Cognex Corporation

It is now my pleasure to introduce your host, Nathan McKern, Head of Investor Relations. Thank you. Please go ahead.

Thank you, Donna. Morning, 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, annual report on Form 10-K, and a newly introduced quarterly earnings presentation are available on the Investor Relations section of our website. Today's earnings materials and statements we will make during this call contain forward-looking statements and are based upon information we believe to be true as of today. All forward-looking statements are subject to risks and uncertainties that are described in our SEC filings, including our most recent Form 10-K filed this morning for 2023. Before I hand it over to Rob and Paul to discuss the results and outlook, I want to spend a minute explaining changes to our reporting metrics that you will notice. As we previewed with you on last quarter, after the acquisition of Moritex in the fourth quarter, we now have a more material level of acquisition costs and amortization of intangible assets. As our financial results have begun to be more impacted by these non-recurring and purchase accounting charges, we've made changes to our non-GAAP measures to exclude those charges from the reporting of our adjusted earnings figures. This change in methodology applies to our calculation of non-GAAP operating expense, operating income, and net income per share. We have also introduced, and we expect to be reporting on and speaking to more frequently, adjusted gross margin, adjusted EBITDA, and free cash flow. These changes and the new non-GAAP measures referenced on our call today are clearly defined with a historical look back to prior period impacts in the earnings presentation posted to our website this morning. You can also see a reconciliation of certain items from GAAP to non-GAAP in our earnings press release. We want to emphasize that our previously communicated long-term financial targets of 15% revenue growth, mid-70% gross margin, and over 30% operating margin are unchanged and should be evaluated on an adjusted basis, excluding these non-recurring and purchase accounting charges. Next, Rob will discuss our fourth quarter and 2023 results. Paul will then provide additional detail on the financials, and Rob will conclude with our outlook and a discussion on how our execution of strategic initiatives in 2023 sets us up for the future growth. With that, I'll turn the call over to Rob.

Thanks, Nathan. Hello, everyone, and thank you for joining us. 2023 was a year of perseverance at Cogmex. We advanced many high potential strategic initiatives while navigating a global manufacturing recession. We continued to take important steps towards achieving our strategic priorities and long-term goals. After growing almost 30% in 2021, fueled by pandemic-related acceleration in logistics and electronics investments, Revenue was slightly down in 2022 and declined 17% in 2023. Customers have remained cautious with investments as we observed lower confidence in near-term end demand, leading to increased CAPEX scrutiny and delayed orders. PMI readings have now reached 15 consecutive months in contraction territory. which is the longest such stretch since the tech bubble and 9-11 period over 20 years ago. Investment in China remains especially needed. In addition to these macro challenges faced by both Cognex and its peers, our high exposure to the leaders in the industries we serve was a headwind for us in 2023. About half of our 2023 revenue decline was driven by two large, long-standing customers who reduced their spending after heavy investment in prior years. However, we are confident that we still maintained or gained share with each of these customers. In some of our end markets, notably EV battery and semiconductor manufacturing, large investment plans are underway. Many of these projects have not reached the stage where significant volume of our products is ordered, but we anticipate our customers manufacturing projects that broke ground in 2022 and 2023 will represent future revenue opportunity for Cognex. Throughout 2023, we stayed disciplined in our approach to discretionary spending and thoughtful about hiring. We have faced challenging periods before in our 43-year history, and we have shown the ability to evolve. For example, in the year 2000, semi-customers accounted for over half of our revenue, and we saw a significant downturn in that business. To adjust, we moved fast to diversify our business towards factory automation and penetrate the Chinese market. While different today, we see disruptive trends playing out in our markets, such as the shift away from internal combustion engines towards EVs and deep learning machine vision technology becoming accessible to an increasing number of customers and applications. We are mobilizing to capitalize on these trends and remain focused on the long term and on continuing to evolve to deliver future growth. Before I go into more detail on this evolution and our outlook, let me turn it over to Paul for the financial results for the quarter.

