Cognex (NASDAQ:CGNX) Q1 2020 Earnings Call

0:00 Greetings. Welcome to the Cognex first quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Susan Conway. You may begin.

0:25 Good evening, and thank you for joining us. I'm Susan Conway. Senior Director of Investor Relations. I hope everyone is faring well and staying healthy. Joining us today are Cognex's Chairman, Dr. Bob Shillman, President and CEO, Rob Willett, and Chief Financial Officer, Paul Todgen and his team. 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.investorrelations.com. Cargnex.com forward slash investor. Both contain highly detailed information about our financial results.

1:11 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 filing, including our most recent Form 10-K and our Form 10-Q filed tonight for Q1. Now, I'd like to turn the call over to Dr.

2:05 Bob.

2:07 Thanks, Sue, and hello, everyone. Welcome to our first quarter of 2020 earnings calls. Tonight, Cognix announced results for Q1 of 2020, which are pretty good. But one quarter doesn't tell the whole story. After a challenging year in 2019, we were looking forward to improved macroeconomic conditions in 2020, but all of that has changed in recent weeks. And like many other companies, we are now preparing for difficult days and perhaps months ahead due to the restrictions that governments around the world have placed on travel, and on their businesses and on their citizens. At a time like this, our strong balance sheet with 845 million in cash and investments and having no debt provides us with the breathing room and flexibility that many other companies just do not have.

3:06 And because of that, we will be able to continue our long-term product development efforts, which should enable us to emerge from this crisis and even a stronger competitive position than we held in the past. Right now, we're all participating remotely on this call. For further details on the first quarter and for a high-level view of our plans in the current challenging environment, I'll turn the call over to my partner, our CEO, Rob Willett. Rob, the microphone is yours.

3:42 Thank you. Dr. Bob and good evening everyone. Our results for the first quarter of 2020 were in line with our expectations. Revenue and gross margin were delivered at the high end of our expected ranges. Operating expenses and the tax rate were lower than anticipated. The team did a good job managing the supply chain despite some component shortages from Chinese suppliers that had postponed delivery dates. We now see many of those manufacturers successfully ramping up production as China goes back to work. We also were able to successfully accommodate an unusually high number of requests to either accelerate or in some cases delay order deliveries in March.

4:35 In recent weeks, conditions have become more challenging in most regions of the world, most notably in Europe, and the Americas. Many customers are locked down or operating with reduced capacity and that's impacting our ability to engage with them and get new orders. Particularly hard hit is the automotive industry, which was our largest end market last year. There's a long-term potential for growth as the market transitions from internal combustion engines to electric vehicles. but the near-term outlook has deteriorated significantly. Many customers have suspended production and are not allowing our sales engineers into facilities to help with previously planned automation projects that are now on hold.

5:30 In consumer electronics, we have found that it's too early to predict the timing and magnitude of this year's investment cycle. which we typically have insight into by now. Our largest customers are asking for, in fact counting on, us to be ready with product shipments and onsite support for their advanced automation initiatives. However, we recognize that there are risks around both the timing and the size of those automation projects given the current situation. The best end market for us right now is clearly logistics, which was our third largest market in 2019.

6:15 Online e-commerce sales are accelerating as a result of COVID-related restrictions. As the recognized leader in machine vision and barcode reading for e-commerce, Cognix is well positioned to capitalize on this trend. E-commerce companies and retailers with e-commerce presence are continuing to implement Cosmex Vision and ID products to increase both productivity and capacity. Our technology has become even more valuable in this crisis as our customers are able to achieve higher throughput and are better able to maintain social distancing in their distribution centers. In the immediate future, our priorities are supporting our customers at a time like this.

7:03 and helping Cognoids be healthy, safe and productive. Cognex is primarily a software company. We have the processes and systems in place for Cognoids to work quite effectively from their homes. Most Cognoids are now doing that, working hard to maintain product development schedules, making video sales calls and product demonstrations and remotely supporting our customers' critical manufacturing and logistics operations. We have taken measures to maintain a safe environment for those employees who are on site at Cognex facilities supporting essential business functions. We are working with many customers in critical industries, including logistics, life sciences, and medical-related businesses that have formally asked us to continue supplying them through the current crisis.

7:58 Because of our move-fast culture, we're able to quickly come up with changes to our operations that allowed us to meet In terms of our supply chain, sourcing component parts and accessories for our products is a challenge, but thankfully it's not a widespread issue for us today. We're managing well under the circumstances and we continue to work closely with our suppliers to mitigate risks to our delivery schedules. In addition, our strong balance sheet, together with our have enabled us to build a buffer of critical component inventory for times like these. Even so, we recognize the possibility of further closures and disruption down the road.

