COGNEX CORP 10-Q

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements 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 our use of the words “expects,” “anticipates,” “estimates,” “believes,” “projects,” “intends,” “plans,” “will,” “may,” “shall,” “could,” “should,” and similar words and other statements of a similar sense. These statements are based upon our current estimates and expectations as to prospective events and circumstances, which may or may not be in our control and as to which there can be no firm assurances given. These forward-looking statements, which include statements regarding business and market trends, future financial performance, the expected impact of the COVID-19 pandemic on our business and results of operations, customer order rates and timing of related revenue, future product mix, restructuring and other cost savings initiatives, research and development activities, investments, liquidity, strategic plans, and estimated tax benefits and expenses and other tax matters, involve known and unknown risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include: (1) the impact, duration and severity of the COVID-19 pandemic; (2) current and future conditions in the global economy, including the impact of the COVID-19 pandemic and the imposition of tariffs or export controls; (3) the loss of, or curtailment of purchases by, a large customer; (4) the reliance on revenue from the consumer electronics or automotive industries; (5) the inability to penetrate the logistics industry and other new markets; (6) the inability to achieve significant international revenue; (7) fluctuations in foreign currency exchange rates and the use of derivative instruments; (8) information security breaches or business system disruptions; (9) the inability to attract and retain skilled employees; (10) the failure to effectively manage our growth; (11) the reliance upon key suppliers to manufacture and deliver critical components for our products; (12) the failure to effectively manage product transitions or accurately forecast customer demand; (13) the inability to design and manufacture high-quality products; (14) the technological obsolescence of current products and the inability to develop new products; (15) the failure to properly manage the distribution of products and services; (16) the inability to protect our proprietary technology and intellectual property; (17) our involvement in time-consuming and costly litigation; (18) the impact of competitive pressures; (19) the challenges in integrating and achieving expected results from acquired businesses, including the recent acquisition of Sualab; (20) potential impairment charges with respect to our investments or for acquired intangible assets or goodwill; (21) exposure to additional tax liabilities; and (22) potential disruptions to our business due to restructuring activities and the failure of such activities to generate the anticipated cost savings. The foregoing list should not be construed as exhaustive and we encourage readers to refer to the detailed discussion of risk factors included in Part I - Item 1A of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as updated by Part II - Item 1A of this Quarterly Report on Form 10-Q. 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. Executive Overview Cognex Corporation is a leading worldwide provider of machine vision products that capture and analyze visual information in order to automate manufacturing and distribution tasks where vision is required. In addition to product revenue derived from the sale of machine vision products, the Company also generates revenue by providing maintenance and support, consulting, and training services to its customers; however, service revenue accounted for less than 10% of total revenue for all periods presented. Cognex machine vision is used to automate manufacturing and distribution processes in a variety of industries, where the technology is widely recognized as an important component of automated production and quality assurance. Virtually every manufacturer can achieve better quality and manufacturing efficiency by using machine vision, and therefore, Cognex products are used by a broad base of customers across a variety of industries, including consumer electronics, automotive, consumer products, food and beverage, pharmaceuticals, and medical devices. Cognex products are also used to automate distribution processes in the logistics industry, including for applications in retail distribution and ecommerce to scan, track, and sort goods through distribution centers. Revenue for the second quarter of 2020 totaled $169,097,000, representing a decrease of 15% from the second quarter of 2019. Our business has been adversely and materially impacted by deteriorating global economic conditions resulting from the COVID-19 pandemic. This impact was most notable in the automotive industry, our largest market, for which revenue continued to decline from the first quarter of 2020 and was significantly lower than 29 the second quarter of 2019. Gross margin was 70% for the second quarter of 2020 compared to 74% for the second quarter of 2019 due to higher