Cognex Corporation (CGNX) Earnings Call Transcript & Summary

All right. Good morning, everyone. I'm Brian Gesuale, Senior Analyst at Raymond James. Delighted to have Cognex here to present their story. We have the company's Chief Executive Officer, Rob Willett, here to take us through it. He's going to start with a handful of slides, give you the kind of the overview and the background. Then we're going to move into a fireside chat format and then adjourn to the breakout room. But with that, Rob, I'll turn it over to you.

Great. Okay. Good morning, everyone. Thanks for getting up early. If you're here and your vision is a little blurry, you came the right place because this is Cognex machine vision. I'm going to give you a quick overview about the company. I'm Rob Willett, I've been the CEO for the last 13 years and with the company for 15 years. I'm going to make some forward-looking statements. They're correct based on what [ it'll do ] today, but you should definitely study literature and be aware of risks. Okay. So a quick snapshot of Cognex, right? So we're a 40-year-old AI technology company, right? We came out of MIT. Everything we do is in the field of machine vision, sometimes called computer vision, right? We have the biggest installed base of machine vision systems in manufacturing around the world, making over 2 billion products a day with our technology around the world. Our technology is primarily software, which explains our gross margins. And when we're growing, certainly, our operating margins and the fall-through on those can be pretty exceptional. Last year, we had revenue of over $800 million, and we've been up around $1 billion, and I'll explain a little bit about that story. Okay. So this is the Cognex growth story, right? So we're a company that really invest a lot in technology, and we're in some great growth markets. And for the 10-year period up through 2021, we had 14%, essentially organic growth for the business and a period of very strong growth before that. We're essentially a CapEx business, right? So we're selling hardware in which our software resides into industrial businesses, and I'll talk about the end markets. So our business can be lumpy, right? We've had periods and technology changes that have driven huge growth for us. And here, I'm thinking of things like solar, smartphones, OLED screens, e-commerce, each of which were responsible for some of those big growth periods that we experienced over our life, right? And then we saw strong growth up into 2021, driven a lot by work from home electronics, as we all bought a lot of those. And then e-commerce, right? So we serve the most sophisticated companies in those spaces. And we are the technology leader and companies, look, their engineering teams, work with our engineering teams to drive that growth. But then since then, we've seen a slowdown in the business driven by overinvestment in those areas through the pandemic that has been offset. And we -- but we obviously expect returning to the kind of growth we've seen in the past. Let's get grounded on what is machine vision? Like what is the technology that we we're in the business of. And I think it's helpful just to think of your own vision, right? You have a head. You have an eye and a brain, right? Your eye is grabbing information from around you. And you're phenomenally good at that, as mammals we're incredibly good gathering inflation, right? And then we send that information to the brain that makes sense of it, right? It's the same in machine vision. You have a camera essentially an array of pixels. You have light optics, and you have a lens that write gathers the data from the world and turn -- and directs that light onto pixels and the pixels create a value, and they send those values, 5 megapixels array, 5 million specific values that go to a processor. On the processor resides Cognex vision algorithms and vision tools that make sense of it, right? So -- and it's still a very fast emerging technology, even though we've been in it for 40 years or more. And vision is very difficult, partly as if you think of your own vision, things are changing so much and so rapidly based on the light that you're seeing things, based on the angle at which you see things based on movement, color and all those things. So it's certainly an area where there's a huge amount of data and technology that goes into it. It's 1 reason why we're so happy to focus exclusively on that area and it's technology that we think has a long way to go, specifically with developments going on in technology around AI, generative AI and new types of deep learning technology that are going to be applied and are being applied by us to that field. To that point, we spent about 15% of revenue historically on R&D. We came out of MIT. We have many of the foremost machine vision technologists working at Cognex and have done for a long time. We have a large patent portfolio and huge amounts of know-how in terms of how we apply this technology to the