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 assets, 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, capital projects, 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 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 third quarter of 2020 totaled $251,073,000, representing an increase of 37% from the third quarter of 2019. This increase was driven largely by higher revenue from certain customers in the electronics industry and ecommerce customers in the logistics industry. Both of these industries have benefited recently from higher consumer demand during the COVID-19 pandemic. These increases were partially offset by lower revenue from 29 customers in the automotive industry, which represented our largest industry in terms of revenue for fiscal year 2019, and continues to be negatively impacted by global economic conditions resulting from the COVID-19 pandemic. Gross margin was 76% for the third quarter of 2020 compared to 74% for the third quarter of 2019. Margin expansion was due to the favorable impact of the higher revenue on fixed manufacturing costs, as well as favorable product mix toward relatively higher-margin electronics revenue. Operating expenses increased by 2% from the third quarter of 2019, as incentive compensation accruals were partially offset by lower travel expenses resulting from COVID-19 restrictions. We reported operating income of 38% of revenue in the third quarter of 2020 compared to 24% of revenue in the third quarter of 2019, demonstrating the substantial operating leverage from the incremental revenue. We reported net income of 35% of revenue in the third quarter of 2020, or $0.49 per share, compared to 23% of revenue in the third quarter of 2019, or $0.24 per share. Results of Operations Revenue Revenue increased by $67,748,000, or 37%, for the three-month period and $31,549,000, or 6%, for the nine-month period. The increase was due largely to higher revenue from large customer deployments in the electronics industry and ecommerce customers in the logistics industry, which have experienced a significant increase in demand during the COVID-19 pandemic. In contrast, other industries we serve have experienced significantly lower demand, including the automotive industry, which was our largest industry in terms of revenue for fiscal year 2019. Accordingly, significant portions of our business have been adversely and materially impacted by deteriorating economic conditions resulting from the COVID-19 pandemic. Although revenue from customers in the automotive industry was lower than the prior year for both the three-month and nine-month periods, revenue from customers in this industry increased sequentially from the second quarter of 2020. In addition, revenue from customers in certain industries in which we have a smaller presence, including medical devices, pharmaceuticals, and life sciences, also increased sequentially from the prior quarter. Although we continue to experience certain disruptions to our business from COVID-19 and the situation is continuously changing, these conditions have improved in the third quarter. From a geographic perspective, revenue from customers based in the Americas increased by 33% for the three-month period and 4% for the nine-month period due primarily to higher revenue in the logistics industry, partially offset by lower revenue in the automotive industry, for which the decrease was more significant in the nine-month period. Revenue from customers based in Europe was relatively flat for the three-month period and decreased by 20% for the nine-month period due primarily to lower sales in the automotive and electronics industries. Revenue from customers based in Greater China increased by 152% for the three-month period and 52% for the nine-month period due primarily to higher revenue in the electronics industry, partially offset by lower revenue in the automotive industry, for which the decrease was more significant in the nine-month period. In recent years, there has been a shift in procurement for certain electronics orders for Cognex products used on assembly lines in China. This procurement shift has resulted in an increase in revenue reported in Greater China that was previously reported in Europe. Revenue from other countries in Asia was relatively flat for the three-month period and increased by 15% for the nine-month period due primarily to higher revenue in the electronics industry. As of the date of this report, we expect revenue for the fourth quarter of 2020 to be lower than the third quarter of 2020 but higher than the fourth quarter of 2019. The decrease from the third quarter of 2020 is expected to result from lower revenue in the electronics industry. The Company's revenue in this industry has an annual cycle based on large customer deployments, with higher revenue quarters typically in the second or third quarters or a combination of both. This year's revenue was primarily concentrated in the third quarter. Although we expect revenue in the electronics industry to be sequentially lower in the fourth quarter of 2020, we anticipate that it will be higher than the fourth quarter of 2019, as we expect to continue to benefit