Cognex Corporation (NASDAQ:CGNX) Q4 2023 Earnings Call Transcript

Cognex Corporation (NASDAQ:CGNX) Q4 2023 Earnings Call Transcript February 15, 2024

Cognex Corporation reports earnings inline with expectations. Reported EPS is $0.11 EPS, expectations were $0.11. Cognex Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the Cognex Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Nathan McCurren, Head of Investor Relations. Thank you. Please go ahead.

Nathan McCurren: Thank you, Donna. Good morning, everyone. Thank you for joining us. With me on today’s call are Rob Willett, Cognex’ President and CEO; and Paul Todgham, our CFO. Our results were released earlier today. The press release, annual report on Form 10-K and a newly introduced quarterly earnings presentation are available on the Investor Relations section of our website. Today’s earnings materials and statements we will make during this call contain forward-looking statements and are based upon information we believe to be true as of today. All forward-looking statements are subject to risks and uncertainties that are described in our SEC filings, including our most recent Form 10-K filed this morning for 2023. Before I hand it over to Rob and Paul to discuss the results and outlook, I want to spend a minute explaining changes to our reporting metrics that you will notice.

As we previewed with you on last quarter, after the acquisition of Moritex in the fourth quarter, we now have a more material level of acquisition costs and amortization of intangible assets. As our financial results have begun to be more impacted by these nonrecurring and purchase accounting charges, we’ve made changes to our non-GAAP measures to exclude those charges from the reporting of our adjusted earnings figures. This change in methodology applies to our calculation of non-GAAP operating expense, operating income and net income per share. We have also introduced and we expect to be reporting on and speaking to more frequently adjusted gross margin, adjusted EBITDA and free cash flow. These changes and the new non-GAAP measures referenced on our call today are clearly defined with a historical look back to prior period impacts in the earnings presentation posted to our website this morning.

You can also see a reconciliation of certain items from GAAP to non-GAAP in our earnings press release. We want to emphasize that our previously communicated long-term financial targets of 15% revenue growth, mid-70% gross margin and over 30% operating margin are unchanged and should be evaluated on an adjusted basis, excluding these nonrecurring and purchase accounting charges. Next, Rob will discuss our fourth quarter and 2023 results, Paul with then provide additional detail on the financials and Rob will conclude with our outlook and a discussion on how our execution of strategic initiatives in 2023 sets us up for the future growth. With that, I’ll turn the call over to Rob.

Rob Willett: Thanks, Nathan. Hello, everyone, and thank you for joining us. 2023 was a year of perseverance at Cognex. We advanced many high potential strategic initiatives while navigating a global manufacturing recession. We continue to take important steps towards achieving our strategic priorities and long-term goals. After growing almost 30% in 2021, fueled by pandemic-related acceleration in logistics and electronics investments, revenue was slightly down in 2022 and declined 17% in 2023. Customers have remained cautious with investments as we observed lower confidence in near-term end demand, leading to increased CapEx scrutiny and delayed orders. PMI readings have now reached 15 consecutive months in contraction territory, which is the longest such stretch since the tech bubble and 9/11 period over 20 years ago.

Investment in China remains especially muted. In addition to these macro challenges faced by both Cognex and its peers, a high exposure to the leaders in the industries we serve was a headwind for us in 2023. About half of our 2023 revenue decline was driven by two large long-standing customers who reduced their spending after heavy investment in prior years. However, we are confident that we still maintained or gained share with each of these customers. In some of our end markets, notably EV battery and semiconductor manufacturing, large investment plans are underway. Many of these projects have not reached a stage where significant volume of our products is ordered, but we anticipate our customers’ manufacturing projects that broke ground in 2022 and 2023 will represent future revenue opportunity for Cognex.

Throughout 2023, we stayed disciplined in our approach to discretionary spending and thoughtful about hiring. We have faced challenging periods before in our 43-year history, and we have shown the ability to evolve. For example, in the year 2000, semi customers accounted for over half of our revenue and we saw a significant downturn in that business. To adjust, we moved fast to diversify our business towards factory automation and penetrate the Chinese market. While different today, we see disruptive trends playing out in our markets, such as the shift away from internal combustion engines towards EVs and deep learning machine vision technology becoming accessible to an increasing number of customers and applications. We are mobilizing to capitalize on these trends and remain focused on the long term and on continuing to evolve to deliver future growth.

