve years, $3,680,000 to completed technologies to be amortized over six years, $1,110,000 to trade names, trademarks, and non-competition agreement to be amortized over four years, $17,846,000 to deferred tax liability, and the remainder of $74,331,000 to goodwill, which is assigned to the MVSD segment. None of the acquired intangible assets, including goodwill, are deductible for tax purposes. The Company obtained third-party valuations of the acquired intangible assets. The allocation of the purchase price is subject to future refinement.

The following summarized, pro forma results of operations assume the acquisition took place at the beginning of the respective periods (in thousands, except per share amounts).

On July 21, 2005, the Company’s Board of Directors declared a cash dividend of $0.08 per share. The dividend was paid on August 19, 2005 to all shareholders of record at the close of business on August 5, 2005.

On October 28, 2005, the Company’s Board of Directors declared a cash dividend of $0.08 per share. The dividend is payable on November 25, 2005 to all shareholders of record at the close of business on November 11, 2005. Future dividends will be declared at the discretion of the Board of Directors and will depend upon such factors as the Board of Directors deems relevant. The Board of Directors may modify the Company’s dividend policy from time to time.

Certain statements made in this report, as well as oral statements made by the Company from time to time, constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Readers can identify these forward-looking statements by the Company’s use of the words “expects,” “anticipates,” “estimates,” “believes,” “projects,” “intends,” “plans,” “will,” “may,” “shall,” and similar words and other statements of a similar sense. These statements are based upon the Company’s current estimates and expectations as to prospective events and circumstances, which may or may not be in the Company’s control and as to which there can be no firm assurances given. These forward-looking statements involve known and unknown risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include: (1) global economic conditions that impact the capital spending trends of manufacturers in a variety of industries; (2) the cyclicality of the semiconductor and electronics industries; (3) the inability to achieve significant international revenue; (4) fluctuations in foreign exchange rates; (5) the loss of, or a significant curtailment of purchases by, any one or more principal customers; (6) the reliance upon certain sole-source suppliers to manufacture and deliver critical components for the Company’s products; (7) the inability to attract and retain skilled employees; (8) the inability to design and manufacture high-quality products; (9) inaccurate forecasts of customer demand; (10) the technological obsolescence of current products and the inability to develop new products; (11) the inability to protect the Company’s proprietary technology and intellectual property; (12) the Company’s involvement in time-consuming and costly litigation; (13) the impact of competitive pressures; (14) the inability to achieve expected results from acquisitions; and (15) the challenges in integrating acquired businesses. The foregoing list should not be construed as exhaustive and the Company encourages readers to refer to the detailed discussion of risk factors included in Part I — Item 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. The Company cautions readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. The Company disclaims any obligation to subsequently revise forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date such statements are made.

Cognex Corporation (the “Company”) designs, develops, manufactures, and markets machine vision systems, or computers that can “see,” which are used to automate a wide range of manufacturing processes where vision is required. The Company’s Modular Vision Systems Division (MVSD) specializes in machine vision systems that are used to automate the manufacture of discrete items, while the Company’s Surface Inspection Systems Division (SISD) specializes in machine vision systems that are used to inspect the surfaces of materials processed in a continuous fashion.

In addition to product revenue derived from the sale of machine vision systems, the Company also generates revenue by providing maintenance and support, education, consulting, and installation services to its customers. The Company’s customers can be classified into three categories: semiconductor and electronics capital equipment manufacturers, discrete manufacturing customers in the factory automation area, and surface inspection customers. Semiconductor and electronics capital equipment manufacturers purchase Cognex machine vision systems and integrate them into the capital equipment that they manufacture and then sell to their customers in the semiconductor and electronics industries that either make computer chips or make printed circuit boards containing computer chips. Although the Company sells to original equipment manufacturers (OEMs) in a number of industries, these semiconductor and electronics OEMs have historically been large consumers of the Company’s products. The discrete manufacturers in the factory automation area include a wide array of manufacturers who use machine vision for applications in a variety of industries, including the packaging, automotive, consumer electronics, food and beverage, and personal care industries. The majority of these customers are end users who purchase Cognex machine vision systems and install them directly on their production lines. The last category, surface inspection customers, includes manufacturers of materials processed in a continuous fashion, such as paper and steel.

