Greetings and welcome to the Cognex Third Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Susan Conway, Senior Director of Investor Relations. Thank you. You may begin.

Good evening, everyone. Thank you for joining us today. With us are Cognex’s Chairman, Dr. Bob Shillman; President and CEO, Rob Willett; and Chief Financial Officer, Paul Todgham. I’d like to point out that our earnings release and quarterly report on Form 10-Q are available on our Investor Relations website at www.cognex.com/investor. Both contain highly detailed information about our financial results. During the call, we may use a non-GAAP financial measure if we believe it is useful to investors or if we believe it will help investors better understand our results or business trends. You can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 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. Things often change however 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 subsequent quarterly reports on Form 10-Q. Now, I’d like to turn the call over to Dr. Bob.

Thanks, Sue, and hello everyone. I am actually physically here with the team at this time. And I’m happy to be here enjoying the beautiful fall colors. Not so happy to experience the gray rainy weather, but it does remind me why I left many years ago for Southern California. Well, as shown in the news release earlier today, we reported terrific results. Q3 was the second highest quarterly revenue in our 39-year history, along with terrific profitability. In addition, Cognex’s Board of Directors increased the quarterly cash dividend to $0.06 a share. And the dividend increase demonstrates our confidence in Cognex’s financial strength and long-term growth prospects despite the current difficult business environment. Now, you’re not here just to hear that -- those platitudes, you’re here to hear more details. And for those, I’m going to turn it over to my partner Cognex’s CEO, Rob Willett. And Rob, the microphone is now yours.

Thank you, Dr. Bob, and good evening, everyone. Cognex reported strong results for the third quarter. Revenue was $251 million, which represents 37% growth year-on-year. We were highly profitable reporting an operating margin of 38%. The 14-point increase over Q3 of 2019 demonstrates the substantial operating leverage we have in our business model. Earnings for the quarter more than doubled year-on-year to $0.49 per share. We expected Q3 to be our best quarter of the year. And it even exceeded our expectations that we gave the guidance last quarter. This high level of achievement was made possible by the efforts of Cognoids around the world. They worked hard to meet the increased demands of some of our existing customers to win new customers and to successfully manage our own supply chain during these difficult times. Because of their efforts, we won more orders than we expected during Q3, particularly in the Americas. Also, we met accelerated delivery requirements from existing customers concerned about potential disruption in Q4. Consumer electronics delivered impressive growth in the quarter. Revenue from this market has an annual cycle with large revenue generating quarters typically in Q2 or Q3. This year, that happened in Q3. Much of our revenue in consumer electronics relates to the assembly of smartphones and the manufacturing of related components. However, this year, online learning and the work-from-home dynamic are making a notable contribution. People need tablets, laptops and wearable devices for a world where connecting virtually has become even more important. Cognex machine vision is enabling the precise and rapid manufacturing of those products. In logistics, we reported another record revenue quarter due to continued strong demand in the e-commerce sector. We delivered on both recent orders as well as on a backlog of orders. Major e-commerce and big-box retailers are…

Thanks, Rob, and hello, everyone. Obviously this was a busy quarter both professionally and personally. My wife and kids and I packed up our home in the San Francisco Bay Area and moved to a new home near Cognex’s headquarters. We are excited to see the house when we arrived because we literally had never physically seen it. I generally wouldn’t recommend buying a home based on photos, floor plan and a FaceTime call with a realtor, but it went well. I think we’re all doing things during COVID that we never expected we do. Turning now to our results. Revenue for the third quarter was $251 million, which represents substantial growth both year-on-year and sequentially and was significantly higher than the guidance we gave you last quarter. Growth came from consumer electronics and e-commerce sector of logistics, where revenue from a few large customers was even stronger than we expected. In the broader factory automation market, we successfully fulfilled a stronger than anticipated pick-up in demand and accelerated customer delivery requests that were previously scheduled for Q4. And new COVID-related business that Rob just spoke about contributed nicely. Automotive remained a drag for considerably less so than in Q2. Gross margin was 76%, which was higher than we expected and an increase over both Q3 of 2019 and the prior quarter. And that is even after excluding an $8 million excess inventory charge we took in Q2. The stronger performance was due to a favorable product mix and leverage on higher volume. Gross margin and logistics, while still dilutive to the company overall, continues to improve. As we discussed three months ago, we recorded one-time charges in Q2 for a restructuring and a write-down of intangible assets that totaled approximately $35 million. Restructuring charges in Q3 were very modest…

