Greetings, and welcome to the Cognex Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded I would now like to turn this conference over to your host, Ms.

Susan Conway, Senior Director of Investor Relations. Thank you, ma'am. You may begin..

Thank you. Good evening, everyone. Welcome to our third quarter earnings conference call. With us are Rob Willett, Cognex' President and CEO; and Paul Todgham, Chief Financial Officer. We'll start with prepared remarks, and then we'll open the call for questions.

I'd like to remind you that our earnings release and quarterly report on Form 10-Q are available on the Investor Relations section of our website at www.cognex.com/investor. Both contain detailed information about our financial results.

During the call, you may use a non-GAAP financial measure if we believe it is useful to investors, we think it will help them better understand our results or business trends. You can see a reconciliation of certain items from GAAP to non-GAAP in exhibit two of the earnings release.

Any forward-looking statements we made in the earnings release or any that we may make during this call are based upon information that we believe to be true as of today. However, things can change, and actual results may differ materially from those projected or anticipated.

For a detailed list of risk factors, you should refer to our SEC filings, including our most recent Form 10-K and the Form 10-Q we filed tonight for Q3. Now I'll turn the call over to Rob..

Thanks, Sue. Hello, everyone. Thank you for joining us. As shown in today's news release, Cognex reported the highest quarterly revenue in our 40-year history for the third quarter of 2021. Demand for Cognex products is high worldwide as manufacturers implement machine vision to improve their throughput and the quality of their products.

Revenue grew by 13% over a high-growth quarter in Q3 of 2020. It was at the midpoint of the range we gave as guidance in August. Logistics was again our largest end market in Q3 and the biggest growth driver. We reported another record revenue quarter in logistics, beating the prior record set last quarter.

Demand continues to be strong, particularly in the e-commerce sector where Cognex is widely recognized as the technology leader for machine vision. E-commerce and omnichannel retailers are investing in automation and Cognex' industry-leading products to help them fulfill orders rapidly, reliably and cost effectively.

Furthermore, sectors that struggled in 2020, such as traditional brick-and-mortar retail are investing again in logistics automation to compete more effectively for e-commerce sales. Among other industries we serve, revenue grew well in automotive, semi and medical-related industries, particularly life sciences.

An exception was consumer electronics, which was a substantial headwind in Q3 as expected. You may recall that last year's third quarter included big incremental investments for new smartphone technologies and capacity for online learning and remote work demands that drove substantial growth for Cognex.

This year, consumer electronics revenue is expected to be modestly lower overall and is more balanced between Q2 and Q3. Turning next to gross margin.

The challenging supply environment intensified in Q3, like many companies were encountering record-long component lead times, vendors struggling to supply parts, freight delays and capacity constraints, labor shortages and COVID concerns. At Cognex, customer first is our number one company value.

We prioritize quality and delivery ahead of cost with an eye to delighting customers and maintaining our exceptional reputation. In Q3, we were tenacious in living these values and added significant incremental costs in order to supply customers on time.

While most of the supply chain impact related to higher costs for chips, expedited freight and designing out unavailable components, we also experienced longer delays on some higher-margin product sales that we now expect to recognize as revenue in Q4 and beyond.

Furthermore, we provided a higher level of support on a large deployment by a customer in logistics that we discussed on our August call. We view this as the worthwhile cost of winning share with a customer that we believe has high potential for substantial future business with us.

Combined, these factors reduced our reported gross margin to 70% in Q3. While many companies would applaud a 70% gross margin, we're dissatisfied given the high-value software content in Cognex products. We view the lower-margin business associated with the customer in logistics as a one quarter phenomenon.

However, we anticipate the supply situation will continue to be a drag on our gross margin for the next several quarters. We've taken mitigating actions, including new product designs and pricing initiatives to offset incremental costs at the operating income level.

Supply challenges notwithstanding, there are macro trends underway that we believe will benefit Cognex for years to come. These include the rise of e-commerce, the transition to electric vehicles and the shortening of supply chains.

Coupled with today's cost pressure and labor shortages, market conditions are favorable for automation and machine vision. The excitement was apparent last month at the VISION Show, a major machine vision trade show held in Storgard, Germany. Cognex's booth was busy and well attended.

