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spk10: Greetings and welcome to the Cognex fourth quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Nathan McCurran, head of investor relations. Thank you. Please go ahead.
spk11: Thank you, Donna. Good evening, everyone. Thank you for joining us. With me on today's call are Rob Willett, Cognex's President and CEO, and Paul Todgham, our CFO. Our results were released earlier today. The press release and annual report on Form 10-K are available on the Investor Relations section of our website. 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 earnings release 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 risks and uncertainties that are described in our SEC filings, including our most recent Form 10-K filed tonight for 2022. With that, I'll turn the call over to Rob.
spk04: Thanks, Nathan. Hello, everyone, and thank you for joining us. We continue to navigate a challenging environment Our fourth quarter results were largely in line with our guidance, but are not representative of our long-term growth expectations. The focus of my remarks today will be on the near-term challenges we're facing, and then on the reasons why we remain excited and confident in our long-term growth opportunities. Our largest challenge was in our logistics business. we continued to see a post-pandemic slowdown with a few of our largest e-commerce customers who have temporarily reduced their investments to absorb excess capacity. Looking beyond this temporary pause, we continue to expect logistics to be our highest growth end market over the mid to long term. We also saw lower new business activity in the quarter. Bookings were below our expectations, and generated less revenue in quarter than is typical. Despite these challenges, revenue increased on a constant currency basis by 1% for the full year compared to 2021, a year where we reported strong growth of 28%. Outside of logistics, Revenue from the remainder of our end markets grew in 2022 roughly in line on a constant currency basis with what we would expect over the long term. As our history demonstrates, we can experience periods of softness in between periods of robust growth. Our revenue growth target of 15% is a multi-year annual target. With that lens, revenue of over $1 billion in 2022 represented double-digit annual growth compared to 2020 and 2019. Gross margin of 71% in Q4 and 72% for the full year was in line with our latest expectations. Margins in both periods were below our long-term target mid-70% level due to the elevated purchase of scarce components through brokers. Before I go into detail on our end markets and an outlook for Q1, I'd like to turn it over to Paul to walk you through more of the results.
spk03: Thank you, Rob, and hello, everyone. Revenue was $239 million in Q4, a 2% decline year on year, or an increase of 4% on a constant currency basis. This includes the approximately $20 million catch up from deliveries that were delayed in Q3 following the fire. In addition to the slowness with a few large e-commerce customers throughout the quarter and slower business activity more broadly at the end of the year, foreign currency translation lowered revenue by $45 million or 4% in 2022 and by 6% in the fourth quarter. Looking at the change in revenue for Q4 from a geographic perspective, Each primary region grew year on year on a constant currency basis. Asia increased by 9%, excluding an 11 percentage point reduction from currency exchange rates. Revenue growth from semi and automotive more than offset softness from the challenging environment in China. Revenue from Europe increased by 4%, excluding an 11 percentage point reduction from currency exchange rates. Growth was led by revenue from automotive and consumer electronics, that offset a decline in logistics. In the Americas, revenue grew by 1% year on year. Lower investments by a few large customers in logistics were offset by growth in automotive, consumer electronics, food and beverage, and medical-related industries, among others. Gross margin was 71% in Q4 compared to 72% in Q4 of 2021 and 73% in Q3. The decline from Q3 is due to the significant premiums we've been paying to replenish component inventory destroyed in the fire. These purchases negatively impacted gross margin by approximately 500 basis points in the quarter and approximately 400 basis points for the year. We are pleased our broker buy activity is winding down now that we've replenished post-buyer and the supply environment has improved. We expect it will take a couple quarters for the higher price components to work their way through the P&L resulting in a minimal impact by the second half of 2023. Moving on to operating expenses. Our reported operating expenses included a fire loss in both Q3 and Q4 of 2022 and a modest restructuring charge in Q4. Excluding these charges, Q4 operating expenses increased by 3% from Q3. Comparing year on year, operating expenses decreased by mid-single digits primarily due to the favorable impact of currency exchange rates and lower incentive compensation. These benefits were partially offset by the incremental investments we've been making in sales and engineering headcount. Operating margin on a GAAP basis was 23% in Q4. Non-GAAP operating margin was 24% in Q4, an improvement from 23% in Q4 of 2021 and 20% in Q3. This level of profitability is below our 30% long-term target due to lower gross margin and operating deleverage from revenue softness. The effective tax rate excluding discrete tax items was 22% in Q4 and 16% for the full year. Reported earnings were 32 cents per share in Q4. Non-GAAP earnings per share were 27 cents in Q4 compared with 30 cents in Q4 of 2021 and 21 cents in Q3. excluding the one-time charges mentioned earlier and tax adjustments. Turning to the balance sheet, Cognex continues to have a strong cash position with $854 million in cash and investments and no debt. The strength of our balance sheet enabled us to aggressively replenish components lost in the June fire. As a result, we caught up on customer deliveries quickly during the second half of the year and ended 2022 in a healthy inventory position. During the year, We also had a substantial return of capital to shareholders, with over $200 million of share repurchase activity and more than $45 million of dividends paid. Now, I'll turn it back over to Rob for color on our end markets and on our outlook.