Thank you, Rob, and hello, everyone. Turning to results for the fourth quarter, revenue declined 18% on a reported basis. This includes $7 million of revenue or a three percentage point contribution from Moratex. I'll also remind you that we're comparing against a fourth quarter in 2022 that included $20 million of revenue that shifted from the third quarter due to the fire at our primary contract manufacturer. From an end market standpoint, our biggest year-on-year declines remained in consumer electronics and semi. Broader softness continued across our other factory automation businesses, such as automotive, medical-related, consumer products, and food and beverage. The underlying business conditions we are seeing in each of these end markets remain consistent with what we reported the past two quarters. These end markets were roughly flat sequentially, but declined year-on-year, mostly driven by the timing of 2022 revenue due to the fire. Within automotive, we continued to see softness across the internal combustion business and increasing demand from EV battery manufacturers. Logistics remained stable, contributing growth sequentially and roughly flat year on year. On a geographic basis, revenue in the Americas increased sequentially driven by growth in logistics, Revenue in China stepped down further in the quarter as we continued to see a challenging economic environment. Year on year, revenue declined across all regions with the steepest decline in China. Adjusted growth margin in Q4 was in line with expectations at 70.7% or 68.7% on a reported basis, including $4 million of acquisition costs and intangible asset amortization in cost of sales. Compared to last year, Favorability from the decline in broker buys was offset by volume deleverage, Moritex, and unfavorable mix. On a sequential basis, adjusted gross margin was down slightly due to Moritex. Let's turn now to operating expenses. Adjusted operating expenses increased $5 million, or 5% sequentially, and $6 million, or 6% year-on-year. The sequential increase is due to the timing of incentive compensation and other employee benefits. and the addition of Moratex. The year-on-year increase is driven by the investment in the Emerging Customer Initiative and Moratex, partially offset by continued diligent cost management and lower incentive compensation. Excluding the Emerging Customer Initiative and Moratex, adjusted OpEx would have declined by $4 million, or 4% year-on-year. As you'll see in our non-GAAP reconciliation tables, we had $8 million of acquisition costs and $2 million of amortization of acquisition-related intangibles in the quarter. Adjusted EBITDA was 13% in Q4, below Q4 of 2022, due primarily to operating deleverage and our investment in emerging customers. Adjusted diluted earnings per share was 11 cents in Q4, a year-on-year decline driven by lower revenue and margins partially offset by a lower tax rate and share count. Turning to the balance sheet, Cognex reported a strong net cash position at the end of Q4 with $576 million in cash and investments and no debt. The $270 million quarter-on-quarter decline was driven by the closing of the Moritex transaction in the quarter. After acquiring Moritex, we believe we still have sufficient capital to support our growth plans and to continue to return capital to shareholders through stock buybacks and dividends. With that, I'll turn it back over to Rob to discuss the future growth drivers and the outlook.

Thanks, Paul. And thank you, Paul, for being a valued member of our executive team over the past four years. As previously announced, Paul will be leaving Cognix on March the 15th. He's made significant contributions to Cognix's success, including enhancing Cognix's planning and budgeting process and overseeing investments in Cognix's CRM platform. The external search for our next CFO is progressing well. I am pleased with the quality of candidates we're seeing, and we will update you with developments as they become available. Now, let me spend some time discussing how we continue to invest in the future despite near-term macro challenges. Last year, Cognoids worked hard to release more products than in any previous year in Cogmex history. Our portfolio of new products leverages the best rule-based vision while incorporating more human-like inspection capabilities made possible by advances in deep learning and edge learning artificial intelligence technology. As with many industries, developments in AI have profound implications for industrial machine vision. We were early to identify major advancements in AI technology, leading to the acquisition of Vidi Systems and Suolab in 2017 and 2019. These acquisitions jump-started our innovation around the use of convolutional neural networks, the technology now powering our deep learning and edge learning products. AI makes our products easier to use and sell and makes machine vision more human-like, enabling Cognex to expand its applications where human inspectors have previously been the only viable option. Increases in the cost and scarcity of labor continues to be a problem for our customers. We estimate that 35 million people across the globe are manually completing vision inspection tasks, such as examining products for scratches, dents, and defects. One of our customers estimates that they spend over a billion dollars per year on human visual inspectors. AI-enabled machine vision can complete this work more cost-effectively while helping to improve quality and productivity. Our deep domain knowledge allows us to leverage the best of rule-based deep learning and edge learning technologies to address the full spectrum of customer needs. We remain dedicated to helping the world's most sophisticated manufacturers and logistics providers achieve their goals while also bringing Cognex machine vision technology to more markets and new customers. To reach the broader customer base that can now be served by our new, easier-to-use edge learning technology, we launched our Emerging Customer Initiative, a Salesforce expansion that drove $28 million of OpEx in 2023. Our initial emerging customer sales class is now trained and has started to sell. We expect this initial class of emerging customer sales nodes to generate over $50 million of incremental revenue and positively contribute to operating income in 2024. Early orders reinforce our belief that this initiative can be gross margin accretive. Now equipped with the right products, and with a defined process for hiring and training, we are well positioned to welcome our second class of emerging customer sales noise this year. We have budgeted approximately $25 million of additional OPEX for this initiative in 2024. I'll turn now to our outlook for the first quarter, along with a few thoughts on the full year. In the first quarter, we expect the following results. Revenue between $190 million and $205 million, which represents flat year-on-year and sequential growth, reflecting another challenging quarter. I will note that this is narrower than our normal $20 million range, as we continue to see a relatively stable operating environment. Moritex should contribute 6% to 8% of revenue in Q1 and for the year. Adjusted gross margin in the high 60% range. Gross margin continues to be below our long-term targets given volume, deleverage, and negative mix. A full quarter of Moritex is expected to be an approximately 2 percentage point drag on gross margin, an incremental 100 basis point headwind compared to Q4. Our gross margin guidance also includes an approximately two percentage point drag from a strategic logistics project with a large customer. The project has higher upfront cost, but includes high margin recurring revenue enabled by our edge intelligence software. We expect adjusted operating expenses to increase mid single digits on a sequential basis due to investment in our emerging customer initiative, higher incentive compensation, and the impact of a full quarter of Moritech's operations. For the full year, we expect the incremental $25 million of emerging customer OPEX to ramp throughout the year, similar to the investment we made in 2023. We also expect incentive compensation to be a $15 to $20 million year-on-year headwind. While we continue to see a challenging operating environment in the first quarter, We are more optimistic about the back half of the year. We have started to see signs in longer cycle businesses that momentum could be building. For the full year, we expect logistics to grow as we start to see infrastructure investment plans materializing, though logistics growth this year will likely still be below the long-term market growth we expect. We expect our EV battery business to be a strong growth driver long-term, but we are seeing more tentativeness from these customers driven by uncertainty around end-user demand and the political environment. The semi-landscape is improving, as you have heard from the leading semi-equipment manufacturers with more optimistic 2024 outlooks. Consumer electronics has positive long-term trends, but the timing and in-year contribution remains uncertain. As usual, we expect to have more visibility by next quarter and to give you more clarity for the year on our next earnings call. While we expect to deliver below target growth in the first half, we remain confident in our 15% annual revenue growth target over the medium to long term. Based on double digit market growth, expansion of our served markets, our pipeline of new products, and our reputation with leading manufacturers, We believe the progress Cognoids have made last year on several promising initiatives positions us well for the future. Now, we will open the call for questions. Operator, please go ahead.

