Cognex (CGNX) 10-K2020 FY Annual report

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This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws. Readers can identify these forward-looking statements by our use of the words “expects,” “anticipates,” “estimates,” “believes,” “projects,” “intends,” “plans,” “will,” “may,” “shall,” “could,” “should,” and similar words and other statements of a similar sense. Our future results may differ materially from current results and from those projected in the forward-looking statements as a result of known and unknown risks and uncertainties. Readers should pay particular attention to considerations described in the section captioned “Risk Factors,” appearing in Part I - Item 1A of this Annual Report on Form 10-K. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. We disclaim any obligation to subsequently revise forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date such statements are made.

Cognex Corporation was incorporated in Massachusetts in 1981. Our corporate headquarters are located at One Vision Drive, Natick, Massachusetts 01760 and our telephone number is (508) 650-3000.

Cognex is a leading worldwide provider of machine vision products that capture and analyze visual information in order to automate manufacturing and distribution tasks where vision is required. Machine vision is the technology that gives computers and automation equipment the ability to see. Machine vision products are used to automate the manufacturing and tracking of discrete items, such as mobile phones, aspirin bottles, and automobile tires, by locating, identifying, inspecting, and measuring them during the manufacturing or distribution process. Machine vision is important for applications in which human vision is inadequate to meet requirements for size, accuracy, or speed, or in instances where substantial cost savings are obtained through the reduction of labor or improved product quality.

Although Cognex sells to customers in a variety of industries, our largest industries are the consumer electronics, logistics, and automotive industries, which combined represented approximately 70% of our total revenue in 2020. While we sell to a variety of customers in the automotive industry, we have two large customers in the consumer electronics and logistics industries that each represented a significant portion of revenue in their respective industries and each represented over 10% of our total revenue in 2020. Our total revenue and quarterly timing of revenue is impacted by the purchasing cycles of these two large customers.

Cognex operates in one segment, machine vision technology. We offer a variety of machine vision products that have similar economic characteristics, have the same production processes, and are distributed by the same sales channels to the same types of customers.

Cognex machine vision is used to automate manufacturing and distribution processes in a variety of industries, where the technology is widely recognized as an important component of automated production and quality assurance. Virtually every manufacturer can achieve better quality and manufacturing efficiency by using machine vision, and therefore, Cognex products are used by a broad base of customers across a variety of industries, including consumer electronics, automotive, consumer products, food and beverage, and medical-related. Cognex products are also used to automate distribution processes in the logistics industry for applications in retail distribution and ecommerce to scan, track, and sort goods through distribution centers.

Although we consider Cognex to be one of the leading machine vision companies in the world, reliable estimates of the machine vision market and the number and relative size of competitors are not readily available. Our competitors include other vendors of machine vision systems, controllers, and components; manufacturers of image processing systems, sensors, and components; and system integrators. We may also compete with internal engineering departments of current or prospective customers, as well as open source tools available for free by various companies. In recent years, we have encountered increased competition from low-cost vision providers in China.

Cognex’s ability to compete depends upon our ability to design, manufacture, and sell high-quality products, as well as our ability to develop new products and functionality that meet evolving customer requirements. The primary competitive factors affecting the choice of a machine vision system include vendor reputation, product functionality and performance, ease of use, price, and post-sales support. The importance of each of these factors varies depending upon the specific customer’s needs.

Our goal is to expand our position as a leading worldwide provider of machine vision products for industrial customers. We are selective in choosing growth opportunities that we believe will maintain our historically high gross margin percentages, which have ranged in the mid 70 percent range for the past several years and reflect the value our customers place on our innovative products. Our high gross margins have the potential to provide us with strong operating leverage in our financial model, as any incremental revenue at such margins falls through to operating income at a high ratio. Our strong and unique corporate culture reinforces our values of customer first and innovation, and enables us to attract and retain smart, highly educated, experienced talent who are motivated to solve the most challenging vision tasks.

We invest heavily in research and development in order to maintain our position as a technology leader in machine vision. We invest in technology that makes vision easier to use and more affordable, and therefore, available to a broader base of customers, such as our vision sensor products that enable customers with a lower budget to use machine vision without the help of sophisticated engineers. We also invest in technology that addresses the most challenging vision applications, such as our 3D vision products that solve applications where a height or volume measurement is required and our deep learning vision software that solves complex applications with unpredictable defects and deviations. We invest through internal development, as well as the acquisition of businesses and technologies. We believe that our acquisition of Sualab Co., Ltd. in 2019 will continue to expand our deep learning technology to visual inspection tasks that could replace human inspectors and make automated inspection tasks fast, easy, and cost-effective.

We continue to invest in our core markets, such as consumer electronics and automotive, where we are a leading provider of vision and ID products for factory automation, while making significant investments in the logistics market, where we are moving beyond barcode reading into more complex applications in retail distribution and ecommerce.

We reach a broad base of customers through our worldwide direct sales force that sells to large, strategic customers, as well as through our network of distributors and integrators that sell primarily to smaller customers who may be more geographically remote and may require supplemental technical support or integration assistance. We invest in emerging, high-growth regions where many manufacturers can benefit from incorporating machine vision into their production processes. This includes investment in China, where rising wages for assembly workers and a greater focus on product quality are driving assembly automation, particularly in the consumer electronics industry.

Our business strategy includes selective expansion into new machine vision applications and markets through the acquisition of businesses and technologies.

On October 16, 2019, Cognex acquired Sualab Co., Ltd. (Sualab), a provider of deep learning-based vision software for industrial image analysis based in Korea. The total consideration of approximately $194 million included cash payments of $170 million and deferred payments of $24 million that may become payable on the fourth anniversary date of the closing, contingent upon continued employment of key talent. Sualab's intellectual property, engineering expertise, and market coverage are expected to increase the Company's deep learning capabilities. Combined with intellectual property acquired from ViDi Systems S.A. in 2017, we believe that Cognex is now a leading provider of deep learning-based industrial vision software.

Management considers business acquisitions to be an important part of our growth strategy, and although we continue to actively seek out acquisition opportunities, we are selective in choosing businesses that we believe will enhance our long-term growth rate and profitability, as well as fit within our corporate culture. We plan to continue to seek opportunities to expand our product lines, customer base, distribution network, and technical talent through acquisitions in the machine vision industry.

Cognex offers a full range of machine vision systems and sensors, vision software, and industrial image-based barcode readers designed to meet customer needs at different performance and price points. Our products range from low-cost vision sensors that conduct simple presence/absence inspections, to deep learning solutions that

solve complex applications with unpredictable defects and deviations. Our products also have a variety of physical forms, depending upon the user's needs. For example, customers can purchase vision software to use with their own camera and processor, or they can purchase a standalone unit that combines camera, processor, and software into a single package.

Cognex engages in research, development, and engineering (RD&E) to enhance our existing products and to develop new products and functionality to address market opportunities. In addition to internal research and development efforts, we intend to continue our strategy of gaining access to new technology through strategic relationships and acquisitions where appropriate.

RD&E expenses as a percentage of revenue were 16% in 2020, 16% in 2019, and 14% in 2018. We believe that a continued commitment to RD&E activities is essential in order to maintain or achieve product leadership with our existing products and to provide innovative new product offerings, as well as to provide engineering support for large customers. In addition, we consider our ability to accelerate time to market for new products to be critical to our revenue growth. Therefore, we expect to continue to make significant RD&E investments in the future, and intend to continue our product development plans during periods of lower revenue levels. At any point in time, we have numerous research and development projects underway.

We rely on the technical expertise, creativity, and knowledge of our personnel, and therefore, we utilize patent, trademark, copyright, and trade secret protection to maintain our competitive position and protect our proprietary rights in our products and technology. While our intellectual property rights are important to our success, we believe that our business as a whole is not materially dependent on any particular patent, trademark, copyright, or other intellectual property right.

Cognex’s products are manufactured utilizing a turnkey operation whereby the majority of component procurement, system assembly, and initial testing are performed by third-party contract manufacturers. Cognex’s primary contract manufacturer is located in Indonesia. The contract manufacturers use specified components sourced from a vendor list approved by Cognex and assembly/test documentation created and controlled by Cognex. Certain components are presently sourced from a single vendor that is selected based on price and performance considerations. In the event of a supply disruption from a single-source vendor, these components may be purchased from alternative vendors.

After the completion of initial testing, a fully-assembled product from the contract manufacturers is routed to our distribution centers in Cork, Ireland or Natick, Massachusetts, USA, where trained Cognex personnel load Cognex software onto the product and perform quality control procedures. Fully-configured finished products for customers in the Americas, with the exception of certain products stocked locally in Mexico, are then shipped from our Natick,

Massachusetts distribution center, while finished products for customers outside of the Americas are shipped from our Cork, Ireland distribution center. In 2020, the Company began stocking certain fully-configured finished products in its Mexico facility in order to provide faster delivery to local customers.