spk04: Thanks, Paul. I would like to now give a little historical context. You may remember we went through a restructuring in 2020. As part of that action, we reorganized our R&D and engineering teams. These teams are focused on groundbreaking edge learning technology and standard product architectures that can deploy on innovations more efficiently and at a faster rate. As a result of these improvements, we now have many new products coming to market in 2023. Recent product launches include our new DataMan 5 AT. This fixed-mount barcode reader is designed for five- and six-sided Cognex modular vision tunnels. for use in the most demanding logistics applications. Pairing this product with Cognix 3D Vision Systems helps logistics customers to apply a label on a package in a spot that does not cover other information on that package, a surprisingly difficult task to automate. This results in optimizing processes by increasing line speeds and traceability without lowering read rates. In another product launch, we expanded the capabilities of our Insight 2800 vision system to include deep learning enabled optical character recognition. This allows customers to deploy powerful AI-based OCR technology regardless of their skill level. Prior industry solutions required hours of programming by highly trained engineers, preventing many companies from automating this type of inspection.
spk00: Now,
spk04: Models can be set up and deployed directly on the device in minutes with as few as 10 sample images. Food and beverage manufacturers will be able to easily read expiration dates, even on curved metal surfaces. Electric vehicle manufacturers can quickly locate and read the alphanumeric text etched on the bottom sides of EV batteries for traceability. And logistics businesses can decipher codes and text on a variety of package types to ensure proper routing and prevent rework. We believe these products and many others planned for 2023 launch position us to broaden the market we serve and capture more share. With that, let's jump into more detail about what we're seeing in each of our end markets. Our largest end market in 2022 was automotive, which represented approximately 25% of our revenue. We reported record revenue from automotive and double-digit growth year on year in constant currency. This is primarily driven by the increase in electronic components in vehicles and the ongoing transition to electric vehicles. The transition to electric vehicles has generated an increase in new model introductions and demand for EV batteries. We have strong relationships with the major EV battery manufacturers who projected continued growth within Asia and new growth in the Americas and Europe. In the fourth quarter, we acquired Sirius Advanced Cybernetics GmbH, or SAC, a German computational lighting company. Combining SAC's capabilities with Cognex's vision and AI tools equips us with an industry-leading offering for battery inspection. The SAC acquisition will support our strategy to capture a larger share of the high-growth battery inspection market. Moving on to logistics. Logistics represented approximately 20% of our total revenue in 2022. After over 60% growth in logistics in 2021, annual revenue from logistics contracted by 25% in 2022. Aside from the few large e-commerce customers who reduced investment, revenue from the remainder of our logistics business grew both in the quarter and year. We believe logistics will continue to be an important growth driver for us over the long term. The market is still in the early stages of adopting machine vision. Most companies are still highly reliant on labor, and very few warehouses globally are realizing the full potential of automation. An example of the type of opportunities that exist in logistics is a recent win with a Fortune 50 retailer that was previously a relatively small customer of ours. In 2022, we deepened our relationship with this company who had previously announced a multi-billion dollar investment to enhance its shopping experience. They're establishing regional sortation centers and converting in-store stockrooms into sortation centers to pack and ship orders direct to consumers. Cognex was chosen to provide machine vision because of our best-in-class algorithms that can reliably read barcodes at angles Our tunnel solution enabled our customer to increase the number of products on a high-speed conveyor by reducing the gaps between them while still reading barcodes at near-perfect read rates. After initial wins and excellent execution support, the customer has asked Cognex to add value in additional areas, such as converting manual operations to automated tunnels to offset labor shortages and costs in existing regional distribution centers. Shifting to consumer electronics. Our third largest end market in 2022, representing approximately 20% of revenue, consumer electronics grew in the mid-teens year-on-year on a constant currency basis. Growth was primarily driven by the premium end of the smartphone market, with an additional contribution from other consumer electronics products, such as tablets and accessories. We had particularly strong demand for our deep learning and 3D solutions in this market. Turning now to our outlook. We expect revenue in the first quarter will be between $180 million and $200 million, which represents a meaningful step down year on year. You may recall that the first quarter of 22 was an exceptionally strong one for us. as we reported an unusual sequential increase in revenue, led by our second highest quarter ever for logistics. We had strong demand broadly across our business, even from consumer electronics, which is typically quiet in Q1. We also caught up on $20 million of orders in backlog caused by supply chain delays in the fourth quarter of 2021. In contrast, new business activity at the end of 2022 was slower than we anticipated, and we've had a slow start to 2023. Lower activity with our largest logistics customers continues, and we're also seeing a broader slowdown across many of our end markets as customers are wary of committing to significant investment. We believe gross margin in Q1 will remain in the low 70% range The supply environment has improved and our broker buy activity has wound down, but the impact of what we've already purchased will take a couple of quarters to flow through our P&L. We expect operating expenses in Q1 will increase by approximately 10% on a sequential basis, excluding the charges related to restructuring and the fire in Q4. This increase is driven by investments we're making in our new emerging customer sales force. along with merit increases and a weaker U.S. dollar. Throughout 2023, we expect to see a ramp down in the impact of broker buys and a ramp up in our emerging customer sales force investment. From an operating margin standpoint for the year, we expect these two drivers to roughly offset. We expect the emerging customer initiative to broaden our reach increase penetration, and further diversify our customer base. Representing potentially hundreds of thousands of businesses, this custom segment is looking for automation solutions that are easy to implement, easy to use, and provide the highest performance. Our newest edge learning and ID products position us well for this initiative. To directly reach these customers, we're expanding our sales force. We've already hired the initial salesnoids focused on this segment. We'll onboard and train more in the quarters ahead. We expect costs from this initiative to ramp through the first three quarters of this year. While our continued investment during a slower growth period will result in near-term operating deleverage, we believe it's an important initiative for long-term growth. We remain committed to tightly managing operating costs in this environment, and we also believe it's important to continue to invest in high ROI initiatives. We're excited about our long-term growth prospects. Though timing is uncertain, we expect large e-commerce customers to shift back into investment mode, EV battery growth to continue, China to more meaningfully reopen, and our emerging customer initiative to start to deliver. I'm proud of how Cognoids responded in a year with many challenges. It gives me even more confidence in having the right team to deliver strong growth and new customer value together in the years to come. Now, we will open the call for questions. Operator, please go ahead.