Before I go into more detail on this evolution and our outlook, let me turn it over to Paul for the financial results for the quarter.

Paul Todgham: Thank you, Rob, and hello, everyone. Turning to results for the fourth quarter. Revenue declined 18% on a reported basis. This includes $7 million of revenue or a three percentage point contribution from Moritex. I’ll also remind you that we’re comparing against the fourth quarter in 2022 that included $20 million of revenue that shifted from the third quarter due to the fire at our primary contract manufacturer. From an end market standpoint, our biggest year-on-year declines remained in consumer electronics and semi. Broader softness continued across our other factory automation businesses such as automotive, medical-related, consumer products and food and beverage. The underlying business conditions we are seeing in each of these end markets remain consistent with what we reported in the past two quarters.

These end markets were roughly flat sequentially, but declined year-on-year, mostly driven by the timing of 2022 revenue due to the fire. Within automotive, we continue to see softness across the internal combustion business and increasing demand from EV battery manufacturers. Logistics remained stable, contributing growth sequentially and roughly flat year-on-year. On a geographic basis, revenue in the Americas increased sequentially driven by growth in logistics. Revenue in China stepped down further in the quarter as we continue to see a challenging economic environment. Year-on-year, revenue declined across all regions with the steepest decline in China. Adjusted gross margin in Q4 was in line with expectations at 70.7% or 68.7% on a reported basis, including $4 million of acquisition costs and intangible asset amortization and cost of sales.

Compared to last year, favorability from the decline in broker buys was offset by volume deleverage, Moritex and unfavorable mix. On a sequential basis, adjusted gross margin was down slightly due to Moritex. Let’s turn now to operating expenses. Adjusted operating expenses increased $5 million or 5% sequentially and $6 million or 6% year-on-year. The sequential increase is due to the timing of incentive compensation and other employee benefits and the addition of Moritex. The year-on-year increase is driven by the investment in the Emerging Customer initiative and Moritex, partially offset by continued diligent cost management and lower incentive compensation. Excluding the Emerging Customer initiative in Moritex, adjusted OpEx would have declined by $4 million or 4% year-on-year.

As you’ll see in our non-GAAP reconciliation tables, we had $8 million of acquisition costs and $2 million of amortization of acquisition-related intangibles in the quarter. Adjusted EBITDA was 13% in Q4, below Q4 of 2022 due, primarily to operating deleverage and our investment in emerging customers. Adjusted diluted earnings per share was $0.11 in Q4, a year-on-year decline driven by lower revenue and margins, partially offset by a lower tax rate and share count. Turning to the balance sheet. Cognex reported a strong net cash position at the end of Q4 with $576 million in cash and investments and no debt. The $270 million quarter-on-quarter decline was driven by the closing of the Moritex transaction in the quarter. After acquiring Moritex, we believe we still have sufficient capital to support our growth plans and to continue to return capital to shareholders through stock buybacks and dividends.

With that, I’ll turn it back over to Rob to discuss the future growth drivers and the outlook.

Rob Willett: Thanks, Paul. And thank you, Paul, for being a valued member of our executive team over the past four years. As previously announced, Paul will be leaving Cognex on March 15. He’s made significant contributions to Cognex’ success, including enhancing Cognex’s planning and budgeting process and overseeing investments in Cognex’ CRM platform. The external search for our next CFO is progressing well. I am pleased with the quality of candidates we’re seeing, and we will update you with developments as they become available. Now let me spend some time discussing how we continue to invest in the future despite near-term macro challenges. Last year, Cognoids worked hard to release more products than in any previous year in Cognex history.

Our portfolio of new products leverages the best rule-based vision while incorporating more human-like inspection capabilities made possible by advances in deep learning and edge learning artificial intelligence technology. As with many industries, developments in AI have profound implications for industrial machine vision. We were early to identify major advancements in AI technology, leading to the acquisition of ViDi Systems and Sualab in 2017 and 2019. These acquisitions jump-started our innovation around the use of convolutional neural networks, the technology now powering our deep learning and edge learning products. AI makes our products easier to use and sell and makes machine vision more human-like, enabling Cognex to expand its applications where human inspectors have previously been the only viable option.

