Cognex (NASDAQ:CGNX) Q2 2020 Earnings Call

0:00 Greetings. Welcome to Cognex's second 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 Susan Conway, Senior Director of Investor Relations. Thank you. You may begin.

0:30 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 Podger. 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 forward slash investor. Both contain highly detailed information about our financial results. 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.

1:21 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 SPC filing, 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. Baugh.

1:58 Thanks, Sue. Hello, everyone, and welcome to our second quarter of 2020 earnings. It has been a very busy three months since I talked to you on earnings. That time in our business and most others have deteriorated substantially due to the worldwide government-ordered shutdowns attributed to COVID-19. Because of that, we had to make difficult measures to align our company to the slowdown, and that resulted in large write-downs in Q2, severely affected our reported financial results. The details on those results and on what Cognex has been doing this past quarter, I'll turn the call over to my partner, Cognex's CEO, Rob Willis.

2:48 Rob, the microphone is yours.

2:52 Thank you, Dr. Bob, and good evening, everyone. Tonight, Cogmex announced financial results for Q2 of 2020 that reflect the difficult business environment we expected when we talked with you in April. Good news to report is that revenue increased by 1% over the prior quarter. This was better than we anticipated due to our faster-than-expected delivery on a substantial backlog of orders from the logistics market. Cognoids worked hard to manage our supply chain and deliver Cognex products to customers despite significant components shortages. However, revenue declined by 15% year-on-year due to lower spending by customers in Europe and the Americas.

3:43 The downturn was most noticeable in the automotive market, which was our largest end market in 2019. Growth in logistics, STEMI, and life sciences helps offset that decline. Business activity is improving, but demand in many of our markets is weak, and it's expected to remain so through the end of the year. Despite that, there are two areas of strength in our business that are contributing positively. One is the e-commerce sector of logistics. Even though most retail stores, airport baggage handling customers, and postal accounts are struggling, major online and big box retailers are stepping up their investments in Cosmex Machine Vision to enable higher throughput and productivity in their distribution centers.

4:41 The other sector that's doing well is consumer electronics. We are now delivering large deployments of Cognex products that we expect will be recognized as revenue in Q3. In addition, we're pleased with how productive our sales team has been during these times of limited customer access. Sales noise and application engineers have been successful holding technical discussions and product demonstrations via video conferencing. and winning a lot of business in this matter, even with new customers. Next, let's talk about the plan we announced during Q2 to lower Cosmoid headcount by 8%. The decision was a difficult one, given our company culture and the value we place on perseverance, but it was something we had to do given the circumstances.

5:37 We entered 2020 staffed to achieve significant new revenue levels, perhaps exceeding a billion dollars in a year or two. But unfortunately, that is unlikely to occur due to the economic disruption, and therefore we right-sized the team for more modest near-term growth. As part of the restructuring, we saw an opportunity to reduce duplication and redundancies that had built up in our business from years of global expansion and acquisitions. We reorganized our engineering teams around the world in a way that we believe sharpens our focus on specific growth areas and enables us to leverage Cognex's unique capabilities more efficiently. After the restructuring, we still have the capacity for significant growth.

6:26 We've not changed our product roadmap, nor have we delayed new product development. We're also moving forward with other initiatives that Thank you for joining us. As a result, our projected revenue for Sewolab has been pushed out, thereby reducing the value of that asset.

7:18 We continue to be bullish about our overall deep learning business. Deep learning's bookings have increased by more than 50% year-on-year, making it our fastest-growing product category. A major step was the launch of Cognex's Insight D900 smart camera in April. The D900 makes advanced deep learning technology accessible to the tens of thousands of manufacturers who have standardized their factory automation on our industry-leading Insight platform. Initial sales are growing nicely as customers discover how effectively the D900 finds defects on complex parts and accurately reads badly deformed, skewed, and poorly etched codes.

8:04 In other product news, we launched the Insight 8505P, a high-performance 5-megapixel smart camera with Cognex HDR Plus technology that is ideal for integrating into tight spaces on production lines. It's important for our Asia region, where electronics manufacturers and OEMs value its combination of precision, speed, and small form factor for demanding applications, such as inspecting assembled devices for manufacturing defects. We're proud of these new Insight products and doubly proud to have launched them in the current environment. They demonstrate the advantage that our culture brings as we effectively work together during these challenging times.

