Business Breakdowns
· Matt Reustle, Brett Larson
[00:00:00] S0: Within that context, on semiconductors, it sounds like it's a meaningful chunk of the business, but not something that maybe has captured the same tailwind of the actual market itself with semiconductors. What drives the disconnect there? What would you tie that to where it's not just this massive chunk of the business right now as we're seeing this cycle play out. [00:00:00] S1: They actually did a bolt-on acquisition of a company called Moritex in late 2023 and Moritex sells optics and lighting. A lot of that goes into the semiconductors end market. Prior to that, Cognex's semiconductor exposure was quite small, probably sub 5%. And then after that acquisition it's bigger. It grew quite quickly in 2024 for example, the expectation it's going to grow very strongly again in 2025 at this point in time. So I think that kind of explains why it's the size that it is. [00:00:00] S0: Yeah, everything you mentioned, just in terms of the various big customers, the auto market being tepid or modest at best at the moment, all align. One thing we didn't get into when we talked about the History was the culture more so the leadership. What would you point to just in terms of the evolution of the culture and then management team?
· Brett Larson
[00:00:00] S1: I think it's rare that you get to this point in the discussion before you talk about the culture at Cognex. It really is very unique. As I mentioned, their employees are called Cognoids and they've had two CEOs in the past four and a half decades. So the founder, Dr. Robert Shillman, is one of a kind. He goes by Dr. Bob. And I was thinking about how to describe him quickly for a podcast. And I think there's one theory that he says tongue in cheek, that I think captures him quite well. He says it tongue in cheek, but he says that he doesn't believe in exercise because basically your body's a bunch of mechanical joints and anything mechanical has a finite amount of use. And just from that you can see he's clearly an engineer. He's really smart. He's very skeptical individual and a bit rebellious. He's got a really good sense of humor. And he was also very intentional with culture from the very beginning. Cognex's motto is work hard, play hard, move fast. It's very engineering centric. I believe they have the largest collection of PhDs and machine vision in the world, working on just advancing the field. They hire really smart people and give them the room to make autonomous decisions. And they say be right. Most of the time they're willing to fail and try new things, but they also try to have a lot of fun when they're doing it. Some examples of that, on leap years, a few employees are selected to go jump out of a plane with Dr. Bob and I think he dresses up like a frog or something. Ridiculous. One year they rolled in an armored vehicle to deliver the cash bonuses. And Halloween every year is a huge event. They have without question the best annual reports in the business. They're themed, so you should take a look at those. They're really fun. But what's interesting is they've really managed to maintain the culture from what I can tell. And I think there's two reasons they've been able to do this after Dr. Bob. So first, they have what are called ministers of culture in every office around the world who are responsible for maintaining the culture. And it's actually an incremental job in addition to their existing job. And they have meetings and they actually get a separate check in terms of compensation for this job. And it's viewed as very important to the company. So Rob Willett is the current CEO.
· Brett Larson, Matt Reustle
He joined from Danaher in 2008 and became CEO in 2011. Dr. Bob stayed on as Chief Culture Officer until 2021. He really ensured the culture endured through the transition and Rob's really embraced it. That long handoff as well I think is really interesting and unique. The fruits of the culture is obviously things like voluntary attrition is half of their industry peers. But I also think it's just critical in terms of being nimble and adopting new technology to stack all these new S curves. Over time it ultimately comes back to the culture. [00:00:00] S0: There's no culture like a funky or fun engineering group. I think it's one of the more unique things out there in the market when you find one. Quite interesting to hear about. It did bring up one point just given the technical background. Is there a big patent portfolio or IP focus for the business? [00:00:00] S1: You can go on their website and they list hundreds of patents. [00:00:00] S0: I want to get to just some of the numbers on the business as well. I think we've danced around them a bit. But if I'm thinking about what the cost of their equipment is to visualize for a factory purchasing these, is there a general sense of what the average selling price would be?
· Matt Reustle, Brett Larson
[00:00:00] S0: I want to get to just some of the numbers on the business as well. I think we've danced around them a bit. But if I'm thinking about what the cost of their equipment is to visualize for a factory purchasing these, is there a general sense of what the average selling price would be? [00:00:00] S1: These new like Edge Learning products might only be one or $2,000 per system and a customer might need a couple of those. So at the low end of the spectrum you can think of an order being as maybe $10,000 or something like that. And then obviously at the high end of the spectrum the individual sensor or vision system can cost over $10,000 and there could be many of them on a single implementation. So those orders would be running in the hundreds of thousands of dollars. [00:00:00] S0: The turnaround time for something being contracted to actually being delivered. I would imagine there's a lot of lead time in terms of when they're building out a facility. What does that look like? Is it something where they have to be building this to spec when the customer gives them the order or do they have off the shelf stuff that they can deliver? What does that look like?
· Matt Reustle, Brett Larson
[00:00:00] S0: The turnaround time for something being contracted to actually being delivered. I would imagine there's a lot of lead time in terms of when they're building out a facility. What does that look like? Is it something where they have to be building this to spec when the customer gives them the order or do they have off the shelf stuff that they can deliver? What does that look like? [00:00:00] S1: The smaller purchase orders I think it's more book and ship type of business, very short cycle and then their largest, most strategic customers with complex CapEx plans and the like. There's more of a lead time then. You could think of it as they're going to build the shell of the factory first and then the lines and then after. That's when the machine vision cameras go on or they're selling to the machine builders that obviously have their own lead times for those larger customers. I think they generally have not crazy visibility, but a little bit of visibility. [00:00:00] S0: Taking it down to gross margins and operating margins, where do those typically hover and how much cyclicality is there?
· Brett Larson
[00:00:00] S1: Longer term they target 15% top line and constant currency and 40% incrementals. And then they layer on capital allocation from there, starting with revenue. So in the 10 year period ending either 2020, 2021, 2022, so just before this down cycle and adjusted for divestitures that they did, they've grown about 13% excluding M&A and then mid teens in constant currency. So they've been right there. I think actually the right long term bogey and what most people have in mind, understanding we're at a cyclical place, so a few years above this, but is more like low double digit top line. Longer term is how most people think about it. But again, we're at the end of a very long down cycle and there's this new customer base that's being added to Cognex that hopefully should drive some revenue at least in the nearer term that's above that on margins. Similarly, they're depressed cyclically right now and also they have the headwind from the emerging customer initiative investment, salesforce investment, and they actually expect the emerging customer initiative to be operating margin accretive. It already is gross margin accretive, but operating margins last year were 13% and that's down from a peak above 30%. And there's a couple hundred basis points of the emerging customer initiative headwind in there. But longer term they target regaining 30% level. As the leverage returns to the business, they get back to growing and then obviously the salesforce investment flips from a headwind to a tailwind to margins.