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 two 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, and then get back in queue for any additional questions. Again, that's star one to register a question at this time. Our first question is coming from Andrew Vescalia of BMP Paribas, please go ahead.

Hey, good morning, guys. Good morning. So in your commentary for your Q1 guidance, you talk about some signs of stabilization or stabilization and guidance implies just a modest sequential decline. Where are you seeing that stabilization? It sounds like logistics is a little bit better than you would have expected. And then can you just comment around some of the other end markets I know visibility is limited, but where you see that momentum building?

Yes, thanks, Andrew. So, you know, we have a sales funnel. You know, we see order patents that exist across our business. So we have some pretty good, you know, kind of visibility about how the business is looking and the sort of volatility that we see in that. So the overall picture seems to be stabilizing overall. As you say, I think we're at a more sort of positive spot. Momentum, yes, in logistics, we see that building across a number of other markets of our larger markets also. We see EV battery continues to have a nice growth momentum behind it. Generally, our European business also seems to be pretty stable and growing in a way in terms of its momentum overall. So those would be positive areas. I think more uncertainty, you know, would be around China, right? As we mentioned, we'll give you a better readout on consumer electronics, whether we know kind of how that's looking for the year. But, you know, there's nothing particularly to report at this point about that. So I think that's, you know, the overall color. It's not strong, but it's not the sort of, whipsaw and decline that we saw. You know, if you go back into last year, back a few quarters that we were seeing, we see more relative stability. Yeah. Okay.

Okay. And then just some clarification on the Q1 guide for margins. You know, is it fair to say, you know, excluding, it sounds like a two-point dilution from Mortex, two points from this logistics project, you're closer to 70%. And then following up on that, how do you figure this initiative is gross margin accretive? Or can you talk about some of the pilots you've done or something to give us confidence that will lead to positive contributions to margins?

Yeah, Andrew, this is Paul. Why don't I start with your specific kind of gross margin questions, and then Rob can chime in on emerging customers and any additional color. So, We are expecting adjusted gross margin in the high 60% range in Q1. The sequential step down, which is about 200 to 300 basis points, that really is driven by a full quarter of more attacks, and then the strategic logistics projects that we called out in Q1, which brings with it additional high margin recurring revenue. So those are really drivers from Q4 to Q1. If we think kind of relative to our full target, our target of mid-70%, I think there's really three drivers there, and two of which are the same. One is we expect deleverage from muted volume and negative mix to continue to be 200 to 300 basis point headwind in the first quarter. And again, that's driven by a few factors, just lower revenue levels overall. as well as product mix. Q1 is typically a lower quarter for consumer electronics, for instance, which is primarily software and comes with it with very high, higher gross margins. And then Moratex, a full quarter of Moratex is overall at 200 basis point rough headwind, and that's an incremental 100 basis point to Q4. And then the strategic project we referenced is also about a two percentage point or 200 basis point drag. This is something We don't tend to report very often. Actually, I was looking through my notes. I think Q3 2021 was the last time we called out any one project having a strategic impact. So it's not something that we would generally expect to be reporting. And I don't have visibility to more of those this year. But it is very opportunistic. And when we see a great opportunity to build a long-term revenue, even if it comes with some upfront costs, we'll, of course, make that investment.

