Greetings, and welcome to the Cognex Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Ms. Susan Conway, Senior Director of Investor Relations. Thank you, ma'am. You may begin.

Thank you. Good evening, everyone. Welcome to our third quarter earnings conference call. With us are Rob Willett, Cognex's President and CEO; and Paul Todgham, Chief Financial Officer. We'll start with prepared remarks, and then we'll open the call for questions. I'd like to remind you that our earnings release and quarterly report on Form 10-Q are available on the Investor Relations section of our website at www.cognex.com/investor. Both contain detailed information about our financial results. During the call, you may use a non-GAAP financial measure if we believe it is useful to investors; we think it will help them better understand our results or business trends. You can see a reconciliation of certain items from GAAP to non-GAAP in exhibit two 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. However, things can change, and actual results may differ materially from those projected or anticipated. For a detailed list of risk factors, you should refer to our SEC filings, including our most recent Form 10-K and the Form 10-Q we filed tonight for Q3. Now I'll turn the call over to Rob.

Thanks, Sue. Hello, everyone. Thank you for joining us. As shown in today's news release, Cognex reported the highest quarterly revenue in our 40-year history for the third quarter of 2021. Demand for Cognex products is high worldwide as manufacturers implement machine vision to improve their throughput and the quality of their products. Revenue grew by 13% over a high-growth quarter in Q3 of 2020. It was at the midpoint of the range we gave as guidance in August. Logistics was again our largest end market in Q3 and the biggest growth driver. We reported another record revenue quarter in logistics, beating the prior record set last quarter. Demand continues to be strong, particularly in the e-commerce sector where Cognex is widely recognized as the technology leader for machine vision. E-commerce and omnichannel retailers are investing in automation and Cognex's industry-leading products to help them fulfill orders rapidly, reliably, and cost-effectively. Furthermore, sectors that struggled in 2020, such as traditional brick-and-mortar retail are investing again in logistics automation to compete more effectively for e-commerce sales. Among other industries we serve, revenue grew well in automotive, semi, and medical-related industries, particularly life sciences. An exception was consumer electronics, which was a substantial headwind in Q3 as expected. You may recall that last year's third quarter included significant incremental investments for new smartphone technologies and capacity for online learning and remote work demands that drove substantial growth for Cognex. This year, consumer electronics revenue is expected to be modestly lower overall and is more balanced between Q2 and Q3. Turning next to gross margin. The challenging supply environment intensified in Q3, like many companies, we encountered record-long component lead times, vendors struggling to supply parts, freight delays, capacity constraints, labor shortages, and COVID concerns. At Cognex, 'customer first' is our number one company value. We prioritize quality and delivery ahead of cost with an eye to delighting customers and maintaining our exceptional reputation. In Q3, we were tenacious in living these values and added significant incremental costs to supply customers on time. While most of the supply chain impact related to higher costs for chips, expedited freight, and designing out unavailable components, we also experienced longer delays on some higher-margin product sales that we now expect to recognize as revenue in Q4 and beyond. Furthermore, we provided a higher level of support on a large deployment by a customer in logistics that we discussed on our August call. We view this as the worthwhile cost of winning share with a customer that we believe has high potential for substantial future business with us. Combined, these factors reduced our reported gross margin to 70% in Q3. While many companies would applaud a 70% gross margin, we're dissatisfied given the high-value software content in Cognex products. We view the lower-margin business associated with the customer in logistics as a one-quarter phenomenon. However, we anticipate the supply situation will continue to be a drag on our gross margin for the next several quarters. We've taken mitigating actions, including new product designs and pricing initiatives to offset incremental costs at the operating income level. Supply challenges notwithstanding, there are macro trends underway that we believe will benefit Cognex for years to come. These include the rise of e-commerce, the transition to electric vehicles, and the shortening of supply chains. Coupled with today's cost pressure and labor shortages, market conditions are favorable for automation and machine vision. The excitement was apparent last month at the VISION Show, a major machine vision trade show held in Storgard, Germany. Cognex's booth was busy and well attended. The show had a more European-centric attendance this year, reflecting challenges of travel to and from the Americas and Asia. We heard very favorable feedback from many manufacturers and automation leaders about our deep learning products. They're enthusiastic about the power and benefits that Cognex's industry-leading technology provides them as they seek to improve their productivity and product quality. We believe this underscores the value of our long-term development and investment in R&D. Cognex’s industry-leading vision and ID technologies are key differentiators for us in solving our customers' most challenging applications as they implement automation. Now, I will hand the call over to Paul for details of the quarter.

