Cognex Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 2, 2024

There are 10 speakers on the call.

Operator

Greetings. Welcome to the Cognix First Quarter 20 24 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. I will now turn the conference over to your host, Nathan McCurran, Head of Investor Relations.

Operator

You may begin.

Speaker 1

Thank you, Shamali. Good morning, everyone. Thank you for joining us. Our results were released earlier today. The press release, earnings presentation and quarterly report on Form 10 Q are available on the Investor Relations section of our website.

Speaker 1

Both the press release and our call today will reference non GAAP measures. You can find a reconciliation of certain items from GAAP to non GAAP in our press release. Any forward looking statements we made in the press release, the accompanying presentation posted to our website or any that we may make during this call are based upon information that we believe to be true as of today. Our actual results may differ materially from our projections due to the risks and uncertainties that are described in our SEC filings, including our most recent Form 10 ks and our Form 10 Q filed this morning for Q1 2024. On today's call, Rob Willett, Cognex's President and CEO, will discuss our Q1 results.

Speaker 1

I will then provide additional detail on the financials and Rob will conclude with an update on our strategic initiatives and our outlook. Laura McDonald, our Corporate Controller and Interim Principal Financial Officer has also joined us in the room for the Q and A portion of the call. With that, I'll turn the call over to Rob.

Speaker 2

Thanks, Nathan. Hello, everyone, and thank you for joining us. Our first quarter results reflect a challenging but stable business environment. Revenue was above the high end of our guidance range as we saw order volumes slightly higher than we had expected. Revenue, excluding the contribution of Martex, increased sequentially from the 4th quarter, but remained down year on year across most of our factory automation end markets.

Speaker 2

While customers remain cautious with their CapEx investments, I'm encouraged by the early indications of recovery we have started to see in certain end markets. We also expect the slight improvement of macro leading indicators such as the PMI in many of our most important geographies to be a tailwind for our business. This year, we have taken important steps in executing against our strategic initiatives. We expanded the application of our edge learning technology by launching the Insight L38, the world's 1st AI enabled 3 d industrial vision system. Our 2023 cohort of emerging customer sales noise entered the field and began actively calling on customers.

Speaker 2

And we operated the Maritex business for a full quarter and advanced its integration. We remain on track for this acquisition to be accretive to adjusted operating margin and adjusted EPS in 2024. I would like to take a moment to welcome Dennis Fair, who we announced this morning will become our new Chief Financial Officer effective tomorrow, May 3. Dennis will lead the company's global finance and information technology organizations. Dennis brings over 20 years of experience spending the last 6 years as a CFO, most recently as the CFO of 6 ks Inc.

Speaker 2

Dennis joined 6 ks after spending 5 years as the CFO of Fluence Energy, which he led through an IPO in 2021. Prior to Fluent Energy, Dennis was Vice President of Finance at Siemens, where he spent the first 15 years of his career. Dennis brings broad international experience to Cognex. This includes time living and working in China, Mexico, Germany and Indonesia. This knowledge will be a great value to Cognex as we continue to execute on our global growth strategy.

Speaker 2

You will hear from Dennis on our Q2 earnings call. Before I go into further commentary on the business and outlook for Q2, I'd like to turn the call back over to Nathan to walk you through more of the results.

Speaker 1

Thank you, Rob. I will walk through our financial highlights, which you can see on Page 4 of our earnings presentation posted to the website this morning. 1st quarter revenue of $211,000,000 increased by 5% year on year with a contribution from Moritex of just under 8% of total revenue. Excluding Moritex and foreign exchange effects, revenue declined 3%. Turning to margins, adjusted gross margin was 68.8% in Q1, in line with guidance and down from 71.8 percent a year ago.

Speaker 1

Gross margin included a 2 percentage point dilution effect from a full quarter of Moritex. There was also 1.6 percentage points of unfavorable one time events in the quarter, primarily the strategic logistics project with future recurring revenue that we mentioned on our last call. Sequentially, adjusted gross margin stepped down due to more attacks and one time effects. Adjusted operating expenses increased 3% year on year as expected, driven by a full quarter of Moritex and increased investment in our emerging customer initiative. Excluding these strategic investments, adjusted OpEx declined 6% year on year.

Speaker 1

Sequentially, adjusted operating expenses increased 5% as expected. In addition to higher costs for the emerging customer initiative and a full quarter of Moritex, there was a reset in incentive compensation at the beginning of the year as we mentioned last quarter. Adjusted EBITDA margin was 11.9% in Q1, down from 13.5% a year ago. This was driven by a lower gross margin and higher operating expenses related to emerging customers, partially offset by the positive contribution of the Moritex acquisition, which was accretive to adjusted EBITDA margin. Diluted earnings per share on a GAAP basis was $0.07 down year on year due to lower operating margins, acquisition and amortization costs and unfavorable discrete tax items.

Speaker 1

Sequentially, GAAP diluted EPS increased 7%. Adjusted diluted EPS was $0.11 down $0.02 year on year and flat sequentially. The adjusted effective tax rate was 16% in both Q1 of 2024 and Q1 of 2023. I will now go through our end market results, which you can find on Slide 5 of the earnings presentation. I'll discuss the end market and geographic results, excluding the contribution of Moritex.