8:47 Adding more uncertainty is that governments have implemented and continue to implement restrictions on the movement of people and goods. These are indeed very challenging times for our business that has suppliers and customers around the world. Regarding our new products, early this month, we held a number of large-scale live virtual meetings for our sales engineers and distributor partners. They received an in-depth look at our new products, including our groundbreaking Insight D900 smart camera, featuring Cosmex industry-leading vidi deep learning software. Leveraging Insight's widely recognized EasyBuilder interface, This product launch brings deep learning technology to a wider audience and allows customers to solve complex visual inspection tasks with relative ease.

9:43 Also presented was the Cognex DataMan 475V. The V is for verifier. DataMan 475V is an inline system that measures the accuracy and quality of a barcode based on globally recognized standards. Importantly, this is performed in line, on high-speed production lines, as the barcodes are being printed and used in industries including automotive, life sciences, consumer products, and logistics. Let's talk about Cosnoids, our people. At a time like this, I feel very grateful to be leading such a committed, talented, and creative group of people. Throughout this crisis, they have exemplified our strong culture, working hard and moving fast in this volatile environment.

10:33 Our work hard, play hard, move fast culture is a significant advantage on full display to all our stakeholders, our customers, our employees, our vendors, our local communities, and last but not least, our shareholders. That advantage is particularly effective as we strategize for the year ahead and think about how we can work together to meet the needs of our customers and reallocate our efforts to promising growth areas. Before we move on to the details from our first quarter, I'd like to extend a warm welcome to our new CFO, Paul Todrum, who joined Cognex in early March. To say that Cognex joined at an interesting time would be something of an understatement.

11:18 Paul brings extensive experience leading financial teams and in strategic and operational planning after working at large-scale businesses over the past 20 years. We're very pleased to have him with us. Paul, over to you.

11:35 Thank you, Rob, and hello, everyone. My first two months on the job have indeed been a unique adventure, but I'm very excited to be part of Cognex. and to help drive our future. I'm particularly impressed with the people I've met, the strong work ethic and Cognex's move fast culture. I look forward to meeting many of you in the investment community in the coming months. And I hope all of you on this call and your loved ones are safe and healthy. Let's turn now to our financial results for Q1 of 2020. Revenue was $167 million, which is at the top end of our February guidance.

12:22 As expected, revenue declined year on year and sequentially due to continued softness in automotive and the broad factory automation market. Compared to guidance, the decline in the manufacturing sector was partially offset by customers accelerating orders in March to buffer possible supply risks that they feared. Despite the lower revenue, Gross margin of 75% represents an increase over both Q1 of 2019 and Q4 of 2019 as a result of a shift in revenue mix to higher margin products. Operating expenses increased by 8% year on year and were down slightly on a sequential basis. Over the past year, we added employees and other recurring costs related to the SUA Lab acquisition and we made investments to support our strategic priorities.

13:16 These expenses were partially offset by lower travel and other discretionary expenses in the quarter. Operating margin was 13%, down from 17% in Q1 of 2019. On a sequential basis, operating margin increased by three percentage points as a result of the higher gross margin and lower operating expenses compared with Q4. The effective tax rate in Q1 was 17% before discrete tax items, which is lower than our expected rate of 19% due to a shift in income to lower tax jurisdictions. Excluding discrete tax items, earnings per share were 11 cents in Q1 compared with 17 cents in Q1 of 2019 and 11 cents in Q4.

14:08 Looking at the change in revenue for Q1 year-on-year from a geographic perspective, Asia performed the best of any region as a result of higher revenue from consumer electronics. China increased in the mid-teens over a relatively weak quarter a year ago despite business shutdowns, and the rest of Asia grew by approximately 20% in Q1 year-on-year. Revenue from the Americas declined by high single digits year-on-year. This was primarily a result of the timing of revenue from logistics. The logistics sector, as Rob noted, continues to perform well for us. We're building a substantial order backlog to be delivered in the coming months when access to distribution centers is less restricted. In Europe, revenue declined in the high teens year on year due primarily to softness in automotive.

14:58 Unfortunately, we don't see many bright spots in Europe at the moment. Turning to our balance sheet, as noted by Dr. Bob, We ended the quarter with $845 million in cash and investments and no debt. Cognex has a history of consistent cash generation as well as a financially disciplined board of directors and management team. Uses of cash are primarily to support our long-term growth objectives. We also share our many years of success with shareholders through stock buybacks and dividends. In that regard, we repurchased 1.2 million shares of Cognex stock totaling $51 million in Q1 and added a new $200 million authorization to our repurchase program. We are fortunate to have the ability to continue the buyback program and still have cash for acquisitions if opportunities arise.

15:48 We also paid nearly $10 million in dividends to shareholders. Now, I'll turn the call back over to Rob.

15:56 Thank you, Paul. Those of you who follow Cognix know that we typically provide guidance one quarter out. However, given the current business shutdowns, widespread travel restrictions, and potential disruptions we may face in our supply chain, there's too much uncertainty today for us to be overly specific. Our customers and vendors have shared some of their plans with us, but they are also facing uncertainties. I can say, however, that we believe both revenue and earnings per share excluding discrete tax items will decline in Q2 on both a year-on-year and sequential basis. Although we have performed reasonably well overall in April, demand in the overall factory automation market is deteriorating, particularly in Europe and the Americas.

16:51 Gross margin for Q2 is expected to remain in the mid-70% range, although lower than the gross margin reported for Q1. As for expenses, our leadership team has experience with severe economic downturns, and we are working together to aggressively manage costs. We expect to reduce operating expenses in Q2 by greater than 10% on a sequential basis. Savings include lower travel and discretionary expenses and a more restricted hiring plan. Lastly, the effective tax rate is expected to be 17% excluding discreet tax items. Now, we will open the call for questions. Operator, please go ahead.

17:43 Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Please limit yourself to one question and one follow-up prior to getting back in the queue. One moment please while we poll for questions. Our first question is from Jim Ricciuti from Needham Company. Please proceed with your question.

18:30 Hi. Thank you. Good afternoon. I wanted to just, if I could, go back to the comment you made about, Rob, that I think you made about usually high number of requests to both accelerate or delay. Was the net effect of that? More on the positive side, and was that tied more to the comment you made about consumer electronics in Asia?

18:57 Yeah, hi, Jim. Thanks for your question. So, really, what I was referring to was right around the end of the quarter, we saw quite a few customers asking to have their delivery dates moved in earlier. and we saw others say they wanted them pushed out. I would say net it was probably an increase, perhaps of a few million dollars, but it was both ways and it wasn't really industry specific, I would say.

19:28 Got it. That's helpful. And it sounds like you're still seeing pretty or at least the activity level on the logistics side is still encouraging and I'm wondering If I look at your traditional brick-and-mortar retailers, which I guess has been a fast-growing part of the business, how's this business holding up? I mean, how would you characterize this? Is it holding up because you're aligned with some of the key players who seem to be doing better in this market, presumably?

20:05 Yeah, Jim, I would say, you know, I would segment it like this. The customers who have become proficient in e-commerce, whether they started there or they're moving coherently and aggressively into e-commerce, you know, I'd say they're doing well. You know, they see a lot of business and they've moved their systems, you know, online, right? Those who haven't, I think we're seeing their businesses deteriorate. So I think e-commerce players I think are very well positioned to succeed as a result of what's going on and Cognex I think will succeed with them. And I would say that's the part of logistics obviously where we're strongest and have the largest share. But then there are certainly those customers more traditional e-commerce bricks and mortar players who haven't automated their interactions with customers and taken them online and then other companies we consider part of our logistics business, maybe global post offices, airport baggage type businesses that I think are looking very, very weak at this time. So we would expect to see our business with them drop off.

21:17 But the summer ramp from one customer, is that still on track? And I'll stop there. Let somebody else ask.

21:24 Yes, Jim. Certainly, I think the timing of it, the timing of some of the bigger logistics orders we have will depend on their ability to implement. A lot of these companies are operating at higher rates than they've ever operated at at their highest peak moments in previous years. So the idea that we can go in, stop the line, and do automation implementation at this time is is obviously not happening, although orders are coming in, I think, at a good clip in that market. So our ability to report that as revenue, I think, you know, certainly is a second-half phenomenon for us at this point, and the timing will depend on a number of factors, one of which certainly is our ability to get access to their facilities and their engineers to implement these improvements.

22:13 Got it. Thank you. Our next question is from Joe Ritchie from Goldman Sachs. Please proceed with your question.

22:28 Thank you. Good afternoon, everybody. Hope you're all well. Hi, Joe. Maybe just touching on the China comments, I saw on the queue China was up 16% this quarter. I'm just curious, you guys hit the high end of your revenue range for the quarter. It seems like it was Fairly orderly, at least in Asia Pac. As we're coming out of, you know, and things are starting to normalize in China, you know, maybe talk a little bit about like what the order patterns look like as the quarter progressed. And if you could provide some more commentary around, you know, what really drove the strength in China this past quarter, that would be helpful.

23:15 Sure, Joey, give us some color on that. So, yeah, I mean, I think the interesting thing about running a global business is you've sort of seen this kind of challenge kind of evolve around the world. And we saw it in January in Asia, and I was in Asia in January. And, you know, you saw the challenge that it was putting on supply chains, and then China got into Chinese New Year, which is always slow, and then wasn't able to come back, you know, for a number of weeks after that. But, you know, they're ahead. And what we now see is that production, you know, from both the companies we source parts from, but much more importantly, really, I guess, in this case, our customers, you know, is starting to come back. And I would say it came back in March quicker than we expected, mostly due to high demand from customers really in the electronics ecosystem.

24:08 and April continued to improve as a result of China production coming back. And we're seeing manufacturers have been pulling forward orders in some cases to reduce the risk of shortages in their supply chain. And so we've been, I think, very effectively managing this shifting demand at that time. But then there's, as we can all read, there's still shifting schedules on actually when production in certain large Electronics businesses will ramp up. So certainly that's, you know, that's somewhat in doubt as we look for the timing of some of these things. But what we did see was, you know, a faster pickup in March than expected, continued ramping, and then pretty aggressive action to make sure that companies were supplied, you know, coming out of this challenge.