Cognex sells its products through a worldwide direct sales force that focuses on the development of strategic accounts that generate or are expected to generate significant sales volume, as well as through a global network of distribution and integration partners. Our distribution partners provide sales and local support to help Cognex reach the many prospects for our products in factories around the world, and our integration partners are experts in vision and complementary technologies that can provide turnkey solutions for complex automation projects using vision. Sales engineers call directly on targeted accounts, with the assistance of application engineers, and manage the activities of our distribution and integration partners within their territories in order to provide an advantageous sales model for our products.

Sales to customers based outside of the United States represented approximately 65% of our total revenue in 2020, with approximately 26% from customers based in Europe, 21% from customers based in Greater China, and 18% from customers based in other regions outside the United States. Sales to customers based in Europe are denominated in Euros and U.S. Dollars, sales to customers based in Greater China are denominated in Yuan for sales within Mainland China and U.S. Dollars in other territories, and sales to customers based in other regions are denominated in U.S. Dollars, Japanese Yen, Korean Won, and Mexican Pesos.

Cognex’s service offerings represent less than 10% of our total revenue and include maintenance and support, consulting, and training services. Maintenance and support programs include hardware support programs that entitle customers to have failed products repaired, as well as software support programs that provide customers with application support and software updates to the latest software releases. Application support is provided by technical support personnel located at Cognex regional offices, as well as by field service engineers that provide support at the customer’s production site. We provide consulting services that range from a specific area of functionality to a completely integrated installed application. Training services include a variety of product courses that are available at our offices worldwide, at customer facilities, and online.

At Cognex, we refer to our employees as "Cognoids." As of December 31, 2020, Cognex employed 2,055 Cognoids, including 1,149 in sales, marketing, and service activities; 537 in research, development, and engineering; 164 in manufacturing and quality assurance; and 205 in information technology, finance, and administration. Of our 2,055 Cognoids, 1,247 are based outside of the United States. We have not experienced any work stoppages due to labor disputes. We believe that our employee relations are good.

We have a robust talent development process that focuses on identifying and developing high-potential employees, as well as succession planning for key positions. Our compensation programs are based on pay-for-performance, with a greater percentage of total compensation tied to variable incentive programs, such as performance-based bonuses and stock-based awards, as Cognoids advance to more senior positions.

Cognex’s capital expenditures, earnings, and competitive position are not materially affected by compliance with federal, state, and local environmental provisions which have been enacted or adopted to regulate the distribution of materials into the environment.

Cognex maintains a website at www.cognex.com. We make available, free of charge, on our website in the “Company” section under the caption “Investor Information” followed by “Financial Reports” and then “SEC FiIings,” our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, including exhibits, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed

with, or furnished to, the SEC. Cognex’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. Information contained on our website is not a part of, or incorporated by reference into, this Annual Report on Form 10-K.

The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect our company in the future. If any of these risks were to occur, our business, financial condition, or results of operations could be materially and adversely affected. This section includes or refers to certain forward-looking statements. We refer you to the explanation of the qualifications and limitations on such forward-looking statements, appearing under the heading "Forward-Looking Statements" in Part II - Item 7 of this Annual Report on Form 10-K.

The COVID-19 (also referred to as “coronavirus”) outbreak developed into a global pandemic in March 2020. The COVID-19 outbreak had a modest adverse impact on our business in the first quarter of 2020, primarily near the end of the quarter. This impact expanded and accelerated into the second quarter of 2020, as we noted lower demand for our products in certain industries, additional disruptions to our supply chain, longer customer delivery times, higher delivery costs, and further shutdowns of customer facilities. These conditions triggered a review of long-lived assets that resulted in intangible asset impairment charges of $19,571,000 and excess inventory exposures that resulted in charges of $7,718,000 in the second quarter of 2020. Although the impact of these conditions on our business to date appears to have been most severe in the second quarter of 2020, certain industries we serve continue to be adversely impacted by the global pandemic, most notably the automotive industry, which was our largest market in 2019. Furthermore, the impact of the pandemic could worsen in any of our major industries or geographies in the future, resulting in deteriorating economic and business conditions and adverse effects on our business, results of operations, and financial condition. We face several risks and uncertainties related to the impact of COVID-19 on our business. It is difficult for us to quantify the duration and severity of this impact due to many factors beyond our control and knowledge, including changing governmental regulations and the scope and duration of social distancing and commercial restrictions. These risks and uncertainties include, among others:

These risks and uncertainties could have a material adverse effect on the continuity of our business, results of operations, and financial condition. This situation is continuously changing and additional impacts on our business may arise of which we are not currently aware.

In May 2020, our Board of Directors approved a restructuring plan intended to reduce our operating costs, optimize our business model, and address the impact of the COVID-19 pandemic. The restructuring plan included a workforce reduction of approximately 8% and office closures. These restructuring actions, together with other actions to reduce the Company's overall costs, were designed to generate an aggregate annualized cost savings of approximately $25 million versus our original planned cost structure. As of December 31, 2020, the majority of these actions have been completed to achieve the annualized cost savings from this restructuring plan. Furthermore, as of the date of this report, business levels have improved from our financial projections in May 2020, when we believe the impact of the pandemic on our business was most severe. While we do not anticipate further restructuring actions, we continue to tightly manage our operating costs and optimize our business model. Although we expect to continue to make investments in strategic areas, the restructuring actions we completed in 2020 may nevertheless negatively impact programs we believe are important to the long-term success of our company, such as the ability to accelerate time to market for new products. In addition, our ability to provide a high level of service to our customers may be negatively impacted by these actions, particularly in regions where we have downsized our operations.

In 2020, the Company had two large customers in the consumer electronics and logistics industries that each represented a significant portion of revenue in their respective industries and each represented over 10% of our total revenue in 2020. Our total revenue and quarterly timing of revenue is impacted by the purchasing cycles of these two large customers.

Large customers may divert management’s attention from other operational matters and pull resources from other areas of the business, resulting in potential loss of revenue from other customers. In addition, large customers may receive preferred pricing and a higher level of support, which may lower our gross margin percentage. Furthermore, in certain instances due to long supplier lead times, we may purchase inventory in advance of receipt of a customer purchase order, which exposes us to an increased risk of excess or obsolete inventory and resulting charges. The loss of, or further curtailment of purchases by, any one or more of our larger customers could have a material adverse effect on our operating results.

Revenue from customers in the automotive industry, which was our largest market in 2019, declined by approximately 20% in 2020. It has been reported that the automotive industry has been significantly and adversely impacted by the COVID-19 pandemic, as consumer demand for new automobiles has been curtailed and investment in new electric vehicle technology has been delayed. Furthermore, the surge in demand for electronics during the pandemic has resulted in chip shortages that may constrain vehicle production and delay a recovery of our business in this industry. Despite the decline in revenue from customers in the automotive industry in 2020, automotive revenue continues to represent a significant portion of our total revenue, and we are dependent upon revenue from customers in this industry to achieve our longer-term, high-margin growth plans. As a result, our operating results could continue to be materially and adversely affected by further declining sales in this industry.

A significant portion of our products is manufactured by a third-party contractor located in Indonesia. This contract manufacturer has agreed to provide Cognex with termination notification periods and last-time-buy rights, if and when that may be applicable. We rely upon our contract manufacturers to provide quality product. We engage in extensive product quality programs and processes, including actively monitoring the performance of our third-party manufacturers; however, we may not detect all product quality issues through these programs and processes. We also rely upon our contract manufacturers to meet delivery schedules.

We have in the past experienced, and may continue in the future to experience, delays in the delivery of our finished products from our contract manufacturers due to the impact of the COVID-19 pandemic or other factors. Although our primary contract manufacturer has the ability to shift production to plants in other regions when operations in its Indonesia plant are disrupted, production and test equipment located at the Indonesia plant that is unique to the manufacture of Cognex products creates practical challenges to doing so in a timely manner. Furthermore, this contract manufacturer sources components for our finished products from China and other regions that experienced interruptions in production and delivery during the pandemic as factories were closed. These challenges in obtaining components and maintaining production have resulted in delays, and may continue to result in delays, in meeting our delivery schedules that, in turn, result in delayed deliveries to our customers past their requested delivery date and negatively impact customer satisfaction.