spk10: Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press Star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the Star keys. We do ask that you please limit yourself to one question and one follow-up, but you may rejoin the queue for any additional questions that you have. Our first question today is coming from Josh Pokowinski of Morgan Stanley. Please go ahead.
spk05: Hi. Good evening, all.
spk04: Hi, Josh.
spk05: Just first question on sort of the 1Q guide. I know that we've gone through a decent amount of off-cycle revenue volatility with the fire and some of the supply chain stuff and the catch-up on the other side, backlog position in e-commerce. But should we think of 1Q as kind of representing normal seasonality without any kind of unusual big items as we think about the rest of the year? I know you're going to give guidance, but just trying to make sure there's no other kind of noise in there.
spk04: Right, yes. So, you know, Q1 is looking slow. You know, we've seen slow periods like this before. And, you know, we've come out of them and delivered meaningful growth. I think, you know, I think you know that our business inflects quickly and it's not kind of backlog driven as some of our peers are. And additionally, we're comparing to what is a particularly tough Q1 situation. given last year's unusually high revenue from logistics and other markets. But I think it's also fair to say that we see lower PMI data across all of the regions that we serve in our regular business. And that's certainly reflected in the activity that we're seeing, which is at a lower rate than we were expecting a few months ago. And then, of course, as I think I've explained quite a lot, the logistics business is really at a very low level, really as a result of the large customers really pulling back on e-commerce spending. So that's the kind of color that we're looking at. For those of you who have followed Cognix for a long time, we know that historically Q1 was always our lowest quarter. That somewhat got changed with large logistics orders coming in or sometimes high consumer electronics business in Q1, but this looks like a quarter without any of that.
spk05: Got it. That's helpful. I appreciate that color. And then just thinking about something you said in the prepared remarks there, I want to make sure I understand better. A reduction in broker buys through the year, which sounds like a good guy. And then you mentioned a ramp in some of these target investment customers. Sorry, I get the exact phrasing wrong. But both of those sound good, or are you saying it's a ramp in the expense to develop that Salesforce, that product capability? Is it a ramp in the expense or that customer revenue?
spk03: It's a ramp in the expense, Josh. This is Paul. So, you know, the way to think about this is we had about 400 basis points of broker by impact to gross margin in our 2022 results. So think of it as around $40 million or so off a billion of revenue. We're expecting to see roughly a $25 to $30 million reduction in that expense this year, ramping up over time. We still expect in the first quarter to have reflected in our low 70s gross margin about a 300 to 400 basis point impact of broker buys. But we should see a $25 to $30 million savings to gross margin from broker buys. And that's roughly comparable to the level of investment we expect to make in our emerging customer initiative in OpEx. So it's an increase over, you know, ramping up over the first three quarters. So there's some of that reflected in our Q1 OpEx guidance, which is why we see the sequential, one part of the sequential OpEx increase from Q4. But we'll expect to see more of that in Q2 and Q3. Crystal clear. Thanks, Paul.
spk10: Thank you. Excuse me. The next question is coming from Joe Ritchie of Goldman Sachs. Please go ahead.
spk15: Thanks. Good afternoon, everybody.
spk13: Hi, Joe.
spk15: Hey, so I want to touch on the logistics commentary a little bit further. You know, so as you kind of think about the rest of the year, you know, clearly there was volatility throughout the year in 2022. It sounds to me like things have kind of worsened. And so while logistics might have been down 25% for the year, it's probably down a lot more maybe in the fourth quarter. I'm just trying to understand going forward, you know, where would you expect logistics, particularly the bottom, just based on what you see in the conversations that you're having with your customers?
spk04: So, yeah, so logistics represent about, you know, 20% of revenue in 2020. 2020 to approximately $225 million. And it was the second largest market, right? And it contracted. And we saw that contraction kind of increase as we went through the year. It was relatively strong in the first half. And then I think it's really a story of two different customer types. We've got regular logistics customers who are growing nicely, and we expect those to continue to grow. a little less than half of that, you know, overall logistics business roughly. And then we've got large customers, you know, very few of them, you know, some of them pretty famous businesses. And they've really, you know, really overinvested for a period through COVID and then now have really reined in investment. Some of them are going through restructuring. And, you know, that's going on right now. And we expect they'll emerge from that. And then as we get through the year, they'll start to invest again. That may not happen until late in the year or even next year, right? But we do expect to see more investment going on. But even at those customers, there's still significant work that goes on with kind of productivity improvements, regular business, regular automation projects. So that's not like that business has gone away completely, but certainly a lot of the green fields, really all of the green fields that some of these bigger customers have been stopped or significantly delayed. So that's really the state of play.
spk03: And Joe, to your question about quarterly versus annual growth rates and so on, again, we don't consistently provide data on each end market by quarter, but I think we did call out in the Q3 earnings that Q3 2022 was a particularly unfavorable comparison. It was very low for logistics in 2022, and that was I think our highest ever logistics quarter in Q1 of 2023. So certainly that quarter was difficult. In Q4, you know, our growth rate or contraction logistics was pretty comparable to the year on year. And then I would say we're up against another tough compare in Q1. You know, Q1 was the biggest logistics quarter of 2022. And then obviously there was some announcements about, you know, pauses in new capacity expansion and so on that, you know, muted our logistics revenue from Q2 to Q4 last year.
spk15: Got it. That's super helpful. If I could ask just one more. It is interesting. It is very helpful to get the color on the 2022 baseline for your three biggest end markets. I feel bad asking for the fourth, but I'm curious. One of the end markets maybe just emerged and now is a sizable percentage of your business as well. If you maybe want to provide... I don't know if it's in, like, food and beverage or consumer products or semis, but just provide some color around that end market and what your expectation is for 2023.
spk04: Well, yeah, Joe, I think, you know, I think we talked about our big end markets, right, consumer electronics, automotive being the largest consumer electronics and logistics, and then other markets, you know, for Cognix are pretty broad, and they include medical-related industries, consumer products, food and beverage, product security. So I think if I'm understanding your question correctly, you're really asking about those kind of markets in general. And they provide good, solid growth for us in line with our overall growth expectations. And there's variation among those markets, but generally they continue to grow much in the way the rest of the business does. But let me ask for clarification. Were you asking about a specific market or something?
spk14: Yeah. I was just wondering whether one of the end markets has, has grown to be more substantial than the others and, and what's really been driving that. Yeah.
spk04: It sounds like you're pretty well diversified by the big three. Yeah. Yeah. Yeah. I mean, we, we got some nice growth drivers. I could, I could talk at length about, you know, like life sciences and some of what we're seeing in those spaces and, uh, you know, food and beverage. But I don't think that's really going to, you know, moving the needle in terms of our results in a significant way currently.
spk03: And I think we've spoken to this before, but obviously over the last couple of years, you know, semiconductor has, you know, which is generally small for us, you know, kind of might have been 5% of our business two or three years ago and still below 10, but it's certainly, you know, has experienced, you know, quite robust growth. So obviously we're seeing some cyclicality, you know, there. We are starting to group medical related overall as about 10% of our business, which we discussed at analyst day. But generally speaking, yeah, the trends across that diverse range of our business with the exclusion of kind of semi, which is more volatile, I would say have been fairly consistent.
spk04: And building on that, I think the medical business is growing nicely and steadily and the semi business has had a great run. I think we're into a slower period as many semiconductor companies are reporting as we look at 2023. Okay. Thank you for the color.
spk10: Thank you. The next question is coming from Joe Giordano of Cowan. Please go ahead.
spk02: Hey guys.
spk13: Hi Joe.
spk02: I wanted to just follow up on logistics a little bit. You know, obviously it's not surprising to hear the commentary about the large players. And I think most people appreciate that the outside of those mega players, the kind of like ground floor logistics is much stronger, but it, Rob, you talked about the declining globally. When did that start to impact that group of customers? Is it likely that PMIs trend lower, below 50, that logistics for even for those people who are behind, but are they still going to reflect the economic cycle and likely decline in that sort of environment?
spk04: Right. So, Joe, I think your question is how is sort of lower PMI affecting our base logistics business. Is that what you're getting at? Yeah. We have really strong underlying technology and growth trends in our base logistics business, and we still have relatively low share and a lot of great growth drivers. So I would say that as we're looking at that business, we're expecting good, strong growth from it as we look forward. But, you know, it's not immune either to PMI activities. So we do see, you know, customers more tentative about placing orders, delay, you know, longer cycles to close business, et cetera, in that space too. But the underlying, you know, growth prospects are very good, I think, really, regardless of kind of the kind of PMI data we're seeing now, although, you know, it will slow it down a little bit.
spk03: Yeah. I mean, a good number of those customers delayed some investments early in COVID and are just Just now, I can speak to my former employer, for instance, just getting back to those plans back in place and, again, depending on the consumer exposure they have. In many cases, the consumer data is a little more robust than the manufacturing production data we've seen. So I think in a low PMI environment, we might see a higher percent of projects delayed, but generally the investment cycles of building a new distribution center and so on tend to transcend a shorter-term economic cycle.
spk04: And then I would say as we look at that business too, we really have so much opportunity to grow our business in Europe and Asia where we have still low share and a lot of competitive advantage. So certainly we're expecting outsized and seeing outsized growth in those areas of our business.
spk02: Okay. So just it's fair to say that that based business and logistics in the environment that we're in right now, you'd still expect it to grow. I mean, things can obviously change between now and the end of the year, but given where things are, that would be a fair statement to make? Yes. Okay. And then my follow-up would be on the emerging customer stuff that you're doing. Where are you on the actual products? Like I know you're talking about, you know, developing like smart sensors and things that are easier to use and kind of like a different type of product than you've done historically. So I know you're ramping up the cognoids and getting the sales organization ready to support this, but where are you on the products themselves?
spk04: Yeah, right now we have a good range of very, very competitive products for emerging customer sales noise to sell, right? And there are more coming. But, you know, we're out in the field and they're very, very well equipped to close a lot of business that they see at these small customers.
spk02: I'll pass it on. Thanks, guys.
spk10: Thank you. The next question is coming from Guy Hardwick of Credit Suisse. Please go ahead.
spk13: Hi. Good afternoon. Hello. I know in your preamble you referred to a slow start to the year. Obviously, logistics is well known, and you also referenced the semiconductor market. Are there any other markets which are showing weakness? Could you expand a little bit on that?
spk04: Yeah, I think, you know, I think, I think broadness is, I think weakness is pretty broad in general, as you described and as witnessed in, you know, PMI data overall. I think if there's anything else that I would, well, if there are some other things, broad themes I'd draw, one is, you know, obviously at the start of the year, we're still seeing COVID-related disruption in China, right? And then, you know, and I think obviously rising interest rates, creating challenges in approving capital. And really, a lot of our business is driven by capital spend. And then I think there's a couple of regulatory things I would call out. So the Inflation Reduction Act is going to drive a lot of EV battery investment in the United States. And it's going to draw some of that investment away from Asia and Europe. So we're seeing projects that we were expecting to be winning and installing in Europe or in Asia have been delayed because they're moving into America. So that's going on. And a somewhat similar dynamic with the CHIPS Act, restricting exports to China is causing some changes among those customers where I think near term they'll be spending less. Long term, I expect them to be equipping more facilities there. outside of China. And that's, you know, so that's causing some delays also.
spk13: So just as a follow-up, if tier one logistics CapEx comes back in 2024, I mean, what are your logistics partner integrators telling you? Don't discussions on projects have to start really by the middle of this year? Have any impact in 2024 given typically 18-month lead times?
spk04: Yes, you're right. Was there a question there?
spk13: I mean, generally, what are your partner integrators telling you in terms of potential outlook for longer term? If you want to return back to the logistics growth that you referenced at the investor day, you've got to have kind of recovery in 24.
spk04: Yeah, so I think maybe one thing to understand is for those big customers, we do directly with the company itself, right? And we're working often with their engineers on implementing their technology plans and their rollout. And then we think of integrators really as more capacity to help execute their plans, right? So we see we're in a dry period. not clear to us exactly when it comes back, certainly not in this first half. And I think, you know, beyond that, we'll share more information when we have something more solid and meaningful to share. We think it will come back. We think, you know, we're optimistic about that. But the timing of it, is it second half? Is it 24? We're not clear ourselves on that. And I don't think our customers necessarily are clear on that either. Thank you.
spk10: Thank you. The next question is coming from Jacob Levinson of Milius Research. Please go ahead.
spk01: Good evening, everyone. Good evening. Just on this acquisition SAC that you did in the quarter, it sounds pretty interesting, but can you help us understand a little bit about how that, what the differentiation is, what the technology that they're really doing, and why it I guess, why is that so important in the battery inspection process in particular?
spk04: Yeah, yeah, thank you. Appreciate the question. Yeah, so something that goes on in machine vision is you acquire an image, right, and then you use vision tools to, you know, decode and make sense of that image, right? And, you know, Cognex, I think, is undisputed in our ability to... to make sense of and to interpret images, and particularly with our deep learning technology. We really have phenomenal capabilities in that area. But image acquisition is something where we felt we really wanted to do better relative to our competitors, and we saw a big need in this market to do that. The company, SAC, that we've acquired is really a leader in this area of computational lighting or computational optics. And what that technology does is think of it like a dome of light that sits on top of an image that's being analyzed. And there are LEDs that are lit up in a very controlled and specific way using very sophisticated software to create almost like a 3D image of what's underneath them. In this case, it very often is illuminating dents and scratches on the surface that's being analyzed. They can do it very quickly and almost with 3D type capability. This technology is better at doing that than any other that we've seen in the market so far. What is that going to allow us to do? It's going to help us serve some really important needs in battery production, in EV battery production. And, you know, looking at material, like even just take the outside of a cylindrical battery that, you know, is pretty, you know, pretty widely used and pretty widely out there, you know, in the world of EV. Dents and scratches can cause, you know, fire and other problems and have done, right? So it's a very hot topic for sure. As companies are rolling out new EV battery technology and they're building, you know, billions of dollars of manufacturing capability, this is a technology we think will be highly prized and will help us drive growth in years to come in that space. So that's a little bit of an overview.
spk01: Super interesting. And just one for Paul quickly. I know you guys prior to the fire in Indonesia were embarking on a supply chain diversification plan, for lack of a better description. But Maybe you can just update us on whether you've been able to qualify some other contract suppliers or manufacturers, rather.
spk03: Yeah, sure. Thanks, Jacob. As I think we've reflected in our previous queues and in this case, really since 2021, we've been bringing online a second contract manufacturer as well as a couple sites for our primary contract manufacturer. And we're making good progress there. The second manufacturer is producing at this point in Q1. So we're happy with that and has the capacity to do quite a bit more. And we'll continue to ramp that up over this year. So this will be a journey, a progress, but I think we are headed in the right direction. as well as there are broader efforts to diversify some of our supply chain risk, including distribution centers. We moved to a much larger distribution center in the Americas, for instance, earlier in 2022, and looking at potential opportunities globally for distribution and warehousing.
spk01: Perfect. Good luck in 2023, guys. Thank you.
spk10: Thank you. The next question is coming from Jim Rashudi of Needham. Please go ahead.
spk07: Thank you. You've given some commentary, some color around many of the end markets. And, Rob, I'm wondering if you would maybe talk a little bit more about your expectations for automotive. You've got some puts and takes. Obviously, the EV market still seems like it's fairly healthy. What's your sense as you look at the automotive part of your business this year?
spk04: Yeah, I think we're pretty optimistic about the automotive market overall. I mean, revenue from automotive in 2022 grew 13% in constant currency, which is, you know, above what we expect for that market over the long term. And, you know, we do see a lot of multi-year investment in new capacity, you know, particularly EV battery manufacturing capacity getting teed up, right? And We also see more of that investment going into the United States, where we have a very, very strong share and a very, very strong team able to execute on the needs of those companies. And then we have the SAC acquisition that I mentioned, which brings a really powerful tool to bear into what is a very difficult manufacturing problem. And our deep learning capabilities in general and our edge learning tools really, I think, are going to be very valuable in those applications. So, yeah, I think we remain pretty optimistic about the outlook for automotive over the coming quarters and years.
spk07: And I know that you don't normally have a lot of... color on the consumer electronics market. The question I have more in that area is around the reports that we've all been seeing about more production, consumer electronics shifting to places like India, including for applications around smartphones. First of all, are you seeing any signs of that? And how soon, how far out if that were actually occurring and is occurring, would you see orders as that capacity gets built out in places like that?
spk04: Well, I think, you know, some major smartphone manufacturers are on a multi-year journey to diversify their manufacturing footprint. And I think, you know, various recent, you know, various things that have been going on in the world are certainly, you know, continuing to drive that kind of sentiment. For sure, production is being moved to other markets such as India and Vietnam, and we've been seeing that over a number of years, and it's definitely continuing and gathering pace. And yes, we are certainly receiving orders and doing business for business that historically might have been done in China and is now being done in India. Thank you,
spk10: Thank you. The next question is coming from Rob Mason of Baird. Please go ahead.
spk12: Yes, good evening. I had a question about the build-out of the emerging customer sales force. If you think about at the end of this year or maybe even over the course of the next two years, what percent of your sales headcount would you expect that sales force to comprise?
spk04: Yeah, I think we're going to get that information just for competitive reasons. You know, we have competitors in this space that are, you know, very tight-lipped about their own investments, et cetera. But, you know, certainly if you do the math on kind of what Paul told us about investment, you know, it's going to be a significant number of heads we would expect to add this year and train and put into the field. And then, you know, I could see this as being an initiative that's going to build, really deliver for us over time. many, many years as our products get better for that market and our sales force becomes more established. Maybe there's another kind of, you know, trend or data point I'd point to is like, you know, certainly five plus years ago when we were talking in about 50% of our business was going through distribution, right? But, you know, as our products have got more powerful and easier to implement and and our businesses got bigger you know it's really 70 percent of our business now is direct and only 30 percent through distribution so certainly we recognize that continued growth is going to going to mean continued end user direct sales head count and uh and that's a path we're on and we'll continue to be on i see okay um
spk12: And then just as a follow-up, maybe echoing a little bit the last question, but just around consumer electronics, and again, I know you don't have great visibility at this point in the year, but just sizing up the year that you just had, which I think played out better overall than maybe you were thinking at the outset of the year, are you seeing anything, any indications that would support, I guess, growth? Um, this year, um, just given the typical cadence that that business often is on, or is there, is there anything that you would call out, um, you know, that we should think about as we try to model out 23?
