Earnings Call Transcript - CGNX Q1 2020

Operator, Operator

Greetings. Welcome to the Cognex First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to our host, Susan Conway. You may begin.

Susan Conway, Senior Director of Investor Relations

Good evening and thank you for joining us. I’m Susan Conway, Senior Director of Investor Relations. I hope everyone is faring well and staying healthy. Joining us today are Cognex’s Chairman, Dr. Bob Shillman; President and CEO, Rob Willett; and Chief Financial Officer, Paul Todgham and his team. I’d like to point out that our earnings release and quarterly report on Form 10-Q are available on our Investor Relations website at www.cognex.com/investor. Both contain highly detailed results. During the call, we may use a non-GAAP financial measure if we believe it is useful to investors or if we believe it will help investors better understand our business results or business trends. You can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the earnings release. Any forward-looking statements we made in the earnings release or any that we may make during this call are based upon information that we believe to be true as of today. Things often change, however, and actual results may differ materially from those projected or anticipated. For a detailed list of risk factors, you should refer to our SEC filings, including our most recent Form 10-K and our Form 10-Q filed tonight for Q1. Now, I’d like to turn the call over to Dr. Bob.

Dr. Bob Shillman, Chairman

Thanks, Sue, and hello, everyone. Welcome to our first quarter of 2020 earnings conference call. Tonight, Cognex announced results for Q1 of 2020, which are pretty good, but one quarter doesn’t tell the whole story. After a challenging year in 2019, we were looking forward to improved macroeconomic conditions in 2020, but all of that has changed in recent weeks. Like many other companies, we are now preparing for difficult days and perhaps months ahead due to the restrictions that governments around the world have placed on travel and on their businesses and on their citizens. At a time like this, our stronger balance sheet— we have $845 million in cash and investments, and having no debt, provides us with breathing room and flexibility that many other companies just do not have. And because of that, we will be able to continue our long-term product development efforts, which should enable us to emerge from this crisis in an even stronger competitive position than we held in the past. Right now, we’re all participating remotely on this call to provide details on the first quarter and for a high-level view of our plans in the current challenging environment. I’ll turn the call over to my partner, our CEO, Rob Willett. Rob, the microphone is yours.

