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 demand and order rates and timing of related revenue, managing supply shortages, future product mix, restructuring and other cost-savings initiatives, research and development activities, sales and marketing activities, new product offerings, capital expenditures, investments, liquidity, dividends and stock repurchases, strategic and growth 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; (6) disruptions in the supply chain, which could impact timely delivery of customer orders, cause customer orders to decrease, or increase costs to fulfill orders, including costs for components or freight; (7) the failure to effectively manage product transitions or accurately forecast customer demand; (8) the inability to design and manufacture high-quality products; (9) the inability to attract and retain skilled employees and maintain our unique corporate culture; (10) the failure to effectively manage our growth; (11) the inability to achieve growth in revenue and profits from the logistics industry; (12) the technological obsolescence of current products and the inability to develop new products; (13) the failure to properly manage the distribution of products and services; (14) the impact of competitive pressures; (15) the challenges in integrating and achieving expected results from acquired businesses; (16) potential disruptions in our business systems; (17) information security breaches and cyber-attacks; (18) the inability to protect our proprietary technology and intellectual property; (19) potential impairment charges with respect to our investments or acquired intangible assets; (20) exposure to additional tax liabilities; (21) fluctuations in foreign currency exchange rates and the use of derivative instruments; (22) our involvement in time-consuming and costly litigation; (23) unfavorable global economic conditions; and (24) 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. Revenue for the third quarter of 2021 totaled $284,848,000, an increase of 13% from the third quarter of 2020. The 25 increase was due to significantly higher revenue from the logistics industry, which was our largest and fastest-growing market in the third quarter of 2021, partially offset by lower consumer electronics revenue that was primarily driven by the timing of large customer deployments. Gross margin as a percentage of revenue was 70% for the third quarter of 2021 compared to 76% for the third quarter of 2020, primarily due to an unfavorable revenue mix, as well as higher prices paid to purchase inventories in the third quarter of 2021. Operating expenses increased by $16,892,000, or 18%, for the third quarter of 2021 compared to the same quarter in 2020, which had relatively low operating expenses due to our restructuring actions in the second quarter of 2020. The increase was due, in part, to higher personnel-related costs, which included the impact of headcount additions to support our future growth plans, as well as higher incentive compensation costs and the impact of foreign currency exchange rate changes. As a result of the lower gross margin percentage and higher operating expenses, operating income decreased to 31% of revenue for the third quarter of 2021 from 38% of revenue for the third quarter of 2020. Net income was 28% of revenue for the third quarter of 2021, or $0.44 per diluted share, compared to 35% of revenue for the third quarter of 2020, or $0.49 per diluted 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 increased by $33,775,000, or 13%, for the three-month period and increased by $205,628,000, or 35%, for the nine-month period. The most significant increase came from customers in the logistics industry, particularly in the e-commerce and omni-channel retail sectors. Growth in the automotive, semiconductor, medical-related, and consumer products industries also contributed to the increase. The increases in these industries were partially offset by a decrease in revenue from the consumer electronics industry. A higher concentration of consumer electronics revenue from large customer deployments in the third quarter of 2020 resulted in a more significant decrease in revenue in this industry for the three-month period in 2021. We believe the increases in revenue for the three-month and nine-month periods would have been moderately higher were it not for global supply shortages that continued to delay customer deliveries of certain products and worsened throughout the quarter. Based in part on product availability, the Company was able to fulfill customer orders in the logistics industry in the third quarter of 2021 that were originally expected to be fulfilled in the fourth quarter of 2021, which lessened the impact of delays of other customer deliveries during the third quarter. From a geographic perspective, revenue from customers based in the Americas increased by 32% for the three-month period and 53% for the nine-month period driven primarily by higher revenue in the logistics industry. Revenue from customers in medical-related industries was also notably higher for nine-month period. Revenue from customers based in Europe increased by 8% for the three-month period and 26% for the nine-month period. Changes in foreign currency exchange rates resulted in a higher level of reported revenue in 2021, as sales denominated in Euros were translated into U.S. Dollars at a higher rate. Excluding the impact of foreign currency exchange rate