Thank you, Paul. In summary, Cognex had a strong third quarter, but the substantial consumer electronics revenue we expect in Q3 is behind us for this year. It would likely be several quarters until we report revenue as high as we did in Q3. We believe revenue for Q4 will be between $190 million and $210 million, which represent an increase year-on-year due to growth in consumer electronics, logistics, medical-related industries and semi. Automotive is improving but remains at a significantly lower level than in recent years. There also continues to be a high degree of uncertainty in today’s environment and business conditions are difficult overall. Gross margin is expected to be in the mid-70% range and lower than we reported for Q3, given the expected increase in logistics revenue as a percentage of total revenue. Operating expenses are expected to increase by mid-single digits on a sequential basis and to decline year-on-year due to cost saving measures and lower travel and entertainment costs. Lastly, the effective tax rate is expected to be 18%. That excludes all discrete tax items such as the expected $12 million benefit described earlier by Paul. Now, we will open the call up for questions. Operator, please go ahead.

[Operator Instructions] Our first question comes from the line of Josh Pokrzywinski with Morgan Stanley.

Hi, good evening, all. I guess first question on the consumer electronic strength, which was pretty notable, I guess, pretty consistent with what we've seen and heard out of the supply chain constraints, low inventory lead times extended out so things like PCs and notebooks. Yes, I guess first question, how long do you expect that to continue? And what of your customers told you about your kind of future investments, they're given that this is not something that they would have anticipated, six, nine months ago, either.

But I'd say this is a good year for consumer electronics, not a great year, like 2017. And it's changing in dynamic kind of, as it often does, obviously, there's new technologies rolling out like 5G and some of the sort of more virtual reality type technology we're starting to see adopted. And if you joined us for our Analyst Day, about a year ago, I think, we were sort of, I think we sort of suggested that these new technologies were coming, and they're always coming in consumer electronics, there's always innovation, and it's always challenging to manufacture. And that's why we need the great vision, technology and automation to do it. So I think there's a fairly regular cadence of that going on, I think, what can drive higher or lower revenue years, but some of the dynamics we've talked about, like big model changes, and shifts to new technology. And in this case, obviously, market dynamics, like the work from home high level of orders that we see. And then new features like screens, a lot of great new OLED screens for new suppliers hitting the market now currently. But , that I think, really, that's as much as I can tell you, I'm not a -- I don't have a great insights into next year's roadmaps or the demand profile, unlike the companies that actually make these products.

Understood, appreciate that, Rob. And then I guess, just a follow up on the cost side for whoever wants to take it. If I think about operating expenses, clearly some good work done in the cost containment side in the second quarter are getting good leverage off that here in the medium term, as we get kind of back into a normal ice growth environment. At the corporate level, how should we think about either growth in operating expenses? Whether it's revenue growth, or just as a percentage of sales that there's a target in mind, because I think if you look over the past few years, it's been all over the map, depending on investment mode or cost containment?

Yes, well, I'll start and then I'll invite Paul to give some color. I mean, I think, we at Cognex have long term plan to grow the company substantially at high gross margins. And we are investing in R&D to support that growth and salesforce where necessarily to grow that -- to grow the company over the long term. And as you can see tonight, and as you see many quarters or Cognex, substantial fall through on revenue growth to the bottom line. So that's kind of our model. Now, we believe at the moment we have capacity to grow revenue substantially without significant headcount additions, we think we're pretty well sized. And we're still not as big as we were in 2018 in terms of the size of the business if you take our guidance for Q4. So I think we have plenty have room to grow and without adding a lot of cost, but of course, there is more detail as your salary increases and other things that inevitably got businesses absorbed. And other factors as well. But generally, I think we're pretty well sized expense wise to grow without adding a lot of expense. Paul?