Speaker 1

Markets have been mixed to begin 2024 as we have seen both continued weakness as well as pockets of positive signals. Starting with automotive, revenue was down year on year, but flat sequentially. EV battery revenue continues to be lumpy and in the Q1, we saw customers delay some project spending as they face uncertain near term demand. Moving on to logistics, revenue grew year on year, but was flat sequentially. Much of the business remained stable and we executed a sizable strategic project in the quarter driving year on year growth.

Speaker 1

Consumer electronics revenue was down year on year, although the rate of decline slowed compared to the back half of twenty twenty three. Rob will go into more detail regarding what we expect from consumer electronics for the full year. Semi had strong momentum in the quarter with year on year growth turning positive after 4 quarters of significant declines. From a geographic viewpoint, revenue growth was strongest in Asia outside of China, led by strength in semi and logistics. Americas also grew in the quarter, driven by its higher logistics mix.

Speaker 1

Outside of logistics, Americas experienced continued softness across our factory automation business as was also the case for Europe. China remained challenging as revenue in the region declined year on year for the 6th consecutive quarter. Turning to the balance sheet. Cognex continues to have a strong cash position with $557,000,000 in cash and investments and no debt. Free cash flow in Q1 was $10,000,000 compared to $22,000,000 a year ago, reflecting lower GAAP net income and increased working capital investment as we continue to scale new supply chain initiatives.

Speaker 1

We returned $22,000,000 to shareholders in the form of stock buybacks and dividends. Now, I'll turn it back over to Rob. Thanks, Nathan.

Speaker 2

Let me spend some time discussing the progress we're making on our strategic priorities. We are making strong progress introducing world class AI to the field of industrial machine vision. Our latest examples of this is our Insight L38 3 d vision system, which combines AI, 2 d and 3 d vision technologies to solve a range of inspection and measurement applications. The Insight L38 greatly simplifies the process of configuring 3 d systems, thanks to embedded AI technology that uses pre trained models with domain specific data. Cognex has captured these data through our long history of serving customers.

Speaker 2

The Incyte L38 example based training replaces complex programming steps previously required in vision application development and enables our technology to address a broad array of applications. The Insight L38's unique AI powered 3 d tools can be set up in minutes, requiring as few as 5 to 10 labeled images to automate a task. With a few simple point and click training examples, customers can guide robotic arms to locate items on a conveyor, measure glue to ensure its consistent application or lead tire identification numbers on low contrast black rubber material. Example based learning solves 3 d applications in a more intuitive and human like way, enabling Cognex to expand its application where human inspectors or offline measurements have previously been the only viable option. I'll shift now to give you an update on our emerging customer initiative.

Speaker 2

Our excitement continues to build to this initiative as it broadens our customer base and deepens our penetration into end markets such as packaging. Our initial emerging customer sales cohort fully entered the field and began to sell at the beginning of this year. These sales nodes have been demoing and selling to customers we have not previously called on. We've seen a lot of new applications with these customers. Some examples of emerging customer applications include inspecting the quality of food items like bread, pizzas and biscuits, detecting presenceabsence of sealing caps on air fresheners, verifying bottle caps are properly sealed, confirming the correct insertion of connectors for an electronics customer and optical character recognition and the classification of parts

Operator

for an

Speaker 2

automotive parts manufacturer. We are building a funnel of opportunities with this initiative and are encouraged by what we have seen. We expect our emerging customer sales noise to make over 80,000 customer visits this year. We've had early success across geographies and end markets, and we continue to build this team towards delivering at least $50,000,000 of incremental revenue in 2024. Early orders continue to reinforce our belief that this initiative will be gross margin accretive.

Speaker 2

We're excited to grow this initiative by welcoming our 2nd cohort of emerging customer sales noise in 2024. Let me now give you an update on our integration of Maritex. We made good progress on the integration in Q1. Our engineering teams are already collaborating on optics innovation and our sales teams are driving successful customer engagements. The experienced leaders who joined us from Maritex are now leading Cognex Japan.

Speaker 2

While we expect Moritex products to be slightly dilutive to total company gross margin in the medium term, we continue to expect the acquisition to be accretive to adjusted operating margin and adjusted EPS in 2024 and beyond. I'll turn now to our outlook for the Q2. In the Q2, we expect revenue between $230,000,000 $245,000,000 This step up from the first quarter is in line with our typical Q1 to Q2 consumer electronics seasonality. I will remind you that Q2 of last year included $15,000,000 of consumer electronics revenue that we originally expected in the Q3 of 2023. Adjusting for that baseline effect and excluding Maritex, this range implies revenue to be slightly down year on year.