The show had a more European-centric attendance this year, reflecting challenges of travel to and from the Americas and Asia. We heard very favorable feedback from many manufacturers and automation leaders about our deep learning products.

They're enthusiastic about the power and book foments that Cognex' industry-leading technology provides them as they seek to improve their productivity and product quality. We believe this underscores the value of our long-term development and investment in RD&E.

Cognex' industry-leading vision and ID technologies are key differentiators for us in solving our customers' most challenging applications as they implement automation. Now, I will hand the call over to Paul for details of the quarter..

Thanks, Rob, and hello, everyone. Revenue for Q3 was $285 million. As Rob mentioned, that's a new record for quarterly revenue, surpassing the prior record set last quarter. As expected, the growth rate moderated in Q3 from the 30-plus percent pace that we reported for the previous four quarters.

We delivered revenue at the midpoint of our expected range in a difficult supply environment. It's worth noting that revenue was 55% above the pre-COVID period of two years ago.

Two of our three largest end markets, logistics and automotive, made strong contributions to year-on-year growth, other sectors also grew at a good clip, including Life Sciences and semi. As expected, consumer electronics was a substantial headwind in the quarter.

Even though Q3 was our largest revenue-generating quarter for consumer electronics this year, it was down significantly from last year, primarily due to the timing of the industry's annual spend. Reported gross margin for Q3 was 70% and lower than both Q3 of 2020 and the prior quarter. It was also at the low end of our guidance range.

As Rob mentioned, an unfavorable revenue mix and higher supply chain costs contributed to a gross margin that was below what we typically report. There were three parts to the unfavorable revenue mix. First, we made a strategic decision around a major deployment by a high potential customer in logistics that was completed in the quarter.

Second, shipments of certain higher-margin products were delayed due to supply constraints. And third, we were able to fulfill logistics orders earlier than anticipated in the current supply environment. Remember that logistics is an emerging market for machine vision.

Our gross margin in that sector is improving but is currently lower than our business overall as the market develops. Regarding supply, we are incurring higher costs to secure components and expedite customer orders. We anticipated some of that in our guidance.

However, the supply situation intensified more than expected as we move through the quarter and continues to be a headwind for us. Operating expenses increased by 3% on a sequential basis which is at the low end of our guidance range.

Looking year-on-year, operating expenses increased by 18% over Q3 of 2020, which was a particularly low quarter due to our restructuring actions the previous quarter. Higher costs included incremental investments in sales and engineering headcount and variable incentive compensation.

We also experienced an unfavorable impact from currency exchange rate fluctuations. Operating margin was a healthy 31% in Q3 of 2021, even so, it compares unfavorably with an exceptional 38% in Q3 of 2020 and 34% in the prior quarter due to this quarter's lower gross margin and higher operating expenses.

Regarding the tax provision, we recorded substantial discrete tax items in all periods that make comparisons difficult. In Q3 of 2021, discrete items combined for a net benefit of $6 million. The effective tax rate, excluding discrete tax items, was 18% in both Q2 and Q3 of 2021 and in Q3 of 2020.

Reported earnings were $0.44 per share in Q3 compared with $0.49 in Q3 of 2020 and $0.43 in Q2 of 2021. On a non-GAAP basis, earnings were $0.40 per share in Q3 compared with $0.47 in Q3 of 2020 and $0.43 in Q2 of 2021. That's excluding discrete tax items and restructuring and other charges that we removed for comparison's sake.

Looking at the change in revenue for Q3 from a geographic perspective, revenue from the Americas increased by over 30% year-on-year and delivered the largest contribution in absolute dollars due to growth in logistics. In Europe, revenue increased by 8% and that includes a 1 percentage point contribution from currency exchange rates.

Strong growth in logistics, automotive, consumer products and other industries in Europe's broad factory automation market, was largely offset by a decline in revenue from consumer electronics.

Revenue from Asia increased by 1% year-on-year, continued growth in automotive, logistics, semi and the broader market, plus a 5 percentage point contribution from currency exchange rates was offset by lower revenue from consumer electronics. Turning to the balance sheet.