25:04 Got it. That's helpful, Rob. And I guess maybe just following up on that comment and some of your prepared comments on consumer electronics, you said that your customers wanted to make sure that you guys were ready when they were ready to kind of maybe turn the spigot back on from a CapEx standpoint. I guess at what point do you guys think you'll have visibility and what are maybe kind of What are some of the indicators you're looking for, just from a timing perspective, on when you think they'll be ready to make those types of decisions, you know, to really accelerate investment again?

25:48 Yeah, it's a difficult question because, you know, normally at this time of year, we have that visibility and we, you know, and we don't have that at the moment. I think really the primary issue here is the ability to scale up manufacturing. And I think, you know, obviously it's going on in multiple countries, so that's part of the challenge, but China followed by probably Vietnam and Korea, you know, are the key markets. And it's the ability for those markets to be ready to really scale up. And I do think it's not just a matter of getting people on site and processes on site. It's also a matter of their suppliers, sometimes who are our OEM customers, to be able to supply a product to startups, particularly what would be large new products, which can be a big part of our business in this market.

26:48 So, you know, I think it's going to happen. You know, I'm very confident about the timing of it and the magnitude of it, I think, are more in question. I sort of talked slightly about this at our last call when I said, you know, an issue can become as a window in which to implement certain new features. And if that window is shorter, it likely means fewer new features get included in new products that are launched. So any extension of that window can be helpful for Cogmex. You know, we can provide more engineering support and more technology and production. But obviously it will mean the revenue that we're used to seeing in Q2 or Q3 is certainly going to be a second half phenomenon for us this year.

27:30 That makes a lot of sense. Appreciate all the color today.

27:32 Thank you. Our next question comes from Karen Law from Jordan Haskett. Please proceed with your question.

27:44 Thanks. Good afternoon, everyone, and welcome, Paul. When I asked about project inquiry, I realized in terms of sales, it's impacted by your ability to deliver on site. I'm curious, when you look at your project inquiry from customers, are they still... Pretty robust across geography and markets. It sounds like from a logistic standpoint that's still pretty robust, but if you can provide some comments in terms of what you're seeing in terms of project inquiry. I'm just trying to gauge when things start to improve and these restrictions get lifted, how quickly can sales bounce back. Okay.

28:32 Sure, it's not really one answer. I'd sort of almost go around the world and give you a range of answers here, Karen. I think certainly in China, I think we've seen a very, as I hinted or talked about, we've seen a good ramping up of business activity in the last few weeks. And then in America, we actually saw decent activity until, you know, through March and even into the start of April. But then we've seen that fall off quite significantly. And, you know, and then Europe, a similar case to America, but more so. I would say we saw really activity really fall off.

29:18 So if one's to draw an analogy that, you know, Europe and America are like going to come back like Asia, you know, well, we would see it start to come back as the market starts to open up. but of course our businesses in these markets are very different. Asia is much more of an electronics business, you know, so a lot of the demand can be driven by ramping up of, you know, major electronics products that are slated for introduction around the holidays, right, while in Europe and America it's much more of an automotive phenomenon. And certainly, you know, the automotive industry, I would say, as I hinted at in my, or as I mentioned in my prepared remarks, looks like it's much more seriously impacted at the moment than those others. So it's difficult to give you one answer. I would say, you know, we were perhaps a little surprised with how well demand in Europe and America held up through the end of, you know, in terms of activity through the end of March and even into April.

30:16 But then we've really started to see a decline. And then the opposite picture in China coming out, we were quite, I think, surprised that How well activities seem to be picking up there post kind of loosening of restrictions.

30:31 Okay, great. Appreciate the color. I guess, and then on the project side, I was curious, are you seeing much push out and cancellation in projects across various sectors? In other words, you know, maybe as things start to improve, you know, we start to see some pent-up demand come back, but a lot of these projects that were in planning phase, they got halted, and so restarting them would sort of take time, and that in turn creates some sort of air pocket, whether it's in auto or logistics. Do you see, are you seeing any kind of that, like, you know, pause or cancellation right now that would give you maybe a bit of a risk of an air pocket down the road?

31:16 Well, again, it's a complex picture. I'll kind of go through the industries and kind of to come up. You said, I think, correctly with logistics, I think we're seeing a lot of potential, you know, growth getting deferred later in the year and more intense interest. So we feel that's the best industry for us. In electronics, it's a difficult call, I think. I mean, I, you know, kind of how that's going to play out, certainly second half phenomenon for us. I think in automotive, you know, another way to sort of look at the automotive industry for us, which, you know, is a big part of our Americas and European businesses, MRO-type business, more maintenance, you know, is really just very weak at the moment as plants are shut down and budgets are put on ice.