Speaker 2

We expect the Maritex business to contribute 6% to 8% of revenue in Q2. Gross margin continues to be below our long term targets given volume deleverage and an approximately 2 percentage point dilution effect from Maritex. We expect the Q1 to be the low point for the year in adjusted gross margin. For the Q2, we expect adjusted gross margin slightly above 70%, a sequential step up as we move past the gross margin dilutive one time events in Q1 and expect stronger revenues as just mentioned. We expect adjusted operating expenses to increase low to mid single digits on a sequential basis due to additional investment in the emerging customer initiatives and higher incentive compensation.

Speaker 2

As we disclosed last quarter, we expect an incremental $25,000,000 of emerging customer OpEx for the full year, the timing of which should ramp throughout 2024 similar to the investment made in 2023. We also expect incentive compensation to be a $15,000,000 to $20,000,000 year on year headwind materializing mostly in the second through 4th quarters. Logistics has continued to be stable and we believe is well positioned to grow as automation penetration increases and ecommerce investment returns. For the full year, we expect logistics to grow as we start to see infrastructure investment plans materializing. Though logistics growth this year will likely still be below the 30% growth we target long term in this market.

Speaker 2

Consumer Electronics has positive long term trends, but the timing and revenue contribution can be lumpy. We do not expect 2024 to be a significant growth year for consumer electronics. For the full year, we expect revenue in 20 be approximately in line with 2023 with continued uncertainty of project size and timing. We are seeing more tensitiveness from EV battery customers driven by concern around near term end user demand and political uncertainty. We started to see delayed projects result in a reduction in the pace of greenfield investments from our EV customers.

Speaker 2

We are still seeing customers invest in productivity improvements and product upgrades on existing lines, and we still expect our EV battery business to be a robust growth driver over the long term. The semi landscape is improving as leading equipment manufacturers have communicated more optimistic 2024 outlooks. We're excited that Moritex gives us additional opportunities in this market, which looks well positioned for strong growth. We are encouraged by the positive macro signals we have started to see, and we believe the progress we are making on our strategic initiatives keeps us well positioned to capitalize on exciting industry trends as the operating environment begins to improve. Now, we will open the call for questions.

Speaker 2

Operator, please go ahead.

Operator

Thank you. At this time, we will be conducting a question and answer session. Our first question Our first question comes from the line of Damon Karas with UBS Securities. Please proceed with your question.

Speaker 3

Hi, good morning everyone. Can you hear me?

Speaker 2

Yes, good morning. We can hear you. Go ahead, Hernan.

Speaker 3

Terrific. Congratulations on completing that CFO search.

Speaker 1

Thank you.

Speaker 2

I thought you started off

Speaker 3

by yes, I know you put a lot of efforts into that. Maybe you could begin by getting your perspective a bit more on the logistics market. You kind of characterize it as stable, but you're expecting to get some more modest growth as the year progresses. Can you just talk about what you're seeing across the logistics market? Are there some more strategic projects in the funnel that you've got some good visibility that are likely to hit later this year?

Speaker 3

And just curious what indications you might have from your largest customer in this space?

Speaker 2

Thanks. So let's start with a bit of context. So our logistics business grew 65% in 2021. It was around 300,000,000 dollars fueled by a lot of investment in e commerce particularly. And then as that kind of investment really slowed down and stopped, it contracted by 25% in 2022 and by 21% in 2023.

Speaker 2

So I think we've seen a big downturn in that industry. We're now feeling much more positive that it's starting to come to really come back. So logistics revenue grew 24% year on year in the Q1 of this year, although it was flat if we exclude the very large project that we talked to you about on the last call. But we're having positive conversations and starting to see early indications of recovery. We expect a return to growth of logistics for this year, although still below the target of 30% growth that we're expecting from that industry over the long term.

Speaker 2

And as we over the long term, we're expecting to see large e commerce customers, broader warehouse automation going on. We're starting to penetrate more into parcel and post where we see our technology is really starting to be very, very competitive and we're seeing some really good trials with some of the major names in that industry. We're also seeing smaller customers grow nicely with Cognex and the opportunities we see growing there. We're seeing more adoption of other technologies beyond barcode reading that we're marketing such as Edge Intelligence, which is the technology I referred to in the last call that brings us recurring revenue from customers. And we're bringing more vision to allow us to inspect packages for damage, do dimensioning, etcetera, products like the EnSight 2,800 detector that we referred to.

Speaker 2

In reference to sort of larger customers and investments, yes, we're starting to see more positive signs that those kind of investments will be returning back to what I would consider more normal levels. Although some of those opportunities may result in bookings this year from us, but revenue next year because there's a fairly long lead time on that. It would also just be worth saying that our logistics business is relatively concentrated in the United States, nicely penetrated and growing in Europe over the long term. But we see a lot of growth potential in Asia, and particularly India and emerging markets. So that's kind of an overall view.

Speaker 3

Very helpful color. Thank you. And then I wanted to ask you about semis. It sounds like the business is improving more than you had expected. Could you just maybe give us a sense for how much of a recovery, how much of a snapback you think you could see in semis this year?

Speaker 3

And your initial guide for more techs was up 6% to 8%. Was that factoring in already a better semis outlook for this year? Or just based on what you're seeing, do you could that possibly be tracking better?