Over the past few years, the Company has been successful in diversifying its customer base beyond semiconductor and electronics capital equipment manufacturers. Demand from these capital equipment manufacturers is highly cyclical, with periods of investment followed by temporary downturns. During the first half of 2004, the Company experienced an increase in orders from these customers that has since been curtailed. Although demand from capital equipment manufacturers has increased sequentially in each quarter of 2005, it is still well below the level experienced in the first half of 2004, resulting in a 45% decrease in sales to this sector for the nine-month period ended October 2, 2005 as compared to the prior year. Sales to discrete manufacturers in the factory automation area and surface inspection customers increased in the nine-month period ended October 2, 2005 from the prior year by 43% and 24%, respectively, which nearly offset the impact of the downturn in the semiconductor and electronics capital equipment sector.

During the nine-month period ended October 2, 2005, the Company continued to focus its spending in strategic areas that help drive revenue growth in the factory automation area. On May 9, 2005, the Company acquired DVT Corporation. This acquisition provides the Company with a worldwide network of distributors to sell its expanding line of low-cost, easy-to-use vision products to the factory automation market.

As a result of the slight decline in revenue, as well as the investment in sales and marketing activities in the factory automation area, the Company reported net income as a percentage of revenue of 15% in the nine-month period ended October 2, 2005, compared to 20% in the prior year.

Revenue for the three-month and nine-month periods ended October 2, 2005 totaled $58,256,000 and $156,057,000, respectively, compared to $55,412,000 and $158,048,000 for the same periods in 2004, representing a 5% increase for the three-month period and a 1% decrease for the nine-month period. Although sales to customers who make capital equipment for the semiconductor and electronics industries declined by 40% and 45% for the three-month and nine-month periods ended October 2, 2005, respectively, this decrease was offset by increased sales to discrete manufacturers in the factory automation area (including $7,545,000 and $13,006,000, respectively, of revenue from acquired DVT products) and higher sales to surface inspection customers. Demand from these capital equipment manufacturers is highly cyclical, with periods of investment followed by temporary downturns. During the first half of 2004, the Company experienced an increase in orders from these customers that has since been curtailed. However, sales to discrete manufacturers in the factory automation area and surface inspection customers for the three-month and nine-month periods ended October 2, 2005 increased 47% and 39%, respectively. As a result, revenue from these customers outside of the capital equipment sector represented 73% and 74% of total revenue for the three-month and nine-month periods ended October 2, 2005, respectively, compared to 52% for each of the same periods in 2004.

Product revenue for the three-month and nine-month periods ended October 2, 2005 totaled $52,634,000 and $138,688,000, respectively, compared to $48,319,000 and $138,839,000 for the same periods in 2004, representing a 9% increase for the three-month period and remaining essentially flat for the nine-month period. The increase in product revenue for the three-month period was primarily due to a higher volume of machine vision systems sold to discrete manufacturers in the factory automation area, as well as a higher volume of sales to surface inspection customers. Service revenue, which is derived from the sale of maintenance and support, education, consulting, and installation services, totaled $5,622,000 and $17,369,000 for the three-month and nine-month periods ended October 2, 2005, respectively, compared to $7,093,000 and $19,209,000 for the same periods in 2004, representing a 21% decrease for the three-month period and a 10% decrease for the nine-month period. The decrease in service revenue was due principally to lower maintenance and support revenue that is sold bundled with MVSD products, as well as lower revenue from consulting services. Service revenue represented 10% and 11% of total revenue for the three-month and nine-month periods ended October 2, 2005, respectively, compared to 13% and 12% of total revenue for the same periods in 2004.

MVSD revenue for the three-month and nine-month periods ended October 2, 2005 totaled $48,803,000 and $130,426,000, respectively, compared to $48,632,000 and $137,353,000 for the same periods in 2004, remaining essentially flat for the three-month period and decreasing 5% for the nine-month period. MVSD revenue was relatively flat in both periods, as the lower volume of systems sold to customers who make capital equipment for the semiconductor and electronics industries was offset by an increase in sales to discrete manufacturers in the factory automation area. SISD revenue for the three-month and nine-month periods ended October 2, 2005 totaled $9,453,000 and $25,631,000, respectively, compared to $6,780,000 and $20,695,000 for the same periods in 2004. The increase in SISD revenue was due principally to a higher volume of SmartViewâ system deliveries and installations. SISD revenue increased as a percentage of total revenue to 16% for both the three-month and nine-month periods ended October 2, 2005, respectively, compared to 12% and 13% for the same periods in 2004.

Gross margin as a percentage of revenue remained consistent at 73% and 71% for the three-month and nine-month periods ended October 2, 2005, respectively, compared to the same periods in 2004. The consistency of the gross margin percentage was primarily due to revenue remaining relatively flat.