Rob Willett, President and CEO

Thank you, Dr. Bob. And good evening, everyone. Our results for the first quarter of 2020 were in line with our expectations. Revenue and gross margin were delivered at the high end of our expected ranges. Operating expenses and the tax rate were lower than anticipated. The team did a good job managing the supply chain, despite some component shortages from Chinese suppliers that had postponed delivery dates. We now see many of those manufacturers successfully ramping up production as China goes back to work. We also were able to successfully accommodate an unusually high number of requests to either accelerate or, in some cases, delay order deliveries in March. In recent weeks, conditions have become more challenging in most regions of the world, most notably in Europe and the Americas. Many customers are locked down or operating with reduced capacity, and that’s impacting our ability to engage with them and get new orders. Particularly hard hit is the automotive industry, which was our largest end market last year. There’s a long-term potential for growth as the market transitions from internal combustion engines to electric vehicles, but the near-term outlook has deteriorated significantly. Many customers have suspended production and are not allowing our sales engineers into facilities to help with previously planned automation projects that are now on hold. In consumer electronics, we have found that it’s too early to predict the timing and magnitude of this year’s investment cycle, which we typically have insight into by now. Our largest customers are asking for, in fact counting on us to be ready with product shipments and on-site support for their advanced automation initiatives. However, we recognize that there are risks around both the timing and the size of those automation projects, given the current situation. The best end market for us right now is clearly logistics, which was our third largest market in 2019. Online e-commerce sales are accelerating as a result of COVID-related restrictions. As the recognized leader in machine vision and barcode reading for e-commerce, Cognex is well-positioned to capitalize on this trend. E-commerce companies and retailers with e-commerce presence are continuing to implement Cognex vision and ID products to increase both productivity and capacity. Our technology has become even more valuable in this crisis as our customers are able to achieve higher throughput and are better able to maintain social distancing in their distribution centers. In the immediate future, our priority is supporting our customers at a time like this and helping Cognoids to be healthy, safe, and productive. Cognex is primarily a software company. We have the processes and systems in place for Cognoids to work quite effectively from their homes. Most Cognoids are now doing that, working hard to maintain product development schedules, making video sales calls and product demonstrations, and remotely supporting our customers’ critical manufacturing and logistics operations. We have taken measures to maintain a safe environment for those employees who are on-site at Cognex facilities, supporting essential business functions. We are working with many customers in critical industries, including logistics, life sciences, and medical-related businesses that have formally asked us to continue supplying them through the current crisis. Because of our move-fast culture, we’re able to quickly implement changes to our operations that allow us to meet their needs. In terms of our supply chain, sourcing component parts and accessories for our products is a challenge. But thankfully, it’s not a widespread issue for us today. We’re managing well under the circumstances, and we continue to work closely with our suppliers to mitigate risks to our delivery schedules. In addition, our strong balance sheet together with our conservative manufacturing philosophy have enabled us to build a buffer of critical component inventory for times like these. Even so, we recognize the possibility of further closures and disruption down the road. Adding more uncertainty is that governments have implemented and continue to implement restrictions on the movement of people and goods. These are indeed very challenging times for our business that has suppliers and customers around the world. Regarding our new products, early this month, we held a number of large-scale live virtual meetings for our sales engineers and distributor partners. They received an in-depth look at our new products, including our groundbreaking In-Sight D900 smart camera, featuring Cognex industry-leading ViDi deep learning software. Leveraging In-Sight’s widely recognized EasyBuilder user interface, this product launch brings deep learning technology to a wider audience and allows customers to solve complex visual inspection tasks with relative ease. Also presented was the Cognex DataMan 475V, the V is for verifier. DataMan 475V is an inline system that measures the accuracy and quality of a barcode based on globally recognized standards. Importantly, this is performed in-line on high-speed production lines, as the barcodes are being printed and used in industries including automotive, life sciences, consumer products, and logistics. Let’s talk about Cognoids, our people. At a time like this, I feel very grateful to be leading such a committed, talented, and creative group of people. Throughout this crisis, they have exemplified our strong culture, working hard and moving fast in this volatile environment. Our work hard, play hard, move fast culture is a significant advantage on full display to all our stakeholders: our customers, our employees, our vendors, our local communities, and last but not least, our shareholders. That advantage is particularly effective as we strategize for the year ahead and think about how we can work together to meet the needs of our customers and reallocate our efforts to promising growth areas. Before we move on to the details from our first quarter, I’d like to extend a warm welcome to our new CFO, Paul Todgham, who joined Cognex in early March. To say that Cognex joined at an interesting time would be something of an understatement. Paul brings extensive experience leading financial teams and in strategic and operational planning after working at large scale businesses over the past 20 years. We’re very pleased to have him with us. Paul, over to you.