industrial world. What do we do? What do we really do with this technology? Well, basically, we do 4 things, right? We guide. So a smart camera, like the 1 you see here, might be guiding a robot to put a windshield on a car or a chip on a board or glue on an automotive component. We identify, which means we read letters and numbers and barcodes. We're the best company in the world in terms of performance reading of difficult damage barcodes at high speed in manufacturing. We gauge, it really means we measure, right? This is the picture on the bottom left of a 3D vision system looking at a brake pad, is that groove on a brake pad, the right width and depth. And we inspect. So the bottom right, we inspect things like lithium-ion batteries or smartphone cases for damage and other qualities and things that should or should not be there. Everything we do is in line, right? It's not offline. They don't take the product away to use our machine vision system. They do it in line, and it can be very high speed. It's also almost always discrete, not continuous pieces of material, like overall. And then in terms of these areas, 1 of the ones that's growing most quickly and where technology is changing things most greatly is in the area of inspection, right? And it's where deep learning technology and generative AI is making vision more human-like to perform more in the way that we see things as humans. We're very good at inspecting things. And up until this point rules-based machine vision, the sort of the technology that's been primary in our industry is less good at those kind of what we call anything, anywhere problems. So why is this a great market? Well, 1 reason is there are 360 million people in the world who go and manufacture things every day. And about 35 million of those, we estimate do things only with their eyes, they're human visual inspectors. One customer, just 1 customer of us, tells us they spend over $1 billion a year on human visual inspectors. I travel the world and I see these human visual inspectors. And basically, they're looking at things and saying, is something right or something wrong, often looking down a microscope or down some to kind of an optical device, right? Those humans are not generally good at these tasks. And they're expensive, as we know, and this is not great work for anyone to be doing overall, particularly for 8, 10 hours in a row. So -- and machine vision is coming to the point where it's going to be outperforming these type of workers significantly, I think, over the next decade. Other trends driving machine vision growth is labor shortages, right? We all know about those. Deloitte estimates, but by 2030, there will be over 2 million unfilled manufacturing jobs in the United States alone. The data on the left is about Europe. You can see -- we all know, it's very hard to find high-quality labor and machine vision essentially is replacing -- at least the ability to replace some of that labor and outperform it in manufacturing. Customers use us also because they want to run their manufacturing lines faster. They want to ensure quality, which is, as we all know, incredibly costly to have bad quality in manufacturing and they also want traceability, right? They want supply chain security and traceability. So it's the thing that they are selling the parts within it what they should be, when they don't work, tracing it back to suppliers, [ winning ] counterfeiting diversion, other problems like that. And then another trend that's been driving some of our business recently is more of the trend towards supply chain hardening and near-shoring as companies look to change their -- the kind of risk and performance calculus of their supply chains. So we, at Cognex, I think that we serve about a $6.5 billion market. This is a served market, not an addressable market. So if we got every dollar with which we should, our products can perform we think we'd be a $6.5 billion market. We have about a 15% market share overall is how we think of it. If I go through the markets, automotive is an important market for us. We think it will grow -- the market it will grow at about 10% over the medium to long term, right? Some things that are really driving the growth in that market. EV cars, certainly, but particularly for us, EV battery manufacturing, right? That's a complex, expensive, capital-intensive and dangerous activity where machine vision can really inspect in quality and help with performance. One customer I visited last year told me they scrap between $200,000 and $300,000 of bad batteries per day. And I shouldn't say bad batteries, they scrap batteries. They're not sure if they're good or bad, right? And our technology can help them inspect in higher quality and higher yield on their manufacturing. Electronics has been and continues to be a very important and strong market for us. We think that market should grow at 15% over the long term. And some of the reasons, certainly, there's new technology coming, new AI technology, new