Yeah, thanks, Paul. And I think, so I give maybe some longer-term color. You know, I think it will be difficult to get back to our mid-70% gross margin target this year until we have a recovery in volumes and fully integrate Maritex. But I think how we see, or I know how we see our gross margins kind of improving over time include three factors I'll point out. One is emerging customers. So we're outselling highly profitable embedded systems through that channel. And we're excited about what we see with those products and that sales force. New products. So we have a pipeline of new products we've introduced last year that are ramping nicely, very nicely. Some of our most successful products ever. And they come with a strongly accretive gross margin for Cognix. And a third factor would be the consumer electronics business. It was the worst performing of our large markets last year. It can have a cyclicality and a volatility, and we fully expect it to return and deliver some strong growth at some point, whether that's this year or not. We'll certainly all help to boost our gross margins right back to where we expect them to be. Other things I think are worth pointing out on the broader margin discussion. One is that Marutex is a drag on our gross margin, but comes with very strong operating margins that are accretive to us as a business. And as we continue to integrate it and sell its products more directly attached to Cogmex Vision Systems, and we developed the specialty optics business that they and we bring together and integrate them. We expect this to be a nice tailwind for us on our operating margin. So still challenging in 2024, but what we have shown through our history and many times in my 15 years here is when we pivot back to growth, there's very, very strong fall through on incremental revenue that occurs at Cognex. That also gives us great confidence that we should be able to get back to our overall targets.

Okay. Thanks for the answers. Appreciate it.

Thank you. The next question is coming from Jim Rashudi of Needham & Company. Please go ahead.

Thank you. Two questions. First, on the EV portion of the business, just in light of the – mixed demand trends that we've all been reading about geographically on the EV business. How are you seeing that business? For instance, what's your line of sight? Because my sense is you may be a little bit removed from what's happening on the EV battery side.

Yeah, thanks, Jim. I've spent a lot of time in the last two quarters out meeting with a lot of EV battery manufacturing companies. So I can tell you that there's a huge investment going on in that industry, particularly in Europe and America. So Cognex has two really kind of vectors, I would say, on that growth. One is just building lines. These customers are building EV production lines to coat and cut in the line and stack and inspect um ev batteries right and they're you know they're i visited just in europe last week two companies that are investing over a billion dollars to do that right and not all of it in automation obviously but but um real real momentum that is not a short-term thing right so and machine vision is is key to them doing that so there's new lines new builds where you know as one would expect you know cognex is one of the preferred suppliers for what is quite a challenging machine vision kind of a task that goes on. The second, so I think that's sort of the, if you like, the new build green field type scenario that we might be familiar with from other industries at Cogmex. But there's a second thing going on, which is manufacturing of EV batteries is, it's very competitive on the innovation side, but it's also pretty dangerous and legally concerning I'm saying for these companies. So they're very concerned to inspect in quality. And we've been developing technology in that market that is very advantaged, both through the computational imaging company we bought last year, SAC, I should say in 2022. And then our deep learning technology, which those two technologies together allow us to image in with incredible speed and definition, scratches, dents, problems, and then diagnose them with deep learning technology to see whether that's a problem or not. I visited a number of companies in the last six months who have just said what an extraordinarily challenging and expensive task that is for them, where they're scrapping huge numbers of good batteries that they're just concerned can become problems, cause fires, et cetera, for them later. So there are those two things going on, Jim, which is really, I would say, the sort of sweet spot of what Cognix is doing. On the downside, and I think this is what you're hearing, and I think we're hearing it too, is there's anxiety. There's anxiety about will EVs be as successful as we think? Are they perhaps niche, kind of... products for wealthy customers, or are they broadly going to cannibalize a lot of the internal combustion engine business that's out there? So that's kind of one issue. On the one hand, we all see the slowing sales of EVs and the relatively poor EV numbers reporting out of some of the big companies. So I think there's concern that they are becoming a little more cautious, the end-user consumers. And then there's another end-user vector, which is one Chinese company, BYD, is talking about developing and selling a $12,500 EV car and really selling it very broadly in some of the markets that perhaps in America we're less focused on. there's plenty to be interested in and confused on that vector. And then the final one in terms of long-term demand, which we see with our customers too, is there is some concern about political changes and support for EV business, right? So most one, one specific large EV producer from Asia, you know, certainly communicated that they're putting some of their investments in the U S on hold until they see more of a, clarity in the political environment and what that means for some of the subsidies that they would be expecting to receive through the Inflation Reduction Act. So Jim, it's a long answer, but I hope it's helpful.

No, thank you, Rob. There are a lot of puts and takes, and I think you've highlighted those. And the next question may be a little easier and simpler, just on the early customer business. You sound encouraged. Can you elaborate on where you're getting traction? Is that $50 million, by the way, essentially from this first class of salespeople, or are you including some from the second class that's underway? And is this spread out over the course of the year or back end?