Yes, I mean, I think that's right, Rob, we're in the middle of our budget cycle. And we'll have more to share with you in February related to expectations for Q1 and so on. But I think it is that balance of being very disciplined in the short term, we are being disciplined around headcount growth, being disciplined around all of our operating expenses, while ensuring that we continue to be positioned well for longer term growth. Of course, there'll be some puts and takes, right; we saved money on travel and entertainment this year. I assume that'll be fairly conservative next year. But we hope to be able to travel more, and see customers more often, by the end of this quarter will have annualized our Sualab costs. So that won't be a variance we'll be talking about in the New Year, which will be great to so.

Our next question comes from the line of Joseph Giordano with Cowen.

Hey, guys. Along those same lines are you kind of rethinking the Salesforce kind of organization a little bit at this point, because you're obviously being successful with people not traveling? I know, that's a huge part of your, historically a huge part of that sale and being face to face with customers. But now with the ability to kind of do things remote, or are you organizing it entirely different? Are people covering it and not regional anymore? How do you think about this and kind of like the new world of connectivity?

Well, around the restructuring we did earlier in the year, we did do some work on the Salesforce, more just to align them with their capabilities in areas where we needed, we saw strong growth potential over the coming years. So there's some realignment; on your point about changing the way we work. I mean, I think we were pretty successful at changing to online sales and marketing. And we've kind of pivoted into that pretty well, in the spring, we've been seeing as much as, 50% of our sales activity really being online, and works very well. Background noise and it works. It works. That was not a sales call going on in the background refresh later. So anyway, it works. It works pretty well, selling online for us, customers are engineers, and often sometimes they don't even want to meet with people in person, they're introverts and they enjoy kind of getting into the technology. And we found that to be very receptive to kind of an online selling model. But where it can be more challenging or areas where we have very sophisticated technology that requires hands on work on a customer site, right. And we would have expected to see some more sales, particularly from deep learning technology and replacing human inspectors in Asia, we kind of talked about that, I think a little bit in the last conference call, where it does require more on site work. Fortunately now, things in Asia are opening up much more, and we're able to do much more of that. So it's a long way of saying, I think that we've adapted pretty well, we've reorganized our salesforce to kind of address what we see in front of us.

I also wanted to ask on logistics. I mean, I know you have some core customers that are large retailers, and that makes sense. Curious as to the momentum you're seeing on new customer front, whether it's [PPO] types companies or like a FedEx UPS type companies or just smaller, smaller retailers looking at more omni channel, like just what's the pacing on new customer acquisition into that space?

So we've been in this market about five years. And so certainly in the Americas market, where we have the majority of our logistics revenue, where we're well known, I think to sort of the big technically sophisticated players in this market. And they certainly respect and know our technology, but we're also expanding to a lot of new companies that are coming up, particularly in the e-commerce space, we had one very nice customer in this quarter who sold pet related products online, for instance, one that was a new customer for us and sort of innovative startup companies, I think like cosmetics technology and like the way we work so, so we're seeing some kind of growth in that area. I think customers we would really like to be doing more business and feel or not in a great place at the moment. Our bricks and mortar retailers and customers that really haven't developed an e-commerce model and they're now struggling whether financially or logistically to do it, right. We also have had a good business in airport baggage handling. But as you can imagine, that isn't going anywhere right now. So there definitely have some parts of the logistics market that are down, and not really signing up new customers for us.

Our next question comes from the line of Richard Eastman with Robert W. Baird.

Yes. Thank you. And congrats on a fantastic quarter. Hey just a question on the logistics business and the e- commerce business that you referenced. When we think about consumer electronics, there is a seasonal demand to get in front of the holiday season. So it's logical that falls off seasonally. But the logistics business, there was some big orders book by some of the upstream players in the second quarter, lots of commentary on how that would, that those bookings would ship well into 2021? How does the backlog look for you and logistics or e-commerce? And is there the same seasonal pattern there? Or is there enough panic by the e-commerce players to get square footage in place? That business can be consistent from Q3 to Q4 and run well into 2021.