augmented reality technology, but also certainly so much labor in that market, which is a challenge for many reasons for the big players and we're specialists in working with the most sophisticated players. Logistics is a market we entered only about 10 years ago, and we saw up until 2021, 50% compound annual growth over a 5-year period up to $300 million of business in 2021. We work with the most sophisticated e-commerce players in that space, but we're broadening the business that we do in logistics, and we have a large number now with retail customers who are using Cognex vision for e-commerce fulfillment. And then we have a number of other industries, including semiconductor, where we see very strong long-term growth potential medical-related packaging type applications, pharmaceuticals, consumer goods, beverage, et cetera, on the right-hand side. We entered 2 new markets last year. One is high-end optics. So we acquired a Japanese business called Moritex last year, our largest ever acquisition, and they are the premier brand in Japan, if not the world, for high-end lenses and lights for sale into machine vision. So a lot of good synergies for us and helped us build our share and position in Japan, which is a challenging market for us. We also launched vision sensors, which is technology using machine vision that we expect to replace optical sensors, more simple optical sensors and proximity sensors and other technology. And we're building -- we might talk about it later, a large sales force who can sell those easy-to-use products to customers who we can now serve. Why their businesses deploy machine vision? I think we've covered it, operational efficiency, quality, of course, is important and traceability and compliance. Why do they choose Cognex? Our technology is very powerful. It's very easy now and flexible to use. It didn't used to be, used to need to be a PhD like 25 years ago, use a vision system. Now we can hire someone out of college, train them for 6 months and deploy it very easily in almost all of our technologies. We have the highest performance. We spend the most on R&D in our industry and it shows in our technology. We can align things with speed and precision in manufacturing that no none else can. We can read barcodes to a read rate higher, sometimes 1, 2, 3 percentage points higher than any of our competitors. If you think of what that means, if you're a large e-commerce player, you're shipping 1 million packages a day out of 1 of your 100-plus facilities, right? If we can read your barcode 1 percentage better out of just that 1 facility, it's 10,000 packages that they'll have to get. We circulated relabeled and up late to customers. So the payback for those customers is pretty phenomenal. And we have a great reputation. We take quality very seriously. During the chip shortage, we spent $50 million on -- with brokers to ensure that we could get chips to ship to our customers so that they got our products on time. We didn't take that money to the bank. And it hurt our gross margin. But in the long term, we believe very much that's the way to run a business. Final thing to say about Cognex is we have a really strong culture. I'd like to say that the founder of our company, Dr. Bob Shillman had a PhD from MIT in computer science and artificial intelligence. But 1 of his real points of genius was culture, right? We've created a culture that we describe as work hard, play hard, move fast. And it means we have a very reliable, very qualified and motivated workforce. We call ourselves Cognoids. We work hard, like these are really very capable, skilled engineers who come to work at Cognex and they work really hard. And they have to. We'll have to do that. But we want to make it really fun. So we play hard, right? We have a lot of fun at work. Just this month in February, it was a leap year, right? So we had leap day, February 29. Cognoids around the world enter the contest, 10 of them will come to California and leap out of a plane with Dr. Bob Shillman, right? Pictures of our Halloween festival there. We go very seriously. You'll see -- I encourage you to see our annual report in a couple of weeks when it comes out. It won't just disappoint you in terms of its wackiness and creativity. And then finally, move fast is really important in a technology company, right? Those that get passed by other innovators, ones that are moving too slowly. So we take that really seriously. An example would be we have something called CQ to a Cognex. It stands for Cognoids cutting crap. And what it is, we invite Cognoids to write in and say, what are the things we can stop doing, right? Why do we count inventory every quarter? Why do we do all the dumb things, Rob. Why do you make me write that report every month that you don't read anymore? And we're like, you're right, here's $1,000, and we're going to implement your idea, right? So as we become bigger, we don't want to get bureaucratic and slow, right? So that is my quick overview on Cognex.