changes, revenue from customers based in Europe increased by 7% for the three-month period and 20% for the nine-month period. The increase came from customers in a variety of industries, most notably logistics, automotive, and consumer products, partially offset by lower revenue in the consumer electronics industry. The decline in revenue from consumer electronics was partially a result of procurement changes made by certain customers, shifting their purchases to China from Europe. Revenue from customers based in Greater China decreased by 15% for the three-month period and increased by 21% for the nine-month period. Changes in foreign currency exchange rates resulted in a higher level of reported revenue in 2021, as sales denominated in Chinese Renminbi were translated into U.S. Dollars at a higher rate. Excluding the impact of foreign currency exchange rate changes, revenue from customers based in Greater China 26 decreased by 22% for the three-month period and increased by 13% for the nine-month period. Although revenue increased in a variety of industries over the prior year, most notably automotive and semiconductor, this increase was offset by a decrease in consumer electronics revenue for the three-month period, as there was a higher concentration of this revenue from large customer deployments in the third quarter of 2020 as compared to the third quarter of 2021. Revenue from other countries in Asia increased by 48% for the three-month period and 28% for the nine-month period due to higher revenue in a range of industries, including automotive and semiconductor. As of the date of this report, we expect revenue for the fourth quarter of 2021 to be lower than the third quarter of 2021 and relatively flat with the fourth quarter of 2020. The decrease from the third quarter of 2021 is expected to result from lower revenue in the consumer electronics and logistics industries, due particularly to the timing of large customer deployments in these industries, as well as the earlier fulfillment of customer orders in the logistics industry in the third quarter of 2021. Revenue in the fourth quarter of 2020 benefited from higher consumer demand for electronic products that we believe related to the COVID-19 pandemic. Our current expectations regarding revenue for the fourth quarter of 2021 assume continued delays of customer deliveries for certain products due to global supply shortages that we believe will continue throughout the quarter, while similar challenges did not exist in the prior year. Gross Margin Gross margin as a percentage of revenue was 70% and 74% for the three-month and nine-month periods in 2021, respectively, compared to 76% and 74% for the same periods in 2020. The decrease for the three-month period was primarily due to an unfavorable revenue mix. This decrease was a result of delays of higher-margin product sales due to global supply shortages, as well as a greater percentage of total revenue coming from the logistics industry, which has relatively lower gross margins. Logistics revenue for the third quarter of 2021 included some comparatively lower margins from strategic logistics projects. The decrease for the three-month period was also due to higher prices paid to purchase inventories in 2021 due primarily to global supply chain constraints, including higher costs for components and freight, that we expect to continue for several quarters. For the nine-month period, the unfavorable impact of a higher percentage of logistics revenue and higher inventory purchases prices was offset by lower provisions for excess and obsolete inventories as compared to the prior year and manufacturing efficiencies related to the higher revenue level. The higher provisions for excess and obsolete inventories in 2020 took into account the global economic conditions resulting 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 2021 to be in the low-70% range. We expect to have a more favorable revenue mix in the fourth quarter of 2021 as compared to the third quarter of 2021. We also expect higher inventory purchase prices in the fourth quarter of 2021 as compared to the third quarter of 2021. Operating Expenses Research, Development, and Engineering Expenses Research, development, and engineering (RD&E) expenses increased by $4,236,000, or 14%, for the three-month period and $3,300,000, or 3%, for the nine-month period as detailed in the table below (in thousands). Three-month period Nine-month period RD&E expenses in 2020 $ 30,240 $ 96,583 Foreign currency exchange rate changes 492 3,057 Incentive compensation 377 1,928 Outsourced engineering services 1,171 950 Personnel-related costs 1,506 (1,131) Other 690 (1,504) RD&E expenses in 2021 $ 34,476 $ 99,883 RD&E expenses increased due to foreign currency exchange rate changes, as costs denominated in foreign currencies were translated into U.S. Dollars at a higher rate. Incentive bonus accruals were also higher than the prior year based on management's assessment of the Company's expected performance against relevant full-year goals. Higher spending on outsourced engineering services due to the timing of product development activities, 27 including engineering prototypes for large sales opportunities, also contributed to the increase. These increases were partially offset by lower personnel-related costs for the nine-month period due to a workforce reduction in the second quarter of 2020. Higher costs from annual salary increases and fringe benefits provided to