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 on 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, new product offerings, capital expenditures, investments, liquidity, dividends and stock repurchases, 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) potential disruptions to our business due to restructuring activities; (3) the loss of, or curtailment of purchases by, large customers in the consumer electronics and logistics industries; (4) the reliance on revenue from the automotive industry; (5) the reliance on key suppliers to manufacture and deliver critical components for our products and potential disruptions to the supply chain, which could impact timely delivery of customer orders; (6) the failure to effectively manage product transitions or accurately forecast customer demand; (7) the inability to design and manufacture high-quality products; (8) the inability to attract and retain skilled employees and maintain our unique corporate culture; (9) the failure to effectively manage our growth; (10) the inability to achieve growth in revenue and profits from the logistics industry; (11) the technological obsolescence of current products and the inability to develop new products; (12) the failure to properly manage the distribution of products and services; (13) the impact of competitive pressures; (14) the challenges in integrating and achieving expected results from acquired businesses; (15) potential disruptions in our business systems; (16) information security breaches; (17) the inability to protect our proprietary technology and intellectual property; (18) potential impairment charges with respect to our investments or acquired intangible 24 assets; (19) exposure to additional tax liabilities; (20) fluctuations in foreign currency exchange rates and the use of derivative instruments; (21) our involvement in time-consuming and costly litigation; (22) unfavorable global economic conditions; and (23) economic, political, and other risks associated with international sales and operations. 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, 2020, 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, and medical-related. Cognex products are also used to automate distribution processes in the logistics industry, including for applications in retail distribution and e-commerce to scan, track, and sort goods through distribution centers. The second quarter of 2020 was marked by a disruption to our business precipitated by the COVID-19 pandemic. In response, the Company's Board of Directors approved a restructuring plan intended to reduce the Company's operating costs and optimize its business model. As a result of this plan, Cognex recorded restructuring, intangible asset impairment, and excess and obsolete inventory charges totaling over $42 million in the second quarter of 2020. Unless indicated otherwise, these charges are reflected in applicable year-on-year comparisons. Additional detail on these charges can be found by referring to the Notes to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Revenue for the second quarter of 2021 totaled $269,158,000, an increase of 59% from the second quarter of 2020, which was adversely impacted by global economic conditions related to the COVID-19 pandemic. The increase came from a broad base of industries, and most notably from the logistics, automotive, and consumer electronics industries. Gross margin as a percentage of revenue improved to 75% for the second quarter of 2021 from 70% for the second quarter of 2020, primarily due to lower provisions for excess and obsolete inventories. Operating expenses decreased by $16,774,000, or 13%, for the second quarter of 2021 compared to the same quarter in 2020, as restructuring and intangible asset impairment charges of $34,369,000 recorded in the second quarter of 2020 did not repeat. Excluding these charges, operating expenses increased by $17,595,000, or 19%, primarily due to higher incentive compensation costs and the impact of foreign currency exchange rate changes, partially offset by savings from cost-cutting measures implemented in 2020. Operating income expanded to 34% of revenue for the second quarter of 2021 compared to an operating loss of 4% of revenue for the second quarter of 2020. Net income was 29% of revenue for the second quarter of 2021, or $0.43 per diluted share, compared to net loss of 1% of revenue for the second quarter of 2020, or $0.01 per diluted share. Results of Operations Revenue Revenue increased by $100,061,000, or 59%, for the three-month period and increased by $171,853,000, or 51%, for the six-month period. This increase reflected a broad-based recovery from the COVID-19 pandemic, which most significantly impacted our business in the second quarter of 2020. Although revenue increased from the prior year in all major industries we serve, the most significant dollar increases came from our three largest markets of logistics, automotive, and consumer electronics. Included in our logistics growth is higher revenue from e-commerce customers that we believe may be benefiting from an online ordering trend that has grown since the COVID-19 pandemic. Growth in other industries also contributed to the increase, including higher revenue from customers in 25 the semiconductor and medical-related industries. Compared to the first quarter of 2021, revenue increased by $30,131,000, or 13%, due largely to the timing of revenue in the consumer electronics industry. Revenue for the second quarter of 2021 was modestly impacted by delays of customer deliveries for certain products due to global supply shortages. From a geographic perspective, revenue from customers based in the Americas increased by 57% for the three-month period and 67% for the six-month period driven by higher revenue in the logistics industry, and to a lesser extent, from applications in medical-related and automotive industries. Revenue from customers based in Europe increased by 67% for the three-month period and 38% for the six-month period as a result of higher revenue from customers in a variety of industries, most notably automotive and logistics. Changes in foreign currency exchange rates accounted for approximately 10% of the revenue