Chapter One

Of the many cases that I have investigated with my friend, Sherlock Holmes, I cannot recall a case as puzzling as the sharp decline in manufacturing defects we observed around the world during 2016. After months of arduous research we had yet to arrive at a plausible explanation.

Then, on a frosty day in January of the year 2017, a loud and authoritative tap on my office door caught my attention. It was Holmes. “Come, Watson, come!” he cried. “Follow me!”

We hurried to Holmes’s study, where he revealed his new theory. “I believe the decline in manufacturing defects is tied directly to the sharp increase in the use of machine vision and barcode reader systems manufactured by Cognex Corporation.”

“I suspected the same, but couldn’t be sure!” I exclaimed. “How can we figure it out for certain?"

Settling into armchairs around the tea-stained mahogany desk, we began our investigation by pondering one simple question: How was it possible, in a year of sluggish industrial sector spending, for Cognex to report the following outstanding results from continuing operations?

• Record revenue of $521 million, a 16% increase over 2015
• Operating margin of 31%, an increase of 390 basis points over 2015
• Record net income of $150 million, a 39% increase over 2015
• Net margin of 29% compared to 24% in 2015
• Record earnings per share of $1.72, up from $1.22 in 2015

After digesting these impressive figures, Holmes stroked his chin, then perked up as though a light had been turned on inside his head. It was a look that told me the game was afoot.

“It’s elementary, my dear Watson, and a most interesting case,” he said. “Shall I share the details?” Without awaiting my reply, he began to sketch out his theory.

“The data is quite clear,” he began. “The three largest industries contributing to Cognex’s total factory automation revenue in 2016—automotive, consumer electronics, and logistics—all showed double-digit growth. And further investigation shows that other markets, such as consumer products and pharmaceuticals, also grew well. In addition, Cognex is benefitting from the rapid expansion of vision-guided robotics.”

The thought of functioning robots, I must confess, gave me pause. “Robots?” I wondered. “What do you make of that?”

He allayed my concern by explaining that robots are used today in manufacturing, particularly for automotive assembly. Holmes went on to say that Cognex vision products are already specified by four of the world’s five largest robot manufacturers, and they’ve been designed into several extraordinary new automatons called “collaborative robots” that can work safely alongside humans!

“Well done, Holmes!” I cried.

I was beginning to see the source of Cognex’s superior financial performance—the company's revenue is up, and because of its unique business model, much of that incremental revenue falls to its bottom line.

Chapter Two

Suspecting there was more to tell, I shifted in my chair and encouraged Holmes to continue. “I feel there’s another angle to this success story, Sherlock. Is my hunch correct?”

“Quite, quite,” Holmes said, pacing the room impatiently. “The other angle has to do with regional performance. Demand for Cognex products continues to grow in Asia, especially in China. That’s where a trend toward reducing labor costs, along with the miniaturization of parts in the consumer electronics industry, requires an increase in the use of Cognex vision and ID products.”

As proof, he offered me a crinkled financial document. It turns out that in 2016, factory automation revenue from Asia increased 23% over 2015, led by growth in China and Korea.

“Amazing results to be sure,” I said, “but something still baffles me.” I looked over at the detective, who was now reclining on a musty sofa. “Surely there are other suppliers that offer machine vision and ID. If that’s true, why do customers buy from Cognex rather than its competitors?”

I wanted to know Cognex's secret.

Chapter Three

When I asked Holmes what separates Cognex from its competitors—what’s the company’s secret—he leapt up to his feet like a spring uncoiled. “Why, Watson! Cognex technology is infernally clever!”

Holmes then rattled off some of the new products the company introduced in 2016. “The MX-1000 mobile terminal is an innovative new product that unites two marvels of modern technology—machine vision and the smartphone—into one fantastically capable device that offers a better way for delivery and service professionals to capture and communicate data.”

“Ingenious!” I exclaimed. “But, as I recall, that wasn’t the only marvel that Cognex concocted. Cognex also introduced the In-Sight® Micro 8000, a smart camera that delivers PC-level speed and performance in an ultra-compact package.”

“Very true,” Holmes replied. “And Cognex also launched the In-Sight® VC200. It’s a powerful new platform that allows users to add multiple smart cameras to a single In-Sight® system without slowing performance.”

“It’s rather clear that Cognex sets a brisk pace when it comes to innovation,” I stated. “But the question is, how?”

“It isn’t surprising when you look at the company's substantial engineering investment,” Holmes offered. “In 2016, Cognex invested 15% of revenue in RD&E, and plans to spend between 10% and 15% of revenue in engineering every year.”

He then framed his argument more rationally. “Consider this, Watson: Cognex invests heavily in engineering, which drives best-in-class technology, which, in turn, drives both Cognex’s revenue and gross margins. It’s all very logical.”

It made perfect sense to me as well.