Yes, hi, Rick. And generally backlog is not something we comment on, except just at the end of the year. And obviously, we did give some color maybe a year ago on some larger orders that were going out for longer periods. I would say this, I would say, we're still getting to know the logistics market. I think it's a market where we can see pretty consistent revenue. And over quarters, however, it can be lumpy when larger orders hit. So it's not obvious to me now being in this market, that it's a great market in a particular quarter or poor market in a particular quarter, there's not as sort of cyclicality or seasonality that I observed, and there is some lumpiness, but I draw your attention that I think we've seen a very good sequential quarter growth in logistics, and I think, we're well set in general, if we take out lumpy stuff to see that going forward.

And I might just add part of what's contributing to our expanded guidance range that we've had the last couple quarters beyond just sort of COVID related uncertainty is how we balance, meeting customer's demands, trying to pull orders in, for instance, in anticipation of a challenging supply environment or not being able to get in to deliver certain orders and so on. And so the logistics has grown, it has added a bit of uncertainty to kind of that revenue timing for us.

Okay and did you have more than one 10% customers in the quarter?

Again, Rick, that's not something we disclose, you can read our 10-K at the end of the year what will tell you.

Okay, fair enough. Could I just ask the D900 that you introduced back in the spring? My recollection is that, the first target market or significant kind of first adopter in vertical was around consumer electronics for some of those tough to inspect applications. Can I just ask that then the D900 have a measurable impact in Q3 growth? I mean, it does have that success.

Well, Rick, first thing I'd say is no. You misunderstood if you thought it was a consumer electronics product specifically. I think our expectation curve is going to be very large in automotive. So the success we're having isn't driven by the buoyancy of that market I will say that, but it's very widely used, some of the COVID related applications. I talked about deployed the D900 to do inspection of things like vials and masks.

Our next question comes from the line of Karen Lau with Gordon Haskett.

Hi, sorry. I was on mute. Sorry about that. Good afternoon, everyone. I was wondering if you guys are still to an extent restricted by access to customers sites entering this period, which I guess would lead to still plenty of catch up pent-up demand from projects that were, orders they were placed before? Or has that largely been caught up already? If you can just comment on that.

Well, as I kind of mentioned in my opening remarks, it's a difficult call to know, kind of if you have, I'd say quite a lot of sort of volatility going on where customers, some of them are really pulling in demand, because they're worried about supply chain and, the second wave of COVID shutting factories, or causing disruption, right. And then you have other ones who are, like you suggests hasn't really had the resources in time, or given us the access to drive the products and the projects. So it's not something I can really quantify for you. Something I would say is kind of in person sales activity kind of varies around the world, like, in China, it's 100% what it was before, it's going great guns in other markets. Japan, parts of Europe, it's much less good, less than 50% of sales activity in person. So clearly, I think that's and along with kind of spending anxiety in those kind of markets, certainly depressing sales, and I would expect that to improve when we kind of get back to normal business in those markets.

Got it. And then I was wondering could you comment on kind of the cadence of improvement in the outside of fee and logistics, which obviously have been very strong, but in auto and the other general industrial markets foods and beverage and what not? How much are they still down year-over-year, first of all, and what's the cadence of sequential improvement that you were seeing? Did you see maybe over the somewhere like going sort of big ramp up and then now as the sequential improvement is kind of more steady petering out, or has just been kind of steady improvement, if you can talk about the cadence of like the activities that you're seeing in those markets.

Yes, so I sort of mentioned, I think on our last conference call that our automotive business was I think I sit down around 40% in the second quarter, it was much less right last quarter. We don't get into the business of giving quarterly growth rates on industries, but certainly bad but a lot less bad than it was. And I think we all know that automotive was our biggest market last year. So that's a pretty substantial headwind that we're starting to overcome. But a lot of other industries actually kind of did pretty well, I would say, obviously, we've talked about electronics, but food and beverage, life science, medical devices, pharmaceuticals, were all showing much more improved growth rates as we got into the third quarter. Consumer products maybe was not as strong as we would have liked to have seen in terms of overall growth, and again that may have to do with more access to factories and problems, particularly around food processing, and things like that.

Okay, and then their cadence of sequential improvement, like are you seeing like a big ramp sometime in to the summer, and then it's just kind of petering out, or it has been proven and sort of steady over the course of the quarter?