Speaker 2

So we're seeing our semi business after a couple of more difficult years in well in 2023, is starting to return back to some pretty nice potential growth. Revenue year on year in Q1 was up 6%, excluding Maritex. So still I think pretty early on in seeing that start to ramp, but this is a market where we have some longer term exposure and long term relationships with OEMs. Some characteristics certainly like investments in high bandwidth memory, which is really being driven by growth in AI investments. They're starting to look very positive for us.

Speaker 2

And then, Maritex is a very, very highly regarded brand with a lot of great relationships with machine builders. I had the pleasure of visiting a bunch of them in Japan a couple of weeks ago. And that's a business that as those companies start to see their business grow, it should be very beneficial for us in the longer term. So I think we've probably been going through a period where there's been some recalibration around changes that are going on in the market, particularly related to China and perhaps the scaling up of big AI investments and investments such as around the CHIPS Act. So we're optimistic over the long term as those work their way through and those investments become finalized and automation is spent in that we'll really see a nice return to strong growth in that market.

Speaker 2

And then if we sort of size semi for you, it's around when we include Maritex around 10% of our business overall with a lot of strong growth potential in the next few years.

Speaker 1

And Damian, I just point out, you mentioned Moritex. There's some puts and takes in terms of end market growth and timing. We originally guided to 6% to 8% of our total revenue coming from Oratech's for the year and that's still our guidance for that end market just given how some of the other pieces of the businesses are expected to move throughout the year.

Speaker 3

Okay, got it. Thank you very much. I'll pass it along. Best of luck.

Operator

Thank you. Our next question comes from the line of Rob Mason with Robert W. Baird. Please proceed with your question.

Speaker 4

Yes. Good morning. Thanks for taking the question. So Rob, you said consumer electronics probably tracks flat year over year with last year. I'm just curious how the makeup of that business would compare on a flat basis and really maybe the composition coming from what your historically larger customer versus other customers?

Speaker 4

And have there been any efforts to change the customer mix, diversification efforts on that front that you would comment on?

Speaker 2

Rob, I think you're right in interpreting what I said as sort of broadly flat. There isn't a broad change in our overall exposure to different customers. We do business with a lot of the major names in that industry, although historically we've had one very large customer. I would say my sort of outlook for the industry is broad across a range of customers not being overly swung one way or another by a particular customer overall. But as I did mention, industry can be lumpy.

Speaker 2

We can see features coming into products that perhaps might have been expected next year coming in or this year moving out. So that can move around quite a lot in our experience.

Speaker 4

Sure. And just as a follow-up on your emerging customer initiative, curious if you could just comment, I know it's early with all the force just being in the field to start the year, but early reads on maybe productivity levels. And if you've had any feedback from the field just in terms of things that Cognex can do to help them be more successful and understanding it's kind of a tougher market you're selling into as well. But whether that's lead generation, product tweaks, product portfolio enhancements? I'm just curious what the early feedback is.

Speaker 2

Yes. I think central thesis around emerging customers was traditionally we've been very strong at the most sophisticated accounts in the world where they really like to work engineer on engineer. And, but a couple of years ago, we developed this technology called edge learning, which makes difficult machine vision applications pretty easy to demo and sell. So the 2,800 is the best example of product in that area. And then we also have a nice ID portfolio, which is broadly considered the best in the world at reading industrial barcodes such as laser printed 2 d matrix barcodes on metal applications, those types of things.

Speaker 2

So with that kind of strength, we realized we needed to go and get this technology to more customers. And if we serve 30,000 or so customers today, there is perhaps 200,000 customers or more that we could be reaching with this technology as it becomes easier. So with that, we brought in some very strong young salespeople, most of them engineers, and we've trained them, and they're going into the field now. We at the same time, we've implemented salesforce dotcom over the last few years and we have like a lot of intelligence now in terms of what activity goes on, where we're demoing, how to generate leads and get those to those salespeople. So that process is kind of, I think, getting implemented.

Speaker 2

And I think we're pretty pleased with what we're seeing. I mentioned, we expect that team that's gone in the field to make about 80,000 customer visits this year. They're certainly on target to do that. We're going to be able to help them get in front of more customers over time as they as our lead generation engine spools up, as they learn about how to be effective in front of customers. So we expect their productivity.

Speaker 2

And I would say in the data that I see, on average, they're selling more and more each month currently. So, and they're getting in front of new customers. And I gave you examples of applications that you probably well, we certainly few years ago would have probably walked away from because there was just going to be too much engineering to work, make some of those things work. But now our emerging customers, salespeople can demo and sell those products in perhaps 2 visits. It's generally what I would observe.

Speaker 2

So we're going to see the metrics keep moving up. We're pretty pleased with what we're seeing. We will see more products coming to market and more tools enabling them to address more applications and it builds from here. So based on that confidence, we're bringing in another full class and we're training them up and we're getting better all the time. It does feel like turning a flywheel, it's getting faster and faster.

Speaker 4

Very good. That's very helpful. Thanks.

Operator

Thank you. Our next question comes from the line of Joe Giordano with Cowen and Company. Please proceed with your question.