Paul Todgham, Chief Financial Officer

Thank you, Rob, and hello, everyone. My first two months on the job have indeed been a unique adventure. But I’m very excited to be part of Cognex and to help drive our future. I’m particularly impressed with the people I’ve met, their strong work ethics, and Cognex’s move-fast culture. I look forward to meeting many of you in the investment community in the coming months. I hope all of you on this call and your loved ones stay safe and healthy. Let’s turn now to our financial results for Q1 of 2020. Revenue was $167 million, which is at the top end of our February guidance. As expected, revenue declined year-on-year and sequentially, due to continued softness in automotive and the broad factory automation market. Compared to guidance, the decline in the manufacturing sector was partially offset by customers accelerating orders in March, fearing possible supply risks. Despite the lower revenue, gross margin of 75% represents an increase over both Q1 of 2019 and Q4 2019, as a result of the shift in revenue mix to higher margin products. Operating expenses increased by 8% year-on-year and were down slightly on a sequential basis. Over the past year, we added employees and other recurring costs related to the Sualab acquisition, and we made investments to support our strategic priorities. These expenses were partially offset by lower travel and other discretionary expenses in the quarter. Operating margin was 13%, down from 17% in Q1 of 2019. On a sequential basis, operating margin increased by 3 percentage points as a result of the higher gross margin and lower operating expenses compared with Q4. The effective tax rate in Q1 was 17% before discrete tax items, which is lower than our expected rate of 19% due to a shift in income to lower tax jurisdictions. Excluding discrete tax items, earnings per share were $0.11 in Q1, compared with $0.17 in Q1 of 2019 and $0.11 in Q4. Looking at the change in revenue for Q1 year-on-year from a geographic perspective, Asia performed the best of any regions as a result of higher revenue from consumer electronics. China increased in the mid-teens over a relatively weak quarter a year ago, despite business shutdowns, and the rest of Asia grew by approximately 20% in Q1 year-on-year. Revenue from the Americas declined by high single digits year-on-year. This was primarily a result of the timing of revenue from logistics. The logistics sector, as Rob noted, continues to perform well for us. We’re building a substantial order backlog to be delivered in the coming months when access to distribution centers is less restricted. In Europe, revenue declined in the high teens year-on-year, due primarily to softness in automotive. Unfortunately, we don’t see many bright spots in Europe at the moment. Turning to our balance sheet, as noted by Dr. Bob, we ended the quarter with $845 million in cash and investments, and no debt. Cognex has a history of consistent cash generation, as well as a financially disciplined Board of Directors and management team. Uses of cash are primarily to support our long-term growth objectives. We also share our many years of success with shareholders through stock buybacks and dividends. In that regard, we repurchased 1.2 million shares of Cognex stock totaling $51 million in Q1 and added a new $200 million authorization to our repurchase program. We are fortunate to have the ability to continue the buyback program and still have cash for acquisitions if opportunities arise. We also paid nearly $10 million in dividends to shareholders. Now, I’ll turn the call back over to Rob.

Rob Willett, President and CEO

Thank you, Paul. Those of you who follow Cognex know that we typically provide guidance one quarter out. However, given the current business shutdowns, widespread travel restrictions, and potential disruptions we may face in our supply chain, there’s too much uncertainty today for us to be overly specific. Our customers and vendors have shared some of their plans with us, but they’re also facing uncertainty. I can say, however, that we believe both revenue and earnings per share, excluding discrete tax items will decline in Q2 on both a year-on-year and sequential basis. Although we have performed reasonably well overall in April, demand in the overall factory automation market is deteriorating, particularly in Europe and the Americas. Gross margin for Q2 is expected to remain in the mid-70% range, although lower than the gross margin reported for Q1. As for expenses, our leadership team has experience with severe economic downturns, and we are working together to aggressively manage costs. We expect to reduce operating expenses in Q2 by greater than 10% on a sequential basis. Savings include lower travel and discretionary expenses and a more restricted hiring plan. Lastly, the effective tax rate is expected to be 17% excluding discrete tax items. Now, we will open the call for questions. Operator, please go ahead.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. Our first question is from Jim Ricchiuti from Needham & Company. Please proceed with your question.

Jim Ricchiuti, Analyst

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

Rob Willett, President and CEO

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

Jim Ricchiuti, Analyst

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

Rob Willett, President and CEO

Yes. I would break it down like this. Customers who have become skilled in e-commerce, whether they started there or are aggressively transitioning into it, are performing well. They are seeing significant business and have moved their systems online. In contrast, those who haven't embraced e-commerce seem to be facing declines in their business. E-commerce companies are well-positioned to thrive under the current circumstances, and I believe Cognex will do well alongside them. This is clearly the aspect of logistics where we excel and hold the largest market share. However, there are still traditional brick-and-mortar retailers who have not automated their customer interactions or taken them online. Additionally, some sectors of our logistics business, such as global postal services and airport baggage operations, seem to be struggling at this time. Consequently, we anticipate a decline in our business dealings with them.

Jim Ricchiuti, Analyst

The summer ramp from one customer, is that still on track? And I’ll stop there, let somebody else ask.

Rob Willett, President and CEO

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

Operator, Operator

Our next question is from Joe Ritchie from Goldman Sachs. Please proceed with your question.

Joe Ritchie, Analyst

Thank you. Good afternoon, everyone. I hope you're all doing well. I wanted to touch on the comments about China. I noticed that revenue in China increased by 15% this quarter. I'm curious, since you reached the high end of your revenue range for the quarter and it appeared to be quite stable in Asia Pacific. As we come out of current challenges and things start to normalize in China, could you share some insights on the order patterns throughout the quarter? It would also be helpful to understand what specifically contributed to the strong performance in China this past quarter.