32:02 I would think that has to come back at some point as, you know, business starts to pick up. But then on the CapEx side, the existing plants, also that to me looks pretty weak relatively on hold awaiting plans to start up while strategic investments you know things like new vehicles or electric electric vehicles looks stronger right so I think you know that's probably the part of the business in automotive that is likely to be prioritized much as we prioritize you know most you know the most important long-term technology for us I think we're going to see that in industries like auto as well and then yeah I think other industries some you know some of whom we deal with you know we have a wide range of other industries like what we sort of might refer to them as packaging type businesses and food and beverage pharmaceuticals medical devices I think we might probably a phenomenon we see there is a slowing down of demand basically for the same issues that companies are operating under very restrictive situations where their workforce is very limited as well they can do and I think those industries I would expect to be relatively strong whenever they start to come out of this situation because I think demand for them in some areas of their business is quite strong.

33:22 We read about that consumer packaged goods strength, for instance. And I think, therefore, we might see in that industry some pent-up demand where companies want to implement improved automation projects but just don't have the capacity to open their plants and bring us in and have us work with engineers when they're operating under social distancing.

33:44 Appreciate the color. Thank you. Our next question is from Joe Giordano from Cohen. Please proceed with your question.

33:58 Hey, guys. Good afternoon. Hey, Joe. So I just wanted to make sure if I could square some of the commentary on consumer electronics. So You mentioned that China came back strong, electronics leading that, but also at the same time, like not having much visibility at all in terms of like the big, the big bills from the major customers. So like what's driving that now? Is this kind of like ramp up of suppliers to those large players? Like you getting them kind of ready for them to manufacture their parts?

34:31 Yeah. Yeah. I, I, you know, I, I, I think we were all expecting 2020 to be a pretty strong year for electronics, particularly around 5G and some of the other technologies that's planned for rollout. So, you know, I would say probably some of what we're seeing, the supplies of those technologies gearing up production.

34:53 Got it. And then I just wanted to make sure I understood the comments on auto. So, you know, obviously when these markets open up, they'll be, you know, Car Sales will go up, but obviously that's not where you guys are. So, like you mentioned, the R&D type projects, you expect that to come back, but not the traditional CapEx? Maybe I misheard that. I was writing something down. So, can you go through that again?

35:17 Yeah. Yeah, I mean, I would say if we segmented this MRO kind of maintenance business, right? You know, if the plants just shut down, that business is not really happening. If the plants will open, that'll probably come back, right? Then I think I would segment CapEx into two pieces. There's like existing plants, right? I think probably with the automotive industry in quite a lot of financial distress or challenge at the moment, CapEx and existing plants, I wouldn't expect that to come back very quickly. I think it will be challenged. Then there's other CapEx, which is really CapEx on strategic projects. New vehicles and new technology is being implemented.

36:02 Electric vehicles, of course, is one example of that. That business, I see that remaining strong through this period. I think it's the future of the industry, and I think it's the things that companies will at least want to compromise on. That's clear. Thank you. Our next question is from Richard Eastman with Baird. Please proceed with your question.

36:33 Yes, thanks for the question. Welcome, Paul. Just quickly to circle around and stick on the consumer electronics for a minute or two. Rob, the business in the first quarter, and again, strong in China and the rest of Asia is stronger. Is your business there with some of the component vendors involved? and assembly on some of the component vendors that will go into the final devices. You know, the applications that Cognex is involved in, you know, and I'm thinking perhaps displays or some of those, you know, components that are going to end up in a logical place come fall. Is that what the strength is in particular, you know, outside of China?

37:23 Broadly speaking, Rick, yes. That's correct. Components, key components and technologies, particularly coming out of Korea and Vietnam, I'd say we've seen some strengthening of that and we saw that coming and it's continued.

37:42 And just in related, does the scale up there, does it provide you with any sense of demand as you look forward towards the end of the year? You know, given product strategies, product portfolios from your bigger customers?

38:02 Well, yeah, difficult, difficult call to make, really, I would say, because, you know, while one might say yes, you know, it seems like people are scaling up. Experience working in this industry tells me that that's not necessarily the case, right? Some suppliers may be building capacity that won't be fully utilized, right? Others, you know, others may... and many more.

38:54 moving from, you know, traditionally from COGS over to, you know, your R&D. Is R&D up and COGS down because of your mix in the quarter?

39:09 Paul, do you want to answer that?

39:11 Sure.

39:12 Yeah. Hi, Richard. No, really, I mean, the margin was mostly a product mix phenomenon. So, We have a wide range of margins, all much healthier than my former employer, that makes up our gross margin. It really was just a higher share of software revenue as well as revenue in consumer electronics, which comes in at higher margin generally, and then the margin was also improved in the quarter. That was really the big driver. I don't think there was a big difference in, you know, are the only that hit OPEX versus hit COGS for the quarter. Okay.