Speaker 1

Good morning. This is Michael on for Joe.

Speaker 2

Good morning. Yes, you can. Yes, please go ahead, Michael. Great. Thank

Speaker 1

you so much. So on the end market front, I think you're surprised on like the semi strength in the quarter based on some of the industry commentary there. What was driving that outperformance in the quarter? And I have a follow-up. Thank you.

Speaker 2

Well, we in semi, we're very strong in the wafer process, particularly where we're reading IDs, barcodes, letters, numbers on reflective surfaces of wafers. So that's been a very strong area for Cognex for a very long time. And with Spectrum with many most of the leading OEMs in those types of spaces and the fabs rely on our equipment. So that business is strengthening nicely. We have good team in ASEAN, markets such as Malaysia, certainly where we're seeing strong investments going on in that area.

Speaker 2

But as we're also reading, more and more semi is coming to other markets like Europe and America. But I would say more of the growth that we're seeing is around some of the areas I described, reading wafers and also kind of inspection and alignment in applications such as high bandwidth memory. And Michael, one

Speaker 1

thing I'd add is just a reminder that our business is much shorter cycle than a number of our peers who are supplying to this industry. So as you look at the type of customers who we serve here, they've given very positive outlooks for 2024. You would expect Cognex to react to that a bit faster than some of the other suppliers into the industry given the short cycle nature of our business. And we on the geography front, a lot of the business here in Asia beyond China. So our other Asia business is where we saw a lot of that activity.

Speaker 1

Great. That's super helpful. And just one more, if I may. You had mentioned that you thought logistics was up for the year, CE likely flat, but can you discuss the puts and takes on the auto side, I mean, the growth expectations there, maybe cadence throughout the year as well? Thank you.

Speaker 2

Yes, sure. You asked about automotive. I think context, automotive was our largest and best performing market last year, representing 25% of our revenue. It looks to be entering a more difficult period at the moment. I think we see that particularly around some of EV battery investments, which are over the long term look very good, over the short term have really been scaled back, pushed out, right?

Speaker 2

So that can give our revenues some big bumps. And we saw a pretty nice EV battery order in the Q1 of last year in China, and that did not repeat this year. So certainly there's some tentativeness there. Much as you're reading probably about automotive, we are seeing customers, some of them move more quickly into hybrid, back into hybrid, if you like, and we've seen some success with customers there. But the broad view is that, that automotive is slowing down, looks challenging for this year and EV investments are being pushed out.

Operator

Thank you. Our next question comes from the line of Jacob Levinson with Melius Research. Please proceed with your question.

Speaker 5

Hi, good morning, everyone.

Speaker 2

Good morning, Jacob.

Speaker 1

I know

Speaker 5

AI and deep learning is certainly something you folks been doing for quite a while now. But can you help us understand how the proliferation of high density compute, if you want to call it that, really changes the or it doesn't change for that matter, the capabilities. And I would imagine it'd be pretty expensive to put GPUs in the computer next to a lot of your cameras. But I guess how does this computing power that hasn't been available before really change the product roadmap for you folks?

Speaker 2

Yes. Thanks, Jacob, for the question. So if we start with a longer term view, deep learning technology has kind of been something that's been around for a long time. But I think we really began to see in 2013, 2014, the work of Geoffrey Hinton started to make that really workable. We saw then it started to be usable in machine vision and factory automation later in the decade and we acquired Vidi in 2017 and SulaLab in 2019.

Speaker 2

So I do credit Cognex with seeing this trend early and leading the application of deep learning technology and then as we move now into generative AI to be a leader in that space as it applies to factory automation. And you can really see that and I really encourage you to come to our website and look at our Insight L38 3 d vision system, which is taking that powerful technology, making it really easy to use and putting it into a point cloud environment to do 3 d vision. And so historically, vision has really been 2 d, but 3 d adds an extra dimension. So that's really an exponential amount of data one has to manage. So it's quite computer intensive.

Speaker 2

So your question is kind of how have chips changed that? Well, one thing is, as one works with AI and applies it, these models used to be very, very difficult, computer intensive, slow to manage. But now with cloud capability and GPUs, we're able to use and train and manage huge data sets very quickly and effectively. But then the reality of factory automation is that it's really happening at the edge, right? So we have to take all that powerful technology, put it into a pretty small form factor and apply it right at the point of manufacturer, right on the line, right.

Speaker 2

And something Cognex has been extremely good at is making processors run efficiently. And in this case, we've taken deep learning technology and developed something called edge learning, which pre trains models and applies them to edge based devices in a very efficient way. So as chips get faster, we're able to bring that technology right to the edge and make it work very, very effectively. So that's kind of the process we've been going through, and it really is making our products much easier to use, easier to sell and broaden into applications that used to be really only really managed effectively through humans. So those are some of the changes going on.

Speaker 2

They're really powerful chips that I think you're perhaps referring to, that's still going on in the cloud. It's not coming to the edge in the next few years, I wouldn't say. But like as we all know with Moore's Law and everything, those chips become more powerful, smaller and I think create a lot of opportunity to see some very powerful machine vision performance in the years to come. And you can bet we'll be expect to be right at the leading edge of that.