Rob Willett, President and CEO

Sure. Joe, let me give you some color on that. So, yes, I mean, I think the interesting thing about running a global business is sort of seeing this kind of a challenge evolve around the world. And we saw it in January in Asia, and I was in Asia in January, and you saw the challenge that it was putting on supply chains and then China got into Chinese New Year, which is always slow and then wasn’t able to come back for a number of weeks after that. But they’re ahead. And what we now see is that production from both the companies, we saw source parts from, but much more importantly really, I guess in this case our customers, is starting to come back. And I would say, came back in much quicker than we expected, mostly due to higher demand from customers really in the electronics ecosystem. April continued to improve as a result of China production coming back. And we’re seeing manufacturers pulling forward orders in some cases to reduce the risk of shortages in their supply chain. And so, we’ve been, I think, very effectively managing the shifting demand at that time. But then there’s, as we can all read, there’s still shifting schedules on actually when production in certain large electronics businesses will ramp up. So, certainly that’s someone in doubt, as we look forward to the timing of some of these things. But what we did see was a faster pickup in March than expected, continued ramping, and then a pretty aggressive action to make sure that the companies were supplied coming out of this challenge.

Joe Ritchie, Analyst

Thank you, Rob. To follow up on your remarks about consumer electronics, you mentioned that your clients want to ensure you're prepared when they are ready to resume investment. When do you anticipate having clarity on this, and what indicators are you monitoring regarding the timing of their decisions to increase spending again?

Rob Willett, President and CEO

It’s a challenging question because we usually have more visibility at this time of year, which we currently lack. The main issue is our ability to scale up manufacturing, which is happening in several countries. China, followed by Vietnam and Korea, are key markets, and we need those markets to be prepared to scale effectively. It's not only about having personnel and processes in place but also ensuring that suppliers, who are sometimes our OEM customers, can provide the necessary products to initiate production, especially for larger new products that are significant for our business in this market. I believe this will happen, although the timing and magnitude are uncertain. I mentioned this in our last call, noting that a challenge can create an opportunity to introduce new features. A shorter window may mean fewer new features and products at launch, while a longer window would benefit Cognex, allowing us to offer more engineering support and technology. However, it suggests that the revenue typically expected in Q2 or Q3 will likely occur in the second half of the year instead.

Operator, Operator

Our next question comes from Karen Lau from Gordon Haskett.

Karen Lau, Analyst

I want to ask about project inquiry. I realize that a lot of your sales are impacted by your ability to deliver on site. I'm curious, when you look at your project inquiries from customers, are they still strong across different regions and markets? It sounds like from a logistics standpoint that's still solid, but could you provide some comments on what you're seeing regarding project inquiries? I'm trying to understand how quickly sales can recover once restrictions are lifted.

Rob Willett, President and CEO

Sure. It’s not really one answer; it’s almost go around the world and give you a range of answers here, Karen. I think certainly in China, I think we’ve seen a very, as I hinted or talked about, we’ve seen a good ramping up of business activity in the last few weeks. And then, in America, we actually saw decent activity until through March and even into the start of April, but then we’ve seen that fall off quite significantly. And then Europe, a similar case to America, but more so, I would say we saw early activity really fall off. So, if one is to draw an analogy that Europe and America are likely to come back like Asia, we would see it start to come back as the market starts to open up. But of course our businesses in these markets are very different. Asia is much more of an electronics business. So, a lot of the demand there can be driven by ramping up those major electronics products that are slated for introduction around the holidays, while in Europe and America, it’s much more of an automotive phenomenon. And certainly, the automotive industry, I would say, as I hinted at in my prepared remarks, looks like it’s much more seriously impacted at the moment than those others. So, it’s difficult to give you one answer. I would say we were perhaps a little surprised with how well demand in Europe and America held up through the end of March and even into April, but then we’ve really started to see a decline and then the opposite picture in China coming out; we were quite surprised how well activities seem to be picking up there post kind of loosening of restrictions.