Thanks, Rob, and hello, everyone. Revenue for Q3 was $285 million. As Rob mentioned, that's a new record for quarterly revenue, surpassing the prior record set last quarter. As expected, the growth rate moderated in Q3 from the 30-plus percent pace that we reported for the previous four quarters. We delivered revenue at the midpoint of our expected range in a difficult supply environment. It's worth noting that revenue was 55% above the pre-COVID period of two years ago. Two of our three largest end markets, logistics and automotive, made strong contributions to year-on-year growth, and other sectors also grew at a good clip, including Life Sciences and semi. As expected, consumer electronics was a substantial headwind in the quarter. Even though Q3 was our largest revenue-generating quarter for consumer electronics this year, it was down significantly from last year, primarily due to the timing of the industry's annual spend. Reported gross margin for Q3 was 70% and lower than both Q3 of 2020 and the prior quarter. It was also at the low end of our guidance range. As Rob mentioned, an unfavorable revenue mix and higher supply chain costs contributed to a gross margin that was below what we typically report. There were three parts to the unfavorable revenue mix. First, we made a strategic decision around a major deployment by a high-potential customer in logistics that was completed in the quarter. Second, shipments of certain higher-margin products were delayed due to supply constraints. And third, we were able to fulfill logistics orders earlier than anticipated in the current supply environment. Remember that logistics is an emerging market for machine vision. Our gross margin in that sector is improving but is currently lower than our business overall as the market develops. Regarding supply, we are incurring higher costs to secure components and expedite customer orders. We anticipated some of that in our guidance. However, the supply situation intensified more than expected as we moved through the quarter and continues to be a headwind for us. Operating expenses increased by 3% on a sequential basis, which is at the low end of our guidance range. Looking year-on-year, operating expenses increased by 18% over Q3 of 2020, which was a particularly low quarter due to our restructuring actions in the previous quarter. Higher costs included incremental investments in sales and engineering headcount and variable incentive compensation. We also experienced an unfavorable impact from currency exchange rate fluctuations. Operating margin was a healthy 31% in Q3 of 2021; even so, it compares unfavorably with an exceptional 38% in Q3 of 2020 and 34% in the prior quarter due to this quarter's lower gross margin and higher operating expenses. Regarding the tax provision, we recorded substantial discrete tax items in all periods that make comparisons difficult. In Q3 of 2021, discrete items combined for a net benefit of $6 million. The effective tax rate, excluding discrete tax items, was 18% in both Q2 and Q3 of 2021 and in Q3 of 2020. Reported earnings were $0.44 per share in Q3 compared with $0.49 in Q3 of 2020 and $0.43 in Q2 of 2021. On a non-GAAP basis, earnings were $0.40 per share in Q3 compared with $0.47 in Q3 of 2020 and $0.43 in Q2 of 2021. That's excluding discrete tax items and restructuring and other charges that we removed for comparison's sake. Looking at the change in revenue for Q3 from a geographic perspective, revenue from the Americas increased by over 30% year-on-year and delivered the largest contribution in absolute dollars due to growth in logistics. In Europe, revenue increased by 8%, which includes a 1 percentage point contribution from currency exchange rates. Strong growth in logistics, automotive, consumer products, and other industries in Europe's broad factory automation market was largely offset by a decline in revenue from consumer electronics. Revenue from Asia increased by 1% year-on-year; continued growth in automotive, logistics, semi, and the broader market, plus a 5 percentage point contribution from currency exchange rates, was offset by lower revenue from consumer electronics. Turning to the balance sheet. Cognex continues to have a strong cash position with $985 million in cash and investments and no debt. We spent $27 million to repurchase Cognex stock in Q3, and a total of $48 million year-to-date. We plan to continue to buy back stock in Q4 at a regular pace, while maintaining flexibility to be more opportunistic. As we announced tonight, our Board of Directors has increased the quarterly cash dividend by 8% to $0.065 per share. We believe this demonstrates their continued confidence in Cognex's financial strength and long-term growth prospects. The dividend is payable on December 3 to all shareholders of record on November 19. Also noteworthy on the balance sheet is the increase in our inventory balance this year. We are bringing in components to support customer orders and replenish some strategic inventory, and we're doing so at higher costs. Now I'll turn the call back over to Rob.