provisions for excess and obsolete inventories as a result of the deteriorating business conditions. Operating expenses increased by 30% from the second quarter of 2019. In order to more closely align our cost structure to the lower level of business, we implemented a variety of cost-cutting measures in the second quarter, including a workforce reduction and office closures, and recorded restructuring charges of $14,798,000 from these actions. The significant decline in business levels also triggered a review of long-lived assets that resulted in intangible asset impairment charges of $19,571,000. Excluding these charges, operating expenses decreased by 6% from the second quarter of 2019 due primarily to lower travel expenses resulting from COVID-19 restrictions. As a result of the lower revenue level and charges related to excess inventories, restructuring actions, and intangible asset impairments, we reported an operating loss of 4% of revenue in the second quarter of 2020 compared to an operating profit of 26% of revenue in the second quarter of 2019. We reported a net loss of 1% of revenue in the second quarter of 2020, or $0.01 per share, compared to a net profit of 24% of revenue in the second quarter of 2019, or $0.28 per share. Results of Operations As foreign currency exchange rates are a factor in understanding period-to-period comparisons, we believe the presentation of results on a constant-currency basis in addition to reported results helps improve investors’ ability to understand our operating results and evaluate our performance in comparison to prior periods. We also use results on a constant-currency basis as one measure to evaluate our performance. Constant-currency information compares results between periods as if exchange rates had remained constant period-over-period. We generally refer to such amounts calculated on a constant-currency basis as excluding the impact of foreign currency exchange rate changes. Results on a constant-currency basis are not in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and should be considered in addition to, and not as a substitute for, results prepared in accordance with U.S. GAAP. Revenue Revenue decreased by $29,950,000, or 15%, for the three-month period and decreased by $36,199,000, or 10%, for the six-month period. Changes in foreign currency exchange rates did not have a material impact on revenue. Deteriorating global economic conditions resulting from the COVID-19 pandemic, which had a modest impact on our business in the first quarter of 2020, had a more significant impact in the second quarter, as we noted lower demand for our products in certain industries, additional disruptions to our supply chain, longer customer delivery times, and further shutdowns of customer facilities. This impact was most notable in the automotive industry, for which revenue declined from the first quarter of 2020 and was significantly lower than the prior year for both the three-month and six-month periods. Revenue in the logistics industry increased from the first quarter of 2020 and was higher than the prior year for both the three-month and six-month periods driven by higher demand from ecommerce customers. This was partially offset, however, by lower demand from retail distribution customers and delays in revenue recognition related to customer facility access for on-site installations caused by COVID-19 conditions. The timing of revenue recognition also impacted revenue in the electronics industry, which was lower than the prior year for the three-month period and relatively flat for the six-month period. From a geographic perspective, revenue from customers based in the Americas decreased by 11% for the three-month period and 9% for the six-month period with the most significant decrease coming from the automotive industry. Revenue from customers based in Europe decreased by 40% for the three-month period and 29% for the six-month period also due to lower sales in the automotive industry, as well as in the electronics industry. Revenue from customers based in Greater China decreased by 11% for the three-month period due to lower sales from the automotive industry and were relatively flat for the six-month period, as lower revenue in the automotive industry was offset by higher revenue in the electronics industry. Revenue from other countries in Asia increased by 23% for the three-month period and 22% for the six-month period due to higher sales from the electronics industry. As of the date of this report, we expect revenue for the third quarter of 2020 to be higher than both the second quarter of 2020 and the third quarter of 2019 due to anticipated higher revenue in the electronics industry. We expect COVID-19 to continue to adversely impact our revenue in the third quarter of 2020 as compared to the prior year outside of electronics, logistics ecommerce, and a few smaller industries, with the most notable adverse impact expected in the automotive industry. It is difficult for us to quantify this impact due to many factors beyond our control and knowledge, including changing governmental regulations and the scope and duration of social distancing and commerce restrictions, including access to customer facilities for on-site installations. 