Karen Lau, Analyst

I appreciate your insights. On the project side, I'm curious if you're experiencing delays or cancellations across various sectors. As improvements occur, there may be some pent-up demand returning. However, many projects that were in the planning phase were put on hold, and restarting them will take time. This could potentially create some gaps, whether in the auto sector or logistics. Are you currently seeing any pauses or cancellations that might indicate a risk of such gaps in the future?

Rob Willett, President and CEO

It's a complex situation. I'll review the different industries. In logistics, we see significant growth potential that has been pushed to later in the year, with increased interest, making it our strongest sector. The electronics sector is challenging, and I anticipate that it will primarily be a factor in the second half of the year. In automotive, which is a key segment for our operations in the Americas and Europe, the maintenance, repair, and operations segment is currently very weak due to plant shutdowns and frozen budgets. I expect this will rebound when business starts to pick up. However, on the capital expenditure side, existing plants also appear weak and are on hold, waiting for plans to resume, while strategic investments, like new vehicles or electric vehicles, seem to be stronger. This part of the automotive sector is likely to receive priority, similar to our focus on long-term technology. Additionally, in other sectors that we serve, such as food and beverage, pharmaceuticals, and medical devices, demand has slowed due to companies operating under restrictive conditions with limited workforces. I expect these industries to be relatively strong when they recover since there is still substantial demand in some areas. For example, we hear about strength in consumer packaged goods, which suggests that once these companies can implement improved automation projects, there will be a backlog of demand because they currently lack the capacity to operate their plants and collaborate with engineers while adhering to social distancing guidelines.

Operator, Operator

Our next question is from Joe Giordano from Cowen.

Joe Giordano, Analyst

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

Rob Willett, President and CEO

Yes. Hi, Joe. I think we are all expecting 2020 to be a pretty strong year for electronics, particularly around 5G and some of the other technologies that plan for rollout. So, I would say probably some of what we’re seeing is the suppliers of those technologies gearing up production.

Joe Giordano, Analyst

I wanted to clarify your comments regarding the automotive sector. It's clear that car sales will increase as these markets reopen, but that doesn’t pertain to your business. You mentioned that you anticipate R&D projects to resume, but not the traditional capital expenditures. I might have misunderstood that while I was taking notes. Could you explain that again?

Rob Willett, President and CEO

Certainly. If we break it down, there’s the maintenance, repair, and operations business. This aspect will struggle while plants are closed, but we anticipate it will recover once they reopen. I also see capital expenditures as divided into two categories. The first relates to existing plants, and given the current challenges in the automotive sector, I don’t expect spending in this area to bounce back quickly. It will likely remain under pressure. The second category involves capital expenditures for strategic initiatives, such as new vehicles and the implementation of new technologies like electric vehicles. I expect this area to remain robust throughout this period, as it represents the future of the industry, and companies will likely be hesitant to cut back on these investments.

Operator, Operator

Our next question is from Richard Eastman with Baird. Please proceed with your question.

Richard Eastman, Analyst

Yes. Thanks for the question. Welcome, Paul. Very just quickly circle around the consumer electronics for a minute or two. Rob, the business in the first quarter again strong in China and the rest of Asia stronger. Is your business there with some of the component vendors and assembly and some of the component vendors that were going to the final devices, given that applications that Cognex is involved in? And I’m thinking perhaps displays or some of those components that are going to end up in a logical place come fall. Is that where the strength is in particular outside of China?

Rob Willett, President and CEO

Broadly speaking, Rick, yes. That’s correct. Key components and technologies, particularly coming out of Korea and Vietnam, I’d say we’ve seen some strengthening of that. And we saw that coming and it’s continued.

Richard Eastman, Analyst

And related to the scale-up, does it give you any insight into demand as you look ahead to the end of the year, considering the product strategies and portfolios from your larger customers?

Rob Willett, President and CEO

Well, yes. A difficult call to make really I would say. Because while one might say, yes, it seems like people have scaling up experience, working in this industry tells me that that’s not necessarily the case; like some suppliers may be building capacity that won’t be fully utilized. Others may see demand come on much stronger, and then we’ll be hustling in the middle of the year to support increased throughput there. So, I wouldn’t necessarily draw a linear relationship between what we’ve seen at the beginning of the year and what we’re going to see now at the back end of the year. But it has to be a positive sign.