Certain components are presently sourced from a single vendor that is selected based on price and performance considerations. In the event of a supply disruption from a single-source vendor, these components may be purchased from alternative vendors, which may result in manufacturing delays based on the lead time of the new vendor and higher costs. Certain key electronic and mechanical components that are purchased from strategic suppliers, such as processors or imagers, are fundamental to the design of Cognex products. A disruption in the supply of these key components, such as a last-time-buy announcement, natural disaster, financial bankruptcy, or other event, may require us to purchase a significant amount of inventory at unfavorable prices resulting in lower gross margins and higher risk of carrying excess inventory. If we are unable to secure adequate supply from alternative vendors, we may have to redesign our products, which may lead to a delay in manufacturing and a possible loss of sales. Furthermore, the surge in demand for electronics during the COVID-19 pandemic has resulted in chip shortages that may impact the supply for our products. Although we are taking certain actions to mitigate supply risk, an interruption in, termination of, or material change in the purchase terms of any key components could have a material adverse effect on our operating results.

Because the market for our products is characterized by rapid technological changes, we frequently introduce new products with improved ease-of-use, improved hardware performance, additional software features and functionality, or lower cost that may replace existing products. Among the risks associated with the introduction of new products are difficulty predicting customer demand and effectively managing inventory levels to ensure adequate supply of the new product and avoid excess supply of the legacy product.

We may strategically enter into non-cancelable commitments with vendors to purchase materials for our products in advance of demand to take advantage of favorable pricing, address concerns about the availability of future supplies, or build safety stock to help ensure customer shipments are not delayed should we experience higher than anticipated demand for materials with long lead times. These measures to purchase inventory may expose us to an increased risk of excess or obsolete inventory and resulting charges if actual demand is lower than anticipated.

Deteriorating global economic conditions from the COVID-19 pandemic resulted in lower projected sales of excess inventories, for which the company recorded provisions totaling $7,718,000 in the second quarter of 2020. Our failure to effectively manage product transitions or accurately forecast customer demand, in terms of both volume and configuration, has led to, and may again in the future lead to, an increased risk of excess or obsolete inventory and resulting charges.

If flaws in either the design or manufacture of our products were to occur, we could experience a rate of failure in our products that could result in significant delays in shipment and material repair or replacement costs. Our release-to-market process may not be robust enough to detect significant design flaws or software bugs. While we engage in product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers and contract manufacturers, these actions may not be sufficient to avoid a product failure rate that results in:

Any of these results could have a material adverse effect on our operating results.

To support our growth and execute on our operating plans and strategic initiatives, we must effectively attract, train, develop, motivate, and retain skilled employees, while maintaining our unique corporate culture. During the COVID-19 pandemic, many of our employees have worked remotely from their homes to comply with governmental regulations, with the primary exception of our distribution center employees who have remained on-site in shifts throughout the pandemic to deliver products to essential businesses. While we have been able to effectively conduct most business activities in this manner, these conditions have made it more challenging to maintain our collaborative corporate culture. When regulatory and health conditions allow, we anticipate returning to a more collaborative, largely on-site work environment. If work-from-home conditions continue longer than anticipated or we are unable to successfully bring people back into the office once safe to do so, the company's business and ability to execute its plans could be adversely affected in a material way.

We are highly dependent upon the management and leadership of our senior management team. Although we have many experienced and qualified senior managers, the loss of key personnel could have a material adverse effect on our company.

We use stock options and restricted stock units (RSUs) as a key component of our employee compensation program in order to align employee interests with the interests of our shareholders, provide competitive compensation packages, and encourage employee retention. Our stock price volatility may cause periods of time during which option exercise prices might be less than the sale price of our common stock or the value of RSUs might be less competitive, which may lessen the retentive attributes of these awards. We are limited as to the number of stock options and RSUs that we may grant under our stock plans, and we are unsure how effective different stock-based awards with different vesting schedules will be to retain key talent. Accordingly, we may find it difficult to attract, retain, and motivate employees, and any such difficulties could materially adversely affect our business.

We have in the past experienced, and may again in the future experience, periods of rapid revenue growth due to such factors as the level of investment from key customers or the impact of general economic recoveries on automation spending. The growth and expansion of our business and product offerings place significant demand on our employees and, in particular, our management team. This growth may require significant additional resources, which may not scale in a cost-effective manner or may negatively impact our customers’ experience. We may not be able to hire and train new employees and contractors quickly enough to meet our business needs. If we fail to quickly adapt our hiring and training plans to our business levels or effectively execute on our hiring plans, our efficiency and ability to meet our operating goals could suffer. Furthermore, employee productivity, morale, and retention could suffer, which may have a material adverse effect on our business and operating results.

We are pursuing applications to automate distribution processes in the logistics industry including applications for retail distribution and ecommerce to scan, track, and sort goods through distribution centers. Our future growth plans are dependent upon growth in this industry. Our gross margin percentage in this industry is currently lower than our average gross margin percentage, as certain sales in this industry are for application-specific customer solutions that include deployment services. Our strategy is to shift our focus as the logistics market matures from Cognex providing deployment services to utilizing partner integrators to provide these services for end users, which we believe will result in improved gross margins that will be more in line with our overall average over time. In addition, we are making significant investments in engineering and sales to further develop our logistics business. Failure to generate revenue in this industry in the amounts and at the gross margins anticipated may have a material adverse impact on our revenue growth and operating results.

The market for our products is characterized by rapidly changing technology. Accordingly, we believe that our future success will depend upon our ability to accelerate time-to-market for new products with improved functionality, ease-of-use, performance, and price. There can be no assurance that we will be able to introduce new products in accordance with scheduled release dates or that new products will achieve market acceptance. Our inability to keep pace with the rapid rate of technological change in the high-technology marketplace could have a material adverse effect on our operating results.

Product development is often a complex, time-consuming, and costly process involving significant investment in research and development with no assurance of return on investment. Our strong balance sheet allows us to continue to make significant investments in research, development, and marketing for new products and technologies. Research is by its nature speculative and the ultimate commercial success of a product depends upon various factors, many of which are not under our control. We may not achieve significant revenue from new product investments for a number of years, if at all. Moreover, new products, if introduced, may not generate the gross margins that we have experienced historically.

We utilize a direct sales force, as well as a network of distribution and integration partners, to sell our products and services. Successfully managing the interaction of our direct and indirect sales channels to reach various potential customers for our products and services is a complex process. In addition, our reliance upon indirect selling methods may reduce visibility to demand and pricing issues.

Finished products for customers in the Americas, with the exception of certain products stocked locally in Mexico, are shipped from our Natick, Massachusetts distribution center, while finished products for customers outside of the Americas are shipped from our Cork, Ireland distribution center. In 2020, we began stocking certain fully-configured finished products in our Mexico facility in order to provide faster delivery to local customers. To support the expansion of our business internationally, we may decide to make changes to our operating structure in other countries in the future when we believe these changes will make us more competitive by offering faster delivery, importation services, and/or local currency sales. These new operating models may require changes in legal structures, business systems, and business processes that may result in significant business disruption and negatively impact our customers’ experience, resulting in loss of sales. Furthermore, as we assume more responsibility for the importation of our products into other countries, we face higher compliance risk to adhering to local regulatory and trade requirements. Finally, the local stocking of finished products in countries outside of our primary distribution centers may result in higher costs and increased risk of excess or obsolete inventory associated with maintaining the appropriate level and mix of stock in multiple inventory locations, resulting in lower gross margins.

The machine vision market is highly fragmented and competitive. Our competitors include other vendors of machine vision systems, controllers, and components; manufacturers of image processing systems, sensors, and components; and system integrators. We may also compete with internal engineering departments of current or prospective customers, as well as open source tools available for free by various companies. In recent years, we have encountered increased competition from low-cost vision providers in China. Any of these competitors may have greater financial and other resources than we do. We may not be able to compete successfully in the future and our investments in research and development, sales and marketing, and support activities may be insufficient to enable us to maintain our competitive advantage. In addition, competitive pressures could lead to price erosion that could have a material adverse effect on our gross margins and operating results.

In 2019, we completed our largest acquisition to date when we acquired Sualab Co., Ltd., a provider of deep learning-based vision software based in Korea. Our business may be negatively impacted by risks related to this acquisition, as well as other smaller acquisitions we have completed in the past few years, and future acquisitions that we may make. These risks include, among others:

Acquisitions are inherently risky and the inability to effectively manage these risks could have a material adverse effect on our operating results.

In 2021, the Company is making significant investments in business systems related to our sales processes, including systems to help our sales team more efficiently manage customer relationships and sales opportunities. We expect these new sales systems to be placed into service in the first quarter of 2022. Implementing new business systems requires a significant investment of time and money, and may divert management’s attention from other operational matters. The implementation of a new system and changes to associated business processes, particularly those that are customer-facing, may result in significant business disruption and negatively impact our customers’ experience, resulting in loss of sales. The Company intends to continue to make IT-related investments to improve its management information systems and support the expansion of our business internationally. Any disruption occurring with our business systems may have a material adverse effect on our operating results.