Yes. So we did pilots starting about a year and a half ago. So we have a few salesnoids who are kind of helping us understand. We did a lot of experiments, as you might imagine, And then we went out and hired, you know, pretty large, a large number of this first class, which came in starting sort of in April. The last last of them came in in October or so. And we've trained them and almost all of them are now in the field. And that's the whole ballgame really this year, you know, regarding our growth expectations. Right. And then we're going to be hiring the second class. you know, as we move through the year at different points based on, you know, kind of when they become available and the locations we're hiring. And so I wouldn't expect them to contribute meaningfully to any kind of revenue growth in 2024, the second class. And then this is a group of salesnoids that we've trained and given them our great really very advantaged edge learning and ID products. And they're out in the field and we're driving them towards metrics about which include activity, kind of number of sales calls and other, other good sales metrics. Um, and, uh, you know, we're, we're measuring that performance and we do expect there to be learning curve effects, right? As they become better and, uh, and, uh, you know, and, and better trained and better able to execute. And we sort of factored that into our numbers. They'll contribute in the first quarter nicely, but we expect them to contribute more sequentially each quarter as we move through the year.

And I would just add, you know, this is, we believe, gross margin accretive based on all the tests and pilots we've run so far. And the drivers of that really are, you know, twofold. One is many of these customers, not all, but many of them are lower volume customers. So expectations around volume discounts and so on are clearly lower and we're, you know, our list price realization is higher. And secondly, you know, we're selling our easiest to use products which have less service associated with them. You know, great technology, again, the power in the software that's allowing us to command quite high margins when we sell. Thank you.

Thank you. The next question is coming from Jacob Levinson of Melius Research. Please go ahead.

Good morning, everyone. Good morning. Good morning. Paul, I appreciate your help over the years and wish you the best of luck in your next endeavor and hope you get to work hard and play hard and move fast in whatever that next chapter is. Thanks, Jacob. Just on China, I know this is a market I think sometimes it's just hard to know what's really happening if you're not there, and it's certainly been a challenge for a lot of companies that we cover. And obviously a big piece of that for you folks is consumer electronics. And maybe we have to wait another quarter to hear how that's shaping up. But Rod, maybe if you can just give us a sense of what you're hearing broadly from the field in terms of sentiment. And we've heard some companies indicate that January was actually off to a pretty good start. So just curious what you're seeing there.

Yeah. So I visited China recently. in the fall for the first time since pre-COVID, so it has changed. Certainly, some of the enthusiasm and growth expectations are different very much. Greater China, for us, experienced the largest year-on-year revenue decline of any of our major regions. We were down 29% in Q4 year-on-year and 28% for the year. So I think, you know, and I think it's going to dampen growth expectations for many companies where, you know, that market was such a driver of growth over such a long period. You know, the decline we experienced in automotive, you know, was most pronounced in China around the world for Cogmex. So then certainly electronics. is a key part of our business in China. And as I mentioned, certainly with large customers, we're confident that we're maintaining share. And what we do for large smartphone companies and also in the EV space is highly advantaged. And we think we're very well positioned to grow and help them grow as they need to in China. But also, I think we're all seeing when the early innings of a long-term shift in manufacturing away from China that could benefit us nicely this year and beyond. We're seeing production capacity moving from China, particularly for us, to India and Vietnam. And we're making sure that we have strong presence and relationships in both places to help with that transition. And then obviously some of the EV battery opportunities that are sort of where there's overcapacity in China and stagnation there, it is resulting in more businesses around the world, particularly in Europe and the U.S., growing. So that's my overall view, I would say. In our own business, we have a strong group of committed cognoids in China. We're seeing very, very low turnover in terms of people leaving the business. And a lot of enthusiasm around our new products and new technology. We celebrated with them our 40th anniversary near the end of last year. And so a lot of kind of Cognex culture playing out strongly. And we have a very seasoned management team. But certainly, I think the business that we can all expect in China in the years to come will be lower and will result in opportunities elsewhere.

And Jacob, I'll just add a couple points specific to kind of our financials and maybe your first comment about You know, I've heard China's off to maybe a little better start in January. So, you know, seasonality in China and Asia more broadly is slightly different than other parts of our business. We do typically see, you know, a step up from Q4 to Q1. So your comment may be, you know, very, very true. And we would see it ourselves from a seasonality perspective. We, you know, We're basically flat against a year ago and flat against Q4 in our Q1 guide. But the answer is quite different. If you're looking sequentially, we're seeing a little bit of a step up in Asia. If you're looking year over year, we're expecting China to be weaker than it was a year ago. So again, depending on your lens, that's one aspect. And the other color I would give on our full year results Again, as Rob mentioned, we were down 28% on the year for China. That's 23% in constant currency and a five percentage point drag on FX with a weaker CNY. The biggest piece of that, the biggest contributor to that is our consumer electronics business or was our consumer electronics business in 2023. So while the overall business was weak, our numbers were worse because of the disproportionate impact that consumer electronics plays in that, which generally does follow different you know, macroeconomic drivers and factors than the core Chinese business. So I think it's important to sort of separate those two. And certainly as we're going through the year, I know the team will call out those differences where they're meaningful.