Cognex continues to have a strong cash position with $985 million in cash and investments and no debt. We spent $27 million to repurchase Cognex stock in Q3, and a total of $48 million year-to-date. We plan to continue to buy back stock in Q4 at a regular pace, while maintaining flexibility to be more opportunistic.

As we announced tonight, our Board of Directors has increased the quarterly cash dividend by 8% to $0.065 per share. We believe this demonstrates their continued confidence in Cognex' financial strength and long-term growth prospects. The dividend is payable on December 3 to all shareholders of record on November 19.

Also noteworthy on the balance sheet is the increase in our inventory balance this year. We are bringing in components to support customer orders and replenish some strategic inventory and we're doing so at higher costs. Now I'll turn the call back over to Rob..

Thank you, Paul. Moving next to guidance. We expect revenue for the fourth quarter will be between $210 million and $230 million. At the midpoint, we expect revenue will be relatively flat year-on-year. We expect consumer electronics and logistics will be quieter in this year's final quarter.

Last year in Q4, we reported growth exceeding 30% year-on-year for Cognex overall due to higher spending by customers in those end markets. In consumer electronics, we expect annual revenue in 2021 will be modestly lower overall, and we believe that will play out in Q4 as well.

In logistics, we expect a low growth quarter primarily because customers are digesting large deployments of Cognex products as they turn their attention to fulfilling orders for the upcoming holiday season. Another factor we considered in our revenue guidance was the supply environment.

We believe the situation will continue to be challenging and constrained revenue growth in Q4. We expect to exit the year with a substantial backlog. Looking at gross margin, we believe the higher supply chain costs we're incurring for components and freight will continue to flow into cost of goods sold.

As a result, we believe gross margin in Q4 will be in the low 70% range. I want to point out that we've not changed our long-term gross margin target from the mid-70% range. In the near term, we expect our pricing actions to roughly offset the gross margin dilution at the operating income level.

Longer term, we expect our gross margin will return to our mid-70% target range as the higher cost to expedite component deliveries proceeds. We expect operating expenses will increase by mid-single digits on a sequential basis. We expect higher spending around various growth initiatives within Cognex.

This includes adding resources and engineering and sales, furthering new product development and increasing sales and marketing activities. Lastly, we expect the effective tax rate will be 18%, excluding discrete tax items. Now, we will open the call for questions. Operator, please go ahead..

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Josh Pokrzywinski with Morgan Stanley. You may proceed with your question..

Good evening, Rob, Paul and Sue. Just for question on logistics.

I guess how large was this pull forward in 3Q? And how are you seeing kind of that market evolve maybe more downstream? Obviously, a lot of stuff has to come together for these implementations? Like are there bottlenecks that are beyond the scope of Cognex projects that are holding up that supply chain as well?.

Well, Q3 was our largest revenue quarter ever in logistics, and it did benefit from some customers wanting product from us sooner, right? So I'm not sure that we want to cite that specifically, I'll ask call in a moment. But we did benefit from some of that.

To answer your question, certainly, deployment in logistics does depend on integrators and their readiness to implement more complicated systems and integrations downstream from us. So that can dictate some of the timing on the implementation of systems. Broadly, I think our supply is being pretty good, very good in that industry.

So, I don't consider that being much of a drag on what we wanted to do. It's been more downstream from us in terms of customers, willingness to receive products and integrate as readiness to integrate it. And that certainly had been delays I would say downstream from us to some paths, some of the implementation for our customers.

And in terms of the revenue outlook, Josh, In Q2, I think we quoted that we believe supply constraints held us up by about 5% in revenue growth in the quarter. And we'd assumed roughly a similar drag in Q3, kind of 5% of orders that were pushed out that would be harder to fulfill.

It ended up being a little larger than that in certain supply situations intensified and the logistics but we were able to partially offset that by more favorable supply conditions in logistics.

So again, it was small, it was sort of a moderate impact, but it was a modest benefit against other decreases in ability to supply customers as quickly as we expected..

Got it. That's super helpful color.