Product gross margin as a percentage of revenue remained consistent at 77% and 75% for the three-month and nine-month periods ended October 2, 2005, respectively, compared to the same periods in 2004. Service gross margin as a percentage of revenue was 31% and 38% for the three-month and nine-month periods ended October 2, 2005, respectively, compared to 47% and 44% for the same periods in 2004. The decrease in service margin was due principally to lower maintenance and support revenue that is sold bundled with MVSD products.

MVSD gross margin as a percentage of revenue was 78% and 75% for the three-month and nine-month periods ended October 2, 2005, respectively, compared to 77% and 75% for the same periods in 2004. SISD gross margin as a percentage of revenue was 49% for both the three-month and nine-month periods ended October 2, 2005, respectively, compared to 42% and 45% for the same periods in 2004. The increase in SISD margin was due principally to the higher sales volume of SmartViewâsystems.

Research, development, and engineering expenses (R,D&E) for the three-month and nine-month periods ended October 2, 2005 were $7,224,000 and $20,724,000, respectively, compared to $6,552,000 and $20,105,000 for the same periods in 2004, representing a 10% increase for the three-month period and an 3% increase for the nine-month period. MVSD R,D&E expenses for the three-month and nine-month periods ended October 2, 2005 increased 11% and 3%, respectively, from the same periods in 2004 primarily due to additional engineering personnel resulting from the acquisition of DVT Corporation on May 9, 2005. SISD R,D&E expenses for the three-month and nine-month periods ended October 2, 2005 remained relatively flat compared to the same periods in 2004.

Selling, general, and administrative (S,G&A) expenses for the three-month and nine-month periods ended October 2, 2005 were $21,351,000 and $60,353,000, respectively, compared to $18,099,000 and $51,981,000 for the same periods in 2004, representing an 18% increase for the three-month period and a 16% increase for the nine-month period. MVSD S,G&A expenses for the three-month and nine-month periods ended October 2, 2005 increased 25% and 22%, respectively, while SISD S,G&A expenses were essentially flat for both periods. The increase in MVSD expenses was primarily due to investments in sales and marketing activities intended to grow the Company’s base of discrete manufacturing customers in the factory automation area, partially offset by lower company bonus accruals. The acquisition of DVT Corporation on May 9, 2005 resulted in incremental sales and marketing expenses and the amortization of acquired intangible assets. Corporate expenses that are not allocated to a division decreased 4% for the three-month period and 5% for the nine-month period due principally to lower company bonus accruals.

During the three-month and nine-month periods ended October 2, 2005, the Company recorded foreign currency losses of $410,000 and $602,000, respectively, compared to losses of $502,000 and gains of $73,000 for the same periods in 2004. The Company recognizes foreign currency gains and losses on the revaluation and settlement of accounts receivable and payable balances that are reported in one currency and collected or paid in another.

Investment and other income for the three-month and nine-month periods ended October 2, 2005 totaled $1,156,000 and $3,599,000, respectively, compared to $1,043,000 and $3,348,000 for the same periods in 2004, representing an 11% increase in the three-month period and a 7% increase in the nine-month period. The increase in investment and other income was due to higher yields on the Company’s invested balances.

The Company’s effective tax rate for the three-month and nine-month periods ended October 2, 2005 was 26% compared to 29% for the same periods in 2004. The decrease in the effective tax rate was due primarily to more of the Company’s profits being earned and taxed in lower tax jurisdictions.

At October 2, 2005, the Company’s cash, cash equivalent, and investment balances decreased $78,360,000 to $312,716,000 from $391,076,000 at December 31, 2004 due to $111,591,000 of cash payments to acquire DVT Corporation and $11,173,000 of dividend payments, partially offset by positive cash flows from operations and proceeds from the issuance of common stock under the Company’s stock option plans. The Company’s cash requirements during the nine-month period ended October 2, 2005 were met with the Company’s existing cash, cash equivalent, and investment balances, as well as positive

cash flow from operations and proceeds from the issuance of common stock under the Company’s stock option plans. Cash requirements consisted of operating activities, capital expenditures, the payment of dividends, and the purchase of DVT Corporation. Capital expenditures during the nine-month period ended October 2, 2005 totaled $2,909,000 and consisted principally of expenditures for computer hardware.

On June 30, 2000, Cognex Corporation became a Limited Partner in Venrock Associates III, L.P. (Venrock), a venture capital fund. A director of the Company is a Managing General Partner of Venrock Associates. In the original agreement with Venrock, the Company committed to a total investment in the limited partnership of up to $25,000,000, with the commitment period expiring on January 1, 2005. In January 2005, the Company signed an amendment to the original agreement, which reduces its commitment to $22,500,000 and extends the commitment period through December 31, 2010. As of October 2, 2005, the Company had contributed $17,450,000 to the partnership, which includes $1,575,000 during 2005. The remaining commitment of $5,050,000 can be called by Venrock in any period through 2010.