Perfect, Rob. Thanks so much. It's a great overview. That's a reward to jump out of a plane. I just want to be clear on that.

I kind of entered that one. But 100s too. I love it.

Better be a top performer.

We have low attrition. So how do you manage those stuff, right? My lawyer is anxious now. Anyway.

Maybe before we jump into some of the questions, you're in the early stages of a CFO transition. Maybe give folks the latest on that?

Yes. Yes. Thank you. So Paul Todgham, our CFO of the last 4 years, will be leaving the company next Friday, right? We announced that a couple of months ago, I think. And we're in such -- for a new CFO, we're seeing some very good candidates. But we almost certainly won't have a new CFO on board by the time he leaves. So we have a very experienced finance team, our Controller, who's been with the company over 30 years will be the Chief Accounting Officer, if that's the right term. And then Sheila DiPalma, also with 30-year former Treasurer of the company, and I will be managing during the interim.

Fantastic. I wanted to go back to 1 of the charts you put up there around market share in some of your end markets. Can you talk about any changes in the competitive landscape? And maybe sort out who the competitors are by market share? You have about mid-teens percent. Those markets are generally growing the last couple of years, Cognex has been impaired from a growth perspective. What's the latest really on how you're thinking about that?

Yes, yes. So what to know about that? I think we've been in a sustained global manufacturing recession, right, for the last 17 or so months. So I think everybody I see in our market is shrinking, just to get that out there. We've been shrinking more because of our exposure to some of the technology leaders in some of the industries, specifically around logistics, overall, and the fact we've been working with the big innovators who lead into investment early beamed out, early for my take. Our main competitor around the world is a Japanese company called Keyence. If you don't know them, you should look at their financials, I think it tells you where we can get to as a company if we can really perform and grow. It's great to have a high-performing competitor, who's a good competitor, who we admire. Then we have a lot of other companies who've been in the market quite a long time, Datalogic would be examples of those. And then we have some new entrants, perhaps most importantly, to point out some Chinese competitors overall, particularly the [indiscernible], there's an up and comer, certainly. Over the company's life and over my time, we've tended to see Keyence as they're very consistent competitor and a very strong competitor with strong share in Japan. We've seen others really come and go, and we've seen a lot of companies try to get into our industry, particularly some of the big automation players spend $20 million, $30 million, $50 million more and realize that this is a very difficult thing that we're doing with a lot of barriers to entry, a lot of technology, right, a lot of know-how. It's not just doing something, not just a really smart kid in the lab, make an amazing algorithms, although we've got a lot of those, right? It's how we apply them, how we look after customers, how we support them, how we tune them, how we make them work in the real world, right, is a part of our business. Share wise, obviously, we have very strong market share in the United States, pretty strong in Europe, weak in Japan, explains part of why we made the acquisition in Japan that we made. And then China is a bit of a dogfight. A lot of players, we have good share, but so do quite a lot of the players, and things are pretty aggressive in that market currently.

Fantastic. That's a natural segue maybe to thinking about your geographic exposure. Would you take people through kind of your regional exposure of the business? And I'd like you maybe to take in rate from 1 to 5, 1 being weak, 5 being strong, how you see the demand environment in each of those regions?

Yes, sure. So I think -- so let's start with the United States. So yes, we're the market leader in that market. Automotive is a very big market for us, as is logistics, right, in that space. It's about 40% of our revenue sort of in recent years has come from the Americas, primarily United States. Europe, also pretty automotive-focused overall. But as those of you who know the machinery market and automation, there a lot of great OEMs building machines and machines in Europe to do things like packaging, pharmaceutical packaging, particularly Southern Germany, Northern Italy, et cetera. So those would be some of the big markets, and they're selling into markets like food and beverage, pharmaceutical packaging, cigarette manufacturing, other activities that they service. Very high precision, high-performance machines that rely on Cognex vision for -- to optimize and run. If we move to Asia, well, Its a broad term. In India, it's a very exciting and fast growth market. I go there pretty regularly. I was there last month, and a lot of exciting things happening in India, and we see that as still a small but very fast-growing market in which we are invested in heavily. It's not a clear winner in that market, I would say, at the moment, not really many domestic players as I wouldn't expect this stage of the technology evolution, but a lot of opportunity. Automotive is big in that market. Electronics as you probably read companies are moving their supply chains, some of them partially are in India and Vietnam. ASEAN, if we think of that broad bucket, again, a lot of electronics in that space overall, as we said. And then Japan, a very advanced economy quite served very strongly by Japanese suppliers. We have a competitor ,[indiscernible] in that market who's not strong globally necessarily, but had some strength in that market, too. So I don't know if -- I didn't really do your number ranking.