Speaker 5

That's super interesting, Rob. Just switching gears on China, a market that I think is often hard to know what's going on if you're not actually there. And I know that obviously wraps in some of your comments around the other end markets, but just trying to get a sense of what you're hearing from your folks on the ground in terms of your customers' investment plan for this year?

Speaker 2

Yes. The China market is certainly the most difficult market geographically for us at the moment. We've seen revenue decline year on year for 6 straight quarters. In China, it was down 17% year on year in Q1 excluding MarTechs. We have a pretty large team in China and we're very successful with larger customers, particularly in that space.

Speaker 2

So I think we see this as a broad based phenomenon. I can't think of a company in the automation space that's putting up good results in China at the moment. So I think this is pretty typical of what we're seeing. It's certainly intense competition as one would expect in that market. We've seen quite a lot of PE and BC funded companies kind of in that market over recently.

Speaker 2

And I think some of them are obviously struggling with the market conditions that we're seeing there. Decline in automotive in the quarter was most pronounced in China also. So that's certainly a tough situation. We do see the phenomenon of customers moving production or diversifying production away from China. I think we're all familiar with that phenomenon.

Speaker 2

So into markets, particularly India and Vietnam. So that's another dynamic that's going on there. In terms of Cognoids and the team, I think we're enthusiastic about adding Martex to our business and Martex has a good business in China and is able to be very competitive now selling more alongside Cognoids. So that's a positive development. And the kind of technology that we talked about, our 3 d AI technology, certainly something that our Cognoids there are very enthusiastic about demoing and selling and I'm very pleased with the progress that I see them starting to make with our edge learning technology broadly in that market.

Speaker 2

So plenty to work on, but difficult conditions.

Speaker 5

Great. Thank you, Rob. Pass it on.

Operator

Thank you. Our next question comes from the line of Tommy Moll with Stephens Inc. Please proceed with your question.

Speaker 6

Good morning and thank you for taking my questions. Good morning, Tommy. I wanted to start on logistics where in the quarter it looks like revenue was flat year over year excluding the large project that you've referenced a number of times. You've given us some reason to be optimistic about the recovery in that end market. And so my follow-up question is, are you seeing those positive signs fairly concentrated among a smaller list of customers?

Speaker 6

And the reason I ask that is just because it looks like the base business there was still flat year over year. Maybe I'm missing something

Speaker 2

Yes, so thanks for your question. So my optimism about logistics really comes from our funnel. So we certainly see a nice build of our business overall. The logistics win we had was with a big customer, but not necessarily our biggest customer in that space. Nice progress in penetrating parcel and post where we've seen we're seeing obviously that's an industry dominated by some very large names that we're all aware of and we're making now a lot of progress with our new modular vision tunnel that we've launched this year, which brings a lot of functionalities, demoing really well with those customers.

Speaker 2

Now in terms of smaller customers, we see we do see that as a growth part of our business and continues to feel that way. I don't know if, Nathan, you can give us any color on Q1 and base logistics on Yes.

Speaker 1

I mean, I think you're probably referencing we said stable year over year. And I think the thing to point out is we are seeing kind of broader based funnel optimism. And so we saw typically this business has been higher penetration in Americas. We saw some strength in other parts of Asia in the quarter and expect to see going forward growth from both the large e commerce customers that we've referenced as well as our base logistics. I think you should probably expect a little bit less of a bifurcation there than what we've talked over the past 18 months or so, just given really the hyper growth that happened in with the large e commerce customers followed by really a pause in their greenfield investment.

Speaker 1

We would expect those to converge a little bit more going forward and see more similar trends across the full spectrum.

Speaker 6

Thank you both. And then following up on emerging customer initiatives, which quarter this year do you hit the full run rate for the expense investment there? Is it Q4 or is it really Q1 of next year before we'll see that full run rate? And a related question, Rob, is there any chance that you roll out a 3rd cohort here as well? It sounds like things have gone well, but the first you're ramping a second.

Speaker 6

Just wonder what else might be on the marker board? Thanks.

Speaker 1

Yes. Why don't I I'll take the cost side first. I mean, as we talked last year, the initiative ramped throughout the year, and there's kind of 2 components to it in 2024. First is really the run rate of the investment that we made in 2023, which you should expect that to be pretty stable throughout the year. And then the second piece is what Rob will speak to more in a second is the class that we're bringing in, in 2024.

Speaker 1

And that part of the cost you should expect to ramp throughout the year with and last year, I mean, just keep in mind what the investment is here. A lot of this is hiring of college graduates, so a lot of summer start dates. And so that really ramps linearly up through Q3 with Q3 and Q4 looking fairly similar. So really kind of Q3 being the peak and Q4 looking similar to Q3 is the expectation on the OpEx side.

Speaker 2

Yes. And your question about your 20 25, obviously too soon to make a call on that. But we would see emerging customers as a long term initiative with a lot of long term potential to, as I say, take our customers from 30,000 to with like 100 of 1000. So this is a multiyear initiative. Overall, I would see it as that.