On March 31, 2003, the Company acquired the wafer identification business of Siemens Dematic AG for 7,000,000 Euros in cash (or approximately $7,630,000) paid at closing, with the potential for an additional cash payment in the fourth quarter of 2005 of up to 1,700,000 Euros (or approximately $2,044,000) depending upon the achievement of certain performance criteria.

On December 1, 2003, the Company acquired the machine vision business of Gavitec AG for 3,777,000 Euros in cash (or approximately $4,516,000), including 3,477,000 Euros paid at closing, 100,000 Euros (or approximately $123,000) paid on December 1, 2004, and 200,000 Euros (or approximately $240,000) to be paid on December 1, 2005. There was the potential for two additional cash payments of up to 250,000 Euros (or approximately $323,000) each in the third quarter of 2004 and first quarter of 2005 depending upon the achievement of certain performance criteria. These criteria were not met, and therefore, these contingent payments were not made.

On December 12, 2000, the Company’s Board of Directors authorized the repurchase of up to $100,000,000 of the Company’s common stock. During 2002, a total of 1,768,452 shares were repurchased at a cost of $26,425,000. There have been no other shares repurchased under this program. The Company may repurchase additional shares under this program in future periods depending upon a variety of factors, including the market value of the Company’s common stock and the average return on the Company’s invested balances.

On July 21, 2005, the Company’s Board of Directors declared a cash dividend of $0.08 per share. The dividend, amounting to $3,768,000, was paid on August 19, 2005 to all shareholders of record at the close of business on August 5, 2005. On October 28, 2005, the Company’s Board of Directors declared a cash dividend of $0.08 per share. The dividend is payable on November 25, 2005 to all shareholders of record at the close of business on November 11, 2005. Future dividends will be declared at the discretion of the Board of Directors and will depend upon such factors as the Board of Directors deems relevant. The Board of Directors may modify the Company’s dividend policy from time to time.

The Company believes that its existing cash, cash equivalents, and investment balances, together with cash flow from operations, will be sufficient to meet its operating, investing, and financing activities in 2005 and the foreseeable future.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 123R, “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123R requires companies to recognize compensation cost for all share-based payments to employees (including stock option and employee stock purchase plans) at fair value. SFAS No. 123R will be effective for public companies no later than the beginning of the first fiscal year after June 15, 2005. The Company will adopt SFAS No. 123R beginning in the first quarter of 2006 using the modified prospective method in which compensation cost is recognized beginning on the effective date.

The Company currently recognizes compensation costs using the intrinsic value based method and, as such, generally recognizes no compensation cost. Accordingly, the adoption of SFAS No. 123R’s fair value based method will have a significant impact on the Company’s results of operations, although it will have no impact on its overall financial position. The impact of the adoption of SFAS No. 123R will depend upon levels of share-based payments granted in the future. Had the Company adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and net income per share in Note 1 to the Company’s consolidated financial statements.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an Amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4.” SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing” to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current-period charges. In addition, SFAS No. 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005. The Company has adopted the provisions of SFAS No. 151 and its adoption did not have a material impact on the Company’s financial condition, results of operations, or cash flows.

In October 2004, the American Jobs Creation Act of 2004 (the “AJCA”) was passed. The AJCA provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. The AJCA also provides for a two-year phase-out of the existing extra-territorial income exclusion for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004.” FSP No. 109-1 treats the deduction as a “special deduction” as described in SFAS No. 109. This special deduction has no effect on deferred tax assets and liabilities existing at the enactment date and the effect of this deduction will be reported in the same period in which the deduction is claimed in the Company’s tax return.

The AJCA also creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. This deduction is subject to a number of limitations. Whether the Company will ultimately take advantage of this provision depends upon a number of factors, including reviewing future Congressional guidance. Until a decision can be made, the Company will not change its current intention to indefinitely reinvest the accumulated earnings of its foreign subsidiaries.

There have been no material changes to the Company’s exposures to market risk since December 31, 2004.

As required by Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, the Company has evaluated, with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, the effectiveness of its disclosure controls and procedures (as defined in such rules) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer concluded that such disclosure controls and procedures were effective as of that date. From time to time, the Company reviews its disclosure controls and procedures, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended October 2, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.