I appreciate the color. I'll keep it to one question today. Thank you.

Thank you. The next question is coming from Joseph Donahue of Baird. Please go ahead.

Hey, guys. I'm on for Rob today. I wanted to dig into your discussion about the logistics outlook a little bit. Can you talk about where the optimism is coming from? Is it more greenfield or brownfield, larger or small customers, and kind of your expectations for the timing on when we might see an uptick?

Sure. Yeah. Yeah, thanks, Joe. Revenue contracted last year 21% in logistics, and it was down 25% in 2020, after growing 65% in logistics for us in 2021. So certainly we've seen kind of, as we know, pandemic-fueled investment, particularly around e-commerce in the United States in 2021, and then overcapacity that's being kind of worked through. And so that trend is continuing to play out, perhaps as we might have expected. Our logistics business among newer, smaller customers continues to grow nicely, not as much as we would like last year, but good underlying growth potential playing there. And we expect that to see. So we did see nice quarter-on-quarter growth in logistics in Q4. So there's a picture developing that we think is pivoting back to growth quite nicely. It's coming from those smaller customers. It's coming from customers beginning to embrace vision technology and edge intelligence. It's coming from penetrating parcel and postal applications. We're seeing some nice wins from some Big names, which are indicative of bigger business coming further. We see potential in a lot of geographies around the world, notably e-commerce in India. So there are certainly those trends happening nicely. Among our larger customers, we are confident that they will return to being larger customers of Cognix over time. The timing of that might still be a little tricky to call at this point. But I would... I would say that our business is growing, kind of the momentum in the business, the reach, our technology, its acceptance in the market is growing nicely. I think as one looks around, what one would read that is relevant perhaps to Cognix, not necessarily customers specifically, although possibly Walmart is a great example of the potential in logistics. The company has said they plan to automate or partially automate many of its 100 plus U.S. warehouses in the coming years. So we see that as a nice example. UPS certainly has been pretty open about their intention to automate and improve the production and throughput in their warehouses and is certainly, we think, a very strong potential user of advanced automation and vision technology. So these would be examples of some of the things that we see going on. You will note, you know, in our filings that we didn't have a 10% customer last year. So you know, you know, that that's obviously notable. But I you know, I think there are certainly better days ahead pretty much across the board for our entire logistics business. We do expect it to grow this year.

Okay, thank you. And then related to that, next question would be kind of, could you talk about whether we should have this margin headwind from this logistics project run beyond the first quarter? And then related to that, is the recurring revenue that you've described that's associated with this project something that you think could be kind of expanded in terms of the software you're developing to other customers? Or is it more of a unique situation that it's going to be a one-off?

So the quick answer is it's an in-quarter event where we took the decision to help a large, important customer implement some of this technology that we call edge intelligence. This is a product we've been developing for quite a long time, and what it allows us to do is manage all of our vision systems It's very appropriate for large customers with large deployments to manage them through middleware, which allows us to calibrate, support, upgrade, but also provide a lot of key manufacturing data to our customers. And we've taken the view for a long time that customers should pay on a monthly subscription basis for that business. And so this is our largest success with that product so far. And we will be you know we sign a contract that will allow us to build Monthly for that and and really hopefully add more functionality over time through it right then we we have when we got an install now in some of our applications we Provide this technology to customers and we invite them to use it after a free trial period so this is a this is a one of our main pushes to try to get our business more on a subscription type basis. And, you know, that business should be highly profitable as it continues to grow. We've been working really hard on this for a long time. It's still early days in terms of its commercial rollout. This is a really nice first example, and we do expect to see many more as that technology kind of matures and customers become aware of its value. Thank you.

Thank you. The next question is coming from Joe Ritchie of Goldman Sachs. Please go ahead.

Thanks. Good morning. Paul, wish you the best of luck. And then love the slides. So thank you for the additional detail this morning. My first question, maybe just starting on slide six. I know it's really early in the year, Rob, and kind of hard to have a perfect crystal ball on exact growth rates for 2024. But I'm curious, you already mentioned the logistics you expect to grow in 24. If you had to force rank your different end markets or businesses in 24 and where you would expect to see the most growth versus potentially the least growth, I'd love to hear any color you would have at this point.