Richard Eastman, Analyst

Is your cost of goods sold slowing down as some Cognoids transition from cost of goods sold to research and development? Is research and development increasing while cost of goods sold decreases due to your mix this quarter?

Paul Todgham, Chief Financial Officer

The margin was primarily influenced by our product mix. We have a diverse range of margins, all significantly better than those at my previous company, which contributes to our gross margin. This improvement was largely due to a greater proportion of software revenue, along with revenue from consumer electronics, which generally has a higher margin. Additionally, there was an increase in revenue during the quarter, which also boosted the margin. I don’t believe there was a significant change in R&D and engineering expenses affecting operating expenses compared to cost of goods sold for the quarter.

Richard Eastman, Analyst

Okay. So, with that reply, does the R&D from a dollar perspective just run out pretty much at the current level? I mean, does it increase quarterly?

Paul Todgham, Chief Financial Officer

Yes, broadly speaking, we have reduced our discretionary expenses, as mentioned earlier. We were down from Q4, and we anticipate a further decline in Q2. This applies to all of our operating expenses. We don’t differentiate between line items, like R&D and SG&A. We do expect them to decrease sequentially, although some factors are likely to impact sales more, such as reduced travel during the quarter, rather than our R&D. However, restrictions on hiring or discretionary expenses would be applicable across the board.

Operator, Operator

Our next question comes from Nick Amicucci from UBS.

Unidentified Analyst, Analyst

Just a quick question, I’m just trying for the final point on some of the commentary, like weak March month. Can we kind of get a magnitude of kind of the decline we saw in the U.S. and Europe? So, I mean, China was a little bit better in March?

Rob Willett, President and CEO

Sure. I think I wouldn't describe March as weak necessarily. I believe we are on the high end of guidance. However, we experienced a lot of fluctuations with orders being pulled in and pushed out. I might characterize it more as inconsistent. It really depends on whether you're comparing our expectations or looking at year-on-year results. In the Americas, for example, we did see some customers putting investments on hold and canceling projects due to facility closures, distancing protocols, and lower consumer demand. We definitely observed some of that. Conversely, other sectors in America performed very well or even increased their demand from us, particularly in life sciences and medical-related fields, which are seeing heightened demand due to the current medical COVID situation. But I'm not certain that I fully addressed your question.

Unidentified Analyst, Analyst

I mean, I was just kind of looking at the U.S. and Europe, right down double digits, year-on-year both geographic areas. I was just trying to get a gauge of if that was kind of in the March month, on order of magnitude, how it kind of was impacted by the shutdown?

Rob Willett, President and CEO

Yes. If I’m to provide another explanation and another way of looking at it would be automotive, right. I mean, I think we really saw a deterioration in automotive, which we didn’t see in other parts of our business, in the Americas and Europe as we came through March and into April.

Unidentified Analyst, Analyst

Okay, great. When considering the acceleration and delays of orders, have you experienced complete cancellations, or are the orders just indefinitely postponed until you gain more clarity on the situation?

Rob Willett, President and CEO

We are experiencing some order cancellations, though it's not a significant number. Some customers have indeed canceled orders. There are also delays, which I would characterize as short-term. In several cases, we've shipped products to plants, and upon arrival, the plants were closed, resulting in returns in some instances. Conversely, we also see acceleration in certain orders, as customers are anxious about maintaining production and want to receive our products as quickly as possible. There's a concern that suppliers like us might not consistently provide what they need. While we are not worried about this, it appears that many customers are exhibiting a kind of hoarding behavior, similar to what we see in our personal lives, as they feel the need to secure their supplies due to potential elongation in electronics supply chains before lead times extend.

Operator, Operator

Our next question is from Andrew Buscaglia from Berenberg.

Andrew Buscaglia, Analyst

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

Paul Todgham, Chief Financial Officer

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

Andrew Buscaglia, Analyst

Okay, got it. Okay. And sort of a comment that a lot of people are making throughout this whole crisis is the new normal once we emerge. Are you guys hearing anything around the trend towards reshoring that seems to come up as you’d be a long term beneficiary of that? Just curious if you had some conversations year-to-date on that?