You didn't. I was going to call you out on that, too.

We like numbers at Cognex. Go ahead.

If you could just maybe give us some perspective on -- you tend to have such a good window into PMI recoveries. Your stock is very sensitive to that, your demand environment. Maybe if you just talk about the relative strength of those markets from a 1 to 5?

Yes, yes. I don't see -- there's not a lot of current strength in those markets. So there hasn't been -- generally, that's a general statement for the last 4 4or 5 quarters. There's no way to say that any differently. I think the European market actually has gone a little bit stronger than we were expecting it to. I think, overall, and the United States market to some degree, is a little bit stronger path than the PMI suggests. And I think some of that has to do with things like investment in EV batteries overall in green technology, which is certainly an enabler in that space. But I do think probably a big kind of a dark cloud that's been hanging over a lot of our industry and our business has been what's going on in China. China has been such a huge growth driver for Cognex. When I joined Cognex to give you some context, 15 years ago, our stock price was down to split adjusted $2.5 at 1 point, and we have $4 million of sales in China, right? But with some of the growth that we've seen coming out of that -- through that period, it's -- our business in China is perhaps -- it's been 50x size, if my math is correct. And we saw a lot of growth. But the dynamics are certainly changing but now where there's more movement away from manufacturing to more services. You all know that. So we expect some of the growth dynamic to change certainly in that space and see other markets like India and Vietnam certainly grow. Korea, grow more strongly. And then more investment in manufacturing technology, billions and billions of dollars going into things like semiconductor and EV battery in America, particularly but Europe, Japan everywhere. So we are going to be beneficiaries of that investment. There's no doubt. And just so you understand, the way it works is companies break ground, they build, they create lines, machine vision tends to get spec pretty late during that process. So we have optimism that we will see some strong growth coming in that market. And it's a little bit difficult to know because these projects seem to get delayed, right, and partly for labor shortages, which they just use machine vision, maybe they wouldn't have to [indiscernible]. And now I'm going to just say 1 more thing, logistics, right? Logistics has been a headwind for them -- for us over the last -- since really the post-COVID period where people went back to stores and they had excess capacity overall. But we do expect that market to return to the kind of strong 30% for us, 20%, I think, for the market overall growth that we will see in the long term. We see signs of that returning. Again, the timing is not completely clear to us, and we don't give full year guidance, but we're optimistic about that market returning. We've seen our base business, if we take out a few of the larger e-commerce players has continued to grow throughout the cycle, a little more slowly, but it's been -- it's on a growth vector, and we think it will keep returning as economic confidence is there. And -- but the big players, we expect them to return back into investment growth mode, and we're excited about that. We have strong share and we've maintained or grown our share with those buyers.

Anything you're -- speaking of logistics, anything you can add to some of the investments you're making specifically, not specific customers, but anything you'd want to share about those investments?

Well, so our business in Logistics has historically been pretty U.S. focused. It's been with very large players. We don't mix in customers by name, but they're real technology leaders who love our technology, love working with our engineers to -- we make it possible for them to do that. And it's been primarily barcode reading, right? So something we do better than anybody. But over time, we're seeing our new technology getting applied more broadly within logistics. And here, I'm thinking of the technology we call edge learning. It allows customers to set up and run vision systems very easily to do things like inspect packages for damage or labels on a package that should be like a hazardous, warning label, very important. Are all the things in a box that should be there. You're packing box, it should have seven balls and a barbie doll, does it have 6 balls and a barbie doll, right? These are things that we can look at very effectively and clearly. So we see more vision applications growing there, more inspection applications, and that's going to drive some of our growth. Also, 3D vision. Most of our vision is 2D. We have a lot of great 3D products, and we have more coming in that space, which can do things like dimensioning, is that the right size box, are we being charged the right amount for that box?