And then we've just heard from some of your distributors that the model there is maybe changing a bit more direct anything from like a corporate level that you guys are doing differently with respect to your distributors and kind of direct sales force as you guys have kind of expanded the business and found some of these new markets?.

No, I don't think there's anything radical to communicate there. I would say about 70% of our business currently is moving through direct sales overall. And certainly, every year, we evaluate our distributors, and we're looking for those who can provide more value added and are investing in that business.

So it's a continual process of evaluating those relationships going forward. But I don't think there's a major change. We have some great partners who supply products in locations and into industries that they serve very, very well, and they're a very important part of our model..

Our next question comes from the line of Jacob Levinson with Melius Research. You may proceed with your question..

If we could just spend a second on the consumer electronics side, I know there's usually some volatility in that market depending on your customers' investment cycles, but at the risk of getting ahead of ourselves here.

Is that a market that gets better going into 2022? Or do you have any visibility in what's coming down the pipeline there over the next couple of quarters?.

Yes, I'll add some color. We don't really give guidance for '22 and often what happens is we have a clearer view of how the electronics market is shaping up, normally around our April conference call. So that in May, that's when we would sort of share more of the view for the year.

I would say this -- excuse me, it's been a lackluster year to consumer electronics after growing more than 30% in 2020.

Unlike last year, customers -- our customers are focused on upgrading existing lines and not making big incremental investments for new smartphone technologies and new capacity for online learning and remote work demands, this is a market that can cycle. And so often in the past, after lower years, we have more higher periods of investment.

It's too soon to make that call currently. But manufacturers turn to us to help them bring new products to market and to realize productivity and quality gains.

So example of things that we would do for them, help them as they miniaturize products and how they bring new technologies that are challenging to assemble such as wireless charging stations, micro LED displays, smart watches, virtual and augmented reality headsets.

As they look to eliminate cosmetic defects and as they implement automation in a world of labor shortages and less desirable jobs and health concerns around the world. And I see demand for those continuing to be very strong for a long period.

It's more of a matter of how they play out in investment cycles, this year with the down cycle after a pretty good upcycle last year..

Okay. That's helpful. And just switching gears quickly to the auto side of things. It feels like every day, we get a new mega project around electric vehicles and battery manufacturing.

On the battery side, I mean, is that a market where you see the same kind of upside potential in terms of applying machine vision as you would get in traditional combustion platforms or other big verticals for you guys like consumer electronics for that matter in terms of the content?.

So certainly, EV battery manufacturing is a really attractive and high potential market for Cognex. We continue to see automakers crystallized investment plans towards battery manufacturing and retrofitting of existing assembly capacity towards EVs.

We're having a very strong year in automotive and certainly the EV part of it and the battery part of it is a very major contributor towards that.

Longer term, for Cognex, we see this continuing, and we see more and more applications for our world-leading deep earnings for inspection and increasing the use of electronics in automobiles, definitely driving further revenue for us.

So, after what was really a couple of difficult years for us in automotive in '18 and '19, we're really starting to see a very healthy this year and a lot of optimism, I think, about what we're going to be able to do for those customers, particularly around EV in the medium to long term..

Our next question comes from the line of Joe Ritchie with Goldman Sachs. You may proceed with your question..

So I think my first question really just wanted to understand the pricing dynamics and the gross margin dynamics over the next several quarters. So clearly, it sounds like you're not really putting through any surcharging and at this juncture, feeling it in the margins for all the increased logistics costs.

Is there may be potentially going to be like a change of philosophy going forward given what you're seeing from a freight perspective? And then secondly, on gross margins over the next several quarters, will we be kind of in the low 70s for the next few quarters because of the decrease inflationary costs?.

Yes, let me -- I'll kick it off. It's Rob, and then I'll invite Paul to comment. So we've taken actions that we implemented at the -- in the latter part of last quarter, which we think have been pretty well received in the marketplace. And we're pleased with how we've implemented them.

And we think on a dollar level, it's going to offset the gross margin dilution we're seeing from supply chain costs that are hitting us. We think those supply chain costs are temporary. They may go on for a number of quarters.