from higher consumer demand for electronics products during the COVID-19 pandemic. We also expect revenue in the logistics industry in the fourth quarter of 2020 to be higher than the same quarter in 2019 due to continued strength in the ecommerce sector. Anticipated growth in electronics and logistics is expected to be partially offset by lower revenue in the automotive industry and certain other industries that have been adversely impacted by the COVID-19 pandemic. It is difficult for us to quantify the future impact of COVID-19 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 76% and 74% for the three-month and nine-month periods in 2020, respectively, compared to 74% for both periods in 2019. The increase in the gross margin percentage was primarily due to the favorable impact of the higher revenue on fixed manufacturing costs, as well as favorable product mix toward relatively higher-margin electronics revenue. This impact was partially offset by higher provisions for excess and obsolete inventories for the nine-month period, which totaled $9,386,000 and $4,121,000 for the nine-month periods in 2020 and 2019, respectively. The higher level of provisions recorded in the nine-month period in 2020 was due to lower projected sales of excess inventories as a result of the deteriorating global economic conditions from the COVID-19 pandemic. As of the date of this report, we expect gross margin as a percentage of revenue for the fourth quarter of 2020 to be in the mid-70s range, but lower than the percentage reported in the third quarter of 2020 due to the anticipated lower revenue level and less favorable product mix. Operating Expenses Research, development, and engineering (RD&E) expenses increased by $2,125,000, or 8%, for the three-month period and increased by $10,147,000, or 12%, for the nine-month period as detailed in the table below (in thousands). Three-month period Nine-month period RD&E expenses in 2019 $ 28,115 $ 86,436 Incentive compensation 2,311 4,860 Acquisition deferred compensation 1,310 3,930 Personnel-related costs (711) 2,322 Travel expenses (581) (1,352) Stock expenses (870) (1,042) Other 666 1,429 RD&E expenses in 2020 $ 30,240 $ 96,583 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 the fourth quarter. RD&E expenses also increased due to higher compensation costs 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 increase in RD&E expense of $1,310,000 for the three-month period and $3,930,000 for the nine-month period. Although this acquisition also resulted in higher personnel-related costs from headcount additions related to a team of deep learning engineers, the impact of this incremental headcount was offset by a workforce reduction in the second quarter of 2020. These increases were partially offset by lower travel expenses resulting from COVID-19 restrictions. We expect these restrictions to continue in the fourth 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 12% and 16% for the three-month and nine-month periods in 2020, respectively, compared to 15% 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. We currently expect to continue to make significant RD&E investments to support our product development plans during the COVID-19 pandemic and other business disruptions generally. 31 Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses were relatively flat for the three-month period and decreased by $6,045,000, or 3%, for the nine-month period as detailed in the table below (in thousands). Three-month period Nine-month period SG&A expenses in 2019 $ 64,486 $ 199,542 Travel expenses (3,659) (10,247) Contract labor (797) (1,923) Foreign currency exchange rate changes 270 (1,587) Marketing programs (125) (1,356) Incentive compensation 5,863 9,646 Personnel-related costs (1,195) 1,412 Other (637) (1,990) SG&A expenses in 2020 $ 64,206 $ 193,497 SG&A expenses decreased due to lower travel expenses resulting from COVID-19 restrictions. We expect these restrictions to continue in the fourth quarter of 2020. In addition, the Company reduced spending on contract labor and marketing programs as part of actions taken to reduce operating costs during the global pandemic. Foreign currency exchange rate changes also resulted in a lower level of SG&A expenses for the nine-month period, as costs denominated in foreign currencies were translated to U.S. Dollars at a lower rate due to a relatively stronger U.S. Dollar. 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 the fourth quarter. Personnel-related costs were lower for the three-month period due to the impact of a workforce reduction in the second quarter of 2020. 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 $15,388,000, of which $14,798,000 was recorded in the second quarter and $251,000 was recorded in the third quarter of 2020. The second quarter charge of $251,000 included a net favorable adjustment of $663,000 resulting from actual costs coming in lower than original estimates. The remaining charge of approximately $339,000 is expected to be recorded in the fourth quarter of 2020. 