30 Gross Margin Gross margin as a percentage of revenue was 70% and 73% for the three-month and six-month periods in 2020, respectively, compared to 74% for both periods in 2019. The decrease in the gross margin percentage was due to higher provisions for excess and obsolete inventories, which totaled $7,718,000 and $8,783,000 for the three-month and six-month periods ended June 28, 2020, respectively, compared to $933,000 and $1,713,000 for the same periods in 2019. The higher level of provisions recorded in the three-month period ended June 28, 2020 was due to lower projected sales of excess inventories as a result of the deteriorating global economic conditions from the COVID-19 pandemic. Gross margin as a percentage of revenue would be relatively consistent for all periods presented excluding the provisions for excess and obsolete inventories. As of the date of this report, we expect gross margin as a percentage of revenue for the third quarter of 2020 to be similar to the percentage reported in the first half of 2019. Although we expect provisions for excess and obsolete inventory to be lower than the second quarter of 2020, we expect a greater percentage of revenue from application-specific customer solutions, which have relatively lower margins. Operating Expenses Research, development, and engineering (RD&E) expenses increased by $2,318,000, or 8%, for the three-month period and $8,022,000, or 14%, for the six-month period as detailed in the table below (in thousands). Three-month period Six-month period RD&E expenses in 2019 $ 28,079 $ 58,321 Personnel-related costs 1,405 3,033 Acquisition deferred compensation 1,310 2,620 Incentive compensation 1,601 2,549 Travel expense (671) (771) Stock expense (1,130) (172) Other (197) 763 RD&E expenses in 2020 $ 30,397 $ 66,343 RD&E expenses increased due to higher personnel-related costs primarily from headcount additions related to a team of deep learning engineers from the Company's acquisition of Sualab in the fourth quarter of 2019. The consideration for this acquisition included deferred payments that are being recorded as compensation expense over four years from the closing date, which accounted for an additional increase in RD&E expense of $1,310,000 for the three-month period and $2,620,000 for the six-month period. In addition, the Company recorded higher incentive compensation accruals for annual plans with relevant performance goals for 2020. We will continue to monitor the achievement of these performance goals for the remainder of the year due to the impact of COVID-19 on our business, among other factors, which may result in adjustments to our incentive compensation accruals in future quarters. These increases were partially offset by lower travel expenses resulting from COVID-19 restrictions. We expect these restrictions to continue in the third quarter of 2020. The Company also recorded lower stock expense as a result of a lower total value of awards granted in 2020 as compared to 2019, as well as the impact on the timing of stock expense recognition from a shift in our compensation practices toward the granting of restricted stock units with cliff vesting. In addition, credits were recorded to stock expense in the second quarter of 2020 for awards cancelled as a result of a workforce reduction. RD&E expenses as a percentage of revenue were 18% and 20% for the three-month and six-month periods in 2020, respectively, compared to 14% and 16% for the same periods in 2019. We believe that a continued commitment to RD&E activities is essential in order to maintain or achieve product leadership with our existing products and to provide innovative new product offerings, as well as to provide engineering support for large customers. In addition, we consider our ability to accelerate time to market for new products to be critical to our revenue growth. Therefore, we expect to continue to make significant RD&E investments in the future, and currently intend to continue our product development plans during periods of lower revenue levels. 31 Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses decreased by $8,092,000, or 12%, for the three-month period and $5,765,000, or 4%, for the six-month period as detailed in the table below (in thousands). Three-month period Six-month period SG&A expenses in 2019 $ 68,245 $ 135,056 Travel expense (4,843) (6,588) Foreign currency exchange rate changes (1,074) (1,857) Marketing programs (949) (1,231) Contract labor (636) (1,126) Stock expense (1,810) (25) Incentive compensation 2,654 3,783 Other (1,434) 1,279 SG&A expenses in 2020 $ 60,153 $ 129,291 SG&A expenses decreased due to lower travel expenses resulting from COVID-19 restrictions. We expect these restrictions to continue in the third quarter of 2020. Foreign currency exchange rate changes also resulted in a lower level of SG&A expenses in 2020, as costs denominated in foreign currencies were translated to U.S. Dollars at a lower rate due to a relatively stronger U.S. Dollar. In addition, the Company reduced spending on marketing programs and contract labor in response to the lower