Thank you, Paul. Moving next to guidance. We expect revenue for the fourth quarter will be between $210 million and $230 million. At the midpoint, we expect revenue will be relatively flat year-on-year. We expect consumer electronics and logistics will be quieter in this year's final quarter. Last year in Q4, we reported growth exceeding 30% year-on-year for Cognex overall due to higher spending by customers in those end markets. In consumer electronics, we expect annual revenue in 2021 will be modestly lower overall, and we believe that will play out in Q4 as well. In logistics, we expect a low growth quarter primarily because customers are digesting large deployments of Cognex products as they turn their attention to fulfilling orders for the upcoming holiday season. Another factor we considered in our revenue guidance was the supply environment. We believe the situation will continue to be challenging and constrain revenue growth in Q4. We expect to exit the year with a substantial backlog. Looking at gross margin, we believe the higher supply chain costs we're incurring for components and freight will continue to flow into cost of goods sold. As a result, we believe gross margin in Q4 will be in the low 70% range. I want to point out that we've not changed our long-term gross margin target from the mid-70% range. In the near term, we expect our pricing actions to roughly offset the gross margin dilution at the operating income level. Longer term, we expect our gross margin will return to our mid-70% target range as the higher cost to expedite component deliveries proceeds. We expect operating expenses will increase by mid-single digits on a sequential basis. We expect higher spending around various growth initiatives within Cognex. This includes adding resources in engineering and sales, furthering new product development, and increasing sales and marketing activities. Lastly, we expect the effective tax rate will be 18%, excluding discrete tax items. Now, we will open the call for questions. Operator, please go ahead.

At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Josh Pokrzywinski with Morgan Stanley. You may proceed with your question.

Good evening, Rob, Paul, and Sue. Just for a question on logistics. I guess how large was this pull forward in Q3? And how are you seeing kind of that market evolve maybe more downstream? Obviously, a lot of stuff has to come together for these implementations? Like are there bottlenecks that are beyond the scope of Cognex projects that are holding up that supply chain as well?

Well, Q3 was our largest revenue quarter ever in logistics, and it did benefit from some customers wanting product from us sooner. To answer your question, certainly, deployment in logistics does depend on integrators and their readiness to implement more complicated systems and integrations downstream from us. So that can dictate some of the timing on the implementation of systems. Broadly, I think our supply is being pretty good, very good in that industry. So, I don't consider that being much of a drag on what we wanted to do. It's been more downstream from us in terms of customers' willingness to receive products and their readiness to integrate. And that certainly had been delays I would say downstream from us to some paths, some of the implementation for our customers. And in terms of the revenue outlook, Josh, in Q2, I think we quoted that we believe supply constraints held us up by about 5% in revenue growth in the quarter. And we'd assumed roughly a similar drag in Q3, kind of 5% of orders that were pushed out that would be harder to fulfill. It ended up being a little larger than that in certain supply situations intensified in logistics, but we were able to partially offset that by more favorable supply conditions in logistics. It was a moderate impact but a modest benefit against other decreases in ability to supply customers as quickly as we expected.

Got it. That's super helpful color. And then we've just heard from some of your distributors that the model there is maybe changing a bit more direct. Anything from like a corporate level that you guys are doing differently with respect to your distributors and kind of direct sales force as you guys have kind of expanded the business and found some of these new markets?