Yeah. Hi, Joe. How you doing? Well, I, um, you know, we, you know, we don't give full guidance and we don't give certainly a full year guidance and we don't give guidance by industry, but I will, I'll comment a little, I will also say, and I've been running, um, industrial companies for the best part of 25 years. And this is always a bit of a dark, confusing period as we come into January and as a lot of businesses don't really kind of get in gear. through January, and then we have Chinese New Year. So it's too early to call some of these things. But if I talk about our industries overall, I think it's probably pretty in line with how we think of our long-term growth plans as I look at this year. I think logistics, we expect to see it grow this year. And I think we're confident we're getting back to strong growth there. It's perhaps notable in logistics to say that can be longer cycle business. So what we might see in bookings may not turn into revenue until possibly 25, but we're confident about we'll be reporting good results in logistics. Consumer electronics has the potential to really come back strongly, but as I said, too early to say. Automotive, we view that as sort of a 10% long-term grower. And, you know, that industry looks like it's having some challenges at the moment. EV, I think, you know, we're very confident about that, contributing and driving some growth, potentially offsetting declines in internal combustion engine business. So probably I would rank that as the lower of our big industries with expectations. But things can change quickly. So those are just a few sort of thoughts for you, Joe. Thank you.

Yeah, that's helpful and totally appreciate the potential volatility, but it is helpful color. And I guess maybe two other real quick ones. So just making sure that I've thought through the gross margin progression correctly from the first quarter through the rest of the year. It sounds like you do expect to get back to 70 plus percent gross margins by 2Q. And then also just had a question around free cash flow. Just what are kind of expectations for free cash flow this year? It seemed a little bit lighter than we anticipated in 4Q. Any comments around that would be great. Sure.

So I think, you know, again, without guiding beyond the current quarter, just by virtue of a roughly 200 basis point drag from one strategic logistics project, I think you kind of get back to hopefully what you're seeing. You know, the Moritech's drag versus our long-term, you know, we'll certainly persist for a while until we, you know, fully integrate and achieve more synergies. And then the impact of volume deleverage and mix. That'll change a little bit quarter to quarter, but obviously growth is the driver there that's going to help us get back to target margins. Specifically for free cash flow, you know, the biggest driver of free cash flow for us is obviously our profit. And so, you know, as we get more leverage on growth, which we expect to do, obviously that would help We did have a little higher investment in working capital in Q4. Some of that is sort of strategic decisions we're making around inventory. So we may see elements of that going forward. But generally speaking, this is a business that continues to generate cash. We do feel quite good about the inventory we have to deliver on our growth expectations. So hopefully shouldn't be seeing major drags on the capital side.

Okay, good to hear. Thank you, guys.

Thank you. The next question is coming from Piyush Abbasi of Citi. Please go ahead.

Good morning, guys. Thanks for taking my questions. Just quickly on Moritax, I think it's at 6% to 8% contribution. Can you elaborate on trends you're seeing in Japan and particularly the semi and electronics and market there? Are you seeing some stabilization in those markets as well? And I know it's still early, but have you started to see any synergies as you continue to integrate?

Thanks for your question. Plenty of synergies with Marutex, and we're out of the gate fast on that. A lot of the synergies have to do with helping to sell their product more broadly and across Cognex, but we're also integrating our businesses in Japan, and we're excited about the reputation and leadership that Marutex brings us in Japan. You asked about Semi. You know, our business in semi, and we're overweight semi in our Japan business now, both between Cogmex and the Marutex piece that we've acquired. It did experience a period of tremendous growth in 2021 and the first half of 22. And then the trajectory slowed a lot in the second half of 2022. And, you know, there are signs, you know, that we may see, you know, we have more optimism about SEMI coming back later in the year. And I think it's hard to call it beyond that at this point.

Got it. And just following up on the margin commentary, it was very helpful. Like, I think you've talked about some cost management actions. And then you continue to invest across your emerging customer initiatives. Maybe elaborate on how you are balancing these two heading into 24. And for the cost management actions, are these more structural in nature that can provide you a longer-term tailwind or more transitory that when sales improve, these costs might come back?

Yes, thanks. So, you know, I think if we look at kind of pieces of Cogmex's cost, you know, we have sales, big sales expense. We're investing, you know, heavily, as you saw, in our emerging customers, right? And we see that as the potential to make our sales force more productive, where, you know, those sales, those emerging customer salespeople will be delivering leads and opportunities to the rest of the sales force. So we're being careful about how we're building that sales force to balance both the more sophisticated and the emerging customer sales force and also balance it in terms of the sophistication but ease of use of our technology. So there is some sort of changes going on there which are allowing us to be careful on the cost side in that area. Our engineering teams certainly are benefiting from the new AI tools that are available to engineers and those who write software. So, certainly, those are some things that we're looking at carefully to make sure that we can increase capacity and manage cost carefully. And then, like every company, you know, we have a GNA-type functions, again, that are benefiting from process improvement. And in general, we're really not adding headcount or haven't added headcount, you know, outside of the Martex acquisition. in really all of the, if I put aside the MarTechs and emerging customer pieces, we've been very careful to reduce headcount in the rest of the business.

Yeah, and I think just practically, this is true for all companies, the biggest variable costs, if we outperform or if we underperform, tend to be our incentive compensation. So we've called out, that's a headwind of $15 to $20 million, just a reset towards our budget targets for 2024, where we are expecting to grow. And outperformance of those internal obviously will drive some incremental commissions and company bonus, and underperformance will drive some leverage. But we're obviously starting from a very low incentive compensation in 2023. That's really the biggest driver of the things that are going to change in year, depending on our company's performance.