We rely on our information technology infrastructure and management information systems to effectively run our business. We may be subject to information security breaches caused by hacking, malicious software, or acts of vandalism or terrorism. Our security measures or those of our third-party service providers may not detect or prevent such breaches. Any such compromise to our information security could result in theft of our intellectual property, including software source code, a misappropriation of our cash or other assets, an interruption in our operations, the unauthorized publication of our confidential business or proprietary information, the unauthorized release of customer, vendor, or employee data, the violation of privacy or other laws, and the exposure to litigation or regulatory penalties, any of which could harm our business and operating results. We have experienced cybersecurity incidents in the past that have included malware, viruses, phishing attacks, and intrusion attempts to Cognex’s internet-facing systems. To date, these incidents have not had a material impact on our operations or financial results; however, future cybersecurity incidents could have a material adverse effect on our business, financial condition, or operating results.

We rely on our proprietary software technology and hardware designs, as well as the technical expertise, creativity, and knowledge of our personnel to maintain our position as a leading provider of machine vision products. Software piracy and reverse engineering, specifically from companies in Russia and China, may result in counterfeit products that are misrepresented in the market as Cognex products or pirated products that contain stolen technology such as software source code. Although we use a variety of methods to protect our intellectual property, we rely most heavily on patent, trademark, copyright, and trade secret protection, as well as non-disclosure agreements with customers, suppliers, employees, and consultants. We also attempt to protect our intellectual property by restricting access to our proprietary information by a combination of technical and internal security measures. These measures, however, may not be adequate to:

Our pending and future patent applications may not issue as patents or, if issued, may not issue in a form that will provide us with any meaningful protection or any competitive advantage. Even if issued, existing or future patents may be challenged, narrowed, invalidated, or circumvented, which could limit our ability to stop competitors from developing and marketing similar products or limit the length of patent protection we may have for our products. Furthermore, other companies may design around technologies we have patented, licensed, or developed. Moreover, changes in patent laws or their interpretation in the United States and other countries could also diminish the value of our intellectual property or narrow the scope of our patent protection. In addition, the legal systems of certain countries do not favor the aggressive enforcement of patents, and the laws of foreign countries may not protect our rights to the same extent as the laws of the United States. As a result, our patent portfolio may not provide us with sufficient rights to exclude others from commercializing products similar to ours. Any of these adverse circumstances could have a material adverse effect on our operating results.

As of December 31, 2020, we had approximately $498 million of debt securities in our investment portfolio. These debt securities are reported at fair value, with unrealized gains and losses, net of tax, included in shareholders’ equity as other comprehensive income (loss) since these securities are designated as available-for-sale securities. As of December 31, 2020, our portfolio of debt securities had an unrealized gain of $5,690,000, and no unrealized losses. However, at any point in time, we may hold securities in an unrealized loss position. Management monitors its debt securities that are in an unrealized loss position to determine whether a loss exists related to the credit quality of the issuer that would be reported in current operations. It is our policy to invest in investment-grade debt securities that minimize our exposure to credit losses.

As of December 31, 2020, we had approximately $16 million in acquired intangible assets, consisting primarily of acquired technologies and customer relationships. These assets are susceptible to changes in fair value due to a decrease in the historical or projected cash flows from the use of these assets, which may be negatively impacted by economic trends. Deteriorating global economic conditions from the COVID-19 pandemic triggered a review of long-lived assets for potential impairment, which resulted in intangible asset impairment charges totaling $19,571,000 in the second quarter of 2020, primarily related to lower projected cash flows from the technologies and customer relationships acquired from Sualab. A further decline in the cash flows generated by these or other intangible assets may result in future impairment charges.

If we determine that any of these investments or intangible assets are impaired, we would be required to take a related charge to earnings that could have a material adverse effect on our results of operations.

We are subject to taxes in the United States, as well as in numerous foreign jurisdictions, including income taxes, indirect taxes such as value-added taxes (VAT), and payroll-related taxes and withholding obligations. Significant judgment is required in determining our worldwide provision for income and other taxes. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are regularly under audit by tax authorities and may be assessed additional taxes, penalties, fees or interest, which could have an adverse effect on our financial position, liquidity, or results of operations.

Although we believe our tax positions are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in our financial statements and could have a material adverse effect on our income tax provision, net income, or cash flows in the period in which the determination is made.

We face exposure to foreign currency exchange rate fluctuations, as a significant portion of our revenues, expenses, assets, and liabilities are denominated in currencies other than the functional currencies of our subsidiaries or the reporting currency of our company, which is the U.S. Dollar. In certain instances, we utilize forward contracts to hedge against foreign currency fluctuations. These contracts are used to minimize foreign currency gains or losses, as the gains or losses on the derivative are intended to offset the losses or gains on the underlying exposure. We do not engage in foreign currency speculation. If the counterparty to any of our hedging arrangements experiences financial difficulties, or is otherwise unable to honor the terms of the contract, we may experience material losses.

The success of our foreign currency risk management program depends upon forecasts of transaction activity denominated in various currencies. To the extent that these forecasts are overstated or understated during periods of currency volatility, we could experience unanticipated foreign currency gains or losses that could have a material impact on our results of operations. In addition, our failure to identify new exposures and hedge them in an effective manner may result in material foreign currency gains or losses. Furthermore, our ability to hedge the Chinese Yuan is limited, which has resulted in unhedged exposures. To date, foreign currency gains and losses related to the Chinese Yuan have been immaterial to our total results; however, further fluctuations in this currency may result in material foreign currency gains or losses in the future.

In addition to the U.S. Dollar, a significant portion of our revenues and expenses are denominated in the Euro and Chinese Yuan, and to a lesser extent the Japanese Yen, Korean Won, and Mexican Peso. We estimate that approximately 45% of our sales in 2020 were invoiced in currencies other than the U.S. Dollar, and we expect sales denominated in foreign currencies to continue to represent a significant portion of our total revenue. While we also have expenses denominated in these same foreign currencies, the impact on revenues has historically been, and is expected to continue to be, greater than the offsetting impact on expenses. Therefore, in times when the U.S. Dollar strengthens in relation to these foreign currencies, we would expect to report a net decrease in operating income. Conversely, in times when the U.S. Dollar weakens in relation to these foreign currencies, we would expect to report a net increase in operating income. Thus, changes in the relative strength of the U.S. Dollar may have a material impact on our operating results.

Our revenue levels are impacted by global economic conditions, as we have a significant business presence in many countries throughout the world. Economic downturns may cause industrial companies to delay or reduce spending for automation projects, including those with machine vision, amid weaker general manufacturing confidence and heightened uncertainty around global trade. When global economic conditions are unfavorable, our revenue and our ability to generate operating profits could be materially adversely affected.

As a result of global economic conditions, our business is subject to the following risks, among others:

As of December 31, 2020, the Company had approximately $767 million in cash and investments. In addition, Cognex has no long-term debt and we do not anticipate needing debt financing in the near future. We believe that our strong cash position puts us in a relatively good position to weather economic downturns. Nevertheless, our operating results have been materially adversely affected in the past, and could be materially adversely affected in the future, as a result of unfavorable economic conditions and reduced capital spending by manufacturers worldwide.

In 2020, approximately 65% of our revenue was derived from customers located outside of the United States. We anticipate that international sales will continue to account for a significant portion of our revenue. In addition, we source components from suppliers located outside of the United States, including China, and utilize third-party contract manufacturers, primarily located in Indonesia, to assemble certain of our products. We intend to continue to expand our sales and operations outside of the United States and expand our presence in international emerging markets. As a result, our business is subject to the risks inherent in international sales and operations, including, among other things:

Any of these factors could have a material adverse effect on our operating results. In recent years, trade tariffs imposed by the United States on certain components imported from Chinese suppliers resulted in higher costs for our products. To date, these cost increases have been immaterial to our total cost of goods sold and primarily relate to components sourced in China for new products that we build in the United States in their infancy before they are moved to our contract manufacturer in Indonesia; however, cost increases as a result of trade tariffs could become material in the future.

Trade tariffs have also had an indirect impact on the economic climate in China, which in turn, has had a negative impact on the Company's revenue from customers based in China. Further escalations of trade conflicts between the United States and China, or other countries where Cognex has operations, may have a further adverse effect on our revenue. In addition to trade tariffs, United States export controls that place restrictions on the exportation of our products or a subset of our products, including, without limitation, any applicable regulations promulgated by the U.S. Commerce Department’s Bureau of Industry and Security, have had a negative impact on our revenue from customers based in China. To date, the impact of these restrictions has been immaterial to our total revenue; however, further or continued restrictions could have a material adverse effect on our operating results in the future.