8:49 While many Cognoids are still working from home, we're maintaining our product development plans and remaining on schedule with our operations and process improvement plans. Regarding supply, Managing our global supply chain continues to be a challenge currently, but we're navigating well under the circumstances. In Q2, we saw some vendors struggle to supply parts. We also continue to see freight deliveries taking longer and costing significantly more. Our close relationship with suppliers and our practice of holding substantial component inventory have helped us in the current crisis. Even so, we recognize and continue to plan for the possibility of supplier and customer closures and further disruption down the road.

9:38 Let's now turn to details from our second quarter. Paul, over to you.

9:46 Thank you, Rob, and hello, everyone. As you know, Cognex is known for being straightforward. We typically discuss our results Almost exclusively on a GAAP basis, but we believe some pro forma disclosures will be helpful this quarter, given the actions we took in Q2. With that in mind, let's get into the details. Revenue for the quarter was $169 million, which was better than we expected, still weak. That level represented a substantial decline year on year in the broad factory automation market, particularly automotive. The impact was most noticeable in Europe and the Americas because of widespread business disruptions in both regions.

10:32 Partially offsetting the decline was growth in logistics, where e-commerce fulfillment customers performed well. Logistics also increased on a sequential basis. That growth, combined with returning production in China, offset the decline we experienced in other areas of our business, from Q1 to Q2. Reported gross margin was 70%. which included a reserve of $7.7 million for excess inventory resulting from the business decline. Gross margin was 75% excluding that non-cash charge, which is consistent with Q1. It was slightly better than we expected due to a favorable product mix and improving gross margins in logistics. Operating expenses in Q2 included a restructuring charge of $14.8 million, primarily for the workforce reduction discussed by Rob.

11:23 Our restructuring actions were substantially completed by the end of the quarter. We expect a residual charge of between $1 to $2 million in the second half, primarily in Q3. We also recorded a non-cash charge of $19.6 million in Q2, primarily to write down a portion of the intangible assets from our acquisition of SULAB. Excluding these one-time charges, the combined total of RD&E and SG&A declined by 14% Thank you. Thank you. which was approximately 800 basis points higher on a sequential basis.

12:28 The decline year on year was due to the lower revenue as compared with Q2 of 2019. The effective tax rate in Q2 was 19% excluding the free tax items. That was higher than we expected because we now believe more of our profits in 2020 will be earned and taxed in higher tax jurisdictions. On a non-GAAP basis, earnings were 18 cents per share in Q2 compared with $0.28 in Q2 of 2019 and $0.11 in Q1 of 2020, excluding discrete tax items and the free charges just mentioned. Looking at the change in revenue for Q2 year-on-year from a geographic perspective, our best-performing region was Asia, which increased by low single digits year-on-year.

13:16 Higher revenue from consumer electronics and semi offset a decline in automotive. Our customers in Asia are now largely back to work, and in that regard, ahead of other regions. In the Americas, revenue declined by low double digits year on year. Growth in logistics almost offset a substantial decline in revenue from automotive. Spending by manufacturing customers is gradually improving. Facilities are reopening, and we are winning business from companies that are scaling up production for COVID-related products. The most challenging region in Q2 was Europe. where revenue declined by 40% year-on-year. Business shutdowns further worsened already weak fundamentals in automotive. The timing of revenue from consumer electronics was also a factor.

14:05 In that regard, large order revenue from consumer electronics in 2019 was split between Q2 and Q3. This year, we expect that business will be mostly concentrated in Q3 and with a higher proportion benefiting our Asia region. Turning to our balance sheet, we ended the quarter with approximately $900 million in cash and investments and no debt. Our approach to capital allocation remains unchanged despite the difficult business conditions. We continue to manage Cognex for the long term while also sharing our many years of success with shareholders. We paid approximately $10 million in dividends to shareholders during Q2, and tonight we announced a similar payment to be made in Q3. We did not buy back any stock in the quarter.

14:53 Our inventory balance decreased by approximately $7 million, or 12% from the end of 2019. However, including the substantial E&O reserve we recorded in Q2, inventory was roughly flat over the six-month period. Now I'll turn the call back over to Rob.

15:12 Thank you, Paul. Moving next to guidance. We expect Q3 will be the best quarter of the year by far, with revenue between $200 million and $220 million. That range represents an increase both year-on-year and sequentially due to higher expected revenue from consumer electronics, which we believe will be mostly concentrated in Q3 this year. We also expect another strong quarter in the e-commerce sector of logistics. as we deliver on business that we have been working on for some time. Despite that strength, which can be attributable to a few large customers in e-commerce, family, and electronics, overall demand is lackluster, and it's unclear when that will change.