Speaker 2

But in terms of 2025, we start to really think about get concrete on our plans probably in the fall for that as we start to get into recruiting for next year and next season and plan our budget for that period.

Speaker 6

Thanks for the insight. I'll turn it

Operator

back. Thank you. Our next question comes from the line of Andrew Buscaglia with BNP Paribas Asset Management. Please proceed with your question.

Speaker 7

Hey, good morning guys.

Speaker 4

Good morning, Andrew.

Speaker 7

So So you made the comment that you think gross margin marks the low point in Q1 and guided obviously a step up into Q2. Couple of questions on that. I guess what gives you that confidence that, that is the low point? Presumably, you have logistics improving and you got a large order that was somewhat dilutive to that gross margin. So I guess you're not assuming any larger orders the rest of the year.

Speaker 7

And can you just comment on some of the things that you see in the back half that would give some confidence in that comment?

Speaker 2

Yes. Well, first of all, Q1 gross margin was dragged down by that larger order we described, right, and a low revenue quarter. It was so those are kind of factors that impacted us. But overall through the year, Maritex is about a 2% headwind, so with that as sort of context. But then what should lift gross margin for Cognex going forward is obviously revenue, revenue particularly in markets like electronics, but particularly factory automation.

Speaker 2

Factory automation for us is a high margin business in a broad based way, right? And so as we begin to see that market recover, that has strong gross margins overall. And as we've discussed, it's been under pressure is selling is selling high gross margin, very, very competitive products. So that's going to be gross margin accretive for us also we expect. And generally selling to smaller customers who perhaps don't get the same kind of discounts that larger customers do.

Speaker 2

So there are many reasons to feel positive about gross margin and our return back in the long run to that 75% target that we have. But in the near term, which is I think I sense is why you're more interested, those one time factors being behind us in Q1 the build of business, particularly consumer electronics, which tends to be high gross margin business and semi also and then scale going back and return a factory automation business.

Speaker 7

Yes. Okay. Okay. And then my next question, I wanted to go back to consumer electronics.

Speaker 2

It's

Speaker 7

flattish this year. And you commented on uncertainty around project size and timing. I'm wondering there's not much innovation in phones and handsets these days, but the latest is implementation of AI features. And I'm wondering, that's not a physical form factor change, but I'm wondering what you're referencing there in terms of these projects, whether the timing is tough, but does AI have an influence on machine vision as it relates to consumer electronics?

Speaker 2

Well, if we talk more about kind of the market our customers and why we are excited about the long term potential there. This is a market that has waves of innovation that comes through it, right? And I think we're living through a couple of years where that innovation hasn't come through in products, but I'm very confident it will, right? And I think if we think of all the AI technology and chips that we're starting to see broadly released in the world, that's going to drive a whole generation of new products. It may be smartphones, it may be augmented reality, virtual reality also.

Speaker 2

And I think some of the spending and investment we're seeing in semi that we all understand will drive growth in that area. The second reason that I think I expect Cognex's business to grow is in just in the replacement of humans in the manufacturing of electronics, particularly smartphones. And I think the potential of that technology is so big. And as perhaps I've mentioned on occasion, just some one of our customers spends over $1,000,000,000 a year on human visual inspectors, right? So it gives you an idea, the potential that exists to replace some of that with machine vision.

Speaker 2

And machine vision, when you look at our newest launches, is becoming more human like in what it can do. So in the long run, the potential for those in that industry and that kind of technology in that industry is very significant. I don't see that popping this year, right, but I'm aware of kind of roadmaps from many companies in that industry and the exciting plans that they have. And we might get lucky and see some of it in the products that are launched ahead of the holidays this year. But I think at this point, we're assuming that maybe out further years out for us.

Operator

Our next question comes from the line of Piyush Abbasi with CDE Research. Please proceed with your question.

Speaker 8

Good morning, guys. Thanks for taking my questions.

Speaker 2

Good morning.

Speaker 8

Following up on your auto commentary, Rob, you have been very constructive on the EV battery space. Can you help us better understand on what surprised you? I understand some bigger projects being pushed out, but for ezbach investments in China, is that something for you guys as well?

Speaker 2

So yes, I think for maybe on the order of 6 months now, we've started to see sort of concern around EV battery investment that it may be getting out a little ahead of demand in general in the world. And we've been working we're working closely with really all the large EV battery manufacturers. I think 10 of them, I think, have really constitute most of the investment going on and it's huge investment that's going on with the idea that this is a multiyear phenomenon, right? And there are 2 ways in which Cognex really benefits, can really help those customers and where we do very well. One is just helping them build out their capacity and we've been working with customers in that area.

Speaker 2

And I would say, I can think of quite a few instances where those plans have been slowed down over the last 6 months and pushed out. Partly that's just to do with demand. Customers are not buying as many EVs as perhaps the industry had expected. And secondly, just uncertainty about the political environment and whether the subsidies that are being discussed for consumers who buy cars and for companies that invest in building out battery plants and EV plants, whether those are still going to be there. So I think that's that kind of concern.

Speaker 2

I think over the long term, EVs no doubt will have a larger and larger market share of automotive overall. There'll be waves of technology coming, whether that's the current cylindrical prismatic pouch technologies that we see moving more perhaps to solid state. So there are going to be waves of investment. Those are challenging technical problems to deal with. And we're certainly working closely with customers and I think they recognize the value of our technology.

Speaker 2

But if this building out of greenfields, which is the challenge, the second area is just increasing the productivity of manufacturing batteries. And this is an area where Cloudnex excels and particularly applying our computational optics technology, partly that we acquired with SAC that we have more strength with Maritex to create fantastic almost 3 d images of battery surfaces and to inspect them and then applying our deep learning and edge learning tools to those applications. And what that really allows, if I could sort of make it real for a moment, what that allows a customer to do is take an inspector surface and tell whether dents or scratches or the position of a defect on a battery is a problem and should lead it to be rejected or whether it's not a problem and the battery can pass through. And there's a very high scrap rate going on today and there's a very high rate of human inspection going on of those surfaces. And one customer I visited over the last 6 months told me that they scrap $200,000 to $300,000 of good batteries per day, good batteries they're throwing away because they're concerned about quality and our technology can help reduce that significantly.

Speaker 2

So that's one example of where Cognex technology can help that industry and one of the reasons based on all the investment plans and all the challenges that we see, we're expecting long term growth in that industry.

Speaker 8

Got it. Helpful. Next for my follow-up like a 2 part question. 1, like we have been hearing a lot about India and the growth potential there. Maybe if you and you have kind of mentioned India and Vietnam a couple of times, so maybe size the opportunity for us.

Speaker 8

And then on Japan, the yen has been under pressure, but you reiterated your 6% to 8% revenue contribution from Molotex. Maybe a little color there like how the trends you are seeing in the end market, any concerns related to FX?

Speaker 1

That would be helpful.

Speaker 2

Yes. Thanks. I'm mindful of the time. So I'm going to answer your question quickly. Please excuse me.

Speaker 2

Yes, India, huge opportunity. I visited regularly. I was there early in the Q1 and just huge potential. We see we're building our business there. It's still relatively small part of Cognex overall, but the growth dynamics is probably one of our, if not our fastest growing market.

Speaker 2

The yen, yes, the weak yen, it creates some interesting dynamics. It certainly is helping the cost of goods for some of our competitors and helping their gross margins and making the strong dollar in a way making business environment more challenging for us. But we have great technology and we're on a great team in Japan, so we're able to be competitive.

Speaker 8

Appreciate all the color guys. Thank you.

Speaker 2

Okay. I think we have time for one more question.

Operator

Yes. Last question comes from the line of of Jairam Nathan with Daiwa Capital Markets. Please proceed with your question.

Speaker 9

Hi, thanks for taking my question. Just 2 of them. Just I wanted to clarification first on the recurring revenue and the large project that you had on logistics. Are those the same things? And has recurring revenue started flowing in?

Speaker 9

Or is that a future business?

Speaker 2

Yes. So that large project came with comes with a nice piece of regular recurring revenue, which

Speaker 9

to do

Speaker 2

with our Edge Intelligence, allowing to extract huge value out of our vision data and manage our vision systems more effectively and build on a kind of a regular basis. And tied to that large installation where we took a lower price to get this technology embedded and we're excited about that.

Speaker 9

Okay, great. And then finally, if you look at your biggest competitor, they kind of equate revenue growth to employees, employee headcount increases. And I just wanted to kind of I understand if I look at sales per employee or marketing employee for you guys, for the emerging market emerging customer would not be as high as it is currently just because of the nature of large customers in your current mix. But when you look at and I understand it's early days, but if how is the salesmen playing on the emerging customer tracking? How do you expect it to track compared to the current average?

Speaker 9

Or is that one way you get to the $50,000,000 And I'm just trying to understand what's the potential here?

Speaker 2

Yes. For competitive reasons, there's not necessarily data that we share at this point. But certainly, yes, emerging customers, we have much more modest expectations for them out of the gate. We expect to see good improvement. And obviously, our emerging customer initiative, we hope will create salespeople, which will go on and manage larger accounts in the future.

Speaker 2

So a nice feeding ground for that. But certainly, it's going to dilute sales per salesperson in the initial years.

Speaker 9

Okay. Okay. Like do you think it will be they could do a like if I kind of look at your best emerging customer employee or salesperson like can you give us an idea of how they are tracking versus the average or average?

Speaker 1

Yes, Jair, I mean, this initiative will naturally ramp over time, and so we'll expect to see more revenue as they go on. But I think we're not give an actual number on what we expect for each of those heads versus a more tenured sales employee.

Speaker 9

Okay. Great. Thank you.

Operator

Thank you. And we have reached the end of the question and answer session. I'll now turn the call back over to Rob Willett for closing comments.

Speaker 2

Well, thank you for joining us this morning. Thank you for your interesting questions. We've enjoyed talking with you and we look forward to speaking with you again on next quarter's call.

Operator

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Cognex Q1 2024
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