I appreciate all the color-organized messages, Paul, and good luck this year.

Thank you. The next question is coming from Jaram Nathan of Daiwa. Please go ahead.

Yeah, hi. Thanks for taking my question. So just wanted to get some more details on the $50 million in emerging customer. If you kind of look at it from a 2023 perspective, it's almost 6% revenue growth. Just wanted to kind of better understand which end markets are you seeing the first initial success in, and what's the kind of, are you seeing a different set of customers, of competitors, and the success rate in bids, if you can give some more information on those.

Great, yeah, thank you. Thanks for the question. Yeah, so we're really enthusiastic about what's going on in that market. It is the many, many emerging customer sales noise we have out our are calling more broadly on manufacturing industries and finding opportunities that are more weighted towards industries like packaging and consumer products and food and beverage. Visited, went on a ride along with one of the team members and we visited a company that made pretzels. Would not have seen a Cognex customer before really, certainly not a target for us. So to give you an idea of that, And then, yeah, so there was another aspect of your question, I think. Oh, competitors, yeah, yeah. So, yeah, thank you. I think, so the competitors that we're seeing in that market tend to be more weighted towards optical sensor type companies, right? So, of course, we still see our traditional competitors, like some of our Japanese competitors, but it's a broader market. We're finding ourselves in newer situations and where we're seeing more um, German American optical sensor suppliers who traditionally we haven't thought of our competitors, but where we can, where we can replace potentially many of their products with one of our snap insight, snap vision sensor, for instance. So there, there are opportunities we're seeing there that are taking us to new places. Um, and through the pilots that we did last year and in what we're seeing, these are really great opportunities for us now and to do further work to help our customers, um, realize more value. I would say just finally to profile those customers, generally they're going to be much less sophisticated than the large customers we work with probably may not have engineers on staff. So our products now, the ones we're selling through that channel are very easy to demonstrate and very easy to install even for the person we send out, the sales note that we send out. So yeah, it's a new world and we're kind of excited about it.

Okay. And just following up on, like, you know, if I kind of think of a measure like sales per, you know, sales employee or salesperson, where do you see the potential here compared to or the gap between the new cohort, the 2023 cohort versus, you know, your regular sales force?

Okay.

Well, most of these new sales noids are coming out of college, right? And so they have a new training and background. Most of them do have engineering backgrounds, but they're sort of much, I think, more comfortable with technology and interfacing with it. And as the world moves, this might sound like, you know, isn't that something that's already happened? But, you know, from analog to digital and less sort of, deep specialty programming. It's a different speed, a different cycle, I would say, in how sales occur. But I think what Cognix offers to some of those new sales nodes is a great career path, right? We're investing in their training and development. They love our culture. We love what they bring to our culture, the energy that they bring, and we hope to see them develop, many of them more into bigger roles, more sophisticated sales opportunities, management, and all of that. So, yeah, that's how we're thinking about it.

Okay.

I think we have time for one more question, I think. Yes, please, go ahead.

Thank you. Our last question for today is coming from Ken Newman of KeyBank Capital Markets. Please go ahead.

Hi, this is Katie Fleischer. Yeah, thank you. This is Katie Fleischer on for Ken today. Thanks for squeezing me in. just had one question so you mentioned in the prepared remarks uh that you're starting to see um you know healthy project starts in ev battery and semi and markets but they haven't really gotten to the point where cogmex is involved yet um i know visibility into these secular trends is pretty limited but do you have any sense of when you might start to see those impacts um flowing through to your um your results and maybe like when Cognex will typically get involved in projects like that?

Yes. Well, I should say that, you know, we have a healthy, you know, a pretty significant EV battery business we're building over the last two years. You know, we see some nice growth for that. So my comment was really a lot about the funnel and the opportunities we've seen, which have grown hugely, I would say, over the last 12 to 18 months. And, you know, plants are breaking ground. And generally with machine vision, we tend to be something that's pretty late in the cycle in terms of when it's purchased and installed. So my comment was really around that. And so we do expect, we've planned and expect to see very healthy growth in that business this year. And then what potentially could become a problem is if projects get delayed. They can get delayed in semi and EV because Execution is slow, right? We've seen that, right? Can't get labor, can't get the technical expertise that's needed to get these plants launched on time. And then political issues, I think, and I definitely see concern about whether changes in Europe and America are going to go on supporting the level of investment that was sort of touted over the last year or two. So those are some of the uncertainties, but the trend and the opportunity and the value of machine vision is clearly there.

Okay. Helpful. Thank you.

Thank you. At this time, I would like to turn the floor back over to Mr. Willett for closing comments.

All right. Thank you so much. Thank you for joining us this morning, and we look forward to speaking with you again on next quarter's call.

Ladies and gentlemen, thank you for your participation and interest in Cognex. This concludes today's event. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.