business levels. The Company also recorded lower stock expense as a result of a lower total value of awards granted in 2020 as compared to 2019, as well as the impact on the timing of stock expense recognition from a shift in our compensation practices toward the granting of restricted stock units with cliff vesting. In addition, credits were recorded to stock expense in the second quarter of 2020 for awards cancelled as a result of a workforce reduction. These decreases were partially offset by higher incentive compensation accruals for annual plans with relevant performance goals for 2020. We will continue to monitor the achievement of these performance goals for the remainder of the year due to the impact of COVID-19 on our business, among other factors, which may result in adjustments to our incentive compensation accruals in future quarters. Restructuring Charges On May 26, 2020, the Company's Board of Directors approved a restructuring plan intended to reduce the Company's operating costs, optimize its business model, and address the impact of the COVID-19 pandemic. The restructuring plan included a global workforce reduction of approximately 8% and office closures. The Company estimates the total restructuring charges from these actions to be approximately $16,445,000, of which $14,798,000 has been recorded in the second quarter. The remaining charges of approximately $1,647,000 are expected to be recognized during the second half of 2020, primarily in the third quarter. The actions described above, together with actions already taken to reduce the Company's overall costs, were designed to generate an aggregate annualized cost savings of approximately $25,000,000 versus the Company's original planned cost structure. Management does not believe these cost-saving measures will impair the Company's ability to conduct its key business functions. Intangible Asset Impairment Charges The significant decline in business levels triggered a review of long-lived assets for potential impairment in the second quarter of 2020. This review resulted in intangible asset impairment charges totaling $19,571,000 recorded in the second quarter, primarily related to lower projected cash flows from the technologies and customer relationships acquired from Sualab as a result of the deteriorating global economic conditions from the COVID-19 pandemic. 32 Non-operating Income (Expense) The Company recorded foreign currency gains of $336,000 and foreign currency losses of $2,667,000 for the three-month and six-month periods in 2020, respectively, compared to foreign currency gains of $140,000 and foreign currency losses of $108,000 for the same periods in 2019. Foreign currency gains and losses result primarily from the revaluation and settlement of accounts receivable, accounts payable, and intercompany balances that are reported in one currency and collected in another. The higher level of foreign currency losses for the six-month period in 2020 was primarily related to the revaluation of an intercompany balance that was created by the migration of acquired intellectual property from one subsidiary to another in the fourth quarter of 2019. This intercompany balance is expected to be settled in the third quarter of 2020. Investment income decreased by $1,932,000, or 37%, for the three-month period and $1,608,000, or 16%, for the six-month period. The decrease was due to lower yields on the Company's portfolio of debt securities and a lower average invested balance. The Company recorded other income of $203,000 and $20,000 for the three-month and six-month periods in 2020, respectively, compared to other expense of $144,000 and other income of $783,000 for the same periods in 2019. Other income (expense) includes fair value adjustments of contingent consideration liabilities arising from business acquisitions. The Company recorded a $1,060,000 decrease in the fair value of its GVi contingent consideration liability in the first quarter of 2019, resulting from a lower level of revenue in the Americas’ automotive industry. Income Tax Expense The Company’s effective tax rate was a benefit of 51% of pre-tax loss and an expense of 7% of pre-tax income for the three-month and six-month periods in 2020, respectively, compared to an expense of 14% and 12% of pre-tax income for the same periods in 2019. The effective tax rate included a decrease in tax expense of $4,413,000 and $6,093,000 for the three-month and six-month periods in 2020, respectively, and $1,248,000 and $3,978,000 for the same periods in 2019, primarily from the excess tax benefit arising from the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes from stock exercises. The Company cannot predict the level of stock option exercises by employees in future periods. Other discrete tax items included an increase in tax expense of $3,267,000 and $3,509,000 for the three-month and six-month periods in 2020, respectively, primarily from the final true-up of the prior year's tax accrual upon filing the related tax return. Excluding the impact of these discrete items, the Company’s effective tax rate was a benefit of 1% of pre-tax loss and an expense of 19% of pre-tax income for