Just, I mean, it's difficult to say, I think there's, as I say a lot of volatility. Paul, do you want to comment?

Yes. I mean we don't spend a lot of time talking about month to month color, but we do see obviously that April was kind of a weak point. And we've improved since then and again, still a bit soon for us to say whether this is a V shaped recovery or kind of some of the pulling in of orders or recovering from a quite a depressed Q2.

Our next question comes from the line of Andrew Buscaglia with Berenberg Capital Markets.

Good evening, guys. So you gave a last quarter you gave a pretty strong guide for Q3 and you exceeded it by quite a bit. So I'm wondering where you were mostly surprised. I mean you called out the e-commerce logistics, consumer electronics and you also called out some online learning working from home kind of it seems like a pick up in that activity, but where I guess, where were you guys surprised?

Well, I'll kick off, Paul can give some more color and certainly e-commerce fulfillment is very, very strong first consumer electronics also I think came in stronger as we move through the quarter. But, and then geographically, Americans certainly did better, I think than we were expecting as we move through the quarter.

Yes, I mean, obviously, growth versus prior year, consumer electronics and logistics really were the drivers out performance versus our guidance, we saw kind of steady improvements through the quarter, a lot of that really was driven by base business as well just converting orders more quickly than we're used to seeing just higher average daily sales versus kind of what we had projected at the time kind of showing, again, a steady recovery. Those are kind of big drivers of which the Americas clearly not there, but we thought pretty broad based across our regions.

Okay. Yes, it's quite --yes, we haven't seen it quite a bit like that on your own guidance. And sometimes so it's interesting that those trends are even stronger than you anticipated.

We're proud of the revenue results where we're not as proud about the guidance versus that , it is a very difficult business to predict.

Yes, imagine. And I wanted to ask you to on the AI deep learning, you made a comment that a D900 was year's most successful product launch. What I guess what's behind that statement? It doesn't seem I get too material right now. And you're tying it to more automotive? So as a follow up, where, if we were to try to model in some material impact next year from this, what, which end markets do we assume that comes in?

Yes, deep learning is a technology that's changing and expanding the serve market of vision, right. And the D900 really brings very powerful techniques for inspection, particularly on to this world best selling smart camera platform we own called In-Sight. And In-Sight has tens or hundreds of thousands of users who know how to program and it and now they have all these extra tools available to them in the D900. So and what's wonderful is that's a very wide spread product, there's pretty much all the markets that we serve. And so it's bringing that technology, I think we would expect, yes, automotive, but really almost all the markets that we serve, we expect the D900 to be a big player. Where it might be less of a kind of a move to growth overall would be in Asia, where it tends to be more interesting using PC based vision software is loaded on two powerful computers and used in the factory. And that's generally not used in other markets in that way. But fortunately, in that market, we now have Sualab. And the technology we acquired there, which is very powerful on PC platforms, and useful for inspection. So Cognex, when you launch a new product, you don't see hundreds of millions of dollars in the first year, this is not like a consumer market, right. So normally, it can tend to ramp and we can -- it can approach a peak in the third year. So I would sort of, I would attempt to your expectations, but the initial signs we see in the first six months in terms of its ramp are as good as any I've seen, or what I really like about it is, it's getting us to new customers who couldn't use machine vision because it was either too difficult, or it couldn't do the inspection that they currently use, or it's going to existing customers who have applications and tasks they couldn't do before. And now we can do for them with the D900. So we're excited about expanding our serve market. Then to give you kind of another data point, if you joined -- if you were with us our at analysts meeting last year, we sized the deep learning market globally and machine vision at that point at about $100 million and we said we thought it was growing at 75%, right. So the ease of use is helping annually, 70% annually. The ease of use certainly is helping you to broaden that application served and the speed of adoption and that may give you a sense of scale about what the overall opportunity is for technology like that.

Our next question comes from the line of Blake Gendron with Wolfe Research.