increase in both periods, and related to the translation of Euro denominated revenue to U.S. Dollars. Revenue from customers based in Greater China increased by 87% for the three-month period and 68% for the six-month period due largely to higher revenue in the consumer electronics and automotive industries. A portion of the increase was driven by the timing of revenue in the consumer electronics industry, as there was a higher concentration of this revenue in the second quarter of 2021 compared to the second quarter of 2020. Changes in foreign currency exchange rates accounted for a relatively small percentage of the revenue increase in both periods, and related to the translation of Chinese Yuan denominated revenue to U.S. Dollars. Revenue from other countries in Asia increased by 27% for the three-month period and 20% for the six-month period due primarily to higher revenue in the semiconductor and automotive industries. As of the date of this report, we expect revenue for the third quarter of 2021 to be higher than the second quarter of 2021, due primarily to higher revenue from customers in the consumer electronics and logistics industries. Although we expect a sequential increase in revenue from the consumer electronics industry, we expect revenue from this industry to be lower than the prior year. Our estimates for the third quarter of 2021 assume continued delays of customer deliveries for certain products due to global supply shortages. Gross Margin Gross margin as a percentage of revenue was 75% and 76% for the three-month and six-month periods in 2021, respectively, compared to 70% and 73% for the same periods in 2020. The increase in the gross margin percentage was primarily due to lower provisions for excess and obsolete inventories as compared to the prior year. The higher provisions in 2020 took into account the global economic conditions resulting 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 manufacturing efficiencies related to the higher revenue level were partially offset by a greater percentage of total revenue coming from the logistics industry, which has relatively lower gross margins. In addition, we paid higher prices to purchase inventories in the second quarter of 2021 due to global supply shortages that we expect to continue for the remainder of the year. As of the date of this report, we expect gross margin as a percentage of revenue for the third quarter of 2021 to be in the low-to-mid 70% range, but likely lower than the 75% reported for the second quarter of 2021. We expect a sequential decrease due to lower margins from strategic logistics projects, as well continued higher inventory purchase prices. 26 Operating Expenses Research, Development, and Engineering Expenses Research, development, and engineering (RD&E) expenses increased by $905,000, or 3%, for the three-month period and decreased by $936,000, or 1%, for the six-month period as detailed in the table below (in thousands). Three-month period Six-month period RD&E expenses in 2020 $ 30,397 $ 66,343 Personnel-related costs (1,350) (2,637) Stock-based compensation expense 554 (1,014) Foreign currency exchange rate changes 1,215 2,565 Incentive compensation 789 1,551 Other (303) (1,401) RD&E expenses in 2021 $ 31,302 $ 65,407 Personnel-related costs were lower due to a workforce reduction in the second quarter of 2020, partially offset by annual salary increases and higher fringe benefits provided to employees. Stock-based compensation expense decreased for the six-month period due to changes in equity awards over time ( e.g. , increased number of restricted stock units, varied vesting schedules, etc.), as well as the cancellation of awards resulting from the workforce reduction. This decrease was partially offset by credits related to the workforce reduction that were recorded in the second quarter of 2020 and did not repeat, the impact of which resulted in an increase in stock-based compensation expense for the three-month period. Foreign currency exchange rate changes resulted in a higher level of RD&E expenses as compared to the prior year, as costs denominated in foreign currencies were translated to U.S. Dollars at a higher rate. Incentive bonus accruals were higher than the prior year based on management's assessment of the Company's expected performance against relevant full-year goals. RD&E expenses as a percentage of revenue were 12% and 13% for the three-month period and six-month period, respectively, compared to 18% and 20% for the same periods in 2020. 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 the time to market for new products to be critical to our revenue growth. This quarterly percentage is impacted by revenue levels and investing cycles. Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses increased by $16,690,000, or 28%, for the three-month period and $19,976,000, or 15%, for the six-month period as detailed in the table below (in thousands). Three-month period Six-month period SG&A expenses in 2020 $ 60,153 $ 129,291 Incentive compensation 6,214 11,361 Foreign currency exchange rate changes 2,955 5,822 Business system investments 494 1,307 Marketing programs 702 971 Stock-based compensation expense 1,963 449 Personnel-related costs 603 (1,021) Travel expenses 1,749 (195) Other 2,010 1,282 SG&A expenses in 2021 $ 76,843 $ 149,267 The increase from the prior year was due to higher expenses related to annual incentive compensation plans, which include incentive bonuses and sales commissions. Incentive bonus accruals were higher than the prior year based on management's assessment of the Company's expected performance against relevant full-year goals. Likewise, sales commissions increased due to the higher business levels. 