the three-month and six-month periods in 2020, respectively, compared to an expense of 17% and 16% of pre-tax income for the same periods in 2019. The increase in the effective tax rate, excluding the impact of discrete items, for the six-month period from 16% in 2019 to 19% in 2020 was due to more of the Company's profits being earned and taxed in higher tax jurisdictions. This adjustment to the effective tax rate resulted in an 18 percentage-point impact on the effective tax rate for the three-month period ended June 28, 2020. Liquidity and Capital Resources The Company has historically been able to generate positive cash flow from operations, which has funded its operating activities and other cash requirements and has resulted in an accumulated cash and investment balance of $896,192,000 as of June 28, 2020. The Company has established guidelines relative to credit ratings, diversification, and maturities of its investments that maintain liquidity. The Company’s cash requirements for the six-month period ended June 28, 2020 were primarily met with positive cash flows from operations. Cash requirements consisted of operating activities, the repurchase of common stock, the payment of dividends, and capital expenditures. Capital expenditures for the six-month period ended June 28, 2020 totaled $6,985,000 and consisted primarily of computer hardware and software, manufacturing test equipment related to new product introductions, and improvements made to the Company's headquarters building in Natick, Massachusetts and various leased facilities. The Company intends to continue to invest in capital projects in the second half of 2020 despite the current lower business levels, particularly related to its management information systems, which we believe are important to support our longer-term growth objectives. Our business has been adversely and materially impacted by deteriorating global economic conditions resulting from the COVID-19 pandemic. In order to more closely align our cost structure to the lower level of business, we implemented a variety of cost-cutting measures in the second quarter of 2020, including a workforce reduction and 33 office closures. The Company estimates the total restructuring charges from these actions to be approximately $16,445,000, of which $3,145,000 represents non-cash charges, $4,689,000 was paid in the second quarter of 2020, and the remainder is expected to be paid out in the second half of 2020, primarily in the third quarter. In October 2018, the Company's Board of Directors authorized the repurchase of $200,000,000 of the Company's common stock. As of June 28, 2020, the Company repurchased 2,816,000 shares at a cost of $121,348,000 under this program, including 1,215,000 shares at a cost of $51,036,000 in the first quarter of 2020, leaving a remaining balance of $78,652,000. No shares were repurchased during the second quarter of 2020. On March 12, 2020 the Company's Board of Directors authorized the repurchase of an additional $200,000,000 of the Company's common stock. Purchases under this March 2020 program will commence upon completion of the October 2018 program. The Company may repurchase shares under these programs in future periods depending on a variety of factors, including, among other things, the impact of dilution from employee equity awards, stock price, share availability, and cash requirements. The Company is authorized to make repurchases of its common stock through open market purchases, pursuant to Rule 10b5-1 trading plans, or in privately negotiated transactions. The Company’s Board of Directors declared and paid cash dividends of $0.050 per share in the first, second, and third quarters of 2019. The dividend was increased to $0.055 per share in the fourth quarter of 2019, the first quarter of 2020, and the second quarter of 2020. Total dividends paid amounted to $18,972,000 for the six-month period ended June 28, 2020. Future dividends will be declared at the discretion of the Company’s Board of Directors and will depend upon such factors as the Board deems relevant including, among other things, the Company’s ability to generate positive cash flows from operations. The Company believes that its existing cash and investment balances, together with cash flow from operations, will be sufficient to meet its operating, investing, and financing activities for the next twelve months. As of June 28, 2020, the Company had $896,192,000 in cash and investments. In addition, the Company has no long-term debt and does not anticipate needing debt financing in the near future. We believe that our strong cash position has put us in a relatively good position to maintain our liquidity during downturns in our business related to COVID-19 and with respect to our longer-term liquidity needs. New Pronouncements Refer to Part I - Note 2 within this Form 10-Q, for a full description of recently issued accounting pronouncements including the expected dates of adoption and the expected impact on the financial position and results of operations of the Company. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes to the Company’s exposures to market risk since December 31, 2019.