spk04: You know, I think, you know, I think you're right in the characterization of last year. You know, we, as normal last year, as I'll tell you now, we really don't have a clear picture of how it's going to play out. Um, And we'll have a much better picture when we talk next, you know, in May. And we'll give you, I think, a clearer read at that point. And then last year, yeah, we thought high single digits and, you know, our growth rate was substantially north of that, right? So as the year played out. But, you know, there are things that drive our growth in electronics. And I think there are factors that are, you know, coming together quite nicely as we look over time. longer periods, right? Certainly, you know, continued waves of investment in consumer electronics. You know, there's a lot of new innovation coming and, you know, we see it particularly in areas like virtual reality and augmented reality. We see electronics manufacturers beginning to diversify their supply chains outside of China, particularly, and generally that's new equipment that we're helping them install in those markets. And then I think a really major trend really links to deep learning and edge learning, which is the desire to replace. There are millions of visual inspectors that are working in these markets today where I think COVID has made customers particularly sensitive to their vulnerability to large numbers of human inspectors. And as a result, I think we're seeing a lot more interest in applying our technology to help address that vulnerability that they have. So I don't really know how this year is going to shape up. I have a lot of optimism about our future in electronics, and we'll have a clearer view on this year's kind of CapEx and timing and spending. We certainly expect to at least maintain, if not gain share, with some of those large consumer electronics customers that we have where we've built such great relationships over time. And you can see, you know, one of them referenced as one of our largest customers last year, as they have in a number of years. Fair enough. Thank you.
spk10: Thank you. The next question is coming from Paul Chung of J.P. Morgan. Please go ahead.
spk06: Hi. Thanks for taking my question. So just on OpEx, you know, you have a large kind of sequential increase here in the first quarter. But does that OpEx level kind of stay at that, you know, north of 110 kind of quarterly run rate for the rest of the year? Or I think you mentioned some offsets, but how do we think about overall OpEx levels as we exit 23?
spk03: Yeah. Hey, Paul. This is Paul. You know, again, we don't have full year guidance on that, but I think... Our increase of about, what we said, about 10% sequentially, that's driven by a few factors. It's driven by our investment in our emerging customer sales force. It's driven a little bit by just a weaker dollar, which helps us from a revenue perspective, but hurts us a bit from an OPEX perspective. Some investments in product launches and so on. I think this is a decent starting point to sort of model a year. I think if I were to compare versus... A year ago, with this guide, if we're up 10% on average, sort of sequentially, or approximately 10%, we're up a little less versus Q1 2022. But we are expecting to see some of our emerging customer expenses to ramp up a little bit over time. So I could see us being up a little more than in the sort of 5% to 10% range overall for the year. Again, that's a combination of being very, very disciplined about discretionary expenses and investing in a couple really important long-term growth initiatives.
spk06: Great. That's very helpful. And then just to follow up on product mix by vertical, so consumer electronics continues to kind of shrink relative to logistics and auto given the growth rates there, but how do we think about longer-term gross margin impacts? I think you mentioned in the past that, you know, kind of logistics comes in as slightly relatively lower gross margins. So how do we think about those moving pieces as we kind of model out gross margins longer term? Thank you.
spk03: Yeah, I mean, I think, you know, on a long-term basis, our mid-70s gross margin target is really the right way to think about that. And I expect and hope that you will you know, be able to see that in the second half of this year. You know, by far the biggest contribution to getting back to that will be the wind down of the broker buys. And again, from a new purchase activity, that wind down has already occurred, you know, absent some new crisis emerging. And now it's just a function of, you know, how it flows to our P&L, you know, in the current quarter we're in and next quarter. And ideally by then we're mostly through it. The mix between industries, certainly, yes, logistics remains slightly dilutive to our margins overall. We have some good initiatives, including the modular vision tunnel in session, some of the standardized solutions that we've spoken about before and Rob spoke about in the prepared remarks that I think will help on that front. But overall, the product mix factors and the industry mix factors, I feel like are quite manageable within our mid-70s. Obviously, as we continue to grow, we should get some leverage on our fixed costs that may offset if a disproportionate amount of that might be coming from a slightly lower gross margin area.
spk06: Great. Thank you.
spk10: Thank you. The next question is coming from Matt Somerville of DA Davidson. Please go ahead.
spk08: Thanks. I really just have one at this point, Rob. I'm just curious about that emerging customer initiative. I guess, why now? Why not a year ago? Why not a year from now? What sort of end markets and applications are you targeting? Is this broad from a geographic standpoint? And maybe more importantly, how much does this widen your TAM? Thank you.
spk04: Great. Thanks. Yeah, thanks for the question. Well, why now is because we got the products. right we've uh you know we've been launching we've been developing this edge learning technology which is really you know and it's it's you can see it in our insight 2800 and you can see it in the um ocr version we just launched which it really takes cognix has you know kind of been famous in our life for um serving the most challenging applications you know the most sophisticated companies in the world want to work with us and their engineers on the most difficult machine vision problems, and we've shined in that segment. But now, edge learning technology takes a lot of the power of our technology, and it makes it really available for people who aren't trained automation engineers or vision experts. And that together with our ID products, which are also becoming increasingly easy to use and powerful, means we have a basket of products finally that we can put into the hands of relatively inexperienced and sales-noids that we train and send out to do that. So that's what this initiative looks like. That's why we're doing it now. Certainly our competitors have some very strong share in those segments of the market, and we're looking forward to sharing our products with those types of customers. They're going to be very broad ranges of customers. They're going to be customers who work in a lot of, you know, who manufacture in a lot of different industries who may not have a lot of automation already, may not use machine vision already, but are keen to adopt the technology and what it can do for them. So that's kind of how to think about it. Geographically, yes, the potential is to deploy very diverse globally around these types of initiatives.