39:56 So with that reply then, the R&D from a dollar perspective, does it just run out pretty much at the current level? I mean, run out quarterly?

40:10 Yeah, I'd say broadly speaking. I mean, you know, we have reduced our discretionary expenses as noted in the call. We were down, you know, from Q4, and we expect to be down in Q2. And we think of that across all of our operating expenses. We don't do kind of line item differences per se for RD&E versus ST&A. So we do expect them to be down sequentially, though I would say some of the factors are more likely to hit such as reduced travel, for instance, in the quarter is more likely to hit sales, let's say, than RD&E. But restrictions on hiring or discretionary expenses would be pretty broad-based, I'd say.

40:53 Okay. All right, awesome. Well, thank you. Thanks for the questions. Our next question comes from Nick Amacucci from UBS. Please proceed with your question.

41:08 Hey, guys. Thanks for the time, and welcome, Paul. Just a quick question. I just want to try and put a final point on some of the commentary about the week, March month. Can we kind of get a magnitude of kind of the decline we saw in the U.S. and Europe, assuming China was a little bit better in March? Sure. So, you know, I think... I'm not sure I'd describe March as weak necessarily. I think, you know, we were on the high end of guidance, but we did see a lot of both pulling in and pushing out of order. So, I might describe it more as noisy, you know, and I guess it depends if you're measuring against our expectations is what we thought or whether, you know, whether you're referring to kind of year on year.

42:06 So, but I think, you know, in the Americas, for instance, we did see customers placing some investments on hold and canceling projects as a result of slant closures, you know, distancing protocols, lower consumer demand. We certainly saw some of that. And we saw... Other industries in America holding up very well or even upping their demand from us, particularly in areas like life sciences and medical related businesses who obviously are seeing a lot of demand related to the current medical COVID situation. But I'm not sure I necessarily answered your questions.

42:51 Well, yeah, I mean, I was just kind of looking at the U.S. and Europe, right, down double digits year on year, both geographic areas. I'm just trying to get a gauge of if that was kind of in the March month, an order of magnitude, how it kind of was impacted by the shutdown. Yeah, I think if I'm to, you know, put up, you know, Another explanation, another way of looking at it would be automotive, right? I mean, I think we really saw deterioration in automotive, which we didn't see in other parts of our business in America and Europe as we came through March and into April.

43:38 Okay, great. And then just kind of when thinking about the pushing and pulling, acceleration and delaying of orders, From the delaying side, have you guys received any full-on cancellations of orders or is it just kind of indefinitely delayed until we kind of get more clarity on this? Certainly we're seeing some cancellation of orders. Not a large amount or anything, but certainly some customers have cancelled orders. And then definitely delays, and I describe the delays as Short-term delays, well, literally, you know, in a number of cases, we've shipped product out to plants and then when they arrive, the plants are closed, right?

44:26 So, you know, they're coming back in some situations like that. And in other cases, as we mentioned, they're getting accelerated, really, where I think customers are worried about being able to maintain production and getting our product as soon as possible. Perhaps concerned that companies like us won't be able to supply on a regular basis. We're not concerned about that. But I can see among our customers there is a sense that perhaps as we do in our own personal lives there's a hoarding phenomenon kind of going on and thinking that supply chain electronics may be elongated and they need to make sure they're getting theirs before lead times go out. All right, thanks for the time, guys. I'll leave it there.

45:17 And once again, as a reminder, if anyone has any questions, you may press star 1 on your telephone keypad. Doing so will place yourself into the question queue. Our next question is from Andrew Vizcalia from Barenburg. Please proceed with your question.

45:34 Hey, guys. I wanted a quick clarification on discourse margins going forward. and that it seems as though electronics is picking up and you're seeing some better mix. So you might have said this, I might have missed it, but just why the sequential decline in gross margins? And then presumably if things improve towards the back half of the year for that segment, do you think you can grow them this year, year over year?

46:01 Sure.

46:02 Yeah, Andrew, this is Paul. Yeah, so our gross margins of 75% in Q1 were were obviously high and driven primarily by the mix of business, higher electronics, and then even just particular sub-segment mix within that, the mix of different products and so on, as we have quite a range. Going forward for Q2, we do expect them to be lower. And again, that is largely a mixed phenomenon. As we talked about some deferrals of of Logistics Revenue. You know, logistics is a strategic priority for us. It comes with improved margins over time, but still dilutive to our base business. So, as that continues to grow, we will see some margin pressure, but overall we expect to be, you know, roughly in the sort of mid-70s range that we've been historically.

47:02 Okay, got it. Okay, and, you know, sort of a A comment that a lot of people are making throughout this whole crisis is the new normal once we emerge. Are you guys hearing anything around the trend towards reshoring that seems to come up as you'd be a long-term beneficiary of that? I'm curious if you've had some conversations yet to date on that.