“Cognex also acquired four companies in markets where it expects to see high rates of growth,” Holmes continued. “Three of these acquisitions—AQSense, EnShape, and Chiaro Technologies—add new 3D hardware and software capabilities to the Cognex portfolio, and the last, Webscan, is a leader in barcode verification software.”

With each additional revelation by Holmes, I imagined more and more manufacturing defects around the world disappearing like soap bubbles popping in the air.

Chapter Four

This was already a lot of data to assimilate, but I knew my friend well enough to guess that we had not yet looked at everything. And, as Holmes was fond of saying, “one should always look for a possible alternative.” So I offered a suggestion.

“This is truly remarkable,” I began tentatively, “but I’m not sure it can fully explain Cognex’s 2016 success. Perhaps there’s another source of revenue, some new market bringing business to Cognex?”

“Brilliant deduction, Watson!” Holmes exclaimed. “This is a most thrilling part of the story! Cognex has been expanding its addressable market and has exciting progress to report. Look at this.”

With that, he reached into the pocket of his Victorian cape and pulled out a device, which he dropped on the desk in front of me. He then began tying the pieces together.

“You heard me mention a few moments ago that 3D is an area of high potential,” said Holmes. “Well this, Watson, is a 3D vision sensor, a magnificent device that is enabling many new applications in advanced automation. And in 2016, Cognex reported more than $20 million of revenue from 3D vision sales—an increase of 138% over 2015.”

“Astounding!” I blurted out in amazement.

“But Cognex isn’t content with the here and now,” he continued. “The company has a very exciting product roadmap that could help increase its share of the rapidly growing $200 million 3D vision market in years to come.”

Given the gusto with which he presented his case, it was clear that Holmes was now on a roll.

“And other adjacent markets offer exciting opportunities as well,” he continued. “One example is the Life Science/OEM market, where scientists are creating amazing new machines to automate all sorts of medical tests and processes. To serve these customers, Cognex produces a tiny vision device called an image engine, small enough to fit into the bowl of my pipe!”

As it happens, in 2016, these powerful image engines were specified by OEMs for nine new models of equipment that should come to market this decade. Several of these machines each have the potential to produce a consistent revenue stream of more than $10 million over their lifetimes.

Holmes powered on: “But those aren’t the only markets Cognex penetrated in 2016. You’ve heard me speak with pride of my ability to accurately track the movement of any suspect?”

I nodded in the affirmative.

“Well, Cognex is making my skills obsolete! Their high-performance image-based barcode readers, which are quickly becoming the standard in distribution centers, are now being used to track luggage at airports with near 100% reliability! In fact, four major international airports are already using Cognex barcode readers for this purpose, and there are many more opportunities like that in the pipeline.”

“What a story, Holmes!” I exclaimed. “Congratulations on a fantastic feat of deduction. I believe you’ve now fully explained how Cognex’s extraordinary 2016 results were responsible for the disappearance of manufacturing defects around the world!”

Holmes clasped his hands behind his back, meandered over to the window, and stared out.

Suddenly, he seemed lost in thought.

Chapter Five

Unbeknownst to me, I had struck somewhat of a nerve with my last comment. There remained one final piece to the Cognex puzzle that Holmes had failed to detail.

That final piece was people.

“Success is more than a single year’s financial performance, Watson,” observed the detective. “There are additional attributes that are critical to a company’s long-term prospects. In these, Cognex also has much to offer. Consider the following facts: Cognex operates a business with high intellectual property and low capital intensity; with strong operating margins and strong cash flow from operations. And, Cognex is in a high-growth industry where there are a lot of potential applications in new markets.”

I stood up and joined him by the window.

“And let’s not forget about Cognex’s factory automation business,” he continued. “It has grown revenue by double digits in constant currency each year for the past four years. Cognex is helping manufacturers around the world become more efficient and cost effective through smarter automation. And its technology is enabling the manufacture of fantastic new inventions such as OLED screens and virtual reality headsets.”

“But there’s one reason you can’t quite quantify,” I interrupted. “It’s the people who come to work every day at Cognex that separate it from the competition.”

Holmes turned around and met my stare with his own. “You knew it all along, didn’t you?”

“I picked up on it straightaway,” I said, barely above a whisper. “Cognoids are smart, hardworking, and dedicated to excellence. Over the years, I’ve seen how your arch-enemy, Professor Moriarty, forced you to tap your deepest resources of resolve and ingenuity. Well, Cognoids have their own arch enemy—Professor Mediocrity. Cognoids abhor being average, and each day they call on their own deep reserves of creativity and perseverance to produce superior vision and ID technology.”

“A keen observation, dear friend,” said Holmes, who then placed a hand upon my shoulder. “I can learn much from you.”

“And I, you.”

“Now hurry off, Watson,” exclaimed Holmes, escorting me to the door. “Make your scribbles and tell the world what we have discovered—that Cognex is a force to be reckoned with, in 2016 and beyond!”

And that, my dear reader, concludes the case of Cognex and the disappearing defects. Or maybe, it’s only the beginning...