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Author: cnaylor Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 41315  
Subject: Re: Rappin' Cognex Date: 7/22/2002 5:19 PM
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I've followed this company for about four years but never yet bought. Initially I resisted for lack of confidence. I was just beginning to invest seriously and was hesitant to get caught up in what I perceived to be a euphoria. (Now, if someone had bothered to tell me that the market, and Cognex, would climb to dizzying heights before the drop I anticipated, maybe this story would sound different. But noooo…..) I also wasn't confident of my ability to assess the industry or the quality of the business. (I still don't feel great about my ability vis-à-vis the former, but the latter I'm more comfortable with.)

All of the market gyrations notwithstanding, I've always felt this company had a great franchise. My real problem with the company, which I'm having a hard time getting a handle on, is that the business appears to be undergoing a fundamental shift.

Prior to 2000, the business primarily served OEMs, the majority semiconductor equipment manufacturers, who incorporated their machine vision systems into their devices before re-selling them. This was a nice arrangement which allowed Cognex to deal with a (relatively) limited number of clients and offer them highly flexible support and assistance. They left the business of working with the end-user, which Dr. Shillman seemed to disdain, to the OEMs, competitors and other consulting companies which sprang up within the industry. However by 1998 or 1999, as was evident by the uninvested cash piling up on the balance sheet, the opportunities to grow this business had largely petered out. The OEM business was no longer a growth driver.

Cognex, in a bid to make its machines more widely available, has for the past couple of years been developing more products to try to take advantage of the end user community. Sounds good, you say, why should I have a problem with that? Well, coming from a position where I spent a few years installing specialized software for end-users, I've seen what can happen to a business when the product and the process isn't right. Commitments to clients became like anvils tied around our collective ankle and I spent a lot of time (and a lot of the company's money) going places putting out fires and fixing messes. Needless to say, in many cases, these additional visits weren't anticipated and so the revenue generated by the sale in many cases didn't begin to cover the costs involved – not to mention the customers we upset when we pushed back their implementations because no one was available to do them.

Long story short, I continue to worry that Cognex's push into the end-user market will place a higher burden on them for support and services that will significantly erode gross and operating margins. But because of the turmoil in the semiconductor industry, it's hard to get a handle yet on what to expect gross margins to be. Has anyone else looked at this problem and come to a conclusion?

I think they've got great management leadership (if a little goofy), and the company's balance sheet is as solid as they come. It's not clear to me that Dr. Shillman is entirely shareholder friendly, as there isn't even a token dividend, but I don't think his intentions are off-base. It's just that he either hasn't accepted the fact that there's no way to invest that capital at a reasonable return or he's got some ideas that are taking a long time to implement. The company has also taken the lead in a long-running suit over patent infringement claims by the estate of Jerome Lemelson, and though I find Mr. Lemelson's claims outrageous and completely unwarranted, it's always hard to tell with the justice system, so that might account for it. (A good account of the dispute from Fortune can be found at this link: http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=202216) Anyway, that covers most of my thoughts on Cognex. I'd be interested to hear others'.

Chris
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