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. Actual savings anticipated from these actions have been achieved as expected in the third quarter of 2020 as described in personnel-related costs savings in RD&E expenses and SG&A expenses. Intangible Asset Impairment Charges Deteriorating global economic conditions from the COVID-19 pandemic 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 of 2020, primarily related to lower projected cash flows from the technologies and customer relationships acquired from Sualab. Non-operating Income (Expense) The Company recorded foreign currency gains of $2,357,000 and foreign currency losses of $310,000 for the three-month and nine-month periods in 2020, respectively, compared to foreign currency losses of $1,295,000 and $1,403,000 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. 32 Investment income decreased by $2,624,000, or 51%, for the three-month period and $4,232,000, or 28%, for the nine-month period. The decrease was due to lower yields on the Company's portfolio of debt securities. The Company recorded other expense of $173,000 and $153,000 for the three-month and nine-month periods in 2020, respectively, compared to other income of $456,000 and $1,239,000 for the same periods in 2019. Other income (expense) includes fair value adjustments of contingent consideration liabilities arising from business acquisitions. The Company recorded favorable fair value adjustments to its GVi contingent consideration liability in 2019, resulting from a lower level of revenue in the Americas’ automotive industry. Income Tax Expense The Company’s effective tax rate was 14% and 12% of pre-tax income for the three-month and nine-month periods in 2020, respectively, compared to 12% of pre-tax income for both periods in 2019. The effective tax rate included a decrease in tax expense of $4,354,000 and $10,447,000 for the three-month and nine-month periods in 2020, respectively, and $569,000 and $4,547,000 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 option 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 $129,000 and $3,638,000 for the three-month and nine-month periods in 2020, respectively, primarily from the final true-up of the prior year's tax accrual upon filing the related tax return, and a decrease in tax expense of $1,327,000 and $1,330,000 for the same periods in 2019, consisting primarily of the expiration of the statutes of limitations for certain reserves for income tax uncertainties. Excluding the impact of these discrete items, the Company’s effective tax rate was 18% of pre-tax income for the three-month and nine-month periods in 2020, respectively, compared to 16% for the same periods in 2019. The increase in the effective tax rate, excluding the impact of discrete items, was due to more of the Company's profits being earned and taxed in higher tax jurisdictions. The Company has filed its U.S. federal tax return in the fourth quarter of 2020 for tax year 2019, and as a result, is expected to record a discrete tax benefit in excess of $12,000,000 in the fourth quarter. This benefit was the result of new regulations issued by the IRS relating to the use of foreign tax credits as allowable to reduce the tax associated with foreign operations under Global Intangible Low-Taxed Income (“GILTI”). These credits were generated from taxes paid relating to the acquisition of Sualab in October 2019. 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 approximately $1 billion as of September 27, 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 nine-month period ended September 27, 2020 were primarily met with positive cash flows from operations and the proceeds from stock option exercises. Cash requirements consisted of operating activities, the repurchase of common stock, the payment of dividends, and capital expenditures. Capital expenditures for the nine-month period ended September 27, 2020 totaled $9,829,000 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 currently intends to continue to invest in capital projects, particularly related to its management information systems, that we believe are important to support our longer-term growth objectives. The Company implemented a variety of cost-cutting measures in the second quarter of 2020 to address the impact of the COVID-19 pandemic, including a workforce reduction and office closures. The Company estimates the total restructuring charges from these actions to be approximately $15,388,000, of which $2,957,000 represents non-cash charges and adjustments, $8,775,000 was paid in the second and third quarters of 2020, and the remainder is expected to be paid out in the fourth quarter of 2020. In October 2018, the Company's Board of Directors authorized the repurchase of $200,000,000 of the Company's common stock. As of September 27, 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 or third quarters 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 33 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, as well as the first, second, and third quarters of 2020. Total dividends paid amounted to $28,554,000 for the nine-month period ended September 27, 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 September 27, 2020, the Company had approximately $1 billion 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.