Increases in the cost and specialty of labor continues to be a problem for our customers. We estimate that 35 million people across the globe are manually completing vision inspection tasks, such as examining products for scratches, dents and defects. One of our customers estimates that they spend over $1 billion per year on human visual inspectors. AI-enabled machine vision can complete this work more cost effectively while helping to improve quality and productivity. Our deep domain knowledge allows us to leverage the best of rule-based deep learning and edge learning technologies to address the full spectrum of customer needs. We remain dedicated to helping the world’s most sophisticated manufacturers and logistics providers achieve their goals while also bringing Cognex machine vision technology to more markets and new customers.

To reach the broader customer base that can now be served by our new easier-to-use edge learning technology, we launched our Emerging Customer initiative, a sales force expansion that drove $28 million of OpEx in 2023. Our initial Emerging Customer sales class is now trained and has started to sell. We expect this initial class of Emerging Customer salesnoids to generate over $50 million of incremental revenue and positively contribute to operating income in 2024. Early orders reinforce our belief that this initiative can be gross margin accretive. Now equipped with the right products and with a defined process for hiring and training, we are well positioned to welcome our second class of Emerging Customer salesnoids this year. We have budgeted approximately $25 million of additional OpEx for this initiative in 2024.

I’ll turn now to our outlook for the first quarter, along with a few thoughts on the full year. In the first quarter, we expect the following results: revenue between $190 million and $205 million, which represents flat year-on-year and sequential growth, reflecting another challenging quarter. I will note that this is narrower than our normal $20 million range as we continue to see a relatively stable operating environment. Moritex should contribute 6% to 8% of revenue in Q1 and for the year. Adjusted gross margin in the high 60% range. Gross margin continues to be below our long-term targets given volume deleverage and negative mix. A full quarter of Moritex is expected to be an approximately two percentage point drag on gross margin, an incremental 100 basis point headwind compared to Q4.

Our gross margin guidance also includes an approximately two percentage point drag from a strategic logistics project with a large customer. The project has higher upfront cost but includes high-margin recurring revenue enabled by our edge intelligence software. We expect adjusted operating expenses to increase mid-single digits on a sequential basis due to investment in our Emerging Customer initiatives, higher incentive compensation and the impact of a full quarter of Moritex operations. For the full year, we expect the incremental $25 million of Emerging Customer OpEx to ramp throughout the year, similar to the investment we made in 2023. We also expect incentive compensation to be a $15 million to $20 million year-on-year headwind. While we continue to see a challenging operating environment in the first quarter, we are more optimistic about the back half of the year.

We have started to see signs in longer cycle businesses that momentum could be building. For the full year, we expect logistics to grow as we start to see infrastructure investment plans materializing, though logistics growth this year will likely still be below the long-term market growth we expect. We expect our EV battery business to be a strong growth driver long term, but we are seeing more tentativeness from these customers, driven by uncertainty around end-user demand and the political environment. The semi landscape is improving, as you have heard from the leading semi equipment manufacturers, with more optimistic 2024 outlooks. Consumer electronics has positive long-term trends, but the timing and in-year contribution remains uncertain.

As usual, we expect to have more visibility by next quarter and to give you more clarity for the year on our next earnings call. While we expect to deliver below target growth in the first half, we remain confident in our 15% annual revenue growth target over the medium to long term. Based on double-digit market growth, expansion of our served markets, our pipeline of new products and our reputation with leading manufacturers, we believe the progress Cognoids have made last year on several promising initiatives positions us well for the future. Now we will open the call for questions. Operator, please go ahead.

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Q&A Session

Operator: [Operator Instructions] Our first question is coming from Andrew Buscaglia of BNP Paribas. Please go ahead.

Andrew Buscaglia: Hi, good morning, guys.

Rob Willett: Good morning.

Andrew Buscaglia: And so in your commentary for your Q1 guidance, you talked about some signs of stabilization or stabilization, and the guidance implies just a modest sequential decline. Where are you seeing that stabilization? It sounds like logistics, is a little bit better than you would have expected. And then can you just comment around some of the other end markets, I know visibility is limited, but where you see that momentum building?

Rob Willett: Yes. Thanks, Andrew. So we have a sales funnel. We see order patterns that exist across our business. So, we have some pretty good kind of visibility about how the business is looking, and the sort of volatility that we see in that. So the overall picture seems to be stabilizing overall. As you say, I think where there is more sort of positive momentum, yes, in logistics. We see that building across a number of other markets, of our larger markets also. And we see EV battery, continues to have a nice growth momentum behind it. Generally, our European business also seems, to be pretty stable and growing, in a way, in terms of its momentum overall. So those would be positive areas. I think more uncertainty would be around China, right?