Additionally, we are subject to applicable anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, and similar anti-corruption and anti-kickback laws in the jurisdictions in which we operate. These laws generally prohibit offering, promising, giving, or authorizing others to provide anything of value, either directly or indirectly, to a government official or private party in order to influence official action or otherwise gain an unfair business advantage, such as to obtain or retain business. Particularly as a result of our global operations, including in developing countries, and our growing international sales force, our relationships with our customers and resellers could expose us to liability under these laws. Violations of anti-corruption laws may result in severe civil and criminal penalties for noncompliance. Even an unsuccessful challenge or investigation into our practices is costly to defend, and could cause adverse publicity, and thus could have a material adverse effect on our business, financial condition, or operating results.

Finally, Brexit, or the withdrawal of the United Kingdom (U.K.) from the European Union, resulted in a new trade agreement between these two parties that became effective on January 1, 2021. Revenue from customers in the U.K. represented approximately 1% of our total revenue in 2020. Under the new trade process, our U.K. customers have experienced, and may continue to experience, delivery delays as additional customs documents are required to complete delivery.

From time to time, we may be subject to various claims and lawsuits by competitors, shareholders, customers, distributors, patent trolls, former employees, or other parties arising in the ordinary course of business, including lawsuits charging patent infringement, or claims and lawsuits instituted by us to protect our intellectual property and confidential information or for other reasons. These matters can be time consuming, divert management’s attention and resources, and cause us to incur significant expenses. Furthermore, the results of any of these actions may have a material adverse effect on our operating results.

None

In 1994, Cognex purchased and renovated a 100,000 square-foot building located in Natick, Massachusetts that serves as our corporate headquarters and is occupied by employees primarily in research, development, and engineering, manufacturing and quality assurance, and administration functions. In 1997, Cognex completed construction of a 50,000 square-foot addition to this building.

In 1995, Cognex purchased an 83,000 square-foot office building adjacent to our corporate headquarters that is occupied by employees primarily in sales, marketing, service, logistics, finance, and information technology functions.

In 1997, Cognex purchased a three and one-half acre parcel of land adjacent to our corporate headquarters. This land is being held for future expansion and is currently used as an Ultimate Frisbee Field for our Cognoids.

In 2007, Cognex purchased a 19,000 square-foot building adjacent to our corporate headquarters. This facility serves as the distribution center for customers in the Americas.

In 2014, Cognex purchased a 50,000 square foot building in Cork, Ireland where we had previously leased space for several years. This facility serves as the distribution center for customers outside of the Americas.

Cognex conducts certain of its operations in leased facilities. These lease agreements expire at various dates through 2030. Certain of these leases contain renewal options, retirement obligations, escalation clauses, rent holidays, and leasehold improvement incentives.

Not applicable.

The following table sets forth the names, ages, and titles of Cognex’s executive officers as of December 31, 2020:

Dr. Shillman and Mr. Willett, who are both members of the Company's Board of Directors, have been employed by Cognex in their current positions for no less than the past five years.

Ms. DiPalma joined Cognex in 1992. She has served for more than 25 years in a series of increasingly responsible roles in the finance function, including six years as Cognex Treasurer, before transitioning to Employee Services in 2016. Prior to joining Cognex, Ms. DiPalma was a member of the audit firm PricewaterhouseCoopers. She holds a Bachelor of Science degree in Accounting from Boston College, a Master of Science degree in Taxation from Bentley College, and is a Certified Public Accountant.

Mr. Gerst joined Cognex in 1999. He worked in a number of product-focused roles before being promoted to Senior Vice President of the ID Products Business Unit in 2014. In 2020, Mr. Gerst was promoted to Executive Vice President of Vision and ID Products and his leadership role was expanded to include Vision Products and Global Marketing Communications. Prior to joining Cognex, Mr. Gerst held roles in engineering, sales, and product marketing for Hand Held Products (now Honeywell Imaging and Mobility), a leading supplier of Automatic Identification and Data Collection equipment. Mr. Gerst holds a Bachelor of Science degree in Electrical Engineering from Clarkson University and a Master in Business Administration from the Simon School of Business at the University of Rochester.

Mr. Todgham joined Cognex in March 2020. Prior to joining Cognex, Mr. Todgham spent six years at Levi Strauss & Company, where he held a range of senior leadership positions, including leading finance for the company’s Global Supply Chain, Distribution, Merchandising, Planning, Design, and Marketing teams. He previously served as Vice President of Finance for Ross Stores, Inc., where he oversaw financial planning & analysis and treasury functions. Earlier in his career, Mr. Todgham worked at The Boston Consulting Group, advising clients in the technology and consumer sectors on issues of strategy, operations, and organization. Mr. Todgham holds a Master in Business Administration from Stanford University, a Master in Economics from the University of Cambridge, and a Bachelor of Arts degree in Applied Mathematics from Harvard University.

The Company’s common stock is traded on The NASDAQ Stock Market LLC, under the symbol CGNX. As of January 31, 2021, there were approximately 650 shareholders of record of the Company’s common stock. The Company believes the number of beneficial owners of the Company’s common stock on that date was substantially greater.

In October 2018, the Company's Board of Directors authorized the repurchase of $200,000,000 of the Company's common stock. As of December 31, 2020, the Company repurchased 2,816,000 shares at a cost of $121,348,000 under this program, including 1,215,000 shares at a cost of $51,036,000 during 2020, leaving a remaining balance of $78,652,000. On March 12, 2020, the Company's Board of Directors authorized the repurchase of an additional $200,000,000 of the Company's common stock. Purchases under this March 2020 program will commence upon completion of the October 2018 program. The Company may repurchase shares under this program in future periods depending on a variety of factors, including, among other things, the impact of dilution from employee stock awards, stock price, share availability, and cash requirements. The Company is authorized to make repurchases of its common stock through open market purchases, pursuant to Rule 10b5-1 trading plans, or in privately negotiated transactions.

The following table sets forth information with respect to purchases by the Company of shares of its common stock during each fiscal month of the fourth quarter of 2020:

Certain statements made in this report, as well as oral statements made by the Company from time to time, constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Readers can identify these forward-looking statements by our use of the words “expects,” “anticipates,” “estimates,” “believes,” “projects,” “intends,” “plans,” “will,” “may,” “shall,” “could,” “should,” and similar words and other statements of a similar sense. These statements are based on our current estimates and expectations as to prospective events and circumstances, which may or may not be in our control and as to which there can be no firm assurances given. These forward-looking statements, which include statements regarding business and market trends, future financial performance, the expected impact of the COVID-19 pandemic on our assets, business and results of operations, customer order rates and timing of related revenue, future product mix, restructuring and other cost-savings initiatives, research and development activities, capital projects, investments, acquisitions, liquidity, dividends and stock repurchases, strategic plans, and estimated tax benefits and expenses and other tax matters, involve known and unknown risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include: (1) the impact, duration, and severity of the COVID-19 pandemic; (2) potential disruptions to our business due to restructuring activities; (3) the loss of, or curtailment of purchases by, large customers in the consumer electronics and logistics industries; (4) the reliance on revenue from the automotive industry; (5) the reliance on key suppliers to manufacture and deliver critical components for our products; (6) the failure to effectively manage product transitions or accurately forecast customer demand; (7) the inability to design and manufacture high-quality products; (8) the inability to attract and retain skilled employees and maintain our unique corporate culture; (9) the failure to effectively manage our growth; (10) the inability to achieve growth in revenue and profits from the logistics industry; (11) the technological obsolescence of current products and the inability to develop new products; (12) the failure to properly manage the distribution of products and services; (13) the impact of competitive pressures; (14) the challenges in integrating and achieving expected results from acquired businesses; (15) potential disruptions in our business systems; (16) information security breaches; (17) the inability to protect our proprietary technology and intellectual property; (18) potential impairment charges with respect to our investments or acquired intangible assets; (19) exposure to additional tax liabilities; (20) fluctuations in foreign currency exchange rates and the use of derivative instruments; (21) our involvement in time-consuming and costly litigation; (22) unfavorable global economic conditions; and (23) economic, political, and other risks associated with international sales and operations. The foregoing list should not be construed as exhaustive and we encourage readers to refer to the detailed discussion of risk factors included in Part I - Item 1A of this Annual Report on Form 10-K. The Company cautions readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. The Company disclaims any obligation to subsequently revise forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date such statements are made.

Cognex Corporation is a leading worldwide provider of machine vision products that capture and analyze visual information in order to automate manufacturing and distribution tasks where vision is required. In addition to product revenue derived from the sale of machine vision products, the Company also generates revenue by providing maintenance and support, consulting, and training services to its customers; however, service revenue accounted for less than 10% of total revenue for all periods presented.