27 Foreign currency exchange rate changes resulted in a higher level of SG&A expenses as compared to the prior year, as costs denominated in foreign currencies were translated to U.S. Dollars at a higher rate. Expenses were also higher due to investments the Company is making in business systems related to its sales process, including systems to help our sales team more efficiently manage customer relationships and sales opportunities. A portion of these costs is expensed as incurred, while the majority of these investments will be accounted for as a capital asset that is expected to be placed into service in the first quarter of 2022. The Company also increased spending on marketing programs in an effort to generate future sales opportunities, particularly related to new product introductions. Finally, stock-based compensation expense increased due primarily to credits related to the workforce reduction that were recorded in the second quarter of 2020 and did not repeat, partially offset by decreases due to the impact of forfeiture rates revised in the first quarter of 2021 and changes in equity awards over time. These increases were partially offset by lower personnel-related costs for the six-month period due to the workforce reduction, net of higher costs from annual salary increases and higher fringe benefits provided to employees. For the three-month period, there was a lesser impact due to the timing of the workforce reduction that took place on May 26, 2020. In addition, during the second quarter of 2021, the Company increased its sales headcount in strategic growth areas of the business. Travel expenses were slightly lower for the six-month period, but were higher for the three-month period, as restrictions related to COVID-19 that were still in place in the first quarter of 2021 were eased in certain regions in the second quarter of 2021. Restructuring and Intangible Asset Impairment Charges In the second quarter of 2020, the Company recorded restructuring charges totaling $14,798,000 as a result of actions related to the Company’s restructuring plan, which included a global workforce reduction of approximately 8% and office closures. In addition, the adverse impact of 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. Non-operating Income (Expense) The Company recorded foreign currency losses of $639,000 and $1,647,000 for the three-month and six-month periods in 2021, respectively, compared to foreign currency gains of $336,000 and foreign currency losses of $2,667,000 for the same periods in 2020. 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. Investment income decreased by $1,568,000, or 48%, for the three-month period and $5,243,0000, or 62%, for the six-month period. The decrease was due primarily to lower yields on the Company's portfolio of debt securities. The Company recorded other expense of $127,000 and $295,000 for the three-month and six-month periods in 2021, respectively, compared to other income of $203,000 and $20,000 for the same periods in 2020. Other income (expense) includes fair value adjustments of contingent consideration liabilities arising from business acquisitions. Income Tax Expense (Benefit) The Company’s effective tax rate was 17% and 14% of pre-tax income for the three-month and six-month periods in 2021, respectively, compared to a benefit of 51% of pre-tax loss and an expense of 7% of pre-tax income for the same periods in 2020. The effective tax rate included a decrease in tax expense of $1,431,000 and $6,638,000 for the three-month and six-month periods in 2021, respectively, and $4,413,000 and $6,093,000 for the same periods in 2020, related to stock options, 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 accurately predict the level of stock option exercises by employees in future periods. Other discrete tax items included an increase in tax expense of $535,000 for both the three-month and six-month periods in 2021, and an increase in tax expense of $3,267,000 and $3,509,000 for the three-month and six-month periods in 2020, respectively, 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 an expense of 18% of pre-tax income for both the three-month and six-month periods in 2021, compared to a benefit of 1% of pre-tax loss and an expense of 19% of pre-tax income for the same periods in 2020. The decrease in the effective tax rate for the six-month period, excluding the impact of discrete items, was due to a lower percentage of the Company's pre-tax income being earned and taxed in higher tax jurisdictions. There was an adjustment in the three-month period in 2020 to bring the year-to-date effective tax rate to 19%. 28 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 $951,749,000 as of July 4, 2021. 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 July, 4, 2021 were primarily met with positive cash flows from operations and the proceeds from stock option exercises. Cash requirements consisted of operating activities, the payment of dividends, the repurchase of common stock, and capital expenditures. Cash flows from operating activities included increases in accounts receivable and inventories related to higher business levels. The Company expects inventory levels to continue to increase for the remainder of the year as we receive inventory that we purchased in response to global supply chain challenges. Capital expenditures for the six-month period ended July 4, 2021 totaled $6,550,000 and consisted primarily of computer hardware and software, as well as manufacturing test equipment related to new product introductions. In 2021, the Company is making investments in business systems related to its sales process, the majority of which will be accounted for as a capital asset that is expected to be placed into service in the first quarter of 2022. In October 2018, the Company's Board of Directors authorized the repurchase of $200,000,000 of the Company's common stock. As of July 4, 2021, the Company repurchased 3,075,000 shares at a cost of $142,225,000 under this program, including 258,000 shares at a cost of $20,877,000 during the six-month period ended July 4, 2021, leaving a remaining balance of $57,775,000. 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 this program in future periods depending on a variety of factors, including, among other things, the impact of dilution from employee stock 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 $0.060 per share in the first and second quarters of 2021, totaling $21,192,000. 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 flow 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. 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 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, 2020. 29