47:31 Yeah, hi. It's Rob here. I would say there are a lot of Potentially very positive things for machine vision, you know, kind of when we come through this course. But I wouldn't list the reshoring of manufacturing, you know, as very high on the list in terms of, you know, what we're hearing or in terms of my own, you know, views about it. You know, clearly e-commerce fulfillment will benefit from this situation, right? And logistics will become increasingly automated. and with more flexible operations and you know even in the short term I think you know people don't want to be sharing touched items like handheld barcode readers and Cognex has you know the best fixed mount barcode readers in the world and you know I think we're seeing more interest in them replacing handheld barcode readers so you know there was a there was a kind of and some things one sees.

48:28 I think certainly visual inspections in manufacturing with large groups of people kind of sitting close together as you see in China, you know, certainly that's a phenomenon I think which is likely to play to automation and, you know, and operator-free manufacturing. So, you know, basically we're replacing eyes and brains in manufacturing with robots and automation. I'd say obviously medical applications, you know, I think probably will be a beneficiary of what we're seeing as well. You know, we've been working for many years on the life science market and it's been a long road for us, but one where we've developed a lot of really good customer relationships and a lot of important design wins. And we think there, you know, that that will also be a market that will be better and better for machine vision and will benefit from what we can bring and we're deep learning as a role to play replacing kind of lab technicians and more quickly automating.

49:31 So and I think probably also if it's something we've all observed living through this is that connectivity is really important. So whether it's 5G or what kind of electronics things we're seeing and the kind of drive we're seeing in the semiconductor industry right now can only be I think accelerated as a result of all of that. A lot of very, very positive things. I don't see a global movement towards reshoring as a result of this, but I wouldn't claim to be an expert on that subject. And then, obviously, to temple that, I think automotive is likely in for a prolonged slowdown. So I think that'll be a drag on a lot of the very positive things we expect to see coming out of this situation.

50:19 Okay. Thank you. Our next question is from Paul Costner from JP Morgan. Please proceed with your question.

50:31 Yeah, thanks. The last question really kind of got to the point, I think, on the new normal. So many of my questions have been answered, Rob, but just a couple of things. You seem to believe the auto industry is going to take longer to come back. Is that simply a function of just how much stress there is on their balance sheets and that they'll be constrained in investing for a period, or... Do you also believe that the ICE to EV transition is going to take longer for some reason?

51:04 Yeah, well, I would say what's making me say that? Conversations we're having with customers, certainly, you know, tier one suppliers and brand owners, you know, who had a difficult year last year. And I think we were all expecting to see that business sort of turn around. You know, optimistically in the back half of this year, and I think we no longer think that's going to be the case. So I think that's one factor. Another factor would be, you know, I have to believe that, you know, consumers are going to have less cash to spend and less ability to take out loans to buy cars as a result of this. So I would imagine, you know, and my sense is from the conversations I've had in the industry that that's got to be weighing on people's minds also.

51:51 If there's a countervailing factor to that, though, it may be government stimulus. And I have read, certainly, there's no particular insight I have into this other than just reading and being in the industry is some major automotive businesses are pressuring governments to try to implement buying back of older cars and investing in stimulus around electric vehicles. So that's a A general sense, but I really have no clarity on that subject for you.

52:22 All right, got it. If this recession lasts for more than one quarter and is deep for more than one quarter, obviously there could be very lasting consequences. But, I mean, generally speaking, Cognix's view of its long-term growth opportunity, how much has it changed as a result of what we're going through at the moment?

52:44 Difficult to answer, but I would say it hasn't. It hasn't changed. We're still very strong believers in machine vision and the importance of automation and the growth of automation and the role we have to play in it. And those growth drivers that we discussed at Analyst Day and since, things like deep learning, logistics, 3D, Industry 4.0, we think those are all intact and and I also think the strength of Cosmex and our balance sheet and our willingness to invest for the long term ought to mean we're better positioned than most of the industry as we come out of this.

53:22 Got it, thanks so much. And our next question is from Jaram Nathan from Daiwa Securities. Please proceed with your question.

53:36 Hi, thanks for taking my question. Just going back to the CNA expense a bit here, you mentioned in the queue that there was some reallocation to regions with higher labor costs and at the same time it looks like U.S. and Europe are probably, you see lesser opportunities for growth there. So can you kind of explain that comment a bit more and then I had a follow-up.

54:03 Yeah, and it's your question about our expenses in those I'm not quite sure what you're asking.

54:11 Yeah, so in your Q, you mentioned for his G&A expense, you saw an increase, and some of that increase was related to sales resources being shifted to regions with higher labor costs. Yeah. Yeah.

54:32 Thank you. I think probably, I'm sorry if we confused you, so it's not necessarily sales resources moving geographically, it's moving functionally. So for instance, certainly we're fortunate at Cognix to have a lot of very talented sales engineers who have deep knowledge of machine vision. So we're pretty used to reallocating them dynamically to areas where we see growth opportunities. So we might, for instance, be moving them towards logistics. and away from automotive.