Cognex machine vision is used to automate manufacturing and distribution processes in a variety of industries, where the technology is widely recognized as an important component of automated production and quality assurance. Virtually every manufacturer can achieve better quality and manufacturing efficiency by using machine vision, and therefore, Cognex products are used by a broad base of customers across a variety of industries, including consumer electronics, automotive, consumer products, food and beverage, and medical-related. Cognex products are also used to automate distribution processes in the logistics industry, including for applications in retail distribution and ecommerce to scan, track, and sort goods through distribution centers.

Revenue for the year ended December 31, 2020 totaled $811,020,000, representing an increase of 12% from 2019. This increase was driven largely by higher revenue from certain customers in the consumer electronics industry and ecommerce customers in the logistics industry. We believe that both of these industries benefited in 2020 from higher consumer demand during the COVID-19 pandemic. These increases were partially offset by lower revenue from customers in the automotive industry, which was our largest market in 2019 and continues to be negatively impacted by global economic conditions resulting from the COVID-19 pandemic.

Gross margin improved to 75% of revenue in 2020 from 74% of revenue in 2019. Gross margin expansion was due to the favorable impact of the higher revenue on fixed manufacturing costs, as well as favorable product mix. Operating expenses increased by 10% from the prior year due primarily to one-time restructuring charges and intangible asset impairment charges. Excluding these charges, operating expenses were relatively flat with the prior year, as higher incentive compensation costs were offset by lower travel expenses resulting from COVID-19 restrictions and savings from restructuring actions.

Operating income expanded to 21% of revenue in 2020 compared to 20% of revenue in 2019. A higher level of discrete tax benefits in 2019 related to tax structure changes resulted in net income of 22% of revenue in 2020 compared to 28% of revenue in 2019, and net income per diluted share of $1.00 in 2020 compared to $1.16 in 2019.

The following table sets forth certain consolidated financial data as a percentage of revenue:

As foreign currency exchange rates are a factor in understanding period-to-period comparisons, we believe the presentation of results on a constant-currency basis in addition to reported results helps improve investors’ ability to understand our operating results and evaluate our performance in comparison to prior periods. We also use results on a constant-currency basis as one measure to evaluate our performance. Constant-currency information compares results between periods as if exchange rates had remained constant period-over-period. We generally refer to such amounts calculated on a constant-currency basis as excluding the impact of foreign currency exchange rate changes. Results on a constant-currency basis are not in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and should be considered in addition to, and not as a substitute for, results prepared in accordance with U.S. GAAP.

Gross margin as a percentage of revenue improved to 75% in 2020 compared to 74% in 2019. The increase in the gross margin percentage was primarily due to the favorable impact of the higher revenue on fixed manufacturing costs, as well as favorable product mix. In 2020, revenue from customers in the consumer electronics and logistics industries each represented a greater percentage of our total revenue than the prior year. Although our logistics margins are lower relative to our total gross margin, these margins improved from 2019 and the impact of logistics on our gross margin was more than offset by a greater contribution of relatively higher-margin consumer electronics revenue.

The favorable impact of sales volume and product mix was partially offset by higher provisions for excess and obsolete inventories, which totaled $9,908,000 in 2020 compared to $5,296,000 in 2019. The higher level of provisions in 2020 was due to lower projected sales of excess inventories as a result of the deteriorating global economic conditions from the COVID-19 pandemic.

As of the date of this report, we expect gross margin as a percentage of revenue for the first quarter of 2021 to be in the mid 70 percent range, but likely lower than the 75% reported for the fourth quarter of 2020. The decrease is anticipated to be due to a greater percentage of total revenue coming from the logistics industry, which has relatively lower gross margins.

Research, Development, and Engineering Expenses

Research, development, and engineering (RD&E) expenses in 2020 increased by $11,555,000, or 10%, from the prior year as detailed in the table below (in thousands).

RD&E expenses increased due to higher compensation costs related to the Company's acquisition of Sualab Co., Ltd. in the fourth quarter of 2019. These incremental compensation costs included a new team of deep learning engineers, as well as deferred payments from the acquisition that are being recorded as compensation expense over four years from the closing date that accounted for $4,189,000 of this increase. Excluding the addition of the Sualab deep learning team, RD&E personnel-related costs decreased slightly from 2019 to 2020, as the impact of

incremental resources added largely in 2019 were offset by savings from a workforce reduction in the second quarter of 2020.

RD&E expenses also increased due to higher expenses for annual incentive compensation plans. Relevant performance goals for these plans are set at the beginning of each year, with the ability to earn upside if the goals are exceeded. The Company did not achieve its performance goal to earn a company bonus in 2019, while the goal set for 2020 was exceeded based on the Company's operating income margin. Expenses for the fourth quarter of 2020 included a true-up of the annual liability to reflect the upside achievement based on our strong operating results for this quarter that exceeded our prior estimates. These annual incentive compensation plans will be reset with relevant performance goals for 2021 and incentive compensation expenses will reflect our estimates of achievement throughout the year, which we expect will result in lower expense for the first quarter of 2021 as compared to the fourth quarter of 2020.

These increases were partially offset by lower stock-based compensation expense as a result of a lower total value of awards granted in 2020 as compared to 2019, as well as the impact on the timing of expense recognition due to changes in restricted stock unit vesting schedules. In addition, credits were recorded to stock-based compensation expense in the second quarter of 2020 for awards canceled as a result of a workforce reduction. The Company also incurred lower travel expenses resulting from COVID-19 restrictions. We expect these restrictions to continue into 2021.

RD&E expenses as a percentage of revenue were 16% for both 2020 and 2019. We believe that a continued commitment to RD&E activities is essential in order to maintain or achieve product leadership with our existing products and to provide innovative new product offerings, as well as to provide engineering support for large customers. In addition, we consider our ability to accelerate time to market for new products to be critical to our revenue growth. We currently expect to continue to make significant RD&E investments to support our product development plans during the COVID-19 pandemic and other business disruptions generally.

Selling, General, and Administrative Expenses

Selling, general, and administrative (SG&A) expenses decreased in 2020 by $6,249,000, or 2%, from the prior year as detailed in the table below (in thousands).

SG&A expenses decreased due to lower travel expenses resulting from COVID-19 restrictions. The majority of these savings came from sales activities, which were redirected to online efforts due to shutdowns of customer facilities for portions of 2020. We expect these restrictions to continue into 2021. In addition, the Company reduced spending on contract labor, marketing programs, and recruiting activities as part of actions taken to reduce operating costs during the global pandemic.

These decreases were partially offset by higher expenses for annual incentive compensation plans. Relevant performance goals for these plans are set at the beginning of each year, with the ability to earn upside if the goals are exceeded. The Company did not achieve its performance goal to earn a company bonus in 2019, while the goal set for 2020 was exceeded based on the Company's operating income margin. Expenses for the fourth quarter of 2020 included a true-up of the annual liability to reflect the upside achievement based on our strong operating results for this quarter that exceeded our prior estimates. Likewise, sales commissions were higher than the prior year due to a greater portion of our sales team exceeding the performance goals set in their commission plans in 2020 versus 2019. These annual incentive compensation plans will be reset with relevant performance goals for 2021 and incentive compensation expenses will reflect our estimates of achievement throughout the year, which we expect will result in lower expense for the first quarter of 2021 as compared to the fourth quarter of 2020.

SG&A personnel-related costs were relatively flat from the prior year, as the impact of incremental resources added largely in 2019 were offset by savings from a workforce reduction in the second quarter of 2020.

Restructuring Charges

In May 2020, the Company's Board of Directors approved a restructuring plan intended to reduce the Company's operating costs, optimize its business model, and address the impact of the COVID-19 pandemic. The restructuring plan included a global workforce reduction of approximately 8% and office closures. The Company recorded restructuring charges from these actions totaling $15,924,000 in 2020. As of December 31, 2020, the majority of these actions were completed and no additional charges are expected to be incurred in future periods in relation to this restructuring plan.

These restructuring actions, together with other actions to reduce the Company's overall costs, were designed to generate an aggregate annualized cost savings of approximately $25 million versus the Company's original planned cost structure. As of the date of this report, we are on track to achieve this target for 2021, with actual savings from these restructuring and other cost-saving actions in 2020 estimated to be approximately $16 million.

Intangible Asset Impairment Charges

Deteriorating global economic conditions from the COVID-19 pandemic triggered a review of long-lived assets for potential impairment in the second quarter of 2020. This review resulted in intangible asset impairment charges totaling $19,571,000 recorded in the second quarter of 2020, primarily related to lower projected cash flows from the technologies and customer relationships acquired from Sualab.

The Company recorded foreign currency gains of $3,697,000 in 2020 and foreign currency losses of $509,000 in 2019. Foreign currency gains and losses result primarily from the revaluation of cash, accounts receivable, accounts payable, and intercompany balances that are reported in one currency and denominated in another. In 2020, the Company recognized foreign currency gains related to the revaluation of intercompany payables reported on the Company's China entity that are denominated in U.S. Dollars. The Company currently does not hedge its Chinese Yuan exposures due to limitations in hedging instruments available for this currency.