No, I don't think there's anything radical to communicate there. I would say about 70% of our business currently is moving through direct sales overall. And certainly, every year, we evaluate our distributors, and we're looking for those who can provide more value-added services and are investing in that business. So it's a continual process of evaluating those relationships going forward. But I don't think there's a major change. We have some great partners who supply products in locations and into industries that they serve very, very well, and they're a very important part of our model.

Our next question comes from the line of Jacob Levinson with Melius Research. You may proceed with your question.

If we could just spend a second on the consumer electronics side, I know there's usually some volatility in that market depending on your customers' investment cycles, but at the risk of getting ahead of ourselves here. Is that a market that gets better going into 2022? Or do you have any visibility on what's coming down the pipeline there over the next couple of quarters?

Yes, I will provide some additional insights. We typically do not issue guidance for 2022, and we tend to have a clearer understanding of the electronics market's trajectory around our April conference call. By May, we can share more insights about the year ahead. I can say that it has been a lackluster year for consumer electronics following a growth of over 30% in 2020. This year, our customers are more focused on upgrading existing products rather than making significant investments in new smartphone technologies and additional capacity for online learning and remote work. This market tends to experience cycles. Historically, after periods of decline, we often see stronger investment phases. It's too early to make definitive predictions at this point. However, manufacturers rely on us to assist them in launching new products and enhancing productivity and quality. For instance, we support them as they miniaturize products and introduce complex technologies that are difficult to assemble, such as wireless charging stations, micro LED displays, smartwatches, and virtual and augmented reality headsets. As they aim to reduce cosmetic defects and incorporate automation amid labor shortages and health concerns, I anticipate sustained strong demand in these areas for an extended period. The timing of these investments will depend on market cycles, particularly following the recent downturn after a robust upcycle last year.

Okay. That's helpful. And just switching gears quickly to the auto side of things. It feels like every day we get a new mega project around electric vehicles and battery manufacturing. On the battery side, I mean, is that a market where you see the same kind of upside potential in terms of applying machine vision as you would get in traditional combustion platforms or other big verticals for you guys like consumer electronics for that matter in terms of the content?

Certainly, EV battery manufacturing is a really attractive and high potential market for Cognex. We continue to see automakers crystallize investment plans towards battery manufacturing and retrofitting of existing assembly capacity towards EVs. We're having a very strong year in automotive and certainly the EV part of it and the battery part of it is a very major contributor towards that. Longer term, for Cognex, we see this continuing, and we see more and more applications for our world-leading deep learning for inspection and increasing the use of electronics in automobiles, definitely driving further revenue for us. After what was really a couple of difficult years for us in automotive in '18 and '19, we're starting to see a very healthy year and a lot of optimism about what we're going to be able to do for those customers, particularly around EV in the medium to long term.

Our next question comes from the line of Joe Ritchie with Goldman Sachs. You may proceed with your question.

So I think my first question really just wanted to understand the pricing dynamics and the gross margin dynamics over the next several quarters. So clearly, it sounds like you're not really putting through any surcharging and at this juncture feeling it in the margins for all the increased logistics costs. Is there maybe potentially going to be like a change of philosophy going forward given what you're seeing from a freight perspective? And then secondly, on gross margins over the next several quarters, will we be kind of in the low 70s for the next few quarters because of the decrease in inflationary costs?

Yes, let me start. It's Rob, and then I'll invite Paul to share his thoughts. We implemented some actions in the latter part of last quarter that we believe have been well received in the marketplace. We're satisfied with how we've executed these changes. We believe, in terms of dollar impact, they will help offset the gross margin dilution caused by supply chain costs that are currently affecting us. We think these supply chain costs are temporary and may persist for several quarters. However, we don't expect the need to expedite freight or pay high prices to brokers for timely supplies to continue for too long, though it may be a challenge for a few quarters. That's our perspective overall. I'll let Paul elaborate on some additional surcharges and situations we are encountering.