Rob Willett, President and CEO

Yes, it's Rob here. I believe there are numerous potentially positive developments for machine vision as we navigate through this crisis, but reshoring or manufacturing isn't a top priority for me. From what we're hearing, e-commerce fulfillment is likely to benefit, and logistics will become increasingly automated with greater operational flexibility. In the short term, there's a clear reluctance to share touch items like handheld barcode readers, which gives us an advantage since Cognex offers the best fixed mount barcode readers available. We're observing increased interest in these as replacements for handheld devices. Additionally, visual inspections in manufacturing, particularly in environments where many people are close together, like in China, will likely shift towards automation and operator-free manufacturing. We're essentially implementing robotics and automation to handle these tasks. Medical applications are also expected to gain from our current situation. We've invested years into the life science market, building strong customer relationships and securing vital design wins. We believe this sector will continue to grow for machine vision, especially as deep learning helps automate processes and replace lab technicians more efficiently. Furthermore, we've noticed the heightened importance of connectivity during this time, whether it's through 5G or advancements in electronics, and the semiconductor industry's momentum will likely be amplified as a result. While I see many positive outcomes, I don't perceive a global shift towards reshoring from this crisis, and I must admit I'm not an expert in that area. However, I do anticipate that the automotive sector may face a prolonged slowdown, which could dampen some of the bright prospects we expect to arise from the current situation.

Operator, Operator

Our next question is from Paul Coster from JP Morgan.

Paul Coster, Analyst

Last question really kind of got to the point, I think on the new normal. So, many of my questions have been answered Rob. But just a couple of things. You seem to believe the auto industry can take longer to come down? Is that simply a function of just how much stress there is on their balance sheets and they’ll be constrained in investing for a period, or do you also believe that the ICE to EV transitions can take longer for some reason?

Rob Willett, President and CEO

What leads me to say that is the discussions we're having with customers, particularly Tier 1 suppliers and brand owners who experienced a tough year last year. We had been hoping for a turnaround in their business in the latter half of this year, but I no longer believe that will happen. This is one reason. Another reason is that I suspect consumers will have less disposable income and diminished capacity to secure loans for purchasing vehicles due to these circumstances. From my conversations in the industry, I believe this is also on people's minds. The only potential mitigating factor could be government stimulus. I've seen reports suggesting that some major automotive companies are urging governments to consider programs for buying back older vehicles and investing in incentives for electric vehicles. That's the overall impression I have, but I don't have any specific insights on that matter for you.

Paul Coster, Analyst

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

Rob Willett, President and CEO

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

Operator, Operator

And our next question is from Jairam Nathan with Daiwa Securities.

Jairam Nathan, Analyst

Firstly, I want to revisit the SG&A expense. You mentioned in the Q that there was some relocation to areas with higher labor costs, and it seems that in the U.S. and Europe, there are fewer opportunities for growth. Can you elaborate on that comment? I also have a follow-up question.

Rob Willett, President and CEO

Yes. Are you asking about our expenses in those markets or how we’re investing? I'm not entirely sure what you're asking.

Jairam Nathan, Analyst

Yes. In the quarter, you noted that there was an increase in SG&A expense, and part of that increase was due to the relocation of sales resources to regions with higher labor costs.

Rob Willett, President and CEO

I apologize for any confusion. It’s not that we're moving sales resources geographically; rather, it's a functional shift. We’re fortunate at Cognex to have many talented sales engineers with extensive knowledge of machine vision. We typically reallocate them dynamically to where we identify growth opportunities. For example, we have been shifting our focus towards logistics and away from automotive. That’s what we were attempting to convey.

Jairam Nathan, Analyst

Okay, got it. And as a follow-up, just wanted to understand, given the situation, are you seeing more favorable or attractive M&A opportunities, which, given your balance sheet, you can take advantage of?