Hey, thanks everybody. I want to circle back on the third leg that still being automotive. Somewhat scary to think if you had all three of your major markets working at the same time, USR surprising the upside, I know you're not going to give us exact cadence of recovery in that market. I guess looking past the pandemic, things like electric vehicles seem to be, there's some pent-up optimism, particularly around the battery technology breakthroughs that we've seen from Tesla and others. So I guess my question is where does Cognex stand on sort of the ice to EV transition? What sort of uplift could we see from an intensity standpoint here, just considering that technological inflections are really what drive your demand?

Yes, well, first of all, Blake, thanks for the question. I wouldn't say the third leg, if I was referring to automotive, I'd say, the third wheel. But keeping that in mind as we talk about it. Yes, automotive is a big market for us where the majority of our business has been and will be for a while, and internal combustion engine type back activities. But you're quite right to point to electric vehicles and battery manufacturers being kind of the area where we see very challenging applications, huge capital investment, particularly in Asia, around a battery manufacturer, and techniques in that space, where machine vision can really make a difference in terms of yield and performance and scaling up for that work that has to happen. So EV is still a very small, a small part of our overall automotive revenue. It's growing very quickly. And but I think it'll be a while before, I'd say it's the majority of our business and based on what I see a new product plans from customers.

Got you. I want to circle back on working capital, great execution in the quarter, particularly in collections. Where can working capital go from here? And what are some of the puts and takes to the free cash conversion? Is it a segment mix sort of input? Is it a customer mix input? As deep learning and maybe some of the software centric capabilities get to be a bigger part of the business? Is that going to have a structural impact on working capital moving forward?

Yes, I don't see a lot of changes in structurally in working capital already. So thank you for the compliment, we're very happy, but also pleasantly surprised by how good the collections environment has been. Our team has been working hard, but also just really good partnership with our customers too and so on. So yes, I mean, I think in terms of put some takes, we need each customer kind of where they are and where they need to be, we look for opportunities to partner with them, we work with them, we obviously do have a tremendous balance sheet, it can be a source of competitive advantage for us in challenging times. But we've seen fewer issues with collection from customers than we might have expected given the pandemic, it helps that I think we are a priority investment for them. And they can't get more products sometimes until they pay us. But generally speaking, we have a great relationship. And I don't see big changes going forward.

I'll just, it's Rob here. I'll just build on something. I mean, if you followed Cognex for a while, we're not like a normal company, we really believe strongly in paying our suppliers on time and getting the best support and having the best relationship with them. And keeping plenty of inventories to make sure we can supply the technologies that we have that have quite long roadmap. So we're not looking to optimize working capital, we're looking to optimize high margin growth and the quality of our company. The other thing I would say, in dealing with some of these very large customers, some of them are very pull long term payers right. And as a pull into that our balance sheet really gives us the air cover to do that without any concern.

Our next question comes from a line of Joseph Giordano with Cowen.

Hey, thanks. So let me jump back in, just, well I just want to quickly comment by something you said. I think I missed the beginning of it. You said in Asia there, there are customers there that are more inclined in some cases to use PC vision. Was that for a particular application? Or I didn't hear exactly what you were referring to.

No, it's the market dynamics in general, right. There's a lot of very high quality capable engineers in China particularly, and who are less expensive I think and more eager to deploy vision. And for those customers we have the best most powerful PC vision suite in the world called Vision Pro. So a lot of them favor using that. And a lot of them who have very big manufacturers use it very effectively.

Got it, thanks.

Joe. Sorry to clarify. And were you asking about deep learning? Or were you asking about vision in general?

I was just curious, like, is this something? Are you competing against PCBs vision for traditional, like, consumer electronic inspection like there? I didn't think that was the case. So just curious as to like where are competing against that tech more often?

Yes. So you see the larger share of PC based vision in Asia and electronics is a big, big market there.

We have reached the end of the call. I would now like to turn it back over to Dr. Bob, for closing comments.

Well, thank you very much. And I want to thank all of those who have called in and asked questions. While machine vision plays an increasingly important role in automating the manufacture of items, the tracking of those items, and even today, the delivery of those items. In view with that and in view of our leadership position, we remain bullish on the long-term prospects of Cognex despite current difficult business conditions, and we look forward to talking to you next quarter and reporting what I hope are going to be very good results. Thank you again.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a great rest of your evening.