But certainly, some of the actions we've had to take around expediting freight or paying for paying very high prices in -- from brokers and in the gray market to make sure we can supply on time. We don't think those are going to be things that are going to continue for many quarters, but certainly for a few.

So that's kind of how we're seeing it overall. I'll invite Paul to comment more on some other surcharges and situations that we're seeing..

Sure. Yes. And Joe, I think to understand our gross margin outlook, at least for Q4, it helps to understand Q3 and we can speak in comparison and then we won't go into any detail about next year, except for just to say that we think it will be challenging through the first half of next year.

So in Q3 we think about our business as having a typically kind of mid-70s, 75% gross margin, and there were really three factors in Q3 that brought us down to the 70%. And they were roughly equal or keep it simple. So the first was helping this customer in logistics deploy a large installation of our technology.

So that's both kind of idiosyncratic to Cognex and also specific to Q3, and that was expected. It was built -- it was reflected in our guidance and will not repeat. Second, we are incurring higher costs, particularly for components and freight to ensure customer deliveries, and that was mostly expected in our guidance, too.

And then third, supply constraints did disproportionately affect sales of our higher-margin products in the quarter, which led to a higher percent of sales in logistics broadly. So that resulted in a less favorable revenue mix. And that was largely unexpected. So that's why we were on the lower end of our guidance for Q3.

If we then turn to Q4 and you think about those three factors, the first factor goes away. The second factor intensifies, and the third factor largely goes away as well. So it really is that second factor getting a little bigger. So that led us to give guidance at the low 70% range, but we do expect we'll do better than we delivered this quarter.

In terms of the pricing, as Rob said, we're looking to offset these incremental costs, most of which we believe are temporary at the operating income level. So naturally, that's going to have somewhat of a dilutive impact on price -- on gross margin in the near term. You can build a simple model of it.

But essentially, you offset about 1/3 of your gross margin impact, but you offset 100% at the operating income dollar level..

Got it. That's super helpful. And then maybe just one follow-on, I notice you have some reasonable visibility in a given year on your electronics growth rate for a year, typically around the March, April plan frame. I guess just given the supply chain issues that, that specific end market is experiencing.

I don't know, how do you think about 2022? Is it in your conversations with your customers, do you think you're going to have reasonable visibility by then? Or is it too early to tell at this point?.

I would expect we'll have a good sense of how things are shaping up by the time we talk with you in early May. Yes, I think we're really part of their implementation plans. We have very long and deep relationships with many of the major players in that industry, and we'll be able to give you, I think, I expect visibility at that point..

Our next question comes from the line of Joe Giordano with Cowen & Co. You may proceed with your questions..

Hey, this is Robert in for Joe. I just wanted to know if you could quantify how much revenue, wasn't recognized in the quarter due to some of the supply component shortages on those high margin products? That'd be helpful..

Yes. I mean, again, we went in thinking we might have about a 5% constraint to growth on the quarter, and in the end, you may be faced about $10 million more an incremental revenue that was pushed to subsequent quarters. So combined kind of we're in that general range to look at our basis, it's kind of a little about $20 million or so..

Okay. That's helpful. And then I know you said backlogs elevated going into end of the year.

Was there any change in placing orders from customers like towards the end of the quarter, as these supply chain issues kind of increased?.

Yes. We’ve certainly seen a dynamic. I wouldn't say it's around the end of the quarter. We've seen a dynamic where customers are giving us orders with longer lead times because I think they're concerned about supply generally and they're trying to plan their own implementations with some more reliability.

So that's a dynamic I see, that's been going on, I'd say, for certainly more than a quarter now, more than three months in terms of what we see. It's helping actually helping give us visibility, so we can supply them reliably. But that was not an end-of-the-quarter phenomenon..

Okay. No, that's helpful. And then just one more, if I may.

Just Rob, just on the deep learning step that you mentioned, just is that still on track to be around your aspirational goal of 100% growth this year? And how is that kind of looking?.

I don't think we're going to give specific forecast by product area. I would say we're very pleased with that technology and how it's performing, and we're seeing extraordinary and strong growth in that area.