As we mentioned, we’ll give you a better readout on consumer electronics, whether we know kind of how that’s looking for the year. But it’s not – there’s nothing particularly to point at this point about that. So, I think that’s the overall color. It’s not strong, but it’s not the sort of whipsaw decline that we saw, if you go back sort of into last year back a few quarters that, we were seeing, we see more relative stability.

Andrew Buscaglia: Yes. Okay, okay. And then just some clarification on the Q1 guide for margins. Is it fair to say excluding — it sounds like a two-point dilution from more tax, two points from this logistics project, you’re closer to 70%. And then following-up on that, how do you figure this initiative is gross margin accretive? Or can you talk about some of the pilots, you’ve done or something to give us confidence that that will lead, to positive contributions to margin?

Paul Todgham: Yes. Andrew, this is Paul. Why don’t I start with your specific kind of gross margin question and then Rob can chime in on emerging customers, and any additional color. So we are expecting adjusted gross margin in the high 60% range in Q1. The sequential step down, which is about 200 to 300 basis points, that really is driven by a full quarter of Moritex. And then the strategic logistics projects that we called out in Q1, which brings with it additional high-margin recurring revenue. So the – those are really the drivers from – yes, from Q4 to Q1. If we think kind of relative to our full target, our target of mid-70%, I think there’s really three drivers there, and two of which are the same. One is we expect deleverage from muted volume and negative mix to continue to be 200 to 300 basis point headwind in the first quarter.

And again, that’s driven by a few factors, just lower revenue levels overall as well as product mix. Q1 is typically a lower quarter for consumer electronics, for instance, which is primarily software and comes with very high – higher gross margins. And then Moritex, a full quarter of Moritex is overall a 200 basis point rough headwind, and that’s an incremental 100 basis points, compared to Q4. And then the strategic project we referenced is also about a two percentage point or 200 basis point drag. This is something we don’t tend to report very often extent. I was looking through my notes. I think Q3, 2021 was the last time we called out any one project having a strategic impact. So it’s not something that we would generally expect to be reporting.

And I don’t have visibility, to more of those this year. But it is very opportunistic. And when we see a great opportunity to build a long-term revenue even if it comes with some upfront costs, we’ll, of course, make that investment.

Rob Willett: Yes. Thanks, Paul. And I think – so I give maybe some longer-term color. I think it will be difficult to get back to our mid-70% gross margin target this year until we have a recovery in volumes and fully integrate Moritex. But I think how we see – or I know how we see our gross margins kind of improving over time include three factors I’ll point out. One is emerging customers, right? So, we’re out selling highly profitable embedded systems through that channel, and we’re excited about what we see with those products and that sales force. New products. So we have a pipeline of new products, we’ve introduced last year that are ramping nicely, very nicely, some of our most successful products ever. And they come with a strongly accretive gross margin for Cognex.

And the third factor would be the consumer electronics business. It was the worst performing of our large markets last year. It can have a cyclicality and a volatility, and we fully expect it to return and deliver some strong growth at some point, whether that’s this year or not, will certainly all help, to boost our gross margins right back, to where we expect them to be. Other things, I think are worth pointing out on the broader margin discussion, one is that Moritex is a drag on our gross margin, but has come with very strong operating margins that are accretive to us as a business. And as we continue to integrate it, and sell its products more directly, attached to Cognex vision systems, and we develop the specialty optics business that they bring – and we bring together and integrate them, we expect this to be a nice tailwind for us on our operating margin.

So still challenging in 2024. But what we have shown through our history and many times in my 15 years here is when we pivot back to growth, there’s very, very strong fall-through on incremental revenue that occurs at Cognex. So that also gives us great confidence that we should be able to get back to our overall targets.

Andrew Buscaglia: Okay. Thanks for the answers. Appreciate it.

Operator: Thank you. The next question is coming from Jim Ricchiuti of Needham & Company. Please go ahead.

Jim Ricchiuti: Thank you. Two questions. First on the EV portion of the business, just in light of the mixed demand trends that we’ve all been reading about geographically on the EV business. How are you seeing that business? For instance, what’s your line of sight? Because my sense is you may be a little bit removed from what’s happening on the EV battery side?