Rob Willett, President and CEO

I think it’s probably too early to say that. But you’re right, we have a very strong balance sheet, and we’re not afraid to be opportunistic. And certainly, we spend a lot of time studying and thinking about acquisition opportunities in the market. But I think anyone who’s covered Cognex for a long time knows that we’re very selective about the companies we acquire. And some of those companies that I think perhaps have weaker balance sheets or might be challenged by the current environment aren’t necessarily companies we would want to acquire there. They wouldn’t fit well within our high gross margin, high performance, move fast kind of culture. So, I wouldn’t expect us to make any kind of large bolt-on acquisitions with many, many hundreds of people. If you look at the acquisitions we’ve made, it’s more around technology companies with great engineering, great products, et cetera. There are plenty of those, but it’s not clear to me whether they’re becoming more actionable as a result of what they’re seeing. But when, when if and when they do, you can bet we’ll be looking at them.

Operator, Operator

And our next question is from Josh Pokrzywinski from Morgan Stanley.

Josh Pokrzywinski, Analyst

I have a question about electronics. Some customers are being told to be prepared, which suggests there’s some detail about what they should be ready for. Rob, do you have any insights into how 5G and other emerging technologies might impact Cognex’s opportunities or the products in a plant? I understand the goal is to expand over time, and there are other initiatives in play. Is there anything about this new generation of products that represents a significant advancement for Cognex, similar to what we experienced with OLED a few years back?

Rob Willett, President and CEO

Right. Yes, thanks for the question. I don’t think our view about this topic has changed over the last six months in general. I mean, I think we’re very connected to the large players in the industry and we see some of the challenges that exist with 5G, challenges around the power requirements of 5G technology, the dangers around batteries, etc., handling those and inserting them, some of the new sensors and screens and foldable screens and all those things that we’ve been talking about for a while. So, I sort of see those things as kind of making progress and automation kind of gearing up to be able to implement what’s in product roadmaps. I think more the issue changing coming out of this is the magnitude of that in the second half. That’s maybe a more difficult thing to call. You have to think that I have to think consumers would be less ready to spend on high-end technology and new technology as a result of this. But I’m no expert on that. So, I think we see quite clearly that machine vision has a key role to play in the implementation of 5G technology and new technologies coming into electronics. I think the question is the timing and the magnitude of that. The timing clearly for us is second half; the magnitude is still a little unclear. And I wish last year, the last few years we’ve been able to give you quite a lot of clarity at this stage. And it’s different this year as a result of what we’re seeing on in the global health situation.

Josh Pokrzywinski, Analyst

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

Rob Willett, President and CEO

Yes. Cognex is very globally diversified in terms of dealing with really all the major Tier 1 suppliers and really all the major end-user brands. We’re less well penetrated geographically in Japan, as you might expect. But, we have strong relationships and would be on the preferred supplier list of almost every automotive OEM brand and Tier 1 supplier globally. So, I think we’re in good position there. I think if weaker companies fail, and I am no expert. But, I would say they may get acquired by other companies. And I think that that should play out well for us, given what we’ve seen happen in industry over the last few years. And then, I think machine vision is a very important technology for manufacturing lithium-ion batteries. And we all know that that’s a key enabling technology for electric vehicles. And capacity is growing very quickly and costs are coming down very quickly. And it’s a very intensive process, in some cases 30 different steps, most of which involve machine vision. So, those are markets I think that should be very strong for us. And I think that’s a long-term phenomenon with at least six global players competing for process capability in technology to win. So, I think that’s a long-term phenomenon that we should be well-positioned and our industry should be well-positioned to go on benefiting from for some years.

Josh Pokrzywinski, Analyst

Got it. I appreciate the color. All the best.

Rob Willett, President and CEO

Thank you.

Operator, Operator

And we have reached the top of the hour. Therefore, we have reached the end of the question-and-answer session. And I will now turn the call back over to Dr. Shillman for closing remarks.

Dr. Bob Shillman, Chairman

Thank you. As I’ve mentioned, our strong balance sheet, our culture, and our focus on the long term will enable Cognex to weather the current disruptions better than most companies. But, business is not likely to improve until lockdowns end. In that vein, we urge governments to better balance the risks of COVID with the disastrous effects that lockdowns are having on our economies and on our lives. Thank you for joining us tonight. We’ll speak with you again on our next quarter’s call.

Operator, Operator

This concludes today’s conference. And you may disconnect your line at this time. Thank you for your participation.