The only areas where it may not be growing as quickly as we would aspire to would be in consumer electronics where deployment of it is somewhat correlated to the slightly down year we're seeing in that industry. But that's a long-term play for us, and we're very pleased with the progress we're making with the technology..

[Operator Instructions] Our next question comes from the line of Andrew Buscaglia with Berenberg Capital Markets. You may proceed with your question..

So automotive last quarter perked up the first time in a while, was about your fastest-growing segment again? And then you mentioned life sciences picking up.

What exactly drove that?.

Yes. So I think we're seeing a strong year for automotive, and it certainly was another strong quarter. I think I mentioned earlier that logistics really is our fastest-growing market, certainly. And I think I'm right in saying that it was fastest growing market last quarter also.

But we've seen a really nice strong rebound in automotive this year, which is very pleasing..

Yes. Automotive was accretive to our growth rate in the quarter but didn't compare with the growth rate we had in logistics and the dollar contribution of logistics..

And then turning to your question about Life Sciences. Life Sciences is a market we've been kind of working away out hard for a very long period, and it's sort of an OEM market where one is specified into life science OEM machine builders, big names in the medical and life science world.

And we measure our success internally by design wins, and that's the number of machines that we get specified into. And then we've been having really a lot of success in design win over a number of years, approximately 20 design wins per year.

And what we're seeing, as I think we expected is, those design wins are turning into revenue and orders and bookings, sometimes three, four years after we've been selected to supply those customers and the rollout of their products.

And their products are machines that are used in hospitals and medical facilities to analyze medical samples often blood for instance. And so, what we're seeing is that those products that are entering the market and are starting to purchase from us. And what I really like about that business, so I like many things about that business.

But what I really like is the consistency and long-term prospects for those orders. We expect those machines to have about a 7- to 11-year life, and we expect to see pretty reliable business from them, and it's coming in nicely.

It's outgrowing Cognex overall, and I think it will provide a nice repeating, consistent additional revenue stream for us over a very long period when we continue to win design wins..

Okay. That's helpful. And you mentioned you were at the VISION Show recently.

I'm wondering what some of the commentary from customers around maybe some of the newer setting things you're working on with AI deep learning? And then maybe any commentary or any update around plans for kind of getting into more subscription-based services that I think you guys alluded to back in your past Analyst Day?.

Yes. So, it's normally a once every two-year show, it's in Stuttgart, Germany called the VISION Show, it's kind of industries get together, I would say where it's a lot of technology companies coming as well. And so it's a great venue in which to see the industry.

And I was pretty pleased with what I saw there in terms of how our plans are resonating with customers and with the other technology I see at other companies in the industry. We heard a lot about our deep learning capabilities. We need with some of the most sophisticated customers and is very engineering focused, who comes to that meeting.

And I certainly heard a lot about the power of our tools, how they're getting easier to implement and how they fit into overall product road maps for big automotive companies, Tier 1 automotive suppliers, electronics companies, particularly, but a whole range of machine builders and how they are those technologies roll out in their road maps.

And it was pleasing to hear them say that they see this as an area where they plan to invest and where they see us as the strong technology leader in the industry. So, there's certainly something that, and then you had a second part to your question, recurring revenue. Yes.

So -- we do see -- we do have a small amount of recurring revenue, particularly around software licensing and our business for vision software and for deep learning capabilities. And we're seeing that kind of come into the business, but it's not a material part of our business.

It's going to be a long road, I think, for us to generate substantial recurring revenue, but it is a focus for us. It is designed to our road maps and we are getting it, I think, as we expected..

We also launched our Edge Intelligence product, which has also has a recurring revenue component to it. And then, actually tied back to your Life Sciences question, Andrew, even though Life Sciences from a revenue recognition point of view is not strictly speaking subscription or recurring revenue.

There's a predictability to it that I think does actually sort of help us and drive that recurring revenue, again, even if the accounting treatment is a little different..

[Operator Instructions] We have reached end of today's call. I would now like to turn this call back over to Mr. Rob Willett for closing comments..

Well, I'd like to thank everyone for joining us tonight, and we look forward to speaking with you again on next quarter's call. Good night..

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time..