spk08: Thanks. And then, Rob, if you've mentioned this already, I apologize, but can you maybe talk about, you know, it sounded like 22, auto had a record year for you guys, up double digits, constant currency. What's your kind of big picture expectation for auto and EV battery this year, particularly with, you know, the ongoing cutover to EV? Just maybe your overall thoughts on how auto plays out this year versus 22.
spk04: Yes. Automotive grew in 2022 about 13% in constant currency. We've seen some good momentum and strong growth potential there. It is EV and EV batteries and the use of more and more electronics in automotive design, sensors and entertainment, etc., which is really I think, driving the use of machine vision that's somewhat offset, but certainly not completely offset by reduction in internal combustion engine type business powertrain, which is where most machine vision used to be sold in that segment. We're feeling optimistic about the long-term growth drivers for that. There will be some, you know, no pun intended, bumps in the road, you know, around the timing of deployment of some of the EV spend, I think, which will lead to some volatility in that. But I think over... I think we're in a pretty good, you know, three-year period with what's going on in the industry, our capabilities, the SEC acquisition we discussed. Yes, a lot of drivers, I think, really, again, no pun intended, helping us grow that business over the years to come.
spk03: Yeah, and if you want a little bit of color, you know, kind of by quarter, Rob gave some feedback about the slow start to the year more broadly. I will say automotive is a piece of that. References to some legislation that are potentially, along with PMI, leading to some delays in investment and reshuffling of plans and so on. Auto would be a piece of that. Historically, automotive is one of our less volatile industries, quarter on quarter and so on. I think we think we're off to a slower start this year. And then if we looked against last year, obviously Q3 was a particularly low quarter for automotive, just given the fire and other factors. So those would be the sort of relevant call-outs, Q1 being low, Q3 ideally would be up. So a little more back half optimism. Thank you, guys.
spk10: Thank you. The next question is coming from Jarm Natham of Daiwa. Please go ahead.
spk09: Hi, thanks for taking my question. I just wanted to kind of dig a little deeper on this auto opportunity, especially on the battery side, because it seems to be kind of incremental to what Cognix had before, and especially with IRA and the shift to US. If you kind of compare what you saw in China over the last two years in terms of batteries, Housh, can you size the opportunity in some way or in a different way? I think last year you gave us an addressable market of 1.5 billion in automotive, I believe. Can that number grow given what we are seeing in IRA or was that included the battery opportunity?
spk04: Yeah, I think we talk generally about the size of our automotive market and the long-term growth potential. Yeah, we sized it at $1.5 billion, and we see estimated long-term market growth of 10%. I think that's going to cycle up and down over time periods, but I definitely think EV battery investment and the timing of that when it comes is going to, and helped drive higher growth rates for us last year and I hope to see that again in the years to come. We obviously see great need for our technology in that space. So I think what some of what we've been doing recently, such as the SEC acquisition, means that we would hope to gain more share in that space and have better and more deployable solutions for customers. So we'll see how that plays out. We'll see what our competitors um, come with also, but we're, um, we're optimistic about, uh, you know, uh, that, and then I think, you know, you, you mentioned, and it's a, it's another thing that potentially lifts our business here is the IRA, um, uh, you know, investment plans from the U S government will mean, you know, much more investment in the United States where, you know, we just have, you know, big share and a great reputation and a lot of experience with, uh, with U.S. automotive companies who were obviously putting up the money to do this. So, yeah, we're optimistic about the space.
spk09: And just finally related to that, I think historically you guys have talked about how you are more focused on the auto supplier supply base rather than the OEMs. Is that still the case, or do you see some of that changing, especially given the move away from ICE?
spk04: Yeah, it's a really interesting question. So, yes, I think historically we've seen the majority of our automotive business being with Tier 1 automotive suppliers. That dynamic may change over time. You're seeing a lot of kind of joint ventures and relationships between brand names and then big Asian technology suppliers. We see that playing out in partnerships. And then you see also Pureplay, companies that are really going into business to manufacture batteries. So certainly there's plenty of change going on in that space. But, you know, quite where that ends up, you know, I wouldn't claim to know. We tend to look at applications and needs and often those are driven by the end users themselves and how they're executed can be through third parties, you know, like tier one's. or in partnership between end-user brands and Tier 1s. So, yeah, it's an evolving space, one I look forward to talking with you about in future. Okay, thank you. Thanks, Todd.
spk10: Thank you. Unfortunately, we are out of time for questions today. I would like to turn the floor back over to Mr. Willett for any additional or closing comments.
spk04: Yes, well, thank you for joining us tonight. We look forward to speaking with you again on next quarter's call. Good night.
spk10: Thank you for your participation. This concludes today's event. You may disconnect your lines at this time and enjoy the rest of your day.
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