55:04 I think that's probably what we were trying to get at. Okay, got it. And as a follow-up, I just wanted to understand, given the situation, are you seeing more favorable or attractive M&A opportunities which, given your balance sheet, you can take advantage of?

55:24 I think it's probably too early to say that. But you're right, we have a very strong balance sheet and we're not afraid to be opportunistic. And certainly we spend a lot of time studying and thinking about acquisition opportunities in the market. But I think anyone who's covered Cognix for a long time knows that we're very selective about the companies we acquire. and some of those companies that I think perhaps have weaker balance sheets or might be challenged by the current environment aren't necessarily companies we would want to acquire. They wouldn't fit well within a high gross margin, high performance, move fast kind of culture. So I wouldn't expect to see us making any kind of large bolt-on acquisitions with many, many hundreds of people.

56:09 If you look at the acquisitions we've made, it's more around technology companies with great engineering, great products, etc. There are plenty of those, but it's not clear to me whether they're becoming more actionable as a result of what they're seeing, but if and when they do, you can bet we'll be looking at them. Okay, great. Thank you. And our next question is from Josh Porzywinski from Morgan Stanley. Please proceed with your question.

56:43 Hi, good evening all, and welcome, Paul. Just a question on electronics. I guess with some customers now telling you to be ready, presumably it comes with a little bit of detail on kind of ready for what. Any sense, Rob, on how 5G or some of the other newer technologies add to Cognex's kind of area of opportunity or content in a plant? I know the ambition is to get more over time and there's other stuff that can do that, but is there anything about this new product generation that's coming out that is another kind of step function shift for Cognex, kind of like we saw with OLED back a few years ago?

57:36 Thanks for the question. I don't think our view about this topic has changed over the last six months in general. I think we're very connected to the large players in the industry and we see some of the challenges that exist with 5G. Challenges around the power requirements of 5G technology, the danger issues around batteries, etc., handling those and inserting them, you know, cut some of the new sensors and screens and foldable screens and all those things that we've been talking about for a while. So, you know, I sort of see those things as kind of making progress and automation kind of gearing up to be able to implement what's in product roadmaps.

58:23 I think more the issue changing coming out of this is the magnitude of that in the second half. That's maybe a more difficult thing to call. You have to think that a I have to think consumers would be less ready to spend on high-end technology and new technology as a result of this, but I'm no expert on that. So I think we see quite clearly that machine vision has a key role to play in the implementation of 5G technology and new technologies coming into electronics. I think the question is the timing and the magnitude of that. The timing clearly for us is second half. The magnitude is still a little unclear. And I wish last year, last few years, we've been able to give you quite a lot of clarity at this stage. And it's different this year as a result of what we're seeing in the global health situation.

59:19 Understood. And then just checking over to Otto, Rob, can you talk a little bit about customer diversity there? You mentioned kind of a more shallow recovery, maybe some challenges in the industry. I would imagine some smaller or weaker players might not survive. Clearly, in the last couple of years, there's been kind of an explosion of newer car companies, particularly in China, maybe not as impacted. But can you talk a bit about how well you feel like you're diversified and if you do see some players go away, if that ends up being an issue or more of a temporary setback?

1:00:02 Cosmex is very globally diversified in terms of dealing with really all the major tier one suppliers and really all the major end user brands. We're less well penetrated geographically in Japan, as you might expect, but we have strong relationships and would be on the preferred supplier list of almost every automotive brand, OEM and tier one supplier. you know, globally. So, you know, I think we're in good position there. I think if we could companies fail, you know, I am no expert, but I would say they may get acquired by other companies. And I think, you know, that should play out well for us given what we've seen happen in industry over the last few years.

1:00:50 You know, and then I think machine vision is a very important technology for manufacturing lithium ion batteries, right? and we all know that that's key enabling technology for electric vehicles and capacity is growing very quickly and costs are coming down very quickly and it's a very intensive process. In some cases, 30 different steps, most of which involve machine vision. So those are markets I think that should be very strong for us and I think that's a long-term phenomenon with at least six global players competing for jobs process, you know, process capability and technology to win. So, you know, I think that's a long-term phenomenon that we should be well positioned and our industry should be well positioned to go on benefiting from for some years.

1:01:40 Got it. I appreciate the call. All the best. Thank you. And we have reached the top of the hour. Therefore, we have reached the end of the question and answer session. And I will now turn the call back over to Dr. Shillman for closing remarks.

1:01:57 Thank you. As I've mentioned, our strong balance sheet, our culture, and our focus on the long term will enable Cognix to weather the current disruptions better than most companies. But business is not likely to improve until lockdowns end. In that vein, we urge governments to better balance the risks of COVID with the disastrous effects that lockdowns are having on our economies, and On Our Lives. Thank you for joining us tonight. We'll speak with you again on the next quarter's call. This concludes today's conference and you may disconnect your line at this time. Thank you for your participation.