Investment income decreased by $6,695,000, or 34%, from the prior year. The decrease was due to lower yields on the Company's portfolio of debt securities, and to a lesser extent, lower average investment balances.

The Company recorded other expense of $309,000 in 2020 and other income of $1,212,000 in 2019. Other income (expense) includes fair value adjustments of contingent consideration liabilities arising from business acquisitions. In 2019, the Company recorded favorable fair value adjustments related to its acquisition of GVi Ventures, Inc., resulting from a lower level of revenue in the Americas' automotive industry.

The Company’s effective tax rate was an expense of 6% of pre-tax income in 2020 compared to a benefit of 25% of pre-tax income in 2019. The effective tax rate in both years reflected several discrete tax items described below.

The effective tax rate included a decrease in tax expense of $12,788,000 in 2020 and $6,472,000 in 2019 related to stock options, primarily from the excess tax benefit arising from the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes from stock option exercises. The Company cannot predict the level of stock option exercises by employees in future periods.

In 2020, the Company recorded discrete tax items related to the final true-up of the prior year tax accrual upon filing the related tax return. This included a decrease in tax expense of $13,984,000 primarily to recognize a foreign tax benefit on certain gains taxed outside of the United States based on clarifications to rules related to the use of foreign tax credits. This benefit was partially offset by tax expense for a transfer price adjustment in China of $3,267,000 and smaller tax expense adjustments related to foreign tax filings of $843,000.

In 2020, interpretations of a German law relating to withholding taxes on intellectual property rights emerged. The Company conducted a careful review of the interpretation and believes it has adequate reserves for this German tax exposure. Management will continue to monitor this law and court rulings in Germany.

In 2019, the Company made changes to its international tax structure as a result of European Union tax reform legislation, and as a result, recorded a net discrete tax benefit of $87,500,000. Also, in 2019, the Company migrated acquired intellectual property to certain subsidiaries, and as a result, recorded a discrete tax expense of $28,528,000.

Other discrete tax items, none of which were individually material, resulted in a net decrease in tax expense of $307,000 in 2020 and $1,932,000 in 2019. Excluding the impact of all discrete tax items, the Company’s effective tax rate was an expense of 17% of pre-tax income in 2020 and 16% of pre-tax income in 2019. The increase in the effective tax rate excluding discrete tax items was due to more of the Company's profits being earned and taxed in higher tax jurisdictions, as well as the impact of changes in 2019 to the Company's international tax structure.

Gross margin as a percentage of revenue was 74% for both 2019 and 2018. The unfavorable absorption of manufacturing overhead costs over the lower level of revenue was offset by favorable product mix.

Research, Development, and Engineering Expenses

Research, development, and engineering (RD&E) expenses in 2019 increased by $2,982,000, or 3%, from the prior year as detailed in the table below (in thousands).

RD&E expenses increased due to higher personnel-related costs resulting primarily from headcount additions to support new product initiatives, of which $1,013,000 related to a new team of deep learning engineers from the Company's acquisition of Sualab Co., Ltd. on October 16, 2019. The consideration from this acquisition included deferred payments that are being recorded as compensation expense over four years from the closing date, which accounted for an additional $1,092,000 of the increase in personnel-related costs. These increases were partially offset by lower expenses related to incentive compensation plans resulting from lower levels of achievement on performance plans that were set at the beginning of the year.

Selling, General, and Administrative Expenses

Selling, general, and administrative (SG&A) expenses in 2019 increased by $11,143,000, or 4%, from the prior year as detailed in the table below (in thousands).

SG&A expenses increased due to higher personnel-related costs resulting primarily from headcount additions, principally sales personnel. In addition to salaries and fringe benefits, these personnel-related costs included sales commissions and travel expenses related to the additional headcount. These increases were partially offset by lower expenses related to incentive compensation plans resulting from lower levels of achievement on performance plans that were set at the beginning of the year. Changes in foreign currency exchange rates also resulted in a lower level of expenses, as costs denominated in foreign currencies were translated to U.S. Dollars at a lower rate. Expenses were also lower due to project costs incurred in 2018 related to the Company's new Enterprise Resource Planning (ERP) system. This system was placed into service during the third quarter of 2018, and therefore, similar costs were not incurred in 2019.

The Company recorded foreign currency losses of $509,000 in 2019 and $1,064,000 in 2018. Foreign currency gains and losses result primarily from the revaluation of cash, accounts receivable, accounts payable, and intercompany balances that are reported in one currency and denominated in another.

Investment income increased by $4,974,000 or 34%, from the prior year. The increase was due to higher yields on the Company's portfolio of debt securities, and to a lesser extent, higher average investment balances.

The Company recorded other income of $1,212,000 in 2019 and other expense of $219,000 in 2018. Other income (expense) includes fair value adjustments of contingent consideration liabilities arising from business acquisitions. A higher level of fair value adjustments to income was recorded in 2019 related to the Company's acquisition of GVi Ventures, Inc., resulting from a lower level of revenue in the Americas' automotive industry.

The Company’s effective tax rate was a benefit of 25% of pre-tax income in 2019 compared to an expense of 7% in 2018.

The European Union has enacted a series of tax reform legislation over the past few years regarding low tax structures. The Company made changes to its international tax structure in the fourth quarter of 2019 as a result of this legislation, and as a result, recorded a net discrete tax benefit of $87,500,000.

Excluding the impact of these discrete events, the Company’s effective tax rate was an expense of 16% of pre-tax income in 2019. This represents an increase in the effective tax rate excluding discrete events from 14% in 2018 due to more of the Company's profits being earned and taxed in higher tax jurisdictions.

The Company has historically been able to generate positive cash flow from operations, which has funded its operating activities and other cash requirements and has resulted in an accumulated cash and investment balance of $767,438,000 as of December 31, 2020. The Company has established guidelines relative to credit ratings, diversification, and maturities of its investments that maintain liquidity.

The Company’s cash requirements in 2020 were primarily met with positive cash flows from operations, maturities and sales of investments, and the proceeds from stock option exercises. Cash requirements consisted of operating activities, the payment of dividends, the repurchase of common stock, and capital expenditures. Working capital requirements included an increase in accounts receivable resulting from the higher business level and the timing of invoicing for a material customer, as well as an increase in gross inventories to support the higher business level and build safety stock to mitigate the Company's exposure to demand changes or supply disruptions. Cash outlays in the first quarter of 2021 are planned to include incentive compensation payments that were earned and accrued in 2020.

Capital expenditures in 2020 totaled $13,303,000 and consisted primarily of computer hardware and software, manufacturing test equipment related to new product introductions, and improvements made to the Company's headquarters building in Natick, Massachusetts and various leased facilities. In 2021, the Company is making significant investments in business systems related to its sales process, including systems to help our sales team more efficiently manage customer relationships and sales opportunities. As of the date of this report, the Company estimates cash outlays for this initiative to be up to $10 million, a large portion of which we expect will be capitalized and placed into service in the first quarter of 2022.

The Company implemented a variety of cost-cutting measures in the second quarter of 2020 to address the impact of the COVID-19 pandemic, including a workforce reduction and office closures. The Company estimates the total restructuring charges from these actions to be approximately $15,924,000, of which $3,938,000 represents non-cash charges and adjustments, $9,597,000 was paid in 2020, and the remainder of $2,389,000 expected to be paid in 2021.

The following table summarizes the Company’s material contractual obligations, both fixed and contingent (in thousands):

In conjunction with the acquisition of Sualab, the Company migrated acquired intellectual property to certain subsidiaries in 2019, which resulted in a foreign tax payment of approximately $27,000,000 in 2020.

The Tax Cuts and Jobs Act of 2017 subjected unrepatriated foreign earnings to a one-time transition tax, which is expected to result in tax payments of $51,113,000 starting in 2021 through 2025.

The Company believes that its existing cash and investment balances, together with cash flow from operations, will be sufficient to meet its operating, investing, and financing activities for the next twelve months. As of December 31, 2020, the Company had $767,438,000 in cash and investments. In addition, the Company has no long-term debt and does not anticipate needing debt financing in the near future. We believe that our strong cash position has put us in a relatively good position with respect to anticipated longer-term liquidity needs.

As of December 31, 2020, the Company has no off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Our discussion and analysis of the Company’s financial condition and results of operations are based on the consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and various other assumptions believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Changes in accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ from these estimates under different assumptions or circumstances resulting in charges that could be material in future reporting periods. We believe the following critical accounting policies require the use of significant estimates and judgments in the preparation of our consolidated financial statements.