employees, as well as headcount additions to support new product initiatives, partially offset the lower costs from the workforce reduction in the nine-month period and resulted in an increase in costs for the three-month period. RD&E expenses as a percentage of revenue were 12% and 13% for the three-month period and nine-month period, respectively, compared to 12% and 16% 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 $12,907,000, or 20%, for the three-month period and $32,883,000, or 17%, for the nine-month period as detailed in the table below (in thousands). Three-month period Nine-month period SG&A expenses in 2020 $ 64,206 $ 193,497 Incentive compensation 2,931 14,292 Foreign currency exchange rate changes 1,207 7,029 Personnel-related costs 4,313 3,292 Business system investments 624 1,931 Stock-based compensation expense 1,037 1,486 Marketing programs 455 1,426 Recruiting costs 524 1,187 Travel expenses 949 754 Other 867 1,486 SG&A expenses in 2021 $ 77,113 $ 226,380 SG&A expenses increased 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. Personnel-related costs increased due to higher costs from annual salary increases and fringe benefits provided to employees, as well as sales headcount additions in strategic growth areas of the business. The increase was more significant in the three-month period than in the nine-month period due to the impact of the workforce reduction that took place in the second quarter of 2020. In addition to salaries and fringe benefits, these personnel-related costs included sales commissions and travel expenses related to the additional headcount. The headcount additions also drove higher recruiting costs. 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 into 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. In addition, stock-based compensation increased as a result of changes in equity awards over time (e.g., increased number of restricted stock units, varied vesting schedules, timing of awards, etc.), partially offset by decreases due to the impact of forfeiture rates revised in the first quarter of 2021. Stock-based compensation expense for the nine-month period also increased due to credits related to the workforce reduction that were recorded in the second quarter of 2020 and did not repeat. The Company also increased spending on marketing programs in an effort to generate future sales opportunities, particularly related to new product introductions, and incurred higher travel expenses as restrictions related to COVID-19 continued to ease in certain regions. 28 Restructuring and Intangible Asset Impairment 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 Company recorded restructuring charges of $251,000 and $15,049,000 for the three-month and nine-month periods in 2020, respectively, as a result of actions related to the 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 $586,000 and $2,233,000 for the three-month and nine-month periods in 2021, respectively, compared to foreign currency gains of $2,357,000 and foreign currency losses of $310,000 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 $742,000, or 30%, for the three-month period and $5,985,0000, or 54%, for the nine-month period. The decrease was due primarily to lower yields on the Company's portfolio of debt securities, partially offset by higher invested balances. The Company recorded other expense of $125,000 and $420,000 for the three-month and nine-month periods in 2021, respectively, compared to other expense of $173,000 and $153,000 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 11% and 13% of pre-tax income for the three-month and nine-month periods in 2021, respectively, compared to 14% and 12% for the same periods in 2020. The effective tax rate included a decrease in tax expense of $3,250,000 and $9,888,000 for the three-month and nine-month periods in 2021, respectively, and $4,354,000 and $10,447,000 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 a decrease in tax expense of $3,012,000 and $2,477,000 for the three-month and nine-month periods in 2021, respectively, and an increase in tax expense of $129,000 and $3,638,000 for the same 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 18% of pre-tax income for the three-month and nine-month periods in both 2021 and 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 $985,386,000 as of October 3, 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 nine-month period ended October 3, 2021 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. Cash flows from operating activities included an increase in inventories to support higher business levels and to secure key strategic components. The Company expects inventory levels to continue to increase for the remainder of the year as we receive inventory that we are purchasing in response to global supply chain challenges. Capital expenditures for the nine-month period ended October 3, 2021 totaled $10,689,000 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. 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 29 common stock. As of October 3, 2021, the Company repurchased 3,398,000 shares at a cost of $169,643,000 under this program, including 581,000 shares at a cost of $48,294,000 during the nine-month period ended October 3, 2021, leaving a remaining balance of $30,357,000. 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, second, and third quarters of 2021, totaling $31,800,000. 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.