16:02 Gross margin for Q3 is expected to be in the mid-70% range, slightly tempered by the high volume of revenue we expect from logistics. The combined total of RD&E and SG&A, which excludes the charges that we discussed tonight, is expected to be relatively flat, both year on year and sequentially. Lastly, the effective tax rate is expected to be 19%, excluding discrete tax items. Now, we will open the call for questions. Operator, please go ahead. Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation cell will indicate your line is in the question queue.

16:50 You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Karen Lau with Gordon Haskett. Please proceed.

17:09 Good afternoon, everyone. Rob, you sound pretty downbeat on markets excluding e-commerce and CE. I was wondering, are you guys not seeing any meaningful sequential improvements in markets outside of those two? And can you maybe comment on kind of the rate of decline you saw in April versus the exit rate you saw in June or maybe July even?

17:41 Hi, Karen. I think the story really is that the automotive market, which was our largest market last year, looks weak. I think that's the main source of it. There are other markets that we serve, medical-related industries, including life sciences, medical devices, pharmaceuticals, product security, a broad range of our markets, more the other markets, actually which are performing reasonably well and showing some growth. So I don't wish to sound overly negative, but certainly automotive is the market that is giving us substantial headwinds.

18:19 And to that point, can you comment on kind of the exit rates that you're seeing in auto in June and July? Kind of how much is it down year over year?

18:34 Yeah, yeah, I'll give you some color on that. I mean, so So I think automotive was our largest market in 2019, and it was stopped coming into this year. But we were optimistic at the start of the year that we thought things might pick up in the second half, and probably we no longer expect that to happen given the COVID situation. Demand from automotive deteriorated sharply around the COVID outbreak and revenue from automotive declined by 40% year-on-year in Q2. So it's roughly $25 million of headwind for us in the quarter. It continues to look weak worldwide, including spending even on electric vehicles, not really showing the strength we might have expected.

19:26 In terms of exit rate, I mean, there's Some sign that it's improving from its lows. I would certainly say I think we've hit bottom there. But in terms of getting to the level that we had hoped coming into the year or the return to the kind of solid 10% growth that we've become used to over the past few years, we don't expect that to happen probably until the middle of next year.

19:54 Thanks for the cover. And then on CE, so with the delivery expected in the third quarter, can you comment on how much the overall is going to be up this year? And then maybe put it into context for us. I believe your CE business peaked in 2017. If your council would increase this year, how much would you still be down versus that peak level?

20:22 Generally, we don't give fully projections, as you know, forecasting for Cognex, nor would we give specific guidance like that. What I would say, I think you're right, is that 2017 was our best year ever in electronics, and I wouldn't expect us to outperform that this year. But we're putting up some good growth in that market. I would say coming into the year, we thought there was a very good chance we would see very strong growth in consumer electronics and we're seeing growth, but it may not be quite at the level that we would like. So I think there's a bunch of things going on.

21:08 One is outside of phones, outside of smartphones, the accelerated online learning and working from home and is certainly driving growth. We're seeing a lot of growth in that area. And then we certainly are seeing some nice growth related to 5G and OLED screens. But I think some of that growth that we had hoped would come this year looks like it may be getting pushed out a little. But despite that, I think it'll be a good year for us in consumer electronics. So we expect consumer electronics will be our largest market this year, but Logistics may just give it a run for its money, and automotive is not in the running to be our largest market this year, I would say.

21:57 Okay, understood. I'll pass it on. Thank you.

22:00 Thank you. Our next question is from Andrew Vascazulia with Thornburg Capital Markets. Please proceed.

22:11 Hey, guys. Can you, out of consumer electronics, Is there a reason to believe, just given how unprecedented these times are with Q1 and Q2, that we could see some atypical seasonality in consumer electronics in Q4? Is there any indication that that is likely this year?

22:38 I think we certainly think that most of this year's revenue will be recognized in Q3. Last year it was Q2 and Q3. Pretty much if you look back through the last five years or so, which have been really big electronics years for us, it's always been Q2 and Q3. This year, as we sort of discussed in previous calls, it's got pushed into Q3. I wouldn't expect large amounts of it to flow into Q4, but there's no reason why we from where it looks from here.

23:23 Okay. And, you know, you took some substantial restructuring that you haven't taken in a long time, which would indicate you wouldn't expect really a pickup in demand anytime soon. But, you know, it seems like Q3 is picking up a bit. And can you comment on, like, you know, am I reading into that wrongly that you don't expect, you know, Much of a lift beyond Q3 or Q4.

23:54 Yeah, I wouldn't read it in such a short-term way. I think, you know, we've grown our headcount and we've made a lot of acquisitions, seven acquisitions in the last four years. And I think we were soft. I know we were soft entering 2020 like we expected to return to some pretty strong growth after having the first down year in nine years in 2019. So we were kind of ready to go, expecting the kind of growth we're seeing in logistics, expecting a strong year in electronics, expecting a better year in automotive. And then after COVID, we recognized that we needed just to take action. And we viewed the current environment as an opportune time to sharpen our focus on growth areas, leverage talent more effectively, reduce some of the redundancies we saw in the business.

24:44 So I think we really aligned our capabilities better following many years of growth. So, you know, we're really long-term thinkers at Cognex, and, you know, this is something that probably needed to happen. We needed to align ourselves better, and the downturn in DuBond really was very clear to us that this is the time to get on with that. But we, as I said in my prepared remarks, I think we have plenty of capacity for growth We really are, I think, well-structured for growth. So we could expect to grow our business substantially without adding much cost, you know, other than variable costs. You know, not much headcount, not much investment, I think.

25:29 We're still well set for that.

25:32 All right. That's helpful. Thank you. Our next question is from Joe Giordano with Callen & Company. Please proceed.

25:44 Hey guys, how you doing?

25:46 Hi Joe.

25:48 I'm wondering, can you kind of like scale the content that you're getting on some of these CE and logistics kind of orders? Like if you were to think about it like in a given production line for CE or in a given amount of square footage at like a logistics facility, like how does your content look Now versus a few years ago. I mean, not looking for specific dollar amounts, obviously, but how has that like-for-like content expanded over time?

26:21 Well, it's an interesting question. We don't generally think of it that way. I think we tend to think of numbers of lines, or in the case of logistics, numbers of facilities, and then we think of what we do in terms of Features or specific tasks that are being added there? I would say overall the level of content and capability we're adding to lines is similar probably that it's been over previous years in facilities, but it's changing. I think it's more vision related, higher value. So I would say probably kind of similar but evolving in what it is more to Higher value applications. We used to perhaps be doing more basic barcode reading and things like that, and now we would be doing more vision, more dense learning, higher value type applications.

27:21 That's fair. And then on auto, third-party estimates right now, and obviously those can change wildly over time, but right now we're talking about pretty substantial year-on-year productions. I want to make sure I understand your question. You're saying in automotive? Yeah, in auto, they're expecting production ramps next year, pretty substantial on a year-on-year, obviously off a low base, but I'm just curious, you know, you're more on the investment side of things, so how do you think your business would operate in that sort of production?

28:14 So you're talking more about unit volumes of production?

28:19 Yeah, unit volumes look like they're going to go up. I'm just curious as to how you think about what that means for your business next year.

28:25 Yeah, yeah, I think for us it's going to be more about new lines and retrofitting existing lines. So, you know, I think I don't necessarily see unit volume driving a lot of incremental investment in automation. What I would see is the introduction of new models, you know, and new technologies would be, that's more of a lever you know there are you know there are speculation that there are perhaps you know 60 new electric vehicle models coming to market over the next few years those kind of things can really drive a lot of growth for Gagnex but of course you know when big automotive or tier one automotive who are our customers in that space if they're struggling you know if they're conserving cash then they're likely to do less retrofits or upgrades in general so it does have an impact on us but More of that kind of metric to gauge future growth for us would likely be around introduction of new models and new technologies into automotive.

29:32 And if I could just sneak one last one in. You know, e-commerce, you're doing quite well there. You mentioned a few big customers driving some of that business now. Given what's going on and everyone kind of scrambling to get supply chains adjusted to the current reality, does this year strike you for your business as like, Well, I think we see logistics as, you know, a great growth market for us.

30:07 And we've said in the past, you know, we have ambitious plans to grow that business at 50% a year. And we've been able to do that pretty well in most of the last few years. I think, you know, because we just see so much demand for machine vision in helping productivity develop supply chains and as those supply chains move to more online and more e-commerce type models, you know, we just have it's a great market and we have a great technical advantage in it to play. I think so what we're seeing at the moment is we're seeing that growth is being very skewed towards, you know, winners in that marketplace, particularly those and what's been disappointing to us more in the logistics area is those customers in broad retail, like formerly bricks-and-mortar retailers who we would have expected to see growing strongly at the moment, but of course they're really struggling, right? And I think they're struggling with liquidity and their own futures.

31:14 So we're not seeing the same level. We're not seeing the same level of investment there we would like to have. have gone very cold this year. So I think it's a bit of a varied story, but the really good growth we're seeing, better than expected, is in e-commerce. I think longer term we would expect some other markets, like the ones I discussed, more regular retail, to come back more strongly for us in future. And then I think the other thing we're expecting and we're seeing already is broader use of machine vision beyond and I think that demand will come back once we're through this current situation.

32:02 Thank you. Our next question is from Joe Ritchie with Goldman Sachs. Please proceed.

32:33 Hi. Good afternoon, everyone. Hi, Joe. So, Rob, I think if I recall correctly, at the end of last year, you guys talked about something like $40 million or so of logistics revenue that got deferred, and I think you expected to ship it in the third quarter of this year. Did some of that get shipped in 2Q or is that predominantly still on track to kind of ship for 3Q?

33:02 Yeah, I'm not sure we gave a specific number, but I think, you know, directionally, you know, you're correct that we did. We saw a big backlog of logistics business building and deliveries getting delayed. You know, and we're really – we're seeing a lot of that business come, you know, through Qs 2, 3, and 4. and how it looks. And we're also, you know, we're also seeing a pretty great backlog build in addition to that. So broadly speaking, that's kind of what is happening, I think, as we expected there.

33:34 Got it. Okay, that's helpful. And look, some of the, you know, some of the integrators like Honeywell, for example, their Intelligrated business, they just reported, you know, their orders were up something like 300% this quarter and Keyon's orders were also doubled this quarter. I guess, how should we think about their businesses as it relates to yours in being able to, you know, whether there's any type of, I don't know, capacity constraint in being able to ensure that your products are being installed, you know, within a reasonable timeframe? Like, is there any kind of, like, bubble that's forming that... could potentially constrain your ability to get your products installed and delivered on time?

34:22 Well, I think the way it works is there's a group of, we call them integrators out there, Integrated, the division of Honeywell, I think you're referring to as one of them. There are many others, Domatic, Randall, Andy, Bastian, Toyota, there's quite a number of those businesses over the years. Generally, they're getting very, very large contracts that sometimes can be two years out. In some ways, the dynamic is a little bit like what a line builder does in automotive. They're getting contracts for new car models that are a couple years out, and then as the product becomes closer, nearer to implementation, we work with them on putting the vision system in, but we're specified normally by the end user.

35:09 So, you know, when you look at some of those kind of reports that we're hearing, you know, it's indicative of years of growth ahead, which will be coming our way probably in a year or so, depending on how the product rollout schedule changes between now and then. So, you know, I view it as leading indicators and in line with what I would expect.

35:34 That's great to hear. And I guess just lastly, maybe just following up on some of the on the consumer electronics question. You did reference like online learning and OLED screens specifically. I'm just curious, you know, if you can give maybe just a little bit more color on end market application. It doesn't sound like it's smartphones. I don't know if it's like iPads or what specifically this is going into.

36:00 Yeah, so, you know, so Cognix, we sell, we really sell to all the major players in consumer electronics. and so they, you know, most of them really have a broad portfolio of products. You know, our business has been very much in smartphones this year. You know, still very solid in smartphones, for sure, is how it looks. But it's perhaps growing better, you know, it's stronger than we would have expected more in tablets and laptops and other electronics and devices. I think everyone's seen an uptick in that business, which is a result of everybody equipping themselves to work at home.

36:45 That's how it looks. In terms of OLED screens, that's a market we've been working on heavily for the best part of five years, and we saw a very big spike in our business in 2017. We still see some good Strength and growth in that business, and we've diversified, you know, generally the base of that business more to China, et cetera, where we're working with some of the major players there. But I think, you know, in terms of our expectations, maybe OLED isn't – this is not a blow-the-doors-off year for OLED. You know, it's sort of growth, and we're working there. And, by the way, those companies really value our deep learning technology for inspection because, you know, the value of yield in that market is massive.

37:30 but in terms of perhaps what would be big growth drivers, 5G and OLED, it's similar or maybe not quite as good as one might have hoped coming into the year and that's being offset with some of these other better areas that I spoke about earlier.

37:45 That's super helpful. Thank you, guys.

37:50 Thanks. Our next question is from Paul Koster. with J.P. Morgan. Please proceed.

37:59 Yeah, thanks for taking my question. So you mentioned that the gross margins might be a little lighter because of the logistics mix. I'm just wondering, did I hear that right? And if I did hear it right, what is it in the product mix that leads to slightly lower gross margins for that end market?

38:19 Yes, so, Paul, so, yeah, yeah, and I'll invite, I'll talk on a product level, and then Paul will talk a little bit more about that, too. When we, to give you the long, you know, the long view, when we go into logistics, you know, we work with some very major customers in electronics who require more implementation from us. So, we're doing more application engineering. some of that which can be dilutive to our margins so it has the more service related pieces and it also has more integration which may mean in some cases we're selling lower margin accessories or metal frames or other things that currently we need to do in order to fulfill the needs of customers but we're developing products that are more modular and we're developing relationships with systems integrators who are taking more and more of that business away and allowing our

39:25 I think you landed it, but logistics is still slightly dilutive to our overall gross margin, but it is improving versus a year ago or certainly versus three years ago. It's similar to the strategy we use for developing the factory automation market. Solve people's problems for a little more service and then figure out how to effectively productize it and

39:54 Thank you very much.

40:17 Gotcha. So just a quick question on the deep learning front. Obviously you've taken action, changed course really quickly and I think that's awesome that you sort of identify the need to do so and act precipitously. The question I've got though is does this kill your interest in further acquisitions in that area knowing that there's all this sort of integration work involved or is it just an anomalous situation?

40:47 Let me kind of back up for a minute. So I think we see deep learning as kind of a revolution going on in machine vision, and it's allowing us to approach machine vision problems in a new and better way. And we made the acquisition of Vidi three and a half years ago, and that technology is remarkably good at running on low power chips, and that's demonstrated with a lot of performance, right? Now, then we've acquired... Google Lab has very, very powerful capabilities around the application of convolutional neural networks to industrial machine vision, and they're ideal for doing other things like classifying images with great precision and inspecting complex images. So it's almost like some of the technology they have is sort of further down the road, and we'll be assimilating it over time, but some of the nearer term applications for it did require on-site work with very sophisticated engineering teams in Asia.

42:02 And that's the thing we really haven't been able to do at the moment. So, because, you know, just access to site and working closely with operators in those kind of environments. We're still going to do that. It's just delayed. And then Zoolab brings great engineers and great technology, which will help us with and all the other things we want to do in deep learning. So M&A will remain the sort of key area of focus? Yeah, I think we've got a lot of horsepower now in deep learning, but we're always out there looking for interesting assets to acquire in deep learning or in other growth areas of the business. Generally, we're always on the lookout for great engineers who bring a lot of capability to our organization. So that's an ongoing kind of cadence at Cognex.

42:58 Gotcha. Thank you very much. Thank you. Our next question is from Richard Eastman with Robert W. Baird. Please proceed.

43:10 Yes, good afternoon. Thank you for the time. Rob, just to be clear, the upside in revenue in the second quarter to your previous thoughts that the second quarter would look like less than the first, was that upside? Did I capture it right? China came back sequentially faster, and then some of the logistics business that you shipped came out of backlog. Are those the two primary factors for the upside?

43:42 Yes. I'll let Paul comment. I mean, certainly we were able to, you know, win and shape more logistics business than we expected in the quarter with a big driver. And then, yeah, and certainly, you know, the recovery in our China business was probably stronger than we had anticipated. Paul, any other cover you'd like to give?

44:02 Yeah, I mean, the commentary on China was more about kind of Q1 revenue levels to Q2 revenue levels, not so much, you know, our expectation for Q2. I think, you know, for why we beat our Q2 forecaster, we didn't give guidance except for that we thought we would be down versus Q1 and we were up slightly. That was more driven by strength and logistics and just, I'd say, managing our supply chain and, you know, potential component shortages and other sort of risks in our business didn't materialize as negatively as we had feared. We're certainly seeing higher costs and logistical challenges to work through, but our ability to convert it to revenues and niche customer demands is pretty good. So you put a push... Yeah, Rick.

44:46 Yeah, Rick. Sorry, it's Rob again. I think, you know, just to make sure we understand, the funding order activities during the quarter, while So I wouldn't want you to think that we made Q2's beat off backlog necessarily. We didn't. We had good strong orders as well.

45:14 Yeah, I understand.

45:15 And was China, again, China year over year was down 11%, but that Other Asia number, Other Asia was plus 23%. It's not massive dollars, but what was that kind of $6 million increase that amounts to Other Asia? in APAC. What end market was that particularly driven by?

45:38 CE? It's semi and CE. And obviously there is some element of inorganic from Suolab in there too, but very modest.

45:51 I see. So if we had a nice quarter in the second quarter to be sure and we built backlog, is the logistics business Would you expect it sequentially to be higher in Q3 than it was in Q2? I mean, is that kind of timing on backlog? Is that a doable expectation?

46:12 So, yeah, so we've got some good momentum in the logistics business. We had a record quarter of revenue in Q2, and we expect Q3 to be higher. So, yeah, that's what we expect. So, yeah, we definitely have, you know, good momentum and it's not getting concentrated in particular quarters at this point.

46:33 Understood. And just, I'm sorry, my last question here, just a promise. Would you expect in consumer electronics to have a 10% customer in 2020 given, you know, current backlog and trends? Obviously, you have some help, the fact that our nation business is down. But just curious, would you expect to see a 10% customer in CE this year?

46:59 Well, yeah, that's not really a question I feel like I'm ready to answer at this point. So I'm going to pass on that one. They're just giving sensitivity to that market.

47:10 Okay, understood. Thank you. Thank you. Our next question is from Marcus Nittermayer with UBS. Please proceed.

47:23 Yeah, hi, good afternoon, everyone. Two questions from my side, please. One more long-term and one on the second half. Maybe I'll start with a longer-term question. Given the sort of 8% hit count reduction that you did, which, you know, isn't easy in any case, but particularly probably in the Cognix culture, how do you think, you know, about supporting that long-term growth that you have throughout the cycle, right? I mean... Some of your competitors, particularly on the Salesforce side, have probably significantly larger Salesforce. I'm just trying to think about strategically how you think about that through the cycle. That's long-term. And then on the second half, I don't want to belabor all the seasonality issues around consumer electronics, et cetera, but maybe just some color where you can and where you might have some visibility in customer conversations, maybe Q3, Q4.

48:18 Is there sort of some special effects around COVID, maybe also to the upside? I'm thinking about, you know, e-commerce. Is there access issues maybe in some of the customers, given how busy the distribution centers are? Just trying to understand the puts and takes here from, you know, into Q3, Q4. Thank you.

48:40 Great, yeah. So to your first question about the 8% headcount reduction, I mean, I think if you go back, Even with the headcount reduction, it's well below what it was in 2016. We see it as having plenty of capacity for growth. I think we came in thinking we were going to grow into that capacity this year with revenue being lower. We had a lot more capacity than we needed. I don't really feel constrained on that. You kind of talked about sales productivity and We do, you're right, we do compete with customers that have bigger sales forces, but we combat that in two ways. One is we're pure play machine vision.

49:27 So Cosmic Salesnoid is not selling PLCs or robots. They're focused very much on their experts in machine vision. And then we do have a good network of systems integrators and distributor partners who cover those areas that we don't reach. I'm not at all concerned about a lack of coverage and I do think there's a lot of opportunity for us to grow into our current headcount and deliver leverage to the bottom line. That's where we see opportunities to focus there in the next couple of years I would say at this point. Your second question kind of was around opportunities for growth or other areas and I think it's worth saying that we have seen some Nice activity and interest in the use of Cognex machine vision for COVID-related applications. So we've seen certainly medical, pharmaceutical applications are those that are – we've seen some interesting demand for our products in that area. And I do think as companies scale up, Deep Learning Technology more broadly is an area that I think we see good upside potential for us as we move through this year and into next. So those would be some of the areas that come to mind.

51:01 Great. Thank you. And maybe a quick follow-up. Do you think that could be material near term or is that sort of in early stages? I'm just trying to think through. I understand the seasonality around CE and Q3, etc., But then as you think into Q4, you know, you mentioned Q3 is probably going to be the best quarter. You know, anything that you see early in customer conversations that could be a material factor in Q4 that we might not have on the radar at the moment, or is that too early?

51:31 Yeah, I think material, you know, in its true definition, probably answer that question, Stations in Q4. But the other answer is really it's too soon to say. You know, I think in that, I think other, more things that might move the needle for us later in the year might be more around whether there's, you know, earlier investment in electric vehicles or if there's more electronics kind of business coming in earlier or perhaps more than those in general might be logistics. You know, more, you know, more and stronger demand near the back end of the year which can happen in our business. So, But generally, I don't want to give you an overly optimistic picture of Q4. As we said in the remarks or whatever, that we do expect Q3 to be our best quarter, and certainly that's how it looks to us right now.

52:26 Great. Thanks so much. I'll talk it on. Our next question is from Darum Nathan with Daiwa Capital Markets. Please proceed.

52:38 Hi, thanks for taking my question. Just to kind of ask it in a different way to the earlier question here on consumer electronics, how should we think about the diversity within consumer electronics in 2020 compared to 2017? Has it gotten a little more diverse?

53:02 Yeah, so we've worked certainly hard over the last few years to try to, you know, take our technology and apply it more broadly, whether that's more into component type, you know, areas such as like housing and, you know, screens and other things rather than just final assembly and test and packaging, which is where we were highly concentrated a few years ago. And then, you know, obviously more in accessories as we discussed, you know, certainly you see, and in portable type products, you know, like So, you should see our business as being much more diversified in terms of its applications in that market. Although, as we know, the end users, I'm sorry, the brand owners are pretty concentrated.

53:48 Okay. And with regard to logistics, is it still a largely U.S. or bill-based business? And what's the scope for expanding into Europe and Asia?

54:04 Yep, so, you know, the majority of our revenue today is still in the U.S., but we've been investing and we're seeing good, you know, percentage, very good percentage growth rate in the European market and in parts of Asia, certainly. So, and, you know, we expect probably the majority of growth to come from those areas as we go over the long term. But right now we're definitely still highly concentrated in the United States.

54:31 Okay, and I know there's an annual exercise that you do on addressable markets, but how should we think about logistics addressable market from, I don't remember the number, but what it was, like is it a multiple of that, you think, based on what's happened?

54:50 Yeah, I don't really feel ready to answer that. We said it was a billion dollar served market, you know, and I would have thought, Thank you very much. I think of that being a great market overall in logistics. We sized it at a billion dollars when we told you last.

55:30 We think it can grow, I think we said, in the mid-teens.

55:33 And I view it very similar now, just with a different complexion.

55:38 Okay. And final question on the competitive environment, given the difficulties, have you seen it getting a little easier in terms of Have you seen any competitors going bankrupt or exiting the business?

55:57 Yeah, I'm sorry. I didn't quite understand your question. Have we seen it getting more difficult with who?

56:03 No, any of your competitors have exited the business or given the tough conditions.

56:11 I see, competitors. No, I wouldn't say we've seen a major change in the competitive industry.

56:20 Okay, thank you. Thanks a lot. Our next question is from Karen Lau with Gordon Hassett. Please proceed.

56:31 Taking a follow-up. So just that one op-ex follow-up question for Paul. I think it sounded like in the second quarter you didn't realize any of the savings from the restructuring. I think the number is million savings fund rates. So We would kind of, you know, starting the third quarter, but sequentially OPEX is flat. So, if the idea that some of the temporary cost, that temporary cost savings that took place in the second quarter is coming back, but, you know, just threshold savings, you know, kicking in, so they kind of offset, or is there some temporary cost associated with the higher delivery? in the third quarter that is like kind of masking that sequential savings, structural savings uptick.

57:22 Sure. Yeah, Karen, it's mostly puts and takes. I mean, if we take a step back to 2020, going into the year, we said we'd be adding about $25 million to our cost structure associated with, you know, reset of incentive plans and some hiring and the integration of SULAB. And then we've now committed to a $25 million annualized cost reduction. of which we did realize a portion of it in Q2, but certainly Q3 we'll be realizing more. So the payroll savings and some of the savings in depreciation and renovation and so on in Q3 will be partially offset by a little more travel, just as you've got more sales activities going on. Travel will still be significantly down for the year, but with facilities open, our sales noise are going and paying visits.

58:13 We did get some one-time benefits associated with the restructuring in Q2 in our incentive compensation that won't repeat in Q3. So that's also one of the takes to offset the... For sure.

58:28 Thank you. And Rob, if I can ask you a quick one on Stemline. I understand Stemline developed a small market for you. And I think it has something to do with mostly software. So the ASP is but I guess in the context of maybe deep learning applications and then we have the fact that's going on in you know building trips everywhere is you know can that vary over time whether it's like you know more in terms of your content to that market

59:12 Yeah, we're having a good year, but generally that has been around 5% of our business. We deal with it as kind of a cyclical, you know, probably, you know, why? Well, it's kind of Moore's Law, where, you know, you can produce more and more chips on fewer and fewer lines, right? I think that is... You can see some, you know, some pops in investment, you know, and there's some areas... Great technology, but overall growth over the long term.

59:47 Okay, I understand.

59:49 Your original question to the one piece, obviously just with a higher revenue mix or a higher revenue level in Q3 versus Q2, that'll also bring some effects, right? Think about emissions and so on. So there's enough. Thank you. We have reached the end of our call. I will now turn the call back over to Dr. Shillman for questions.

1:00:17 Thank you. Well, we're all in very challenging times, but our strong balance sheet, our focus on the long term, and our unique culture will enable Cognix to weather the current disruptions better than most.

1:00:35 Thank you all for joining us tonight, and we look forward to speaking with you on our next question.

1:00:40 Let's conclude today's conference. You may disconnect your lines at this time and thank you for your participation.