Management exercises judgment when determining the amount of revenue to be recognized each period. Such judgments include, but are not limited to, assessing the customer’s ability and intention to pay substantially all of the contract consideration when due, determining when two or more contracts should be combined and accounted for as a single contract, determining whether a contract modification has occurred, assessing whether promises are immaterial in the context of the contract, determining whether material promises in a contract represent distinct performance obligations, estimating the transaction price for a contract that contains variable consideration, determining the stand-alone selling price of each performance obligation, determining whether control is transferred over time or at a point in time for performance obligations, and assessing whether formal customer acceptance provisions are substantive.

As of December 31, 2020, the Company’s investment portfolio of debt securities totaled $498,365,000. These debt securities are reported at fair value, with unrealized gains and losses, net of tax, included in shareholders’ equity as other comprehensive income (loss) since these securities are designated as available-for-sale securities. As of December 31, 2020, the Company’s portfolio of debt securities had an unrealized gain of $5,690,000, and no unrealized losses.

The fair value of the Company's debt securities is based on model-driven valuations in which all significant inputs are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset. Management is responsible for estimating the fair value of these financial assets, and in doing so, considers valuations provided by a large, third-party pricing service. This service maintains regular contact with market makers, brokers, dealers, and analysts to gather information on market movement, direction, trends, and other specific data. They use this information to structure yield curves for various types of debt securities and arrive at the daily valuations.

Inventories are stated at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less readily predictable costs of completion, disposal, and transportation. Management estimates excess and obsolescence exposures based on assumptions about future demand, product transitions, and market conditions, and records reserves to reduce the carrying value of inventories to their net realizable value. Volatility in the global economy makes these assumptions about future demand more judgmental. Among the risks associated with the introduction of new products are difficulty predicting customer demand and effectively managing inventory levels to ensure adequate supply of the new product and avoid excess supply of the legacy product. In addition, we may strategically enter into non-cancelable commitments with vendors to purchase materials for products in advance of demand to take advantage of favorable pricing or address concerns about the availability of future supplies and long lead times. Estimates in 2020 took into account the global economic conditions resulting from the COVID-19 pandemic. As of December 31, 2020, the Company’s reserve for excess and obsolete inventory totaled $14,578,000, or 19% of the gross inventory balance. A 10% difference in inventory reserves as of December 31, 2020 would have affected net income by approximately $1,210,000.

The Company's intangible assets are susceptible to shortened estimated useful lives and changes in fair value due to changes in their use, market or economic changes, or other events or circumstances. The Company evaluates the potential impairment of intangible assets whenever events or circumstances indicate the carrying value may not be recoverable. Factors that could trigger an impairment review include historical or projected results that are less than the assumptions used in the original valuation of an acquired asset, a change in the Company’s business strategy or its use of an acquired asset, or negative economic or industry trends.

If an event or circumstance indicates the carrying value of intangible assets may not be recoverable, the Company assesses the recoverability of the assets by comparing the carrying value of the assets to the sum of the undiscounted future cash flows that the assets are expected to generate over their remaining economic lives. If the carrying value exceeds the sum of the undiscounted future cash flows, the Company compares the fair value of the intangible assets to the carrying value and records an impairment loss for the difference. The Company generally estimates the fair value of its intangible assets using the income approach based on a discounted cash flow model. The income approach requires the use of many assumptions and estimates including future revenues and expenses, discount factors, income tax rates, the identification of groups of assets with highly independent cash flows, and assets’ economic lives. Volatility in the global economy makes these assumptions and estimates more judgmental. Actual future operating results and the remaining economic lives of our intangible assets could differ from those used in assessing the recoverability of these assets and could result in an impairment of intangible assets in future periods.

Deteriorating global economic conditions from the COVID-19 pandemic triggered a review of intangible assets for potential impairment in the second quarter of 2020. This review resulted in intangible asset impairment charges totaling $19,571,000 recorded in the second quarter of 2020, primarily related to lower projected cash flows from the technologies and customer relationships acquired from Sualab. No impairment charges related to intangible assets were recorded in 2019 or 2018.

Compensation expense is recognized for all grants of stock options and restricted stock units. Determining the appropriate valuation model and estimating the fair values of these grants requires the input of subjective assumptions, including expected stock price volatility, dividend yields, expected term, and forfeiture rates. The expected volatility assumption is based partially upon the historical volatility of the Company’s common stock, which may or may not be a true indicator of future volatility. The assumptions used in calculating the fair values of stock option grants represent management’s best estimates, but these estimates involve inherent uncertainties and the application of judgment. As a result, if factors change and different assumptions are used, stock-based compensation expense could be significantly different from what the Company recorded in the current period.

Significant judgment is required in determining worldwide income tax expense based on tax laws in the various jurisdictions in which the Company operates. The Company has established reserves for income taxes by applying the “more likely than not” criteria, under which the recognition threshold is met when an entity concludes that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination by the relevant tax authority. All tax positions are analyzed periodically and adjustments are made as events occur that warrant modification, such as the completion of audits or the expiration of statutes of limitations, which may result in future charges or credits to income tax expense.

As part of the process of preparing consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which the Company operates. This process involves estimating the current tax liability, as well as assessing temporary differences arising from the different treatment of items for financial statement and tax purposes. These differences result in deferred tax assets and liabilities, which are recorded on the Consolidated Balance Sheets.

The Tax Cuts and Jobs Act of 2017 imposed a minimum tax on foreign earnings related to intangible assets, known as the Global Intangible Low-Taxed Income (GILTI) tax. In 2019, the Company elected to account for the impact of the GILTI minimum tax in deferred taxes, a change from the Company’s initial election made in 2018 whereby the GILTI minimum tax was included in income tax expense as incurred on an annual basis. Management has determined that this change is considered preferable, based on the conclusion that it appropriately matches the Company’s current and deferred income tax implications related to the change in tax structure noted below.

In 2019, the Company made changes to its international tax structure as a result of tax reform legislation enacted by the European Union that resulted in an intercompany sale of intellectual property based on the fair value of this

intellectual property. Also in 2019, in connection with the acquisition of Sualab Co. Ltd., the Company migrated acquired intellectual property to certain subsidiaries to align with its corporate tax structure. Significant judgment was required to estimate the fair value of the migrated intellectual property, including management estimates related to forecasted future cash flows and discount rates.

Business combinations are accounted for under the acquisition method of accounting. Determining what constitutes a business to qualify as a business combination requires some judgment. Allocating the purchase price requires the Company to identify and estimate the fair values of various assets acquired and liabilities assumed. Management is responsible for determining the appropriate valuation model and estimated fair values, and in doing so, considers a number of factors, including information provided by an outside valuation advisor. Management primarily establishes fair value using the income approach based on a discounted cash flow model. The income approach requires the use of many assumptions and estimates including future revenues and expenses, as well as discount factors. Contingent consideration liabilities are reported at their estimated fair values based on probability-adjusted present values of the consideration expected to be paid, using significant inputs and estimates. Key assumptions used in these estimates include probability assessments with respect to the likelihood of achieving certain milestones and discount rates consistent with the level of risk of achievement. The fair value of these contingent consideration liabilities are remeasured each reporting period, with changes in the fair value included in current operations. The remeasured liability amount could be significantly different from the amount at the acquisition date, resulting in material charges or credits in future reporting periods.

In May 2020, the Company's Board of Directors approved a restructuring plan intended to reduce the Company's operating costs, optimize its business model, and address the impact of the COVID-19 pandemic. The restructuring plan included a global workforce reduction of approximately 8% and office closures. The majority of these actions were completed as of December 31, 2020 and resulted in total restructuring charges of $15,924,000 in 2020.

The Company enters into economic hedges utilizing foreign currency forward contracts with maturities of up to 45 days to manage the exposure to fluctuations in foreign currency exchange rates arising primarily from foreign-denominated receivables and payables.

A change in foreign currency exchange rates could materially impact the fair value of these contracts; however, if this occurred, the fair value of the underlying exposures hedged by the contracts would change by a similar amount. Accordingly, management does not believe that a material change in foreign currency exchange rates used in the fair value of our derivative instruments would materially impact operations or cash flows.

The Company’s investment policy allows investment in debt securities with effective maturities up to ten years, however as of December 31, 2020, 97% of the investment portfolio has effective maturity dates of less than three years. Given the relatively short maturities and investment-grade quality of the Company’s portfolio of debt securities as of December 31, 2020, a sharp rise in interest rates should not have a material adverse effect on the fair value of these instruments. As a result, the Company does not currently hedge these interest rate exposures.

The following table presents the hypothetical change in the fair value of the Company’s portfolio of debt securities arising from selected potential changes in interest rates (in thousands). This modeling technique measures the change in fair value that would result from a parallel shift in the yield curve plus or minus 50 and 100 basis points (BP) over a twelve-month time horizon.

INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA