Cognex Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 4, 2023

There are 13 speakers on the call.

Operator

Greetings, and welcome to the Cognex First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Nathan McEwen, Head of Investor Relations.

Operator

You may begin.

Speaker 1

Thank you, Shamali. Good morning, everyone, and thank you for joining us. With me on today's call are Rob Willett, Cognex's President and CEO And Paul Podgem, our CFO. Our results were released earlier today. The press release 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 see a reconciliation of certain items from GAAP to non GAAP in Exhibit 2 of the press release. Any forward looking statements we made in the press release or anything 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 on our Form 10 Q filed this morning for Q1. With that, I'll turn the call over to Rob.

Speaker 2

Thanks, Nathan. Good morning, everyone, and thank you for joining us. As anticipated, we had a challenging Q1 of 2023. Revenue from our largest e commerce customers remained low, and we continue to see cautious investment by customers across many of our end markets. More projects in our Sales funnel are being delayed by spending cuts and additional levels of executive approval at our customers amid concerns about near term demand.

Speaker 2

Manufacturing PMI have decreased slightly in our largest regions, partially offset by an improvement in China compared to the January lows. We've seen slow periods like this before, and we've come out of them delivering meaningful growth. Our business is short a cycle and not as backlog driven as many of our peers, so it tends to inflect more quickly. Additionally, we are comparing to an exceptionally strong Q1 of 2022, highlighted by large logistics projects and backlog catch up as the supply environment improved. Gross margin of 71% in Q1 was in line with our yet still below our mid-seventy percent long term target due to the elevated prices we paid to buy scarce components and replenish inventory through brokers.

Speaker 2

We believe that pressure is behind us going forward. Before I go into further commentary on the business and outlook for Q2, I'd like to turn the call over to Paul to walk through more of the results.

Speaker 3

Thank you, Rob, and good morning, everyone. 1st quarter revenue was $201,000,000 which was slightly above the high end of our guidance range, yet a meaningful step down year on year. In addition to the drivers that Rob touched on, Foreign currency translation reduced revenue by $8,000,000 or 3% year on year on a reported basis. Let's now go into more detail about what we are seeing in our end markets in the Q1. Turning first to automotive, our largest end market in 2022.

Speaker 3

The ongoing transition to electric vehicles is driving multiyear investments and we continue to develop strong customer relationships worldwide with an industry leading offering for EV battery inspection. Even so, automotive spending in the Q1 was tepid, driven by more cautious investment from our customers as they see demand for their products soften. EV battery revenue can be lumpy and large project timing can be uncertain. We had a very strong Q1 of 2022 that resulted in a tough compare this quarter, but we continue to expect our EV battery revenue to grow substantially in 2023. Moving next to logistics.

Speaker 3

Declines at a few of our largest e commerce customers accounted for over half of our total company year on year revenue decline. Outside of these few large customers, we saw growth in the remainder of our logistics business. Logistics is still in the early innings of adopting machine vision. Most companies rely heavily on labor and very few warehouses globally are realizing the full potential of automation. E commerce and omnichannel players beyond our largest e commerce customers are investing as they strive to automate more and we continue to make progress in parcel and post.

Speaker 3

These customers are important for us going forward. While a few of our largest e commerce customers have accounted for over half of our logistics revenue in the past several years, These customers represent less than 5% of global warehouse space. So the remainder of the logistics market, which is also much less automated, Remains a significant growth opportunity for us over the long term. Shifting to consumer electronics. A significant portion of our consumer electronics business is related to the premium segment of smartphones and other smart devices.

Speaker 3

As many of you know, smartphone shipments were down in 2022 and expect it to be down again in 2023, albeit less significantly in the premium segment. This weakened demand has led to conservative capital spending. Rob will go into more detail on what we expect from this end market going forward. In other smaller end markets that we serve, Revenue declined year on year, primarily due to the softer macro conditions compared to the strong business environment we were still seeing in the Q1 of 2022. Looking at the change in revenue for Q1 on a geographic basis, Europe was our best performing region with flat revenue growth year on year on a constant currency basis or slightly down on a reported basis.

Speaker 3

Declines from our largest e commerce customers were offset by growth in automotive and the remainder of our logistics customers. The Americas and Asia were our weakest performing regions. Revenue in the Americas was down 36%, driven by the concentration of large e commerce customers. Revenue in Asia was down 35% or 28% on a constant currency basis. This was consistent across both China and the remainder of Asia with softness across the end markets, yet most pronounced in consumer electronics, which was also lapping a strong Q1 of 2022.

Speaker 3

In China, we had slowness in the beginning of the Q1, but momentum began to pick up in March April. Turning now to margins. Gross margin was 71% in Q1. Broker buy activity continued to pressure gross margin below our mid-seventy percent long term target. The flow through of this higher cost inventory was an approximately 300 basis point impact in the Q1, which was an improvement compared to the approximately 500 basis point impact In Q4, we've not made significant broker buys since early Q4, so this higher priced inventory has nearly worked its way through the P and L.

Speaker 3

Operating expenses increased by approximately $5,000,000 or 4% year on year. The majority of this was driven by investment in our emerging customer initiative. The remainder was primarily driven by personnel related costs, including a typical annual increase in employee compensation, partially offset by the favorable impact of currency exchange rates. Operating margin of 11% It was below both Q1 of 2022 and our 30% long term target due primarily to operating deleverage from softer revenue. The effective tax rate excluding discrete tax items was 16% in both Q1 of 2023 and 2022.

Speaker 3

Reported earnings were $0.15 per share in Q1. Non GAAP earnings per share were $0.13 excluding discrete tax adjustments. Turning to the balance sheet. Cognex continues to have a strong cash position with $844,000,000 in cash and investments and no debt. Cash flows in Q1 reflected lower net income level and we returned $36,000,000 to shareholders in the form of stock buybacks and dividends.

Speaker 3

Now I'll turn it back over to Rob.

Speaker 2

Thanks, Paul. As our history demonstrates, Cognex can experience periods of softness in between periods of robust growth. We're excited about the growth drivers that we expect to materialize over the next few years, driven by both secular and regulatory tailwinds. In the U. S.

Speaker 2

Alone, companies have committed more than $200,000,000,000 to manufacturing projects since Congress passed the CHIPS Act and the IRA, A 5 times increase over what was announced last year prior to the passage of these subsidies. Clean tech and semiconductor investments are beginning to ramp up now. We expect these will be medium to long term growth drivers Significant investment is also happening beyond the United States. In the Q1, I spent 3 weeks in Asia, is increasing in these countries and there is a significant opportunity for further automation enabled by machine vision across both factory automation and logistics. In India, investments are being made in electronics to support large customers diversifying their manufacturing outside of China.

Speaker 2

One manufacturing facility I visited employs 25,000 people. They expect to double their workforce over the next few quarters. A large portion of these people perform manual visual inspection. This is just one example where Cognex products My time with executives from EV Battery Manufacturers reinforce this as an important strategic growth priority for us. EV battery manufacturers are responding favorably to our industry leading technology that combines the computational lighting products We acquired with SAC and our deep learning vision software.

Speaker 2

As EV battery investments accelerate over the next several years, We are well positioned to capture a substantial share of the machine vision growth. I also spent time with Cognex's own contract manufacturers. Both our long term partner and our new supplier are among the 10 largest contract manufacturers in the world. We are on track at our 2nd contract manufacturer to ramp up production across many of our largest unit volume products by the end of Q2. Deepening relationships and diversifying our supply is helping us professionalize and scale our operations.

Speaker 2

Let's shift to an update on product innovation. Our reorganization in 2020 led to a product development process centered on common products and platforms. This has teed us up for more efficient and rapid product launches with a focus on ease of implementation and ease of use. The Incyte 3,800 is a great example of this. Just 12 months after launching the Incyte 2,800, our first edge learning enabled vision system, We launched a 2nd generation that offers similar capabilities at more than twice the processing speed.

Speaker 2

The InSight 3,800 is the fastest embedded smart camera in the market today. It can perform tasks such as automated inspection on high speed production lines in as little as 10 milliseconds, which is less than 1 third the time of the blink of an eye. This accommodates the fastest line speeds to maximize throughput, while delivering the high accuracy that customers have come to expect Cognex Edge Learning technology offers ease of use That enables customers to independently and quickly set up the EnSight 3,800 to solve a wide range of manufacturing applications. After launching this product at the beginning of April, we're getting very positive responses from customers and we've already seen meaningful orders. In addition to new platforms, our new approach to innovation is resulting in the launch of many platform extensions.

Speaker 2

For example, the DataMan 282, which launched in March, extends the Cognex DataMan 280 series of fixed mount barcode readers To increase throughput and improve worker safety in manufacturing and logistics, the DataMan 282 provides accurate Expanding our product portfolio with easy to use products It's positioning us well to broaden our customer base. With our emerging customer initiative, we're investing to address Smaller or less technically sophisticated customers who are looking for reliable, high performance automation solutions that are easy to implement and use. We've made strong progress on this initiative in Q1 and are encouraged by the KPIs we received for our initial pilots, Representing up to 10 times as many customers as our current customer base, we're excited about the potential contributions these customers can make Turning now to our outlook. As we look to the remainder of 2023, As many of you know, revenue from consumer electronics As a result, we expect annual revenue from consumer electronics will be modestly lower this year after growing in the mid teens on a constant currency basis in 2022. Overall, In the Q2, we expect revenue of between $225,000,000 $245,000,000 This Step up from the Q1 is relatively in line with our typical Q1 to Q2 seasonality.

Speaker 2

We expect gross margin in the mid-seventy percent range, in line with our long term margin target, as we move beyond the elevated costs by lower stock based compensation. Lastly, I remain confident in our team and their ability to execute. Cognoids tend to be long term minded, so morale and retention remains strong as we look ahead at our growth opportunities. Voluntary attrition of our employees remains about half that of our peers. Additionally, with the layoffs And low morale as some of our peers in a big tech companies, we are recruiting some exceptional talent.

Speaker 2

While this quarter did not represent the performance that we aim for, we have the right ingredients in place to get back to our long term growth model. Now, we will open the call up for questions. Operator, please go ahead.

Operator

At this time, we will be conducting a question and answer session. A confirmation tone will indicate your line is in the question Our first question comes from the line of Joe Giordano with TD Cowen. Please proceed with your question.

Speaker 4

Good morning, guys.

Speaker 2

Good morning, Joe.

Speaker 4

So you mentioned that the logistics decline is from large customers and that the smaller customers We're still growing. And I know we've heard commentary from a lot of companies that those smaller players We're investing in logistics expect to kind of keep spending through a potential recession. I guess my question is, do you believe that? We're not really feeling that necessarily the nature impacts of recession yet. Once we start feeling that, do you think that these customers will You'll continue to spend, you're saying that now?

Speaker 2

I think if we strip out our Very small number of large e commerce customers. What we're seeing is the rest of our customers continue to grow. So that's the good news. But I also don't think that they are completely immune to the macro conditions that we're all seeing. So as I visited some of those Over the Q1, I'm hearing also pressures on costs generally within those companies too and more scrutiny of capital spend.

Speaker 2

So we see this as a great growth opportunity for us, the base logistics Business, it's growing and we expect it to go on growing nicely, but it's not immune to pressure would be my take on it.

Speaker 4

Yes, that's fair. When you look at the sequential uptick in the 2Q here, would you say that's reflective of end demand? Or is this kind of a delivery of backlog that maybe had been maybe past due or delayed a little bit?

Speaker 2

Yes. Hey, Joe, this is Paul.

Speaker 3

I think the biggest driver is just sort of seasonality in our consumer electronics business. That's the biggest piece. We did call out that China is improving given where China started the year. So that's another factor. Otherwise, overall demand is weak, as Rob sort of mentioned, and It's no real further commentary on that right now, I would say.

Speaker 4

Just sneak in one last question, more high level. We're hearing a lot of talk about RFID more recently. And if there's a what does that mean for you if there's a more protracted Move from Barcode toward RFID or how do you even think about that progression? Is that an area that you're interested in or think about? Thanks.

Speaker 2

Yes. So, been in this industry for about 25 years and we've certainly seen RFID trials. We see them from time to time Over a long period, we've seen them at some major customers of ours. And generally, they haven't got great traction because RFID is an Technology and it doesn't work in certain environments. I think we've all probably seen some big quite high profile RFID Trials going on at a large parcel delivery company.

Speaker 2

So I think that's what's perhaps creating some noise. What I would say is, I don't see RFID and machine vision competing significantly with one another. I think they just offer very different Attribute's machine vision is very powerful over a whole range of applications and RFID, I think is a more Specific technology around very high value often smaller slower moving assets. So I observed some of that, but I don't see it taking any business from us currently nor have I over a long period nor do I really expect to in future periods.

Speaker 4

Thanks guys.

Operator

Our next question comes from the line of Guy Hardwick with Credit Suisse. Please proceed with your question.

Speaker 5

Hi, good morning. Joe kind of asked my main question. So it does seem like It's returned to kind of normal seasonality. Would you also say that's going to be the from what you can see from now that the second half will also reflect normal seasonality?

Speaker 2

I think we don't really give guidance for the second half, but there's obviously quite a lot of noise we're going to see when we compare to Prior year, we had as many of you know, we had logistics customers really Tap the brakes as we went in or put the brakes on firmly as we went into the second half of last year and we also had a fire in our main Contract Manufacturers Warehouse, which certainly caused some distortion. So we're going to get much easier compares as we go into the In terms of seasonality, it's hard to call, but I think we history tells us we can expect Q2 23 to be large consumer electronics quarter for us. And in Q4, it's very hard to call that as we go out further. And it really depends on the overall environment. We can see a lot of year end spending in different markets.

Speaker 2

We may have a better sense of How logistics is looking as we get into Q4, whether there is as we can see some large year end projects and committed coming through in our bookings, But that's too hard to call at this point.

Speaker 3

And I would just add, I think the sell side sorry, Guy, I think the sell side understands this Really well, but for others listening, I think our year over year comparisons in 2023 are much more of a function of the 2022 base than they are Our business trajectory, I think kind of the seasonality is it does look sort of relatively normal this year, especially compared to last year.

Speaker 5

And so Paul, just one more. In terms of the operating expense guidance, it does seem to benefit from lower stock option expensing. But if you have to exclude stock option expensing, Compare what you're projecting for Q2 versus Q2 last year, what would it be in terms of growth?

Speaker 3

It's mostly most growth, I'd say, excluding stock option would be driven by the emerging customer Initiatives that we've made, we are carrying some additional headcount beyond that, but really the bulk of the headcount has been Investment for that initiative and then we do have merit and promotions and such sort of annual comp increases that you lap in any year over year comparison. So those are probably the biggest factors. I don't know

Speaker 2

if this will hold in Q2,

Speaker 3

but certainly in Q1, Travel was up a little bit versus a year ago, which we view as a very good thing that we're able with COVID restrictions basically entirely behind us, we're able to pay more customer visits and deepen those relationships, which we know pay off over time. But those would be the things I would call out.

Speaker 6

Thank you.

Operator

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

Speaker 7

Good morning and thank you for taking my questions.

Speaker 3

Hi, Tommy.

Speaker 7

I wanted to Stay on the topic of the emerging customer initiative. So per the guidance, it looks like the level of investment is up Sequentially in the Q2. I'm just curious, do you have any visibility beyond Q2? Do you expect to continue to layer in Incremental investment there or does Q2 feel like a full run rate? And then as you think about harvesting the return on this Investment.

Speaker 7

What kind of timeline should we be thinking about in terms of being able to

Speaker 2

Hi, Tommy. I'll paint the sort of high level picture on this and give you some thoughts and then I'll hand it over to Paul for some more details. But just to get us all level set, So Cognex traditionally has been very, very successful with the most sophisticated manufacturers of discrete products and they love our technology and It's remarkable, right? Very strong relationships, but there's a whole part of the market. If we serve 30,000 customers today in the sort of top of that segment, we think there is many as 300,000 customers further down The pyramid that really can benefit from our technology, but we haven't had the ease of use and ease of implementation with our products that was needed To make those customers absorb our technology and for us to serve them profitably, that's really changed over the last Couple of years and probably one of the main things or definitely one of the main things that's changed is edge learning, right?

Speaker 2

This is products that allow very easy training, so we can look at a technology, a Component or closure on a model or all kinds of applications in markets, consumer products would be a good example. And with relatively low skill and low automation capability, we can take machine vision and apply it to customers there. So that's been a real trigger for us. We talked about it at Analyst Day back in September. And we're on a process to build out a sales network If this goes well, I could see This being a very long term initiative where we continue to build out our sales force and we would see substantial growth over long periods, we're starting it now.

Speaker 2

So right now, we're building out those capabilities. We're recruiting and training salespeople to go into the field. And I think we can expect that to ramp as we move forward. It will ramp as we move through the year. And if all goes well, I would to ramp into next year as well and in subsequent years.

Speaker 2

And I think we would expect those salespeople to be selling very Profitable products, similar to our current gross margin profile and operating margin Accretive once they're selling volume in the field.

Speaker 3

Yes. And Tommy, just to add some expense color there, we communicated this in February, but We expect this to be a roughly $25,000,000 to $30,000,000 OpEx investment on the full year for 2023, And it is ramping up from Q1 to Q3. Again, think about it consistently as it's primarily an investment in headcount That's following a campus recruiting cycle in the different geographies we serve. So Q2 will be up from Q1 and we would expect Q3 to be up from there. So the run rate is going to be a little higher than if you took 25 to 30 divided by 4 as we given kind of the ramp up period, it's sort of thinking about going into future years.

Speaker 3

And then in terms of the return, as Rob said, we're really excited about this. We're in pilot mode and learning a lot and seeing great initial traction. But We are tempering expectations from a timing perspective. If you just think about hiring folks primarily on a campus recruiting kind of timeline, Quite a long training period because they're starting from scratch unlike most of our salespeople which we're hiring with several years of experience from competitors or distributors or other participants in our market. And then just the natural ramp up period of how salesperson is in their 1st 6 months versus their 2nd 6 months, their 2nd year versus their 1st year and even their 3rd year versus their 2nd year.

Speaker 3

So I think we'll have a lot more to share next year on the progress we're making and sort of the results. But I think in the near term period, we're really in investment, Hiring, training and pilot mode right now.

Speaker 7

That's all very helpful. I appreciate the insight. And as a follow-up, I wanted to ask About some recent news flow regarding OLED screens and tablets, noted your commentary on the broader consumer electronics end market Looking like a down year for 2023, but maybe not specific to this year, just in general, how big of a commercial

Speaker 2

Well, we've done substantial business Over the last 10 years really on screens as they and whether it's micro LED, OLED, those Complex products demand in that chat. So generally, when there is a major capital investment to ramp up production at NuScreen Technologies, That can be very beneficial for Cognex. We saw that most pronounced in 2017. As I look at electronics, there are roadmaps that are under development. We have pretty good insights With our major customers and then as we move through the year, we see whether these technologies actually scale, right?

Speaker 2

So, any new technology, whether it be Virtual reality type technology that perhaps may be under development, we can find that can inflect As we move ahead, I'm not sure exactly what you're referring to, but I would say certainly very high definition MicroLED and more importantly OLED type technology, I think is a very interesting area As it relates to a screen very close to the eye, which is of course key for virtual reality and augmented reality type products. So I'm very bullish on that long term, but I wouldn't be banking on necessarily reaching large scale commercialization this year.

Speaker 3

Thank you. I'll turn it back.

Operator

Our next question comes from the line of Jacob Devinson with Melius Research, please proceed with your question.

Speaker 6

Hi. Good morning, everyone. Good morning. You talked quite a bit about the opportunity in the EV battery space, and we're certainly seeing some Eye popping numbers, I guess, around the spend that's going there. But I think from the outside, at least it's going to be hard to know what that Really means in terms of machine vision content, I think it's quite an automated process, but maybe I'm wrong.

Speaker 6

Maybe you can just speak to what that how the content compares and maybe that versus some of the other big verticals that you saw on so?

Speaker 2

Yes. Thanks for the question. It's an area we've been very focused on currently and I've Spend quite a lot of time walking and spending time with some of the major line builders and also the key technology providers In this space, it's there's very substantial capital investment going into build out EV Lines planned over the next few years. And it's hard for me to see also how that wouldn't continue to scale For a very long period, just given the appetite that seems to be existing for conversion from combustion engine to EV going out into the future and the commitments that governments and auto OEMs seem to be making to trans Form their fleets and general population of cars, right? So I see that.

Speaker 2

And as I visit line builders and I visit end users and I meet with senior executives at Large EV battery manufacturers, and that's really where the opportunity primarily is for us. It's in companies that are scaling up production of EV batteries, there are 3 general types. I mean, it's cylindrical, prismatic, some of the ones that you read about. And There's a lot of investment. If you walk one of these lines, they can be 1,000 feet long.

Speaker 2

They can have multiple Fixtures, the products move through and many of those fixtures, perhaps if there are 30 fixtures on the line, More than half would have potential for machine vision content, be it as simple as barcode reading or alignment. But for us, where we see some of the most advantage of our technology is more inspection Of the battery material and the finished battery as it moves through production, inspection for damage, such as Scratches and dents that can result in fires, right? So I read an article recently and talking to Cognoids in China, It's an interesting statistic that about 7 cars per day in China, which has I think the most EV battery Intensive fleet of cars on the road, 7 cars a day, a cash fire, right? So this is a very serious problem for Companies making EV batteries and a real root cause of those problems is dents and scratches and defects in manufacturing. We have two pieces of technology that are coming together for us really nicely in that space.

Speaker 2

1 is The computational optics business, lighting business that we acquired late last year, that really gives us the best image acquisition of these types of things. It gives us sort of almost 3 d light accuracy at very high speed that can look at The depth of a dent or the nature of a scratch can determine whether it's dangerous or not, whether it needs to be rejected or not. And then we have a business we've been developing for about 7 years now, deep learning, intense deep learning Vision technology that really allows us to inspect those scratches and dents and determine which ones are problematic and which are not, Right. So that's a I would say that's an area where we're really excelling. But I my expectation and hope is that that Technology leadership we have in the inspection area can lead to lots of other opportunities throughout those 28 or so fixtures in a normal EV battery line.

Speaker 6

Okay. That's super helpful. And just on On a related topic, I guess, the tide has certainly since they've gone out in a pretty dramatic fashion In the tech startup world, we've done a couple of interesting acquisitions that you mentioned over the last couple of years. Maybe you can speak to the M and A funnel and whether we've got some things that may be closer to getting over the finish line today given The environment out there?

Speaker 2

Yes, I think it is one of the most target rich Kind of environments we've been in for M and A for quite a long time. I think we see a lot of companies coming up for sale currently where Perhaps their business models about how quickly they would turn cash positive or how much they would grow haven't really come to pass, right? So we seek quite a lot of those. We're pretty selective as we look at them. We definitely like to look at excellent technology or excellent engineering teams, who would integrate well into our businesses.

Speaker 2

We've done very successfully over longer periods of time. Then there are other types of acquisitions, larger companies perhaps Head owner founders that are looking to retire or changes of ownership and we're also seeing some of those More coming to market. We're very I think we're very good evaluators of those types of businesses and pretty selective. And we're finding ourselves going to many more management presentations and seeing much more activity than we have in the past. I do think probably there's still some expectations about valuation, which may be a little outdated, which may lead to some deals Being a little bit more difficult to get done, I think, but it will be interesting to see kind of how that progresses.

Speaker 2

But it's certainly a very fruitful environment right now, and we're very active.

Speaker 3

And happy to have a very strong balance sheet at a time when the external new funding environment for non profitable startups is terrible.

Speaker 6

All sounds encouraging. Thank you guys. I'll pass it on.

Operator

Our next question comes from the line of Josh

Speaker 8

Robbie, you mentioned the consumer electronics environment maybe being down a little bit this year. I know that that typically has a little bit more second half seasonality I just want to level set since the next time we'll all talk is when you'll give 3Q guidance. Respecting you don't Really want to talk about the second half and kind of specifics. Maybe just a reminder with all the comps and supply chain interruption last year, Maybe where you see kind of the toughest real comp in consumer electronics in the second half, 3Q, 4Q or anything one time you call out?

Speaker 2

Yes. I'll sort of Give you some big picture perspective on that and then invite Paul to comment. So generally for us consumer electronics is a Q2, Q3 phenomenon, Right. And so I'd say that's generally been the case in recent years. It was Pretty much the case last year.

Speaker 2

Paul will fill in on the Q3 question because I'm wondering about the fire and how it impacted that. But I think we see something similar this year, right? Our consumer electronics was business was a little lower than prior year in Q1, Right. So there were some things going on last year related to some larger specific projects. And then what can tend to happen as we move through the year, there can be changes.

Speaker 2

Last year, we at this stage, we were thinking of a sort of a mid to high single digits type growth Opportunity for us in Consumer Electronics, it ended up being perhaps 10 points higher than that once we got through the year, just ballpark numbers. So things can change, But this year, we're expecting Q2, Q3 probably relatively evenly balanced. Q4 will be a wild card basically, I think more around how companies are ramping up for their 2024 plans.

Speaker 3

Yes. Thanks, Rob. No, I think last year, Electronics is one of the only areas that really wasn't impacted by the fire. It's a little more software intensive. The predictability of The build and the lead up actually the product gets shipped before the revenue gets recognized.

Speaker 3

So it was a little more isolated from events that happened as of 2nd week of June last year. So last year, consumer electronics was pretty balanced Q2 versus Q3, Josh. And this year, we're expecting the same. 2021 2020 were a little more Q3 weighted. 2020 was very specific.

Speaker 3

COVID really Delayed the ramp up of line for quite some period of time and so on. So we are expecting things to be a little more balanced in Q2 and Q3 and that's reflective of our guide. The only call out I'll make is there's a lot of large project timing here that can be quite lumpy. So we're doing our best at any time to predict that, There always can be slight shifts depending on delays in supply, a COVID outbreak that might shut down a factory for a week or 2 and so on. We're doing our best, but right now that's what we're seeing, kind of pretty balanced between Q2 and Q3.

Speaker 8

Got it. Super helpful. I appreciate that color there. And then just on the logistics market, I apologize I missed the start of the call, lots going on this morning. But any additional comment or I guess Rate of change that you would point out, maybe just kind of separate from 2Q specifically more in aggregate, I guess, In March, we saw some of the big integrators see another step down in orders, some industrial, I guess warehouse REITs, So you lower utilization.

Speaker 8

Is that something you guys are seeing as well? Or is it just a little too early to calibrate that yet?

Speaker 2

Yes. I don't think I see a real change compared to what I saw at the last earnings On this, we see kind of the large e commerce type businesses have really pared back spending. And I think all of us are kind of trying to understand when that comes back. I don't think there's much real clarity on that at the moment. And I think smaller customers continue to invest and build out, although as I mentioned at the start of the call, there's perhaps Additional question there too, companies are just reading the macro environment and perhaps some of the consumer spending sentiment that might impact their businesses.

Speaker 2

So I think that's what I see overall. I think it's important to know that some of the larger integrators, perhaps the one that talk more publicly, these can be large Businesses that are implementing projects over a very long period of time, some of them have had very high levels of inventory that they're really still working through. And when they purchase from us, some of that may take time for them to absorb and fulfill. So I would kind of point to that as a potential dynamic.

Speaker 5

Understood. Super helpful. Best of luck guys.

Operator

And our next question comes from the line of Jim Ricchiuti with Needham and Company. Please proceed with your question.

Speaker 9

Hi, good morning. This is actually Chris Gringa on for Jim. You had mentioned that you're beginning to see some indications that Cleantech could be ramping. What applications is Cognex's portfolio best suited for or most differentiated within CleanTech. And how are you thinking about the potential content, the potential Cognex Content in one of these typical cleantech fabs for lack of a better word?

Speaker 9

Thank you.

Speaker 2

Yeah. I think when we think of Plinta, we think of EV batteries. It's the big play for us, right? And we've talked a bit about that. So certainly building out large Lines to manufacture EV batteries, we see as going to be perhaps the big driver of growth.

Speaker 2

That said, certainly we do see more spending and investment and levels of interest in the solar market currently in the United States, Not just panels, but things like inverters, for instance, certainly are one can see that The level of investment and plans ramping there. So I think there are sort of secondary benefits, but nowhere on the order of EV Which I think will be the big clean tech mover for Cognex with my expectation over a long period.

Speaker 9

Got it. And Europe held

Speaker 3

up well. Could you elaborate

Speaker 9

a little bit more on what you're seeing there and

Speaker 2

Yes. So Europe performed better than the Americas and Asia in Q1, but still below kind of the target growth rate. I'd say that any the softness we saw in Europe related quite a lot to large customers in logistics that buy Products from us. So I think most of us on the call understand that Cognex is has a larger percentage of its Automotive in Europe grew year on year over what was a relatively tepid quarter a year ago. And the PMI doesn't look that Strong in Europe.

Speaker 2

So it's it performed better, but I wouldn't say it performed well.

Speaker 5

Thank you very much.

Operator

And our next question comes from the line of Rob Mason with Baird, please proceed with your questions.

Speaker 10

Yes, good morning. Good morning. It's quite clear that Your large customers put on the brakes abruptly last year, e commerce customers and logistics. I'm just curious, as we Now stand a year from that, have they reached a base level of spending that you can tell, a floor, so to speak?

Speaker 2

Rob, I think it's a good question and we're talking about a few customers there. I would say broadly, I'm hopeful that the answer is yes to that question, but I can't say definitively it is. And as I look at our Funnel and business that we're doing with some of these large customers, there's a good base of kind of productivity and improvement Related projects that I think will certainly should keep us moving along at the level we are. And then I think when they start to lean into more investments and then there are more distribution centers, big new investments in automation coming, which I see can potentially come back next year, then I think we're really going to see an inflection. So that would be my take on it.

Speaker 3

Yes. And certainly, Rob, from a sort of full year basis 2022 versus 2023 in logistics, just Given kind of what we've already shared about Q1, right, we were down about $80,000,000 in revenue for the whole business. Our Few largest e commerce and omni channel customers were responsible for more than half of that decline in the quarter. Yes. I would say on a full year basis, logistics this year versus logistics last year, it's Yes, very hard to model in growth right now with just what we've already done in Q1.

Speaker 3

But I think on a quarter to quarter basis now that we're Past that tough compare and we've had a few quarters, things are looking a little more steady.

Speaker 2

Yes. And to pile on to that, I think, when I was Answering you, I was thinking about kind of orders and I was thinking about sales funnel and projects, right? And Obviously, there's a can be a bit of a tail to revenue for where you see when you see through our financial results the business turning down. But I think there's cause for hope that it's bottomed and will be coming back over many quarters.

Speaker 3

Sure, sure.

Speaker 10

Just as a follow-up, Rob, in your earlier commentary, you talked about EV, and I thought you said you still For you expected strong growth this year, I just wanted to clarify that, did I hear that correctly? And if that's the case, is that Any change in the view that you may have had from the discussion we had 3 months ago on the call and you talked about Just kind of the regional diversification efforts were slowing some of the deployments. If anything has changed there and strong year

Operator

over year growth this year?

Speaker 2

Yes, Rob. So yes, definitely, we see EV as a strong source of growth for Cognex this year and perhaps for many years to come, Right. And we yes, so we're very positive about that. Certainly, there's Large investments, some of the IRA type investments I referred to in my prepared remarks are good examples of that. And I think we do see some of that spend getting pivoted towards America, right?

Speaker 2

And that has caused some projects to get delayed, right, which we've referenced in previous conference calls, right, but that will be happening. And

Speaker 3

as I

Speaker 2

think of that EV market, I think there Perhaps 10 major companies, technology providers and investors in this space or so. So that means the business can be a little lumpy, Right. The business was not is growing as quickly as perhaps we would have expected on a revenue basis in Q1, mostly because of Prior year's business we've seen with some large China suppliers, but all of those customers I'm thinking of are those big ten companies are Cognex customers evaluating our technology have ambitious rollout schedules and certainly we see as a market for great growth.

Speaker 10

Understood. Thank you.

Operator

Our next question comes from the line of Jairaj Nathan with Daiwa Capital Markets. Please proceed with your question.

Speaker 11

Hi, thanks for taking my question. Just I wanted to focus a little on the ex China numbers, they were down and I kind of And you talked about CE and maybe to the earlier question, EV batteries, EV deductions and with China improving, do you see some sequential growth there going forward?

Speaker 2

Yes, I'll start off and Paul might want to come in also. So yes, We saw a relatively slow start to the year in China prior to Chinese New Year, slower than one would normally expect. I think that was probably a result of COVID and their difficult time coming in through the start of the year, but then after Chinese New Year, we did see Some positive improvement in the business perhaps at or beyond our expectations. We're seeing some better outlook there. And then I think it's worth pointing out that our business in China is it's broad, But it does have a significant consumer electronics component to it.

Speaker 2

So certainly that normally and I would expect this year also should see some nice sequential growth for As we move into Q2 and then with Q3 also being positive for us.

Speaker 3

Yes. And I would just call out, I think we've said sort of our sequential increase from Q1 to Q2 in revenue, two factors we've called out. 1 is The seasonal ramp up of our consumer electronics business and that's by far the bigger factor. Now the way we report our geographies, a lot of that is going to play out in China next year next quarter this quarter, Q2. And then the second is just a general ramp up and improvement in business conditions in China from Q1 to Q2.

Speaker 3

So both of those signs point to a strong China in Q2. But of the factors, we really think the consumer electronics is the bigger driver of the sequential ramp up than Kind of the improvement in broader factory automation business right now.

Speaker 11

Okay. Thanks. And I just had a longer term question on your, I think your operating margin target of 30%. So given the emerging customer initiative, Do you see kind of underperforming the target in the near term? Of course, the revenues are having an impact, But how should we kind of look at that return to 30% operating margin?

Speaker 11

Could it take longer?

Speaker 2

Right. So yes, so you're correct. I think you said at the beginning of 2020, 30% is our operating margin target and We're very confident in that over the longer term, right? I think as you think about our operating Margins this year, I think much more of it's going to be driven by volume really. I think we're as we said, we're through The challenge we had around broker buys is that goes away.

Speaker 2

So that's going to we should help. But I think if we can't get the sort of volume at that Due to the slower market conditions, that's likely the way in our operating margins. And certainly, our emerging customer investment, which full For you, I think between $25,000,000 $30,000,000 you will wait on our operating margins. But I think as we so this year, There are challenges that I think we will understand as we move into next year. I think that the emerging customer segment Should start to contribute, and we'll see some good performance there.

Speaker 2

We expect gross margins in that business to be Strong, similar to the current profile of our business and then we'll be investing in sales heads to reach More and more customers and so that will weigh potentially on our operating margin, but I still feel very positive about Getting it up to 30 as we have, particularly if we see our overall business bounce back.

Speaker 3

Yes. Yes, I think if we looked at last year, Jairam, We delivered GAAP operating income of about 24.5 percent on a full year basis. And obviously, that was with about $1,000,000 in revenue. If I think about the levers there that would have taken us to 30% or very close, our gross margin was about 300 basis below our midterm mid year target, right, rounded to 72% versus a mid-seventy percent target. And then we had about a $20,000,000 loss So think of that as about a 2% drag on operating income.

Speaker 3

I think if we look at this year, We're not going to we're expecting the gross margins to improve as we've communicated in our Q2, but on a full year basis, we'll still obviously have the Q1 there. We've sized the emerging customers' investment, which again, we're not seeing any payback this year. So that's just a pure investment this year. And then the rest is really a function of how our revenue performs relative to our sort of fixed costs. But overall, it's not a difficult path with a bit more revenue growth and emerging customers starting to become an investment that's paying off versus a pure investment to and gross margin problems behind us to be back at our target.

Speaker 11

Okay. And just quickly, which region do you think you will start seeing this Did they benefit from the emerging customer first initially? Or is that difficult to say?

Speaker 2

We're thinking of it in global terms. We don't really want to disclose too much at this point for competitive reasons.

Speaker 11

Okay. Thank you. Thanks a lot, guys.

Operator

Our next question comes from the line of Keith Toussaint with Northcoast Research. Please proceed with your question.

Speaker 12

Good morning, guys. I appreciate the opportunity here. In terms of the demand environment that you're seeing out there, we're hearing a lot of feel pauses and delays. But Help me understand that when is the decision made to buy a Connex product versus like when the CapEx spending happens? Is there a long lead time between the two events?

Speaker 2

So I think there are different pieces of our business, right? Probably let's size it roughly 2 thirds is Relatively short cycle business, so customers are identifying and executing products and placing orders within their 60 day window or so. And it's worth pointing out that we generally supply very quickly and We have some the distributors we have or the end users don't hold inventory of products. So I think we you're going to see our business inflect more quickly in that kind of environment. Then we have the rest of our business might be much larger customer related and we spent a lot of time talking about that in e commerce and there are some So in consumer electronics, big smartphone businesses and then to Some of these EV battery businesses we're talking about, they have a longer time frame.

Speaker 2

So they may be implementing an automation project that's 18 months in duration, we would be in discussions with them and they may be placing orders then for to turn into revenue over a longer period, possibly 6 months in nature, right, as they commission bring up their lines and we recognize revenue. But I'd say 2 thirds short cycle, 1 third Kind of longer cycle in a normalized business for Cognex over the last few years or so.

Speaker 3

Okay. That's helpful. That's helpful.

Speaker 12

As a follow-up, we're hearing also obviously delays in longer sales cycle in the decision making process. But how is the pipeline, I guess, before you get to that process, is the pipeline growing as you're seeing more lease deals kind of being delayed?

Speaker 2

Yes. We We've implemented salesforce.com over the last few years and we really we're very pleased with the progress we're making on kind of our CRM and understanding of our business. And we are we see large opportunities in a big funnel, but I think the expectation is that that's going to shift to the right As projects get delayed and customers, although there's lots of things they want to do with Cognex Vision, we all know that and the payback can be very good. Definitely, we see that tightening going on. I've been to a few customers over the last few weeks who are definitely seeing that from the automation engineers who are Struggling to get projects approved that have great paybacks.

Speaker 11

So

Speaker 2

lots of opportunity, Lots of caution is how I would describe it. Great. Thank you.

Operator

We have reached the end of the question and answer session. I'll now turn the call back over to Ron Willett for closing remarks.

Speaker 2

Well, thank you for joining us this morning. We look forward to

Operator

And 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 2023
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