Rob Willett: Yes. Thanks, Jim. I’ve spent a lot of time in the last two quarters out meeting with a lot of EV battery manufacturing companies. So, I can tell you that there’s a huge investment going on in that industry, particularly in Europe and America. It’s — so Cognex has two really kind of vectors, I would say, on that growth. One is just building lines. These customers are building EV production lines to coat and cut in the line and stack and inspect EV batteries, right? And they’re – I visited just in Europe last week, two companies that are investing over $1 billion to do that, right? Not all of it in automation, obviously, but real momentum. That is not a short-term thing, right? So – and machine vision is key to them doing that.

So there’s new lines, newbuilds where, as one would expect, Cognex is one of the preferred suppliers for what, is quite a challenging machine vision kind of a task that goes on. The second – so I think that’s sort of the, if you like, the newbuild greenfield type scenario that we might be familiar with from other industries at Cognex. But there’s a second thing going on, which is manufacturing of EV batteries is very competitive on the innovation side, but it’s also pretty dangerous and legally concerning thing for these companies. So they’re very concerned to inspect in quality. And we’ve been developing technology in that market that, is very advantaged both through the computational imaging company, we bought last year, SAC – actually, I should say in 2022.

And then our deep learning technology, which help – those two technologies together allow us to image with incredible speed and definition scratches, dents, problems. And then diagnose them with deep learning technology, to see whether that’s a problem or not. I visited a number of companies in the last six months, who have just said what an extraordinarily challenging and expensive task that is for them, where they’re scrapping huge numbers of good batteries that, they’re just concerned can become problems, cause fires, et cetera, for them later. So there are those two things going on, Jim, which is really, I would say, the sort of sweet spot of what Cognex is doing. On the downside, and I think this is what you’re hearing and I think we’re hearing it too, is there’s anxiety.

There’s anxiety about will EVs be successful as we think? Are they perhaps niche kind of products for wealthy customers, or are they broadly going to cannibalize a lot of the internal combustion engine business that’s out there? And I’ve – so that’s kind of one issue. On the one hand, we will see the slowing sales of EVs and the relatively poor EV numbers reporting out of some of the big companies. So, I think there’s a concern that they are becoming a little more cautious, the end-user consumers. And then there’s another end user vector, which is one Chinese company, BYD, is talking about developing and selling a $12,500 EV car. So – and really selling it very broadly in some of the markets that perhaps in America, we’re less focused on. So there’s plenty to be interested in and confused on that vector.

And then the final one, in terms of long-term demand, which we see with our customers too, is there is some concern about political changes and support for EV business, right? So most – one specific large EV producer from Asia, has certainly communicated that they’re putting some of their investments in the U.S. on hold. Until they see more of a clarity in the political environment and what that means for some of the subsidies that they would be expecting to receive through the Inflation Reduction Act. Jim, it’s a long answer, but I hope it’s helpful.

Jim Ricchiuti: No. Thank you, Rob, for the – there are a lot of puts and takes, and I think you’ve highlighted those. And the next question, maybe a little easier and simpler, just on the early customer business. You sound encouraged. Where – can you elaborate on where are you getting traction? Is that $50 million, by the way, essentially from this first class of salespeople? Or are you including some from the second class that’s underway? And is this spread out over the course of the year or back end?

Rob Willett: Yes. So we did pilots starting about 1.5 years ago, so we have a few salesnoids who are kind of helping us understand. We did a lot of experiments, as you might imagine. And then we went out and hired pretty – a large number of this first class, which came in starting sort of in April, the last of them came in, in October or so. And we’ve trained them and almost all of them are now in the field. And that’s the whole ball game really this year regarding our growth expectations, right? And then we’re going to be hiring the second class as we move through the year at different points based on kind of when they become available in the locations we’re hiring. And so we wouldn’t — I wouldn’t expect them to contribute meaningfully to any kind of revenue growth in 2024, the second class.

And then this is a group of salesnoids that we’ve trained and given them a great really very advantaged edge, learning and ID products. And they’re out in the field and we’re driving them towards metrics about — which include activity, kind of number of sales calls, and other good sales metrics. And we’re measuring that performance. And we do expect there, to be learning curve effects, right, as they become better and better trained, and better able to execute and we sort of factored that into our numbers. They’ll contribute in the first quarter nicely, but we expect them to contribute more sequentially each quarter, as we move through the year.