Wonderful. Speaking of investments, you've made some investments that seem to be paying dividends in the EV space. That's a market that I think has a lot of long-term opportunity, but it's kind of get a checkered near-term view as we've seen a lot of things kind of delayed. Can you talk about maybe a few vectors of this. One, your content on an ICE versus an EV in that process? And then second, what your outlook is? Most people seem to think CapEx is down in that market this year and how CapEx could grow through that?

Yes. So how does that play out for us? Well, we've been serving the automotive industry for a long time, all the leading automotive and Tier 1 suppliers do use Cognex vision. And so I think that industry is going through some big changes as we all know. I think -- and I think it's going to happen in kind of waves and it's going to be a period of -- periods of confidence and investment in periods of drawback, right? And then this geopolitical things going on about where, where in the world are these investments going to go? So what's it like for Cognex, right? So Automotive has been 1 of our big 3 markets, and I fully expect it to go on being for a long period of time. And we were doing and we still do a lot of business in powertrain, right, which is kind of going away, right? And we do -- and we're now doing increasing and large and fast-growing amounts of business in EV batteries, which is replacing powertrain, billions of dollars of capital being spent in that market, right? And we're helping customers through the process of creating EV batteries, right? Really nice growth vector. As I mentioned, there are -- as I visit a lot of these lines, there may be 30 steps. We're doing ID alignment, but particularly exciting for us is inspection. So is it dent or a scratch on an EV battery, something that's dangerous that needs to be taken out of production? I read an article that said every day on the streets of China, 6 EV cars combust, right, just catch fire, right? EV batteries are dangerous technologies. So we can't -- that will not be acceptable. It isn't acceptable anywhere, but certainly not within the U.S. litigious environment. So customers really care about that, and our technology can help them figure out if that dent is 3 microns deep or 30 microns deep, and if it's shaped that in that place, it's a big old problem or it's not. And we can do it at hundreds or thousands of minutes, right? So that's the kind of technology we're talking out. So we see that as exciting for growth. Then -- and broadly speaking, I think in the long term, maybe this is prognostication, but maybe EV battery opportunities in business for Cognex and ICE will kind of replace in the powertrain, right? Then what's going on is another growth driver that I think will mean we'll be able to grow or exceed at that 15% target for us. And the 10% -- sorry, 10% target we see for us in that industry overall is your car is becoming a smartphone on wheels, right? And it's becoming a luxury environment in which you sit. And our technology is playing very well there in terms of the sensors and the electronics that goes into your car, how there's an aid, how they're installed, how they work and inspecting your car is everything in the right place. There's more glue that goes into making our car today than welding the way it's put together, right? So there are lots of -- lots and lots of automotive opportunity and still labor and labor challenges that automotive face is still large. So that's why we're confident about continued growth in that market and how EV will play out.

Okay. Rob, I want to give you kind of the last word and speak directly to the audience and really tell them why they should consider investing in Cognex. I have a lot more to cover. We're going to cover a lot in the breakout room, but we're out of time, and I'm going to leave it with Rob here for the last 30 seconds.

I'll be super fast. So it's a great market. Machine vision is a great market. It's not for the faint of heart, right? It grows very quickly in periods. It has periods of challenge like we're in now, but the ultimate growth trajectory is huge. We're the technology leader. We're focused. We're very profitable. When we grow quickly, the fall-through on incremental revenue can be phenomenal. So we continue to grow, and we're investing a lot in sales to take our easier-to-use technology more broadly in the market to customers who couldn't serve before. So thanks for coming.

Perfect. Thanks, everyone.