Sure. Yes. And Joe, I think to understand our gross margin outlook, at least for Q4, it helps to understand Q3 and we can speak in comparison, and then we won't go into any detail about next year, except to say that we think it will be challenging through the first half of next year. In Q3, we think about our business as typically having a mid-70s, 75% gross margin, and there were really three factors in Q3 that brought us down to the 70%. And they were roughly equal. The first was helping this customer in logistics deploy a large installation of our technology. So that's idiosyncratic to Cognex and specific to Q3, and that was expected. It was reflected in our guidance and will not repeat. Second, we are incurring higher costs, particularly for components and freight to ensure customer deliveries, and that was mostly expected in our guidance, too. And then third, supply constraints did disproportionately affect sales of our higher-margin products in the quarter, which led to a higher percent of sales in logistics broadly. So that resulted in a less favorable revenue mix. That was largely unexpected. So that's why we were on the lower end of our guidance for Q3. If we then turn to Q4 and think about those three factors, the first factor goes away. The second factor intensifies, and the third factor largely goes away as well. So it really is that second factor getting a little bigger. That led us to give guidance at the low 70% range, but we do expect we'll do better than we delivered this quarter. In terms of pricing, as Rob said, we're looking to offset these incremental costs, most of which we believe are temporary at the operating income level. You can build a simple model of it. Essentially, you offset about one-third of your gross margin impact, but you offset 100% at the operating income dollar level.

Got it. That's super helpful. And then maybe just one follow-on, I notice you have some reasonable visibility in a given year on your electronics growth rate, typically around the March, April plan frame. I guess just given the supply chain issues that this specific end market is experiencing. I don't know, how do you think about 2022? Is it in your conversations with your customers, do you think you're going to have reasonable visibility by then? Or is it too early to tell at this point?

I would expect we'll have a good sense of how things are shaping up by the time we talk with you in early May. Yes, I think we're really part of their implementation plans. We have very long and deep relationships with many of the major players in that industry, and we'll be able to give you, I think, I expect visibility at that point.

Our next question comes from the line of Joe Giordano with Cowen & Co. You may proceed with your questions.

Hey, this is Robert in for Joe. I just wanted to know if you could quantify how much revenue wasn't recognized in the quarter due to some of the supply component shortages on those high margin products? That'd be helpful.

Yes. I mean, again, we went in thinking we might have about a 5% constraint to growth on the quarter, and in the end, you may be faced about $10 million more in incremental revenue that was pushed to subsequent quarters. So combined kind of, we're in that general range to look at our basis, it's kind of a little over $20 million or so.

Okay. That's helpful. And then I know you said backlogs were elevated going into the end of the year. Was there any change in placing orders from customers towards the end of the quarter as these supply chain issues kind of increased?

Yes. We’ve certainly seen a dynamic. I wouldn't say it's around the end of the quarter. We've seen a dynamic where customers are giving us orders with longer lead times because I think they're concerned about supply generally, and they're trying to plan their own implementations with some more reliability. So that's a dynamic I see, that's been going on for certainly more than a quarter now, more than three months in terms of what we see. It's actually helping give us visibility, so we can supply them reliably. But that was not an end-of-the-quarter phenomenon.

Okay. No, that's helpful. And then just one more, if I may. Just Rob, just on the deep learning step that you mentioned, just is that still on track to be around your aspirational goal of 100% growth this year? And how is that kind of looking?

I don't think we're going to give specific forecast by product area. I would say we're very pleased with that technology and how it's performing, and we're seeing extraordinary and strong growth in that area. The only areas where it may not be growing as quickly as we would aspire to would be in consumer electronics, where deployment of it is somewhat correlated to the slightly down year we're seeing in that industry. But that's a long-term play for us, and we're very pleased with the progress we're making with the technology.

We have reached the end of today's call. I would now like to turn this call back over to Mr. Rob Willett for closing comments.

Well, I'd like to thank everyone for joining us tonight, and we look forward to speaking with you again on next quarter's call. Good night.

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time.